BANKING LAW NOTES

MODULE: 1
1. Structure of Indian Banking and Financial Institutions.

Reserve Bank of India is the central bank of the country and regulates the banking system of
India. The structure of the banking system of India can be broadly divided into scheduled
banks, non-scheduled banks and development banks.

(a) Scheduled Banks: Scheduled Banks in India are the banks which are listed in the
Second Schedule of the Reserve Bank of India Act,1934. The scheduled banks enjoy
several privileges as compared to non- scheduled banks. Scheduled banks are entitled
to receive refinance facilities from the Reserve Bank of India. They are also entitled
for currency chest facilities. They are entitled to become members of the Clearing
House. Besides commercial banks, cooperative banks may also become scheduled
banks if they fulfill the criteria stipulated by RBI.
(b) Unscheduled banks: These are those banks which are not included in the Second
Schedule of the Reserve Bank of India. Usually, those banks which do not conform to
the norms of the Reserve Bank of India within the meaning of the RBI Act or
according to specific functions etc. or according to the judgement of the Reserve
Bank, are not capable of serving and protecting the interest of depositors are classified
as non-scheduled banks.
(c) Development Financial Institutions or Development Banks : Development banks
are specialized institutions that provide medium and long-term credit lending
facilities. Their main objective is to serve the public interest instead of earning profits.
They provide financial assistance to both public as well as private sector institutions.
Example- NABARD
2. Classification of Banking Institutions

There are two broad categories under which banks are classified in India-

1. Scheduled Banks

2. Unscheduled Banks
 1. Scheduled Banks

Scheduled banks are covered under the 2nd Schedule of the Reserve Bank of India Act,1934.
To qualify as a scheduled bank, the bank should conform to the following conditions:

 A bank that has a paid-up capital of Rs. 5 Lakh and above qualifies for the schedule
bank category.
 A bank requires to satisfy the central bank that its affairs are not carried out in a way
that causes harm to the interest of the depositors.
 A bank should be a corporation rather than a sole-proprietorship or partnership firm.

Scheduled Commercial Banks in India are categorised in 5 different groups according to their
ownership / nature of operation. These bank groups are:

(i) State Bank of India

(ii) Nationalised Banks,

(iii) Regional Rural Banks,

(iv) Foreign Banks

(v) Other Indian Scheduled Commercial Banks (in the private sector).

Every Scheduled Banks enjoys following facilities;

1. Scheduled Banks are eligible for obtaining debts/loans on bank rate from the RBI.
2. Scheduled Banks automatically acquires the membership of the clearing house.
3. Scheduled Banks get the facility of the rediscount of first class exchange bills from
RBI. This facility is provided by the RBI only if the Scheduled Banks deposit average
daily cash with the RBI which is decided by the RBI itself and presents the recurring
statements under the provision of RBI Act, 1934 and Banking Regulation Act, 1949.
2. Non- Scheduled Banks:

The banks which are not included in the list of the scheduled banks are called the Non-
Scheduled Banks. At present there are only 3 such banks in the country. Non- Scheduled
Banks have to follow CRR conditions. These banks can have CRR fund with themselves as
no compulsion has been made by the RBI to deposit it in the RBI. Non- Scheduled Banks are
also not eligible for having loans from the RBI for day today activities but under the
emergency conditions RBI can grant loan to them. Example: All local area banks are called
the Non-scheduled banks.

3. Commercial Banks

Commercial Banks are regulated and managed under the Banking Regulation Act, 1949.
These are profit making banks based on their business model. Granting loans to the
government, general public, and corporate and accepting deposits counts as the primary
function. There are four types of commercial banks:

(i) Public Sector Banks

(ii) Private Sector Banks
(iii) Foreign Banks
(iv) Regional Rural Banks

(i) Public Sector Banks: These are the nationalised banks and account for more than
75 per cent of the total banking business in the country. Majority of stakes in these
banks are held by the government. In terms of volume, SBI is the largest public
sector bank in India and after its merger with its 5 associate banks (as on 1st April
2017) it has got a position among the top 50 banks of the world. There are a total
of 20 nationalised banks in India.
(ii) Private Sector Banks: These include banks in which major stake or equity is held
by private shareholders. All the banking rules and regulations laid down by the
RBI will be applicable on private sector banks as well.
(iii) Foreign Banks: A foreign bank is one that has its headquarters in a foreign
country but operates in India as a private entity. These banks are under the
obligation to follow the regulations of its home country as well as the country in
which they are operating.
(iv) Regional Rural Banks: These are also scheduled commercial banks but they are
established with the main objective of providing credit to weaker sections of the
society like agricultural labourers, marginal farmers and small enterprises. They
usually operate at regional levels in different states of India and may have
branches in selected urban areas as well. Other important functions carried out by
RRBs include- Providing banking and financial services to rural and semi-urban
areas
 Government operations like disbursement of wages of MGNREGA workers, distribution
of pensions, etc. Para-Banking facilities like debit cards, credit cards and locker facilities.

4. Cooperative Banks

Run by the elected members of a managing committee and registered under the
Cooperative Societies Act, 1912 are the cooperative banks. These are no-profit, no-loss
banks and mainly serve entrepreneurs, industries, small businesses, and self-employment.
Cooperative banks can be of two types:

(i) Urban Co-operative Banks refer to the primary cooperative banks located in
urban and semi-urban areas. These banks essentially lent to small borrowers and
businesses centered around communities, localities work place groups. According
to the RBI, on 31st March, 2003 there were 2,104 Urban Co-operative Banks of
which 56 were scheduled banks. About 79% of these are located in five states, –
Andhra Pradesh, Gujarat, Karnataka, Maharashtra and Tamil Nadu.
(ii) A State Cooperative Bank is a federation of the central cooperative bank which
acts as custodian of the cooperative banking structure in the State.
3. Development Banking and its Types

Development banks can be known as special industrial financial institutions. These banks
were mostly established after World War II in both developed as well as developing countries
in the world. Just like elsewhere, the development banks in India are responsible for
accelerating the economic development of the country.

Objectives of Development Banks

 One of their primary objectives is to promote industrial growth.

