MASTER OF BUSINESS LAWS (MBL)–PART I

COURSE NO. II
MODULE NOS. I-IX

BANKING LAW

MODULE ASSIGNMENT

SUBMITTED BY:

RAJ RAJESHWARI SHUKLA

I.D. NO.8987
YEAR OF ADMISSION 2007-2008

DISTANCE EDUCATION DEPARTMENT

NATIONAL LAW SCHOOL OF INDIA UNIVERSITY
BANGALORE-560 072
 MODULE – I

STRUCTURE AND FUNCTIONS OF COMMERCIAL BANKS AND

FINANCIAL INSTITUTIONS.

Ans.1. Regional Rural Banks (RRB’s): The RRB’s have been set up
under the Regional Rural Banks Act of 1976. The main objective of
RRB’s is to provide credit and other facilities particularly to small and
marginal farmers, agricultural laborers, artisans and small entrepreneurs
and develop agriculture, trade, commerce, industry and other productive
activities in rural areas.

The first RRB was set up on October 2, 1975 in Moradabad in Uttar

Pradesh (U.P.). The authorised capital of each Regional Rural Bank is
Rs. 5 crores, out of which 50% shall be subscribed by the Central
Government, 15% by the concerned State Government and the
remaining 35% by the Sponsor Bank.

Since the inception of these Banks till June 2003, 196 RRB’s have been
operating through 14,522 branches. The advances granted to small and
marginal farmers, landless labourers and rural artisans constitutes little
more than 90 percent of the total deposits granted.

National Bank for Agriculture and Rural Development (NABARD). The

NABARD was set up on July 12,1982 as the leader of the entire Rural
Credit system. It has taken over the functions of the agricultural credit
department of RBI and the Agricultural Refinance and Development
Corporation (ARDC).

NABARD is responsible for the development, policy planning operational

matters, coordination, monitoring, research, training etc. relating to rural
credit. It provides refinance to Cooperatives, RRB’s for short, medium
and long term requirements.

Relationship between NABARD and RRB – As NABARD provides

medium term loans from one and a half years to seven years to Regional
Rural Bank’s for agricultural and rural development. In this regard it is a
Bank to RRB’s who can always approach NABARD when in need.
NABARD has the authority to ask for information and statements from
RRB’s with regard to there operations etc. under the Banking Regulation
Act, 1944 RRB’s are required to furnish to NABARD copies of returns
submitted to the Reserve Bank of India. NABARD also has the power to
inspect the RRB’s whenever it feels it is required.

Another interesting part of their relationship is that NABARD undertakes

training to its own staff as well as the staff of Regional Rural Banks in
order to upgrade the technical skills and competence of the staff.

To remedify the various problems concerning RRB’s the Narsimhan

Committee (1991) on RRB’s recommended that the rural subsidiaries of
Commercial Banks should be treated at par with Regard to cash reserves
and statutory liquidity requirements and refinance facilities from
NABARD. All concessions in lending to agriculture and to small industry
should be phased out, and there would be saving in costs of
administration brought through the process of rationalization.

The Narsimhan Committee also recommended that NABARD should help

RRB’s to earn higher level of interest income for their surplus cash
balances and for their funds presently invested in Government Securities
or in Government guaranteed securities for SLR Compliance. This would
also help to increase the earning capacity of RRB’s.

The Reserve Bank of India appointed M C Bhandari Committee to

suggest measures for destructing RRB’s. The committee recommended
that in view of the unsatisfactory recovery position of RRB’s , NABARD
monitors the working of RRB’s, on a quarterly basis, as regards
productivity, cash management, advances portfolio and recovery
performance.

NABARD has devised a package of short term measures for RRB’s:

(a) RRB’s are freed from their service area obligations;

(b) They are allowed to increase there non target group financing
from 40 percent to 60 percent;
(c) They are permitted to relocate same of their loss making branches
at agricultural produce centres, market yards mandis etc.;
(d) They are given freedom to open extension counters;
(e) They are allowed to provide for non – priority sector purposes like
loans for consumer durables and loans for various purposes to both
target groups and non target groups; and
(f) Upgrading and deepening the range of there activities to cover non
fund business such as remittance and discount facilities.

Ans.2. State Bank of India (SBI): The first half of the 19th century, three
Presidency Banks were started with the financial participation of the
Government. In the year 1921, the three presidency banks at Calcutta,
Bombay and Madras were merged into the Imperial Bank vide Imperial
Bank of India Act, 1920.

The Reserve Bank of India appointed a Rural Credit Survey Committee

which recommended the setting up of a State Bank of India. Accordingly,
the State Bank of India was set up in July 1955 which took over the
assets, liabilities and establishment of the Imperial Bank of India.

The State Bank of India is a Shareholder’s Bank, in which majority of the

shares are held by the RBI, and the private shareholders are the minority
shareholders.

The State Bank is managed by the Central Board of Directors consisting

of 20 members. The Central Board (CB) shall be guided by the Central
Government. All such directions of the Central Government shall be
given through the Reserve Bank of India. The Central Board shall consist
of the Chairman to the appointed by the Central Government in
consultation with the Reserve Bank of India, two Managing Directors
appointed by the Central Government in consultation with Reserve Bank
of India, presidents of thirteen local boards and four elected members
elected by shareholders other than by the Reserve Bank of India provided
shareholders hold more than 25% of the share capital. One director taken
from the workmen to be appointed by the Central Government, one
director to be appointed by the Central Government from employees, not
less than two and not more than six directors to be appointed by the
Central Government in Consultation with Reserve Bank of India from
persons having the special knowledge of the working of Cooperative
institutions and of rural economy on experience in commerce, industry,
banking on finance. One nominated Director by the Central Government
and one nominated Director by Reserve Bank of India.

The local boards of all local head offices comprise of the chairman of
officio and Directors of the Central Government coming from that are ex-
officio, six members nominated by the Central Government in
Consultation with Reserve Bank of India, one elected member from the
shareholders other than Reserve Bank of India and Chief General
Manager of the Area. The Governor of the RBI in consultation with
chairman of SBI shall nominate members of the local board.

The local boards shall exercise all powers and perform all functions and
duties of the SBI as may be approved by the Central Board. All questions
are decided by the majority. Similarly local boards are also to meet at
such place and time and observe such rules and procedures as may be
prescribed.

It is quite evident from the above discussion that the Composition of

Board of Directors both at the Central and local level is responsible for
maintaining the operation of efficiency of the State Bank of India. Apart
from performing all the functions, which a commercial bank performs, it
also acts as on agent of Reserve Bank of India at all places in India
where it has a branch and where the Reserve Bank of India has no
Branch. It also plays a special role in rural credit, namely, promoting
Banking Habit in the rural areas and catering to their credit needs.

Ans. 3. Role of State Bank of India: The State Bank of India is the
single largest commercial bank in the country with total deposits of
Rs.96,400/- in 1995 – 96. The SBI Associate banks had total deposits of
Rs.31,200 crores. SBI has the largest amount of deposits, extend the
highest percentage of advances and performs the role of the Reserve
Bank of India wherever the latter has no office.
The State Bank of India Act has been amended recently under
which:
(a) RBI shareholding of SBI has been reduced from 99% to 67%; and
(b) 10% of voting rights have been given to shareholders.
The State Bank of India and other nationalized Banks have been
permitted to raise equity and debentures in the market. SBI has raised
Rs. 3200 crores through public issue of shares and bonds.

The development activities of the State Bank of India and its subsidiaries
have included, besides opening new branches in non banking areas, the
financing of the co-operation movement and of small scale industries. By
March 2005 the State Bank and its associates assisted over 13,800 small
scale business units and other small operations. The most spectacular
progress has been achieved in the filed of rural credit, where the loans
outstanding rose to over Rs. 7450 crores to farmers.

General Assistance of State Bank:

(1) Remittance Facilities – The order to provide extended remittance
facilities, the State Bank has liberalized remittance facilities to State
and Central Co-operative banks and now permits free transfer
facilities.

(2) Loans to Co-operative Banks – The State Bank has also been
granting short term credit facilities to the state and Central Co-
operative Banks against Government securities at a concessional
rate of interest, viz, one half or one percent below its usual advance
rate. The Co-operative Banks and Societies in turn make these
finds available to the farmers.

(3) Financial Accommodation to Marketing and Processing Societies –

The State Bank has undertaken an important aspect of direct
finance to co-operative marketing and processing societies in areas
where they are not able to secure prompt and adequate finance
from Central Co-operative Banks.

Ans. 4.Capital Formation by Commercial Banks – Commercial Banks

accelerate the process of economic development in an economy by
capital formation. It has been seen throughout the years that inadequacy
of capital is the single most influential reason for economic development’s
slow rate.

Commercial Banks by stimulating the savings and investment brings in

capital in to the economy.
A sound banking system mobilizes the small and scattered savings of the
people and makes them available for investment in productive
enterprises.

In this connection, the Banks perform two important functions –

(a) Attracting Deposits - Banks attract deposits by offering high rate of
interest, thus converting savings which would have remanded idle into
active capital; and
(b) They distribute these savings through loans among enterprises, which
are connected with economic development.
During this process of reconing and granting loans and advances to
people, banks also earn rate of interest on the amount advances.

Commercial Banks indirectly also makes capital through the process of

Capital Formation by credit creation. Credit creation means the
multiplication of loans and advances. As every bank loan creates an
equivalent deposit, credit creation by banks implies also multiplication of
loans and advances. As every bank loan creates an equivalent deposit,
credit creation by banks implies also multiplication of Bank deposits. The
word “creation” implies that banks are unique institutions and they can
create Bank deposits or create bank money by giving loans and
purchasing bills and bonds but of nothing. Thus banks indirectly creates
capital by creating credit more liberally and thereby make finds available
for the development of various projects.

This tool of capital formation by credit creation is the exclusive tool in the
hand of commercial banks. Thus we can conclude that Commercial
Banks helps directly as well as indirectly in capital formation.

Ans. 5. Government’s Interference and inefficiency – The Industrial

Finance Corporation of India (IFCI) is the best example for this.

For a long time, IFCI was used by the Finance Ministry of the
Government of India and its politicians to finance many doubtful and
financially week enterprises. In fact, in the initial years the IFCI under the
chairmanship of Sir Shri Ram (of Delhi Cloth Mills) lent extensively to the
textile mill sector which soon became sick. Heavy accumulation of non
paying assists badly affects and burdens IFCI. After making it financially
weak, the Finance Ministry took a series of steps to help IFCI. First, IFCI
was converted into a public limited company under the Indian Companies
Act, 1950 and was given the freedom to function as a public limited
company from July 1993. The Finance Ministry hoped that as an
independent financial company, IFCI would be able to improve its working
and rehabilitate itself.

It was increasingly felt that the IFCI could not be rehabilitated simply by
pumping in additional funds. The Government of India has now agreed to
merge IFCI with Punjab National Bank.

Ans. 6. Industrial Development Bank of India – The Industrial

Development Bank of India was set up in July 1964 as a wholly owned
subsidiary of Reserve Bank of India. Under the Public Financial
Institutions Laws (Amendment Act 1976 ownership of the IDBI was
transferred from the Reserve Bank of India to the Government of India.
Also various other responsibilities of the Reserve Bank of India vis – a –
vis the financial institutions was vested in the IDBI. Today IDBI is an apex
institution in the area of development banking.

Management of IDBI – The management of the affairs and business of

the development bank is vested in a Board of Directors.
The Board consists of-
(a) A Chairman and a Managing Director appointed by the Central
Government.
(b) A Deputy Governor of the Reserve Bank nominated by that bank.
(c) Not more than 20 Directors nominated by the Central Government.

Industrial Credit and Investment Corporation of India (ICICI) – The

Industrial Credit and Investment Corporation of India (ICICI) was set up in
1955 and its issued capital has been taken up by Indian Banks, insurance
companies and others.

The aim of ICICI was to stimulate the promotion if new industries, to

assist expansion and modernization of existing ones and to furnish
technical and managerial aid so as to increase production and afford
employment opportunities.

ICICI has merged with ICICI Bank in May 2002 and has now ceased to
exist as an all India Development Financial Institution.

