LPB-Module: 1 INTRODUCTION TO BANKING

Table of Contents

Introduction:

A bank is a financial intermediary for the safeguarding, transferring, exchanging, or lending of money. Banks distribute “money” – the medium of exchange. A bank is a business and banks sell their services to earn money, and they need to market and manage those services in a competitive field.

What is a Bank?

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 may be defined as an institution that accepts deposits, makes loans, pays checks and provides financial services. A bank is a financial intermediary for the safeguarding, transferring, exchanging, or lending of money.

The term bank refers to a financial institution which deals with deposits and advances and other related services. Bank received money from those who want to save in the form of deposits and it lends money to those who need it.

Definition of Bank:

According to oxford Dictionary bank as defined “an establishment for custody of money which it pays out on customer’s order”.

The Indian Banking Companies Act, 1949 “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”

Functions of Bank:

1. PRIMARYFUNCTIONS

Primary banking functions of the commercial banks include:

  1. Acceptance of deposits,
  2. Advancing loans,
  3. Creation of credit
  4. Clearing of cheques,
  5. Financing foreign trade,
  6. Remittance of funds
  1. ACCEPTANCEOFDEPOSITS

Commercial bank accepts various types of deposits from public especially from its clients. These deposits are payable after a certain time period. Banks generally accept three types of deposits.

(a) Current Deposits

(b) Savings Deposits

(c) Fixed Deposits and

(d)Recurring Deposit.

(a) Current Deposits: These deposits are also known as demand deposits. These deposits can be withdrawn the customer is required to leave a minimum balance undrawn with the bank.

(b) Savings Deposits: This is meant mainly for professional men and middle class people to help them deposit their small savings. It can be opened without any introduction. Money can be deposited at any time but the maximum cannot go beyond a certain limit.

(c) Fixed Deposits: These deposits are also known as time deposits. These deposits cannot be with drawn before the expiry of the period for which they are deposited or without giving a prior notice for withdrawal.

(d) Recurring Deposit: Recurring Deposits are a special kind of Term Deposits offered by banks in India which help people with regular incomes to deposit a fixed amount every month into their Recurring Deposit account and earn interest at the rate applicable to Fixed Deposits. It is similar to making FDs of certain in amount in monthly instalments, forexampleRs1000 every month.

  1. ADVANCINGLOANS

Loans are made against personal security, gold and silver, stocks of goods and other assets. The second primary function of a commercial bank is to make loans and advances to all types of persons, particularly to businessmen and entrepreneurs. The most common way of advancing loans are given below:

(a) Overdraft Facilities: In this case, the depositor in a current account is allowed to draw over and above his account up to a previously agreed limit. Suppose a businessman has only Rs.6,000/- in his current account in a bank but requires Rs. 12,000/- to meet his expenses. He may approach his bank and borrow the additional amount of Rs. 6,000/-.

(b) Cash Credit: Under this account, the bank gives loans to the borrowers against certain security. But the entire loan is not given at one particular time, instead the amount is credited into his account in the bank; but under emergency cash will be given. The borrower is required to pay interest only on the amount of credit availed to him.

(c) Discounting Bills of Exchange: This is another type of lending which is very popular with the modern banks. The holder of a bill can get it discounted by the bank, when he is in need of money. After deducting its commission, the bank pays the present price of the bill to the holder. Such bills form good investment for a bank.

(d) Money at Call: Banks grant loans for a very short period, generally not exceeding 7 days to the borrowers, usually dealers or brokers in stock exchange markets against collateral securities like stock or equity shares, debentures, etc., offered by them. Such advances are repayable immediately at short notice hence; they are described as money at call or call money.

(e) Term Loans: Banks give term loans to traders, industrialists and now to agriculturists also against some collateral securities. Term loans are so-called because their maturity period variesbetween1 to 10years.

(f) Consumer Credit: Banks also grant credit to households in a limited amount to buy some durable consumer goods such as television sets, refrigerators, etc., or to meet some personal needs like payment of hospital bills etc. Such consumer credit is made in a lump sum and is repayable in instalments in a short time.

(g) Miscellaneous Advances: The other forms of bank advances there are packing credits given to exporters for a short duration, export bills purchased/discounted, import finance-advances against import bills, finance to the self employed, credit to the public sector and credit to the cooperative sector.

  1. CREATION OF CREDIT

Credit creation is the multiple expansions of banks demand deposits. It is an open secret now that banks advance a major portion of their deposits to the borrowers and keep smaller parts of deposits to the customers on demand. Even then the customers of the banks have full confidence that the depositor’s lying in the banks is quite safe and can be withdrawn on demand.

  1. PROMOTE THE USE OF CHEQUES, DD OR ONLINE TRANSACTIONS

The commercial banks render an important service by providing to their customers a cheap medium of exchange like cheques. It is found much more convenient to settle debts through cheques rather than through the use of cash. The cheque is the most developed type of credit instrument in the money market.

  • FINANCINGFORINTERNALANDFOREIGNTRADE

The bank finances internal and foreign trade through discounting of exchange bills. Some times, the bank gives short-term loans to traders on the security of commercial papers. This discounting business greatly facilitates the movement of internal and external trade.

  • REMITTANCEOFFUNDS

Commercial banks, on account of their network of branches throughout the country, also provide facilities to remit funds from one place to another for their customers by issuing bank drafts, mail transfers or telegraphic transfers on nominal commission charges. As compared to the postal money orders or other instruments, bank drafts have proved to be a much cheaper mode of transferring money and have helped the business community considerably.

2. SECONDARYFUNCTIONS:

  1. AGENCYSERVICES:

Commercial banks act as attorney for their clients. They buy and sell shares and bonds, receive and pay utility bills, premiums, dividends, rents and interest for their clients. Banks also perform certain agency functions for and on behalf of their customers. The agency services are of immense value to the people at large. The various agency services rendered by banks are as follows:

(a) Collection and Payment of Credit Instruments: Banks collect and pay various credit instruments like cheques, bills of exchange, promissory notes etc., on behalf of their customers.