 Since many backward areas are overlooked, development banks develop such
neglected areas.
 Development banks also create many employment opportunities by employing
people themselves, starting new projects, and financing existing ones.
 Because they provide finance and assist entrepreneurs, they promote self-
employment projects with funds.
Types of Development banks in India

(i) Industrial Development Bank of India (IDBI ): The Industrial Development

Bank of India, popularly known as IDBI, came into existence as a Development
Institution under the IDBI Act of 1964. It is headquartered in Bombay,
Maharashtra.
The IDBI is regarded as a public financial institution as per the Companies Act
1956. It continued as DPI till 2004 when it was converted into a banking
organization. The Industrial Development Bank of India Act of 2003 was passed
to convert the DPI into a bank.
It is a public sector bank as the government of India owns more than 70%
shareholding of the bank.
(ii) National Housing Bank (NHB): The National Housing Bank (NHB) is a state-
owned bank and regulatory authority in India established under section 6 of the
National Housing Bank Act of 1987. It was created on 08th July 1988. The NHB
is headquartered in New Delhi.
The NHB is responsible for regulating and re-financing social housing activities
including research, etc. It is owned by the Reserve Bank of India and was
established to promote private real estate acquisition. The institution further aims
to promote inclusive expansion with stability in the housing finance sector.
(iii) Small Industries Development Bank of India (SDBI): The Small Industries
Development Bank of India (SIDBI) was set up in 1990 under an Act of
Parliament. It was a wholly-owned subsidiary of the Industrial Development Bank
of India. Presently, SIDBI’s ownership is held by 33 government of India-owned/
controlled institutions. SIDBI is headquartered in Lucknow.
(iv) Export-Import Bank of India (EXIM): The Export-Import Bank of India
(EXIM Bank) is a financial institution created by the Export-Import Bank of India
Act of 1981. It is a public sector financial institution. The main aim of the EXIM
Bank is to finance the Indian exports that generate foreign exchange for the
country. It also extends term loans for foreign trade.
The EXIM Bank is a statutory corporation wholly owned by the government of
India. It was established on 01st January 1982 with an aim to finance, facilitate,
and promote foreign trade in India.
(v) National Bank for Agriculture and Rural Development (NABARD) : The
National Bank for Agriculture & Rural Development (NABARD) is the prime
development bank in India. Under the special act by the parliament, the NABARD
was set up on 12th July 1982.
Its main focus is to uplift rural India by increasing the credit flow for the
promotion of the agriculture and non-farm sector. NABARD is headquartered in
Bombay (Maharashtra). It is considered as the apex bank of the country, which
takes care of the cottage industry, small and village industries, and other rural
establishments.
(vi) Industrial Finance Corporation of India (IFCI): The IFCI (Industrial Finance
Corporation of India) was the first specialized financial institution to provide term
finance to large businesses in India. It was set up under the Industrial Finance
Corporation Act (1948) on 01st July 1948.
4. Indian Banking System – Features, Money Lenders
DUTIES OF BANK
(a) Accepting Deposits: Banks accept deposits from the public in various forms like
savings accounts, fixed deposits, and current accounts.
(b) Providing Loans: Banks gain additional money by providing loans for a variety of
products. The bank earns the additional funds by lending money to the qualifying
person at predetermined rates.
Banks now provide loans for a variety of purposes, including study loans, vehicle
loans, housing loans, personal loans, and so on.
(c) Withdrawal and payment facilities: Customers can use a bank’s numerous payment
and withdrawal services to receive their money quickly and easily. Customers can use
cheques and draughts to withdraw money, as well as ATMs established by banks at
various sites throughout the city.
(d) E-banking services: Modern banks now provide internet services, which is another
element of a bank. The growth of the internet and its integration into the banking
industry has made it even easier for customers to do numerous transactions. Through
their apps, banks are providing online services. A person can pay their bills, buy
groceries, and shop without having cash in hands.
(e) Business: Banking’s sole purpose is not to supply consumers with banking services.
To make additional money, all banks are involved in subsidiary enterprises. Their only
 responsibility is to deliver optimum customer satisfaction and maximum interest rates
in order to attract more clients to bank with them. To make a profit, money is moved
from one hand to the next.
(f) Offering Investment Services: Banks may offer investment products like mutual
funds, stocks, and bonds.

Money lenders:

Although the country is acquainted with a strong network of financial institutions, oftentimes,
the recourse of such institutions is not accessible to the rural regions. In addition to this,
because of the rigid KYC and collateral requirements, it becomes complicated for the small
rural banks to provide loans to the small farmers. It is when a money lender comes into the
picture. They are non-banking financial institutions that perform a gap-filling function by
reaching out to the class of borrowers whose financial needs are not catered to by banks or
other financial institutions.

According to the definition, a money lender is referred to as an individual or group of

individuals who use to lend small amounts of money at higher interest rates compared to
financial institutions. The reason why money lenders charge a higher rate of interest than
banks is that the lending risks are relatively higher.

Features:

(a) Moneylenders’ funds are mostly owned funds. Generally, they do not borrow from
each other, or banks, or other financial institutions. They may receive small amounts
of temporary deposits from clients, relatives, and friends. But such deposits are a very
small proportion of the total money-lenders’ capital.
(b) The borrowers from moneylenders are mostly economically weaker sections of the
community small and marginal fanners, agricultural labour and village artisans in
rural areas, factory and mine workers, peons, menials, and other low-paid workers and
small traders.
(c) The moneylenders’ credit has been known to be highly exploitative.
(d) The moneylenders’ credit is unregulated.
(e) The moneylenders’ credit may be secured or unsecured.
 5. Narasimham Committees’ Report and Recommendations.

India nationalized most of its banks during the 1960-1970s. This halted the balance of
payments crisis of the economy where India had to retrieve gold from the International
Monetary Fund (IMF) to lend funds to meet its financial debts, which initiated economic
liberalization in India in 1991.

By the late 1980s, Indian Government took many measures to remodel the country’s financial
system as many drawbacks and rigidities had developed serious concerns in the Indian
banking system. Two Narasimham committees were set up in the 1990s to satisfy the banking
requirements.

