STD.

XI

VOCATIONAL BANKING

PAPER – I

By R. U. Shinde
Ness Wadia College of Commerce, Pune – 1.
 THE NATURE OF BANKING AND FUNCTIONS OF A BANKER
(DEFINITION, FUNCTIONS AND SERVICES OF A BANK)
There is no unanimity of opinion among economists and bankers about the meaning of the term
`Banking’. The term ‘Banking’ has not been defined in any of the legislative enactments. Thus the
word “bank” is easy to understand but difficult to define.

The term “bank” is said to have been derived from the word “Banco”, “Banque” and “Bancus”. The
word “Banco” in Portuguese means a bench. The same is the meaning of the other terms mentioned
above, which are of Italian or French origin. It appears that the word “Bank” must have been derived
from the word “Banco” and must have acquired its present meaning in England, ever-since the
fourteenth century. Money lending and banking business was mainly in the hands of the Jews. These
Jews used to have their business in Lombard Street, London, where they used to keep money on the
bench and transact business. In those days, money was made of metal coins, but unfortunately there is
no proof to show that the word “Bank” originated from the word “Banco. “

In modern times, a bank means an institution which performs the functions of accepting deposits and
advancing loans as and when demanded. In addition to this, several other functions are performed by
modern banks.

DEFINITION OF BANK:
1. Bank:
Bank is an institution which deals in cash and credit.

2. Dr. H. L. Hart.
“A banker is one who in the ordinary course of his business, honours cheques drawn upon him
by persons from and for whom he receives money on current account”.

3. Kinley:
“Bank is an establishment which makes to individuals such advances of money or other means of
payments as may be required and safely made and to which individuals entrust money or means
of payment when not require by them for use”.

4. Sir John Paget:

“No person or body corporate or otherwise can be banker who does not-
i) Take deposit accounts, ii) take current accounts, iii) Issue and make payment of cheques
drawn upon himself iv) collect cheques crossed and uncrossed for his customer”.

Sir John further adds that one who claims to be banker must satisfy two more conditions.
1. The Banker must be one whom the public acknowledged and accepts as a banker &
2. Banking should be his only or main business.

5. Banking Regulation Act’1949: [sec. 5 (b)]

“Banking means accepting, for the purpose of lending or investment of deposit of money from
public, repayable on demand or otherwise, and withdrawable by cheque, order or otherwise.”

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FEATURES OF A BANK:

1. Business of banking:
A bank deals mainly with other people’s money. Bank accepts deposits from the public. If a bank
does not receive deposit and only deals with its own money, it cannot be called a bank. It can, at
best be called a money lending firm.

2. Repayment of Deposit:
Bank repays deposits to the depositors either on demand or after the expiry of a specified period by
honouring cheques or by other instruments of withdrawals.

3. Not subsidiary to any other business:

A banks main business should be banking. It should not be subsidiary to any other business.

4. Right to utilize the money:

A bank is a borrower which reserves the right to utilise the money given to it in a way it considers
best.

5. Name:
A bank should add the word ‘bank’ to its name and let people know that it is a bank.

6. Performance of other activities:

A bank can perform other subsidiary services in addition to its main function of accepting and
lending of deposits.

IMPORTANCE OF BANKS:
Banking is an aid to trade. Business activities can not operate smoothly without banking services. The
efficient administration of the banking system can provide a healthy and prosperous life to the nation.
Banking is useful to trade and commerce in the following ways.
1. Safety of money : Money deposited in a bank remains safe. Precious articles can be kept in the
safe custody or in the safe deposit vaults in the banks.

2. Increase in credit : Customers with bank accounts enjoy better credit worthiness in the business
world. Banks also provide credit to their customer.

3. Savings : Banks encourage the habit of saving and thrift among the people. They mobilize public
savings and invest them in productive avenues. They increase the rate of capital formation in the
country.

4. Transfer of money : Banks provide a remittance facility to the customer for transferring their
money from one place to another. Moreover, payments made through cheques/Demand Drafts
provide a legal proofs of the transaction.

5. Collection of money: Banks collects and realize the bills, interest, etc. on behalf of their
customers.

6. Facilitate Foreign Trade: Foreign trade can not be carried on smoothly without banking. Banks
receive and make payments, provide credit and deal in foreign exchange. They issue letter of
credit and provide information on the credit worthiness of importers. They give financial
references on behalf of their customers.
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TYPES OF BANKS:

1. Commercial banks: These are joint stock banks which receive deposit from the public and
business firms. They also provide short term, medium term and long term loans to customers.
These banks carry on all kinds of banking functions within the framework of the Banking
Regulation Act 1949 in India. Commercial banks are classified into two broad categories –
scheduled and non-scheduled banks. Scheduled banks are those included in the second schedule
of the Reserve bank of India Act and which paid up capital plus reserves are more than Rs. 5
lakh. A non-scheduled bank is one which do not comply with the abovementioned conditions.

In India, banking business is divided into public sector and private sector. The banks working in
public sector are owned by the government.

Bank of Maharashtra, Bank of Baroda, State Bank of India, Union Bank of India, Punjab
National Bank etc. are examples of public sector banks. Global Trust Bank, Bank of Rajastan
etc. are the examples of private sector banks. The State Bank of India is the largest commercial
bank in India.

3. Central bank: The central bank is the apex banking and monetary institution of the country.
It’s main function is to control, regulate and stabilize the banking and monetary system of the
country in the interest of the nation. The Reserve Bank of India is the central bank of India.
The RBI is established on 1st April 1935 under the Reserve Bank of India Act 1934 and
nationalised in the year 1948. Its head office is in Mumbai. The chief person of the bank is
called as the Governor. Dr. ………………….. is the present Governor of the RBI.

3. Industrial banks: These banks play an important role in the industrial development of the
country. They provide medium and long term finance to the industrial concerns. They provide
managerial and technical assistance to industries. E.g. Industrial Development Bank of India
(IDBI), Industrial Finance Corporation of India (IFCI), Maharsthra State Financial Corporation
(MSFC) etc.

4. Co-operative banks: These banks are organized by the people with limited means for their
mutual benefits and are managed on a co-operate basis. Like commercial banks, they accept
deposits from the depositors and grant loans to their members at concessional rates of interest.
Such banks are found in both rural and urban areas. Co-operative banks encourage the habit of
savings among their members. In rural areas there are agricultural co-operative banks which
accept deposits and give loans to the farmers and rural artisans. Co-operative banks are
controlled by the District Central Co-operative Bank and State Co-operative Bank, at district
level and state level respectively.

5. Exchange banks: These banks provide foreign currency and other related facilities to the
importers and exporters. They buy and sell foreign currency exchange (currency) and specialize
in financing foreign trade. They are also called foreign exchange banks. These banks also
render services such as collecting and supplying information about the foreign customers,
remittance of funds from one country to another, etc.
e.g. The Export and Import Bank (EXIM).

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6. Foreign banks: These banks finance the foreign trade of a country. Therefore, they deal in
foreign currency. These banks also render other services such as collecting and supplying
information about foreign customers, providing remittance facilities etc. Like ordinary
commercial banks, these banks also deal in usual banking business. These banks have their head
offices in located outside India. E.g. American Express Bank (USA, City Bank (USA).

7. International banks: These banks work at the international level. They look after financing
large projects which require foreign investments involving many currencies. The members of an
international bank are various countries, which keep their deposits with the bank at the
government level in their own currencies which can be utilized for settling imports and exports
and also for international co-operation in the field of industry, commerce, agriculture, technology
etc. Such banks collect long term deposits from industrially advanced nations and lend them on
easy terms to underdeveloped countries for industrialization and development.
E.g. International Monetary Fund (IMF), Asian Development Bank (ADB), International
Finance Corporation (IFC), World Bank, International Bank for Reconstruction and
Development (IBRD).

8. Land Development Bank / Land Mortgage / Agricultural Banks: These banks finance the
agriculture and provide medium and long term loans to the farmers against the security of their
land. In agriculture long term loans are very essential for purchasing tools, implements, cattle,
and making permanent improvement (tube-well, Water pipe line, Well, Land Leveling etc.) The
long term loan is recovered in annual installments. These banks do not accept deposits from the
public but instead raise huge funds by issuing of long period debentures. E.g. The National Bank
for Agriculture and Rural Development (NABARD).

9. Savings banks / Post Office Banks: These banks accept various types of deposits from the
public and give a low rate of interest on these deposits. They invest this money in bonds etc.
Generally restrictions are placed on the number and amount of withdrawals during a month.
Savings banks encourage savings and thrift. They collect the small savings of the people but do
not advance them. These banks are popular in the villages where banking facilities are not
available. Post office serves as savings banks for the benefit of the general public. The post
office also provides facilities like making payment through a) Postal Stamps, b) Postal Orders
and c) Money orders.

10. Indigenous Bankers and Money Lenders: These are money lenders in villages and small
towns. They accept deposits from and grant loans to farmers, artisans and local traders. The also
deal in hundies. Hundies are regarded as native bills of exchange. They generally charge high
rate of interest. E.g. Mahajans, Seths, Sahukars, Shroffs, Sarafs, etc.

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FUNCTIONS OF A BANK:
Modern commercial banks perform a large number of functions and services to industry and commerce.

The functions and services rendered by modern banks can be grouped under the following heads.

I Banking Functions or Primary Functions

II Non-Banking Functions or Secondary Functions or Subsidiary Functions

I PRIMARY FUNCTIONS: (Banking Functions)

Broadly speaking, there are four functions, which come under this category.

A) Receiving deposits:
This is an important function because banks mainly depend on the funds deposited with them by
the public. By offering various types of deposits accounts, banks mobilise the savings of the
community. A bank’s financial strength is measured by its ability to attract the various types of
deposits. People who have surplus money deposit the same with a bank for safe-keeping. The
commercial banks not only protect deposits but also give interest on such deposits.

Bank receives deposits from the following four types of deposit accounts.
1) Current Account 2) Savings Bank Account
3) Fixed Deposit Account 4) Recurring Deposit Account.

1) Current Account:
Following are the important features of current accounts.
a) Current account indicates deposits always payable on demand. Hence they are called
demand deposits or running account.
b) There is no restriction on the number and amount of withdrawals from this account.
c) Banks insist [ to urge, to press] on the maintenance of certain minimum balance
on current account. If the balance goes below this amount, the bank has a right to close that
account.
d) Generally no interest is given on this type of account. Recently some banks have started to
give nominal interest on this account.
e) Overdraft facilities are given in case of current accounts only.
f) Current account suits the requirements of businessmen, joint stock companies, institutions,
societies, public authorities and public corporations etc.
g) Banks are given full freedom to decide the rules and regulation regarding the operation of
current accounts.

2) Savings Bank Account:”

Following are the main features of this account.
a) As the name indicates, the accounts are opened for the purpose of mobilising savings. These
accounts are meant to encourage savings and to develop the habit of thrift.

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b) Though money can be deposited in this account, as often as the depositor wishes, it can not
be withdrawn more than twice or thrice a week. At present 25 withdrawals are permitted
quarterly by most of the banks. Rules in this regard may vary from bank to bank from time
to time and from place to place.
c) This account can be opened even by depositing Rs. 500/-.
d) The rate of interest payable by the banks on this account is generally prescribed by the
Central Bank of the country. It is generally 3.5% to 5% p.a. Interest is calculated on
minimum monthly balances at credit of the account, generally between the close of the sixth
day and the last day of each calendar month. (Interest may be paid twice a year.)
e) Money from this account can be withdrawn by cheques or by using bank’s withdrawal slips.
f) No limit is prescribed in India for the maximum amount that may be held in savings bank
account. But banks in India allow interests on a maximum balance of Rs. one lakh only in
one SB account.
g) Savings account is not given overdraft facilities like current accounts.
h) This account is more suitable to salary earners, wage earners and persons of limited means.
i) Other banking services are also provided to savings bank account holders.

3) Fixed Deposit Account:

a) Fixed deposits are deposits received for a fixed period, specified in advance. No withdrawal
is allowed during this period. Therefore they are called time deposits also.
b) The fixed deposit receipt is non-transferable. It is not a salable asset.
c) This depositor is neither given a cheque-book nor a passbook.
d) The depositor gets attractive rate of interests on money deposited in this account. The rate of
interest allowed varies with the period. The longer period of deposit gets the higher rate of
interest. Interest is paid half yearly.
e) If the depositor is in need of money before the due date, he can borrow from the same bank
against the security of his fixed deposit receipt. Of course, he has to pay a slightly higher
rate of interest. In India as per the directives of the Reserve Bank of India, banks can charge
a minimum of 1% above the rate payable on such deposits.
f) Individuals, firms or companies with surplus money may invest their idle funds in this
account. The person who want safety of funds and steady return, deposit their money in this
account. These are called earning assets.

4) Recurring Deposit Account:

The notable features of this type of account are as follows.

a) This type of account is the latest innovation with most of the banks in India. Banks have
introduced this scheme with the object, to help the small depositors’ convenience incentive
for savings.

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b) A depositor, opening a recurring deposit account is required to deposit an amount chosen by him,
generally, a multiple of Rs. 5/- or Rs. 10/- in this account every month, for a period selected by him.
The period of recurring deposit varies from bank to bank, generally between one to ten years.

c) The rate of interest given on recurring account stands favourable as compared with the savings bank
account because the former partly resembles the fixed deposit account. According to the latest
directives of the Reserve Bank of India, banks are required to ensure that the rates of interest offered
by them on recurring deposits are generally in accordance with the rates prescribed for various term
deposits.

d) At the expiry of the period, the depositor gets a lump sum amount and handsome interest on his
savings.

e) In case the depositor needs money before the due date he may borrow up to 90% of the amount in
the account at the prevailing rate of interest.

f) Recurring deposit accounts are transferable from one branch to another without charge.

g) Any person can open the recurring deposit account, more than one person jointly and by a guardian
in the name of a minor and even by a minor.

In addition banks have introduced many attractive schemes of collecting deposits such as daily
collection schemes, fixed deposits, etc. with payment of interest every month, festival deposit schemes
etc.

B) Advancing Loans:
The money that is received by banks, by way of deposits, is utilised for granting loans and
advances to the worthy borrowers. Apart from playing a vital role, in the development of the
economy, banking is a business with a motive to earn profit.

The successful operation of the function, forms the main source of income i.e. profit of a bank.
Bank advances to commerce, trade & industry to meet their short term and long term
requirements of funds. In recent years, the lending attitude of banks has undergone a marked
change. Now, advances granted by the banks are expected to develop all sectors of the economy.

Banks lend money against various securities like government bonds, movable and immovable
property, industrial securities etc. In suitable cases loans are also given on personal security.
The strength of a bank is judged by the soundness of its advances. The advances by banks may
be made in any one or more of the following forms.

1) Overdrafts 2) Cash Credit 3) Loans

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1) Overdrafts:
a) This facility is given only to Current Account Holders.
b) Here a current account holder is permitted by the banker to draw more than what stands to
his credit.
c) The banker may take some collateral security or may grant such advances on the personal
security.
d) The customer is permitted to withdraw the amount as and when he needs and to make deposit
in his/her account as and when it is convenient.
e) Interest is charged on the amount and for the period it is utilised.
f) This facility is given as a temporary arrangement for a short time.

