Fundamentals of Banking and Insurance

BCM4A14/BBA4A14: Banking and Insurance
MODULE - 1
ORIGIN AND DEVELOPMENT OF BANKING
The banking history is interesting and reflects evolution

in trade and commerce. It also throws light on living style,
political and cultural aspects of civilized mankind. The
strongest faith of people has always been religion and God.
The seat of religion and place of worship were considered safe
place for money and valuables. The history of banking begins
with the first prototype banks of merchants of the ancient
world, which made grain loans to farmers and traders who
carried goods between cities. This began around 2000 BC in
Assyria and Babylonia. In olden times people deposited their
money and valuables at temples, as they are the safest place
available at that time. The practice of storing precious metals
at safe places and loaning money was prevalent in ancient
Rome.
However modern Banking is of recent origin. The
development of banking from the traditional lines to the
modern structure passes through Merchant bankers,
Goldsmiths, Money lenders and Private banks. Merchant
Bankers were originally traders in goods. Gradually they
started to finance trade and then become bankers. Goldsmiths
are considered as the men of honesty, integrity and reliability.
They provided strong iron safe for keeping valuables and
money. They issued deposit receipts (Promissory notes) to
people when they deposit money and valuables with them. The
School of Distance Education, University of Calicut 1

goldsmith paid interest on these deposits. Apart from accepting

deposits, Goldsmiths began to lend a part of money deposited
with them. Then they became bankers who perform both the
basic banking functions such as accepting deposit and lending
money. Money lenders were gradually replaced by private
banks. Private banks were established in a more organised
manner. The growth of Joint stock commercial banking was
started only after the enactment of Banking Act 1833 in
England.
India has a long history of financial intermediation. The
first bank in India to be set up on modern lines was in 1770 by
a British Agency House. The earliest but short-lived attempt to
establish a central bank was in 1773. India was also a
forerunner in terms of development of financial markets. In the
beginning of 18th century, British East India Company
launched a few commercial banks. Bank of Hindustan (1770)
was the first Indian bank established in India. Later on, the
East India Company started three presidency banks, Bank of
Bengal(1806), Bank of Bombay(1840) and Bank of
Madras(1843) These bank were given the right to issue notes
in their respective regions. Allahabad bank was established in
1865 and Alliance Bank in 1875. The first bank of limited
liability managed by Indians was Oudh Commercial Bank
founded in 1881. Subsequently, the Punjab National Bank was
established in 1894. In the Beginning of the 20th century,
Swadeshi movement encouraged Indian entrepreneurs to start
many new banks in India. Another landmark in the history of
Indian banking was the formation of Imperial bank of India in

1921 by amalgamating 3 presidency banks It is the Imperial

Bank which performed some central banking functions in
India. A number of banks failed during the first half of the 20
Century. It affected the people’s belief and faith in Banks.
By independence, India had a fairly well developed
commercial banking system in existence. In 1951, there were
566 private commercial banks in India with 4,151 branches,
the overwhelming majority of which were confined to larger
towns and cities. Savings in the form of bank deposits
accounted for less that 1 per cent of national income, forming
around 12 per cent of the estimated saving of the household
sector. The Reserve Bank of India (RBI) was originally
established in 1935 by an Act promulgated by the Government
of India, but as a shareholder institution like the Bank of
England. After India's independence, in the context of the need
for close integration between its policies and those of the
Government, the Reserve Bank became a state - owned
institution from January 1, 1949. It was during this year that
the Banking Regulation Act was enacted to provide a
framework for regulation and supervision of commercial
banking activity.
By independence, India had a fairly well developed
commercial banking system in existence. Reserve bank of
India was nationalized in the year 1949. The enactment of the
Banking Companies Act 1949 (Later it was renamed as
Banking Regulation Act) was a bold step in the history of
banking in India. In 1955, Imperial Bank of India was
nationalized and renamed as State bank of India (SBI). The

SBI started number of branches in urban and rural areas of the

country.
In 1967, Govt introduced the concept of social control on
banking sector. Nationalization of 14 commercial banks in
1969 was a revolution in the history of banking in India. Six
more commercial banks were nationalized in 1980. Other
landmarks in the history of Indian banking were the
establishment of National Bank for Agricultural and Rural
Development (1988), merger of New Bank of India with
Punjab National Bank (1993), merger of State Bank of
Sourashtra with SBI (2008) and the merger of State Bank of
Indore with SBI (2010). At present, there are 27 Public sector
banks, 20 private sector banks, 30 Foreign banks and 82
Regional Rural Banks in India.
MEANING AND DEFINITION OF BANK
Finance is the life blood of trade, commerce and
industry. Now-a-days, banking sector acts as the backbone of
modern business. Development of any country mainly depends
upon the banking system. The term bank is either derived from
old Italian word banca or from a French word bunque both
mean a Bench or money exchange table. In olden days,
European money lenders or money changers used to display
(show) coins of different countries in big heaps (quantity) on
benches or tables for the purpose of lending or exchanging. A
bank is a financial institution which deals with deposits and
advances and other related services. It receives money from
those who want to save in the form of deposits and it lends
money to those who need it.

Definition of a Bank
Oxford Dictionary defines a bank as "an establishment
for custody of money, which it pays out on customer's order."
According to H. L. Hart, a banker is “one who in the
ordinary course of his business honours cheques drawn upon
him by person from and for whom he receives money on
current accounts”.
Banking Regulation Act of 1949 defines banking as
“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”.
Characteristics / Features of a Bank
1. Dealing in Money
Bank is a financial institution which deals with other
people's money i.e. money given by depositors.
2. Individual / Firm / Company
A bank may be a person, firm or a company. A banking
company means a company which is in the business of
banking.
3. Acceptance of Deposit
A bank accepts money from the people in the form of
deposits which are usually repayable on demand or after the
expiry of a fixed period. It gives safety to the deposits of its
customers. It also acts as a custodian of funds of its customers.

4. Giving Advances
A bank lends out money in the form of loans to those
who require it for different purposes.
5. Payment and Withdrawal
A bank provides easy payment and withdrawal facility to
its customers in the form of cheques and drafts, It also brings
bank money in circulation. This money is in the form of
cheques, drafts, etc.
6. Agency and Utility Services
A bank provides various banking facilities to its
customers. They include general utility services and agency
services.
7. Profit and Service Orientation
A bank is a profit seeking institution having service
oriented approach.
8. Ever increasing Functions
Banking is an evolutionary concept. There is continuous
expansion and diversification as regards the functions, services
and activities of a bank.
9. Connecting Link
Bank acts as a connecting link between borrowers and
lenders of money. Banks collect money from those who have
surplus money and give the same to those who are in need of
money.

10. Banking Business

A bank's main activity should be to do business of
banking which should not be subsidiary to any other business.
11. Name Identity
A bank should always add the word "bank" to its name to
enable people to know that it is a bank and that it is dealing in
money.
Importance of banks
Bankers play very important role in the economic
development of the nation. The health of the economy is
closely related to the growth and soundness of its banking
system. Although banks create no new wealth but their fund
collection, lending and related activities facilitate the process
of production, distribution, exchange and consumption of
wealth. In this way, they become very effective partners in the
process of economic development.
1. Banks mobilise small, scattered and idle savings of the
people, and make them available for productive purposes
2. By offering attractive interests, Banks promote the habit
of thrift and savings
3. By accepting savings, Banks provide safety and security
to the surplus money
4. Banks provide convenient and economical means of
payments
5. Banks provide convenient and economical means of
transfer of funds

6. Banks facilitate the movement of funds from unused

regions to useful regions
7. Banking help trade, commerce, industry and agriculture
by meeting their financial requirements
8. Banking connect saving people and investing people.
9. Through their control over the supply of money, Banks
influence the economic activities, employment, income
level and price level in the economy.
Types of banks
Functional classification
1. Commercial banks/Deposit banks
Banks accept deposits from public and lend them mainly
for commercial purposes for comparatively shorter periods are
called Commercial Banks. They provide services to the general
public, organisations and to the corporate community. They
are oldest banking institution in the organised sector.
Commercial banks make their profits by taking small, short-
term, relatively liquid deposits and transforming these into
larger, longer maturity loans. This process of asset
transformation generates net income for the commercial bank.
Many commercial banks do investment banking business
although the latter is not considered the main business area.
The commercial banking system consists of scheduled banks
(registered in the second schedule of RBI) and non scheduled
banks. Features of Commercial banks are;
• They accepts deposits on various accounts.

• Lend funds to organisations, trade, commerce, industry,

small business, agriculture etc by way of loans,
overdrafts and cash credits.
• They are the manufacturers of money.
• The perform many subsidiary services to the customer.
• They perform many innovative services to the customers.
2. Industrial banks/Investment banks
Industrial banks are those banks which provide fixed
capital to industries. They are also called investment banks, as
they invest their funds in subscribing to the shares and
debentures of industrial concerns. They are seen in countries
like US, Canada, Japan, Finland, and Germany. In India
industrial banks are not found. Instead, special industrial
finance corporations like IFC and SFC have been set up to
cater to the needs of industries. Features of Industrial Banks
are:
• Participate in management.
• Advise industries in making right investment
• Advise govt. on matters relating to industries
3. Agricultural banks
Agricultural banks are banks which provide finance to
agriculture and allied sectors. It is found in almost all the
countries. They are organised generally on co-operative basis.
In India, Co- operative banks are registered under the Co-
operative Societies Act, 1912. They generally give credit
facilities to small farmers, salaried employees, small-scale

industries, etc. Co-operative Banks are available in rural as

well as in urban areas. Agricultural banks are of two types;
Agricultural co-operative banks: They provide short term
finance to farmers for purchasing fertilizers, pesticides and
seeds and for the payment of wages.
Land Development Banks: They provide long term finance
for making permanent improvement on land. They assist to
purchase machinery, equipments, installation of pump sets,
construction of irrigation works etc.
4. Exchange banks
Exchange banks finances foreign exchange business
(export, import business) of a country. Special exchange banks
are found only in some countries. The main functions of
exchange banks are remitting money from one country to
another country, discounting of foreign bills, buying and
selling gold and silver, helping import and export trade etc.
5. Savings bank
Savings banks are those banks which specialise in the
mobilisation of small savings of the middle and low income
group. In India, saving bank activities are done by commercial
banks and post offices. Features of savings banks are;
 Mobilise small and scattered savings
 Promote habit of thrift & savings
 Keep only small portion in hand and invest major part
in govt. securities
 They do not lend to general public.

6. Central / National banks

It is the highest banking & monetary institution in a
country. It is the leader of all other banks. Since it is occupying
a central position, it’s known as Central Bank. It is operating
under state’s control and is not a profit motive organisation.
Reserve Bank of India (India), Bank of Canada (Canada),
Federal Reserve System(USA) etc are the examples of Central
Banks. The main functions of a Central Bank are;
 Monopoly of currency issue
 Acts as banker to the govt.
 Serves as bankers’ bank
 Act as controller of credit
 Custodian of nation’s gold and foreign exchange
reserve.
INDIAN BANKING SYSTEM
The Indian banking structure comprises both organised
and unorganised banking sector. The unorganised banking
sector consists of indigenous bankers and money lenders. The
organised sector comprises the central bank at the top level and
commercial banks, specialised banks, institutional banks and
non- banking financial institutions.
1. Unorganised Sector
a. Indigenous Bankers The exact date of existence of
indigenous bank is not known. But, it is certain that the old
banking system has been functioning for centuries. Some
people trace the presence of indigenous banks to the Vedic

times of 2000-1400 BC. It has admirably fulfilled the needs of

the country in the past. However, with the coming of the
British, its decline started. Despite the fast growth of modern
commercial banks, however, the indigenous banks continue to
hold a prominent position in the Indian money market even in
the present times. It includes shroffs, seths, mahajans, chettis,
etc. The indigenous bankers lend money; act as money
changers and finance internal trade of India by means of
hundis or internal bills of exchange.
The main defects of indigenous banking are:
(i) They are unorganised and do not have any contact with
other sections of the banking world.
(ii) They combine banking with trading and commission
business and thus have introduced trade risks into their
banking business.
(iii) They do not distinguish between short term and long
term finance and also between the purpose of finance.
(iv) They follow vernacular methods of keeping accounts.
They do not give receipts in most cases and interest which they
charge is out of proportion to the rate of interest charged by
other banking institutions in the country.
b. Moneylenders — Moneylenders are the second element
of the unorganised sector. They depend entirely on their own
funds for lending. They include large farmers, merchants,
goldsmiths etc. They charge a very high rate of interest for
their loans.

2. Organised Sector
The organised banking system in India can be
classified as given below:
Reserve Bank of India (RBI)

The Reserve Bank of India (RBI), the central bank of
India, which was established in 1935, has been fully owned by
the government of India since nationalization in 1949. Like the
central bank in most countries, Reserve Bank of India is
entrusted with the functions of guiding and regulating the
banking system of a country.

Commercial Banks
There are three types of commercial banks in India
1. Public sector banks
2. Private Banks
3. Foreign banks
Public sector banks
These are banks where majority stake is held by the
Government of India or Reserve Bank of India. In 2012, the
largest public sector bank is the State Bank of India. This
consists of 14 banks which are nationalised in the year 1969
and 6 banks which are nationalised in the year l980.
Private Banks
Private Banks are banks that the majority of share capital
is held by private individuals. In Private sector small
scheduled commercial banks and newly established banks with
a network of 8,965 branches are operating. To encourage
competitive efficiency, the setting up of new private bank is
now encouraged.
Foreign Banks
Foreign banks are registered and have their headquarters
in a foreign country but operate their branches in India. Apart
from financing of foreign trade, these banks have performed all
functions of commercial banks and they have an advantage
over Indian banks because of their vast resources and superior
management.

Co-operative banks
Co-operative banks are banks incorporated in the legal
form of cooperatives. Any cooperative society has to obtain a
license from the Reserve Bank of India before starting banking
business and has to follow the guidelines set and issued by the
Reserve Bank of India.
Primary Credit Societies:
Primary Credit Societies are formed at the village or
town level with borrower and non- borrower members residing
in one locality. The operations of each society are restricted to
a small area so that the members know each other and are able
to watch over the activities of all members to prevent frauds.
Central Co-operative Banks:
Central co-operative banks operate at the district level
having some of the primary credit societies belonging to the
same district as their members. These banks provide loans to
their members (i.e., primary credit societies) and function as a
link between the primary credit societies and state co-operative
banks.
State Co-operative Banks:
These are the highest level co-operative banks in all the
states of the country. They mobilize funds and help in its
proper channelization among various sectors. The money
reaches the individual borrowers from the state co-operative
banks through the central co- operative banks and the primary
credit societies.

Regional rural Banks

The regional rural banks are banks set up to increase the
flow of credit to smaller borrowers in the rural areas. These
banks were established on realizing that the benefits of the co-
operative banking system were not reaching all the farmers in
rural areas.
Regional rural banks perform the following two functions:
1. Granting of loans and advances to small and marginal
farmers, agricultural workers, co - operative societies including
agricultural marketing societies and primary agricultural credit
societies for agricultural purposes or agricultural operations or
related purposes.
2. Granting of loans and advances to artisans small
entrepreneurs engaged in trade, commerce or industry or other
productive activities.
Development Banks
Development Banks are banks that provide financial
assistance to business that requires medium and long-term
capital for purchase of machinery and equipment, for using
latest technology, or for expansion and modernization. A
development bank is a multipurpose institution which shares
entrepreneurial risk, changes its approach in tune with
industrial climate and encourages new industrial projects to
bring about speedier economic growth. These banks also
undertake other development measures like subscribing to the
shares and debentures issued by companies, in case of under
subscription of the issue by the public. There are three

important national level development banks. They are;

Industrial Development Bank of India (IDBI)
The IDBI was established on July 1, 1964 under an Act
of Parliament. It was set up as the central co-ordinating
agency, leader of development banks and principal financing
institution for industrial finance in the country. Originally,
IDBI was a wholly owned subsidiary of RBI. But it was
delinked from RBI w.e.f. Feb. 16, 1976.
IDBI is an apex institution to co-ordinate, supplement
and integrate the activities of all existing specialised financial
institutions. It is a refinancing and re-discounting institution
operating in the capital market to refinance term loans and
export credits. It is in charge of conducting techno-economic
studies. It was expected to fulfil the needs of rapid
industrialisation. The IDBI is empowered to finance all types
of concerns engaged or to be engaged in the manufacture or
processing of goods, mining, transport, generation and
distribution of power etc., both in the public and private
sectors.
Industrial finance Corporation of India (IFCI)
The IFCI is the first Development Financial Institution in
India. It is a pioneer in development banking in India. It was
established in 1948 under an Act of Parliament. The main
objective of IFCI is to render financial assistance to large scale
industrial units, particularly at a time when the ordinary banks
are not forth coming to assist these concerns. Its activities
include project financing, financial services, merchant banking
and investment.

Till 1993, IFCI continued to be Developmental Financial

Institution. After 1993, it was changed from a statutory
corporation to a company under the Indian Companies Act,
1956 and was named as IFCI Ltd with effect from October
1999.
Industrial Credit and Investment Corporation of India
(ICICI)
ICICI was set up in 1955 as a public limited company. It
was to be a private sector development bank in so far as there
was no participation by the Government in its share capital. It
is a diversified long term financial institution and provides a
comprehensive range of financial products and services
including project and equipment financing, underwriting and
direct subscription to capital issues, leasing, deferred credit,
trusteeship and custodial services, advisory services and
business consultancy.
The main objective of the ICICI was to meet the needs of
the industry for long term funds in the private sector. Apart
from this the Industrial Reconstruction Corporation of India
(IRCI) established in 1971 with the main objective of revival
and rehabilitation of viable sick units and was converted in to
the Industrial Reconstruction Bank of India (IRBI) in 1985
with more powers Development banks have been established
at the state level too. At present in India, 18 State Financial
Corporation’s (SFCs) and 26 State Industrial investment/
Development Corporations (SIDCs) are functioning to look
over the development banking in respective areas /states.

Specialized Banks
In India, there are some specialized banks, which cater to
the requirements and provide overall support for setting up
business in specific areas of activity. They engage themselves
in some specific area or activity and thus, are called
specialized banks. There are three important types of
specialized banks with different functions:
Export Import Bank of India (EXIM Bank):
The Export-Import (EXIM) Bank of India is the principal
financial institution in India for coordinating the working of
institutions engaged in financing export and import trade. It is
a statutory corporation wholly owned by the Government of
India. It was established on January 1, 1982 for the purpose of
financing, facilitating and promoting foreign trade of India.
This specialized bank grants loans to exporters and importers
and also provides information about the international market. It
also gives guidance about the opportunities for export or
import, the risks involved in it and the competition to be faced,
etc.
The main functions of the EXIM Bank are as follows:
(i) Financing of exports and imports of goods and services,
not only of India but also of the third world countries;
(ii) Financing of exports and imports of machinery and
equipment on lease basis; (iii) Financing of joint ventures
in foreign countries;
(iv) Providing loans to Indian parties to enable them to
contribute to the share capital of joint ventures in foreign

countries;
(v) to undertake limited merchant banking functions such as
underwriting of stocks, shares, bonds or debentures of
Indian companies engaged in export or import; and
(vi) To provide technical, administrative and financial
assistance to parties in connection with export and
import.
Small Industries Development Bank of India
This specialized bank grant loan to those who want to
establish a small-scale business unit or industry. Small
Industries Development Bank of India (SIDBI) was established
in October 1989 and commenced its operation from April 1990
with its Head Office at Lucknow as a development bank,
exclusively for the small scale industries. It is a central
government undertaking. The prime aim of SIDBI is to
promote and develop small industries by providing them the
valuable factor of production finance. Many institutions and
commercial banks supply finance, both long-term and short-
term, to small entrepreneurs. SIDBI coordinates the work of all
of them.
Functions of Small Industries Development Bank of India
(SIDBI):
(i) Initiates steps for technology adoption, technology
exchange, transfer and upgradation and modernisation of
existing units.
(ii) SIDBI participates in the equity type of loans on soft
terms, term loan, working capital both in rupee and

foreign currencies, venture capital support, and different

forms of resource support to banks and other institutions.
(iii) SIDBI facilitates timely flow of credit for both term
loans and working capital to SSI in collaboration with
commercial banks.
(iv) SIDBI enlarges marketing capabilities of the products of
SSIs in both domestic and international markets.
(v) SIDBI directly discounts and rediscounts bills with a
view to encourage bills culture and helping the SSI units
to realise their sale proceeds of capital goods /
equipments and components etc
(vi) SIDBI promotes employment oriented industries
especially in semi-urban areas to create more
employment opportunities so that rural-urban migration
of people can be checked.
National Bank for Agricultural and Rural Development
It was established on 12 July 1982 by a special act by the
parliament. This specialized bank is a central or apex
institution for financing agricultural and rural sectors. It can
provide credit, both short- term and long-term, through
regional rural banks. It provides financial assistance,
especially, to co- operative credit, in the field of agriculture,
small-scale industries, cottage and village industries
handicrafts and allied economic activities in rural areas .its
important functions are:
a) Takes measures towards institution building for
improving absorptive capacity of the credit delivery

system, including monitoring, formulation of

rehabilitation schemes, restructuring of credit
institutions, training of personnel, etc.
b) Co-ordinates the rural financing activities of all
institutions engaged in developmental work at the field
level and maintains liaison with Government of India,
State Governments, Reserve Bank of India (RBI) and
other national level institutions concerned with policy
formulation
c) Undertakes monitoring and evaluation of projects
refinanced by it.
d) NABARD refinances the financial institutions which
finances the rural sector.
e) The institutions which help the rural economy,
NABARD helps develop.
f) NABARD also keeps a check on its client institutes.
g) It regulates the institution which provides financial help
to the rural economy.
h) It provides training facilities to the institutions working
the field of rural upliftment.
i) It regulates the cooperative banks and the RRB
Indian Bank-like financial institution
In India, there are some Bank-like financial institutions
that provide financial services. There are two types of such
institution that are important to the development on India:
Microfinance Institutions
Microfinance Institutions are Bank-like financial

institutions that providing financial services, such as

microcredit, micro savings or micro insurance to poor people.
In addition, they also perform the following important
functions:
1. provide financing facilities, with or without collateral
security, in cash or in kind, for such terms and subject to
such conditions as may be prescribed, to poor persons for
all types of economic activities including housing, but
excluding business in foreign exchange transactions
2. To buy, sell and supply on credit to poor persons
industrial and agricultural inputs, livestock, machinery
and industrial raw materials
3. To provide professional advice to poor persons regarding
investments in small business and such cottage industries
as may be prescribed.
Development financial institutions (DFIs)
DFIs are specialized financial institutions the
Government established to promote investments in the
manufacturing and agricultural sectors.
Their functions include:
1. Extending financial assistance in the form of medium-
and long-term loans, participating in equity capital,
underwriting and wherever relevant, acting as issuing
house for public shares issues and providing guarantees
for loans
2. Specialize in medium- and long-term financing in

addition to supplying financial services not normally

provided by commercial banks and finance companies
3. In addition, they help in identifying new projects,
participate in their promotion, and where appropriate,
provide ancillary financial, technical and managerial
advice.
CUSTOMERS OF A BANK
In the ordinary language, a person who has an account in
a bank is considered its customer. The term customer also
presents some difficulty in the matter of definition. There is no
statutory definition of the term either in India or in England.
However, the legal decisions on the matter throw some light on
the meaning of the term.
Thus, in order to constitute a person as a customer, he
must satisfy the following conditions:
1. He must have an account with the bank — i.e., saving
bank account, current deposit account, or fixed deposit
account.
2. The transactions between the banker and the customer
should be of banking nature i.e., a person who
approaches the banker for operating Safe Deposit Locker
or purchasing travellers cheques is not a customer of the
bank since such transactions do not come under the orbit
of banking transactions.
3. Frequency of transactions is not quite necessary though
anticipated.

