Banking Financial Institutions

BANKING AND FINANCIAL
INSTITUIONS
Semester – III
B.com
Student Workbook
Edition: 2020
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Module-1
COMMERCIAL BANKS
Evolution and Role of Commercial Banks – Functions of Commercial Banks, nationalization of

commercial banks and objectives, Relationship between banker and customer. Negotiable
instruments– Meaning & Definition – Features – Kinds of Negotiable instruments, Endorsements:
Meaning, Essentials & Kinds of Endorsement.
1.1 Introduction
1.2 Commercial Banks
1.3 Functions of Commercial Banks
1.4 Nationalization of Commercial banks
1.5 Objects of Nationalization
1.6 Second Phase of Nationalization
1.7 Banker
1.8 Customer
1.9 Negotiable Instruments
1.10 Bill of Exchange
1.11 Holder and Holder in Due course
1.12 Cheques
1.13 Endorsement
1.14 Summary
1.15 Terminal Questions
1.16 References
1.1 Inroduction
The Reserve Bank, as the central bank of the country, started their operations as a private
shareholder’s bank. RBI replaced the Imperial Bank of India and started issuing the currency
notes and acting as the banker to the government. Imperial Bank of India was allowed to act as
the agent of the RBI. RBI covered all over the undivided India. In order to have close integration

between policies of the Reserve Bank and those of the Government, It was decided to nationalize
the Reserve Bank immediately after the independence of the country. From 1st January 1949, the
Reserve Bank began functioning as a State-owned and State-controlled Central Bank. To
streamline the functioning of commercial banks, the Government of India enacted the Banking
Companies Act,1949 which was later changed as the Banking Regulation Act 1949. RBI acts as
a regulator of banks, banker to the Government and banker’s bank. It controls financial system in
the country through various measures.
1.2 Commercial banks

Commercial banks are organised on joint stock company system, primarily for the purpose of
earning a profit. The can be either of the branch banking type, as seen in most of the countries,
with a large network of branches, or of the unit banking type, as seen mainly in the USA, where
a bank’s operations are confined to a single office or to a few branches within a strictly limited
area. Although, the commercial banks attract deposits of all kinds-current, savings and fixed-
their resources are chiefly drawn from current deposits which are repayable on demand. So, they
attach much importance to the liquidity of their investments and as such they specialise in
satisfying the short-term credit needs of business rather than the long-term.

1.3 FUNCTIONS OF COMMERCIAL BANKS
Prof. Syers, defined banks as “institutions whose debt—usually referred to as ‘bank deposits’—
are commonly accepted in final settlement of other people’s debts”. According to Banking
Regulation Act of 1949, “Banking means the 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”. From the above definitions we can analyze that the primary
functions of banks are accepting of deposits, lending of these deposits, allowing deposits to
withdraw through cheque whenever they demand. The business of commercial banks is primarily
to keep deposits and make loan and advances for short period up to one or two years made to
industry and trade either by the system of overdrafts of an agreed amount or by discounting bills
of exchange to make profit to the shareholders. From the above discussion, we can say that the
following are the functions of commercial banks.
Functions of Commercial Banks

A. Primary Functions:
1. Receiving of Deposits
The most important function of the commercial banks is to receive deposits from the public. The
commercial banks not only protect them but also help transfer of funds through cheques and
even undertake to repay the money in legal tender money. deposits received by the commercial
banks are of various types, - fixed deposits, savings deposits, current deposits and recurring
deposits.
2. Making loans and Advances
The second principal function of the commercial bank is to make loans and advances out of the
public deposits. direct loans and advances are given to all persons against personal security, gold
and silver and other movable and immovable assets. This the banks do by overdraft facilities,
that is, by allowing the borrower to overdraw his current account and also by discounting bills of
exchange. Thus the merchants and manufacturers are enabled to obtain adequate funds for
production of goods and services. They help in the development of those industries which
perform the most useful service to the community. The loans and advances made by the

commercial banks are of various forms, like cash credit, overdraft, demand loan, hire purchase
loan, etc.
3. Credit Creation:
It is one of the important functions of commercial banks. When a bank sanctions a loan to the
customer, it does not give cash to him. The banker opens an account in the name of the customer
and deposits the amount of loan sanctioned. The customer withdraws the money whenever he
needs. Thus, when a bank sanctions a loan it automatically creates a deposit. Thus banks help in
increasing the money supply to the economy. This function is called credit creation.
B. Secondary Functions:
1. Agency Services
A commercial bank provides a range of investment services. Customers can arrange for
dividends to be sent to their bank and directly remitted into their bank accounts, or for the bank
to detach coupons from bearer bonds and present them for payments and to act upon
announcements in the Press of drawn bonds, coupons payable, etc. orders for the purchase or sale
of stock exchange securities are executed through the banks ’brokers who will also give their
opinions on securities or lists of securities.
Agency functions include:
1. Collection of cheques, dividends, interests
2. Payment of rent, insurance premiums
3. dealing in Foreign exchange
4. Purchasing and selling of securities
5. Acting as trustee, executor etc.
6. Acting as correspondence
7. Preparations of income-tax returns
2. General Utility Services

These services are those in which the bankers ’position is not that of an agent for his customer.
They include the issue of credit instruments like letters of credit and travelers ’cheques, the
acceptance of bills of exchange, the safe custody of valuables and documents, the transaction of
foreign exchange business, acting as a referee as to the respectability and financial standing of
customers and providing specialized advisory service to customers.
3. Information and other Services
As part of their comprehensive banking services, many banks act as major sources of
information on overseas trade in all aspects. Some banks produce regular bulletins on trade and
economic conditions at home and abroad, and special reports on commodities and markets. In
some cases they invite enquiries for those wishing to extend their foreign trade, and are able
through their correspondents to furnish the names of reputable and interested dealers of goods
and commodities and to advise on the appointment of suitable agents. other services of the banks
are necessary for trade and industry, banks help in distribution of funds between regions; banks
create credit and help in business expansion; banks promote capital formation; banks influence
interest rates, ATM facilities, Credit card facilities and Merchant banking services.
1.4 Nationalization Of Commercial Banks

Banking Companies (Acquisition of Undertakings) Act, 1970
The Government of India promulgated an ordinance called the Banking Companies (Acquisition
of Transfer of undertakings) ordinance on 19 July 1969, in terms of which the Central
Government acquired the undertakings of the following 14 major Indian banks which had
deposits of not less than Rs. 50 crore each as on the last Friday of June 1969:
1.Central Bank of India limited

