“Meaning and Functions of Bank”

By Nidhi Bhatt

I. Introduction
 Evolution of Banking

Bank is the term derived from the German word 'banck' which means, heap or mound or joint sock
fund with this the Italian word 'banca' which means heap of money was coined. There is the other
opinion among the scholars that the word 'bank' derived from the French words 'bancus', or
'banque¹which means a 'bench' or 'money exchange table'. The Jewish people transacted their
everyday business on benches in the market place and as their practice the bench shadowed the
modern banking counter. If the 'banque'(bench) is broken or not able to use it by the people or
failed then the 'banque' become' bankrupt'.

Banks are financial institutions authorized to receive deposits and provide credit. Other functions
of banks may include financial services like wealth management, safe deposit boxes, and currency
exchanges.

There are several types of banks that are designated to perform all of the above-mentioned
functions. The most common types of banks are retail banks, corporate banks, and investment
banks. In most countries, these banks are regulated either by the national government or a central
bank. In India, all the banks and financial institutions are regulated by the Reserve Bank of India
(RBI).

 History of Banking in India

Banking in India has a very special origin; it started with giving of loans to others. Banking was
synonymous with money lending. Manusmirithi speaks of deposits, pledges, loans and interest
rate. Interest could be legally charged between 2% to 5% per month according to the transaction.
The state regulated these transactions to prevent over charge of interest by the lenders and
collection of usury was not allowed during those periods. The debtor or his family member had a
pious obligation to repay the debt on the heir of the dead person. With the development in trade
and commerce, the traders evolved system of money transfer. The main instrument used in that
period was the bill of exchange or hundi. The Indian bankers acted as treasurer, insurer money
changer.

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 Definition

Section 5 (b) “banking” means the accepting, for the purpose of lending or investment, of deposits
of money from the public, repayable on demand or otherwise, and withdraw able by cheque, draft,
order or otherwise

Use of words “bank”, “banker”, “banking” or “banking company”:

(1) No company other than a banking company shall use as part of its name [or in connection
with its business] any of the words “bank”, “banker” or “banking” and no company shall
carry on the business of banking in India unless it uses as part of its name at least one of
such words.
(2) No firm, individual or group of individuals shall, for the purpose of carrying on any
business, use as part of its or his name any of the word’s “bank”, “banking” or “banking
company”.
(3) Nothing in this section shall apply to—
(a) a subsidiary of a banking company formed for one or more of the purposes mentioned
in sub-section (1) of section 19, whose name indicates that it is a subsidiary of that banking
company;
(b) any association of banks formed for the protection of their mutual interests and
registered under section 25 of the Companies Act, 1956 (1 of 1956).]

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II. Concept of Bank and Banker

The banking sector plays a vital role in the economic development of a country. Banks facilitate
financial transactions, mobilize savings, and provide credit for business expansion and personal
needs. The Banking Regulation Act, 1949, g overns and regulates banking activities in India. This
document elaborates on the concept of bank and banker and the functions of a bank as per the Act.

 Definition of Bank

A bank is a financial institution that accepts deposits from the public and lends money to
individuals, businesses, and the government. According to Section 5(b) of the Banking Regulation
Act, 1949, "banking" is defined as the accepting of deposits of money from the public, repayable
on demand or otherwise, and withdraw able by cheque, draft, or otherwise."

 Definition of Banker

A "banker" refers to any person or institution engaged in the banking business. Banks act as
intermediaries between depositors and borrowers. In legal terms, a banker is an entity that follows
the regulations set by the Reserve Bank of India (RBI) and the Banking Regulation Act, 1949.

 Characteristics of a Bank
 Acceptance of Deposits: Banks accept deposits from individuals, businesses, and
institutions.
 Lending of Money: Banks provide loans and advances to borrowers.
 Payment and Settlement Mechanism: Banks facilitate payment systems through cheques,
drafts, and electronic transfers.
 Monetary Control: Banks play a role in controlling the supply of money in the economy.
 Regulated by RBI: The Reserve Bank of India (RBI) supervises and regulates banks under
the Banking Regulation Act.