(b) Purchase and Sale of Securities: Banks purchase and sell various securities like shares, stocks, bonds, debentures on behalf of their customers.

(c) Collection of Dividends on Shares: Banks collect dividends and interest on shares and debentures of their customers and credit them to their accounts.

(d) Acts as Correspondent: Sometimes banks act as representative and correspondents of their customers. They get passports, traveler’s tickets and even secure air and sea passages for their customers.

(e) Income-tax Consultancy: Banks may also employ income tax experts to prepare income tax returns for their customers and to help them to get refund of income tax.

(f) Execution of Standing Orders: Banks execute the standing instructions of their customers for making various periodic payments. They pay subscriptions, rents, insurance premium etc., on behalf of their customers.

(g) Acts as Trustee and Executor: Banks preserve the ‘Wills’ of their customers and execute them after their death.

Modern functions of banks:

Ø It provides lockers facility to the customers where the customers can keep the valuable documents and ornaments etc.

Ø It underwrites the company debentures and shares.

Ø It provides information’s about the customers.

Ø It issues travelers cheques, letter of credit etc. to the customers and it accepts bills on behalf of the customers.

Origin of banking:

The banking sector development can be divided into three phases:

Phase I: The Early Phase which lasted from 1770 to 1969

Phase II: The Nationalization Phase which lasted from 1969 to 1991

Phase III: The Liberalization or the Banking Sector Reforms Phase which began in 1991 and continues to flourish till date

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:

· The General Bank of India (1786-1791)

· Oudh Commercial Bank (1881-1958)

· 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.

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 nationalised under the Banking Regulation Act, 1949. Whereas, the Reserve Bank of India was nationalised in 1949.

Following it was the formation of State Bank of India in 1955 and the other 14 banks were nationalised 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 nationalised 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 nationalised, 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

Apart from the above mentioned 20 banks, there were seven subsidiaries of SBI which were nationalised in 1959:

1. State Bank of Patiala

2. State Bank of Hyderabad

3. State Bank of Bikaner & Jaipur

4. State Bank of Mysore

5. State Bank of Travancore

6. State Bank of Saurashtra

7. State Bank of Indore

All these banks were later merged with the State Bank of India in 2017, except for the State Bank of Saurashtra, which merged in 2008 and State Bank of Indore, which merged in 2010.

Impact of Nationalisation

There were various reasons why the Government chose to nationalise the banks. Given below is the impact of Nationalising Banks in India:

· This lead to an increase in funds and thereby increasing the economic condition of the country · Increased efficiency

· Helped in boosting the rural and agricultural sector of the country

· It opened up a major employment opportunity for the people

· The Government used profit gained by Banks for the betterment of the people

· The competition decreased, which resulted in increased work efficiency

This post Independence phase was the one that led to major developments in the banking sector of India and also in the evolution of the banking sector

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

Banker and Customer Relationship (General and special relationship):

The relationship arises between a banker and a customer with the opening of an account by the customer with a banker. The application for opening an account is considered as a letter of agreement for establishing the banker-customer relationship. The general view is that the banker-customer relationship is mainly that of a debtor and a creditor with certain special features.

However, today the range of banking services is more extensive, and indeed is expanding all the time, so it must be expected that other relationships will arise besides that of debtor and creditor. For instance, the relationship of principal and agent is present when the customer instructs his bank to buy or sell stocks on his behalf, and when items are held in safe-custody the relationship is that of bailer and bailee.

Where the bank’s executorships service takes on the administration of a deceased’s estate the relationship is that of trustee and beneficiary. Duties akin to a trusteeship might also happen when a branch comes into possession of funds or property that belongs to a third party, as when

the bank has sold property in mortgage, and has a surplus to pass to the subsequent mortgagee. Obviously, the relationship with the customer in that situation is that of a mortgagor with a mortgagee. However, if the security had been given by a third party then another state of affairs would exist between the lender and his surety. There, duties and obligations would arise irrespective of the banker-customer relationship with the borrowing customer.

The nature of the relationship depends upon the type of services rendered by the banker, which has two aspects: one is legal and another is behavioural. Some of the important relationships they share are depicted below.

Relationship between Banker and Customer

A) General Relationship between Banker and Customer

B) Special Relationship between Banker and Customer

A) General Relationship between Banker and Customer

1. Debtor and Creditor

2. Creditor and Debtor

3. Agent and Principal

4. Trustee and Beneficiary

5. Pledgee and Pledger

6. Bailee and Bailor

7. Advisor and Client

1. Debtor and Creditor

When a ‘customer’ opens an account with a bank or he enters into an agreement/contract with the banker or deposits money in his account, banker becomes the debtor and the customer becomes the creditor.

Why Banker is a Dignified Debtor?

1. Banker is called a ‘dignified debtor’. Virtually banker borrows money but it is given a name called ‘deposit’. No security need be given for the borrowing.

2. Customer is not the secured creditor of the bank, as he is not having any charge on any asset of the bank. He is only an unsecured creditor.

3. Customer’s balance at bank is not repayable until a demand for repayment was made by the customer. There should be an express demand for it.

4. Banker should pay the deposit money on demand by the customer. The deposit should be paid at the appropriate place.

5. The demand should be made by the customer on working days and during the business

hours and it should be made in proper form.

2. Creditor and Debtor

Lending money is the primary activity of a banker. When banker lends money to customer, the banker becomes the creditor and the customer becomes the debtor.

3. Agent and Principal

Agent is a person who acts for and on behalf of the principal. Banker collects cheques, bills and makes payment to various authorities’ such as rent, telephone bills, insurance premium, subscription etc., on behalf of its customers. In all such cases banker acts as an agent of his customer and the customer acts as a principal.

4. Trustee and Beneficiary

A trustee is an entity who takes care of assets and performs certain functions for the gain or benefit of another person known as beneficiary. For instance, when a customer gives certain standing instructions to the banker about the usage of certain sum of money, the banker becomes the trustee and the customer becomes beneficiary.