Management of ICICI – ICICI is efficiently managed by a Board of

Directors comprising personalities drawn from such diverse fields as
finance and banking, industry and Government service. The day to day
affairs are handled by the Managing Director supported by the Senior
Executive of ICICI.

The main objective is encouraging and promoting the private ownership

of industrial investments and the expansion of investment.

Industrial Finance Corporation of India (IFCI) – IFCI was the first

development bank to be established for providing medium and long term
credits to industrial concerns. IFCI was established under such
circumstances where normal banking accommodation was inappropriate
and recourse to capital issue methods was impracticable. The IFCI
provides assistance in all forms – sanction of rupee loans and foreign
currency loans, underwriting of and subscribing to share and debenture
issues, guaranteeing of deferred payments etc.

All the three IDBI, ICICI and IFCI are all India Financial Institutions. They
all are All India Development Banks. The management and the
organization structure of ICICI have produced spectacular success since
its inception in 1955.

In tune with, the changing environment, the Development Financial

Institutions have been diversifying their operations and reorienting their
business strategies. For example IDBI has expanded the scope of its
venture capital scheme to include a wide spectrum of projects – both new
and technology and new products and process with a high element of risk
and high potential returns. ICICI promoted a new company to provide
registry and transfer services to investors, it started a commercial bank –
ICICI Bank and floated a mutual fund by the name of Prudential – ICICI.
Following Narsimhan Committee (1991) recommendation and in tune with
the growing environment of competition, the system of consortium finance
by DFI’s is being gradually replaced by informal loan syndication.

The Reserve Bank of India has also issued guidelines on prudential

norms to be followed by the five all India DFI’s. The norms are broadly
similar to those prescribed for scheduled commercial banks. The DFI’s
have recognised the importance of prudential norms as a means to
maintain financial health and have also been following norms for credit
concentration, asset classification, income reorganization.

Ans. 7. Branch Banking – In the branch banking system, every bank, as

a single legal entity having one Board of Directors and one group of
shareholders, operations through a network of branches through out the
country.

In England, the tendency has been for banking services to be

concentrated in the hands of a very small number of banks – the “Big
five” as they are called each having a large number of branches all over
Britain. India have also adopted the Branch Banking system. Advantages
of Branch Banking – Following are the advantages of branch banking.

(1) Proper distribution of Capital – Branch banking results in

transfer of capital from regions which have surplus to those which require
capital. This means that capital is put to the most productive use and
thus it promotes increased output and national income of the country.
(1) Diversification of Deposits and Assets – Since the branch banking
system covers a wide geographical area, there are greater possibilities
of diversification affecting both deposits and assets.
(2) Loans and advances made on merit – Under branch banking, loans
and advances are made purely on merit and not on other
considerations. The branch manger is not influenced by personal on
local considerations in the granting of loans.
(3) Large Financial Resources – The branch banking system offers
large financial resources. The requirements of large customers can be
easily met by this system.
(4) Efficiency in management – The branch banking system makes for
greater efficiency in management.
(5) Economy in working – Besides efficiency in management, the
branch banking system ensures greater economy in its working.

Disadvantages of Branch Banking – Following are the disadvantages

of branch banking –

(1) Delays and Red Tapism: There may be delays in granting special
loans and advances. This is because of the lack of sufficient authority to
branch members.

(2) The branch managers may not be familiar with local conditions and
with the special problems and difficulties of local borrowers

(3) The funds of a particular locality may not be available for the
development of that area but may be used elsewhere.

To sum up, the branch banking system has far more substantial merits
and has greater power of survival than the unit Banking system. Even in
America, traditionally considered as the home of unit Banking, trend since
1930’s has been towards branch banking, or to get the advantages of
branch banking by what are known as group banking and chain banking
system.

Ans. 8. State Bank of India – The State Bank of India was set up in July
1955, which took over the assets, liabilities and establishment of the
Imperial Bank OF India.

The shares of State Bank of India were held by the Reserve Bank of
India, insurance companies and the general public who were formerly
shareholders of the Imperial Bank of India.

The SBI Act has been amended recently under which –

(1) Reserve Bank of India shareholding of SBI has been reduced from
99 percent to 67 percent; and
(2) 10 percent voting rights have been given to shareholders.
The State Bank of India performs all the commercial banking functions
which the Imperial Bank of India performed before viz, receiving deposits,
advancing and lending, making investment and so on.

Besides, it also acts as the agent of the Reserve Bank of India at all
places in India where it has a branch and where the Reserve Bank of
India has no branch. Apart from these normal functions which the State
Bank of India has “inherited” from the Imperial Bank of India, it has been
required to play a special role in rural credit, namely, promoting banking
habit in the rural areas and catering to there credit needs.

The establishment of the State Bank has marked a significant step in the
filed of integrated rural credit. It performs the following:-

(1) Remittance facilities to state and central co-operative banks.

(2) Loans to Cooperative Banks.
(3) Assistance to Land Development Banks.
(4) Financial accommodation to marketing and processing
societies.

Ans. 9. Mutual Funds – Mutual funds are institutions accepting finances

from its members and investing in long term capital of companies both
directly in primary market as well as indirectly in the capital market.
Financial institutions acting as portfolio managers receive funds from
public and manage the funds for and on behalf of the depositors. This
portfolio managers undertake the responsibility of managing the funds of
the principal so as to generate maximum return.

Mutual Funds in India

(1) UII – Unit Trust of India

(2) LIC – Life Insurance Corporation of India
(3) GIC – General Insurance Corporation of India
UII was established by an act of parliament in 1964, and it plays an
important role in tapping the savings of the small investors through sale of
units and channelising them into corporate investments.

The trust has built up a portfolio of investments, which is balanced

between the fixed income bearing securities and variable income bearing
securities. The main objective of the trust investment policy is to secure
maximum income consistent with safety of capital. The bulk of the
investible funds has been invested in companies which are on regular
dividend payment paying basis. Barring investments in bonds of public
corporations, the Trusts funds have been invested in financial, public
utility and manufacturing enterprises.

The trust has now floated its own Bank, UII Bank Ltd. Securities and
Exchange Board of India (SEBI) has the authority to issue guidelines and
to supervise and regulate the working of mutual funds. The guidelines
issued by the SEBI relate to advertisements and disclosures and
reporting requirements. The investors have to be informed about the
status of their investments in equity, debentures and government
securities.
SEBI has introduced a uniform set of regulations governing the mutual
funds in the country. Under these regulations, known as SEBI (Mutual
Fund) Regulations, 1993 –
(a) Mutual Funds have to be formed as trusts and managed by a
separate Asset Management Company (AMC) and supervised by
a board of trusts.
(b) AMC must have a minimum net worth of Rs. 6 crores of which the
sponsors must contribute at least 40 percent.
(c) SEBI should approve the offer documents of schemes of Mutual
Funds.
(d) SEBI prescribes the minimum amount to be raised by each scheme
– a close ended scheme should raise a minimum of Rs. 20 crores,
and open – ended scheme should raise a minimum of Rs. 50
crores.
In case the amount collected falls short by the prescribed minimum,
the subscription amount must be reduced within a period of 6
weeks.
(e) The advertisement code prescribes norms for fair and truthful
disclosure by the mutual funds in advertisements and publicity
materials.

The SEBI (Mutual Funds) Regulation, 1993 were later revised on

the basis of the recommendations of the Mutual Funds, 2000 report
prepared by SEBI. The revision includes, increase in net worth of
AMC’s from Rs. 5 crores to Rs. 10 crores, permission to have cross
trusteeship and cross directorships between AMC’s.

Ans. 10. Non Banking Functions of Commercial Banks - In recent

times many of the commercial banks indulge more in non banking
functions then the conventional banking operations.
With the world economy and getting more and more influenced with
globalization, commercial banks have today also acquired a new role.

Modern Banks performs services. Such as –

(1) The issue of various forms of credits, eg. Letters of credit, traveller’s
cheque, credit cards and circular notes;
(2) Underwriting of capital issues;
(3) The acceptance of bills of exchange, whereby the banker lends his
name to his customers in return for a commission;
(4) The safe custody of valuables;
(5) Acting as executors and trustees for customers;
(6) Preparing income tax returns for their customers;
(7) Furnishing guarantees on behalf of customers etc.

From a mere depository of surplus cash, it has gradually developed into

an institution, which provides for practically every financed requirement of
commerce and business as well as of the general public. The modern
bank has made itself indispensable not only the custodian of deposits of
surplus balances of the community, but also as a repository of financial
advice and commercial information. It gives advise to investors, buys and
sells securities on there behalf, helps government and corporations in
raising loans etc.
Ans. 11. Nationalized Banks - Nationalized Banks are managed by
the board of directors having 15 nominated members including two
fulltime directors of whom one is the managing director.

The Board has to meet al least 6 times in a year and once in each quarter
and the head office of the Bank of at such other place as the board may
decide. All questions are to be decided by majority votes. The scheme
also provide for appointment of regional competitive committees for six
regions. The functions of these committees shall review banking
developments and recommend on such matters.

It is a fact that nationalization of commercial banks have to some extent

brought inefficiency and corrupt practice in banking operations.

According to Narasimhan Committee (1991), direct investment and direct

credit programmes are the two major causes for this state of affairs.

(a) Government Investment - The Government of India used the

provisions of the Banking Regulation Act, 1949 and the Reserve Bank
of India Act, 1934 to force the commercial banks to invest a high
proportion of their deposit funds in government and public sector
securities under statutory liquidity requirements and cash Reserve
Requirements banks had to keep as much as 53.5 percent in
government securities and the securities of public sector financial
institutes.
(b) Directed credit programmes – A major objective of Indian’s
development credit policy, at the time of Bank nationalization in 1969,
was to extend the reach of bank credit both geographically to
unbanked regions and functionally to other neglected sectors. This
system of government – directed credit programme has been
achieved at the cost of security oriented credit.
(c) Political and Administrative interference - The most serious damage
to the banking system was the political and administrative interference
in credit decision making.
 The Centre and the States directed public sector banks to continue
to extend credit to sick industrial units often against their better
commercial judgment.
(d) Mounting Expenditure of Banks – There was mounting expenditure
of Banks over the two decades since nationalization due to the
following reasons.
(a) Phenomenal increase in branch banking, without any relation to
demonstrated need and potential viability.
(b) Rapid growth of staff in numbers and in acceleration promotions - this
has led to deterioration in the quality of manpower, over manning at all
levels.
(c) Extension of the coverage of bank credit to agriculture and small
industry where the unit cost of administering the loans tended to be
high.
 Module No. II

Reserve Bank of India: Structure and Functions

Ans. 1. Regulation of Foreign Exchange – The regulation and

conservation of foreign exchange is a major function of the Reserve Bank
under the Foreign Exchange Regulation Act (FERA), 1973.

The Supreme Court in Life Insurance Corporation of India V. Escorts

Limited held the Reserve Bank to be the ‘custodian general’ of foreign
exchange. The Central Government is vested with several powers under
the act including, the power to give general on special direction to the
Reserve Bank under Section 73. The Bank is obliged to comply with
such direction in the discharge of its functions under the act. The Act
imposes certain restrictions on dealings in foreign exchange, import and
export of currency and payment of exported goods.

The Indian Banks were not doing this business on a large scale and there
operations were confined to India. This was so because the overseas
trade of India was handled by foreign banks, generally known as
‘Exchange Banks’ with the attainment of independence and growth and
diversification of India’s foreign trade the Indian Banks entered into the
foreign exchange business. During the last two decades the position has
changed substantially and the Indian Banks now handle 75 percent of
country’s foreign trade.

The Indian Banks now extend assistance to importers and exporters by

their expertise and they finance exports by way of –

(1) packing credits

(2) loans against duty
(3) advance against bill for collection
(4) purchase of export bills.
(5) post shipment term finance
(6) guidance in exchange control formalities.
The problems arising out of the devaluation of the rupee and sterling and
more recently the revaluation of the Deutsche Marks have proved the
capacity of Indian Banks in dealing with them intelligently.

Now, studies have begun on the feasibility of having one central banking
organization for conducting foreign exchange business of Indian Banks
thereby releasing larger resources and personnel which are necessary for
this type of business.

