BANKING LAW, NEGOTIABLE AND INSTRUMENTAL ACT

Study Material for B. (5Year) –

VIII Semester

 

 

CONTENTS UNIT - I

Banking Definition

Commercial Banks

Functions

Systems of Banking

Unit Banking

Branch Banking

Group Banking

Chain Banking

Law Relating to Banking in India

The Banking Regulation Act 1949

Important Questions UNIT -II

Central Bank - Evolution

Characteristics

Functions of Central Bank

The Reserve Bank of India

Objectives of RBI

Organizational Structure

Legal Status and Functions

Important Questions

UNIT -III

Lending by Banks Principles of Good Lending Guarantee Kinds of Guarantee Surty's Rights and Liabilities Debt Recovery Tribunals (DRT) Important Questions UNIT - IV

Merchant Banking in India SEBI (Merchant Banker) Regulations 1992 Letter of Credit and Defend Guarantee

 

 

Negotiable Instruments Act 1881 Kinds of Negotiable Instruments Holder and Holder in Due Course Important Questions References

UNIT - V

Negotiable Instruments Act 1881 Negotiation Presentment Discharge from Liability Dishonour The Paying Banker The Collecting Banker Customer-Bank Relationship

Important Questions Suggested Readings

 

 

UNIT - I BANKING- DEFINITION According to some economists, the word 'Bank' has been derived from the German word 'BANC' which means a joint stock firm. But some other economists say that it has been derived from the Italian word 'BANCO' which means a heap or mound. As the matter of fact, at the time of establishment of Bank of Venice in 1157, the Germans were influential and hence, perhaps the word Banc or 'Banco' was used by Italians to denote the accumulation of securities or money with a joint stock firm which later on with the passage of time came to be known as 'Bank'. There is still another group of people who believe that the word 'Bank' has been derived from the Greek word 'BANQUE' which means a bench. In the older days, when Jews started their money transactions business as bankers they started using a bench for sitting and if they were not able to pay their obligations, the bench would be broken into pieces and he was taken as Bankrupt. Thus, both the words Bank or Bankrupt are said to have their origin from the word 'Banque'. Definitions: First of all we discuss the definition given under Banking Regulation Act 1949. Sec. 5 (b) "Banking" means the accepting for the purpose of lending or investment, of deposit of money from public, repayable on demand or otherwise, and withdraw able by cheque, draft, order or otherwise. According to, Sir John Paget "No person or body, corporate or otherwise, can be a banker who does not (1) take deposit accounts (2) take current account (3) issue and pay cheque and (4) collect cheques, crossed and uncrossed, for his customers." This definition denotes only the essential feature of Banking company stead of Banking. 'Banking company' means that which transacts the business of banking in India. Explanation: Any company which is engaged in the manufacture of goods or carries on any trade and which accepts deposits of money from the public merely for the purpose of financing its business; as such manufacturer or trader shall not be deemed to transact the business of banking within the meaning of this clause. (Sec 5c of Banking Regulation Act 1949) Forms of Business in which banking company may engage: According to sec 6, the following business may be undertaken by a banking company - a) The following functions form the bulk of a bank's activities and are called its main functions:

I. The borrowing, raising or taking of money; II. The lending or advancing of money either upon security or without security;

III. The drawing, making, accepting, discounting, buying, selling, collecting and dealing in bills of

exchange, hundis, promissory notes, coupons, drafts, bills of lending, railway receipts, warrants,

 

 

debentures, certificates, scripts and other instruments and securities whether transferable or negotiable or not;

IV. The granting and issuing of letters of credit, travellers' cheques and circular notes;

V. The buying, selling and dealing in bullion and species;

VI. The buying and selling of foreign exchange including foreign bank notes;

VII. The acquiring, holding, issuing on commission, underwriting and dealing in stock, funds, shares, debentures, debenture stock, bonds, obligations, securities and investments of all kinds;

VIII. The purchasing and selling of bonds, scrips and other forms of securities on behalf of constituents or others;

IX. the negotiating of loans and advances;

X. The receiving of all kinds of bonds, scrips and other forms of securities on behalf of constituents or others;

XI. The providing of safe deposit vaults; and

XII. The collecting and transmitting of money and securities. b) It may act as an agent of the Government, local authority or person and can carry on agency business

but it cannot act as secretary and treasurer of a company.

c) It may contract for public and private loans and negotiate and issue the same.

d) It may effect, insure, guarantee, underwrite, participate in managing and carrying out of any issue of State, municipal or other loans or of shares, stock, debenture stock of companies and may lend money for the purpose of any such issue.

e) It may carry on and transact every kind of guarantee and indemnity business. f) It may manage, sell and realise any property which may come into its possession in satisfaction of its

claims.

g) It may acquire and hold and deal with any property or any right, title or interest in any such property which may form the security for any loan or advance.

h) It may undertake and execute trusts.

i) It may undertake the administration of estate as executor, trustee or otherwise.

 

 

j) It may establish, support and aid associations, institutions, funds, trusts, etc., for the benefit of its present or past employees and may grant money for charitable purposes.

k) It may acquire, construct and maintain any building for its own purpose.

l) It may sell, improve, manage, develop, exchange, lease, mortgage, dispose of all or any part of the property and rights of the economy.

m) It may acquire and undertake the whole or any part of the business of any person or company, when such business is of a nature described in Sec. 6(1).

n) It may do all such things which are incidental or conducive to the promotion or advancement of the business of the company.

o) It may undertake any other form of business which the Central Government may specify as a form of business in which it is lawful for a banking company to engage.

COMMERCIAL BANKS Meaning: A Banking company is one which transacts the business of banking which means the accepting for the purpose of lending all investments, of deposits of money from the public, repayable on demand or otherwise and withdrawble by cheque, draft or otherwise. The discussion in the preceding pages indicate that commercial banks provide useful services in all walks of life. They function as a catalytic agent for bringing about economic, industrial and agricultural growth and prosperity of the country. The banking can therefore be conceived as a 'a sector of economy on the one hand and as a lubricant for the whole economy on the other'. FUNCTIONS The functions of the commercial banks are now wide and diverse. They have assumed great significance in the role of an agent for economic renaissance and social transformation because of their vital role in mobilization of resources well as their deployment for meeting the said objectives. They are no longer considered as institutions only for affluent sections of the population. They have acquired broad base and have emerged as effective catalytic agents of social economic change. In order to understand better the functions of commercial banks, it will be better to study them under the following two categories. (I) Primary Functions of commercial Banks.

(II) Secondary Functions of commercial Banks.

I. Primary Functions of Commercial Banks The primary functions of commercial banks are: (i) Accepting of deposits, and (ii) Lending of money.

 

 

Accepting of Deposits: Deposits are an important source of a banks funds. They can broadly be classified into three categories.

(a) Savings Deposits: These deposits are of small amounts and are accepted by banks to encourage persons of small means to make savings; frequent withdrawals are not allowed.

(b) Fixed Deposits: These deposits are made with the banks for fixed periods specified in advance. They are also known as term deposits.

(c) Current Deposits: These deposits are repayable on demand. The banks undertake the obligation of paying all cheques drawn against these deposits by the customers till they have adequate funds of the customer. The banks usually do not pay any interest in respect of such deposits. These deposits accounts are usually kept by large business houses.

Lending of Money: A major portion of the deposits received by a bank is lent by it. This is also the major source of a bank's income. However, lending money is not without risk and, therefore, a banker must take proper precautions in this process. The lending may be in any of the following forms:

(a) Loan: It is a kind of advance made with or without security. It is given for a fixed period at an agreed rate of interest. The amount of loan is usually credited to the credit of the customer's account who may withdraw from there as per his requirements. The loan may be secured or unsecured.

(b) Cash Credit: It is an arrangement by which a banker allows his customer to borrow money upto a certain limit against security of goods.

(c) Overdraft: It is an arrangement whereby a customer has been allowed temporarily to overdraw his current account. It is without any security.

(d) Discounting and Purchasing of Bills: Time bills are discounted while demand bills are purchased by the banks. In both the cases the banks credit the account of their customers by the amount of bills less any discount or commission charged for such discounting or purchasing of the bills.

Thus, commercial banks render a unique service by tapping savings from a wide spectrum of people and lending to those who really need and use them for various productive purposes. They play an active and not a passive role in the economic development of the country. Secondary Functions of Commercial Banks

These functions can be classified into the following two categories: (a)Agency Service: In many cases the commercial banks act as the agents of their customers. As agents they provide the following services:

 

 

(i) Collection of drafts, bills, cheques, dividend etc. on behalf of customers.

(ii) Execution of standing orders of the customers viz-payment of subscription, rent, bills, promissory notes, insurance premium etc.

(iii) Conducting stock exchange transactions i.e., purchasing and selling of securities for the

customers. (iv) Acting as a correspondent on representative of customers, other banks and financial corporations. (v) Functioning as an executor, trustee or administrator of an estate of a customer. (vi) Preparation of income tax return, claiming of tax refunds and checking of assessments on behalf

of the customers. (b) General Utility Services: Commercial banks provide a variety of general utility services viz.

issue of letters of credit, travelers cheques, accept valuables for safe custody, acting as a referee as to the respectability and financial standing of the customers, providing specialized advisory services to customer, issue of credit cards, providing of information through regular bulletins about general trade and economic conditions both inside and outside the country etc.

With the opening up of the insurance sectors, banks can now take up insurance business. In the discussion paper issued by the RBI in 1999, it was stated that insurance comes within the scope of universal banking. The term universal banking refers to the combination of commercial banking and investment banking. In other words universal banks refer to those banks that offer a wide range of financial services beyond commercial banking and investment banking such as Insurance. However, as per the guidelines issued by the Reserve Bank of India, banks are not allowed to conduct insurance business departmentally. They cannot also set up separately subsidiary companies for this purpose. However, they can set up joint venture companies for insurance as per government or insurance regulatory and development authority guidelines and with prior permission of Reserve Bank of India. SYSTEMS OF BANKING UNIT BANKING Unit banking is a system where the operations of a bank are confined to a single office located in a particular area. A unit bank has virtually no branches. In order to provide facilities to its customers in remittance and collection of funds, a unit bank resorts to correspondent banking system. In case of this system small banks serving small communities place deposits in nearby city banks which in turn hold deposits in giant banks located in giant cities. The gaint banks also hold reciprocal deposits of one another. Consequently, every bank gets connected directly or indirectly with each other and it can safely make payment on behalf of other banks. Branch Banking is a system where a bank with a network of branches throughout the country carries out its banking operations. Sometimes branches are also opened outside the country. However, small banks may like to restrict their branches or offices to a certain region of the country.

 

 

Features: The main features of branch banking system are as follows: (i) The bank is owned by a group of shareholders and controlled by a single Board of Directors. (ii) The bank has a central office popularly termed as the Head Office of the bank which controls the

operations of different branches. (iii) Each branch is managed by a branch manager who manages the affairs of the branch as per the

directives and policies of the Head office. (iv) For external reporting the assets and liabilities of the branches and the Head Office are

aggregated. The branch banking system which developed in England is prevalent in most countries of the world including Australia, Canada, South Africa, India, Pakistan etc. In India the public sector banks, numbering 27 in all have more than 90% of the branches of all commercial banks. The also control more than 90% of the banking business in all. Advantages of Brach Banking: The protagonist of branch banking put forward the following arguments in favour of branch banking:

1. Economies of Scale: In case of branch banking the level of operations is quite large as compared to unit banking. As such the cost per unit of service in case of the former is lower as compared to the latter. Moreover, under branch banking system it is possible to hire more competent and qualified staff and have better division of work resulting in increase in overall efficiency.

2. Lower Cash Reserves: A large bank with a number of branches can manage its business with lower cash reserves since each of its branch can draw upon the resources of another branch or branches, if an emergency arises. However, a unit bank cannot confidently depend upon the resources of another unit bank. Hence, it may be required to keep higher cash reserves to run its operations smoothly.

3. Diversification of Risk: In branch banking industrial as well geographical diversification of loan risks is possible. As a result the loss suffered by branches on account of fall in industrial activity in a particular area may be more than compensated on account of profit made by branches in areas where there may be boom in business and industrial activity. This is not possible in case of unit banking where a bank is having its operation only in a particular area.

4. Better Customer Service: Branch banking provides better service to customers in remittance and collection of funds. Moreover, the objective of opening branches is to take banking service to the doors of the people who need them. Thus, service is cheap as well as convenient. Each branch has to handle a limited number of customers of the locality, hence the branch manger can personally look to their problems.

 

 

5. Greater Mobility of Capital: Branch banking permits better mobility of capital and thus bring

more uniformity in interest rates. Surplus funds can be transferred from one area to another with convenience and speed and thus bring equilibrium in demand and supply of funds resulting in better returns to the investors.

6. Safety of Loans: While lending money, the branches of banks follow the policies as laid down by their Head office. The chances of favouritism are therefore reduced to the minimum. Moreover, loans beyond a particular limit are to be approved by the Head Office as per the prescribed procedure. This all ensured safety of loans and reduces the chances of banks suffering losses due to bad loans.

7. Emergence of Strong and Solvent Banks: Branch banks have large resources, better management; and greater diversification of risk. All this results in emergence of strong and solvent banks. The chances of bank failures are reduced to the minimum.

Disadvantages of Branch Banking: The protagonists of unit banking raise the following objections against branch banking:

1. Individual Needs Ignored: In case of branch banking the branches are guided by the policies laid down by the Head Office which is quite unaware of the individual needs. The Branch Manager has not much role to play, while a unit bank operates only in a limited area and hence it is possible for it to take personal care of the individual needs of each of its customers.

2. Red Tapism: In branch banking, a branch manager is required to take the instructions of the Head office from time to time. He cannot take several decisions at this level. Thus, there is bound to be red tapism and delay in processing loan applications etc. In unit banking all matters are decided at the unit bank level itself. Thus, there is quicker and better service.

3. Lack of Effective Control: In case of branch banking, the banks sometimes become unmanageable due to large increase in the number of branches. As a result, the control gets slackened and it increases the chances of frauds and manipulations.

4. Local Needs Ignore: Branch banks do not have attachment with a particular place. Branch managers are also not local people. They are subject to frequent transfers. The funds collected from local sources may be used for meeting the requirements of other places where the bank may find the investment more lucrative. Thus, local needs are not given that much of attention in case of branch banking as is done in case of unit banking.

5. Failure of Banks: In branch banking unremunerative and inefficient branches continue to exist at the expense of remunerative and efficient branches. In case this practice goes too far, it may cause failure of banks having repercussions throughout the country.

 

 

6. Concentration of Economic Power: The branch banks have huge resources raised from a wide spectrum of people. The Boards of Directors of these banks, therefore, possess immense economic power which they may use for promoting their own business interests. It may thus cause concentration of economic power in a few hands. As a matter of fact, this was one of the important reasons for the first phase of nationalisation of 14 major commercial banks in India.

Here we have explained the advantages and disadvantage of branch banking versus unit banking. A close perusal of the disadvantages of branch banking show that they are not too serious as they are made out to be. Proper orientation of lending policies, delegation of authority at different levels and proper fixation of priorities can improve the matter. As a matter of fact, branch banking is the logical development of growth of banking industry in any country. Group Banking and Chain Banking Chain Banking and Group Banking are the outcome of unit banking system devised to avail some of the advantages of branch banking system. They are both common in United State of America. GROUP BANKING It is a system where two or more banks are controlled by a holding company. Thus, group banking is similar to chain banking except with the difference that instead of an individual or group of individuals or members of family, an incorporated company having a separate legal entity holds majority of the voting power in the companies of the group. Such holding company mayor may not be engaged in the banking business. CHAIN BANKING Chain Banking is a system where an individual or group of individuals or members of a family control the operations of two or more banks. The control is exercised either through holding majority of shares in each bank or inter-locking directorships. However, each bank retains its individual entity. Chain banking or group banking brings the advantages of pooling of resources, economies of scale and reducing idle cash balances etc., to the member banks. However, it has the disadvantages of lack of effective control over member units, and misutilisation of resources of the member units particularly by the holding company. Moreover, it leads to concentration of economic power in a few hands. Due to these disadvantages, the system of chain banking or group banking is considered to be unworthy of adoption. LAW RELATING TO BANKING IN INDIA THE BANKING REGULATION ACT The Banking Regulation Act came into effect on 16 March, 1949 and applies to the whole of India. Scheme of the Act: The Banking Regulation Act, 1949 has been divided into the following parts: Part I Preliminary (Section 1 to SA) Part II Business of Banking Companies (Section 6 to 36A)

 

 

Part II A Control over Management (Sections 36AA to 36AC) Part II B Prohibition of certain activities in relation to Banking companies (Section 36AD) Part II C Acquisitions of the undertakings of Banking companies in certain cases (Sections 36 AE

to 36 AJ) Part III Suspension of Business and Winding up of Banking Companies (Sections 36B to 45) Part III A Special provisions for speedy disposal of winding up proceeding (Section 45A to 45X) Part III B Miscellaneous Section (46 to 55A) Part IV Application of the Act to cooperative Banks (Sections 56, effective from 1st March,

1966). General Provisions Definition Banking: According to Section 5(b) of the Act 'banking' means: "the accepting for the purpose of lending or investment of deposits of money from the public repayable on demand or otherwise, and withdrawable by cheque, draft, order or otherwise." The chief characteristics of banking business are:

i) There should be acceptance of deposits: Generally, when a mounts are borrowed on condition that they should be repaid on the expiry of a term, they are regarded as loans rather than deposits. In case of deposits, the liability to repay arises only when a demand for repayment has been made.

ii) Deposits should be from the public. iii) Repayable on demand or otherwise. iv) Withdrawable by Cheque, draft order or otherwise: Withdrawal may be permitted in any

other form ego a request may be made to transfer funds from one account to some other account.

v) Purpose of Acceptance of Deposits: The purpose of accepting deposit should be 'lending' or 'investment' .

