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Commercial Banking

S P Mohanty Deputy General Manager Department of Banking Supervision Reserve Bank of India Bhubaneswar

Evaluation
Evaluation
Components Weights (%)
Two Quizzes 20%......10 Marks Each

Mid Term - 30%


End Term 50%

Introduction to Banking Overview of Banking

Evolution of commercial banking, Challenges


Banker-Customer Relationships Characteristics of Negotiable Instruments

Cheque and its characteristics


Customers Deposit Accounts

Definition of the Bank


British LawBank of England under Banking Act 1947

defined Banking to accept deposits. Bank must perform at least following essential functions for Banking Business

Take Deposit accounts (checking Accounts)

Issue and pay Cheques Collect cheques for customers

Definition of the Bank

USA Law (by the Act of the congress). business of Dealing in credits and by a Bank, it includes all persons, firms or company having a place of business where credits are opened by the deposits or collection of money or currency, subject to be paid or remitted on draft, cheque or money is advanced or loaned on stocks, bonds, bullions, bills of exchange or promissory notes are received for discount or sale. Banks pay interest only on term deposits and follow the directions issued by Regulatory authorities..Comptroller of the Currency( COC).Federal Reserve(FED) Federal Depository Insurance Commission (FDIC) and Office of Thrift Supervision (OTS).

Indian Law.The Banking Regulation (BR) Act, 1949


Indication of BR ACT,1949

The Banking Regulation Act 1949 defines 'Banking


as accepting for the purpose of lending or

investment of deposits of money from the public,


repayable on demand or otherwise and withdrawal

by cheque , draft order or otherwise

The Banking Regulation Act 1949 defines 'Banking as accepting for the purpose of lending or investment

of deposits of money
from the public repayable on demand or otherwise and withdrawal by cheque , draft, order or otherwise

Commercial Banking System..India


Scheduled Banks

Scheduled Commercial Banks

Scheduled Co-operative Banks

Private Sector Bank

Public Sector Bank

Foreign Bank

Regional Rural Bank

Urban Co-operative Bank

State Co-operative Bank

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Banking Sector Reforms in India


The first bank in India was established in 1770.

From 1770 till today, the journey of Indian Banking System can be segregated into three distinct phases. Early phase from 1770 to 1969 of Indian Banks..Phase I Nationalisation of Indian Banks in 1969 and up to 1991 prior to Indian banking sector Reforms....Phase II New phase of Indian Banking System with the advent of Indian Financial & Banking Sector Reforms after 1991....Phase III

Banking Sector Reforms in India


The modern banking system began with the opening of Bank

of England in 1694. Bank of Hindustan was the first bank to be established in India, in 1770. The General Bank of India was set up in the year 1786. The East India Company established Bank of Bengal (1806), Bank of Bombay (1840) and Bank of Madras (1843) as independent units and called it Presidency Banks. These three banks were amalgamated in 1921 and Imperial Bank of India was established which started as private shareholders banks, mostly Europeans shareholders.

Which in turn became the State Bank of India in 1955.

Banking Sector Reforms in India


In 1865 Allahabad Bank was established and first time

exclusively by Indians Punjab National Bank Ltd. was set up in 1894 with headquarters at Lahore. Between 1906 and 1913, Bank of India, Central Bank of India, Bank of Baroda, Canara Bank, Indian Bank, and Bank of Mysore were set up. RBI Act 1934. Reserve Bank of India came in 1935. Main function as per statute usually known as traditional functions of a central bank .. issue of currency, banker / debt manager to the government , banker to the banks.

Banking Sector Reforms in India


Reserve Bank of India was vested with extensive

powers for the supervision of banking in India as the Central Banking Authority. Government of India came up with The Banking Companies Act, 1949 which was later changed to Banking Regulation Act 1949 as per amending Act of 1965 (Act No. 23 of 1965).

Banking Sector Reforms in India


1949 : Enactment of Banking Regulation Act. 1955 : the Imperial Bank of India(1921) was christened on

30 April 1955 as the State Bank of India, and this transformation from the Imperial Bank of India to the State Bank of India was given legal recognition in terms off an Act of the Parliament of India, which came into force from 1 July 1955. 1959 : Nationalisation of SBI subsidiaries. 1961 : Insurance cover extended to deposits. 1969 : Nationalisation of 14 major banks. 1971 : Creation of credit guarantee corporation. 1975 : Creation of regional rural banks. 1980 : Nationalisation of seven banks with deposits over 200 crore.

Banking Sector Reforms in India


This phase has introduced many more products and

facilities in the banking sector in its reforms measure. In 1991, under the chairmanship of M Narasimham, a committee was set up by his name which worked for the liberalisation of banking practices.

Banking Sector Reforms in IndiaPhase III


Narasimham Committee I (1991).

Narasimham Committee II (1998).

The major recommendations made by the Narasimham I committee


Establishment of a four-tier hierarchy for the banking structure

consisting of three to four large banks with SBI at the top. The private sector banks should be treated equally with the public sector banks and govt. should contemplate to nationalize any such banks. The ban on setting new banks in private sector should be lifted and the licensing policy in the branch expansion must be abolished. The govt. has to be more liberal in the expansion of foreign bank branches and also foreign operations of Indian banks should be rationalized. The Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR) should be progressively brought down.

