THEORY AND PRACTICE OF MODERN BANKING

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 MODULE I

 Banking System

A banking system is a group or network of institutions that provide financial services.

The major types of banking systems include those made up of commercial, national, and
investment banks and credit unions may also be part of a banking system

 Definition of a Bank

Chamber’s Twentieth century Dictionary defines a bank as, “an institution for the
keeping, lending and exchanging etc. of money”.

According to Banking Regulation Act, “Banking means the accepting for the purpose
of lending or investment of deposits of money from the public, repayable on demand or
otherwise and withdrawable by cheque, draft, and an order or otherwise”.

 Evolution of Banking

The term bank is either derived from Old Italian word banca or from a French word banque
both mean a Bench or money exchange table. According to some authorities, the work
“Bank” itself is derived from the words “bancus” or “banqee,” that is, a bench. The early
bankers, the Jews in Lombardy, transacted their business on benches in the market place.
There are others, who are of the opinion that the word “bank” is originally derived from the
German word “back” meaning a joint stock fund, which was Italianized into “banco” when
the Germans were masters of a great part of Italy. This appears to be more possible. But
whatever is the origin of the word ‘bank’, “It would trace the history of banking in Europe
from the Middle Ages.”
 History of Banking

As early as 2000 B.C., the Babylonians had developed a banking system. There is evidence to
show that the temples of Babylon were used as banks and such great temples as those of
Ephesus and of Delbhi were the most powerful of the Greek banking institutions. But the
spread of irreligion soon destroyed the public sense of security in depositing money
andvaluables in temples, and the priests were no longer acting as financial agents. Some
experts briefed the history of modern banking as: The first public banking institution was The
Bank of Venice, founded in 1157. The Bank of Barcelona and the bank of Genoa were
established in 1401 and 1407 respectively. These are the recognized forerunners of modern
commercial banks. Exchange banking was developed after the installation of the Bank of
Amsterdam in 1609 and Bank of Hamburg in 1690. The credit for laying the foundation of
modern banking in England goes to the Lombard’s of Italy who had migrated to other
European countries and England. The bankers of Lombardy developed the money
lending business in England. The Bank of England was established in 1694. The
development of joint stock commercial banking started functioning in 1833. The
modern banking system actually developed only in the nineteenth century.

 History of Banking in India

The first bank in India, though conservative, was established in 1786. From 1786 till
today, the journey of Indian Banking System can be segregated into three distinct
phases:

Phase 1 (1786 to 1969)

The first bank in India, the General Bank of India, was set up in 1786. Bank of
Hindustan and Bengal Bank followed. The East India Company established Bank of Bengal
(1809), Bank of Bombay (1840), and Bank of Madras (1843) as independent units and called
them Presidency banks. These three banks were amalgamated in 1920 and the Imperial Bank
of India, a bank of private shareholders, mostly Europeans, was established. Allahabad Bank
was established, exclusively by Indians, in 1865. Punjab National Bank was set up in 1894
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with headquarters in Lahore. Between 1906 and 1913, Bank of India, Central Bank of India,
Bank of Baroda, Canara Bank, Indian Bank, and Bank of Mysore were set up. The Reserve
Bank of India came in 1935.

During the first phase, the growth was very slow and banks also experienced periodic
failures between 1913 and 1948. There were approximately 1,100 banks, mostly small. To
streamline the functioning and activities of commercial banks, the Government of India came
up with the Banking Companies Act, 1949, which was later changed to the Banking
Regulation Act, 1949 as per amending Act of 1965 (Act No. 23 of 1965). The Reserve Bank
of India (RBI)
was vested with extensive powers for the supervision of banking in India as the Central
banking authority. During those days, the general public had lesser confidence in banks. As
an aftermath, deposit mobilization was slow. Moreover, the savings bank facility provided by
the Postal department was comparatively safer, and funds were largely given to traders.

Phase 2 (1969 to 1991)

The government took major initiatives in banking sector reforms after Independence.
In 1955, it nationalized the Imperial Bank of India and started offering extensive banking
facilities, especially in rural and semi-urban areas. The government constituted the State
Bank of India to act as the principal agent of the RBI and to handle banking transactions of
the
Union government and state governments all over the country. Seven banks owned by the
Princely states were nationalized in 1959 and they became subsidiaries of the State Bank of
India. In 1969, 14 commercial banks in the country were nationalized. In the second phase of
banking sector reforms, seven more banks were nationalized in 1980. With this, 80 percent of
the banking sector in India came under the government ownership.
 Phase 3 (1991 onwards)
This phase has introduced many more products and facilities in the banking sector as
part of the reforms process. In 1991, under the chairmanship of M Narasimham, a committee
was set up, which worked for the liberalization of banking practices. Now, the country is
flooded with foreign banks and their ATM stations. Efforts are being put to give a satisfactory
service to customers. Phone banking and net banking are introduced. The entire system
became more convenient and swift. Time is given importance in all money transactions.

 Indian Banking Structure

The structure of banking in India consists of following components:

1. Central Bank – Reserve Bank of India (RBI)
2. Commercial Banks
a. Public sector Banks
b. Private Banks
c. Foreign Bank. Co-operative Banks
a. Primary Credit Societies
b. Central Co-operative Banks
c. State Co-operative Banks
4. Regional Rural Banks
5. Development Banks
6. Specialized Banks
a. Export Import Bank of India
b. Small Industries Development Bank of India
c. National Bank for Agricultural and Rural Development
7. Microfinance institutions
8. Development financial institutions.

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 Commercial Banking

Commercial banking focuses on products and services that are specifically designed for
businesses, such as deposit accounts, lines of credit, merchant services, payment
processing, commercial loans, global trade services, treasury services, and other business-
oriented offerings

 Commercial Bank

A commercial bank is a financial institution which accepts deposits from the public and gives
loans for the purposes of consumption and investment to make profit. Commercial banks are
profit making organizations that accept deposits and use these funds to make loans. They are
playing the most important role in modern economic organisation.

There are mainly two types of commercial banking institutions in India such as public
sector banks and private sector banks. The commercial banking group consists of 27 Public
sector banks, 29 private sector banks, 36 Foreign Banks operating in India, 196 Regional
Rural Banks and 4 Local Area Banks.
Functions of Commercial Banks
Commercial banks perform a variety of functions. All functions of commercial banks may be
broadly classified into two -primary functions and secondary functions.
Primary Functions
Primary functions consist of accepting deposits, lending money and investment of funds.
1. Accepting deposits: Bank receives idle savings of people in the form of deposits. It borrows
money in the form of deposits. These deposits may be of any of the following types:
(a) Current or demand deposit: In the case of current deposits money can be deposited and
withdrawn at any time. Money can be withdrawn only by means of cheques. Usually a bank
does not allow any interest on this kind of deposit because, bank cannot utilize these short
term deposits. This type of deposits is generally opened by business people for their
convenience.
 Current account holders should keep a minimum balance of Rs. 2000, to keep the account
running.
(b) Fixed or time deposits: These deposits are made for a fixed period. These can be
withdrawn only after the expiry of the fixed period for which the deposits have been made.
The bank gives higher rate of interest on this deposit. The rate of interest depends upon the
duration of deposit. The longer the period the higher will be the rate of interest. For the
evidence of the deposit, the banker issues a ‘Fixed Deposit Receipt’.
(c) Savings Deposits: As the name suggests, this deposit is meant for promotion of savings
and thrift among the people. In the case of savings deposits there are certain restrictions on
the number of withdrawals or on the amount that can be withdrawn per week. A minimum
balance of Rs. 100 should be maintained and if cheque book facility is allowed, the minimum
balance should be Rs. 1000. On the savings deposit, the rate of interest is less than that on the
fixed deposit.
(d) Recurring deposits: This is one form of savings deposit. In this type of deposit, at the end
of every week or month, a fixed amount is deposited regularly. The amount can be withdrawn
only after the expiry of the specified period. This deposit works on the maxim ‘little drops of
water make a big ocean’. It may be opened for monthly installments in sums of Rs. 100 or in
multiples of Rs. 100 with a maximum of Rs. 1000.
2. Lending Money: Lending constitutes the second function f a commercial bank. Out of the
deposits received, a bank lends money to the traders and businessmen. Money is lent usually
for short periods only. A commercial bank lends in any one of the following ways
(a) Loans: In case of loan, the banker advances a lump sum for a certain period at an agreed
rate of interest. The amount granted as loan is first credited in the borrower’s account. He can
withdraw this amount at any time. The interest is charged for the full amount sanctioned
whether he withdraws the money from this account or not. Loan is granted with or without
security.
(b) Cash credit: Cash credit is an arrangement by which the customer is allowed to borrow
money up to a certain limit. The customer can withdraw the amount as and when required.
Interest is charged only for the amount withdrawn and not for the whole amount as in the case
of loan.

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 (c) Overdraft: overdraft is an arrangement between a banker and his customer by which the
customer is allowed to withdraw over and above the credit balance in the current account up
to an agreed limit. The interest is charged only for the amount sanctioned. This is a temporary
financial assistance. It is given either on personal security or on the security of assets.
(d) Discounting of bills: Bank grants advances to their customers by discounting bills of
exchange or pronote. In other words, money is lent on the security of bill of exchange or
pronote. The amount after deducting the interest (discount) from the amount of the bill is
credited in the account of the customer. Thus in this form of lending, the interest is received
by the banker in advance. Bank, sometimes, purchases the bills instead of discounting them.
3. Investment of funds: Another function is investing the funds in some securities. While
making investment a bank is required to observe three principles, namely liquidity,
profitability and safety. A bank invests its funds in government securities issued by central
government as well as state government. It also invests in other approved securities like the
units of UTI, shares of GIC and LIC, securities of State Electricity Board etc.
4. Credit Creation: -It is a unique function of Commercial Banks. When a bank advances loan
to its customer if doesn’t lend cash but opens an account in the borrowers name and credits
the amount of loan to that account. Thus, whenever a bank grants loan, it creates an equal
amount of bank deposits. Creation of deposits is called Credit Creation. In simple words we
can define Credit creation as multiple expansions of deposits. Creation of such deposits will
results an increase in the stock deposits. Creation of such deposits will results an increase in
the stock of money in an economy.
 Secondary Functions
Secondary functions include agency services and general utility services
Agency Services: Modern commercial banks render a number of services to its customers. It
acts as an agent to its customers. The following are the important agency services rendered by
a commercial bank:
1. It collects the cheques. bills and pronotes for and on behalf of its customers
2. It collects certain incomes like dividend on shares, interest on securities etc., on behalf of
its customers.
3. It undertakes to purchase or sell securities for its customers.
4. It accepts bill of exchange on behalf of its customers.
 5. It acts as a referee by supplying information regarding the financial position of its
customers when inquiries made by other business people and vice versa. It supplies this
information confidently.
6. It acts as an executor, administrator and trustee.
General Utility Services: General utility services are rendered not only to its costumers but
also to the general public. The following are the important general utility services
renderedmby a commercial bank.
1. It facilitates easy and quick transfer of funds from one place to another place by means of
cheques, drafts, MT, TT etc.
2. It issues letter of credit, traveler’s cheques, gift cheques etc.
3. It deals with foreign exchange transactions thereby helping the importers and exporters.
4. It undertakes the safe custody of valuables. For this purpose safe deposit vaults are
maintained. Vault is a strong room for keeping the valuables safe.
5. Bank makes arrangements for transport, insurance and warehousing of goods.
6. It underwrites the shares and debentures of the newly promoted joint stock companies.
7. Some commercial banks undertake merchant banking business equipment leasing business.
8. It provides tax consultancy services. It gives advice on income tax and other personal
taxes.
It prepares customers annual statement, files appeals etc.,
9. It provides consultancy services on technical, financial, and managerial and economic
aspects for the benefit of micro and small enterprises.
 Credit Creation

Credit creation separates a bank from other financial institutions. In simple terms, credit creation
is the expansion of deposits. And, banks can expand their demand deposits as a multiple of their
cash reserves because demand deposits serve as the principal medium of exchange

 Methods of Credit Creation

The following points highlight the two methods of creating credits through deposits. These
methods are:

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 1. Primary or Passive Deposits:
The banks create passive deposits when they open deposit accounts in the name of those
customers who bring cash or cheques to be credited to their accounts. The banks make loans
and advances to their customers out of these deposits. But these primary or passive deposits
do not make any net addition to the money which is in the circulation, these deposits merely
convert currency money into deposit money.
2. Derivative or Active Deposits:
Derivative or active deposits are created by the bank by opening a deposit account in the
name of the person concerned who contacts bank to borrow money. Then the bank plays an
active role in the creation of such deposits. This type of dealings is known as an active
deposits or derivative deposits.
For example, Suppose, the bank allows a loan of Rs. 2,00,000 to its customer against any
collateral security. What the bank will do is that it will open an account in the name of the
person who has been granted loan. The bank will credit Rs. 2, 00,000 in it. The bank will not
pay Rs. 2,00,000 in cash to the borrower.

 Limitations of Credit Creation.

1. Cash Reserve Ratio: The credit creation power of banks depends upon the amount of cash
they possess with themselves. The larger the cash, the larger the amount of credit creation
by banks. Thus, the bank's power of creating credit is limited by the cash it possesses.A
higher CRR reduce the capacity of creating credit.
2. Banking Habits of People: If the banking habits of the people are well-developed, then all
of their transactions would be through banks, and this will lead to expansion of credit. As
well as If the banking habits of the people are not well-developed or bad, then transactions
would not be through banks, and this will reduce the credit creation.
3. Supply of Securities: Loans are sanctioned on the basis of the securities provided to the
banks. If securities are not available to the public then the credit creation will be less.
4. Heavy Withdrawl of Cash by the Borrowers: If the borrowers heavily withdraw cash, then
the balance of cash deposits will be disturbed. With the withdrawal of cash, the excess
reserves of the banks are automatically reduced. This reduces the power of credit creation.
5. Monetary Policy of Central Bank: While credit is created by commercial banks, it is
controlled by the Central Bank. Credit control is one important function of the central bank.
Central Bank uses various methods of Credit Control from time to time and thus influences
the banks to expand or contract credit.