Narasimham Committee 1

The Narasimham Committee 1 was established in 1991 by Finance Minister Dr. Manmohan
Singh to examine the functioning of banks. In August 1991, a nine-member committee was
appointed to suggest reforms to the financial system. The committee submitted its
recommendations and the report in December 1991 to the Parliament. The Report was titled
Narasimham Committee Recommendations on the Financial System (1991).

Narasimham Committee 2

In 1998, the Narasimham Committee 2 was formed by Finance Minister P. Chidambaram to

intimate on the banking sector reforms. The committee submitted its recommendations to the
government in April 1998. The government undertook the report and recommendations as it
emphasized more human resource development, technological upgradation, and strengthening
of the foundation of the banking system by structure, which was the need of the hour.

Recommendations of Narasimham Committee 1

The Narasimham Committee 1 report presents the following recommendations on the

financial system:

1. Reduction in SLR and CRR: During 1991, both Statutory Liquidity Ratio (SLR) and
Cash Reserve Ratio (CRR) were extremely high. Due to this, bank resources were not
available for government use. The committee recommended reducing the SLR and
 CRR from 38.5 percent to 25 percent and from 15 percent to 3 to 5 percent,
respectively.
2. Reorganization of the Banking sector: The Narasimham Committee 1
recommended reduction in the number of public sector banks. The committee
suggested mergers and acquisitions increase the bank’s efficiency. The Committee
recommended nationwide the national recognition of 8 to 10 banks.
3. Establishment of the ARF Tribunal: During the 1991 economic crisis, banks’ bad
debts and Non-Performing Assets (NPA) were concerning. The committee
recommended setting up an Asset Reconstruction Fund (ARF) to take over the
proportion of bad and doubtful debts from banks and financial institutions.
4. Removal of Dual Control: At that point, the banking sector in India was regulated by
the RBI and the Ministry of Finance. The committee proposed RBI be the sole
primary regulator of banking in India.
5. Stop the Directed Credit Program: The committee recommended eliminating
government interest rate controls as they were not profitable.
6. Interest Rate Determination: The committee highlighted that the interest rates
should be determined based on market forces and not by the Government, which was
earlier the case.
7. More Freedom to Banks: To improve the workings of banks, the Narasimham
Committee 1 recommended that every bank be free and autonomous to carry out its
work. Over-regulation and over-administration should be avoided, and the selection of
the Chief Executive and board of directors should be made solely on merit.

Narasimham Committee 2 Recommendations

The Narasimham Committee 2 was formed in 1998 and suggested banking sector reforms.
The recommendations by the Narasimham Committee 2 are as follows:

1. Robust Banking System: The Committee recommended merging major public sector
banks to boost trade.
2. NPAs and the Concept of Narrow Banking: High Non-Performing Assets (NPAs)
were a problem back in 1998, so the Committee recommended Narrow Banking
Concept where the banks could put their funds in short-term and risk-free assets. The
recommendations led to the Securitization and Reconstruction of Financial Assets and
Enforcement of Security Interest Act, 2002.
 3. Role of RBI: The Narasimham Committee 2 recommended that RBI be the regulator.
But, at the same time, they should not have ownership in any bank.
4. Capital Adequacy Ratio: The committee proposed the government should increase
the Capital Adequacy Ratio norms.
5. Foreign Exchange: The Committee recommended that the foreign exchange open
position limits carry 100% risk weight. The Committee also proposed that the
minimum start-up capital for foreign banks should be increased to $25 million from
$10 million.
6. Nationalisation of Commercial Banks and its impact.

Nationalisation of Banks means transferring control and ownership of private banks into the
hands of the government. This means the government becomes the majority shareholder in an
erstwhile private bank, and the bank operates as a public sector entity.

Nationalisation of Commercial Banks in India

The Government first went for partial nationalisations as an experimental basis. After this
experimentation went successful, the Government decided to go for complete nationalisation
of banks. Accordingly, the Banking Nationalisation Act, 1969 was passed, under which a total
of 20 private banks were nationalized in the following two phases:

 Phase 1 of Nationalisation of Banks in India

In Phase 1 of Nationalisation of Banks in India, 14 banks with deposits more than ₹50
crores were nationalised in July 1969.
 Phase 2 of Nationalisation of Banks in India
In Phase 2 of Nationalisation of Banks in India, 6 banks with deposits more than ₹200
crores were nationalised in April 1980.

Impact of nationalisation:

Positive Impacts-

1. Removal of Barriers: Nationalisation of banks in India meant that there were no

longer any barriers, social, economic, or political between the bankers and customers.
This enabled in a massive quantitative expansion in the customer base and also helped
improve the services.
2. Enabled Banks to Widen their Reach: The banks began to expand into the rural
areas. With this the economy also expanded and employment opportunities were
created even in the remote corners of the country.
3. Expansion of Branch Network: During the last 28 years of nationalisation of banks,
the branches of the public sector banks rose 800 percent from 7,219 to 57,000, with
deposits and advances taking a huge jump by 11,000 percent and 9,000 percent.
4. Reorientation of Bank Lending: Accelerated the process of development of the
priority sectors of the economy, which were hitherto not getting sufficient attention
from commercial banks.
5. Increased Credibility of Indian Banking System: Ease of factor access and
increased banking habits led to increased credibility of the Indian banking system.
6. Priority Sector Lending: Priority Sector Lending (PSL) scheme, that was initiated
post nationalisation of banks, meant that the agriculture and allied sectors emerged as
the largest contributors to the national income.
7. Mobilization of Savings: Nationalisation helped mobilize the savings of the people to
a great extent and utilize them for productive purposes.
8. Development of the agriculture sector: Banks assisted agriculture in many ways. It
provided increased finance to agriculture. This helped in reducing exploitation of
farmers by money-lenders.