Narasimham Committee I
The directed credit program should be re-examined and the priority

sector should be redefined to comprise small and marginal farmers, the tiny industrial sector, small business operators and weaker sections.
Banking industry should follow BIS/Basel norms for capital adequacy

within three years.


Interest rates should be deregulated to suit the market conditions. The govt. should tighten the prudential norms for the commercial

banks.

Narasimham Committee I
In respect of doubtful debts, provisions should be created

to the extent of 100 percent of the security shortfall. The govt. share of public sector banks should be disinvested to a certain percentage like in case of any other PSU.
Each public sector bank should set up at least one

rural banking subsidiary and they should be treated at par with RRBs.

Narasimham II committee
The committee favored the merger of strong public sector

banks and closure of some weaker banks if their rehabilitation was not possible. It recommended corrective measures like recapitalization is undertaken for weak banks and if required such banks should be closed down. The committee had also suggested an amicable golden handshake scheme for surplus banking sector staff. Suggesting a possible short term solution to weak banks, the report observed that the narrow banks could be allowed as a mean of facilitating their rehabilitation.

Narasimham II committee
Expressing concern over rising non-performing assets, the committee

provided the idea of setting up an asset reconstruction fund to tackle the problem of huge non-performing assets (NPAs) of banks under public sector. The report emphasized the need of enhancement of capital adequacy norms from the present level of 8 percent but did not specify the amount to which it should be raised. The Banking Sector Reform Committee further suggested that existence of a healthy competition between public sector banks and private sector banks was essential. The report envisaged flow of capital to meet higher and unspecified levels of capital adequacy and reduction of targeted credit.

Types of reform measures for the banking sector..Phase III


1.Competition Enhancing Measures
Allowing operational autonomy and reduction of public

ownership in public sector banks by raising capital from equity market up to 49 percent of paid up capital. Transparent norms for entry of Indian private sector banks, foreign banks and joint venture banks. Permission for foreign investment in the financial sector through foreign direct investment (FDI) as well as portfolio investment.

Contd.
The banks are allowed to diversify product portfolio

and business activities. Roadmap for foreign banks and guidelines for mergers and amalgamation of private sector banks with other banks and NBFCs. Instructions and guidelines on ownership and governance in private sector banks.

2.Measures enhancing role of market forces


Reduction in pre-emption through reserve requirement,

market determined pricing for govt. securities, disbanding of administered interest rates and enhanced transparency and disclosure norms to facilitate market discipline. Introduction of auction-based repos and reverse repos for short term liquidity management, facilitation of improved payments and settlement mechanism. Significant advancement in dematerialization and markets for securitized assets are being developed.

3.Prudential measures
Introduction of international best practices norms on capital to risk

asset ratio (CRAR) requirement, accounting, income recognition, provisioning and exposure. Measures to strengthen risk management though recognition of different component of risk, assignment of risk weights to various asset classes, norms of connected lending, risk concentration, application of market to market principle for investment portfolio limits on deployment of fund in sensitive activities. Introduction of capital charge for market risk, higher graded provisioning for NPAs, guidelines for ownership and governance, securitization and debt restructuring mechanism norms, etc. Introduction and roadmap for implementation of Basel II by 31 March 2007.

4. Institutional and legal measures


Setting up of debt recovery tribunals, asset reconstruction

companies, settlement advisory committees, corporate debt reconstructing mechanism, Lok-Adalat (peoples court), etc. for quick recovery of debts. Promulgation of Securitization and Reconstruction of Financial Assets and Enforcement of Securities Interest (SARFAESI) Act, 2002 and its subsequent amendment to ensure creditor rights.

Setting up of Clearing Corporation of India

Limited (CCIL) to act as a counter party for facilitating payment and settlement system relating to fixed income securities and money market instruments. Setting up of Credit Information Bureau of India Limited (CIBIL) for information sharing on defaulters as also other borrowers.

Supervisory measures
Establishment of Board of Financial Supervision as the apex supervisory authority for commercial banks, financial institutions and non-

banking financial companies. Move towards risk based supervision, consolidated supervision of conglomerates, strengthening of off-site surveillance through control returns.Annual Financial Inspection

Recasting of the role of statutory auditors, increased

internal control through strengthening of internal audit. Strengthening corporate governance, enhance due diligence on important shareholders, fit and proper test for directors.

Banker and Customer Relationship


The relationship between the banker and customer is

very important. Both serve the society to grow and the economy to expand. Before we discuss the relationship between the banker and the customer, it seems necessary that the two terms banker and customer are made clear,

Who is a Banker?
The Banking Regulation Act 1949 defines 'Banking' as accepting for the purpose of lending or investment of deposits of money from the public, repayable on demand or otherwise and withdrawal by cheque, draft order or otherwise (Section 5b) and says that any company which transacts the business of banking is a 'Banking Company' (Section 5c). It further stipulates that a company which carries the business of banking in India must use the words, 'Bank, Banker, Banking or Banking Company' as a part of its name.

