Indian Financial System & Indian Banking Sector PDF

1 Indian Financial System & Indian Banking Sector The banking system in India consists of commercial banks and co-operative banks. Commercial banks, which also include foreign banks and private...

1 Indian Financial System & Indian Banking Sector The banking system in India consists of commercial banks and co-operative banks. Commercial banks, which also include foreign banks and private banks, are the predominant segment. Cooperative banks, which are organized on the ‘unit’ banking principle, are mainly rural based although there are urban cooperative banks also operating in urban areas. A financial institution is a business entity whose primary activity is buying, selling or holding financial assets. Financial institutions provide various types of financial services. Financial intermediaries are a special group of financial institutions that obtain funds by issuing claims to market participants and use these funds to purchase financial assets. The focus of this write-up is on the Financial System and Banking Sector of India. It divides into two sections; First section describes the general overview of financial system which includes the constituents of the Financial System. It also describes the concept of bank, Historical Background, Functions and types of banks. Section B explains the phases of Indian Financial System & the Present Organizational Structure. It also focuses on the evolution of Indian Commercial Banking. It also explains the Historical Background of the Financial and Indian Banking sector. INTRODUCTION: A Financial system, which is inherently strong, functionally diverse and displays efficiency and flexibility, is critical to our national objectives of creating a market driven, productive and competitive economy. The financial system in India comprises financial institutions, financial markets, financial instruments and services. The Indian financial system is characterized by its two major segments- an organized sector and a traditional sector that is also known as informal credit market. Financial intermediation in the organized sector is conducted by a large number of financial institutions which are business organizations providing financial institutions whose activities may be either specialized or may overlap are further classified as banking and non-banking entities. The Reserve Bank of India (RBI) as the main regulator of credit is the apex institution in the financial system.  2 The banking system in India consists of commercial banks and co-operative banks. Commercial banks, which also include foreign banks and private banks, are the predominant segment. Cooperative banks, which are organized on the ‘unit’ banking principle, are mainly rural based although there are urban cooperative banks also operating in urban areas. Additionally NBFIs, government owned post offices also mobilize deposits, but they do not undertake lending activity. Besides, there is an extensive network of all India and State development banks catering to agriculture, industry, housing and exports. Also there exists several financial institutions like UTI, LIC, GIC and its subsidiaries, mutual funds, investment and loan companies and equipment leasing and hire purchase companies, that are engaged in mobilizing resources and providing financial services in medium as well as long term investment. The National Bank of Agriculture and Rural Development (NABARD), the Industrial Development Bank of India (IDBI), Export Import Bank (Exim bank) and the National Housing Bank (NHB) have been established to serve as apex banks in their specific areas of responsibility and concern. The three important term-lending institutions namely IDBI, ICICI and IFCL dominate the term-lending market and provide medium and long term financial assistance to corporate sector. The banking system in India is characterized by excessive concentration of business in a small number of scheduled public sector banks. Excluding Regional Rural Banks (RRBs), there are 12 Public Sector and 21 Private Sector banks operating in India. The concentration of banking business has been brought about through the policy of mergers and consolidation of banks and their Government ownership. This fact enables them to be dominant in not only the deposit and credit markets, but allows them to play important role in money and capital markets. Financial intermediation in India grew after independence and more rapidly after the nationalizations of major 14 banks in 1969. By the end of eighties, the Indian financial sector had registered tremendous growth in volume and variety. This included the stock market, mutual funds, non-banking finance companies and other institutions. But the country’s financial system was saddled with an inefficient and financially unsound banking sector. Some of the reasons for this are high reserve requirements, administrated interest rates, directed credit, poor supervision, lack of competition and political interference. The agenda of financial sector reforms consists of easing of external constraints such as administrative structure of interest rates and reserve requirements of banks, exploring indirect monetary control instruments, prescribing Prudential regulations and Norms, strengthening the supervisory apparatus and facilitating entry of new institutions. On a number of recommendations, the Government and RBI have taken follow up action, summed up below: The SLR has been gradually brought down from an average effective rate of 37.4% in 1992 to the statutory minimum 18.00% at present. The effective Cash Reserve ratio (CRR), which was as high as 15% in 1992 has been brought down to 4.50% as on May 2024. SECTION-A FINANCIAL SYSTEM AND BANKING SYSTEM - IN GENERAL FINANCIAL SYSTEM - GENERAL VIEW “Finance is a means of assuring the flow of capital. Historically, it has also been a means for guiding that flow. In the first case, it is a mechanism in aid of the industrial system as we know it. In the second, it is a power controlling it”. A FINANCIAL SYSTEM is the whole congeries of institutions and of institutional arrangements which have been established to serve the needs of modern economy: to meet the borrowing requirements of business firms; individuals and government; to gather and to invest savings; and to provide a payment mechanism. The institutions may be publicly owned or privately owned, may be partnerships or  3 corporations, may be specialized or non-specialized in character. Whatever their legal or economic character, either they have evolved overtime in response to developing needs or they were established. World wide experience confirms that the countries with well-developed financial system grow faster and more consistently than those with weaker systems. The financial sector plays a central role in organizing and coordinating an economy; it makes modern economic society possible. For every real transaction there is a financial transaction that mirrors it. If the financial sector doesn’t work, the real sector doesn’t work. All trade involves both the real and the financial sector. The financial sector has a vital role in promoting efficiency and growth as it intermediates in the flow of funds from those both sector has vital role in promoting efficiency and growth who want to save a part of their income to those who want to invest in productive assets. The efficiency of intermediating depends on the width, depth and diversity of the financial system. CONSTITUTENTS OF THE FINANCIAL SYSTEM: The three main constituents of the financial system are: The Financial Institutions The Financial Markets The Financial Assets FINANCIAL INSTITUTIONS A financial institution is a business whose primary activity is buying, selling or holding financial assets. Financial institutions provide various types of financial services. Financial intermediaries are a special group of financial institutions that obtain funds by issuing claims to market participants and use these funds to purchase financial assets. Intermediaries transform funds they acquire into assets that are more attractive to the public. By doing so, financial intermediaries do one or more of the following: i) Provide maturity intermediation; ii) Provide risk reduction via diversification at lower cost; iii) Reduce the cost of contracting and information processing; or iv) Provide payments mechanism. The principal financial institutions fall into the following four categories:- (i) Depository institutions - Financial institutions whose primary financial liabilities are deposits in checking or savings accounts. It includes commercial banks, savings and loan associations, mutual savings banks and credit unions. (ii) Contractual intermediaries - Financial institutions that holds and stores individuals’ financial assets, fall in this category. These intermediaries acquire funds at periodic intervals on a contractual basis. Because they can predict with reasonable accuracy how much they will have to pay out in benefits in the coming years, they do not have to worry as much depository institutions about losing funds. As a result, the liquidity of assets is not as important a consideration for them, and thus they tend to invest in long-term securities. This category includes – pension funds, life insurance companies and fire and casualty insurance companies. (iii) Investment Intermediaries - Intermediaries falling under this type provide a mechanism through which small savers pool funds to invest in a variety of financial assets and therefore result in DIVERSIFICATION. Diversification, here, means spreading and therefore lowering risk by holding shares or bonds of many different companies. This category includes-finance companies, mutual funds, and money market mutual funds. (iv) Financial Brokers - A broker is an entity that acts on behalf of an investor who wishes to execute orders. It is important to realize that the brokerage activity does not require the broker to buy and sell or hold in inventory the financial asset that is the subject of trade. Rather, the broker receives, transmits and  4 executes investors’ orders with other investor. The broker receives an explicit commission for these services, and the commission is a transactions cost of the securities’ markets. FINANCIAL MARKETS A financial market is a market where financial assets and financial liabilities are bought and sold. Financial markets perform the essential economic function of channelling funds from savers who have an excess of funds to spenders who have a shortage of funds. This function is shown schematically in figure below:- INDIRECT FINANCE Financial markets can perform this basic function either through direct finance (the route at the bottom of figure), in which borrowers borrow funds directly from lenders by selling them securities or through indirect finance, which involves a financial intermediary who stands between the lenders-savers and borrowers-spenders and helps transfer funds from one to the other. This channelling of funds improves the economic welfare of everyone in the society because it allows funds to move from people who have  5 no productive investment opportunities to those who have such opportunities, thereby contributing to increased efficiency in the economy. CLASSIFICATION OF FINANCIAL MARKETS The following are the descriptions of several categorizations of financial markets: (i) Classification by Nature of Claim: (a) Debt