1

BANKING PRINCIPLES AND L T P C Hrs

P20M
PRACTICE 3 1 0 4 40

Course Objectives
1. To be conversant with banking functions and operations.
2. To be aware of different lending activities available in the banking industry
3. To know the Asset Liability Management of Commercial Banks.
4. To be aware of the Negotiable Instrument Act.
5. To have an understanding of the use of technology in banking services

Course Outcomes
After completion of the course, the students will be able to
CO1- Understand the banking system in India
CO2-Know the different types of lending activities available in the banking industry
CO3-Understand the Asset Liability Management of Commercial Banks.
CO4-Aware of the Negotiable Instrument Act.
CO5- Understand the modern activities of the Banking Industry
Unit I: Introduction to Banking

Evolution of Banking – Banking in India –Types of Banks – Commercial Banks – Functions of Commercial
Banks – Credit Creation by Commercial Banks – Deposit mobilization by Commercial Banks – Types of
Deposits – Bank Customers – Banker-Customer Relationship – KYC Norms – Marketing of Bank Products and
Services-Financial Inclusion.

Unit II: Bank Lending

Forms of Bank Lending – Loans, Advances, Cash Credits, Overdrafts, Bills purchasing and Discounting –
Different types of Advances – Security for Advances – Types of Collaterals and their characteristics – Working
Capital Loans – Norms for WCL to businesses – Non-Performing Assets – Nature and Significance – Problems
of NPAs in Banking Industry in India.

Unit III: Asset Liability Management

Asset Liability Management (ALM) in banks: Components of Liabilities and Components of assets,
Significance of Asset Liability Management, Purpose and objectives. Prerequisites for ALM, Assets and
Liabilities Committee (ALCO) - Activities of ALCO

Unit IV: Negotiable Instruments ACT

The Negotiable Instruments Act 1881-Features of Negotiable instruments-Important concepts and explanations
under the Negotiable Instruments Act- The Paying Banker- Dishonour of cheques-Negotiation-Endorsement-
The Collecting Banker-Negligence-Bills of exchange and promissory note-Discharge of Negotiable instruments
-Hundis.

Unit V: Banking Technology

Banking Technology - Concept of Universal Banking-Home banking- ATMs- Internet banking-

Mobile banking- Core banking solutions- Debit, Credit, and Smart cards - Electronic Payment
Systems-MICR- Cheque Truncation-ECS- EFT- NEFT-RTGS
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Text Books
1. Sundharam and Varshney, Banking and Financial System, Sultan Chand & Sons
2. Banking Theory and Practice – K.C. Shekhar &Lekshmy Shekhar – Vikas Publishing
3. Indian Banking – S. Natarajan & R. Parameswaran – S. Chand Publishing

Reference Books
1. Modern Banking in India – O.P. Agarwal – Himayala Publishing House
2. Banking Theory, Law and Practice – Gordon & Natarajan – Himalaya Publishing House
3. Bank Credit Management – Murti &Subbakrishna – Himalaya Publishing House
4. Banking Operation Management – Bimal Jaiswal – Vikas Publishing

Web References
http://www.arraydev.com/commerce/JIBC/

http://www.businessfinancemag.com/

https://www.rbi.org.in/scripts/banklinks.aspx

https://www.rbi.org.in/Scripts/AboutusDisplay.aspx
COs/POs/PSOs Mapping

Program Outcomes (Pos)

Cos
PO1 PO2 PO3 PO4 PO5
1 1 1 - - 1
2 1 2 1 - -
3 - 1 1 2 1
4 1 1 - 1 1
5 1 1 1 - 1

Banking system and structure in India

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Evolution of Indian Banks

Banking in India originated in the last decades of the 18th century.

The first bank was The General Bank of India, which started in 1786.
Bank of Hindustan was the 2nd bank, which started in 1790; both are now defunct.
The oldest bank in existence in India is the State Bank of India, which originated in the Bank of
Calcutta in June 1806, which almost immediately became the Bank of Bengal.

The period between 1906 and 1911, saw the establishment of banks inspired by the Swadeshi
movement. A number of banks established then have survived to the present such as Bank of India,
Corporation Bank, Indian Bank, Bank of Baroda, Canara Bank and Central Bank of India.
During the First World War (1914–1918) through the end of the Second World War (1939–
1945), and two years thereafter until the independence of India were challenging for Indian banking.
From t h e Bank of Hindustan in 1770, the evolution of banking in India can be divided into three
different periods as follows :
Phase I: Early phase of primitive Indian banks to Nationalization of Banks in 1969
Phase II: From the Nationalization of India banks in 1969 up to the advent of liberalization and
banking reforms in 1991
Phase III: From Indian Financial and Banking Sector Reforms
1991 onward
Post Independence

India observed the emergence of large number of institutions for providing finance to different
sectors of the economy.
The entry activities of private sector and foreign banks were restricted through branch licensing
and regulation norms.
Steps taken by Indian Govt. to regulate banking are:
Reserve bank of India was nationalized on January 1, 1949 under the terms of Reserve bank of India.
In 1949, the Banking Regulation Act was in the act.
The Banking Regulation Act also provided that no new bank or branch of an existing bank could
be opened without a license from the RBI.
No two banks could have common directors.
Nationalization
The nationalization of banks in India took place in 1969 by Mrs. Indira Gandhi. It nationalized 14
banks. Before the steps of nationalization of Indian banks, only the State Bank of India (SBI) was
nationalized.
Nationalization of Seven State Banks of India (formed subsidiary) took place on 19th July
1960.
The second phase of nationalization of Indian banks took place in the year 1980. Seven more banks
were nationalized with deposits of over 200 crores.
The stated reason for the nationalization was to give the government more control of credit
delivery.
Adoption of banking technology

The IT revolution had a great impact on the Indian banking system:

Introduction of online banking in India.
Formation of the committee on Mechanization in the banking industry in 1984, providing
the use of standardized cheque forms and encoders.
Formation of the committee on Computerization in Banks (1988) which emphasized that
settlement operations must be computerized in the clearing houses of RBI.
Focused on computerization of branches and increasing connectivity among branches
through computers.
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Formation of Committee on Technology Issues relating to Payments System, Cheque