Ans. 2(a) Bank of Issue – The Reserve Bank of India issues and
regulates the issue of currency in India. In fact the Reserve Bank of India
is sole authority for issue of currency in the country. This power enables
the Reserve Bank of India to regulate and control money supply in the
country.

The assets of the issue department against which bank notes are issued
consist of the following:-

(i) gold coins and bullion

(ii) foreign securities
(iii) rupee coins
(iv) government of India rupee securities
(v) the bills of exchange and promissory notes payable in India,
which are eligible for purchase by the bank.

The aggregate value of gold coins and bullion shall not at any time be
less than Rs. 115 crores and together with foreign securities not less than
Rs. 200 crores. Reserve Bank of India is also empowered to reduce its
holding of foreign exchange in the issue department to any lesser amount
with the previous sanction of the Central Government.

Refund of Notes – under Section 27 of the Act, Reserve Bank has a duty
not to reissue bank notes which are torn, defaced on excessively failed.
This is to ensure the quality of notes in circulation.

Section 28 stipulates that no person shall have a right to recover from the
central government or the Reserve Bank the value of any lost, stolen,
mutilates on imperfect currency note on bank note. However, as matter
of grace, the value of such currency notes on bank notes may be
refunded in certain conditions and circumstances. The conditions for
refund are prescribed in the Reserve Bank of India (Note Refund) Rules
framed under the proviso to section 28. Refund is available from the
Reserve Bank and also from authorized branches of commercial banks.

Ans. 2(b) Bank Notes – The Notes issued by the Reserve Bank are
referred to as bank notes under section 26 of Reserve Bank of India Act,
1934, every bank note shall be legal tender at any place in India in
payment or on account for the amount expressed therein.

Section 4 of the Negotiable Instruments Act defines a promissory note as

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

The definition under Section 4 specifically excludes the following

notes –
(a) Bank notes – A bank note may be defined as any bill, draft or
note issued by a banker, promising to pay a certain sum to the
bearer on demand. In its nature it is like cash and differs from
bonds and other securities which are only evidence of money
being due and are not money itself.
(b) Currency notes – A currency note issued by the government
incorporates an undertaking by the government to pay the
bearer of the note on demand the specified sum.

Though Bank notes and currency notes satisfy all requirements of

promissory notes, they are themselves money and legal tender for the
amount represented by them, and hence excluded form the purview of
the Act.

Reserve Bank is exempted under Section 29 of the Act from payment of

stamp duty in respect of bank notes issued by it.
Ans. 2(c) Cash Reserve – Section 42 of the Reserve Bank of India Act
and Section 18 of the Banking Regulation Act deal with cash reserves to
be kept with the Reserve Bank by schedule banks and non-scheduled
banks respectively.

A ‘Scheduled bank’, as defined in Section 2(c) of the Reserve Bank of

India Act means a bank included in the second scheduled of the Act.

Every schedule bank is under an obligation to keep a cash reserve with

Reserve Bank of India called statutory Reserve. Every scheduled bank is
required to maintain with Reserve Bank of India an average daily balance
equal to at least 3% of its demand and time liabilities. Average daily
balance means the average of balances held at the close of business on
each day of the fortnight. Reserve Bank of India is empowered to
increase the rate of statutory cash reserve from 3% to 20% of the total
deposit liabilities.

Additional Cash Reserve – RBI is authorized to direct every scheduled

bank to maintain with it, in addition to the above, on additional average
daily balance at a rate specified by it. This additional cash reserve is not
to be maintained on the entire amount of demand and time liabilities but
on the excess of such liabilities.

The Reserve Bank of India may pay interest to the scheduled banks on –
(i) the cash reserve maintained by the latter in excess of the
statutory minimum of 3% of their total liabilities,
(ii) the additional cash reserves.

But they shall be entitled to such interest if they maintain the above cash
reserves to the full extent as required by RBI. If a scheduled bank
maintains a balance in excess of the enhanced reserve requirements or
additional reserve requirement, no interest shall be payable on that
excess amount.

Yes, there are provisions for commercial banks to get loans from Reserve
Bank. When difficulties arise, Reserve Bank is a lender of last Resort for
Banks. The availability of credit from the Bank is dependent on the
prevailing credit policy. Sector 17 authorizes the Reserve Bank to give
financial accommodation to scheduled Banks. Rediscount facilities are
available under various provisions of Section 17 (2) of the Act for
financing commercial or trade transactions, agricultural operations,
production or marketing activities of cottage and small scale industries.

Ans. 3. Bank of the Central Government - The Reserve Bank is the

banker to the Central and State Governments. Under Section 20 of the
Act, it is obligatory for the Reserve Bank to undertake the banking
business of the Central Government. The Bank has also to manage the
public debt of the Central Government. In turn the Central Government
has a duty to entrust the Reserve Bank with all its money, remittance and
deposit free of interest all its cash balance with the bank.

The management of public debt concerns with the raising of finance by

the Government. Under the provisions of the Public Debt Act, 1944, the
management of public debt is with the Reserve Bank.

For raising public loans Government issues securities in various forms,

namely –
i) Stocks transferable by registration in the books of the Reserve
Bank.

ii) promissory notes payable to order and

iii) bearer bonds payable to bearer.

The public debt functions are carried out through the Public Debt Office
operating at the local brand offices of the Reserve Bank. The long term
objectives of public debt management is to ensure adequate finance for
the government and avoid recourse to short term borrowings from the
Reserve Bank as far as possible.

As an agent of the Government, the Reserve Bank issues treasury bills at

a discount, which can be rediscounted with the bank at any time before
maturity. Apart from this, the Reserve Bank also advises the central and
state Governments regarding the time, quantum and the other aspects of
issue of new plans.
Ans. 4. Acceptance of Deposits by unincorporated Bodies - The fast
growth of non banking institutions in the country and there accepting
deposits from the public at a very high rates of interest raised the
question of regulating their activities. Hence control over the acceptance
of deposits by non-banking institutions was conceived as an adjunct to
monetary and credit policy and also with a view to protecting the interest
of the depositors. Chapter III C of the Reserve Bank of India Act prohibits
acceptance of deposits by individuals, firms or unincorporated bodies
from more than the number of depositors specified therein.

Accordingly an individual may not accept deposits from more than if

persons excluding relatives of the individual.

In the case of firms the ceiling is twenty five depositors per partner and
two hundred and fifty depositors in all excluding relatives of partners. In
the case of unincorporated associations also the limit is twenty five
depositors per individual and two hundred and fifty depositors in total
excluding relatives of the individuals forming the association. Relatives for
this purpose are defined in the explanation to Section 45 S(2). However,
any period not exceeding 6 months in any accounted relating to mutual
dealings in the ordinary course of trade or business shall not be deemed
to be a depositor on account of such balance.

The acceptance of deposits from more depositors than specified being in

contravention of the provisions of the Act, the Reserve Bank can initiate
prosecution under Section 58 B read with 58 E of the Act.

Ans. 4 (b) Regulation of Non-Banking institutions – Chapter III – B

of the Reserve Bank of India Act was introduced in 1964 by an
amendment of the act conferring powers on the Reserve Bank to regulate
the acceptance of deposits by non-banking institutions.

Sections 45 I, 45 K and 45 L of the Act empower the Reserve Bank to

regulate acceptance of deposits by non-banking institutions. The term
‘Deposit’ is defined in Section 45 I (bb) includes any receipt of money by
way of deposit or loan or any other except those specifically excluded.
The excluded categories are -
(i) Amounts raised by way of share capital.
(ii) Share capital brought in by partners.
(iii) Amounts received from banks and financial institutions

Non-banking institution as defined in Section 45 I (e) means a company,

corporation or cooperative society. Financial institutions as defined in
clause (c) of Section 45 –I means any non-banking institution, which
carries on the types of business specified therein.

Section 45 J, provides for the Reserve Bank to regulate or prohibit in

public interest issue of prospects or advertisement soliciting deposits from
the public. Section 45 K provides for collection of information from non-
banking institution regarding deposits and also for issuing directions on
matters relating to receipt of deposits, including rates of interest and
period of the deposit. On failure to comply with such directions,
acceptance of deposits may be prohibited.

Ans. 4 (c) Government’s control over acceptance of deposits by

companies chapter III – B of the Reserve Bank of India Act was
introduced in 1964 an amendment of the Act conferring powers on the
Reserve Bank to regulate the acceptance of deposits by non – banking
institutions.

The term ‘Non-banking institution’ is defined in Section 45 I (e) as a

company, corporation or co-operative society.

Section 45J, provides for the Reserve Bank to regulate or prohibit in

public interest issue of prospects or advertisement soliciting deposits from
the public.

Under 45 L, Reserve Bank may call for information from financial

institutions and give directions relating to the conduct of the business of
financial institutions. Non-banking institutions have a duty to furnish
statements, information and particulars as called for by the Reserve
Bank. There is also provision under Section 45, for inspection of non-
banking institutions by Reserve Bank. Further soliciting of deposits on
behalf of a non – banking institutions persons is prohibited.
With an amendment to Companies Act, 1956 introducing Section 58A the
Central Government is empowered to exercise control over acceptance of
deposits by non-banking non – financial companies and over
advertisements for acceptance of deposits by all clauses of companies.

Directions: Under the authority of Section 45 J, 45 K and 45 L, the

Reserve Bank has issued the Non Banking Financial Companies
(Reserve Bank Directions 1977, the Miscellaneous Non-Banking
Companies (Reserve Bank) Directions, 1977 and the Residuary Non
Banking Companies (Reserve Bank) Directions, 1987. These directions
are applicable to financial companies or other non-banking companies
impose several restrictions on rate of interest, period of deposit,
maintenance of assets etc., which are modified from time to time.
 Module No. III

Law of Banking Regulations

Ans. 1. General Provisions about licensing - Section 22 of the

Banking Regulation Act deals with the licensing provisions of Banking
Companies.
No banking company can commence or carry on banking business in
India until it holds a licence granted to it by the Reserve Bank for the
purpose in the case of banking companies to be started, before granting
a licence to them the Reserve Bank may require to be satisfied whether
the conditions given in Sub – Section (3) of Section 22 are fulfilled. By
the Banking Laws (Amendment) Act, 1983 clauses (C) w.e.f. 15.2.1984
so as to widen the scope of the matters, which the Reserve Bank may
consider before granting a licence.

Before granting any license under this section, the Reserve Bank may
required to be satisfied by an inspection of the books of the company or
otherwise that the following are fulfilled, namely –

(a) That the company is on will be in a position to pay its present or

future depositors in full as their claims accrue.
(b) That the affairs of the company are not being, or are not likely to be
conducted in a manner detrimental to the interests of its present on
future depositors;
(c) That the general character of the proposed management of the
company will not be prejudicial to the public interest on the interest
of its depositors;
(d) That the company has adequate capital structure and earning
prospects;
(e) That the public interest will be served by the grant of a licence to
the company to carry on banking business in India;
(f) Its working would not be prejudicial to the operational and
consolidation of the banking system consistent with monetary
stability and economic growth
3A - Before granting any licence under this section to a company
incorporated outside India, the Reserve Bank may require to be satisfied
by an inspection of the books of company or otherwise that the conditions
specified in Sub – Section (3) are fulfilled and that the carrying on of
banking business by such company in India will be in the public interest
and that the government on low of the country in which it is incorporated
does not discriminate in any way against Banking companies registered
in India and that the company companies with all the provisions of this act
applicable to banking companies outside India.

This section originated with the demand for licensing of foreign banks
doing business in India and was also recommended by the Indian Central
Banking Enquiry Committee, mainly with the object of prohibiting the
entry of banks started in countries, which discriminated against banks
started in India. Laws of certain foreign countries such as Switzerland,
U.S.A. and Sweden have almost similar provisions.

Paid up capital and reserves – The aggregate value of paid up capital and
reserves of a foreign bank shall not be less than Rs. 15 lakhs and if it has
a place of business in the city of Mumbai or Calcutta, or both Rs. 20
lakhs. The Act also requires a foreign banking company t0 deposit with
the Reserve Bank at the end of each calander year an amount equal to
20% of the profit of that year.