Markets - A debt market is a market where debt instruments are exchanged. The most common method to obtain funds in a financial market is to issue a debt instrument, such as bond or a mortgage, which is a contractual agreement by the borrower to pay the holder of the instrument fixed amounts at regular intervals until a specified date (the maturity date), when a final payment is made. A debt instrument is short term if its maturity is less than a year and long term if its maturity is ten years or longer. Debt instruments with a maturity between one and ten years are said to be of intermediate term. (b) Equity Market - An equity market is a market where equities are traded. The second method of raising funds is by issuing equities which are claims to share in net income and the assets of a business. An equity holder is a ‘residual claimant’. (ii) Classification by seasoning of claim: (a) Primary Market - A market where newly-issued financial assets are sold. The primary markets for securities are not well known to the public because the selling of securities to initial buyers takes place behind closed doors. An important financial institution that assists in the initial sale of securities in the primary market is the investment bank. It does this by underwriting securities. Sellers in this market also include venture capital firms. Whereas investment banks only assist in selling their stock, venture capital firms often are partnerships that invest their own money in return for part ownership of a new firm. (b) Secondary Market - A market in which previously issued financial assets can be bought and sold. Security brokers and dealers are crucial to a well-functioning secondary market. Brokers are agents of investors who match buyers with sellers of securities; dealer’s link buyers and sellers by buying and selling securities at state prices. Examples of secondary market are stock exchanges, foreign exchange markets, future markets and option markets. (iii) Classification by maturity of claim: (a) Money Market - The money market is a financial market in which only shorter-term debt instruments are traded. Money market securities are more widely traded and so tend to be more liquid. The short-term securities have smaller fluctuations in prices than long-term securities, making them safer investments. As a result, corporation and banks actively use this market to earn interest on surplus funds they expect to have only temporarily. (b) Capital Market - The capital market is the market in which longer term debt and equity instruments are traded. Capital market securities, such as stocks and long-term bonds, are often held by financial intermediaries such as insurance companies and pension funds, which have little uncertainty about the amount of funds they will have available in the future. (iii) Classification by Organizational Structure: (a) Exchanges - One method of secondary market is to organize exchanges, where buyers and sellers of securities (or their agents or brokers) meet in one central location to conduct traders. (b) Over-the-Counter (OTC) Market - The other method of organizing a secondary market is to have an OTC market, in which dealers at different locations who have an inventory of securities stand ready to buy and sell securities “over the counter” to anyone who comes to them and is willing to accept their prices. Because over- the-counter dealers are in computer contact and know the prices set by one  6 another, the OTC market is very competitive and not very different from a market with an organized exchange. FINANCIAL ASSETS: An asset is something that provided its owner with expected future benefits. Financial assets are assets, such as stocks or bonds, whose benefit to the owner depends on the issuer of the asset meeting certain obligations. These obligations are called financial liabilities. Every financial asset has a corresponding financial liability; it’s that financial liability that gives financial asset its value. The financial markets perform the important role of channelling funds from lender savers to borrower spenders, through securities (instruments) traded in the financial markets financial assets/instruments are divided into money market assets and capital market assets. BANKING SYSTEM – IN GENERAL “The judicious operations of banking by providing, if I may be allowed so violent a metaphor, a sort of wagon way through the air; enable a country to convert, as it were, a great part of its highways into good pastures and cornfields, and thereby to increase very considerably the annual produce of its land and labor”. THE WEALTH OF NATIONS The modern financial and monetary system has developed around commercial banks. It is not very unusual to find that in the history of economic growth in different countries of the world, the importance of the banking institutions and their role in the national developmental projects have been found to be of great significance. Economic history of various developed countries like USA. Japan, Britain, Germany, etc. reveals that banking industry in their respective country has played the key role in making a organized and self-sufficient economy. Schumpeter regarded banking system as one of the two key agents (the other being entrepreneurship) in the whole process of development. Alexander Gerschenkron highlighted the important role the banking system played in European economic development. Alexander Gerschenkron looks at banks as a substitute for deficiencies in the original accumulation of liquid wealth in moderately backward economies. Banks mobilize the scattered savings of the community and redistribute them into more useful channels. They are the storehouses of the country’s wealth and are reservoirs of resources necessary for economic development. Thus, banks constitute the lifeblood of the economy. SECTION-B INDIAN FINANCIAL AND BANKING SYSTEM INDIAN FINANCIAL SYSTEM An efficient articulate and developed financial system is indispensable for the rapid economic growth of any economy. The process of economic development is invariably accompanied by a corresponding and parallel growth of financial organizations. However, their institutional structure, operating policies, regulatory/legal framework differ widely and largely influenced by the prevailing politico- economic environment. Planned economic development in India had greatly influenced the course of financial development. The liberalization/deregulation/globalization of the Indian economy since the early nineties has had important implications for the future course of development of the financial system. The evolution of the Indian financial system falls, from the viewpoint of exposition, into three distinct phases: (i) Up to 1951, corresponding to the post - independence scenario, on the eve of the initiation of planned economic development. (ii) Between 1951 and the mid-eighties reflecting the imperatives of planned economic growth, and (iii) After the early nineties responding to the requirements of liberalized/deregulated /globalized economic environment.  7 A brief description of the three phases of Indian financial system is given below: Phase I: Pre-1951 Organization During the first phase, the organization of the financial system was immature and rudimentary, reflecting the underdeveloped nature of the industrial economy of the country. It was incapable of sustaining a high level of capital formation and accelerated pace for industrial development. Phase II: 1951 to Mid-Eighties During the second phase, the mixed economy model with growing accent on ambitious industrialization programmed had a significant bearing on the evolution of the financial system and greatly conditioned the institutional structure and regulatory framework. The main elements of the financial organization in planned economic development could be categorized into four broad groups: (i) Public/Government ownership of financial institutions. (ii) Fortification of the institutional structure (iii) Protection to investors (iv) Participation of financial institutions in corporate management. In brief, a unique financial system emerged in India by the mid-eighties in conformity with the requirements of planning and the dominant role of the government in the Indian economy. Phase III: Post Nineties With the liberalization /globalization of the economy, especially since the beginning of the nineties, the organization of the Indian financial system has been characterized by profound transformation. The notable developments during this phase are with reference to- (i) Privatization of financial institutions, (ii) Re-organization of institutional structure and (iii) Investor’s protection. In brief, the role of the Government in the distribution of finance and credit is marked by a considerable decline and the Indian financial system is witnessing capital market oriented developments. The capital market has emerged as the main agency for the allocation of resources. The essence of these developments is the fact that the Indian financial system is poised for integration with the savings pool in the domestic economy and abroad. INDIAN BANKING SYSTEM EVOLUTION OF COMMERCIAL BANKING IN INDIA Although evidence regarding the existence of money lending operations in India is found in the literature of the Vedic times, i.e. 2000 to 1400 B.C., no information is available regarding their pursuit as a profession by a section of community, till 500 B.C. From this time onwards, India possessed a system banking, which admirably fulfilled her needs and proved very beneficial, although its methods were different from those of modern western banking. Banking on modern lines was started by the English Agency Houses in Calcutta (now Kolkata) and Bombay (now Mumbai). They began to conduct banking business besides their commercial business. From this time, the business and power of the indigenous bankers began to wave. The English agency houses in Calcutta and Bombay that began to serve as bankers to the East India Company, the members of the services and the European merchants in India, had no capital of their own and depended upon deposits for their funds. They financed the movement of crops, issued paper money and paved the way for the establishment of joint stock banks. Several of these banks failed on account of speculation and mismanagement. The Bank of Bengal, the first of the Presidency Banks, was established in 1806; the Banks of Bombay and Madras were established on 1840 and 1843. The Presidency banks established branches at many  8 important trade centers, but they lacked points of contact, the want of which often deplored. On many occasions it was felt strongly that there should be only one bank of this kind for the whole country. In 1920, with an Act, the three presidency banks were amalgamated into the Imperial Bank of India. As a result of the recommendations of the Royal Commission on Indian Currency and Finance (1926), it was proposed to establish a central Reserve Bank. The Reserve Bank of India Act was passed in 1934 and the Reserve Bank of India (RBI) came into existence in 1935. The banking system in the pre-independence ere was devoid of any definite shape and policy, as a result of which the banking growth and development was haphazard and unsystematic. India inherited an extremely weak banking structure at the time of independence. The number of banks in existence was 648, an unwieldy number not amenable for closer