 Banking Ombudsman

Banking Ombudsman is a body created by the RBI to take care of the banking complaints of
the general public in India. RBI appoints a senior official or Ombudsman who addresses and
resolves all the complaints and grievances of the customers. The Ombudsman is a senior
official, who has been appointed by the Reserve Bank of India to address grievances and
complaints from customers, pertaining deficiencies in banking services. This body covers
almost all kind of complaints for banking services.

 What are the types of complaints accepted by the banking

ombudsman?

Some of the assumably trivial issues such as rude behaviour from the bank officials, delays in
the disbursing of loans, or even forcing customers to buy insurance policies for processing
loans etc., are all addressed by this organization and the process of complaining simple
requires filling up a form online or sending in a filled form to a postal address

 Delay in Providing any services.

 Charging higher rate of interest linked to BPLR on Housing Loan

 Levying of charges without any notice or Information.
 Any Loss suffered because of lack of coordination from Bank side
 Fraudulent transactions against lost credit card
 Unreasonable credit card charges
 Cheque lost in transit by the bank
 Non-updation of CIBIL records
 Fraudulent transfer of funds by using net banking
 Closure of any account with providing any information or reason
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  When bank demands unreasonable proofs for opening of account
 Loss of cheque from Cheque drop box
 Change in terms and conditions without notice or valid reason
 Mis-selling of Insurance product
 Forcing customers to take insurance policies for processing Loans
 Casual approach from Bank on performing its duties
 Rejection of Loans on unfair grounds
 Harassing customer or misbehaviour for any reason

 How to lodge the complaint ?

There are two ways of filing your complaint:

1. Online Complaint: You can file a complaint to Banking ombudsman on the Internet by
filling up the form on their website. Once you are done filling up the form, you may require
to upload proofs such as bank rejection letter, bank’s reply or anything else that is in a PDF or
TXT format.
2. Offline Complaint: You need to download the form from the Internet and fill up the
complaint. You simply need to include your contact information including your name and
address of the bank against which you are lodging the complaint, documentary evidence and
the compensation that you require. When done, filling up the form, you can send it to one of
the 15 Banking Ombudsman address which comes under your jurisdiction.
 Non-Performing Asset (NPA)
Definition: A non performing asset (NPA) is a loan or advance for which the principal or
interest payment remained overdue for a period of 90 days.

 Types of NPA

 Substandard NPA: Those NPA that have remained overdue for a period of less than or
equal to12 months.
  Doubtful NPA: Those NPA that have remained in the substandard category for a period
of equal to or more than 12 months.

 Loss Assets: This occurs when the NPA has been recognized as a loss by the bank, or the
internal or external auditor or on Reserve Bank of India (RBI) inspection but the loan has
not been forgiven completely.

 Central Bank
In every economy there is a need for one apex institution to regulate, control and monitor the
monetary system. A central bank is the apex institution of the monetary and banking system
of a country. It controls and supervise the functioning of commercial banks operating in the
country. It acts as the sole authority of issuing and regulating currency and credit in the
economy. It generally performs the following common functions:
 The currency notes issued and circulated by the central bank are accepted as legal
tender throughout the country.
 The central bank acts as banker, agent and advisor to the government.
 Central bank acts as Bankers’ Bank.
 Controller of credit
 Central bank act as a custodian of foreign exchange reserve of a country.

 Reserve Bank of India (RBI)

The RBI is the Central Bank of our country. It is the open Institution of India Financial and
monetary system. RBI came into existence on 1st April, 1935 as per the RBI act 1935. But
the bank was nationalised by the government after Independence. It became the public sector
bank from 1st January, 1949. Thus, RBI was established as per the Act 1935 and
empowerment took place in banking regulation Act 1949. RBI has 4 local boards basically in
North, South, East and West – Delhi, Chennai, Calcutta, and Mumbai.

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 Functions of RBI
I. Traditional Functions
1. Issue of Currency Notes: The RBI has the sole right or authority or monopoly of
issuing currency notes except one rupee note and coins of smaller denomination.
These currency notes are legal tender issued by the RBI. Currently it is in
denominations of Rs. 5, 10, 20, 50, 100, 200, 500, and 2,000. The RBI has powers
not only to issue and withdraw but even to exchange these currency notes for
other denominations.
2. Banker to other Banks: The RBI being an apex monitory institution has
obligatory powers to guide, help and direct other commercial banks in the
country. The RBI can control the volumes of banks reserves and allow other
banks to create credit in that proportion.
3. Banker to the Government: The RBI being the apex monitory body has to work
as an agent of the central and state governments. It performs various banking
function such as to accept deposits, taxes and make payments on behalf of the
government.
4. Exchange Rate Management: It is an essential function of the RBI. In order to
maintain stability in the external value of rupee, it has to prepare domestic
policies in that direction. Also it needs to prepare and implement the foreign
exchange rate policy which will help in attaining the exchange rate stability.
5. Credit Control Function: As a central bank of the nation the RBI has to look for
growth with price stability. Thus it regulates the credit creation capacity of
commercial banks by using various credit control tools.
6. Supervisory Function: The RBI has been endowed with vast powers for
supervising the banking system in the country.
II. Developmental / Promotional Functions of RBI
1. Development of the Financial System: The financial system comprises the
financial institutions, financial markets and financial instruments. The sound
and efficient financial system is a precondition of the rapid economic
development of the nation.
2. Provision of Industrial Finance: Rapid industrial growth is the key to faster
economic development. In this regard, the adequate and timely availability of
credit to small, medium and large industry is very significant. In this regard
the RBI has always been instrumental in setting up special financial
institutions such as ICICI Ltd. IDBI, SIDBI and EXIM BANK etc.
3. Provisions of Training: The RBI has always tried to provide essential
training to the staff of the banking industry. The RBI has set up the bankers'
training colleges at several places. National Institute of Bank Management i.e
NIBM, Bankers Staff College i.e BSC and College of Agriculture Banking i.e
CAB are few to mention.
4. Collection of Data: Being the apex monetary authority of the country, the RBI
collects process and disseminates statistical data on several topics. It includes
interest rate, inflation, savings and investments etc. This data proves to be
quite useful for researchers and policy makers.
5. Publication of the Reports: The Reserve Bank has its separate publication
division. This division collects and publishes data on several sectors of the
economy. The reports and bulletins are regularly published by the RBI. It
includes RBI weekly reports, RBI Annual Report, Report on Trend and
Progress of Commercial Banks India., etc. This information is made available
to the public also at cheaper rates.
6. Promotion of Banking Habits: As an apex organization, the RBI always tries
to promote the banking habits in the country. It institutionalizes savings and
takes measures for an expansion of the banking network. During economic
reforms it has taken many initiatives for encouraging and promoting banking
in India.

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 7. Promotion of Export through Refinance: The RBI always tries to encourage the
facilities for providing finance for foreign trade especially exports from India. The
Export-Import Bank of India (EXIM Bank India) and the Export Credit Guarantee
Corporation of India (ECGC) are supported by refinancing their lending for export
purpose.
III. Supervisory function of RBI
1. Granting license to banks: The RBI grants license to banks for carrying its
business. License is also given for opening extension counters, new branches,
even to close down existing branches.
2. Bank Inspection: The RBI grants license to banks working as per the directives
and in a prudent manner without undue risk. In addition to this it can ask for
periodical information from banks on various components of assets and liabilities.
3. Control over NBFIs: The Non-Bank Financial Institutions are not influenced by
the working of a monitory policy. However RBI has a right to issue directives to
the NBFIs from time to time regarding their functioning. Through periodic
inspection, it can control the NBFIs.
4. Implementation of the Deposit Insurance Scheme: The RBI has set up the
Deposit Insurance Guarantee Corporation in order to protect the deposits of small
depositors. All bank deposits below Rs. One lakh are insured with this
corporation. The RBI work to implement the Deposit Insurance Scheme in case of
a bank failure.

 Role of RBI in Credit Control (Techniques/Methods)

As controller of credit, the central bank attempts to influence and control the volume of Bank
credit and also to stabilize business condition in the country.
o General / Quantitative Credit Control Methods:-
Quantitative credit controls are used to maintain proper quantity of credit of money supply in
market. Some of the important general credit control methods are:-
1. Bank rate Policy:- Bank rate (discount rate) refers to the interest rate at which the
domestic banks borrow money from a nation's Central Bank based on the monetary
policy of the country as a short-term loan.
 2. Cash Reserve Ratio (CRR) :- The Cash Reserve Ratio (CRR) is an effective
instrument of credit control. Under the RBl Act of, l934 every commercial bank has to
keep certain minimum cash reserves with RBI. A high CRR reduces the cash for
lending and a low CRR increases the cash for lending. The current CRR is 4% (2022).

3. Statutory Liquidity Ratio:- Under SLR, the government has imposed an obligation
on the banks to; maintain a certain ratio to its total deposits with RBI in the form of
liquid assets like cash, gold and other securities. The current SLR is 18% (2022).

4. Repo Rate:- Repo rate is a interest rate at which the central bank of a country
(Reserve Bank of India in case of India) lends money to commercial banks in the
event of any shortfall of funds. The current Repo rate is 4.90%.

5. Reverse Repo Rate :- Reverse Repo Rate is a interest rate at which the Reserve
Bank of India (RBI) borrows money from banks for the short term. It is an important
monetary policy tool employed by the RBI to maintain liquidity and check inflation in
the economy. The current Reverse Repo rate is 3.35%.

o Selective/ Qualitative Credit Control Method:-

Under Selective Credit Control, credit is provided to selected borrowers for selected
purpose, depending upon the use to which the control tries to regulate the quality of
credit - the direction towards the credit flows. The Selective Controls are:-
1. Ceiling on Credit
The Ceiling on level of credit restricts the lending capacity of a bank to grant
advances against certain controlled securities.
2. Margin Requirements
A loan is sanctioned against Collateral Security. Margin means that proportion of the
value of security against which loan is not given. Margin against a particular security is
reduced or increased in order to encourage or to discourage the flow of credit to a particular
sector

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 3. Discriminatory Interest Rate (DIR)
Through DIR, RBI makes credit flow to certain priority or weaker sectors by charging
concessional rates of interest. RBI issues supplementary instructions regarding granting of
additional credit against sensitive commodities, issue of guarantees, making advances etc. .
4. Directives
The RBI issues directives to banks regarding advances. Directives are regarding the
purpose for which loans may or may not be given.
5. Direct Action
It is too severe and is therefore rarely followed. It may involve refusal by RBI to
rediscount bills or cancellation of license, if the bank has failed to comply with the directives
of RBI.
6. Moral Suasion
Under Moral Suasion, RBI issues periodical letters to bank to exercise control over
credit in general or advances against particular commodities. Periodic discussions are held
with authorities of commercial banks in this respect.

 Reserve Bank of India Act 1934.

Reserve Bank of India Act, 1934 is the legislative act under which the Reserve Bank of
India was formed. This act along with the Companies Act, which was amended in 1936, were
meant to provide a framework for the supervision of banking firms in India. There are various
section in the RBI Act but the most controversial and confusing section is Section 7. Although this
section has been used only once by the central govt it puts a restriction on the autonomy of the
RBI. Section 7 states that central government can legislate the functioning of the RBI through the
RBI board, and the RBI is not an autonomous body.

 Section 17 of the Act defines the manner in which the RBI (the central bank of India) can conduct
business. The RBI can accept deposits from the central and state governments without interest.
It can purchase and discount bills of exchange from commercial banks.
 Section 18 deals with emergency loans to banks. Section 21 states that the RBI must conduct
banking affairs for the central government and manage public debt. Section 22 states that only
the RBI has the exclusive rights to issue currency notes in India. Section 24 states that the
maximum denomination a note can be is ₹10,000 (US$130).

 Section 26 of Act describes the legal tender character of Indian bank notes.

 Section 28 allows the RBI to form rules regarding the exchange of damaged and imperfect notes.

 Banking Regulation act, 1949

The Banking Regulation Act is legislation in India that regulates all banking firms in
India. The Act provides a framework under which commercial banking in India is supervised
and regulated. The Act supplements the Companies Act 1956.The Act vested in the Reserve
Bank the responsibility relating to licensing of banks, branch expansion, and liquidity of their
assets, management and methods of working, amalgamation, reconstruction and liquidation.

The Banking Regulation Act, 1949 is a legislation in India that regulates all banking
firms in India. Passed as the Banking Companies Act 1949, it came into force from 16 March
1949 and changed to Banking Regulation Act 1949 from 1 March 1966. It is applicable in
Jammu and Kashmir from 1956. Initially, the law was applicable only to banking companies.
But, 1965 it was amended to make it applicable to cooperative banks and to introduce other
changes. In 2020 it was amended to bring the cooperative banks under the supervision of
the Reserve Bank of India.

 Objectives of Banking Regulation act, 1949

I. It prohibits non-banking companies from accepting deposits repayable on demand.

II. It prohibits trading by banking companies to eliminate nonbanking risks.
III. It prescribes a minimum capital standards to prevent bank failures due to inadequacy
of capital.

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 IV. It introduces a comprehensive system of licensing of banks and their branches in
order to avoid indiscriminate opening of new branches and thereby ensuring balanced
development of banking companies.
V. It includes in the scope of the legislation banks incorporated or registered outside
India.
VI. It empowers the Central Government and the Reserve Bank of India to regulate and
supervise the working of banking companies in India.
VII. It provides a quick and easy procedure for liquidation of banks.

 Extent and applicability of the Banking Regulation Act

The Banking Regulation Act extends to the whole of India and is applicable toi.
I. Private Sector Banks
II. Public Sector Banks
III. Co-operative Banks excluding
 Primary Agricultural Credit Societies;
 Non-agricultural Primary Credit Societies with paid up capital and reserves of
less than Rs.1lakh.
 Cooperative Credit Societies where principal business is not banking but which
accept deposits only from members and provide financial help only to them.
 Cooperative Societies not carrying on banking business.
 Land Mortgage Banks.