Banking Company ['Sec. 5(c)]: Banking company means "any company which transacts the business of banking in India" Banking policy [Section 5(ea)]: Banking policy means any policy which is specified from time to time by the Reserve Bank in the interest of the banking system or in the interest of monetary stability or sound economic growth, having due regard to the interests of the depositors, the volume of deposits and other resources of the bank and the need for equitable allocation and the efficient use of these deposits and resources. "Branch" or "Branch Office" [See 5(cc)]: Branch or branch office in relation to banking company, means any branch or branch office, whether called a pay office or sub pay office or by any other name, at which deposits are received, cheques cashed or moneys sent.

 

 

Company [See 5(d)]: Company means any company as defined in section 3 of the Companies Act 1956, and includes a foreign company within the meaning of section 591 of that Act. According to section 3 of the companies Act, "company means a company formed and registered under this Act or an existing company". 'Demand' and 'Time' Liabilities [Sec. 5(f)]: 'Demand' liabilities means liabilities which must be met on demand, and 'Time' liability means liabilities which are not demand liabilities. Secured Loan or Advance [Sec. 5(n)] : 'Secured loan or advance' means a loan or advance made on the security of assets the market value of which is not at any time less than the amount of such loan or advance and "unsecured loan or advance" means a loan or advance not so secured. Banking may engage in the following forms of business (Sec. 6) a) The main functions of a bank include: i) Borrowing raising or taking up of money. ii) Lending or advancing secured or unsecured loan iii) The drawing, making, accepting, discounting, buying, selling, collecting and dealing in

negotiable instruments. iv) The granting and issuing of letters of credit, travellers cheques and circular notes. v) Providing of safe deposit vaults. vi) Negotiating of loans and advances. b) Acting as an agent for any government or local authority or any other person or persons. c) It may carry on and transact every kind of guarantee and indemnity business. d) It may carry on any other form of business which the central government may, by notification in the official gazette, specify as a form of business in which it is lawful for a banking company to engage. Requirements as to Minimum Paid up Capital and Reserves (Sec. 11): As per the amendment in 1961, a banking company commencing business after the coming into force of the Banking Companies (Amendment) Act, 1962, shall have a paid up capital of not less than RS.5 lakhs irrespective of the number of places of its business. A banking company incorporated outside India shall deposit with the Reserve Bank either in cash or in the form of unencumbered approved securities or partly in cash and partly in the form of such securities: i) An amount which shall not be less than the minimum required as above. ii) As soon as may be after the expiration of each calendar year, an amount calculated at 20% of its

profit for that year in respect of all business transacted through its branches in India, as disclosed in the profit and loss account prepared with reference to that year under section 29.

 

 

Reserve Fund (Sec. 17) : Every banking company incorporated in India is required to transfer at least 20% of its profits of each year, prior to the declaration of dividend to the Reserve fund. Management and Control Restrictions regarding Employment of Managerial Personnel; Restrictions on certain forms of Employment (Sec. 10) A banking company shall not employ or continue the employment of any of the following persons:

i) Who is or at any time has been adjudicated insolvent or has suspended payment or has compounded with his creditors, or who is or has been convicted by a criminal court of an offence involving moral turpitude.

ii) Whose remuneration or part of whose remuneration takes the form of commission or of a share in the profits of the company. However, the above provision shall not apply to the payment by a banking company of:

a) any bonus in pursuance of settlement or award arrived at or made under any law relating to

industrial disputes or in accordance with any scheme framed by such banking company or in accordance with the usual practice prevailing in banking business.

b) Any commission to any broker, cashier, contractor, clearing and forwarding agent, auctioneer or any other person, employed by the banking company under a contract otherwise than as a regular member of the staff of the company.

iii) Whose remuneration is, in the opinion of the Reserve Bank, excessive.

iv) A banking company shall not be managed by a person

v) Who is Director of any other company; or

vi) Whose term of office as a person managing the company is for a period exceeding 5 years at one

time.

Provided that, the term of office of any such person may be renewed or extended by further periods not exceeding 5 years on each occasion, subject to the condition that such renewal or extension shall not be sanctioned earlier than 2 years from the date on which it is to come into force. Constitution of Board of Directors (Sec. 10A): It provides that not less than 51 % of the total number of members on the Board of Directors of a banking company shall consist of persons who satisfy the following conditions: 1) They shall have special knowledge or practical experience in respect of one or more of the following

matters, namely: i) Accountancy

ii) Agriculture and rural economy

 

 

iii) Banking

iv) Cooperation

v) Economics

vi) Finance

vii) Law

viii) Small scale industry

ix) any other matter the special knowledge or practical experience in which would, in the opinion of the Reserve Bank, be useful to the banking company.

2) They shall not:

a) have substantial interest in, or be connected with, whether as employees, managers of : i) any company, not being a company registered u/s 25 of the companies act 1956, or ii) any firm, which carries on any trade, commerce or industry and which, in either case is not a small scale industrial concern, or

b) be proprietors of any trading, commercial or industrial concern, not being a small scale industrial concern.

Where the Reserve bank is of opinion that the composition of the Board of Directors of a banking company is such that it does not fulfill the above requirements, it may, after giving to such

banking company a reasonable opportunity of being heard, by an order in writing, direct the banking company to re-constitute its Board of Directors as to ensure that the said requirements are fulfilled. If within two months from the date of receipt of that order, the banking company does not comply with the directions made by the Reserve Bank, the Reserve Bank may remove such persons from the Board who do not satisfy the requirements prescribed and appoint suitable persons to fill in the vacancies so caused.

Moreover, a director of a banking company, other than its Chairman or whose time director cannot hold offence continously for a period exceeding 8 years. Chairman (Sec.10B) Every banking company shall have one of its directors as a whole time or a part time chairman. The chairman shall exercise his power subject to the superintendence, control and direction of the Board of Directors. Where a chairman is appointed on a part time basis, the following additional provisions shall be applicable:

i) Such appointment shall be with the previous approval of the Reserve Bank and subject to such conditions as the Reserve Bank may specify while giving such approval.

 

 

ii) The management of whole of affairs of such a banking company shall be trusted to a managing director who shall exercise his powers subject to the superintendence, control and direction of the Board of Directors.

A whole time chairman or a managing director of a banking company shall hold office for such period not exceeding 5 years as the Board of Directors may fix. However, he shall be eligible for re-election or re-appointment.

A person shall be disqualified for being a whole time chairman or a managing director of a banking company if he:

a) is a director of any company other than (i) a company which is subsidiary of the banking

company, (ii) a company registered u/s 25 of the Companies Act. b) is a partner of any firm which carries on any trade, business or industry, or c) has substantial interest in any other company or firm, or d) is a director, manager, partner or proprietor of any trading, commercial or industrial concern, or e) is engaged in any other business or vocation.

Prohibition of Common Directors (Sec. 16): A banking company incorporated in India:

a) cannot have as a director in its board of directors any person who is a director of any other banking company, and

b) cannot have in its board of directors more than 3 directors who are directors of companies which among themselves are entitled to exercise voting rights in excess of 20% of the total voting rights of all the share holders of that banking company.

Loans and Advances Restrictions on Loans and Advances (Sec. 20): A banking company shall not:

a) grant any loans or advances on the security of its own shares, or b) enter into any commitment for granting any loan or advance to on behalf of

i) any of its director ii) any firm in which any of its directors in interested as partner, manager, employee or

guarantor, or iii) any individual in respect of whom any of its directors is a partner or guarantor. Remission of Debts (Sec. 20A): A banking company cannot, except with the approval of the Reserve Bank remit in whole or in part any debt due to it by :

a) Any of its directors, or b) any firm or company in which any of its directors is interested as director, partner, managing

agent on guarantor, or c) any individual if any of its directors is his partner or guarantor.

Assets of a Banking Company

 

 

Maintenance of Liquid Assets (Sec. 24): Every banking company is required to maintain in India in cash, gold or unencumbered approved securities, valued at a price not exceeding the current market price, an amount which shall not at the close of business on any day be less than 25% of the total of its time and demand liabilities in India. This is known as statutory liquidity ratio (SLR). The Resene Bank has the power to increase this ratio up to 40% and thus compel the banking company to maintain a larger portion of their liabilities in liquid form. Assets in India (Sec. 25): The assets in India of every banking company at the close of business on the last Friday of every quarter or, if that Friday is a public holiday under the Negotiable instruments Act, 1881, at the close of the business on the preceding working day, shall not be less than 75%, of its demand and time liabilities. Monthly Returns [Section 27(1)]: Every banking company is required to submit to the Reserve Bank before the close of the month succeeding that to which it related, a return in the prescribed form and manner showing its assets and liabilities in India at the close of business on the last Friday of every month or if that Friday is a public holiday under the Negotiable Instruments Act, 1881, at the close of the business on the preceding working day. Powers of the Reserve Bank

1. Election of New Directors (Sec. 12A): The Reserve bank may, by order, require any ban king company to call a general meeting of the shareholders of the company within such time, not less than 2 months from the Date of the order, as may be specified in the order or within such further time as the Reserve bank may allow in this behalf, to elect, in accordance with the voting rights permissible under this Act, fresh directors.

2. Cash Reserve (Sec. 18): Under Section 42 of the Reserve Bank of India Act, every scheduled bank has to maintain a sum equal to at least 3% of its time and demand liabilities in India as cash reserve with the RBI. The Reserve bank has the power to increase the percentage up to 20% by a notification in the government Gazette.

3. Licensing of Banking companies (Sec. 22): Prior to granting license to a banking company, the Reserve bank may require to be satisfied by an inspection of the books of the banking company or all or any of the following conditions should be fulfilled, namely:

a) What the company is or will be in a position to pay its present or future depositors in full as they become due

b) That the affairs of the company are not being, or are not likely to be conducted in a manner detrimental to the interest of the depositors.

c) In the case of a company incorporated outside India that the carrying on of banking business by such company in India will be in the public interest and that the government or law of the country

 

 

in which it is incorporated does not discriminate in any way against banking companies registered in India.

Cancellation of the License: The license of any banking company may be cancelled by the Reserve Bank due to the following reasons:

i) If the company ceases to carry on banking business in India; or ii) If any of the conditions imposed by the Reserve bank are not fulfilled.

Any banking company aggrieved by the decision of the Reserve bank cancelling a license may, within thirty days from the date on which such decision is communicated to it, appeal to the central government. 4) Opening of New and Transfer of Existing place of Business (Sec. 23): Without obtaining prior approval of the Reserve Bank:

a) No banking company shall open a new place of business in India or change otherwise than within the same city, town or village, the location of an existing place of business situated in India.

b) No banking company incorporated in India shall open a new place of business outside India or change, otherwise than within the same city, town or village in any country or area outside India, location of an existing place of business situated in that country or area.

The permission of the Reserve bank is not necessary where a banking company opens a temporary place of business for a period not exceeding one month, within a city, town or village within which the company has already a place of business, for the purpose of affording the banking facilities to the public on the occasion of an exhibition, a conference or a mela or any other like occasion. 5) Power to call for information relating to the business of any banking company [Sec. 27(2)] : Sec. 28 gives power to the Reserve Bank to publish such information if it considers it proper to do so in the public interest. The Reserve bank can at any time a banking company to furnish within the specified time, with such statements and information relating to business of the banking company as the Reserve bank may consider necessary. 6) Power of Inspection (Sec. 35) : The Reserve Bank may at any time, and shall at the direction of the central government inspect a banking company and its books and accounts to find out whether or not the affairs of the banking company are conducted in the interest of the depositors. The central government may after giving reasonable notice to the banking company, publish the report submitted by the Reserve Bank of such portion thereof as may appear necessary 7) Power to give Directions (Sec. 34) : The Reserve Bank may from time to time issue directions to banking companies generally or to any banking company particularly. The Reserve Bank shall do so when it deems it necessary to issue such directions : a) in the public interest; or b) to secure the proper management of any banking company generally.

 

 

c) to prevent the affairs of any banking company being conducted in a manner detrimental to the interest of the depositors or in a manner prejudicial to the interests of the banking company; 8) Reserve Bank's approval necessary for the amendment of provisions relating to appointment of managing directors (Sec. 35B) : The appointment or reappointment of a managing or a whole time director, manager or chief executive officer, by whatever name called, shall not have any effect unless it is made with the previous approval of the Reserve Bank. 9) Power of Reserve Bank to appoint additional directors (Sec. 36AB) : The Reserve Bank, if considers necessary for the protection of the interest of depositors, from time to time may appoint additional directors but the number should not exceed five or one third of the maximum strength fixed for the Board by the articles whichever is less. Additional directors shall hold office at the pleasure of the Reserve bank not exceeding three years at a time. 10) Power of Reserve Bank to remove managerial and other persons from office (Sec. 36AA): For preventing the affairs of the banking company, the Reserve bank may remove any director, chief executive officer by writing an order the order shall contain reasons for his removal and the date from which it is effective. Reasonable opportunity should also be given to such a person for explaining his position before such order is actually passed against him. Such person, within 30 days, can appeal to central government. Further powers and functions of the Reserve Bank (Sec. 36)

a) It may on a request being made, assist in a proposal for the amalgamation of banking companies concerned.

b) It may assist any banking company by means of the grant of a loan or advance to it. c) It shall make an annual report to the central government on the trend and progress of the banking

in the country. It shall also include in such report its suggestions for the strengthening of banking business throughout the country.

Accounts and Audit Profit and Loss Account and Balance Sheet (Sec. 29): At the expiration of each calendar year or at the expiration of a period of 12 months ending with such date as the central government may, by notification in official gazette specify in this behalf, every banking company incorporated outside India, in respect of all business transacted through its branches in India, shall prepare with reference to that year or the period, as the case may be a balance sheet and a profit and loss account as on the last working day of the year of the period in the forms set out in the third schedule or as near thereto as circumstances admit : The balance sheet and profit and loss account shall be signed:

a) In the case of a banking company incorporated in India, by the manager or the principal officer of the company and where there are more than three directors of the company, by at least three of those directors, or where there are not more than three directors, by all the directors, and

 

 

b) In the case of a banking company incorporated outside India, by the manager or principal officer of the company in India.

Audit of Bank Accounts (Sec. 30) : According to Sec. 30, the balance sheet and profit and loss account prepared in accordance with Sec. 29 shall be audited:

a) In the case of a banking company incorporated in India, by a person duly qualified under any law for the time being in force to be auditor of companies;

b) In the case of banking company incorporated outside India, either by such an auditor as aforesaid or by a person duly qualified to be an auditor under the law of the country in which the company is incorporated.

Submission of Returns (Sec. 32) : The profit and loss account and balance sheet together with the auditor's report shall be published in the prescribed manner and three copies thereof shall be furnished as return to the Reserve Bank within 3 months from the last day of the period to which they refer. This period may, however, be extended by the Reserve Bank by a further period not exceeding 3 months. Three copies of the profit and loss account and balance sheet together with auditors report shall also be sent by the banking company to the registrar or companies at the same time when it sends them to the Reserve bank. Display of Audited balance sheet by Companies incorporated outside India (Sec. 33): Every banking company incorporated outside India is required not later than the first Monday in August of every year in which it carries on business, to display in a conspicuous place in its principal office and in every branch office in India a copy of its last audited balance sheet and profit and loss account prepared u/s 29. Production of Document of Confidential Nature (Sec. 34A): A banking company cannot be compelled by any authority before which any proceedings under the industrial Disputes Act, 1947 are pending to produce any document or furnish or disclose any statement or information which is of a confidential nature and the production furnishing or disclosure of which would result in disclosure of information relating to:

a) any reserves not shown in its published balance sheet; or b) any particulars not shown therein in respect of provisions made for bad and doubtful debt and

other usual or necessary provisions. Acquisition of Banking Companies (Sec. 36AC): This section gives power to the central government to acquire the undertaking of a banking company. It provides that if on receipt of a report the central government is satisfied that a banking company.