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III. Types of Banks

 Banks can be classified into various types. Given below are the bank types in India:-

1. Central Bank

2. Cooperative Banks

3. Commercial Banks

4. Regional Rural Banks (RRB)

5. Local Area Banks (LAB)

6. Specialized Banks

7. Small Finance Banks

8. Payments Banks

1. Central Bank

The Reserve Bank of India is the central bank of our country. Each country has a central bank that
regulates all the other banks in that particular country.

The main function of the central bank is to act as the Government’s Bank and guide and regulate
the other banking institutions in the country. Given below are the functions of the central bank of
a country:
- Guiding other banks
- Issuing currency

- Implementing the monetary policies

- Supervisor of the financial system

In other words, the central bank of the country may also be known as the banker’s bank as it
provides assistance to the other banks of the country and manages the financial system of the
country, under the supervision of the Government.

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2. Cooperative Banks

These banks are organised under the state government’s act. They give short-term loans to the
agriculture sector and other allied activities.

The main goal of Cooperative Banks is to promote social welfare by providing concessional loans.
They are organized in the 3-tier structure

i) Tier 1 (State Level) – State Cooperative Banks (regulated by RBI, State Government,
NABARD)
- Funded by RBI, the government and NABARD. Money is then distributed to
the public
- Concessional CRR and SLR apply to these banks. (CRR- 3%, SLR- 25%)
- Owned by the state government and top management is elected by members
ii) Tier 2 (District Level) – Central/District Cooperative Banks
iii) Tier 3 (Village Level) – Primary Agriculture Cooperative Banks

3. Commercial Banks

- Organized under the Banking Companies Act, 1956

- They operate on a commercial basis and its main objective is profit.

- They have a unified structure and are owned by the government, state, or any private entity.

- They tend to all sectors ranging from rural to urban

- These banks do not charge concessional interest rates unless instructed by the RBI

- Public deposits are the main source of funds for these banks

The commercial banks can be further divided into three categories:

1. Public sector Banks – A bank where the majority stakes are owned by the Government or
the central bank of the country.
2. Private sector Banks – A bank where the majority stakes are owned by a private
organization or an individual or a group of people

3. Foreign Banks – The banks with their headquarters in foreign countries and branches in
our country, fall under this type of bank

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4. Regional Rural Banks (RRB)

- These are special types of commercial Banks that provide concessional credit to agriculture
and rural sectors.

- RRBs were established in 1975 and are registered under the Regional Rural Bank Act,
1976.

- RRBs are joint ventures between the Central government (50%), State government (15%),
and a Commercial Bank (35%).

- 196 RRBs have been established from 1987 to 2005.

- From 2005 onwards government started the merger of RRBs thus reducing the number of
RRBs to 82

- One RRB cannot open its branches in more than 3 geographically connected districts.

Aspirants can check the list of Regional Rural banks in India in the linked article.

5. Local Area Banks (LAB)

 Introduced in India in the year 1996

 These are organized by the private sector

 Earning profit is the main objective of Local Area Banks

 Local Area Banks are registered under Companies Act, 1956

 At present, there are only 4 Local Area Banks all of which are located in South India

6. Specialized Banks

Certain banks are introduced for specific purposes only. Such banks are called specialized banks.
These include:

- Small Industries Development Bank of India (SIDBI) – Loans for a small-scale industry or
business can be taken from SIDBI. Financing small industries with modern technology and
equipment is done with the help of this bank

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- EXIM Bank – EXIM Bank stands for Export and Import Bank. To get loans or other
financial assistance with exporting or importing goods by foreign countries can be done
through this type of bank
- National Bank for Agricultural & Rural Development (NABARD) – To get any kind of
financial assistance for rural, handicraft, village, and agricultural development, people can
turn to NABARD.

There are various other specialized banks and each possesses a different role in helping develop
the country financially.

7. Small Finance Banks

As the name suggests, this type of bank looks after the micro industries, small farmers, and the
unorganized sector of society by providing them with loans and financial assistance. These banks
are governed by the central bank of the country.