Ans. 2. Submission of Returns etc, to Reserve Bank - Under the

provisions of Section 27 –
(1) Every banking Company shall, before the close the month
succeeding that to which it relates, submit to the Reserve Bank a return
in the prescribed form and manner showing its assets and liabilities in
India as at the close of business on the last Friday or every Friday or if
that Friday is a public holiday under the Negotiable Instruments Act,
1881 at the close of business on the preceding working day.

(2) The Reserve Bank may at any time direct a banking company to
furnish it within such time as may be specified by the Reserve Bank,
with such statements and information relating to business or affairs of
the banking company as the reserve Bank may consider necessary, and
without prejudice to the generality of the foregoing power may call for
information every half year regarding the investments of a banking
company and the classification of its advances in respect of industry,
commerce and agriculture.

The monthly return in the prescribed form and the manner showing its
assets and liabilities as at the close of business on the last Friday of
every month is required to be submitted not later than the close of the
succeeding month. Sub Section (2) authorizes the Reserve Bank at any
time to require a banking company to furnish it with any statements and
information relating to the business of the banking company.

The right to call for information and statements from commercial Banks
is now recognized in most countries. In England, the Bank of England
has been authorized under the Bank of England Act, 1945 to call for any
information and statements, provided it does not affect the privacy of an
account.

Ans. 3. Evaluation of Banking Regulation Act, 1949 -

(1) Regulation of Management organs – RBI has general
regulatory power on the management of the banking companies in
general and nationalized Banks in particular. The Central Government
has also some controlling function. It has been found over the years
that the Central Government having two powers, namely, power in the
role of ownership and power in the role of a controller and the Reserve
Bank having its own powers and control, often may have conflicting
interests. The ownership interest of the government and the controlling
interest of the RBI may conflict. In most of these conflict interest
situations RBI fails to have its say. This has weakened the management
of nationalized Banks. Thus an amendment is required in this regard,

(2) The basic purpose of the Banking Registration Act, 1949 was to
protect the depositors and for this purpose it planned to control, direct
and monitor the banking system. The practice, however, the
Government of India used the Finance Ministry to abuse the
provisions of the Act and command the resources of the banking system
to finance its borrowing programs. For instant, the Government raised
 the statutory liquidity Ratio (SLR) from 25 percent to 38.5 percent and
compelled the banking sector to invest in government securities and
bonds of the public sector institutions, these securities and bonds
carried rates of interest much below the market rate of interest and after
much below the market rate of interest which the banks themselves had
to offer to their depositors.

The Government of India was also responsible for adversely affecting

the working of the Indian Banking system through some of its poverty
elevation programmes, priority sector banking etc.

Apart from these amendments, what ultimately is needed for a sound

and efficient banking system is not fine banking legislation, but sound
bankers and a non-interfering Government.

Ans. 4. Cash Reserve Ratio – Section 42(1) of the Reserve Bank of

India Act requires every bank included in the second schedule annexed
thereto, to maintain an average daily balance with the Reserve Bank of
India, the amount of which shall not be less than three percent of the total
of the demand and time liabilities in India, as shown in the return referred
to in the next sub section of the said sub section.

Under the provision of the above section, before it was amended in 1962,
the average daily balance to be maintained was five percent of the
demand liability and two percent of the time liabilities in India. The powers
relating to additional reserve requirements were first exercised by the
Reserve Bank when, by a notification by it on March 11, 1960 all
scheduled banks were required to maintain with it in the form of additional
deposits, 25 percent of any additions to there demand and time liabilities
after March 11, 1960, over and above the minimum requirements Viz, 5
percent on demand and 2 percent on time liabilities.

The CRR at the time of nationalization was 3%. The percentage of CRR
goes on changing every six months, when the credit policy for six months
is announced by the Reserve Bank.
Sub section (3) of Section 42 provides for payment of penal interest by a
scheduled bank on the amount of any shortfall in the cash balance
required to be maintained by it with the Reserve Bank in terms of Sub
Section (1) or Sub Section (IA) of Section 42. Such penal interest will
initially be at the rate of 3 percent above the Bank rate for the first
fortnight of default, and if the default is not made good, at the rate of 5%
above the bank rate.

Statutory Liquidity Ratio (SLR) – According to Section 24 (2A) of the

Banking Regulation Act, 1949 as amended by the banking laws
(Amendment) Act, 1983, a scheduled bank in addition to the cash reserve
required to be maintained under Section 42 of the Reserve Bank of India
Act, and every other banking company, in addition to the cash reserve
which it is required to maintain under section 18 of the Banking
Regulation Act, shall maintain under Section 18 of the Banking
Regulation Act, shall maintain in India – (a) cash (b) in gold valued at a
price not exceeding the current market price on in unencumbered
approved securities valued at a price determined in accordance with such
one or more of, on combination of, the methods proved in the section, an
amount which shall not, at the close of business on any day, be less than
255 on such other percentage not exceeding 40% as the Reserve Bank
may, from time to time, by notification in the official Gazette specify, of the
total of its demand and time liabilities in India, as on the last Friday of the
second preceding fortnight.

Ans. 5. Securitisation According to Kenneth Cox securitisation is

a process in which pools of individual loans or receivables or actionable
claims are packaged, under written and distributed to investors in the
form of securities. It is a process of liquidizing assets appearing in the
Balance Sheet of a bank or financial institution which represent long term
receivables by issuing marketable securities there against. It involves
conversion into cash flow from a portfolio of assets in negotiable
instruments on assignable debts, which are sold to investors.

Obstacles on Securitisation in India – The present legal environment

about securitisation is inadequate, in appropriate and unfriendly.
Immediate steps are required to remove the legal hurdles and save this
promising instrument.

A two dimensional Government action is necessary, Viz.

(i) removal of all legal barriers; and
(ii) providing appropriate incentives and adequate infrastructural
facilities.

Some of the requirements are as follows:

(a) Stamp Duty remission – The law relating to stamp duties are both
Centre and State subjects. It is necessary to give complete remission on
securitisation so that the growth of the market instruments bring more
liquidity which will offset the loss on account of remission of stamp duty
and wide confusion arising out of present law relating to stamp duty.

(b) Income Tax incentives – It is suggested by many market friendly

economists that securitisation require tax incentives in the line of Section
88A of the Income Tax Act.

(c) Development of infrastructual facilities – SEBI may prepare

guidelines for listing of such securities and for other marketing practices.
It is necessary for Reserve Bank of India to make regulations for the
management of ‘portfolios’ with suitable rules of set off and protection.
Various tax incentives can be given to institutions for popularizing the
process of securitisation among them.

Ans. 6 Mutual Funds - In the recent years, mutual funds are the most
important among the newer capital institutions. Several public sector
banks and financial institutions have set up mutual funds on a tax-exempt
basis virtually on the same footing as the unit Trust of India (UTI). Their
main function is to mobilise the savings of the general public and invest
them in stock market securities. Accordingly, mutual funds have attracted
strong investor support and have shown significant progress. The
Government has thrown the filed open to the private sector and joint
sector mutual funds.
SEBI has the authority to issue guidelines and to supervise and regulate
the working of mutual funds. The guidelines issued by SEBI relate to
advertisements and disclosures and reporting requirements. The
investors have to be informed about the status of their investments in
equity, debentures and Government securities.

SEBI has introduced a uniform set of regulations governing the mutual

funds in the country. Under these regulations, known as SEBI (Mutual
Fund) Regulations, 1993 -

(a) Mutual funds have to be formed as trusts and managed by a

separate Asset Management Company (AMC) and supervised by a
board of trustees.
(b) AMC must have a minimum net worth of Rs. 6 Crores of which the
sponsors must contribute 40 percent.
(c) SEBI should approve the offer documents of schemes of mutual
funds.
(d) SEBI prescribes the minimum amount to be raised by each scheme
- a close ended scheme should raise a minimum of Rs. 20 Crores
and open ended scheme should raise a minimum of 50 Crores. In
case the amount collected falls short by the prescribed minimum,
the subscription amount must be refunded within a period of six
weeks.
(e) The advertisement code prescribes norms for fair and truthful
disclosure by the mutual funds in advertisements and publicity
materials.

As of January 2004 there were 31 mutual funds (excluding the Unit Trust
of India), of which is belonging to public sector and 21 were in the private
sector. They manage 393 schemes and have total assets of Rs. 1,40,000
Crores.

Ans. 7. Opening of Branches – Under the provisions of Section 23, the

Reserve Bank of India has been empowered to control the opening of
new and transfer of existing places of business of banking companies as
follows:
(1) Without the prior permission 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, and

(b) No banking company incorporated in India shall open a new place

of business outside India or change otherwise than with the same city,
town or village in any country or area outside India, the location of an
existing of business situated in that country or area.

Provided that nothing in this sub section shall apply to the opening for a
period not exceeding one month of a temporary place of business within
a city, town or village within which the banking company already has a
place of business, for the purpose of affording banking facilities to the
public on the occasion of an exhibition, a conference on a mela or any
other like occasion.

The Reserve Bank of India takes into account the following factors in
deciding the application of the bank for opening branches.
(i) The financial condition and history of the company,
(ii) The general character of its management.
(iii) The adequacy o fits capital structure and earning prospects.
(iv) Whether public interest will be served by the opening change of
location of the place of business.

If RBI is satisfied by an application or otherwise about the above

mentioned factors, permission is granted by RBI.

Ans. 8. The powers of the Reserve Bank of India over the

management of the banks is very wide. The Reserve Bank of India is
armed with Draconian powers under the Banking Regulation Act, 1949 as
amended from time to time. These powers are spread over a number of
sections of the Act.

Section 10 A - This section was introduced the sub serve the purpose of
social control. The section prescribes the nature and composition of
Board of Directors who are responsible for the management of the
banking company.

Sub Section (6) Every appointment, removal or reconstitution duly

made, and every election duly held, under this section shall be final and
shall not be called into question into any court.

Sub Section (7) Every direction elected, or, as the case may be
appointed under this section shall hold the office until the date upto which
his predecessor would have held office, if the election had not been held,
or, as the case may be, the appointment had not been made.

Ans. 9. Entry of Private Banks - For well over decades, after the
nationalization of 14 larger banks in 1969, no bank has been allowed to
be set up on the private sector. Over this period, the public sector banks
have expanded their branch network considerably and catered to the
socio – economic needs of large masses of population, especially the
weaker section and those in the rural area.

It is necessary that while permitting the entry of new private sector banks
the following considerations have to be kept in view –

(a) They sub serve the underlying goals of financial sector reform
which are to provide competitive, efficient and low cost financial
intermediation services for the society at large.

(b) They are financially viable.

(c) They should result in the up-gradation of technology in the banking
sector.
(d) They should avoid the shortcomings such as unfair preemption and
concentration of credit, monopolization of economic power, cross
holdings with industrial groups.

(f) Freedom of entry in the banking sector may have to be

managed carefully and judiciously.

The Reserve Bank of India has also laid certain guidelines in this regard.
 (a) Such a bank shall be registered as a public limited company
under the companies Act, 1956;
(b) The RBI may, on merit grant licence under the Banking
Regulation Act, 1949 for such a bank. The bank may also be
included in the Second Schedule of the Reserve Bank of India
Act, 1934 at an appropriate time.

The decision of the Reserve Bank of India shall be final in this regard.
 Module No. IV and V
Negotiable Instruments: Law and Procedure

Ans.1. The issue consideration in the present case is the law

relating to ‘non negotiable’ crossing and stopping of payment of a cheque.

Not Negotiable Cross – Section 130 of the Negotiable Instrument Act,

1881 deals with not negotiable crossing.

“A person taking a cheque crossed generally or specially bearing in either

case the words, ‘not negotiable’ shall not have, and shall not be capable
of giving, a letter title to the cheque than that which the person from
whom he took it had”

Thus the transferee of such a crossed cheque would not be able to get a
title letter than that of the transferor. So, no one can become the holder
in due course of such a cheque. Although the instrument remains
transferable, its essential negotiability stands diluted by this type of
crossing.

The object of ‘not negotiable’ crossing is clearly to afford extra protection

to holder on drawer of a cheque.