What is the meaning of a Customer?


A customer is a person who maintains an account with

the bank, without taking into consideration the duration and frequency of operation of his account.

To constitute a customer of the bank. One should have an account with the bank. One should deal with the bank in its nature of regular banking business. One should deal with the bank without consideration of the duration and frequency of operation of his account.

Banker and Customer Relationship


The relationship between the banker and customer is

very important. It is generally studied under the following two heads.


General Relationship Special Relationship

GENERAL RELATIONSHIP
CREDITOR-DEBTOR

Relationship between the customer having a deposit


account and the banker. Depositor is the lender and the banker is the borrower. Depositor is the creditor and the banker is the debtor. The money handed over to the bank is a debt. The money once deposited in the bank becomes the money of the bank and it is prerogative of the bank to use that money as it deems fit. The depositor remains a creditor that too an unsecured creditor

GENERAL RELATIONSHIP
DEBTOR-CREDITOR When the 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 debtor- creditor relation, the customer being a debtor and the banker a creditor.

SPECIAL RELATIONSHIP
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. Here there is delivery of goods or securities from one person to the other which amounts to the bailment. As per section 148 of Indian Contract Act 1872, the delivery of goods from one person to the other for some purpose upon the contract that the goods will be returned when the purpose is accomplished. The customer is the bailer and the banker is the bailee.

SPECIAL RELATIONSHIP

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 relationship seizes once the customer dies, becomes insane or becomes insolvent. The proceedes of the cheques sent for collection,which are in transit, not created to the customer account are not the moneys of the banker till such time as they are credited into the customer account.

SPECIAL RELATIONSHIP
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.

SPECIAL RELATIONSHIP
Pawner and Pawnee
When a customer Pledge goods and documents as

security for an advance he then become Pawner (Pledger) and the bank becomes the pawnee (pledgee). The pledged goods are to be returned intact to the pawner after the debt is repaid by him.

SPECIAL RELATIONSHIP
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 for advance, the customer becomes mortgager and banker is the mortagee.

SPECIAL RELATIONSHIP
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 ( 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.

Executer, attorney, guarantor


The bank also acts as executor, attorney and guarantor

for his customer.

OBLIGATIONS OF THE BANK


Obligation to honour the cheque Under section 31 of NI Act 1881, the banker is obliged to make payment of the cheque ,with mandate, properly presented, provided there is balance in the account. However, when a garneshee order is served on the banker, the banker may seek refuse under order 21 of code of civil procedure 1908 and the banker may not pay the cheque when such order is served.If a debtor fails to pay the debt to the creditor, the latter may approach a court of law to issue a garneshee order on the banker of his debtor.

OBLIGATIONS OF THE BANK


Obligation to maintain secrecy Section 13 of banking companies Act 1970 stipulates the banks to maintain secrecy of their customers accounts and dealings with them. However there are exceptions.The exceptions are : When law requires When the practices and usages among bankers warrants exchange of information.

RIGHTS OF BANKER
Right of general lien- Lien is the right of the creditor to retain the goods

and securities owned by the debtor untill the debt due from him is paid. It conferes upon the creditor to retain the securities of the debtor. It does not confer the right to sell. There are two types of liens General lien and particular lien. Section 171 of Indian contract Act 1872 conferes general lien on bankers. Bankers lien is tantamount to implied pledge. The reason being the banker is bestowed with a right even to sell securities without the intervention of the court. Pledge Section 172 of Indian contract Act 1872- bailment of goods as security for payment of a debt or performance.

RIGHTS OF BANKER
Right of set off The mutual claims of a debtor and a creditor are adjusted together and only the remainder amount due is payable. Right of appropriation - If the customer has more than one loan account , the customer can direct the repayment of the loan as credit into any other

accounts. If there is no specific directions from the customers the banker has a right to appropriate as per his choice. Right to charge interest- As a creditor the banker has right to charge interest on the funds he lends as per the norms and as per the contract.

BANKERS BOOKS EVIDENCE ACT


Despite the fact the banker has to maintain secrecy he has to disclose the accounts and an order from the court. Earlier the books of accounts were required to be produced in court of law as evidence. However on the advent of bankers books evidence act 1891.The banker can produce certified copies of the records of the accounts as evidence which are tenable as evidence in court of law.

RIGHTS AND DUTIES OF THE CUSTOMER TOWARDS THE BANKER

The main rights and duties of a customer towards the

banker in brief are as under:

Rights of a customer:
A customer who has deposited money can draw check

on his account up to the extent of his credit balance or according to overdrawing limit sanctioned by the bank.

A customer has the right to receive statement of

accounts from the bank. A customer has the right to sue the bank for compensation of a wrongful dishonor of his check. A customer has a right to sue and demand compensation if the bank fails to maintain the secrecy of his account.

Duties of a customer
It is the duty of the customer to present checks and

other negotiable instruments during the business hour of the bank. The instruments of credit should be presented by the customer with in due time from their dates of issue. A customer must keep the check books issued by the bank in safe custody. In case of theft or loss, it is the duty of the customer to report the matter immediately to the bank.