monitoring and control. They had 4288 branches mostly in urban areas. Only some banks, especially in the south, were having branches in smaller towns and rival areas. There were 15 exchange banks operating in Bombay, Madras and Calcutta financing the foreign trade. Thus, most of the banks lacked the all India character and had limited geographical coverage in their business. The Imperial Bank was operating with its imperialistic posture, distancing itself away from the common man. Commercial banks were generally characterized by conservatism, rigidity and lack of farsightedness, during the period of traditional banking which broadly continued up to year 1951. The Evolution of Indian Banking in the Post 1951 period can be, for purposes of exposition, divided into three broad phases: A. Phase of Banking Consolidation: 1951-1964. B. Phase of Innovative Banking: 1964-1990. C. Phase of Prudential Banking: Since early nineties. A. Phase of Banking Consolidation: 1951-1964: During the phase of consolidation, the weaknesses in the banking structure inherited at the time of independence were removed and as a result of the rigorous official measures taken by the RBI under the Banking Regulation Act, 1949, a unified and compact banking system came into being in India. The objective of enacting the Banking Regulation Act, 1949, was to weed out the small, nonviable banking units; tone up the administration by eradicating unsound practices, and managerial abuses; and to afford greater protection to depositors. As a result, the number of banks progressively declined from 566 in 1951 to 292 in 1961 and further, to 108 in March 1966. The aim was to integrate the banking operations with planning priorities. A major banking development in 1950s was the nationalization of Imperial Bank of India and its transformation into State Bank of India effective from July1, 1955. In 1960, seven banks became subsidiaries of the State Bank of India. This step was intended to accelerate the pace of extension of banking facilities all over the country. Another significant development, since the mid-fifties, was related to the widening of range of banking operations, which includes, term lending and underwriting of securities, as forms of finance. The directing of bank funds to the requirements of the five year plans was reflected in the flow of bank credit to the priority sector. But the quantitative magnitude to these new areas remained insignificant to materially alter the basic structure of India banking. Till mid-sixties, the banks were essentially oriented to the supply of short-term finance for meeting the working capital requirements of the large industries. The most notable change in the policies of the commercial banks during the consolidation phase was the marked shift in favour of industrial financing and the corresponding sharp fall in the financing of commerce and trade which accounted for the bulk of bank credit at the beginning of the phase. These changes were the result of policy initiatives and encouragement by the Government.  9 B. Phase of Innovative Banking: 1964-1990: The period after 1964 may be aptly described as the phase of ‘innovative banking’ or ‘revolutionary phase’ or the beginning of the ‘big change’. After 1964, there was a significant shift in the tenor of politics in India’s. In fact, the period 1964-67 witnessed the ‘ascendancy of radicalism ideology’ at the political front and there was an increasing concern about the problem of concentration of economic power in few hands and the widening economic disparities. In operational terms, an equitable distribution of bank credit among the various classes of borrower became the central issue of an acrimonious debate. The main features of this phase were: Social control, Nationalization and Bank credit to priority sectors. In response to the persistent deficiencies of the banking system i.e., the lack of geographical and functional coverage, that the scheme of social control was introduced at the end of 1967. The basic postulate of this scheme was that the bank credit was an instrument for the attainment of the socio- economic objectives of the state policy. Its main objectives were “achieving a wider spread of bank credit, preventing its misuse, directing large volume of credit flow to priority sectors and making it a most effective instrument of development”. It sought to remove the control of the business houses over banks without removing the private ownership of banks. This was sought to be achieved by reforming their management and making them receptive to the changing concepts and goals of banking. Although the banking system had taken several measures for achieving the objectives of social control, there were still serious reservations amongst a sizeable section of the political leadership about the effectiveness of the social control measures without abolishing the framework of the profit-oriented private ownership of banks. To satisfy this radical ideology, 14 major banks with individual deposits exceeding Rs.50 crores were nationalized on 19th July, 1969. The broad aims of nationalization were: “To control the heights of the economy and meet progressively and serve better the needs of development of the economy in conformity with national policy and objectives”. At the time of nationalization of these banks, the share of public sector in Indian banking in terms of branch network, deposits and assets was 79.7 per cent, 82.7 per cent and 83.7 per cent respectively. Nationalization was visualized to provide a great impetus to changes and also to give a new orientation to the banking system. Six more banks were later nationalized in 1980. Thus, the path breaking measures were taken to achieve the desired social and economic objectives. Thus, ‘Class Banking’ was replaced by ‘Mass Banking’. Another significant feature of this phase is that the flow of bank credit to the priority sector was considerably accelerated following the Bank Nationalization. As with this structural reorientation the commercial banks were assigned the role of instruments of development. Simultaneously, official policy initiatives were taken to regulate and ration the bank credit available to large industry, as suggested by Tandon and Chore Committees. C. Phase of Prudential Banking - Since early nineties: In the context of deregulated/liberalized/globalized economic environment since the early nineties, the post 1991 era of Indian banking is essentially a phase of prudential / viable / profitable banking. The committee on Financial Sector (CFS), 1991 (Narsimham Committee I) had set a comprehensive agenda for transforming Indian banking against the background of serious deficiencies in the system in the post- nationalization era. The post-nationalization era (1969-91) saw the rise of a geographically wide and functionally diverse banking system in conformity with the expanding and emerging needs of the Indian economy. They impressive progress of Indian banking in achieving social goals (social banking) as reflected in geographical reach and functional spread has indeed been a major development input. “The banking system evolved under an active promotion policy appropriate to the early phase of financial development and the policy of promotion combined with regulation to instill depositor confidence  10 achieved notable success in terms of resource mobilization and credit extension to industry and agriculture and thus assisted in meeting the major development objectives against the background of reasonable stability”. Serious weaknesses developed in the form of decline in productivity and efficiency of the banking system and consequently a serious erosion of its profitability with implication for its viability itself. Gross profits progressively declined to the level of 1.1 per cent of working funds. In case of some banks, the incremental cost of operation per rupee of working funds was more than the incremental income per rupee of working funds. “The erosion of profitability adversely affected the ability of the system to expand its range of services in the context of assisting in the creation of competitive vitality and efficiency in the rural economy”. The factors that adversely affected the profitability of the banking system were partly external in terms of macro policy environment and partly in terms of organization, staffing and branch spread. It is in the context of the foregoing features of the Indian banking in the post-nationalization period, since the early nineties there was crying need of Indian banking has been the restoration of a competitive and professionally managed structure, policies and practices, and with the implementation of the recommendations of NC-I and NCII, this is fast becoming a reality. The approach of NC-I to reform was to ensure that the system operates on the basis of operational flexibility and functional autonomy with a view to enhancing efficiency, productivity and profitability. The integrity of operations of banks was by far the more relevant issue than the question of their ownership. The focus of reforms until 1997 was on arresting the qualitative deterioration in the functioning of the banking system and a measure of success attended those efforts. The NC-II has outlined a comprehensive framework to consolidate those gains to strengthen the system within the purposive regulation and strong and effective legal system. Financial sector management and reform is a process rather than an event. Many of the recommendations are being implemented by the RBI in a phased manner. A significant step in this direction has been the application of internationally accepted norms to capital adequacy, asset classification and provisioning and income recognition. Also, the reduction in SLR and CRR, setting up of special recovery tribunals, deregulation of interest rates, etc. Thus, the post 1991 phase of Indian banking is characterized by the beginning of ‘sound banking’ in contrast to the social/mass banking’ in contrast to the social/mass banking of the nationalization phase. The future financial viability of the banking sector depends upon the capital support from the Government and enhancing the ability of banks to access the capital market to meet their capital requirements in terms of Basel III recommendations. The future of Indian banking which has already leveraged the Information Technology to the hilt is likely to grow at a faster pace and the shift is largely seen towards a cashless banking system with multiple channels of digital transactions becoming a norm. The digital payments system in India has evolved the fastest amongst the countries. It is evident from the record number of UPI transactions per month. UPI transactions are expected to breach 100 crore transactions per day by FY27, according to a report by PwC India, which projects UPI to dominate the retail digital payments landscape, accounting for 90 per cent of the total transaction volumes over the next five years. The opportunities and potential to grow digitally are virtually unlimited. Post pandemic, increased use of Digital platforms, we may call it a digital revolution, is playing a bigger role than ever in banking. Banks, including our Bank are learning and participating in the digitizing of all aspects of banking. Every form of traditional banking is exploring digitization and significant headways have been made in payments, mobile banking, online banking, digital lending, e-KYC, remote customer servicing etc. Digital and cashless banking is seen as a tool to infuse more transparency and vibrancy in the economic system of the country. In the wake of these developments, the J&K Bank is on the path to proactively put in place a digital architecture which would entail futuristic banking based on international competitions and expectations.  