8. Payments Banks

A newly introduced form of banking, the payments bank has been conceptualized by the Reserve
Bank of India. People with an account in the payments bank can only deposit an amount of up to
Rs.1,00,000/- and cannot apply for loans or credit cards under this account.
Options for online banking, mobile banking, the issue of ATMs, and debit cards can be done
through payments banks. Given below is a list of the few payments banks in our country: Airtel
Payments Bank, India Post Payments Bank, Fino Payments Bank, Jio Payments Bank, Paytm,
Payments Bank and NSDL Payments Bank

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IV. Banking Regulation Act, 1949

The Banking Regulation Act, 1949 or RBI Act 1949 is a regulation in India that manages all
banking firms in India. Passed as the Banking Companies Act 1949, it came into power from
Sixteen March 1949 and changed to Banking Regulation Act 1949 from first March 1966. It has
been in Jammu and Kashmir since 1956. At first, the law was material just to banking
organizations. In 1965 it was developed to make it suitable to helpful banks and to present different
changes. The Banking Regulation Act, 2020 came up after it was altered to bring the cooperative
banks under the management of the Reserve Bank of India. The Act gives a system under which
business banking in India is directed and controlled. The Act supplements the Companies Act,
1956.

The Act gives the Reserve Bank of India (RBI) the ability to permit banks, have regulation over
shareholding and casting ballot rights of investors; oversee the arrangement of the sheets and the
board; manage the activities of banks; set down guidelines for reviews; control ban, consolidations
and liquidation; issue mandates in light of a legitimate concern for public great and on banking
strategy, and force punishments. In 1965, the Act was revised to incorporate cooperative banks
under its domain by adding Section 56. Cooperative banks, which work just in one state, are shaped
and run by the state government. Yet, RBI controls the permitting and directs the business
operations. The Banking Act was an enhancement to the past acts connected with banking.

The Banking Regulation (Amendment) Bill, 2020 was presented in Lok Sabha by the Minister of
Finance, Ms. Nirmala Sitharaman, on March 3, 2020. The Bill tries to alter the Banking Regulation
Act, 1949, concerning cooperative banks. The Act directs the working of banks and gives ideas
from different angles, for example, authorizing the board, and activities of banks. The Act doesn’t
matter to specific cooperative organizations.

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V. Functions of a Bank Under the Banking Regulation Act, 1949

The functions of banks can be broadly categorized into primary functions, secondary functions,
and regulatory/statutory functions.

 Primary Functions of a Bank

These are the core activities of banks that directly impact customers.
1. Accepting Deposits (Section 6(1)(a))
The banks accept deposits from their customers, who can withdraw their funds at will.
Customers can deposit money and leave their funds with the bank in any type of bank
account – savings account, current account, or fixed deposit account.
A savings bank also pays interest to their customers on the deposits. Such banks are very
popular with small savers. A current account is a running account that can be operated
multiple times during a working day. Whereas, a fixed deposit account is responsible for
holding deposits for a fixed period and a higher rate of interest is paid on such accounts.
Banks collect deposits from the public and provide interest on savings. Deposits are
categorized as:
- Demand Deposits: Withdraw able at any time (e.g., Savings & Current Accounts).
- Time Deposits: Fixed for a specific period (e.g., Fixed Deposits, Recurring Deposits).

2. Granting Loans and Advances (Section 6(1)(b))

A bank lends funds to needy people at a certain rate of interest. Banks provide loans mainly
to agriculturists, industrialists, and businessmen who intend to invest in their ventures for
their own profit and to contribute to the economic development of the country.
Banks provide various types of credit facilities to individuals and businesses, such as:
- Term Loans: Loans for a fixed period, repayable in installments.
- Cash Credit: A short-term borrowing facility for businesses.
- Overdraft: A facility allowing withdrawal of more than the account balance.

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3. Investment in Government and Other Securities (Section 6(1)(c)) Banks invest in

Government Bonds, Treasury Bills, and Corporate Bonds to ensure liquidity and
profitability.