2) Cash Credit:
a) Under this scheme, the banker specifies a limit for a customer up to a certain limit the
customer is permitted to borrow against security or guarantee.
b) The customer is allowed to withdraw from this account as and when he needs money and
deposits in this account any surplus that he has.
c) Generally the customer is required to provide tangible assets as a security to cover the
amount is borrowed.
d) For the cash credit facility it is not necessary to have an account with the bank.
e) This method of borrowing is very popular in India, accounting for about 90 percent of the
total bank credit. Cash Credit facility is regularly granted to commercial and industrial
concerns for longer periods.
f) Interest is charged on the amount actually utilized by the borrower.

3) Loans:
a) A fixed amount sanctioned for a definite period of time is called loan.
b) Loans are repayable at one time or in installments as agreed.
c) Interest is charged on the total amount of loan sanctioned, whether it is utilised or not.
d) Loans are given on the security of shares, Government Securities/Bonds, Life Insurance
Policies, Gold and other assets. In suitable cases, unsecured advances are also granted by
banks. [Unsecured advances means a advances which is not secured by way of any security)]
e) There are different types of loans i.e. Term Loans, (short, medium, long), Participation Loans
and Personal Loans.
f) Banks charge a slightly lower rate of interest on loan account than overdraft and cash credit.
Other things are being equal.

C) Discounting of Bills of Exchange:

Bill of exchange is a written acknowledgement of the debt, written by the creditor and accepted
by the debtor. Banks also offer financial help to trade and commerce through discounting of
Bills of Exchange and Promissory Notes. Discounting of bills is practically lending for short
periods. Discounting bills is the most important form in which a bank lends without any
collateral security. Bills are self-liquidating papers in the sense that they become payable
automatically after the expiry of the period stated therein.

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Bill discounting provides a banker with an ideal form of investment for the following reasons.

Advantages:
a) Certainty of payment:
Bills-of-exchange is considered to be an ideal self liquidating asset because it becomes due
for payment after the expiry of the period mentioned therein. The payment of bill on due
date is regarded as a matter of honour and hence there is certainty of it. (“Bill of Exchange is
an instrument in writing, containing an unconditional order, signed by the maker, directing a
certain person to pay a certain sum of money”. – The Negotiable Instrument Act’1881- sec.
5)

b) Stability in the value:

As compared with corporate and other securities, bills are not subject to fluctuations in
prices. The amount payable on account of a bill is fixed and the parties are liable to pay the
same in full.

c) Investment for a definite period:

As the banker knows in advance the dates on which the bills discounted will mature; he can
invest his funds in such a way that the same are profitably utilised to maximum extent. A
bank manager can so arrange his bill portfolio as will enable him to meet all the unforeseen
[unexpected] demand without maintaining large cash balance.

d) Re-discounting facility:
When the banker is in need of cash, he can get the bill rediscounted with the central bank of
the country. A central bank is always prepared to rediscount the bills of the commercial
banks. (provided them confirm to the standard laid down by the central bank).

e) Profitability:
The yield from discount is slightly higher than that from interest on loan. This is because in
case of bill, discount is deducted in advance form the amount lent. In case of other types of
loans and advances, interest is payable by the debtor quarterly or half-yearly.

D) CREDIT CREATION:

Creation of credit is one of the outstanding functions of a bank. Banks are not only purveyors of
money but also manufacturers of money.

Deposits of banks arise in two ways. They arise out of cash deposited in the bank by its
customers. These deposits are called primary deposits. The second way of deposits arises when
customers’ accounts are credited with the amount of loans and advances. Deposits arising by
this way are called derived deposits. When the bank creates a liability by accepting a deposit, it
does not create new money but when it creates a liability by giving loans & advances, it creates
new money.
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[Banks lend not only what they receive but also much more than what they receive. This extra
money which a banker is able to lend in excess of what he receives may be considered as
“Created Money”.]

This created money plays a very important role in the development of trade, commerce and
industry. Thus, it is possible for banks to create credit by giving loans and advances, by
discounting bills and promissory notes and by purchasing securities.

II SECONDARY FUNCTIONS (or Subsidiary Functions or Non-Banking Functions)

These functions are also called as subsidiary or supplementary services. By providing wide
variety of such services, banks attract more deposits and get increasing business.

These non-banking or subsidiary services can be classified in two main divisions.

A) Agency Services &

B) General Utility Services or miscellaneous services.

There is a continuous increase in the non-banking functions of modern banks due to various
reasons like competition among banks, social and economic changes and growing confidence in
bank.

A) Agency Services:

The agency services are provided to regular customers of the bank. While providing agency
services, banker acts as the agent of the customer. Nominal service charges are taken from the
customers but valuable services are offered to them. While providing services, bankers should
work strictly according to the instructions of the customers. Banker should insist [to urge, to
press] for instructions in writing from customers.

a) Payment of insurance premium, subscriptions and contributions etc. of societies, clubs and
association etc.
b) Collection of salary and pension bills, dividend coupons, and interest receivable on debentures
and other securities.
c) Transfer of funds of customers from one bank to another by means of bank drafts, mail or
telegraphic transfers.
d) Purchase and sale of stocks, shares, debentures and other securities as per instructions from the
customer.
e) Collection and payment of cheques, bills, and promissory notes etc.
f) Acting as an attorney or representative of clients.
g) Acting as a trustee, executor and administrator.
h) Execution of standing orders/instructions e.g. payment of electric bills, water charges,
corporation taxes, telephone bills, LIC premium etc.
i) Collection of postal orders.
j) Filing of Income-Tax returns.
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B) General Utility Services:

Under utility or miscellaneous services may be included a number of functions performed by a

modern bank. These services are of general nature and any customer can take the benefit of the
same. Banks charge some commission or service charges for providing these services. Here, the
banker does not act as the agent of the customer but provides the services directly. Some
important utility services are as follows.

a) Receiving in safe custody customer’s valuables, ornaments and jewels, documents and important
deeds.
b) Issuing of letters of credit, circular notes, bank drafts, travelers’ cheques.
c) Underwriting loans to be raised by the Government, public bodies and corporations.
d) Compilation and distribution of statistics and business information regarding trade, commerce
and industry.
e) Promotion of savings and economy.
f) Acceptance of bills of exchange for customers.
g) Dealing in foreign exchange, foreign trade and business in connection with import-export
transactions.

**************

Meaning : unanimity (complete agreement) ; enactments [en-act-ment -> a law]; derived – to draw from, to obtain;
Compilation - a book made of selections; purveyors - one who supplies provisions; bill portfolio - bag;
collateral - secondary, indirect; vital – essential, important; prevailing - current, resembles - to be like;
innovation - novelty, change; thrift - habit of savings.

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EVOLUTION OF INDIAN BANKING

In all modern economies, banks perform variety of useful functions. All modern economies are money
economies i.e. they use money in all their economic activities. In advanced countries, as much as 85 to
90 percent of the total money supply is in the form of “Bank Deposits” or “Bank Money”. Even in
developing country, like India, bank money accounts for more than half of the total supply of money.

In modern times, person who save and person who have plans of investment are not the same. It,
therefore, becomes necessary for some agency to act as an intermediary (a mediator) between these two
sets of people and banks act as this type of agency. In fact, in every economic activity like production,
distribution, exchange, banks have an important role to play. So, we can say that banks in modern times
have a key role to play in the process of economic development by promoting savings, channeling
investment by developing enterprises, impressing managerial and business skills in men. Banks are
nothing less than the backbone of modern economies.

Banking can be discussed in the following periods/phases.

A) Banking in Ancient times:

B) Phase of pre-British banking
C) Indian banking during British period.
D) Banking during independence period.

A) BANKING IN ANCIENT TIMES:

In tracing the evolution of banking, we must note that the early banking practices were in way similar to
the modern banking practices. Banking in India was an early age of human civilization. We have
historical evidences and references to early banking activities in the old Vedic literature. Kautilya’s
“Arthashastra” and Manus “Dharmasutra” also provide us useful reference about Indian banking of
ancient days. (Apprxo. from the time of Manu and Kautilya i.e. about two and three centuries before
Christ). Money lending and vague [not clear, doubtful] type of banking was in vogue [popularity, current
fashion], but there is no evidence about their methods of working. The maximum and minimum rates
chargeable as interest have been mentioned from 15% to 60% present per annum on secured and
unsecured loans and advances in Kautilya’s “Arthashastra”.

During the Muslim, Moghul, Maratha and European rules money lending was practiced [performed] on
very large scale. This can be provided very easily from historical records which are now available.
(The earliest bank known in history was established in Venice in the year 1157. In Spain, the magistrate
of “Barcelona” established a bank in the year 1401)

Even some Indian surnames, which were and are in vogue serve as an evidence of the existence of the
money lending. These moneylenders were known by the different names in different parts of the
country. For example, Shetties, Shreshties, Shroffs, Sarafs, Mahajans, Malgujars and Sahukars are some
of the surnames in existence even today.

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B) PHASE OF PRE-BRITISH BANKING:

Period before 17th century and particularly that of Mughal Empire was indeed a period of Indigenous
[native] banking. Banking business along with the use of Hundi (Bills of Exchange), Promissory Note
and Indian Bills of Exchange had become familiar activity and assumed importance in the political and
administrative sphere. [ -a place to duty].

In Greece, the temples served as a bank because the temples commanded the trust of the people and
hence they could attract deposits and other valuables, from people. They also lent funds to the people
and charged a marginal interest on these loans.

The banking practices in ancient Rome, however, bear a close to modern banking practices in many
respects. These banks changed money, gave loans and some of them even used bank drafts and cheques.
Some Roman banks collected taxes on behalf of the Government. (One of the important functions
performed by central bank of the country in the modern times.)

(The Bank of Venice was established in 1157; the Bank of Sweden in 1556; the Bank of Genoa in 1407).

The banks, which served as a model for many European banks were the Bank of Amsterdam, established
in 1609 and Bank of England, established in 1694.

C) INDIAN BANKING DURING BRITISH PERIOD:

Britain’s entry, (East India Company) with a view of obtaining trade and commerce was responsible for
bringing a new phase in Indian Banking in early 17th Century. By this time Britain and other European
nations knew the joint stock banking based on limited liability. When British people came in India, they
found that indigenous banking most unsuitable for the growth of their trade and commerce activities.
For indigenous banking in those days was carried out in vernacular [the native / local language or mother
tongue], which was unknown to the British people. Indigenous banking was largely concentrated in rural
part and was mainly concerned with internal trade. East India Company was initially depended on well
known indigenous banker like Jagat Seth of Calcutta for financial accommodation but that time British
people found it necessary in their own interest, to evolve [to develop] joint stock banking in India.

The rise of joint stock banking:

First joint stock bank named “Hindustan Bank” was established in 1770. A new epoch [- important period
of time] in banking activity thus appeared in India. This trend in banking in India was brought about
mainly to facilitate and develop foreign trade activity of British traders.

European joint stock banking continued to growth under British government till the end of 19th century.
The indigenous banking continuously suffered a set back due to lack of government shelter and strong
competition by European joint stock banks.
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Emergence of Indian joint stock banking and co-operative banking:

From 1906 onwards under “Swadeshi Movement” a few Indians made attempts of starting Indian Joint
stock banks on the lines of European joint stock banking. By this time, three European joint stock banks
known as presidency banks [Bank of Bengol – 1806, Bank of Madras – 1840 and Bank of Bombay –
1843] had come to their prominence [importance] in the Indian banking system. Little before the
beginning of Indian joint stock banks, introduction of co-operative banking in 1904 made an important
landmark in the evolution of Indian banking.

Towards Central Banking Institution:

By 1920, there was rapid growth of both joint stock banking and co-operative banking in India. By this
time, Post Office Savings Banks and Land Mortgage Banks had also come to stay in Indian banking
system. Now, at that time Indian banking system conspicuously [ remarkable, easily] felt an absence
of central banking institution. In response to this feeling and also with a view to serve British
Government’s interest, three presidency banks were amalgamated in 1921. Thus Imperial Bank of India
was established to act as the central bank of the country. It however, did not serve the purpose
effectively and therefore, a more sincere and systematic effort was made to evolve a real type of central
bank in India. Accordingly, Reserve Bank of India Act was passed in 1934 and India’s Central Bank i.
e. “Reserve Bank of India” was established on 1st April, 1935.

D) INDIAN BANKING DURING INDEPENDENCE PERIOD:

It is clearly observed that Indian banking during independence period has evolved from free and
private type of banking in to public sector by nationalisation and planned banking system to a
certain extent.

a) The stage of consolidation, integration and diversification [1947-1966)

[Consolidation- combination, Integration- brining together, Diversification- modification,
alteration]

Reserve Bank of India was nationalised in 1948. In the same year, Banking Companies Act was
also passed. Certain provision of this act empowered the nationalised Reserve Bank to check the
growth of unsound banking units by regulating their capital requirements and different methods
of operations. The Reserve Bank of India in short, followed a policy of combination. Through
this policy, the Reserve Bank of India could reduce the total number of commercial banks from
12000 (branches approx,) to 620 in 1949 and to 156 in 1964. (15 years – 464 banks were
amalgamated)

The total number was further reduced to 78 in 1968. A sweeping structural change was evolved
by RBI with the help of legal provisions. The process of consolidation was effective even in
case of co-operative banking. [In the short period i.e. 1947 to 1966 there was a remarkable
change in the form of consolidation.]
……15
 : 15 :

Nationalisation of Imperial Bank of India and establishment of State Bank of India in the year 1955 was
a great change as a part of integration process. The policy of integration also aimed at linking together
as close as possible. There were two divided sectors of Indian banking a) Organised banking sector &
b) Unorganised banking sectors, (Indigenous bankers). The process of the diversification implied the
base and structure of Indian banking by introducing variety of institutions dealing separately with the
credit problems of industries (large and small scale), export sector and agriculture sector. That is called
development banking. The process began with the establishment of Industrial Development Bank of
India (I D B I) on 1st July 1964. Industrial Finance Corporation of India was established on 1st July
1948. Industrial Credit & Investment Corporation of India established on 5th January 1955 followed by
setting up a number of state financial corporations in 1951. And before that, Tamilnadu Govt. was
established a corporation in 1949 in the name of “Tamilnadu Industrial Development Corporation”,
working as the state’s financial corporation. At present there are 18 industrial development
corporations.

b) Social Control (1967)

However, these new trends (patterns) would not bring the overall banking mostly the private commercial
banking together for the development aims and policy of the government of India. The credit needs
particularly of small farmers, small businessmen and other neglected sectors and unbanked areas, the
Government of India introduced a scheme of social control in 1967. But the social control, however,
did not seem to be an effective scheme for the same. It could bring only changes in the management and
introduce a greater government policy or policies.

c) Nationalisation of 14 big commercial banks in 1969.