5. Pledgee and Pledger

The relationship between banker and customer can be that of Pledgee and Pledger as well. This happens when a customer pledges (promises) certain assets or security with the banker in order to get a loan. In this case, the customer becomes the Pledger and the banker becomes the Pledgee. Under this agreement, the assets or security will remain with the banker until the customer repays the loan.

6. Bailee and Bailor

The relationship between banker and customer can be that of Bailee and Bailor. Bailment is a contract for delivering goods by one party to another to be held in trust for a specific period and returned when the purpose is ended. Bailor is the party who delivers property to another. Bailee is the party to whom the property is delivered. So, when a customer gives valuables to the banker for safe keeping, the customer becomes the bailor and the banker becomes the bailee.

7. Advisor and Client

The banker acts as an advisor when a customer invests in securities. While giving advice the banker has to take maximum care and caution. Here, the banker becomes an Advisor, and the customer becomes the client.

B) Special Relationship between Banker and Customer

1. Rights of a Banker and

2. Obligations of a Banker

1. RIGHTS OF A BANKER

It is not that the bank has only duties towards its customers; it too has certain rights to his customers.

The rights can broadly be classified as:

i) Banker’s Right to Lien

ii) Banker’s Right to Set-Off

iii) Banker’s Right to appropriate payments

iv) Right to Charge Interest and Commission

v) Right under Garnishee order

i) Banker’s Right to Lien

A lien is the right of a creditor in possession of goods, securities or any other assets belonging to the debtor to retain them until the debt is repaid. The creditor (bank) has the right to maintain the security of the debtor but not to sell it. There are two types of lien:

a) Right of Particular Lien and

b) Right of General Lien

(a) Right of Particular Lien: A ‘particular lien’ gives the right to retain possession only of those goods in respect of which the dues have arisen. It is also termed as ordinary lien. If the bank has obtained a particular security for a particular debt, then the banker’s right gets converted into a particular lien.

(b) Right of General Lien: A ‘general lien’ gives the right to retain possession of any goods in the legal possession of the creditor until the whole of the debt due from the debtor is paid. Banker has a right of general lien against his borrower. General lien confers banks right in respect of all dues and not for a particular due.

ii) Banker’s Right to set-off

The banker has the right to set off the accounts of its customer. It is a statutory right available to a bank, to set off a debt owed to him by a creditor from the credit balances held in other accounts of the borrower. This right is applicable in respect of dues that are due and are becoming due shortly. It is not applicable on future debts. It is applicable in respect of deposits that are due for payment.

i) Banker’s Right to Appropriate payment

It is the right of the customers to direct his banker against which debt (when more than one debt is outstanding) the payment made by him should be appropriated. In case no such direction is given, the bank can exercise its right of appropriation and apply it in payment of any debt.

ii) Banker’s right to charge interest and commission

Banker has an implied right to charge for services rendered and sold to a customer. Banker charges interest on amount advanced, processing charges for the advance, charges commission etc. depending on the terms and conditions of advance banks charge interest at monthly, quarterly or semi-annually or annually. Banker charges commission for online share trading.

iii) Banker’s Right to Garnishee order

Garnishee Order is a court order instructing a garnishee (a bank) that funds held on behalf of a debtor (the judgment debtor) should not be released until directed by the court.

2. BANKER’S OBLIGATIONS

The various Bankers’ Obligations are as follows:

i) Obligation to honor the customer’s cheques.

ii) Obligation to maintain secrecy of customer’s account.

iii) Obligation to maintain proper records.

i) Banker’s obligation to honor customer’s cheques

When a customer of a bank issues cheque and demand money the banker must honor the customer’s cheque after the necessary verifications. The drawee (banker) of a cheque having sufficient funds of the drawer (customer) in his hands must pay the cheque amount.

ii) Banker’s obligation to maintain secrecy of customer’s Account

The banker has an implied obligation to maintain secrecy of the customer’s account. He should not disclose matters relating to the customer’s financial position since it may adversely affect the customer’s credit and business.

iii) Banker’s obligation to maintain proper records

The banker should maintain the proper records of customer’s transactions. Any mistake of maintaining the records, customer is not liable.

Origin and growth of commercial banks in India:

Indian banking came into existence in a small way during 19th century. Some industrialists established a few banks at that time. In the early years of 20th century the swadeshi movement gave a stimulus for the setting up of banks in India by Indian national. In the beginning banks faced severe financial crisis. Particularly during and after the First World War, about 87 banks liquidated. During great depression in 1930s the bank failure in India was very severe. During

1937-48, as many as 620 banks failed. Thus the development of banking in India before independence was lopsided. It was characterized as a crop of bank failures.

The Second World War brought a revolutionary change in the Indian banking system. In the wake of huge war expenditure, deposits of the banks increased. Branches were opened in Public sector and self-employment was to receive their due share in obtaining bank finance.

Apart from this the banks are required to reconstitute their board of directors. The government set up National credit council in 1968. The Finance Minister was the chairman and the Governor of the Reserve Bank was the vice chairman of the council. The main functions of the National credit council were:

Ø Assessing the volume of credit required for the economy as a whole.

Ø Providing guidelines for the distribution of credit to the priority sector.

Ø Ensuring equitable distribution of credit in the economy.

Types of Banks in India:

Banks are financial institutions that perform deposit and lending functions. There are various types of banks in India and each is responsible to perform different functions.

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.