 General Provisions

1. Forms of business in which the banking company may engage (Section 6)

A banking company may engage in the following forms of business in addition to the usual
banking business:
a) Basic Business
i. Borrowing, raising or taking up of money
ii. Lending or advancing of money either upon or without security

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 iii. Drawing, making, accepting, discounting, buying, selling, collecting and dealing in bills
of exchange, hundies, promissory notes, coupons, drafts, bill of lading, railway receipts,
warrants, debentures, certificates, scrips and other instruments and securities whether
transferable or negotiable or not
iv. Granting and issuing of letters of credit, traveller’s cheques and circular notes
v. Buying, and selling of foreign exchange including foreign bank notes
vi. Acquiring, holding, issuing on commission, underwriting and dealing in stocks, funds,
shares, debentures, debenture stocks, bonds, obligations, securities and investments of all
kinds
vii. Purchasing and selling of bonds, scrips or other forms of securities on behalf of
constituents or others; the negotiating of loan and advances.
viii. Receiving of all kinds of bonds, scrips or valuables on deposit or for safe custody or
otherwise
ix. Providing of safe deposit vaults; the collecting and transmitting of money and securities

b) Agency Business

2. Prohibition of Trading (Section 8)

A banking company cannot get in directly or indirectly contracts in buying or selling or
exchange of goods.
3. Disposal of Non-Banking assets (Section 9)
Banks cannot hold any property for more than 7 years for the purpose of settlements of debts
or obligations. Such time limit of 7 years can be augmented by the Reserve Bank of India for
another 5 years, if it thinks appropriate.
4. Charge on Unpaid Capital(Section 14)
No banking company shall create any charge upon any unpaid capital of the company and
any such charge shall be invalid, if created.
5. Payment of Dividend(Section 15)
 A banking company cannot pay any dividend on its shares until all its capitalised expenses
including preliminary expenses, organisation expenses, brokerage, etc. have been completely
written off

6. Reserve Fund (Section 17)

Every banking company must generate a reserve a fund out of its earnings after tax and
interest. Such reserve amount should be at any rate 20 per cent of such profits. Exemption can
be provided only if the cumulative amount of reserve fund and securities premium is greater
than the paid up capital of the company.
7. Cash Reserve (Section 18)
At least 3 per cent of the total demand and time liabilities should be kept as reserve or should
be secured in current account with Reserve Bank of India
8. Loans and Advances(Section 20)
It prohibits banks from granting any loans or advances to any of its Directors.

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 MODULE II

 Modern Trends in Banking services

 Innovative Banking
Innovation means something new or something which had not been done before. The same goes
for banking section as well. There are many sections in banks which are going through or have
gone through innovation in recent past. They are no longer restricted to age-old (traditional)
methods. Thus, to increase the business avenues and capture the new market banks are resorting
to innovation. This term innovative banking is being in use a lot nowadays. Examples are Mobile
Banking, Internet Banking, Narrow Banking etc.
 Social Banking
Social banking used to refer to sustainable banking. The expression has evolved and
nowadays also covers banking activities conducted through social networking channels

or social lending such as peer-to-peer (P2P) lending .

The main focus of the banking sector is on putting resources into local areas, giving freedoms
to the hindered, and supporting social, ecological and moral planning. Banks currently
underscores on accomplishing triple main concern of benefit, individuals and planet
o Objectives of Social Banking
 To provide credit facility to small farmers, small traders, self employed
persons etc.
 To provide financial resources for the welfare objectives.
 To give priority to industries which produce essential goods.
 Major Social Banking Scheme
 Lead Banking
The lead bank acts as a leader for coordinating the efforts of all credit institutions in the
allotted districts to increase the flow of credit to agriculture, small-scale industries and
other economic activities included in the priority sector in the rural and semi-urban areas,
with the district being the basic unit in terms of geographical area.
 Objectives of the Lead Bank Scheme
 To identify those regions which are unbanked and underbanked in districts and also
to evaluate their physiographic, agro climatic end Socio-economic conditions through
economic survey.
 To help in removing regional imbalances through appropriate credit deployment.
 To extend banking facilities to unbanked areas.

 Differential Rate of interest scheme

Differential Rate of Interest (DRI) scheme is also known as DIR, it was launched in
the year 1972 to provide credit access to low income groups. The loan scheme
enables banks to lend to weaker section of the society at a concessional interest rate.
Features of DRI
 Lending at lower rate
 Banks monitor the utilization of loans
 Short term, long term, Medium term loans are provided under this scheme.

 Micro Finance
It involved giving small credit loans to poor and backward populations. The idea was
introduced by Muhammad Yunus. This is done through the establishment of Grameen
Bank, Self help groups, NGOs etc.

 Village Adoption Scheme

This scheme involved adoption of a particular village to cater to financial needs of the
targeted population with formulation of projects, infrastructure development etc.

 Service Area approach

It was introduced in 1989 with the objective of planned development in banking
services so that all the targeted population is covered in a given area in coordination
with the urban banks and rural banks. It led to development of each area with micro
level financing

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 Offshore Banking
An offshore bank is a bank located outside the country of residence of the depositor, typically
in a low tax jurisdiction (or tax haven) that provides financial and legal advantages.

Advantages of Offshore Banking

 Offshore banks can sometimes provide access to politically and economically stable
jurisdictions. This will be advantageous for residents in areas with a risk of political
turmoil who fear their assets may be frozen, seized, or disappear.
 Some offshore banks may operate with a lower cost base and provide higher interest
rates than the legal rate in the home country due to lower overheads and a lack of
government intervention.
 Offshore banks generally pay interest without tax being deducted. This is an
advantage to individuals who do not pay tax on worldwide income or do not pay tax
until the tax return is agreed upon or feel that they can illegally evade tax by hiding
the interest income.
 Some offshore banks offer banking services that domestic banks may not offer, such
as anonymous bank accounts, higher or lower rate loans based on risk, and investment
opportunities not available elsewhere.

Disadvantages of Offshore Banking

 Offshore bank accounts are sometimes less financially secure.

 Offshore banking has been associated in the past with the underground economy
and organized crime through money laundering
 Offshore jurisdictions are often remote and costly to visit, so physical access and
access to information can be difficult
 Hi-Tech Banking

Hi-tech banks are new generation banks. These banks not only accept deposits and lend
money but also provide variety of other services to its customers. Some of the hi tech banking
services are provision of. ATMs, mobile banking, internet banking, anytime banking, EFTs,
credit cards merchant banking etc.
 Financial Services of Banks
 Venture Capital Financing
Venture capital financing is a type of funding by venture capital. It is private
equity capital that can be provided at various stages or funding rounds. Common funding
rounds include early-stage seed funding in high-potential, growth companies (startup
companies) and growth funding (also referred to as series A). Funding is provided in the
interest of generating a return on investment or ROI through an eventual exit through a
share sale to an investment body, another trading company or to the general public via
an Initial public offering (IPO).

 Housing Finance
Housing Finance means financing provided to individuals for the construction, purchase
of residential house/apartment and for purchase of plot and construction thereupon. The
finance availed for the purpose of making improvements in house/apartment shall also
fall under this category. You can avail a home loan from banks or a non-banking finance
companies (NBFCs). Housing Finance Companies (HFCs) are a part of NBFCs. You can
choose between a bank or an HFC by comparing tenure, interest rate, and processing fees
offered by them. Examples of Housing finance companies in India are HDFC Housing
Finance, LIC Housing Finance ltd, PNB Housing Finance Limited etc.

 Hire Purchase.
Hire purchase is an arrangement for buying expensive consumer goods, where the buyer
makes an initial down payment and pays the balance plus interest in instalments. Hire
purchase is the one of the important services of Banks and financial institutions.

Advantages of Hire Purchasing

 No Immediate cash:- Hire purchase finance helps asset creation without having
to immediately part with the cash.

26
 Economic Growth:- hire purchase finance helps the growth of the economy by
enhancing, investment and sales.
  Thrift :- Hire purchase forces the saving habit on the buyer so that it becomes
possible to pay instalment without defaults.

Disadvantages of Hire purchase

 Available only to reputed buyers
 Buyer has to mortgage future income
 Higher prices thus making the purchase and expensive proposition.

 Electronic Banking or E-Banking

E-banking is a blanket term used to indicate a process through which a customer is allowed
to carry out, personal or commercial banking transactions using electronic and
telecommunication network.

Advantages of E-Banking

 It enables digital payments, which encourages transparency.

 It allows 24/7 access to the bank account.

 It also sends notifications and alerts to get updated with the banking transactions and
changes in the rules.

 It lowers transaction cost for the banks.

 The operating cost per unit services is lower for the banks.

 It offers convenience to customers as they are not required to go to the bank's

premises.

 There is very low incidence of errors.

 The customer can obtain funds at any time from ATM machines.

 The credit cards and debit cards enables the Customers to obtain discounts from
retail outlets.

 The customer can easily transfer the funds from one place to another place
electronically.

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 Popular services covered under E-Banking
 Plastic Money

Plastic money may refer to the use of plastic cards like debit/credit cards in the form of
electronic transactions keeping in mind the need of the customer while making the large
transactions so that they don’t keep actual paper money with them. Various forms of
plastic money include debit cards, credit cards, Money access cards, client cards, key
cards, and Cash cards

1. Debit Card: Debit cards are used in our day to day life so as to perform end
number of transactions. Debit cards are linked to the customer’s bank account and
so the customer only needs to swipe the card, in order to make payment at Point of
Sale (POS) outlets, online shopping, ATM withdrawal. In this way, the amount is
deducted from the customer’s account directly.
2. Credit Card: Just like a debit card, a credit card is also a payment card which the
banks issue to the customers on their request, after checking their credit score and
history. It enables the cardholder to borrow funds upto the pre-approved limit and
make payment. The limit is granted by the banks which issue the card. The
cardholder promises to repay the amount within a stipulated time, with some
charges, for the use of credit card.
3. Smart Card : A smart card is a physical card that has an embedded integrated
chip that acts as a security token. Smart cards are typically the same size as a
driver's license or credit card and can be made out of metal or plastic. Smart card
microprocessors or memory chips exchange data with card readers and other
systems over a serial interface. The smart card itself is powered by an external
source, usually the smart card reader.

4. Cheque Guarantee Card: A cheque guarantee card was an abbreviated

portable letter of credit granted by a bank to a qualified depositor in the form of
a plastic card that was used in conjunction with a cheque. The scheme provided
retailers accepting cheques with greater security. The retailer would write the card
number on the back of the cheque, which was signed in the retailer's presence, and
the retailer verified the signature on the cheque against the signature on the card.
 The cheque could not be stopped and payment could not be refused by the bank.
Each bank would set a limit on the maximum amount of an individual cheque that
could be guaranteed. The guarantee only applied to cheques drawn on an account
provided by the bank that issued the card, and could result in an overdraft with
penalty interest on the cardholder

5. ATM Card: These cards are used to withdraw money from the Automated Teller
Machine or ATM. ATM cards can be separately issued or a debit card can also be
used as an ATM card. The advantages of ATM are:

a) 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.

b) 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.

c) ATM reduces the workload of bank's staff.: ATMs reduce the work pressure
on bank's staff and avoids queues in bank premises.

d) 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.

e) ATM is very beneficial for travellers: ATMs are of great help to travellers.
They need not carry large amount of cash with them.

f) 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.

g) ATM provides privacy in banking transactions: Most of all, ATMs provide

privacy in banking transactions of the customer.

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 6. Private Label Card :
A private label credit card is a store-branded credit card that is intended for use at
a specific store. A private label credit card is a type of revolving credit plan
managed by a bank or commercial finance company for either retail or wholesale
manufacturers, such as department and specialty stores. Private label credit cards
do not carry a credit card network logo such as Visa or Mastercard and generally
are not accepted by other merchants.
7. Affinity Group Card : An affinity card is a type of credit card issued by a bank
and, most often, a charitable organization whose logo appears on the card. Each
time the cardholder uses the credit card to make a purchase, a percentage of the
transaction amount is donated to the charity by the bank. Other types of
organizations—such as sports teams, professional associations, universities, and
alumni associations—can also have affinity cards.

 E-Commerce and Banking

E-commerce is the activity of electronically buying or selling of products on online services
or over the Internet. E-commerce will create new forms of competition and compel banks to
make choices about the services they offer, the size of their branch networks, and the extent
of their support for interbank payment networks.

 Internet Banking
Internet Banking, also known as net-banking or online banking, is an electronic payment
system that enables the customer of a bank or a financial institution to make financial or
non-financial transactions online via the internet.

o Advantages of Internet Banking

Some of the most prominent advantages of internet banking include the following:

a) Transferring Funds
With internet banking, you can transfer money from one account to another. You can
initiate inter and intrabank fund transfers, domestically and internationally.

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 You can send funds to beneficiaries within an hour using money transfer channels like
NEFT, RTGS, and IMPS.
b) Booking Deposits

Another benefit of internet banking is that you can conveniently open fixed and recurring
deposit accounts online. You can choose your preferred deposit type (cumulative or non-
cumulative), amount, and investment term.
c) Paying Bills & Recharging

You can pay utility bills like electricity, telephone, gas, etc., from the comfort of your
home and enable auto-debit options never to miss a payment. You can also effortlessly
recharge your mobile and DTH connections through your internet banking account.
d) Tracking Account and Checking balances

You can constantly track your account and check account balances from anywhere, at
any time, whether you are in India or overseas. You can get mini statements or download
account statements from years ago under the ‘view account statement’ section on the
internet banking platform.
e) Placing Orders For Bank Products

Internet banking also allows you to place orders for bank products like cheque Books and
Bank Cards. You can order primary and add-on debit cards and even apply for credit
cards and priority passes for international airport lounge access (if applicable).
f) Add-on Services

You can enjoy a wide variety of add-on services, including buying or selling mutual
funds, buying insurance policies, and applying for various types of loans. Your internet
banking account also allows you to set auto-payments for all recurring expenses.

o Disadvantages of Internet Banking

Like all things in life, internet banking also has a few disadvantages:

a) No Cashless Deposit Option

There is no provision for cash deposits. You must visit your nearest bank branch or cash
deposit machine to deposit money.

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 b) Internet Requirement

Your access to Internet banking services can be hindered in the absence of a stable
internet connection. It can also be affected when bank servers are down.
c) Internet Fraud

You could become a victim of internet fraud if you do not comply with the security
measures prescribed by the bank, such as not setting strong passwords, sharing
passwords, or not logging out from your internet banking account.