2. Bank of India limited
3. Punjab National Bank limited
4. Bank of Baroda limited
5. United Commercial Bank limited

6. Canara Bank limited
7. United Bank of India limited
8. Dena Bank limited
9. Syndicate Bank limited
10. Union Bank of India limited
11. Allahabad Bank limited
12. Indian Bank limited
13. Bank of Maharashtra Bank limited
14. Indian overseas Bank limited
These banks together had total deposits of Rs. 2,741.76 crore. Together with the State Bank of
India and its subsidiaries this constituted 85 per cent of the total deposits.
After the takeover, the undertaking of each bank including its assets, liabilities, rights, etc was
transferred to and vested in the corresponding new bank which becomes a new statutory
corporate body. The general superintendence and direction of affairs of each of the nationalized
banks were vested in a custodian who was authorized to exercise all powers that might be
exercised by the bank. The Chairman of each of the nationalized banks who was holding office
as such immediately prior to the nationalization was appointed as custodian for the
corresponding new bank.
Immediately after the promulgation of the ordinance, some writ petitions were filed in the
Supreme Court, and a full bench of 12 judges passed on 22 July 1969 an interim stay order
pending the disposal of the writ petitions in respect of three matters in the ordinance. under the
stay order, the Central Government was prevented from appointing any Advisory Board for any
of the 14 banks removing any of the 14 Chairmen of the banks who were given the designation
of custodians, and issuing any direction to any of the 14 banks contrary of the existing provisions
of the Banking Regulation Act.
A bill to replace the ordinance was passed on 9 August 1969. A fresh stay order was issued on 8
September 1969, following write petitions filed against the Act. This order did not debar the
government from appointing Advisory Boards, but earlier prohibitions in respect of removal of
Chairmen and issue of directions by the government to any of the 14 banks were reimposed.

on 10 February 1970, the Supreme Court, while upholding the legislative competence of
Parliament in the matter of acquisition of undertakings of the banking companies, held firstly
that there had been a hostile discrimination against the 14 banking companies, in so far as they
had been debarred, after the acquisition of undertaking, from carrying on banking business when
other banks were permitted to do so and secondly, the principles and methods laid down in the
Act for determining the quantum of compensation proposed to the paid by the government were
invalid. As the provisions held void by the Court were not severable from the main Act, the
entire Act was struck down.
The undertaking of the 14 banks which had been acquired by the Central Government under the
authority of the Act reverted to those companies following the Act being declared void. A fresh
ordinance was issued on 14 February 1970 which did not contain the offending provisions of the
earlier Act. under the ordinance, the government again took over the undertaking of each of these
banks with effect from the original date, i.e., 19 July 1969. This ordinance, unlike the void Act,
did not set out any principles for the determination of compensation to be paid to each of the 14
limited companies whose undertaking were acquired, but fixed a specific amount of
compensation to each of the 14 nationalized banks to be paid within 60 days from the date the
banking company applies for it. These banking companies were given three options or any mix
of these, i.e., in the form of cash, 10-year Central Government Securities at par carrying interest
at 4 1⁄2 per cent per annum and 30-years Central Government Securities at par carrying interest
at 5 1⁄2 per cent per annum. of the 14 nationalized banks, two banks opted for payment of the
entire amount of compensation in cash and the remaining 12 banks opted for payment of
compensation partly in cash and partly in government securities.
The Banking Companies (acquisition and Transfer of undertakings) Act was passed by both
Houses of Parliament towards the end of March 1970 and received the assent of the President on
31 March 1970.
In July 1970, the Central Government in consultation with the Reserve Bank constituted the first
Board of directors for each of the nationalized banks. With the constitution of the first Board of
directors, the Reserve Bank’s directive requiring the nationalized banks to obtain its prior
approval for certain types of transactions was withdrawn and the banks were advised that the

matters referred to therein should thenceforward be decided by their respective Board of
directors.
Subsequently, a scheme, 1970 was framed by the Central Government under Section 9 of the
Banking Companies (Acquisition and Transfer of undertakings) Act, 1970. under the scheme,
each nationalized bank will have on its Board directors not exceeding 15. And every Board so
constituted shall include representatives of the employees and depositors of such banks and such
other persons as may represent the interest of each of the following categories, viz., farmers,
workers and artisans.
The Government is empowered to appoint not more than five directors from among persons
having special knowledge or practical experience in respect of one or more matters which are
likely to be useful for the working of the nationalized banks. There will also be not more than
two full time directors, of whom one shall be the Managing director. Besides, there will be one
official of the Reserve Bank of India and one official of the Central Government on each of these
Boards. As indicated earlier, the scheme makes provision for the appointment in each
nationalized bank two employees on the Board-one from among workmen. The director from the
employees who are workmen is to be appointed by the government out of a panel of three names
furnished by the Representative union in the concerned bank. The other director from among
employees who are not workmen would be appointed by the government in consultation with the
Reserve Bank.
With regard to their overseas branches, then nationalized banks have taken suitable steps
according to local laws in each country for effecting the transfer of properties and other assets,
etc standing in the names of the then existing banks to the corresponding new banks.
1.5 Objects of Nationalization

The then Prime Minister, in a broadcast to the nation on the nationalization of banks, observed
thus;
‘An institution, such as the banking system, which touches and should
touch the lives of millions, has necessarily to be inspired by a larger social purpose and has to
subserve national priorities and objectives. That is why there has been a widespread demand that
major banks should be not only socially controlled but publicly owned....?