 Secondary Functions of a Bank

These functions support banking operations and enhance financial services.

1. Agency Functions (Section 6(1) (d)) Banks act as agents for customers in performing:

- Collection of Cheques, Bills, and Dividends

- Payment of Taxes and Utility Bills
- Buying and Selling Securities

2. Remittance of Money (Section 6(1) (e)) Banks facilitate the transfer of funds through:

- NEFT (National Electronic Funds Transfer)

- RTGS (Real Time Gross Settlement)
- IMPS (Immediate Payment Service)

3. Foreign Exchange Transactions (Section 6(1) (f)) Banks deal in foreign currency exchange and
support international trade by issuing Letters of Credit (LCs) and foreign remittances.

4. Credit Creation (Implied under Section 5(b)) Banks create credit by issuing loans while
maintaining a fractional reserve, influencing the money supply.

5. Safe Custody & Locker Facility (Section 6(1)(o)) Banks offer safe deposit lockers for
valuables, important documents, and jewelry.

6. E-Banking & Digital Services (Covered under RBI Guidelines) Banks provide digital banking
services such as:

- Internet Banking
- Mobile Banking
- UPI (Unified Payments Interface) Transactions

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VI. Statutory and Regulatory Functions of Banks

Banks are required to follow regulations set by the RBI and the Government of India.

1. Maintenance of CRR and SLR (Section 24 & Section 42 of RBI Act, 1934)

Banks must maintain:

- Cash Reserve Ratio (CRR): A percentage of total deposits that banks must keep with the
RBI.
- Statutory Liquidity Ratio (SLR): A minimum percentage of deposits that banks must
maintain in liquid assets like gold and government securities.
2. Compliance with RBI Guidelines (Section 35A)

Banks must follow monetary policies and regulations issued by the RBI, such as interest rate
policies and capital adequacy requirements.

3. Prevention of Money Laundering (Section 35A & PMLA Act, 2002)

Banks adhere to Know Your Customer (KYC) and Anti-Money Laundering (AML) norms to
prevent illegal financial activities.

4. Priority Sector Lending (Directed under RBI guidelines based on Section 21 & Section
35A)

Banks must allocate a portion of credit to sectors like:

- Agriculture
- Micro, Small, and Medium Enterprises (MSMEs)
- Education Loans and Housing Loans

5. Consumer Protection and Financial Inclusion (Section 35A & RBI Circulars)

Banks are responsible for ensuring transparency, fair interest rates, and financial inclusion
initiatives for the unbanked population.

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VII. Role of the Reserve Bank of India (RBI)

 The RBI acts as the regulator of banks under the Banking Regulation Act, 1949. The key functions
of the RBI include:
 Supervision and Regulation of Banks (Section 35 & Section 36)
 Formulation of Monetary Policy (Section 21)
 Issuance of Currency Notes (RBI Act, 1934 - Section 22)
 Foreign Exchange Regulation and Management (FEMA Act, 1999)
 Ensuring Stability of the Financial System (Section 45JA, RBI Act, 1934)

 RBI is the Central Bank of India, here are few functions of Central Bank
1. Issuing Notes – The central bank has the exclusive right to issue currency notes, ensuring
a stable and controlled money supply in the economy.
2. Banker to Government – It manages the accounts of the government, facilitates borrowing,
and handles public debt, ensuring smooth financial operations.
3. Bankers’ Bank – A Bankers' Bank is a financial institution that provides services
exclusively to commercial banks, rather than to individuals or businesses. It plays a crucial
role in maintaining the stability of the banking system by offering liquidity support,
clearing services, and regulatory oversight.
4. Lender of the Last Resort – It provides emergency financial assistance to banks facing
insolvency or liquidity crises to prevent financial system collapse.
5. Custodian of Foreign Exchange – It manages foreign currency reserves, stabilizes
exchange rates, and implements forex policies to maintain external stability.
6. Clearing House Function – It facilitates smooth clearing and settlement of interbank
transactions, reducing risks and delays in financial operations.
7. Control of Credit – It regulates the money supply and credit creation in the economy
through monetary policies like CRR, SLR, repo, and reverse repo rates.