11 Role of RBI as Regulator in Indian Economy In every country there is one organization which works as the central bank. The function of the central bank of a country is to control and monitor the banking and financial system of the country. In India, the Reserve Bank of India (RBI) is the Central Bank. The RBI was established in 1935. It was nationalised in 1949. The RBI plays role of regulator of the banking system in India. The Banking Regulation Act 1949 and the RBI Act 1953 has given the RBI the power to regulate the banking system. The RBI has different functions in different roles. Below, we share and discuss some of the functions of the RBI. RBI is the Regulator of Financial System The RBI regulates the Indian banking and financial system by issuing broad guidelines and instructions. The objectives of these regulations include: Controlling money supply in the system, Monitoring different key indicators like GDP and inflation, Maintaining people’s confidence in the banking and financial system, and Providing different tools for customers’ help, such as acting as the “Banking Ombudsman.” RBI is the Issuer of Monetary Policy The RBI formulates monetary policy twice a year. It reviews the policy every quarter as well. The main objectives of monitoring monetary policy are: Inflation control Control on bank credit Interest rate control The tools used for implementation of the objectives of monetary policy are: Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR), Open market operations, Different Rates such as repo rate, reverse repo rate, and bank rate. RBI is the Issuer of Currency Section 22 of the RBI Act gives authority to the RBI to issue currency notes. The RBI also takes action to control circulation of fake currency. RBI is the Controller and Supervisor of Banking Systems The RBI has been assigned the role of controlling and supervising the bank system in India. The RBI is responsible for controlling the overall operations of all banks in India. These banks may be: Public sector banks Private sector banks Foreign banks Co-operative banks, or Regional rural banks The control and supervisory roles of the Reserve Bank of India is done through the following: Issue of License: Under the Banking Regulation Act 1949, the RBI has been given powers to grant licenses to commence new banking operations. The RBI also grants licenses to open new branches for existing banks. Under the licensing policy, the RBI provides banking services in areas that do not have this facility.  12 Prudential Norms: The RBI issues guidelines for credit control and management. The RBI is a member of the Banking Committee on Banking Supervision (BCBS). As such, they are responsible for implementation of international standards of capital adequacy norms and asset classification. Corporate Governance: The RBI has power to control the appointment of the chairman and directors of banks in India. The RBI has powers to appoint additional directors in banks as well. KYC Norms: To curb money laundering and prevent the use of the banking system for financial crimes, The RBI has “Know Your Customer” guidelines. Every bank has to ensure KYC norms are applied before allowing someone to open an account. Transparency Norms: This means that every bank has to disclose their charges for providing services and customers have the right to know these charges. Risk Management: The RBI provides guidelines to banks for taking the steps that are necessary to mitigate risk. They do this through risk management in basel norms. Audit and Inspection: The procedure of audit and inspection is controlled by the RBI through off-site and on-site monitoring system. On-site inspection is done by the RBI on the basis of “CAMELS”. Capital adequacy; Asset quality; Management; Earning; Liquidity; System and control. Foreign Exchange Control: The RBI plays a crucial role in foreign exchange transactions. It does due diligence on every foreign transaction, including the inflow and outflow of foreign exchange. It takes steps to stop the fall in value of the Indian Rupee. The RBI also takes necessary steps to control the current account deficit. They also give support to promote export and the RBI provides a variety of options for NRIs. Development: Being the banker of the Government of India, the RBI is responsible for implementation of the government’s policies related to agriculture and rural development. The RBI also ensures the flow of credit to other priority sectors as well. Section 54 of the RBI gives stress on giving specialized support for rural development. Priority sector lending is also in key focus area of the RBI. Apart from the above, the RBI publishes periodical review and data related to banking. The role and functions of the RBI cannot be described in a brief write up. The RBI plays a very important role in every aspect related to banking and finance. Finally the control of NBFCs and others in the financial world is also assigned with RBI.  13 Laws related to banking Banking in India forms the base of the economic development of the country. Modern-day banking started around the last decades of the 18th century, with the General Bank of India and Hindustan Bank coming into existence. Then the three presidency banks were made which were – Bank of Madras, Bombay and Calcutta. But the landmark event which marks the evolution of banking in India happened in 1934 when a decision to set up Reserve Bank of India was taken. It started functioning in 1935. RBI has since been the central bank of the country and the regulator of the banking sector. Since then major changes in the banking system and management have been seen in order to regulate the overall banking system in India. However, given the importance of Banks in the economy, they are kept under strict regulation. A proper Bank regulatory structure has been developed to maintain a control over the standardized practices of these banking intuitions, which, among other things, create transparency between the banking intuitions and the individuals and the corporations with whom they conduct business. Various banking laws and regulations have been framed which are mainly or partly related as to how the banks function in the country. Banking laws include broad term for laws that govern the banks and other financial institutions in course of their business. However, the key statutes and regulations that govern the banking industry in India are: 1. The Banking Regulation Act, 1949; 2. The Reserve Bank of India Act, 1934; 3. The Negotiation of Instruments Act, 1881; 4. Indian Contract Act, 1872; 5. Indian Partnership Act, 1932; 6. Limited Liability Act, 2008; 7. Indian Companies act,2013; 8. Securitisation & Reconstruction of Financial Asset and Enforcement of Security Interest Act, 2002; 9. Insolvency and Bankruptcy Code, 2016; 10. Right to Information Act, 2005 11. Prevention of Money Laundering Act, 2002. The common objectives of these Laws are as under: i. Prudential—to reduce the level of risk to which bank creditors are exposed. ii. Systemic risk reduction—to reduce the risk of disruption resulting from adverse trading conditions for banks causing multiple or major bank failures. iii. Avoid misuse of banks—to reduce the risk of banks being used for criminal purposes,e.g.laundering the proceeds of crime. iv. To protect banking confidentiality. v. Credit allocation—to direct credit to favored sectors. vi. It may also include rules about treating customers fairly and having corporate social responsibility. The summary of the laws which are mainly used to regulate banking in India are as follows: The Banking Regulation Act, 1949 Banking in India is mainly governed by Banking Regulation Act, 1949. The Reserve Bank of India and the Government of India exercise control over banks from the opening of the Branches to their winding up by virtue of the powers conferred under this statute.  14 It was enacted to consolidate and amend the laws relating to banking and to provide for suitable framework for regulating the Banking Companies and covers co-operative banks as well. The Act does not apply to primary agriculture societies, and cooperative and development banks. The provisions of the act are applicable to banking companies in addition to other laws, which are applicable to such companies. The Act regulates entry into banking business by licensing as provided in section 22 thereof. It also put restrictions on share holding, directorship, voting powers and other aspects of banking companies. There are several provisions in the Act regulating the business of banking such as restrictions on loans and advances, provisions relating to rate of interest, requirements as to cash reserve ratio, provisions regarding audit and inspection and submission of balance sheet and accounts. The act also provides for control over the management of banking companies. Statutory Liquidity Ratio According to Section 24 (2-a) of the Banking Regulation Act, every banking company in India whether scheduled or non-scheduled, is required to maintain in India in Cash, Gold or unencumbered, approved securities a specified amount out of its demand and time liabilities in India. This is known as Statutory Liquidity Ratio (SLR). The Reserve Bank is empowered to increase this ratio. For calculating the SLR, the following liquid assets are taken into account.  Cash in hand in India.  Balances in current account with the State Bank of India and its associates.  Balance maintained with the RBI in excess of the minimum CRR requirements.  Investments in Government Securities, Treasury Bills and other approved securities in India. However, the approved securities must be value data price not exceeding the current market price. At present SLR is 18% Reserve Bank of India Act, 1934 The Act was enacted on 06th March, 1934 to constitute the Reserve Bank of India and has been amended from time to time to meet the demands of changing times. It as following objectives:  To regulate the issue of Bank Notes  For keeping reserves for securing monitory stability in India  To operate the currency and credit system of the country to its advantage The Act deals with the following:  Incorporation, capital management and business of the bank  Central banking functions like Issue of Bank Notes, monitory control, acting as banker to the Government and Banks, lender of last resort etc.  Collection and furnishing credit information.  Acceptance of deposits by Non-Banking Financial Institution (NBFI).  Handling Reserve Fund, Credit funds, publication of bank rate, audit and accounts etc.  