1) Has failed to comply with the directions given to it by the Reserve Bank relating to policy matters u/s 21 and 35A, or

2) Is being managed in a manner detrimental to the interest of its depositors, and that a) in the interests of the depositors of such banking company, or b) in the interest of banking policy, or

 

 

Before acquiring the under taking of any banking company the central government shall give a reasonable opportunity to the banking company proposed to be acquired of showing cause against the proposed action. Suspension, Winding up and Miscellaneous Suspension of Business (Sec. 37): The high court may, on the application of a banking company which is temporarily unable to meet its obligations, make an order stating the commencement or continuance of all actions and proceedings against the company for some period. This temporary suspension of the enforcement of liability against the banking company is called "Moratorium". The period of "Moratorium" shall not exceed 6 months in all. Where the Reserve Bank is satisfied that the affairs of a banking company is respect of which a moratorium order has been made, are being conducted in a manner detrimental to the interests of the depositors, it may make an application to the high court for winding up of the company. Winding up of a Banking Company: A banking company can be wound up like any other company Le. may be wound up compulsorily or voluntarily or subject to the supervision of the court. Winding Up by the Court: The high court shall order the winding up of a banking company:

- If the banking company is unable to pay its debts; or - If an application for its winding up has been made by the Reserve Bank.

A banking company shall be deemed to be unable to pay its debts in the following circumstances:

a) If it has refused to meet any lawful demand made at any of its offices within two working days, if such demand is made at a place where there is office, branch, or agency of the Reserve bank or within five working days if such demand is made elsewhere; and

b) If the Reserve Bank certifies in writing that the banking company is unable to pay its debts. Liquidator: Sec. 38A provides for the appointment of a liquidator by the central government who should be attached to every high court. He shall conduct all winding up proceedings in the case of winding up of a banking company by the high court. Notice to Preferential Claimants and Secured and Unsecured Creditors (Sec. 41 A) : The official liquidator shall within 15 days of the winding up order of a banking company, for the purpose of making an estimate of the debts and liabilities of the banking company (other than its liabilities and obligations to depositors), serve a notice on the following persons:

1. Every claimant entitled to preferential payment u/s 530 of the companies act, 1956.

2. Every secured and every unsecured creditor.

 

 

The notice shall require each claimant to send to the official liquidator within one month from the date of service of the notice, a statement of the amount claimed by him. Preferential Payment of Depositors (Sec. 43A) : After making the adequate provisions for preferential payments, the liquidator shall pay within 3 months, to depositors in the following order:

a) In the first place, to every depositor in the savings bank account of the banking company a sum of two hundred and fifty rupees or the balance at his credit, whichever is less and thereafter.

b) In the next place to every other depositor of the banking company a some of two hundred and fifty rupees or the balance at his credit, whichever is less, in priority to all other debts from out of remaining assets of the banking company available for payment to general creditors. But the sum total of the amounts paid under clause (a) and clause (b) to anyone person who in his own name (and not jointly with any other person) is a depositor in the savings bank account of the banking company and also a depositor in any other account, shall not exceed the sum of two hundred and fifty rupees.

Powers of the High Court in Voluntary Winding up (Sec. 44): A banking company cannot be voluntarily wound up unless the Reserve bank certifies in writing that the company is able to pay all its debts to its creditors as they accrues. Where a banking company is being voluntarily wound up, the high court may:

a) make an order that the voluntary winding up shall continue but subject to the supervision of the court, or

b) order for the winding up of the company by the high court if at any stage during the voluntary winding up proceedings, the company is not able to meet its debts as they accrue; or voluntary winding up cannot to continued without detriment to the interests of the depositors.

Amalgamation of Banking Companies (Sec. 44A): No banking company can amalgamate with another banking company unless a scheme containing the terms of such amalgamation has been placed in draft form before the shareholders of each of the banking companies concerned separately, and approved by a resolution passed by a majority in number representing two thirds in value of the shareholders of each of the said companies. If the scheme of amalgamation is approved by the requisite majority of shareholders in accordance with the provisions of this section. If the scheme is sanctioned by the Reserve bank by an order in writing it shall be binding on the banking companies concerned and also on all the shareholders thereof. Restrictions on Compromise or Arrangement (Sec. 448): No high court can sanction a compromise or arrangement between a banking company and its creditors or shareholders unless the compromise or the arrangement is certified by the Reserve bank as not being incapable of being worked and as not being detrimental to the interest of the depositors of such banking company.

 

 

Power of the Reserve Bank to apply to the Central government for suspension of business by a banking company and to prepare scheme of reconstruction or amalgamation (Sec. 45) - The central government may, after considering the application of the Reserve Bank, make an order of moratorium for period not exceeding six months in all. During the period of moratorium if the Reserve Bank is satisfied that -

1. in the public interest, or

2. in the interest of depositors or

3. in the order to secure the proper management of the banking company or

4. in the interest of the banking system as a whole it is necessary so to do, the reserve bank may

prepare a scheme

i) for the reconstruction of the banking company or

ii) for the amalgamation of the banking institution with other banking institution. The scheme of amalgamation of reconstruction, may contain provisions for all or any of the following matters:

a) The constitution, name and registered office, the capital, assets, powers, rights, interests, authorities, the abilities, duties and obligation of the banking company.

b) Any change in the Board of Directors or the appointment of a new Board of Directors, of the banking company.

c) The alteration of memorandum and articles of association of the banking company.

d) The continuance of the services of all the employees of the banking company, excepting those mentioned in the scheme, at the same remuneration and on the same term and conditions:

A copy of the scheme prepared by the Reserve Bank shall be sent in draft to the banking company and also to the transferee bank and any other banking company concerned in the amalgamation for suggestions and objections, if any, within such period as the Reserve Bank may specify for this purpose. Special Provisions for Speedy Disposal of Winding up Proceedings (Sec. 45A to 45X): The main provisions are as follows: Power of the High Court to Decide all Claims (Sec. 458 and 45C): Where any legal proceedings are pending against the banking company in respect of which high court has the jurisdiction, in any court on the date of the winding up order, they will be stayed. The official liquidator shall submit to the high court, within three months from the date of the winding up order the details of all such pending proceedings. On receipt of such a report the high court may give the parties concerned an opportunity to show cause why the proceedings should not be transferred to itself. In case the high court decides to transfer to itself the pending proceedings, they shall be disposed of by the high court.

 

 

Settlement of the List of Debtors (Sec. 450): The high court may settle in, the following manner the list of debtors of a banking company which is being wound up :

1. The official liquidator shall, within six months from the date of the winding up order, from time to time file to the high court a list of debtors.

2. On receipt of such a list the high court shall, wherever necessary, cause notices to be issued on all

persons affected and after making an enquiry it shall make an order settling the list of debtors.

3. At the time of settlement of any such list the high court shall pass an order for the payment of amount due by each debtor.

4. Every such order shall, subject to the provisions for appeal, be final and shall be deemed to be a

decree in a suit. Calls on Contributories (Sec. 45E): The high court may, if necessary, at any time after making a winding up order, make a call on and order payment thereof by any contributory under Sec. 470(1) of the Companies Act, 1956, if such contributory has been placed on the list of contributories by the official liquidator and has not appeared to dispute his liability. Nomination of Deposit Accounts and Lockers Nomination for Payment of Depositor's Money (Sec. 452A):

1. Where a deposit is held by a banking company to the credit of one or more persons, the depositor or, as the case may be, all together, may nominate, in the prescribed manner, one person to whom in the event of the death of the sole depositor or the death of all the depositor, the amount of deposit may be returned by the banking company.

2. Where the nominee is a minor, it shall be lawful for the depositor making the nomination to appoint in the prescribed manner any person to receive the amount of deposit in the event of his death during the minority of the nominee.

3. Payment by a banking company in accordance with the provision of this section shall constitute a full discharge to the banking company of its liability in respect of the deposit.

Notice of Claims of other persons Regarding Deposits not Receivable (45ZB): No notice of the claim of any person, other than the person or person in whose name a deposit is held by a banking company, shall be receivable by the banking company nor shall the banking company be bound by any such notice even though expressly given to it. Nomination for return of articles kept in safe custody with Banking company (45ZC) : No notice of the claim of any person other than the person or persons in whose name a deposit is held by a banking

 

 

company, shall be receivable by the banking company nor shall the banking company be bound by any such notice even though expressly given to it. Nomination for Return of Articles Kept in Safe Custody with Banking Company (45ZC)

1. Where any person leaves any article in safe custody with a banking company, such person may nominate, in the prescribed manner one person to whom in the event the death of the person leaving the article in safe custody, such article may be returned by the banking company.

2. Where the nominee is a minor, it shall be lawful for making the nomination to appoint in the prescribed manner any person to receive the article deposited in the event of his death during the minority of the nominee.

3. The banking company shall before returning any articles under this section to the nominee or the person appointed under sub section (2), prepare, in such manner as may be directed by the Reserve Bank from time to time, an inventory of the said articles which shall be signed by such nominee or person and shall deliver a copy of the inventory so prepared to such nominee or person.

Release of Contents of Safety Lockers (45ZE)

1. Where an individual is the sole hirer of a locker from a banking company, whether such locker is located in the safe deposit vault of such banking company, or elsewhere, such individual may nominate one person to whom, in the event of the death of such individuals, the banking company may give access to the locker and liberty to remove the contents of the locker.

2. Every nomination under sub section (1) or sub section (2) shall be made in the prescribed manner. 3. On the removal of the contents of any locker by any nominee and survivors as aforesaid the

liability of the banking company in relation to the contents of the locker shall stand discharged. 4. No suit, prosecution or other legal proceedings shall lie against a banking company for any

damage caused or likely to be caused, for allowing access to any locker, and liberty to remove the contents of such locker in pursuance of the provisions of sub section (1) or sub section (2), as the case may be.

Miscellaneous: Some of the miscellaneous provisions dealt in the Banking Regulation Act are discussed below: Penalties (Sec. 46) : Some of the penalties prescribed under the Act are as follow:

1. Whoever in any return, balance sheet or other document or in an information required or

furnished by under the Banking Regulation Act, willfully makes a statement which is false in any material particular, knowing it to be false or willfully omits to make a material statement, shall be punishable with imprisonment for a term which may extend to 3 years and shall so be liable to fine.

2. If any person fails to produce any book, account or other document or to furnish any statement or information u/s 35(2), or answer any question relating to business of a banking company which is asked by an officer making an inspection under that section, he shall be punishable with a fine

 

 

which may extend to RS.2000 in respect of each offence. If the offense continues, he shall be punishable with a further fine which may extend to RS.100 for every day which the offence continues.

3. If any deposits are received by a banking company in contravention of an order under clause (a) sub section (4) of section 35, every director or other officer of the banking company, unless he proves that the contravention took place without his knowledge or that he exercised all due diligence to prevent it, shall be deemed to be guilty of such contravention. Such person shall be punishable with a fine which may extend to twice the amount of the deposit so received.

4. Where a contravention or default has been committed by a company every person who, at the time the contravention or default was committed, was in-charge of and was responsible to the company, for the conduct of the business of the company as well as the company, shall be deemed to be guilty of the contravention or default and shall be liable to be proceeded against all punished accordingly.

IMPORTANT QUESTIONS Q.1. Explain the functions of commercial banks. Q.2. Describe the banking system following:

a) Unit Banking b) Branch Banking c) Group Banking d) Chain Banking

Q.3. The salient features of the Banking Regulation Act 1949. Q.4. What types of Business are run by

Banking Company?

 

 

UNIT - II CENTRAL BANK – EVOLUTION In Europe prior to the 17th century most money was commodity money, typically gold or silver. However, promises to pay were widely circulated and accepted as value at least five hundred years earlier in both Europe and Asia. The medieval European Knights Templar ran probably the best known early prototype of a central banking system, as their promises to pay were widely regarded, and many regard their activities as having laid the basis for the modern banking system. At about the same time, Kublai Khan of the Mongols introduced fiat currency to China, which was imposed by force by the confiscation of specie. As the first public bank to "offer accounts not directly convertible to coin", the Bank of Amsterdam established in 1609 is considered to be the "first true central bank". This was followed in 1694 by the Bank of England, created by Scottish businessman William Paterson in the City of London at the request of the English government to help pay for a war. Although central banks are generally associated with fiat money, under the international gold standard of the nineteenth and early twentieth centuries central banks developed in most of Europe and in Japan, though elsewhere free banking or currency boards were more usual at this time. Problems with collapses of banks during downturns, however, were leading to wider support for central banks in those nations which did not as yet possess them, most notably in Australia. With the collapse of the gold standard after World War II, central banks became much more widespread. The US Federal Reserve was created by the U.S. Congress through the passing of the Glass-Owen Bill, signed by President Woodrow Wilson on December 23, 1913, whilst Australia established its first central bank in 1920, Colombia in 1923, Mexico and Chile in 1925 and Canada and New Zealand in the aftermath of the Great Depression in 1934. By 1935, the only significant independent nation that did not possess a central bank was Brazil, which developed a precursor thereto in 1945 and created its present central bank twenty years later. When African and Asian countries gained independence, all of them rapidly established central banks or monetary unions. CHARACTERISTICS A central bank, reserve bank, or monetary authority is a banking institution granted the exclusive privilege to lend a government its currency. Like a normal commercial bank, a central bank charges interest on the loans made to borrowers, primarily the government of whichever country the bank exists for, and to other commercial banks, typically as a 'lender of last resort'. However, a central bank is distinguished from a normal commercial bank because it has a monopoly on creating the currency of that nation, which is loaned to the government in the form of legal tender. It is a bank that can lend money to other banks in times of need. Its primary function is to provide the nation's money supply, but more active duties include controlling subsidized-loan interest rates, and acting as a lender of last resort to the banking sector during times of financial crisis (private banks often being integral to the national financial system). It may also have supervisory powers, t ensure that banks and their financial institutions do not behave recklessly or fraudulently.

 

 

FUNCTIONS OF CENTRAL BANK The important functions f Central Banks are as flows:

1. Sole Right of Note Issue: The Central Bank in every country, now, has the monopoly note issue. The issue of notes is governed by certain regulation which is enforced by the state.

2. Banker to the State : A Central Bank acts as a banker to the government. It holds cash balances of the government free of interest.

3. Banker's Bank: The central bank acts as a banker to the commercial banks.

4. Banker's Clearing House: The Central Bank acts as a clearing house for the settlement of mutual obligations of different commercial banks. If a difference exists, it is paid by a cheque drawn on the banks accounts carried at the Central Bank.

5. Lender to the Last Resort: The Central Bank helps the member banks in times of crisis.

6. Financial Agent: The Central Banks act as financial agents for the government. It is an agent for the government in purchasing and selling of gold and foreign exchange.

7. Effective Monetary Policy: The aim of the government is to create employment in the country, resist undue inflation and achieve a favorable balance of payment.

THE RESERVE BANK OF INDIA

The Reserve Bank of India was established on 1st April 1935 with the capital of RS.5 crores. The bank was started originally as a shareholders bank and the bank took over the function of currency issue from the government of India and power of credit control from the Imperial Bank of India.

The Reserve Bank of India as the Central Bank, has to perform not merely the negative role of controlling credit and currency in the economy to maintain the internal and external value of the rupee to ensure price stability in the economy. But also to act as a promoter of financial institutions in the country so that its policies could be effective promoting economic growth as per the guidelines and policies formulated by the Government backward element. When the Reserve Bank of India was established in 1935, our country was a backward country which lacked a well-developed commercial banking system apart from the absence of a well-developed money market in the country. After 1948 the Reserve Bank of India became very active to take steps to promote and develop financial institutions so that the Reserve Bank of India can pursue appropriate credit and monetary policies for economic growth and development in an era of planned economic development of the country.

OBJECTIVES F RBI

Monetary Authority

 

 

• Formulates, implements and monitors the monetary policy. • Objective: maintaining price stability and ensuring adequate flow of credit to productive sectors.

Regulator and Supervisor of the Financial System.

• Prescribes broad parameters of banking operations within which the country's banking and financial system functions.

Objective: maintain public confidence in the system, protect depositors' interest and provide cost-effective banking services to the public. The Banking Ombudsman Scheme has been formulated by the Reserve Bank of India (RBI) for effective redressal of complaints by bank customers. Manager of Exchange Control

• Manages the Foreign Exchange Management Act, 1999. • Objective to facilitate external trade and payment and promote orderly development and

maintenance of foreign exchange market in India. Issuer of Currency

• Issues and exchanges or destroys currency and coins not fit for circulation. • Objective: the main objective is to give the public adequate supply of currency of good quality

and to provide loans to commercial banks to maintain or improve the GDP (Gross Domestic Product).

The basic objectives of RBI are to issue bank notes, to maintain the currency and credit system of the country to utilize it in its best advantage, and to maintain the reserves. RBI maintains the economic structure of the country so that it can achieve the objective of price stability as well as economic development, because both objectives are diverse in themselves. Developmental Role

- Performs a wide range of promotional functions to support national objectives. Related Functions

- Banker to the Government: performs merchant banking function for the central and the state governments; also acts as their banker.

- Bank to banks: maintains banking accounts of all scheduled banks There is now an international consensus about the need to focus the tasks of a central bank upon central banking. RBI is far out of touch with such a principle, owing to the sprawling mandate described above. The recent financial turmoil world over, has however, vindicated the Reserve Bank's role in maintaining financial stability in India. ORGANIZATIONAL STRUCTURE

 

 

The affairs of RBI are managed by the Central Board and Local Boards. Central Board Central Board The control board consists of following members under section 8 of RBI Act 1934

1. A Governor and not more than four Deputy Governor appointed by the Central Government. 2. Four Directors nominated by the Central Government one from each of the four Local Boards. 3. Ten Directors nominated by the Central Government. 4. One government official nominated by the central government.