Special Types of Customers

Special types of customers are those who are
distinguished from other types of ordinary customers by some
special features. Hence, they are called special types of
customers. They are to be dealt with carefully while operating
and opening the accounts. They are:
I. Minors:
Under the Indian law, a minor is a person who has not
completed 18 years of age. The period of minority is extended
to 21 years in case of guardian of this person or property is
appointed by a court of law before he completes the age of 18
years. According to Indian Contract Act, a minor is recognised
as a highly incompetent party to enter into legal contracts and
any contract entered into with a minor is not only invalid but
voidable at the option of the minor. The law has specially
protected a minor merely because his mental faculty has not
fully developed and as such, he is likely to commit mistakes or
even blunders which will affect his interests adversely. It is for
this reason; the law has come to the rescue of a minor. A
banker can very well open a bank account in the name of a
minor. But the banker has to be careful to ensure that he does
not open a current account.
If a current account is opened and stands overdrawn
inadvertently, the banker has no remedy against a minor, as he
cannot be taken to a court of law. It is for this reason that the
banker should be careful to see that he invariably opens a
savings bank account.

The conditions for opening and maintaining accounts in

the names of the minors are:
1. The minor should have attained the age of discretion, i.e.,
he must be about l4 years of age. He must be capable of
understanding what he does.
2. The minor should be able to read and write.
3. The minor should be properly introduced. The account
opening form should be signed by the minor in the
presence of a bank officer who should be able to identify
the minor. The date of birth of the minor should be
recorded in the account opening form.
4. Banks usually stipulate limits up to which deposits in
such accounts can be accepted.
5. Amount tendered by the minor should as far as possible
be in cash.
6. In case of time deposits, the amount should be paid in
cash on maturity. Prepayment cannot be allowed.
Periodical payment of interest on deposits may be made
to the minor.
Legal Provisions Regarding Guardianship of a Minor
According to Hindu Minority and Guardianship Act,
1956, a Guardian is one who is recognised by law to be one of
the following:
(a) Natural Guardian:
According to Section 6 of the Hindu Minority and
Guardianship Act, 1956, in case of a minor boy or an

unmarried girl, his/her father and after him the mother shall be
the natural guardian. In case of a married girl (minor), her
husband shall be the natural guardian. The terms father or
mother do not include step-father or step-mother.
(b) Testamentary Guardian:
A Hindu father, who is entitle to act as the natural
guardian of his minor legitimate children may, by will, appoint
a guardian for any of them in respect of the minor’s person or
property. Such guardian acts after the death of the father or the
mother.
(c) Guardian Appointed by Court:
A guardian may be appointed by the court under the
Guardians and Wards Act, 1890, but the court shall not be
authorised to appoint or declare a guardian of the person of a
minor, if his father is alive and is not, in the opinion of the
court, unfit to be guardian of the person of the minor. Similar
is the case of a minor girl, whose husband is not, in the opinion
of the court, unfit to be guardian of her person. Thus the father
(or the husband in case of a married girl) is exclusively entitled
to be the guardian.
II. Lunatics:
A lunatic or an insane person is one who, on account of
mental derangement, is incapable of understanding his
interests and thereby, arriving at rational judgement. Since a
lunatic does not understand what is right and what is wrong, it
is quite likely that the public may exploit the weakness of a
lunatic to their advantage and thus deprive him of his

legitimate claims. On account of this, the Indian Contract Act

recognises that a lunatic is incompetent to enter into any
contract and any such contract, if entered into, is not only
invalid but voidable at the option of the lunatic. Since a lunatic
customer is an incompetent party, the banker has to be very
careful in dealing with such customers. Bankers should not
open an account in the name of a person of unsound mind. On
coming to know of a customer’s insanity, the banker should
stop all operations on the account and await a court order
appointing a receiver. It would be dangerous to rely on hearsay
information. The bank should take sufficient care to verify the
information and should not stop the account unless it is fully
satisfied about the correctness of the information. In case a
person suffers from a temporary mental disorder, the banker
must obtain a Certificate from two medical officers
regarding his mental soundness at the time of operation on the
account.
III. Drunkards:
A drunkard is a person who on account of consumption
of alcoholic drinks get himself intoxicated and thereby, loses
the balance over his mental capacity and hence, is incapable of
forming rational judgement. The law is quite considerable
towards a person who is in drunken state. A lawful contract
with such a person is invalid. This is for the simple reason that
it is quite likely that the public may exploit the weakness of
such a person to their advantage and thus, deprive him of his
legitimate claims. A banker has to be very careful in dealing
with such customers. There cannot be any objection by a

banker to open an account. In case a customer approaches the

banker for encashment of his cheque especially when he is
drunk, the banker should not make immediate payment. This is
because the customer may afterwards argue that the banker has
not made payment at all. Therefore, it is better and safer that
the banker should insist upon such a customer getting a
witness (who is not drunk) to countersign before making any
payment against the cheque.
IV. Married Women:
An account may be opened by the bank in the name of a
married woman as she has the power to draw cheques and give
valid discharge. At the time of opening an account in the
name of a married woman, it is advisable to obtain the name
and occupation of her husband and name of her employer, if
any, and record the same to enable detection if the account is
misused by the husband for crediting there in cheques drawn in
favour of her employer. In case of an unmarried lady, the
occupation of her father and name and address of her
employer, if any, may be obtained and noted in the account
opening form. If a lady customer requests the bankers to
change the name of her account opened in her maiden name to
her married name, the banker may do so after obtaining a
written request from her. A fresh specimen signature has also
to be obtained for records.
While opening an account of a purdah lady (purdah
nishin), the bank obtains her signature on the account
opening form duly attested by a responsible person known to
the bank. It is advisable to have withdrawals also similarly

attested. In view of practical difficulties involved, it would be

better not to open accounts in the names of purdah ladies.
V. Insolvents:
When a person is unable to pay his debts in full, his
property in certain circumstances is taken possession of by
official receiver or official assignee, under orders of the court.
He realises the debtor’s property and rateably distributes the
proceeds amongst his creditors. Such a proceeding is called
‘insolvency’ and the debtor is known as an ‘insolvent’. If an
account holder becomes insolvent, his authority to the bank to
pay cheques drawn by him is revoked and the balance in the
account vests in the official receiver or official assignee.
VI. Illiterate Persons:
A person is said to be illiterate when he does not know to
read and write. No current account should be opened in the
name of an illiterate person. However, a savings bank account
may be opened in the name of such a person. On the account
opening form the bank should obtain his thumb mark in the
presence of two persons known to the bank and the depositor.
Withdrawal from the account by the account holder should be
permitted after proper identification every time. The person
who identifies the drawer must be known to the bank and he
should preferably not be a member of the bank’s staff.
VII. Agents:
A banker may open an account in the name of a person
who is acting as an agent of another person. The account
should be considered as the personal account of an agent, and

the banker has no authority to question his power to deal with

the funds in the account unless it becomes obvious that he is
being guilty of breach of trust. However, if a person is
authorised to only act on behalf of the principal, the banker
should see that he is properly authorised to do the acts which
he claims to do. If he has been appointed by a power of
attorney, the banker should carefully pursue the letter-of-
attorney to confirm the powers conferred by the document on
the agent. In receiving notice of the principal’s death, insanity
or bankruptcy, the banker must suspend all operations on the
account.
VIII. Joint Stock Company
A joint stock company has been defined as an artificial
person, invisible, intangible and existing only in contemplation
of law. It has separate legal existence and it has a perpetual
succession. The banker must satisfy himself about the
following while opening an account in the name of a company:
(a) Memorandum of Association:
Memorandum of Association is the main document of the
company, which embodies its constitution and is called the
charter of the company. It gives details, especially regarding
objects and capital of the company’s copy of this document
should be insisted upon while opening an account.
(b) Articles of Association:
The Articles of Association contain the rules and
regulations of the company regarding its internal management.
It contains in detail all matters which are concerned with the

conduct of day-to-day business of the company. The Articles

of Association is also another document that a banker insists
upon. It enables the banker to know the details of company’s
borrowing powers quantum, persons authorised to borrow etc.
This will also enable the banker to understand whether the acts
of the officers are within the orbit of the Company’s
Memorandum and Articles.
(c) Certificate of Incorporation:
This is another vital document the banker has to verify
and insist upon receiving a copy. This document signifies that
the company can commence its business activities as soon as it
gets this Certificate which is not the case with a public
company.
(d) Certificate to Commence Business:
Only for public companies, the banker insists upon this
document for verification. This document gives the clearance
to public companies to commence their business activities. A
company can borrow funds provided it has obtained this
certificate.
(e) Application Form and Copy of the Board’s Resolution:
A copy of the prescribed application form duly
completed in all respects has to be submitted in the beginning
and that too duly signed by the company’s authorised officers.
Along with this, a copy of the resolution passed at the meeting
of the board regarding appointment of company’s bankers is
quite necessary to make everything lawful. The resolution
copy should be signed by the company’s Chairman and

Secretary in addition, a copy of the specimen signatures of the

officers empowered to operate the bank account has to be
furnished.
(f) A Written Mandate:
This is also another document that a banker insists upon.
It contains all the details regarding operation, overdrawing of
the account and giving security to the bank by the officers of
the company. This document is useful to the bank for opening
as well as for operating the account of the company.
(g) Registration of Charges:
Whenever a company borrows, it has to give certain
assets by way of security and in case the banker accepts them
as security, it has to be properly recorded in the company’s
books, register of charges and duly registered.
(h) Any Change in the Company’s Constitution or Offices:
Whenever there is any change in the constitution like
Memorandum or in respect of company’s offices, it has to be
communicated in writing to the bank and it should not in any
way affect the earlier contracts entered into by the company
with the bank. To this effect, the bankers usually take an
undertaking from the company.
IX. Clubs, Associations and Educational Institutions:
Clubs, Associations and Educational Institutions are non-
trading institutions interested in serving noble courses of
education, sports etc. The banker should observe the following
precautions in dealing with them:

(a) Incorporation
A sports club, an association or an educational institution
must be registered or incorporated according to the Indian
Companies Act, 1956, or the Co-operative Societies Acts. If it
is not registered, the organisations will not have any legal
existence and it has no right to contact with the outside parties.
(b) Rules and by-laws of the Organisation:
A registered association or organisation is governed by
the provisions of the Act under which it has been registered. It
may have its own Constitution, Charter or Memorandum of
Association and rules and by-laws, etc., to carry on its
activities. A copy of the same should be furnished by the
organisation to the banker to acquaint the latter with the
powers and functions of the persons managing its affairs. The
banker should ensure that these rules are observed by the
persons responsible for managing the organisation.
(c) A Copy of Resolution of Managing Committee:
For opening a bank account, the managing committee of
the organisation must pass a resolution –
(i) Appointing the bank concerned as the banker of the
organisation.
(ii) Mentioning the name/names of the person or persons,
who are authorised to operate the account.
(iii) Giving any other directions for the operation of the said
account. A copy of the resolution must be obtained by
the bank for its own record.

(d) An Application Form:

An application form duly completed in all respects along
with specimen signatures of the office bearers of the institution
is quite essential for operation of the account.
(e) A Written Mandate:
It is an important document which contains specific
instructions given to the banker regarding operations, over
drawing etc.
(f) Transfer of Funds:
All funds and cheques which are in the name of the
Institution should be invariably credited to the Institution
account and not to the personal or private accounts of the
office bearers of the institution.
(g) Death or Resignation:
In case the person authorised to operate the account on
behalf of a organisation or association dies or resigns, the
banker should stop the operations of the organisation’s account
till the organisation nominates another person to operate its
account.10.
X. Partnership Firm:
A partnership is not regarded as an entity separate from
the partners. The Indian Partnership Act, 1932, defines
partnership as the “relation between persons who have agreed
to share the profit of the business, carried on by all or any of
them acting for all.” Partnership is formed or constituted on
account of agreement between the partners and with the sole

intention of earning and sharing profits in a particular ratio.

Further, the business is carried on either by all the partners or
some partners acting for all. The partners carry joint and
several liabilities and the partnership does not possess any
legal entity. A banker should take the following precautions
while opening an account in the name of a partnership firm:
(a) Application Form:
A prescribed application form duly completed in all
respects along with specimen signatures of the partners of firm
is quite essential for operation of the account.
(b) Partnership Deed:
The banker should, very carefully examine the
partnership deed, which is the charter of the firm, to acquaint
himself with the constitution and business of the firm. This
will help him to know his position while advancing funds to
the firm.
(c) A Mandate:
A mandate giving specific instructions to the banker
regarding operations, overdrawing etc., is quite necessary. It
will enable the banker to handle the accounts according to the
needs of the firm.
(d) Transfer of Funds:
The banker has to be very careful to see that the funds
belonging to the firm should not be credited to the personal or
private accounts of the partners.

(e) Sanctioning of Overdraft:

While sanctioning funds by way of overdraft, the banker
has to check up the partnership deed and examine the
borrowing powers of the partners empowered to borrow and he
can even ask for the financial statements of the previous years
for information and perusal.
XI. Joint Accounts:
When two or more persons open an account jointly, it is
called a joint account. The banker should take the following
precautions in opening and dealing with a joint account:
(a). The application for opening a joint account must be
signed by all the persons intending to open a joint
account.
(b). A mandate containing name or names of persons
authorised to operate an account.
(c). The full name of the account must be given in all the
documents furnished to the banker, even if the account is
to be operated upon by one or a few of the joint account
holders.
(d) Banker must stop operating an account as soon as a
notice of death, insolvency, insanity etc., of any one
account holder is received.
(e) The joint account holder, who is authorised to operate the
joint account, himself alone cannot appoint an agent or
attorney to operate the account on his behalf. Such
attorney or agent may be appointed with the consent of

all the joint account holders.

(f) If all the persons are operating the account, then banker
must see that any cheque drawn on him is duly signed by
all.
(g) Banker must stop making payments as soon as letter of
revocation is obtained. (h) Banker must see that no loan
or overdraft is granted without proper security.
XII. Joint Hindu Family:
Joint Hindu family is an undivided Hindu family which
comprises of all male members descended from a common
ancestor. They may be sons, grandsons and great grandsons,
their wives and unmarried daughters. “A joint, Hindu family is
a family which consists of more than one male member,
possesses ancestral property and carries on family business.”
Therefore, joint Hindu family is a legal institution. It is
managed and represented in its dealings and transactions with
others by the Kartha who is the head of the family. Other
members of the family do not have this right to manage unless
a particular member is given certain rights and responsibilities
with common consent of the Kartha. The banker has to
exercise greater care in dealing with this account.
(a) He must get complete information about the joint Hindu
family including the names of major and minor
coparceners and get a declaration from the Kartha to this
effect along with specimen signatures and signatures of
all coparceners.
(b) The account should be opened either in the personal

name of the Kartha or in the name of the family business.

(c) The documents should be signed by the Kartha and major
coparceners.
(d) The account should be operated on only by the Kartha
and the authorised major coparceners.
(e) While making advances, the banker should ascertain the
purpose for which the loan is obtained and whether the
loan is really needed by the joint Hindu family for
business.
XIII. Trustees:
According to the Indian Trusts Act, 1882, “a trust is an
obligation annexed to the ownership of property and arising
out of a confidence reposed in an accepted by the owner, or
declared and accepted by him, for the benefit of another, or of
another and the owner.” As per this definition, a trustee is a
person in whom the author or settler reposes confidence and
entrusts the management of his property for the benefit of a
person or an organisation who is called beneficiaries. A trust is
usually formed by means of document called the “Trust Deed.”
While opening an account in the names of persons in their
capacity as trustees the banker should take the following
precautions:
(a) The banker should thoroughly examine the trust deed
appointing the applicants as the trustees.
(b) A trust deed which states the powers and functions of
trustees must be obtained by the banker.

(c) In case of two or more trustees, the banker should ask for
clear instructions regarding the person or persons who
shall operate the account.
(d) In case of death or retirement of one or more trustees,
banker must see the provision of the trust deed.
(e) The banker should not allow the transfer of funds from
trust account to the personal account of trustee.
(f) The banker should take all possible precautions to
safeguard the interest of the beneficiaries of a trust,
failing which he shall be liable to compensate the latter
for any fraud on the part of the trustee.
(g) The insolvency of a trustee does not affect the trust
property and the creditors of the trustee cannot recover
their claims from trust property.
(h) A copy of the resolution passed in the meeting of trustees
open the account should be obtained.
FUNCTIONS OF COMMERCIAL BANK
Functions of a Commercial Bank can be classified into
three.
1. Principal/ Primary/ Fundamental functions
2. Subsidiary/ Secondary/ Supplementary functions
3. Innovative functions.
Principal functions
Commercial banks perform many functions. They satisfy
the financial needs of the sectors such as agriculture, industry,
trade, communication, so they play very significant role in a

process of economic social needs. The functions performed by

banks, since recently, are becoming customer-centred and are
widening their functions. Generally, the functions of
commercial banks are divided into two categories; primary
functions and the secondary functions. Two ‘acid test’
functions of commercial banks are Accepting deposits and
Lending loans. These functions along with credit creation,
promotion of cheque system and investment in Government
securities form basic functions of commercial banks. The
secondary functions of commercial banks include agency
services, general utility services and innovative services.
1. Receiving deposits
Most important function of a commercial bank is to
accept deposit from those who can save but cannot profitably
utilise this savings themselves. By making deposits in bank,
savers can earn something in the form of interest and avoid the
danger of theft. To attract savings from all sorts of customers,
banks maintain different types of accounts such as current
account, Savings bank account, Fixed Deposit account,
Recurring deposit account and Derivative Deposit account.
Features of Current Accounts
— It is generally opened by trading & industrial concerns.
— It is opened not for profit or savings but for convenience
in payments
— Introduction is necessary to open the account.
Any number of transactions permitted in the account.
Withdrawals are generally allowed by cheque Deposit is

repayable on demand
— No interest is allowed but incidental charges claimed.
— Minimum balance requirement varies from bank to bank.
Features of Saving Bank (SB) accounts
— It is generally opened by middle/low income group who
save a part of their income for future needs
— Introduction is necessary to open the account if cheque
facility is allowed.
— There are some restrictions on number of withdrawals.
— Fair interest (less than FD) is offered on the deposits of
this account. Features of Fixed Deposit accounts
o It is generally Opened by small investors who do not
want to invest money in risky industrial securities like
shares.
o No introduction is necessary to open the account.
o No maximum limit for investing.
o Minimum period of investment is 15 days
o Withdrawal is allowed only after the expiry of a fixed
period.
- Withdrawal is generally allowed by surrendering FD
Receipt
— Higher rate of interest is offered on the deposits of this
account,
Features of Recurring Deposit accounts / Cumulative

Deposit account.
— This account is meant for fixed income group, who can
deposit a fixed sum regularly.
- The amount is paid back along with interest after a
specified period.
- High rate of interest is offered on recurring deposits.
- Passbook is the means through which deposits and
withdrawals are made
2. Lending of funds
The second important function of commercial banks is to
advance loans to its customers. Banks charge interest from the
borrowers and this is the main source of their income. Modern
banks give mostly secured loans for productive purposes. In
other words, at the time of advancing loans, they demand
proper security or collateral. Generally, the value of security or
collateral is equal to the amount of loan. This is done mainly
with a view to recover the loan money by selling the security
in the event of non-refund of the loan.
Commercial banks lend money to the needy people in the
form of Cash credits, Term loans, Overdrafts (OD),
Discounting of bills, Money at call or short notice etc.
(i) Cash Credit: In this type of credit scheme, banks
advance loans to its customers on the basis of bonds,
inventories and other approved securities. Under this scheme,
banks enter into an agreement with its customers to which
money can be withdrawn many times during a year. Under this
set up banks open accounts of their customers and deposit the

loan money. With this type of loan, credit is created.

(ii) Term loans: A term loan is a monetary loan that is
repaid in regular payments over a set period of time. In other
words, a loan from a bank for a specific amount that has a
specified repayment schedule and a floating interest rate is
called Term loan. Term loans usually last between one and ten
years, but may last as long as 30 years in some cases. It may be
classified as short term, medium term and long term loans.
(iii) Over-Drafts: It is the extension of credit from a bank
when the account balance reaches zero level. Banks advance
loans to its customer’s up to a certain amount through over-
drafts, if there are no deposits in the current account. For this,
banks demand a security from the customers and charge very
high rate of interest. Overdraft facility will be allowed only for
current account holders.
(iv) Discounting of Bills of Exchange: This is the most
prevalent and important method of advancing loans to the
traders for short-term purposes. Under this system, banks
advance loans to the traders and business firms by discounting
their bills. While discounting a bill, the Bank buys the bill (i.e.
Bill of Exchange or Promissory Note) before it is due and
credits the value of the bill after a discount charge to the
customer's account. The transaction is practically an advance
against the security of the bill and the discount represents the
interest on the advance from the date of purchase of the bill
until it is due for payment. In this way, businessmen get loans
on the basis of their bills of exchange before the time of their
maturity.

(v) Money at Call and Short notice: Money at call and

short notice is a very short-term loan that does not have a set
repayment schedule, but is payable immediately and in full
upon demand. Money- at-call loans give banks a way to earn
interest while retaining liquidity. These are generally lent to
other institutions such as discount houses, money brokers, the
stock exchange, bullion brokers, corporate customers, and
increasingly to other banks. ‘At call’ means the money is
repayable on demand whereas At short notice’ implies the
money is to be repayable on a short notice up to 14 days.
3. Investment of funds in securities
Banks invest a considerable amount of their funds in
government and industrial securities. In India, commercial
banks are required by statute to invest a good portion of their
funds in government and other approved securities. The banks
invest their funds in three types of securities—Government
securities, other approved securities and other securities.
Government securities include both, central and state
governments, such as treasury bills, national savings certificate
etc. Other securities include securities of state associated
bodies like electricity boards, housing boards, debentures of
Land Development Banks, units of UTI, shares of Regional
Rural banks etc.
4. Credit Creation
When a bank advances a loan, it does not lend cash but
opens an account in the borrower’s name and credits the
amount of loan to this account. Thus a loan creates an equal

amount of deposit. Creation of such deposit is called credit

creation. Banks have the ability to create credit many times
more than their actual deposit.
5. Promoting cheque system
Banks also render a very useful medium of exchange in
the form of cheques. Through a cheque, the depositor directs
the banker to make payment to the payee. In the modern
business transactions by cheques have become much more
convenient method of settling debts than the use of cash.
Through promoting cheque system, the banks ensure the
exchange of accounted cash. At present, CTS (Cheque
Truncation System) cheques are used by Indian Banks to
ensure speedy settlement of transactions in between banks. In
contrast to the declining importance of cheques, the use of
electronic payment instruments at the retail level has been
growing rapidly.
Subsidiary functions
1. Agency services : Banks act as an agent on behalf of the
individual or organisations. Banks, as an agent can work for
people, businesses, and other banks, providing a variety of
services depending on the nature of the agreement they make
with their clients. Following are the important agency services
provided by commercial banks in India.
 Commercial Banks collect cheques, drafts, Bill of
Exchange, interest and dividend on securities, rents etc.
on behalf of customers and credit the proceeds to the
customer’s account.

 Pay LIC premium, rent, newspaper bills, telephone bills

etc.
 Buying and selling of securities.
 Advise on right type of investment.
 Act as trustees (undertake management of money and
property), executors (carry out the wishes of deceased
customers according to will) & attorneys (collect interest
& dividend and issue valid receipt) of their customers.
 Serve as correspondents and representatives of their
customers. In this capacity, banks prepare I-Tax returns
of their customers, correspond with IT authorities and
pay IT of their customers.
2. General Utility Services In addition to agency services,
modem banks performs many general utility services for the
community. Following are the important general utility
services offered by Commercial Banks
• Locker facility: Bank provide locker facility to their
customers. The customers can keep their valuables such
as gold, silver, important documents, securities etc. in
these lockers for safe custody.
• Issue travellers’ cheques: Banks issue traveller’s cheques
to help their customers to travel without the fear of theft
or loss of money. It enable tourists to get fund in all
places they visit without carrying actual cash with them.
• Issue Letter of Credits: Banks issue letter of credit for
importers certifying their credit worthiness. It is a letter
issued by importer’s banker in favour of exporter

informing him that issuing banker undertakes to accept

the bills drawn in respect of exports made to the importer
specified therein.
Act as referee: Banks act as referees and supply
information about the financial standing of their customers on
enquiries made by other businessmen.
• Collect information: Banks collect information about
other businessmen through the fellow bankers and supply
information to their customers.
• Collection of statistics: Banks collect statistics for giving
important information about industry, trade and
commerce, money and banking. They also publish
journals and bulletins containing research articles on
economic and financial matters.
• Underwriting securities: Banks underwrite securities
issued by government, public or private bodies.
• Merchant banking: Some bank provide merchant banking
services such as capital to companies, advice on
corporate matters, underwriting etc.
Innovative Functions
The adoption of Information and Communication
technology enable banks to provide many innovative services
to the customers such as;
1. ATM services
Automated Teller Machine (ATM) is an electronic
telecommunications device that enables the clients of banks to

perform financial transactions by using a plastic card.