Clearing and Securities Settlement in the Banking Industry (1994) emphasized on Electronic
Funds Transfer (EFT) system, with the BANKNET communications network as its carrier.
ATMs installed in India by various banks as of the end of March 2005 is 17,642.
Types of Banks :
The public sector banks are owned and operated by the government, which has a major
share in them. The major focus of these banks is to serve the people rather than
earn profits. Some examples of these banks include the State Bank of India, Punjab
National Bank, Bank of Maharashtra, etc.
The regional rural banks were brought into operation with the objective of providing
credit to the rural and agricultural regions and were brought into effect in 1975 by
the RRB Act. These banks are restricted to operate only in the areas specified by t h e
government of India. These banks are owned by State Government and a sponsor
bank. This sponsorship was to be done by a nationalized bank and a State
Cooperative bank. Prathama Bank is one such example, which is located in
Moradabad in U.P.
The private sector banks are owned and operated by private institutes. They are free
to operate and are controlled by market forces. A greater share is held by private
players and not the government. For example, Axis Bank, Kotak Mahindra Bank etc.
Performance of public sector bank.

The financial system of any country consists of financial institutions, financial markets, financial
instruments, financial services, and financial assets. An efficient and smooth financial system plays
an important role in the nation's economic development. A well-developed country will have a
well-organized Financial Institutions.
Financial Institutions are an important part of the Indian Financial System. The institutions are
divided into two categories, banking and non-banking. Banks play a pivotal role in India's
economy. The year 1969 was a landmark in the history of commercial banking in India. In July
1969, the government nationalized 14 major commercial banks of the country. In 1980, 6
more banks were nationalized.
The First Five Year Plan held in 1951 according the development of the rural areas as the
highest priority. The plan was for the time period between 1951‒1956. The All India Rural
Credit Survey Committee advised the government to create state-partnered and state owned
banks. An act was passed in the parliament in May 1955 and the State
Bank of India was constituted. Later the State Bank of India Act was passed in 1959 to take
over the associate banks of SBI and its subsidiaries.
The pre-nationalization period saw a lion's share in the industrial sector to the bank's credit.
Large scale industries cornered a large portion of the credit and the share of small scale
industries was marginal. There were many reasons for the dominance of the large-scale
industries in the banking sector. Many commercial banks were under the ownership and control
of big industrial houses. A disturbing feature of the pre - nationalization banking policy was
the negligence of t h e agriculture sector to the bank's credit. This share hovered around 2% of
the total commercial bank credit. The privately-owned commercial banks were neither
interested nor geared up to meet the risky and small credit requirements of the farmers.
Similarly, the share of other non-industrial sectors was also very low. Since the commercial
banks were under the control of big industrialists, the loanable funds of the banks were sometimes
used to finance socially undesirable activities like hoarding essential commodities.
The post-nationalization period witnessed certain drastic changes in the economy. All the
leading commercial banks of the country were nationalized in the year 1969 with some
objectives in mind. The objectives of nationalization were as follows:
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 To break the ownership and control of banks by a few business families.

 To prevent concentration of wealth and economic power.
 To mobilize savings of the masses from every nook and corner of the
country.
To pay more attention to the priority sectors of the economy like agriculture and small scale
industries, the post-nationalization period saw a remarkable expansion in the banking and
financial system. The biggest achievement of nationalization was the reallocation of sectoral
credit in favor of agriculture, small scale industries and exports. Within agriculture, credit for
the procurement of food grains, i.e., food credit was a major thing. Other agriculture
activities included poultry farming, dairy and piggery.
Certain other sectors of the economy which also received attention for credit allocation were
professionals, self-employed individuals, artisans and other weaker sections of the society.
Conversely, there was a sharp fall in bank credit to large scale industries. However, the share
of small-scale industry registered an upward trend. Nationalization of commercial banks had
many pros and cons for the economy. The government paid more attention to agriculture
than industry. The country witnessed increasing numbers of bank branches in the rural
areas. Branch expansion program resulted in mobilization of savings from all parts of the
country.
Commercial Banking
A commercial bank is a type of bank that provides services such as accepting deposits, making
business loans, and offering basic investment products.

Structure of commercial bank

The commercial banks can

1. Scheduled Banks:
Scheduled Banks refer to those banks which have been included in the
Second Schedule of Reserve Bank of India Act, 1934.
In India, scheduled commercial banks are of three types:
(i) Public Sector Banks:
These banks are owned and controlled by the government. The main
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objective of these banks is to provide service to the society, not to make

profits. State Bank of India, Bank of India, Punjab National Bank, Canada
Bank and Corporation Bank are some examples of public sector banks.
Public sector banks are of two types:
(a) SBI and its subsidiaries;
(b)Other nationalized banks

Private Sector Banks:

These banks are owned and controlled by private businessmen. Their main objective is
to earn Profit . ICICI Bank, HDFC Bank are some examples of Private sector Banks.
Foreign Banks:

These banks are owned and controlled by foreign promoters. Their number
has grown rapidly since 1991, when the process of economic liberalization
had started in India. Bank of America, American Express Bank, Standard
Chartered Bank are examples of foreign banks.

2. Non-Scheduled Banks:
Non-Scheduled banks refer to those banks which are not included in the
Second Schedule of Reserve Bank of India Act, 1934.

