BANKING LAW & PRACTICE

UNIT-I

INTRODUCTION

The word „Bank‟ has been derived from the Latin word „bancus’ or ‘banque’. The meaning
of it in English is a bench. The early bankers transacted their business at benches in a market place.
According to some authorities, the word bank was originally derived from German word bank.

A bank is a financial institution which deals with deposits and advances and other related
services. It receives money from those who want to save in the form of deposits and it lends money
to those who need it. A bank is a financial institution and a financial intermediary that accepts
deposits and channels those deposits into lending activities, either directly by loaning or indirectly
through capital markets. A bank is the connection between customers that have capital deficits and
customers with capital surpluses.
Definitions:
The Indian Banking Companies Act, 1949 : sec 5 (b) “Banking means the acceptance for
the purpose of lending or investment, of deposits of money from the public repayable on demand or
otherwise, and withdrawal by cheque, draft, order or otherwise”.

Characteristics / Features of Bank:

Characteristics of a bank can be given as follows:
1) Dealing in Money:
Bank is a financial institution which deals with other people's money i.e. money given by depositors.
2) Individual / Firm / Company:
A bank may be a person, firm or a company. A banking company means a company which is in the
business of banking.

3) Acceptance of Deposit :
A bank accepts money from the people in the form of deposits which are usually repayable on
demand or after the expiry of a fixed period. It gives safety to the deposits of its customers. It also
acts as a custodian of funds of its customers.
4) Giving Advances :
A bank lends out money in the form of loans to those who require it for different purposes.
5) Payment and Withdrawal :
A bank provides easy payment and withdrawal facility to its customers in the form of cheques and
drafts. It also brings bank money in circulation. This money is in the form of cheques, drafts, etc.
6) Agency and Utility Services:
A bank provides various banking facilities to its customers. They include general utility services and
agency services.
7) Profit and Service Orientation:
A bank is a profit seeking institution having service oriented approach.
8) Ever increasing Functions:
Banking is an evolutionary concept. There is continuous expansion and diversification as regards the
functions, services and activities of a bank.
History of Banking
Phases-I

Pre Independence Period (1786-1947)

The first bank of India was the “Bank of Hindustan”, established in 1770 and located in the then Indian
capital, Calcutta. However, this bank failed to work and ceased operations in 1832.

During the Pre Independence period over 600 banks had been registered in the country, but only a few
managed to survive.

Following the path of Bank of Hindustan, various other banks were established in India. They were:

 Bank of Bengal (1809)

 Bank of Bombay (1840)

 Bank of Madras (1843)

During the British rule in India, The East India Company had established three banks: Bank of Bengal, Bank of
Bombay and Bank of Madras and called them the Presidential Banks. These three banks were later merged into
one single bank in 1921, which was called the “Imperial Bank of India.”

The Imperial Bank of India was later nationalised in 1955 and was named The State Bank of India, which is
currently the largest Public sector Bank.

Phases-II

Post Independence Period (1947-1991)

At the time when India got independence, all the major banks of the country were led
privately which was a cause of concern as the people belonging to rural areas were still dependent on
money lenders for financial assistance.

With an aim to solve this problem, the then Government decided to nationalise the Banks.
These banks were nationalized under the Banking Regulation Act, 1949. Whereas, the Reserve Bank
of India was nationalized in 1949.

Candidates can check the list of Banking sector reforms and Acts at the linked article.

Following it was the formation of State Bank of India in 1955 and the other 14 banks were
nationalized between the time duration of 1969 to 1991. These were the banks whose national
deposits were more than 50 crores.
Given below is the list of these 14 Banks nationalized in 1969:

1. Allahabad Bank
2. Bank of India
3. Bank of Baroda
4. Bank of Maharashtra
5. Central Bank of India
6. Canara Bank
7. Dena Bank
8. Indian Overseas Bank
9. Indian Bank
10. Punjab National Bank
11. Syndicate Bank
12. Union Bank of India
13. United Bank
14. UCO Bank

In the year 1980, another 6 banks were nationalized, taking the number to 20 banks. These banks
included:

1. Andhra Bank
2. Corporation Bank
3. New Bank of India
4. Oriental Bank of Comm.
5. Punjab & Sind Bank
6. Vijaya Bank

Phases-III

Liberalization Period (1991-Till Date)

Once the banks were established in the country, regular monitoring and regulations need to
be followed to continue the profits provided by the banking sector. The last phase or the ongoing
phase of the banking sector development plays a hugely significant role.
 To provide stability and profitability to the Nationalised Public sector Banks, the
Government decided to set up a committee under the leadership of Shri. M Narasimham to manage
the various reforms in the Indian banking industry.