The broad aims of nationalization of banks as stated in the preamble to the Banking Companies
(Acquisition and Transfer of undertaking) Act, 1970 are to control the heights of the economy in
conformity the national policy and objectives.
More specifically, the important objectives of bank nationalization are:

1. The removal of control by a few;
2. Provision of adequate credit for agriculture and small industry
and exports.
3. The giving of a professional bent to bank management;
4. The encouragement of new classes of entrepreneurs and
5. The provision of adequate training as well as reasonable terms
of service for bank staff.
Criticisms
Nationalization of banks has been assailed by a number of people, mainly on the following
grounds:
1. The Scheme of Social Control over banks has not been given a fair trial.
2. Foreign banks and the smaller banks are left out of the purview of nationalization.
3. Public ownership will lead to inefficiency in the working of banks.
4. Public ownership will mean elimination of healthy competition and initiative.
All these criticisms have been satisfactorily answered during the debate on the Banking
Companies (Acquisition and Transfer of undertakings) Bill. It has been observed that ...the
weakness of social control was that in many banks people who had been controlling their polices
in the continued presence of the old chairman or vice-chairman on the Boards. The banks might,
as some did, obey the instructions and directions given to them. But there is all the difference in
the world between people who carry out a policy wholeheartedly and with enthusiasm and those
who do so only because of certain instructions. even these directions were not followed by many
of the banks and we cannot continue to ignore the impatience and frustration with which the
under privileged look at our efforts to help them stand on their own feet...... ’

The criticism that nationalization will lead to inefficient functioning of banks can best be
answered by pointing out the example of the State Bank of India. The enormous growth in the
deposits of the State Bank of India since its inception and its performance in the priority sector
credit as compared to the other commercial banks stand to provide that the efficiency of an
organization need not necessarily depend on its ownership. Professionalization of bank
managements and adequate training to bank staff are important objectives under the new system.
It has been made clear that there will be autonomy for each bank and the Boards of directors will
have well defined powers. direction will be issued only on policy and general issues and not on
specific loans to specific parties. Thus, public ownership need not necessarily mean the
elimination of healthy competition or initiative.
As against the criticism of leaving out the small banks, it has been pointed out that the operations
of smaller banks are limited to certain specific regions, and with their wider coverage the bigger
banks would be in a better position to implements the polices of the government as compared to
smaller banks.
Answering the criticism that foreign banks are not included in the legislation, it has been
observed that they are part of world-wide organization and this enables them to give certain
special facilities
and services to exporters and importers. They have a distinctive part to play in advancing foreign
currency loans and administering them on behalf of their parents offices, rendering services to
tourists and in disseminating information about business opportunities in India and in other
countries in which they operate.
There is often a misconception that nationalization is a peculiarly socialistic measure. The

peculiar nature of banking industry which distinguishes it from other industries has been the
main consideration for many countries to bring their banking systems under public ownership.
France and Sweden are such examples.

1.6 Second Phase of Nationalization.
As a further step in the government’s action when it wanted the larger banks to fall in line with
its goal of attaining national objectives, six more banks have been nationalized in April 1980.
These banks are:
1.Andhra Bank
2. Corporation Bank
3. New Bank of India
4. Punjab and Sind Bank
5. oriental Bank of Commerce
6. Vijaya Bank
The individual deposits of all these newly nationalized banks were below Rs.50 crore at the time
of the first nationalization of banks in July 1969. Between 1969 and 1978, almost all of them had
crossed the Rs.200 crore marks in their deposits, the only exception being oriental Bank of
Commerce which had about Rs.180 crore at the end of 1978.
Achievements
In the context of the objectives set before the nationalized banks, it became necessary for them to
reorient the concept of security for loans, to pay special attention to the growth potential and
developmental needs of local areas where the branches are situated, to make better care of the
requirements of underdeveloped areas and backwards
sections of the population, to forge close relations with development and term financing
institutions, to reach mutual understanding with state government, to ensure that large borrowers
do not have more access to resources of the bank than is actually required for productive use, and
to prevent use of credit for speculative and other unproductive purposes. Simultaneously, they
were required to intensify their efforts, through a coordinated branch expansion programmed, for
mobilization of deposits in all parts of the country and from all sections of people.
It is gratifying to note that the nationalized banks have considerably diversified their lending
policies. Simultaneously, they effected organizational changes to set up different cells or
departments to handle proposals for advances to small scale industries as well as to agriculture.

To handle this work trained staffs have been appointed and services of experts have been secured
for consultation. Field officers have also been recruited, whose of experts function would be to
find out prospective customers, contact them for ascertaining their requirements, prepare regular
proposals and put them before the cells/ departments and where necessary, to transmit them to
Head offices. They would also ensure proper utilization of advances granted and arrange to
affect the recovery of loans as an when due. Arrangements have been made to give extensive
publicity through newspapers and periodicals in regional languages regarding the type of
facilities provided by the banks.
Nationalized Banks and Branch Expansion

The progress recorded by the nationalized banks in the expansion of branch network since
nationalizations is commendable. At the time of the nationalization of 14 major commercial
banks, they had a total of 4,133 branches. This number increased to 37,775 by the end of March
2008. It is no exaggeration to state that this order of expansion has no parallel anywhere in the
world. And the phenomenal increase in branch expansion has been the reason for a sharp decline
in the national average of population covered by bank offices. In the programmed of branch
expansion, there has been a distinct shift in favour of rural areas during this period. The
proportion of bank branches of nationalized banks in rural areas increased from 22.4 per cent of
the total as at the end of the June 1969 to 34.94 per cent as at the end of March 2008.
1.7 Banker:
According to dr. H C Hart, a banker or a bank is a person or company carrying on the business of
receiving money and collecting drafts, for customers subject to the obligation of honoring
cheques drawn upon them from time to time by the customers to the extent of the amounts
available in their currentaccounts.
i) Receiving money and collecting drafts means accepting the money on current account
and collecting the cheques and drafts on behalf of the customers.
ii) The obligation of honoring cheques drawn upon them, making payment across the
counter on demand by the customers to the extent of money available at the credit of

customer’s account or up to the sanctioned limit in case of overdrafts.
iii) The mainline of activity of the organization should be the banking

business. (It was held in a court decision Stafford vs. Henry that one Mr. labertouch, who
carried wide variety of business activities in his organization was not a banker as his
main line of activity was riot banking business.
According to H.P. Sheldon the function of receiving money from his customers and repaying it
by honoring their cheques as and when required is the function above all the other function
which distinguishes a banking business from any other kind of business. This definition stresses
the function of current account operating.
He is of the opinion that ‘the banker, when he receives money from customers, does not hold the
money in a fiduciary capacity. To say that money is deposited with a banker is likely to cause
misapprehension, what really happens is that money is not deposited with, but lent to the banker
and that the banker agrees to do is to discharge the debt by paying over an equal amount when
called upon.
1.8 Customer:
Sir John Paget’s view holds good here about the term customer. “To constitute a customer, there
must be some recognizable course or habit of dealing in the nature of regular banking business.
Itis difficult to reconcile the idea of a single transaction with that of a customer. The word
customer surely predicates even grammatically, some minimum of custom antithetic to an
isolated act. It is believed that a tradesman differentiates between a customer and a casual
purchaser.”
This viewpoint indicates that two aspects are essential to constitute a customer:
i) There must be some recognizable course of habit of dealing between
the person and the bank and
ii) The transactions must be in the nature of regular banking business.
Banker-Customer Relationship