Negative Impacts

1. Failed in objectives: The Estimates Committee of Lok Sabha stated that nationalised
banks have largely failed in achieving the main objectives of bank nationalisation like
removing regional disparities through developing banking facilities in backward
areas.
2. Low Profitability: A major defect of banking after nationalisation is that the
nationalised banks are either operating under losses or experiencing falling dividends.
The profits of the commercial banks, which were quite high during fifties and sixties,
have declined considerably in the post-nationalisation period.
3. Low Efficiency: Nationalisation has created a bureaucratic attitude in the functioning
of the banking system. Lack of responsibility and initiative, red-Tapism, inordinate
delays are common features of nationalised banks. As a consequence, the efficiency of
these banks has reduced.
 4. Increasing NPAs: Govt pressure from the top for implementing even loss making
schemes or full waiver of loans for electoral benefits has led to an increase in NPAs to
a dangerous level.
7. Bank and Customer Relationship

Banking is a trust-based relationship. There are numerous kinds of relationships between the
bank and the customer. The relationship between a banker and a customer depends on the
type of transaction. Thus, the relationship is based on contract, and certain terms and
conditions. These relationships confer certain rights and obligations both on the part of the
banker and on the customer.

Classification of Relationship

The relationship between banker and customer is of utmost importance. The relationship
between a bank and its customers can be in the form of-

1. Debtor-Creditor: A debtor is an entity that owes a debt to another entity. The entity
may be an individual, a firm, a government, a company or other legal person. The
counterparty a creditor. When the counterpart of this debt arrangement is a bank, the
debtor is more often referred to as a borrower.
(a) Bank as debtor: The principal relationship of bank-customer is that of debtor-creditor
in case of deposit accounts like Savings Bank account, Current account, Fixed
Deposit account and Recurring Deposit account.
(b) Bank as creditor: The relationship between bank-customer becomes that of creditor-
debtor, when customer has borrowed money from the bank by way of OD(Overdraft),
CC (Cash credit), Demand loan, Term loan, Bills discount or any other kind of loan or
advance, either on secured or unsecured basis.
2. Trustee and Beneficiary: When a bank receives money or other valuable securities,
then the banker’s position is of a trustee. On the other hand, when a bank receives
money and uses it in various sectors, the bank becomes the beneficiary.
3. Pledger and Pledgee: When a customer pledges an article (goods and documents)
with the banker as a security for the payment of debt or performance of the promise,
the customer becomes a pledger and the banker becomes the pledgee.
4. Bailor and Bailee: The person delivering the good is called the bailor and the person
to whom the good is delivered is called the bailee. Banks secure their advances by
taking some tangible assets as securities. Sometimes they keep valuable items, or land
 and other things as security. By doing so, the bank becomes the bailee and the
consumer becomes the bailor.
5. Lessor and Lessee: The relationship between the bank and the customer is that of the
lessor and lessee. Banks lease (hire lockers to their customers) their immovable
property to the customer and give them the right to enjoy such property during the
specified period i.e. during the office/ banking hours and charge rentals.
6. Agent and Principal: An agent is a person who acts for or represents another. The
principal is the person who gives authority to another, called an agent, to act on his or
her behalf.
Bank acts as an agent of a customer, when
 Purchasing and selling securities on behalf of the customers.
 Collecting dividend warrants and interest warrants.
 Paying club subscription, insurance premium, rent and other bills, as per instruction
of the customer.
7. Hypothecator and Hypothecatee: The relationship between customer and banker
can be that of Hypothecator and Hypothecatee. This happens when the customer
hypothecates certain movable or immovable property or assets with the banker to get
a loan. In this case, the customer became the Hypothecator, and the Banker became
the Hypothecatee.
8. Custodian and Guarantor: A custodian is a person who acts as a caretaker of
something. Banks take legal responsibility for a customer’s securities. While opening
a D-Mat account bank becomes a custodian. Banks give guarantees on behalf of their
customers and enter into their shoes.
9. Advisor and Client: When a customer invests in securities, the banker acts as an
advisor. The advice can be given officially or unofficially. While giving advice the
banker has to take maximum care and caution. Here, the banker is an Advisor, and the
customer is a client.

RIGHTS OF BANKER

1. Right of set-off: A debtor can recover any debt due from a creditor before settlement
of debt with the creditor. This is called “Right of set-off”
 When a bank accepts deposit from customer, he is a Debtor
 When a bank lends money to the customer, the banker is a creditor and customer
becomes Debtor.
  In this situation, if the customer approaches the bank for closing his deposit account,
the bank will allow the customer to close the account only after recovering the loan
taken by the customer, from his deposit money.
2. Right of Lien: Lien is a right of a banker, by which he can retain any security coming
to his possession for the purpose of any loan due by customer.
3. Right of appropriation: is a right exercised by a creditor upon his debtor for the
purpose of setting loan account.
4. Right to charge, interest, commission and brokerage: A banker grants loan and
advances to customers and charges interest on the same. Banker usually debits the
customer’s account when the customer fails to pay the interest amount every month.
Similarly for collecting cheques, dividends and interest warrants, the banker can
charge commission and brokerage.
5. Right to close the account of undesirable customer: Undesirable customer is one
who has been frequently issuing cheques which are bouncing or which are getting
dishonoured. Due to this, the reputation of the bank is affected.
In such situation, the banker after giving due notice to the customer, can close the
account.

DUTIES OF A BANKER

1. Duty to honour cheque: It is the duty of the banker to honour cheque of customer
which are drawn properly and presented during the working hours of the bank.
2. Duty to Maintain Secrecy of Customer’s Account: The banker has an obligation
towards customer to maintain secrecy about the status of account. He should not
reveal the secrecy of customer’s account in the normal course of business. However,
in the following conditions the secrecy of the customer’s account will be disclosed.
(i) Express or Implied consent of the customer
(ii) Under compulsion of law
(iii) In the course of banking business
(iv) Disclosure in the public interest
(v) Bankers among themselves
3. Duty to render proper account of deposits made and withdrawn by customer: It
is the duty of the banker to render proper account of deposits and withdrawals by the
customer by making entries in passbook and statement of account of customers.
TERMINATION OF THE RELATIONSHIP BETWEEN A BANK AND A
CUSTOMER:

The relationship between a bank and a customer cease on:

(a) The death, insolvency, lunacy of the customer;

(b) The customer closing the account i.e. Voluntary termination;

(c) Liquidation of the company;

(d) On the receipt of notice of Assignment of credit balance by the customer to the banker.