Automated Teller Machines are established by banks to enable
its customers to have anytime money. It is used to withdraw
money, check balance, transfer funds, get mini statement,
make payments etc. It is available at 24 hours a day and 7 days
a week.
2. Debit card and credit card facility
Debit card is an electronic card issued by a bank which
allows bank clients access to their account to withdraw cash or
pay for goods and services. It can be used in ATMs, Point of
Sale terminals, e-commerce sites etc. Debit card removes the
need for cheques as it immediately transfers money from the
client's account to the business account. Credit card is a card
issued by a financial institution giving the holder an option to
borrow funds, usually at point of sale. Credit cards charge
interest and are primarily used for short- term financing.
3. Tele-banking :
Telephone banking is a service provided by a bank or
other financial institution, that enables customers to perform
financial transactions over the telephone, without the need to
visit a bank branch or automated teller machine
4. Internet Banking:
Online banking (or Internet banking or E-banking) is a
facility that allows customers of a financial institution to
conduct financial transactions on a secured website
operated by the institution. To access a financial institution's
online banking facility, a customer must register with the

institution for the service, and set up some password for

customer verification. Online banking can be used to check
balances, transfer money, shop online, pay bills etc.
5. Bancassurance:
It means the delivery of insurance products through
banking channels. It can be done by making an arrangement in
which a bank and an insurance company form a partnership so
that the insurance company can sell its products to the bank's
client base. Banks can earn additional revenue by selling the
insurance products, while insurance companies are able to
expand their customer base without having to expand their
sales forces
6. Mobile Banking:
Mobile banking is a system that allows customers of a
financial institution to conduct a number of financial
transactions through a mobile device such as a mobile phone
or personal digital assistant. It allows the customers to bank
anytime anywhere through their mobile phone. Customers can
access their banking information and make transactions on
Savings Accounts, Demat Accounts, Loan Accounts and
Credit Cards at absolutely no cost.
7. Electronic Clearing Services :
It is a mode of electronic funds transfer from one bank
account to another bank account using the services of a
Clearing House. This is normally for bulk transfers from one
account to many accounts or vice- versa. This can be used both
for making payments like distribution of dividend, interest,

salary, pension, etc. by institutions or for collection of amounts

for purposes such as payments to utility companies like
telephone, electricity, or charges such as house tax, water tax
etc
8. Electronic Fund Transfer/National Electronic Fund
Transfer (NEFT):
National Electronic Funds Transfer (NEFT) is a nation-
wide payment system facilitating one-to-one funds transfer.
Under this Scheme, individuals, firms and corporate can
electronically transfer funds from any bank branch to any
individual, firm or corporate having an account with any other
bank branch in the country participating in the Scheme. In
NEFT, the funds are transferred based on a deferred net
settlement in which there are 11 settlements in week days and
5 settlements in Saturdays.
9. Real Time Gross Settlement System (RTGS):
It can be defined as the continuous (real-time) settlement
of funds transfers individually on an order by order basis .
'Real Time' means the processing of instructions at the time
they are received rather than at some later time. It is the fastest
possible money transfer system in the country.
NEFT RTGS
• Based on Demand Net • Based on Gross

Settlement (DNS) Settlement
• Fastest method of money • Slower than RTGS
transfer transfer

• Complete transactions in • Complete transactions

batches individually
• There is no minimum • Minimum amount to be
limit of transactions remitted
• Settlement on hour basis • Settlement in real time (at
(11 settlements from 9 am the transfer order is
to 7 pm) processed)
Role of commercial banks in a developing economy

A well developed banking system is necessary pre-
condition for economic development of any economy. Apart
from providing resources for growth of industrialisation, banks
also influence direction in which these resources are utilised.
In underdeveloped and developing nations banking facilities
are limited to few developed cities and their activities are
focussed on trade & commerce paying little attention to
industry & agriculture. Commercial banks contribute to a
country’s economic development in the following ways.
1. Capital formation
Most important determinant of economic development is
capital formation. It has 3 distinctive stages
 Generation of savings
 Mobilisation of savings
 Canalisation of saving
Banks promote capital formation in all these stages. They
promote habit of savings by offering attractive rate of return
for savers. Banks are maintaining different types of accounts to

mobilise savings aiming different types of customers. They

make widespread arrangements to collect savings by opening
branches even in remote villages. Moreover, banks offer their
resources for productive activities only.
2. Encouragement to entrepreneurial innovations
Entrepreneurs in developing economies, generally
hesitate to invest & undertake innovations due to lack of
fund. Bank loan facilities enable them to introduce innovative
ideas and increase productive capacity of the economy.
3. Monetisation of economy
Monetisation means allow money to play an active role
in the economy. Banks, which are creators and distributors of
money, help the monetisation in two ways;
 They monetise debt i.e., buy debts (securities) which are
not as acceptable as money and convert them to demand
deposits which are acceptable as money.
 By spreading branches in rural areas they convert non-
monetised sectors of the economy to monetised sectors.
4. Influencing economic activity
They can directly influence the economic activity & pace
of economic development through its influence on
(a) The rate of interest (reduction in rates make investment
more profitable and stimulates economic activity)
(b) Availability of credit. (Through Credit creation banks
helps in increasing supply of purchasing power)

5. Implementation of monetary policy

Well developed banking system is necessary for effective
implementation of monetary policy. Control and regulation of
credit is not possible without active co-operation of banks.
6. Promotion of trade and industry
Economic progress of industrialised countries in last 2
centuries is mainly due to expansion in trade &
industrialisation which could not have been made possible
without development of a good banking system. Use of
cheques, drafts and BoE as a medium of exchange has
revolutionalised the internal and international trade which in
turn accelerated the pace of industrialisation.
7. Encouraging right type of industries
In a planned economy it is necessary that banks should
formulate their loan policies in accordance with the broad
objectives and strategy of industrialisation as adopted in the
plan.
8. Regional development
Banks can play role in achieving balanced development
in different regions of the economy. They can transfer surplus
funds from developed region to less developed regions, where
there is shortage of funds.
9. Development of agricultural & other neglected sectors
Under developed economies primarily agricultural
economies and majority of the population live in rural areas.
So far banks were paying more attention to trade and

commerce and have almost neglected agriculture and industry.

Banks must diversify their activities not only to extend credit
to trade, but also to provide medium and long term loans to
industry and agriculture.
ROLE OF BANKS IN ECONOMIC DEVELOPMENT
Besides performing the usual commercial banking
functions, banks in developing countries play an effective role
in their economic development. The majority of people in such
countries are poor, unemployed and engaged in traditional
agriculture. There is acute shortage of capital. People lack
initiative and enterprise. Means of transport are undeveloped.
Industry is depressed. The commercial banks help in
overcoming these obstacles and promoting economic
development. The role of a commercial bank in a developing
country is discussed as under.
1. Mobilising Saving for Capital Formation:
The commercial banks help in mobilising savings
through network of branch banking. People in developing
countries have low incomes but the banks induce them to save
by introducing variety of deposit schemes to suit the needs of
individual depositors. They also mobilise idle savings of the
few rich. By mobilising savings, the banks channelize them
into productive investments. Thus they help in the capital
formation of a developing country.
2. Financing Industry:
The commercial banks finance the industrial sector in a
number of ways. They provide short-term, medium-term and

long-term loans to industry. In India they provide short-term

loans. Income of the Latin American countries like Guatemala,
they advance medium-term loans for one to three years. But in
Korea, the commercial banks also advance long-term loans to
industry.
In India, the commercial banks undertake short-term and
medium-term financing of small scale industries, and also
provide hire- purchase finance. Besides, they underwrite the
shares and debentures of large scale industries. Thus they not
only provide finance for industry but also help in developing
the capital market which is undeveloped in such countries.
3. Financing Trade:
The commercial banks help in financing both internal
and external trade. The banks provide loans to retailers and
wholesalers to stock goods in which they deal. They also help
in the movement of goods from one place to another by
providing all types of facilities such as discounting and
accepting bills of exchange, providing overdraft facilities,
issuing drafts, etc. Moreover, they finance both exports and
imports of developing countries by providing foreign exchange
facilities to importers and exporters of goods.
4. Financing Agriculture:
The commercial banks help the large agricultural sector
in developing countries in a number of ways. They provide
loans to traders in agricultural commodities. They open a
network of branches in rural areas to provide agricultural
credit. They provide finance directly to agriculturists for the

marketing of their produce, for the modernisation and

mechanisation of their farms, for providing irrigation facilities,
for developing land, etc.
They also provide financial assistance for animal
husbandry, dairy farming, sheep breeding, poultry farming,
pisciculture and horticulture. The small and marginal farmers
and landless agricultural workers, artisans and petty
shopkeepers in rural areas are provided financial assistance
through the regional rural banks in India. These regional rural
banks operate under a commercial bank. Thus the commercial
banks meet the credit requirements of all types of rural people.
5. Financing Consumer Activities:
People in underdeveloped countries being poor and
having low incomes do not possess sufficient financial
resources to buy durable consumer goods. The commercial
banks advance loans to consumers for the purchase of such
items as houses, scooters, fans, refrigerators, etc. In this way,
they also help in raising the standard of living of the people in
developing countries by providing loans for consumptive
activities.
6. Financing Employment Generating Activities:
The commercial banks finance employment generating
activities in developing countries. They provide loans for the
education of young person’s studying in engineering, medical
and other vocational institutes of higher learning. They
advance loans to young entrepreneurs, medical and
engineering graduates, and other technically trained persons in

establishing their own business. Such loan facilities are being

provided by a number of commercial banks in India. Thus the
banks not only help inhuman capital formation but also in
increasing entrepreneurial activities in developing countries.
7. Help in Monetary Policy:
The commercial banks help the economic development
of a country by faithfully following the monetary policy of the
central bank. In fact, the central bank depends upon the
commercial banks for the success of its policy of monetary
management in keeping with requirements of a developing
economy. Thus the commercial banks contribute much to the
growth of a developing economy by granting loans to
agriculture, trade and industry, by helping in physical and
human capital formation and by following the monetary policy
of the country.
TYPES OF BANKING
Banks can be classified into different groups either on the
basis of their structure or on the basis of their function.
Structurally banking can be divided into Branch banking and
Unit Banking. Functionally, banking can be divided into
Deposit Banking, Investment Banking and Mixed Banking.
Branch Banking:
This refers to a system under which two or more banks
are opened under a single ownership. Examples are State Bank
of India, Punjab National Bank, Indian Bank etc. which have
several branches spread all-over India.

Unit Banking:
This refers to that system of banking in which banking
operations are carried on through a single organisation, without
any branches. This system used to be popular in America. One
great advantage of branch banking is that the same bank can
cater to several parts of a large country (through its branches
situated in those parts) which a unit bank would find difficult
to do. As against this, a unit bank has the advantage that its
efforts are concentrated in one area so that it can serve that
area well.
Group Banking:
This is a system under which two or more banks,
separately incorporated, are connected by being controlled by a
single holding company as trust.
Chain Banking:
This is similar to Group Banking. Here two or more
banks are controlled by a single group through the ownership
of shares or otherwise.
Deposit Banking:
In this category, the banks act as custodian or trustees of
the depositors.
Correspondent banking system:
It is another important type of banking system. A
correspondent bank is one which connects the two banks under
unit banking system. The best examples of correspondent bank
in India are RBI or central bank.

Investment Banking:
This refers to banks whose main function is to provide
finance for investment to industrial concerns. They provide
this by purchasing shares and debentures of newly floated
companies.
Mixed Banking:
Most banks in India play both roles. Deposit Banking and
Investment Banking. Such type of banking is called mixed
banking.
RESERVE BANK OF INDIA (RBI)
The Reserve Bank of India is now the apex financial
institution of the country which is entrusted with the task of
controlling, supervising, promoting, developing and planning
the financial system. RBI is the queen bee of the Indian
financial system which influences the commercial banks’
management in more than one way. The RBI influences the
management of commercial banks through its various policies,
directions and regulations. Its role in banking is quite unique.
In fact, the RBI performs the four basic functions of
management, viz., planning, organizing, directing and
controlling in laying a strong foundation for the functioning of
commercial banks.
RBI possesses special status in our country. It is the
authority to regulate and control monetary system of our
country. It controls money market and the entire banking
system of our country.

Management
The Reserve Bank's affairs are governed by a central
board of directors. The board is appointed by the Government
of India in keeping with the Reserve Bank of India Act.
The organization structure of RBI consists of a Central
Board and Local Board.
Central Board: The general supervision and control of the
bank’s affairs is vested in the Central Board of Directors which
consists of 20 member team including a Governor, 4 Deputy
Governors and 15 Directors (of which 4 are from local boards,
and one is a finance secretary of Central Government). All
these persons are appointed or nominated by Central Govt. The
chairman of the Board and its Chief Executive authority is the
Governor. Governors and Deputy Governors hold office for
such a period as fixed by Central Government not exceeding 5
years and are eligible for reappointment. Directors hold office
for 4 years and their retirement is by rotation. As a matter of
practical convenience, the Board has delegated some of its
functions to a committee called the Committee of the Central
Board. It meets once in a week, generally Wednesdays. There
are sub committees to assist committees such as building
committee and staff sub-committee.
Local Board: For each regional areas of the country viz.,
Western, Eastern, Northern and Southern, there is a Local
Board with head quarters at Bombay, Calcutta, New Delhi and
Madras. Local boards consist of 5 members each appointed by
the Central Government. The functions of the local boards are

to advise the central board on local matters and to represent

territorial and economic interests of local cooperative and
indigenous banks; advice on such matters that may generally
be referred to them and perform such duties as the Central
Board may delegate to them.
The Central office of the RBI, located at Mumbai is
divided into several specialized departments. The main
departments are:
1. Issue Department: - It arranges for the issue and
distribution of currency notes among the different centers
of the country.
2. Banking Department: - It deals with Government
transactions and maintains the cash reserves of the
commercial banks.
3. Department of Banking development:- It is concerned
with the development of banking facilities in the
unbanked and rural areas in the country.
4. Department of Banking operations: - This department
supervises and controls the working of the banking
institutions in the country.
5. Non-Banking Companies Department: - It regulates the
activities of non-banking financial companies existing in
the country.
6. Agricultural credit Department: - This department studies
the problems connected with the agricultural credit in the
country.

7. Industrial finance Department: It is concerned with the

provision of finance to the industrial units in the country.
8. Exchange control Department: - The entire business of
sale and purchase of foreign exchange is conducted by
this department.
9. Legal Department: - The main function of this
department is to give legal advices to the other
departments of RBI.
10. Department of Research and Statistics: - This department
is concerned with conducting research on problems
relating to money, credit, finance, production etc.
Objectives of RBI
Prior to the establishment of the Reserve Bank, the
Indian financial system was totally inadequate on account of
the inherent weakness of the dual control of currency by the
Central Government and of credit by the Imperial Bank of
India.
The Preamble to the Reserve Bank of India Act, 1934
spells out the objectives of the Reserve Bank as: “to regulate
the issue of Bank notes and the keeping of reserves with a
view to securing monetary stability in India and generally to
operate the currency and credit system of the country to its
advantage.”
The important objectives are:
1. To act as Monetary Authority: Formulates implements
and monitors the monetary policy to maintain price stability

and ensuring adequate flow of credit to productive sectors.

2. To Regulate and supervise the financial system of the
country: It prescribes broad parameters of banking operations
within which the country's banking and financial system
functions. It helps to maintain public confidence in the system,
protect depositors' interest and provide cost-effective banking
services to the public.
3. To Manage the Exchange Control: Manages the Foreign
Exchange Management Act, 1999 to facilitate external trade
and payment and promote orderly development and
maintenance of foreign exchange market in India.
4. To issue currency: Issues and exchanges or destroys
currency and coins not fit for circulation to give the public
adequate quantity of supplies of currency notes and coins and
in good quality.
5. To undertake developmental role: RBI performs a wide
range of promotional functions to support national objectives.
6. To undertake related Functions by acting as:
• Banker to the Government: performs merchant banking
function for the central and the state governments; also
acts as their banker.
• Banker to banks: maintains banking accounts of all
scheduled banks.
• Owner and operator of the depository (SGL-Subsidiary
General Ledger account) and exchange (NDS)
Negotiated Dealing System is an electronic platform for

facilitating dealing in Government Securities and Money

Market Instruments that will facilitate electronic submission of
bids/application for government bonds.
To sum up the objectives include:
1. To manage the monetary and credit system of the
country.
2. To stabilizes internal and external value of rupee.
3. For balanced and systematic development of banking in
the country.
4. For the development of organized money market in the
country.
5. For facilitating proper arrangement of agriculture finance
and be in successful for maintaining financial stability
and credit in agricultural sector.
6. For proper arrangement of industrial finance.
7. For proper management of public debts.
8. To establish monetary relations with other countries of
the world and international financial institutions.
9. For centralization of cash reserves of commercial banks.
10. To maintain balance between the demand and supply of
currency.
11. To regulate the financial policy and develop banking
facilities throughout the country.
12. T o remain free from political influence while making
financial decisions

13. To assist the planned process of development of the

Indian economy.
Besides the traditional central banking functions, with the
launching of the five-year plans in the country, the Reserve
Bank of India has been moving ahead in performing a host of
developmental and promotional functions, which are normally
beyond the purview of a traditional Central Bank.
Functions of RBI
RBI performs various traditional banking function as
well as promotional and developmental measures to meet the
dynamic requirements of the country. Main functions of RBI
can be broadly classified into three. These are
I. Monetary functions or Central banking functions
II. Supervisory functions
III. Promotional and Developmental functions.
I. Monetary functions include
A. Issue of currency notes
B. Acting as banker to the Government
C. Serving as banker of other banks
D. Controlling credit
E. Controlling foreign exchange operations
A. Issue of currency notes: -
Under Section 22 of the Reserve Bank of India Act of
1934, the Reserve Bank of India is given the monopoly of note
issue. Now RBI is the sole authority for the issue of currency
notes of all denominations except one rupee notes and coins in

the country. One rupee notes and coins are issued by Ministry
of Finance of GOI. The RBI has a separate department called
the Issue Department for the issue of currency notes.
Since 1956 system of Note Issue changed from
Proportional Reserve System to minimum reserve system.
Under Proportional reserve system of note issue, not less than
409c of the total volume of notes issue by the RBI was to be
covered by gold coins, bullion and foreign securities. But
under the Minimum reserve system of note issue, RBI is
required to maintain a minimum reserve of gold or foreign
securities or both against the notes issued. No maximum limit
is fixed on the volume of notes. RBI maintains gold and
foreign exchange reserves of Rs.200 crores of which 115
crores is in gold & balance in foreign securities, Govt. of India
securities, eligible commercial bills, Pro-notes of NABARD
for any loans etc.
This change from Proportional Reserve system to
Minimum Reserve system is made because of two major
reasons. Firstly, the planned economic development of the
country called for an increased supply of money, which could
not be had under the proportional reserve system. Secondly,
the foreign exchange held as reserve by the Reserve bank had
to be released for financing the five year plans. In short, this
was to enable the expanding currency requirements of the
economy.
B. Acting as Banker to government: -
The Reserve bank act as a banker to the Central and State

Governments. As a banker to the Government RBI acts in

three capacities, viz., (a) as a banker,(b) as a financial agent,
and (c) as a financial advisor
(a) As a banker: - RBI renders the following services
1. Accepts deposits from the Central and State Government.
2. Collects money on behalf of Government.
3. Makes payments on behalf of the Government, in
accordance with their instructions.
4. Arranges for the transfer of funds from one place to
another on behalf of the Governments
5. Makes arrangements for the supply of foreign exchange
to the Central and State Governments.
6. It maintains currency chests with treasuries and other
agencies in places prescribed by the Government of
India. These chests are supplied with sufficient currency
notes to meet the requirements for the transactions of the
Government.
7. Short term advances are granted to Central and State
Governments for a period not exceeding three months.
These advances are granted up to a certain limit without
any collateral securities.
8. In times of emergencies like war, extraordinary loans are
also granted to the Governments by the RBI. (b) As a
financial agent: - The services given are
1. Acts as an agent of the Central and State Governments in
the matter of floatation of loans. On account of Reserve Bank’s

intimate knowledge of the financial markets, it is able to obtain

the best possible terms for the Government in this matter.
Further by coordinating the borrowing programmers of the
various Governments, it is able to minimize the adverse effects
of Government borrowings on the money and securities
market.
2. On behalf of Central Government RBI sells treasury
bills of 90 days maturity at weekly auctions and secures short-
term finance for the Central Government. Apart from that RBI
also sells adhoc treasury bills of 90 day’s maturity to the State
Governments, Semi-Government Departments and foreign
central banks on behalf of the Central Government.
3. RBI manages and keeps the accounts of the public debts
of the Central and State Governments. It arranges for the
payment of interest and principal amount on the public debt on
the due dates.
4. As an agent RBI also represents Government of India in
the International institutions like the IMF, the IBRD etc.
The Reserve Bank is agent of Central Government and of
all State Governments in India except for that of Jammu and
Kashmir and Sikkim.
(c) As a Financial Adviser: - renders following services
1. It advices the Central and State Government on all
financial and economic matters such as the floating of loans,
agricultural and industrial finance etc.
2. Advice on matters of International finance is also given
to Central Government.

3. It collects the recent information on current economic

and financial developments in India and abroad, with the help
of its Research and Statistics Department and keeps
Government informed periodically.
C. Banker’s bank: -
RBI acts as banker to Scheduled banks. Scheduled Banks
include commercial banks, foreign exchange banks, public
sector banks, state co-operative banks and the regional rural
banks. As a bankers’ bank it renders the following services:
1. It holds a part of the cash balances of the commercial
banks:- Every commercial bank in India is required to
keep with the Reserve Bank a cash balance of not less
than 6% of its demand and time liabilities. This rate can
be increased up to 20%. The two main purposes of
maintaining cash reserve by commercial banks are as
follows. Firstly to protect the interest of the depositors,
secondly to enable the Reserve Bank to accommodate the
commercial banks on times of difficulties and thirdly the
Reserve Bank can control the credit created by the
commercial banks by varying the statutory cash reserve
requirements.
2. It acts as the clearing house: - By acting as clearing
house the Reserve bank helps the member banks in the
settlement of the mutual indebtedness without physical
transfer of cash.
3. It provides cheap remittance facilities to the
commercial banks

4. It provides financial accommodation to the commercial

banks: - At times of financial crisis the RBI is the lender
of last resort for the commercial banks. Financial
assistance is given by The Reserve bank either by
rediscounting eligible bills or by granting loans against
approved securities.
D. Control of Credit: -
RBI undertakes the responsibility of controlling credit in
order to ensure internal price stability and promote sufficient
credit for the economic growth of the country. Price stability is
essential for economic development. To control credit, RBI
makes use of both quantitative and qualitative weapons by
virtue of the powers given to it by Reserve Bank of India Act
of 1934 and the Indian Banking Regulation Act of 1949. These
weapons are listed below.
(a) Quantitative weapons
1. Bank rate policy:
Bank rate is the lending rate of central bank. It is the
official minimum rate at which central bank of a country
rediscounts the eligible bills of exchange of the commercial
banks and other financial institutions or grants short term loans
to them. By increasing bank rate, RBI can make bank credit
costlier.
2. Open Market Operations:
RBI Act authorizes the RBI to engage in the purchase of
securities of central and State Government and such other
securities as specified by Central Govt. But by and large, its

open market operations are confined to Central Government

Securities and to a very limited extend to State Government
Securities. RBI uses this weapon to offset the seasonal
fluctuations in money market. When there is an excessive
supply of money, RBI sells the securities in the open market.
In that way RBI is able to withdraw the excess money from
circulation. But when there is shortage of money supply in the
market, it purchases securities from the open market and as a
result, more money is arrived at for circulation
3. Variable Cash reserve ratio:
Under the RBI Act of 1934, every scheduled and non-
scheduled bank is required to maintain a fixed percentage of
total time and demand liabilities as cash reserve with RBI. It is
called statutory Cash Reserve Ratio (CRR). An increase in
CRR reduces lending capacity of the bank and a decrease in
CRR increases the lending capacity. RBI can prescribe a CRR
ranging up to 15% which is at present 4% (as on April ’2016).
4. Variable Statutory Liquidity Ratio
According to sec 24 of BRA 1949, every commercial
bank is required to maintain a certain percentage of its total
deposits in liquid assets such as cash in hand, excess reserve
with RBI, balances with other banks, gold and approved
Government and other securities. This proportion of liquid
assets to total deposits is called SLR. BRA empowers RBI to
fix the SLR up to 40%. The variation of the SLR is intended to
reduce the lendable funds in the hands of the commercial
banks and to check the expansion of bank credit. An increase

in SLR will decrease the lendable funds in the hands of

commercial banks and vice versa. Present rate of SLR is
21.25%. (As on April 2016).
5. Repo Rate and Reverse Repo Rate
Repo rate is the rate at which RBI lends to commercial
banks generally against government securities. Reduction in
Repo rate helps the commercial banks to get money at a
cheaper rate and increase in Repo rate discourages the
commercial banks to get money as the rate increases and
becomes expensive. Reverse Repo rate is the rate at which RBI
borrows money from the commercial banks. The increase in
the Repo rate will increase the cost of borrowing and lending
of the banks which will discourage the public to borrow money
and will encourage them to deposit. As the rates are high the
availability of credit and demand decreases resulting to
decrease in inflation. This increase in Repo Rate and Reverse
Repo Rate is a symbol of tightening of the policy. As of April
2016, the repo rate is 6.50 % and reverse repo rate is 6%.
b. Selective credit controls (Qualitative weapons)
1. Credit Ceiling
In this operation RBI issues prior information or
direction that loans to the commercial banks will be given up
to a certain limit. In this case commercial bank will be tight in
advancing loans to the public. They will allocate loans to
limited sectors. Few example of ceiling are agriculture sector
advances, priority sector lending.