Cooperative Banks

These banks are organized 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

· Tier 1 (State Level) – State Cooperative Banks (regulated by RBI, State Govt, NABARD) · Funded by RBI, government, NABARD. Money is then distributed to the public · Concessional CRR, SLR applies to these banks. (CRR- 3%, SLR- 25%)

· Owned by the state government and top management is elected by members Tier 2 (District Level) – Central/District Cooperative Banks Tier 3 (Village Level) – Primary Agriculture Cooperative Banks

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

Public Sector BanksCo Private Sector BankForeign Banks
State Bank of IndiaCatholic Syrian BankAustralia and New Zealand Banking Group Ltd.
Allahabad BankCity Union BankNational Australia Bank
Andhra BankDhanlaxmi BankWestpac Banking Corporation
Bank of BarodaFederal BankBank of Bahrain & Kuwait BSC
Bank of IndiaJammu and Kashmir BankAB Bank Ltd.
Bank of MaharashtraKarnataka BankHSBC
Canara BankKarur Vysya BankCITI Bank
Central Bank of IndiaLakshmi Vilas BankDeutsche Bank
Corporation BankNainital BankDBS Bank Ltd.
Dena BankRatnakar BankUnited Overseas Bank Ltd
Indian BankSouth Indian BankJ.P. Morgan Chase Bank
Indian Overseas BankTamilnad Mercantile BankStandard Chartered Bank
Oriental Bank of CommerceAxis BankThere are over 40 Foreign Banks in India
Punjab National BankDevelopment Credit Bank (DCB Bank Ltd) 
Punjab & Sind BankHDFC Bank 
Syndicate BankICICI Bank 
Union Bank of IndiaIndusInd Bank 
United Bank of IndiaKotak Mahindra Bank 
UCO BankYes Bank 
Vijaya BankIDFC 
IDBI Bank Ltd.Bandhan Bank of Bandhan Financial Services 

Regional Rural Banks (RRB)

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

· RRBs were established in 1975 and are registered under a 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 merger of RRBs thus reducing the number of RRBs to 82

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

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) – Loan for a small scale industry or business can be taken from SIDBI. Financing small industries with modern technology and equipments is done with the help of this bank

· 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.

Payments Banks

A newly introduced form of banking, the payments bank have 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 ATM, and debit card can be done through payments banks. Given below is a list of the few payments bank in our country:

· Airtel Payments Bank

· India Post Payments Bank

· Fino Payments Bank

· Jio Payments Bank

· Paytm Payments Bank

· NSDL Payments Bank

Banks’ Lending:

After accepting deposits from the customer, a bank goes for lending or for investment in different types of securities, such as government, company etc. For deposits received under savings account and fixed deposits, the bank has to pay an agreed interest rate. This, the bank has to pay only from its earnings. On the investments, the bank earns a good return. Similarly, when the bank lends, it earns a higher interest rate. From out of the return on investments and from the interest earned on loans, the bank will be able to offer interest for the deposits, the difference between the interest offered on deposits, and the interest earned on lending will be the profit of the bank.’

“Bank lending refers to the process of disposing of money or property with the expectation that the same thing will be returned along with specified interest.”

Principles of Lending

Bank lending involves risk; banks need to follow certain basic principles at the time of lending loans and advances. Some of the principles to be followed are:

1. Principle of Safety

Safety is the most important principle of good lending. When a banker lends, he must feel certain that the advance is safe and the money will definitely come back. If the borrower invests the money in an unproductive or speculative venture, or if the borrower himself is dishonest, the advance would be in danger.

2. Principle of Liquidity

The borrower must be in a position to repay within a reasonable time after a demand for repayment is made. This can be possible only if the money is employed by the borrower for short-term requirements and not locked up in acquiring fixed assets, or in schemes which take a long time to pay their way. The reason why bankers attach as much importance to ‘liquidity’ as to safety’ of their funds is this.

3. Principle of Purpose

The purpose should be productive so that the money not only remain safe but also provides a definite source of repayment. The purpose should also be short termed so that it ensures liquidity. Banks should discourage advances for hoarding stocks or for speculative activities.

4. Principle of Profitability

Profitability is a financial benefit that is realized when the amount of revenue gained from a business activity exceeds the expenses, costs and taxes needed to sustain the activity. Banks must make profits because they have to pay interest on the deposits received by them. They have to deserve expenses on establishment, rent, stationery, etc.

5. Principle of Security

It has been the practice of banks not to lend as far as possible except against security. The banker carefully examines all the different aspects of an advance before granting it.

6. Principle of Spread

The principle of good lending is the diversification of advances. An element of risk is always present in every advance, however secure it might appear to be. In fact, the entire banking business is one of taking calculated risks and a successful banker is an expert in assessing such risks.

7. Principle of National Interest, Suitability, etc.

Even when an advance satisfies all good principles, it may still not be suitable. The advance may run counter to national interest. The Central Bank may have issued a directive prohibiting banks to allow a particular type of advance

5 C’s of Lending Principles

The important 5 C’s of Lending Principles are:

(a) Character: The character of the borrower indicates two things: the ability to pay versus the willingness to pay. The ability to pay refers to the borrower’s financial credibility to pay. The lender should check on the borrower’s character.

(b) Capacity: Capacity refers to the sources of repayment, i.e. the cash flow. The borrower must be able to meet all his financial obligations on the due dates.

(c) Capital: Capital represents the degree of commitment and the ability to sustain this commitment during bad times.

(d) Conditions: Condition refers to the macroeconomic environment. For example, if the loan is needed for setting up a retail business in a particular area, then the lender must make a study of the economic conditions (the degree of propensity to spend by residents in that locality).

(e) Collateral: Collateral is the lender’s second line of defense. If the payback is derived from cash flows, then the collateral will not be liquidated for repayment.

Different types of borrowing facilities granted by Banks

1. Loan

2. Cash credit

3. Overdraft

4. Bills purchasing

4. Bills discounting

5. Letters of credit

1. Loan

Loan is an arrangement in which a lender gives money to a borrower and the borrower agrees to return the money along with interest after a fixed period of time. Examples: Home Loans, Car Loans, Personal Loans etc.

2. Cash credit

Cash credit is a short-term cash loan to a company. A bank provides this type of funding, but only after the required security is given to secure the loan. Once a security for repayment has been given, the business that receives the loan can continuously draw from the bank up to a certain specified amount.

3. Overdraft

Overdraft is the amount by which withdrawals exceed deposits or the extension of credit by a lending institution to allow for such a situation.

A bank overdraft is a limit on borrowing on a bank current account.

4. Bills discounting

Bill discounting refers to the trading or selling a bill of exchange prior to the maturity date at a value less than the par value of the bill. The amount of the discount will depend on the amount of time left before the bill matures and on the perceived risk attached to the bill.