A customer should fill the check with utmost care. If a customer find any forgery in the amounts of the

check issued by him. It should then immediately be reported to the bank.

Types of Bank Accounts


Fixed / Time deposit account Savings Bank account

Current account
Recurring deposit account Flexible account

Fixed or Time deposit accounts


Money deposited for fixed period Minimum 7 days. Maximum-10 years

Yield curve generally moves upward-Interest increases

with increase in time period Cumulative / Non-cumulative Premature withdrawal-Banks decide their own penalty rate

Savings Bank account


Individuals can open in their own name Society/ Club association can also open Interest rate decided by the banks Upto Rs 1 lakh uniform interest rates > Rs 1 lakh banks can offer differential interest rates based on Amount and tenure of deposit but no discrimination among customers Restrictions on number of withdrawal Interest calculated on daily product basis w.e.f. April 1, 2010 Earlier interest was calculated on the minimum balance standing between 10th and last day of the month.

Documents generally required to open the account


Photographs Specimen signature

Identity proof- Driving Licence, IT PAN card, Voter

ID,Passport etc Address Proof- Passport, Utility bills etc Introduction

Current Account
Current account sometimes called open account or

running account Customer can deposit money into and withdraw from any number of times in a day Mainly use for business purpose No interest is paid Facilities like paying through cheques, third party cheques, bills for collection, overdraft facilities available to customers

Documents generally required to open the account


Individuals-same as savings account and business

details Partnership-Partnership deed though not must but banks insists Companies-Certificate of incorporation, certificate of commencement of business, Articles of association, memorandum of association I

Recurring deposit account


Predetermined amount deposited into account at

fixed interval generally every month /quarter Interest rate normally equal to interest rate paid to term deposit accounts of similar tenure Premature withdrawal allowed

Flexible accounts
Banks using modern technology are providing some

innovative accounts under different names Hybrid characteristics of both savings and term deposits After keeping some specified minimum amount in Savings account remaining amount automatically transferred to term deposit account Whenever customer requires money it is transferred back to savings account immediately For intervening period the customer also get higher interest rate on the transferred amount.

Bankers need to take additional care while opening

following accounts Hindu Undivided family Married women Pardanashin women Illiterate person Blind persons Insolvent persons Insane person

Intoxicated person Executors or Administrators Liquidator / Receiver / Assignee Trusts Societies / Clubs Minors Agency / Attorney Joint Accounts Partnership firms Companies

Hindu Undivided Family


Ancestral common ownership Hindus, Sikhs & Jains can have HUF

Male members (by birth or adoption) are coparceners


Senior most male member-Karta Documents signed by Karta as Karta and male

coparceners in the personal capacity Karta is liable personally as well as Karta and male coparceners are not unless specifically agreed.

HUF contnd.
Karta can (i) compromise and refer to arbitration (ii)

give valid discharge to debt and make part payment (iii) enter into partnership and delegate authority to operate the account to any one. Karta cant revive a time barred debt. A coparcener cant countermand a cheque unless specifically authorized. In case of death, insolvency, or insanity of a coparcener / Karta-does not dissolve the HUF. Fresh AOF and HUF declaration to be taken.

Married women
A separate legal entity Section 14 of Hindu succession act provides property

of a Hindu female is her absolute property Can raise loans against her property Solvency not related to her husband Husband liable for her debts if has consented and stands surety/ loan is availed for necessities of her life

Pardanashin Lady
Contract with her is not free from defects Presumption of undue influence

Generally discourage accounts in her name as her

identity can not be ascertained Absolute care to be taken while dealing with her

Illiterate persons
Get introduction and witness Photograph to be recent- generally change every three

years Take identification marks Payment only in person In case of any dispute-take independent witness Noting of ILLITERATE A/C to be made on the ledger

Blind person
Get introduction and witness Photograph to be recent and change every three years

Take identification mark


Payment / receipt to be got witnessed by independent

witness In case of any dispute-take independent witness Noting of BLIND PERSON to be made on the ledger Advised to open joint account

Insolvent Persons
All transactions made subsequent or during last six

months are invalid Cant obtain credit for more than Rs.50 Minor / Lunatics cant be treated as insolvent Account of person declared insolvent should be stopped & balance disposed as per instructions of the official receiver Insolvent person cant act as an agent under Indian Contract Act, section 201

Insane Person
Incapable of entering contract On notice of lunacy operation should be stopped and

balance disposed off as per courts directions In case of temporary disorder payment to be made after obtaining certificate from two approved doctors who certify mental soundness at the time of payment

Intoxicated Person
Contracts in a drunken state is void Payments to an intoxicated person is to be made only

after taking two independent witnesses regarding the condition of the person

Executors and Administrators


The person named in will of the deceased person is

executor. Account can be opened on production of probate Person appointed by Court is an administrator and must produce letter of administration Payment can be stopped by any executor (when more than one executor are there) Withdrawal should be done by both Upon death, the powers vested with surviving executor Can borrow for immediate needs of the property

Liquidator / Receiver / Assignee


Liquidator appointed when company in liquidation Receiver / assignee to manage the property of an

insolvent person Letter of probate / administration to be taken Style and status to be mentioned in the title of the account No loan can be granted

Trusts
Trust deed examined Insolvency of trustee doesnt affect trust property

Transfer of funds from Trust account to personal

account normally not allowed. Allow loans only if allowed in the trust deed and after taking guarantee of the trustee. Trustees to act jointly. They have no authority to delegate unless specifically mentioned Any trustee can stop payment

Societies and Clubs


By-laws to be obtained and read carefully Registration certificate

Resolution passed regarding opening and conduct of

account Death of authorised signatory-operation stopped till new resolution received. A/c can be opened for unregistered clubs, institutions, societies, association, schools etc. after satisfactory explanation about reputation, responsibility and standing of the office bearers.