2. Credit Authorization Scheme

Credit Authorization Scheme was introduced in
November, 1965 when P C Bhattacharya was the chairman of
RBI. Under this instrument of credit the commercial banks are
required to obtain the RBI’s prior authorization for sanctioning
any fresh credit beyond the authorized limits.
3. Moral Suasion
Moral Suasion is just as a request by the RBI to the
commercial banks to follow a particular line of action. RBI
may request commercial banks not to give loans for
unproductive purpose which does not add to economic growth
but increases inflation.
4. Regulation of margin requirements:
Margin refers to the difference between loan amount and
the market value of collateral placed to raise the loan. RBI
fixes a lower margin to borrowers whose need is urgent. For
e.g. if RBI believes that farmers should be financed urgently,
RBI would direct to lower the margin requirement on
agricultural commodities. RBI has used this weapon for a
number of times.
5. Issuing of directives:
BRA empowers RBI to issue directives to banks and
banks are bound to comply with such directives. RBI
directives may relate to:
- Purpose for which advance may or may not be made
- Margins requirement

- Maximum amount of loan that can be sanctioned to any

company, firm or individual
- Rate of interest and other terms and conditions on which
loans may be given
E Control of foreign Exchange operations
One of the central banking functions of the RBI is the
control of foreign exchange operations. For the control of
foreign exchange business, the RBI has set up a separate
department called the Exchange Control Department in
September, 1939. This Department has been granted wide
powers to regulate the foreign exchange business of the
country. As the central bank of India, it is the responsibility of
the RBI to maintain the external value of the Indian rupee
stable. India being member of the IMF, the RBI is required to
maintain stable exchange rates between the Indian rupee and
the currencies of all other member countries of the I.M.F.
Besides maintaining stable exchange rates, RBI also acts as the
custodian of the foreign exchange reserves of the country. The
foreign exchange reserves of the country held by RBI includes
Euro, U.S. dollars, Japanese yen etc.
RBI also acts as the administrator of exchange control. It
ensures that the foreign exchange reserves of the country are
utilized only for approved purposes and the limited foreign
exchange reserves of the country are conserved for the future.
II. Supervisory functions
RBI has been given several supervisory powers over the
different banking institutions in the country. The supervisory

functions relate to licensing and establishment, branch

expansion, liquidity of assets, amalgamation, reconstruction
and liquiditation of commercial banks and co- operative banks
III. Promotional and developmental functions
RBI is also performing promotional and developmental
functions. These functions includes the following
a) Provision of Agricultural Credit: For the promotion of
agricultural credit RBI has set up a separate department called
the Agricultural Credit Department. It. has also set up two
funds namely – 1. The National Agricultural Credit (Long term
operations) and 2. The National Agricultural credit
(stabilization) fund for facilitating Long term, Medium term
and Short term finance for agricultural purposes.
b) Provision for Industrial finance: - RBI has played a very
significant role in the field of industrial finance by helping the
setting up of a number of public sector industrial finance
corporations that provide short term, medium term, and long
term finance for industrial purpose. These industrial finance
corporations include 1. Industrial finance Corporation of India
(IFCI), 2. State Finance Corporations (SFC), Industrial
Development Bank of India (IDBI), 3. Industrial
Reconstruction Corporation of India (IRCI), 4. Refinance
Corporation of India, and 5. Unit Trust of India (UTI).
Besides the above RBI also renders the Credit Guarantee
Scheme which intends to give protection to banks against
possible losses in respect of their advances to small scale
industrial units.

c.) Development of Bill Market: - A bill market is a place

where short term bill of 3 month duration are generally
discounted or rediscounted. RBI plays a very important role in
the promotion of Bill Market as a well-developed bill market is
essential for the smooth functioning of the credit system.
d.) Collection and publication of statistics on financial and
economic matters: - These functions of RBI are extremely
useful to the Government in knowing and solving the various
economic problems. They are also of immense help to
financial institutions, business and industry and for general
public.
e.) Miscellaneous functions:- RBI has established training
centers for staff for its own staff and other banks. Bankers’
training college Mumbai, National Institute of Bank
Management Mumbai, Staff Training College Madras, and
College of Agricultural Banking at Pune are the institutions
run by RBI.
EMERGING TRENDS IN BANKING
In 1990’s Indian banking sector saw a great emphasis on
the replacement of technology with the new innovations.
Banks began to use these new technologies to provide
better and quick services to the customers at a great speed.
Some of the innovations techniques introduced in Indian
banking sector in post reform era are as follows:
E-Banking
E-banking involves information technology based
banking. Under this I.T system, the banking services are

delivered by way of a Computer-Controlled System. This

system does involve direct interface with the customers. The
customers do not have to visit the bank's premises.
Advantages of E-Banking
1. The operating cost per unit services is lower for the
banks.
2. It offers convenience to customers as they are not
required to go to the bank's premises. There is very low
incidence of errors.
3. The customer can obtain funds at any time from ATM
machines.
4. The credit cards and debit cards enables the Customers to
obtain discounts from retail outlets.
5. The customer can easily transfer the funds from one
place to another place electronically.
Popular services covered under E-Banking
1. Automated Teller Machines,
2. Credit Cards,
3. Debit Cards,
4. Smart Cards,
5. Electronic Funds Transfer (EFT) System,
6. Mobile Banking,
7. Internet Banking,
8. Tele-banking
9. Home banking
10. Demat facility
11. Cheques Truncation Payment System

1. Automated Teller Machine:

An ATM is a computerized Tele-communication device
which provides the customers the access to financial
transactions in public places without human inter-mention. It
enables the customers to perform several banking operations
such as withdrawals of cash, request of mini- statement etc.
The advantages of ATM are:
1. ATM provides 24 hours service: ATMs provide service
round the clock. The customer can withdraw cash up to a
certain a limit during any time of the day or night.
2. ATM gives convenience to bank's customers : ATMs
provide convenience to the customers. Now- a-days, ATMs are
located at convenient places, such as at the air ports, railway
stations, etc. and not necessarily at the Bank's premises.
3. ATM reduces the workload of bank's staff.: ATMs
reduce the work pressure on bank's staff and avoids queues in
bank premises.
4. ATM provide service without any error: ATMs provide
service without error. The customer can obtain exact amount.
There is no human error as far as ATMs are concerned.
5. ATM is very beneficial for travellers: ATMs are of great
help to travellers. They need not carry large amount of cash
with them.
6. ATM may give customers new currency notes: The
customer also gets brand new currency notes from ATMs. In
other words, customers do not get soiled notes from ATMs.

7. ATM provides privacy in banking transactions: Most of

all, ATMs provide privacy in banking transactions of the
customer.
2. Electronic Transfer of Funds:
This is an electronic debit or credit of customers account.
Bank customers can buy goods and services without caring
cash by using credit or debit cards. There cards are issued to
the customers by the bankers. This system works on a pin
(personal identification number).
The Customer swipes the card by using the card reader
device to make the transactions. The development of electronic
banking and internet banking helped the customers to utilize
their services.
3. Tele-Banking:
It is increasingly used in these days. It is a delivery
channel for marketing, banking services. A customer can do
non-cash business related banking over the phone anywhere
and at any time. Automatic voice recorders are used for
rendering tale-banking services.
4. Mobile Banking:
It is another important service provided by the banks
recently. The customers can utilize it with the help of a cell
phone. The bank will install particular software and provide a
password to enable a customer to utilize this service.
5. Home Banking:
It is another important innovation took place in Indian

banking sector. The customers can perform a no. of

transactions from their home or office. They can check the
balance and transfer the funds with the help of a telephone. But
it is not that popularly utilized in our country.
6. Internet Banking:
It is the recent trend in the Indian banking sector. It is the
result of development took place in information technology.
Internet banking means any user or customer with personal
computer and browser can get connected to his banks website
and perform any service possible through electronic delivery
channel. There is no human operator present in the remote
location to respond. All the services listed in the menu of bank
website will be available.
7. Demate Banking:
It is nothing but de-materialization. This is a recent
extant in the Indian banking sector. The customer who wants
to invest in stock market or in share and stock needs to
maintain this account with the commercial banks. The
customer needs to pay certain annual charges to the banks for
maintaining this type of accounts.
8. Credit Cards
A credit card is a small plastic card issued to users as a
system of payment. It allows its holder to buy goods and
services based on the holder's promise to pay for these goods
and services. The issuer of the card creates a revolving account
and grants a line of credit to the consumer (or the user) from
which the user can borrow money for payment to a merchant

or as a cash advance to the user. A credit card is different from

a charge card: a charge card requires the balance to be paid in
full each month. In contrast, credit cards allow the consumers a
continuing balance of debt, subject to interest being charged. A
credit card also differs from a cash card, which can be used
like currency by the owner of the card. Most credit cards are
issued by banks or credit unions.
9. Debit Card
A debit card (also known as a bank card or check card) is
a plastic card that provides the cardholder electronic access to
his or her bank account/s at a financial institution. Some cards
have a stored value against which a payment is made, while
most relay a message to the cardholder's bank to withdraw
funds from a designated account in favour of the payee's
designated bank account. The card can be used as an
alternative payment method to cash when making purchases.
In some cases, the cards are designed exclusively for use on
the Internet, and so there is no physical card. In many countries
the use of debit cards has become so widespread that their
volume of use has overtaken or entirely replaced the check
and, in some instances, cash transactions. Like credit cards,
debit cards are used widely for telephone and Internet
purchases. However, unlike credit cards, the funds paid using a
debit card are transferred immediately from the bearer's bank
account, instead of having the bearer pay back the money at a
later date.

Credit Card Vs Debit Card
Credit card Debit card

1 It is a “pay later product” It is “pay now product”
2 The card holder can avail Customers account is debited
of credit for 30-45 days immediately
3 No sophisticated Sophisticated communication
communication system is network/ system is required
required for credit card for debit card operation (eg.
operation ATM)
4 Opening bank account and Opening bank account and
maintaining required maintaining required amount
amount are not essential are essential
5 Possibility of risk of fraud Risk is minimised through
is high using PIN
10. Smart Card

A smart card resembles a credit card in size and shape,
but inside it is completely different. First of all, it has an inside
-- a normal credit card is a simple piece of plastic. The inside
of a smart card usually contains an embedded microprocessor.
The microprocessor is under a gold contact pad on one side of
the card.
Smarts cards may have up to 8 kilobytes of RAM, 346
kilobytes of ROM, 256 kilobytes of programmable ROM, and
a 16-bit microprocessor.
The most common smart card applications are:
o Credit cards

o Electronic cash
o Computer security systems O Wireless communication
o Loyalty systems (like frequent flyer points) O Banking
o Satellite TV
o Government identification
11. Cheques Truncation Payment system (CTPS)
Truncation is the process of stopping the flow of the
physical cheque issued by a drawer to the drawee branch. The
physical instrument will be truncated at some point en- route to
the drawee branch and an electronic image of the cheque
would be sent to the drawee branch along with the relevant
information like the MICR fields, date of presentation,
presenting banks etc. Thus with the implementation of cheque
truncation, the need to move the physical instruments across
branches would not be required, except in exceptional
circumstances. This would effectively reduce the time required
for payment of cheques, the associated cost of transit and delay
in processing, etc., thus speeding up the process of collection
or realization of the cheques.
12. Social Banking
Social banking means banking policy to meet the socio-
economic obligations of the country. It includes allocation of
credit according to the requirements of the planned economic
development of the country.
13. No frills Account
Now a day, RBI has advised the banks to allow people to
open no-frills accounts, i.e., accounts with nil balance or very

low minimum balance.

14. Off-shore Banking
Off-shore bank is a bank located outside the country of
residence of the depositor , typically in a low tax area that
provides financial and legal advantages.
15. Banking Ombudsman Scheme
16. Capital Adequacy Norms

MODULE 2
NEGOTIABLE INSTRUMENTS
Definition of a Negotiable Instrument

The law relating to negotiable instruments is contained in
the Negotiable Instruments Act, 1881. It is an Act to define
and amend the law relating to promissory notes, bills of
exchange and cheques.
The Act does not affect the custom or local usage relating
to an instrument in oriental language i.e., a Hundi.
The term ”negotiable instrument” means a document
transferable from one person to another. However the Act has
not defined the term. It merely says that "A .negotiable
instrument” means a promissory note, bill of exchange or
cheque payable either to order or to bearer. [Section 13(1)]
A negotiable instrument may be defined as "an
instrument, the. property in which 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, from which it follows
that an instrument cannot be negotiable unless it is such and in
such a state that the true owner could transfer the contract or
engagement contained therein by simple delivery of
instrument”
The Act recognizes only three types of instruments viz., a
Promissory Note, a Bill of. Exchange and a Cheque as
negotiable instruments. However, it does not mean that other

instruments are not negotiable instruments provided that they

satisfy the following conditions of negotiability:
1. The instrument should be freely transferable by the
custom of trade. Transferability may be by (i) delivery or (ii)
endorsement and delivery.
2. The person who obtains it in good faith and for
consideration gets it free from all defects and can sue upon it
in his own name.
3. The holder has the right to transfer. The negotiability
continues till the maturity.
Important Characteristics of Negotiable Instruments
Following are the important characteristics of negotiable
instruments:
(1) The holder of the instrument is presumed to be the owner
of the property contained in it.
(2) They are freely transferable.
(3) A holder in due course gets the instrument free from all
defects of title of any previous holder. (4)The holder in due
course is entitled to sue on the instrument in his own name.
(5) The instrument is transferable till maturity and in case of
cheques till it becomes stale (on the expiry of 6 months from
the date of issue).
(6) Certain equal presumptions are applicable to all
negotiable instruments unless the contrary is proved.

Classification of Negotiable Instruments

The negotiable instruments may be classified as under:
(1) Bearer Instruments
A promissory note, bill of exchange or cheque is payable
to bearer when (i) it is expressed to be so payable, or (ii) the
only or last endorsement on the instrument is an endorsement
in blank, A person who is a holder of a bearer instrument can
obtain the payment of the instrument.
(2) Order Instruments
A promissory note, bill of exchange or cheque is payable
to order (i) which is expressed to be so payable; or (ii) which is
expressed to be payable to a particular person, and does not
contain any words prohibiting transfer or indicating an
intention that it shall not be transferable.
(3) Inland Instruments (Section 11)
A promissory note, bill of exchange or cheque drawn or
made in India, and made payable, or drawn upon any person,
resident in India shall be deemed to be an inland instrument.
Since a promissory note is not drawn on any person, an inland
promissory note is one which is made payable in India. Subject
to this exception, an inland instrument is one which is either:
a. drawn and made payable in India, or
b. drawn in India upon some persons resident therein, even
though it is made payable in a foreign country.
(4) Foreign Instruments
An instrument which is not an inland instrument, is

deemed to be a foreign instrument. The essentials of a foreign

instrument include that:
(i) it must be drawn outside India and made payable outside
or inside India; or
(ii) it must be drawn in India and made payable outside India
and drawn on a person resident outside India.
(5) Demand Instruments (Section 19)
A promissory note or a bill of exchange in which no time
for payment is specified is an instrument payable on demand.
(6) Time Instruments
Time instruments are those which are payable at
sometime in the future. Therefore, a promissory note or a bill
of exchange payable after a fixed period, or after sight, or on
specified day, or on the happening of an event which is certain
to happen, is known as a time instrument. The expression
”after slight” in a promissory note means that the payment
cannot be demanded on it unless it has been shown to the
maker. In the case of bill of exchange, the expression "after
sight" means after acceptance, or after noting for non-
acceptance or after protest for non-acceptance.
Ambiguous Instruments (Section 17)
An instrument, which in form is such that it may either
be treated by the holder as a bill or as a note, is an ambiguous
instrument. Section 5(2) of the English Bills of Exchange Act
provides that where in a bill, the drawer and the drawee are the
same person or where the drawee is a fictitious person or a

person incompetent to contract, the holder may treat the

instrument, at his option, either as a bill of exchange or as a
promissory note.
Bill drawn to or to the order of the drawee or by an agent
on his principal, or by one branch of a bank on another or by
the direction of a company or their cashier are also ambiguous
instruments. A promissory note addressed to a third person
may be treated as a bill by such person by accepting it, while a
bill not addressed to anyone may be treated as a note. But
where the drawer and payee are the same e.g., where A draws
a bill payable to A's order, it is not an ambiguous instrument
and cannot be treated as a promissory note. Once an instrument
has been treated either as a bill or as a note, it cannot be treated
differently afterwards.
Inchoate or Incomplete Instrument (Section 20)
When one person signs and delivers to another a paper
stamped in accordance with the law relating to negotiable
instruments, and either wholly blank or having written thereon
an incomplete negotiable instrument, he thereby gives prima
facie authority to the holder thereof to make or complete, as
the case may be ,upon it a negotiable instrument, for any
amount specified therein, and not exceeding the amount,
covered by the stamp. Such an instrument is called an inchoate
instrument. The person so signing shall be liable upon such
instrument, in the capacity in which he signs the same, to any
holder in due course for such amount. provided that no person
other than a holder in due course shall recover from the person
delivering the instrument anything in excess of the amount

intended by him to be paid thereon.

The authority to fill up a blank or incomplete instrument
may be exercised by any "holder" and not only the first holder
to whom the instrument was delivered. The person signing and
delivering the paper is liable both to a "holder" and a "holder-
in-due-course". But there is a difference in their respective
rights. A "holder" can recover only what the person signing
and delivering the paper agreed to pay under the instrument,
while a "holder-in- due-course" can recover the whole amount
made payable by the instrument provided that it is covered by
the stamp, even though the amount authorised was smaller.
Kinds of Negotiable Instruments
The Act recognises only three kinds of negotiable
instruments under Section 13 but it does not exclude any other
negotiable instrument provided the instrument entitles a person
to a sum of money and is transferable by delivery. Instruments
written in oriental languages i.e. hundis are also negotiable
instruments. These instruments are discussed below:
(I) Promissory Notes
A "promissory note" is an instrument in writing (not
being a bank note or a currency note) containing an
unconditional undertaking, signed by the maker to pay a
certain sum of money to, or to the order of, a certain person, or
only to bearer of the instrument. (Section 4)
Parties to a Promissory Note:
A promissory note has the following parties:

(a) The maker: the person who makes or executes the note
promising to pay the amount stated therein.
(b) The payee: one to whom the note is payable.
(c) The holder: is either the payee or some other person to
whom he may have endorsed the note.
(d) The endorser.
(e) The endorsee.
Essentials o/a Promissory Note:
To be a promissory note. an instrument must possess the
following essentials:
(a) It must be in writing. An oral promise to pay will not do.
(b) It must contain an express promise or clear undertaking
to pay. A promise to pay cannot be inferred. A mere
acknowledgement of debt is not sufficient. If A writes to B "I
owe you (I.O.U.) Rs. 500", there is no promise to pay and the
instrument is not a promissory note.
(c) The promise or undertaking to pay must be
unconditional. A promise to pay "when able", or "as soon as
possible", or "after your marriage to I?", is conditional. But a
promise to pay after a specific' time or on the happening of an
event which must happen, is not conditional, e.g. "I promise to
pay Rs. 1,000 ten days after the death of B", is unconditional.
(d) The maker must sign the promissory note in token of an
undertaking to pay to the payee or his order.
(e) The maker must be a certain person, Le., the note must

show clearly who is the person engaging himself to pay.

