Dr SHAKUNTALA MISRA NATIONAL REHABILITATION

UNIVERSITY

Lucknow

Faculty of Law

PROJECT ON

[ASSIGNMENT SHEET FOR MODULE 01]

For

COURSE ON ‘LAW OF BANKING & INSURANCE

CLASS: B.Com. LL. B (Hons.) 7th Semester

Submitted by

[SHUBHAM PATHAK]

[Roll No – SU17001067]

Academic Session: 2020-2021

Under the Supervision of

Mr. Shail Shakya

Faculty of Law
Dr Shakuntala Misra National Rehabilitation University

LESSON 01: BANK & BANKING STRUCTURES

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ASSIGNMENT 01:

Whether ‘listing of functions’ effectively attempts to define the term ‘banking’? Whether
categorization of a company as a ‘bank’ confers some privileges under Banking Regulation
Act, 1949? Write your observations.

As per my observation ‘listing of functions’ effectively attempts to define the term ‘banking’.
The German Banking Act adopts the list approach. First it must be made clear which
activities on the list, if not all, a body must perform to be treated as a bank. Moreover, the law
must specify whether banks are confined only to these, and incidental, activities- it will not
always be an easy issue which activities are incidental or whether they have a free rein. More
fundamentally, the list approach will soon become dated as the business of banking changes,
so that there must be a mechanism for its constant updating.
 
 
All banks have to perform two major primary functions namely:

1. Accepting of deposits
2. Granting of loans and advances
Accepting of Deposits-A very basic yet important function of all the commercial banks is
mobilising public funds, providing safe custody of savings and interest on the savings to
depositors. Bank accepts different types of deposits from the public such as:
1. Saving Deposits: Saving deposits encourages saving habits among the public. It is
suitable for salary and wage earners. The rate of interest is low. There is no restriction
on the number and amount of withdrawals. The account for saving deposits can be
opened in a single name or in joint names. The depositors just need to maintain
minimum balance which varies across different banks.
2. Fixed Deposits: Fixed deposits also known as Term Deposits. Money is deposited for
a fixed tenure. No withdrawal money during this period allowed. In case depositors
withdraw before maturity, banks levy a penalty for premature withdrawal. As a lump-
sum amount is paid at one time for a specific period, the rate of interest is high but
varies with the period of deposit.
3. Current Deposits: Current deposits are opened by businessmen. The account holders
get overdraft facility on this account. These deposits act as a short- term loan to meet
urgent needs.
4. Recurring Deposits: A certain sum of money is deposited in the bank at a regular
interval. Money can be withdrawn only after the expiry of a certain period. A higher
rate of interest is paid on recurring deposits. This type of account is operated by
salaried persons and petty traders.
 
 Granting of Loans & Advances-The deposits accepted from the public are
utilised by the banks to advance loans to the businesses and individuals to

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 meet their uncertainties. Bank charges a higher rate of interest on loans and
advances than what it pays on deposits. The difference between the lending
interest rate and interest rate for deposits is bank profit.

Yes, categorization of a company as a ‘bank’ confers some privileges under Section

6(1) of Banking Regulation Act, 1949.

 Section 5B: Bank can accept deposit for lending or investment;

 Section 7: No other organization permitted to use name as Bank or Banker;
 Section 21A: Rate of interest charged by banks are not subject to scrutiny by Court;
 Section 26: Bank can hold unclaimed deposit up to 10 years;
 Section 44A: Permitted banks for amalgamation but RBI permission required;
 Bank can open any branch for one month without taking prior license;
 It acts as agents for any Government or local authority or any other person or persons,
giving of receipts and discharges and otherwise acting as an attorney on behalf of
customers;
 Contracting for public and private loans and negotiating and issuing the same; 
 Carrying on and transacting every kind of guarantee and indemnity business; 
 Managing, selling and realising any property which may come into the possession of
the company in satisfaction or part satisfaction of any of its claims; 
 Acquiring and holding and generally dealing with any property or any right, title or
interest in any such property which may form the security or part of the security for
any loans or advances or which may be connected with any such security;  
 Establishing and supporting or aiding in the establishment and support of associations,
institutions, funds, trusts and conveniences calculated to benefit employees or ex-
employees of the company or the dependents or connections of such persons; granting
pensions and allowances and making payments towards insurance; subscribing to or
guaranteeing moneys for charitable or benevolent objects or for any exhibition or for
any public, general or useful object;  
 The acquisition, construction, maintenance and alteration of any building or works
necessary or convenient for the purposes of the company; 
 Selling, improving, managing, developing, exchanging, leasing, mortgaging,
disposing of or turning into account or otherwise dealing with all or any part of the
property and rights of the company; 
 Acquiring and undertaking the whole or any part of the business of any person or
company, when such business is of a nature enumerated 
 Doing all such other things as are incidental or conducive to the promotion or
advancement of the business of the company; 

ASSIGNMENT 02:

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India has adopted the policy of ‘financial inclusion’ which provides for banking facilities to
be made available for all. Do you think that this may expose banks to extended fragility? Do
you think that principle of branch separateness would be of any help in this?

Financial inclusion refers to efforts to make financial products and services accessible and
affordable to all individuals and businesses, regardless of their personal net worth or
company size. Financial inclusion strives to remove the barriers that exclude people from
participating in the financial sector and using these services to improve their lives. Yes,
‘financial inclusion’ may expose banks to extended fragility. Hon’ble Prime Minister, Sh.
Narendra Modi on 15 August 2014 announced “Pradhan Mantri Jan-Dan Yojana (PMJDY)”
which is a National Mission for Financial Inclusion. The task is gigantic and is a National
Priority. Purpose of the Scheme Pradhan Mantri Jan Dan Yojana (PMJDY) is National
Mission for Financial Inclusion to ensure access to financial services, namely, Banking/
Savings & Deposit Accounts, Remittance, Credit, Insurance, Pension in an affordable
manner. Account can be opened in any bank branch or Business Correspondent outlet.
Accounts opened under PMJDY are being opened with Zero balance. However, if the
account-holder wishes to get cheque book, he/she will have to fill minimum balance criteria.
Because of this scheme banks will not get deposits and this may expose banks to extended
fragility. Yes, the principle of branch separateness will help in ‘financial inclusion’. Ordinary
customers can now withdraw moneys (make demand) wherever an automatic teller machine
is located, and with telephone and internet banking need not have a branch at all. The courts
have given banks the privilege of combining the accounts of a customer held at different
branches when one of them is in deficit.

ASSIGNMENT 03:

Which provisions in Banking Regulation Act, 1949 do you think could be of help in
preventing ‘concentration of economic power’ and ‘conflict of interests’ due to rise of
multifunctional banking in India?

The emergence of the multifunctional bank has raised a variety of legal issues. Prominent
among them is that of risk as core banking is combined with other financial activities. It is
this concern which prompted the separation of core banking from securities activities in the
US Glass-Steagall Act. Section 8 defines Prohibition of Trading which will help in
preventing ‘concentration of economic power’ and ‘conflict of interests’ due to rise of
multifunctional banking in India. According to this section, notwithstanding anything
contained in section 6 or in any contract, no banking company shall directly or indirectly deal
in the buying or selling or bartering of goods, except in connection with the realisation of
security given to or held by it, or engage in any trade, or buy, sell or barter goods for others
otherwise than in connection with bills of exchange received for collection or negotiation or
with such of its business as is referred to in clause (i) of sub-section (1) of section 6. The
remainder of this section confines itself to a issue, the conflicts of interest thrown up in the
operation of the multifunctional bank. Consider when an issue of securities is being

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underwritten by a bank or when a bank is a market-maker in securities, that is holds itself out
as willing to buy and sell particular securities. The bank may be tempted to recommend these
securities to customers, or place them in accounts or funds it is managing, if they are unsold
in the case of an underwriting or the bank has taken a position as a market-maker.