Functions of commercial banks

1. Primary or Principle functions
2. Secondary or Subsidiary function

1. Primary or Principle functions

Receiving deposits
Accepting various types of deposits is an important function of the commercial banks. Deposits
constitute the main sources of the funds for commercial banks. Deposits are of various types like
demand deposits, savings deposits and fixed deposits.
Demand deposits
Demand deposits also known as current deposits are those which can be withdrawn by the
depositor at any time by means of cheques. The bank does not pay any interest on demand deposits.
In fact, a bank makes a small charge on the customers with a current account. It is convenient for
businessmen to pay creditors by drawing cheques and also get the cheques received by them
collected.
Savings deposits
Savings deposits are those deposits on which a bank pays a certain percentage of interest to the
depositors but the bank places certain restrictions on their withdrawals. For instance, today in India
only 150 withdrawals in a year are allowed by the banks. Further the total amount withdrawals that
can be made is restricted to Rs.20, 000. Or 10% of the credit balance in the customer’s accounts
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whichever is greater. A proper and satisfactory introduction is necessary to open savings bank
account. These accounts are meant for encouraging thrift and a habit of savings among the people.
Fixed deposits
There are deposits which can be withdrawn after the expiry of a specified fixed period these are also
called time deposits. The rate of interest is higher than that allowed on savings deposit. The fixed
deposits are withdrawn by surrendering the fixed deposit receipts, obtained from the bank at the
time of depositing the money.
Lending of funds
The bank lends fund by means of loans, overdrafts, cash credits and discounting of bills.
Loan
Loan is financial accommodation under which bank grants an advance on a separate account called
loan account. Interest is charged on the entire amount of loan sanctioned. Loans are given to all
types of persons against the personal security of the borrower or against the personal movable or
immovable properties.
Overdraft
An overdraft is a financial accommodation under which a current account holder is permitted to
overdraw his account upto an agreed limit. Interest is charged on the exact amount overdrawn by
the customer. It is granted against the security of the borrower. It is advantageous to the borrower
because interest is charged only on the amount actually overdrawn by him.
Cash credit
A cash credit is a financial accommodation under which an advance is granted on a separate account
called cash credit account upto a specified limit. Interest is charged on the amount made use of by
the borrower. It is granted against the security of goods or personal security of one or more persons
other than the borrower. Traders prefer cash credit to direct loans as they need not pay interest on
the entire amount.
Discounting of bills
Discounting of bills is a financial arrangement under which a customer holding a bill of exchange can
get a loan equivalent to the value of the bill, less discount. The discount represents interest on the
money lent for the unexpired period of the bill. On maturity, the banker collects the proceeds of the
bill from its acceptor.

Investment of funds on securities

Investment of funds in securities is one of the important functions of commercial banks; they
invest a considerable amount of their funds in Government and industrial securities.

Secondary or subsidiary Functions

The secondary or subsidiary functions of a bank can be divided into two classes,
viz
a) Agency service
Agency services are those services which are rendered by the
bank as an agent of their customer. They are:
 Collection of cheques, drafts, etc. on behalf of the customer.
 Payment of bills of exchange, life insurance premium
etc., on behalf of the customer.
 Purchase and sale of securities on behalf of the customer.
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 Arranging for transfer of money from one place to

another on behalf of the customer.
 Acting as a trustee, executors, administrators and attorney.
 Acting as correspondents of other banks and financial institutions.
 Banks also issue credit cards to their customers.
b) General utility services
These are the services rendered not only to the customers but also to
the general public as well.
 Accepting valuables and securities for safe custody
 Providing foreign exchange to the importers and exporters.
 Issuing of travelers cheques, circular notes, etc
 Underwriting shares, debentures and Govt securities.
 Acting as referees and providing information relating to
the credit worthiness of their customer.
 Collection of information useful to the customers or to
the general public and their publication
.

Banker may institute scholarship endowment establish book banks for the benefit of the
students, arrange exhibitions and undertake any such other activities beneficial to the
community in general .

Role of commercial banks in socio economic development

Banks help in accelerating the economic growth of a country in the following ways:

1. Accelerating the Rate of Capital Formation:

Commercial banks encourage the habit of thrift and mobilise the savings of
people. These savings are effectively allocated among the ultimate users of
funds, i.e., investors for productive investment. So, savings of people result
in capital formation which forms the basis of economic development.
2. Provision of Finance and Credit:
Commercial banks are a very important source of finance and credit for
trade and industry. The activities of commercial banks are not only confined
to domestic trade and commerce, but extend to foreign trade also.
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3. Developing Entrepreneurship:
Banks promote entrepreneurship by underwriting the shares of new and
existing companies and granting assistance in promoting new ventures or
financing promotional activities. Banks finance sick (loss-making)
industries for making them viable units.
4. Promoting Balanced Regional Development:
Commercial banks provide credit facilities to rural people by opening
branches in the backward areas. The funds collected in developed regions
may be channelized for investments in the under developed regions of the
country. In this way, they bring about more balanced regional development.
5. Help to Consumers:
Commercial banks advance credit for purchase of durable consumer items
like Vehicles, T.V., refrigerator etc., which are out of reach for some
consumers due to their limited paying capacity. In this way, banks help in
creating demand for such consumer goods.

Services rendered by commercial banks

1. Accepting Deposit
Accepting deposit from savers or account holders is the primary function of
bank. Banks accept deposit from those who can save money, but cannot
utilize in profitable sectors.People prefer to deposit their savings in a bank
because by doing so, they earn interest.
2. Advancing Of Loans

Banks are profit oriented business organizations. So they have to

advance loan to public and generate interest from them as profit. After
keeping certain cash reserves, banks provide short-term, medium-term and
long-term loans to needy borrowers.

3. Discounting of bill of exchange

Bill of exchange is a negotiable instrument, which is accepted by the debtor,

drawn upon him/her by the creditor and agrees to pay the amount mentioned
on maturity. Discounting bill of exchange is another function of modern
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commercial bank. Under this, banks purchase bill of exchange from holder
in discount after making some marginal deduction in the form of
commission. The banks pay the deducted value to the holders when traders
discount it into bank.
4. Cheque Payment

Banks provide cheque pads to the account holders. Account holders can
draw cheque upon bank to pay money. Banks pay for cheques of
customers after formal verification and official procedures. .
5. Remittance

Remittance is a system, through which cash fund is transferred from one

place to another. Banks provide the facilities of remittance to the customers
and earn some service charge.

6. Collection and Payment Of Credit Instruments

In modern business, different types of credit instruments such as bill of

exchange, promissory notes, cheques etc. are used. Banks deal with such
instruments. Modern banks collect and pay different types of credit
instruments as the representative of the customers.
7. Foreign Currency Exchange

Banks deal with foreign currencies. As the requirement of customers, banks

exchange foreign currencies with local currencies, which is essential to
settle down the dues in the international trade.

8. Consultancy

Modern commercial banks are large organizations. They can expand their
function to consultancy business. In this function, banks hire financial,
legal and market experts, who provide advices to customers in regarding
investment, industry, trade, income, tax etc.
9. Bank Guarantee

Customers are provided the facility of bank guarantee by modern

commercial banks. When customers have to deposit certain fund in
governmental offices or courts for specific purpose, bank can present itself
as the guarantee for the customer, instead of depositing fund by customers.
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Credit creation and deployment of funds

• An important function performed by the commercial banks is the creation of credit.