Even if such a cheque goes into wrong hands and from there it is
transferred to a holder in due course, the true owner will not loose his
rights against such an endorsee. Thus, such a crossed cheque must be
accepted with extra caution about the antecedents of the endorser.
In the current case X had issued a ‘Not Negotiable’ crossed cheque to Y.
Y endorsed the cheque to Z. Later Z lost the cheque and it was found by
F, who transferred it to E. E got the payment through his account with the
State Bank of India.

Now at the time when Z had lost the cheque, he must had intimated the
drawer of the cheque to stop the payment from the bank. But it seems
from the fact of the case that I had made no such efforts to stop the
payment from X’s account. Thus neither X nor his banker is at fault while
they made the payment from his account. It is to be noted that there is no
privity of contract between the holder of the cheque and the banker to
who it is drawn. It is for this reason that, when it is desired to stop the
payment of a lost cheque, the holder has to ask the drawer to instruct the
banker to do so, as otherwise, the paying banker may refuse to act
according to the instructions of the holder of the cheque.

Thus it is quite clear that Z cannot claim the money X. But had he
intimated X about the stopping of payment from the farmer’s account Z
would had got the right to claim money.

Ans. 2.The issue under consideration in the present case is the law
relating to inchoate instruments.

The term inchoate instrument’s means an instrument incomplete in some

respects e.g. an instrument, which does not mention the amount payable
on the name of the payee.

When a person signs and delivers to another a blank or incomplete

stamped instrument, it implies that he authorizes the other person to
make or complete the instrument for any amount not exceeding the
amount covered by the stamp. When the instrument is so filed up, the
person signing the instrument becomes liable to any holder in due course
for such amount in the capacity in which he signed it. The liability of the
person signing is restricted to the amount specified in the instrument.

A Bill of exchange must be properly stamped as required under the Indian

Stamp Act, 1899, and each stamp must be duly cancelled also.

In the current case, M drew a bill on C, and later endorsed the bill to B of
Bangalore. B later sent a notice to C for the payment of the Bill. The
notice came returned with a remark ‘office kept’ closed. Now the fact is
that M, the drawer had wrongly affixed the stamp worth Rs. four hundred
as per the Indian Law. But later M endorsed this bill to B and thus both
the parties to the bill belong to India now.

Now if the jurisdiction of the Indian courts is valid, then B shall be allowed
to recover the money from S, because –B in this case is a holder in due
course, and the holder in due course has a right to because such amount.
B is the recipient from M and this makes him holder in due course.

Ans. 3. The issue under consideration in the present case is the

implication of the phrase “After Sight” on a bill of exchange.

The phrase ‘after sight’ on a bill of exchange should always be

accompanied but the period after which the bill would become payable,
as for example 6 months after sight etc. sight must appear in a legal way
i.e. after acceptance if the bill has been accepted or after nothing for non
acceptance or protest for non acceptance. [Homes V. Kerrison]

Detailed Rules for calculating maturity – To overcome some practical

problems that crop up while determining the date of maturity of an
instrument, sections 23 to 25 have laid down some rules which are given
below:

1) If the instrument is made payable a stated numbers of months after

sight, it would mature on the third day after the corresponding date of the
month after the stated number of months.

2) If the month in which the stated period would terminate has no

corresponding date, the period shall be held to terminate on the last date
of such a month.

3) If an instrument is made payable a certain number of days after

sight, the maturity to the calculated by excluding the day on which the
instrument is drawn on presented for acceptance or sight or on which the
event happens.

4) If the date on which a bill or note is at maturity happens to be a

public holiday, the instrument shall be deemed to be due on the next
preceding business day, i.e. a day earlier.

5) If an instrument is payable by installments, three days of grace are

to be allowed on each installment (Section 67).
Ans. 4. Arguments on behalf of the defendant –
(1) Forgery by the Plaintiff – Section 470 of Indian Penal code states
that ‘a false document made wholly or in part by forgery is designated’ a
forged document’. Section 471 further observes that the use as genuine
of a forged document has to be with an intent dishonest has to be with an
intent dishonest or fraudulent. A mere erroneous belief and persistence
in a wrong on perverse opinion cannot be said to be offence tainted with a
dishonest or fraudulent intention [Bank of India Vs. State of Maharashtra]

Section 464 – Making a false document. A person is said to make a false

document.

Firstly – When dishonestly or fraudulently makes, signs, seals or

executes a document on part of a document, or makes any mark
denoting the execution of a document, with the intention of causing it to
be believed that such document or part of the document was made,
signed, sealed or executed by or by the authority of a person by whom or
by whose authority he knows it was not made, signed, sealed or executed
on at a time at which he knows it was not made, signed, sealed or
executed.

Secondly – Who, without lawful authority, dishonestly or fraudulently, by

cancellation or otherwise, alters a document in any material part there of,
after it has been made or executed either by himself or by any other
person, whether such person be living or dead at the time of such
alteration.

(2) As per the principle of Natural equity and justice, one who seeks
justice must also do justice. In this case, the plaintiff had himself not
done justice and thus he cannot ask for justice in the court of law.

Ans.6. Section 76 provides for situations in which the presentment for

payment is unnecessary, and the instrument in such a case is dishonored
at the due date for presentment. These situations are as follows:
(1) When Prevented - Whenever the marker, drawer or acceptor
intentionally prevents the presentment, then the holder need not present
the requirement.

(2) When business place closed – if the place of business of such

maker etc. is closed on a working day during business hours the
presentment is not necessary, because in such a case the presumption is
that it has been deliberately kept closed to avoid payment.

(3) When no person at place of payment – The same rule applies, if

the instruments is payable at a specified place, and when the holder goes
there for presentment there is no person present who can either authorize
payment or refuse it.

(4) When the waiver etc. cannot be found - The holder is required to
search diligently for the maker etc. If the instrument does not specify a
place of payment. If after due search the maker etc. can not be found,
the parties to the instrument are liable on it without the presentment.

Ans. 7. Privileges of a Holder in Due Course – The holder in due couse

enjoys a privileged position under the Negotiable Instruments Act in
comparison to a mere ‘holder’. He has the rights superior to those of
holder. Following are the privileges.

(1) Better title than that of the transferor - A person who is only a holder
gets a title over the instrument, which is at par with the transferor. If
there is a defect in transferors title, the holder would suffer from the same
defect. But the holder in due course would acquire a better title than that
of the transferor.

(2) Privilege in case of inchoate instrument - In the case of inc

stamped instrument, if its original payee or holder fills an amount more
than what was authorized, he cannot enforce the instrument for the entire
amount.

(3) Rights against prior parties – All prior parties to negotiable

instrument i.e. its maker or drawer, acceptor and intervening indorses,
continue o remain liable to a holder in due course both jointly and
severally i.e. he can hold any or all prior parties liable, until the instrument
is duly satisfied (Sec.36). Whereas, only preceding party is liable to a
holder

(4) Privilege in case of fictitious bills – When a bill of exchange is

drawn in a fictitious name and is made payable to another fictitious
person i.e. where both drawer and payee of a bill are fictitious persons,
the bill is said to be a fictitious bill. But, if such a bill, during its negotiation
of such a bill would be liable to him.

(5) Rights under an instrument delivered conditionally – When a

negotiable instrument is endorsed or delivered conditionally or for a
special purpose only, such as, to make it a collateral security or for safe
custody, and not with the idea of transferring the rights therein, the
property in the instrument does not pass to an indorsee, and he becomes
merely a bailee with limited title and power of negotiating it.

(6) Estoppel against denying capacity of payee to indorsee - No maker

of a note and no acceptor of a bill payable to order shall, in a suit thereon
by a holder in due course, be permitted to deny the payees capacity, at
the date of the note, or the bill, to indorse the same. But the condition is
that payee must be competent to indorse the instrument.

Ans. 8. Payment in due course - the payment made under a negotiable

instrument by the person liable must be made in such a way which could
be called “payment in due course”. Only such a payment will endorse as
a valid discharge of the instrument against the holder. Section 10 lays
down that a payment under a negotiable instrument shall amount to a
‘payment in due course’ if the following conditions are satisfied –

(1) The payment must be in accordance with the apparent tenor of the
instrument. It should be made at or after its maturity. A payment before
maturity cannot be a, payment in due course so as to discharge the
instrument.. The instrument, even if paid before the last day of grace, can
be indorsed further. Similarly, the bankers should not make payment of a
post-dated cheque before the date mentioned therein.
(2) The payment must be made in good faith and without any
carelessness. It must be made under a honest belief that the person
demanding the payment is a bonafide person and is legally entitled to it.
The payee must not act carelessly while making the payment. If there
are circumstances to arouse suspicion, the payment will not be a
payment in due course.

(3) The payment must be made in return of the instrument. A payment

will not be a payment in due course if it is made without presentment of
the instrument.

(4) The payment must be made in money only unless the holder
agrees to accept payment in any other form or by cheque or draft or in
kind, as a discharge of the debtor.

(i) “Pay Ramesh an amount of Rs.5000/-, sixty days after arrival fo the
ship ‘victory’ at Bombay.
Such a document is not a valid as Bill of Exchange i.e. a negotiable
instrument. The order to pay on the Bill of Exchange must be
unconditional i.e. payment must be made under all circumstances and it
should not be on a contingency. A Bill of Exchange payable on a
contingency is void ab initio, but such contingency or defect be apparent
on the face of it. In such cases, even the happening of the contingency
cannot make the bill of exchange valid. A Bill of Exchange is not based
on contingency merely because there is an uncertainty regarding the
person having the right to enforce it under particular circumstances.

(ii) I promise to pay on demand a sum of Rs. 10,000/- at my convenience.

This document is not a valid Promissory note i.e. a negotiable instrument,

Section 4 of the Negotiable Instruments Act which defines a Promissory
Note lays down a condition that a promissory note must contain an
unconditional and definite promise to pay a certain sum. In this case the
promise to pay is at the convenience of the drawer, and thus this makes
the document conditional.
(iii) “Rs. 1000 balance, due to you and I am indebted to pay on
demand”.

This is a valid Promissory note. A promissory note is a promise in writing

by a person to pay a certain sum of money to a specified person. The
above document is unconditional and definite promise to pay a certain
sum of money.

(iv) “I promise to pay a Rs.1000 and all fines accordingly to rules”.

The above document is not a valid Promissory note, as they do not

satisfy the requirements laid down in the definition.

Ans. 10. The issue under consideration in the present case is the law
relating to instruments.
The term ‘inchoate instrument’ means an instrument incomplete in some
respects e.g. an instrument, which does not mention the amount payable
or the name of the payee.

When a person signs and delivers to another a blank or incomplete

stamped instrument, it implies that he authorizes the other person to
make or complete the instrument for any amount not exceeding the
amount covered by the stamp. When the instrument is so filled up, the
person signing the instrument becomes liable to any holder in due course
for such amount in the capacity in which he signed it. The liability of the
person signing is restricted to the amount specified in the instrument. It
may noted here that no person other than a holder in due course can
recover from the person delivering the instrument anything in excess of
the amount intended to be paid by him.

The following points are important in connection with an inchoate

instrument –

(1) The liability of the person who signs and delivers an incomplete
stamped instrument, arises when the blanks are filled in and the
instrument is completed.
(2) The signatory becomes liable only when the instrument is delivered
to the transferee. Thus, where a person sings his name on a stamped
promissory note, and keeps it in his drawer, and some person steals it
and completes the instrument, then he cannot recover the amount from
the signatory. It may be noted that in such a case, even a holder in due
course cannot recover the amount from the signatory because he did not
get it through negotiation.

(3) The instrument must be stamped, and the stamp affixed must be
sufficient to cover the amount filled in the instruments.

(4) The person who completes an inchoate instrument cannot himself

become a holder in due course. Only the recipient from him can become
a holder in due course if he receives it in good faith, and for value.
(Kadarkarni V. Arumugam 1992 AIR Mad 346)
 Module No. VI

Banker – Customer Relation

Ans.1.
Pledge Pledge along with hypothecation form a major chunk of bank
especially for trade or commercial purposes. Section 172 of the Indian
Contract Act defines pledge as: The bailment of goods as security for
payment of a debt or performance of a promise is called pledge.