The biggest development was the introduction of Private sector banks in India. RBI gave license to
10 Private sector banks to establish themselves in the country. These banks included:

1. Global Trust Bank

2. ICICI Bank
3. HDFC Bank
4. Axis Bank
5. Bank of Punjab
6. IndusInd Bank
7. Centurion Bank
8. IDBI Bank
9. Times Bank
10. Development Credit Bank

The other measures taken include:

 Setting up of branches of the various Foreign Banks in India

 No more nationalization of Banks could be done

 The committee announced that RBI and Government would treat both public and private
sector banks equally

 Any Foreign Bank could start joint ventures with Indian Banks

 Payments banks were introduced with the development in the field of banking and
technology

 Small Finance Banks were allowed to set their branches across India

 A major part of Indian banking moved online with internet banking and apps available for
fund transfer

Thus, the history of banking in India shows that with time and the needs of people, major
developments have been brought about in the banking sector with an aim to prosper it.
 Classification of banks

Scheduled banks are those banks that are listed under Schedule II of the Reserve Bank
of India Act, 1934. The bank's paid-up capital and raised funds must be at least Rs. 5 lakh to qualify
as a scheduled bank. These banks are liable for low interest loans from the RBI.

Commercial Bank
A commercial bank is a kind of financial institution that carries all the operations related to
deposit and withdrawal of money for the general public, providing loans for investment, and other
such activities. These banks are profit-making institutions and do business only to make a profit.

1. Public sector bank –: It is a type of bank that is nationalized, and the government holds a
significant stake. For example, Bank of Baroda, State Bank of India (SBI), Dena Bank,
Corporation Bank, and Punjab National Bank.
 Key Characteristics:

 Government Ownership:
Public banks are distinguished by significant government ownership, influencing their
policies and operations.
 Public Interest Focus:
They prioritize social welfare, often offering lower interest rates on loans and
providing services to underserved areas.
 Financial Regulation:
Public banks operate within the framework of government-defined financial
regulations, ensuring stability and reliability.
 Examples:
In India, the State Bank of India (SBI) is a prominent example of a public sector bank,
holding a large percentage of the market share.
Benefits of Public Banks:
 Financial Inclusion:
Public banks play a crucial role in extending financial services to rural areas and
promoting financial inclusion.
 Lower Costs:
They often offer loans and other services at competitive or lower interest rates
compared to private sector banks.
 Public Trust:
Government ownership can inspire greater public trust and confidence in the safety of
deposits.
 Social Welfare Initiatives:
Public banks are known for introducing schemes and initiatives aimed at benefiting the
public.

2. Private bank –: It is a type of commercial banks where private individuals and businesses own a
majority of the share capital. All private banks are recorded as companies with limited liability.
Such as Housing Development Finance Corporation (HDFC) Bank, Industrial Credit and
Investment Corporation of India (ICICI) Bank, Yes Bank, and more such banks.
 Key Characteristics:
 Ownership:
Private sector banks are owned and managed by private individuals,
companies, or groups.
 Regulation:
They are regulated by the Reserve Bank of India (RBI), ensuring they adhere
to banking regulations and guidelines.
 Services:
They offer a variety of banking services, including savings and current
accounts, loans, credit cards, and investment options.
 Focus:
While some focus on specific customer segments (like retail, corporate, or
rural banking), they generally aim to provide comprehensive financial
solutions.
 Examples:
Some of the prominent private sector banks in India include HDFC Bank,
ICICI Bank, Axis Bank, Kotak Mahindra Bank, IndusInd Bank, and Yes
Bank.