The nationalisation of 14 big commercial banks having paid up capital Rs. 28.50 crore, deposits 2629
crore and loans 1813 crore were nationalised on 19th July 1969 with their 4134 branches. Mrs. Indira
Gandhi, the Late Prime Minister of India, boldly undertook the step of removing the private ownership
of the 14 commercial banks and declared them as the nationalised banks. The Nationalisation of 14 big
commercial banks was indeed, a bold, historic and timely step in the Indian circumstances which
certainly contributed in giving a new shape and new direction to the Indian Banking. With
nationalisation of the 14 big banks, the Indian banking got divided more clearly in to public and private
sectors giving lion’s (major) share of 80% to public sectors.

1) Provision for adequate credit for agricultural and small-scale industries.

2) Provision for credit for exports.
3) Giving a professional bent (touch) to bank management.
4) Provision for adequate training as well as reasonable terms of service of bank staff.

……16
 : 16 :

With nationalisation of 14 big banks, the total numbers of banks in public sector went up to 22
(including State Bank of India and its seven subsidiaries). Again in 1980, other 6 commercial banks
were nationalised. The “New Bank of India was merged with Punjab National Bank on 4th September
2000. Thus, at present, there are 27 nationalised commercial banks in the public sector.

************

SUMMARY

Name of Bank Year of Establishment

1. Bank of Genoa 1407

2. Bank of Venice 1157
3. Bank of Sweden 1556
4. Bank of Amsterdam 1609
5. Bank of England 1694
6. Hindustan Bank 1770
1. Presidency Banks
a) Bank of Bengol 1806
b) Bank of Madras 1840
c) Bank of Bombay 1843

8. Imperial Bank of India 27/1/1921

(Established by amalgamating the said
presidency banks)

Nationalised in the name of 01/7/1955.

State Bank of India

-------------------------------------------------------------------------------------------------------------------

Intermediary [MTrmaIiDArI- a mediator, acting between, vague - not clear, doubtful

vogue - popularity, current fashion sphere - a place to duty
Familiar - well-known / common vernacular - the native/mother tongue
bear - to suffer, to carry, to produce to evolve - to develop
epoch - important period of time
empowered - to give power, authority conspicuously - remarkable, easily
combination - consolidation. sweeping - to pass swiftly

……17
 : 17 :
BANKS IN INDIA
Name of Bank Authorised Established on
share Cap.
(Rs. in crore)
st
A) Reserve Bank of India 1 April 1935
Nationalised in 1948
B) Industrial Finance Corp. of 01/7/1948
India Ltd. (I F C I)
C) Industrial Credit & Investment 05/1/1955
Corporation of India (I C I C I)
D) Industrial Development Bank 01/7/1964
of India (I D B I)
E) National Bank for Agricultural & 100 12/7/1982
Rural Development (NABARD)
F) Export Import Bank of India 2000 (old 500) 01/01/1982
G) Small Industries Development 02/4/1990
Bank of India (SIDBI)
H) National Housing Bank (NHB) 100 09/7/1988
I) Unit Trust of India 5 01/02/1964 (1963)
I) Commercial Banks In Public Sector:
1) State Bank of India Nationalised in 1955.
Subsidiaries of SBI:
a) State Bank of Hyderabad 1942
b) State Bank of Patiala 1917
c) State Bank of Mysore 1913
d) State Bank of Travancore 1946
e) State Bank of Bikaner & Jaipur 1944,1943

State Bank of Indore 1920 merged with SBI

State Bank of Saurashtra 1902 Merged with SBI

Other Nationalised Banks

1) Allahabad Bank 19/7/1969
2) Bank of Baroda 19/7/1969
3) Bank of India 19/7/1969
4) Bank of Maharashtra 19/7/1969
5) Canara Bank 19/7/1969
6) Central Bank of India 19/7/1969
7) Dena Bank 19/7/1969
8) Indian Bank 19/7/1969
9) Indian Overseas Bank 19/7/1969
10) Punjab National Bank * 19/7/1969
11) Syndicate Bank 19/7/1969
12) Union Bank of India 19/7/1969
13) United Bank of India 19/7/1969
14) UCO Bank (United Commercial Bank) 19/7/1969
15) Andhra Bank (Vaishya Bank) 1980
16) Corporation Bank 1980
17) Oriental Bank of Commerce 1980
18) Punjab & Sind Bank 1980
19) Vijaya Bank 1980
20) Women’s Bank of India
* 21) New Bank of India 1980
* (New Bank of India merged with Punjab National Bank on 04/9/2000.)
…..18
 : 18 :

Banking Regulation Act’1949

The Banking regulation Act 1949 is a landmark in the history if banking legislation in India. The act
was passed in the year 1949 and came into effect from 16th March 1949 to regulate banking
business/transaction. It extends to whole India.

This act was passed in order to remove the defects in the banking systems and to strengthen the
banking structure so that the banking system can be used as an instrument of economic change in the
country. This act also gives powers to the Reserve Bank of India to control and supervise the
activities of the commercial banks in India.

Some of the important provisions of the Banking Regulation Act 1949 are as follows.

1. Definition of Banking : “Banking means accepting, for the purpose of lending or investment of
deposit of money from public, repayable on demand or otherwise, and withdrawable by cheque,
order or otherwise.” [sec. 5 (b)]

2. It prohibits trading i.e. (a bank cannot directly or indirectly deal in the buying or selling of
goods). [sec. 8]
3. It prohibits managing agents i.e. Director, Chairman or Secretary of any company. (sec.16)
4. Power of RBI to control Loans and Advance. [sec. 35]
5. It requires that a bank has to maintain a certain minimum balance as reserve in cash (CRR) or
securities with RBI. [sec. 18]
6. It prohibits banks to give advances against their own shares to the public. [sec. 20]
7. Every banking company has to obtain a license from RBI for its banking business in India. [sec.
22]
8. Restriction on opening new branches of any bank. (under RBI permission only, bank can open
a new branch.) [sec. 23]
9. Control on voting rights on share holder.
10. Every banking company has to prepare Balance Sheet & Profit & Loss Account at the expiry
of each year. [sec. 29 to 33]
11. The Balance sheet must be audited by a duly qualified auditor.
12. Power to inspect the commercial banks. (Sec. 35)
13. Power of the RBI for the following directions.
a) In the public interest.
b) In the Interest of banking policy of the government.
c) Control over the management of the banking industry.

…..19
 : 19 :

CENTRAL BANKING SYSTEM

RESERVE BANK OF INDIA (RBI)
INTRODUCTION:
The central bank is the apex banking and monetary institution whose main function is to control,
regulate and stabilize the banking and monetary system of the country in the interests of the nation. The
Reserve Bank of India is the central bank of our country. The Reserve Bank of India was established on
1st April 1935 under the Reserve Bank of India Act, which was passed in the year 1934 by the British
government. The Reserve Bank of India was started originally as a shareholders’ bank and its paid up
capital was Rs. 5 crores. When the Reserve Bank of India was established, it took the function of
currency issue from the Government of India and the power of credit control from the Imperial Bank of
India.

NATIONALISATION:
The Reserve Bank of India was nationalised in the year 1948. The question which arises is why the
Reserve Bank of India was nationalised in 1948 soon after Independence. There are two/three reasons
which accounts for the nationalisation of the Reserve Bank of India in 1948.
1. Firstly, immediately after the end of the Second World War there was a trend towards
nationalisation of central banks all over the world. The Bank of England was nationalised in
1946.

2. Secondly, in India, there was inflation right from 1939 onwards and it was thought advisable to
nationalise the Reserve Bank of India in order to control inflation in the country effectively.

3. Thirdly, as India had to embark upon a programme of economic development and growth, it
was necessary to have a complete control over the activities of a central bank so that it could be
used effectively as an instrument of economic change in the country.

ORGANISATION & MANAGEMENT OF THE RESERVE BANK OF INDIA

The affairs of the Reserve Bank of India are managed by the Central Board of Directors. The Chairman
of the Central Board of Directors of the RBI is called the Chief Executive Authority of the Bank and he
is known as the Governor. The Governor has the powers of general Superintendence and direction of
the affairs and business of the bank and he is authorised to exercise all the powers which may be
exercised by the bank. In the absence of the Governor, the Deputy Governor nominated by him
exercises his powers.

Dr. ……………………………….. is the present Governor of the Reserve Bank of India.

The Reserve Bank of India has the Headquarters in Mumbai and Local Boards Offices at Mumbai, New
Delhi, Kolkata and Chennai. The Local Board consists of five members and these members are
appointed by the Central Government to represent territorial and economic interest and the interest of
co-operatives and indigenous banks.

The work of RBI is divided in to 8 departments. These are-

1) Administration Dept. 2) Agricultural Credit Dept., 3) Secretary’s Dept.
4) Premises Dept., 5) Exchange Control Dept., 6) Non-Banking Companies
7) Industrial Finance Dept. 8) Dept. of Banking Operations and Development.

…..20
 : 20 :

The Central Board of Directors of the RBI, consist of 20 members as follows.

1 A Governor and not more than four Deputy Governors appointed by he Central 5 members
Government under Section 8 (1) (a) of the Reserve Bank of India Act, 1934.
2 Four Directors nominated by the Central Government, one from each of the four 4 members
Local Boards in terms of Section 8 (1) (b).
(Local Boards are at New Delhi, Mumbai, Kolkata & Chennai)
3 Ten Directors nominated by the Central Government under Section 8 (1) (c). 10 members
4 One Government official nominated by the Central Government 5 members
under Section 8 (1) (d)

FUNCTIONS OF THE RESERVE BANK OF INDIA:

The Reserve Bank of India performs all the important functions which are expected of a central bank as
such it performs the following functions.

1. Monopoly of note issue:- The Government of India grants the exclusive right to the Reserve Bank
of India issues and regulates the issue of currency in India on its behalf. In fact the Reserve Bank
of India has the sole authority and monopoly to issue currency notes in the country. This power
enables the Reserve Bank of India to regulate and control money supply in the country. In India,
all currency notes are printed and issued by the Reserve Bank of India. One rupee notes (which are
no longer being issued) were issued by the Ministry of Finance. In order to inspire public
confidence in paper currency, the central bank is required to maintain a minimum balance of Rs.
200 crores in the form of gold & silver and foreign currency against the issue of notes.

2. Banker, Agent, and Adviser to the Government:- The Reserve Bank of India acts as a banker to
the Central and State Governments. The Reserve Bank of India looks after the current financial
transactions of the Government and managers the public debts of the government.
As a banker to the Government, the Reserve Bank of India has the obligation to transact the
banking business of the Central Government, to make payment on behalf of the Central
Government. The Reserve Bank undertakes to accept money on account of the Government, to
make payments on behalf of the Government. It also carries out to exchange remittance and other
banking operations including the management of the pubic debts.

3. Banker’s Bank: The Reserve Bank of India acts as a banker to all the commercial banks in the
country. This means, all the commercial banks are the customers of the Reserve Bank of India.
Just as the private individuals keep and maintain their accounts with commercial banks, commercial
banks keep and maintain their accounts with the Reserve Bank of India. They (commercial banks)
borrow money from the Reserve Bank of India when necessary. In case of difficulties, the Reserve
Bank of India acts as a lender of the last resort to commercial banks. The central bank provides
short term loans and bill discounting facilities to the commercial banks. It also advises the
commercial banks on various matters relating to their business.

The commercial banks have to keep a certain proportion of their total deposits in the form of cash
as the reserve with the Reserve Bank of India. This is called Cash Reserve Ration (CRR). At
present the CRR is 5%. This reserve enables the central bank to exercise control over credit created
by commercial banks.

…….21
 : 21 :

4. Controller of Credit: The Reserve Bank of India exercises its control over the volume of credit
created by the commercial banks in order to insure price stability. The main function of the
Reserve Bank of India is to aim at maximum employment, a favourable balance of payments; the
control of inflation and the growth of the economy. It tries to achieve this by exercising control on
the credit giving capacity of commercial banks. Credit control is done by the central bank by
exercising BANK RATE, CRR, SLR, REPO RATE, REVERSE REPO RATE, etc.

5. Custodian of Foreign Exchange: The central is the sole custodian of gold and foreign currency
reserves of the country. Foreign exchange reserves are needed for making payments to foreign
countries. When the balance of payments is unfavourable, foreign exchange reserves are reduced.
Therefore, the central bank advices the Government to encourage exports and to restrict imports in
such a way that the balance of payment may be favourable to the country.

Balance of Payment & Balancing Trade:

The difference between the imports and exports of a country is called the “Balance of Trade”. The extent of adverse
[unfavourable, opposite] or favourable balance of trade, depends on the item included in imports and exports and on the
method of valuation. If the value of commodities imported and exported is also taken, it would not show the real
position. In order to have a clear picture, it is necessary to include the “Invisible’ items also, such as shipping services,
insurance services, interest on foreign investment, banking facilities etc. When these are included it would be more
accurate to be called the “Balance of Indebtedness” or “Balance of Payment”.

Balance of Payment:
Balance of payments is a wider term than balance of trade, embraces [to accept, to include], not only visible but also
invisible imports and exports for our imports we must pay and in turn for our exports we must receive payments. The
balance of payments is thus the difference between our payments and our receipts (income) for visible as well as
invisible imports and exports respectively.

The balance of payments of a country is a systematic record of all economic transactions between the residents of the
country and residents of foreign countries during given period of time, normally a year. It is a record of a country’s
estimated international transactions both commercial and non-commercial, during a given period.

6. Maintaining the Exchange Rate (Maintenance of Home Currency Value): The Reserve Bank
of India has the responsibility to maintain not only the internal value of the currency, i.e. the Indian
Rupee, but it has also to maintain external value of the currency. The central bank makes all
possible efforts to maintain a stable Exchange Rate. Exchange rate is the rate at which the home
currency can be exchanged for a foreign currency. The central bank keeps a watch on the
exchange rate. However there are wide fluctuations in the Exchange Rate, the central bank buys
and sells foreign currencies to stabilise the Exchange Rate. The Central Bank is authorised to fix
and change the exchange rate ratio.

7. Providing Clearing House: The central bank provides Clearing House facility to the commercial
banks. In other words, it settles the claims of commercial banks through a process of book entries.
The daily balances between the commercial banks can be adjusted by means of debit and credit
entries in their respective accounts with the central bank or Clearing House.

In simple words, clearing house a place where commercial banks exchange their liabilities and
settle their dues.

…….22
 : 22 :

2. Development Functions: Every central bank performs the traditional and regulatory functions.
But in a developing country like India, the Central Bank also performs certain promotional and
development function. It has to perform not only the negative role of controlling credit and
currency in the economy to maintain internal and external value of the rupee to ensure price
stability in the economy, but also to act as a promoter of financial institutions in the country so that
its policies could be effective in promoting economic growth as per the guidelines and policies
formulated by the government.