The governor and deputy governor shall devote their whole to the affairs of the bank and shall receive such salaries and allowances as may be determined by the central board, with the approval of the central government. The governor and deputy governor shall hold office for such term not exceeding five years as the central government may fix when appointing them and shall be obliged for reappointment. The chairman of the central board of directors of the bank is called the chief executive authority of the bank and he is known as the Governor. The Governor has the power of general superintendence and direction of the affairs and business of the bank and he is authorised to exercise all power, which may be exercised or done by the bank. In the absence of the governor the deputy governor nominated by the governor in this behalf exercises his powers. Local Boards A local board shall be constituted for each of the four areas specified in the first schedule and consists of five members to be appointed by the central government to represent, as far as possible, territorial and economic interest and the interest of co-operative and indigenous banks. Every member of a local board shall hold office for a term of four years and thereafter until his success or shall have been appointed and shall be eligible for re-appointment. The bank has local boards with headquarters at Mumbai, Kolkata, Chennai and New Delhi. LEGAL STATUS AND FUNCTIONS A bank is a body corporate by the name of the Reserve Bank of India, having perpetual succession and a common seal, and shall by the said name sue and be sued. Main Functions

1. Monetary Authority: The Reserve Bank of India Formulates, implements and monitors the monetary policy. Its main objective is maintaining price stability and ensuring adequate flow of credit to productive sectors.

2. Regulator and Supervisor of the Financial System: Prescribes broad parameters of banking operations within which the country's banking and financial system functions. Their main objective is to maintain public confidence in the system, protect depositors' interest and provide cost-effective banking services to the public.

 

 

3. Manager of Exchange Control: The manager of the exchange control department manages the Foreign Exchange Management Act, 1999. His main objective is to facilitate external trade and payment and promote orderly development and maintenance of foreign exchange market in India.

4. Issuer of Currency: Under Section 22 of the Reserve Bank of India Act, the Bank has the sole right to issue bank notes of all denominations. The distribution of one rupee notes and coins and small coins all over the country is undertaken by the Reserve Bank as agent of the Government. The Reserve Bank has a separate Issue Department which is entrusted with the issue of currency notes. The Bank shall not be liable to the payment of any stamp duty under the Indian Stamp Act, 1899 (2 of 1899) in respect of bank notes issued by it

5. Banker to Government: The Reserve Bank of India is to act as Government banker, agent and adviser. The Reserve Bank is agent of Central Government and of all State Governments in India. The Reserve Bank has the obligation to transact Government business, via. to keep the cash balances as deposits free of interest, to receive and to make payments on behalf of the Government and to carry out their exchange remittances and other banking operations. The Reserve Bank of India helps the Government - both the Union and the States to float new loans and to manage public debt.

6. Controller of Credit: The Reserve Bank of India is the controller of credit i.e. it has the power to influence the volume of credit created by banks in India. It can do so through changing the Bank rate or through open market operations. According to the Banking Regulation Act of 1949, the Reserve Bank of India can ask any particular bank or the whole banking system not to lend to particular groups or persons on the basis of certain types of securities. Since 1956, selective controls of credit are increasingly being used by the Reserve Bank.

7. Developmental Role : The Reserve Bank of India performs a wide range of promotional functions to support national objectives. The promotional functions are such as contests, coupons, maintaining good public relations.

8. Banker to Banks: The Reserve Bank of India acts as the bankers' bank. According to the provisions of the Banking Companies Act of 1949, every scheduled bank was required to maintain with the Reserve Bank a cash balance equivalent to 5% of its demand liabilites and 2 percent of its time liabilities in India. By an amendment of 1962, the distinction between demand and time liabilities was abolished and banks have been asked to keep cash reserves equal to 3 per cent of their aggregate deposit liabilities. The minimum cash requirements can be changed by the Reserve Bank of India. The scheduled banks can borrow from the Reserve Bank of India on the basis of eligible securities or get financial accommodation in times of need or stringency by rediscounting bills of exchange. Since commercial banks can always expect the Reserve Bank of India to come to their help in times of banking crisis the Reserve Bank becomes not only the banker's bank but also the lender of the last resort.

 

 

9. Amalgamation of Banking Company by Reserve Bank: No banking company shall be amalgamated with another banking company, unless a scheme containing the term of such amalgamation, drafted by the companies, has been approved by the reserve bank of India. The bank will also determine the purchase consideration for swapping of share between the two companies.

10. Issuing of Bank Notes: This function which was once considered to be the most paying part of a banker's business, is in modern times performed generally by central banking institutions in most of the countries of the world. Its importance to banks in general has dwindled in some of the countries, in which the cheque currency has replaced bank-notes to a large extent. For instance in England and in the United States of America, the part which is played by bank notes is becoming less and less significant althought they are still very popular in certain European countries such as France and Germany, where serious efforts are being made to popularise the use of cheques as a means of payment.

11. Transferring Money from Place to Place: Modern banks are, generally, in a position to remit

money, from one place or country to another, by means of drafts drawn upon their branches or agents. They are, also by purchasing bills of exchange, enable merchants and others to receive money from their debtors, in other cities or countries. Of late such transfers are also made electronically. These facilities have helped not only the internal trade of different countries, but also the international commerce.

12. Granting Licenses to Banking Companies: The RBI is empowered to grant licenses for banking companies which have requested for them under Section 22 of the RBI Act, for carrying on the business of banking in India. Before granting the licence, the RBI will satisfy itself that the applicant bank fulfills the following conditions:

a) That the capital structure and earning prospects of the company are adequate. b) The general character of the proposed management is of a high order and not detrimental to the

interests of the depositors; c) That the granting of licence will be in public interest. d) That the granting of licence would not be prejudicial to the operation and consolidation of the

banking system, and that it will be consistent with the monetary stability and economic growth.

13. Official Liquidator: In any proceeding for the winding up of a Banking Company, upon an application made to High Court, the High Court shall appoint Reserve Bank as the official liquidator of the Banking Company. The liquidator, if any, all ready functioning ain such proceeding shall vacate office upon such appointment.

Supervisory Functions In addition to its traditional central banking functions, the Reserve bank has certain non-monetary functions of the nature of supervision of banks and promotion of sound banking in India. The Reserve Bank Act, 1934, and the Banking Regulation Act, 1949 have given the RBI wide powers of supervision and control over commercial and co-operative banks, relating to licensing and establishments, branch expansion, liquidity of their assets, management and methods of working, amalgamation, reconstruction,

 

 

and liquidation. The RBI is authorised to carry out periodical inspections of the banks and to call for returns and necessary information from them. The nationalisation of 14 major Indian scheduled banks in July 1969 has imposed new responsibilities on the RBI for directing the growth of banking and credit policies towards more rapid development of the economy and realisation of certain desired social objectives. The supervisory functions of the RBI have helped a great deal in improving the standard of banking in India to develop on sound lines and to improve the methods of their operation. Promotional Functions The Bank now performs a variety of developmental and promotional functions, which, at one time, were regarded as outside the normal scope of central banking. The Reserve Bank was asked to promote banking habit, extend banking facilities to rural and semi-urban areas, and establish and promote new specialized financing agencies. Accordingly, the Reserve Bank has helped in the setting up of the IFCI and the SFC; it set up the Deposit Insurance Corporation in 1962, the Unit Trust of India in 1964, the Industrial Development Bank of India also in 1964, the Agricultural Refinance Corporation of India in 1963 and the Industrial Reconstruction Corporation of India in 1972. These institutions were set up directly or indirectly by the Reserve Bank to promote saving habit and to mobilise savings, and to provide industrial finance as well as agricultural finance. As far back as 1935, the Reserve Bank of India set up the Agricultural Credit Department to provide agricultural credit. But only since 1951 the Bank's role in this field has become extremely important. The Bank has developed the co-operative credit movement to encourage saving, to eliminate moneylenders from the villages and to route its short term credit to agriculture. The RBI has set up the Agricultural Refinance and Development Corporation to provide long-term finance to farmers. IMPORTANT QUESTIONS Q.1. Explain the main functions of RBI. Q.2. Describe the organizational structure of RBI. Q.3. Promotional Role in Indian Banking system of RBI. Q.4. Write short note on supervisory functions of RBI. Q.5. What do you mean by Central Bank? Explain the function of Central Bank.

 

 

UNIT - III LEADING BY BANKS The concept of bank lending has been undergoing a change since the introduction of social control over commercial banks and more especially after the nationalisation of major banks in 1969. Prior to nationalisation, the commercial banks provided credit only to large customers with larger resources at their command against the securities which were more than adequate to cover the advances. In other words, a large part of the banks lending was security oriented and that to a selected customers in the corporate sector. However, since nationalisation there has been a view that the bankers should not insist on security in consideration of the proposals for advances. They should look at the productivity of a proposal in terms of its potentialities to contribute to increased production. Lending of funds to the constituents, mainly business and industrial enterprises, traders, constitutes the main business of the banking company. The major portion of the bank's fund is employed by way of loans and advances, which is the most profitable employment of its funds. The business of lending, nevertheless, is not without certain inherent risks. Largely depending on the borrowed funds a banker cannot afford to take undue risks in lending. When banker lending his finds, follows a very cautious policy and conducts his business on the basis of the well known principles of sound lending in order to minimise the risks.

1) Safety: 'Safety first' should be the first guiding principle of a banker. A banker must look to the safety of the funds as he cannot afford to lose the money he lends. He should take a long term view rather than the immediate prospects. Banks always provided fully secured loans and advances in the ordinary course of his business. This has led people to believe that bank will never advance any loan unless it is fully secured. Such is no doubt the ideal conception of banking, but as a result of competition from other banks, every bank has sometimes to grant loans to its customer against their personal security. In many cases, the manager of the bank uses his discretion and never lends a sum obviously beyond his customer's recourses.

2) Liquidity: Secondly, the banker while making advances must see that the money he is lending is

not going to be locked up for a long time, which should make his loans and advances less liquid and more difficult to release in case of emergency. Banks always depend on borrowed funds; they spread their investment in such a way that they are in a position to acquire cash with in short period of time. Their borrowings also come from deposits which are usually not for a very long period.

3) Profitability: Commercial banks are profit earning institutions. The nationalized banks are no

exception to this. They must employ their funds profitably so as to earn sufficient income out of which to pay interest to the depositors, salaries to the staff and to meet various other

 

 

establishment expenses and distribute dividend to the shareholders. The rates of interest charged by banks were in the past primarily dependent on the directives issued by Reserve Bank. Now banks are free to determine their own rates of interest on advances of above Rs. 2 Lakhs. The variations in the degree of risk are involved in lending to them. A customer with high reputation is charged the lower rate of interest as compared to an ordinary customers. The sound principle of lending is not to sacrifice safety or liquidity for the sake of higher profitability. That is to say that the banks should not grant advances to unsound parties with doubtful repaying capacity, even if they are ready to pay a very high rate of interest.

4) Security: The security offered against the loan may consist of a large variety. It may vary from a piece of land or a building to a commercial paper or bullion. There may be cases where there is no security except the personal security of the debtors. Whatever be the security, a banker must realize that it is only a cushion to fall back upon in case of need and its adequacy alone should not from the sole consideration for judging the suitability of a loan. Of course, the security, if accepted, must be adequate, readily marketable, easy to handle and free from encumbrance.

5) Loans Repayable on Demand: Bankers generally make their loans repayable on demands, although there may be an understanding that the customer would be allowed to use the funds for at least a certain period, provided he complies with the term of the agreement. They also reserve to themselves the power of cancelling or reducing the amount of advances, but generally they have to give a reasonable notice.

For expo: A banker who has promised his customer an overdraft to the extent of Rs.20,000/-, wishes to reduce its amount to Rs. 15,000/-. He cannot refuse to honour his customer's cheque issued before the receipt of the notice by the customer, so long as it does not exceed the limit of the overdraft originally agreed upon Rouse Vs. Bradford Banking company (1894) AC 595.

6) Investment of Their Fund in Various Sectors : It is also necessary to remember that a prudent

banker must avoid lending the major portion of his funds in meeting the needs of any one industry on anyone group of Industries for consideration of self -

Interest as well as the large public good. The imprudence of putting one's all eggs in one basked can not be too often reiterated.

7) Adequate Return on his Investment: Another important factor that will determine the decision

of the banker whether or not to grant a loan will depend upon the answer to the question whether or not he will get a fair return on his investment. The difference between his borrowing and lending rates constitutes his gross profit and no banker ordinarily will think of an advance without a satisfactory margin of profit. No hard and fast rules can however, be laid down regarding this margin between borrowing and lending rates, but generally 2 to 2112 % is considered reasonable.

GUARANTEE Contracts of Guarantee have special importance in banking business as a means to ensure safety to banker's funds lent to customers. The bank while lending to customers generally secure a charge over the tangible assets of the borrowers and/or personal security of the debtor. But when the value of tangible

 

 

assets offered by a borrower is not sufficient to cover the amount of loan or where the borrower has no tangible assets to offer and the personal security of the borrower is not considered sufficient, an additional security is sought by the banker in the form of a guarantee of one or more persons who have some standing in the eyes of the banker. The person who provides guarantee is known as 'Guarantor' or 'surety'. The surety undertakes the liability to pay to the creditor (banker) if the debtor (borrower) makes a default in repaying the amount of loan according to the terms of contract. The guarantor, therefore, is the personal security of a third person to the creditor to pay the amount of loan and other dues, if the debtor fails to pay. Contract of Guarantee: A contract of guarantee is a specific contract and is governed by provisions of the Indian Contract Act. 1872. Section 126 of the Indian Contract Acts defines a contract of guarantee as lOa contract to perform the promise or discharge the liability of a third person in case of this default". There are, therefore, three parties in a contract of guarantee. The person who undertakes the liability to pay the liability of third person the debtor is called the surety or the guarantor. The person in respect of whose default, the guarantee is given is called the principal debtor and the person to whom the guarantee is given is called the creditor. A contract of guarantee is thus a secondary contract and is enforceable only when the principal contract between the principal debtor and the creditor is not fulfilled or discharged. The contract of guarantee may be either written or oral (Sec. 126) Essential Features of a Contract of Guarantee: A contract of guarantee like other contracts must possess all the elements of a valid contract. But, there are certain distinctive features of a contract of guarantee which are as follows:

1. A contract of guarantee may be either oral or written: Bankers, however have the contract of guarantee in writing to avoid mis-constructed interpretation and likely conflicts in future and to bind the surety by his words.

2. The bank should see that the guarantor should not be under the direct control or authority of the principal debtor or he should not be in some other fiduciary relationship with him like doctor and patient, father and son, wife and husband or a trustee and a beneficiary.

3. There are two contracts in a contract of guarantee i.e. between creditor and principal debtor and between creditor and surety. The first contract is a principal contract and the second one is a secondary contract.

4. There are three parties in a contract of guarantee the principal debtor, the creditor and the surety.

5. A contract of guarantee, like any other contract, must have consideration. According to section 127 of Indian Contract Act, 1872, "anything done or any promise made, for the benefit of the principal debtor may be a sufficient consideration to the surety for giving the guarantee."

6. A Contract of guarantee is not a contract of uberrimae fidei (requiring good faith). Nevertheless, the suretyship relation is one of the trust and confidence, and the validity of the contract depends upon good faith on the part of the creditor of guarantee must have all the essentials of a valid contract and competency of parties, free consent of parties consideration and lawful object.

Purpose: Contracts of guarantee are usually entered into (a) to secure the performances of something linch may be immediately related to a mercantile engagement, or (b) to secure the honesty and fidelity of

 

 

someone who is to be appointed to some office, or (c) to secure someone from injury arising out of some wrong committed by another. KINDS F GUARANTEE Contracts of guarantee may be (1) specific (2) continuing.

1) Specific Guarantee: Specific guarantee means a guarantee for one specific transaction. In this case the liability of the surety extends only to a single transaction.

Example: UCO bank guarantees payment to B of price of five sacks of flour to be delivered by B to C and to be paid in a month. B delivers 5 sacks to C. C pays for them. Afterwards B delivers four sacks to C, which C does not pay. The guarantee given by UCO bank was only a specific guarantee and accordingly it is not liable for the price of the four sacks.

2) Continuing Guarantee: A continuing guarantee is that which extends to a series of transactions

(Sec. 129) Revocations of a Continuing Guarantee

1) By Notice: (Sec. 130) A continuing guarantee ~ay at any time be revoked by the surety as to future transactions, by giving a distinct notice to the creditor.

2) By Death : (Sec. 131) Death of the surety will operate as a revocation of the continuing guarantee with regard to the future transactions unless the contract provides otherwise. No notice of death need be given to the creditor.