Minors
Contract void ab initio A/c can be opened under the guardianship of mother/

father/ legal guardian No loan be allowed even against sufficient security Under NIA can bind all others excepting himself Minor can be admitted for benefits of partnership. On becoming a major he has the option to repudiate his liability within six months. Can be appointed as an agent but shall not be personally responsible to his principal who shall be responsible for the acts of the minor agent

Agent / Attorney
Terminated upon Death / insolvency / insanity of principal

Principal revokes agents authority


Agent renounces the agency Business of the agency is completed

Joint Account
Appointment of agent to be confirmed by all Operation to be stopped in case of death, insolvency /

insanity of any one. Payments to be made to the survivors, the legal heirs of the deceased Anyone can stop payment Alteration in a cheque drawn should be confirmed by the drawer

Partnership Firm
Max. no of partners -20 (10 in banking) Registration not mandatory, but only registered firms

can file a suits to enforce contract Minor can be admitted only to the benefits A partner can bind the firm by doing usual business on behalf of the firm A partnership is not treated as a separate entity from the partners Death of a partner / admission of a partner dissolves the partnership firm

Joint Stock Companies


Third party cheques drawn by company should not be

credited to personal accounts of directors Insolvency / death / insanity of a director does not affect the functioning of a company. Private Limited Companies Min 2 Max 50 shareholders Directors- Min 2 Max 7 Name must end with Private Limited

Public Limited Companies Share holders- Min-7, max no limit

Directors- Min 3, Max no limit


Name must end with Limited

Government Companies
51% or more share to be held by the Government

NEGOTIABLE INSTRUMENTS
Negotiability in mercantile law means transferable

quality A negotiable instrument is an instrument capable of being transferred by endorsement or delivery so as to pass to holder the right to sue in his own name.

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NEGOTIABLE INSTRUMENTS
It is an instrument embodying an obligation for the

payment of money and is called negotiable when the legal title to the instrument itself and to the whole amount of money expressed in its face,with the right to sue therefor in his own name may be transferred from one person to another person without a formal assignment,but by mere endorsement and delivery by the holder or by delivery only.

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NEGOTIABLE INSTRUMENTS
A negotiable instrument is a written promise or

request for the payment of a certain sum of money to order or bearer Any written security which may be transferred by endorsement and delivery or by delivery merely,so as to vest in the endorsee the legal title,and thus enable him to sue thereon in his own name are called negotiable instruments.

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PREAMBLE
AN ACT TO DEFINE THE LAW RELATING TO

PROMISSORY NOTES, BILLS OF EXCHANGE AND CHEQUES Contains 147 Sections,with subsections and proviso

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Section 4- Promissory Note


An instrument in writing(not being a bank-note or

currency-note)

containing

an

unconditional

undertaking, signed by the maker, to pay a certain sum


of money only to, or to the order of, a certain person,

or to the bearer of the instrument

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Prerequisites of PNs
Must be signed by the maker Maker must be certain

Sum payable must be certain


Instrument must contain a promise to pay money and

money only Payee must be certain

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Section 5- Bill of exchange


An instrument in writing containing an unconditional

order, signed by the maker, directing a certain person to pay a certain sum of money only to, or to the order of, a certain person or to the bearer of the instrument

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Bill of Exchange - requisites


Drawee must be certain Sum payable must be certain

Must contain an order to pay money and money only


Payee must be certain

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Section 6- Cheque
It 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 and a cheque in the electronic form

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Difference b/w Cheque and Bill of Exchange CHEQUE BILL OF EXCHANGE


Requires no acceptance and is intended for immediate payment 2. Payable immediately w/o any grace 3. Drawee is always a banker
1.

Must be accepted before the acceptor is made liable upon it 2. Normally entitled to 3 days grace
1. 3. Drawee

may be anyone including a banker


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Difference b/w Cheque and Bill of Exchange CHEQUE BILL OF EXCHANGE


4. Drawer of a cheque is not discharged by the holders delay in presenting it for payment 5. May be crossed 4. Must be duly presented for payment or else the drawer will normally be discharged

5. No crossing

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Section 8 - Holder
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 thereon from the parties thereto

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Section 10 Payment in due course


means payment made in accordance with the

apparent tenor of the instrument in good faith and without negligence to any person in possession thereof under circumstances which do not afford a reasonable ground for believing that he is not entitled to receive payment of the amount therein mentioned

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Requisites of payment in due course


Payment should be in accordance with the apparent

tenor of the instrument Apparent tenor means what appears on the face of the instrument, the intention of the parties Person to whom payment is made should be in possession of the instrument Payment to be made in good faith w/o negligence and under circumstances that do not afford a reasonable ground for believing that the person to whom it is made is not entitled to receive the amount.