Pledge has the following essential characteristics –

a) The pledge article must be delivered to the pawnee.

b) The delivery must be either for payment of a debt or the

performance of a promise.

c) On the pawner’s repaying the debt or performing his promise the

goods must be returned to him.

Pledge of Shares - In case shares of an incorporated company are

pledged it is not necessary for the pledge to be duly filed in the transfer
form. In re Bengal Silk Mills case it was held that a transferee in the
case of a transfer to shares in blank has the right to fill in the necessary
particulars including his own name as a transferee and the date of the
transfer, even after the death of the original transferor. The transfer so
made will be a valid one and transferee will be entitled to have his name
registered in the company register as the holder of shares.

In Kunhunni Elaya Nayar V. P.N. Krishna Pattar and others, the court
while considering the question whether a pledge of shares can be created
by the mere deposit of the share certificate, held that the shares are
“goods” and therefore pledge able. They can only be pledged by the
deposit of the share certificate. The court observed that it appears that it
appears that by including shares in the definition of goods in the sale of
goods Act, the legislature must have associated shares with the share
certificate, which is marketable. Otherwise, it is difficult to see how
shares can be goods and the subject of pledge, the essence of which is
delivery. The word “goods” in the Indian contract Act should receive the
same meaning, which it has in the sale of goods Act. The court also
observed that to say that there can only be a pledge of shares when the
share certificate is accompanied by a deed of transfer is making the
transaction something more than a pledge.

Therefore, when a person delivers a share certificate to another to be

held by him as security, there is under the law a pledge, which can be
enforced. But unless the pledge at the time of the deposit securities a
deed of transfer which he can use in the case of necessity or obtains one
from his debtor at a later stage, he must have recourse to the court when
he wishes to enforce his security.

Ans. 2.
The issue under consideration in the present case is the law relating to
the rights of the pawner.

In M.R. Dhawan Vs. Madan Mohan & others, AIR 1969 Del. 313, the
Delhi High Court held that “it will be seen that the pawnee acquires a
right, after notice, to dispose of the goods pledged. This amounts to his
acquiring only a “special property” in the goods pledged. The general
property therein remains in the and wholly reverts to him on payment of
the debt or performance of the promise. Any accretion in the case of
dividends, bonus or right shares, issued in respect of the pledged shares
will, therefore, be in the absence of any contract to the contrary, the
property of the pawner”

The general property of the shares pledged thus remains in the pawner
and he remains entitled to all the dividends that may be declared on
shares and to the bonus and right shares that may be issued in respect of
the shares pledged that there is no contract to the contrary.

The Delhi High Court in this case also made the distinction between
pledge and mortgage. It observed that pledge is a kind of bailment and
security. Its primary purpose is to put the goods pledged in the power of
the pawnee to reimburse himself for the money advanced, when on
becoming due it remains unpaid by selling the goods after serving the
pawner with a due notice. The _at no time becomes the owner of the
goods pledged. He has only a right to retain the goods until his claim for
the money advanced thereon has been satisfied, with a power to sell the
goods pledged, after due notice in case of default by the pawner. It is
only a special property in the goods pledged, which is acquired by the
pawnee, leaving the general property intact with the pawner.

Ans. 3.
Mortgage - A mortgage is defined by Section 58 of the Transfer of
Property Act, 1882, as “the transfer of an interest in specific immovable
property for the purpose of receiving the payment of money advanced or
to be advanced by way of loan, an existing or future debt, or the
performance of an engagement which may give rise to a pecuniary
liability”. The essential future of a mortgage is the transfer of an interest
in specific immovable property for the purpose of securing a debt or an
obligation. If the transfer is made for any other purpose such as the
discharge of a debt, it cannot be called a mortgage. Moreover, the
immovable property to be mortgaged must be specific, that is, it should
be such as can be clearly described. It may be noted here that
immovable property referred above, does not include grass, crop or
standing timber.

Equitable Mortgage – When a loan of money is secured by the deposit

of title deeds it is taken as an equitable mortgage, because in such a
case not legal transfer of property takes place. In Foster v. Barnard,
Lord Haldone said – “The deposit of title deeds – with bankers makes the
bankers mortgages in the eye of equity. Under English law, such a
mortgage gives the mortgage no rights against the property, but only a
personal right against its owners.

Ans. 4.
The issue under consideration in the present case is the law relating to of
the Indian Contract Act, 1872.

“Where a person lawfully does anything for another person, or delivers

anything to him, not intending to do so gratuitously, and such another
person enjoys the benefit thereof, the latter is bound to make
compensation to the former in respect of or to restore, the thing so done
or delivered.
Example – A fire breaks out in M/s factory. The fire brigade reaches the
spot and extinguishes the fire; M is not bound to pay because the act of
the fireman was not done with the intention to be paid.

The requirements for this rule are that one person should have lawfully
done something or delivered something for the benefit of another but with
an intention to be paid for it, and the other person should have enjoyed
the benefit of it, understanding dearly that the service is being rendered
non gratuitously.

Doing an illegal act for another will not be covered by this section. Also
the section intends that the service should have been rendered without
an express request. If a person renders a non-gratuitous service at the
request of the beneficiary, this becomes a case of clear contract between
the two persons. Further, the beneficiary of the service should not be an
incompetent person.

Thus the fact that L was the beneficiary does not include him within the
ambit of Section 70. The Bank had not done anything on its own for L,
and L got the benefit from C and H.

Ans. 5.

The issue under consideration in the present case is the law relating to
set off of certain deposits.

A set – off must be in the form ofa cross claim for a liquidated amount and
it can be pledged only in respect of a liquidated claim. Both the claims
and the set off must be mutual details, due from and to the same parties,
under the same right. A claim by a person in representative capacity
cannot be set off against a personal claim. Thus if a claims Rs.500 as the
balance due to him from his banker, while as trustee of B, A owes to the
banker Rs. 300, no set off can be claimed be claimed by the banker.
Even a claim against the estate of deceased cannot be set off against a
debit, which was due to the customer from his banker, during the farmer
life time, whether the accounts are with one or more offices of the banker,
it does not materially affect the position in any way.

In case of Joint Account (repayable to either or survivor) the bank cannot

set off A debt due from alone against joint debt nor can A set off such a
debt against a separate debt due from him to the bank (Nath Bank
Limited v. Sisir Kumar Sarkar). The Patna High Court in Radha Raman
Choudhary v. Chota Nagpur Banking Association Limited, has also held
that the bankers have a right to combine one or more accounts of the
same customer. But a Banker cannot combine a customer’s personal
account with a joint account of the customer and another person.

It is to be noted that – A Banker’s right of set off cannot be exercised after

the money in his hands has been validly assigned or in any case after he
has been notified of the fact of an assignment. (Official Liquidator K.P.T.
Nodar and others).

Ans. 6.

The banker’s power to combine different accounts is called the right to set
off. Between the ordinary debtor and creditor, there is an undoubted right
to set off amounts due to and from each other in the ordinary course of
business. For ex – A buys cement from B, a trader for Rs. 10,000. Later,
A sells to B steel worth Rs.5000/-. B is now perfectly entitled to set off the
cost of steal against his liability for cement and need to pay only
Rs.5000/- in settlement of the net debt.

In the current case there were two partnerships firms functioning under
different names but comprising the very same parties. The Bank has now
credited the amount of one of the firms into the account of another.

In Firm Jaikishan Dass Ram v. Central Bank of India two partnerships

firms with same set of partners had two separate accounts with the bank
was entitled to appropriate the monies who belong to a firm for payment
of an overdraft of another firm. Because although two separate firms are
involved they are not two separate legal entitles and cannot be
distinguished from the members who compose them. Mutual demands
existed between the banks on the one hand and the persons constituting
the firm on the other. Nor it could be said that these demands did not
exist between the parties in the same right.

In veerapa Chettiar Vs. J.V.Pirrie and others, the claim for setting off an
amount due by the bank to the plaintiff and his mother, payable to either
or survivor, in respect of an fixed deposit against an account due to the
bank by the plaintiff on overdraft account was allowed, on the ground that
the fixed deposit amount absolutely belonged to the plaintiffs.

Ans. 7.
Liquidators – Bankers should always be careful while dealing with
persons appointed to wind up the affairs of the companies. A liquidator’s
business is to realise the company’s assets and to collect such amounts
as may be due to the company from its shareholders and debtors. He
has to apply the funds thus collected in payment of the company’s debts
and distributes the balance if any, among its shareholders. He has the
power to borrow money against the security of the Company’s assets and
to draw, accept, make and endorse bills and notes, in the name and on
behalf of the company. In the exercise of any such powers, he is free
from any personal liability.

In Madras Provincial Cooperative Bank Limited Vs. Official Liquidator,

South Indian Match Factory Limited the official liquidator of the company
did not open an account with the bank as required under the Companies
Act and the rules formed by the Madras High Court. A cheque drawn in
favour of the official liquidator the bank was put on enquiry and was
negligent in paying him personally. The payment was not made in due
course within the meaning of Section 85 of the Negotiable Instruments
Act and the bank was therefore liable for the amount.

Ans. 8.
In the current case, Bank had granted an overdraft to R on the security of
a fixed deposit in his sons’s name with a firm of bankers. The son had
given the fixed deposit receipt to Bank alongwith a letter authorizing it to
collect the amount on maturity and appropriate towards the over draft.
He gave the bank another letter addressed to the firm asking it to pay to
the bank the amount of the deposit and the interest thereon. On the due
date, when the bank asked for payment, the firm refused to pay saying
that the amount, the firm refused to pay saying that the amount had been
adjusted against a debt to it from the depositor.

In official liquidator, Hanuman Bank Ltd. Vs. K.P.T. Nadar and others that
a bankers right of set off cannot be exercised after the money n his hands
has been validly assigned or in any case after he has been notified of the
fact if an assignment.

Rule of set off in bankruptcy does not rest on the same principle as the
right to set off between solvent parties. (I.S. and C. Machado V. Official
Liquidator).

Ans. 9.
Bailor - Bailee Relation – one of the many services offered by a
commercial bank is called safe custody facility. Bank accepts from its
customers sealed boxes and packets for safe custody. In most of the
cases the banker can open such safe custody articles, boxes or packets
only as per the instructions of the person who deposits the same for safe
custody.

A customer can chose to keep with his bank his last will and tesament. In
such a case he may also instruct his bank to open the packet on receipt
of the notice or knowledge of his death. And if in the will the bank is
appointed by the deceased as his executor or trustee the bank will have
to take care of the assets of the deceased and execute the wil in toto.

The Supreme Court of India in united commercial Bank V. Hem Chandra

Sarkar decided the question of law, whether in the circumstances of the
case the appellant bank was an agent of the respondent or bailee in
respect of goods entrusted for delivery to the respondent against
payment.

The law of bailment is explained in the Indian Contract Act, Section 148.
A bailment is the delivery of goods by one person to another for some
purpose, upon a contract, that they shall, when the purpose is
accomplished, be returned or otherwise disposed of according to the
directions of the person delivering them.
 Module No. VII & VIII

Advances, Loans and Securities

Ans.1.

Hypothecation – Hypothecation is another method of creating a charge

over the movable assets, neither ownership nor possession of goods is
transferred to the creditor but an equitable charge is created in favour of
the latter. The goods remain in the possession of the borrower, who
binds himself, under an agreement, to give the possession for the goods
to the banker, whenever the latter requires him to do so. The charge of
hypothecation is thus converted into that of a pledge and the banker or
the hypothecatee enjoys the powers and rights of a pledgee.

In Gopal Singh Hira Singh Vs. Punjab National Bank, the Delhi High
Court observed that in case of hypothecation, the borrower is in actual
physical possession but the constructive possession is still of the bank
because, according to the deed of hypothecation, the borrower holds the
actual physical possession not in his own right as the owner of the goods
but as the agent of the bank.

Hypothecation is convenient device to create a charge over the movable

assets in circumstances in which transfer of possession is either
inconvenient or impractical.