• The process of banking must be considered in terms of monetary
flows, that is, continuous depositing and withdrawal of cash from the
bank.
• It is only this activity which has enabled the bank to manufacture money.
Therefore, the banks are not only the purveyors of money but manufacturers
of money

Basic of Credit Creation

The basis of credit money is the bank deposits. The bank deposits are of two kinds viz.,
(1) Primary deposits, and
(2) Derivative Deposits
Primary deposits

• Primary deposits arise or formed when cash or cheque is deposited by customers.

• When a person deposits money or cheque, the bank will credit his account.
• The customer is free to withdraw the amount whenever he wants by cheques.
• These deposits are called “primary deposits” or “cash deposits.”
• It is out of these primary deposits that the bank makes loans and
advances to its customers.
• The initiative is taken by the customers themselves. In this case,
the role of the bank is passive.
• So these deposits are also called “passive deposits.” These deposits
merely convert currency money into deposit money. They do not
create money.

• They do not make any net addition to the stock of money. In other
words, there is no increase in the supply of money.
Derivative Deposits:
• Bank deposits also arise when a loan is granted or when a bank
discounts a bill or purchase government securities.
• Deposits which arise on account of granting loan or purchase of
assets by a bank are called “derivative deposits.”
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• Since the bank play an active role in the creation of such deposits,
they are also known as “active deposits.”
• Thus, credit creation implies multiplication of bank deposits. Credit
creation may be defined as “the expansion of bank deposits through
the process of more loans and advances and investments.”
• Process of Credit
 Process of Credit Creation
• An important aspect of the credit creating function of the
commercial banks is the process of multiple-expansion of credit.
• The banking system as a whole can create credit which is several
times more than the original increase in the deposits of a bank.
• This process is called the multiple-expansion or multiple-creation of credit.
• Similarly, if there is withdrawal from any one bank, it leads to the process of
multiple- contraction of credit
The process of multiple credit-expansion can be illustrated by assuming:
a) The existence of a number of banks, SBI, BARODA, AXIS etc., each
with different sets of depositors.
b) Every bank has to keep 20% of cash reserves, according to law, and,
c) A new deposit of Rs. 1,000 has been made with SBI to start with.
Limitation on Credit Creation

The commercial banks do not have unlimited power of credit creation.

Their power to create credit is limited by the following factors:
1) Amount of Cash Cash
2)Reserve Ratio
3)Banking Habits of the People

4)Nature of Business Conditions in the Economy

5)Leakages in Credit-Creation

6)Sound Securities

7)Liquidity Preference

8)Monetary Policy of the Central Bank

Role of RBI as a regulator

The central bank of the country is the Reserve bank of India( RBI).
It was established in April 1935 with a share capital of Rs.5 crores on the
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basis of the recommendations of the Hilton young Commission. The share

capital was divided into shares of Rs.100 each fully paid which was entirely
owned by private shareholders in the beginning. The Govt held shares of
nominal value of Rs.2, 20,000.
RBI was nationalized in the year 1949. The general superintendence and
direction of the bank is entrusted to central Board of Directors of 20
members, the Governor and four deputy Governors, one Govt official from
the Ministry of finance, ten nominated Directors by the central Govt to
represent the four local Boards with the headquarters at Mumbai, Kolkata,
Chennai and New Delhi. Local Boards consists of five members each
central Govt appointed for a team of four years to represent territorial and
economic interests and the interests of co-operative and indigenous banks.
The Reserve Bank of India Act 1934 was commenced on April1,
1935. The Act, 1934 (II of 1934) provides the statutory basis of the
functioning of the bank.
The bank was constituted for the need of following:
 To regulate the issue of banknotes.
 To maintain reserves with a view to securing monetary stability
 To operate the credit and currency system of the country to its advantage.

Role of GOI as a regulator of the Banking System

Bank regulations are a form of government regulation which subject banks to certain requirements,
restrictions and guidelines. This regulatory structure creates transparency between banking
institutions and the individuals and corporations with whom they conduct business, among other
things.
Given the interconnectedness of the banking industry and the reliance that the national (and global)
economy hold on banks, it is important for regulatory agencies to maintain control over the
standardized practices of these institutions. Supporters of such regulation often hinge their
arguments on the "too big to fail" notion. This holds that many financial institutions (particularly
investment banks with a commercial arm) hold too much control over the economy to fail without
enormous consequences. This is the premise for government bailouts, in which government financial
assistance is provided to banks or other financial institutions who appear to be on the brink of
collapse. The belief is that without this aid, the crippled banks would not only become bankrupt, but
would create rippling effects throughout the economy leading to systemic failure.

Objectives of bank regulation

Objectives of bank regulation, and the emphasis, vary between jurisdictions.
The most common objectives are:
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1. Prudential—to reduce the level of risk to which bank creditors are

exposed (i.e. to protect depositors)
2. Systemic risk reduction—to reduce the risk of disruption resulting
from adverse trading conditions for banks causing multiple or
major bank failures
3. Avoid misuse of banks—to reduce the risk of banks being used for criminal
purposes,
e.g. laundering the proceeds of crime
4. To protect banking confidentiality
5. Credit allocation—to direct credit to favoured sectors
6. It may also include rules about treating customers fairly and having
corporate social responsibility (CSR)

General Principles of Bank Regulation :

Minimum requirements

Requirements are imposed on banks in order to promote the

objectives of the regulator. Often, these requirements are closely tied
to the level of risk exposure for a certain sector of the bank. The
most important minimum requirement in banking regulation is
maintaining minimum capital ratios. To some extent, U.S. banks
have some leeway in determining who will supervise and regulate
them.

Supervisory review

Banks are required to be issued with a bank license by the regulator

in order to carry on business as a bank, and the regulator supervises
licensed banks for compliance with the requirements and responds
to breaches of the requirements through obtaining undertakings,
giving directions, imposing penalties or revoking the bank's license.
Market discipline

The regulator requires banks to publicly disclose financial and other

information, and depositors and other creditors are able to use this
information to assess the level of risk and to make investment
decisions. As a result of this, the bank is subject to market discipline
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and the regulator can also use market pricing information as an

indicator of the bank's financial health.