(e) On the receipt of the Garnishee order to customer’s account by Court.

(f) On the receipt of notice of second charge on the securities already charge to the bank.

MODULE: 2 NEGOTIABLE INSTRUMENTS

MEANING: The word negotiable means transferable and the word instrument mean a
document. The term ‘negotiable instrument’ means a document, which is transferable from
one person to another.

As per Section 13 of the Act, “negotiable instrument” means a promissory note, bill of
exchange or cheque payable either to order or to bearer.

CHARACTERSTICS OF NEGOTIABLE INSTRUMENTS

1. Written Document: Negotiable Instrument is always a written document it is one of

the most important features of the negotiable instrument. Underwriting includes
handwritten notes, printed engraved type, etc.
2. Signed: The negotiable instrument must be properly signed.
3. Easy Negotiability: Negotiable instrument are easily and freely transferable.
There are no formalities for much paperwork involved in any transformation under
the negotiable instrument. The ownership of an instrument can transfer simply by the
delivery or by a valid endorsement.
4. Transferable Infinitum: A negotiable instrument may be freely transferred as many
times as necessary until it reaches maturity.
5. Promise or order to pay money: A negotiable instrument acts as a promise or order
to pay money.
 6. Payment of money only: A negotiable instrument can be drawn only for the payment
of money.
7. Right to sue: When a negotiable instrument is dishonoured, the transferee of the
negotiable instrument has the right to sue in his own name. In such a case, the
transferee may bring a claim against a negotiable instrument in its own name without
notifying the original debtor of the transfer.
8. Presumption: A negotiable instrument is subject to certain presumptions as specified
in S.118.
According to S.118, until contrary is proved, the following presumptions shall be
made:
⟶ Of consideration
⟶ As to date
⟶ As to time of acceptance.
⟶ As to time of transfer
⟶ As to order of indorsements
⟶ As to stamp
⟶ That the holder is a holder in due course.

KINDS OF NEGOTIABLE INSTRUMENTS

Negotiable Instruments by Statutes

As per Section 13 of the Act, the classification of the negotiable instruments is made into 3
broad categories which are as follows:

1. Promissory Note (S. 4 of NIA)

2. Bill of Exchange (S. 5 of NIA)
3. Cheques (S. 6 of NIA)
1. Promissory Note (Section 4 of the NI Act): These are legal instruments in which one
party promises to pay in writing a specific sum of money to the other party, either
after a stipulated time period or on-demand under specific terms.
Whenever someone borrows the money from commercial banks then they have to
sign a promissory note. Thus, these notes can also be bought and sold.

The parties to a promissory note

Following are the parties to a promissory note:

 (i) Maker of the instrument: the one who makes the promissory note and promises to
pay a certain amount as stated in a pro note.
(ii) Payee of the instrument: the one to whom the promissory note is paid.
(iii) Holder of the instrument: the person in whose name the pro note is endorsed.

Essentials of a Promissory Note

i. In writing: Promissory note must be in writing; an oral promise cannot

constitute a promissory note.
ii. Promise to pay
 It must contain an undertaking or promise to pay. Thus, a mere
acknowledgment of indebtedness is not sufficient.
 However, the word ‘promise’ need not be used, what is necessary is
that whatever language is used, it must clearly show that the maker is
making himself bound to pay the sum.
iii. Definite and unconditional promise
 The promise must be definite and unconditional i.e. it must not be vague or
uncertain. In other words, the promise to pay must not depend upon a
contingency.
 A promise to pay is not conditional merely because of the fact that the
performance of promise is dependent upon an event which is certain to happen
even though the time of its occurrence may be uncertain. e.g. Death.
 Similarly, a promise to pay money only at a particular place or at a particular
time is not conditional
iv. Promise to pay money only
 The instrument must be payable in money and money only. An
instrument is not a promissory note if the promisor promises to pay –
Something other than money, or
 Something in addition to money.
v. The sum payable must be certain: For a valid promissory note it is also
essential that the sum of money promised to be payable must be certain and
definite.
 vi. Designated parties must be certain: The parties to the instrument must be
designated with reasonable certainty. There are two parties to a promissory
note, namely, the person who makes the note, known as the maker and the
payee, with whom promise is made. Both the maker and the payee must be
indicated with certainty on the face of instrument.
vii. Signed by the maker: The promissory note must be signed by the maker,
otherwise, it is of no effect. Even if it is written by the maker himself and his
name appears in the body of the instrument, it shall not constitute a valid
promissory note, if it is not signed by the maker.
viii. Must be duly stamped under the Indian Stamp Act: It means that the
stamps of the required amount and description must have been affixed on the
instrument.
2. Bills of Exchange (Section 5 of the Act): Section 5 of the Act defines, “A bill of
exchange is an instrument in writing containing an unconditional order, signed by the
maker, directing a certain person to pay a certain sum of money only to, or to the
order of a certain person or to the bearer of the instrument”.
A bill of exchange, therefore, is a written acknowledgement of the debt, written by the
creditor and accepted by the debtor. There are usually three parties to a bill of
exchange drawer, acceptor or drawee and payee. Drawer himself may be the payee.
Essential Conditions of Bill of Exchange
i. It must be in writing.
ii. It must be signed by the drawer.
iii. The drawer, drawee and payee must be certain.
iv. The sum payable must also be certain.
v. It should be properly stamped.
vi. It must contain an express order to pay money and money alone.
vii. The order must be unconditional

Difference Between Bill of Exchange and Promissory Note

Point of Comparison Promissory Note Bill of Exchange

A Promissory Note is a Bills of Exchange is a
financial instrument in written document that binds
Meaning writings issued by the one party to pay a certain
purchaser of the goods (the amount to another party on
 debtor) as a promise to pay a demand or on the expiry of a
certain fixed amount to the fixed period of time.
seller either on demand or
on expiry of a certain fixed
period.
There are only two parties to There are three parties to the
Parties a Promissory Note, namely bills of exchange, namely
The Drawer and the Payee. the Drawer, the Drawee, and
the Payee.
Drawer It is drawn by the purchaser It is drawn by the seller or
or the debtor. the creditor.
Nature It is a promise to pay. It is an order to pay.
Acceptance No acceptance is needed as It must be accepted and
such. signed by the drawee.
The liability of the drawer is The liability of the drawer is
Liability primary. secondary. He is liable only
when the drawee does not
pay the amount
The Drawer cannot be the The Drawer can be the
A Drawer as a Payee Payee as he is the person payee if he retains the bill
liable to pay the amount. till the date of maturity.
A promissory note must bear No stamping is needed in
Stamps a stamp always. case of bills payable “on-
demand”.