 Mobile Banking
It is an application on your smartphone which serves as your own pocket bank. This app
operates without a need to go out and stay in the queues waiting to be served. Your bank
suggests you sign up for an app where you can deposit checks, keep track of your bank
balance, get notified about the latest news, updates, and offers, find ATMs in your area,
and other mobile banking benefits offered to its customer disposal.

o Advantages of Mobile Banking :-

a) Improved Customer experience
When it comes to the banking business, a relationship with a customer is key. By
maintaining a good, respectful, and healthy relationship with the client you have
higher chances to both keep them and attract new ones with the help of word of
mouth. Due to being available 24/7, mobile banking is great for those who are not
always able to visit the actual bank during its working hours.

b) Time Efficiency
All the operations (e.g. transactions) are managed automatically, so this saves time
and cost for the organization.

c) Work load capacity

Mobile banking eliminates the human factor during the different work operations.
Plus it boosts productivity and quality, and causes a lot of issues clients can fix by
themselves through an app.
 d) Data Storage
As financial institutions use automated systems, it allows for storing and processing
more data than manual analysis.

e) Cost Reduction
Reduction concerns a variety of possible expenses: marketing costs, rent, workforce,
etc.

o Disadvantages of Mobile Banking:-

a) Security
Even though banks are trying their best in developing the safest, most secure system,
they usually fail to do so.

b) Tech Issues
Limitations of mobile banking may occur because of bugs that occur during the
development and sometimes after the launch of the mobile application. It is important
to find and fix all the issues in the program with help of a testing service, to keep
your client satisfied.

c) Extra Charges for Internet Services:-

One of the mobile banking disadvantages is the presence of extra charges for some of
the bank services (and we’re not talking about commissions) Certain features like
insurance may charge extra fees.

 Payment Banking:-
A payments bank is like any other bank, but operating on a smaller scale without
involving any credit risk. In simple words, it can carry out most banking operations
but can’t advance loans or issue credit cards. It can accept demand deposits (up to Rs
1 lakh), offer remittance services, mobile payments/transfers/purchases and other
banking services like ATM/debit cards, net banking and third party fund transfers.

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 Electronic Money
Electronic money refers to money that exists in banking computer systems that may be used
to facilitate electronic transactions. Although its value is backed by fiat currency and may
therefore, be exchanged into a physical, tangible form, electronic money is primarily used
for electronic transactions due to the sheer convenience of this methodology.

 Pros and Cons of Electronic Cash

o With the new monetary landscape that has been built, e-money presents several
advantages, including:

a) The ability to move money quickly, literally at the speed of light.

b) Better recordkeeping.

c) Global money transfers.

d) The ability to move large sums of money without any physical burden.

o But advantages always come with their own disadvantages. These include:

a) Cybercrime and new digital forms of money laundering.

b) Users must have a minimum level of training and knowledge, especially with more
complicated forms of electronic transfers.

c) Some types of e-money, most notably cryptocurrencies, are closely linked to criminal
activity.

d) Both hardware and software are required to perform transfers of electronic cash.
 Cryptocurrency
A cryptocurrency is a digital or virtual currency that is secured by cryptography, which
makes it nearly impossible to counterfeit or double-spend. Many cryptocurrencies are
decentralized networks based on blockchain technology—a distributed ledger enforced
by a disparate network of computers.

o Advantages of Cryptocurrency.
a) Protection from inflation –
Inflation has caused many currencies to get their value declined with time. Almost
every cryptocurrency, at the time of its launch, is released with a fixed amount. The
source code specifies the amount of any coin; like, there are only 21 million
Bitcoins released in the world. So, as the demand increases, its value will increase
which will keep up with the market and, in the long run, prevent inflation.
b) Self-governed and managed –
Governance and maintenance of any currency is a major factor for its development.
The cryptocurrency transactions are stored by developers/miners on their hardware,
and they get the transaction fee as a reward for doing so. Since the miners are
getting paid for it, they keep transaction records accurate and up-to-date, keeping
the integrity of the cryptocurrency and the records decentralized.
c) Secure and private –
Privacy and security have always been a major concern for cryptocurrencies. The
blockchain ledger is based on different mathematical puzzles, which are hard to
decode. This makes a cryptocurrency more secure than ordinary electronic
transactions. Cryptocurrencies, for better security and privacy, use pseudonyms that
are unconnected to any user, account or stored data that could be linked to a profile.
d) Currency exchanges can be done easily –
Cryptocurrency can be bought using many currencies like the US dollar, European
euro, British pound, Indian rupee or Japanese yen. With the help of different
cryptocurrency wallets and exchanges, one currency can be converted into the other

38
by trading in cryptocurrency, across different wallets, and with minimal transaction
fees
 e) Cost-effective mode of transaction –
One of the major uses of cryptocurrencies is to send money across borders. With the
help of cryptocurrency, the transaction fees paid by a user is reduced to a negligible
or zero amount. It does so by eliminating the need for third parties, like VISA or
PayPal, to verify a transaction. This removes the need to pay any extra transaction
fees.
f) A fast way to transfer funds –
Cryptocurrencies have always kept itself as an optimal solution for transactions.
Transactions, whether international or domestic in cryptocurrencies, are lightning-
fast. This is because the verification requires very little time to process as there are
very few barriers to cross.

o Disadvantages of Cryptocurrency

1. Can be used for illegal transactions –

Since the privacy and security of cryptocurrency transactions are high, it’s hard for the
government to track down any user by their wallet address or keep tabs on their data.
Bitcoin has been used as a mode of exchanging money in a lot of illegal deals in the
past, such as buying drugs on the dark web.
2. Data losses can cause financial losses –
The developers wanted to create virtually untraceable source code, strong hacking
defenses, and impenetrable authentication protocols.
This would make it safer to put money in cryptocurrencies than physical cash or bank
vaults. But if any user loses the private key to their wallet, there’s no getting it back.

3. Some coins not available in other fiat currencies –

Some cryptocurrencies can only be traded in one or a few fiat currencies.
4. Susceptible to hacks –
Although cryptocurrencies are very secure, exchanges are not that secure. Most
exchanges store the wallet data of users to operate their user ID properly. This data can
be stolen by hackers, giving them access to a lot of accounts.

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5. No refund or cancellation policy –
If there is a dispute between concerning parties, or if someone mistakenly sends funds
to a wrong wallet address, the coin cannot be retrieved by the sender. This can be used
by many people to cheat others out of their money. Since there are no refunds, one can
easily be created for a transaction whose product or services they never received.

 Bitcoin
Bitcoin is a cryptocurrency, a virtual currency designed to act as money and a form of
payment outside the control of any one person, group, or entity, and thus removing the
need for third-party involvement in financial transactions. It is rewarded to blockchain
miners for the work done to verify transactions and can be purchased on several
exchanges.

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 MODULE III

 INSTRUMENTS AND DEPOSIT ACCOUNTS IN BANKING SERVICES

 Instruments
Banking instrument means the documentation of agency and bank sponsor concurrence on the
objectives and administration of the bank that describes in detail the physical and legal
characteristics of the bank, including the service area, and how the bank will be established
and operated. Banking instrument means a cheque, draft, telegraphic or electronic transfer or
other similar instrument;

1. Cheque :-
A cheque, or check (American English; see spelling differences), is a document that
orders a bank (or credit union) to pay a specific amount of money from a person's account
to the person in whose name the cheque has been issued.

o Parties to cheque –

There are three parties to cheque –

 Drawer – The person who draws the cheque, i.e., signs and orders the bank to pay
the sum.
 Drawee – The bank on which the cheque is drawn or who is directed to pay the
specified sum written on the cheque.
 Payee – The beneficiary, i.e., to whom the amount is to be paid.

Apart from the above-mentioned parties, there are two more parties to a cheque:

 Endorser: When a party transfers his right to take the payment to another party,
he/she is called endorser.
 Endorsee: The party in whose favor, the right is transferred, is called endorse

42
o Features of a Cheque:-

 A cheque is an unconditional order

 It is always drawn on a particular bank
 Signature on the exchequer is a mandate and should be only by the maker
 The amount is always a certain sum of money of one’s account
 A cheque is always payable on demand
 A cheque’s payment is always in cash
 The cash amount is to be paid to the person mentioned therein, or order, or the bearer.

o Advantages of Cheque:-

 It is safer and more convenient to carry around than cash

 It is a negotiable instrument which can be endorsed in favour of a third party.
 It can be easily traced if lost.

a) Crossing of Cheque :-
A crossed cheque is a cheque that has been marked specifying an instruction on the way
it is to be redeemed. A common instruction is for the cheque to be deposited directly to
an account with a bank and not to be immediately cashed by the holder over the bank
counter. There are two types of crossing of cheque. Which are following :-

i. General crossing :- A crossed cheque generally is a cheque that only bears two
parallel transverse lines, optionally with the words 'and company' or '& Co.' (or any
abbreviation of them) on the face of the cheque, between the lines, usually at the top
left corner or at any place in the approximate half (in width) of the cheque.
ii. Restrictive or special crossings:- Where some customary instruction is written between
the two parallel transverse lines (constituting crossing of cheque) that may result in
imposing certain restrictions on the collecting or paying banker, it is called restrictive
crossing. The example is "State Bank of India". In these cases, the respective restrictions
mandate to pay the cheque through State Bank of India (acting as collecting banker) only.
b) Endorsing the Cheque:-
 When you are paid with a check, you will normally sign it on the back so that you can
deposit it in your bank account or cash it. Signing a check in this way is known as
endorsing it
o Different Types of Endorsing a cheque:-
a) Restrictive Endorsement
The most secure way to do this is called a restrictive endorsement. To make one, you
should, in any order:
Write “For Deposit Only” on one line, Write the account number on another line, Sign
your name on another line

b) Endorsing a Check to a Third Party

It’s possible to utilize a check made out to you to pay someone else. Essentially, you are
sending the money associated with the check directly from the payee to someone
else. This is known as a special endorsement.

c) Blank Endorsement
A blank endorsement is by far the least secure way of endorsing a check, but it is also the
most common. To do this, you simply sign your name on the back of the check and then
tell the bank teller whether you want to deposit it to a particular account or cash it.

d) Business Endorsement
Sometimes a check will be made out to a business rather than an individual. In this case,
a check must be endorsed on behalf of the business, and this must be done by an
authorized individual.

e) Mobile Endorsement
If you use your bank’s smartphone app or online system to deposit your check, it might
be that you need to endorse it in a particular way. A few banks will require you to write
“mobile deposit” if you use this method, so check your bank’s guidelines.

2. Bill of Exchange
A bill of exchange is a binding agreement by one party to pay a fixed amount of cash
to another party as of a predetermined date or on demand. Bills of exchange are

44
 primarily used in international trade. Their use has declined as other forms of
payment have become more popular. There are three entities that may be involved
with a bill of exchange transaction. They are as follows:

 Drawee. This party pays the amount stated on the bill of exchange to the payee.

 Drawer. This party requires the drawee to pay a third party (or the drawer can be
paid by the drawee).

 Payee. This party is paid the amount specified on the bill of exchange by the
drawee
Features of Bill of Exchange

 It is important to have a bill of exchange in writing

 It must contain a confirm order to make a payment and not just the request

 The order should not have any condition

 The bill of exchange amount should be definite

 Fixed date for the amount to be paid

 The bill must be signed by both the drawee and the drawer

 The amount stated on the bill should be paid on-demand or on the expiry of a fixed time

 The amount is paid to the beneficiary of the bill, specific person, or against a definite order

Types of Bill of Exchange

 Documentary Bill- In this, the bill of exchange is supported by the relevant documents that
confirm the genuineness of sale or transaction that took place between the seller and buyer.

 Demand Bill- This bill is payable when it demanded. The bill does not have a fixed date of
payment, therefore, the bill has to be cleared whenever presented.

 Usance Bill- It is a time-bound bill which means the payment has to be made within the
given time period and time.

 Inland Bill- An Inland bill is payable only in one country and not in any other foreign
country. This bill is opposite to the foreign bill.
 Clean Bill- This bill does not have any proof of a document, so the interest is comparatively
higher than the other bills.

 Foreign Bill- A bill that can be paid outside India is termed as a foreign bill. Two examples
of a foreign bill are an export bill and import bill.

 Accommodation Bill- A bill that is sponsored, drawn, accepted without any condition is
known as an accommodation bill.

 Trade Bill- This kind of bill is specially related only to trade.

 Supply Bill- The bill that is withdrawn by the supplier or contractor from the government
department is known as the supply bill.

Advantages of Bill of Exchange

 Legal Document- It is a legal document, and if the drawee fails to make the payment, it will
be easier for the drawer to recover the amount legally.

 Discounting Facility- In cases where the drawer is in immediate need of money, the bill can
be converted into cash by discounting it from a bank by paying some nominal charges.

 Endorsement Possible- This bill of exchange can be exchanged from one individual to
another for the adjustment of the debt.

3. Promissory Note
A promissory note is a debt instrument that contains a written promise by one party (the
note's issuer or maker) to pay another party (the note's payee) a definite sum of money,
either on-demand or at a specified future date. A promissory note typically contains all
the terms pertaining to the indebtedness, such as the principal amount, interest rate,
maturity date, date and place of issuance, and issuer's signature.
4. PAY-IN-SLIP

This is also known as deposit Slip. It is a form supplied by a bank for a depositor to fill
out and to deposit the money in the bank. Pay-in-slip is used to deposit the amount in the
bank. These slips contains the following particulars to be filled: Name of the Depositor
having bank account.