Penalties for violation of the provision of the act or direction issued thereunder. Important Provisions: Scheduled Bank According to Section 2 (e), Scheduled Bank means a bank whose name is written in the 02 nd schedule of RBI Act, 1934 and which satisfies the conditions laid down in Section 42(6) – Paidup capital and reserves of not less than Rs. 05 lac, satisfaction of RBI that the affairs will not be conducted by the bank in a way to jeopardize the interests of the depositor. It may be a State Co-operative Bank, a company defined in  15 Companies Act, 2013, an institution notified by Central Government for the purpose and a corporation or a company incorporated by or under any law in force, in any place outside India. Any bank that is not included in the 02nd Schedule of RBI is called Non-Scheduled Bank. Bank Rate Policy: Section 49 definesitas “The Standard Rate at which it (the bank) is prepared to buy or rediscount bills of exchange or other commercial paper eligible for purchase under this Act”. By varying the bank rate, RBI can to a certain extent regulate the commercial bank credit and the general credit situation of the country. The impact of this tool has not been very great because of the fact that RBI does not have a mechanism to control the unorganized sector. Further the money market in our financial system is not fully developed, so that the Bank rate policy will have desired impact on the financial system. Cash Reserve Ratio (CRR): Section 42 defines the Cash reserves of scheduled bank to be kept with RBI. The permissible range of CRR rate is between 3% to 15%. Inspection of Banks: The most significant supervisory function exercised by RBI is the inspection of Banks. The basic objectives of inspection of banks are to safeguard the interests of the depositors and to build up and maintain a sound banking system in conformity with the banking laws and regulations as well as the country‘s socio-economic objectives. Accordingly, inspections serve as a tool for overall appraisal of the financial and managerial systems and performance of the banks, toning up of their procedures and methods of operation and prevention of serious irregularities. The RBI’s powers to conduct inspections are contained in various provisions of the Banking Regulation Act, the most important being Section 35. This apart, inspections may be necessary under the provisions of Section 23, 37, 38, 44, 44A, 44B and 45 of the Act. Audit of Annual Accounts of Banks: Banks have to close their books of accounts every year as at March 31 st and prepare a Balance Sheet and Profit and Loss account as prescribed in the III schedule of the Banking Regulation Act. These annual accounts are required to be audited by auditors appointed by the Bank each year with prior approval of RBI, as per Section 30 (1A) of the Banking Regulation Act, in respect of private sector banks. Section 10 (1) of the Banking Companies [Acquisition and Transfer of Undertakings] Act, 1970 / 1980 provides for audit of annual accounts of banks in the case of nationalized banks. Negotiable Instrument Act, 1881: The NI Act, 1881 lays down the laws relating to payment of the customers cheques by a banker and also protection available to a banker. The relationship between banker and customer being debtor–creditor relationship, the bank is bound to pay the cheques drawn by his customers. This duty on part of Bank to honor its customer’s mandate is laid down in section 31 of the NI Act. Section 10, 85, 89 and 128 of the NI Act grants protection to a paying banker.  16 Various Sections under Negotiable Instrument Act, 1881 Sec- Term Meaning tion 3 Banker Banker includes any person acting as a Banker and any post office saving bank. 4 Promissory A Promissory Note is an instrument in writing, containing an Unconditional undertaking signed by maker, to pay a certain sum of money only to or to the order of a certain person Note or to the bearer of the instrument. A Bill of Exchange is an instrument in writing containing an Unconditional order, signed by the maker, directing a certain person to pay certain sum of money only to or to the 5 Bill of order of a certain person or to the bearer of the instrument. Here, the promise to pay is not Exchange conditional. 6 Cheque A cheque is a Bill of Exchange drawn on a specified banker and not expressed to be payable otherwise than on demand and it includes the electronic Image of a truncated cheque & a cheque in the electronic form. 7 Drawee The maker of a Bill of Exchange or Cheque is called the drawer, the person thereby directed Payee to pay is called the Drawee. Payee The person named in the instrument, to whom or to whose order the money is, by the instru- ment directed to be paid, is called the payee.  17 8 Holder 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 bill of exchange or cheque is lost or destroyed, its holder is the person so entitled at the time of such loss or destruction. Holder in due course means any person who for consideration became the possessor of the promissory note, bill of exchange or cheque, if payable to bearer, or the payee or en- dorsee 9 Holder In Due thereof, if, before the amount mentioned in it became payable and without having sufficient course cause to believe that any defect existed in the title of the person from whom he derived his title. Payment in due course, means payment in accordance with the apparent tenor of the instru- 10 Payment in ment in good faith and without negligence to any person in possession thereof under circum- Due course stances which do not afford a reasonable ground for believing that he is not entitled to receive payment of the amount therein mentioned. A Promissory Note, Bill of Exchange or Cheque drawn or made in and made payable in or 11 Inland drawn upon any person resident in (India) shall be deemed to be an Inland Instrument. Instrument 13 Negotiable ANI means Promissory Note, Bill of Exchange or Cheque payable either to order or to the Instrument bearer. 14 Negotiation When a Promissory note, bill of exchange or cheque is transferred to any person, so as to constitute the person the holder thereof, the instrument is said to be negotiated. 15 Endorsement When the maker or the holder of the negotiable instrument signs the same, otherwise than as such maker, for the purpose of the negotiation, on the back or the face thereof or on as lip 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 endorse the same is called the Endorser. 16 Endorsement If the endorser signs his/her name only, the endorsement is said to be in blank and if heads direction to pay, the amount mentioned in the instrument, or to the order of a in Blank and specified person the endorsement is said to be in full and the person so specified is called the endorsee of the instrument. Full Where one person signs and delivers to another person a paper stamped in accordance 20 Inchoate with the law relating to negotiable instrument then in force in India and either, wholly stamped instru- blank or having written thereon an incomplete negotiable instrument, he thereby gives prima ment facie authority to the holder thereof to make or complete, as the case may be, upon it a negotiable instrument, for any amount specified therein and not exceeding the amount covered by the stamp. The person so signing shall be liable upon such instrument, in the capacity in which he signed the same, to any holder in due course for such amount. 21 In a promissory note or bill of exchange the expressions sight and on presentment means on Sight / pre- demand The expression after sight means, in a promissory note, after presentment for sight sentment / and in a bill of exchange after acceptance or noting for non-acceptance, or protest for non- Sight acceptance.  18 22 Maturity The maturity of a promissory note or bill of exchange is the due date at which it falls due. Every promissory note or bill of exchange which is not expressed to be payable on demand, at sight or on presentment is at maturity on the third day after the day on which it is expressed to be payable. 25 When When the day on which a promissory note or bill of exchange is at maturity is a public holi- maturity is a day, the instrument shall be deemed to be due on the next preceding business day. holiday 26 Minor A minor may draw, endorse, deliver and negotiate such instruments so as to bind all parties except himself. 30 Liability of the The drawer of a bill of exchange or cheque is bound in case of dishonor by the drawee or Drawer acceptor thereof, to compensate the holder, provided due notice of dishonor has been given to or received by the drawer as hereinafter provided. 46 Delivery The making, acceptance or endorsement of a promissory note, bill of exchange or cheque is completeby delivery, actual or constructive. 47 Negotiation A promissory note, bill of exchange, or cheque, payable to be are negotiable by delivery thereof. By delivery A promissory note, bill of exchange, or cheque, payable to order is negotiable by the holder by 48 Negotiation by endorsement and delivery ther Endorsement 49 Conversion The holder of a negotiable instrument, endorsed in blank may without signing his own of name by writing above the endorser‘s signature direction to any other person as endorsee, Endorse- convert the endorsement in blank into an endorsement in full. ment in Blank into full 77 Liability of When a bill of exchange, accepted payable at a specified bank, has been duly presented there for Banker for payment and dishonored, if the bankers on egligently or improperly keeps, deals with or delivers negligently back such bill as to cause loss to the holder, he must compensate the holder for such loss. dealing with bill presented for payment. 85 Cheque pay- Where a cheque is payable to order purports to be endorsed by or on behalf of the payee, the able to order Drawee is discharged by payment in due course. 87 Effect of Any material alteration of a negotiable instrument renders the same void as against any one Material whom is a party thereto at the time of making such alteration and does not consent thereto, unless Alteration it was made in order to carry out the common intention of the original parties. 115 Drawee in Where a Drawee in case of need is named in a bill of exchange or in any endorsement thereon, Case of need the bill is not dishonored until it has been dishonored by such Drawee. 123 Cheque Where a cheque bears a cross its face an addition to the words and company or any abbreviation crossed gener- thereof, between two parallel transverse line, or of two parallel transverse lines simply, either ally with or without the words “not negotiable”, that addition shall be deemed a crossing, and the cheques shall be deemed to be crossed generally.  19 124 Cheque Where a cheque bears across its face an addition of the name of a banker either with or with- crossed spe- out the words “not negotiable”, that addition shall be deemed a crossing, and the cheque shall cially be deemed to be crossed specially and to be crossed to that banker. 128 Payment in Where the banker on whom a crossed cheque is drawn has paid the same in due course, the banker paying the cheque, and (incase such cheque has come to the hands of the payee) the drawer thereof , Due course shall respectively been titled to the same rights, and be placed in the same position in all respects, a s of crossed they would respectively been titled to and placed in if the amount of the cheque had been paid to and cheque received by the true owner thereof. 