Provisions of Banking Regulation Act and

Reserve Bank of India Act
S. No. Parts Topics Sections
covered

1. I Preliminary 1 to 5A

2. II Business of Banking Companies 6 to 36 A

3. IIA Control over management 36AA to 36AC

4. IIB Prohibition of certain activities in relation to banking Companies 36AD

5. IIC Acquisition of the undertakings of Banking Companies in certain 36AE to 36AJ

cases

6. III Suspension of business and winding up of Banking Companies 36B to 45

7. IIIA Speedy provision for speedy disposal of winding up proceedings 45A to 45X

8. IIIB Provision relating to certain operation of Banking Companies 45Y to 45ZF

9. IV Miscellaneous 46 to 55A

10. V Application of the Act to cooperative Banks 56

Applicability of the Banking Regulation Act, 1949

This Act applies to following categories of Banks:

• Nationalized Banks
• Non-Nationalized Banks
• Cooperative Banks
Business of banking Companies - Section 6(1) and 6(2) r.w. 56(b)
• Borrowing, raising or taking of money
• Giving advance
• Bills business
• L/C , Bank Guarantee, Indemnity
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• Foreign exchange
• Providing safe deposit vaults
• Collecting and transmitting money
• Managing, selling and realizing any property that may come into the
possession of the bank in satisfaction or part satisfaction of any of its
dues
• Acquiring, holding and dealing with any property or any right, title
or interest in any such property that may form the security or part of
the security for any loans or advances or which may be connected
with such security
• Undertaking and executing trusts
• Acquiring, constructing, maintaining and altering of any building
for the purpose of the bank
• Acquiring and undertaking the whole or part of the business of
any person or bank / company if its nature of business is as per the
allowed business for the bank
• Doing all such other things as are incidental or conducive to the
promotion or advancement of the business of the bank
• Any other business the Central Govt. may by notification specify as a allowed
business
• Banks are prohibited to do any other business
Cash Reserve (CRR) – Section 18 r. w. 56 (j)
• Every bank is required to keep cash reserve, with itself or by way of
balance in the current account with RBI or Central / District Co-
operative Bank or net balance in all such way, of minimum
prescribed % amount of its DTL as of last Friday of fortnight
• A return about this has to be submitted to RBI before 15thof each
month about alternate Friday
Statutory Liquidity Ratio
• Bank shall maintain unencumbered approved securities, valued not
exceeding the current market price, or an amount which shall not be
less than 24% of the total of its demand and time liabilities (DTL)

Restrictions on loans and advances

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• (1) Notwithstanding anything to the contrary contained in section

77 of the Companies Act, 1956 (1 of 1956), no banking company
shall,
• (a) grant any loans or advances on the security of its own shares, or
• (b) enter into any commitment for granting any loan or advance to or on behalf of
• (i) any of its directors,
• (ii) any firm in which any of its directors is interested as partner,
manager, employee or guarantor, or
• (iii) any company [not being a subsidiary of the banking company or
a company registered under section 25 of the Companies Act, 1956
(1 of 1956), or a Government company] of which 61[or the
subsidiary or the holding company of which] any of the directors of
the banking company is a director, managing agent, manager,
employee or guarantor or in which he holds substantial interest, or
• (iv) Any individual in respect of whom any of its directors is a partner or
guarantor.

Licensing of banking companies

• Save as hereinafter provided, no company shall carry on banking
business in India unless it holds a license issued in that behalf by the
Reserve Bank and any such license may be issued subject of such
conditions as the Reserve Bank may think fit to impose.]
• Every banking company in existence on the commencement of this
Act, before the expiry of six months from such commencement,
and every other company before commencing

• banking business [in India], shall apply in writing to the Reserve

Bank for a license under this section.

Power to publish information

• The Reserve Bank or the National Bank, or both, if they consider it
in the public interest so to do, may publish any information obtained
by them under this Act in such consolidated form as they think fit.

Banker and Customer relationship

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Types of relationship between banker and customer

1. General feature of the relation

 Commencement of primary general relationship
The primary general relationship between a banker and a customer
starts from the time the customer opens a bank account by
depositing money.
 Contractual primary general relationship
The primary general relationship between a banker and a customer
arises from a contract between the two. So, it is a contractual
relationship. As it is a contractual relationship, it is governed by the
various terms of agreement between the two parties.
 Nature of primary general relationship
When a banker receives deposits of money from a customer, he is
neither a bailee nor a trustee nor an agent, but only a debtor of the
customer. This view has been endorsed by several authorities on
banking law and also confirmed by many court decisions.
 Not a bailee or depositors of customer’s money
A banker is not a bailee or depositary of customer’s money. This is
because a bailee accepts the bailment of certain things on the
condition that the things bailed will not be utilized by him and the
identical things will be returned. But a banker doesn’t accept the
money from the customer on the condition that the money deposited
with him will not be utilized by him and that the identical money
(i.e. the same currency notes or coins deposited with him by the
customer) will be returned.
 Not a trustee of customer’s money
A banker is not a trustee of the customer’s money. This is because a
trustee is required to use the trust money in accordance with the trust
deed, render an account to the beneficiary for everything he does
with the money and is bound to handover the profits earned from the
use of trust money to the beneficiary. But a banker is not bound to
employ the customer’s money in accordance with the terms of any
trust deed is not required to render an account to the customer for
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everything he does with the money and is not the use of the
customer’s money.

 Not an agent in respect of customer’s money

When a banker accepts deposits of money from a customer, he is not
an agent of the customer. This is because an agent is bound to act
according to the instructions of the principal, while investing the
principal’s money, render a detailed account for everything he does
with the principal’s money to the principal and is required to
handover to the principal the incomes he earns from the use of
principal’s money.
 Only a debtor in respect of customer’s money
The banker is just a debtor and the customer is a creditor when he
accepts and has the deposits of the customer. Of course, in case the
customer’s account is overdrawn or the customer has taken loan or
any other form of financial accommodation from the banker, the
customer becomes the debtor and the banker becomes the creditor.
So, one can conclude that the primary relationship between a banker
and a customer is that of a debtor and a creditor and their respective
positions are determined by the existing state of the bank account.
Subsidiary feature of the relationship
 Bailee and bailer relationship
When a banker accepts valuable and documents form a customer for
safe custody, he becomes a bailee and the customer becomes a
bailer.
As a bailee, the banker owes some duties and liabilities to the customer. They are:
a) He is required to safeguard the safe custody deposits of the
customer in his hands with reasonable care.
b) It he fails to take reasonable care in the preservation of the safe
custody deposits and the customers suffers loss as a
consequence; he becomes liable to compensate the customer for
the loss.
In this context, it should be noted that the banker is liable only
for the losses arising out of his negligence and not for those
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losses arising out of reasons beyond his control, such as fire,

burglary, etc. this is because, a banker is only a bailee and not an
insurer of the safe custody deposits left with him.
c) He is required to handover the safe custody deposits to the
depositor, whenever he demands them back.