46
Advantages of Slip System

 No need for subsidiary books;

 Helps in keeping customers account up-to-date;
 It reduces the possibility of errors and frauds;
 It saves a lot of time since it is prepared by the customers themselves;
 It helps in auditing;
 Proper evidence for future when needed;
 Provide reliability in accounts as slips are filled by customers themselves;
 It provides a good system of internal check etc.
Disadvantages of Pay in Slip
 It suffers from the risk of loss of slips;
 Misappropriation or destruction of slips since they are loose;
 Where customers are in large in a bank, it is difficult and expensive to keep record
date-wise;
 Difficult to fill by the uneducated customers
 Points Promissory Note Bill of Exchange
1. Number There are mainly two parties- There are mainly three parties-
of parties maker and the payee. drawer, drawee and the payee. The
drawer may be the payee and in that
case the
number of parties will be two.
2. Promise/ It contains an unconditional It contains an unconditional order to
Order promise to pay. pay.
3. Acceptance Acceptance of the payee is The drawee must accept the bill.
not required.
4. Debtor/ The maker is the debtor. The drawer is the creditor.
Creditor
5. Liability of The liability of the maker is The liability of the drawer is
the Maker/ primary and absolute. secondary and conditional in the
Drawer event of failure
of the drawee.
6. Relationship The maker stands in The drawer stands in immediate
of Maker/ immediate relationship with relationship with the drawee.
Drawer the payee.
 Accounts

1. Demand Draft (DD)

A demand draft or a DD is a negotiable instrument issued by the bank. The meaning
of negotiable instrument is that it guarantees a certain amount of payment mentioning
the name of the payee. It cannot be transferred to another person in any situation. The
bank issues the draft to a client (drawer) directing another bank or own branch to pay
the specific amount to the payee.
Demand drafts can be compared to cheques but these are hard to counterfeit and more
secure. This is because the drawer has to pay before issuing a demand draft to the
bank whereas cheque can be issued without ensuring the sufficient funds in your bank
account. Therefore, cheques can bounce but drafts assure a safe and on-time payment.
48
 A draft is valid for a period of 3 months from the date of issue. The draft will
be expired after that period if not presented to the bank. However, despite being
expired, the money will not be refunded in the drawer’s account. The drawer then has
to approach the bank to revalidate the draft.
o Types of DD
a) Sight Demand Draft: This type of DD is approved and paid only after
the verification of certain documents. The payee will not be able to
receive any money if he/she fails to present any of the required
documents.

b) Time Demand Draft: A Time DD is payable only after a specific

period of time and before that, it cannot be drawn from the bank

BASIS FOR CHEQUE DEMAND DRAFT

COMPARISON

Meaning A cheque is a written document which Demand Draft is a negotiable instrument, issued
contains an order to the bank, to pay a by the bank in favour of a certain person or
certain sum of money to a specified entity, to transfer of money from one place to
person. another.

Order of payment By the account holder to the bank. By the branch of a bank to another branch of the
same bank.

Payment Payable either to order or to bearer. Always payable on demand to a specified party.

Issuance The cheque is issued by a customer of Demand Draft is issued by a bank.

the bank.

Bank Charges for No Yes

issuance

Drawer Customer of the bank. Bank itself.

Signature It must be signed by the party issuing it, It contains seal and signature of the authorized
be it an individual or authorized officer and the rubber stamp of the bank.
signatory of a firm.

Parties Involved Three Parties Two Parties

Dishonor Yes No

o Difference between Cheque and DD

50
 o How to Cancel a DD

You Paid Through Cash: You have to submit the original draft along with
the receipt to the bank to get the refund. The bank will deduct around Rs. 100
to Rs. 150.

You Paid Through Cheque: If you paid the amount through cheque and the
amount is deducted from your bank account, you need to submit the original
draft with a duly filled cancellation form and the amount will be credited back
to your account with a deduction of Rs. 150.

2. MT Payment
Means any electronic or other message utilized by a financial institution to instruct the
Bank to make a payment of a certain amount to an MT Beneficiary, which
message may be: (i) a SWIFT MT102, SWIFT MT102+, SWIFT MT103, SWIFT
MT103+ or any other MT100-series message under the SWIFT message system or (ii)
any other type of message, including one sent via telex or the internet,
MT Payment means any payment made from time to time by an MT Payor to
the Bank in consideration of which the Bank incurs an obligation to make either a
corresponding deposit to an account of an MT Beneficiary at the Bank or a payment
to an MT Beneficiary that is (or is of the type that qualifies to be) notified to the Bank
via an MT Payment Order (which obligation of the Bank is in no way altered by the
transactions contemplated by the Transaction Documents).

3. Telegraphic Transfer (TT)

A telegraphic transfer (TT) is an electronic method of transferring funds utilized

primarily for overseas wire transactions. These transfers are used most commonly in
reference to Clearing House Automated Payment System (CHAPS) transfers in the
U.K. banking system. Telegraphic transfers are also known as telex transfers. It is a
quick and safe mode of transferring money overseas.
 o Advantages of TT
 The child will receive the funds quickly within 1-5 business days. In
case the child needs money for moving houses the following week,
they won't have to wait a long time to receive the funds to pay for it
 Since it is electronic, it is a safe and secure mode of sending money.
 It can be easily tracked, eliminating the need to figure out how much
money was sent, and when was it sent.
 Transfer of funds can be initiated from anywhere, at any time
o Disadvantages of TT
 The speed of transfer influenced by many factors
 No uniform standard for charging fees, which depends on different
banks
 Require much information to confirm and it may cause unnecessary
steps
 Not suitable for small transfer from small businesses

4. Real-Time Gross Settlement (RTGS)

Real-time gross settlement is the continuous process of settling interbank payments
on an individual order basis across the books of a central bank. This system's process
is opposed to netting debits with credits at the end of the day. Real-time gross
settlement is generally employed for large-value interbank funds transfers. RTGS
systems are increasingly used by central banks worldwide and can help minimize the
risks related to high-value payment settlements among financial institutions.

o How to make an RTGS Transaction?

RTGS transactions can be carried out online as well as offline. Depending on the
mode you opt for, you would need to follow the steps mentioned below:

52
 1) RTGS Through Netbanking
To transfer funds instantly, you must first register yourself for RTGS services
online through your net banking portal. Once that is done, you need to enter the
RTGS details for the beneficiary, the amount you would like to transfer and
authenticate the payment.
2) RTGS Through Bank
If you do not have access to RTGS net banking, you can still transfer money from
one account to another using the Real-Time Gross Settlement system offline. All
you need to do is visit your nearest bank branch, fill in the RTGS form with the
beneficiary details, and pay the amount in cash or cheque

o Pros or Advantages of RTGS:

1. RTGS is one of the safest as well as the fastest mode of interbank transfer.
2. It is a paperless transfer of funds.
3. There are no additional charges levied for RTGS transactions.
4. The beneficiary is not required to visit the bank, to deposit the money.
5. The funds can be transferred using the internet banking service.
6. This facility is available on all business days, whose timings may vary from bank
to bank.
7. It is an immediate fund transfer mechanism.
8. RTGS is now available 24*7 from Monday to Sunday.
9. RTGS facility can be availed either online through mobile or internet banking or
offline through the bank branch.
10. It does not involve any credit and settlement risk for the recipients as every
transaction is settled instantly.
11. The customers are enabled to predict the cash flow by knowing when their
account will be credited and debited.
 o Cons or Disadvantages of RTGS:
1. RTGS does not provide the facility to track the transaction to its customers. As
only the provide confirmation is implemented by the central bank. In which the
remitting bank gets a message of fund transfer to the beneficiary bank, from the
central bank.
2. RTGS is that the gross system has the gridlock risk that does not have enough
money.
3. The minimum amount that can be remitted through RTGS is Rs 2 lac with no
upper limit.
4. The RBI of India has only implemented the positive confirmation in which the
remitting bank receives a message of fund transfer to the beneficiary bank from
the RBI
5. Foreign Inward Remittance Scheme (FIRS)
Every year, non-resident Indians worldwide send billions of rupees to India for a
variety of reasons, from funding investments to supporting family back home. Inward
remittance refers to the transfer of money to Indian from abroad. For example, when
you receive money in your Indian bank account from a relative abroad, it is called
inward remittance.

6. Savings Bank (SB) Account

A savings account is an interest-bearing deposit account held at a bank or other
financial institution. Though these accounts typically pay a modest interest rate, their
safety and reliability make them a great option for parking cash you want available
for short-term needs.

o Savings Account Advantages

1. Access and availability. Savings accounts are easy to open and you can withdraw
and deposit money anytime (within federal limits) at ATMs or via 24-hour, online
access, unlike long-term investment accounts. Many institutions will allow you to
link your savings account to other accounts, like a checking account, which can help

54
you to avoid costly overdraw fees. This also allows you to quickly transfer funds
from one account to another.
2. Protection. A savings account at a bank that is a member of FDIC, (Federal Deposit
Insurance Corporation) insures your money for up to $250,000. If you use a credit
union covered by NCUA insurance, your account is also covered up to $250,000.
3. It’s a liquid asset. Savings accounts deal in cash, which means you don’t have to
worry about selling investments or making other complicated moves to access your
money.
4. Savings accounts accrue interest. Although interest rates have been extremely low
since 2007, you will still accrue interest over time with a savings account. The rates
depend on the bank, but the national average is about 0.09 percent, with high-yield
interest rates of up to 2.05%.
5. Low startup requirement. Many savings accounts can be started for few amounts.
Some institutions allow an account to be opened for as little as, so you can begin
saving with even a modest amount.
6. Automated bill payments. Many financial institutions allow bills to be paid
automatically out of a savings account without being subjected to the withdrawal and
transfer laws, helping you avoid late fees or missed payments.
7. No lock-in period. You’re not locked in for any period of time, which means you can
switch savings accounts as often as you like.

o Savings Account Disadvantages

1. Minimum Balance Requirements. Most savings accounts have minimum balance

requirements or monthly maintenance fees. If your savings account falls below the
minimum balance requirement, the bank will deduct fees from your account, negating
from interests you earned.
2. Low Interest Rates. Interest rates are lower compared to other types of accounts or
investments, such as money market accounts or certificate of deposits (CD).
3. Federal Withdrawal Limits. Due to Regulation D, savings accounts have federal
limits when withdrawing funds, which is six times per month. The banks will charge
you a fee if you exceed the federal limits, or they can change your account from
savings to checking accounts if you continue on withdrawing more than six times per
month.
56
4. Access and availability. Yeah, we know this is in the advantage category, too, but if
you find easy access to these funds is too much of a temptation, then that could make
long-term saving difficult.
5. Rates can change. Savings account interest rates are variable, meaning that financial
institutions are free to set and change interest rates as they wish. High-interest savings
account rates will stay largely in line with the movements of the federal rate.
6. Inflation. If your savings account doesn’t pay a competitive interest rate, inflation
could be eating up the value of your earned interest, leaving you with an account
balance that’s worth less a year from now than it is in today’s dollars
7. Compounded interest. Most traditional banks or credit unions compound your
savings account interest monthly, or even annually. This means the full potential of
your money isn’t always realized, especially when compared to other investment
opportunities.

7. Fixed Deposit (FD) Account

All Banks offer fixed deposits schemes with a wide range of tenures for periods
ranging from 7 days to 10 years. These are popularly known as Fixed Deposit (FD) or
Term Deposit (TD) accounts. A fixed deposit, also known as an FD, is an investment
instrument offered by banks, as well as non-banking financial companies (NBFC) to
their customers to help them save money. With an FD account, you can invest a
sizeable amount of money at a predetermined rate of interest for a fixed period. At the
end of the tenure, you receive the lump sum, along with an interest, which is a good
money-saving plan. Banks offers different rates of interest for a fixed deposit account.

o Features of FD
 The investment tenure of FDs ranges from one day to several years, and it varies
across banks
 The return on investment is compounded periodically, and it may be monthly,
quarterly, or annually
 Senior citizens are provided with slightly higher returns (0.5% higher)
 Partial or full withdrawals are permitted (with penalties)
  Taxpayers can invest in tax-saver FDs to save taxes under Section 80C
 Once the investment matures, investors can reinvest for another term
 Loan against FDs are available
 Investors will accumulate higher returns if they invest for a more extended period

o Benefits of FD
 Returns are assured as they are not tied with the market
 At times of financial emergencies, one can avail a loan against their FDs
 Investment is safe as banks and other financial institutions are always under the
purview of the Reserve Bank of India (RBI)
 Compounded interest makes your investment grow at a much faster rate
 Premature withdrawals are allowed, so you will always have a corpus to fall back
on at times of crisis.
8. Current Deposit (CD)
Current Accounts are basically meant for businessmen and are never used for the
purpose of investment or savings. These deposits are the most liquid deposits and
there are no limits for number of transactions or the amount of transactions in a day.
Most of the current accounts are opened in the names of firm/company accounts.
Cheque book facility is provided and the account holder can deposit all types of the
cheques and drafts in their names. No interest is paid by banks on these accounts. In
some cases, banks even charge certain service charges, on such accounts. The
important features of Current Accounts are as follows:
Features of CD
a) The main objective of Current Account holders in opening this type of
account is to enable them to conduct their business transactions smoothly.
b) There are no restrictions on the number of times of deposits in cash or
cheques.
c) Usually banks do not pay any interest on such current accounts. However, in
recent times some banks have introduced special current accounts where
interest (as per banks’ own guidelines) is paid.

58
 d) The current accounts do not have any fixed maturity as these are on
continuous basis accounts.

o Benefits of a Current Account

 Allows for prompt business transactions
 No limit on withdrawals
 No limit on deposits in the home branch
 Enables businessmen to make direct payments using cheques, demand drafts, or
pay orders
 Provides overdraft facility
 Provides internet banking and mobile banking facilities

9. Recurring Deposit
This is one form of savings deposit. In this type of deposit, at the end of every week or
month, a fixed amount is deposited regularly. The amount can be withdrawn only
after the expiry of the specified period.

o Features of RD Account

 Recurring Deposit schemes aim at inculcating a regular habit of saving in people

 The minimum amount for deposits often varies from one bank to another. You could
invest with an amount as small as Rs. 1000.
 The minimum period of deposit is six months, while the maximum period of a deposit
is 10 years
 The rate of interest is equivalent to that offered for a Fixed Deposit. Therefore, the
interest rates are higher than Savings Account.
 Premature withdrawals are However, depending on the bank, they may allow you to
close your account before the maturity period on certain conditions.
 A Recurring Deposit can be funded periodically through Standing Instructions that are
usually instructions given by the customer to the bank, to credit the RD account every
month from his/her Savings or Current Account.
 10. NRI Account
An NRI Account refers to the accounts opened by a Non-Resident Indian (NRI) or a
Person of Indian Origin (PIO) with a bank or financial institution which is authorised
by the Reserve Bank of India (RBI), to provide various services.