5. Letters of Credit (LOC)

Letter of Credit refers to a letter from a bank guaranteeing that a buyer’s payment to a seller will be received on time and for the correct amount. In the event that the buyer is unable to make payment on the purchase, the bank will be required to cover the full or remaining amount of the purchase. It is a payment term generally used for international sales transactions.

RBI: History-Role & Functions.

History: The Reserve Bank of India was set up on the basis of the recommendations of the

Hilton Young Commission.

The Reserve Bank of India Act, 1934 (II of 1934) provides the statutory basis of the functioning of the Bank, which commenced operations on April 1, 1935.

The Bank was constituted to

* Regulate the issue of banknotes

* Maintain reserves with a view to securing monetary stability and

* To operate the credit and currency system of the country to its advantage.

The Bank began its operations by taking over from the Government the functions so far being performed by the Controller of Currency and from the Imperial Bank of India, the management of Government accounts and public debt. The existing currency offices at Calcutta, Bombay, Madras, Rangoon, Karachi, Lahore and Cawnpore (Kanpur) became branches of the Issue Department. Offices of the Banking Department were established in Calcutta, Bombay, Madras, Delhi and Rangoon.

Burma (Myanmar) seceded from the Indian Union in 1937 but the Reserve Bank continued to act as the Central Bank for Burma till Japanese Occupation of Burma and later upto April, 1947. After the partition of India, the Reserve Bank served as the central bank of Pakistan upto June 1948 when the State Bank of Pakistan commenced operations. The Bank, which was originally set up as a shareholder’s bank, was nationalized in 1949

OBJECTIVES OF RBI:

Regulating the issue of currency in India;

· Keeping the Foreign Exchange Reserves of the Country;

· Establishing the Monetary Stability in the Country; And

· Developing the Financial Structure of the Country On Sound Lines

·Consistent With the National Socio-Economic Objectives and Policies.

Role of RBI:

As the central bank of the country, the RBI is the one of the architects of the nation’s economy and its decisions touch everyday lives of all Indians. From ensuring stability of interest rates and exchange rates to providing adequate liquidity for productive sectors and ensuring adequate supply of currency, the Reserve Bank of India also monitors flow of credit to desired sectors and ensures orderly development of financial markets and institutions.

· Monetary Authority

The Reserve Bank of India constantly works towards keeping inflation under check and ensuring adequate supply of liquidity for the productive sector as also towards financial stability.

· Supervisor of the Financial System Prescribes regulations for sound functioning of banks and financial institutions, including non-banking finance companies – Promotes best practices in risk management and corporate governance to protect depositors’ interest and to enhance public confidence in the financial system of the country – Encourages use of technology in banks to provide cost-effective service to consumers.

· Issuer of Currency Ensures good quality coins and currency notes in adequate quantity – Mops up notes and coins unfit for circulation – Advises the Government on designing of currency notes with the latest security features.

· Manager of Foreign Exchange Formulates policies to facilitate external trade and payments, facilitates foreign investments in India and Indian investments abroad and promotes orderly development of foreign exchange markets.

· Banker to the Government Maintains accounts of central and state governments. Performs merchant banking function for the central and the state governments – Encourages development and orderly functioning of Government securities market – Advises central and state governments in better cash management.

· Payment Systems Work towards establishment of modern, robust, efficient, secure and integrated payment and settlement system for the country.

· Bankers’ Bank Ensures adequate liquidity in the financial system and in individual banks, on a daily basis – Performs lender of the last resort function.

· Developmental Role Performs a wide range of functions to support national objectives such as ensuring orderly growth and development of financial markets and institutions, creating institutions to serve specialized financial needs and extending the organized financial sector to all parts of the economy.

· Under Research Serves as the primary source of information on Indian economy and financial system – Analyses the issues and problems affecting the Indian economy – Renders advice for policy formulation and shaping monetary, banking and financial policies – Prepares the Bank’s publications – Warehouses data to enable decision-making.

FUCTIONS OF RBI:

There are various functions which are performed by Reserve Bank of India, which are following:

a) Traditional functions

b) Development functions

c) Supervisory functions

  1. Traditional functions

1. RBI issues Currency Notes

Section 22 of the Reserve Bank of India Act 1934 provides that RBI has sole right to issue currency notes except one rupee note and coins of smaller denomination. RBI issues, against the security of gold bullion, foreign securities, rupee coins, exchange bills, promissory notes and government of India bonds etc, currency notes of Rs. 2, 5, 10, 20, 50, 100, 500,2000.

2. As a banker to other Banks

RBI guides, helps and directs other commercial banks of the country. RBI keeps control the bank reserves. Every commercial bank has to maintain a part of their reserves with RBI which is called Cash Reserve. If bank need fund they approach to RBI for fund and RBI lend to them

Banker of the Government RBI also works as an agent of the governments. RBI makes payments, taxes and deposits etc on the behalf of governments. It represents the government at international level also. It maintains accounts of government and also provides financial advice to the government whenever required

3. Management of Exchange Rate

RBI prepares domestic policies for maintaining value of rupee. It also prepares and implements also the foreign exchange rate policy which helps in attaining the exchange rate stability. It brings demand and supply of foreign currency (U.S.) dollar close to each other for maintenance of exchange rate stability.

4. Credit Control

RBI has to balance growth with stability. Thus it checks the credit creation capacity of commercial banks by using various credit control tools. If the credit creation by commercial banks is unregulated then it may lead the economy into inflationary cycles

5. Supervision

RBI has to supervise the commercial banks. It has the power to give license to new banks which are going to open or to new branches to be established. It guides and conducts the audit of other banks.

  • Development functions:

1. Financial System Development:

The financial system includes many things like, financial institutions, financial markets and financial instruments. For rapid economic development of the nation’s economy, sound and efficient financial system is necessary for which RBI encourages the banking and non – banking institutions.

2. Agricultural Development-

RBI always pays attention to agriculture sector by assessing credit needs of this particular sector. Regional Rural Banks (RRBs), National Bank for Agriculture and Rural Development (NABARD) which are only for agriculture finance are under the direct control of RBI.