3. Cheques (Section 6 of NI Act): Section 6 of the Act defines “A cheque is a bill of

exchange drawn on a specified banker, and not expressed to be payable otherwise
than on demand”.
A cheque is bill of exchange with two more qualifications
(i) it is always drawn on a specified banker, and
(ii) it is always payable on demand. Consequently, all cheque are bill of exchange, but
all bills are not cheque.
Distinction Between Bills of Exchange and Cheque
 Basis Cheque Bill of Exchange
A document used for A written document
Meaning immediate payments on indicating a debtor’s
demand, transferable indebtedness to a creditor.
through delivery.
A bill of exchange drawn on An instrument in writing
a specified banker and containing an unconditional
Definition payable on demand. order, signed by the maker,
Includes electronic forms directing a certain person to
and truncated cheques. pay a certain sum of money.
Governing Section Section 6 of the Negotiable Section 5 of the Negotiable
Instruments Act, 1881. Instruments Act, 1881.
Drawn Only on a particular banker. On any person, including
bankers.
Payable on demand to the If payable on demand,
Validity bearer. considered void as per
Section 31 of the Reserve
Bank of India Act, 1934.
Acceptance No formal acceptance Requires formal acceptance
required. from the drawee
Grace Period Not applicable, payable on A grace period of three days
demand. allowed for time bills.
Discharge from Liability Drawer not discharged if Drawer discharged if not
payment delayed. presented for payment.
Parties Involved

 Drawer: The person who writes the cheque.

 Drawee: The bank on which the cheque is drawn.
 Payee: The person or entity to whom the payment is made.

Essentials of a Cheque

i. In writing: The cheque must be in writing.

ii. Express order to pay: It must contain an express order to pay.
 iii. Definite and unconditional order: The order to pay must be definite and
unconditional.
iv. Certain sum of money: It must contain an order to pay a certain sum of money.
v. Signed by the drawer: It must be signed by the drawer.
vi. Drawn upon a banker: A cheque is always drawn upon a banker and is always
payable on demand.
vii. Does not require stamping: A cheque does not require stamping.
viii. Does not require acceptance: A cheque doesn’t require acceptance.

Types of Cheques

1. Bearer Cheque: The bearer cheque is a type of cheque in which the bearer is
authorised to get the cheque encashed. This means the person who carries the cheque
to the bank has the authority to ask the bank for encashment.
This type of cheque can be used for cash withdrawal. This kind of cheque is
endorsable. No kind of identification is required for the bearer of the cheque.
2. Order Cheque: This type of cheque cannot be endorsed, i.e., only the payee, whose
name has been mentioned in the cheque is liable to get cash for that amount . The
drawer needs to strike the “OR BEARER” mark as mentioned on the cheque so that
the cheque can only be encashed to the payee.
3. Blank Cheque: When a cheque only has a drawer’s signature and all the other fields
are left empty, then such a type of a cheque is called a blank cheque.
4. Stale Cheque: In India, any cheque is valid only until 3 months from the date of
issue. So if a payee moves to the bank to get withdrawal for a cheque which was
signed 3 months ago, the cheque shall be declared a stale cheque.
5. Mutilated Cheque: If a cheque reaches the bank in a torn condition, it is called a
mutilated cheque. If the cheque is torn into two or more pieces and the relevant
information is torn, the bank shall reject the cheque and declare it invalid, until the
drawer confirms its validation.
If the cheque is torn from the corners and all the important data on the cheque is
intact, then the bank may process the cheque further.
6. Post Dated Cheque: If a drawer wants the payee to apply for withdrawal or transfer
of money after the present date, then he/she can fill a post-dated cheque.
7. Open Cheque: An open cheque is the bearer cheque. It is payable over the counter on
presentment by the payee to the paying banker.
 8. Crossed Cheque: A crossed cheque is not payable over the counter but shall be
collected only through a banker. The amount payable for the crossed cheque is
transferred to the bank account of the payee.
9. General Crossing : Cheque bears across its face an addition of two parallel
transverse lines.
10. Special Crossing: Cheque bears across its face an addition of the banker’s name.

Negotiable Instruments by Custom or Usage

According to Section 137 of the Transfer of Property Act, 1882, Instruments may be
negotiated by custom and their negotiability will be recognised by courts. The Instruments
falling under this category are Hundi, Bank Draft, Bank Notes etc.

It is to note that the N.I. Act doesn't stipulate that only promissory notes, bills of exchange
and cheques are the Negotiable Instruments.

Thus, other instruments may also be included in this list of Negotiable Instruments provided
they fulfil the following two conditions:

(a) They are transferable by mere delivery or by endorsement and delivery; and
(b) Holder in due course can sue in his own name.

NEGOTIATION

According to section 14 of the Act, ‘when a promissory note, bill of exchange or cheque is
transferred to any person so as to constitute that person the holder thereof, the instrument is
said to be negotiated.’

There must be a transfer of the instrument to another person; and

The transfer must be made in such a manner as to constitute the transferee the holder of the
instrument.

Mode of Negotiation of an Instruments/ Transfer of Negotiable Instrument

An instrument may be negotiated in the following two ways:

1. Negotiation by Delivery: As per Section 47 of the Act, an instrument may be

negotiated by delivery of it. It means that whenever a negotiable instrument is payable
to a bearer, it may be negotiated by mere delivery only. For example, C, a holder of
 the instrument payable to the bearer delivers it to A’s agent in order to keep it for A.
Here, it can be said that the instrument is negotiated by delivery.
2. Negotiation by Endorsement: As per Section 48, a negotiable instrument can also be
negotiated by endorsement. This means that when the maker of the instrument signs
the same, it is endorsed and negotiated.