Types of NRI Account

1) Non- Resident Ordinary (NRO) Account
An NRO or Non-Resident Ordinary Account may be opened with earnings arising
from India. The source of income can range from assets or investments in the form of
rent, dividends, interest, etc.

Here are some important features related to the NRO account:

o Even though deposits can be in INR or any other foreign currency, the withdrawals
can only be in Indian rupees in an NRO account.
o An NRO account can be operated jointly either with an Indian Resident or an NRI.
o Interest earned on the income in an NRO account is liable for taxation.
o Earned income from pension, rents, etc. can be sent through an NRO account.
o The main purpose of an NRO account is to house funds from the earned income in
India or abroad.

2) Non-Resident External (NRE) Account

NRIs may initiate and maintain a Non-Resident External or NRE Account from their
income originating in their country of employment/ residence.

Here are some key features related to NRE Account:

o The account shall be denominated in Indian Rupees.

60
o An NRE account can be in the form of a Current account, Savings account, Recurring
Deposit account, or Fixed Deposit account.
o An NRE account can be operated jointly but only with another NRI.
o Deposits in an NRE account can be made of earnings from a foreign country only and
not of earnings made in India.
o Withdrawals can be made in the currency in which the NRI resides in and therefore
there is a possibility of amount fluctuation.
o Funds from one NRE account can be transferred to another NRE or NRO account
easily.
o Income from the NRE account is tax-free as the principal and interest amounts are
exempted from taxation.
o Investments in India can be made with the help of the NRE (Non-Resident External)
account.

3) Foreign Currency Non-Resident (Banks) Account

Foreign Currency Non-Resident (Banks) Account or FCNR-B comprises bank

deposits made by NRIs, PIOs, and OCIs. These deposits may be denominated in any
one of the foreign currencies prescribed by the Reserve Bank of India.

Here are some key points related to an FCNR (Foreign Currency Non-Resident)
account:

o The currencies in which FCNR-B deposits may be held in an Account are – US

Dollars (USD), Great Britain Pound Sterling (GBP), Euro (EUR), Singapore Dollar
(SGD), Hong Kong Dollar (HKD), Canadian Dollar (CAD), Australian Dollar
(AUD), Swiss Franc (CHF) and Japanese Yen (JPY).
o Money can be deposited in an FCNR account in any currency approved by RBI.
o FCNR accounts are considered to be term deposit accounts and not savings accounts
o . Interest rates vary from the tenure of deposit and currency deposited in the FCNR
account.
o The rate of interest is fixed in an FCNR account and does not fluctuate throughout the
deposit tenure.
o In case of change in residential status, an account can be held till maturity but the
interest rate may fluctuate as per bank guidelines.
o An FCNR account can be operated jointly either with a close Indian resident or an
NRI.
o FCNR Account tenure ranges from 1 year to 5 years.
o Income from the FCNR account is tax-free as the principal and interest amounts are
exempted from taxation.
o The rate of interest does not fluctuate in an FCNR (Foreign Currency Non-Resident)
account because of the deposits and withdrawals made in foreign currencies.

o Advantages of NRI Account

1) Enables Inward Remittances

One of the primary benefits of the NRI account is that NRIs can repatriate their
income to their dependents in India. For example, Mr. Aayush is employed in San
Jose, USA, but his father, a dependent individual, stays in Mumbai. He remits USD
2000 every month in his NRO Savings Account to meet his father’s daily expenses.
The balance in this NRO account is denominated in Indian Rupees. Assuming an
exchange rate of 1USD = Rs.75, the remittance of USD 2000 would be denominated
as Rs. 1,50,000 in the NRO Account.

2) Assures Continuity of Income

One of the benefits of the NRI account is that NRIs can continue to earn income from
their assets in India. For example, Ms. Manasi, who is residing in London, Great
Britain, has a residential flat in Bengaluru, which she has leased to Mr. Kishore. To
receive rental income from the lease, Ms. Manasi may direct Mr. Kishore to deposit
the monthly rent in an NRO account opened with a bank in Bengaluru.

62
3) Enables Investment in India

NRIs can invest in Indian investment avenues such as equity, mutual funds, debt
instruments, etc., through the NRI account. These investments are facilitated through
the Portfolio Investment Scheme (PIS), a scheme enabled by the Reserve Bank of
India, through banks and FIs, to facilitate trading and investments by NRIs in India.

4) Avoidance of Exchange Rate Fluctuations

The deposits made by NRIs from their income earned in a foreign country in an
FCNR-B account need not be converted into INR. This facility allows NRIs to
mitigate the risk of foreign currency rate fluctuations and the resultant reduction in
deposit value.

5) Attractive Returns

NRIs can earn interest income at attractive rates by investing in NRI accounts such as
NRE FDs or FCNR-B deposits. Interest rates in India have been higher than in many
western countries for many years.

6) No Tax Liability

Interest income on NRE and FCNR (B) accounts does not have any tax liability under
the Income Tax Act 1961.

7) Loan Facility

The authorized bank/ FI can sanction loans in India to the NRI account holder or any
third party against the security of the money deposited in the NRI account. The term
‘loan’ would include all types of fund-based/non-fund-based facilities.

********************
 MODULE IV

 Loans and Advances in Banking Services

 Advances

Advances are the source of finance, which is provided by the banks to the companies to
meet the short-term financial requirement. It is a credit facility which should be repaid
within one year as per the terms, conditions and norms issued by Reserve Bank of India for
lending and also by the schemes of the concerned bank.

11. Types of Advances

Some types of Advances are given below :
1. Loan
2. Cash Credit (CC)
3. Over Draft (OD)
4. Discounting of Bills

1. Loans

Funds borrowed by an entity from another entity, repayable after a specific period carrying
interest rate is known as Loans. The amount lent by the lender to the borrower for a specific
purpose like the construction of the building, capital requirements, purchase of machinery
and so on, for a particular period of time is known as Loan. In general, loans are granted by
the banks and financial institutions. It is an obligation which needs to be repaid back after
the expiry of the stipulated period. Loan may be of two types -
a) Demand Loan: Demand loans are repayable on demand of the bank. These are short
term loan repayable within a period of 36 months but bank can recall the amount at any
time. Such loan are raised normally for meeting working capital need, like purchase of raw
materials, making payment of short-term liabilities etc.
b) Term loan: Medium and long term loan are called term loan. Term loans are granted for
more than a year and repayment of such loans is spread over a longer period. Term loan is
64
given for the purpose of starting a new business activity, renovation, modernization,
expansion of existing units and for financing fixed assets.
o Advantages of Loan
Following are the advantages of loan
i. Simple and Profitable: Loan system is simple compared to other credit system.
It is profitable for banks because bank charge interest on the total amount
sanctioned not on the actual amount withdrawn by the borrowers.
ii. Review of Loan Account: Banker can review the loan account of the borrower
as and when a loan is granted or renewed. If the banker is not satisfied, the
account may be discontinued.
iii. Financial Discipline: In loan system the time and the amount of instalment for
repayment is fixed in advance. This bring a great degree of financial discipline.

o Disadvantages of Loan
 Larger loans will have certain terms and conditions or covenants that you must
adhere to, such as the provision of quarterly management information.
 Loans are not very flexible - you could be paying interest on funds you're not
using.
 You could have trouble making monthly repayments if your customers don't pay
you promptly, causing cash flow problems.
 In some cases, loans are secured against the assets of the business or your
personal possessions, eg. your home. The interest rates for secured loans may be
lower than for unsecured ones, but your assets or home could be at risk if you
cannot make the repayments.
 There may be a charge if you want to repay the loan before the end of the loan
term, particularly if the interest rate on the loan is fixed
2. Cash Credit (CC)
Cash credit is an arrangement whereby the bank allows the borrower to draw amounts
upto a specified limit. The amount is credited to the account of the customer. The
customer can withdraw this amount as and when he requires. Interest is charged on the
amount actually withdrawn. Cash credit is granted as per agreed terms and conditions
with the customers

Important Features of Cash Credit

a) Borrowing limit :- A cash credit comes with a borrowing limit determined by the
creditworthiness of the borrower. A company can withdraw funds up to its established
borrowing limit.

b) Interest on running balance :- In contrast with other traditional debt financing methods
such as loans, the interest charged is only on the running balance of the cash credit
account and not on the total borrowing limit.

c) Minimum commitment charge :- The short-term loan comes with a minimum charge
for establishing the loan account regardless of whether the borrower utilizes the available
credit. For example, banks typically include a clause that requires the borrower to pay a
minimum amount of interest on a predetermined amount or the amount withdrawn,
whichever is higher.

d) Collateral security :-The credit is often secured using stocks, fixed assets, or property as
collateral.
e) Credit period :-Cash credit is typically given for a maximum period of 12 months, after
which the drawing power is re-evaluated.

66
o Advantages of Cash Credit

a) Source of working capital financing :- A cash credit is an important source of working

capital financing, as the company need not worry about liquidity issues.
b) Easy arrangement :- It can be easily arranged by a bank, provided that collateral
security is available to be pledged and the realizable value of such is easily determined.
c) Flexibility :- Withdrawals on a cash credit account can be made many times, up to the
borrowing limit, and deposits of excess cash into the account lower the burden of interest
that a company faces.
d) Tax-deductible :- Interest payments made are tax-deductible and, thus, reduce the
overall tax burden on the company.
e) Interest charged :- A cash credit reduces the financing cost of the borrower, as the
interest charged is only on the utilized amount or minimum commitment charge

 Disadvantages
a) High rate of interest :- The interest rate charged by a loan on cash credit is very high
compared to traditional loans.
b) Minimum commitment charges :- A minimum commitment charge is imposed on
the borrower regardless of whether the company utilizes its cash credit or not.
c) Difficulty in securing :- The short-term loan is extended to the borrower depending
on the borrower’s turnover, accounts receivable balance, expected performance, and
collateral security offered. Therefore, it can be difficult for new companies to obtain.
d) Temporary source of finance :- The loan is a short-term source of financing. A
company cannot rely on it for an extended period of time. After the expiration of the
loan, it must be renewed under new terms and conditions.

3. Over Draft (OD)

Overdraft is also a credit facility granted by bank. A customer who has a current account
with the bank is allowed to withdraw more than the amount of credit balance in his
account. It is a temporary arrangement. Overdraft facility with a specified limit is allowed
either on the security of assets, or on personal security, or both.
 Advantages of Over Draft
a) Perfect for mismatch of cash :- When payment dates arrive before all receivables
do, overdrafts are very helpful. For example, a business keeps only 5,00,000 in its
bank account and three checks amounting to a total of 6,00,000 need to be paid. In
such a case, the overdraft can be used to settle the outstanding check balances. The
account funds will be restored as receivables are paid.
b) Prevents bouncing checks :- Bouncing checks harms one’s credit standing. With a
bank account overdraft, bouncing checks is prevented.
c) Enables on-time payments :- In addition to the previous point, no payments are late
due to insufficient funds, because the overdraft shoulders the deficit. This protects the
account holder’s credit score and also helps them to avoid having to pay late fees to
suppliers
d) Saves time and paper :- Compared to standard long term loans, bank account
overdrafts are relatively easy to handle, requiring minimal paperwork.
e) Provides convenience :- Overdrafts can be made anytime, as needed, as long as the
agreement is not withdrawn by the bank.

4. Discounting of Bill.
Banks provide short-term finance by discounting bills that is, making payment of the
amount before the due date of the bills after deducting a certain rate of discount. The party
gets the funds without waiting for the date of maturity of the bills. In case any bill is
dishonoured on the due date, the bank can recover the amount from the customer. Bank
grants short term advances by discounting Bills of Exchange. Banks invest a good
percentage of their funds in discounting bills of exchange. This method is very much
popular in developed countries.

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 Classification of Advances/ Loans
Loans and advances may be divided into two broad categories on the basis of security offered
against loan. It may be secured advance or unsecured advance.

 Secured Loan
Secured advances are given on the security of some tangible assets like goods, building,
securities etc. According to sec. 5(i) (n) of Banking Regulation Act, “secured advance means
advance made on the security of assets the market value of which is not at any time less than
the amount of such loan.
 Types of Secured Loan

1. Pledge
Pledge is used when the lender (pledgee) takes actual possession of assets (i.e.
certificates, goods). Such securities or goods are movable securities. In this case the
pledgee retains the possession of the goods until the pledgor (i.e. borrower) repays the
entire debt amount.
Important features of pledge
(i) The person, whose goods are bailed is called pawnor or pledger, and to whom the
goods are pledged as pawnee or pledgee.
(ii) Ownership of the property is retained by the pledger, which is subject only to the
qualified interest which passes to the pledgee by the bailment.
(iii) The essential feature of a pledge is the actual or constructive delivery of the goods to
the pledgee. By constructive delivery it is meant that there will be no physical transfer of
goods from the custody of the pledger/ pawnor to the pledge/ pawnee. All that is required
is that the goods must be placed in the possession of the pawnee or of any person
authorized to hold them on his behalf.
(iv) The delivery of the goods may be 'physical' when goods are actually transferred and
'symbolic' as in the case of delivery of the key or 'constructive' as in the case of
adornment.
(v) Pledge can be created only in the case of existing goods (and not on future goods)
which are in the possession of the pledger himself.
(vi) Since the possession of goods is the important feature of pledge and therefore,
pledge is lost when possession of the goods is lost.
(vii) An agreement of pledge also known as deed of pledge may be implied from the
nature of the transaction or the circumstances of the case
(viii) To protect the interests of the concerned parties the agreement in writing should
clearly indicate the terms and conditions.

2. Hypothecation
Hypothecation is used for creating charge against the security of movable assets, but
here the possession of the security remains with the borrower itself. Thus, in case of
default by the borrower, the lender (i.e. to whom the goods / security has been
hypothecated) will have to first take possession of the security and then sell the same.
The best example of this type of arrangement is Car Loans. In this case Car / Vehicle
remain with the borrower but the same is hypothecated to the bank / financer.

Important features of Hypothecation

a) The charge hypothecation is applicable to movable assets.
b) The ownership and possession are held by the borrower of the assets
(security).
c) The document (hypothecation agreement) provides for a covenant, whereby
the borrower agrees to give possession of the goods (movable assets) when
called upon to do so by the creditor.
3. Mortgage
Mortgage is used for creating charge against immovable property which includes land,
buildings or anything that is attached to the earth or permanently fastened to anything
attached to the earth (However, it does not include growing crops or grass as they can
be easily detached from the earth). The best example when mortgage is created is
when someone takes a Housing Loan / Home Loan.