essentially the relationship between the banker and the customer is that of a contractual
relationship. This relationship is of two types-
i) General relationship and ii) Special relationship.
General relationship may be further be called as ‘Primary and secondary relationship’.
The primary relationship speaks about the debtor-creditor relationship created between the
banker and customer which are explained in detail below:
1. Debtors -Creditors Relationship: According to Sir John Paget “The relation of a banker
and a customer is primarily that of a debtor and a creditor, the respective position being
determined by the existing state of the account. Instead of the money being set apart in a safe
room, it is replaced by a debt due from the banker. The money deposited by a customer with
the banker becomes the latter’s property and is absolutely at his disposal”. Hence, there
exists a relationship of debtor and creditor; the banker, being the debtor, is bound to repay
the deposited as and when the customer asks for it.
2. The Banker as a Privileged or Dignified Debtor: A banker as a debtor is not the same as
that of an ordinary commercial debtor. An ordinary commercial debtor’s duty is to seek out the:
creditor and pay the money. But, a banker as a debtor enjoys many privileges, and hence, he is
called a privileges debtor. The privileges enjoyed by a banker have been listed below:
• Creditor seeking out the Debtor: the creditor i.e., the customer must come to the banker and
make an express demand in writing for repayment of the money.
• Importance of Place: In the case of an ordinary commercial debt, the debtor can repay the
money to the creditor at any place. But in the case of a banking debt, the demand by the
creditors must be made only at the particular branch where the account is kept.
• Without Security: The banker is able to get the deposited money without giving any security
to the customer, while it is not possible in the case of an ordinary debtor. Thus, the customer
‘is acting only as an unsecured creditor. It is really privilege given to the banker.
3. Non-applicability of the law of limitation act: The law of limitation which is applicable to
all debts lay down that a debt will become a bad one after the expiry of three years from the date
of the loan. But this law is not applicable to a banking debt. Practically, when the demand is
made, the banker will return the money immediately and so this law does not apply to a banking
debt.
4. Right to Combine Accounts: The banker as a debtor has the right to combine the accounts of
a customer provided he has two or more accounts in his name and in the same capacity. This is
another of his privilege.
5. No Right to Close the Account: Similarly an ordinary debtor can close the account of his
creditor at any time. But, a banker cannot close the account of his creditor at any time without
getting his prior approval.
6. A Banker as a Creditor: The debtor-creditor relationship holds good in the case of a deposit
account. But, in the case of loan, cash credit and overdraft the banker becomes a creditor and the
customer-assumes the role of a debtor. Here again the banker is a privileged person, because he
is acting as a secured creditor. He insists upon the submission of adequate securities by the
customer to avail of the loan or cash credit facilities. Moreover, the law of limitation will operate
in such cases from the date of the loan unless it is renewed.
7. Repayable on Demand only: Customer’s balance at bank is not repayable until a demand for
repayment was made by the customer. There should be an express demand for it. Banker should
pay the deposit money on demand by the customer. The deposit should be paid at the appropriate
place. The demand should be made by the customer on working days and during the business
hours and it should be made in proper form.
Under the general relationship, there is also secondary relationship between the banker
and the customer which can be explained as follows:
1. Banker as a Trustee: The banker acts as a trustee for managing the assets of others. Today
many banks have separate departments to look after this function, The customer may request the
bankers to keep his valuables in safe vaults or one may deposit some account and can request the
bank to manage that the fund for a specific become a trustee for debentures holders or the bank

collects the cheques, hundies of the customers in the capacity of trustee.Thus there are wide
varieties of trustee’s related functions discharged by the banker.
2. Banker as an Agent: There are certain agency functions discharged by the banker. He
collects Cheque, hundies, drafts of the customers, collects dividends, interest on securities, pays
fees, duties, subscriptions, premiums on behalf of the costumers, acts as an agent for-buying and
selling corporate securities for his customers etc. in this case, the banker and customer
relationship is in the form of an Agent and Principal.
As far as the legal position is concerned, the law relating to agent and principal will prevail. The
banker being an agent enjoys all the rights of an agent and is bound by all responsibilities that the
stipulated in the law relating to an agent. Basically, he should carry out the instructions of his
principal (customers) and give all profits and benefits to his principal, derived out of agency
transactions. He is entitled only to
Banker as a Bailee: The customers can keep his valuables or any secret documents in the bank
for safe custody. When the banker accepts the same, he will be accepting it as a ’‘Bailee’. As a
bailee, he should protect the valuables ’in his custody with reasonable care. If the customer
suffers any loss due to the negligence of the banker in protecting the valuables, the banker is
liable to pay such loss. If any loss is incurred due to the situation beyond the control of the
banker, he is not liable for penalty because, banker is not an insurer and he is only a bailee.
lastly, the banker should hand over these valuables on demand by the customer.
To conclude, the primary general relationship exists when the account is opened by the customer
with the bank. The relationship is that of debtor and creditor. When the bank acts as trustee or
agent or bailee for the valuables, he will be establishing a subsidiary or a secondary relationship.
1.9 Definition and Meaning of Negotiable Instruments:
Section 13 of the Indian Negotiable Instruments Act, 1881 defines a Negotiable Instrument as “a
promissory note, bill of exchange or cheque payable either to order or to the bearer”. This
definition merely states about the promissory note, bill of exchange or cheque, but does not give
the meaning of negotiable instruments.

A negotiable instrument can be defined as a document or instrument whose property (legal right
to money represented by it) can be transferred from one person to another by mere delivery or by
endorsement and delivery, and which gives a valid title to the bonafide holder for value.
Characteristics of Negotiable Instruments
The chief characteristics of a negotiable instrument are:

1. Free Transferability
The basic characteristic of a negotiable instrument is that it is freely transferable from one person
to another. i.e., the ownership of the property in a negotiable instrument is freely transferable. If
it is a bearer instrument, it can be transferred by mere delivery. If it is an order instrument, it can
be transferred by endorsement and delivery.
2. Negotiability
Negotiability feature means that the bonafide transferee of a negotiable instrument (i.e. the
person who gets a negotiable instrument for value and in good faith and without the knowledge
of the defect in the title of the transferor) becomes a holder in due course, and gets a better title
than that of the transferor or any of the previous holders. The bonafide transferee is not affected
by the defect in the title of the transferor or any of the previous holders.
3. Right of action in his own name
The holder in due course of a negotiable instrument gets the right to sue upon the instrument in
his own name. In other words, the holder in due course of a negotiable instrument is entitled to
sue the transferor or any other person liable on the instrument in his own name without giving
him (i.e., the transferor or any other party liable on the instrument) any notice.
4. Presumptions
Certain presumptions apply to all negotiable instruments. Section 118 of the Negotiable
Instruments Act, 1881 provides that, unless the contrary is proved, the following presumptions
shall be made by the court as to a negotiable instrument:
a. every negotiable instrument was made, drawn, accepted, endorsed, negotiated or transferred
for consideration.
b. every negotiable instrument bearing a date was made or drawn on that date.