(f) The payee must be certain. The promissory note must
contain a promise to pay to some person or persons ascertained
by name or designation or to their order.
(g) The sum payable must be certain and the amount must.
not be capable of contingent additions or subtractions. If A
promises to pay Rs. 100 and all other sums which shall
become due to him, the instrument is not a promissory note.
(h) Payment must be in legal money of the country. Thus, a
promise to pay Rs. 500 and deliver 10 quintals of rice is not
a promissory note.
(i) It must be properly stamped in accordance with the
provisions of the Indian Stamp Act. Each stamp must be duly
cancelled by maker's signature or initials.
(j) It must contain the name of place, number and the date
on which it is made.
However, their omission will not render the instrument
invalid, e.g. if it is undated, it is deemed to be dated on the date
of delivery.
Note: A promissory note cannot be made payable or issued to
bearer, no matter whether it is payable on demand or after a
certain time
(Section 31 of the RBI Act).
(ii) Bills of Exchange
A "bill of exchange" is an instrument in writing
containing an unconditional order, signed by the maker,

directing a certain person to pay a certain sum of money only

to or to the order of, a certain person or to the bearer of the
instrument. (Section 5)
The definition of a bill of exchange is very similar to that
of a promissory note and for most of the cases the rules which
apply l0 promissory notes are in general applicable to bills.
There are however, certain important points of distinction
between the two.
Parties to bills of exchange
The following are parties to a bill of exchange:
(a) The Drawer: the person who draws the bill.
(b) The Drawee: the person on whom the bill is drawn.
(c) The Acceptor: one who accepts the bill. Generally, the
drawee is the acceptor but a stranger may accept it on behalf of
the drawee.
(d) The payee: one to whom the sum stated in the bill is
payable, either the draweror any other person may be the
payee.
(e) The holder: is either the original payee or any other
person to whom, the payee has endorsed the bill. In case of a
bearer bill, the bearer is the holder.
(f) The endorser: when the holder endorses the bill to
anyone else he becomes the endorser.
(g) The endorsee: is the person to whom the bill is endorsed.
(h) Drawee in case of need: Besides the above parties.

another person called the "drawee in case of need", may be

introduced at the option of the drawer. The name of such a
person may be inserted either by the drawer or by any endorser
in order that resort may be had to him in case of need, i.e.,
when the bill is dishonoured by either non-acceptance or non-
payment.
(i) Acceptor for honour: Further, any person may
voluntarily become a party to a bill as acceptor. A person, who
on the refusal by the original drawee to accept the bill or to
furnish better security, when demanded by the notary, accept
the bill supra protest in order to safeguard the honour of the
drawer or any endorser, is called the acceptor for honour.
Essentials of a Bill of Exchange:
(1) It must be in writing.
(2) It must contain an unconditional order to pay money only
and not merely a request
(3) It must be signed by the drawer.
(4) The parties must be certain.
(5) The sum payable must also be certain.
(6) It must comply with other formalities e.g. stamps, date,
etc.
Distinction between Bill of Exchange and Promissory Note
The following are the important points of distinction
between a bill of exchange and a promissory note:
(a) A promissory note is a two-party instrument, with a

maker (debtor) and a payee (creditor). In a bill. there are three

parties-drawer, drawee and payee, though any two out of the
three capacities may be filled by one and the same person. In a
bill; the drawer is the maker who orders the drawee to pay the
bill to a person called the payee or to his order. When the
drawee accepts the bill he is called the acceptor,
(b) A note cannot be made payable to the maker himself,
while in a bill, the drawer and payee may be the same person.
(c) A note contains an unconditional promise by the maker
to pay to the payee
or his order; in a bill there is an unconditional order to the
drawee to pay according to the directions of the drawer.
(d) A note is presented for payment without any prior
acceptance by the maker. A bill payable after sight must be
accepted by the drawee or someone else on his behalf before it
can be presented for payment.
(e) The liability of the maker of a pro-note is primary and
absolute, but the liability of the drawer of a bill is secondary
and conditional.
(f) Foreign bill must be protested for dishonour but no such
protest is necessary in the case of a note.
(g) When a bill is dishonoured, due notice of dishonour is to
be given by the holder to the drawer and the intermediate
endorsee, but no such notice need to be given in the case of a
note.
(h) A bill can be drawn payable to bearer provided it is not

payable on demand. A promissory note cannot be made

payable to be3rer, even if it is made payable otherwise than on
demand.
How Bill of Exchange Originates - Forms of Bills of
Exchange
Bills of exchange were originally used for payment of
debts by traders residing in one country to another country
with a view to avoid transmission of coin. Now-a-days they are
used more as trade bills both in connection with domestic trade
and foreign trade and are called inland bills and foreign bills
respectively.
Inland Bills (Sections 11 and 12)
A bill of exchange is an inland instrument if it is (i)
drawn or made and payable in India, or (ii) drawn in India
upon any person who is a resident in India, even though it is
made payable in a foreign country. But a promissory note to be
an inland should be drawn and payable in India, as it has no
drawee.
Two essential conditions to make an inland instrument
are:
(1) the instrument must have been drawn or made in India;
and
(2) the instrument must be payable in India or the drawee
must be in India.
Examples: A bill drawn in India, payable in USA, upon a
person in India is an

inland instrument. A bill drawn in India and payable in India

but drawn on a person in USA is also an inland instrument or
made in India
Foreign Bills
All bills which are not inland are deemed to be foreign
bills. Normally foreign bills are drawn in sets of three copies.
Trade Bill
A bill drawn and accepted for a genuine trade transaction
is termed as a trade bill. When a trader sells goods on credit, he
may make use of a bill of exchange. Suppose A sells goods
worth Rs. 1,000 to B and allows him 90 days time to pay the
price, A will draw a bill of exchange on B, in the following
terms: "Ninety days after date pay A or order, the sum of one
thousand rupees only for value received". A will sign the bill
and then present it to B for acceptance. This is necessary
because, until a bill is accepted by the drawee, nobody has
either rights or obligations. If B agrees to obey the order of A,
he will accept the bill by writing across its face the word
"accepted" and signing his name underneath and then
delivering the bill to the holder. B, the drawee, now becomes
the acceptor of the bill and liable to its holders. Such a bill is a
genuine trade bill.
Accommodation Bill
All bills are not genuine trade bills, as they are often
drawn for accommodating a party. An accommodation bill is a
bill in which a person lends or gives his name to oblige a
friend or some person whom he knows or otherwise. In other

words, a bill which is drawn, accepted or endorsed without

consideration is called an accommodation bill. The party
lending his name to oblige the other party is known as the
accommodating or accommodation party, and the party so
obliged is called the party accommodated. An accommodation
party is not liable on the instrument to the party accommodated
because as between them there was no consideration and the
instrument was merely to help, But the accommodation party
is liable to a holder for value, who takes the accommodation
bill for value, though such holder may not be a holder in due
course. Thus, A may be in need of money and approach his
friends B and C who, instead of lending the money directly,
propose to draw an "Accommodation Bill" in his favour in the
following form:
"Three months after date pay A or order, the sum of
Rupees one thousand only'
B
To
C
If the credit of Band C is .good, this device enables A to
get an advance of Rs. 1,000 from his banker at the commercial
rate of discount. The real debtor in this case is not C, but A the
payee who promises to reimburse C before the period of three
months only. A is here the principal debtor and Band C are
mere sureties. This inversion of liability affords a good
definition of an accommodation bill "If as between the original
parties to - the bill the one who should prima facie be principal

is in. fact the surety whether he be drawer, acceptor, or

endorser, that bill is an accommodation bill".
Bank Draft
A bill of exchange is also sometimes spoken of as a draft.
It is called as a bank draft when a bill of exchange drawn by
one bank on another bank, or by itself on its own branch, and
is a negotiable instrument. It is very much like the cheque with
three points of distinction between the two. A bank draft can
be drawn only by a bank on another bank, usually its own
branch. It cannot so easily be counter-manded. It cannot be
made payable to bearer.
Specimen of a Bank Draft

A.B.C. Bank
X.Y.Z. Branch
No..................... Date...................
On demand pay ’A’ or order the sum of rupees one
thousand five hundred only for value received.
Rs. 1,5007-
Sd./
Manager
To
’B’ Brunch, (Place)
In the above demand draft the drawer is X.Y.Z. Branch,
the drawee is 'B' branch and the payee is 'A'.

Cheques
Section 6 of the Act provides that a cheque is a bill of
exchange drawn on a specified banker, and not expressed to be
payable otherwise than on demand. Simply stated, a cheque is
a bill of exchange drawn on a bank payable always on demand.
Thus, a cheque is a bill of exchange with two additional
qualifications, namely: (i) it is always drawn on a banker, and
(ii) it is always payable on demand. A cheque being a species
of a bill of exchange, must satisfy all the requirements of a bill;
it does not, however, require acceptance.
Note: By virtue of Section 31 of the Reserve Bank of India
Act, no bill of exchange or hundi can be made payable to
bearer on demand and no promissory note or a bank druft can
be mude payable to bearer at all, whether on demand or afier
a specified time. Only a cheque can be payable to bearer on
demand.
Parties to a cheque
The following are the parties to a cheque:
(a) The drawer: The person who draws the cheque.
(b) The drawee: The banker of the drawer on whom the
cheque is drawn.
(c) (d), (e) and (f) The payee, holder, endorser and endorsee:
same as in the case of a bill.
Essentials of a Cheque
(1) It is always drawn on a banker.
(2) It is always payable on demand.

(3) It does not require acceptance. There is, however, a

custom among banks to mark cheques as good for
purposes of clearance.
(4) A cheque can be drawn on bank where the drawer has an
account.
(5) Cheques may be payable to the drawer himself. It may be
made payable to bearer on demand unlike a bill or a note.
(6) The banker is liable only to the drawer. A holder -has no
remedy against the banker if a cheque is dishonoured.
(7) A cheque is usually valid for fix months. However, it is
not invalid if it is post dated or ante- dated.
(8) No Stamp is required to be affixed on cheques.
Distinction between Cheques and Bills of Exchange
As a general rule, the provisions applicable to bills
payable on demand apply to cheques, yet there are few points
of distinction between the two, namely:
(a) A cheque is a bill of exchange and always drawn on a
banker, while a bill may be drawn on anyone, including
banker.
(b) A cheque can only be drawn payable on demand, a bill
may be drawn payable on demand, or on the expiry of a
specified' period after sight or date.
(c) A bill payable after sight must be accepted before
payment can be demanded, a cheque does not require
acceptance and is intended for immediate payment.

(d) A grace of 3 days is allowed in the case of time bills,

while no grace is given. in the case of a cheque, for payment.
(e) The drawer of a bill is discharged, if it is not presented
for payment, but the drawer of a cheque is discharged only if
he suffers any damage by delay in presentment for payment.
(f) Notice of the dishonour of a bill is necessary, but not in
the case of a cheque.
(g) The cheque being a revocable mandate, the authority may
be revoked by countermanding payment, and is determined by
notice of the customer's death or insolvency. This is not so in
the case of bilt
(h) A cheque may be crossed, but not a bill
A cheque is a bill of exchange drawn on a specified
banker and always payable on demand. A cheque is always
drawn on a particular banker and is always payable on
demand. Consequently, all cheques are bills of exchange but
all bills are not cheques.
Specimen of a Cheque

Comparison Chart
Banker
A banker is one who does banking business. Section 5(b)
of the Banking Regulation Act, 1949 defines banking as,
"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 or otherwise."
This definition emphasises two points: (1) that the primary
function of a banker consists of accepting of deposits for the
purpose of lending or investing the same; (2) that the amount
deposited is repayable to the depositor on demand or according
to the agreement. The demand for repayment can be made
through a cheque, draft or otherwise, and not merely by verbal
order.

Customer
The term "customer" is neither defined in Indian nor in
English statutes. The general opinion is that a customer is one
who has an account with the bank or who utilises the services
of the bank.
The special features of the legal relationship between the
banker and the customer may be termed as the obligations and
rights of the banker. These are:
1. Obligation to honour cheques of the customers.
2. Obligation to collect cheques and drafts on behalf of the
customers.
3. Obligation to keep proper record of transactions with the
customer.
4. Obligation to comply with the express standing
instructions of the customer.
5. Obligation not to disclose the state of customer's account
to anyone else.
6. Obligation to give reasonable notice to the customer, if
the banker wishes to close the account.
7. Right of lien over any goods and securities bailed to him
for a general balance of account.
8. Right of set off and right of appropriation.
9. Right to claim incidental charges and interest as per rules
and regulations of the bank as communicated to the
customer at the time of opening the account.

Liability of a Banker
By opening a current account of a customer, the banker
becomes liable to his debtor to the extent of the amount so
received in the said account and undertakes to honour the
cheques drawn by the customer so long as he holds sufficient
funds to the customer's credit. If a banker, without
justification, fails to honour this customer's cheques, he is
liable to compensate the drawer for any loss or damage
suffered by him. But the payee or holder of the cheque has no
cause of action against the banker as the obligation to honour a
cheques is only towards the drawer.
The banker must also maintain proper and accurate
accounts of credits and debits. He must honour a cheque
presented in due course. But in the following circumstances, he
must refuse to honour a cheque and in some others he may do
so.
8. When Banker must Refuse Payment
In the following cases the authority of the banker to
honour customer's cheque comes to an end, he must refuse to
honour cheques issued by the customer:
(a) When a customer countermands payment Le., where or
when a customer, after issuing a cheque issues
instructions not to honour it, the banker must not pay it.
(b) When the banker receives notice of customer’s death.
(c) When customer has been adjudged an insolvent.
(d) When the banker receives notice of customer's insanity.

(e) When an order (e.g., Garnishee Order) of the Court,

prohibits payment.
(f) When the customer has given notice of assignment of the
credit balance of his account.
(g) When the holder's title is defective and the banker comes
to know of it.
(h) When the customer luis given notice for closing his
account.
When Banker may Refuse Payment
In the following cases the banker may refuse to pay a
customer's cheque:
(a) When the cheque is post-dated.
(b) When the banker has not sufficient funds of the drawer
with him and there is no communication between the bank and
the customer to honour the cheque.
(c) When the cheque is of doubtful legality.
(d) When the cheque is not duly presented, e.g., it is
presented after banking hours.
(e) When the cheque on the face of it is irregular, ambiguous
or otherwise materially altered.
(f) When the cheque is presented at a branch where the
customer has no account.
(g) When some persons have joint account and the cheque is
not signed jointly by all or by the survivors of them.
(h) When the cheque has been allowed to become stale, Le.,

it has not been presented within six months of the date

mentioned on it.
Protection of Paying Banker (Sections 10, 85 and 128)
Section 85 lays down that where a cheque payable to
order purports to be endorsed by or on behalf - of the payee the
banker is discharged by payment in due course. He can debit
the account of the customer with the amount even though the
endorsement turns out subsequently to have been forged, or the
agent of the payee without authority endorsed it on behalf of
the payee. It would be seen that the payee includes endorsee.
This protection is granted because a banker cannot be expected
to know the signatures of all the persons in the world. He is
only bound to know the signatures of his own customers.
Therefore, the forgery of drawer's signature will not
ordinarily protect the banker but even in this case, the banker
may debit the account of the customer, if it can show that the
forgery was intimately connected with the negligence of the
customer and was the proximate cause of loss.
In the case of bearer cheques, the rule is that once a
bearer cheque, always a bearer cheque. Where, therefore, a
cheque originally expressed by the drawer himself to be
payable to bearer, the banker may ignore any endorsement on
the cheque. He will be discharged by payment in due course.
But a cheque which becomes bearer by a subsequent
endorsement in blank is not covered by this Section. A banker
is discharged from liability on a crossed cheque if he makes
payment in due course.

Payment in due Course (Section 10)

Any person liable to make payment under a negotiable
instrument, must make the payment of the amount due
thereunder in due course in order to obtain a valid discharge
against the holder.
A payment in due course means a payment in accordance
with the apparent tenor of the instrument, in good faith and
without negligence to any person in possession thereof. .
A payment will be a payment in due course if:
(a) it is in accordance with the apparent tenor of the
instrument, i.e. according to what appears on the face of the
instrument to be the intention of the parties;
(b) it is made in good faith and without negligence, and
under circumstances
which do not afford a ground for believing that the person to
whom it is made is not entitled to receive the amount;
(c) it is made to the person in possession of the instrument
who is entitled as holder to receive payment;
(d) payment is made under circumstances which do not
afford a reasonable ground believing that he is not entitled to
receive payment of the amount mentioned in the instrument;
and
(e) payment is made in money and money only.
Under Sections 10 and 128, a paying banker making payment
in due course is protected.

Collecting Banker
Collecting Banker is one who collects the proceeds of a
cheque for a customer. Although a banker collects the proceeds
of a cheque for a customer purely as a matter of service, yet the
Negotiable Instruments Act, 1881 indirectly imposes statutory
obligation, statutory in nature. This is evident from Section
126 of the Act which provides that a cheque bearing a "general
crossing" shall not be paid to anyone other than banker and a
cheque which is "specially crossed" shall not be paid to a
person other than the banker to whom it is crossed. Thus, a
paying banker must pay a generally crossed cheque only to a
banker thereby meaning that it should be collected by another
banker. While so collecting the cheques for a customer, it is
quite possible that the banker collects for a customer, proceeds
of a cheque to which the customer had no title in fact. In such
cases, the true owner may sue the collecting banker for
"conversion". At the same time, it cannot be expected of a
banker to know or to ensure that all the signatures appearing in
endorsements on the reverse of the cheque are genuine. The
banker is expected to be conversant only with the signatures of
his customer. A customer to whom a cheque has been
endorsed, would request his banker to collect a cheque. In the
event of the endorser's signature being proved to be forged at
later date, the banker who collected the proceeds should not be
held liable for the simple reason that he has merely collected
the proceeds of a cheque. Section 131 of the Negotiable
Instruments Act affords statutory protection in such a case
where the customer's title to the cheque which the banker has

collected has been questioned. It reads as follows:

"A banker who has in good faith and without negligence
received payment for a customer of a cheque crossed generally
or specifically to himself -shall not, in case the title to the
cheque proves defective, incur any liability to the true owner
of the cheque by reason of only having received such payment.
Explanation: A banker receives payment of a crossed cheque
for a customer within the meaning of this section
notwithstanding that he credits his customer's account with the
amount of-the cheque before receiving payment thereof."
The requisites of claiming protection under Section 131
are as follows:
(i) The collecting banker should have acted in good faith
and without negligence. An act is done in good faith when it is
done honestly. The plea of good faith can be rebutted on the
ground of recklessness indicative of want of proper care and
attention. Therefore, much depends upon the facts of the case.
The burden of proving that the cheque was collected in good
faith and without negligence is upon the banker claiming
protection. Failure to verify the regularity of endorsements,
collecting a cheque payable to the account of the company to
the credit of the director, etc. are examples of negligence.
(ii) The banker should have collected a crossed cheque, i.e.,
the cheque should have been crossed before it came to him for
collection.
(iii) The proceeds should have been collected for a customer,
i.e., a person who has an account with him.

(iv) That the collecting banker has only acted as an agent of

the customer. If he had become the holder for value, the
protection available under Section 131 is forfeited Where for
instance, the banker allows the customer to withdraw the
amount of the cheque before the cheque is collected or where
the cheque has been accepted in specific reduction of an
overdraft, the banker is deemed to have become the holder for
value and the protection is lost. But the explanation to Section
131 says that the mere crediting of the amount to the account
does not imply that the banker has become a holder for value
because due to accounting conveniences the banker may credit
the account of the cheque to the customer's account even
before proceeds thereof are realised.
Overdue, Stale or Out-of-date Cheques
A cheque is overdue or becomes statute-barred after three
years from its due date of issue. A holder cannot sue on the
cheque after that time. Apart from this provision, the holder of
a cheque is required to present it for payment within a
reasonable time, as a cheque is not meant for indefinite
circulation. In India, a cheque, which has been in circulation
for more than six months, is regarded by bankers as stale. If, as
a result of any delay in presenting a cheque, the drawer suffers
any loss, as by the failure of the bank, the drawer is discharged
from liability to the holder to the extent of the damage.
Liability of Endorser
In order to charge an endorser, it is necessary to present
the cheque for payment within a reasonable time of its delivery

by such endorser. 'A' endorses and delivers a cheque to B, and

B keeps it for an unreasonable length of time, and then
endorses and delivers it to C. C presents it for payment within
a reasonable time after its receipt by him, and it is
dishonoured. C can enforce payment against B but not against
A, as qua A, the cheque has become stale.
Rights of Holder against Banker
A banker is liable to his customer for wrongful dishonour
of his cheque but it is not liable to the payee or holder of the
cheque. The holder has no right to en.t0rce payment from the
banker except in two cases, namely, (i) where the holder does
not present the cheque within a reasonable time after issue, and
as a result the drawer suffers damage by the failure of the
banker in liquidation proceedings; and (ii) where banker pays a
crossed cheque by mistake over the counter, he is liable to the
owner for any loss occasioned by it.
Crossing of Cheques
A cheque is either "open" or "crossed". An open cheque
can be presented by the payee to the paying banker and is paid
over the counter. A crossed cheque cannot be paid across the
counter but must be collected through a banker.
A crossing is a direction to the paying banker to pay the
money generally to a banker or to a particular banker, and not
to pay otherwise. The object of crossing is to secure payment
to a banker so that it could be traced to the person receiving the
amount of the cheque. Crossing is a direction to the paying
banker that the cheque should be paid only to a banker or a

specified banker. To restrain negotiability, addition of words

"Not Negotiable" or "Account Payee Only" is necessary. A
crossed bearer cheque can be negotiated by delivery and
crossed order cheque by endorsement and delivery. Crossing
affords security and protection to the holder of the cheque.
Specimen of a general crossing Specimen of a special crossing
Le. Restrictive crossing.

It is general crossing where a cheque bears across its face
an addition of two parallel transverse lines and/or the addition
of the words "and Co." between them, or addition of "not
negotiable". As stated earlier, where a cheque is crossed
generally, the paying banker will pay to any banker. Two
transverse parallel lines are essential for a general crossing
(Sections 123-126).
In case of general crossing, the holder or payee cannot
get the payment over the counter of the bank but through a
bank only. The addition of the words "and Co." do not have
any significance but the addition of the words "not negotiable"
restrict the negotiability of the cheque and in case of transfer,
the transferee will not give a better title than that of a
transferor.

Where a cheque bears across its face an addition of the

name of a banker, either with or without the words "not
negotiable" that addition constitutes a crossing and the cheque
is crossed specially and to that banker. The paying banker will
pay only to the banker whose name appears across the cheque,
or to his collecting agent. Parallel transverse lines are not
essential but the name of the banker is the insignia of a special
crossing.
In case of special crossing, the paying, banker is to
honour the cheque only when it is prescribed through the bank
mentioned in the crossing or it's agent bank.
Account Payee’s Crossing: Such crossing does, in
practice, restrict negotiability of a cheque. It warns the
collecting bunker that the proceeds are to be credited only to
the account of the payee, or the party named, or his agent. If
the collecting banker allows the proceeds of a cheque bearing
such crossing to be credited to any other account, he will be
guilty of negligence and will not be entitled to the protection
given to collecting banker under Section 131. Such crossing
does not affect the paying banker, who is under no duty to
ascertain that the cheque is in fact collected for the account of
the person named as payee.
Not Negotiable Crossing
A cheque may be crossed not negotiable by writing
across the face of the cheque the words "Not Negotiable"
within two transverse parallel lines in the case of a general
crossing or along with the name of a banker in the case of a

special crossing. Section 130 of the Negotiable Instruments

Act provides "A person taking a cheque crossed generally or
specially bearing in either case with the words "not negotiable"
shall not have and shall not be capable of giving, a better title
to the cheque than that which the person from whom he took it
had". The crossing of cheque "not negotiable" does not mean
that it is non-transferable. It only deprives the instrument of the
incident of negotiability. Normally speaking, the essential
feature of a negotiable instrument as opposed to chattels is that
a person who takes the instrument in good faith, without
negligence, for value, before maturity and without knowledge
of the defect in the title of the transferor, gets a good title to the
instrument. In other words, he is called a holder in due course
who acquires an indisputable title to the cheque. (When the
instrument passes through a holder-in-due course, it is purged
of all defects and the subsequent holders also get good title). It
is exactly this important feature which is taken away by
crossing the cheque "not negotiable". In other words, a cheque
crossed "not negotiable" is like any other chattel and therefore
the transferee gets same title to the cheque which his transferor
had. That is to say that the transferee cannot claim the rights of
a holder-in-due-course. So long as the title of the transferors is
good, the title of the transferees is also good but if there is a
taint in the title to the cheque of one of the endorsers, then all
the subsequent transferees' title also become tainted with the
same defect-they cannot claim to be holders-in-due-course.
The object of this Section is to afford protection to the
drawer or holder of a cheque who is desirous of transmitting it

to another person, as much protection as can reasonably be

afforded to him against dishonestly or actual miscarriage in the
course of transit. For example, a cheque payable to bearer is
crossed generally and is marked "not negotiable". It is lost or
stolen and comes into the possession of X who takes it in good
faith and gives value for it, X collects the cheque through his
bank and paying banker also pays. In this case, both the paying
and the collecting bankers are protected under Sections 128
and 131 respectively. But X cannot claim that he is a holder-
in-due course which he could have under the normal
circumstances claimed. The reason is that cheque is crossed
"not negotiable" and hence the true owner's (holder's) right
supercedes the rights of the holder-in-due-course. Since X
obtained the cheque from a person who had no title to the
cheque (Le. from one whose title was defective) X can claim
no better title solely because the cheque was crossed "not
negotiable" and not for any .other reason. Thus "not
negotiable" crossing not only protects the rights of the true
owner of the cheque but also serves as a warning to the
endorsees' to enquire thoroughly before taking the cheque as
they may have to be answerable to the true owner thereof if the
endorser's title is found to be defective.
"Not negotiable" restricts the negotiability of the cheque
and in case of transfer, the transferee will not get a better title
than that of a transferor.
If the cheque becomes "not negotiable" it lacks
negotiability. A cheque crossed specially or generally bearing
the words "not negotiable" lacks negotiability and therefore is

not a negotiable instrument in the true sense. It does not

restrict transferability but restricts negotiability only.
Maturity
Cheques are always payable on demand but other
instruments like bills, notes, etc. may be made payable on a
specified date or after the specified period of time. The date on
which payment of an instrument falls due is called its maturity.
According to Section 22 of the Act, "the maturity of a
promissory note or a bill of exchange is the date at which it
falls due". According to Section 21 a promissory note or bill of
exchange payable "at sight" or "on presentment" is payable on
demand. It is due for payment as soon as it is issued. The
question of maturity, therefore, arises only in the case of a
promissory note or a bill of exchange payable "after date" or
"after sight" or at a certain period after the happening of an
event which is certain to happen.
Maturity is the date on which the payment of an
instrument falls due. Every instrument payable at a specified
period after date or after sight is entitled to three days of grace.
Such a bill or note matures or falls due on the last day of the
grace period, and must be presented for payment on that day
and if dishonoured, suit can be instituted on the next day after
maturity. If an instrument is payable by instalments, each
instalment is entitled to three days of grace. No days of grace
are allowed for cheques, as they are payable on demand.
Where a note or bill is expressed to be payable on the
expiry of specified number of months after sight, or after date,

the period of payment terminates on the day of the month

which corresponds with the date of instrument, or with the date
of acceptance if the bill be accepted or presented for sight, or
noted or protested for non-acceptance. If the month in which
the period would terminate has no corresponding day, the
period shall be held to terminate on the last day of such month.
Illustration
(i) A negotiable instrument dated 31 st January, 2001, is
made payable at one months after date. The instrument is at
maturity on the third day after the 28th February, 2001, Le. on
3rd March, 2001.
(ii) A negotiable instrument dated 30th August, 2001, is
made payable three months after date. The instrument is at
maturity on 3rd December, 2001.
(iii) A negotiable instrument. dated the 31 st August, 2001, is
made payable three months after date. The instrument is at
maturity on 3rd December, 2001.
If the day of maturity falls on a public holiday, the
instrument is payable on the preceeding business day. Thus if a
bill is at maturity on a Sunday. It will be deemed due on
Saturday and pot on Monday.
The ascertainment of the date of maturity becomes
important because all these instruments must be presented for
payment on the last day of grace and their payment cannot be
demanded before that date. Where an instrument is payable by
instalments, it must be presented for payment on the third day
after the day fixed for the payment of each instalment.