 Features of Mortgage
i. The mortgagee has no power to sell the property without the intervention of
the court. In case there is shortfall in the amount recovered even after sale of
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 the mortgaged property the mortgagor continues to be personally liable for
the shortfall.
ii. The mortgagee has no right to get any payments out of the rents and produce
of the mortgaged property
iii. The mortgagee is not put in possession of the property
iv. Registration is mandatory if the principal amount secured is Rs. 100 and
above.
4. Lien
A lien is a claim or legal right against assets that are typically used as collateral to
satisfy a debt. A creditor or a legal judgment could establish a lien. A lien serves to
guarantee an underlying obligation, such as the repayment of a loan. If the underlying
obligation is not satisfied, the creditor may be able to seize the asset that is the
subject of the lien. There are many types of liens that are used to secure assets.

 Features of Lien
a) Possession is essential for exercising the right of lien. Without
possession, there can be no lien
b) The right of lien arises from statute or law, not from a contract.
c) The possession must be rightful, and not obtained by force, fraud or
misrepresentation.
d) The right of lien is a right to possess something, not to sell it.
e) The person holding the right of lien is not the actual owner-he is somebody
other than the owner.
f) The right of lien is not transferable to a third person.
g) The lien terminates when the bailee’s demands are met.
h) When the possession terminates, the lien also terminates.
 Types of Lien
1. Bank Lien :- Bank lien is the lien which is often granted when the individual takes a
loan from a bank to purchase an asset. For instance, you borrow a loan from a bank to
buy yourself a car. The price of the car will be paid by the loan amount. This gives
the bank the legal right to grant lien on the car. Now, in case you fail to repay the
loan and interest that was promised at the time of borrowing the loan, the bank has
the right to take the asset that is the car, into their possession. However, if you
successfully pay off the loan on time, the bank will release the lien and you will
become the rightful owner of the car.
2. Judgement lien :- When a lien is placed on the asset by the court, usually as a result
of a lawsuit, it is referred to as a judgement lien. This judgement lien can be helpful
to the defendant in getting paid back in a nonpayment case by liquidating the assets
of the accused.
3. Mechanic’s lien :- The lien attached to real property in case the owner fails to pay a
contractor for the services he has rendered is referred to as a mechanic’s lien. In case
the owner never goes through with the payment, the contractor has every right to take
the debtor to the court and get a judgement in which usually the property or assets are
auctioned off to pay the lien holder.
4. Real estate lien :- The legal right to seize or sell a real estate property on
nonfulfillment of a contract is referred to as a real estate lien. In case you borrow a
loan from a bank in order to buy a house, a lien is placed on the house by the bank
until you pay off the mortgage. If you fail to repay the mortgage the bank has the
legal rights to seal your property.
5. Tax liens :- Tax liens are the liens created by law. The law often allows tax
authorities to put liens on properties of taxpayers who do not pay the taxes on time.

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Basis Pledge Hypothecation Mortgage

Type of Security Movable. Movable. Immovable.

Possession of Remains with Remains with Usually Remains

the security lender(pledgee). Borrower. with Borrower.

Examples of Gold Loan, Car/Vehilce Housing Loans.

Loan where Advance against Loans, Advance

used NSCs, Advance against stock

against goods and debtors.

(also given under

hypothecation).

Difference between Pledge, Hypothecation and Mortgage

 Principles of Granting Loan

while granting loan the banker should consider the following Principles
a) Safety – ‘Safety’ is the main principle of lending. Safety means that the borrower is in
a position to repay the loan, along with interest. In order to ensure safety the banker
should advance loans and advances only against tangible securities. Further, the
character of the borrower, his capacity to repay and his financial strength should
also be considered before a loan is sanctioned.
b) Liquidity – Liquidity means ability to convert an investment in to cash quickly with
little or no loss in value. Liquidity is the important principle of bank lending. The
banker should ensure that the borrower is able to repay the loan, along with interest
according to the terms of the loan contract.

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c) Profitability – The ultimate objective of lending is to earn profit. Main source of
profit for banks is interest from loans and advances. Bank must employ their funds
profitably so as to earn sufficient income to pay interest on deposit, salaries to the
staff and to meet various other establishment expenses and to ensure a fair return to
the owner of the bank that is shareholders.
d) Security - Banks generally do not lend to customers without security or collateral.
This is because loans are always a risk of default and banks take security to serve as
insurance against such risks.
e) Repaying Capacity :- Bank should ensure that borrower can repay the amount along
with the Interest.
f) Project Appraisal :- Project appraisal means Bank should make a detailed evaluation
of granting loans such as whether borrower can repay the amount, Whether given
details of borrower is right or not. Sometimes banks occur a field survey it is coming
under this.

********************
 MODULE V

 Cyber Crimes in Banking

Digital wrongdoing can be explained as a contravention that includes a place of
wrongdoing, target, instrument, source, PC and a network as a medium. With the increased
digital based business transactions, these wrongdoings have floated towards an advanced
world. These kind of digital assaults are increasing all around and India has been seeing a
sharp increase in digital contravention cases in the previous few years. In 2016 an
investigation by Juniper Exploration evaluated that worldwide expenses of cybercrime could
be as high as 2.1 trillion by 2019
 The below are the effects
i. Financial loss
ii. Infringement of confidential information
iii. Legal consequences
iv. Sabotage and theft to identifiable information
v. Exposed to reputation risks
vi. Operational risks

Digital violations can be comprehensively be arranged into classification such as

digital harassing, programming robbery, wholesale fraud, Email spam, online robbery

Types of cybercrimes connected with banking sector:

i. Hacking
Hacking is a cybercrime that involves a person gaining illegal access to a system or
attempting to circumvent security mechanisms by hacking into customers' accounts
or banking sites. ''A hacker, however, can be prosecuted under Sections 379 and 406
and also u/s 43(a) read with Section 66 of the Information Technology (Amendment)
Act, 2008'' If the crime of hacking is proven, the convicted may be sentenced to
three years in prison or a fine of up to five lakh rupees, or both, under the IT Act.

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ii. Key logging
It is referred to as ''keystroke logging or keyboard capturing''. It is the process of
secretly recording (logging) the keys pressed on a keyboard so that the person using
it is oblivious that their activities are being tracked and these are incredibly harmful
for stealing confidential information such as banking details etc.
iii. Viruses
It is a kind of self � replicating program that infects executable code or documents
by inserting copies of itself. A virus is a programme that afflicts an executable file
and causes the file to behave abnormally after infection. It spreads by linking itself
to executable files such as programme files and operating systems. Loading the
executable file could result in new copies of the virus being created. Worms, on the
other hand, are programmes that can replicate themselves and send copies to other
computers from the victim's computer. Worms do not change or remove any files;
instead, they multiply and send copies to other computers from the user's computer.
iv. Spyware
Spyware is the most common approach of stealing online banking credentials and
using them for fraudulent purposes. Spyware operates by collecting or transmitting
information between computers and websites. It is mostly installed by bogus 'pop up'
advertisements to have software downloaded. Industry standard Antivirus products
detects and removes this type of software, primarily by blocking the download and
installation before it infects the PC.
v. Phishing
Phishing is a kind of swindle in which private information such as Debit/Credit Card
number Customer ID, IPIN, CVV number, Card expiry date, and so on is stolen via
emails that seem to be from a genuine source. Phishing is accomplished through the
use of instant messaging and email spoofing.

In this type of crime, hoaxers act like officials of banks and they create a direct link
that directs the targeted customers to a fake page which looks alike to the actual bank
website. The acquired confidential information is then used to commit deceitful
 transactions on the customer's account. Phishers these days also use SMS
(Smishing) and mobile (voice phishing) to commit such crimes
vi. Pharming
Pharming is carried out through the internet. When a customer logs in to a bank's
website, the attackers hijack the URL in such a way that they are routed to another
website that is false but appears like the bank's original website.
vii. ATM Skimming and Point of Sale Crimes
Installing a skimming device atop the machine keypad to appear as a real keypad or
a device made to be affixed to the card reader to appear as a part of the machine is a
tactic for compromising ATM machines or POS systems. Malware that directly
steals credit card data may also be installed on these devices. Skimmers that are
successfully installed in ATM machines retrieve personal identification number
(PIN) codes and card numbers, which are then copied to perform deceitful
transactions.

 Fraud Management

Fraud management is based on the analysis of the activities of a company, institution, or

organisation that are susceptible to fraud, disloyalty, or breach of trust in its financial
relationships. Fraud management and prevention activities should be framed within the
company’s risk management rulebook. Fraud is one of the main risks faced by companies in
the banking and financial industry due to the nature of their operations.
Revenue assurance and fraud management must be implemented throughout all company’s
branches and departments with fraud management solutions that assess the operational, legal,
labour, commercial, and financial areas. This will allow a complete understanding of all the
fraud risks and complications that may arise in the normal development of the company’s
activities.

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 Fraud Management Purpose

 Development of preventive measures through the implementation of fraud

management solutions that guarantee maximum security in the company’s activities.
 Supervision of all company processes to minimise the detection time as much as
possible.
 Ensuring fluent and secure internal communication to create a safe channel for
detection and reporting.
 Investigate any fraud or fraud attempt (such as bank manager fraud) from a 360º
approach.
 Follow-up of the implemented plans of action.

 Fraud Case Management Stages/ Steps of Fraud Management plan

Anti-fraud risk management organisations warn companies and institutions of the
importance of creating a comprehensive fraud management system that successfully
prevents, detects, and corrects any fraud attempts before they cause irreversible damage
to the company
These comprehensive fraud management plans usually have 5 main stages

1. Implement a fraud risk management policy as part of corporate governance and

create a scorecard covering all competencies necessary for fraud detection and
prevention.
2. Conduct a rigorous fraud risk assessment using the information collected from the
alerts and controls set out in the fraud management policy
3. Implement preventive and detective fraud risk control activities and
solutions that enable to take action in the shortest time possible to minimise possible
damage.
4. Develop an effective and secure fraud reporting process to enable an effective
investigation and the implementation of corrective actions.
5. Monitor the fraud case management process to control its results and improve its
performance.
 Information System in Banking
Information system, an integrated set of components for collecting, storing, and processing
data and for providing information, knowledge, and digital products.
Bank Information Systems means Information Systems owned, licensed, maintained, or
used by Bank in the ordinary course of Bank’s business and/or for the purpose of carrying out
Bank’s rights and duties under this Agreement; provided, that Bank Information Systems
shall exclude any Company Information Systems that Bank merely uses or has access to for
purposes of operation of the Plan.
Eg : If you are a guarantor or a security provider to a credit facility granted to a customer of
our Bank: name, gender, marital and family status, residency, financial and economic
background and circumstances, as provided directly from you or from other sources (e.g.
Artemis Bank Information Systems Limited, Land Registry Offices).

 Advantages

Information Systems have improved banking in several ways:

1. More work can be done in lesser time- This benefits both the banks themselves
and the bank users, queues are shorter & less staff need to be employed
2. Quicker decision making- Important decisions can be made a lot quicker- for
example when applying for credit, banks can quickly assess the person through
the IS system by simply using their name & details.
3. Process the transactions quickly- Transactions can be done a lot faster not only
in the bank but also by use of debit card by bank users elsewhere or at ATMs.
4. Manage online transactions- People can now do their banking without going
near the bank by simply using online banking. This again saves on labour for the
banks. You can make payments, transfers or check your bank statement online.
Online banking is a result of implementation of Information systems in the banks.

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 5. Providing better customer care along with other customer support
services- Banks have more information at hand on a person & so can be more
helpful. For example if you wanted to cancel your bank card, information systems
allow the bank to look up one detail about you and find the account you wish to
cancel within minutes.

 Financial Crisis
A financial crisis is any of a broad variety of situations in which some financial assets
suddenly lose a large part of their nominal value. In the 19th and early 20th centuries, many
financial crises were associated with banking panics, and many recessions coincided with
these panics. Other situations that are often called financial crises include stock market
crashes and the bursting of other financial bubbles, currency crises, and sovereign
defaults. Financial crises directly result in a loss of paper wealth but do not necessarily result
in significant changes in the real economy (e.g. the crisis resulting from the famous tulip
mania bubble in the 17th century). Global financial crisis during the period 2007-08 is a
recent example of this.

o Banking Crisis
When a bank suffers a sudden rush of withdrawals by depositors, this is called a bank
run. Since banks lend out most of the cash they receive in deposits (see fractional-
reserve banking), it is difficult for them to quickly pay back all deposits if these are
suddenly demanded, so a run renders the bank insolvent, causing customers to lose their
deposits, to the extent that they are not covered by deposit insurance. An event in which
bank runs are widespread is called a systemic banking crisis or banking panic.

 Risk Management in Banking Sector

Risk refers to an undesirable or an unplanned event concerning finances that can
result in loss of investment or reduced earning. It includes the possibility of losing
some or the entire amount of investment. Risk Management thus refers to managing
the impact of the risks by analyzing, forecasting and making predictions based on
the historical trends. It also includes taking corrective measures to reduce the
impact of the risks.
 Types of Risk
a) Liquidity Risk
b) Market Risk
c) Credit or Default Risk
d) Operational Risk
All these types of risks in detail below:
a) Liquidity Risk
This type of risk arises when an institution is unable to meet its financial
commitments or is able to do so only by external borrowing. This may be
due to the conversion of assets into NPAs. In the modern banking model,
this is the most vulnerable risk that banks are subjected to.
So, how do banks manage liquidity risk? Well, it can be efficiently
managed by creating a difference in the timeframe between asset maturity
and liability maturity. And then, by ensuring that those differences keep
enough funds flowing in the bank to both increase assets and meet
obligations when customers ask for their money.

b) Market Risk
It will not be an understatement to say that banks operate at the whims of the
market! Market risk is the risk that stems from the idea that the value of
investment might decrease due to changes in factors governing a market. It
is also known as a systematic risk because it is related to factors governing
the market such as recession that impacts the entire market and not just one
industry.
Managing market risk is very crucial in times like today when the
market is extremely volatile and unpredictable. The most efficient way to do
manage market risk is by diversification of funds. Ensuring that the assets
are held in a wide range of investment options can minimize the market risk.