129 Payment of Any banker paying a cheque crossed generally otherwise than to a banker or a crossed cheque crossed specially otherwise than to the banker to whom the same is crossed or his cheque agent for collection, being a banker, shall be liable to the true owner of the cheque for any out of due loss he may sustain owing to the cheque having been so paid. course 130 Not Nego- A person taking a cheque crossed generally or specially, bearing in either case the words tiable “not negotiable”, shall not have and shall not be capable of giving, a better title to the cheque than that which the person from whom he took it had. 131 Non liability of banker A banker who has in good faith and without negligence, received payment for a customer of receiving a cheque crossed generally or specially to him-self shall not, in case the title to the cheque payment of proves defective, incur any liability to the true owner of the cheque by reason only of cheque having received such payment. 138 Dishonor of Where any cheque drawn by a person on account maintained by him with a banker for pay- Cheque for ment of any amount of money to another person from out of that account for the discharge, insuf- in whole or in part, of any debtor other liability, is returned by the bank unpaid, either ficiency etc. because of the amount of money standing to the credit of that account is insufficient to of funds in honor the cheque or that it exceeds the amount arranged to be paid from that account by an the account. agreement made with that bank, such person shall be deemed to have committed an offence and shall, without prejudice to any other provision of this Act, be punished with imprisonment for a term which may be extended upto two years, or with fine which may extend upto twice the amount of the cheque, or with both.  20 139 Recent Following are the recent amendments: to amendments 1. Definition of a “cheque” widened to include electronic image of a truncated cheque and a in Negotia- cheque in electronic forms. 147 ble Instru- 2. Right of the banker who received payment on electronic image of a truncated cheque to ments retain the truncated cheques. (amendment 3. Certificate of text of printout of electronic image of truncated cheque by paying Banker as And Misc. proof of payment. Provisions) 4. Doubling of the imprisonment term from one year to two years. Act 2002. 5. Doubling of penalty for the offence, i.e. upto twice the amount of the instrument. 6. Doubling of the period of time to issue demand notice to drawer from 15 to 30 days. 7. Immunity from prosecution for nominee directors, who are nominated by virtue of holding any office or employment in Central Government or State Government or a financial corporation owned or controlled by the Central Government or State Government. 8. Compounding of offence under the N.I. Act.Empowering the magistrate to condone delay in filing complaint Bank‘s slip or Memo having Bank‘s Official mark denoting that the cheque has been dishonored shall be presumed to be the fact of dishonor  21 CHEQUE TRUNCATION: Truncation is the process of stopping the flow of the physical cheque issued by a drawer to the drawee branch. The physical instrument will be truncated at some point en-route to the drawee branch and an electronic image of the cheque would be sent to the drawee branch alongwith relevant information like the MICR fields, date of presentation, presenting banks etc. The images captured at the presenting bank level would be transmitted to the Clearing House and then to the drawee branches with digital signatures of the presenting bank. Thus each image would carry the digital signature, apart from the physical endorsement of the presenting bank, in a prescribed manner. Accordingly, customers are benefitted in the following ways: a. Faster clearing cycle b. Better reconciliation/verification process c. Better Customer Service- Enhanced Customer Window d. T+0 for Local Clearing and T+1for inter- city clearing. e. Elimination of Float- Incentive to shift to Credit Push payments. f. The jurisdiction of Clearing House can be extended to the entire country - No g. Geographical Dependence h. Operational Efficiency will benefit the bottom lines of banks - Local i. Clearing activity is a high cost no revenue activity j. Minimizes Transaction Costs. k. Reduces operational risk by securing the transmission route. The physical instruments are required to be stored for a statutory period. It would be obligatory for presenting bank to warehouse the physical instruments for that statutory period. In case a customer desires to get a paper instrument back, the instrument can be sourced from the presenting bank through the drawee bank. Indian Contract Act, 1872: Banking involves interaction between a banker and customer. A customer of a bank may be a depositor, borrower or any other person merely utilizing one of the various services provided by the banker. The interaction of a bank with its customer creates certain obligations and gives certain rights to both the bank and the customer. All Agreements are contracts, if they are made by parties competent to contract, for a lawful consideration and with a lawful object, and are not expressly declared to be void. All Banking transactions are therefore separate contracts and the knowledge of Indian Contract Act is essential for each Banker. Following are some related Sections to Banking: Section 124: “Contract of indemnity” A Contract by which one party promises to save the other from loss caused to him by the contract of the promisor himself, or by the conduct of any other person, is called a “contract of indemnity”. Section 126: “Contract of guarantee”, “surety”, “principal debtor” and “creditor” A “Contract of Guarantee” is a contract to perform the promise or discharge the liability of a third person in case of his default. The person who gives the guarantee is called the “surety”, the person in respect of whose default the guarantee is given is called the “principal debtor”, and the person to whom the guarantee is given is called the “creditor”. A guarantee may be either oral or written. Section148: “Bailment”, “ bailor” and “bailee” A “bailment” is 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  22 of the person delivering them. The person delivering the goods is called the “bailor” and the person to whom they are delivered is called the “bailee”. Section 172: “Pledge”, “Pawnor” and “Pawnee” 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” and the bailee is called “pawnee”. Section 182: “Agent” and “Principal” An “agent” is a person employed to do any act for another or to represent another in dealing with third persons. The person for whom such act is done or who is so represented is called the “principal”. Indian Partnership Act, 1932: Partnership is the relationship between persons who have agreed to share the profit of a business carried out by all or any of them acting for all. The relationship between partners is governed by Partnership Deed. The partnership deed helps the banker to know all the names of the partners and their relationship. The act of the partner shall be binding on the firm if done:  In the usual business of the partnership.  In the usual way of business.  As a partner i.e; on behalf of the firm and not solely on his own behalf. Limited Liability Partnership Act, 2008: The Limited Liability Partnership (LLP) is viewed as an alternative corporate business vehicle that provides the benefits of limited liability but allows its members the flexibility of organizing the internal structure as a partnership based on a mutually arrived agreement. The LLP form would enable entrepreneurs, professionals and enterprises providing services of any kind or engaged in scientific and technical disciplines, to form commercially efficient vehicles suited to the requirements. Owing to flexibility in its structure and operation, the LLP would also be a suitable vehicle for small enterprises and for investment by venture capital keeping in mind the need of the day, the Parliament enacted the Limited Liability Partnership Act, 2008 which received the assent of the President on 7th January, 2009. Indian Companies Act, 2013: The Companies Act 2013 (which replaced the companies Act 1956) is an Act of the Parliament of India on Indian company law which regulates incorporation of a company, responsibilities of a company, directors, dissolution of a company. Under Section 3 of the Act — (1) A company may be formed for any lawful purpose by— (a) seven or more persons, where the company to be formed is to be a public company; (b) two or more persons, where the company to be formed is to be a private company; or (c) one person, where the company to be formed is to be One Person Company that is to say, a private company, by subscribing their names or his name to a memorandum and complying with the requirements of this Act in respect of registration. A company is a juristic person created by law, having a perpetual succession and common seal distinct from its members. As per Section 464 of the Companies Act, 2013 the maximum number of members in case of a partnership firm should not be more than 100 in case of partnerships. As per the previous Companies Act 1956, the maximum limit in case of partnerships was 10 and 20 for banking business and other businesses respectively. So now as per Companies Act 2013 read with Company Rules 2014 there is no such limitation specific to banking business.  23 The business and the objects of a company and the rules and regulations governing its management is known by two important documents called Memorandum of Association and Article of Association. Securitization & Reconstruction of Financial Asset and Enforcement of Security Interest Act, 2002: (SARFAESI) Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 is an effective tool in the hands of the bank to enforce the security interest and recover the dues thereby reducing NPAs / PWOs. The Act deals with three aspects:  Enforcement of Security Interest by secured creditor (Banks/FIs).  Transfer of non-performing assets to asset Reconstruction Company, which will then dispose of those assets and realize the proceeds.  To provide a legal framework for securitization of assets. Enforcement of Security Interest: Be for enforcing security interest, branches should ensure that the borrowal accounts comply with the following criteria: i. The contractual dues in the account should be more than Rs.1 lac. ii. The default must have occurred i.e. the account should have become NPA as per RBI norms. iii. The security charged to the Bank must be specific, clear and available to the Bank. It must be duly and effectively charged to the Bank and therefore enforceable if the borrower fails to pay in response to the Notice. iv. The security documents in the advance account should be in full force on the date of serving the 60 day notice. As an abundant caution, it should be ensured that they will be inforce even at the time the action that will follow for enforcement of security i.e. at least upto one year from the date of serving the notice. v. The security documents should be duly filled in. vi. After mortgage the bank’s charge over the property should be got noted with the CERSAI. vii. Either our Bank must be the sole banker to the borrower i.e. 100% or incase of consortium lending consent of secured lenders representing not less than 75% of the amount outstanding in value is obtained. viii. In case of multiple Banking, if the security is exclusively charged, the bank can proceed as though it is the sole banker. ix. An action under SARFAESI Act also facilitates abatement of reference from BIFR. x. Since limitation Act applies to action under SARFAESI, care should be taken that the action is within limitation time. Insolvency and Bankruptcy Code, 2016 Insolvency is a situation where individuals or companies are unable to repay their outstanding debt and