At the time of establishment of the RBI, our country was backward country which lacked a well-
developed commercial banking system apart from the absence of a well-developed money market in
the country. After 1948 the Reserve Bank of India became very active to take steps to promote and
develop financial institutions so that the RBI can pursue appropriate credit and monetary policies
for economic growth and development in the era if planned economic development of the country.
(5year development plans)

It tries to provide adequate funds for development of agriculture, trade, transport and industry. The
Reserve Bank of India creates special financial institutions for promoting economic development in
different sectors of the countries. E.g. NABARD, ICICI, IFCI, IDBI, SIDBI etc. The Agricultural
Credit Department of the Reserve Bank of India provides long term credit for agriculture. This
department also co-ordinates with the activities of co-operative credit societies, co-operative banks
and land mortgage banks in rural areas.

The RBI also provides loans to industrial development banks for financing different kinds
industries. The RBI also carries out studies on the economic problems of the country, compiles
data and publishes reports and journals for the use of banks and other agencies. The Reserve Bank
of India also acts as an agent to the international institutions such as the WORLD BANK,
INTERNATIONAL MONETARY FUND, NTERNATIONAL FINANCE CORPORATION etc.

CONTROL OF CREDIT BY CENTRAL BANK:

In modern times, the most important function of a central bank is considered to be the control of credit.
The commercial banks through their lending operations create credit. The central bank controls the
credit to aim at:
a) Stabilising the price level in the country.
b) To eliminate violent fluctuations and to maximize production and employment.
c) To keep Exchange Rate stable.
d) To maintain gold reserves of the country.
e) To keep the rate of growth in business activities normal and steady.

Methods of Credit Control:

The Central Bank employs several methods to regulate and control credit in the country. The methods
of credit control are classified into two categories i.e. (a) quantitative credit control and (b) qualitative
credit control.
The main methods of quantitative credit control are:-
1. Bank Rate Policy
2. Open Market Operations
3. Variable Cash Reserve Requirements

………23
 : 23 :

1. Bank Rate Policy:

The Bank Rate is the rate of interest at which the Reserve Bank of India re-discounts the first
class bills of exchange from the commercial banks or other eligible papers. In other words
Reserve Bank of India lends money at the prescribed Bank Rate through buying or rediscounting
the bills of exchange and / or against the security of other eligible papers. By raising or lowering
the bank rate, the central bank controls the credit that is created by the commercial banks.

With an increase in the bank rate and other monetary rates , like interest is given on deposits
and interest charged on loans, the central bank aims decreasing the credit supply in the market.
As the interest is high, people will deposit more money in the banks to earn interest and since the
interest charged on loans is high, people will borrow less. This encourages people to save and
discourages them from borrowing. This decreases the money supply in the market. The money in
circulation thus declines leading to lower purchasing power of the customer. Demand for goods
thus decreases and prices may fall thereby controlling inflation. Business operations may become
too expensive, business enterprise may be checked and production and trade curtailed from
growing.

Similarly, with decrease in the bank rate and other monetary rates, people will deposit less money
in the banks since a low rate of interest is given and borrow more since the rate of interest charged
on loans is low. This amount of money in circulation will thus increase. Consumers may buy more
thus encouraging business enterprise, production and trade. This remedy is used to control the
recession in the market.

2. Open Market Operations:

The term open market operations, refers to the purchase and sale of the securities in the open
market by the Central Bank. Open market operations exercise direct influence on the supply of
money in circulation and cash reserves of commercial banks. When the Central Bank wants to
decrease the supply of money in the market, it sells securities and collects money from the market.
This is because people/banks will buy the securities thereby reducing the money available with
them.

On the other hand, when the Central Bank wants to increase the money in circulation as well as the
cash reserves of commercial banks, it buys securities thereby releasing money in the market.

The success of open market operation as a technique or credit control depends upon the size of
Government Securities available, their range in variety and the ability of the market to absorb them.
(BUYS to INCREASE, SELLS to DECREASE)

3. Variable Cash Reserve Requirements:

The commercial banks are required to keep a certain percentage of deposits as reserves with the
Reserve Bank of India. The Reserve Bank of India is legally authorised to raise or lower the
minimum reserves that the bank must maintain against the total deposits.

The reserve requirements are of two kinds.

a) Cash Reserve Ratio (CRR): Commercial Bank have to keep a certain percentage of their cash
reserves with the Central Bank known as Cash Reserve Ratio. At Present it is 5 %.
b) Statutory Liquid Requirements (SLR): All the commercial banks have to maintain a certain
percentage of their reserves with themselves in the form of cash. This is to meet their day to day
requirements of withdrawals by the customers. At present it is 25 %.
…..24
 : 24 :

By raising these reserve requirements (CRR & SLR), the Central Banks will be left with less
cash and therefore their credit creation will be reduced. When these reserve requirements are
reduced, the commercial banks will have more cash with them and they would be able to expand
credit. A reduction of about 1% releases nearly Rs. 4000 crores in the country.

4. Selective Credit Control:

The methods discussed above are quantitative in nature. Selective credit controls are qualitative
methods of credit control as these are diverted towards particular uses of credit. The main methods
of selective credit control are as follows.

a) Credit Rationing:
Under this method, the Central Banks limits the amount of credit available to a commercial bank.
The maximum amount of advances which a commercial bank can make for a specific purpose
may be prescribed. Direct action in the form of penal rates of interest, denial of rediscounting
facility etc. may also be taken. Credit rationing is used during periods of exceptional monetary
stringency [strictness] and rapidly declining gold reserves.

b) Moral Suasion (Persuation) :

In this method the Central Bank requests and persuades the commercial bank not to grant credit
for non-essential and speculative activities. It issues directives to commercial banks to give
priority in their lending to particular industries such as those concerned with export, defence, and
agriculture. Commercial banks honour the moral pressure of the Central Bank because it is the
symbol of financial sovereignty (control).

c) Publicity:
The central bank issues weekly reports and other publications. From these publications,
commercial banks become aware of the latest position in the money market, public finance, trade
and industry, etc. of the country. They can therefore adjust their credit operations according to
the market situations.

d) Margin Requirements:
Commercial banks have to keep a margin between the amount of loan granted and the market
value of the security against which it is granted. E.g. they may be asked to grant loans up to 80%
of the security or asset. The borrower, in this situation should arrange for the remaining 20 %
from his own sources. Thus 20 % is the margin requirement. To control credit, in case of need,
this margin may be increased by the Central Bank.

THE RESERVE BANK OF INDIA AND COMMERCIAL BANKS

The commercial banks maintain accounts with the Reserve Bank of India and borrow money when
necessary from the Reserve Bank of India. The Reserve Bank of India thus provides credit to
commercial banks and commercial banks in turn provide credit to their clients to promote economic
growth and development. However, credit can not be extended to an unlimited extent because it would
disturb price stability in the country and therefore, it becomes necessary for the RBI to control the
activities of the commercial banks in the interest of price stability. The RBI controls the activities of the
commercial banks by virtue of the powers vested in it under the Banking Regulation Act, 1949 and the
Reserve Bank of India Act, 1934.

……25
 : 25 :

The Banking regulation Act 1949 is a landmark in the history if banking legislation in India. The act
was passed in the year 1949 and came into effect from 16th March 1949 to regulate banking
business/transaction. It extends to whole India.

This act was passed in order to remove the defects in the banking systems and to strengthen the banking
structure so that the banking system can be used as an instrument of economic change in the country.
This act also gives powers to the Reserve Bank of India to control and supervise the activities of the
commercial banks in India.

Under the Banking Regulation Act, 1949, the Reserve Bank of India is given a power to license to
commercial banks to open branches. No commercial bank can commence the business of banking
without obtaining license from the Reserve Bank of India. The Reserve Bank of India has also power to
withdraw the license once granted in case it is found that the affairs of the bank are not managed
properly.

The RBI has been given a power to inspect the commercial banks under section 35 of the Banking
Regulation Act 1949. Under this power, The RBI can inspect inspection any bank at any time through
one or more of its officers. If there is defect in the books of accounts of the banks concerned, are
required to rectify them. If needed, the RBI can appoint additional directors on the Boards of Directors
of the concern bank.

Under the Banking Regulation Act 1949, the RBI has wide powers of over-all control over the
management of banks. Under this Act, section 35(b), the approval of the RBI is necessary for the
appointment or reappointment or termination of an appointment of a Chairman, Managing Director or
Whole Time Director. The RBI has a power to prevent a commercial bank from undertaking certain
types of transactions. i.e. trading etc.

Under Section 21, the RBI has been given a power to control advances granted by the commercial
banks. This power is known as the power of Selective Credit Control. Under this Section, the Reserve
Bank of India is empowered to determine the policy in relation to advances to be followed by banks
generally or by any bank in particular and under this Section, the RBI has been authorised to issue
directions to banks as regards the purpose of the advances, the margins to be maintained in respect of the
secured conditions on which advances may be made.

Apart from the Selective Credit Control of Credit Exercised by the Reserve Bank of India, the RBI
controls the volume of credit in a quantitative way so as to influence the total volume of bank credit.
The RBI does this through the use of following instruments.

a) The Bank Rate

b) Open Market Operations
c) Variable Cash Reserve Requirements.
d) Selective Credit Control.

…….26
 : 26 :

RESERVE BANK OF INDIA & THE LEAD BANK SCHEME

The development of the country is difficult with the development of the economy. The economic
development depends upon the raise of the standard of the society. The standard of the society depends
upon the employment. Thus the development of the country depends upon the employment.

Therefore, as a part of the development process, the Reserve Bank of India introduced the lead bank
scheme in December, 1969 on the recommendations of a committee “Organisational Framework for
Implementation of Social Objectives” (Chairman - Prof. Gadgil) and FKP Nariman Committee.

The objectives of the scheme are:

1. Removal of unemployment and under employment.
2. Appreciable rise in the standard of living of the poorest sections of the population.
3. Provision of some of the basic needs of the people belonging to the poorer sections.

To achieve these goals, District Credit Plans are prepared with the focus on
a) Increasing productivity, production and employment opportunities in different sectors in rural areas,
specially among the weaker section, to enable them to move above the poverty line.
b) Promoting balanced development of different districts / blocks within the districts.

Under the scheme all the districts of the country have allocated to the banks (except Delhi urban,
Mumbai, Calcutta, Chennai, Ahmedabad, Bangalore-urban, Chandigarh-urban, Hyderabad-
Secundarrabad, Nagpur, Pune, Pimpri-Chinchwad, Kanpur, on the following basis.

The scheme involves participation of Lead Bank, other non-lead commercial banks, RRBs, Co-operative
Banks, other financial institutions like SFCs, RBI, NABARD, and Government Development Agencies.

To activate the implementation of the scheme various coordination forums have been created as under.
a) At the district level.
b) State level
c) National level.

Thus the scheme of Lead Bank was exercised on the above mentioned level under the leadership of the
Reserve Bank of India to Removal of unemployment and under employment, appreciable rise in the
standard of living of the poorest sections of the population and provision of some of the basic needs of
the people belonging to the poorer sections.

Difference between Central Bank and Commercial Bank

 : 27 :

BANKS IN PUBLIC SECTOR

State Bank of India (SBI)
Introduction:
The State Bank of India is the biggest and the leading commercial bank in India. The SBI is established
on 1st July 1955 under the State Bank of India Act 1955 by nationalising the Imperial Bank of India.
The establishment of the State Bank of India is treated as an important landmark in the history and
development of Indian banking system. The State Bank of India has a unique position in the Indian
money market and is playing a significant role in the Indian economy. The establishment of the SBI is
important step towards the socialization of banking system in India. The present chairperson of the SBI
is ………………………………..

Historical background:
The State Bank of India has a long history. The history of the SBI is nothing but the working of
Imperial Bank of India. From 1906 onwards under “Swadeshi Movement” a few Indians made attempts
of starting Indian Joint stock banks on the lines of European joint stock banking. By this time, three
European joint stock banks known as presidency banks [Bank of Bengol – 1806, Bank of Madras – 1840
and Bank of Bombay – 1843] had come to their prominence [importance] in the Indian banking system.

In the year 1921, the Imperial Bank of India was established by amalgamating the abovementioned three
presidency banks through the Imperial Bank of India Act 1920.

Under the Imperial Bank of India Act, 1920, the bank was managed by the Central Board of Directors.
There were three local boards at the three presidency towns. The local boards had fairly wide powers to
manage the local business. They were under the control of the central board.
The central board of the Imperial Bank consisted of the following members.

1. The presidents and vice-presidents of the local boards representing. 2 members

the shareholders
2. The controller of currency representing the Government of India. 1 members
3. Four governors nominated by the Government of India to serve 4 members
the interest of Indian community in general.
4. The secretaries of the local boards and 3 members
5. Two managing governors appointed by the Government of India 2 members
on the advice of the Central Board. Total 12 Members

Functions of the Imperial Bank of India:

Until the establishment of the Reserve Bank of India in 1935, the Imperial Bank of India performed
certain central banking functions, although it was purely a commercial bank.
1. It acted as the sole banker to the government.
2. It was the custodian of public funds and Government cash balances and did all treasury work.
3. It also held the cash balance of the secretary of state through its London office.
4. Most of the commercial banks kept their balances with the Imperial Bank and hence it acted as
the banker’s bank.
5. In addition to the central banking functions the Imperial Bank performed the ordinary
commercial banking functions also. It accepted different kinds of deposits from the public and
lent money on the basis of personal and collateral securities.
…..28
 : 28 :
6. After establishment of the Reserve Bank of India in 1935, the Imperial Bank of India was
appointed as Reserve Bank’s agent to transact government banking business at the places where
the Reserve Bank had no its own office or branch.
7. It also maintained currency (even small coins) chests on behalf of the government in those places
where the Reserve Bank had no branch. Thus the Imperial Bank was able to maintain its prestige
and special position even after the creation of the Reserve Bank and hence it was on better
footing than other commercial banks in the country.

Nationalisation of the Imperial Bank

When the question of the nationalisation of the Imperial Bank of India come up first in February, 1948,
the government accepted the principle of nationalisation, but it was opposed by the Central Board of
Directors and the shareholders. They put forward many arguments against nationalisation and
ultimately, the Government announced in 1949, the indefinite postponement of the questions of
nationalisation of the Imperial Bank of India.
The question of nationalisation of the Imperial Bank was again taken up by the Government when the
All India Rural Credit Survey Committee (appointed by the RBI) recommended in 1952, the creation
of a State Bank of India by amalgamating certain state owned banks with the Imperial Bank.
Accordingly, the State Bank of India Act was passed on 8th May 1955 and the State Bank of India came
into existence on 1st July 1955.
Thus the State Bank of India is established by amalgamating the presidency banks and certain major
state owned banks with their branches and all branches of the Imperial Bank,
State Owned Commercial Banks
1. State Bank of Hyderabad (1942) 5. Bank of Travancore Ltd. (1946)
2. Bank of Jaipur Ltd. (1943) 6. Bank of Mysore Ltd. (1913)
3. Bank of Bikaner Ltd. (1944) 7. Bank of Patiala (1917)
4. Bank of Indore Ltd. (1920) 8. Bank of Saurashtra (1902)

This was in the line with the opinion expressed by the Rural Banking Inquiry Committee in 1950, that
“if these banks could be integrated into one institution and if that one institution could be aligned to
national policies, then indeed that would be extremely important and extremely desirable line of
development.