3. Foreign bank –: These banks are established in foreign countries and have branches in other
countries. For instance, American Express Bank, Hong Kong and Shanghai Banking Corporation
(HSBC), Standard & Chartered Bank, Citibank, and more such banks.
4. Regional Rural Banks are government owned scheduled commercial banks of India that operate
at regional level in different states of India. These banks are under the ownership of Ministry of
Finance, Government of India. They were created to serve rural areas with basic banking and
financial services.

Key Features of RRBs:

 Focus on Rural Areas:
RRBs primarily serve rural populations, aiming to promote financial inclusion and
rural development.
 Sponsored by Commercial Banks:
Each RRB is sponsored by a commercial bank, which provides assistance in terms of
capital, management, and other resources.
 Regulation and Supervision:
RRBs are regulated by the Reserve Bank of India (RBI) and supervised by the
National Bank for Agriculture and Rural Development (NABARD).
 Government Ownership:
RRBs are jointly owned by the central government, the concerned state government,
and the sponsoring bank.
 Objective:
RRBs were established to provide credit and other banking facilities to small and
marginal farmers, agricultural laborers, artisans, and small entrepreneurs in rural
areas.
 Objectives of Regional Rural Banks in India
The objectives of the Regional Rural Banks mainly include:
 Provision of Credit: Adequate and timely credit facilities shall be provided to small and
marginal farmers, agricultural laborers, artisans, and small entrepreneurs in the rural areas.
 Financial Inclusion: Financial inclusions of the rural population by providing basic banking
and other financial services.
 Rural Development: To assist developmental activities in rural areas, especially with regard
to agriculture, small-scale industries, and trade.
 Employment Generation: Help generate employment opportunities by promoting small and
micro-enterprises.
 Poverty Alleviation: Help alleviate poverty by strengthening rural economic activities.

5. Co-operative banks are financial entities established on a co-operative basis and belonging
to their members. This means that the customers of a co-operative bank are also its owners. These
banks provide a wide range of regular banking and financial services
Types of Cooperative Banks:
 Urban Cooperative Banks (UCBs):
 Primarily serve urban and semi-urban areas, offering various banking services.
 State Cooperative Banks (StCBs):
Act as apex institutions for their respective states, overseeing and supporting District
Central Cooperative Banks (DCCBs).
 District Central Cooperative Banks (DCCBs):
Function at the district level, providing financial services to rural areas and affiliated
primary agricultural credit societies.
 Primary Agricultural Credit Societies (PACS):
These are the base-level units in rural areas, providing credit and other financial
services to farmers.
Key Characteristics:
 Member-owned and controlled:
Members are both customers and owners of the bank.
 Democratic governance:
Decisions are made through a democratic process, with each member having one
vote.
 Focus on social and economic development:
Cooperative banks aim to support their members and contribute to the development of
the community.

Non-scheduled banks, by definition, are those that do not LISTED to the RBI's
regulations. They are not mentioned in the II Schedule of the RBI Act, 1934, and are therefore
deemed incapable of serving and protecting depositors' interests.

Components of Indian banking system

Branch banking
Banking Branch Banking System means a system of banking in which a banking having one
head office and more than one branch office. This is the world‟s most practices banking system.
Advantages of the branch banking system;
1. Economics of Large Scale.
2. Spreading of Risk.
3. The economy in Cash Reserves.
4. Diversification of Deposits and Assets.
5. Decentralization of Risks.
6. Easy and Economical Transfer of Funds.
7. Cheap Remittance Facilities.
8. Uniform Interest Rates.
9. Proper Use of Capital.
10. Better Facilities to Customers.
11. Contacts with the Whole Country.
12. Uniform Rates of Interest.

Disadvantages of the branch banking system are;

1. Difficulties of Management. Supervision and Control.
2. Lack of Initiative.
3. Monopolistic Tendencies.
4. Regional Imbalances.
5. Continuance of Non-profitable Branches.
6. Unnecessary Competition.
7. Expensiveness.
8. Losses by Some Branches Affect Others.

Unit banking:
Unit banking refers to a single head office, usually very small bank that provides financial
services to its local community. Typically, a unit bank is independent and operates without any connecting
banks or branches in the area. However, not all unit banks are independent.