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VIII. Leading Case Laws

 In Durga Lai Mohan Lai v. Governor General in Council (AIR 1952 590] it was held that
if a bank received a crossed cheque from his customer for collection, the bank acts as a
banker and an agent of a customer and not as a holder of the cheque in due course. But if
the cheque is discounted or negotiated or purchased by the bank the property with it passes
on to the bank. Then he becomes a holder in due course and ceases to be the customer's
banker or agent in relation to that transaction.
The distinction between a banker who receives a cheque or instrument for collection and
the bank which negotiates the cheque is different. In the first case the bank acts as an agent
and in the second case the banker becomes a holder in due course. When the bank merely
acts as a collecting agent he has, no cause of action against the drawee bank if the drawee
bank refuses payment. The cause of action remains with the customer. When the banker
becomes a holder in due course he is entitled to sue under Section 131 of the Negotiable
Instruments Act which protects the banker who in good faith and without negligence
receives payment for a customer of a crossed cheque, when the title to the cheque proves
defective. In the Indian Law a banker is deemed to receive payment for a customer even
though he credits the customer's account with the amount before receiving payment.

 In S.B.N. Ltd. v. De Lluch (2004) 18 NWLR (Pt.905)341, this "....consist in the issue of
notes payable on demand intended to circulate as money when the banks are banks of issue;
in receiving deposits payable on demand; in discounting commercial paper; making loans
of money on collateral security; buying and selling bills of exchange; negotiating loans,
and dealing in negotiable securities issued by the Government. State and National, and
municipal and other corporations". A person cannot be referred to as a customer of a bank
without holding an account with the bank. It is immaterial whether the account is opened
in the name of a person in trust for another; the name on the bank's record will be regarded
as the customer.

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 The court in NDIC v Okem Enterprises Limited (2004) 10 NWLR (Pt. 880) 107, Ironbar v
FMF (2009) 15 NWLR (Pt. 1165) 506, defines a customer of a bank as any person having
an account with a bank or for whom the bank has agreed to collect items and includes a
bank owning on account with another bank. Thus, a customer is a person whose money has
been accepted by a bank on the undertaken to honour cheques up to the amount standing
to his credit. Customers of the bank may include individuals, firms, organisations and other
banks.

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IX. Conclusion

The banking system plays a crucial role in the economic development of a country by ensuring
smooth financial transactions, providing credit, and maintaining monetary stability. Banks act as
financial intermediaries, mobilizing savings and directing them toward productive investments.
The term "banker" refers to institutions engaged in banking activities such as accepting deposits,
lending funds, and facilitating financial transactions.

Banks can be classified into various types, including commercial banks, cooperative banks,
development banks, and specialized financial institutions, each serving different economic needs.
Among them, the central bank holds a pivotal position as it regulates the entire banking system,
issues currency, controls inflation, and ensures financial stability. It functions as the lender of last
resort, the banker to the government, and the custodian of foreign reserves, ensuring smooth
financial operations.

The Banking Regulation Act, 1949, serves as the cornerstone of banking governance in India,
providing a legal framework for the regulation, supervision, and control of banking institutions. It
empowers the Reserve Bank of India (RBI) to oversee commercial banks, enforce prudential
norms, and maintain banking discipline to safeguard public interest.

In conclusion, a well-regulated and efficient banking system is essential for financial inclusion,
economic growth, and monetary stability. With evolving technology and regulatory advancements,
the banking sector continues to transform, ensuring a more robust and resilient financial system.
Strengthening regulatory measures and adapting to new challenges will further enhance the role
of banks in fostering economic progress.

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X. REFERENCES

Websites

 Casemine.com
 tndalu.ac.in
 indiankanoon.org

Acts, Laws and Statutes

 Banking Regulation Act, 1949

 Regional Rural Bank Act, 1976.
 Companies Act,1956

Book, Guide, Digest, etc.

 Banking Law & Negotiable Instruments Act

Author: R K Bangia
Edition: 7th Edition, 2023

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