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Negotiable instrument Section 13


Negotiable instrument means a promissory

note, Bill of exchange payable to order or to bearer


A negotiable instrument may be made payable to

two or more persons jointly,or it may be made payable in the alternative to one of the two or one or some of several payees.

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Endorsement- Section 15
When the maker or the holder of a negotiable

instrument signs the same, otherwise than as such maker, for the purpose of negotiation, on the back or face thereof or on a slip of paper annexed thereto, he is said to endorse the same and is called the endorser

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Endorsement
Ordinarily means anything written or printed upon the back of a deed or writing for the purpose

of negotiation No particular form of words is necessary for an endorsement The endorsement of a PN, BoE or cheque is completed only by delivery made by the endorser, or by his duly constituted agent, with the intention of passing the property therein
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Endorsement
If the endorser signs his name only, the endorsement

is said to be in blank and if he adds a direction to pay the amount mentioned in the instrument to, or to the order of, a specified person, the endorsement is said to be in full

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Section 18
Where the amount undertaken or ordered to be paid is

stated differently in figures and words, the amount stated in words shall be undertaken or ordered to be paid

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Sec 30 Liability of drawer


The drawer of a Bill of exchange or cheque is bound, in

case of dishonour by the drawee or acceptor thereof, to compensate the holder, provided due notice of dishonour has been given to, or received by, the drawer as hereinafter provided

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Sec 31- Liability of drawee


The drawee of a cheque having sufficient funds of the

drawer in his hands, properly applicable to the payment of such cheque must pay the cheque when duly required to do so, and, in default of such payment must compensate the drawer for any loss or damage caused by such default

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Justifications for dishonour of cheques


If the cheque is post-dated and is presented for

payment prior to the date it bears Insufficient funds Banker is bound to honour the customers cheques only when the funds are properly applicable to the payment of such cheques e.g lien etc.

119

Justifications for dishonour of cheques


Cheques that are irregular or ambiguous or drawn in a

form of doubtful legality When the cheque is presented at a branch other than where it is drawn Notice of the death of the customer By notice that the customer has become mentally unsound, all operations on his account are to be suspended

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Forgery of signature
The drawee bank has no statutory protection when it

pays, even in the normal course and in good faith, a cheque on which the drawers signature is forged

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Material alteration
Any changes in an instrument which causes it to speak

a different language in legal effect from that which it originally spoke, or which changes the legal identity or character of the instrument, either in its terms or the relation of the parties to it, is a material alteration

122

Instances of Material alteration


Alteration of date of the instrument Alteration of the sum payable

Alteration of time of payment


Alteration of the place of payment Alteration of an order cheque to a bearer cheque,

except by or with the consent of the drawer

123

Section 92- Dishonour by non-payment


A PN, BoE or cheque is said to be dishonoured by

non-payment when the maker of the note, acceptor of the bill or drawee of the cheque makes default in payment upon being duly required to pay the same

124

Sec 93- By and to whom notice should be given


When a PN, BoE or cheque is dishonoured by non-

acceptance or non-payment, the holder thereof, or some party thereto who remains liable thereon, must give notice that the instrument has been so dishonoured to all parties who the holder seeks to make severally liable thereon, and to some one of the several parties whom he seeks to make jointly liable thereon

125

Sec 123- General crossing


Where a cheque bears across its face an addition to the

words and company or any abbreviation thereof, between two parallel transverse lines simply, either with or without the words not negotiable, that addition shall be deemed a crossing, and the cheque shall be deemed to be crossed generally

126

Crossing
In India, affixing A/c Payee is a common method of crossing. However, such a crossing is not yet recognised by statute in India, but by course of banking operations. Courts have held that such a crossing is a direction to the collecting bank to apply the proceeds to the payees account A Bank collecting such a cheque for someone other than the payee may be held negligent and thus lose the statutory protection under s131 and

s131A of the Act as the case may be


127

s 124- Cheques crossed specially


Where a cheque bears across its face an addition of

the name of a banker, either with or without the words, not negotiable, that addition shall be deemed a crossing, and the cheque shall be deemed to be crossed specially, and to be crossed to that banker

128

s131 Non-liability of a banker receiving payment of cheque


A banker who has in good faith and without

negligence received payment for a customer of a cheque crossed generally or specially to himself shall not, in case the title to the cheque proves defective, incur any liability to the true owner of the cheque by reason only of having received such payment

129

Conditions to be fulfilled for availing protection under s131


The collecting banker acts in good faith and without negligence
Negligence need not necessarily be with regard to

the collection of the cheque. Negligence in the opening of the account of the customer concerned may bar the bank from seeking protection

That the collecting bank receives payment of the crossed cheque for a customer
Protection not available if the person is not a

customer
130

Conditions to be fulfilled for availing protection under s131 (contd.)