3. Industrial Finance-

For economic growth of the country, Industrial development is necessary and for this purpose RBI supports the industrial sector as well. RBI plays vital role for setting up of industrial finance institutions like ICICI Limited, IDBI, SIDBI, EXIM etc.

4. Promotion of Export

RBI always encourage the facilities for providing finance for foreign trade especially exports from India. The Export Import Bank of India (EXIM), and the Export Credit Guarantee Corporation of India (ECGC) are supported by RBI.

5. Reports Publication

RBI has a separate publication division. It collects and publishes data on different sector of the economy. The reports and bulletins are regularly published by the RBI and available for public.

6. Collection of Data

RBI collects important statistical data about several topics like interest rates, inflation, savings, investments, deflation etc. the data collected by RBI is very much useful for policy makers and researchers.

  • Supervisory functions:

1. License to Banks

RBI provides license to the banks going established. It also provide license to the new branches of existing banks.

2. Inspection of Banks

RBI may as and when required, may inspect the assets and liabilities of the banks which are under its control.

3. Control on Non-Bank Financial Institutions

RBI may issue directives to the NBFIs from time to time with regard to their functioning. It can control the NBFIs through periodic inspection.

Paying banker:

Introduction:

A paying banker is the person who pays the cheque either to his customer or on the instructions of his customer. A cheque is a Negotiable instrument that orders a banker to pay when certain conditions are met.

For example: Ramesh is a customer of State Bank of India and has drawn a Cheque for Rs. 50,000 in the name of Suresh in exchange of goods purchased by him. Suresh, brings the cheque at his bank to clear the amount and encashes the cheque. The Bank from where he enchases the cheque is the Paying Banker in this situation. In other words, the drawee banker is the paying banker who pays the cheque of his customers.

Meaning:

“Paying banker refers to the banker who holds the account of the drawer of the cheque and is obliged to make payment, if the funds of the customer are sufficient to cover the amount of his cheque drawn”

Duties:

· The paying banker has to verify whether the signature on the cheque is done by the account holder or not. The signature on the check must be done by the person who has an account in the bank, only then the check is considered valid. If the signature is fake, the paying banker can take strict action against it.

· The paying banker has to verify that the account holder’s name written on the cheque is still valid. It means his account must be active. For, this they may check the documents available in the bank related to the account holder. If the account is not valid, the transaction cannot be processed.

· The amount written on the check must be available in the account holder’s account. If the amount isn’t available then, the paying banker can stop the transaction. Therefore the account of account holder’s account must have enough balance for the transaction.

Precautions and Statutory Protection and rights:

Precautions to be taken by paying banker while making payment of Cheques

The banker has to take the following precautions while honoring the cheques of his customers:

1. Crossed Cheque: The most important precaution that a banker should take is about crossed cheques. A banker has to verify whether the cheque is open or crossed. He should not pay cash across the counter in respect of crossed cheques. If the cheque is a crossed one, he should see whether it is general crossed or special crossed. If it is general crossing, the holder must be asked to present the cheque through some banker and should be paid to a banker. If the cheque bears a special crossing, the banker should pay only the bank whose name is mentioned in the crossing.

2. Open Cheque: If it is an open cheque, a banker can pay cash to the payee or the holder across the counter. If the banker pays against the instructions as indicated above, he is liable to pay the amount to the true owner for any loss sustained. Further, a banker loses statutory protection in case of forged endorsement.

3. Proper Form: A banker should see whether the cheque is in the proper form. That means the cheque should be in the manner prescribed under the provisions of the Negotiable Instruments Act. It should not contain any condition.

4. Presentment of Cheque: Presentation of the cheque should be in right format and right place. A banker can honor the cheques provided it is presented with that branch of the bank where the drawer has an account or another branch if it is multi-city cheque.

5. Date of the Cheque: The paying banker has to see the date of the cheque. It must be properly dated. It should not be either a post-dated cheque or a stale-cheque. If a cheque carries a future date, it becomes a post-dated cheque. If the cheque is presented on the date mentioned in the cheque, the banker need not have any objection to honor it. If the banker honors a cheque before the date mentioned in the cheque, he loses statutory protection. If the drawer dies or becomes insolvent or countermands payment before the date of the cheque, he will lose the amount. The undated cheques are usually not honored.

6. Words and Figures: The amount of the cheque should be expressed in words, or in words and figures, which should agree with each other. When the amount in words and figures differ, the banker should refuse payment. However, Section 18 of the Negotiable Instruments Act provides that, where there is difference between the amount in words and figures, the amount in words is the amount payable. If the banker returns the cheque, he should make a remark ‘amount in words and figures differ’.

7. Alterations and Overwriting: The banker should see whether there is any alteration or over- writing on the cheque. If there is any alteration, it should be confirmed by the drawer by putting his full signature. The banker should not pay a cheque containing material alteration without confirmation by the drawer. The banker is expected to exercise reasonable care for the detection of such alterations. Otherwise, he has to take risk. Material alterations make a cheque void.

8. Proper Endorsements: Cheques must be properly endorsed. In the case of bearer cheque, endorsement is not necessary legally. In the case of an order cheque, endorsement is necessary. A bearer cheque always remains a bearer cheque. The paying banker should examine all the endorsements on the cheque before making payment.

Statutory Protection for Paying Banker

The paying banker should take the following protection, in order to protect himself and customer’s interest, while making the payment of his customer’s cheques:

(i) Protection regarding the order cheque

In case of an order cheque, Section 85(1) of the NI Act provides statutory protection to the paying banker as follows, where a cheque payable to order purports to be endorsed by or on behalf of the payee, the drawee is discharged by payment in due course.

(ii) Protection in case of bearer cheques

Section 85 (2) of the Negotiable Instruments Act, 1881 states, “Whereas a cheque is originally expressed to be payable to bearer, the drawee is discharged by payment in due course to the bearer thereof, notwithstanding any endorsement whether in full or in blank appearing thereon, notwithstanding that any such endorsement purports to restrict or exclude further negotiation.”