c. every accepted bill of exchange was accepted within a reasonable time after its date and before
its maturity.
d. every transfer of a negotiable instrument was made before its maturity.
e. The endorsements appearing on the negotiable instrument were made in the order in which
they appear therein.
f. A lost or destroyed negotiable instrument was duly stamped and the stamp was duly cancelled.
g. The holder of a negotiable instrument is a holder in due course.
h. In a suit upon a dishonored instrument, the court, on proof of protest, presumes that it was
dishonored unless this fact is disproved.
Types of Negotiable Instruments
Negotiable instruments can be broadly classified into two:

1. Instruments negotiable by law
2. Instruments negotiable by custom or usage of trade.
Instruments negotiable by custom or usage includes Government promissory notes, dividend

warrants, share warrants etc.
In India, law recognizes only three instruments as negotiable and they are:
1.Promissory Note
2. Bill of exchange, and
3. Cheque
Promissory Note
Section 4 of the Negotiable Instruments Act defines a Promissory Note as “ an instrument in
writing (not being a bank note or a 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”.

Thus, a promissory note contains a promise by the debtor to the creditor to pay a certain sum of
money after a certain date. Hence, it is always drawn by the debtor and he is called the ‘maker ’
of the instrument.
Features of Promissory Note:
a. It is an instrument in writing.
b. It is a promise to pay.
c. The undertaking to pay is unconditional.
d. It should be signed by the maker.
e. The maker must be certain.
f. The payee must be certain.
g. The promise must be to pay money and money only.
h. The amount must be certain.
1.10 Bill of Exchange

Section 5 of the Negotiable Instruments Act defines a bill of exchange as “ 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”.
Thus, a bill of exchange is a written acknowledgement of the debt, written by the creditor and
accepted by the debtor. There are usually three parties to a bill of exchange- drawer, drawee or
acceptor and payee. drawer himself may be the payee.
The Drawer: The person who draws the bill.

The Drawee:The person on whom the bill is drawn.
The Acceptor:The person one who accepts the bill. Generally, the drawee is the acceptor but a
stranger may accept it on behalf of the drawee.
The payee:one to whom the sum stated in the bill is payable, either the drawer or any other
person may be the payee.
The holder: is either the original payee or any other person to whom, the payee has endorsed the
bill. In case of a bearer bill, the bearer is the holder.

Drawee in case of need:Besides the above parties. Another person called the “drawee in case of
need” may be introduced at the option of the drawer. The name of such a person may be inserted
either by the drawer or by any endorser in order that resort may be had to him in case of need,
i.e., when the bill is dishonoured by either non-acceptance or non-payment.
Acceptor for honour:Further, any person may voluntarily become a party to a bill as acceptor.
A person, who on the refusal by the original drawee to accept the bill or to furnish better
security, when demanded by the notary, accept the bill supra protest in order to safeguard the
honour of the drawer or any endorser, is called the acceptor for honour.
Essential features:
a. It must be in writing.
b. It must be signed by the drawer.
c. The drawer, drawee and payee must be certain.
d. The sum payable must also be certain.
e. It should be properly stamped.
f. It must contain an express order to pay money and money only. g. The order must be
unconditional.
1.11 Holder and Holder in Due Course Holder of a Negotiable Instrument
In terms of Section 8 of the Negotiable Instruments Act:

‘The holder of a promissory note, bill of exchange or cheque means any person entitle in his own
name to the possession thereof and the receive or recover the amount due thereon from the
parties thereto’.
Thus, the holder of a negotiable instrument is the person who is legally entitled to recover the
amount from the parties of the instrument and who is in possession of the instruments. Here the
Indian law makes a slight departure from the english law. under the Bills of exchange Act, a
holder means the payee or endorsee of a bill or note, who is in possession of it, or the bearer
thereof. In terms of this definition, the holder need not necessarily be a lawful holder.

For instance, the finder of a cheque duly endorsed so as to make it payable to bearer is a holder.
For instance the finder of a cheque duly endorsed so as to make it payable to bearer is a holder.
But according to the Negotiable Instruments Act, the holder must be entitled to receive or
recover the amount due thereon from the parties thereto. Therefore, a person who has obtained
possession of a negotiable instrument by theft or any other unlawful means is not a holder.
Holder in Due Course of a Negotiable Instrument
Section 9 of the Negotiable Instruments Act defines a ‘holder in due course ’as:
‘Holder in due course means any person who for consideration became the possessor of a
promissory note, bill of exchange or cheque if payable to bearer or the payee or endorsee thereof
if payable to order, before the amount mentioned in it became payable, and without having
sufficient cause to believe that any defect existed in the title of the person from whom he derived
his title. ’
Thus, a ‘holder in due course ’is a person who:
1. is in possession of the instrument as defined in Section 8;

2. obtains possession of the instrument before maturity;
3. obtains possession of the instrument for valuable consideration
(valuable consideration in the case of a negotiable instrument is always presumed until the
contrary is proved) and
4. is a holder, without having sufficient cause to believe that any defect existed in the title of the
person from whom he received his title.
Here again, the Negotiable Instruments Act differs slightly from the Bills of exchange Act,
According to Section 29 of the Bills of exchange Act:

‘A holder in due course is a holder who has taken a bill complete and regular on the face of it,
under the following conditions; namely:
(a) that he became the holder of it before it was overdue and without notice that it had been
previously dishonoured, if such was the fact;
(b) that he took the bill in good faith and for value, and that at the time the bill was negotiated to
him he had no notice of any defect in the title of the person who negotiated it. ’
From the above definition, it can be seen that a person who takes an instrument in good faith is a
holder in due course, irrespective of whether or not he takes it negligently. In other words, the
fact that a person has not exercised great caution or has not been negligent is not sufficient to
dispute the title of the holder of a negotiable instrument, provided he has acted in good faith.
However, according to Indian law, a person is a holder in due course only if he takes the
instrument without having sufficient cause to believe that any defect existed in the title of the
person from whom he received his title. Thus, according to the Negotiable Instruments Act
person is expected to take an instrument with reasonable care and without negligence.
A holder in due course obtains absolute title, even if he takes the instrument from a thief. All the
previous parties to the instrument are liable to him. An exception to this general rule may be
found when the instrument bears a forged signature of the true owner. Thus transferee of such an
instrument does not get a valid title except in the case of estoppels.
1.12 Cheques
Section 6 of the Act defines a cheque as “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”.
Thus, a cheque is an instrument in writing, containing an unconditional order, drawn on a
specified banker, signed by the drawer, directing the banker, to pay, on demand, a certain sum of
money only, to a certain person or to his order or to the bearer of the instrument.