The setting up of the State Bank of India was an important step towards the development of a strong
commercial banking system in the country.

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 : 29 :

Organisation and Management of the State Bank of India:

Share Capital:
The State Bank of India has an authorised capital of Rs. 20 crore divided in to 20,00,000 shares of Rs.
100 each. The issued and paid-up capital being Rs. 5.625 crore divided into 5,62,500 fully paid-up
shares. The Reserve Bank of India is required to hold not less than 54 % of the issued capital of the
bank, but today, the RBI actually holds 92% of the issued capital and the balance is held by 1,227
private share holders. (Thus the 8% shares of held by the private share holders.)

Management of the State Bank of India:

1 A Chairman and a Vice-chairman (Dy. Chairman), appointed by the Central 2 members

Government in consultation with the Reserve Bank of India. The appointment
of the chairman and vice-chairman or deputy chairman is for a period of five
years and can be extended.
2 Two managing directors appointed by the central board of directors with the 2 members
prior permission / approval of the Central Government for a period of five
years and can be extended..
3 Six directors to be elected in the prescribed manner by the shareholders other 6 members
than the Reserve Bank for a period of four years.
4 Eight directors to be nominated by the Central Government in consultation 8 members
with the Reserve Bank. Not less than two of them have special knowledge of
the working of the co-operative institutions and of rural economy and the
others should have experience in commerce, trade, industry, banking and
finance.
5 One director to be nominated by the central government. 1 member
6 One director to be nominated by the Reserve Bank of India. 1 member
Total 20 members
The management of the State Bank of India is done by the Central Board of Directors which
consists of 20 members as mentioned follows.

The Chairman, Vice-chairman and the Managing Directors shall hold the office for such terms not
exceeding 5 years as the Central Government may fix when appointing them and shall be eligible for re-
appointment.

The directors elected by the shareholders and nominated by the central government will hold the office
for 4 years and are eligible for re-election and re-nomination.

Besides the central board there are local boards at Kolkata, Mumbai, Chennai, New Delhi, Kanpur,
Hyderabad, Ahmedabad, Bhopal and Patna. (The head office of the State Bank of India is in
Mumbai.)

In addition to this, the Central Board of Directors of the SBI appoints a Local Committee, which may
consist of such a number of members as may be determined by the Central Board. The Local Board of
Directors and the Local Committee together run the administration of the State Bank of India belonging
to that particular region. Similarly, the powers to be exercised and duties to be performed by these local
boards of directors and local committees are fixed by the Central Board of Director.
…..30
 : 30 :

No person is entitled to become a director of the Central Board or a member of the local board or local
committee, if.
a) He is holding the office of manager or director of any banking company or a company.
b) He is a salaried officer of the government and doesn’t specially authorised to work as a director or a
member of the local committee.

c) He was found guilty of bribery or corruption and removed from any office of the government.
d) He is holding an office in the State Bank of India and is paid for it except the office of the
chairman, vice-chairman or managing director.
e) He has been declared as an insolvent person or has suspended payments to his debtors or has
compounded with his creditors.
f) He is of unsound mind or mentally deranged.
g) He is an elected director, then he must hold shares of the State Bank of India worth Rs. 5,000/- and
if he is an elected member then he must hold shares worth Rs. 1,000/-.
h) He happens to be a member of the Parliament or of the Legislature and does not resign such
membership within two months after having been appointed as a member of the board of directors,
or as a member of the local board or committee, of the State Bank.

All these restrictions are very scrupulously [extremely careful] following by the Government while making
appointments.

Functions of the State Bank of India:

The State Bank of India is entitled to carry on the following functions.
1. To act as an agent of the Reserve Bank of India, where the RBI does not have a branch or office and
the State Bank has an office. The SBI can receive and pay money and accept securities on behalf of
the Government of India.

2. To advance and lend money and open cash credit upon the securities of -
a) Stocks and funds
b) Debentures of companies with limited liability.
c) Debentures or other securities issued on behalf of a district board, municipal board or other
local authority, under the authority of law.
d) Stocks, funds and securities in which a trustee is authorised to invest trust’s money.
e) Goods which are hypothecated to the State Bank of India as a security.

3. Drawing, accepting, discounting, buying and selling bills of exchange and other negotiable
securities.

4. Receiving Deposits on various deposit accounts.

5. Buying and selling of gold and silver.

6. Acting as an agent of any co-operative bank which is registered under the law in force.

7. The administration, whether alone or jointly with other persons, of estates for any purpose, whether
as executor, trustee, administrator or otherwise.

…..31
 : 31 :

8. Receiving of all kinds of bonds, title deeds or valuables in safe custody.

9. Rendering Safe Deposit Lockers on rent to the customers.

10. Other banking functions, performed by a commercial bank.

Nature, Working and Progress:

The State Bank of India is running purely as a commercial bank. The primary aim of the bank is the
provision of banking facilities in the rural areas. It provides finances to the small scale units or
industries in India. The Central Government can not interfere in the usual policy matters and day-to-day
working of the bank.

The State Bank of India together with its subsidiary banks is popularly known as the State Bank Group.
The State Bank Group amounts 1/3 of the entire banking business in India. It has created a strong
banking structure with a total of 10000 bank offices approximately. These branches are spread through
out the country and the world.

Subsidiary Banks of the State Bank of India:

The All India Rural Survey Committee had recommended that, in order to strength the base of the State
Bank of India, it would be pleasant to integrate some of the state associated banks with it. Accordingly,
the State Bank of India Act (Subsidiary Bank) was passed in the year 1959. As per this act the
following eight banks have been associated with the State Bank of India and now named as the
subsidiaries of the State Bank.

Subsidiaries of the State Bank of India: (1942 to 1960)

Name of Bank Year of the Set up as Re-named as
Establishment subsidiary on
1. State Bank of Hyderabad. 1942 01.10.1959 State Bank of Hyderabad.
2. Bank of Jaipur Ltd. 1943 01.1.1960 State Bank of Jaipur & Bikaner
3. Bank of Bikaner Ltd. 1944 01.1.1960
4. Bank of Indore Ltd. 1920 01.1.1960 State Bank of Indore
5. Bank of Travancore Ltd. 1946 01.1.1960 State Bank of Travancore
6. Bank of Mysore Ltd. 1913 01.3.1960 State Bank of Mysore
7. Bank of Patiala 1917 01.4.1960 State Bank of Patiala
8. Bank of Saurashtra 1902 01.5.1960 State Bank of Saurashtra

Formerly, all these banks were either promoted or financed by the State in which they were functioning
out of these the Bank of Mysore, Bank of Saurashtra, and Travancore Bank had a share capital of Rs. 2
crore each and the rest Rs. 1 crore each. The State Bank of India, after the nationalisation of these
banks had a capital of Rs. 22.975 crores.

As per the State Bank of India (Subsidiary Bank) Act 1959, The SBI has to hold not less than 55% of
issued share capital of the subsidiaries in practice, it holds more than 55%. The State bank holds 100%
shares of the State Bank of Patiala, Hyderabad and Saurashtra. It holds share capital between 58 % to
92 % of rest of the subsidiaries.

The subsidiary banks are practically independent in their functioning, but the operations are supervised
by the Board of Directors within the framework of the Act and the general policies are laid down by the
State Bank of India.
SUBSIDIARIES OF THE STATE BANK OF INDIA: (1960 onwards)

SBI has five associate banks; all use the State Bank of India logo, which is a blue circle, and all use the
"State Bank of" name, followed by the regional headquarters' name:
1. State Bank of Bikaner & Jaipur
2. State Bank of Hyderabad
3. State Bank of Mysore
4. State Bank of Patiala
5. State Bank of Travancore

(State Bank of Saurashtra and State Bank of Indore merged with SBI)
State Bank of Saurashtra was a government-owned bank in India. It was one of the seven Associate
Banks of the State Bank of India, with which it merged on 13 August 2008. At the time of the merger,
the Bank had a network of 423 branches spread over 15 states and the Union Territory of Daman and
Diu.

Earlier SBI had seven associate banks, all of which had belonged to princely states until the government
nationalised them between October 1959 and May 1960. In tune with the first Five Year Plan, which
prioritised the development of rural India, the government integrated these banks into State Bank of
India system to expand its rural outreach. There has been a proposal to merge all the associate banks into
SBI to create a "mega bank" and streamline the group's operations.
The first step towards unification occurred on 13 August 2008 when State Bank of Saurashtra merged
with SBI, reducing the number of associate state banks from seven to six. Then on 19 June 2009 the SBI
board approved the absorption of State Bank of Indore. SBI holds 98.3% in State Bank of Indore.
(Individuals who held the shares prior to its takeover by the government hold the balance of 1.77%.)
The acquisition of State Bank of Indore added 470 branches to SBI's existing network of branches. Also,
following the acquisition, SBI's total assets will inch very close to the 10 trillion mark (10 billion long
scale). The total assets of SBI and the State Bank of Indore stood at 9,981,190 million as of March
2009. The process of merging of State Bank of Indore was completed by April 2010, and the SBI Indore
branches started functioning as SBI branches on 26 August 2010.

Non-banking subsidiaries
Apart from its five associate banks, SBI also has the following non-banking subsidiaries:
• SBI Capital Markets Ltd
• SBI Funds Management Pvt Ltd
• SBI Factors & Commercial Services Pvt Ltd
• SBI Cards & Payments Services Pvt. Ltd. (SBICPSL)
• SBI DFHI Ltd
• SBI Life Insurance Company Limited
• SBI General Insurance
In March 2001, SBI (with 74% of the total capital), joined with BNP Paribas (with 26% of the remaining
capital), to form a joint venture life insurance company named SBI Life Insurance company Ltd. In
2004, SBI DFHI (Discount and Finance House of India) was founded with its headquarters in Mumbai.
Other SBI service points
SBI has 27,000+ ATMs (25,000th ATM was inaugurated by the then Chairman of State Bank Shri O.P.
Bhatt on 31 March 2011, the day of his retirement); and SBI group (including associate banks) has about
45,000 ATMs. SBI has become the first bank to install an ATM at Drass in the Jammu & Kashmir
Kargil region. This was the Bank's 27,032nd ATM on 27 July 2012.
 : 33 :

NEGOTIABLE INSTRUMENTS
(Act 1881)

Negotiable instruments have great significance in the modern business, world. These instruments have
gained prominence [importance] as the principal instruments for making payments and discharging
business obligations/liabilities. A Negotiable Instrument is a transferable document. These
instruments pass on freely from hand to hand and thus form an essential part of the modern business
mechanism.

The law relating to negotiable instruments in India is the “Negotiable Instruments Act 1881”. This Act
came into force w.e.f. 1st March, 1882. It has 142 sections & 17 chapters. Sections 138 to 142 were
added to the act in 1988 and these sections came into force w.e.f. 1st April, 1989.

Definition:
The term Negotiable Instrument means, “a written document which creates a right in favour of some
person, and which is freely transferable”.

Justice K. C. Wills:
Justice K. C. Wills defines a Negotiable Instrument as “one the property in which is acquired by any
one, who takes it bonafide, and for value, notwithstanding [ ] any defect of title, in the person from
whom he took it”.

[From the above definition we can say that “a Negotiable Instrument is a transferable document either
by the application of the law or by the custom of the trade concerned”]

Negotiable Instrument Act’1881:

The Negotiable Instruments Act 1881 does not define a Negotiable Instrument and merely states that
according to section 13(a) of the Negotiable Instruments Act’1881 “A Negotiable Instrument means a
Promissory Note, Bill of Exchange, or Cheque payable either to `order or bearer’ whether the words
‘order or bearer’ appear on the instrument or not”.

Though, the act recognizes only three instruments (1) a promissory note, (2) a bill of exchange, and (3) a
cheque as negotiable instruments, but it does not exclude the possibility of other instruments which
satisfies the characteristics of negotiability [transferable by delivery or endorsement] and is capable of
being sued upon by the person holding it in his own name, may also be included as Negotiable
Instrument.
The definition simply mentions the names of Negotiable Instruments and does not explain their nature in
the act.
In India, Government Promissory Note, Shah Jog Hundies, Delivery Orders, Dividend Warrants, Trust
Debentures, are considered equivalent to negotiable instruments either by mercantile custom or are
treated as negotiable instruments by usage or custom of trade.

The conditions are as under:

1) The instrument should be freely transferable (by delivery or by endorsement and delivery) by the
custom of the trade, and
2) The person who obtains it in good faith and for value, gets it free from all defects and thus is
entitled to recover the money of the instrument in his own name.
…..34
 : 34 :

Accordingly to above conditions, money order and postal orders, deposit receipts, share certificates, bills
of lading, dock warrants etc. however are not Negotiable Instruments, though they are transferable by
delivery and endorsement yet they are not able to give better title to the bonafide transferee for value
then what the transferor has.

Payable to order:
An instrument is payable to order, if it is expressed to be so payable or if it is expressed to be payable to
a particular person and does not contain certain words prohibiting transfer on indicating an intention that
it shall not be transferable.

ILLUSTRATION:
In the following cases the instrument is payable to order.
1) “Pay to `X’” 2) “Pay to `X’ or order” 3) “Pay to the order of “x’”.

Payable to Bearer:
An instrument is payable to the bearer, if it is expressed to be so payable. In case the instrument is
originally payable to order; but, if it is endorsed in blank, the instrument will become payable to the
bearer.

ILLUSTRATION:
Instruments in the following forms are bearer instruments.
1) “Pay to `X’ or bearer”
2) “Pay to the bearer”
3) A cheque is payable to `X’ . Mr. X endorses it, by merely putting his signature on the back of the
instrument and delivers it to `Z’ with the intention of negotiating it. The instrument becomes bearer
in the hands of `Z’

A negotiable instrument may be made payable to two or more payees jointly or it may be made payable
to several payees. But, where a person promises to pay the sum of money to a specified person or in the
alternative to deposit the money in the court, the instrument is not a negotiable instrument.

ILLUSTRATION:
A) Instrument endorsed in the flowing forms are negotiable instruments.
1) “Pay to `A’ & `B’ “
2) “Pay `A’ or `B’”

B) Instrument endorsed in the flowing forms are not negotiable instruments.