Endorsement/ Indorsement (Section 15 of NI Act)

Section 15: Indorsement—

When the maker or holder of a negotiable instrument signs the same, otherwise than as such
maker, for the purpose of negotiation, on the back or face thereof or on a slip of paper
annexed thereto, or so signs for the same purpose a stamped paper intended to be completed
as a negotiable instrument, he is said to indorse the same, and is called the “indorser”.

Essentials of Endorsement

There are following Essentials of a valid endorsement –

(1) Endorsement must be on the instrument itself. If no space is left on the instrument, it must
be on a separate slip of paper and entered to the instrument.

(2) The Endorser may endorse an instrument by simply writing his name on it, by stating his
name specifically on it, or by adding a note to the effect that the instrument is payable on the
order of the person to whom he has given his endorsement. No specific wording is required
for the endorsement.

(3) The delivery of the instrument into your possession constitutes full endorsement. It’s
crucial to deliver possession of the document with the goal of transferring the property to the
endorsee. It should be noted that the endorser or someone acting on his behalf must make the
delivery of possession.

(4) Endorsement must contain an order to pay. In need not contain any complementary
prefixes and suffixes

Kinds of Endorsement

1. Blank/ General Endorsement (Section 16 and 54 of NI Act): According to Section 16

of the Negotiable Instrument Act 1881, if the endorser signs their name only, it is termed
 a “blank” endorsement. A blank or general endorsement occurs when the endorser signs
the instrument without specifying the recipient’s name or order for payment.
2. Full/ Special Endorsement (Section 16 of NI Act): A special or full endorsement
involves the endorser, in addition to their signature, specifying the person to whom the
payment is to be made. The endorsed person, or endorsee, becomes entitled to sue for the
money on the instrument.
3. Restrictive Endorsement (Section 50): An Endorsement which, by express words,
restricts or excludes the rights of further negotiation to the Endorsee is called restrictive
endorsement.
4. Partial Endorsement: Where an Endorsement purports to transfer to the Endorsee a part
only of the amount of the instrument, the Endorsement is said to be partial. A partial
Endorsement doesn’t operate as a negotiation of the instrument.
5. Conditional Endorsement: An Endorsement is conditional or qualified if it contains any
condition imposed by the Endorser.

HOLDER (Section 8 of NI Act)

The “holder” of a promissory note, bill of exchange or cheque means any person entitled in
his own name to the possession thereof and to receive or recover the amount due thereon
from the parties thereto. Where the note, bill or cheque is lost or destroyed, its holder is the
person so entitled at the time of such loss or destruction.

Conditions to be satisfied for becoming “Holder”

In order to be called a holder a person must satisfy the following conditions:

(i) He should be entitled in his own name to the possession of the instrument, and

(ii) He should have the right to receive or recover the amount due thereon from the parties
thereto.

Holder means a de jure holder

If a person has possession of the instrument but doesn’t have a right to recover the
instruments then he is said to be a de-facto holder. However, if a person has possession as
well as a right to recover then he is said to be de-jure holder.
Holder in case of lost or stolen instrument

Where a note, bill or cheque is lost or destroyed, its holder is the person so entitled to the
instrument at the time of such loss or destruction.

Holder in Due Course (Section 9 of NI Act)

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

Conditions to be fulfilled for becoming a holder in due course

A holder in due course must satisfy the following conditions:

1. He should have acquired the instruments for some consideration.

2. He should have obtained the instruments before its maturity. If the instrument is
taken after its maturity, the person taking it may become a holder but he cannot be
called a holder in due course.
3. He should have obtained the instruments in good faith i.e. without sufficient cause
to believe that defect existed in the title of the person from whom he derived his
title.
4. He must have received the negotiable instrument complete and regular on the face
of it. In other words, he should not receive an inchoate/incomplete instrument.

Privileges of a Holder in Due Course

1. Instrument purged of all defects: A holder in due course who gets the instrument in
good faith in the course of its currency is not only himself protected against all defects
of title of the person from whom he has received it, but also serves, as a channel to
protect all subsequent holders.
2. Rights not affected in case of an inchoate instrument : Right of a holder in due
course to recover money is not at all affected even though the instrument was
originally an inchoate(incorrectly) stamped instrument and the transferor completed
the instrument for a sum greater than what was intended by the maker. (Sec. 20)
 3. All prior parties liable: All prior parties to the instrument (the maker or drawer,
acceptor and intervening indorers) continue to remain liable to the holder in due
course until the instrument is duty satisfied. The holder in due course can file a suit
against the parties liable to pay, in his own name (Sec. 36)
4. Can enforce payment of a fictitious bill: Where both drawer and payee of a bill are
fictitious persons, the acceptor is liable on the bill to a holder in due course. If the
latter can show that the signature of the supposed drawer and the first indorser are in
the same hand, for the bill being payable to the drawer's order the fictitious drawer
must indorse the bill before he can negotiate it. (Sec. 42).
5. No effect of conditional delivery: Where negotiable instrument is delivered
conditionally or for a special purpose and is negotiated to a holder in due course, a
valid delivery of it is conclusively presumed and he acquired good title to it. (Sec.46).
6. No effect of absence of consideration or presence of an unlawful consideration :
The plea of absence of or unlawful consideration is not available against the holder in
due course. The party responsible will have to make payment (Sec. 58).

DISHONOUR OF CHEQUE

The penal provisions contained in Sections 138 to 142 of the Act have been enacted to ensure
that obligations undertaken by issuing cheques as a mode of deferred payment are honoured.

Dishonour of Cheque for Insufficiency etc. of Funds in Accounts (Section 138, NI Act)

According to Section 138 of the Act, the dishonour of cheque is a criminal offence and is
punishable by imprisonment up to two years or with monetary penalty or with both. For
raising criminal liability under Section 138 of the Act, the following ingredients must be
satisfied:

 a person must have drawn a cheque for payment of money to another for the
discharge of any debt or other liability;
 that cheque has been presented to the bank within a period of three months;
 that cheque is returned by the bank unpaid, either because insufficient of funds or that
it exceeds the amount arranged to be paid from that account by an agreement made
with the bank;
 the payee makes a demand for the payment of the money by giving a notice in writing
to the drawer within 15 days of the receipt of information by him from the bank
regarding the return of the cheque as unpaid;
  The drawer fails to make payment to the payee within 15 days of the receipt of the
notice.