ASSIGNMENT 04:

Banks maintain equity holdings in prominent companies of India to meet their customer
demands and for attractive returns. Do you think that it would be unjust for industrial entities
by prohibiting them in obtaining a ‘banking license’ just because of possible ‘conflict of
interest’?

A conflict of interest arises when an individual finds himself or herself occupying two social
roles simultaneously which generate opposing benefits or loyalties. The interests involved
can be pecuniary or non-pecuniary. The existence of such conflicts is an objective fact, not a
state of mind, and does not in itself indicate any lapse or moral error. Conflicts of interest
pose significant reputation and legal risks to corporate finance professionals. Yes, I think it
would be unjust for industrial entities by prohibiting them in obtaining a ‘banking license’
Section-22 of the Banking Regulation Act,1949 deals with licensing of banking companies.
According to Section-22 of the Banking Regulation Act, 1949-
(1) No company shall carryon banking business in India unless it holds a licence issued in
that behalf by the Reserve Bank and any such licence may be issued subject of such
conditions as the Reserve Bank may think fit to impose.
(2) Every banking company inexistence on the commencement of this Act, before the expiry
of six months from such commencement, and every other company before commencing
banking business in India, shall apply in writing to the Reserve Bank for a licence under this
section.
(3) Before granting any licence under this section, the Reserve Banking may require to be
satisfied by an inspection of the books of the company.
(3A) Before granting any licence under this section to a company incorporated outside India,
the Reserve Bank may require to be satisfied by an inspection of the books of the company or
otherwise that the conditions specified in sub-section (3) are fulfilled and that the carrying on
of banking business by such company in India will be in the public interest and that the
Government or law of the country in which it is incorporated does not discriminate in any
way against banking companies registered in India and that the company complies with all
the provisions of this Act applicable to banking companies incorporated outside India.
(4) The Reserve Bank may cancel a licence granted to a banking company under this section.
(5) Any banking company aggrieved by the decision of the Reserve Bank cancelling a licence
under this section may, within thirty days from the date on which such decision is
communicated to it, appeal to the Central Government.

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(6) The decision of the Central Government where an appeal has been preferred to it under
sub-section (5) or of the Reserve Bank where no such appeal has been preferred shall be
final.
Conflict of interest may be avoided, to mitigate reputation and legal risks associated with
transactional conflicts of interest, it is good to avoid that. A hallmark of the traditional
English approach to regulation has been the use of informal mechanisms of control by bodies
such as the Bank of England and an emphasis on self- regulation by financial institutions.
Over the years both the Panel on Takeovers and Mergers and the Stock Exchange have laid
down prescriptions about conflict of interest. In the part these have led banks to take various
internal steps to deal with the problem. The current Takeovers Code, with the panel
administers, contains provisions relevant to conflict of interest. The Code also contains Rules
which recognise that a multifunctional bank may also be engaged in fund management or
market-marketing as well as, for example, advising a bidder or target company in a takeover
situation. 

LESSON 02: INTER-BANK NETWORKS

ASSIGNMENT 05:

What conceptual difficulties in law are resolved by inter-bank networking? Compare the
situation with unitary banking models elsewhere in the world.

The concept of network has been involved in a variety of ways difficulties in the law such as
privity of contract, their argument is, in a way, for a type of organisational liability, with A in
the payment transfer example being able to show any bank in the chain for a mistake, of
another bank, no matter how far the chain is. Others have analysed network from the angle of
economic efficiency: in particular circumstances a network of contract will minimise
transaction cost and maximize flexibility, does offering real advantage to bank and their
customers. Yet others have used the concept of network to theories about systems. These are
over the counter (OTC) market. Rather than and exchange markets. Important among them is
the Inter Bank deposit market (one part of the money markets), the foreign exchange market,
(e.g. financial future exchanges, securities exchanges) and clearing system entities that is not
concerned with examine these in depth. Exchange markets really fall outside the scope of
Banking law. However, an issue which often arises in the relationship between customers and
the banking network. The issue is appropriately addressed. Banking refers to a business
activity in which the entity accepting deposits from the customers, safeguards it and lends it
to those who need it, and earns a profit. Different countries of the world adopt different types
of the banking system. Basically, there are two types of banking system prevalent in most of
the countries, which are unit banking and branch banking. A unit banking is a banking system
in which one bank, generally a small independent bank that renders banking services to its
local community. On the other hand, a branch banking, as the name suggests, is one in which
a bank has more than one office in a country or outside at different locations and renders

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banking services to the customers of that area. Unit Banking implies a banking practice
wherein the banking operations are carried out by only one office, which is situated in a
specified location. It is managed by its own governing body or the Board members. It has an
independent existence, as it is not under the control of any other individual, bank, or body
corporate. A unit bank has no branches at all and for the purpose of providing facilities
related to remittance and collection of funds, a unit bank takes recourse of the correspondent
banking system. A correspondent bank refers to a financial institution, which enters into an
agreement with another bank to render services to the customers as a representative of the
latter. The unit bank serves a limited area, and so it possesses an expert knowledge of the
problems and basic needs of the localities and aims at resolving them. Branch Banking
implies a banking system wherein a banking organization, through its wide network of
branches provides banking services to its customers throughout the country and even in
abroad. It has a central office called as the head office and other offices which are set up at
different locations to serve the customers are called as branches. The branches are controlled
and coordinated by the head office, with the help of their regional or zonal offices. The bank
is under the control of the Board of Directors (BOD) and it is owned by shareholders. Each
bank branch has a manager who looks after the management of the concerned branch of
which he/she is the in charge, as per the policies and instructions laid down from time to time
by the head office. For the purpose of financial reporting at the end of the financial year, the
assets and liabilities of all the branches and the head office are summed up. In a unit banking,
the profits earned by the bank is used either for the development of the bank or for fulfilling
the needs of the local community. On the other extreme, in a branch banking system, the
profits of the banks are shared between the branches and also used for increasing their
presence.

ASSIGNMENT 06

Since correspondent bank is not an agent of the customer’s bank, how the liability is settled
for consequential loses that a customer suffers out of correspondent’s error in banking
transactions?

The correspondent bank is not an agent additional to, or in substitution for, the customer's
bank. As for tort liability, where the correspondent bank is handling negotiable instruments or
securities, the customer as owner may readily establish conversion—a strict-liability tort. But
negligence is a different matter. Although US courts have recognized it, and there is a faint
suggestion in the English jurisprudence that it is possible in the case of a correspondent
bank's error," the weight of English authority is against it. The circumstances would have to
be very special for the correspondent bank specifically to have assumed a responsibility to the
customer in the relevant sense. Finally, the customer may be able to claim against the
correspondent on restitution principles dealt with elsewhere but this would require very
special circumstances. If in the event of a correspondent bank's lapse the customer's bank or
the correspondent itself is to be made liable, either at common law or by statute, the issue of
consequential damages must be faced up to. As a matter of both policy and principle it seems

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inappropriate in the ordinary case to make either bank liable for what may be massive
economic loss suffered by a customer as a result of a lapse in performing a service for what
will typically be a relatively small charge. There are no consequential losses provided under
the European Directive on cross border credit transfers. It is unlikely non-commercial
customers will often suffer them and a money-back guarantee will suffice. The UNCITRAL
Model Law on international credit transfers provides for consequential losses, but only if a
bank has acted with the specific intent to cause loss, or recklessly and with actual knowledge
that loss would be likely to result. Consequential losses are severely limited under Article 4A
of the Uniform Commercial Code to circumstances where the receiving bank agrees in
writing to assume the liability. 