That the cheque is crossed and the crossing must have

been made before the cheque gets into the hands of the collecting bank

131

s138 Dishonour of cheques


When the cheque drawn by a person is returned by the

bank unpaid either because of insufficient funds or that it exceeds arrangement such person shall be deemed to have committed an offence and shall be punished with imprisonment for a term that may extend to two years, or with fine that may extend to twice the amount of the cheque, or with both.

132

s138 Dishonour of chequesProviso


(a)the cheque has been presented to the bank within a period of six months from the date on which it is drawn or within the period of its

validity, whichever is earlier (b)the payee or the holder in due course makes the demand for the payment of the said amount of money by giving notice, in writing, to the drawer of the cheque, within 30 days of receipt of information regarding the return of the cheque as unpaid and (c) the drawer fails to make the payment of the said money within 15 days of the receipt of the said notice
133

s142- Cognizance of offences


Notwithstanding anything contained in Code of Criminal procedure,1973
No court shall take cognizance of any offence

under s138 except upon a complaint in writing, made by the payee or holder in due course Such complaint is made within one month of the date under which the cause of action arises under clause (c) of proviso to section 138 No court inferior to that of the Metropolitan magistrate or a judicial magistrate of the first class shall try any offence punishable under s138
134

Conditions to be fulfilled for prosecution of a drawer


Cheque in discharge of a debt or liability Cheque given as a gift or donation, or in discharge of a moral obligation, or for an unlawful or illegal consideration, would be outside the section Presentment of the cheque to the drawee bank

Reasons for dishonour insufficient funds or exceeds

arrangement

135

Conditions to be fulfilled for prosecution of a drawer (contd.)


Dishonour/ demand notice to the drawer within 30

days of the receipt of notice from the bank Drawer must have failed to make the payment within 15 days of receipt of such notice Filing of written complaint within one month

136

Amendments in 2002
1.Electronic image of a truncated cheque in the

electronic form introduced 2.Term of punishment increased from one year to two years 3.Period for issue of notice by the payee to drawer increased from 15 days to 30 days

137

Amendments in 2002
The

Information Technology Act 2000 made applicable to NI Act 1881 in relation to electronic cheques and truncated cheques Offences under the act made compoundable

138

Cash Credit Overdraft

Demand Loan
Term Loan Schematic Loans

Working Capital
Objective of any business concern-earning profits It requires funds for acquiring fixed assets as well as to

run day to day working Capital requirement can typically be divided into two types Fixed Capital Working Capital

Working capital-concepts

Working capital typically means the firms holding of

current or short-term assets such as cash, receivables, inventory and marketable securities. These items are also referred to as circulating capital Corporate executives devote a considerable amount of attention to the management of working capital.

Definition of Working Capital

Working Capital refers to that part of the firms capital, which is required for financing short-term or current assets such as cash, marketable securities, debtors and inventories. Funds thus, invested in current assets keep revolving fast and are constantly converted into cash and this cash flow out again in exchange for other current assets. Working Capital is also known as revolving or circulating capital or short-term capital.

Accounts Payable

Value Addition

Raw Materials

WIP

Cash

THE WORKING CAPITAL CYCLE (OPERATING CYCLE)

Finished Goods

Accounts Receivable

SALES

For manufacturing industry-funds typically required

for Purchase of raw material/stores/fuel Employment of labour Power charges Storing finished goods till they are sold out Financing sales- sundry debtors / receivable

Current Assets- Assets that in the ordinary course of

business will be converted to cash within a brief period (during the operating cycle of the industry not exceeding one year) Current Liabilities- Liabilities intended at their inception, to be paid in the ordinary course of business within a reasonably short time (Normally within one year) out of the current assets or the income of the business Net Working Capital- Excess of current assets over current liabilities excluding bank borrowings

LIABILITIES Capital & Reserves

ASSETS Fixed Assets

Deferred Liabilities Misc & Non-current Assets Intangible Assets Net Working Capital Current Assets Current Liabilities

Financing Working Capital


Operating Cycle Method- See the following example-1 a. Time taken to acquire raw material and average b. c.

d.

period they are in stores- 60 days Conversion process time-10 days Av. Period finished good in store-20 days Av. Collection period of receivables-30 days Length of operating cycle- a+b+c+d=120 days This means that 365/120= Three cycles of operations in a year

Sales- Rs.1,00,000/ Operating expenses- Rs.72,000/-

Three operating cycles in a year, i.e. each rupee of WC

deployed is turned over 3 times a year Hence Working Capital Requirement (WCR)= operating expenses / No. of cycles per annum = Rs.72,000/- / 3 = Rs.24,000/-

Example-2
Sales- Rs.20000/- p.m. Raw materials- Rs.14000 p.m.