Essentials of a cheque:
1. A cheque must be in writing. oral orders do not constitute a cheque. But, the law has not
specified the writing materials with which a cheque has to be written.
2. It must contain an order. This implies that the cheque must contain an order to pay, and not
a request to pay.
3. The order to pay must be unconditional. No condition should be attached to the order. In
other words, the banker should not be ordered to do anything else except to pay the money.
4. It must be drawn on a banker. It cannot be drawn on any other person, except on the
banker.
5. It must be drawn on a specified banker. It cannot be drawn on any bank, but only on the
particular bank where the drawer has an account.
6. It must be drawn only by the customer of the bank, i.e. only by the account holder.
7. It must be signed by the drawer(i.e. , the account holder) or his authorized holder. Rubber
stamp signature is not accepted by the bankers, though it is legally permissible.
8. The order must be for the payment of money only. The order must direct the banker to pay
only money and not any other thing.
9. The order must be for the payment of certain sum of money. The amount of money
ordered to be paid must be certain.
10. The amount must not be expressed to be payable otherwise than on demand.

11. The amount of the cheque must be made payable to a certain person or to his order or to
the bearer of the cheque.
Kinds of Cheques:
Cheques can be classified into two categories. They are:
1. Bearer Cheques
A bearer cheque is one which is payable to the bearer or the possessor. In case of these cheques,
the payee need not be named. It can be transferred to others by mere delivery without any
endorsement.
2. Order Cheques
An order cheque is a cheque which is payable to a certain person or to his order. It can be
transferred to another person through endorsement and delivery.
Crossing of cheques
Need
Very often, an open or uncrossed cheque payable across the counter of the paying banker lends
to fraud by unscrupulous persons and causes loss either to the customer or to the banker. In order
to avoid such a risk and to protect the true owner of the cheque and the banker, the system of
crossing of cheques has been introduced.
Meaning
Crossing of a cheque means drawing across the face of the cheque two parallel transverse lines
with or without the words “And Company” or “Not Negotiable” or “Account Payee” between the
parallel transverse lines. It can be hand-written or stamped.
Object of Crossing
Crossing affords security and protection to the true owner, since payment of such a cheque has to
be made through a banker. It facilitates the tracing of the person who has received the payment
of the cheque. This traceability ensures the safety of the cheque.

Who can Cross a Cheque?
1. The drawer of a cheque can cross it at the time of issuing it.
2. Any holder can cross an uncrossed cheque.
3. The banker in whose favor a cheque has been crossed can again
cross it in favour of another banker for the purpose of collection.
Types of Crossing:
There are two types of crossing viz.,
1. General Crossing
Section 123 of the Act, defines a general crossing as “where a cheque bears across its face, an
addition of the words “and company” or any abbreviation thereof between two parallel
transverse lines, or of 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”
So, general crossing means drawing across the face of a cheque two parallel transverse lines with
or without the words “And Company” or “Not Negotiable” or “Account Payee” between the
parallel transverse lines.
Essential features:
a. There must be two parallel transverse lines.
b. The two parallel transverse lines must be on the face of the cheque.
c. The lines are generally drawn on the left hand side.
d. The words “and company” or its abbreviation “and co.” or “& Co” do not form a necessary
part of the general crossing.
e. Words, such as “Not Negotiable” or “Account Payee” also do not form an essential partof the
general crossing.
The paying banker is required to pay the amount of a generally

crossed cheque to another banker, but not to the holder at the counter

Special Crossing
Section 124 of the Act defines a special crossing as “where a cheque bears across its face an
addition of the name of a banker 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”. So, special crossing means writing across the face of a cheque the name of some
banker with or without lines or words such as “Not Negotiable” or “Account Payee”.
Essential features:
a. Two parallel transverse lines are not required.
b. The name of the collecting banker must be necessarily specified across the face of the cheque,
this itself constitutes special crossing.
c. Words such as “Not Negotiable” or “Account Payee” also do not form a necessary part of
special crossing.
d. The paying banker is required to pay the amount of a specially crossed cheque only to the
banker named in the cheque or his agent for collection.
e. It makes a cheque safer than general crossing. Not Negotiable Crossing
The words “Not Negotiable” may be included in a general or a special crossing. When a cheque
is crossed generally or specially with the words “Not Negotiable”, it loses its special feature of
negotiability. As a result, such a cheque cannot give to the transferee or the holder a better title
than that of the transferor or the person from whom the transferee received it. But it does not
restrict the transferability of a cheque and does not affect either the paying or the collecting
banker.
Account Payee Crossing

The words, “Account Payee” may be included in a general or special crossing. These words have
no statutory recognition. They are used because of banking practice. It is a warning to the
collecting banker that he should collect only for the benefit of the payee. If the collecting banker
collects such a cheque for a party other than the payee, he will be liable to the true owner of the
cheque under the doctrine of conversion. This type of crossing does not affect the paying banker.