ASSIGNMENT 07

What types of regulatory measures have been adopted by India for regulation of money
markets (popularly inter-bank markets) after 1992 stock market scam? Do you still think that
it is an unregulated area in law?

Major market segments under the regulatory ambit of the RBI are rate markets, including
Government Securities market and money markets; foreign exchange markets; derivatives on
interest rates, prices , repo, foreign exchange rates as well as credit derivatives.
The 1992 scam was the biggest stock market scam ever committed in the Indian Stock
Market, the main perpetrator of which, was a well- known stock broker Harshad Mehta. It
was a systematic stock fraud using bank receipts and stamp paper which caused the Indian
Stock market to crash. A complete structural change of the security system of India ensued.
The scam exposed the inherent loopholes of the Indian financial systems and resulted in a
completely reformed system of stock transactions and an introduction of online security
systems. 
Securities scam refers to the idea of diversion of funds from the banking system to various
stockholders or brokers. The 1992 scam in the security system of India was a systematic
fraud committed by Harshad Mehta in the Indian stock market which made the entire
securities system collapse. Mehta allegedly committed a fraud of over 1000 crores from the
banking system of India to buy stocks on the Bombay Stock Exchange. The scam impacted
the entire exchange system as the securities system collapsed and investors lost thousands of
rupees in the exchange system. The scope of the scam was so large that the net value of the
stocks was higher than the health budget and education budget of India. The scam was
orchestrated in such a way that Mehta secured securities from the State Bank of India against
forged cheques signed by corrupt officials and failed to deliver the securities. Mehta made the
prices of the stocks soar high through fictitious practices and would go on to sell the stocks
that he owned in these companies.
 
 The impact of the scam had many consequences which included the loss of money to lakhs
of families but more importantly the immediate impact of the scam was a sharp fall in the

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share prices. The index fell from 4500 to 2500 representing a loss of Rs. 100,000 crores in
market capitalization. This rapid fall was the largest the stock market had ever seen. The
1992 scam raises many questions which involved many bank officials responsible for
collusion with Mehta. 
The immediate impact of the scam was a fall in share prices and the biggest plunge in the
index the market had ever seen. The scam caused the breakdown of the control system both
within the commercial banks as well as the fundamental system of the RBI. The scam opened
the inherent issues within the security system of India. The scam just resulted in withdrawal
of about ₹3,500 crore from the market, which for a market of the size of ₹2,50,000 crore
which seems to be a small amount in terms of the market price, however, the scam resulted in
a majority collapse of many stock market shares. This was due to the fact that the BSE
resorted to tampering within the records in the trading system. The majority Indian stock
market is based on emotions rather than quantitative analysis and as the scam came to light,
many investors withdrew their capital from the market. This caused a demand and supply
collapse of the prices and quantity which caused the entire system to be affected due to the
1992 scam. As the scam came to light, many banks were impacted as the news of the scam
spread through the financial markets around the world. Several foreign banks like Standard
Chartered and ANZ Grind lays, were implicated in the scam. Standard chartered was accused
of the bank receipt scam as they issued receipts to Mehta while ANZ Grind lays was accused
of pumping money into Mehta's personal account. Therefore, the private sector was the main
participant in the market for the Bank Receipts Scam. The government realized that the
fundamental problem with the financial structure of the stock markets was the lack of
computerized systems which impacted the whole stock market. 

The 1992 scam caused an investigation through which many officials were implicated in
fraudulent charges. The five main accused officials were related to the Financial Fair growth
Services Limited (FFSL) and Andhra Bank Financial Services Ltd (ABFSL). The chairman
of Vijaya Bank committed suicide following the outbreak of news about the bank receipt
scam. The scam also led to the resignation of P. Chidambaram who was accused of owning
shell companies related to Mehta. Mehta was convicted by the Bombay High Court and the
Supreme Court of India for his part in this financial scandal valued at ₹49.99 billion (USD
$740 million). There were many arrests that were made which exposed several bank officials
and led to complete breakdown on many banking System. The changes in the financial
structure of India in 1992 scam saw the Indian Market collapse completely as the stock prices
dropped by almost 40% wiping out market value by ₹1,00,000 Crores. The Indian Financial
system saw a complete restructuring of the fundamental systems. The first structural change
that was enforced was the payments for purchase of investments for which Subsidiary
General Ledgers and Bank Receipts were recorded so as to prevent any defaulted paperwork.
A new committee was formed within the financial systems to overlook the Securities and
Exchange Board of India through the decision of the Janaki Raman Committee. The
committee ordered that the long standing practice of banks entering in to ”ready forward” and
“double ready forward” deals with other banks be restricted under the guidelines of
the Reserve Bank of India(RBI) to only government securities. The committee made changes
to the idea of custodian banks by making all banks custodians rather than principals in

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transactions. The banks were ordered to have a separate audit system for portfolio
management of the banks whose adequacy was monitored by the RBI. The RBI was given
more power and their scope in the financial markets increased. The entire stock system
restructured to prevent any other scams. Yes I think that it is still an unregulated area in law.
ASSIGNMENT 08:

Banking syndicates are formed with the lead bank’s central position where each bank
appoints the lead bank as its agent for discharge of ministerial functions. Take out some
examples from India where features of a ‘banking syndicate’ are present.

A Bank Syndicate or (Bank consortium) comprises a number of banks associated to carry out
some enterprise. The banks will be jointly involved in financing a company, project, or
government, through a syndicated loan or similar facility or by arranging, managing, and
underwriting an issue of securities. The size of, or risk involved in the financing maybe so
large that no one bank can do it alone. The borrower or issuer may wish to involve a number
of banks (perhaps from different jurisdictions) or a syndicated financing may have the
advantage for it of synchronising matters such as repayment periods. The syndicate will be
put together by a lead (sometimes called an arranger or lead manager) bank or a number of
such banks. The syndicate may be a ‘true’ syndicate, where each bank enters into a direct
relationship with the borrower/ issuer; or it may be what is sometimes called a ‘participation’
syndicate, where the lead /arranger bank enters into a bilateral loan or purchases the whole of
the issue and then sells ‘participation’ in the loan for the securities to other banks.  The issue
addressed here is the nature of the interbank relationship in a true syndicate. Before
considering this issue directly a little need to be said about the mechanics of syndication and
of the relevant terms between the banks themselves. The lead Bank will seek to involve other
bank-depending on the extent to which they are to retain an interest in the financing-by
circulating information about the proposed financing, including an information memorandum
from the borrower, and by inviting them to participate. If successful the bank in the syndicate
will ultimately sign an agreement in which they undertake to provide subscribe for so much
of the financing. The banks will also agree terms as to the relationship between themselves.
The 17 lenders to the grounded Kingfisher Airlines, led by State Bank of India, decided, on
Saturday, to auction assets of the defunct carrier in their latest bid to recover part of their dues
of about Rs 8,000 crore (Rs 80 billion), which have not been serviced since January 2013.
The assets to be e-auctioned on December 7 include the equipment and movable assets of the
grounded airline and not bigger properties like the Kingfisher House in Mumbai and the
Kingfisher Villa in Goa. Both have been taken over by the lenders in recent past. In a notice
issued in Mumbai on Saturday, SBI Cap Trustee, which is a security trustee for the lenders
Consortium to the airline, said it would e-auction the cars, towing machines, forklifts,
tractors, fire extinguishers, and iron ladders, among others, of the carrier under their
possession. SBI Cap Trustee, an arm of SBI, has set a reserve price of Rs 65 lakh (Rs 6.5
million), and said the auction will be conducted on December 7. "The persons interested in
participating in the e-auction may confirm their participation by depositing with the seller 10
per cent of the reserve price as earnest money deposit as a confirmation," the notice said,