Wages-Rs.2000 p.m.
Other Manufacturing expenses-Rs.3000 p.m. Operating Cycle- Raw material-15 days, Work in

Progress-2 days, Finished Goods-3 days, Sundry debtors-15 days. Total expense- Rs.19000/-, Operating cycle-35 days WCR= 19000 x 35 / 30 = Rs.22166(approx)

Annual Turnover method for SSI units- (Nayak Committee)


SSI units- fund based WC limit-Rs.5 crore 25% of the output or annual turnover = Working

Capital Requirement Margin money-5% Permissible Bank Finance (PBF)-20%

Example-3
Annual Turnover=Rs.12000 WCR= 25%= Rs.3000

Margin=5%=Rs.600
PBF=3000-600=Rs.2400/-

Maximum Permissible Bank Finance (MPBF) methods


1st method- The quantum of banks short term

advances restricted to 75% of Working Capital Gap (WCG). WCG=Current Asset-Current Liability (other than bank borrowings) Remaining 25% to be met from long term sources

Second Method
NWC should be atleast equal to 25% of the accepted

level of current assets Remaining 75% -to be financed by other current liabilities Bank may finance balance of the requirements

Third Method
Borrower should provide for entire core current assets

and 25% balance current assets from the NWC NWC= Long Term Sources- Long Term Uses NWC= (TNW + TL)- (FA+Non-current Assets) = CACL WCG= CA- (OCL+ Sundry Creditors)

Overdrafts
Overdrafts are allowed in Current Accounts Against security of banks own deposits, Govt.

securities, approved shares and or debentures of companies, LIC policies, Govt. Supply bills, cash incentive and duty drawbacks etc. Temporary overdrafts are also allowed against cheques for collection /bills for collection

Demand Loan
Advance for a fixed amount No debits to account except interest, insurance premia,

sundry charges Secured by a Demand Promissory Note Fixed life period Repayable on demand on one short

Term Loans
A term loan is granted for a fixed term of not less than

three years intended normally for financing fixed assets acquired / to be acquired with a repayment schedule normally not exceeding 8 years

Purpose- Acquisition of capital assets Term loan is an advance not repayable on demand but

only in installments ranging over a period of years The repayment of term loan should come out of the future cash accruals from the activity of the units

Appraisal of term loan


Appraisal considers following four areas Technical feasibility

Economic viability
Financial feasibility Managerial competence

Technical feasibility
Determine the suitability of the technology selected Adequacy of the technical investigation

Technical Design
Technology-Suitable location Size of the Plant-Economy of scale

Type of Technology-Whether tested or totally new?


Labour availability-Training / skill Technical Support

Economic Viability
Market Analysis- Market size, Growth potential,

Expected market share Future-Possible future changes in volume, supply & demand, other substitutes Intermediate product-depends on demand for final product- Jute, Cement, Paper Ancillary industry-Machine tools Export oriented units

Financial feasibility
Reasonable cost of the project Reasonable chance of materialising Financial arrangements are comprehensive without

leaving any gaps and ensures cash availability Earnings and operating costs are realistic Cost of production, profitability Cash flow Break even point Debt service Coverage Ratio- Cash accruals / Maturing annual obligations

Managerial Competence
Strength of Management Change in Managerial set up

Integrity & credit worthiness of persons in charge of

management Experience and expertise in management

Bill Financing
Advances against inland bills are sanctioned in the

form of limits for purchase of bills or discount of bills Demand bills or sight bills are purchased Usance bills are discounted Advance also sanctioned against bills sent for collection Bills should be of genuine trade transaction- not accommodation bills

Non-Fund Based Business


Letter of Credit Issued by bank at the request of customer in favour of

third party Informing him that the bank undertakes to accept the bills drawn on its customer Upto the amount stated in the LC Subject to fulfillment of conditions therein

Basic principle of LC
Facilitate orderly movement of trade- Evidence of

movement of goods is necessary They contain documents to the title of goods Bankers deal with the documents and not goods If documents are in order issuing bank will pay irrespective of quality of goods

Parties to LC

Applicant-Buyer-applicant of LC Beneficiary-Seller-Who supplies goods-in whose favour LC

is issued Issuing Bank-Bank which opens LC Advising Bank-Bank which advises the LC after confirming Authenticity Negotiating Bank-The Bank which negotiates the documents Reimbursing Bank- The bank which reimburses LC amount to negotiating bank Second beneficiary- In case of transferable LC

Types of LC
Revocable / Irrevocable-Revocable LCs can be revoked

by the issuing Banks after issue. Hence not in commercial use. Banks dont accept these kind of LC Confirmed LC- When LC is confirmed by a bank when the seller asks for it. Sight / Usance LC- In sight LCs, beneficiary gets immediate payment upon presentation of documents. In case of usance, the payment is made after the usance period.

LC with advance payment to the seller- LC which

authorises the advising bank to advance a part of LC amount to the seller to meet pre-shipment expenses-called Red clause LC. When Red Clause LC also provides for the cost of storage facilities at the port of shipment- Green Clause LC Revolving LC-The issuing bank undertakes to restore the credit to original amount after it has been utilised. Transferable LC Back to Bank LC-When a bank opens a new LC against the backing of an LC received by the beneficviary.

Bank Guarantees
A contract to perform the promise or discharge the

liability of a third person in case of default. Parties to GuaranteeApplicant Beneficiary Guarantor

Types of Guarantee
Performance Guarantee Financial Guarantee

Differed Payment Guarantee

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