Bankruptcy is a situation whereby a court of competent jurisdiction has declared a person or other entity insolvent, having passed appropriate orders to resolve it and protect the rights of the creditors. Since last one decade the NPA ratio of the Banks grew very high, which led to a prompt action by the government, the first step in this regard led to the birth of the Insolvency and Bankruptcy Code, 2016.The new law seeks to consolidate the existing framework by creating a single law for insolvency and bankruptcy. The mounting NPAs in the banking sector and other financial institutions have crippled lending activities of financial institutions in India, more so by public sector banks. The bankruptcy Code is  24 therefore created to overcome this worst situation faced by the Indian economy. The newly created Code envisages a formal insolvency resolution process (IRP) for businesses, either by coming up with a viable survival mechanism or by ensuring speedy liquidation. Thus, the new Code could curb substantially the number of long-pending cases and also ensure quicker resolution of NPA problems of banks. The introduction of the Bankruptcy Code (IBC) shall give greater relief to lenders in India. As per the Insolvency and Bankruptcy Code, 2016, the insolvency resolution process must be completed within 180 days, extendable by a period of up to 90 days. The Insolvency and Bankruptcy Code (Amendment) Bill, 2019, states that the resolution process is to be mandatorily completed within 330 days. The adjudicating authority for corporate insolvency and liquidation is the NCLT. Appeals from NCLT orders lie to the National Company Law Appellate Tribunal and thereafter to the Supreme Court of India. For individuals and other persons, the adjudicating authority is the DRT, appeals lie to the Debt Recovery Appellate Tribunal and thereafter to the Supreme Court. Right to Information Act, 2005 Right to Information Act or RTI is a central legislation, which enables the citizens to procure information from a public authority. It came into force on 12th October 2005.It provides the mechanism for obtaining information. The purpose of the act is to make the executive accountable and ensure transparency in the implementation of schemes and policies. Right to information includes right to inspect documents. The board of directors of Jammu & Kashmir Bank in June 2019 decided to bring the bank under the J&K RTI Act, 2009 (which has now been replaced by central RTI Act).In order to properly implement the RTI Act in the Bank, a proper machinery has been set in process which includes Assistant Public Information Officers, Public Information Officers and a proper Appellate Authority, the list of all these officers is available on the Bank’s website. The Prevention of Money Laundering Act, 2002 The Prevention of Money Laundering Act, 2002 or the PMLA is an Act of the Parliament of India enacted to prevent money-laundering and to provide for confiscation of property derived from money-laundering. The Act and Rules notified thereunder impose obligation on banking companies, financial institutions, and intermediaries to verify identity of clients, maintain records and furnish information in prescribed form to the competent authorities formed and appointed in that regard [e.g., Financial Intelligence Unit – India (FIU-IND)]. Under Prevention of Money Laundering Act, 2019,banks are required to report information relating to cash and suspicious transactions and all transactions involving receipts by non-profit organisations of value more than rupees ten lakh or its equivalent in foreign currency to the Director, Financial Intelligence Unit-India (FIU-IND) Other Important Acts: a. Transfer of Property Act, b. Information Technology Act, 2000 c. Code of Civil Procedure Act,1908 d. Recovery of Debts due to Banks and Financial Institutions Act,1993 (DRT) e. Stamps Act f. Foreign Exchange Management, Act,1999 g. Bankers Book Evidence Act, 1891  25 Banker Customer Relationship Quick Bites  Definition of Banking, Banker & Customer.  Various type of relationship between Banker & Customer  Various rights available to the Banker like, Lien, set-off and appropriation defined.  Difference between Garnishee order and Income Tax attachment order explained.  Various types of customers covered precisely. Background: The relationship between the Banker and Customer is very important. Both serve the society to grow and economy to expand. Before we discuss the relationship between the Banker and the Customer, it seems necessary that two terms “B anker” and “ C ustomer” are made clear. The term “Banking has been defined under the Banking Regulation Act, 1949, in terms of Section 5(b) of the Act, “ Banking” means “accepting for the purpose of lending or investment of deposits of money received from the public, repayable on demand or otherwise and withdrawable by Cheque, Draft, Order or otherwise”. The person who is disposing the assignments of Banking is called a “Banker”. Essential functions of the Bank as mentioned in RBI Act, Section 6 and Banking Regulation Act,1949 (Section 6), are as listed below:  Acceptance of deposit of money for the purpose of lending or investments  Discounting of Bills  Collection of Cheque and Bills  Remittances  Safe Custody of articles  Hiring of Safe Deposit Lockers  Conducting foreign exchange transactions  Conducting Govt. Transactions.  Issuing Letters of Credit and Guarantees But now, as new Institutions have diversified their businesses and entered into Banking, like- wise Banks were diversified to other line of businesses directly or, otherwise. So, few more functions have been added over the years like Selling of Gold Coins, Credit Card business, third party products selling etc. There is no statutory definition of a “Customer”. A person/company/entity who has an account with a Bank is its Customer. There is no unanimity as regards to the time period of the dealings. However, a casual transaction like encashment of a cheque does not entail a person to be a customer. The duration of association of the Customer with the Bank is of no essence. A Customer is one who has an account with the Bank and to whom the Bank undertakes to extend business of Banking. Duties and Rights of a Banker: i. Duty to maintain secrecy about customer’s account, but under following circumstances Bank is under obligation to disclose the customer information: a. Under compulsion of Law b. To protect National interest c. In the interest of Bank d. With the implied consent of the Customer  26 e. As per Banking Practices f. Information demanded by the Guarantor ii. Duty to honor the cheque if the balance in the account permits debit of the cheque and the cheque is properly drawn. iii. Duty to issue pass-book, statement, etc. iv. Duty to collect Cheques, Bills, etc. Primary rights of a Banker: 1. Right of General Lien 2. Right to set-off 3. Right of appropriation 4. Right to act as per the mandate given by the customers. Lien: It is a right of the Creditor to retain the possession of goods and securities owned by the debtor, until the debt due by the customer is paid. The Banker‘s lien is an implied pledge. A Banker acquires the right to sell the goods, which came into possession in the ordinary course of Banking business. This means that any specific transactions other than as defined under Banking are not subject to general lien e.g; Safe Custody transactions, Locker transactions, money deposited for some specific purpose, etc. However, Section 171 of the Indian Contract Act, 1872 gives a right of General Lien to the Banker. Set-off: Right of set-off is the right of a B anker to adjust a debit balance in a C ustomer’s account, with any balance outstanding to his credit in the books of the Banks. In other words, the Banker has a right to mutually adjust the two accounts of the same customer with certain amount, one in debit and another in credit, which is called right of set-off. The set-off is applicable to debts due and payable on the date of set-off. The account must be in the same name and same capacity. Appropriation: The customer, who deposits the amount has a right to clarify the purpose and account against which the credits to be given by the Banker. It means it is the duty of the customer to specify the nature of the transactions. If he fails to mention the purpose, then Banker has a right to adjust the credit against any debit / dues. This is called the right of appropriation Banker Customer Relationship: Banker: Banking Regulation Act 1949 (Section 5C) defines a banker as a person undertaking business of banking. Banking means (Section 6) accepting deposits from public for the purpose of lending, repayable on demand or otherwise withdrawable by cheque, draft, order or otherwise. Customer: There is no legal definition of a customer, but from various judgments based on section 131/131A of NI Act 1881, a customer means a person who opens an account with proper introduction and account opening form and banker accepts it, contractual relationship is established. A person who only avails services like remittances, encashment of third party cheques (as payee) without having an account is not a customer of a bank. Initial deposit: The initial deposit for opening an account may be cash, a cheque or no deposit even at the time of opening the account, as ZERO balance account can be opened The Banker is rendering various types of services to the customers and non-customers also. During the course of such Banking transactions various relationships arise, some are as under: Banking Transaction Bank Customer  27 Deposit Account with Bank Debtors Creditors Loan from the Bank Creditors Debtors Locker Lessor Lessee Safe custody of Articles Bailee Bailor Collection of Bills / Cheques Agent Principal Purchase of DD / MT / TT Debtors Creditors Payment of Draft Trustee Beneficiary Pledge of goods Pledgee Pledger Mortgage Mortgagee Mortgager Standing instruction Agent Principal Article left by the Bank Trustee Beneficiary Hypothecation of goods Hypothecatee Hypothecator Assignment of securities Assignee Assignor Indemnity Indemnifier Indemnified Creditor-Debtor: Relationship between the customers having a deposit account, Depositor is the Creditor and the Banker is the Debtor. Debtor-Creditor: When a customer avails a loan or an advance, then his relationship with the Banker undergoes a change to what it is, when he is a deposit holder. Since the funds are lent to the customer, he becomes the borrower and the banker becomes the lender. The relation is the D ebtor-Creditor relation, the customer being a debtor and the banker a creditor. Beneficiary-Trustee: If a customer keeps certain valuables or securities with the bank for safe-keeping or deposits a certain amount of money for a specific purpose, the banker, besides becoming a Bailee, is also a trustee. The money or the securities so kept are not at the disposal of the bank. The banker cannot utilize those moneys or securities as he desires since the money does not belong to him. Principal-Agent: Banks provide ancillary services such as collection of cheques, bills etc. They also undertake to pay regularly the electricity bills, phone bills etc. The relationship arising out of these ancillary services is of Principal-Agent between the customer and the bank. The proceeds of the cheques sent for collection, which are in transit, not credited to the customer account are not the moneys of the banker till such time as