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adding that the last day for registration for e-auction is December 2. It can be recalled that
Kingfisher Airlines, started by liquor baron Vijay Mallya in May 2005 with much fanfare,
went onto become the second largest in its heydays even though it never made a single penny
in profit. As cashflow issues mounted on the airline, it has remained grounded since October
2012, and the airline lost its flying licence two months later. The SBI-led lenders consortium
had taken over the tony Kingfisher House near city airport in February worth around Rs 150
crore (Rs 1.5 billion), after winning the case in the local court. They have also taken over the
Kingfisher Villa in Goa, worth around Rs 90 crore (Rs 900 million). So far, the lenders have
recovered around Rs 1,100 crore (Rs 11 billion) from their original exposure of Rs 6,900
crore (Rs 69 billion) by selling pledged shares and other collaterals. Banks are now charging
15.5 per cent compounded interest on this principal amount, which have not been serviced
since January, 2013.
 
LESSON 03: BANKING REGULATION
 
ASSIGNMENT 09:

Reasons for regulation of banks such as systematic risk, prevention of fraud, regulation of
competition etc. appear to be purely administrative in nature. Do you agree? If not, discuss
reasons behind your understanding.

I think the reasons for regulation of banks such as systematic risk, prevention of fraud,
regulation of competition etc. appear to be purely not administrative in nature. There is a
concern to protect depositors against loss through default by individual institutions, public
Policy is also concerned with confidence in the system as a whole Part of the conventional
wisdom in banking is that default by one institution can spread to undermine other
institutions. This is systemic risk. It is separate from the other risks facing individual banks—
credit risk, market risk, political risk, and so on.  There is now firm empirical evidence that if
systematic risk become s a reality, and there is a banking crisis, the costs of its resolution and
output loss in the economy can be some 15-2 0 per cent of GDP. ‘Systematic risk’ is high in
countries that have chain banking model since all banks are inter-linked to each other either
for credit creation or for inter-bank settlement procedures. Systematic risk has been identified
as a prominent tool of regulation for banking business as failure of one bank for any reason,
would definitely impact the overall health of the banking system. There is a systematic risk
because of the public perception that other banks are in the same position as the suspect of
failed bank. There is run on the other banks as the public moves to bank perceived to be the
very strongest, or there is a flight to cash. These banks may be perfectly healthy but will face
a liquidity crisis if there is a rush to withdraw deposits. 
Markets cannot work smoothly unless persons can deal with each other in the knowledge that
fraud is an exceptional, rather than a regular, feature of the environment. As well as this more
theoretical justification, there are the enormous costs of banking fraud. Bank failures through
fraud are a direct economic cost. There are also social costs, such as those caused by the
criminals who could not operate, at least on the same scale, without being able to launder and

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transfer their ill-gotten gains through the banking system. It is difficult to escape the
conclusion that fraud prevention is as important as prudential supervision. Bank fraud may
involve either insiders or outsiders to a bank. The collapse of the international bank, the Bank
of Credit and Commerce International (BCCI), highlighted the problem of insider fraud. This
was not a unique example: insider fraud has featured in the collapse of banking institutions
around the world. 2 6 Insider fraud was in many ways facilitated by the financial
liberalization of the 1980s. It manifests itself in various ways—loans to phoney borrowers, or
borrowers which are nominees of an insider, are two examples. Insider fraud underlines the
point about the considerable overlap of fraud prevention and prudential supervision. Legally,
insider fraud can be combatted in a variety of ways. There is the obvious vetting of those who
arc controllers of hanks. 2 7 Large exposure limits can reduce the opportunities for insiders to
siphon off funds to phoney or nominee borrowers. Bank's auditors now have an enhanced
role in monitoring what goes on in a bank. Insider frauds have also been happening in India
which have come to light and analysis in various scams. Recently unearthed ‘Nirav Modi
Scam’ has led to suspension of various bank employees. There are many unreported of frauds
which have cause significant damage to the entire banking system in India.

ASSIGNMENT 10:

‘Recent mergers/consolidations in banking system were done to create large-size banks’

which appears as a philosophical idea as it does not reflect any immediate risk to banking
system. Do you think that legislative technique of crisis management has been misused in
recent consolidation of Indian banking system?

Yes, I think that legislative technique of crisis management has been misused in recent
consolidation of Indian banking system. Indian banking system has seen some banking
companies defaulting in making time-bound submissions of information required by RBI due
to which banking crisis has happened. Authorization (licensing) is central to the prudential
regulation of banking. It has been mandatory in Europe since the First Banking Directive of
1977.  The notion is of preventing undesirable activity by obliging those who provide
banking services to meet a range of standards and threatening to withdraw approval in the
event of any breach of standards.  While authorization can be a very powerful tool of control,
its success depends on the thoroughness of the vetting, its effectiveness in practice, the extent
to which the behaviour of those authorized is monitored, and the capacity of the regulatory
authority to take disciplinary action against those who infringe standards. There can also be a
tension between effective authorisation on the one hand and the monopoly effects produced
by preventing entry on the other. The threshold conditions for authorization include
measurable factors such as solvency, liquidity, provisioning, and initial capital. As well there
are other relatively objective factors, such as the business to be directed by at least two
individuals and the bank to have adequate records, systems, and internal controls. These are
set out in considerable detail in the FSA's Handbook on Threshold Conditions and the Interim
Prudential Handbook for Banks. Both contain the rules and evidential provisions made under
the FSMA 2000 and the guidance setting out the FSA's expectation of how banks should

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comply: where a bank follows the FSA will normally hold it to be in compliance with the
relevant threshold conditions and other rules. And in respect of other matters as well, such as
conflicts of interest. Central regulator has all rights to seek any information from any member
bank which it deems necessary for the purpose of regulation of banking system.
The bank’s loan book on March 31, 2014, was Rs 55,633 crore, and its deposits were Rs
74,192 crore. Since then, the loan book has grown to nearly four times as much, at Rs 2.25
trillion as on September 30, 2019. While deposit growth failed to keep pace and increased at
less than three times to Rs 2.10 trillion. The bank’s asset quality also worsened and it came
under regulator RBI’s scanner. Yes, Bank has a substantial exposure to several troubled
borrowers, including the Anil Ambani-led Reliance group, DHFL and IL&FS. The tipping
point came when one of the bank’s independent directors Uttam Prakash Agarwal, resigned
from the board in January 2020 citing governance issues. It has led to Yes Bank crisis.
 
ASSIGNMENT 11:

What are priority areas in regulation of ‘multifunctional banks’ in India?