3) Nature of Surety's Liability: Where the parties do not specifically agree as to the extent of the liability or the surety does not put any limit on his liability at time of entering into the contract, the liability of the surety will be coextensive with that of the principal debtor (Sec. 128) The quantum or obligation of the surety will be the same as that of a principal debtor. In other words, whatever amount of money a creditor can legally realise from the principal debtor including interest, cost of litigation, damages etc., the same amount he can recover from the surety.

Example: UCO bank guarantees to B the payment of a bill of exchange by C the acceptor. The bill is dishonoured by C. UCO bank will be liable not only for the amount of the bill but also for any interest and charges, which may have become due on it. SURETY’S RIGHTS AND LIABILITIES Law offers certain protections to the surety in discharge of his legitimate duties under the contract of guarantee. A surety has the following rights:

1. Rights against the creditor

2. Rights against the principal debtor; and

3. Rights against the co-sureties.

a) Rights Against the Creditor: The surety has the following rights against the creditor.

 

 

1. Require the Creditor to Demand Payment: Once the guaranteed debt becomes due to surety has every right to require the creditor to demand payment from the principal debtor.

2. Benefit of Security (Sec. 141) : The Surety is entitled to the benefit of every security which the creditor had accepted from the debtor at the time of entering into contract with the principal debtor irrespective of whether the surety knows of the existence of such security or not. If the creditor loses or parts with such security without the consent of the surety, the surety is discharged from his liability to the extent of the value of security.

3. Right of Set Off : The surety, if pays to the creditor, is entitled to claim the benefit of the principal debtor's set off against the creditor if it arises out of the transaction.

b) Rights Against the Principal Debtor: The surety is primarily concerned with the principal

debtor. His liability is coextensive with that of the principal debtor. If the principal debtor pays the debt or fulfills his promise, the surety has no right against the principal debtor. His rights against the principal debtor arises only when he (the principal debtor) defaults and the surety makes the payment to the creditor according to the contract. In such a case, the surety has the following rights against the principal debtor :-

1. Right of Subrogation (Sec. 140) : According to Sec. 140 of the Indian Contract Act, when the

principal debtor defaults in fulfilling his promise and the surety meets his liability to the creditor, the surety, upon payment or performance of all that he is liable for steps into the shares of the creditor and acquires all the rights of the creditor.

2. Right to be indemnified by the principal debtor (Sec. 145) : Sec. 145 of the Contract Act lays down an implied authority on the principal debtor that he will make good the loss caused to the surety under the contract. The surety has the right to recover all rightful payments made under the contract. The surety has the right to recover all rightful payments made under the contract of guarantee.

3. Right to Revoke Continuing Guarantee: The surety may revoke the continuing guaratee at any time, if he thinks that the principal debtor is failing, fulfill his promise or in repaying the debt according to terms of contract.

c) Rights Against Co-sureties : When two or more persons are co-sureties for the same debt they

are called co-sureties. If the principal debtor fails to fulfill his promise and one of the cosureties pays more than his share of the debt, he has the following rights against co-sureties.

1) Right of equal contribution (Sec. 146): When two or more persons are co-sureties for the same

debt, either jointly or severally and whether under the same or different contracts and with or without the knowledge of each other, the co-sureties, in the absence of any contract to the contrary, are liable, as between themselves, to contribute an equal share of the whole debt, or of that part of it which remains unpaid by the principal debtor. If one of the co-sureties pays more than his share of the debt, he has a right to claim contribution from the other cosureties equally.

 

 

For Example: A, Band C are co-sureties for the sum of Rs.3000 paid by 0 to E. E defaults in making the payment. A, Band C are liable to contribute equally i.e. Rs.1 000 each. If, suppose A pays the whole debt to 0, he can claim contribution of RS.1 000 each from Band C.

If one of the co-sureties becomes insolvent, the solvent co-sureties shall contribute the whole amount equally.

2) Co-sureties bound in different sums (Sec. 147) : Where the co-sureties have guaranteed

different sums, they are bound to contribute to the other co-surety who has paid the amount of debt due from the principal debtor, equally subject to the liability undertaken.

A release of one or more of the co-sureties by the creditor will not discharge the others from the obligations nor will it release the surety so released, from his responsibility to the other co-sureties.

Example: A, Band C are sureties for D, for a debt of Rs.60,000 given to E, in which A is liable for Rs.25,000, B for Rs.20,000 and C for Rs.15,000. E makes default to the extent of Rs.45,000. A, B, C equally contribute Rs.15,000 each.

Liability The nature and extent of surety's liability has been discussed in section 128 of the Indian Contract Act. It provides that the liability of the surety is co-extensive with that of the principal debtor, unless otherwise provided by the contract. The liability of the surety will never be less or more than that of the principal debtor. It may be restricted by a specific contract but it will never be greater. Example: A guarantees the repayment of loan granted to X and Yalongwith interest thereon. The liability of the principal debtor increases by the amount of interest due with the passage of time. The liability of the surety will also increase by the amount of interest. The extent of guarantee may be limited in either of the following two cases: i) He may guarantee only a part of the entire debt, or ii) He may guarantee the whole of the amount of debt but subject to a limit specified in the contract.

- The liability of the surety will commence only at the moment principal debtor defaults. Notice of default is not necessary unless it is required under the contract. If, surety becomes insolvent before the amount of guaranteed loan has become due (or before the default by the principal debtor), the debt cannot be proved before the surety's official receiver or assignee. But, if the principal debtor defaults before the surety's insolvency, the debt can be proved and the creditor can claim the dividend from surety's estate.

- It is also not necessary for the creditor first to exhaust all remedies against the principal debtor before claiming the amount of debt from the surety. It means that surety's liability becomes primary as soon as the principal debtor defaults and the creditor may sue the surety directly before taking any action against the principal debtor. But, if the contract specifically provides to

 

 

sue the principal debtor first in case of default, then the credit shall first take action against the principal debtor and only after that against the surety.

- Liability when principal debtor is not liable: If the original contract between the Principal debtor and creditor is void e.g. when the principal debtor is a minor i.e. not capable of entering into a contract, the other contract between the surety and the creditor is not void and therefore, the surety is not discharged from the liability. In this case, the surety will be liable as principal debtor.

- Liability of Co-sureties: If one of them has paid the entire amount to the creditor, he is entitled to claim contribution from his co-sureties.

Discharge of Surety: Surety will be discharged from his liability in the following cases:

1) By Notice or Death (Sec. 130 and 131): A contract of continuing guarantee may be terminated at any time by notice to the creditor. The death of surety also brings an end to a continuing guarantee. No notice of death need to be given to the creditor.

2) Variations in the terms of the original contract between the principal debtor and the creditor (Sec. 133): If the contract between the creditor and the principal debtor is materially altered without the consent of the surety, the surety is discharged as to transactions subsequent to the alternation. Even the alteration beneficial to the surety would entitle the surety to claim a discharge.

3) By release or discharge of the principal debtor (Sec. 134) : The surety is discharged by any contract between the creditor and the principal debtor, by which the principal debtor is released or by any act or omission of the creditor the legal consequence of which is the discharge of the principal debtor

4) Compounding by Creditor with the principal debtor (Sec. 135) : A contract between the creditor and the principal debtor, by which creditor makes a composition with, or promises to give time to or not to sue the principal debtor discharges the surety unless the surety assents to such contract.

5) Creditor's Act or omission impairing Surety's eventual remedy (Sec. 139): If the creditor does any act which is inconsistent with the rights of the surety or omits to do any act which his duty to the surety requires him to do, and the eventual remedy of the surety himself against the principal debtor is thereby impaired, the surety is discharged.

6) Loss of Security (Sec. 141): If the creditor loses or without the consent of the surety parts with any security given to him at the time of the contract of guarantee, the surety is discharged from liability to the extent of the value of security.

7) By invalidation of the contract of guarantee (Sec. 142, 143 and 144): A contract of guarantee

becomes invalid if guarantee was obtained by fraud or concealment etc. about material facts. Surety, in such a case, will be discharged from his liability.

 

 

Special Types of Guarantors:

1) Minors, Lunatics etc.: Contracts made with minors and persons of unsound mind are absolutely void. The banker should not, therefore, accept guarantees from such persons.

2) Undischarged insolvent: They are also incompetent to contract and therefore, the guarantee given by such persons are void.

3) Married Women: A married Hindu woman can give a valid guarantee which will bind her separate property called stridhan. However, a banker should be extremely cautious while accepting the guarantees of such women.

4) Limited Companies: In case of a guarantee executed by a limited company, a banker has to be extra cautious. The banker must verify from company's memorandum and articles of association, where the company has been expressly given such power.

5) Partnership Firms: A partner of a firm cannot bind his co-partners by giving guarantees for loans given by a bank to other parties.

Issue of Guarantees by Banks: The guarantees issued by the bankers are mainly of two types:

1- Money Guarantees: The banker promises to pay the money due by the customer to a third party in the event of the customer's failure to pay on the due date as agreed.

2- Performance Guarantees: They are given by bankers in favour of the Government or public bodies in case of turn-key projects on behalf of contractors undertaking to pay a penalty in the event of non-fulfilment of the contract.

Precautions while issuing such guarantees.

1) Obtain reliable credit reports regarding the customers for whom it is giving the guarantee. 2) The guarantee should be given for a short period. 3) The guarantee bond should be called back, ~uly cancelled by the beneficiary after the period of

guarantee is over. Rights of the Creditor (Banker): The banker as a creditor enjoys the following rights in a contract of guarantee:

1. Right to demand payment: As soon as the principal debtor refuses to make payment, the banker as creditor, can demand payments from the surety.

2. Right to claim dividend: When surety becomes insolvent, the creditor or banker is entitled to recover the dues from the estate of the insolvent surety and can claim the pro-ratas dividend.

 

 

Obligations (Liabilities of Creditor): In a contract of guarantee, the banker as a creditor has certain obligations towards surety. If the Creditor defaults in his obligations as imposed by the Indian Contract Act 1872, the surety is discharged from his liability.

1. Not to make any change in Original Contract (Sec. 133): The creditor must not change the terms of the original contract between him and the principal debtor without the consent of the surety. If the creditor changes the terms of the contract without taking the surety into confidence, the surety will be discharged as to transactions subsequent to that change.

2. Not to release the principal debtor (Sec. 134) : The banker is under an obligation not to discharge the principal debtor. According to Section 134 the surety is discharged from his liability if:

i. There is a contract as between the creditor and the principal debtor, by which the principal

debtor is released.

ii. There is any act or omission on the part of the creditor, the legal consequence of which is the discharge of the principal debtor.

3. Not to indulge, with the principal debtor (Sec. 135) : Where the creditor enters into a contract

with the principal debtor whereby he makes a composition with or he agrees not to sue the principal debtor or to extend the time of repayment of the debt, the surety will be discharged from his obligation, unless surety assents to such contract.

4. Not to do any act inconsistent with the right of the surety (Sec. 139): The creditor should not do any act which is inconsistent with the right of surety or not to omit any act which his duty to the surety required him to do under the contract of guarantee and the eventual remedy of the surety himself against the principal debtor is thereby unpaired.

Example: A is a surety for the loan taken by B from P.N.B. on the pledge of wheat stored in the godown of B. The banks does not inspect the godown in the rainy season, during which a part of the wheat stock is damaged due to leakage. The surety is discharged to the extent of loss caused by the negligence on the part of the banker.

5) Not to conceal material facts (Sec. 140) : Any guarantee obtained by a creditor on the basis of misrepresentation or by concealing of material facts by keeping silence is invalid and the surety is discharged from his liability. Example: A engages B as clerk to collect money for him. B fails to account for some of his money and A in consequence calls upon him to furnish security for his duly accounting C agreed to become a surety. A does not acquaint C with B's misconduct. B, afterwards, makes a default C will not be liable because guarantee has' been obtained by the concealment of facts.

 

 

DEBTS RECOVERY TRIUNAL (DRT) Keeping in line with the international trends on helping financial institutions recover their bad Debt quickly and efficiently, the Government of India has constituted thirty three Debt Recovery Tribunals and five Debt Recovery Appellate Tribunals across the country. The Debt Recovery Tribunals are located across the country. Some cities have more than one Debt Recovery Tribunal located therein. New Delhi and Mumbai have three Debt Recovery Tribunals. Chennai and Kolkata have two Debt Recovery Tribunals each. One Debt Recovery Tribunal each has been constituted at Ahmdabad, Allahabad, Aurngabad, Bangalore, Chandigrah, Coimbatore, Cuttack, Ernakulam, Guwahati, Hydrabad, Jabalpur, Jaipur, Lucknow, Nagpur, Patna, Pune, Ranchi and Vishakapatnam. Depending upon the number of cases a Debt Recovery Tribunal is constituted. The Debts Recovery Tribunal has been constituted under Section 3 of The Recovery of Debts Due to Banks and Financial Institutions Act, 1993. The original aim of the Debts Recovery Tribunal was to receive claim applications from Banks and Financial Institutions against their defaulting borrowers. For this the Debts Recovery Tribunal (Procedure) Rules 1993 were also drafted. While initially the Debts Recovery Tribunals did perform well and helped the Banks and Financial Institutions recover substantially large parts of their non performing assets, or their bad debts as they are commonly known, but their progress was stunted when it came to large and powerful borrowers. These borrowers were able to stall the progress in the Debts Recovery Tribunals on various grounds, primarily on the ground that their claims against the lenders were pending in the civil courts, and if the Debts Recovery Tribunal were adjudicate the matter and auction off their properties irreparable damage would occur to them. Apart from the above big lacunae, there were a number of shortcomings too. The dues of workmen against a company, the State dues, and the dues of other non secured creditors all got enmeshed before the Debt Recovery Tribunals. As if these were not sufficient, there was clash of jurisdiction between the Official Liquidators appointed by the High Courts and the Recovery Officers of the Debts Recovery Tribunals. The Official Liquidator, an appointee of a superior authority, took into his possession all the properties, which actually belonged to secured creditors who before the Debts Recovery Tribunal. The High Courts also took umbrage on the activities of the Recovery Officers who away the entire amounts and paid off to the banks leaving nothing for the other claimants, including the workmen. All these and other issues lead to drastic amendments to the Recovery of Debts Due to Banks and Financial Institutions Act by means of an amending notification in the year 2000. While the amending notification of 2000 did bring in some amount rationalization in the jurisdiction of the Debts Recovery Tribunal, yet it was not sufficient to coax the big borrowers to acquiesce to the jurisdiction of the Debts Recovery Tribunal easily. The lenders continued to groan under the weight of the Non Performing Assets. This led to the enactment of one more drastic act titled as the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interests Act, also called as SRFAESI Act or SRFAESIA for short.

 

 

This new Act, the SRFAESI Act, empowered the lenders to take into their possession the secured assets of their borrowers just by giving them notices, and without the need to go through the rigors of a Court procedure. Initially this brought in lot of compliance from borrowers and many a seasoned defaulter coughed up the Bank dues. However the tougher ones punched whole in the new Act too. This led Supreme court striking down certain provisions and allowing the borrowers an adjudicatory forum before their properties could be taken over by the lenders. And the adjudicatory forum turned out to be the Debts Recovery Tribunal. The Debts Recovery Tribunal now deals with two different Acts, namely the Recovery of Debts Due to Banks and Financial Institutions Act as well as the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interests Act. While the aim of the both the Acts is one and the same, their route is different. The Debts Recovery Tribunals have to deal with extraordinary complex commercial laws within the narrow ambit of the two laws. Over the years the Debts Recovery Tribunals have evolved into fine bodies with lot of expertise. There is a plethora of judgments from the Supreme Court as well as the various High Courts which have paved the way of the Debts Recovery Tribunals to chart their courses. The Debts Recovery Tribunal of India have become model institutions for many a country to follow. CONSTITUTION Establishment of Tribnal

1) The Central Government shall, by notification, establish one or more Tribunals, to be known as the Debts Recovery Tribunal, to exercise the jurisdiction, powers and authority conferred on such Tribunal by or under this Act.

2) The Central Government shall also specify, in the notification referred to in sub-section (1), the areas within which the Tribunal may exercise jurisdiction for entertaining and deciding the applications filed before it.

Composition of Tribunal

1) A Tribunal shall consist of one person only (hereinafter referred to as the Presiding Officer) to be appointed, by notification, by the Central Government.

2) Notwithstanding anything contained in sub-section (1), the Central Government may authorize the Presiding Officer of one Tribunal to discharge also the functions of the Presiding Officer of another Tribunal.

Qualifications for Appointment as Presiding Officer A person shall not be qualified for appointment as the Presiding Officer of a Tribunal unless he is, or has been, or is qualified to be, a District Judge. Term of Office

 

 

The Presiding Officer of a Tribunal shall hold office for a term of five years from the date on which he enters upon his office or until he attains the age of sixty-two years, whichever is earlier. Staff of Tribunal

1) The Central Government shall provide the Tribunal with one or more Recovery Officers and such other officers and employees as that government may think fit.

2) The Recovery Officers and other officers and employees of a Tribunal shall discharge their functions under the general superintendence of the Presiding Officer.

3) The salaries and allowances and other conditions of service of the Recovery Officers and other officers and employees of a Tribunal shall be such as may be prescribed.