Holder
According to Section 8 of the Act a person is a holder of
a negotiable instrument who is entitled in his own name (i) to
the possession of the instrument, and (ii) to recover or receive
its amount from the parties thereto. It is not every person in
possession of the instrument who is called a holder. To be a
holder, the person must be named in the instrument as the
payee, or the endorsee, or he must be the bearer thereof. A
person who has obtained possession of an instrument by theft,
or under a forged endorsement, is not a holder. as he is not
entitled to recover the instrument. The holder implies de jure
(holder in law) holder and not de facto (holder in fact) holder.
An agent holding an instrument for his principal is not a holder
although he may receive its payment.
Holder in Due Course
Section 9 states that a holder in due course is (i) a person
who for consideration, obtains possession of a negotiable
instrument if payable to bearer, or (ii) the payee or endorsee
thereof, if payable to order, before its maturity and without
having sufficient cause to believe that any defect existed in the
title of the person from whom he derived his title.
In order to be a holder in due course, a person must
satisfy the following conditions:
(i) He must be the holder of the instrument.
(ii) He should have obtained the instrument for value or
consideration.
(iii) He must have obtained the negotiable instrument before

maturity.
(iv) The instrument should be complete and regular on the
face of it.
(v) The holder should take the instrument in good faith.
A holder in due course is in a privileged position. He is
not only himself protected against all defects of the persons
from whom he received the instrument as current coin, but also
serves as a channel to protect all subsequent holders. A holder
in due course can recover the amount of the instrument from
all previous parties, although, as a matter of fact, no
consideration was paid by some of the previous parties to the
instrument or there was a defect of title in the party from
whom he took it. Once an instrument passes through the hands
of a holder in due course, it is purged of all defects. It is like
current coin. Whoever takes it can recover the amount from all
parties previous to such holder.
Capacity of Parties
Capacity to incur liability as a party to a negotiable
instrument is co-extensive with capacity to contract. According
to Section 26, every person capable of contracting according to
law to which he is subject, may bind himself and be bound by
making, drawing, acceptance, endorsement, delivery and
negotiation of a promissory note, bill of exchange or cheque.
Negatively, minors, lunatics, idiots, drunken person and
persons otherwise disqualified by their personal law, do not
incur any liability as parties to negotiable instruments. But
incapacity. of one or more of the parties to a negotiable

instrument in no way, dimlnishes the abilities and the liabilities

of the competent parties. Where a . minor is the endorser or
payee of an instrument which has been endorsed all the parties
accepting the minor are liable in the event of its dishonour.
Liability of Parties
The provisions regarding the liability of parties to
negotiable instruments are laid down in Sections 30 to 32 and
35 to 42 of the Negotiable Instruments Act. These provisions
are as follows:
1. Liability of Drawer (Section 30)
The drawer of a bill of exchange or cheque is bound, in
case of dishonour by the drawee or acceptor thereof, to
compensate the holder, provided due notice of dishonour . has
been given to or received by the drawer. The nature of drawer's
liability is that by drawing a bill, he undertakes that (i) on due
presentation, it shall be accepted and paid according to its
tenor, and (ii) in case of dishonour, he will compensate the
holder or any endorser, provided notice of dishonour has been
duly given. However, in case of accommodation bill no notice
of dishonour to the drawer is required.
The liability of a drawer of a bill of exchange is
secondary and arises only on default of the drawee, who is
primarily liable to make payment of the negotiable instrument.
2. Liability of the Drawee of Cheque (Section 31)
The drawee of a cheque having sufficient funds of the
drawer in his hands properly applicable to the payment of such
cheque must pay the cheque when duly required to do so and,

or in default of such payment, he shall compensate the drawer

for any loss or damage caused by such default.
As a cheque is a bill of exchange, drawn on a specified
banker, the drawee of a cheque must always be a banker. The
banker, therefore, is bound to pay the cheque of the drawer,
i.e., customer, if the following conditions are satisfied:
(i) The banker has sufficient funds to the credit of
customer's account.
(ii) The funds are properly applicable to 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 is unjustified in refusing to honour the
cheque of its customer, it shall be liable for damages.
3. Liability of ”Maker” of Note and “Acceptor’ of Bill
(Section 32)
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 bound to pay the amount thereof at maturity,
according to the apparent tenor of the note or acceptance
respectively. The acceptor of a bill of exchange at or after
maturity is bound to pay the amount thereof to the holder on
demand:
It follows that the liability of the acceptor of a bill
corresponds to that of the maker of a note and is absolute and
unconditional but the liability under this Section is subject to

the contract to the contrary (e.g., as in the case of

accommodation bills) and may be excluded or modified by a
collateral agreement. Further, the payment must be made to the
party named in the instrument and not to any-one else, and it
must be made at maturity and not before.
4. Liability of endorser (Section 35)
Every endorser incurs liability to the parties that are
subsequent to him. Whoever endorses and delivers a
negotiable instrument before maturity is bound thereby to
every subsequent holder in case of dishonour of the instrument
by the drawee, acceptor or maker, to compensate such holder
of any loss or damage caused to him by such dishonour
provided (i) there is no contract to the contrary; (ii) he
(endorser) has not expressly excluded, limited or made
conditional his own liability; and (iii) due notice of dishonour
has been given to, or received by, such endorser. Every
endorser after dishonour, is liable upon the instrument as if it is
payable on demand.
He is bound by his endorsement notwithstanding any
previous alteration of the instrument. (Section 88)
5. Liability of Prior Parties (Section 36)
Every prior party to a negotiable instrument is liable
thereon to a holder in due course until the instrument is duly
satisfied. Prior parties may include the maker or drawer, the
acceptor and all the intervening endorsers to a negotiable
instrument. The liability of the prior parties to a holder in due
course is joint and several. The holder in due course may hold

any or all prior parties liable for the amount of the dishonoured
instrument.
6. Liability interse
Various parties to a negotiable instrument who are liable
thereon stand on a different footing with respect to the nature
of liability of each one of them.
7. Liability of Acceptor of For8ed Endorsement (Section
41)
An acceptor of a bill of exchange already endorsed is not
relieved from liability by reason that such endorsement is
forged. if he knew or had reason to believe the endorsement to
be forged when he accepted the bill.
8. Acceptor’s Liability on a Bill drawn in a Fictitious
Name
An aceeptor of a bill of exchange drawn in a fictitious
name and payable to the drawer's order is not, by reason that
such name is fictitious, relieved from liability to any holder In
due course claiming under an endorsement by the same hand
as the drawer's signature, and purporting to be made by the
drawer.
Negotiation (Section 14)
A negotiable instrument may be transferred by
negotiation or assignment. Negotiation is the transfer of an
instrument (a note, bill or cheque) for one person to another in
such a manner as to convey title and to constitute the transferee
the holder thereof. When a negotiable instrument is transferred

by negotiation, the rights of the transferee may rise higher than

those of the transferor, depending upon the circumstances
attending the negotiation. When the transfer is made by
assignment, the assignee has only those rights which the
assignor possessed. In case of assignment, there is a transfer of
ownership by means of a written and registered document.
Negotiability and Assignability Distinguished
A transfer by negotiation differs from transfer by
assignment in the following respects:
(a) Negotiation requires mere delivery of a bearer instrument
and endorsement and delivery of an order instrument to
effectuate a transfer. Assignment requires a written document
signed by the transferor.
(b) Notice of transfer of debt (actionable claim) must be
given by the assignee to the debtor in order to complete his
title; no such notice is necessary in a transfer by negotiation.
(c) On assignment, the transferee of an actionable claim
takes it subject to all the defects in the title of, and subject to
all the equities and defences available against the assignor,
even though he took the assignment for value and in good
faith. In case of negotiation the transferee, as holder- in-due
course, "takes the instrument free from any defects in the title
of the transferor.
Importance of Delivery
Negotiation is effected by mere delivery of a bearer
instrument and by endorsement and delivery of an order
instrument. This shows that "delivery" is essential in

negotiable instruments. Section 46 expressly provides that

making acceptance or endorsement of negotiable instrument is
not complete until de1ivery, a dual or constructive, of the
instrument. Delivery made voluntarily with the intention of
passing property in the instrument to the person to whom it is
given is essential.
Negotiation by Mere Delivery
A bill or cheque payable to bearer is negotiated by mere
delivery of the instrument.
An instrument is payable to bearer:
(i) Where it is made so payable, or
(ii) Where it is originally made payable to order but the only
or the last endorsement is in blank.
(iii) Where the payee is a fictitious or a non-existing person
(iv) These Instruments do not require signature of the
transferor. The person who takes them is a holder, and can sue
in his own name on them. Where a bearer negotiates an
instrument by mere delivery, and does not put his signature
thereon,-he is not liable to any party to the instrument in case
the instrument is dishonoured, as he has not lent his credit to it.
His obligations are only towards his immediate transferee and
to no other holders.
A cheque, originally drawn payable to bearer remains
bearer, even though it is subsequently endorsed in full. The
rule is once a bearer cheque alWays a bearer cheque.

Negotiation by Endorsement and Delivery

An instrument payable to a specified person or to the
order of a specified person or to a specified person or order is
an instrument payable to order. Such an instrument can be
negotiated only by endorsement and delivery. Unless the
holder signs his endorsement on the instrument, the transferee
does not become a holder. Where an instrument payable to
order is delivered without endorsement, it is merely assigned
and not negotiated and the holder thereof is not entitled to the
rights of a holder in due course, and he cannot negotiate it to a
third person.
Endorsement (Sections 15 and 16)
Where the maker or holder of a negotiable instrument
signs the same otherwise than as such maker for the purpose of
negotiation, on the back or face thereof or on a slip of paper
annexed thereto (called Allonge), or so, signs for the same
purpose, a stamped paper intended to be completed as a
negotiable instrument, he is said to endorse the same (Section
15), the person to whom the instrument is endorsed is called
the endorsee.
In other words, 'endorsement' means and involves the
writing of something on the back of an instrument for the
purpose of transferring the right, title and interest therein to
some other person.
Classes of endorsement
An endorsement may be (a) Blank or General, (b) Special
or Full, (c) Restrictive, or (d) Partial, and (e) Conditional or
Qualified.

(a) Blank or General: An endorsement is to be blank or

general where the endorser merely writes his signature on the
back of the instrument, and the instrument so endorsed
becomes payable to bearer, even though originally it was
payable to order. Thus, where bill is payable to "Mohan or
order", and he writes on its back "Mohan", it is an endorsement
in blank by Mohan and the property in the bill can pass by
mere delivery, as long as the endorsement continues tobe
a/blank. But a holder of an instrument endorsed in blank may
convert the endorsement in blank into an endorsement In full,
by writing above the endorser's signature, a direction to pay the
instrument to another person or his order.
(b) Special or Full: If the endorser signs his name and adds a
direction to pay the amount mentioned in the instrument to, or
to the order of a specified person, the endorsement is said to be
special or in full. A bill made payable to Mohan or Mohan or
order, and endorsed "pay to the order of Sohan" would be
specially endorsed and Sohan endorses it further. A blank
endorsement can be turned into a special one by the addition of
an order making the bill payable to the transferee.
(c) Restrictive: An endorsement is restrictive which prohibits
or restricts the further negotiation of an instrument. Examples
of restrictive endorsement: "Pay A only" or "Pay A for my
use" or "Pay A on account of B" or "Pay A or order for
collection".
(d) Partial: An endorsement partial is one which purports to
transfer to the endorsee a part only of the amount payable on
the instrument. A partial endorsement does not operate as

negotiation of the instrument. A holds a bill for Rs. 1,000 and

endorses it as "Pay B or order Rs. 500". The endorsement is
partial and invalid.
(e) Conditional or qualified: An endorsement is conditional
or qualified which limits or negatives the liability of the
endorser. An endorser may limit his liability in any of the
following ways:
(i) By sans recourse endorsement, Le. by making it clear
that he does not incur the liability of an endorser to the
endorsee or subsequent holders and they should not look to
him in case of dishonour of instrument. The endorser excludes
his liability by adding the words "sans recourse" or "without
recourse", e.g., "pay A or order same recourse".
(ii) By making his liability depending upon happening of a
specified event which may never happen, e.g., the holder of a
bill may endorse it thus: "Pay A-or order on his marrying B”.
In such a case, the endorser will not be liable until A marries
B.
It is pertinent to refer to Section 52 of the Negotiable
Instruments Act, 1881 here. It reads "The endorser of a
negotiable instrument may, by express words in the
endorsement exclude his own liability thereon, or make such
liability or the right of the endorsee to receive the amount due
thereon depend upon the happening of a specified event,
although such event may never happen.
Negotiation Back
Where an endorser negotiates an instrument and again

becomes its holder, the instrument is said to be negotiated back

to that endorser and none of the intermediary endorsees are
then liable to him. The rule prevents a circuity of action. For
example, A, the holder of a bill endorses it to a, B endorses to
C, and C to D, and endorses it again to A. A, being a holder in
due course of the bill by second endorsement by, D, can
recover the amount thereof from B, C, or D and himself being
a prior party is liable to all of them. Therefore, A having been
relegated by the second endorsement to his original position,
cannot sue B, C and D.
Where on endorser so excludes his liability and
afterwards becomes the holder of the instrument, all the
intermediate endorsers are liable to him. the italicised portion
of the above Section is important. An illustration will make the
point clear. A is the payee of a negotiable instrument. He
endorses the instrument 'sans recourse' to B, B endorses to C,
C to D, and D again endorses it to A. In this case, A is not only
reinstated in his former rights but has the right of an endorsee
against B, C and D.
Negotiation of Lost Instrument or that Obtained by
Unlawful Means
When a negotiable instrument has been lost or has been
obtained from any maker, acceptor or holder thereof by means
of an offence or fraud, or for an unlawful consideration, no
possessor or endorsee, who claims through the person who
found or obtained the instrument is entitled to receive the
amount due thereon from such maker, acceptor, or holder from
any party prior to such holder unless such possessor or

endorsee is, or some person through whom he claims was, a

holder in due course.
Forged Endorsement
The case of a forged endorsement is worth special notice.
if an instrument is endorsed in full, it cannot be negotiated
except by an endorsement signed by the person to whom or to
whose order the instrument is payable, for the endorsee obtains
title only through his endorsement. Thus, if an instrument be
negotiated by means of a forged endorsement, the endorsee
acquires no title even though he be a purchaser for value and in
good faith, for the endorsement is a nullity. Forgery conveys
no title. But where the instrument is a bearer instrument or has
been endorsed in blank, it can be negotiated by mere delivery,
and the holder derives his title independent of the forged
endorsement and can claim the amount from any of the parties
to to the instrument. For example, a bill is endorsed, "Pay A or
order". A endorses it in blank, and it comes into the hands of
B, who simply delivers it to C, C forges B's endorsement and
transfer it to D. Here, D, as the holder does not derive his title
through the forged endorsement of B, but through the genuine
endorsement of A and can claim payment from any of the
parties to the instrument in spite of the intervening forgeg
endorsement.
Acceptance of a Bill of Exchange
The drawee of a bill of exchange, as such, has no liability
on any bill addressed to him for acceptance or payment. A
refusal to accept or to pay such bill gives the holder no rights

against him. The drawee becomes liable only after he accepts

the bill. The acceptor has to write the word 'accepted' on the
bill and sign his name below it.. Thus, it is the acceptor who is
primarily liable on a bill.
The acceptance of a bill is the indication by the drawee of
his assent to the order of the drawer. Thus, when the drawee
writes across the face of the bill the word "accepted" and signs
his name underneath he becomes the acceptor of the bill.
An acceptance may be either general or qualified. A
general acceptance is absolute and as a rule, an acceptance has
to be general. . Where an acceptance is made subject to some
condition or qualification, thereby varying the effect of the bill,
it is a qualified acceptance. The holder of the bill may either
refuse to take a qualified acceptance or non-acquiescence in it.
Where he refuses to take it, he can treat the bill as dishonoured
by non-acceptance, and sue the drawer accordingly.
Acceptance for Honour
When a bill has been noted or protested for non-
acceptance or for better security, any person not being a party
already liable thereon may, with the consent of the holder, by
writing on the bill, accept the same for the honour of any party
thereto. The stranger so accepting, will declare under his hand
that he accepts the protested bill for the honour of the drawer
or any particular endorser whom he names.
The acceptor for honour is liable to pay only when the
bill has been duly presented at maturity to the drawee for
payment and the drawee has refused to pay and the bill has

been noted and protested for non- payment. Where a bill has
been protested for non-payment after having been duly
accepted, any person may intervene and pay it supra protest
for the honour of any party liable on the bill. When a bill is
paid supra’ protest, it ceases to be negotiable. The stranger, on
paying for honour, acquires all the right of holder for whom he
pays.
Presentment for Acceptance
It is only bills of exchange that require presentment for
acceptance and even these of certain kinds only. Bills payable
on demand or on a fixed date need not be presented. Thus, a
bill payable 60 days after due date on the happening of a
certain event may or may not be presented for acceptance. But
the following bills must be presented for acceptance otherwise,
the parties to the bill will not be liable on it:
(a) A bill payable after sight. Presentment is necessary in
order to fix maturity of the bills; and
(b) A bill in which there is an express stipulation that it shall
be presented for acceptance before it is presented for payment.
Section 15 provides that the presentment for acceptance
must be made to the drawee or his duly authorised agent. If the
drawee is dead, the bill should be presented to his legal
representative, or if he has been declared an insolvent, to the
official receiver or assigner.
The following are the persons to whom a bill of exchange
should be presented:
(i) The drawee or his duly authorised agent.

(ii) If there are many drawees, bill must be presented to all of

them.
(iii) The legal representatives of the drawee if drawee is dead.
(iv) The official receiver or assignee of insolvent drawee.
(v) To a drawee in case of need, if there is any. This is
necessary when the original drawee refuses to accept the bill.
(vi) The acceptor for honour. In case the bill is not accepted
and is noted or protested for non- acceptance, the bill may be
accepted by the acceptor for honour. He IS a person who
comes forward to accept the bill when it is dishonoured by
non-acceptance.
The presentment must be made before maturity, within a
reasonable time after it is drawn, or within the stipulated
period, if any, on a business day within business hours and at
the place of business or residence of the drawee. The
presentment must be made by exhibiting the bill to the drawee;
mere notice of its existence in the possession of holder will not
be sufficient.
When presentment is compulsory and the holder fails to
present for acceptance, the drawer and all the endorsers are
discharged from liability to him.
Presentment for Acceptance when Excused
Compulsory presentment for acceptance is excused and
the bill may be treated as dishonoured in the following cases:
(a) Where the drawee cannot be found after reasonable
search.

(b) Where drawee is a fictitious person or one incapable of

contracting.
(c) Where although the presentment is irregular, acceptance
has been refused on some other ground.
Presentment for Payment
All notes bills and cheques must be presented for
payment to the maker, acceptor or drawee thereof respectively
by or on behalf of the holder during the usual hours of
business, and if at banker's within banking hours.
Presentment for Payment when Excused
No presentment is necessary and the instrument may be
treated as dishonoured in the following cases:
(a) Where the maker, drawer or acceptor actively does
something so as to intentionally obstruct the presentment of the
instrument, e.g., deprives the holder of the instrument and
keeps it after maturity.
(b) Where his business place is closed on the due date.
(c) Where no person is present to make payment at the place
specified for payment.
(d) Where he cannot, after due search be found. (Section 61)
(e) Where there is a promise to pay notwithstanding non-
presentment.
(f) Where the presentment is express or impliedly waived by
the party entitled to presentment.
(g) Where the drawer could not possibly have suffered any

damage by non-presentment.
(h) Where the drawer is a fictitious person, or one
incompetent to contract.
(i) Where the drawer and the drawee are the same person. m
Where the bill is dishonoured by non-acceptance.
(k) Where presentment has become impossible, e.g., the
declaration of war between the countries of the holder and
drawee.
(I) Where though the presentment is irregular, acceptance
has been refused on some other grounds.
Dishonour by Non-Acceptance
Section 91 provides that a bill is said to be dishonoured
by non-acceptance:
(a) When the drawee does not accept it within 48 hours from
the time of presentment for acceptance.
(b) When presentment for acceptance is excused and the bill
remains unaccepted.
(c) When the drawee is incompetent to contract.
(d) When the drawee is a fictitious person or after reasonable
search can not be found.
(e) Where the acceptance is a qualified one.
Dishonour by Non-payment (Section 92)
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 makes default in

payment upon being duly required to pay the same. Also, a

negotiable instrument is dishonoured by non- payment when
presentment for payment is excused and the instrument when
overdue remains unpaid.
If the bill is dishonoured either by non-acceptance or by
non- payment, the drawer and ail the endorsers of the bill are
liable to the holder, provided he gives notice of such
dishonour. The drawee is liable only when there is dishonour
by non-payment.
Notice of Dishonour (Sections 91-98 and Sections 105-107)
When a negotiable instrument is dishonoured either by
non-acceptance or by non-payment, the holder or some party
liable thereon must give notice of dishonour to all other parties
whom he seeks to make liable. Each party receiving notice of
dishonour must in order to render any prior party liable to
himself, give notice of dishonour to such party within a
reasonable time after he has received it. The object ot giving
notice is not to demand payment but to whom the party
notified of his liability and in case of drawer to enable him to
protect himself as against the drawee or acceptor who has
dishonoured the instrument issued by him. Notice of dishonour
is so necessary that an omission to give 'it discharges all parties
other than the maker or acceptor. These parties are discharged
not only on the bill or note, but also in respect of the original
consideration.
Notice may be oral or in writing, but it must be actual
formal notice. It must be given within a responsible' time of
dishonour.

Notice of Dishonour Unnecessary

No notice of dishonour is necessary:
(a) When it is dispensed with or waived by the party entitled
thereto, e.g. where an endorser writes on the instrument such
words as ”notice of dishonor waived" ,
(b) When the drawer has countermanded payment.
(c) When the party charged would not suffer damage for
want of notice. (d) When the party entitled to notice cannot
after due search be found.
(e) When the omission to give notice is caused by
unavoidable circumstances, e.g., death or dangerous illness of
the holder.
(f) Where the acceptor is also a drawer, e.g., where a firm
draws on its branch.
(g) Where the promissory note is not negotiable. Such a note
cannot be endorsed.
(h) Where the party entitled to notice promises to pay
unconditionally.
Noting and Protest (Sections 99-104 A) Noting
Where a note or bill is dishonoured, the holder is entitled
after giving due notice of dishonour, to sue the drawer and the
endorsers. Section 99 provides a convenient method of
authenticating the fact of dishonour by means of "Noting".
Where a bill or note is dishonoured, the holder may, if he so
desires, cause such dishonour to be noted by a notary public on
the instrument, or on a paper attached thereto or partly on each.