A world-wide tendency is for banks to become multinational functional institutions

('universal banks’). In addition to core banking, banks now engage in other activities, notably
securities and derivative transactions, and insurance. This combination of activities raises
various regulators issues. As a matter of policy, the law must address the different risks
facing core banking and securities business-credit dress with the former, market risk with the
latter, in addition core banking involve deposits, which can be easily moved. On its own, the
case for regulating securities activities focuses mainly on investor protection. This was the
basic of securities regulation in the United State in 1930s, which has provided a general
model for many other countries, in the case of Britain embodied in the financial services act
1986 and subsequently the FSMA 2000. In combination with banking, package for regulating
securities activity is founded largely on risk, historically the issue has been seen as whether
core banking ought to be combined with Riskier activities such as dealing, underwriting, and
investing in securities, Even if, as many argue, securities and derivatives activity is no riskier
then core banking, there is the potential for contagion if the different activities are mixed,
whereas the independent securities form which collapses can probably be wound in an
orderly fashion by selling of it’s mainly marketable assets, if the securities side of a bank
collapses this may mortally wind the banking side. The funding base (deposit) half core
banking is inherently volatile and may evaporate on the slightest hint of trouble in a banking
group as a whole. Involvement of banking companies in securities transaction is not a new
and the same can also be unavoidable as banking transaction is authorities of transparency,
accountability and certainty. Banks work as transactional intermediaries, offer underwriting
services and handle complex securities transactions involving huge amount of public money.
Due to complex structure of banking services often involving internal transaction, the risk
accompanied by multi-functional banking get multiplied. It thus becomes challenge for the
central regulators to manage relation of such diversified multifunctional banks. Regulation of
multi-functional Bank is cumbersome for the reason that diversify the activities of the bank
are so complex and interlink that a proper assessment of risk often becomes difficult. In the

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wake of rendering in -house service, banks tend to develop complex financial structure which
become inseparable with the core-banking functions. Although there are various guidelines to
minimize exposure to risk, complex functioning could not be avoided for abs reasons.
Although core -banking and securities function are related and linked to each other, lessons in
history represent that and excessive engagement of banks in securities business may expose
public deposits tourist of volatility of the stock market and there may be eventual breakdown
of the entire banking system. The point of consideration is this that it could not be an over-
night act that around 3000 banking companies were forced to shut their business during Great
depression in USA 1929-1923.

It is said that derivatives are just one aspect of the financial changes of recent decades along
with interest - rate volatility, high debt, and deregulation they are not so much a cause, but a
consequence, of instability in interest and exchange rates, and achieve stability in these on the
other hand, end-users have suffered considerable losses, and there is the example of the
baring Bank collapse through derivatives activities. Competition leads Bank into to even
more complex derivative deals. Indeed, riskier deals because they give higher returns. A less
benign international economics environment then in recent time could accentuate the
problem. Derivatives are often traded on OTC market rather than regulated exchanges.
Sudden change is a characteristic of the derivative markets. In particular, the amount of credit
exposure bank has on a swap, unlike the credit exposure it has on a loan, constantly fluctuates
in size with the movements in interest rate and exchange rates. A fear of excessive risk, when
core banking is combined which securities business, led the United States, and later Japan, to
impose a strict separation on the different activities. In the United States this took legal form
in the famous glass- Steagall act, the first topic discussed here. At the other end of the
spectrum German law has long sanctioned universal banking banks being able to engage in
securities and other activities. Britain has fallen between the extremes, although not and
usually the law has been silent on the matter. As a matter of tradition, the clearing
(commercial) banks were separated from the merchant (investment) banks, partly because it
was thought risky for the former to engage in dealing in shares and debentures. But that
tradition evaporated in the 1960s and 1970s as clearing banks, unimpeded by law, acquired or
established merchant-bank subsidiaries. The trend was accentuated by the financial
liberalization of the 1980s universal banking is now legally sanctioned in the European
community.

 ASSIGNMENT 12:
 
Whether International banking standards laid down by BASEL Committee have been
successful in establishing uniform banking systems across the world? If not, what are the
possible reasons?
 
The Basel Committee on Banking Supervision (BCBS) is an international committee formed
to develop standards for banking regulation; as of 2019, it is made up of Central Banks and
other banking regulatory authorities from 28 jurisdictions. It has 45 members. Form without a
founding treaty, the BCBS is not a multilateral organization. Instead, the Basel Committee on

Page | 14
Banking Supervision seeks to provide a forum in which banking regulatory and supervisory
authorities can cooperate to enhance the quality of banking supervision around the world, and
improve understanding of important issues in the banking supervisory sphere. The BCBS was
formed to address the problems presented by globalization of financial and banking markets
in an era in which banking regulation remains largely under the purview of national
regulatory bodies. Primarily, the BCBS serves to help national banking and financial markets
supervisory bodies move toward a more unified, globalized approach to solving regulatory
issues. BCBS members include representatives from Argentina, Australia, Belgium, Brazil,
Canada, China, France, Germany, Hong Kong SAR, India, Indonesia, Italy, Japan, Korea,
Luxembourg, Mexico, the Netherlands, Russia, Saudi Arabia, Singapore, South Africa,
Spain, Sweden, Switzerland, Turkey, the United Kingdom and the United States. The BCBS
encourages contact and cooperation between its members and other banking supervisory
authorities. It also circulates papers providing guidance on supervisory matters to banking
regulators all over the world.
International banking standards laid down by BASEL Committee has not been successful in
establishing uniform banking systems across the world. BASEL Norms are strong guidelines
in monitoring financial soundness of banking system, it is for the regulator to keep a check on
all activities pursued by banking companies. All recommendations are timely revisited for
necessary modifications and it is important during this International spread of pandemic that
people look to banks for help and support. The regulator should not side line social aspect of
banking as it is for the public generally that the banking system is functional. Although banks
have been awarded greater autonomy in contemporary scenario, there should be independent
risk assessment criteria in place for each individual bank as scales of operation are different
for each distinct bank. For example, operational risks which arise due to day to day
functioning of banks could not be compensated by depositor’s money and there need to be a
fine assessment by each bank of such operational risks. There is just to quote an example,
there are many others including social risks in banking sector. Exposure to credit and related
activities of banks need extensive planning and monitoring as money in circulation could not
be utilized in times of crisis and there could be eventual failure due to this. Central regulator
single handily could not monitor this for the fact that each individual bank as its own
diversified portfolio which could not be managed continuously by the central bank. There
could be guidelines but there could not be a uniform system of regulation in place.
 

LESSON 04: CENTRAL BANKING

 
Assignment 13:

‘Central bank acts as a banker to the government’. Do you think the RBI also performs the
debt management functions for the central and state governments?

Central bank act as a banker to the government or performs for the government the services a
bank ordinarily provides for customers.  But I think the relationship of a Central bank to

Page | 15
government is not simply that of banker and customer it also performs the debt management
functions for the central and state government. In 1935, Reserve Bank of India, on its
inception became the Banker and Debt Manager to the Government and this is a very
important function. As per the Reserve Bank of India Act 1934, the Central Government
entrusts the Reserve Bank with all its money, remittance, exchange and banking transactions
in India and the management of its public debt. The Government also deposits its cash
balances with the Reserve Bank. However, Reserve Bank may also act as the banker to a
State Governments. This is by an Agreement. Currently, the Reserve Bank acts as banker to
all the State Governments in India, except Jammu & Kashmir and Sikkim. It has limited
agreements for the management of the public debt of these two State Governments.
 
Central Government is required to maintain a minimum cash balance with the Reserve Bank.
Currently, this amount is Rs.10 crore on  a daily basis and Rs.100 crore on Fridays, as also at
the end of March and July. These provisions are as per the administrative arrangements (not
as per any legislation).
 
 
 For Central Government
 
As per the RBI Act, 1934, Central Government entrusts the Reserve Bank with all its money,
remittance, exchange and banking transactions in India and the management of its public
debt. The Government also deposits its cash balances with the Reserve Bank. Further, note
that the central government is required to maintain a minimum cash balance with the Reserve
Bank. Currently, this amount is Rs. 10 Crore on a daily basis and Rs.100 crore on Fridays, as
also at the end of March and July. These provisions are as per the administrative
arrangements (not as per any legislation).
 