According to a recent judgment of the Andhra Pradesh High Court it is

open to the bank to take possession of the hypothecated property on its
own or through the court as per Hypothecation Agreement. Where there
is any specific clause in the Hypothecation Agreement empowering the
hypothecatee to take possession of the goods and sell the same in the
event of default in payment, the hypothecatee can process ahead.
Without the intervention of the Court. (State Bank of India vs. S.B.Shah
Ali)

In State Bank of India Vs. Quality Bread Factory, cash credit facility was
given by the bank on open credit system. Hypothecated goods were lost
by the negligence of the bank. The Court held that it has not been laid
down in the contract Act that this principle applies only to the pledges and
not to the hypothecations. Therefore, the law regarding discharge of
surety as laid down in Section 141 applies equally to open credit system.
The bank as a pledgee therefore should keep requisite vigilance on the
debtor both in the “lock and key” system and “open credit system” in
order to protect himself and the surety against the illegal actions of the
debtor.

Ans. 2.
The issue under consideration in the present case is the low relating to
contract of guarantee.

Section 126 of the Indian contract Act, 1872 defines a contract of

guarantee as” “a contract to perform the promise, in discharge the liability,
of a third person in case of his default”.

The person giving the loan is known as the creditor, the principle taking
the loan is known as the Creditor, and the person giving the guarantee is
known as the surety.

In Punjab National Bank Vs. Mehra Brothers (in liquidation), the debtor
company went into liquidation. The bank filed a suit against the company
in liquidation and three guarantors. The banks claim was admitted by the
official liquidator. The bank later decided to proceed against the
guarantors and not the company. It was contended on behalf of the
guarantors that since the claim of the bank had been admitted by the
Official Liquidator, the bank could not proceed against the guarantors.
The Calcutta High Court held that the Bank could proceed against the
guarantors as the bank filed a suit not only against the principal debtor
but also against the guarantors and by preferring the claim before the
official liquidator the bank had not foregone its right to proceed against
the guarantors. On behalf of the Bank it was contended that Section 137
of the Contract Act provides that more forbearance on the part of the
creditor to sue the principal debtor or to enforce any remedy against him
does not, in the absence of any provision in the guarantee to the contrary
discharge the surety. Reliance was placed on Supreme Court decision in
Bank of Bihar Limited Vs. Damodar Parsad and another.

The Calcutta High Court observed that in view of Section 137 of the
Contract Act and also in view of various judgments on the point, the
surety’s liability towards the creditor remains unaffected, even when the
creditor was chosen not to sue the principal debtor.

Ans. 3.

The issue under consideration in the present case is the law relating to
Garnishee order.

The obligation of a banker to honour his customer’s cheques is

extinguished on receipt of an order of the court, known as the Garnishee
order, issued under order 21, Rule 46 of the Code of Civil Procedure,
1908. If a debtor fails to pay the debt owed by him to his creditors, the
latter may apply to court for the issue of a Garnishee order on the banker
of his debtor. Such order attaches the debts not secured by a negotiable
instrument, by prohibiting the creditor from recovering the debt and the
debtor from making payment thereof.

The account of the customer with the banker, thus becomes suspended
and the banker is under an obligation not to make any payment thereof.
The account of the customer with the banker, thus cannot be debited.
The creditor at whose request the order is issued is called the judgment –
creditor, the debtor whose money is frozen is called judgment debtor and
the banker who is the debtor of the judgment debtor is called the
Ganrishee.

The Herschorn Vs. Evans, where there was a joint account in the name
of husband and wife it was held that the joint account could not be
garnished in execution of a decree obtained against the husbands alone.
It is not for the banker, however, to question the propriety of the court’s
order nor can he, as a garnishee, be compelled to adjudicate upon
conflicting equities.
Thus, Garnishee order is a useful tool in the hand of the creditor, who
cannot realise his money from the debtor.

Ans. 4.
The issue under consideration in the present case is the law relating to
pledge.

Section 172 If the Indian Contract Act defines pledge as follows: “The
bailment of goods as security for payment of a debt or performance of a
promise is called “pledge”. The bailor is in this case called “pawnor”. The
bailee is called “ pawnee”.

So, a borrower of money after furnishing a security is a bailor or pawnor

or pledger. The lender of money would be the bailee, pawnee or pledgee.
The lender takes the goods as security to ensure the return of his money
in time or else he would be able to sell them to recover a part or whole of
his money. Thus, the pledgee acquires a special interest in the goods
whereas the general interest remains with the pledger.

It may also be noted that pledge involves only movable goods, which may
include any physical item, or document which pledger considers as
valuable documents of title, like railway receipt etc can also be pledged.
It is necessary for creation of pledge that the goods are delivered,
through actual or constructive delivery, to the pledgee.

Pledgee’s Liability – where the bank is the pledgee of the goods or is in

possession of the goods and assets of the borrower, it has the obligation
to retrun the same on demand against payment of debt and if it fails to do
so it will be liable in damages. (Lallan Parsad Vs. Rahmat Ali)

A person borrowed moneys from bank, executed a promissory note and

endorsed a railway receipt in favour of the bank as security. The
combined effect of these transactions was that the Bank would remain in
control of the goods till the debt was discharged (Morvi Mercantile Bank
Vs. Union of India).
A person borrowed money from the bank and pledged certain goods. The
government seized the goods, sold it and sought to distribute the money
to the creditor. It was held that the bank being a pledgee has priority over
other claimants on the sale proceeds for payment of its claim against the
borrower.
(Bank of Bihar Vs. State of Bihar).

A banker is bound to take the same core of the property pledged or

entrusted to it as a reasonable prudent and careful man may fairly be
expected to take in respect of his own property of the like description
(UCO Bank Vs. Hem Chandra Sarkar).

Ans. 5.
Hire Purchase Finance – A banker is very often approached to finance
what is known as a hire purchase agreement, in which the owner of the
article / movable property hires it to another known as the hirer on an
understanding that on the hirer paying the owner a specified number of
fixed installments, the property would be transferred by the owner to the
hirer who then becomes the owner of the property.

The essential feature of this form of a contract is that although the trader
undertakes to hire the goods to the customer for a fixed term and to
transfer the property to him when all installments of hire rental have been
paid, the customer on his part does not bind himself to continue the hiring
for longer then he wishes and therefore undertakes no obligation to buy
the goods under the English Law the benefit of a hire purchase
agreement can be assigned but the assignee gets the same title as the
hirer i.e. he stands on the same footing as the hirer.

Even the Indian Law has sought to confer the right of assign mention the
hirer. The Hire – Purchase Act, 1972 governs the hire purchase
transactions in India.

Ans. 6.
Book Debts - A banker sometimes gives an advance to a customer on
the basis of assignment of debts either due or accruing due to the latter.
For example the assignor – customer may be expecting to receive money
either for goods sold or services rendered, or he may be due to receive
money under a will. These debts, which are due to him, the customer
may assign to the banker against the loan advanced to him. Generally,
bankers do not like to advance money against book debts, because these
transactions are brought with risk.

Form of Assignment - A assignment must be in writing and signed by

the assignor. There is no particular format to be followed, only an
intention on part of the assignor to pass on his interest to the assignee,
should clearly be manifested whatever the words used i.e. be it may in
the form of an order or in the form of a request it is immaterial.

Consideration not essential – An assignment may be by way of gift or

otherwise and no separate consideration is necessary to support the
assignment. Once the debtor pays off his debt to a third party on a
direction from his creditor, he is entitled to a valid discharge irrespective
of whether there was any consideration as between the creditor and third
party or not.

Ans. 7. Assignment of pronote in favour of the bank – In

chandrashekara Goude Vs. Canara Bank and others the loan was
advanced by the firm under the hire purchase agreement for purchase of
vehicle. The borrower executed a pronote in favour of the firm advancing
the money.

The firm assigned the promissory note to bank but not the loan covered
by the hire purchase agreement. The court held that it is an elementary
principle of law that unless the actionable claim covered by the hire
purchase agreement was transferred in favour of the bank, the bank had
no locus standi to bring a suit against the borrower only on the basis of
the collateral security executed by them by way of pronote,unless the
loan was transferred as contemplated under section 130 of the Transfer
of Property Act.

Assignment of Fund - In Bharat Nidhi Limited Vs. Takhatmat the bank

advanced money to the borrower against the bills of military and other
authorities. The borrower gave an irrevocable power of attorney in favour
of the bank to present and obtain the payment of bills. The borrower
endorsed one bill in favour of the bank as: “Please pay to the Bharat
Bank Limited, Jabalpur” and handed over the bill to the bank for
collection. The bank forwarded the bill to military authorities. But before
the bank received the payment on T attached the amount due under the
bill in execution of a money decree against the borrower.

The Supreme Court held that under the power of attorney there was an
agreement between the lender and the borrowers that the debt due the
lender would be paid out of the specific fund. The power of attorney
coupled with endorsement as amounted to assignment of the fund and it
is not revocable.

Ans. 8.
The issue under consideration in the present case is the law relating to
mortgage.

Section 58 of the Transfer of Property Act, 1882 defines mortgage as

under:

(a) A mortgage is the transfer of an interest in specific immovable

property for the purpose of securing the payment of money advanced or
to be advanced by way of loan, an existing or future debt, or the
performance of an engagement, which may give rise to pecuniary
liabilities.

The transferor is called a mortgagor, the transferee a mortgagee, the

principal monies and interest of which payment is secured for the time
being are called the mortgage money, and the instrument by which the
transfer is effected is called a mortgage debt.

(b) Simple mortgage - Where, without delivering possession of the

mortgaged property, the mortgager binds himself personally to pay the
mortgage money, and agrees expressly or impliedly, that in the event of
his failing to pay according to his contract, the mortgagee shall have a
right to cause the mortgage property to be sold and all the proceeds of
sale to be applied, so far as may be necessary, in payment of the
mortgage money, the transaction is called a simple mortgage and the
mortgagee a simple mortgagee.

(c) Mortgage by conditional sale - Where the mortgagor ostensibly

sells the mortgaged property – on condition that on default of payment of
the mortgage money on a certain date the sale shall become absolute, or
on condition that on such payment being made the sale shall become
void.

(d) Usfructory mortgage when the mortgagor delivers possession on

expressly or by implication binds himself to deliver possession of the
mortgaged property to the mortgagee, and authorizes him to retain such
possession until payment of the mortgage money, and to received the
rends and profits accruing from the property or any part of such rents and
profits and to appropriate the same in lieu of interest, or in payment of the
mortgage money, or partly in lieu of interest and partly in lieu of interest
money, the transaction is called a Usfructory mortgage and the
mortgagee a Usfructory mortgagee.

(e) English mortgage - Where the mortgagor binds himself to repay

the mortgage money on a certain date, and transfers the mortgaged
property absolutely to the mortgage, but subject to the proviso that he will
retransfer it to the mortgagor upon payment of the mortgage –money as
agreed the transaction is called an English mortgage.

(f) Anomalous Mortgage – A mortgage which is not a simple

mortgage, a mortgage by conditional sale, an English mortgage or a
mortgage by deposit of title deed within the meaning of this section is
called anomalous mortgage.
 Module No. IX

Procedural Aspects of Banking Law

Ans. 1.
Garnishee order – If a debtor fails to pay the debt owed by him to his
creditor, the latter may apply to the court for the issue of a Garnishee
order on the banker by his debtor. Such order attaches the debts not
secured by a negotiable instrument, by prohibiting the creditor from
recovering the debt and the debtor from making payment thereof.

A Garnishee order is issued under order 21, Rule 46 of the code of Civil
Procedure, 1908. The account of the customer with the banker, thus
becomes suspended and the banker is under an obligation not to make
any payment from the account concerned after the receipt of the
Garnishee order. The creditor at whose request the order is issued is
called the judgment creditor, the debtor whose money is frozen is called
judgment debtor and the banker who is the banker of the judgment debtor
is called the Garnishee.

The suspended account may be revived after payment has been made to
the judgment creditor as per the directions of the court. The following
points are to be noted in this connection –

(1) The Amount Attached by the order - A garnishee order may attach
either the entire amount of the judgment debtor with the banker
irrespective of the amount which the judgment – debtor owes to the
creditor or a specified amount only which is sufficient to meet the
creditor’s claim from the judgment debtor.