Advantages of the unit banking system are;

1. Local funds for local people.
2. Intimate Knowledge of Customer.
3. Efficient Management supervision and control.
4. Discontinuance of inefficient branches.
5. Better Service.
6. Close Customer-banker Relations.
7. No Effects Due to Strikes or Closure.
8. No Monopolistic Practices.
9. No Risks of Fraud.
10. Local Development.
11. Promotes Regional Balance.
Disadvantages of the unit banking system are;
1. No Economies of Large Scale.
2. Lack of Uniformity in Interest Rates.
3. Lack of Control.
4. Risks of Bank‟s Failure.
5. Limited Resources.
6. Unhealthy Competition.
7. Wastage of National Resources.
8. No Banking Development in Backward Areas.
9. Local Pressure.

Chain banking
Chain banking is a form of bank governance in which individuals or an entity takes
control of, at least, three banks that are independently chartered. It is not like branch banking or
group banking because banks within such a system are separately-owned and are not part of the
same entity.

Group banking
Group banking is a term that refers to a type of banking plan offered to groups such as
employees in a corporation of people instead of individuals. These plans provide incentives and
other benefits for those who participate, which are not readily available to the bank's other
customers.

Mixed banking
Mixed banking is an approach where banks undertake both commercial and industrial
banking and is a popular banking model in countries like Germany and Japan. German banks
present a typical case of banking where they undertake multiple functions and are thus referred to as
'Universal Banks
Difference between Unit Banking and Branch Banking

BASIS FOR
UNIT BANKING BRANCH BANKING
COMPARISON

Unit banking is that system of Branch banking is a banking method

banking in which there is a single wherein a bank operates in more than
Meaning small banking company, that one place to provide banking services
provides financial services to the to customers, through its branches.
local community.

Affected by the ups and downs of It is not affected by the ups and downs
Local economy
the local economy. of the local economy.

Independence of
More Comparatively less
operations

Supervision Cost Low Comparatively high

Financial
Limited financial resources Large pool of financial resources
Resources

Competition No or little within the bank Exist between the bank branches

Not fixed, as the bank has its own Fixed by the head office, and directed
Rate of interest
policies and norms. by the central bank.

Decision making Quick Time Consuming

 STRUCTURE OF THE INDIAN BANKING SYSTEM
Reserve Bank of India is the central bank of the country and regulates the banking system of India.
The structure of the banking system of India can be broadly divided into scheduled banks, non-scheduled
banks and development banks.
Banks that are included in the second schedule of the Reserve Bank of India Act, 1934 are
considered to be scheduled banks.

Commercial Banks
The institutions that accept deposits from the general public and advance loans with the purpose of
earning profits are known as Commercial Banks.
Commercial banks can be broadly divided into Nationalized, private sector, foreign banks and RRBs.

Nationalized Banks the majority stake is held by the government. After the recent amalgamation of
smaller banks with larger banks, there are 12 public sector banks in India as of now. An example of Public
Sector Bank is State Bank of India.

Private Sector Banks are banks where the major stakes in the equity are owned by private stakeholders or
business houses. A few major private sector banks in India are HDFC Bank, Kotak Mahindra Bank, ICICI
Bank etc.
Cooperative Bank is a financial entity that belongs to its members, who are also the owners as well as
the customers of their bank. They provide their members with numerous banking and financial services.
Cooperative banks are the primary supporters of agricultural activities, some small-scale industries and
self-employed workers. An example of a Cooperative Bank in India is Mehsana Urban Co-operative
Bank.

Development Banks
Financial institutions that provide long-term credit in order to support capital-intensive
investments spread over a long period and yielding low rates of return with considerable social benefits
are known as Development Banks. The major development banks in India are; Industrial Finance
Corporation of India (IFCI Ltd), 1948, Industrial Development Bank of India' (IDBI) 1964, Export-Import
Banks of India (EXIM) 1982, Small Industries Development Bank Of India (SIDBI) 1989, National Bank
for Agriculture and Rural Development (NABARD) 1982.