 For state governments
 
In case of state governments, RBI works has their banker only when a particular state enters
into such agreement with RBI. Currently, the Reserve Bank acts as banker to all the State
Governments in India, except Jammu & Kashmir and Sikkim. It has limited agreements for
the management of the public debt of these two State Governments.

RBI works as Debt Manager of Government. RBI helps both the central government and state
governments to manage their public debt, float new loans, issue and retirement of rupee
loans, interest payment on the loan and operational matters about debt certificates and their
registration. RBI’s debt management policy aims at minimizing the cost of borrowing,
reducing the roll-over risk, smoothening the maturity structure of debt, and improving depth
and liquidity of Government securities markets by developing an active secondary market.
 
ASSIGNMENT 14:

Page | 16
How can one sue RBI for deficiency in services? Do you think that provisions of Banking
Regulation Act,1949 are applicable to RBI?

Any aggrieved person or a customer can sue RBI for deficiency in services under Consumer
Protection Act,1986. When a service is found deficient by a consumer, they can lodge a
complaint under Consumer Protection Act. If a person is not satisfied by the services of bank,
he can also file a complaint under Banking Ombudsman Scheme. The Banking Ombudsman
Scheme is an expeditious and inexpensive forum for bank customers for resolution of
complaints relating to certain services rendered by banks. The Banking Ombudsman Scheme
is introduced under Section 35 A of the Banking Regulation Act, 1949 by RBI with effect
from 1995. The Banking Ombudsman is a senior official appointed by the Reserve Bank of
India to redress customer complaints against deficiency in certain banking services covered
under the grounds of complaint specified under Clause 8 of the Banking Ombudsman
Scheme 2006. All Scheduled Commercial Banks, Regional Rural Banks and Scheduled
Primary Co-operative Banks are covered under the Scheme.
A customer can also lodge a complaint on the following grounds of deficiency in service with
respect to loans and advances:

 Non-observance of Reserve Bank Directives on interest rates.

 Delays in sanction, disbursement or non-observance of prescribed time schedule for
disposal of loan applications.
 Non-acceptance of application for loans without furnishing valid reasons to the
applicant; and
 Non-adherence to the provisions of the fair practices code for lenders as adopted by
the bank or Code of Bank’s Commitment to Customers.
 Non-observance of any other direction or instruction of the Reserve Bank as may be
specified by the Reserve Bank for this purpose from time to time.
 The Banking Ombudsman may also deal with such other matter as may be specified
by the Reserve Bank from time to time.
One can file a complaint before the Banking Ombudsman if the reply is not received from the
bank within a period of one month after the bank concerned has received one's complaint, or
the bank rejects the complaint, or if the complainant is not satisfied with the reply given by
the bank. Section 19 of the Consumer Protection Act says that, Any person aggrieved by an
order made by the State Commission in exercise of its powers conferred by sub-clause (i) of
clause (a) of section 17 may prefer an appeal against such order to the National Commission
within a period of thirty days from the date of the order in such form and manner as may be
prescribed. According to Section 19A of the Consumer Protection Act, an appeal filed before
the State Commission or the National Commission shall be heard as expeditiously as possible
and an endeavour shall be made to finally dispose of the appeal within a period of ninety days
from the date of its admission.

Page | 17
Yes, I think that some provisions of Banking Regulation Act,1949 are applicable to RBI. Part
IIIB of the Banking Regulation Act,1949 deals with the provisions relating to certain
operations of Banking Companies.
 

ASSIGNMENT 15:
 
Prepare a step by step procedure chart to explain RBI’s critical function of controlling money
flow in economy.
 
The functions of the RBI have been enumerated in Chapter III of the RBI Act. The following
are broad functions: 
• Issue and Management of Currency and Distribution of coins 
• Banker to the Government 
• Banker to the Banks 
• Lender of Last Resort 
• Loans and Advances 
• Emergency Advances 
• Controller of Credit 
• Managing the External Value of Rupee 
• Collection and Furnishing of Credit Information Functions of RBI 

 Issue and Management of Currency and distribution of coins: The currency of our
country consists of One-rupee notes and coins (including lower denominations thereof)
as well as Bank notes issued by RBI. In terms of section 22, of the RBI Act, RBI has the
sole right to issue bank notes in India. Such bank notes are issued by a department of
RBI known as Issue Department, which is a separate and wholly distinct department
from the Banking Department which is responsible for banking business of the RBI.
However, the design, form and material of bank notes are to be approved by the Central
Government on the basis of recommendations of Central Board of the RBI. Every bank
note shall be a legal tender at any place in India. On recommendation of the Central
Board, the Central Government may declare any series of bank notes of any
denomination to be not a legal tender. Under Section 24 of RBI Act, RBI has the power
to recommend to Central Government various denominations of bank notes, which shall
be two rupees, five rupees, ten rupees, twenty rupees, fifty rupees, one hundred rupees,
five hundred rupees, one thousand rupees, five thousand rupees and ten thousand rupees