they are credited into the customer account. Lessee-Lessor: The banks provide safe deposit lockers to the customers who hire them on lease basis. The relationship therefore, is that of Lessee and Lessor. In certain banks, this relationship is termed as licensee and licensor. The bank leases out the space for the use of clients. The bank is not responsible for any loss that arises to the lessee in this form of transaction except due to negligence of that bank. Indemnifier-Indemnified: The customer is Indemnifier and the bank is indemnified. A contract by which one party promises to save the other from loss caused to him by the conduct of the promisor himself or the conduct of any other person is called a Contract of Indemnity– Section 124 of Indian Contract Act, 1872. In the case of banking, this relationship happens in transactions of issue of duplicate demand draft, fixed deposit receipt etc. The underlying point in these cases is that either party will compensate the other of any loss arising from the wrong / excess payment. Bailor and Bailment: A bailment is the delivery of goods in trust. A bank may accept the valuables of his customer such as jewellary, documents and securities for safe custody. In such a case the customer is the Bailer and the bank is Bailee. As per Section 148 of Indian Contract Act 1872, the delivery of goods  28 from one person to the other for some purpose upon the contract that the goods will be returned when the purpose is accomplished. Pledger and Pledgee: When a customer Pledge goods and documents as security for an advance he then becomes a Pledger and the bank becomes the pledge.e. The pledged goods are to be returned intact to the Pledger after the debts repaid by him. Mortgager and Mortgagee: 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. When a customer pledges a specific immovable property with the bank as security or advance, the customer becomes Mortgager and banker is the Mortgagee. Clayton’s Rule: The rule in Clayton Case was laid down in Devayaney Vs Nobel. Where does the rule operate: It is applicable incase of accounts such as cash credit and overdraft where the customer deposits and withdraws money from the account frequently. As per this rule, the order in which the credit entry will set off the debit entry is the chronological order. This means that the first item on the debit side will be the item to be discharged or reduced by a subsequent item on the credit side. The rule is of great practical significance to bankers. This rule is applicable mainly in case of overdraft & cash-credit account of other than sole proprietor firm and as per this rule the credit entry will set-off the debit entry, in chronological order. When and how the rule operates: In case of eath or insolvency or insanity of a borrower or joint borrower, a death, insolvency, insanity, retirement of partner in a firm or death, insolvency of guarantor or revocation of guarantee by the guarantor in a loan account, the existing debt due from the borrower is adjusted if subsequent credit are allowed. fresh debits are allowed, these are considered a fresh loan and the bank cannot recover such debt from the assets of the deceased, retired or insolvent partner and may ultimately suffer the loss if the debt cannot be recovered from the remaining partners. Termination of Banker-Customer relationship: The relationship seizes if the: Customer closes the accounts  Customer dies,  Customer becomes insane or  Customer becomes insolvent.  Banker may close the a/c by serving notice to A/C holder Types of Customers: A bank opens accounts for various types of its prospective/existing customers like individuals, partnership firm, trusts, companies, etc. While opening the accounts, the banker has to keep in mind the various legal aspects involved in opening and maintenance of these accounts. Normally banks have to deal with the following types of customers: Individuals: ❖ The account should be opened with cash only and not with cheque, drafts. This is to protect the bank‘s interest under section 131 of the N. I. Act. ❖ “ KYC” norms to be followed ❖ The account can be opened in the single name or joint names. Following are various types of operation instructions for joint accounts of the individuals: ❖ Jointly  29 ❖ Either or Survivor ❖ Former or Survivor ❖ All of them jointly or Survivors or Survivor Minor: According to Section 3 of Indian Majority Act, a person attains majority at the age of 18, except in case where a guardian is appointed by a Court, where the age of majority is 21. As per Indian Contract Act, a minor is not capable to enter into the contract and any contract with the minor is void. Following points are to be kept in mind: i. A minor of any age can open saving account through his/her natural or legally appointed guardian. Minors above the age of 10 years will also be allowed to open and operate a saving bank account independently, if he/she can sign uniformly, however there is a specific ceiling to maintain a maximum balance in the account/s. ii. Operations in the account – by minor or by natural guardian iii. Legal guardian cannot open a joint account iv. No overdraft is created in the account v. Date of majority to be recorded in the account vi. No joint account of two or more MINORS TO BE OPENED. Illiterate Persons: Illiterate persons are competent to enter into contract so that they can open and maintain bank accounts. However, following precautions are to be taken while opening and maintaining such accounts: a. No cheque book should be issued b. No current account should be opened c. Joint account of two illiterates (close relatives can be opened) – operational instructions should be jointly or survivor and not either or survivor d. Joint account of illiterate with literate close relative can be opened but no cheque book should be issued. Blind Persons: Blind persons are competent to enter into contract. They can open and maintain any type of bank accounts. However, following precautions are to be taken while opening and maintaining such accounts: a. Various risks in operations of the account should be explained to the account holder b. Joint account with close relative can be opened c. Cash receipts and payments should be made in presence of witness preferably bank customer d. Account opening form etc. should be stamped e. For withdrawal of the amount he/ she should come personally Proprietorship Firms: A sole proprietorship is the oldest and the most common form of business. It is a one-man organisation where a single individual owns, manages and controls the business. Its main features are: a. Ease of formation is its most important feature because it is not required to go through elaborate legal formalities. No agreement is to be made and registration of the firm is also not essential. However, the owner may be required to obtain a license specific to the line of business from the local administration. b. The capital required by the organisation is supplied wholly by the owner himself and he depends largely on his own savings and profits of his business.  30 c. Owner has a complete control over all the aspects of his business and it is he who takes all the decisions though he may engage the services of a few others to carry out the day-to-day activities. d. Owner alone enjoys the benefits or profits of the business and he alone bears the losses. e. The firm has no legal existence separate from its owner. f. The liability of the proprietor is unlimited i.e. it extends beyond the capital invested in the firm. g. Lack of continuity i.e. the existence of a sole proprietorship business is dependent on the life of the proprietor and illness, death etc. of the owner brings an end to the business. The continuity of business operation is therefore uncertain. Partnership Firms: The account should be opened in the name of the firm. The account opening form should be signed by all the partners. A letter of partnership duly signed by all the partners should be obtained. When a minor is admitted as partner in the firm, a letter of restrictive operations should be obtained. Specific operational instructions duly signed by all the partners to be obtained. Stop payment of the cheque by any partner, even if it is signed by another partner the same can be stopped by any partner. In case of death, insolvency or lunacy of any partner, operations in the account should be stopped. Limited Liability Partnership: LLP is a body corporate having separate legal existence having mixed characteristics of Partnership firm & Companies. It is separate from its partners, can own assets in the name, sue and be sued. It has perpetual succession. Every partner is an agent of the LLP. It is to be registered with ROC. The incorporation document shall contain the name of LLP, proposed business, address of the registered office and name & address of each partner. Name to contain ‘Limited Liability Partnership’ or ‘LLP’ as suffix. Incorporation Document is not required to contain State in which incorporated. Thus, registered office can be changed to any place in India just by informing ROC subject to prescribed conditions. LLP Agreement is required to be filled later. In absence of LLP Agreement, mutual rights and duties will be as specified in first schedule to LLP Act. Thus, practically, each LLP must have LLP Agreement, though not mandatory. No restriction on remuneration to partner but it should be provided in LLP agreement. No provision for registration of charges. Limited Company: Joint stock Companies are governed by the Companies Act, 1956. A Company is incorporated under the Companies Act. The Company is a separate entity from its members. There are four types of the companies viz; Public Limited Company, Private Limited Company, Government Company and Limited Liability Partnership. Certified true copy of following documents are to be obtained at the time of opening of the account: a. Certificate of incorporation b. Certificate of commencement of business in case of Public Limited Co. c. Memorandum of Association (MOA) d. Articles of Association e. Board Resolution to open an account with the bank and operational instructions f. List of the present directors. Following care to be taken while maintaining such accounts: a. The account opening form should be signed as per the resolution passed by the Board. b. Introduction is not necessary for opening of the account because certificate of incorporation issued by Registrar of Companies itself serves the purpose c. Death of a Director does not affect the operation in the account. d. A cheque payable to the company should never be deposited in the personal account of Director.  31 e. While granting any credit facility, purpose clause of MOA of the Company must be verified. f. Provisions of Section 293 (1) (d) of the Companies Act regarding borrowing in excess of Net worth to be observed. Trust Accounts: A trust is an obligation annexed to the ownership of property, arising out of confidence reposed in a person / group of persons and accepted by him / them for the benefit of another or of another and the owner. The persons who, accepts the confidence are called trustees. The instrument / document by which the trust is created are called the “Trust Deed”. While opening of the account of a Trust, following documents are required to be obtained: a) Copy of Trust Deed b) Copy of the certificate issued by Charity Commissioner. c) List of present trustees, d) Resolution