PRESUMPTION IN FAVOUR OF HOLDER (Section 139, NI Act)

Section 139 of the Act provides the rule of presumption that the holder of the cheque has
received the cheque for discharging the whole or part of the debt or liability.

Under section 139 of NI Act, the court will necessarily presume that the cheque has been
issued to discharge certain debts and liabilities under two circumstances, which are as follows

 When the drawer of the cheque admits issuance/execution of the cheque.

 The complainant proves that the cheque was issued/executed by the drawer in the
favour of the complainant.

As a general rule, the burden of proof is on the complainant to prove beyond a reasonable
doubt regarding the certain rights and liabilities that are being asserted by them. However, the
drawer can further challenge such presumption by providing certain evidence which can rebut
such presumption as the phrase ‘unless the contrary is proved’ is mentioned under the
Section.

Defense which may not be allowed in any prosecution under section 138 (Section 140, NI
Act)

It shall not be a defence in a prosecution for an offence under section 138 that the drawer had
no reason to believe when he issued the cheque that the cheque may be dishonoured on
presentment for the reasons stated in that section.

OFFENCES BY COMPANIES (Section 141, NI Act)

Section 141 of NI Act establishes the principle of vicarious liability. According to this
section, if an offence under the NI Act is committed by a company, every person who, at the
time of the offence, was in charge of and responsible for the conduct of the business of the
company, as well as the company itself, shall be deemed to be guilty of the offence.

This provision states that individuals associated with the company can be held liable for the
company's actions.

Scope:
  Section 141 applies to various offences under the NI Act, such as dishonour of
cheques.
 It is important to note that the liability of individuals arises only if the offence is
committed by a company.
 The section does not apply to individuals who commit offences in their personal
capacity.

Proof of Liability:

 Establishing liability under Section 141of NI Act requires proving that the individual
was actively involved in the conduct of the company's business and had a role in the
commission of the offence.
 Mere designation or being a nominal head may not be sufficient.
 The prosecution must demonstrate a direct link between the individual's role and the
commission of the offence.
 The prosecution has to prove that the offence has been committed with consent or
connivance or due to the neglect of the person.

COGNIZANCE OF OFFENCES (Section 142, NI Act)

Notwithstanding anything contained in the Code of Criminal Procedure, 1973

(a) no court shall take cognizance of any offence punishable under section 138 except
upon a complaint, in writing, made by the payee or, as the case may be, the holder in
due course of the cheque;
(b) such complaint is made within one month of the date on which the cause -of- action
arises under section 138;
(c) no court inferior to that of a Metropolitan Magistrate or a Judicial Magistrate of the
first class shall try any offence punishable under section 138.

MODULE: 3

NEW CONCEPTS IN BANKINGS: ISSUES & CHALLENGES

INTERNET BANKING

Definition: “Internet banking” refers to systems that enable bank customers to access
accounts and general information on bank products and services through a personal computer
or other intelligent device.
A system of banking in which customers can view their account details, pay bills, and
transfer money by means of the internet.

In a broad sense, it is the use of electronic means to transfer funds directly from one account
to another, rather than by cheque or cash.

FEATURES OF INTERNET BANKING

1. Faster Transactions: The Internet banking service allows its customers to transfer
funds instantly. Using this service, customers save time as funds are transferred from
one account to another very quickly. It is an automated & online service.
Users no longer have to wait in line to transfer funds or pay their bills; they can easily
do it on their devices. With the help of their device, customers can easily access their
accounts, saving time.
2. Lowers Transaction Cost: Financial transactions can be performed via Internet
Banking at a lower cost. This is referred to as the cheapest method of transacting.
Manpower requirements have been reduced due to the reduction in workload as now
more and more transactions are conducted online. As all transactions are recorded
digitally, it has also reduced paperwork in organizations. As Records no longer need
to be entered and stored manually.
3. Provides 24×7 Service: It is the most significant aspect of internet banking. Online
banking allows customers to access their accounts at any time. Customers can easily
access their accounts from anywhere and anytime without any limitations. This
feature provides loads of convenience to users.
4. Reduces The Chances of Error: The chance of human error has been reduced with
internet banking. As we know that the role of humans in the whole transaction process
has been noticeably reduced.
A fully automated internet banking system operates using digitally recorded and
stored transactions. Each and every record in the books of accounts do not need to be
manually maintained. So, there is minimal chance of human error.
5. Develops Loyalty in Customers: Banks benefit from internet banking by developing
large numbers of loyal customers. With internet banking, banks are able to provide
excellent customer service which means customers are receiving faster & better
service. Being able to receive such a user-friendly interface on the banking website.
customers are more likely to become loyal because they are satisfied with the service
 provided by their banks due to the fact that services can be accessed at any time, even
from their own homes.
6. Removes Geographical Barriers: Transactions can now be performed over the
internet without regard to distance. Through this method, all distance barriers that
customers faced in traditional methods of performing transactions have been
eliminated. Instant transfer of funds is possible both domestically and internationally
through internet banking. All systems are connected to each other online, which
facilitates easy fund transfer.
7. Provides Better Productivity: The role of internet has an effective role in increasing
the productivity of businesses. An automated software system supports the entire
financial transaction system. This system was made for fund transactions. In order to
reduce the workload of business organizations, we have reduced the time it takes to
conduct transactions. They don’t need to keep anything manually because everything
is stored digitally which increases productivity.
8. Reduce Frauds in Transactions: Another significant benefit of Internet banking is
that it allows continuous account monitoring. Every transaction on your account can
be monitored. Fraud In Financial Transactions Can Easily Be Tracked. It provides a
complete digital footprint of anyone who attempts to alter your banking activities and
commit fraud. Transparency improves your accounts, thereby reducing the likelihood
of fraud.