Resignation and Removal

1) The Presiding Officer of a Tribunal or the Chairperson of an Appellate Tribunal may by notice in writing under his hand addressed to the Central Government, resign his office:

Provided that the Presiding Officer of a Tribunal or the Chairperson of an Appellate Tribunal shall, unless he is permitted by the Central Government to relinquish his office sooner, continue to hold office until the expiry of three months from the date of receipt of such notice or until a person duly appointed as his successor enters upon his office or until the expiry of his term of office, whichever is the earliest. FUNCTIONING AND POWERS (According to the Recovery of Debts due to Banks and Financial Institutions Act, 1993) 1. Jurisdiction, Powers and Authority of Tribunals

(1) A Tribunal shall exercise, on and from the appointed day, the jurisdiction, powers and authority to entertain and decide applications from the banks and financial institutions for recovery of debts due to such banks and financial institutions. (Sec. 17)

2. Bar of Jurisdiction

On and from the appointed day, no court or other authority shall have, or be entitled to exercise, any jurisdiction, powers or authority (except the Supreme Court, and a High Court exercising jurisdiction under Articles 226 and 227 of the Constitution) in relation to the matters specified in section 17. (Sec. 18)

3. Sec. (12) The Tribunal may make an interim order (whether by way of injunction or stay or

attachment) against the defendant to debar him from transferring, alienating or otherwise dealing with, or disposing of, any property and assets belonging to him without the prior permission of the Tribunal. (13) (A) Where, at any stage of the proceedings, the Tribunal is satisfied, by affidavit or otherwise, that the defendant, with intent to obstruct or delay or frustrate the execution of any order for the recovery of debt that may be passed against him, (i) is about to dispose of the whole or any part of his property; or

 

 

(ii) is about to remove the whole or any part of his property from the local limits of the jurisdiction of the Tribunal; or

(iii) is likely to cause any damage or mischief to the property or affect its value by misuse or creating third party interest, the Tribunal may direct the defendant, within a time to be fixed by it, either to furnish security, in such sum as may be specified in the order, to produce and place at the disposal of the Tribunal, when required, the said property or the value of the same, or such portion thereof as may be sufficient to satisfy the certificate for the recovery of debt, or to appear and show cause why he should not furnish security.

(B) Where the defendant fails to show cause why he should not furnish security, or fails to furnish the security required, within the time fixed by the Tribunal, the Tribunal may order the attachment of the whole or such portion of the properties claimed by the applicant as the properties secured in his favour or otherwise owned by the defendant as appears sufficient to satisfy any certificate for the recovery of debt. (14) The applicant shall, unless the Tribunal otherwise directs, specify the property required to be attached and the estimated value thereof .. (15) The Tribunal may also in the order direct the conditional attachment of the whole or any portion of the property specified under sub-section (14). (20) The Tribunal may, after giving the applicant and the defendant an opportunity of being heard, pass such interim or final order, including the order for payment of interest from the date on or before which payment of the amount is found due up to the date of realisation or actual payment, on the application as it thinks fit to meet the ends of justice. (22) (1) The Tribunal and the Appellate Tribunal shall not be bound by the procedure laid down by the Code of Civil Procedure, 1908 (5 of 1908), but shall be guided by the principles of natural justice and, subject to the other provisions of this Act and of any rules, the Tribunal and the Appellate Tribunal shall have powers to regulate their own procedure including the places at which they shall have their sittings. (2) The Tribunal and the Appellate Tribunal shall have, for the purposes of discharging their functions under this Act, the same powers as are vested in a civil court under the Code of Civil Procedure, 1908 (5 of 1908), while trying a suit, in respect of the following matters, namely,- (a) summoning and enforcing the attendance of any person and examining him on oath;

(b) requiring the discovery and production of documents;

(c) receiving evidence on affidavits;

(d) issuing commissions for the examination of witnesses or documents; (e) reviewing its decisions;

(f) dismissing an application for default or deciding it ex parte;

(g) setting aside any order of dismissal of any application for default or any order passed by it ex parte;

(h) any other matter which may be prescribed.

 

 

(3) Any proceeding before the Tribunal or the Appellate Tribunal shall be deemed to be a judicial proceeding within the meaning of sections 193 and 228, and for the purposes of section 196 of the Indian Penal Code (45 of 1860), and the Tribunal or the Appellate Tribunal shall be deemed to be a civil court for all the purposes of section 195 and Chapter XXVI of the Code of Criminal Procedure, 1973 (2 of 1974). Transfer of Pending Cases (1) Every suit or other proceeding pending before any court immediately before the date of establishment of a Tribunal under this Act, being a suit or proceeding the cause of action whereon it is based is such that it would have been, if it had arisen after such establishment, within the jurisdiction of such Tribunal, shall stand transferred on that date to such Tribunal: POWER OF TRIBUNAL TO ISSUE CERTIFICATE OF RECOVERY IN CASE OF DECREE OR ORDER (1) Where a decree or order was passed by any court before the commencement of the Recovery of Debts Due to Banks and Financial Institutions (Amendment) Act, 2000 and has not yet been executed, then, the decree-holder may apply to the Tribunal to pass an order for recovery of the amount. (2) On receipt of an application under sub-section (1), the Tribunal may issue a certificate for recovery to a Recovery Officer. (3) On receipt of a certificate under sub-section (2), the Recovery Officer shall proceed to recover the amount as if it was a certificate in respect of a debt recoverable under this Act.] PROTECTION F ACTION TAKEN IN GOD FAITH No suit, prosecution or other legal proceeding shall lie against the Central Government or against 11 [the Presiding Officer of a Tribunal or the Chairperson of an Appellate Tribunal] or against the Recovery Officer for anything which is in good faith done or intended to be done in pursuance of this Act or any rule or order made thereunder. IMPORTANT QUESTIONS

Q.1. What are the principles of good lending which are followed by bank?

Q.2. Explain the kinds of guarantee.

Q.3. What are the rights and liabilities of sureties?

Q.4. Constitution, functioning and power of Debt Recovery Tribunals. (DRT)

 

 

UNIT - IV MERCHANT BANKING IN INDIA Merchant banking, although a non-banking financial activity, resembles banking function. The functions of merchant banking which originated, and grew in Europe, were enriched by American patronage, and these services are now being provided throughout the world by both banking and non-banking institutions. The terms "Merchant Banking" originated among the Dutch and the Scottish traders, and was later on developed and professionalized in Britain. Definition A set of functions and services rendered by a merchant banker may be termed as 'Merchant Banking'.

1. According to Random House Dictionary, "merchant bank is an organisation that underwrites securities for corporations, advises such clients on mergers and is involved in the ownership of commercial ventures." These organizations are sometimes banks which are not merchants and sometimes which are not banks and sometimes houses which are neither merchants nor banks.

2. According to Charles P.Kindleburger, "merchant banking is the development of banking from commerce which frequently encountered a prolonged intermediate stage known in England originally as merchant banking".

3. According to the Securities and Exchange Board of India (Merchant Bankers) Rules, 1992, management either by making arrangements regarding selling, buying or subscribing to securities or acting as manager, consultant, adviser or rendering corporate advisory services in relation to such issue management.

Merchant banking activity was formally initiated into the Indian capital markets when Grindlays bank received the license from Reserve Bank in 1967. Grindlays started with management of capital issues, recognized the needs of emerging class of Entrepreneurs for diverse financial services ranging from production planning and system design to market research. It even provides management consulting services to meet the requirements of small and medium sectors rather than large sector. Citibank set up its merchant banking division in 1970. The various tasks were performed by this division namely assisting new entrepreneur, evaluating new projects, raising funds through borrowing and issuing equity. Indian banks started banking services as a part of multiple services they offer to their clients in 1972, State Bank of India started the merchant banking division. In the initial years the SBI's objective was to render corporate advice and assistance to small and medium entrepreneurs. Merchant banking activities are of course organized and undertaken in several forms. Commercial banks and foreign development finance institutions have organized them through formation of divisions, nationalized banks have formed subsidiaries, companies and share brokers and consultancies constituted themselves into public limited companies or registered themselves as private limited Companies. Some merchant banking outfits have entered into collaboration with merchant bankers abroad with several branches.

 

 

SEBI (MERCHANT BANKERS) REGULATIONS 1992 Registration of Merchant Bankers with SEBI It is mandatory for a merchant banker to register with the SEBI. Without holding a certificate of registration granted by the Securities and Exchange Board of India, no person can act as a merchant banker in India.

1. Only a body corporate other than a non-banking financial company shall be eligible to get registration as merchant banker.

2. The applicant should not carry on any business other than those connected with the securities market.

3. All applicants for merchant bankers should have qualifications in Finance, Law or Business Management.

4. The applicant should have infrastructure like office space, equipment, manpower etc. 5. The applicant must have at least two employees with prior experience in merchant banking. 6. Any associate company, group company, subsidiary or interconnected company of the applicant

should not have been a registered merchant banker. 7. The applicant should not have been involved in any securities scam or proved guilt of any offence

The various categories for which registration can be obtained are:

1. Category I - To carry on the activity of issue management and to act as adviser, consultant, manager, underwriter, portfolio manager.

2. Category II - To act as adviser, consultant, co-manager, underwriter, portfolio manager. 3. Category III - To act as underwriter, adviser or consultant to an issue 4. Category IV - To act only as adviser or consultant to an issue

The capital requirement for carrying on activity as merchant banker: The capital requirement depends upon the category. The minimum net worth requirement for acting as merchant banker is given below: Category I - Rs. 5 crores Category II - Rs, 50 lakhs Category III - Rs. 20 lakhs Category IV - Nil Procedure for Getting Registration: An application should be submitted to SEBI in Form A of the SEBI (Merchant Bankers) Regulations, 1992. SEBI shall consider the application and on being satisfied, issues a certificate of registration in Form B of the SEBI (Merchant Bankers) Regulations, 1992. Registration Fee Payable to SEBI Rs. 5 lakhs should be paid within 15 days of date of receipt of intimation regarding grant of certificate. Validity period of certificate of registration is three years from the date of issue. Three months before the

 

 

expiry period, an application along with renewal fee of 2.5 lakhs should be submitted to SEBI in Form A of the SEBI (Merchant Bankers) Regulations, 1992. SEBI shall consider the application and on being satisfied renew certificate of registration for a further period of 3 years. Merchant Bankers in India: There are 135 Merchant bankers who are registered with SEBI now in India. There are public sector, Private sector and foreign players registered with SEBI. The below are the examples of a few of the Merchant bankers in each of the Public, private and foreign players. Public sector Merchant Bankers

• SBI CAPITAL MARKETS LTD • PUNJAB NATIONAL BANK • BANK OF MAHARASHTRA • IFCI FINANCIAL SERVICES LTD • KARUR VYSYA BANK LTD, • STATE BANK OF BIKANER AND JAIPUR

Private Sector Merchant Bankers

o ICICI SECURITIES LTD o AXIS BANK LTD.(FORMERLY UTI BANK LTD.) o BAJAJ CAPITAL LTD o TATA CAPITAL MARKETS LTD o ICICI BANK LTD o RELIANCE SECURITIES LIMITED o KOTAK MAHINDRA CAPITAL COMPANY LTD o YES BANK LTD.

• GOLDMAN SACHS (INDIA) SECURITIES PVT. LTD. • MORGAN STANLEY INDIA COMPANY PVT LTD • BARCLAYS SECURITIES (INDIA) PVT. LTD • BANK OF AMERICA, N.A • DEUTSCHE BANK • DEUTSCHE EQUITIES INDIA PRIVATE LIMITED • BARCLAYS BANK PLC • CITIGROUP GLOBAL MARKETS INDIA PVT. LTD. • DSP MERRILL LYNCH L TD • FEDEX SECURITIES LTD • LETTER OF CREDIT AND DEFEND GUARANTEE

LETTER OF CREDIT AND DEFEND GUARANTEE A letter of credit is a promise to pay. Banks issue letters of credit as a way to ensure sellers that they will get paid as long as they do what they have agreed to do.

 

 

Letters of credit are common in international trade because the bank acts as an uninterested party between buyer and seller. For example, importers and exporters might use letters of credit to protect themselves. In addition, communication can be difficult across thousands of miles and different time zones. A letter of credit spells out the details so that everybody's on the same page. Letter of Credit Lingo

To better understand letters of credit, it may help to know the following:

Abbreviations for 'letter of credit' include UC, LC, and LOC

Applicant - the buyer in a transaction

Beneficiary - the seller or ultimate recipient of funds Issuing bank - the bank that promises to pay

Advising bank - helps the beneficiary use the letter of credit

The Money Behind a Letter of Credit A bank promises to pay on behalf of a customer, but where does the money come from? The bank will only issue a letter of credit if they know the buyer will pay. Some buyers have to deposit for already have) enough money to cover the letter of credit, and some customers use a line of credit faith the bank. Sellers must trust that the bank issuing the letter of credit is legitimate. Executing a Letter of Credit A seller only gets paid after performing specific actions that the buyer and seller agree to. For example, the seller may have to deliver merchandise to a shipyard in order to satisfy requirements for the letter of credit. Once the merchandise is delivered, the seller receives documentation proving that he made delivery. The letter of credit now must be paid even if something happens to the merchandise. If a crane falls on the merchandise or the ship sinks, it is not the seller's problem. To pay on a letter of credit, banks simply review documents proving that a seller performed his required actions. They do not worry about the quality of goods or other items that may be important to the buyer and seller. Pitfalls f Letters of Credit Letters of credit make it possible to do business worldwide. They are important and helpful tools, but you should be careful when using letters of credit. As a seller, make sure you: Carefully review all requirements for the letter of credit before moving forward with a deal. Understand all the documents required. Can get all the documents required for the letter of credit. Understand the time limits associated with the letter of credit, and whether they are reasonable. Know how quickly your service providers (shippers, etc) will produce documents for you. Can get the documents to the bank on time.

 

 

Make all documents required by the letter of credit match the letter of credit application exactly. Getting a Letter of Credit To get a letter of credit, visit your bank. Ask if they can help you with a letter of credit, or if they have any suggestions. Small banks and credit unions might not be able to accommodate you. Some of the Documents Called for under a Letter of Credit Financial Documents Bill of Exchange, Co-accepted Draft Commercial Documents Invoice, Packing list Shipping Documents Transport Document, Insurance Certificate, Commercial, Official or Legal Documents Official Documents License, Embassy legalization, Origin Certificate, Inspection Cert , Phyto-sanitary Certificate Transport Documents Bill of Lading (ocean or multi-modal or Charter party), Airway bill, Lorry/truck receipt, railway receipt, CMC Other than Mate Receipt, Forwarder Cargo Receipt, Deliver Challan ... etc Insurance Document Insurance policy, or certificate but not a cover note. NEGOTIABLE INSTRUMENTS ACT 1881 The Negotiable Instruments Act was passed in 1881. Some provisions of the Act have become redundant due to passage of time, change in methods of doing business and technology changes. However, the basic principles of the Act are still valid and the Act has stood test of time. The Act extends to the whole of India. There is no doubt that the Act is to regulate commercial transactions and was drafted to suit requirements of business conditions then prevailing. The instrument is mainly an instrument of credit readily convertible into money and easily passable from one hand to another Negotiable Instruments The word "negotiable" means "transferable from one person to another in return for consideration" and "instrument" means a "written document by which a right is created in favour of some person." A negotiable instrument is a document which entitles a person to a sum of money and which is transferable from one person to another by mere delivery or by endorsement and delivery. "The great element of negotiability is the acquisition of property by your own conduct, not by another's, that if you take it bona fide and for value, nobody can deprive you of it. Raephal v. Bank of England1 is

 

 

an authority for this proposition. Some banknotes of the Bank of England were stolen in a robbery. The bank immediately prepared and distributed a list of the stolen notes. The plaintiff who was a money-changer in Paris, also received one such list. Twelve months after the receipt of this notice a man came to the plaintiff to exchange a Bank of England note. The plaintiff had no recollection of the notice and completely forgetting it cashed the note. The note turned out to be a stolen one. It was held that the plaintiff, having taken the note in food faith, was entitled to its payment. He was no doubt somewhat negligent, but he had acted honestly. Characteristics of Negotiable Instrument

1. Freely transferable: The property passes from one person to another by delivery, and by endorsement and delivery if it is payable to order.

2. Title of holder free from all defects: A holder in due course, gets the instrument free from all defects in the title of the transferor.

3. Recovery: The holder can sue upon a negotiable instrument in his own name for the recovery of the amount.

4. Presumptions: Certain presumptions are as follows:

a) Consideration: Every negotiable instrument is presumed to have been made, drawn, accepted, endorsed, negotiated or transferred, for consideration.

b) Date: Every negotiable instrument bearing a date is presumed to have been made or drawn on such date.

c) Time of acceptance. d) Time of transfer. e) Order of endorsements. f) Stamp. g) Holder presumed to be a holder in due course. h) Proof of protest.

KINDS F NEGOTIABLE INSTRUMENTS (1) Negotiable by Statute, or

(2) Negotiable by custom or usage.