(iii) Protection in case of crossed cheques

Regarding payment of crossed cheque, the paying banker gets the protection under Section 128 of the Negotiable Instruments Act, 1881: “Whereas the banker on whom a crossed cheque is drawn has paid the same in due course, the banker paying the cheque and the drawer thereof (in case such cheque has come to the hands of the payee) shall be entitled respectively to the same rights and placed in the same position if the amount of the cheque had been paid to and received by the true owner there of.”

(v) Protection in case of draft

Section 85A of the NI Act states that, Drafts drawn by one branch of a bank on another payable to order where any draft, that is an order to pay money, drawn by one office of a bank upon another office of the same bank for a sum of money payable to order on demand, purports to be endorsed by or on behalf of the payee, the bank is discharged by payment in due course.

Dishonor of Cheque

A cheque is said to be Dishonored when it is refused to accept or pay when presented to the bank. It is a condition in which the paying banker does not pay the amount of the cheque to the payee.

Circumstances or reasons for Dishonor of Cheques:

A paying banker must refuse payment on cheques, issued by his customers, in the following circumstances:

1. Insufficiency of funds: When adequate funds are not available in the account of a customer, then the cheque can be Dishonored. If the banker pays a countermanded cheque, he will not only be required to reverse the entry but also be held liable to pay damages for Dishonoring the cheques presented subsequently which would have been honored otherwise.

2. Notice of the Customer’s Death: The banker should not make payments on cheques presented after the death of the customer. He should return the cheque with the remark ‘Drawer Deceased’.

3. Notice of the Customer’s Insolvency: A banker should refuse payment on the cheques soon after the customer is adjudicated as insolvent.

4. Receipt of the Garnishee Order: Where Garnishee order is received attaching the whole amount, the banker should stop payment on cheques received after the receipt of such an order. But if the order is for a specific amount, leaving the specified amount, cheques should be honored if the remaining amount is sufficient to meet them.

5. Presentation of a post dated cheque: The banker may refuse the cheque when the cheque is presented before the valid date.

6. Stale Cheques: When the cheque is presented after a period of three months from the date it bears, the banker may refuse to make payment.

7. Material Alterations: When there is material alteration in the cheque, the banker may refuse payment.

8. Drawer’s Signature: If the signature of the drawer on the cheque does not tally with the specimen signature, the banker may refuse to make payment.

Grounds of Dishonor: Reasons for Dishonor of Cheque

1. If the cheque is overwritten.

2. If the signature is absent or the signature in the cheque does not match with the specimen signature kept by the bank.

3. If the name of the payee is absent or not clearly written.

4. If the amount written in words and figures does not match with each other.

5. If the account number is not mentioned clearly or is altogether absent.

6. If the drawer orders the bank to stop payment on the cheque.

7. If the court of law has given an order to the bank to stop payment on the cheque.

8. If the drawer has closed the account before presenting the cheque.

9. If the fund in the bank account is insufficient to meet the payment of the cheque

10. If the bank receives the information regarding the death or lunacy or insolvency of the drawer.

11. If any alteration made on the cheque is not proved by the drawer by giving his/her signature. 12. If the date is not mentioned or written incorrectly or the date mentioned is of three months before.

Consequences of wrongful dishonor of Cheques:

(i) Wrongful Dishonor of the customer’s cheque makes the Bank liable to compensate the customer on contractual obligations as well as for injury to his creditworthiness. A return of a cheque would cause injury to the drawer’s reputation.

(ii) Quantum of Damages is not limited to the actual pecuniary loss sustained by reason of such Dishonor. When the customer is a trader he is entitled to claim substantial damages even if he had suffered no actual pecuniary loss sustained by such Dishonor, if he can show that his creditworthiness had suffered by the Dishonor of thecheque.

(iii) A non-trader is not entitled to recover substantial damages unless the damage he has suffered is alleged and proved as special damages, otherwise he would be entitled to nominal damages.

(iv) The Plaintiff’s evidence on the transaction was vague, ill-defined and indeterminate and further he had not proved any actual or special damages, unless special damages are claimed and proved nominal damages will be awarded.

Collecting Banker:

Meaning of Collecting Banker

A Collecting banker is one who undertakes to collect cheques, drafts, bill, pay order, traveller cheque, letter of credit, dividend, debenture interest, etc., on behalf of the customer. For undertaking this collection, the collecting banker will be charging commission.

Examples: ICICI Bank, HDFC Bank, SBI Bank etc.

Duties and Responsibilities of a Collecting Banker:

The duties and responsibilities of a collecting banker are discussed below:

1. Due care and carefulness in the collection of cheque.

2. Serving notice of Dishonor.

3. Agent for collection.

4. Payment of interest to the customer.

5. Collection of bills of exchange.

1. Due Care and carefulness in the Collection of Cheques: The collecting banker is bound to show due care and carefulness in the collection of cheques presented to him. In case a cheque is entrusted with the banker for collection, he is expected to show it to the drawee banker within a reasonable time.

2. Serving Notice of Dishonor: When the cheque is dishonored, the collecting banker is bound to give notice of the same to his customer within a reasonable time. It may be noted here, when a cheque is returned for confirmation of endorsement, notice must be sent to his customer.

3. Agent for Collection: In case a cheque is drawn on a place where the banker is not a member of the ‘clearing-house’, he may employ another banker who is a member of the clearing-house for the purpose of collecting the cheque. In such a case the banker becomes a substituted agent.

4. Payment of Interest to the Customer: In case a collecting banker has realised the cheque, he should pay the interest to the customer as per his (customer’s)direction.

5. Collection of Bills of Exchange: There is no legal obligation for a banker to collect the bills of exchange for its customer. But, generally, bank gives such facility to its customers.

Holder Definition:

Holder is an individual who has lawfully received possession of a Commercial Paper, such as a cheque and who is entitled for payment on such instrument.

Holder for Value

Holder for value is a holder to whom an instrument is issued or transferred in exchange for something of value as a promise of performance or a negotiable instrument.

Example:

A banker becomes a holder for value when: The value of cheque is paid before collection of the cheque.