 Trustee and beneficiary relationship

A banker becomes the trustee of his customer, when he is
entrusted with some trust work. For instance, when a customer
deposits a certain sum of money with the banker with specific
instructions to use the same for a specific purpose, the bankers
becomes the trustee of the customer in respect of that money until
that purpose is fulfilled.
 Agent and principal relationship
When a banker undertakes agency services such as collection
cheques, drafts & bills, collection of interest and dividends on
securities, payment of premium and subscriptions, purchase and sale
of securities, etc, for a customer, he becomes the agent and the
customer becomes the principal.
 As an agent the banker owes some duties to the customer they are:
 He is required to act in accordance with the instruction of the
principal, i.e. the customer.
He is bound to return to the customer all the incomes which he earns
as an agents of the customer.

Banker’s obligation to customers

1. Obligation to honor his customer’s cheques
2. Obligation to maintain the secrecy of the customer’s account
3. Interest rate related complaints
Banks responsibility

 Explain these in writing: give examples

 How is interest calculated?
 Fixed interest- what is the reset clause?
 Floating rate- what is the benchmark used?
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 Clearly state terms/

conditions in loan document.
Customer’s responsibility
 Read before you sign
 Do not ignore your doubts-get them clarified
 Never sign in blank document
4. Service Charges :
Banks responsibility

 Display service charges

 Extend concessional rates to special category persons
 Have a cap on all charges including interest rate and panel charges
 Inform customers of changes; offer option to discontinue
facility
Customer’s responsibility

 Read all the material sent to you by the bank

 Remember
 Banks have freedom to set interest rates/ service charges
 You have option to choose the bank which offers best rate.
 Compare rates-make informed choice
5. Loan Documents , return of securities
Bank s responsibility

 Give customer a complete set of loan agreements and

enclosures at time of sanction/disbursement.
 Return the securities as soon as the loan is repaid.
. Customer’s obligation

 Get a complete set of loan documents from banker

 Read the MITC (Most Important Terms and Conditions)
 Get securities back as soon as loan is repaid.
6 Recovery of bank dues

Bank s Responsibility :
 Place list of recovery agent on website
 Ensure recovery agents follow code of conduct
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 Record all conversations with customers

7. Credit cards
Banks responsibility
 Do not issue unsolicited cards-if activated and charged. Pay prescribed
compensation without demur.
 Do not issue unsolicited products on cards
 Delivery of cards and PINs only to person concerned
 Stop lost cards immediately on report of loss.
 Consider insurance on lost cards
 Send statements on time; use e-statements, SMS alerts, etc to keep the card
holder informed of payments, due dates, etc.
Customer’s responsibility
 Keep your credit card safely
 Be present when card is used by merchant banker
 Do not use public computers for internet purchase through credit cards
 Keep credit card number and help line detail in hand
 Report immediately if you loss card the card
 If you don’t want a card, cut it and send it back to the credit card issuing
authority.
8. 8. ATMs
Banks responsibility
 Ensure ATMs are in working mode at all time
 Have CCTV in all ATMs
 Check audit trails periodically
 Check cash handling processes and procedures
 Check for quality of notes stacked in the ATMs.
Customer’s responsibility
 Keep ATM cards safely
 Don’t keep the PIN with the card

9. Cheque drop facility

Banks responsibility
 Remember-cheque drop facility is only an alternate mode of cheque
collection.
 Box should bear legend indication that it is an alternate mode and that
customer can get acknowledgement if required.
 Install automatic cheque acknowledging machines which give receipt of
dropping the cheque.
Customer’s responsibility
 Insists and obtain acknowledgement for cheques if you want them
10. Cheque collection
Bank’s responsibility
 Display bank’s cheque collection policy
 Adhere to the displayed policy
 Levy charges as per RBI stipulations
 Compensate customer without waiting for request for any delay
Customer’s responsibility
 Read the cheque collection policy
 Insist and obtain admissible compensation for delay.

Right of lien
The legal right of a creditor to sell the collateral property of a debtor who fails to meet the
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obligations of a loan contract. A lien exists, for example, when an individual takes out an
automobile loan.
The condition of the right are:
1. The agent should be lawfully entitled to receive from the principal a sum of money by way of
commission earned or disbursements made or services rendered in the proper execution of the
business of agency.
2. The property over which the lien to be exercised should belong to the principal and it should
have been received by the agent. The property is considered to be sufficient in the possession of
the agent where he has been dealing with it. Thus where an auctioneer was engaged to sell
furniture at the owner’s house, he was held to be sufficiently in possession to exercise lien for his
commission. The property held by an agent for a special purpose implicitly excludes the right.
Similarly, where possession is obtained without the principal’s authority or by fraud or
misrepresentation, there is no lien, briefly, the agent’s possession must be lawful.
3. The agent has only a particular lien. A particular lien attached only to that specific-matter in
respect of which the charges are due. No other property can be retained.
Right of Setoff
• Set-off means- that the bank can adjust the credit balance in a customer's account against a debit
balance in another account maintained by the same customer.
• In an ongoing, situation, the right of set-off can be exercised by a banker- by serving a reasonable
notice on the customer.
• The right of set-off can be exercised by the banker only when the relationship between the
customer and the banker is that of- Debtor and Creditor.
• The banker can exercised the right of set-off only in respect of- debts due and determined.
• The following condition are required to be fulfilled before a banker can exercise the right of set-
off-
(a)The debt must be a sum certain and due immediately,
(b) The debt must be due by and to the same parties and the in the same right,
(c) There should be no agreement to the contrary.
• The right to set-off account arise immediately in the following cases-
(a) On the death, mental incapacity or insolvency of a customer, (
b) On the insolvency of a firm, or on the liquidation of a company, (c) On the receipt of garnishee
order.
• The right of set-off is available to the banker only in respect of- credit balance held in a customer's
account.
• In case of time barred debt- the bank can exercise the right of set-off provided the debts are due in
the same sight.
Customers account with banks
Opening Savings Bank Account A Savings bank account is the most common operating account for
individuals and others for non-commercial transactions. A Savings account helps people to put
through day-to-day banking transactions besides earning some return on the savings made. Banks
generally put some ceilings on the total number of withdrawals permitted during specific time
periods. Banks also stipulate certain minimum balance to be maintained in savings accounts.
Normally a higher minimum balance is stipulated in cheque operated accounts as compared to non-
cheque operated accounts. Banks as a rule do not give overdraft facility in a saving account, but
allow occasional overdrawing to meet contingencies.
Who can open a Savings Account?
* By a person in his / her name;
* By two or more persons in their joint names payable to:
- Both or all of them or the survivor or survivors of them; OR
- Either or any more of them or the survivor or the survivors of them; OR
- Former / latter or survivor of a particular person during his lifetime or survivors jointly or
survivor.
* Certain non-profit welfare organizations are also permitted to open Savings bank accounts with
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banks.