The noting or minute must be recorded by the notary public

within a reasonable time after dishonour and must contain the
fact of dishonour, the date of dishonour, the reason, if any,
assigned for such dishonour if the instrument has not been
expressly dishonoured the reasons why the holder treats it
dishonoured and notary's charges.
Protest
The protest is the formal notarial certificate attesting the
dishonour of the bill, and based upon the noting which has
been effected on the dishonour of the bill. After the noting has
been made, the formal protest is drawn up by the notary and
when it is drawn up it relates back to the date of noting.
Where the acceptor of a bill has become insolvent, or has
suspended payment, or his credit has been publicly impeached,
before the maturity of the bill, the holder may have the bill
protested for better security. The notary public demands better
security and on its refusal makes a protest known as "protest
for better security".
Foreign bills must be protested for dishonour when such
protest is required by the law of the place where they are
drawn. Foreign promissory notes need not be so protested.
Where a bill is required by law to be protested, then instead of
a notice of dishonour, notice of protest must be given by the
notary public.
A protest to be valid must contain on the instrument itself
or a literal transcript thereof, the names of the parties for and
against whom protest is made, the fact and reasons for

dishonour together with the place and time of dishonour and

the signature of the notary public. Protest affords an authentic
evidence of dishonour to the drawer and the endorsee.
Discharge
The discharge in relation to negotiable instrument may be
either (i) Discharge of the instrument or (ii) Discharge of one
or more parties to the instrument from liability.
Discharge of the Instrument
A negotiable instrument is discharged:
(a) by payment in due course;
(b) when the principal debtor 'becomes the holder;
(c) by an act that would discharge simple contract;
(d) by renunciation; and
(e) by cancellation.
Discharge of a Party or Parties
When any particular party or parties are discharged, the
instrument continues to be negotiable and the undischarged
parties remain liable on it. For example, the non-presentment
of a bill on the due date discharges the endorsers from their
liability, but the acceptor remains liable on it.
A party may be discharged in the following ways
(a) By cancellation by the holder of the name of any party to
it with the intention of discharging him.
(b) By release, when the holder releases any party to the
instrument

(c) Discharge of secondary parties, Le., endorsers.

(d) By the operation of the law, Le., by insolvency of the
debtor.
(e) By allowing drawee more than 48 hours to accept the bill,
all previous parties are discharged.
(f) By non-presentment of cheque promptly the drawer is
discharged.
(g) By taking qualified acceptance, all the previous parties
are discharged.
(h) By material alteration.
44. Material Alteration (Section 87)
An alteration is material which in any way alters the
operation of the Instrument and the liabilities of the parties
thereto. Therefore, any change in an instrument which causes it
to speak a different language in legal effect from that which it
originally spoke, or which changes legal character of the
instrument is a material alteration.
A material alteration renders the instrument void, but it
affects only those persons who have already become parties at
the date of the alteration. Those who take the altered
instrument cannot complain. Section 88 provide$ that an
acceptor or endorser of a negotiable instrument is bound by his
acceptance or endorsement notwithstanding any previous
alteration of the instrument.
Examples of material alteration are:
Alteration (i) of the date of the instrument (ii) of the sum

payable, (iii) in the time of payment, (iv) of the place of

payment, (v) of the rate of interest, (vi) by addition of a new
party, (vii) tearing the instrument. in a material part.
There is no material alteration and the instrument is not
vitiated in the following cases :
(i) correction of a mistake, (ii) to carry out the common
Intention of the parties, (iii) an alteration made before the
instrument is issued and made with the consent of the parties,
(iv) crossing a cheque, (v) addition of the words "on demand"
in an instrument where no time of payment is stated.
Retirement of a Bill under Rebate
An acceptor of a bill may make payment before maturity,
and the bill is then said to .be retired, but it is not discharged
and must not be cancelled except by the acceptor when it
comes into his hands. It is customary in such a case to make
allowance of interest on the money to the acceptor for the
remainder of the time which the bill has to run. The interest
allowance is known as rebate.
Hundis
Hundis are negotiable instruments written in an oriental
language. They are sometimes bills of exchange and
sometimes promissory notes, and are not covered under the
Negotiable Instruments Act, 1881. Generally, they are
governed by the customs and usages in the locality but if
custom is silent on the point in dispute before the Court, this
Act applies to the hundis. The term "hundi" was formerly
applicable to native bills of exchange. The promissory notes

were then called "teap". The hundis were in circulation in India

even before the present Negotiable Instrument Act, 1881 came
into operation. The usages attached to these hundis varied with
the locality in which they were in circulation.
Generally understood, the term "hundi" includes all
indigenous negotiable instruments whether they are bills of
exchange or promissory notes. An instrument in order to be a
hundi must be capable of being sued by the holder in his own
name, and must by the custom of trade be transferred like cash
by delivery.
Obviously the customs relating to hundis were many. In
certain parts of the country even oral acceptance was in vague.
The following types of hundis are worth mentioning
1. Shah Jog Hundi
"Shah" means a respectable and responsible person or a
man of worth in the bazar. Shah Jog Hundi means a hundi
which is payable only to a respectable holder, as opposed. to a
hundi payable to bearer. In other words the drawee before
paying the same has to satisfy himself that the payee is a
'SHAH'.
2. Jokhmi Hundi
A "jokhmi" hundi is always drawn on or against goods
shipped on the vessel mentioned in the hundi. It implies a
condition that money will be paid only in the event of arrival
of the goods against which the hundi is drawn. It is in the
nature of policy of insurance. The difference, however, is that
the money is paid before hand and is to be recovered if the ship

arrives safely.
3. Jawabee Hundi
According to Macpherson, "A person desirous of making
a remittance writes to the payee and delivers the letter to a
banker, who either endorses it on to any of his correspondents
near the payee's place of residence, or negotiates its transfer.
On the arrival, the letter is forwarded to the payee, who attends
and gives his receipt in the form of an answer to the letter
which is forwarded by the same channel of the drawer or the
order." Therefore, this is a form of hundi which is used for
remitting money from one place to another.
4. Nam jog Hundi
It is a hundi payable to the party named in the bill or his
order. The name of the payee is specifically inserted in the
hundi. It can also be negotiated like a bill of exchange. Its
alteration into a Shah Jog hundi is a. material alteration and
renders it void.
5. Darsharii Hundi
This is a hundi payable at sight. It is freely negotiable
and the price is regulated by demand and supply. They are
payable on demand and must be presented for payment within
a reasonable time after they are received by the holder.
6. Miadi Hundi
This is otherwise called muddati hundi, that is, a hundi
payable after a specified period of time. Usually money is
advanced against these hundis by shroffs after deducting the

advance for the period in advance. There are other forms of

hundis also like.
Dhani Jog Hundi - A hundi which is payable to "dhani"
Le., the owner.
Fimian Jog Hundi - which is payable to order if can be
negotiated by endorsement and delivery.
Presumptions of Law
A negotiable instrument is subject to certain
presumptions. These have been recognised by the Negotiable
Instruments Act under Sections 118 and 119 with a view to
facilitate the business transactions. These are described below:
It shall be presumed that:
(1) Every negotiable instrument was made or drawn for
consideration irrespective of the consideration mentioned in
the instrument or not.
(2) Every negotiable instrument having a date was made on
such date.
(3) Every accepted bill of exchange was accepted within a
reasonable time before its maturity.
(4) Every negotiable instrument was transferred before its
maturity.
(5) The instruments were endorsed in the order in which they
appear on it.
(6) A lost or destroyed instrument was duly signed and
stamped.

(7) The holder of the instrument is a holder in due course.

(8) In a suit upon an instrument which has been dishonoured,
the Court shall presume the fact of dishonour, or proof of the
protest.
However these legal presumptions are rebuttable by evidence
to the contrary. The burden to prove to the contrary lies upon
the defendant to the suit and not upon the plaintiff.
Payment of Interest in case of dishonour
The Negotiable Instruments Act, 1881 was amended in
the year 1988, revising the rate of interest as contained in
Sections 80 and 117, from 6 per cent to 18 per cent per annum
payable on negotiable instruments from the due date in case no
rate of interest is specified, or payable to an endorser from the
date of payment on a negotiable instrument on its dishonour
with a view to discourage the withholding of payment on
negotiable instruments on due dates.
Penalties in case of dishonour of cheques
Chapter XVII of the Negotiable Instruments Act provides
for penalties in case of dishonour of certain cheques for
insufficiencies of funds in the accounts. Sections 138 to 142
deal with these aspects.
The provisions contained in this Chapter provide that
where any cheque drawn by a person for discharge of any
liability is returned by the bank unpaid for the reason of
insufficiency of the amount of money standing to the credit of
the account on which the cheque was drawn or for the reason
that it exceeds the arrangement made by the drawer of the

cheque with the banker for that account, the drawer of such
cheque shall be deemed to have committed an offence. In that
case, the drawer, without prejudice to the-6fher provisions of
the Act, shall be punishable with imprisonment for a term
which may extend to one year, or with fine which may extend
to twice the amount of the cheque, or with both.
In order to constitute the said offence
(a) such cheque should have been presented to the bank
within a period of six months from the date on which it is
drawn or within the period of its validity, whichever is earlier;
and
(b) the payee or holder in due course of such cheque should
have made a demand for the payment of the said amount of
money by giving notice, in writing, to the drawer of the cheque
within fifteen days of the receipt of information by him from
the bank regarding the return of the cheque unpaid; and
(c) the drawer of such cheque should have failed to make the
payment of the said amount of money to the payee or the
holder in due course of the cheque within fifteen days of the
receipt of the said notice.
It has also been provided that it shall be presumed, unless
the contrary is proved, that the holder of such cheque received
the cheque in the discharge of a liability. Defences which
mayor may not be allowed in any prosecution for such offence
have also been provided to make the provisions effective. The
Supreme Court in Modi Cements Ltd. v. K.K. Nandi, (1988) 28
CLA 491, held that merely' because the drawer issued a notice

to the drawee or to the Bank for 'stop payment', it would not

preclude an action under Section 138 by the drawee or holder
in due course. Usual provisions relating to offences by
companies have also been included in the said new Chapter. In
order to ensure that genuine and h9nest bank customers are not
harassed or put to inconvenience, sufficient safeguard's have
also been provided in the new Chapter, as under:
(a) that no Court shall take cognizance of such offence
except on a complaint in writing, made by the payee or the
holder in due course of the cheque;
(b) that such complaint is made within one month or the date
on which the cause of action arises;
(c) that QO Court inferior to that of a Metropolitan
Magistrate or a Judicial Magistrate of the first class shall try
any such offence.
Electronic Payments
A payment system is any system used to settle financial
transactions through the transfer of monetary value, and
includes the institutions, instruments, people, rules,
procedures, standards, and technologies that make such an
exchange possible. A common type of payment system is the
operational network that links bank accounts and provides for
monetary exchange using bank deposits.
What makes a payment system a system is the use of
cash-substitutes; traditional payment systems are negotiable
instruments such as drafts (e.g., checks) and documentary
credits such as letters of credit. With the advent of computers

and electronic communications a large number of alternative

electronic payment systems have emerged. These include debit
cards, credit cards, electronic funds transfers, direct credits,
direct debits, internet banking and e-commerce payment
systems. Some payment systems include credit mechanisms,
but that is essentially a different aspect of payment. Payment
systems are used in lieu of tendering cash in domestic and
international transactions and consist of a major service
provided by banks and other financial institutions.
Payment systems may be physical or electronic and each
has its own procedures and protocols. Standardization has
allowed some of these systems and networks to grow to a
global scale, but there are still many country- and product-
specific systems. Examples of payment systems that have
become globally available are credit card and automated teller
machine networks. Specific forms of payment systems are also
used to settle financial transactions for products in the equity
markets, bond markets, currency markets, futures markets,
derivatives markets, options markets and to transfer funds
between financial institutions both domestically using clearing
and real-time gross settlement (RTGS) systems and
internationally using the SWIFT network. The term electronic
payment can refer narrowly to e- commerce—a payment for
buying and selling goods or services offered through the
Internet, or broadly to any type of electronic funds transfer.
Requirements for E-payments
1. Security
Since payments involve actual money, payment systems

will be a prime target for criminals. Since Internet services are

provided today on networks that are relatively open, the
infrastructure supporting electronic commerce must be usable
and resistant to attack in an environment where eavesdropping
and modification of messages is easy.
2. Reliability
As more commerce is conducted over the Internet, the
smooth running of the economy will come to depend on the
availability of the payment infrastructure, making it a target of
attack for vandals. Whether the result of an attack by vandals
or simply poor design, an intemiption in the availability of the
infrastructure would be catastrophic. For this reason, the
infrastructure must be highly available and should avoid
presenting a single point of failure.
3. Scalability
As commercial use of the Internet grows, the demands
placed on payment servers will grow too. The payment
infrastructure as a whole must be able to handle the addition of
users and merchants without suffering a noticeable loss of
performance. The existence of central servers through which
all transactions must be processed will limit the scale of the
system. The payment infrastructure must support multiple
servers, distributed across the network.
4. Anonymity
For some transactions, the identity of the parties to the
transaction should be protected; it should not be possible to
monitor an individual's spending patterns, nor determine one's

source of income. An individual is traceable in traditional

payment systems such as checks and credit cards. Where
anonymity is important, the cost of tracking a transaction
should outweigh the value of the information that can be
obtained by doing so.
5. Acceptability
The usefulness of a payment mechanisms is dependent
upon what one can buy with it. Thus, a payment instrument
must be accepted widely. Where payment mechanisms are
supported by multiple servers, users of one server must be able
to transact business with users of other servers.
6. Customer base
The acceptability of a payment mechanism is affected by
the size of the customer base, i.e. the number of users able to
make payments using the mechanism. Merchants want to sell
products, and without a large enough base of customers using a
payment mechanism, it is often not worth the extra effort for a
merchant to accept the mechanism.
7. Flexibility
Alternative forms of payment are needed, depending on
the guarantees needed by the parties to a transaction, the
timing of the payment itself, requirements for auditability,
performance requirements, and the amount of the payment.
The payment infrastructure should support several payment
methods including instruments analogous to credit cards,
personal checks, cashier's checks, and even anonymous
electronic cash. These instruments should be integrated into a
common framework.

8. Convertibility
Users of the Internet will select financial instruments that
best suit their needs for a given transaction. It is likely that
several forms of payment will emerge, providing different
tradeoffs with respect to the characteristics just described. In
such an environment it is important that funds represented by
one mechanism be easily convertible into funds represented by
others.
9. Efficiency
Royalties for access to information may generate
frequent payments for small amounts. Applications must be
able to make these "micropayments" without noticeable
performance degradation. The cost per transaction of using the
infrastructure must be small enough that it is insignificant even
for transaction amounts on the order of pennies.
10. Ease of integration
Applications must be modified to use the payment
infrastructure in order to make a payment service available to
users. Ideally, a common API should be used so that the
integration is not specific to one kind of payment instrument.
Support for payment should be integrated into request-
response protocols on which applications are built so that a
basic level of service is available to higher level applications
without significant modification.
11. Ease of use
Users should not be constantly interrupted to provide
payment information and most payments should occur

automatically. However, users should be able to limit their

losses. Payments beyond a certain threshold should require
approval. Users should be able to monitor their spending
without going out of their way to do so.
Types of E-payments
The following types of electronic payments are most
common today. That said, it is important to realize that new
payment types are continual being discovered and there are
additional methods that exist or are being developed
continuously.
Cards
Credit cards, debit cards and prepaid cards currently
represent the most common form of electronic payments. For
all 3 types of cards the consumer or the business most often
uses a plastic card, commonly with a magnetic stripe. The
cardholder gives his or her card or card number to a merchant
who swipes the card through a terminal or enters the data to a
PC. The terminal transmits data to his or her bank, the
acquirer. The acquirer transmits the data through a card
association to the card issuer who makes a decision on the
transaction and relays it back to the merchant, who gives goods
or services to the cardholder. Funds flow later for settlement
with credit cards and are debited immediately for debit or pre-
paid cards.
Along with magnetic stripe cards, smart cards are and
will increasingly be used for payments. Smart cards are at
present overwhelmingly plastic credit cards with an embedded

computer chip. Until recently, many smart cards operated

using proprietary rather than common standards. A standard
set of specifications, EMV, has been developed and is being
used increasingly so that the chips on smart cards are
interoperable. Korea and Japan are among the most advanced
countries in Asia for smart card payments, with Malaysia
catching up fast due to government mandates for banks to
issue smart cards. Most credit and debit cards are expected to
be issued or reissued as smart cards by 2008 or earlier.
Over time, the chip for payment can be expected to move
onto other devices. A smart card might then become the
computer chip in a phone, PDA or other device that can
perform the same function as chip in a plastic card, eliminating
the need for the actual plastic card. Smart cards could thus
evolve into smart phones, smart PDAs or other smart devices.
Internet
Online payments involve the customer transferring
money or making a purchase online via the internet.
Consumers and businesses can transfer money to third parties
from the bank or other account, and hey can also use credit,
debit and prepaid cards to make purchases online.
Current estimates are that over 80% of payments for
online purchases are made using a credit card or debit card. At
present, most online transactions involve payment with a credit
card. While other forms of payment such as direct debits to
accounts or pre-paid accounts and cards are increasing, they
currently represent a less developed transaction methodology.

Mobile Payments
Mobile phones are currently used for a limited number of
electronic transactions. However, the percentage seems likely
to increase as mobile phone manufacturers enable the chip and
software in the phone for easier electronic commerce.
Consumers can use their mobile phone to pay for
transactions in several ways. Consumers may send an SMS
message, transmit a PIN number, use WAP to make online
payments, or perform other segments of their transaction with
the phone. As phones develop further, consumers are likely to
be able to use infrared, Bluetooth and other means more
frequently to transmit full account data in order to make
payments securely and easily from their phone.
Additionally, merchants can obtain an authorization for a
credit or debit card transaction by attaching a device to their
mobile phone. A consortium in the US also recently
announced Power Swipe, for example, which physically
connects to a Nextel phone, weighs 3.1 ounces, and
incorporates a magnetic stripe reader, infrared printing port,
and pass-through connector for charging the handset battery.
Financial Service Kiosks
Companies and service providers in several countries,
including Singapore and the US, have set up kiosks to enable
financial and non-financial transactions. These kiosks are fixed
stations with phone connections where the customer usually
uses a keyboard and television-like screen to transaction or to
access information. At AXS stations in Singapore, for

example, consumers can make electronic bill payments, send

email or SMS message and make phone calls. Kiosks in the
United States enable the customer to send money via wire
transfers, cash checks, make purchases using cash, and make
phone calls.
Located at convenient public locations such as bus or
subway stations, convenience stores or shopping malls, these
kiosks enable electronic payments by individuals who may not
have regular access to the internet or mobile phones.
Television Set-Top Boxes and Satellite Receiver
Specialized boxes attached to a television can also be
used for payments in some locations. The set-top box attaches
to the television and a keyboard or other device, and customers
can make purchases by viewing items on the television.
Payment is made electronically using a credit card or other
account. While usage is presently low, it could grow
substantially in countries with a strong cable or satellite
television network.
Biometric Payments
Electronic payments using biometrics are still largely in
their infancy. Trials are underway in the United States,
Australia and a limited number of other countries. Most
biometric payments involve using fingerprints as the
identification and access tool, though companies like Visa
International are piloting voice recognition technology and
retina scans are also under consideration. Essentially, a
biometric identifier such as a fingerprint or voice could replace

the plastic card and more securely identifies the person

undertaking the transaction. The electronic payment is still
charged to a credit card or other account, with the biometric
identifier replacing the card, check or other transaction
mechanism.
Electronic Payments Networks
Various countries have electronic payments networks
that consumer can use to make payments electronically. ACH
(Automated Clearing House) in the US, domestic Eh I POS
networks in Australia and Singapore, and other networks
enable electronic payments between businesses and between
individuals. The consumer can go online, to a financial service
kiosk or use other front-end devices to access their account and
make payments to businesses or other individuals.
Person-to-Person (P2P) Payments
P2P payments enable one individual to pay another using
an account, a prepaid card or another mechanism that stores
value. PayPal in the US, which was recently purchased by
Ebay, is one of the most frequently used P2P mechanisms. The
Tower Group estimates that the volume of P2P payments will
grow from 105 million transactions in 2002 to 1.4 billion
transactions by 2005. P2P payments can be made through a
variety of means, including services like PayPal, transfers
using card readers, or other. In the future other devices, such as
mobile phones or PDAs, could also be used to enable P2P
electronic payments.

MODULE 3
E-BANKING
Online banking, also known as internet banking, e-

banking or virtual banking, is an electronic payment system
that enables customers of a bank or other financial institution
to conduct a range of financial transactions through the
financial institution's website. The online banking system will
typically connect to or be part of the core banking system
operated by a bank and is in contrast to branch banking which
was the traditional way customers accessed banking services.
Fundamentally and in mechanism, online banking, internet
banking and e-banking are the same thing.
To access a financial institution's online banking facility,
a customer with internet access would need to register with the
institution for the service, and set up a password and other
credentials for customer verification. The credentials for online
banking is normally not the same as for telephone or mobile
banking. Financial institutions now routinely allocate
customers numbers, whether or not customers have indicated
an intention to access their online banking facility. Customers'
numbers are normally not the same as account numbers,
because a number of customer accounts can be linked to the
one customer number. The customer number can be linked to
any account that the customer controls, such as cheque,
savings, loan, credit card and other accounts.
The customer visits the financial institution's secure

website, and enters the online banking facility using the

customer number and credentials previously set up. The types
of financial transactions which a customer may transact
through online banking usually includes obtaining account
balances, lists of the latest transactions, electronic bill
payments and funds transfers between a customer's or another's
accounts. Most banks also enable a customer to download
copies of bank statements, which can be printed at the
customer's premises (some banks charge a fee for mailing
hardcopies of bank statements). Some banks also enable
customers to download transactions directly into the customer's
accounting software. The facility may also enable the customer
to order cheque-books, statements, report loss of credit cards,
stop payment on a cheque, advise change of address and other
routine actions.
Features of E-Banking
Online banking facilities typically have many features
and capabilities in common, but also have some that are
application specific.
The common features fall broadly into several categories:
• A bank customer can perform non-transactional tasks
through online banking, including —
o Viewing account balances
o Viewing recent transactions
o Downloading bank statements, for example in PDF
format

o Viewing images of paid cheques

o Ordering cheque books
o Download periodic account statements
o Downloading applications for M-banking, E-
banking etc.
• Bank customers can transact banking tasks through
online banking, including —
o Funds transfers between the customer's linked
accounts
o Paying third parties, including bill payments (see,
e.g., BPAY) and third party fund transfers (see, e.g.,
FAST)
o Investment purchase or sale
o Loan applications and transactions, such as
repayments of enrollments
o Credit card applications
o Register utility billers and make bill payments
• Financial institution administration
• Management of multiple users having varying levels of
authority
• Transaction approval process
Some financial institutions offer special internet banking
services, for example:
• Personal financial management support, such as
importing data into personal accounting software. Some
online banking platforms support account aggregation to

allow the customers to monitor all of their accounts in

one place whether they are with their main bank or with
other institutions.
Advantages of E-Banking
There are some advantages on using e-banking both for
banks and customers:
• Permanent access to the bank
• Lower transaction costs / general cost reductions
• Access anywhere
Security aspects of E-Banking
Security of a customer's financial information is very
important, without which online banking could not operate.
Similarly the reputational risks to the banks themselves are
important. Financial institutions have set up various security
processes to reduce the risk of unauthorized online access to a
customer's records, but there is no consistency to the various
approaches adopted. The use of a secure website has been
almost universally embraced. Though single password
authentication is still in use, it by itself is not considered secure
enough for online banking in some countries. Basically there
are two different security methods in use for online banking:
• The PIN/TAN system where the PIN represents a
password, used for the login and TANs representing one-
time passwords to authenticate transactions. TANs can be
distributed in different ways, the most popular one is to
send a list of TANs to the online banking user by postal
letter. Another way of using TANs is to generate them by

need using a security token. These token generated TANs

depend on the time and a unique secret, stored in the
security token (two-factor authentication or 2FA).
• More advanced TAN generators (chip TAN) also include
the transaction data into the TAN generation process
after displaying it on their own screen to allow the user to
discover man-in-the-middle attacks carried out by
Trojans trying to secretly manipulate the transaction data
in the background of the PC.
• Another way to provide TANs to an online banking user
is to send the TAN of the current bank transaction to the
user's (GSM) mobile phone via SMS. The SMS text
usually quotes the transaction amount and details, the
TAN is only valid for a short period of time. Especially
in Germany, Austria and the Netherlands many banks
have adopted this "SMS TAN" service.
• Usually online banking with PIN/TAN is done via a web
browser using SSL secured connections, so that there is
no additional encryption needed.
• Signature based online banking where all transactions are
signed and encrypted digitally. The Keys for the
signature generation and encryption can be stored on
smartcards or any memory medium, depending on the
concrete implementation (see, e.g., the Spanish ID card
DNI electrónico).
Automated Teller Machine (ATM):
ATM is designed to perform the most important function

of bank. It is operated by plastic card with its special features.