1) “Pay to `A’ only” } ( A word `Only’ affix so. Or
2) “Pay `A’ only” } “none else”)
3) “Pay to `A’ and none else”. {

…..35
 : 35 :

ESSENTIAL FEATURES/ CHARACTERISTICS OF NEGOTIABLE INSTRUMENTS:

The special feature of such an instrument is the privilege [a special right, an advantage]. It confers [to
give/grant, to consult with] upon the person who receives it bonafide and for value, to possess good title
thereto, even if the transferor had no title or had defective title to the instrument.
1) Easily Transferable (Negotiability): Negotiability means (a) the instrument is freely transferable
by delivery if it is payable to bearer and by endorsement and delivery if it is payable to order and (b)
A person (i.e. transferee) taking the instrument bonafide for value (known as a holder in due course)
gets an absolute title to the instrument notwithstanding any defect in the title of the transferor or any
prior party. [The Negotiable Instruments are easily transferable from one person to another person
and the ownership of the property in the instrument may be passed on by mere delivery, in case of
bearer instrument and by endorsement & delivery in case of an order instrument. Transferability is
an essential feature of the negotiable instrument but all transferable instruments are not negotiable
instruments. e.g. Railway Receipt, Bill of Lading, Ware House Receipt, Gold & Silver, Land &
Building, Machinery etc., because these instruments satisfy the first feature of negotiability but not
satisfy the second feature i. e. good title] Such instrument are called Quasi Negotiable Instrument.
2) Good Title: A Negotiable instrument gives absolute and good title to the transferee; who takes it in
good faith, for value, without the notice of the fact that the transferor had defective title thereto.
This is one of the most important characteristics of negotiable instruments.
3) Holder-in-Due-Course & his rights: A person who takes a negotiable instrument from another
person, who had stolen it from somebody else, will have absolute and undisputable title to the
instrument, provided he receives the same for value (i.e. after paying its full value) and in good faith,
without knowing that the transferor was not the true owner of the instrument; such person is called
the holder in due course and his interest in the instrument is well protected by the law. This is the
most important characteristic of a negotiable instrument. The Holder-in-Due-Course possesses the
right to sue upon the instrument in his own name though original title may be defective. He can
recover the amount of the instrument from the party liable to pay thereon. Usually, all prior parties
are liable to him.
[The holder in Due Course is not any way affected by the defective title of the transferor or any party. The
term holder in due course means “a holder who has accepted a negotiable instrument for value in good faith
before maturity”.]

4) Payable to bearer and order: A negotiable instrument becomes payable to bearer when it is
expressed to be so payable or if a last endorsement is an ‘endorsement in blank’.
In the case of an instrument payable to the order, it becomes payable to the certain named person or
as per the order of the certain named person whose name is expressed in the instrument. An
instrument does not restrict its transferability i.e. negotiability when the word ‘order’ is mentioned or
not.

5) Recovery : The Holder in Due Course is entitled to sue on the instrument in his own name. He need
not give any notice of transfer to the person liable for payment on the instrument.
[The holder of a negotiable instrument, who is legally called the Holder in Due Course, possesses the right to
sue upon the instrument in his own name. Thus he can recover the amount of the instrument from the party
liable to pay thereon.]

6) Instrument in Writing
The instrument should be in writing. The writing may be in ink or pencil or printing or engraving.
[to carve, to impress deeply, ]
…..36
 : 36 :

7) It contains an unconditional Order/Promise to pay money & money only.

8) Payment:
A negotiable instrument may be made payable to two or more payees jointly or it may be made
payable in alternative one or two or some several parties.

9) Consideration: In negotiable instrument, the consideration is presumed. Consideration means

accepting the instrument against the debt, sale of goods or services, through a deed / agreement (on
contract).

10) Presumptions
Unless the contrary is provided, the following presumptions shall be made in case of all the
negotiable instruments.
a) The instrument was made or drawn for consideration.
b) Every instrument was drawn on a date which is appearing on it.
c) Every bill of exchange (except demand bill) was accepted within a reasonable time and before its
maturity.
d) Every transfer of the instrument was made on or before its maturity.
e) The endorsements upon the instrument were in order in which they appear thereon.
f) The instrument was duly stamped as per the Indian Stamp Act.
g) The holder is a Holder-in-Due-Course.
h) On proof of protest, the fact of dishonour of instrument shall be presumed.

Difference between transferability and negotiability:

1. Transferability:
In case of any goods or a commodity, which is transferable from person to person, the general rule of
law is that transferor can not transfer to the transferee.

E. g. Mr. Ashok purchase an article or a commodity, say a book from Mr. Ravi against payment of
its full value but Mr. Ravi had stolen the book from the house of Mr. Karan. If in case the thief (i.e.
Mr.Ravi) is caught for this theft, or the stolen article or commodity is found with Mr. Ashok, the
latter (Mr. Ashok) shall have to return the same to the true owner of the article (i.e. Mr. Karan). In
this case according to law, Mr. Ashok and Mr. Ravi both are the same responsible and punishable.

2. Title:
A negotiable instrument is an exception to this general rule of law. Suppose in the above
illustration [point, happening] Mr. Ashok takes a cheque (instead of an article or a commodity or a
book) from Mr. Ravi instead of a book for value and without knowledge of the latter’s defective
title, Mr. Ashok is not responsible but only Mr. Ravi is responsible.

The latter will have a right against Mr. Ravi, the thief of the instrument and Mr. Ashok and Mr.
Karan can make a case in the court of law against Mr. Ravi. This privilege [special right] of the
holder of a negotiable instrument in due course constitutes [ to make] the main
difference between a transferable instrument or article, commodity and negotiable instrument.

3) Recovery:
The holder of a negotiable instrument, who is legally called the Holder in Due Course, possesses the
right to sue upon the instrument in his own name. Thus he can recover the amount of the instrument
from the party liable to pay thereon.
….37
 : 37 :

A) PROMISSORY NOTE: [Definition, Specimen, parties & other important points of Pro-note]

Definition: Section 4 of the Negotiable Instrument Act’1881 defines a Promissory Note as under:
“A Promissory Note is an instrument in writing (not being a bank-note or currency note) containing an
unconditional undertaking, signed by the maker, to pay a certain sum of money only to, or to the order
of the certain person or to the bearer of the instrument”

A Promissory Note is drawn and signed by the maker (debtor), who promises to pay to the creditor a
certain sum of money.

Specimen of Promissory Note

1) When promise is made to pay on demand (Demand Promissory Note)

Rs. 5,000/- Pune, 1st September, 2000

On demand, I promise to pay Mr. Rajnish R. Bali or order, the sum of rupees

Five thousand only for value received.

To, STAMP
Mr. Rajnish R. Bali S/d
51, Koregaon Park,
Pune 411 001. Mr. Subhash R Ghai

2) When promise is made to pay money after the expiry of a fixed period/time.

Rs. 5,000/- Pune, 1st September, 2000

Three months after date I promise to pay Mr. Rajnish R. Bali or order, the sum of

rupees Five thousand only for value received.

To, STAMP
Mr. Rajnish R. Bali S/d
51, Koregaon Park,
Pune 411 001. Mr. Subhash R Ghai

….38
 : 38 :

3) Joint/Several liability Promissory Note:

A Promissory Note may be drawn by more than one person also, who may undertake to pay the
amount both in their individual capacities as well as jointly. The specimen of a promissory note
with joint and several liabilities is given below.

Rs. --------------- Pune, --------------------------

On demand, we jointly and severally promise to pay ----------------------------------or

order, the sum of rupees -----------------------------------------------------------------------------

together with interest on such sum from this date at the rate of -------- percent per

annum with -------------------------------- rests for value received.

STAMP
To,
---------------------------------------- Signatures across the stamp

---------------------------------------- Addresses------------------------

---------------------------------------- ---------------------------------------

Parties to a Promissory Note:

1) Promissor / Maker: Maker is the person, who promises to pay the amount stated in the note, is the
debtor. (Mr. Subhash R. Ghai)

2) Promisee / Payee : Payee is the person to whom the amount of the Promissory note is Payable, is
the creditor. (Mr. Rajnish R. Bali)

Essential Features or Characteristics of Promissory Note:

1. It is an instrument in writing. The promise should be in writing. The writing may be in ink or
pencil or printing or engraving. [ to carve, to impress deeply, ] It may be in
any form, it will be a promissory note so long, as it satisfies the other requirements of section 4.

2. It is a promise to pay a certain sum of money only.

There must be an express undertaking or promise to pay. [A mere acknowledgement of the debt
will not suffice [ to enough, to satisfy] the use of the word “promise” in the
instrument is not necessary. If the “promise to pay” can be gathered either from express words
used in the instrument or by necessary implication. ]

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ILLUSTRATION:
a) “Mr. `B’, I O U Rs. 500/-“
b) “Mr. `B’, I have taken from you rupees Five thousand whenever you ask for it, I have to
pay it together with interest”
c) “Mr. `B’, I am liable to pay you Rs. 500/-“

Above examples are not promissory notes because there is no express of promise to pay.

If `A’ writes:
a) “I promise to Pay `B’ or order Rs. 500 for value received”
b) “I acknowledge myself to be indebted to `B’ in Rs. 1000/- to be paid on demand for value
received”

Above examples are promissory notes because there is an express promise to pay.

[Bank notes and currency notes, though are similar to promissory notes in every respect, have
been expressly excluded. They are considered as money and not merely securities for money. A
currency note is a note issued by the Government containing a promise to pay to the bearer on
demand. The banks now cannot issue such notes which are payable to the bearer on demand on
account of section 31 of the Reserve Bank of India Act. Only the Reserve Bank of India is now
authorized to issue such currency notes.]

3. The undertaking to pay is unconditional.

The payment should not depend upon any condition, contingencies which may or may not
happen, because uncertainty badly affects the business and commerce. Thus the following
documents can not be termed as Promissory Note.

a) “I promise to pay Mr. `B’ Rs. 1000/- after marriage with Ms. `C’”. The Marriage with `C’ may
or may not take place.
b) “I promise to pay as soon as possible the sum Rs. 1000/-“
c) “I promise to pay Rs. 500/- seven days after the death of Mr. `B’”
d) When able I promise to pay `B’ or order as sum of Rs. 1000/- value received”.
e) “Rs. 1000/- is required, send it per bearer. The amount will be returned with interest @ 12% p.a.
without delay”

[Here the promise is conditional on the amount being sent as requested”

a) “Sixty days after sight, I* promise to pay `A’ or order a sum of rupees One thousand for Value
received”. [Sight means presence] [Yes, this is promissory note.]

4. It should be signed by the maker.

The person who promises to pay must sign the instrument even though it might have been
written by the promissor himself. There are no restrictions regarding the form or place of
signature in the instrument. It may be in pencil or ink or a thumb impression. The pro-note can
be signed by the authorized agent of the maker but the agent must expressly state as to on whose
behalf he is signing. Otherwise he himself may be held liable as a maker.

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5. The maker must be certain:

The note itself must show clearly who is the person agreeing to undertake the liability to pay the
amount. He may be described by name along with his designation. In case of two or more
persons promise to pay, they may bind, themselves jointly or jointly & severally their liability
cannot be in the form of alternative.

6. The payee must be certain:

The instrument must point out with certainty the person to whom the promise has been made.
The payee may be ascertained [ to describe] by name and by designation. A
note payable to the maker himself is not a pro-note unless it is endorsed by him. In case there is a
mistake in the name of he payee or his designation the pro-note is valid, if the payee can be
ascertained by evidence.

7 The Promise should be to pay money and money only.

8. The amount should be certain.

One of the important characteristics of a promissory note is certainty. Not only regarding the
person to whom or by whom payment is to be made but also regarding the amount. The amount
in figure and words should tally.

9. Other formalities:
The other formalities regarding number, place, date, consideration etc. though usually found
given in the promissory note, but is not essential in law. The date of instrument is not material
unless the amount is made payable at certain time after date. (On demand, I promise). The
words, “value received” are also unnecessary. But, a promissory note must be properly stamped
as required by the Indian Stamp Act. After use each stamp must also be properly cancelled.

A Promissory Note payable on Demand (Immediately) is called Demand Promissory Note and those
payable after a definite period of time are called usance promissory notes. General public is prohibited
from issuing demand or usance promissory note payable to bearer. Bank Notes/Currency Notes can not
be promissory notes since these are money.

Illustrations

`A’ signs instruments in the following terms.

a) “I Promise to pay Mr. `B’ or order Rs. 500/-“

b) “I acknowledge myself to be indebted to `B’ in Rs. 1000/- to be paid on demand, for value received”.
c) “Mr. `B’ I O U Rs. 1000/-“
d) “I promise to pay `B’ Rs. 500/- and all other sums which shall be due to him”
e) “I promise to pay `B’ Rs. 500/- seven days after my marriage with `C’”
f) “I promise to pay `B’ Rs. 500/- on `D’s’ death provided `D’ leaves me enough to pay that sum.

Answers: a & b are promissory notes.

c, d, e, f, are not promissory notes.

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B) BILLS OF EXCHANGE

Definition: According to Negotiable Instrument Act 1881 (Sec. 5)

“An instrument in writing, containing an unconditional order, signed by the maker directing a certain
person to pay a certain sum of money only to or to order of a certain person or to the bearer of the
instrument”.

A Bill of Exchange, therefore, is a written acknowledgement of the debt, written by the creditor and
accepted by the debtor. There are usually three parties to a Bill of Exchange, Drawer, Drawee
(Acceptor), and Payee. A Bill-of-Exchange contains an unconditional order from the creditor to the
debtor to pay a specified amount to a person mentioned therein. (i.e. the payee)

The maker of a bill is called a drawer; a person who is directed to pay the money is called a Drawee
(sec-7) and a person who is entitled to receive the payment is called a Payee. Sometimes the drawer
himself may is the payee.

Specimen of Bill of Exchange

a) A bill where payment is to be made on the expiry of a specified period of time.

Rs. 10,000/- Pune, 21st May 2001

Three months after date pay to Mr. Sachin Tendulkar or order

the sum of rupees ten thousand only for value received.

STAMP
To, Accepted
Mr. Shri Nath
Pune sd/-
Venkat

b) A bill, where payment is to be made on demand. (Acceptance not needed)

Rs. 10,000/- Pune, 21st May 2001

On demand pay to Mr. Sachin Tendulkar or order the sum of

rupees ten thousand only for value received.

STAMP

To,
Mr. Shri Nath sd/-
Pune Venkat

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Parties to Bill of Exchange:

a) Drawer: (Creditor)
The maker of a Bill of Exchange is called the Drawer. (Mr. Venkat)

b) Drawee: (Debtor)
The person, directed to pay the money (to the payee or payee’s order) by the Drawer is called the
Drawee. (Mr. Shri Nath)

c) Payee: (Mr. Sachin Tendulkar)

The person named in the instrument, to whom or to whose order the money is directed to be paid by
the instrument is called the Payee, where he signs his name and makes the instrument payable to
some other person, that the other person does not become payee”

Acceptor:
A person who accepts the bill is called the Acceptor. Usually the drawee is the acceptor.
Sometimes, the other person can accept the bill on behalf of the Drawee.

Essential characteristics or features of a Bill-of-Exchange:

1. It must be in writing.
2. It must be signed by the Drawer.
3. The Drawer, Drawee and Payee must be certain.
4. The sum payable must also be certain.
5. The bill must have a date on which it is written.
6. It should be properly stamped as required by the Indian Stamp Act.
7. It must contain and express an unconditional order to pay money and money only.
8. The amount written in figure and words must be same.
9. It must express a term like `3 months after date’ or `one month after date’ or `90 days after date’
or `30 days after sight’ [ immediately on seeing], “On demand” after the expiry of
the term, the bill matures for payment.