When a cheque is crossed generally or specially with the words “Not Negotiable” or “Account
Payee”, it will possess the features of both “Not Negotiable” crossing and “Account Payee”
crossing.
Double Crossing
double crossing means crossing a cheque especially to more than one banker. A cheque cannot
have double or two crossings, because the very purpose of the first special crossing is defeated
by the second special crossing. The paying banker should refuse to honour such a cheque as it is
prohibited under the Act. However, the collecting banker need not refuse to collect such a
cheque.
Though a cheque cannot have two special crossings, an exception to this rule has been made for
the purpose of collection. By the virtue of this exception, the banker to whom a cheque is crossed
specially may, either because he does not have a branch at the place of the paying banker, or
because of some other reason, cross it especially to another banker who acts as his agent for the
purpose of collection. But, in such a case, the second special crossing must specify that the
banker to whom the cheque has been specially crossed again acts as the agent of the first banker
for the purpose of the collection of the cheque.
Cancelling or opening of crossing

opening of crossing means cancelling the crossing found on a cheque. The law is silent on the
opening of the cheque. But banking custom permits the opening of the cheque.
The crossing is, generally, opened at the request of the payee or the holder who does not have a
bank account. When the crossing is cancelled, the cheque becomes an open cheque or uncrossed
cheque and becomes payable at the counter of the paying banker.
The crossing can be cancelled only by the drawer by striking off the crossing, writing the words
“crossing cancelled, pay cash”, and putting his full signature near the crossing. While paying
such opened cheque, the paying banker should verify the genuineness of the drawer’s signature
confirming the cancellation of the crossing. If the signature is forged and the paying banker
makes the payment then, he becomes liable to the true owner of the cheque.

Marking of Cheque
‘Marking ’means giving a certificate by the banker to a cheque that it is good for payment. This
takes place when a payee has any doubt of the cheque being honoured and not knowing the
whereabouts of the drawer. under such circumstances, the paying banker may be approached for
‘marking’. The paying banker may or may not oblige in such a situation. His refusal to mark the
cheque does not amount to wrongful dishonor of the cheque and does not incur any sort of
liability.
The paying banker, when he simply puts his initial on the cheque or writes the words ‘marked
good for payment ’and puts his initial, the cheque becomes a marked cheque.
The effects of marking are:
1. The drawer has drawn the cheque in good faith.
2. Sufficient funds are available to pay the cheque.
3. It adds to the credit of the drawer and the credit of the paying banker.
The legal aspects of a marked cheque depend upon the circumstances under which it is marked.
Whether it is marked for a drawer or for a payee or the collecting banker or the holder has to be
taken note of.
1. Marking for drawer: The drawer may request the banker to mark the cheque to satisfy the
payee. If the banker marks the cheque, it amounts to constructive payment. This means the
banker cannot dishonor the marked cheque inspite of the death, lunacy or insolvency of the
drawer or even when the garnishee order is against that account. The banker has to earmark the
funds for the payment of the marked cheque and the drawer has no right to countermand the
payment of such cheque.
2. Marking for holder or payee: The banker can also mark the cheque at the instance of the
payee or holder. But such marking does not impose on the paying banker any legal obligation.
Marking in this case simply signifies that there is sufficient amount to meet the cheque at the
time of marking. But the banker need not appropriate funds to meet the obligation of that cheque
when it is presented for payment. It only signifies that the cheque is drawn in good faith.
3.Marking for a collecting banker: When a customer’s cheque is presented by the collecting
banker after the clearing hours, the paying banker can mark the cheque at the request of the
collecting banker. This is done to protect the interest of the customers. When such cheques are

marked, the paying banker should honour the cheque at a later stage. In order to meet such
obligation, he appropriates funds from the drawer’s account. The drawer cannot countermand the
payment of such marked cheques. Such marking is construed as an undertaking to pay the value
of cheque and will be considered as a ‘constructive payment’.
Material Alterations:
A material alteration is an alteration which alters (i.e., changes) materially or substantially the
operation of a cheque, and thereby, the rights and liabilities of the parties thereto. Such
alterations will be material alteration, whether it is beneficial or detrimental to any party to the
instrument.
examples:
1. Alteration of the date or sum payable or place of payment or the name of the payee.
2. Changing an order cheque into a bearer cheque.
3. Cancelling the crossing on a cheque.
4. Changing a specially crossed cheque into a generally crossed cheque.
5. Striking off the words “Not Negotiable” or “Account Payee” from a general or special
crossing.
There are certain alterations which cannot be regarded as material alterations. For example:
1. Changing a bearer cheque into an order cheque.
2. Changing an open or uncrossed cheque into a crossed cheque.
3. Changing a generally crossed cheque into a specially crossed cheque.
4. Adding the words “Not Negotiable” or “Account Payee” to a general or to a special crossing.
5. Completing an inchoate (i.e., an incomplete) cheque by filling up the blanks.
Effects of Material Alteration:

A cheque which contains a material alteration cannot be regarded as a cheque. However, such a
cheque becomes valid, if the material alteration is confirmed by the drawer under his full
signature. When the material alteration is apparent and is presented for payment to the paying
banker, he should see whether it is confirmed by the drawer or not. If it is confirmed then he can

pay such a cheque without any risk. If such alteration is not confirmed then he should return the
cheque unpaid with remark for the same.
If the material alteration is not apparent or is very difficult to detect even on a careful
examination and consequently, the payment is made without the drawer’s confirmation, the
paying banker is protected, provided the payment is made in due course.
Magnetic Ink Character Recognition (MICR)

MICR technology has been introduced by the Reserve Bank of India for speeding up the cheque
clearing process. This process involves the following steps:
1. Standardization of quality/size, printing of cheques or drafts with suitable space for encoding
information at the bottom.
2. encoding in magnetic ink specific details on the cheque itself, to facilitate mechanical sorting.
The code line contains the following information:

a. First six numbers indicate cheque number;
b. Next three numbers indicate city code;
c. Next three numbers indicate bank code; and
d. Next three numbers indicate Branch code.
After some space there is number for transaction code i.e. , whether the transaction relates to a
savings or a current account.The magnetized portion (i.e., read band) when put under MICR
equipment allows instant readability and identification. MICR cheques should not be folded; pins
etc. should be put at the left corner of the cheque. The signature of the drawer, rubber stamp etc.
should be affixed above the code line.
1.13 Endorsement
Endorsement of a cheque means signing ones name either on the back of a cheque or on its face
or on a slip of paper called the allonge for the purpose of transferring the interest, right, property
or title in the cheque to another person. The person who endorses the cheque is called the