The plastic card is replacing cheque, personal attendance of the
customer, banking hours restrictions and paper based
verification. There are debit cards. ATMs used as spring board
for Electronic Fund Transfer. ATM itself can provide
information about customers account and also receive
instructions from customers - ATM cardholders. An ATM is
an Electronic Fund Transfer terminal capable of handling cash
deposits, transfer between accounts, balance enquiries, cash
withdrawals and pay bills. It may be on-line or off-1ine. The
on-line ATN enables the customer to avail banking facilities
from anywhere. In off-line the facilities are confined to that
particular ATM assigned. Any customer possessing ATM card
issued by the Shared Payment Network System can go to any
ATM linked to Shared Payment Networks and perform his
transactions.
Cards/Debit Cards:
The Credit Card holder is empowered to spend wherever
and whenever he wants with his Credit Card within the limits
fixed by his bank. Credit Card is a post paid card. Debit Card,
on the other hand, is a prepaid card with some stored value.
Every time a person uses this card, the Internet Banking house
gets money transferred to its account from the bank of the
buyer. The buyers account is debited with the exact amount of
purchases. An individual has to open an account with the
issuing bank which gives debit card with a Personal
Identification Number (PIN). When he makes a purchase, he
enters his PIN on shops PIN pad. When the card is slurped

through the electronic terminal, it dials the acquiring bank

system - either Master Card or VISA that validates the PIN and
finds out from the issuing bank whether to accept or decline
the transactions. The customer can never overspend because
the system rejects any transaction which exceeds the balance in
his account. The bank never faces a default because the
amount spent is debited immediately from the customers
account.
Smart Card:
Banks are adding chips to their current magnetic stripe
cards to enhance security and offer new service, called Smart
Cards. Smart Cards allow thousands of times of information
storable on magnetic stripe cards. In addition, these cards are
highly secure, more reliable and perform multiple functions.
They hold a large amount of personal information, from
medical and health history to personal banking and personal
preferences.
Tele Banking:
Undertaking a host of banking related services including
financial transactions from the convenience of customers
chosen place anywhere across the GLOBE and any time of
date and night has now been made possible by introducing on-
line Telebanking services. By dialing the given Telebanking
number through a landline or a mobile from anywhere, the
customer can access his account and by following the user-
friendly menu, entire banking can be done through Interactive
Voice Response (IVR) system. With sufficient numbers of

hunting lines made available, customer call will hardly fail.

The system is bi-lingual and has following facilities offered
• Automatic balance voice out for the default account.
Balance inquiry and transaction inquiry
• All Inquiry of all term deposit account
• Statement of account by Fax, e-mail or ordinary mail.
• Cheque book request
• Stop payment which is on-line and instantaneous
• Transfer of funds with CBS which is automatic and
instantaneous
• Utility Bill Payments
• Renewal of term deposit which is automatic and
instantaneous
• Voice out of last five transactions.
E-Cheque:
An e-Cheque is the electronic version or representation
of paper cheque. The Information and Legal Framework on the
E-Cheque is the same as that of the paper cheque’s. It can now
be used in place of paper cheques to do any and all remote
transactions. An E-cheque work the same way a cheque does,
the cheque writer "writes" the e-Cheque using one of many
types of electronic devices and "gives" the e-Cheque to the
payee electronically. The payee "deposits" the Electronic
Cheque receives credit, and the payee's bank "clears" the e-
Cheque to the paying bank. The paying bank validates the e-
Cheque and then "charges" the check writer's account for the
check.

Electronic Clearing Service (ECS)

ECS is an electronic mode of payment / receipt for
transactions that are repetitive and periodic in nature. ECS is
used by institutions for making bulk payment of amounts
towards distribution of dividend, interest, salary, pension, etc.,
or for bulk collection of amounts towards telephone /
electricity / water dues, cess / tax collections, loan instalment
repayments, periodic investments in mutual funds, insurance
premium etc. Essentially, ECS facilitates bulk transfer of
monies from one bank account to many bank accounts or vice
versa. ECS includes transactions processed under National
Automated Clearing House (NACH) operated by National
Payments Corporation of India (NPCI). Primarily, there are
two variants of ECS - ECS Credit and ECS Debit.
ECS Credit is used by an institution for affording credit
to a large number of beneficiaries (for instance, employees,
investors etc.) having accounts with bank branches at various
locations within the jurisdiction of a ECS Centre by raising a
single debit to the bank account of the user institution. ECS
Credit enables payment of amounts towards distribution of
dividend, interest, salary, pension, etc., of the user institution.
ECS Debit is used by an institution for raising debits to a
large number of accounts (for instance, consumers of utility
services, borrowers, investors in mutual funds etc.) maintained
with bank branches at various locations within the jurisdiction
of a ECS Centre for single credit to the bank account of the
user institution. ECS Debit is useful for payment of telephone /
electricity / water bills, cess / tax collections, loan installment

repayments, periodic investments in mutual funds, insurance

premium etc., that are periodic or repetitive in nature and
payable to the user institution by large number of customers
etc.
Based on the geographical location of branches covered,
there are three broad categories of ECS Schemes — Local
ECS, Regional ECS and National ECS.These schemes are
either operated by RBI or by the designated commercial banks.
NACH is also one of the form of ECS system operated by
NPCI and further details about NACH is available at NPCI
web site under the link http://www.npci.org.in/c1earing_
faq.aspx.
Local ECS — this is operating at 81 centres / locations
across the country. At each of these ECS centres, the branch
coverage is restricted to the geographical coverage of the
clearing house, generally covering one city and/or satellite
towns and suburbs adjoining the city.
Regional ECS — this is operating at 9 centres / locations
at various parts of the country. RECS facilitates the coverage
all core-banking-enabled branches in a State or group of States
and can be used by institutions desirous of reaching
beneficiaries within the State / group of States. The system
takes advantage of the core banking system in banks.
Accordingly, even though the inter-bank settlement takes place
centrally at one location in the State, the actual customers
under the Scheme may have their accounts at various bank
branches across the length and breadth of the State / group of
States.

National ECS — this is the centralized version of ECS

Credit which was launched in October 2008. The Scheme is
operated at Mumbai and facilitates the coverage of all core-
banking enabled branches located anywhere in the country.
This system too takes advantage of the core banking system in
banks. Accordingly, even though the inter-bank settlement
takes place centrally at one location at Mumbai, the actual
customers under the Scheme may have their accounts at
various bank branches across the length and breadth of the
country. Banks are free to add any of their core-banking-
enabled branches in NECS irrespective of their location.
Details of NECS Scheme are available on the website of
Reserve Bank of India The list of centres where the ECS
facility is available has been placed on the website of Reserve
Bank of India at Similarly, the centre-wise list of bank
branches participating at each location is available on the
website of Reserve Bank of India
ECS (CREDIT)
ECS Credit payments can be initiated by any institution
(called ECS Credit User) which needs to make bulk or
repetitive payments to a number of beneficiaries. The
institutional User has to first register with an ECS Centre. The
User has to also obtain the consent of beneficiaries (i.e., the
recipients of salary, pension, dividend, interest etc.) and get
their bank account particulars prior to participation in the ECS
Credit scheme. ECS Credit payments can be put through by the
ECS User only through his / her bank (known as the Sponsor
bank). ECS Credits are afforded to the beneficiary account

holders (known as destination account holders) through the

beneficiary account holders’ bank (known as the destination
bank). The beneficiary account holders are required to give
mandates to the user institutions to enable them to afford credit
to their bank accounts through the ECS Credit mechanism The
User intending to effect payments through ECS Credit has to
submit details of the beneficiaries (like name, bank / branch /
account number of the beneficiary, MICR code of the
destination bank branch, etc.), date on which credit is to be
afforded to the beneficiaries, etc., in a specified format (called
the input file) through its sponsor bank to one of the ECS
Centres where it is registered as a User. The bank managing
the ECS Centre then debits the account of the sponsor bank on
the scheduled settlement day and credits the accounts of the
destination banks, for onward credit to the accounts of the
ultimate beneficiaries with the destination bank branches.
Further details about the ECS Credit scheme are contained in
the Procedural Guidelines and available on the website of
ECS (DEBIT)
ECS Debit transaction can be initiated by any institution
(called ECS Debit User) which has to receive / collect amounts
towards telephone / electricity / water dues, cess / tax
collections, loan installment repayments, periodic investments
in mutual funds, insurance premium etc. It is a Scheme under
which an account holder with a bank branch can authorise an
ECS User to recover an amount at a prescribed frequency by
raising a debit to his / her bank account.

The User institution has to first register with an ECS

Centre. The User institution has to also obtain the
authorization (mandate) from its customers for debiting their
account along with their bank account particulars prior to
participation in the ECS Debit scheme. The mandate has to be
duly verified by the beneficiary’s bank. A copy of the mandate
should be available on record with the destination bank where
the customer has a bank account. The ECS Debit User
intending to collect receivables through ECS Debit has to
submit details of the customers (like name, bank / branch /
account number of the customer, MICR code of the destination
bank branch, etc.), date on which the customer’s account is to
be debited, etc., in a specified format (called the input file)
through its sponsor bank to the ECS Centre.
The bank managing the ECS Centre then passes on the
debits to the destination banks for onward debit to the
customer’s account with the destination bank branch and
credits the sponsor bank's account for onward credit to the
User institution. Destination bank branches will treat the
electronic instructions received from the ECS Centre on par
with the physical cheques and accordingly debit the customer
accounts maintained with them. All the unsuccessful debits are
returned to the sponsor bank through the ECS Centre (for
onward return to the User Institution) within the specified time
frame. For further details about the ECS Debit scheme, the
ECS Debit Procedural Guidelines — available on the website
of Reserve Bank of India
The advantages of ECS Debit to customers are many and

include,
• ECS Debit mandates will take care of automatic debit to
customer accounts on the due dates without customers
having to visit bank branches / collection centres of
utility service providers etc.
• Customers need not keep track of due date for payments.
• The debits to customer accounts would be monitored by
the ECS Users, and the customers alerted accordingly.
• Cost effective.
Core Banking (Centralised Online Real time Electronic
Banking)
Core banking is a banking service provided by a group of
networked bank branches where customers may access their
bank account and perform basic transactions from any of the
member branch offices. Core banking is often associated with
retail banking and many banks treat the retail customers as
their core banking customers. Businesses are usually managed
via the Corporate banking division of the institution. Core
banking covers basic depositing and lending of money. Normal
Core Banking functions will include transaction accounts,
loans, mortgages and payments. Banks make these services
available across multiple channels like ATMs, Internet
banking, mobile banking and branches. The core banking
services rely heavily on computer and network technology to
allow a bank to centralise its record keeping and allow access
from any location. It has been the development of banking
software that has allowed core banking solutions to be
developed.

Electronic Fund Transfer (EFT)

An electronic funds transfer (Eh 1’) is a transaction that
takes place over a computerized network, either among
accounts at the same bank or to different accounts at separate
financial institutions EFTs include direct-debit transactions,
wire transfers, direct deposits, ATM withdrawals and online
bill pay services. Transactions are processed through the
Automated Clearing House (ACH) network, the secure transfer
system of the Federal Reserve that connects all U.S. banks,
credit unions and other financial institutions.
For example, when you use your debit card to make a
purchase at a store or online, the transaction is processed using
an EFT system. The transaction is very similar to an ATM
withdrawal, with near-instantaneous payment to the merchant
and deduction from your checking account. Direct deposit is
another form of an electronic funds transfer. In this case, funds
from your employer’s bank account are transferred
electronically to your bank account, with no need for paper-
based payment systems.
The increased use of EFTs for online bill payments,
purchases and pay processes is leading to a paper-free banking
system, where a large number of invoices and payments take
place over digital networks. EFT systems play a large role in
this future, with fast, secure transactions guaranteeing a
seamless transfer of funds within institutions or across banking
networks. EFT transactions, also known as an online
transaction or PIN-debit transaction, also offer an alternative to
signature debit transactions, which take place through one of

the major credit card processing systems, such as Visa,

MasterCard or Discover, and can cost as much as 3% of the
total purchase price. EFT processing, on the other hand, only
charges an average of 1% for debit card transactions.
Real Time Gross Settlement (RTGS)
The acronym 'RTGS' stands for Real Time Gross
Settlement, which can be defined as the continuous (real-time)
settlement of funds transfers individually on an order by order
basis (without netting). 'Real Time' means the processing of
instructions at the time they are received rather than at some
later time; 'Gross Settlement' means the settlement of funds
transfer instructions occurs individually (on an instruction by
instruction basis). Considering that the funds settlement takes
place in the books of the Reserve Bank of India, the payments
are final and irrevocable.
NEFT is an electronic fund transfer system that operates
on a Deferred Net Settlement (DNS) basis which settles
transactions in batches. In DNS, the settlement takes place
with all transactions received till the particular cut-off time.
These transactions are netted (payable and receivables) in
NEFT whereas in RTGS the transactions are settled
individually. For example, currently, NEFT operates in hourly
batches. [There are twelve settlements from 8 am to 7 pm on
week days and six settlements from 8 am to 1 pm on
Saturdays.] Any transaction initiated after a designated
settlement time would have to wait till the next designated
settlement time Contrary to this, in the RTGS transactions are
processed continuously throughout the RTGS business hours.

The RTGS system is primarily meant for large value

transactions. The minimum amount to be remitted through
RTGS is 2 lakh. There is no upper ceiling for RTGS
transactions. Under normal circumstances the beneficiary
branches are expected to receive the funds in real time as soon
as funds are transferred by the remitting bank. The beneficiary
bank has to credit the beneficiary's account within 30 minutes
of receiving the funds transfer message.
National Electronic Fund Transfer (NEFT)
National Electronic Funds Transfer (NEFT) is a nation-
wide payment system facilitating one-to-one funds transfer.
Under this Scheme, individuals, firms and corporates can
electronically transfer funds from any bank branch to any
individual, firm or corporate having an account with any other
bank branch in the country participating in the Scheme. For
being part of the NEFT funds transfer network, a bank branch
has to be NEFT- enabled. The list of bank-wise branches
which are participating in NEFT is provided in the website of
Individuals, firms or corporates maintaining accounts
with a bank branch can transfer funds using NEFT. Even such
individuals who do not have a bank account (walk-in
customers) can also deposit cash at the NEFT-enabled
branches with instructions to transfer funds using NEFT.
However, such cash remittances will be restricted to a
maximum of Rs.50,000/- per transaction. Such customers have
to furnish full details including complete address, telephone
number, etc. NEFT, thus, facilitates originators or remitters to

initiate funds transfer transactions even without having a bank

account. Individuals, firms or corporates maintaining accounts
with a bank branch can receive funds through the NEFT
system. It is, therefore, necessary for the beneficiary to have an
account with the NEFT enabled destination bank branch in the
country.
The NEFT system also facilitates one-way cross-border
transfer of funds from India to Nepal. This is known as the
Indo-Nepal Remittance Facility Scheme. A remitter can
transfer funds from any of the NEFT-enabled branches in to
Nepal, irrespective of whether the beneficiary in Nepal
maintains an account with a bank branch in Nepal or not. The
beneficiary would receive funds in Nepalese Rupees. No.
There is no limit — either minimum or maximum — on the
amount of funds that could be transferred using NEFT.
However, maximum amount per transaction is limited to
Rs.50,000/- for cash-based remittances within India and also
for remittances to Nepal under the Indo-Nepal Remittance
Facility Scheme. No. There is no restriction of centres or of
any geographical area within the country. The NEFT system
takes advantage of the core banking system in banks.
Accordingly, the settlement of funds between originating and
receiving banks takes places centrally at Mumbai, whereas the
branches participating in NEFT can be located anywhere
across the length and breadth of the country. Presently, NEFT
operates in hourly batches - there are twelve settlements from
8 am to 7 pm on week days (Monday through Friday) and six
settlements from 8 am to 1 pm on Saturdays.

Working of NEFT system

Step-1 : An individual / firm / corporate intending to
originate transfer of funds through NEFT has to fill an
application form providing details of the beneficiary (like
name of the beneficiary, name of the bank branch where the
beneficiary has an account, IFSC of the beneficiary bank
branch, account type and account number) and the amount to
be remitted. The application form will be available at the
originating bank branch. The remitter authorizes his/her bank
branch to debit his account and remit the specified amount to
the beneficiary. Customers enjoying net banking facility
offered by their bankers can also initiate the funds transfer
request online. Some banks offer the NEFT facility even
through the ATMs. Walk-in customers will, however, have to
give their contact details (complete address and telephone
number, etc.) to the branch. This will help the branch to refund
the money to the customer in case credit could not be afforded
to the beneficiary’s bank account or the transaction is rejected /
returned for any reason.
Step-2 The originating bank branch prepares a message
and sends the message to its pooling centre (also called the
NEFT Service Centre).
Step-3 : The pooling centre forwards the message to the
NEFT Clearing Centre (operated by National Clearing Cell,
Reserve Bank of India, Mumbai) to be included for the next
available batch.
Step-4 : The Clearing Centre sorts the funds transfer

transactions destination bank-wise and prepares accounting

entries to receive funds from the originating banks (debit) and
give the funds to the destination banks(credit). Thereafter,
bank-wise remittance messages are forwarded to the
destination banks through their pooling centre (NEFT Service
Centre).
Step-5 : The destination banks receive the inward
remittance messages from the Clearing Centre and pass on the
credit to the beneficiary customers’ accounts.
IFSC
IFSC or Indian Financial System Code is an alpha-
numeric code that uniquely identifies a bank-branch
participating in the NEh I system. This is an 11 digit code with
the first 4 alpha characters representing the bank, and the last 6
characters representing the branch. The 5th character is 0
(zero). IFSC is used by the NEFT system to identify the
originating / destination banks / branches and also to route the
messages appropriately to the concerned banks / branches.
Bank-wise list of IFSCs is available with all the bank-branches
participating in NEFT. List of bank-wise branches
participating in NEFT and their IFSCs is available on the
website of Reserve Bank of India . All the banks have also
been advised to print the IFSC of the branch on cheques issued
to their customers. Further, banks have also been advised to
ensure that their branch staff provide necessary assistance to
customers in filling out the required details, including IFSC
details, in the NEFT application form, and also help in
ensuring that there is no mismatch between the IFSC code and

branch details of beneficiary branch as provided by the

customer.
E-purse
Electronic money, or e-money, is the money balance
recorded electronically on a stored-value card. These cards
have microprocessors embedded which can be loaded with a
monetary value. Another form of electronic money is network
money, software that allows the transfer of value on computer
networks, particularly the internet. Electronic money is a
floating claim on a private bank or other financial institution
that is not linked to any particular account. Examples of
electronic money are bank deposits, electronic funds transfer,
direct deposit, payment processors, and digital currencies.
Virtual Banking
A bank that offers services predominately or exclusively
over the Internet. A virtual bank offers normal banking
services, including access to one's checking and savings
accounts and personal and business loans. Even non-virtual
banks almost always offer virtual banking services. A virtual
bank offers of some or all the same types of accounts and
services that traditional bricks-and-mortar banks do, but virtual
banks exist only online. They typically charge lower fees and
pay higher interest because of low overhead. Virtual bank
transactions can be checked in real time, as they happen, rather
than at the end of the banking day or the end of the month --
though those services may also be available through the online
branches of traditional banks. Virtual banks don't have

branches or own ATM machines, so you make deposits

electronically or by mail. Your virtual bank may reimburse
your ATM fees for using other banks' machines. However,
there may be a limit to the number of transactions a virtual
bank will cover each month.
Financial Inclusion
Financial inclusion is a method of offering banking and
financial services to individuals. It aims to include everybody
in society by giving them basic financial services regardless of
their income or savings. It focuses on providing financial
solutions to the economically underprivileged. The term is
broadly used to describe the provision of savings and loan
services to the poor in an inexpensive and easy-to-use form. It
aims to ensure that the poor and marginalised make the best
use of their money and attain financial education. With
advances in financial technology and digital transactions, more
and more startups are now making financial inclusion simpler
to achieve.
Financial inclusion wants everybody in the society to be
involved and participate in financial management judiciously.
There are many poor households in India that do not have any
access to financial services in the country. They are not aware
of banks and their functions. Even if they are aware of banks,
many of the poor people do not have the access to get services
from banks. They may not meet minimum eligibility criteria
laid by banks and hence, they will not be able to secure a
bank’s services. Banks have requirements such as minimum
income, minimum credit score, age criteria, and minimum

years of work experience. A bank will provide a deposit or a

loan to an applicant only if he or she meets these criteria.
Many of the poor people may be unemployed without any
previous employment record due to lack of education, lack of
resources, lack of money, etc. These economically
underprivileged people of the society may also not have proper
documents to provide to the banks for verification of identity
or income. Every bank has certain mandatory documents that
need to be furnished during a loan application process or
during a bank account creation process. Many of these people
do not have knowledge about the importance of these
documents. They also do not have access to apply for
government- sanctioned documents.
Financial inclusion aims to eliminate these barriers and
provide economically priced financial services to the less
fortunate sections of the society so that they can be financially
independent without depending on charity or other means of
getting funds that are actually not sustainable. Financial
inclusion also intends to spread awareness about financial
services and financial management among people of the
society. Moreover, it wants to develop formal and systematic
credit avenues for the poor people.
For several years, only the middle and high classes of the
society procured formal types of credit. Poor people were
forced to rely on unorganised and informal forms of credit.
Many of them were uneducated and did not have basic
knowledge about finance and hence, they got cheated by the
greedy and rich people of the society. Several poor people

have been exploited for years in the context of financial

assistance.
Definition
Financial inclusion is the process of ensuring access to
financial products and services needed by vulnerable groups at
an affordable cost in a transparent manner by institutional
players.
Objectives of Financial Inclusion
• Financial inclusion intends to help people secure
financial services and products at economical prices such
as deposits, fund transfer services, loans, insurance,
payment services, etc.
• It aims to establish proper financial institutions to cater to
the needs of the poor people. These institutions should
have clear-cut regulations and should maintain high
standards that are existent in the financial industry.
• Financial inclusion aims to build and maintain financial
sustainability so that the less fortunate people have a
certainty of funds which they struggle to have.
• Financial inclusion also intends to have numerous
institutions that offer affordable financial assistance so
that there is sufficient competition so that clients have a
lot of options to choose from. There are traditional
banking options in the market. However, the number of
institutions that offer inexpensive financial products and
services is very minimal.
• Financial inclusion intends to increase awareness about

Fundamentals of Banking and Insurance

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BCM4A14/BBA4A14: Banking and Insurance

The banking history is interesting and reflects evolution

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goldsmith paid interest on these deposits. Apart from accepting

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1921 by amalgamating 3 presidency banks It is the Imperial

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SBI started number of branches in urban and rural areas of the

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School of Distance Education, University of Calicut 5

School of Distance Education, University of Calicut 6

10. Banking Business

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6. Banks facilitate the movement of funds from unused

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• Lend funds to organisations, trade, commerce, industry,

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industries, etc. Co-operative Banks are available in rural as

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6. Central / National banks

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times of 2000-1400 BC. It has admirably fulfilled the needs of

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Reserve Bank of India (RBI)

School of Distance Education, University of Calicut 13

School of Distance Education, University of Calicut 14

School of Distance Education, University of Calicut 15

Regional rural Banks

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important national level development banks. They are;

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Till 1993, IFCI continued to be Developmental Financial

School of Distance Education, University of Calicut 18

School of Distance Education, University of Calicut 19

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foreign currencies, venture capital support, and different

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system, including monitoring, formulation of

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institutions that providing financial services, such as

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addition to supplying financial services not normally

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Special Types of Customers

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The conditions for opening and maintaining accounts in

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legitimate claims. On account of this, the Indian Contract Act

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banker to open an account. In case a customer approaches the

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attested. In view of practical difficulties involved, it would be

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the banker has no authority to question his power to deal with

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conduct of day-to-day business of the company. The Articles

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