(2) The order of the court restrains the banker from paying the debts
due or accruing due. The words “accruing due’ mean the debts which are
not payable but for the payment of which an obligation exists. If the
account is overdrawn, the banker owes no money to the customer and
hence the court order ceases to be effective.
(3) The Garnishee order may be served on the Head Office of the bank
concerned and it will be treated as sufficient notice to all of its branches.
However, the head office is given reasonable time to intimate all
concerned branches. If the branch office makes payment out of the
customer’s account before the receipt of such intimation, the banker will
not be held responsible for such payment.

(4) In case of cheques presented to the paying banker through the

clearing house, the effectiveness of the Garnishee order depends upon
the fact whether the time for returning the dishonoured cheques to the
collecting banker has expired or not. Every drawee bank is given
specified time within which it has to return the unpaid cheques, if any, to
the collecting bank.

If such time has not expired and in the meanwhile the bank receives a
garnishee order, it may return the cheque dishonoured. But if the order is
received after such time is over, the payment is deemed to have been
made by the paying banker and the order shall not be applicable to such
amount.

(5) The Garnishee order can attach the amounts deposited into the
customer’s account after the Garnishee order has been served on the
banker. A Garnishee order applies to the current balance at the time the
order is served, it has no prospective operation. Bankers usually open a
new account in the name of the customer for such purpose.

Rights of Attaching Creditor - When the garnishee deposits the attached

amount in the court, the attaching creditor becomes a secured creditor.
In Rikhabchand Mohanlal Surana Vs. The Sholapur Spinning and
Weaving Co. Ltd., the High Court held that – “when the attachment is only
by a prohibitory order then the attaching creditor has no right in the
property attached, but once the property or moneys come into the
possession of the court, then it would follow that they are constructively
held by the court for the attaching creditor. The court does not hold the
money for the debtor more so when the garnishee obtains complete
discharges by making payment in court.
Ans. 2.

The issue under consideration in the present case is the law relating to
Banker’s duty of secrecy.

As the disclosure of matters relative to the customer’s financial position

may do considerable harm to his credit and business, the banker should
take scrupulous care not to disclose the state of his customer’s account.
It is a recognised fact that the banker must not disclose the condition of
his customer’s account except on reasonable and proper occasions and
the obligation to observe secrecy does not end even with closing of the
customer’s account.

When disclosure is justified – It is an implied term of the contract

between a banker and his customer that the former will not divulge to
third persons, without the express or implied consent of the latter, the
state of his accounts. For instance, in cases where the customer has
given his banker as a reference, the latter will be fully justified in
answering all the trade references invited by the customer.

The banking companies are required to make certain disclosures under

these enactments –

(1) Banker’s Book Evidence Act, 1891, Section 4. The Act allows
certified copies of the entries to be produced in legal proceedings in
which the bank is not a party.

(2) The Reserve Bank of India Act, 1934, Section 45B empowers the
Reserve Bank to collect credit information from banking companies. The
Reserve Bank may furnish such information to any other banking
company in accordance with Section 45D.

(3) The Banking Regulation Act, 1949, Section 26 requires every

banking company to submit a return of unclaimed deposits to the Reserve
Bank within 30 days of the close of each calander year.
(4) The Companies Act, 1956 Sections 235 and 237 empower the
Central Government to appoint inspectors to investigate the affairs of any
company. Under Section 240, it should be the duty of all officers,
employees and agents of the company to produce all books and papers
of or relating to the company and give to the inspectors all assistance in
connection with the investigation which they are reasonably able to give.

Ans.3.

Overdraft - Sometimes it may happen that a customer might need a

temporary accommodation i.e. he may need to withdraw more money
then what his account actually holds. In such cases the bank may allow
him to overdraw from his current account, usually against collateral
securities. This arrangement like the one above is advantageous from
the customer’s viewpoint because he is required to pay interest only on
the amount actually drawn by him.

The basic difference between on overdraft and a cash credit is that the
former is deemed to be a kind of a bank credit to be used only
occasionally whereas the latter is generally used for long-term loans by
commercial and industrial concerns doing regular business.

In Indian Overseas Bank, Madras Vs. Naranprasad Govindlal Patel,

Ahmedabad, it was observed by the Gujarat High Court that, “an
arrangement of overdraft between a bank and its customers is a contract
and it cannot be terminated unilaterally by bank. Merely because the
client was not required to execute any document or to furnish any security
would not made such an arrangement an act of grace on behalf of the
bank. Such an arrangement even though temporary is not one which can
be terminated unilaterally and at the sweet will of the bank without giving
notice to its customers.

Ans. 4.
Garnishee order of the court restrains the banker from paying the debts
due or accruing due. The words ‘accruing due’ mean the debts which are
not payable but for the payment of which an obligation exists. If the
account is overdrawn, the banker owes no money to the customer and
hence the court order cases to be effective. A bank is not a garnishee
with respect to the unutilized portion of the overdraft of cash credit facility
sanctioned to its customer and such unutilized portion of cash credit or
overdraft facility cannot be said to be an amount due from the bank to its
customers. The above decision was given by the Karnataka High Court
in Canara Bank Vs. Regional Provident Fund Commissioner. In this
case the Regional Provident Fund Commissioner wanted to recover the
arrears of provident fund contributions from the defaulters bankers out of
the unutilized portion of cash credit facility. Rejecting this claim, the High
Court held that the bank cannot be termed as a garnishee of such
unutilized portion of cash credit, as the banker’s position is that of
creditor.

In the current case, the garnishee appeared in court, in response to the

letter and filed a counter – affidavit. It was held that the same could be
treated as “objections” contemplated by order 21, rule 46C of CPC, 1908,
even though a formal notice under order 21, rule 46 A had not been
issued. Hence the court has a duty under order 21, rule 46C to direct that
the disputed question be tried as an issue and to decide the issue.
(Executive Engineer, R.S.E. Board Vs. I.H. Sharma AIR 1988 Ker. 285).

Ans. 5.

Fixed Deposits and Banker’s Lien – The bank is a debtor, in respect of

the money in fixed deposit. It has no right to press into service of the
doctrine of “banker’s lien” and to retain the money in fixed deposit. There
is no question of the bank exercising the ‘lien’ for the purpose of retaining
the money in fixed deposit, according to the fixed deposit. [Union Bank of
India Vs. R.V. Venugopalan]

According to the view of Kerala High Court, money lodged with banks as
fixed deposits is a loan to the bank. The banker in connection with the
‘fixed deposit’ is a debtor. Accordingly, the depositor would cease to be
the owner of the money in fixed deposit. The said money becomes the
money of the bank, enabling the bank to do as it likes, subject however,
to banker’s obligations to repay the debt on maturity.
Money in fixed deposit, therefore, constitutes a debt against the banker
and a debt cannot be a suitable subject for lien because a lien is a right
recognised in a creditor to retain another man’s property until the debt is
paid.

Set off by the Banker – Banker has the right to set off the account against
another. [United Bank of India Vs. Venugopalan AIR 1990 Ker.223)

Ans. 6.
Contingent and Future Debts – If the money is payable to the judgment
debtor only on a certain contingency, then the decree holder would be
subject to the some disability as his judgment debtor, and has to wait tillt
he happening of that contingency. (K.J. Jung Vs. Mohd. Ali, AIR 1972
A.P 70)

The principle is that there must be money due to the judgment debtor.
Thus, if a builder is paid only on the certificate if the architect, the amount
does not become due to the builder until the certificate is obtained
(Dunlop & Ranken Ltd. Hendall Steel Structures Ltd. (1957) 1 All ER 347.
A mere cause of action which has not ripened into a debt cannot be
attached. It follows that if a deed has been already assigned by the
judgment debtor, it cannot be attached.

There is, however, a distinction between (1) he case where there is an

existing debt, though its payment is deferred, and (ii) the case where both
the debt and its payment rest in the future. In the former case, the debt is
attached. In the latter it is not. The fact that the amount of the debt due
all accruing is not ascertained does not prevent a garnishee order nisi
from being made.

Ans. 7.
If the money is payable to the judgment debtor only on a certain
contingency, then the decree holder would be subject to the same
disability as his judgment debtor, and has to wait till the happening of that
contingency. (K.L. Jung Vs. Mohd. Ali AIR 1972 AP 70). The principle is
that there must be money due to the judgment debtor.
A Bankers garnishee order may not be operative in respect of deposits in
the bank made subsequent to the service of the order. Such deposits do
not constitute “debts” due from bank at the time of the order.

The income – tax authorities cannot freeze an overdraft of account by

order or order the bank to pat them the difference between the limit of
overdraft allowed and the amount overdrawn. An unjustified overdraft
account does not render the banker a debtor in any sense.

Floating charge - When proceeds of goods are under a bank’s floating

charge, garnishee proceedings are not possible for the recovery of the
assessee’s does from the purchased. (Jay Engg. Works Ltd. V.
Syndicate Bank Ltd. (1981) Tax L.R. (Notice of contravention) 173 (Col.)).

Ans.8.
The Garnishee order does not apply to:

(1) The amounts of cheques, drafts, bills, etc. sent for collection by the
customer which remain uncleared at the time of the receipt of the order.

(2) The sale proceeds of the customer’s securities eg. Stocks and
shares in the process of sale, which have not been received by the
banker. In such cases, the banker acts, as the agent for the cases, the
banker acts as the agent for the customer for the collection of the
cheques or for the sale of the securities and the amounts in respect of the
same are not debts due by the banker to the customer, until they are
actually received by the banker and credited to the customer’s account.

But if the amount of such uncleared cheque etc. is credited to the

customer’s account, the position if the banker changes and the garnishee
debtor are applicable to the amount of such uncleared cheques.

The Garnishee order cannot attach the amounts deposited into the
customers account after the garnishee order has been served on the
banker. A Garnishee order applies to the current balance at the time the
order is served, it has no prospective operation. Banker’s usually open a
new account in the name of the customer for such purpose.
Set off by the Banker - Banker has the right to set off one account
against another.

Set off cannot be claimed in respect of an amount becoming due to the

bank after the attachment.

Ans. 9.
Provision in the code of Criminal Procedure, 1973 - In criminal
proceedings, the power of the court to issue summons to produce a
document or other thing is governed by section 91 of the code of Criminal
Procedure,1973 Sub Section (1) of that section gives power to the court
or an officer in charge if a police station for the specified purpose.

When the court or the officer mentioned above considers that the
production if any document or other thing is necessary or desirable for the
purposes of any investigation, inquiry, trial or other proceedings under this
code by or before such court or officer, such court may issue summons,
or such officer a written order, to the person in whose possession or
power such document or thing is believed to be, requiring him to attend
and produce it, or to produced it, at the time and place stated in the
summons or order.

Section 91(3) of the code provides that nothing in the section shall be
deemed to effect the Banker’s Books Evidence Act, 1891. The main
object if the Act of 1891 is to avoid disturbance of the business of banking
and inconvenience to the large number of customers who have to
transact business with banks.

Ans. 10.
The issue under, consideration in the present case is the law relating to
future debts. The cheque, in this case was payable only after the
retirement from service.

If the money is payable to the judgment debtor only on a certain

contingency, then the decree holder would be subject to the same
disability as his judgment debtor, and has to wait till the happenning of
that contingency. (Shanti Prasad V. Director of Enforcement). The
principle is that there must be money due to the judgment debtor. Thus, if
a builder is paid only on the certificate of the architect, then the amount
does not become due to the builder until the certificate is obtained.
(Dunlop and Ranken Ltd. V. Hendall Steel Structures Limited. It follows
that if a debt has already been assigned by the judgment debtor, it cannot
be attached.

There is, however, a distinction between (i) the case where there is an
existing debt, though its payment is deferred, and (ii) the case where both
the payment and the debt rest in the future. In the former case, the debt
is attached, in the latter case, it is not. (O, Driscoll V. Manchester
Insurance Committee). The fact that the amount of the debt due or
accruing, is not ascertained, does not prevent a garnishee order nisi from
being made. (Demurrage Pass V. Capital and Industrial Corporation).

Joint Judgment – If there is a joint judgment against two or more persons,

the decree holder can attach a debt owing to any of those judgment
debtors. (Miller Vs. Myhn, (1859) 28 L.J. O.B. 324).