What a bank asks for while opening an account?

Banks are required to know true identity of the person wanting to open an account. Banks also
seek introduction of the person from an existing account holder. Banks require photograph of the
person to be kept on record for future identification purpose. In terms of government notification
w.e.f. 01.11.1998, banks have to obtain PAN numbers (issued by Income Tax Dept.) of the
account holder at the time of opening of the account. In the absence of PAN number customer
should give a declaration in the prescribed format (form no.60 or 61 as the case may be).
What the Customer needs to know while opening a Savings Account?
Ask the bank officials about :
• Minimum balance requirements.
• Penal provisions if the balance falls below the minimum stipulated amounts or return of
Cheques issued or instruments sent on collection.
• Collection facilities etc. offered and charges applicable.
• Details of charges, if any for issue of cheque books and limits fixed on number of
withdrawals, cash drawings, etc.

Fixed or Time Deposits

Time deposits are deposits accepted by banks for a specified period of time. In terms of RBI
directives the minimum period for which term deposits can be accepted is 15 days. The banks
generally do not accept deposits for periods longer than 10 years.
1. Banks pay interest on term deposits based on the period of deposits and normally pay higher
interest for longer term deposits.
2. Banks have full discretion to fix their interest rates on deposits and these rates are varied from
time to time depending on market conditions.
3.Changes made in interest rates from time to time do not alter the interest paid on the existing
deposits.
4. When banks quote a certain percentage of interest per annum for a given period it is
understood that interest payments are made on a quarterly basis (see IBA Master Charts).
5. The depositor can collect interest on every quarter or its discounted value at monthly rests or
avail quarterly compounding benefits and receive principal and interest on maturity.
6. RBI has now permitted banks to quote a higher rate of interest for individual deposits more
than Rs.15 lacs.
7. Banks are allowed to levy a penalty for premature encashment of deposits at their discretion.
Banks generally pay interest on such deposits as applicable for the period which deposit has been
kept with the bank (less penalty if levied).
8. Bank allow loans against the fixed deposits on demand. Margin retained over the deposit
outstanding and interest rate charged thereon are decided by the bank and may vary from bank to
bank.
Opening of a time deposit Account
Normally the requirements as given under savings bank account apply to time deposits also.
However, photographs are not insisted for deposits below Rs.10,000/-. Also the requirements
regarding furnishing of PAN number applies only to time deposits over Rs.50,000/- made in
cash.
Time deposits - Product variations
To suit the needs of the customers banks have introduced innovative variations in the basic time
deposit format. Flexible deposit is one such innovation. In this case a given deposit is split into
units of smaller amounts for accounting purposes. This enables the customer to encash any
number of units prematurely at any time during the currency of the deposit and earn the
contracted rate of interest on the balance amount.
Current Account
Current accounts are cheque operated accounts maintained for mainly business purposes. Unlike
savings bank account no limits are fixed by banks on the number of transactions permitted in the
Account. Banks generally insist on a higher minimum balance to be maintained in current
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account. Considering the large number of transactions in the account and volatile nature of
balances maintained overnight banks generally levy certain service charges for operating a
Current account.
In terms of RBI directive banks are not allowed to pay any interest on the balances maintained in
Current accounts.
However, legal heirs of a deceased person are paid interest at the rates applicable to Savings
bank deposit from the date of death of the account holder till the date of settlement.
Operation
KYC and Operation
• KYC (Know Your Customer) is a framework for banks which enables them to know /
understand the customers and their financial dealings to be able to serve them better.
• Banking operations are susceptible to the risks of money laundering and terrorist
financing.
Therefore, banks are advised to follow certain customer identification procedure for opening of
accounts and monitoring transactions of a suspicious nature for the purpose of reporting it to
appropriate authority.
• Reserve Bank of India has advised banks to make the Know Your Customer (KYC)
procedures mandatory while opening and operating the accounts and has issued the
KYC guidelines under Section 35 (A) of the Banking Regulation Act, 1949.
• Any contravention of the same will attract penalties under the relevant provisions of
the Act. Thus, the Bank has to be fully compliant with the provisions of the KYC
procedures.
Advantages of KYC
• Sound KYC procedures have particular relevance to the safety and soundness of
banks, in that:
1. They help to protect banks’ reputation and the integrity of banking systems by reducing
the likelihood of banks becoming a vehicle for or a victim of financial crime and
suffering consequential reputational damage;
2. They provide an essential part of sound risk management system (basis for identifying,
limiting and controlling risk exposures in assets & liabilities
Objective of KYC guidelines
• To prevent banks from being used, intentionally or unintentionally, by criminal
elements for money laundering activities. KYC procedures also enable banks to
know/understand their customers and their financial dealings better which in turn help
them manage their risks prudently.
4 key elements of KYC policies
1) Customer Acceptance Policy;
2) Customer Identification Procedures;
3) Monitoring of Transactions; and
4) Risk management
Types of Account
One of the main functions of a commercial bank is to accept deposits of money from the
public. The deposit accepted by a bank may be classifies into two broad categories
Time Deposits Demand Deposits
1. Fixed Deposits 1. Savings Deposits
2. Recurring Deposits 2. Current Deposits
Time Deposits
The time deposits are repayable after expiry of a fixed specified period time while demand
deposits are repayable on demand.
i) Fixed deposits
Fixed deposits are those deposits, which are repayable after the expiry of a fixed
specified period of time. They are also called time deposits. The time or period of
deposit may vary from fifteen days to several years. This period decided by the
depositor according to his convenience. The rate of interest is usually higher than
other types of deposits. The rate of interest on fixed deposit depends on period of
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deposit; the longer the period of deposit, the higher will be the rate of interest. The
RBI decides the interest rate. On the deposit being made, the banker issues a ‘deposit
receipts’
ii) Recurring deposit
Recurring deposits are variants of fixed deposits. Recurring deposits are also
repayable only after the expiry of a fixed specified period of time but the amount is
deposited in monthly installments. These deposits are meant for people having regular
monthly income. The duration of recurring deposits varies from six months to several
years. Generally the rate of interest on these deposits is higher.
Demand Deposits
i) Savings Deposits
Savings bank accounts are introduced by banks to mobilize small savings and
inculcate the habit of savings in the people. These deposits are repayable on demand,
but bank places certain restrictions on the number of withdrawals. These deposits can
be opened with very small amount. The prescribed minimum balance is different in
different banks. Interests is paid on monthly minimum balances and credited to the
respective accounts half yearly according to the rates prescribed by the RBI from time
to time.
ii) Current Accounts or Current Deposits
Current accounts are those deposits, which are repayable on demand. There are no
restrictions on the number of withdrawals. The bank don’t pay interest on current
account or deposits, instead they change incidental charge on customers having
current account. This type of deposit is suitable for businessmen who want to make
payments by means of cheques.
Types of customers
 Lunatics
A lunatic is person of unsound mind (irresponsible person). The position of lunatics
under Indian law, Under Indian contract Act, a contract with or by a lunatic are void. The reason
being the lunatic being of unsound mind is not competent to comprehend a contract.
If the banker without knowing that the person is lunatic opens an account and enters into
a contract acting in good faith is protected. But when once he gets a notice of lunacy of a person,
he should not entertain any contract either existing or new.
 Drunkards
Under section 12 of Indian contract Act 1872, a sane man who is delirious from favor or
who is drunk that he can’t under the contract, or form rational judgment can’t enter into contract
while delirium or drunkenness lasts. When a customer who is drunk presents a cheque across a
counter the payment must be witnessed.
 Minors
Under section 3 of the Indian majority act, 1875, a minor is a person who has not
completed the age of 18 years. In case a guardian to the person or property of minor is appointed
by the court, or the property of the minor is placed under the charge of court wards before he
completes the age of 18 years, he continues to be a minor until he completes the age of 21 years.
 Married women
The law that exists today in India doesn’t make any distinction between the contractual
capacity of a man or an unmarried lady and a married woman. So, a married woman enjoys the
same contractual capacity as a man or an unmarried lady. She can acquire and sell property, lend
or borrow and enter into contracts and bind her personal or separate property called “Stridhan”.
 Partnership firm
Section 4 of partnership act 1932, defines partnership as “the relation between persons
who have agreed to share the profits of a business carried on by all or any of them acting for all”.
So, a partnership is an association of two or more persons who agree to carry on a business
jointly and share the profits of that business. The person who form the partnership are called
“partners” individually and a “firm” collectively. The name under which they carry on the
business is called “firm name”. They can open the account in their firm’s name.
Joint stock companies (Public Limited Companies)
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A joint stock company is an association of persons under the companies act. It is an