Page | 18
 or other denominations not exceeding ten thousand rupees. The issue department keeps
its assets, which forms the backing for note issuance, distinctly separate from that of the
assets of the banking department. Within RBI, the Department of Currency Management
(‘DCM’) has the responsibility of administering the functions of currency management.
Currency management basically relates to the issue of notes and coins and retrieval of
unfit notes from circulation. In order to improve the currency distribution system by
leveraging technology, the RBI adopted a hub-and-spoke model for the distribution of
banknotes across the country. Fresh note remittances are sent to larger currency chests,
which meet the currency needs of a designated area (such as a district). These chests are
identified as hub chests and, in turn, supply notes to smaller currency chests in their
vicinity which act like spokes in the distribution model. Fresh notes are distributed to
every issue office of the RBI as per an allocation plan. RBI has established a chain of
currency chests with several banks in the country. A currency chest is a place where the
RBI keeps all the excess money in the form of cash under the custody of different banks.
Currency chests are designated branches of commercial banks authorised by the RBI to
hold stock of bank notes, rupee notes and coins. The bank notes which are issued and
circulated by RBI are bearer promissory notes and they are exempt from payment of
stamp duty. 
 Banker to the Government: In terms of section 20 of RBI Act, RBI has an obligation
to Act as a banker to the central government. Also, under section 21 of RBI Act, RBI
has a right to transact Government business in India which include money, remittance,
exchange and banking transactions in India; and, the Central Government to deposit free
of interest all its cash balances with the RBI under mutually agreed terms. For carrying
out its duties as banker to the Government of India, it is not paid any remuneration. RBI
is entitled for a commission for managing public debt functions. The Government
transaction work also includes maintaining currency chests at places specified by the
Central Government. Similarly, Section 21A of the RBI Act enables RBI to enter in to
agreements with State Governments to transact their businesses. Under sections 20 and
21(A)(b) of the RBI Act, RBI manages public debt of both Central and State
governments. Float new loans on behalf of Central/State governments, conduct
periodical auctions of Treasury Bills, issue of dated Government securities as well
buying and selling the same are some of the additional work done by RBI in its capacity
as a Banker to the Government. RBI also provides investment services by deploying
temporary surplus cash balances in Government accounts. RBI also advises the
Government on monetary and banking issues when requested to do so. Also manages
Consolidated Fund of India, contingency fund and public accounts as these accounts are
maintained by RBI. 
 Banker to the Banks: This is a special relationship that is created due to statutory
requirements under the RBI Act. Once the name of a bank is included in the Second
Schedule, that Bank is eligible to be called as a Scheduled Bank. Among other
conditions, it is bound to maintain the stipulated Cash reserves under section 42 in an
account with RBI. The Scheduled Bank status to any bank also confers privileges such
as availing financial accommodation from RBI under specified conditions. Reserve
Bank also provides means of transfer and settlement of funds between banks on account
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 of clearing, remittances, lending and borrowing through such accounts. Thus, RBI
provides a platform for inter-bank financial transactions. Such accounts of banks are
maintained by Deposit Accounts Department of RBI.  
  Lender of last resort: When banks exhaust all other means for raising funds for their
operations, they fall back on RBI as a source for finance as provided under the RBI Act.
Hence RBI is known as Lender of last resort. RBI grants financial accommodation to
banks in terms of section 17(2), (3) and 3 (A) “sale, purchase and rediscount of eligible
bills” as well as loans and to advances banks under section 17(4) of RBI Act. 
 Loans and Advances: Section 17(4) of the RBI Act empowers Reserve Bank to grant
loans among others to, Scheduled Banks, State Co-operative Banks, and State Financial
Corporations loans and advances, repayable on demand or on the expiry of fixed periods
not exceeding ninety days. Such loans and advances are granted against the securities of
stocks, funds and other (than immovable property) securities, in which there is an
authorization to a trustee to invest Gold or silver or documents of title to these
Promissory Notes or Bills of Exchange eligible for purchase or rediscount by RBI or
guaranteed by State Government regarding repayment of principal and interest due on
them Promissory notes of any scheduled bank or State Co-operative Bank which are
supported by documents of title to goods (which have been already transferred, assigned
or pledged to any other bank as a security for any advance or loan made of Commercial
or trade transactions or those in respect of financing agricultural operations or marketing
of crops). Further by means of Section 17(3-A) of the RBI Act, RBI grants financial
accommodation at concessional rates on Export oriented bills, repayable on demand or a
fixed period which mature in not exceeding 180 days based on declarations from banks.
For financing under these Schemes RBI had introduced Bill Market Schemes in 1951
and subsequently modified the same in 1970 as New Bill Market Scheme. 
 Emergency Advances: RBI grants emergency advances to specified banks on special
occasions as envisaged in Section 18 of the said Act in the interest of regulating credit to
trade, commerce, agriculture and industries. This special provision is available despite
any restrictions stated under Section 17 and Section 18 to RBI and extend such financial
accommodation to banks on such bills which are not financeable by RBI, otherwise.
Further under Section 18 RBI can make an advance to a State Cooperative Bank or to a
cooperative society based on the recommendations of a State Cooperative Bank. Such
advance is repayable on demand, or on the expiry of fixed period generally not
exceeding 90 days under the terms and conditions specified by RBI.  
 Controller of Credit as Bank: Credit extended by various banks has its own impact on
the economy, one of the key functions for which RBI was constituted was to manage the
credit for the advantage of the country. RBI exercises control over the credit extended
by banks through specific instruments on account of wide powers granted to it by RBI
Act as well as Banking Regulation Act, 1949. In terms of Section 42 of the RBI Act
every scheduled bank in India is required to maintain an average daily balance the
amount of Cash Reserves with RBI as a percentage of Total Net Demand and Time
Liabilities in India. Reserve Bank notifies the percentage of CRR to be maintained by
banks at regular intervals through gazette notifications. Cash Reserve Ratio (CRR) is a

Page | 20
specified minimum fraction of the total deposits of customers, which commercial banks
have to hold as reserves either in cash or as deposits with the central bank. The main
purpose of maintaining CRR by the banks is to secure the monetary stability of the
country. This would lead to scarcity of availability of funds or increase in availability of
funds in the economy resulting in a deflationary or inflationary effect. When the RBI
Act was introduced, the minimum and maximum floor rates of this ratio to be
maintained by banks was specified between 3% to 20% .This was amended 2006 and
floor rates were abolished, to give RBI the flexibility to decide and announce the
percentage of CRR to be maintained by banks from time to time keeping in view the
monetary situation prevailing in the country. By varying CRR, RBI can expand or
contract the credit extended by a bank, thus affecting the quantum of credit a bank can
extend. All scheduled banks and Non-scheduled banks have to maintain CRR as per Sec
18 of the RBI Act. Reserve Bank of India has prescribed statutory returns i.e. Form A
Return (for CRR) under section 42(2) of the RBI Act, and Form VIII Return (for SLR)
under section 24 of the Banking Regulation Act, 1949. In addition to the above an
incremental CRR in terms of section 42(1A) also need to be maintained as advised by
RBI from time to time. At present no incremental CRR need to be maintained.
Provisional return of Form A to be submitted by banks within 7 days and final Form A
to be submitted within 20 days from expiry of the relevant fortnight. As per the latest
directions after calculations, each bank has to maintain at least minimum CRR balances
up to 90 per cent with effect from the fortnight beginning April 16, 2016. With effect
from March 31, 2007 RBI has discontinued paying interest on CRR balances maintained
by banks with RBI. Since June 24, 2006 if a bank defaults in maintaining CRR on daily
basis RBI has powers to recover penal interest at the rate of 3% p.a. over Bank Rate on
the amount which falls short of the balances on that day. If the short fall continues
subsequently on succeeding days, the penal rate will be recovered at a rate of 5% p.a.
over Bank Rate. Presently banks have to maintain 4% of their Net Demand and Time
liabilities as CRR. In terms of section 24 (2A) of Banking Regulation Act, another tool
for controlling credit in the country is available to RBI in the form of Statutory Liquidity
Ratio under which, Liquid assets (in the form of prescribed securities by RBI) have to
be maintained by all scheduled banks in India. Statutory Liquidity Ratio (SLR) is the
Indian government term for the reserve requirement that the commercial banks in India
are required to maintain in the form of cash, gold reserves, government approved
securities before providing credit to the customers. SLR has to be maintained by both
Scheduled and Non-Scheduled banks in India. Scheduled banks have to maintain SLR in
addition to the CRR to be maintained by them under Section 42 of the RBI Act and as
far as Non-Scheduled banks are concerned SLR would be in addition to balances to be
maintained under section 18 of the Banking Regulation Act. Liquid assets are those
assets which can be converted into cash within a shortest time. The main aim of this
statutory obligation for a bank to maintain SLR is to safeguard the interests of the
depositors but it has also been used as an effective credit control instrument in the hands
of RBI. The category of assets to be maintained by banks need to be specified by RBI,
though it was earlier formed part of Banking Regulation Act itself. The procedure for
computation of net demand and time liabilities for the purpose of SLR under section 24