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 c) Credit or Default Risk
Credit or Default Risk is simply the potential of the borrower to fail to meet
its obligations in accordance with the signed contract. Loans are the largest
and most obvious source of credit or default risk for most banks. Amongst
all, this is the most significant risk typically in the Indian banking sector
where NPA size is significantly high.
Although this risk can’t be avoided, there are certain ways that can
help in mitigating the risk. The banks manage this risk mostly by assessing
the worthiness of the borrower before sanctioning the loan. A credit score is
generated keeping various factors in mind, and on the basis of the score, a
loan is sanctioned or suspended
d) Operational Risk
Operational Risk is the risk of loss that arises due to breakdown in the
internal procedures, people and systems or from external events. It is
important to manage operational risk for banks because banks are exposed to
a higher volume of global financial interlinkages and a high level of
automation is being used in rendering banking and financial services.
The operational risk is managed by adding more internal rules and
accountability. Further, adding monitoring programs to identify this risk can
also be beneficial to mitigate the impact of operational risk.

 Financial Derivatives.
The term derivative refers to a type of financial contract whose value is dependent on
an underlying asset, group of assets, or benchmark. A derivative is set between two or more
parties that can trade on an exchange or over-the-counter (OTC).

These contracts can be used to trade any number of assets and carry their own risks.
Prices for derivatives derive from fluctuations in the underlying asset. These financial
securities are commonly used to access certain markets and may be traded to hedge against
risk. Derivatives can be used to either mitigate risk (hedging) or assume risk with
the expectation of commensurate reward (speculation). Derivatives can move risk (and the
accompanying rewards) from the risk-averse to the risk seekers.

o Features of Derivatives
 Derivatives have a maturity or expiry date post which they terminate
automatically
 Derivatives are of three types i.e, futures forwards and swaps and these assets
can equity, commodities,or financial bearing assets foreign exchange.
 All the transaction in the derivatives takes place in a future specified date
Doing this makes it easier to sell because an individual can take of markets
and take the position accordingly because one has more time in derivatives
 A derivative can be used as leverage instruments. The value of the derivative
can move exponentially in comparison to the value of its underlying
 There are no specified limits on the number of units that can be transacted in
the derivative market as there are no physical assets for transactions.
 The derivatives market is liquid and thus the transaction can be effected
easily

o Risk Management in Derivatives.

Risk Management: the prices of the derivates are related to underlying assets.
Thus any change in the prices of these assets will affect the denvatives market
Also, the derivates cannot be used to increase or decrease the risk of owning an
asset. For example, to reduce the risk you may choose to purchase a spot item
and set a futures contract. If the spot price falls, the corresponding futures or
options contract will be affected. You can then repurchase the contract at a
lesser price which will result in a gain. This will help you to partially recover
the loss on the spot item

Price discovery the derivatives market works as a key source of

information about prices. The prices of the derivative instruments can be used to
determine what the market expects the futures spot prices to be. Most often the
future and the forwards market are used as a price discovery mechanism

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 Operational advantage the derivatives market is more liquid than the spot
market. So the transaction costs are lower in this market. Other related costs
like commissions are also lower than the spot market

The derivatives market is much more efficient on account of risk

management, short-selling, price discovery and liquidity

 Banking Issues in 21 st Century

A recent, popular opinion is that the contribution of banks to the economy will diminish
significantly or that banks will even disappear, as the traditional intermediary and liquidity
functions of the bank decline in the face of new financial instruments and technology.
o Challenges/ Issues in Banking Sector
Below, given the challenges for banks and financial institutions in 21st Century.

a) Growth
This is a common goal for banks and financial institutions: enhancing market share
through new products and capabilities, as well as completing mergers and
acquisitions. The question is how to grow strategically, without exceeding a
sustainable pace or exceeding the organization’s risk tolerance.
In the case of M&A, the integration of various operational systems, technology and
workforces poses a range of difficulties, especially if those systems models are not
well-documented or understood across the business.

b) System and Security

As with digital adoption, many banks and financial institutions are weighed down by
legacy technology on the operational side of their business. Outdated back-end
systems may no longer be fit for purpose and are unlikely to integrate well with newer
systems. In some cases, this ‘technical debt’ may lead to vulnerabilities, requiring
frequent and expensive security checks.
c) Anti-Money Laundering
As a result of increased integration in the global financial industry, the misuse of
banking industry has been observed in recent years. These include the use of banking
services for activities like, terrorist financing, drug trafficking and money laundering.
In few countries although there is a comprehensive legislative systems and well
defined enforcement mechanism; but there are a number of countries where the entire
regulatory framework is at initial stage.
d) Rising Expectations
Today’s consumer is smarter, savvier, and more informed than ever before and
expects a high degree of personalization and convenience out of their banking
experience. Changing customer demographics play a major role in these heightened
expectations: With each new generation of banking customers comes a more innate
understanding of technology and, as a result, an increased expectation of digitized
experiences.

e) Customer Retention
Financial services customers expect personalized and meaningful experiences
through simple and intuitive interfaces on any device, anywhere, and at any time.
Although customer experience can be hard to quantify, customer turnover is tangible
and customer loyalty is quickly becoming an endangered concept. Customer loyalty
is a product of rich client relationships that begin with knowing the customer and
their expectations, as well as implementing an ongoing client-centric approach
f) Cyber Crimes :-
Technology and digitalised banking systems are more helpful and very
attractive in the current scenario. Most of banking activities are occurring
through e-banking. At the same time cybercrimes are increased in banking
sector such as hacking, Phishing etc. Banks and customers are facing loss
through this chaos.

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 g) Culture Shift
In the digital world, there’s no room for manual processes and systems. Banks and
credit unions need to think of technology-based resolutions to banking industry
challenges. Therefore, it’s important that financial institutions promote a culture of
innovation, in which technology is leveraged to optimize existing processes and
procedures for maximum efficiency. This cultural shift toward a technology-first
attitude is reflective of the larger industry-wide acceptance of digital transformation.
h) Outdated Mobile experience
These days, every bank or credit union has its own branded mobile application —
however, just because an organization has a mobile banking strategy doesn’t mean
that it’s being leveraged as effectively as possible. A bank’s mobile experience
needs to be fast, easy to use, fully-featured (think live chat, voice-enabled digital
assistance, and the like), secure, and regularly updated in order to keep customers
satisfied. Some banks have even started to reimagine what a banking app could be
by introducing mobile payment functionality that enables customers to treat their
smartphones like secure digital wallets and instantly transfer money to family and
friends.

 Financial Risk in 21 st Century

The 21st century has proven to be as economically tumultuous as the two preceding
centuries. This period has seen multiple financial crises striking nations, regions, and—in the
case of the Great Recession—the entire global economy. So here we discuss the financial
risk in 21st Century.
o The Global Financial Crisis
The global financial crisis (GFC) refers to the period of extreme stress in global financial
markets and banking systems between mid 2007 and early 2009. During the GFC, a downturn
in the US housing market was a catalyst for a financial crisis that spread from the United
States to the rest of the world through linkages in the global financial system.
 o Causes of Global Financial Crisis
i. Increased borrowing by banks and investors
In the lead up to the GFC, banks and other investors in the United States and
abroad borrowed increasing amounts to expand their lending and purchase MBS
products. Borrowing money to purchase an asset (known as an increase in
leverage) magnifies potential profits but also magnifies potential losses.[ As a
result, when house prices began to fall, banks and investors incurred large losses
because they had borrowed so much.
ii. Regulation and policy errors
Regulation of subprime lending and MBS products was too lax. In particular, there
was insufficient regulation of the institutions that created and sold the complex and
opaque MBS to investors. Not only were many individual borrowers provided with
loans so large that they were unlikely to be able to repay them, but fraud was
increasingly common – such as overstating a borrower's income and over-promising
investors on the safety of the MBS products they were being sold.

o Different Financial Issues of 21st Century

a) Limited or Inconsistent cash flow

Most companies struggle with managing cash flow. From simply invoicing
effectively so you bring in enough to cover the monthly bills to accumulating cash to
invest in growth, liquidity is an ongoing issue. Beyond those basics, companies
should develop cash flow forecasts based on historical performance and current
conditions. Always factor in contingencies—industry changes, economic downturns,
customer shifts—and use “what if?” scenarios to develop a realistic financial plan. In
fact, scenario planning is on top of many companies’ to-do lists, to avoid the
unprepared situation many found themselves in when the pandemic hit.
b) Lack of use of Budget
If you’re running your business by the seat of your pants, just hoping that there will
be enough in the bank to pay the bills at the end of the month, it won’t take long to

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 wind up with more debt and financial responsibilities than you can handle. Regularly
update your budget to reflect current circumstances and use it to make good business
decisions. A budget should be a living document, not something you write then toss
in a virtual (or literal) drawer.
c) No Preparation for unforeseen Expenses
Unforeseen expenses can derail any business’ best-laid plans. Having a dedicated
account in which you build up a rainy day fund will give your business a cash
reserve that can get you through tough times—or help you grow when the time is
right.

Here’s how it works: When times are good, put what you can into the account
and let it grow over time. You can also set up automatic transfers from your business
checking account to its savings account so that you don’t need to do it manually; the
money will be accessible if you need to pull some back. One advantage to a rainy day
fund is that it can help you minimize debt, thereby reducing interest expenses. Which
leads us to our next challenge

d) Not raising enough capital

One in five business owners who applied for funding during the prior five years was
denied, according to Nav’s Small Business American Dream Gap Report, and 82% of
all the business owners surveyed didn’t know how to interpret their companies’ credit
scores. The research also shows that individuals who have a better understanding of
their business credit scores are 41% more likely to be approved for a loan.
As we discuss in our piece on determining valuations, there are five main paths to
raising capital:

 Venture funding for young companies with strong growth potential.

 Private equity for those willing to give up a chunk of the company in exchange for
cash now.
 SBA-backed loans. These are somewhat easier to get today than they were a year
ago, but loan amounts are typically small.
 Bank loans without government backing. As always, strongly dependent on good
collateral and stable, growing revenue. Also, in a small business, likely dependent on
your personal credit. Your house may be part of the collateral.
 Friends and family and personal savings—the most popular options, based on data
from the Bureau of Labor Statistics.

e) Too Much Debt

Entrepreneurs are rightfully proud of “bootstrapping” their way to success, so it’s not
unusual for business owners to take on debt to launch their businesses. But
there absolutely is such a thing as too much business debt. Maybe they ran up a little
too much money on a personal credit card, or perhaps their local banker extended a
line of credit that’s now used up and commanding a high interest rate.
Whichever debt vehicle was tapped into, these situations can have significant short-
and long-term impacts on the company. For example, it can take time for a firm’s
positive cash flow to start, and in the meantime, there are employees, suppliers and
overhead to pay

f) Poor Tax Compliance

Cash management is difficult enough as it is; there’s no point in complicating things
by overpaying the IRS. Still, up to 85% of small businesses overpay on their federal
income taxes each year. Others underpay and wind up on the wrong side of the IRS
or other authorities. Both situations take time, effort and money to work through.
One of the biggest issues that businesses face regarding federal taxes isn’t payment.
It’s the cost of compliance. And this burden hits small businesses proportionately
harder than their larger counterparts. According to the IRS companies with under $1
million in revenue bear nearly two-thirds of business compliance costs.

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o How to overcome the financial Problems

a) Identify the Underlying Problem That's Causing the Difficulties

The first step to overcoming financial problems is to identify the underlying issue
that’s causing the financial difficulties. Financial problems are usually a symptom of
a bigger issue. To come up with solutions that work in the long run, take the time to
identify the real source of your financial troubles
b) Create a Budget
One of the best weapons for combating financial problems is a budget. A budget is a
monthly spending plan for your money. Creating a budget is like turning the lights on
to find your way around a dark room. You no longer need to wander in the dark;
banging your shins, tripping over the furniture, and stepping on the dog. Instead, with
the lights on, you can see what’s going on and prevent problems before they happen.
A budget works much the same way; it guides your spending decisions so that you're
spending money on what's really important to you. In this case, you'll spend your
money in a way that helps solve your financial problem.
c) Determine Financial Priorities to Guide Your Spending Choices To
overcome financial problems and solve your difficulties for good, you need to
determine what your priorities are. Some might be clear-cut financial priorities, e.g.
to pay off your credit cards. Others might be lifestyle-goals, based on your values,
e.g. save up for house repairs so that your family has a nice place to call home.
d) Identify Small Steps You Can Take to Address the Problem & Achieve
Your Goals
The solution to financial problems is often to reduce expenses, increase income, or do
some combination of both. This might not be something you want to do, and you’re
not alone. Most people don’t want to make changes to their lifestyle, but faced with
the choice of ongoing money troubles, or making several small changes to ease up on
the financial stress - most people are game to try. Big changes are always much
harder than small changes so to accomplish your goals, identify small steps you can
 take to achieve them. If you keep running into money problems because you’re $50
short every month, then maybe one of your first short term goals could be to pay off a
small credit card balance that requires a $50 minimum payment each month.

e) Develop Your Plan to Overcome Financial Problems for Good

Once you’ve come up with some ideas for how to begin tackling your financial
problems and difficulties, you can put together a realistic plan to accomplish your
goals. Some goals will have a timeline of a few months; others will need a longer
timeline, like 24 - 36 months. Write your goals down, but also write down where
you’re at now in relation to each goal. For example, if one of your goals is to pay off
a 40,000 debt, make sure to write down the current debt balance and your future goal
of paying this down to 0. You’ll want to include in your plan the amount of money
you’re going to pay on this debt every month so that you can pay it off within your
desired time frame. For more help on setting goals, have a look at this. Here are also
some tips on setting financial goals with your spouse.
f) Review How things are going
The last step takes place once you are a few months into working on your plan. Every
once-in-a-while, take a few minutes to review how things are going. Is your plan
working? Are you making progress toward your goals? If not, you’ll need to take a
closer look to figure out why not and adjust your plan. Your plan needs to be
realistic, or it’s not going to work. It should also contain some things you weren’t
doing before you put the plan in place.

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