Holder in Due Course

A holder in due course is the holder of negotiable instruments who has given value in good faith without notice of any previous Dishonor in taking the bill, which appears to be complete and regular.

“Holder in due course”.—“Holder in due course” means any person who for consideration became the possessor of a promissory note, bill of exchange or cheque if payable to bearer, or the payee or endorsee thereof, if 1[payable to order], before the amount mentioned in it became payable, and without having sufficient cause to believe that any defect existed in the title of the person from whom he derived his title.

Duties & Responsibilities:

Duties And Responsibilities Of A Collecting Banker

The Duties And Responsibilities Of A Collecting Banker Are Discussed Below:

1. Due Care and Diligence in the Collection of Cheques:

The collecting banker is bound to show due care and diligence in the collection of cheques presented to him. In case a cheque is entrusted with the banker for collection, he is expected to show it to the drawee banker within a reasonable time. According to Section 84 of the Negotiable Instruments Act, 1881, “Whereas a cheque is not presented for payment within a reasonable time of its issue, and the drawer or person in whose account it is drawn had the right, at the time when presentment ought to have been made, as between himself and the banker, to have the cheque paid and suffers actual damage, through the delay, he is discharged to the extent of such damage, that is to say, to the extent to which such drawer or person is a creditor of the banker to a large amount than he would have been if such cheque had been paid.” In

case a collecting banker does not present the cheque for collection through proper channel within a reasonable time, the customer may suffer loss. In case the collecting banker and the paying banker are in the same bank or where the collecting branch is also the drawee branch, in such a case the collecting banker should present the cheque by the next day. In case the cheque is drawn on a bank in another place, it should be presented on the day after receipt

2. Serving Notice of Dishonor:

When the cheque is Dishonored, the collecting banker is bound to give notice of the same to his customer within a reasonable time. It may be noted here, when a cheque is returned for confirmation of endorsement, notice must be sent to his customer. If he fails to give such a notice, the collecting banker will be liable to the customer for any loss that the customer may have suffered on account of such failure. Whereas a cheque is returned by the drawee banker for confirmation of endorsement, it is not called Dishonor. But in such a case, notice must be given to the customer. In the absence of such a notice, if the cheque is returned for the second time and the customer suffers a loss, the collecting banker will be liable for the loss.

3. Agent for Collection:

In case a cheque is drawn on a place where the banker is not a member of the „clearing-house‟, he may employ another banker who is a member of the clearinghouse for the purpose of collecting the cheque. In such a case the banker becomes a substituted agent. According to Section 194 of the Indian Contract Act, 1872, “Whereas an agent, holding an express or implied authority to name another person to act in the business of the agency has accordingly named another person, such a person is a substituted agent. Such an agent shall be taken as the agent of a principal for such part of the work as is entrusted to him.”

4. Remittance of Proceeds to the Customer:

In case a collecting banker has realized the cheque, he should pay the proceeds to the customer as per his (customers) direction. Generally, the amount is credited to the account of the customer on the customers request in writing, the proceeds may be remitted to him by a demand draft. In such circumstances, if the customer gives instructions to his banker, the draft may be forwarded. By doing so, the relationship between principal and agent comes to an end and the new relationship between debtor and creditor will begin. 5. Collection of Bills of Exchange: There is no legal obligation for a banker to collect the bills of exchange for its customer. But, generally, bank gives such facility to its customers. In collection of bills, a banker should examine the title of the depositor as the statutory protection under Section 131 of the Negotiable Instruments Act, 1881.Thus the collecting banker must examine very carefully the title of his customer towards the bill. In case a new customer comes, the banker should extend this facility to him with a trusted reference. From the above discussion, there is no doubt to say that the banker is acting as a mere agent for collection and not in the capacity of a banker. If the customer allows his banker to use the collecting money for its own purpose at present and to repay an equivalent amount on a fixed date in future the contract between the banker and the customer will come to an end.

Precautions and Statutory Protection to Collecting Banker:

Statutory protection to Collecting Banks under the negotiable instruments Act:

The protection provided by Section 131 is not absolute but qualified. A collecting banker can claim protection against conversion if the following conditions are fulfilled:

1. Good Faith and Without Negligence:

Statutory protection is available to a collecting banker when he receives payment in good faith and without negligence. The phrase in “good faith” means honestly and without notice or interest of dishonesty or fraud and does necessarily require carefulness. Negligence means failure to exercise reasonable care. The banker should have exercised reasonable care and diligence.

2. Collection for a Customer:

Statutory protection is available to a collecting banker if he collects on behalf of his customer only. If he collects for a stranger or noncustomer, he does not get such protection. A bank cannot get protection when he collects a cheque as holder for value

3. Acts as an Agent:

A collecting banker must act as an agent of the customer in order to get protection. He must receive the payment as an agent of the customer and not as a holder under independent title. The banker as a holder for value is not competent to claim protection from liability in conversion. In case of forgery, the holder for value is liable to the true owner of the cheque.

4. Crossed Cheques:

Statutory protection is available only in case of crossed cheques. It is not available in case uncrossed or open cheques because there is no need to collect them through a banker. Cheques, therefore, must be crossed prior to their presentment to the collecting banker for clearance.

Liabilities of collecting bankers following are the liabilities of collecting bankers:

1. Acting as agent: While collecting an instrument, the Bankers works as agent of his customer. As an agent he has to take some steps & precautions to protect the interest or his customer as a man of ordinary discretion would take to safeguard his own interest.

2. Scrutinizing the instruments: Name of the holder, Branch name, amount in world and figure, date, material alteration of any to be checked carefully.

3. Checking the endorsement: Bankers have to check the instrument whether it has been endorsed properly.

4. Presenting the instrument in due time: It is the responsibility of the collecting bank to present the instrument in due time to the paying bank.

5. Collecting the proceeds in the payee’s account: It is the duty of collecting banks to collect and credit the proceeds of the instruments to the proper/correct account.

6. Notice of Dishonor and returning the instruments: If any instrument is Dishonored by the paying bank it should be informed to the customer on the day following the receipt of the unpaid instruments

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