The Bill of Exchange may be classified as follows.

A) Inland Bills and Foreign Bills
B) Time Bills & Demand Bills
C) Trade Bills and Accommodation Bills
D) Clean Bills and Documentary Bills

1) Inland Bills and Foreign Bills:

a) Inland Bill:
A Bill of Exchange, drown or made in India and also made payable in India or drawn upon any
person resident in India, shall be deemed to be an Inland Bill. (Sec-II)
A bill is termed as an inland bill if:-
a) It must be drawn or made in India i.e. the drawer must be in India.
b) It must be payable in India. (Not necessary by a person resident in India).
c) It must be drawn on a person resident in India. (Although it is payable outside India)

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ILLUSTRATION:
a) `X’, a merchant of Mumbai, draws a bill of exchange on `Y’ of New Delhi, payable at
Kanpur. (It is drawn in India and payable in India).

b) `P’, a merchant of Pune, draws a bill of exchange on `Q’, of London, payable in Chennai. (It
is drawn in India and is payable in India though by a foreigner).
c) `R’ of Kolkata, draws a bill of exchange on `S’ of Bangalore, payable at New York. (it is
drawn in India, a person resident in India, though payable outside of India).

b) Foreign Bill:
A Bill of Exchange, which is not drawn, made or made payable as given in section 11 is called a
Foreign Bill of Exchange. Means a Bill of Exchange, drawn, made or made payable outside
India shall be deemed to be a Foreign Bill of Exchange.

A Bill of Exchange is called a Foreign Bill of Exchange if

1) A bill, drawn in India but it is payable out side India to a person residing outside India.
2) A bill, drawn outside India, and made payable outside India.
3) A bill, drawn outside India and made payable in India.
4) A bill drawn outside India, on any person residing outside India.
5) A bill drawn outside India on a person residing in India.

Bills in Sets
Generally foreign bills are drawn in a set of two, three or four in order to avoid delay which may
be caused if a single bill sent for acceptance is lost or miscarried in transit. A bill, therefore,
drawn in parts. The practice of drawing a bill in parts is called, drawing a bill “in a set”. Each
part is called a “Via” [ Through] and is sent by a separate mail, so that at least one of
them safely reaches the drawee for acceptance. When the latter (drawee) receives any of these
parts and accepts it, the remaining ones are treated as “cancelled”. All the parts together
constitute one set and the whole set constitutes [to set up, to form] one bill each one bears a
reference to the other parts as shown in the specimen of a foreign bill. On each part there is a
reference of the other two parts.

L 10,000/- New York

21st May 2001

Three months after sight of the First of Bill of Exchange (Second and Third of
the same tenure and debt being unpaid) pay to Messrs Smith & Company,
London or order, the sum of ten thousand pounds only for value received.

STAMP
To, Accepted
Sd/-
Messrs Johnson & Co Sd/-
A. R. Singh
London

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Rs. 10,000/- New York

21st May 2001

Sixty days after the sight of the First of Bill of Exchange (Second and Third of
the same tenure and debt being unpaid) pay to Messrs White way &
Company, Mumbai or order, the sum of Rupees Ten thousand only for value
received.
STAMP
Sd/- Michel
To, Accepted For Bird & Co.
Messrs Henry Brothers Sd/-
Churchgate, Mumbai

Rules for a bill in sets:

1) Each Part of a bill drawn in a set must bear the number. (e.g. the 1st BoE, 2nd BoE etc.) It
should also specify that it shall continue to be payable only so long as the other parts of the bill
remain unpaid.

2) Each part of a bill must have a reference to the other parts (e.g. “second and third” in the first
copy and “first & third” in the second copy). In case the same is omitted on a part, that part will
become a separate bill if it is acquired by a person who becomes its holder in due course.

3) The drawer should sign all the parts of the bill and dispatch the same to the drawee. But stamp
duty is to be affixed on one part only.

4) The drawee should accept only one part of the bill. After he makes payment of one part, the
entire bill is extinguished. [to put out/to destroy/to terminate]

5) The drawer should sign and deliver all the parts but the acceptance is to be made conveyed only
on one of the parts. In case a person accepts or endorses, different parts of the bill in favour of
different persons, he and the subsequent endorsers of each part are liable on such part as if it
were a separate bill. (Sec. 132)

6) As between holders in due course of the different parts of the same bill, he, who first acquired
title to any one part is entitled to the other parts and is also entitled to claim the money
represented by the bill. (Sec. 133)

Usance:
“Time fixed for the payment of bill drawn in one country and payable in another country is
called Usance”. Length of Usance differs according to the custom in force in each country.
E.g., if Usance is a month, half Usance will be taken as equivalent to fifteen days.
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2) Time Bill & Demand Bill:

i) Time Bill: A bill payable after a fixed time is termed as a time bill. A bill payable “after
date” is a time bill.

j) Demand Bill: A bill payable at sight or on demand is termed as a demand bill.

i) It is expressed to be payable “on demand”, “at sight” or “on presentment” (sec. 21)
ii) No time for payment is specified in it. (Sec. 19)

3) Trade Bill & Accommodation Bill:

a) Trade Bill: A bill drawn and accepted for a genuine trade transaction is called as a trade bill.
Generally the bill is drawn by the seller (creditor) on the buyer (debtor) in respect of
genuine trade transactions. Such bills are drawn for consideration and are called trade bills.
b) Accommodation bill:
A bill drawn and accepted not for a genuine trade transaction but only to provide financial
help to some party is called as an accommodation bill. Sometimes bills of exchange are
drawn not for consideration but to accommodate (i.e. to provide financial assistance) to a
known party. Such bills are called accommodation bills.

ILLUSTATION:
Ramesh is in need of money for three months. He requests his friend Sameer to lend him Rs.
10,000/- If Sameer is unable to lend him this amount, he may ask Ramesh to draw on him, a bill
of exchange for the same amount, for a specific period, which he (Sameer) duly accepts. Thus
the bill is drawn and accepted, becomes accommodation bill. Ramesh may get the bill
discounted from his banker immediately after paying/deducting small sum as discount for the
specific period. Thus he can use the funds for three months. On the due date of the bill Ramesh
will pay Rs. 10,000/- to Mr. Sameer to meet the bill presented by the banker for payment.

In the above example Sameer will be called the Accommodating Party and Ramesh the
Accommodated Party.

In form and all other respects an accommodation bill is quite similar to an ordinary bill of
exchange. There is nothing on the face of the accommodation bill to distinguish it from an
ordinary trade bill.

Rules regarding accommodation bills (Liabilities of the parties)

1) The Accommodating party shall be liable to the holder of the bill, irrespective of the fact
that the latter knew at the time of receipt of the bill that the acceptor was an accommodating
party to the bill.
2) If the accommodated party pays the amount of the bill, he can not recover the amount of the
bill from any person, who becomes subsequently a party to such bill for his accommodation.
3) Section 59 permits that an accommodation bill may be negotiated after its maturity provided
the transferee takes it in good faith and for consideration.
4) The drawer of the accommodation bill is not discharged if the bill is not presented to the
acceptor for payment.
5) In case of accommodation bills, prior parties are not discharged from their liabilities if
proper notice of dishonor is not served on them.
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4) Clean Bill & Documentary Bill:

a) Documentary Bill:
When the drawer of a Bill of Exchange encloses with it document of title to goods or any other
documents, it is called documentary bill. Both in home trade and foreign trade the drawer of a
bill delivers the documents to the banker along with the bill to the drawee.
(Documents: Railway Receipt, Bill of Lading, Invoice, Insurance Policy etc.)

These documents are delivered by the banker, to the drawee of the bill against payment or
acceptance.

[In the former case the bill is called document against payment bill (or D/P Bill) and in the latter
case Document against Acceptance Bill (D/A Bill)].

b) Clean Bill:
If no such type of documents (railway receipt/bill of lading, insurance policy) is attached with
the bill, it is called a clean bill.

Note: 1) A Bill-of-Exchange is an unconditional order to pay money while promissory note is an

Unconditional undertaking/ promise to pay money.

2) Demand Draft issued by Bank fall in the category of Bill-of-Exchange.

3) A Cheque is a bill of exchange but a bill of exchange is not a Cheque because drawee of a Cheque is
only a specified banker as in the case of Bill of Exchange drawee may be any person including a
banker.

4) A Bills of Exchange drawn in vernacular language as per the local use are locally called “Hundi”.

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C) CHEQUE:
Definition: According to Sec. 6 of the Negotiable Instrument Act‘1881-
“A cheque is a Bill of Exchange, drawn on a specified banker and not expressed to be payable
otherwise than on demand”.
A cheque is a Bill-of-Exchange, with two additional qualifications. -
a) It is always drawn on a banker specified therein.
b) It is always payable on demand.
So from the above definition we can say that all cheques are bills of exchange but all bills of
exchange are not cheques. A cheque is an order on the specified banker to pay a certain sum of
money to the payee mentioned in the cheque.
Parties to a Cheque:
a) Drawer: A person who draws the cheque i.e. the depositor of money in the bank. (Account holder)
b) Drawee: Drawee is the drawer’s banker on whom the cheque has been drawn.
c) Payee: Payee is the person who is entitled to receive the payment of a cheque.

Characteristics of a Cheque: From the above definition it follows that an instrument to be called a
cheque must fulfill certain conditions they are:-
1) The Instrument must be in writing. Legally speaking, the writing may be done by means of
printed character, type–writer, or by pen or pencil. But bankers do not generally honour cheques
drawn in pencil, unless it confirmed by the drawer. This is because it is easy to make
unauthorized alterations when a cheque is drawn in pencil.
2) The instrument must contain an unconditional order. If any kind of condition is attached for
the payment then the cheque becomes invalid.
3) The maker of a cheque must sign the instrument. In order to be a valid cheque the instrument
must contain the signature of the drawer (maker). In the case of an illiterate person, his thumb
impression must be there. Also signatures impressed on the cheque by means of a rubber stamp,
pencil is not permitted generally.
4) The order to pay must be addressed to a banker and that banker must be specified one. In other
words the instrument should not only be drawn on a banker but also on a specified banker.
5) The order must be for a certain sum of money only. The term money means legal tender
currency. Thus, if the order is for something other than legal tender currency, the instrument can
not be considered as a cheque. So the sum of money is certain. The amount written in the
instrument must tally both in words & figures.
6) The amount must be payable on demand. The amount of the cheque must be paid on demand
when presented i.e. on or after the date which is written on the instrument.
7) The drawer should direct the drawee (the banker) to pay a fixed amount, which must tally both
in words and figures.
[Since a cheque is not a legal tender [currency], nobody can be compelled to accept cheque towards
settlement of his debts.]

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Specimen of a Cheque with Counterfoil:

Counterfoil Cheque

No AB 750687 STATE BANK OF INDIA Code No. 2

23 Shivajinagar Branch, Pune 411 005.
State Bank of India
Dated……………….. No. AB 750687 Date:
In Favour of ……….. 23
………………………..
Pay to
Previous
Balance or bearer

Deposits
If any Rupees.

Total
Rs.
Less this
Cheque Savings Bank Account No ……………..

Balance

Specimen of Cheque without Counterfoil:

Date:

Pay or bearer

Rupees.
Rs.

A/c No L.F. Intl.

Rupee Co-Operative Bank Ltd. (Scheduled Bank)

Laxmi Road Branch,
Pune 411 005.

262584 411169006 13

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 : 49 :

Drawing a cheque: (How a cheque is drawn)

A cheque can be drawn by a person, on the bank, in which he has an account (SB A/c, Current A/c, CC
A/c, OD A/c). Before drawing a cheque, the drawer must ascertain {to know] that he/she has sufficient
balance in his/her account with the bank, to cover the amount of money written in the cheque. The
cheque would be dishonoured by the bank if his balance is less than the amount he has written in the
cheque excluding the minimum balance in his account.
While drawing a cheque, the drawer must be careful in respect to the following points.
a) Date:
A cheque is honoured by the bank, if it is presented within a reasonable time after the date of its
issue. As such it is very essential that the correct date is put at the proper place on the cheque.
If the cheque is undated, the banker can put down the correct date; but generally he returns
(dishonors) it marked as “Incomplete”. The date can be put by the holder of the cheque as he has
authority to fill up the date.
A cheque bearing an impossible date, say 31.11.99 can be paid on or after 30.11.99 (preceding date).
[A cheque bearing dates as per National Saka Calendar is in order and should be paid. A cheque
dated on Sunday/holiday can be paid]
If a cheque is presented to the bank after six months, it will be returned by the bank as “Stale
Cheque”. (the life of a cheque is maximum 6 months) The stale cheque can be used when its date is
renewed by the drawer with his signature.
A cheque, which bears a date later than the date on which it is issued, is knows as “Post Dated
Cheque”. Such a cheque can be encashed on or after the due date.
b) Payee:
While drawing a cheque, the drawer should clearly specified to whom he intends [plans] the cheque
to be paid. If the drawer of the cheque draws a cheque for himself, the word “My self” or “To Self”
should be written after the words “pay to …………..”.
c) Amount:
The amount should be written very carefully both in figures and words. The amount in words &
figures must be tally otherwise the banker would not honour the cheque. No space [distance] should
be left before or after the amount stated in words and figures. The amount written in words must be
suffixed with the word “only”
d) Drawer’s signature:
A cheque must be signed by the drawer. The drawer’s signature must tally with the specimen
signature given by him (drawer) to the bank at the time of opening of the account. In case, there is
any suspicion [ doubt] about the signature, the banker may return that cheque as
dishonoured.
e) Alterations:
Any material alteration in the cheque can be done only by the drawer. The alteration may be
related to the date, the amount and the name of the payee or the nature of the payment. Each
alteration must be confirmed by the drawer’s signature. The banker does not honour a cheque that
has alteration without the drawer’s signature.
f) Counterfoil: The complete form of a cheque has also its counterfoil. The drawer must fill date,
name of the payee and the amount in the counterfoil for future reference.
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KINDS OF CHEQUES:

1. Open Cheque:
The payment of the bearer cheques and order cheques are made at the counter of the bank, hence
they are called as open cheques. Open Cheques are not very safe. If an open cheque is lost, then
one, who finds it, can make a way to get the payment over the cash counter of the bank.

a) Bearer Cheque:
A bearer cheque is one, which can be encashed by anybody, who presents it to the bank for
payment. In such a cheque, the word “bearer” is suffixed after the payee’s name. Bearer cheques
are transferred from one person to another, without any endorsement & by mere delivery.

b) Order Cheque:
An order cheque is one, which is payable to the payee or his order only. In such cheques, the word
“order” is suffixed after the name of payee. A cheque is treated as the order cheque in case the
word “order” is not written and only the name of the payee (without the suffix word “”bearer” or
“order” after it) is written in the cheque. An order cheque can be transferred only after
endorsement. The payment through order cheque is safer than a bearer cheque. It is because the
person who presents the cheque at the counter of the bank has to prove his identity before the
payment is made to him.