1. Instruments Negotiable by Statute: Promissory notes, Bills of exchange and Cheques are negotiable by Statute.

2. Instruments Negotiable by Custom or Usage: exchequer bills, bank notes, share warrants, circular notes, bearer debentures, dividend warrants, share certificates with blank transfer deeds,

 

 

etc. In India, Government promissory notes, banker's drafts and pay orders, hundis, delivery orders and railway receipts for goods, have been held to be negotiable by usage or custom.

Section 13 of the Negotiable Instruments Act, 1881, provides that negotiable instruments include promissory note, bill of exchange and cheque, whether payable to bearer or order. "Negotiable instrument": (1) A "negotiable instrument" means a promissory note, bill of exchange or cheque payable either to order or to bearer. Explanation (i) - A promissory note, bill of exchange or cheque is payable to the order which is expressed to be so payable or which is expressed to be payable to a particular person, and does not contain words, prohibiting transfer or indicating an intention that it shall not be transferable. Explanation (iij - A promissory note, bill of exchange or cheque is payable to bearer which is expressed to be so payable or on which the only or last endorsement is an endorsement in blank. Explanation (iii) - Where a promissory note, bill of exchange or cheque, either originally or by endorsement, is expressed to be payable to the order of a specified person, and not to him or his order, it is nevertheless payable to him or his order at his option. A negotiable instrument may be payable to two or more payees jointly, or it may be made payable in the alternative to one of two, or one or some of several payees. Promissory Note A 'promissory note' is an instrument in writing (not being a bank note or a currency note) containing an unconditional undertaking signed by the maker, to pay a certain sum of money only to, or to order of, a certain person, or to the bearer of the instrument (Sec. 4 N.!. Act 1881) The person who makes the promissory note and promises to pay is called the payer. Illustration

(a) I promise to pay B or order Rs. 500 (b) I acknowledge myself to be indebted to B in Rs. 1000, to be paid on demand, for value

received. Specimen of a Promissory Note Rs. 1,000 Dehi, February 10,2010 Three months after date I promise to pay Hari Mohan or order the sum of one thousand rupees, for value received. To, Hari Mohan Stamp 222, Ashok Vihar Delhi-110052 Essential Elements

 

 

1. Writing: Writing includes print and typewriting and may also be in pencil or ink 2. Promise to Pay: The instrument must contain an express promise to pay. 3. Definite and Unconditional: The promise to pay must be definite and unconditional. If it is

uncertain or conditional, the instrument is invalid. 4. Beardsley v Baldwin a written undertaking to pay a sum of money within so many days after the

defendant's marriage was not recognized as a promissory note, because possibly the defendant may never marry and the sum may never become payable.

5. Signed by the Maker: Signature means the writing of a person's name in order to authenticate and give effect to the contract contained in the instrument.

6. Certain Parties: The instrument must point out with certainty as to who the maker is and who the payee is. A promissory note cannot be made payable to the maker (promisor) himself.

7. Certain Sum of Money: The sum payable must be certain and must not be capable of contingent additions or subtractions.

8. Promise to Pay Money only: If the instrument contains a promise to pay something other than money or something in addition to money, it cannot be a promissory note.

9. Bank note or currency note is not a promissory note. This is because a bank note or a currency note is money itself.

10. Formalities like number, date, place, consideration, etc. The omission of the words 'for value received', the place where the instrument is made or where it is payable or date (if the date of execution of the instrument can be independently proved) do not invalidate the instrument. The date of a promissory note is also not necessary unless the amount is payable at a certain time after date. But it must bear the necessary stamp under the Indian Stamp Act, 1899.

11. It may be payable on demand or after a definite period of time. 12. It cannot be made payable to bearer on demand. Bill of Exchange

A bill of exchange is an instrument in writing containing an unconditional order, signed by the maker, directing a certain person to pay a certain sum of money only to, or to the order of, a certain person or to the bearer of the instrument (Sec. 5 N.!. Act 1881). Parties to a bill. There are there parties to a bill of exchange, viz., the drawer, the drawee and the payee. The person who gives the order to payor who makes the bill is called the drawer. The person who is directed to pay is called the drawee. When the drawee accepts the bill, he is called the acceptor. The person to whom the payment is to be made is called the payee. Where the payee named in a bill s a fictitious or non-existing person, the bill is treated as payable to bearer. The drawer or the payee who is in possession of the bill is called the holder. When the holder endorses the bill, note or cheque, he is called the endorser. The person to whom the bill, note or cheque is endorsed is called the endorsee.

 

 

When in the bill or in any endorsement thereon the name of any person is given in addition to the drawee to be referred to in case of need, such person is called a drawee in case of need (Sec. 7, para 2). Specimen of a Bill of Exchange Rs. 500 Mumbai, Jan. 10 2010 Three months after date pay to Shyam or order the sum of five hundred rupees, for vaue received. To, Ram 235, Subhash Marg, Delhi-110006 In case of need with Accepted Stamp Canara Bank, Delhi Ram Sd/- Krishan Essential Elements:

1) It must be in writing 2) It must contain an order to pay

In Ruff v Webb3 the plaintiff Ruff was a servant of the defendant Webb. The defendant dismissed him from service and for his wages gave him a draft in the following words: "Mr. Nelson will much oblige Mr. Webb by paying to J Ruff or order, twenty guineas on his account."

Lord Kenyon was of opinion that the "paper ... was a bill of exchange, that it was an order by one person to another to pay money to the plaintiff or his order." It is quite apparent that the language of the draft was very polite, but it has been said that "the introduction of the terms of gratitude does not destroy the promise (or order) to pay."

3) The order must be unconditional 4) It requires three parties. First, the person who makes the bill of exchange, called the drawer; second, the person to whom it is addressed, called the drawee and, thirdly, the payee. All these parties must be indicated with reasonable certainly. Sometimes the drawer and the payee are the same persons as where a bill is drawn "Pay to me or my order". In such a case these are only two parties but without this minimum of two there cannot be a bill of exchange.

5) The parties must be certain. 6) It must be signed by the drawer. 7) The sum payable must be certain. 8) It must contain an order to pay money. 9) The formalities relating to number, date, place and consideration, though usually found in bills,

are not essential in law.

 

 

Distinction between a bill of exchange and a promissory note

1. In a note there are two parties - the maker and the payee. In a bill there are three parties - the drawer, the drawee and the payee.

2. A note contains an unconditional promise to pay. A bill contains an unconditional order to pay. 3. The maker of a note is the debtor and he himself undertakes to pay. The drawer of a bill is the

creditor who directs the drawee (his debtor) to pay. 4. The liability of the maker of a note is primary and absolute, whereas the liability of the drawer of

a bill is secondary and conditional. 5. A note cannot be made payable to the maker himself, whereas in a bill the drawer and the payee,

may be one and the same person. Cheque A cheque is a bill of exchange drawn on a specified banker and not expressed to be payable otherwise than on demand. Sec.6 of N.1. Act 1881. A cheque being a bill of exchange must possess all the essentials of a bill and should also meet the requirements of Section 6.4 For instance, in the case of Cole v Milson5, a document was drawn absolutely in the form of a cheque. It was made payable to "cash or order." The question was whether it was a valid cheque. Section 5 of the Indian Act and Section 3(1) of the English Act require that a bill of exchange must be made payable to or to the order of a specified person or to bearer. This document was made payable to "cash or order". Hence, it was· not payable to any person or to bearer and, therefore, was not a bill of exchange within the meaning of the above sections. And if it was not a bill of exchange, it could not be a cheque either. R. Pillai v S. Ayyar A District Board had its funds in a Government Treasury and used to withdraw money by issuing orders in the form of cheques. One such unconditional order in writing have been issued the question was whether it was a cheque. Ayyar J held that "Treasury is not a bank" and, therefore, the order was not a cheque under Section 6, but a bill of exchange under Section 5. The reason is that every person who receives the money of another and pays it according to hi orders cannot be regarded as a banker, unless he establishes that business for profit. A cheque is a bill of exchange drawn upon a specified banker and payable on demand and it includes the electronic image of a truncated cheque and a cheque in the electronic form. A truncated cheque means a cheque which is truncated during the course of a clearing cycle, either by the clearing house or by the bank whether paying or receiving payment, immediately on generation of an electronic image for transmission, substituting the further physical movement of the cheque in ',vriting. Clearing house" means the clearing house managed by the Reserve Bank of India or a clearing house recognized as such by the Reserve Bank of India [Sec. 6 as substituted by the Negotiable Instruments i Amendment and Miscellaneous Provisions) Act, 2002] A cheque has the following two additional qualifications, viz.,

 

 

It is always drawn on a specified banker, and

It is always payable on demand.

All cheques are bills of exchange, but all bills of exchange are not cheques. A cheque must have all the essential requisites of a bill of exchange. It must be signed by the drawer. It must contain an unconditional order on a specified banker to pay a certain sum of money to or to the order of a specified person or the bearer of the cheque. But it does not require acceptance as it is intended for immediate payment. The usual form of bank cheque is as follows: No……………… Date …………….200

Punjab National Bank

Subzi Mandi, Delhi-110007 Pay …………….. r bearer the sum of Rs…………………………………………………. Rs………….. Sd/- Distinction between a Bill of Exchange and a Cheque

1) A bill of exchange may be drawn on any person, including a banker, but a cheque is always drawn on a banker.

2) A bill must be accepted before the drawee can be called upon to make payment upon it. A cheque requires no acceptance.

3) A bill which is not expressed to be payable on demand is entitled to three days of grace. A cheque is not entitled to any days of grace.

4) A bill may be payable on demand or after the expiry of a certain period after date or sight. A cheque is always payable on demand.

5) A cheque may be crossed but not a bill.

6) A cheque does not require any stamp whereas a bill, except in certain cases, must be stamped. Crossing of Cheque There are two types of cheques, open cheques and crossed cheques. A cheque which is payable in cash across the counter of a bank is called an open cheque. A crossed cheque is one on which two parallel transverse lines with or without the words '& Co.' are drawn. The payment of such a cheque can be obtained only through a banker. Thus crossing is a direction to the drawee banker to pay the amount of money on a crossed cheque generally to a banker or a particular banker so that the party who obtains the payment of the cheque can be easily traced.

 

 

Types of Crossing: There are two types of crossing, viz., (1) General crossing, and (2) special crossing Another type of crossing known as 'restrictive crossing' has developed out of business usage.

1) General Crossing: A Cheque is said to be crossed generally where it bears across its face an addition of

a) The words 'and company' or any abbreviation thereof, between two parallel transverse lines,

either with or without the words 'not negotiable'; or b) Two parallel transverse lines simply, either with or without the words 'not negotiable' (Sec. 123).

Specimens of general crossing: Where a cheque is crossed generally, the drawee banker shall not pay it unless it is presented by a banker (Sec. 126 para 1).

2) Special Crossing: Where a cheque bears across its face an addition of the name of a banker, either with or without the words 'not negotiable', the cheque is deemed to be crossed specially (Sec. 124). Transverse lines are not necessary in case of a special crossing. The payment of a specially crossed cheque can be obtained only through the particular banker whose name appears across the face of the cheque or between the transverse lines, if any Specimens of Special Crossing: Where" a cheque is crossed specially the banker on whom it is drawn shall pay it only to the banker on whom it is crossed, or his agent for collection (Sec. 126, para 2).

3) Restrictive Crossing: In this type of crossing the words 'Ale payee' are added to the general or special crossing.

Specimens of Restrictive Crossing: The words 'Ale Payee' on a cheque are a direction to the collecting banker that the amount collected on the cheque is to be credited to the account of the payee. If he credits the proceeds to a different account, he is prima facie guilty of negligence and will be liable to the true owner for the amount of the cheque it should however be noted that 'Ale Payee' cheques are negotiable.

Not Negotiable Crossing The title of the transferee of such a cheque cannot be better than that of its transferor. The addition of the words 'not negotiable' does not restrict the further transferability of the cheque. It only takes away the main feature of negotiability, which is, that a holder with a defective title can give a good title to a subsequent holder in due course. Anyone who takes a cheque marked 'not negotiable' takes it at his own risk.

 

 

Who may cross a cheque (Sec. 126) A cheque may be crossed by

1) The drawer: He may cross the cheque generally or specially.

2) The holder: Where the cheque is uncrossed, the holder may cross it generally or specially. Where it is crossed generally, he may cross it specially. Where it is crossed generally or specially, he may add the words 'Not Negotiable'.

3) The banker: Where a cheque is crossed specially, the banker to whom it is crossed may again

cross it specially to another banker (his agent) for collection. Holder and Holder in Due Course Holder (Sec. 8): The "holder" of a promissory note, bill of exchange or cheque means any person entitled in his own name (i) to the possession thereof, and (ii) to receive or recover the amount due thereon from the parties thereto. Where the note, bill or chqeue is lost or destroyed, its holder is the person so entitled at the time of such loss or destruction. Sarjoo Prasad v Rampayari Debi. The plaintiff advanced a sum of Rs. 2459 under a hand note. The note was executed not in the name of the plaintiff, but in the name of one X who was a name-lender or a benamidar. On maturity the plaintiff brought an action to recover the amount. The High Court of Patna rejected his claim. He was not entitled to the possession of the note 'in his own name' and, therefore, was not the holder. HOLDER AND HOLDER IN DUE CURSE (SEC.9) 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 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 form whom he derived his title. The phrase "in good faith and for value" has been split up by Section 9 into four elements all of which must concur to make a holder in due course. They are: (1) The holder must have taken the instrument for value. (2) He must have obtained the instrument before its maturity. (3) The instrument must be complete and regular on its face. (4) He must have taken the instrument in good faith and without notice of any defect either in the instrument or in the title of the person negotiating it to him. Any person is a 'holder in due course' if he fulfils the following conditions:

1) That, for consideration, he became (i) the possessor of the negotiable instrument if payable to bearer, or (ii) the payee or endorsee thereof, if payable to order.

 

 

2) That he became the holder of the instrument before its maturity.

3) That he became the holder of the instrument in good faith, i.e., without sufficient cause to believe

that any infirmity in the instrument of defect existed in the title of the person from whom he derived his title.

A holder of a negotiable instrument will not be a holder in due course if -

1) He has obtained the instrument by gift or for an unlawful consideration or by some illegal method; or

2) He has obtained the instrument after its maturity; or 3) He has not obtained the instrument bona fide.

Privileges of a Holder in Due Course: A holder in due course gets title to a negotiable instrument free from equities. The special privileges of a holder in due course are as follows:

1) Inchoate Stamped Instrument: A person, who has signed and delivered to another a stamped but otherwise inchoate instrument, is precluded from asserting, as against a holder in due course, that the instrument has not been filled in accordance with the authority given by him, the stamp being sufficient to cover the amount. Suppose A signs his name on a blank but stamped instrument. He gives the paper to B with authority to fill it up as a promissory note for Rs. 250 only. But B fraudulently fills the paper for Rs 1000, the stamp put upon it being sufficient to cover the amount. He then hands it to H for Rs. 1000, who takes it without notice of fraud.8 A will be bound to pay the full amount to H, because under this section it does not lie in the mouth of the signer to say that in filling the instrument his authority has been exceeded.

2) Liability of Prior Parties: Every prior party to a negotiable instrument is liable thereon to a holder in due course untitle the instrument is duly satisfied.

3) Negotiable Instrument Without Consideration : When a negotiable instrument is made, drawn, accepted or transferred without consideration. An agreement made without consideration is void (Sec. 25 of the Indian Contract Act, 1872). But if the negotiable instrument gets into the hands of a holder in due course, he can recover the amount on it from any of the prior parties thereto.

4) Conditional Delivery: If a bill or note is negotiated to a holder in due course, the other parties to the instrument cannot avoid liability on the ground that the delivery of the instrument was conditional or for a special purpose only (Sec. 46, para 3)

5) Every Holder is a Holder in Due Course: The law presumes that every holder is a holder in due course, although the presumption is rebuttable (Sec. 118).

 

 

6) Presumptions: The first privilege is that "every holder is deemed prima facie to be a holder in

due course". The burden of proving his title does not lie on him. If the defendant intends to set up the defence that there was something wrong in the inception or subsequent negotiations of the bill the burden of proving that lies on him. Once it is shown that the history of the bill is tainted with fraud or illegality the burden is shifted to the holder to prove that he is a holder in due course.9 When the burden of establishing his bona fides is thus cast upon the holder, he has to show either that subsequently to the alleged fraud or illegality value has in good faith been given for the instrument or that he is a bona fide holder for value.

7) Endorsee from Holder in Due Course: A holder who receives an instrument from a holder in due course gets the rights of the holder in due course, even if he had knowledge of the prior defects, provide that he was not a party to them. This will apply to the case of a drawer also who has received back his bill from a holder in due course. A seller drew a bill upon his buyer for the price of two consignments of steel the seller discounted the bill with a bank which transferred it to another bank. It was accepted by the buyer in due course, but he ultimately refused payment because of a dispute about the quality of steel. The bill came back to the seller by the process of negotiation back. The seller claimed payment of the bill from the buyer. It was held that although the seller was the drawer, he was also the holder in due course and his rights fell to be determined as such. Similarly, where a bill came by process of negotiation to the possession of a bank, who was the drawer's banker, and though he knew the drawer to be in insolvent circumstances, he was held to be a holder in due course because he had taken the bill from a holder in due course.