artificial person created by law with perpetual succession and common seal. A joint stock
company is a separate legal entity. So, a bank account can be opened in its name.
However, while opening and maintaining an account in the name of public limited company, a
banker has to be very careful. He is required to take the following precautions in dealing with a
public limited company:
1. He should call for and examine the original certificate of incorporation to ascertain
whether the company is legally incorporated or not. The certificate of incorporation is the
conclusive proof of the incorporation of the company.
It is also advisable for the banker to obtain and retain under his custody a certified copy
of the incorporation certificate for his future reference.
2. He should obtain a certified copy of the memorandum of association of the company as
amended up to date and ascertain the objects for which the company is formed, the
authorized capital of the company and the liability of the members of the company. A
knowledge of the objects of the company as specified in the Memorandum of association
is absolutely necessary for the banker, because any act done, or contract entered by the
company, which is outside the scope of the objects, is ultra-virus, (i.e. beyond the powers
of company) and is, therefore not binding on the company.
 Trustee
Section 3 of Indian Trust contact Act, 1882 defines a trust as an obligation annexed to the
ownership of property and arising out of a confidence reposed in and accepted by the owner or
declared and accepted by him for the benefit of another or of another and the owner” so, a trustee
is person to whom the management of a property is entrusted by one in trust, i.e. out of
confidence reposed in him, for the benefit of another. In short, a trustee is one who manages a
trust.
Nomination
Nomination is a facility that enables a deposit account holder(s) (individual or sole proprietor) or
safe deposit locker holder(s) to nominate an individual, who can claim the proceeds of the
deposit account(s) or contents of the safe deposit locker(s), post the demise of the original
depositor(s) or locker holder(s).
Benefit of nomination
The benefit of nomination is that in the event of death of an account holder(s) or locker holder(s),
the Bank can release the account proceeds or contents of the locker to the nominee(s) without
insisting upon a Succession Certificate, Letter of Administration or Court Order. The nominee holds
the monies in the capacity of a Trustee on behalf of the legal heirs of the deceased account holder(s)
or locker holder(s) and the Bank's liability is duly discharged on payment to the Nominee
• Bank account holders having deposit accounts in their individual names or in joint names of two or
more individuals can appoint a nominee to their accounts
. • A sole proprietor can appoint a nominee to the sole proprietorship account with the bank.
• In the case of a deposit account in the name of a minor, nomination shall be made by a person
lawfully entitled to act on behalf of the minor in respect of a deposit account.
• Safe deposit locker holder(s) can appoint nominee(s) on their Safe deposit locker(s).
• A nomination can be made only in respect of a deposit account which is held in the individual
capacity of the depositor, and not in any representative capacity such as the holder of an office like
Director of a Company, Secretary of an Association, partner of a firm, or Karta of an HUF.