In connection with the order cheque one point must be kept in mind that a bearer cheque can be
made an order cheque by striking off the word “bearer” but an order cheque can not be made a
“bearer” cheque by striking off the word “order”. Only the drawer can change an order cheque into
a bearer cheque by alterations and signature process.

2) Ante -Dated Cheque

A cheque which bears a date earlier than the date on which it (the cheque) presented is called ante-
dated cheque. It is just the opposite of a post-dated cheque.

3) Post Dated Cheque: A cheque which bears a future date is called post dated cheque. It is just the
opposite of an Ante-Dated-Cheque. This cheque bears a future date which is yet to come. The
banker should honour it only on or after the date mentioned in the cheque. E.g. If a cheque is
drawn on 15th September bears the date of 15th December, the cheque is a post dated cheque and it
should be honoured by the banker not earlier than 15th December.

4) Stale Cheque: Usually the life of a cheque is about six months after the date of its issue (date
written in the cheque). This is also termed as an out-of-date cheque. It is the custom of the banker
not to pay cheques which are presented after a certain period of time. (i.e. six months)

[The period varies from banks to banks. In some banks it is 3 months, while in case of others it is 6
months. Generally the period of 6 months is more popular. When such a cheque is presented for
payment to the banker, the (banker) returns it with the answer “out-of-date”. In India, a cheque is
valid for six months]

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5) Crossed Cheque:
A cheque which bears two parallel transverse lines with or without words (like ‘Not Negotiable’,
‘A/c payee’, ‘Payee’s account only’ etc.) on the face of a cheque is known as crossed cheque.

Drawing two parallel lines on the face of the cheque is known as crossing of a cheque. Crossed
cheques are safe for payment. Crossing is an order to the paying banker not to pay the cheque
across the cash counter but credit the amount to the customer’s account.

6) Mutilated Cheque
A cheque is said to be mutilated when it is torned into two or more pieces. Such cheque should not
be honoured unless the banker is satisfied the mutilation was unintentional.

7) Gift Cheque
Gift cheques generally in the denomination of Rs. 11/- to 5001/- are being issued by many of Indian
banks against cash payment with commission or against debiting the customer’s account. These
cheques are printed in attractive designs and are delivered in black ink with beautiful handwriting.

As the name indicates, Gift cheques are intended for giving presents on different good occasions
like birthdays, weddings, etc. Gift cheques are paid at par.

Gift cheque can be encashed at any branch of the bank. In the case of loss of the gift cheque, no
duplicate gift cheque is issued by the bank. The amount of the lost gift cheque can be paid against
indemnity.

8) Banker’s Cheque
A cheque drawn by one branch onto its other branch called banker’s cheque. (Sec 85 (A) of the
Indian Negotiable Instruments Act 1881) Such cheques are issued to customers against cash
payment / debiting the customer’s account along with commission. Such cheques give certainty of
payment. Usually for local payments Bankers cheques are purchased by the customers in stead of
demand drafts.

9) Travellers Cheque
Banks issue travellers cheque for the use of businessmen and tourists who travel widely within the
country or abroad. These cheques help them to receive cash payments at different places of their
travel without carrying cash with them. Traveller’s cheques are issued by banks to avoid risk of
loss or inconvenience in carrying large amount of cash while traveling.

The travellers cheque has not time limit. They are valid till their encashment. Travellers cheque
are dated at the time of encashment. The purchaser or the beneficiary of such cheque need not to
have his account with the bank for purchases of such cheque. Travellers cheque can be encashed at
any branch of the bank and all branches of other bank but by arrangement.

8) Marked cheque
A cheque on which the drawee bank marks or certifies that it is good for payment is called marked
cheque. Such cheque gives certainty of payment as demand draft.

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11) Bank Draft / Demand Draft

A bank draft is a cheque drawn by a bank on its own other branch or on another bank. It is the most
convenient and the cheapest method of remitting money from one place to another. For remitting
money by a bank draft, a person first obtains the bank draft from the bank by paying the amount he
wants to remit and the prescribed commission. He, then, sends the bank draft to the receiver by
post or courier. When the receiver receives the bank draft, he goes to the concern bank and gets it
encashed. The bank draft is payable, only on demand, in cash at the counter. But a crossed bank
draft can be collected only through a collecting bank. It is less costly to send money by bank draft
than by money order.

Is there any risk in sending cheques by ordinary post?

As a precaution against loss in transit [ carrying across], cheques are crossed generally or
specially if they are to be sent by ordinary post. It is desirable that uncrossed or open cheques must
be sent by registered post, or else they may be stolen and encashed with the payee’s signature being
forged [ to make copy of other’s signature or document by
cheating].

If a cheque is stolen in transit and encashed the question arise as to who has to bear the loss. I.e. 1)
Banker, 2) The Sender & 3) The Payee (Receiver).

First the banker has no liability if he makes to payment in due course as he can claim the statutory
(legal) protection. If the cheque is sent by post at the request of the payee, the loss will have to be
borne [suffered] by the payee.

If the cheque is sent by ordinary post by the drawer only the loss will have to be borne by the
drawer under Indian Negotiable Instrument Act’1881 (Sec. 46)

However, the Dept. of Post is not responsible for the loss of cheques, which are sent by ordinary
post. Therefore, the cheques should not be sent by ordinary post. In any case, both the drawer and
payee have an obligation to warn the banker to stop the payment when they came to know the loss
of the cheque in transit.

Difference between bearer cheque and order cheque.

Bearer Cheque Order Cheque

1 After the payee’s name the words After the payees name the words
“or bearer” are suffixed. “or order” are suffixed.
2 It can be encashed by anybody, whether he is It can be encashed by only the payee or whom
the payee or not. the payee orders.
3 The drawee bank is not responsible if the The drawee bank is responsible if the payment
payment is made to a wrong person. is made to a wrong person.
4 It is not safe. It is safe than a bearer cheque.
5 It can be changed into order cheque by It can not be changed into a bearer cheque by
striking off the word “bearer” striking off the word “order”
6 A bearer cheque can be transferred without Order cheque can be transferred after the
endorsement by mere delivery. endorsement.

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Difference between Cheque and Bill-of-Exchange

Cheque Bills of Exchange

1 Cheque is a bill of exchange drawn on a A bill of exchange may be drawn on any
specified banker. person including a banker.
2 The amount is payable on demand. A bill can be payable on demand or after
certain time.
3 Acceptance is not so necessary in the case Acceptance is necessary in the case of a bill of
of cheque. exchange.
4 In the case of a cheque days of grace are In the case of bill of exchange days of grace are
not allowed. allowed.
5 A cheque can be crossed. A bill of exchange can not be crossed.
6 When a cheque is dishonoured, notice of Notice of dishonour is necessary when a bill of
dishonour is not necessary. exchange is dishonoured.
7 A cheque is not noted or protested on A bill is noted or protested on dishonour.
dishonour while a cheque is a kind of bill of
exchange.
8 Stamp Duty not necessary. Stamp duty is not necessary in case of Demand
Bill but in case of usance / time bill it is
necessary.

Difference between Cheque and Promissory Note

Cheque Promissory Note
1 Cheque is a bill of exchange drawn on a A Pro-note is given by the Promissor accepting
specified banker. the debt due to the Creditor (Promisee)
2 The amount is payable on demand. A Pro-note can be payable on demand or after
certain period of time.
3 There are three parties – Drawer, Drawee There are 2 parties – Promissor (Maker) and
& Payee. Promisee (Payee)
4 A cheque does not require Stamp. In the case of Pro-note Stamping is done as per
the Indian Stamp Act.
5 A cheque can be crossed. A Pro-note can not be crossed.

Difference between Trade Bill & Accommodation Bill

Trade Bills Accommodation Bills
1 Trade Bills are used when genuine business They are not the result of trade transaction and
transactions take place. are drawn without consideration.
2 Trade bills finance home trade and foreign They are used for accommodating the parties to
trade. the bill.
3 Drawee is liable to make the payment. Drawer is liable to make the drawee personally
for the payment.
4 There is consideration in the trade bill. There is no consideration in the accommodation
bill.
5 Drawing a trade bill is a general method of Drawing accommodation bills is an easy method
setting business transactions. of borrowing and lending money.
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Difference between Time Bill & Demand Bill

Time Bills Demand Bills
1 Time bills are payable after a fixed period Demand bills are always payable on demand.
of time.
2 They have fixed maturity date. They have no fixed maturity date as they are
payable on demand.
3 Time Bills require acceptance. Demand bills do not require acceptance.
4 Time bills are subject to Stamp Duty. They do not subject to stamp duty.

Difference between Bill-of-Exchange and Promissory Note

Point of difference Bill of Exchange Promissory Note

1. Number of Parties There are 3 principal parties in There are only two principal parties
the case of Bill of Exchange i.e. in the case of Promissory Note i. e.
Drawer, Drawee & Payee. Promissor (Maker) & Promisee
(Payee).
2. Drawer/maker A bill of exchange is drawn by A promissory note is made by the
the creditor. debtor.
2. Promise & Order A bill of exchange contains an A promissory note contains an
unconditional order to pay the unconditional promise / undertaking
sum of money. to pay the sum of money.
3. Acceptance An acceptance is necessary in An acceptance is not necessary in
the case of Bill of Exchange. It the case of promissory note.
can not be enforced unless it
has been duly accepted by the
drawee.
4. Copies Foreign bill are drawn in sets, Only one copy of a foreign
normally 3 copies are prepared. promissory note is prepared.
5. Stamp Duty A bill of exchange payable on A promissory note payable requires
demand does not require stamp stamp duty.
duty.
6. Formalities in case of If the bill is dishonoured either If the promissory note is
Dishonour by non-acceptance or non- dishonoured, notice of dishonour is
(Notice of dishonour) payment the notice of dishonour not necessary to give to the maker.
must given by the holder to all
prior parties (including the
drawer & endorsers).
7. Protest Foreign bills must be protested No protest is necessary in the case of
for dishonour. Such protest is promissory note, whether it is inland
necessary according to the law or foreign.
of place where it is drawn.

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Difference between Cheque and Demand Draft

Pt. of Diff. Cheque Demand Draft (Bank Draft)

1. Drawer A cheque is drawn by a customer on his A bank draft is drawn by one bank on its
bank. branch of head office.
2. When used It is used for making routine payments It is used for remitting money from one
for setting business transactions. place to another place and the payee
does not want to take the risk of the
drawer countermanding the payment.
3. Parties The drawer is a person or a firm. The The drawer and drawee are same. (the
drawee is a specified bank. The payee bank and its own branch).
may be a person or a firm.
4. Dishonour A cheque may be dishonoured due to A draft is generally not dishonoured (at
several reasons. least due to non-payment) as the amount
has already been received by the issuing
bank.
5. Facility to The cheque facility is provided only to A bank draft facility is provided to
whom the regular customers (savings / current / customers as well as outsiders.
CC account holder) of a bank.
6. Clearance The outstation cheques take a number of There is no question of clearance. The
days for clearance. account is instantly credited.

Difference between Noting and Protest

Noting Protest
1 Noting is the minute or note made on the bill Protest is a formal certificate issued by a Notary
by a Notary Public. Public.
2 All inland bills may be noted after dishonour All foreign bills must not only be noted but also
by non-acceptance or non-payment. duly protested for non-acceptance or non-payment.
3 Noting Mentions: Protesting specifies :
a) The fact of dishonour. a) The person at whose request the bill is protested.
b) The date of dishonour. b) The place & date if protest.
c) The reasons if any, for dishonour. c) The reason for protesting the bill
d) The Notary’s charges. (i.e. the demand made, the answer given if any)
4 A copy of the note is also entered in the A certificate of protest containing the above points
Notary’s register. is given to the holder of the dishonoured bill.

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SUMMARY
PARTIES TO NEGOTIABLE INSTRUMENTS:

A) Parties to Promissory Note:

1) Promissor / Maker : Maker is the person, who promises to pay the amount stated in
the Pro-note, is the debtor.

2) Promisee Payee : Payee is the person to whom the amount of the Promissory note
is payable, is the creditor.

B) Parties to Bills of Exchange:

1) Drawer : (Creditor)
The maker of a Bill of Exchange is called the Drawer.

2) Drawee: (Debtor)
The person, directed to pay the money (to the payee or payee’s order) by the Drawer is called
the Drawee.

3) Payee:
The person named in the instrument, to whom or to whose order the money is directed to be
paid by the instrument is called the Payee, where he signs his name and makes the instrument
payable to some other person, that the other person does not become payee”

Acceptor:
An accepter is a person, who accepts the bill on behalf of the drawee. [Sometimes, the
drawee is an acceptor of the bill. If the drawee fails/refuses to pay the amount, then the
Acceptor is held responsible for payment of the said bill.]

Endorser:
When the holder transfers or endorses the instrument to any one else, the holder becomes the
endorser.

Endorsee:
The person to whom the bill is endorsed is called an Endorsee.

Holder:
A person, who is legally entitled to get the possession of the negotiable instrument in his own
name and to receive the amount, thereof is called a holder.

C) Parties to a Cheque:
a) Drawer : A person who draws the cheque i.e. the depositor of money of the bank. (Account
holder)

b) Drawee : Drawee is the drawer’s banker on whom the cheque has been drawn.

c) Payee : Payee is the person who is entitled to receive the payment of a cheque.

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MICR CHEQUES :
(MAGNETIC INK CHARACTER RECOGNITION)
Cheques, Drafts, Banker’s Cheques, Dividend Warrants and other payment instrument in MICR formant
contain a code line at the bottom which contains coded information printed in magnetic ink.

The Code contains 17 digits, first six gives cheque number, next three city code, next three bank code,
next three branch code and after some gap transaction code (SB/CAD etc.)

The transaction code is –

10 for Savings Bank Account

11 for Current Deposit Account
12 for Banker’s Cheque
13 for Cash Credit Account
16 for Demand Draft

MICR code helps in mechanically sorting the clearing the cheques bank-wise and branch-wise at very
high speed through a machine called READER SORTER.

For mechanised processing, instruments have been standardised in the following two sizes.

a) SB A/c Cheques & Traveller’s Cheques = 6½“x2¼“

b) CD A/c Cheques & Drafts = 8” x 2 2/3

Liabilities of a Banker: (Precautions taken by a banker)

What are the precautions to be taken by the banker before he honours a cheque presented to him?

A Banker is one who does banking business. The Banking Regulation Act’1949 defines banking as
“accepting deposits for the purpose of lending, or investment of deposits of money from the public,
repayable on demand or other wise and withdrawable by cheque, draft or order or otherwise”.

Thus it is the prime duty/obligation of a banker to honour the cheques of its customer. Besides that, a
banker may also agree to collect cheques of its customers on their behalf. The relation between a banker
and his customer is that of a debtor and creditor. Banker does not enjoy the position of a trustee of the
money deposited with him by the customer. Money deposited will always belong to the customer and
the bank will be bound to return its equivalent to the customer or to any person to his order on demand.
Thus, a banker should be very cautious both at the time of honouring as well as dishonouring his
customer’s cheques.

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