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of the Banking Regulation Act 1949 is broadly similar to the procedure followed for
CRR purpose. By amending Section 24 of the BR Act, RBI has done away with the
minimum level of SLR to be maintained by banks that is 25% but has retained the upper
cap level of 40%. And in subsequent years the SLR level to be maintained by banks has
been gradually scaled down. If a bank defaults in maintaining SLR, RBI will levy a
penalty for that day at the rate of three per cent per annum above the Bank Rate on the
shortfall and if the default continues on the next succeeding working day, the penal
interest may be increased to a rate of five per cent per annum above the Bank Rate for
the concerned days of default on the shortfall. The effect of increasing SLR would result
in leaving lesser amount of lendable funds at the hands of a Bank. Therefore, this
automatically reduces the supply of funds in the economy resulting in deflationary 40
PP-BL&P effect. The same effect can also be created by increasing the interest rates of
lendable funds. On the other side reducing the SLR would have the opposite effect of
increasing the availability of lendable funds which may lead to inflationary effect. c.
Directives Though one of the core businesses of banking is lending, it has to done by the
banking system in a judicial manner so that all sectors of the economy are benefitted.
One of the key objectives of RBI is to control the credit through which RBI ensures that
credit distribution is in line with national priorities. This casts responsibility on it to
ensure adequate credit to industry, priority sector (that includes agriculture and others),
housing, infrastructure and other consumers. Therefore, RBI has put in special
mechanisms for credit controls which are carried out through General Credit Control
and Selective Credit Control. Under General Credit Control RBI uses monetary policy
instruments such as Repo rate, Bank rate, Open market operations, and moral suasion
and under Selective credit control RBI restricts quantum of credit, margins, maximum
amount, etc. relating to sensitive commodities and sectors. By increasing or reducing the
quantum, rates of interest and period up to which refinance can be availed RBI can
curtail or expand the credit availability in the market. Moral suasion is a persuasion of
banks by Reserve Bank to adhere to the directives and guidelines issued by it. Through
advisories the RBI tries influence the banks to follow a desired practice. This is used a
soft tool in controlling credit in the economy. 
 Managing the external value of Rupee (i.e. Managing Foreign Exchange): Under
section 40 of the RBI Act, there is an obligation on the part of RBI to buy or sell
foreign exchange from or to an Authorised Person based on the exchange rate as
well as other conditions as the Central Government may determine. The
Authorised Persons are those who are licensed to buy or sell foreign exchange
under Foreign Exchange Management Act, 1999 (FEMA). In addition, RBI is
charged with maintaining the foreign exchange reserves of the country and plays a
significant role as controller/regulator of foreign exchange transactions in terms of
wide powers it derives from FEMA. Under the Foreign Exchange Regulation Act
regime from 1973, RBI had a very highly centralized role in the area of foreign
exchange and it had delegated only limited powers to the Authorised Dealers. All
foreign currency inflows were to be surrendered by banks to RBI and it was the
only agency which can supply foreign currency at the rates it had determined.
Therefore, it had a pivotal role in determining and administering rupee exchange

Page | 22
 rate. However gradually over a period from August 1993, due to liberalization and
banking reforms RBI started relaxing many controls over foreign exchange
transactions. Due to this, surrendering of foreign exchange to RBI is no more
obligatory on banks. RBI also had shifted to market determined rates based on
demand and supply for exchanging foreign currency. Authorised persons have
been delegated considerable powers relating to various foreign exchange
transactions including remittances, overseas. As a matter of policy RBI intervenes
in the market along with monetary and administrative measures to stabilize the
exchange rate of Rupee. The main objective of exchange rate management by RBI
is to ensure that exchange rate of Indian rupee reflects the strong economic
fundamentals of the country. Additionally, maintenance of external value of
Indian Rupee is guided by three major objectives: “first, to reduce excess
volatility in exchange rates, while ensuring that the market functions in an orderly
fashion; second, to help maintain an adequate level of foreign exchange reserves,
and; third, to facilitate the development of a healthy foreign exchange market.” 
 Collection and furnishing of Credit Information: Section 45(B) of the RBI Act
empowers the RBI to collect credit information regarding borrowers from banks
and under Section 45(D) to furnish the same to other banks against request in
writing and payment of a nominal fee. The term Credit information includes: 
1. The amounts and the nature of loans or advances and other credit facilities
granted, 
2.  The nature of security taken from any borrower for credit facilities granted, 
3.  The guarantee furnished by a bank for any of its customers, 
4.  The means, antecedents, history of financial transactions and the credit
worthiness of any borrower, 
5.  Any other information which the Bank may consider to be relevant for the
more orderly regulation of credit or credit policy. The information furnished to
or furnished 
by RBI is to be treated as Confidential.   
 
ASSIGNMENT: 16

Write a short note on ‘core-banking’ functions performed by central banks.

Core banking functions differ depending on the specific type of bank. Retail banking, for
example, is geared towards individual customers; wholesale banking is business conducted
between banks; and securities trading involves the buying and selling of stocks, shares and so
on. Core banking systems are often specialized for a particular type of banking. Products that
are designed to deal with multiple types of core banking functions are sometimes referred to
as universal banking systems.
Functions performed by central banks

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1. Issue money. The Central Bank will have responsibility for issuing notes and coins
and ensure people have faith in notes which are printed, e.g. protect against forgery.
Printing money is also an important responsibility because printing too much can
cause inflation.
2. Lender of Last Resort to Commercial banks. If banks get into liquidity shortages
then the Central Bank is able to lend the commercial bank sufficient funds to avoid
the bank running short. This is a very important function as it helps maintain
confidence in the banking system. If a bank ran out of money, people would lose
confidence and want to withdraw their money from the bank. Having a lender of last
resort means that we don’t expect a liquidity crisis with our banks, therefore people
have high confidence in keeping our savings in banks. For example, the US Federal
Reserve was created in 1907 after a bank panic was averted by intervention from J.P.
Morgan; this led to the creation of a Central Bank who would have this function.
3. Lender of Last Resort to Government. Government borrowing is financed by
selling bonds on the open market. There may be some months where the government
fails to sell sufficient bonds and so has a shortfall. This would cause panic amongst
bond investors and they would be more likely to sell their government bonds and
demand higher interest rates. However, if the Bank of England intervene and buy
some government bonds then they can avoid these ‘liquidity shortage’. This gives
bond investors more confidence and helps the government to borrow at lower interest
rates. A problem in the Eurozone in 2011, is that the ECB was not willing to act as
lender of last resort – causing higher bond yields.
4. Target low inflation. Many governments give the Central Bank a target for
inflation, e.g. the Bank of England has an inflation target of 2% +/- 1. See: Bank of
England inflation target. Low inflation helps to create greater economic stability and
preserves the value of money and savings.
5. Target growth and unemployment. As well as low inflation a Central Bank will
consider other macroeconomic objectives such as economic growth and
unemployment. For example, in a period of temporary cost-push inflation, the Central
Bank may accept a higher rate of inflation because it doesn’t want to push the
economy into a recession.
6. Operate monetary policy/interest rates. The Central Bank set interest rates to target
low inflation and maintain economic growth.  Every month the MPC will meet and
evaluate whether inflationary pressures in the economy justify a rate increase. To
make a judgement on inflationary pressures they will examine every aspect of the
economic situation and look at a variety of economic statistics to get a picture of the
whole economy. See: how the Bank of England set interest rates.
7. Unconventional monetary policy. The Central Bank may also need to use other
monetary instruments to achieve macroeconomic targets. For example, in a liquidity
trap, lower interest rates may be insufficient to boost spending and economic growth.
In this situation, the Central Bank may resort to more unconventional monetary
policies such as quantitative easing. This involves creating money and using this
money to buy bonds; the aim of quantitative easing is to reduce interest rates and
boost bank lending

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 8. Ensure stability of the financial system. For example, regulate bank lending and
financial derivatives. Sponsored The assets to be e-auctioned on December 7 include
the equipment and movable assets of the grounded airline and not bigger properties
like the Kingfisher House in Mumbai and the Kingfisher Villa in Goa. Both have been
taken over by the lenders in recent past. In a notice issued in Mumbai on Saturday,
SBI Cap Trustee, which is a security trustee for the lender’s consortium to the airline,
said it would e-auction the cars, towing machines, forklifts, tractors, fire
extinguishers, and iron ladders, among others, of the carrier under their possession.
SBI Cap Trustee, an arm of SBI, has set a reserve price of Rs 65 lakh (Rs 6.5 million),
and said the auction will be conducted on December 7. As cashflow issues mounted
on the airline, it has remained grounded since October 2012, and the airline lost its
flying licence two months later.

 
 

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