The banking system of a country has the capability to heavily influence the development of a
country‟s economy. It is also instrumental in the development of rural and suburban regions of a country
as it provides capital for small businesses and helps them to grow their business. The organized financial
system comprises Commercial Banks, Regional Rural Banks (RRBs), Urban Co-operative Banks (UCBs),
Primary Agricultural Credit Societies (PACS) etc.

Commercial Bank

Commercial banks are those banks which started mainly to earn profit as well as to render
different types of services to their depositors. It enables large payments to be made over long
distances with minimum expenses.

Functions of Commercial Bank

In general, bank refers to a financial institution where we deposit our savings, withdraw our
money in case of emergency and take loans. The banker is under obligation to repay the money to the
depositor as and when demanded by the depositor. The depositor can withdraw his money through
cheques, drafts etc
1. Accepting Deposits:
The most important function of commercial banks is to accept deposits from the public.

(i) Current Deposits:

The depositors of such deposits can withdraw and deposit money whenever they desire.
Since banks have to keep the deposited amount of such accounts in cash always, they carry either no
interest or very low rate of interest.
These deposits are called as Demand Deposits because these can be demanded or withdrawn
by the depositors at any time they want. Such deposit accounts are highly useful for traders and big
business firms because they have to make payments and accept payments many times in a day

(ii) Fixed Deposits:

These are the deposits which are deposited for a definite period of time. This period is
generally not less than one year and, therefore, these are called as long term deposits. These deposits
generally carry a higher rate of interest because banks can use these deposits for a definite time
without having the fear of being withdrawn.

(iii) Saving Deposits:

In such deposits, money up to a certain limit can be deposited and withdrawn as per use of
customer
2. Giving Loans:
The second important function of commercial banks is to advance loans to its customers.
Banks charge interest from the borrowers and this is the main source of their income. Banks advance
loans not only on the basis of the deposits of the public rather they also advance loans on the basis of
depositing the money in the accounts of borrowers. In other words, they create loans out of deposits
and deposits out of loans. This is called as credit creation by commercial banks.

3. Over-Draft:
Banks advance loans to its customer‟s up to a certain amount through over-drafts, if there are
no deposits in the current account. For this banks demand a security from the customers and charge
very high rate of interest.

4. Discounting of Bills of Exchange:

This is the most prevalent and important method of advancing loans to the traders for short-
term purposes. Under this system, banks advance loans to the traders and business firms by
discounting their bills. In this way, businessmen get loans on the basis of their bills of exchange
before the time of their maturity.
Agency Functions:
Banks function in the form of agents and representatives of their customers. Customers give
their consent for performing such functions. The important functions of these types are as follows:

(i) Banks collect cheques, drafts, bills of exchange and dividends of the shares for their customers.
(ii) Banks make payment for their clients and at times accept the bills of exchange: of their
customers for which payment is made at the fixed time.
(iii) Banks pay insurance premium of their customers. Besides this, they also deposit loan
installments, income-tax, interest etc. as per directions.
(iv) Banks purchase and sell securities, shares and debentures on behalf of their customers.
(v) Banks arrange to send money from one place to another for the convenience of their customers.
 The Banking Regulation Act of 1949
The Banking Regulation Act of 1949 is a crucial piece of legislation in India that governs the
operations of banking companies. It aims to ensure the stability and soundness of the banking system
by regulating various aspects of banking, including licensing, capital requirements, management,
and operations. The Act also empowers the Reserve Bank of India (RBI) with significant authority to
supervise and regulate the banking sector.
Key Objectives of the Act:
Preventing bank failures:
The Act mandates minimum capital requirements for banks and regulates branch expansion to
prevent unhealthy competition and ensure financial stability.
Protecting depositors' interests:
By requiring banks to maintain adequate cash and liquidity reserves, the Act aims to safeguard
depositors' funds.
Regulating banking activities:
The Act outlines permissible and prohibited activities for banks, setting standards for lending,
investments, and interest rates.
Supervising the banking sector:
The RBI is granted powers to inspect banks, regulate their management, and oversee mergers and
liquidations.
Promoting sound banking practices:
The Act encourages ethical practices and responsible lending to maintain a healthy banking system.