IMPORTANT QUESTIONS Q.1. Explain the following:

a) Letter of credit b) Guarantee

Q.2. What do you mean by negotiable instruments? Also explain its kinds. Q.3. What do you mean by cheque? State different types of crossing of cheque and effect of each. Q.4. Explain the promissory note and bill of exchange. Q.5. Write short note on

Holder Holder in due course

 

 

UNIT-V NEGOTIABLE INSTRUMENTS ACT 1881 NEGOTIATION One of the essential characteristics of a negotiable instrument is that it is freely transferable from one person to another. This transfer may take place either -

1. by negotiation, or

2. by assignment

1) Transfer by Negotiation: When a promissory note, bill of exchange or cheque is transferred by one party to another, so as to constitute the transferee the holder thereof, the instrument is said to be negotiated (Sec. 14). Two methods of transfer by negotiation, namely- a) Negotiation by delivery. An instrument payable to bearer is negotiable by delivery thereof (Sec. 47). b) Negotiation by endorsement and delivery. An instrument payable to order is negotiable by the holder by endorsement and delivery thereof (Sec. 48). Kinds of Delivery: Delivery may be (1) actual, (2) constructive, or (3) conditional or for a special purpose. Actual delivery takes place when the instrument changes hands physically. Constructive delivery takes place when the instrument is delivered to the agent, or servant of the endorsee on his behalf or when the endorser, after endorsement, holds the instrument as an agent of the endorsee. 2) Transfer by Assignment: When a person transfers his right to receive the payment of a debt. 'assignment of the debt' takes place. The Negotiable Instruments Act does not deal with transfer of negotiable instruments by assignment. Distinction between Negotiation and Assignment Negotiation

1. Consideration is presumed. 2. The title of the transferee (i.e., the holder in due course) is better than that of the transferor.

Instruments payable to bearer are negotiated by mere delivery and instrument payable to order are negotiated by endorsement and delivery. Assignment

 

 

1. Consideration must be proved. 2. The title of the assignee is subject to the defects and equities in the title of the assignor. 3. An assignment can only be made in writing either on the instrument itself or in a separate

document transferring to the assignee the transferor's rights in the instrument. PRESENTMENT Presentment of a Negotiable Instrument: Presentment means showing an instrument to the drawee, acceptor or maker for acceptance, sight or payment. There are, therefore, three kinds of presentment:

1. Presentment of bills of exchange for acceptance.

2. Presentment of promissory notes for sight.

3. Presentment of negotiable instruments for payment.

1. Presentment for Acceptance It is only bills of exchange of a certain type that require acceptance. A bill is said to be accepted when the drawee puts his signature on it signifying his assent to the order of the drawer that he will pay the bill at the time when it is due. The essentials of a valid acceptance are as follows:

a) It must be written on the bill.

b) It must be signed by the drawee personally or through a duly authorized agent.

c) The accepted bill must be delivered to the holder.

Presentment for acceptance must be made at a reasonable hour on a business day and before the bill is overdue (Sec. 61). Modes of Acceptance: An acceptance may be general or qualified. General Acceptance: An acceptance is general or absolute where the drawee, while accepting the bill, does not attach any condition or qualification to it. Qualified Acceptance: An acceptance is qualified where it is given subject to some condition or qualification.

2) Presentment for Sight : A note payable at a certain period after sight must, however, be presented to the maker for sight in order to fix its maturity. The presentment should be made during business hours on a business day. In default of such presentment, no party thereto is liable thereon to the person making such default (Sec. 62).

3) Presentment for Payment: Promissory notes, bills of exchange and cheques must be presented for payment to the maker, acceptor or drawee thereof respectively, by or on behalf of the holder.

 

 

DISCHARGE FROM LIABILITY

The term 'discharge' in relation to a negotiable instrument is used in two senses, viz.,

a) discharge of the instrument, and

b) discharge of one or more of the parties from liability thereon. An instrument is said to be discharged when all rights of action under it are completely extinguished and when it ceases to be negotiable. Discharge of an Instrument

1. By payment in due course. The instrument is discharged by payment made in due course by the party who is primarily liable to pay (Le., the maker or the acceptor), or by a person who is accommodated in case the instrument was made or accepted for his accommodation.

2. By party primarily liable becoming holder. If the maker of a note or the acceptor of a bill becomes its holder at or after its maturity in his own right (Le., he has an absolute title and does not hold it conditionally or as an agent), the instrument is discharged (Sec. 90).

3. By express waiver. When the holder of a negotiable instrument at or after its maturity absolutely and unconditionally renounces in writing or gives up his rights against all the parties to the instrument, the instrument is discharged.

4. By cancellation. Where an instrument is intentionally cancelled by the holder or his agent and the cancellation is apparent thereon, the instrument is discharged.

5. By discharge as a simple contract. A negotiable instrument may be discharged in the same way as any other contract for the payment of money.

Discharge of a Party or Parties

1. By Payment: When payment on an instrument is made in due course, both the instrument and the

parties to it are discharged [Sec. 82 (c)].

2. By Cancellation: When the holder of a negotiable instrument or his agent cancels the name of a party on the instrument with intent to discharge him, such party and all subsequent parties, who have a right of recourse against the party whose name is cancelled, are discharged from liability to the holder [Sec. 82 (a)].

 

 

3. By Release: Where the holder of a negotiable instrument releases any party to the instrument by any method other than cancellation, the party so released is discharged from liability [Sec. 82 (b)].

4. By Allowing drawee more than forty-eight hours: If the holder of a bill of exchange allows the drawee more than forty-eight hours exclusive of public holidays, to consider whether he will accept the same, all previous parties not consenting to such allowance are thereby discharged from liability to such holder (Sec. 83).

5. By Non-presentment of cheque: Where a cheque is not presented by the holder for payment within a reasonable time of its issue and the drawer suffers actual damage through the delay because of the failure of the bank, he is discharged from liability to the extent of such damage.

6. Cheque payable to order: Where a cheque payable to order purports to be endorsed by the payee, the banker is discharged by payment in due course. Where a cheque is originally expressed to be payable to bearer the drawee is discharged by payment in due course to the bearer thereof.

DISHONOUR A bill may be dishonoured by non-acceptance or by non-payment. A promissory note and a cheque are dishonoured by non-payment only. When a negotiable instrument is dishonoured, the holder must give a notice of dishonour to all the prior parties in order to make them liable on the instrument. Dishonour by non-acceptance (Sec. 91) A bill of exchange is dishonoured by non-acceptance in anyone of the following ways:

1. If the drawee does not accept the bill within forty-eight hours from the time of presentment

though it is duly presented for acceptance;

2. If there are several drawees (who are not partners) and all of them do not accept;

3. When presentment for acceptance is excused, and the bill is not accepted;

4. When the drawee is incompetent to contract;

5. When the drawee gives a qualified acceptance;

6. When the drawee is a fictitious person or after reasonable search cannot be found.

Dishonour by non-payment (Sec. 92)

A promissory note, bill of exchange or cheque is said to be dishonoured by non-payment when the maker of the note, acceptor of the bill or drawee of the cheque makes default in payment upon being duly required to pay the same. (Sec. 92). Notice of Dishonour

 

 

When a negotiable instrument is dishonoured either by non-acceptance or by non-acceptance or by non-payment, the holder of the instrument or some party to it who is liable thereon, must give a notice of dishonour to all the prior parties whom he wants to make liable on the instrument. THE PAYING BANKER The bank of while a cheque is drawn (the bank whose name is printed on the cheque) and which pays the amount for which the cheque is writen and deducts that sum from the customer's account. THE COLLECTING BANKERS Collection of cheques, bills of exchange and other instruments on behalf of a customer is an indispensable service rendered by a modern banker to his customer. When a customer of a banker receives a cheque drawn on any other banker he has two options before him - (i) either to receive its payment personally or through his agent at the drawee bank, or (ii) to send it to his banker for the purpose of collection from the drawee bank. In the latter case the banker, deputed to collect the amount of the cheque from another banker, is called the 'collection banker' he presents the cheque of encashment to the drawee banker and on its realisation credits the account of the customer with the amount so realised. A banker is under no legal obligation to collect his customer's cheques but collection of cheques has now become an important function of a banker with the growth of banking habit and with wider use of crossed cheques, which are invariably to be collected through a banker only. While collecting his customer's cheques, a banker acts either. (i) As a holder for value, or (ii) As an agent of the customer The legal position of the collection banker, therefore, depends upon the capacity in which he collects the cheques. It does not make any difference if the collection banker presents the cheque through the clearing house. 1. Collecting banker as Holder for Value: Collection of cheques takes some time, specially in case of

outstation cheques. If the collecting banker pays to the customer the amount of the cheque or credits such amount to his account and allows him to draw on it, before the amount of the cheque is actually realised from the drawee banker, the collecting banker is deemed to be its 'holder for value'. He takes an undertaking from the customer to the effect that the latter will reimburse the former in case of dishonor of the cheque.

A banker becomes its holder for value by giving its value to the customer in any of the following ways: (a) by lending further on the strength of the cheque;

(b) by paying over the amount of the cheque or part of it in cash or in account before it is

cleared;

(c) by agreeing either then or earlier, or as a course of business, that customer may draw

before the cheque is cleared;

(d) by accepting the cheque in avowed reduction of an existing overdraft; and

 

 

(e) by giving cash over the counter for the cheque at the time it is paid in for collection. In any of these circumstances the banker becomes the holder for value and also the holder in due course. He bears the liability and possesses the right s enjoyed by the holder for value. If the last but one endorsement is proved to be forged, he will be liable to the true owner of the cheque. But he shall have the right to recover the money from the last endorser, Le., his own customer. If the customer is unable to pay, the banker himself will bear the loss. If the cheque sent for collection is returned dishonored, the collecting banker can sue all the previous parties after giving them notice of dishonor. It is, however, essential that the amount of the cheque is paid to the customer in good faith. 2. Collecting Banker as an Agent : A collecting banker acts as an agent of the customer if he credits

the latter's account with the amount of he cheque after amount is actually realised from the drawee banker. Thereafter the customer is entitled to draw the amount of the cheque. The banker thus acts as an agent of the customer and charges from him a commission of collecting the amount from outstation banks.

As an agent of his customer, the collecting banker does not possess title to the cheque better than that of the customer. If the customer has no title thereto, or his title is defective, the collecting banker cannot have good title to the cheque. In case the cheque collected by him did not belong to his customer, he will be held liable for 'conversion of money' i.e., illegally interfering with the rights of the true owner of the cheque. Functions of a Collecting Banker (i) Collecting Banker as Holder for Value: When a collecting banker pays to the customer the amount of the cheque or credit such amount to his account and allows him to draw it, before the amount of the cheque is in fact realised from the drawee banker, the collecting banker will be known as holder for value of the cheque. The customer in such case is obliged to reimburse the banker if the cheque is dishonoured. (ii) The Rights of a Banker as Holder for Value: In either case aforementioned, the banker would bear the liability and possess the rights enjoyed by the holder for value. If the last but one endorsement is proved to be forged, the collecting banker would be liable to the true owner of the cheque. (iii) Banker as an Agent: A collecting banker acts as an agent to a principal, who is his customer. Arising from this legal burden the collecting banker enters Ipso facto into the region of Section 212, inter alia of the Contract Act, 1872. This section concerns itself expansively with the skill and diligence required from an agent, by emphasizing that an Agent is bound to conduct the business of agency with as much skill as is generally possessed by persons engaged in similar business, unless the principal has notice of his want to skill. The Agent is always bound to act with reasonable diligence, and to use such skill as he possesses.

 

 

(iv) Conversion: Conversion has not been defined in the Negotiable Instruments Act, 1881. As per Thomson's Dictionary of Banking, "Any person who, however innocently obtains possession of goods or the property of another who has been fraudulently deprived of the possession of them and disposes of them, whether for his own benefit or that of another person is guilty of conversion." Hollins vs. Fowler, (1875) LT 7 HL 757. Conversion means unlawful possession use, deposing or destroying of goods or property by a person, whether for his own benefit or that of another person, in a manner inconsistent with the owner's right of possession. Thus, conversion is the wrongful interference with the goods of another person inconsistent with the owner's right of possession. The term 'goods' includes bill of exchange, cheque or promissory note. Conversion may be committed innocently. Conversion is a wrong that renders the person committing it personally liable. Thus liability exists even when a person acts merely as an agent. For example, A draws a cheque for Rs. one lakh favouring B from whom it is stolen by C, the thief. Here, C is guilty of conversion and liable for the amount of the cheque to B, the true owner. But suppose C pays the cheque into his account with the bank which collects the proceeds from the drawee bank. C then withdraws the money and disappears, or merely spends it. Inspite of complete innocence of the actual theft, C's bank as his agent is itself now liable for conversion when the true owner B, discovers his loss, he will seek to recover it from C's bank which always has ample funds to meet such claims, while the thief has rarely and money or assets to pay over when he is caught. Thus, the bank may be liable for the amount of the cheque which is collect quite innocently as agent of a customer who had no title to it. The term 'customer' of a bank is not defined by law. Ordinarily, a person who has an account in a bank is considered its customer. Banking experts and the legal judgments in the past, however, used to qualify this statement by laying emphasis on the bank. To constitute a customer the following essential requisites must be fulfilled:

(i) a bank account - savings, current or fixed deposit - must be opened in his name by making necessary deposit of money, and

(ii) The dealing between the banker and the customer must be of the nature of banking business. A customer of a banker need not necessarily be a person. A firm, joint stock Company, a society or any separate legal entity may be a customer. Explanation to section 45-Z of the Banking Regulation Act, 1947, clarifies that in that section "customer" includes a Government department and a corporation incorporated by or under any law.

General Relationship between Banker and Customer A banker renders a number of services to his customer. The relationship between them primarily is that of a creditor and a debtor. A banker also acts as an agent r trustee of his customer if the latter entrusts the former with agency or trust work. In such cases, or the banker acts as a debtor an agent and a trustee simultaneously but in relation to the specified business. Relationship as Debtor and Creditor: On the opening of an account the banker assumes the position of a debtor. He is not a depository or trustee of the customer's money because the money handed over to the

 

 

banker becomes a debt due from him to the customer. A depository accepts something for safe custody on the condition that it will not be opened or replaced by similar commodity. A banker does not accept the depositors money on such condition. The money deposited by the customer with the banker is in legal terms, lent by the customer to the banker, who makes use of the same according to his discretion. The creditor has the right to demand back his money from the banker, and banker is under an obligation to repay the debt as and when he is required to do so. But it is not necessary that the repayment is made in terms of the same currency notes and coins. The payment, of course, must be made in terms of legal tender currency of the country. A depositor remains a creditor of his banker so long as his account carries a credit balance. But he does not get any charge over the assets of his debtor/banker and remains an unsecured creditor or the banker. Since the introduction of deposit insurance in India in 1962, the element of risk to the depositor is minimised as the Deposit Insurance and Credit Guarantee Corporation undertakes to insure the deposits up to a specified amount. Banker's relationship with the customer is reversed as soon as the customer's account is overdrawn. Banker becomes creditor of the customer who has taken a loan from the banker and continues in that capacity till the loan is repaid. As the loans and advances granted by a banker are usually secured by the tangible assets of the borrower, the banker becomes secured creditor of his customer. (i) The creditor must demand payment.

(ii) Proper place and time of demand.

(iii) Demand must be made in proper manner

Banker as Trustee: A banker is a debtor of his customer in respect of the deposits made by the latter, but in certain circumstances he acts as a trustee also. A trustee holds money or assets and performs certain functions for the benefit of some other person called the beneficiary. For example, if the customer deposits securities or other valuables with the banker for safe custody, the latter acts as a trustee of his customer. The customer continues to be the owner of the valuables deposited with the banker. The legal position of the banker is as a trustee Banker as Agent: A banker acts as an agent of his customer and performs a number of agency functions for the convenience of his customers. For example, he buys or sells securities in behalf of his customer, collects cheques on his on his behalf and makes payment of various dues of his customers, e.g., insurance premium, etc. the range of such agency functions has become much wider and the banks are now rendering large number of agency services of diverse nature. For example, some banks have established Tax Service Departments to take up the tax problems of their customers. IMPORTANT QUESTIONS Q.1. Who is customer? Explain the relationship between customer and bank. Q.2. What is meaning of collecting banker? Express the duties and functions of collecting bankers.

 

 

Q.3. Write short notes on following:

a) Negotiation

b) Presentment

SUGGESTED READINGS

1. Banking Law & Practice, S.N. Maheshwari

2. Banking Law & Practice, P.N. Varshney

3. The Banking Law in Theory & Practice, S.N. Gupta

4. Negotiable Instrument Act, Dr. Avtar Singh

5. Tannen's Banking Law & Practice in India, M.L. Tannen

6. Banking Law & Practice, T.K. Mukherjee