endorser of the cheque and the person to whom the cheque is endorsed is called the endorsee of
the cheque.
Kinds of Endorsement
There are seven kinds of endorsement. They are:
1. Blank or general Endorsement:
A blank endorsement is an endorsement in which the endorser merely signs his name on the back
of the instrument without mentioning the name of the person to whom the instrument is
endorsed. When an instrument is endorsed in blank, it becomes a bearer instrument, even if it
was originally made payable to order. It can be negotiated further by mere delivery.
Example, (Sd.) R. Suresh
2. Full or special Endorsement:
It is an endorsement in which the endorser writes not only his name, but also the name of the
person to whom the instrument is endorsed on the back of the instrument. It can be negotiated
further only by the endorsee named in the endorsement.
Example, “Pay K.Ganesh or order” (Sd.) R. Suresh
3. Restrictive Endorsement:
It is an endorsement in which the endorser restricts the further negotiation i.e transferability of
the instrument by expressed words or constitutes the endorsee just an agent to endorse the
instrument or to receive its contents for the endorser or some other specified person. The
endorsee cannot negotiate the instrument further as his right to negotiate the instrument further is
restricted. Examples,
(i) “Pay K. Ganesh only” (ii)“Pay K. Ganesh on account of Mahesh (Sd.) R. Suresh (Sd.) R.
Suresh
4. Sans recourse Endorsement:
Generally, when an instrument is endorsed, the endorser undertakes to compensate the endorsee
in case the instrument is dishonoured. But in case of a sans recourse endorsement, the endorser
frees himself from such a liability by writing the words “Sans recourse” or “Without recourse to

me” after writing the name of the endorsee. The endorsee cannot look to the endorser for
payment, in case the instrument is dishonored. Example,
“Pay K.Ganesh or order, sans recourse” (Sd.) R. Suresh
5. Conditional or Qualified Endorsement:
It is an endorsement in which the endorser makes his liability on the instrument or the right of
the endorsee to receive the payment of the instrument depends upon the happening of a specified
event. The endorser becomes liable or the property in the instrument will pass to
the endorsee only if the specified event takes place or if the particular condition is fulfilled.
Example,
“Pay K.Ganesh or order on the arrival of S.S.Nethravathi at New Mangalore Port
By 31stAugust, 2011” (Sd.) R. Suresh
6. Facultative Endorsement:
Generally, the endorser of an instrument is entitled to receive a notice of dishonor from the
holder in case of dishonor of the instrument, if he is to be held liable on the instrument. If he is
not served with the notice of dishonor, he will not be liable to the holder. But, when an
instrument bears a facultative endorsement, the endorser will be liable on the instrument in case
of dishonor even if he is not given any notice of dishonor. Through facultative endorsement, the
endorser waives or surrenders his right to receive the notice of dishonor by writing the words
“Notice of dishonour Waived”, after writing the name of the endorsee. Example,
“Pay K.Ganesh or order. Notice of dishonour Waived” (Sd.) R. Suresh
7. SansFrais Endorsement:
It is an endorsement in which, the endorser makes it clear that no one should incur any expense
on his account in respect of the negotiable instrument by writing the words “Sans Frais” which
means ‘without expense’. Example,
“Pay K.Ganesh or order, Sans Frais” (Sd.) R. Suresh

Who can Endorse?
As per section 51 of the Negotiable Instruments Act, a negotiable instrument can be endorsed by
any one of the following persons:
1. The Payee on the instrument.
2. The drawer of a bill of exchange or a cheque.
3. The maker of a promissory note.
4. The holder of a negotiable instrument.
5. The endorsee of the instrument.
6. All of the several joint payees, drawers, makers or endorsees of the instrument.
1.14 Summary
• Commercial banks are organized on joint stock company system, primarily for the purpose
of earning a profit.
• Nationalization of Commercial Banks: The Government of India promulgated an
ordinance called the Banking Companies (Acquisition of Transfer of undertakings)
ordinance on 19 July 1969, in terms of which the Central Government acquired the
undertakings of the following 14 major Indian banks which had deposits of not less than
Rs. 50 crore each as on the last Friday of June 1969. As a further step in the government’s
action when it wanted the larger banks to fall in line with its goal of attaining national
objectives, six more banks have been nationalized in April 1980.
• The Narasimham Committee (I) which was constituted to consider all relevant aspects of
the structure, organization, function and procedures of the financial system in India
submitted its report in November 1991.
• In India, the law relating to negotiable instruments is contained in the Negotiable
Instruments Act of 1881, which came into force on 1st March, 1882.
• A negotiable instrument can be defined as a document or instrument whose property (legal
right to money represented by it) can be transferred from one person to another by mere
delivery or by endorsement and delivery, and which gives a valid title to the bonafide
holder for value.
• Characteristics of Negotiable Instruments includesFree Transferability, Negotiability,
Right of action in his own name,

• Types of Negotiable Instruments:Promissory Note, Bill of exchange and Cheque
• Promissory Note: Section 4 of the Negotiable Instruments Act defines a Promissory Note
as “ an instrument in writing (not being a bank note or a 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”.
• Bill of Exchange:Section 5 of the Negotiable Instruments Act defines a bill of exchange as
“ 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”.
• Holder of a Negotiable Instrument:In terms of Section 8 of the Negotiable Instruments
Act; ‘The holder of a promissory note, bill of exchange or cheque means any person entitle
in his own name to the possession thereof and the receive or recover the amount due
thereon from the parties thereto’.
• Holder in Due Course of a Negotiable Instrument: Section
9 of the Negotiable Instruments Act defines a ‘holder in due course ’as; ‘Holder in due
course means any person who for consideration became the possessor of a promissory
note, bill of exchange or cheque if payable to bearer or the payee or endorsee thereof if
payable to order, before the amount mentioned in it became payable, and without having
sufficient cause to believe that any defect existed in the title of the person from whom he
derived his title. ’
• Cheques: Section 6 of the Act defines a cheque as “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”.
Types of Cheques:
Bearer Cheques: A bearer cheque is one which is payable to the bearer or the possessor. In case
of these cheques, the payee need not be named. It can be transferred to others by mere delivery
without any endorsement.
Order Cheques: An order cheque is a cheque which is payable to a certain person or to his order.
It can be transferred to another person through endorsement and delivery.

• Crossing of a cheque means drawing across the face of the cheque two parallel transverse
lines with or without the words “And Company” or “Not Negotiable” or “Account Payee”
between the parallel transverse lines. It can be hand-written or stamped.
• ‘Marking ’means giving a certificate by the banker to a cheque that it is good for payment.
This takes place when a payee has any doubt of the cheque being honoured and not
knowing the whereabouts of the drawer.
• A material alteration is an alteration which alters (i.e., changes) materially or substantially
the operation of a cheque, and thereby, the rights and liabilities of the parties thereto. Such
alterations will be material alteration, whether it is beneficial or detrimental to any party to
the instrument.
• MICR (Magnetic Ink Character Recognition)technology has been introduced by the
Reserve Bank of India for speeding up the cheque clearing process.
• Endorsement of a cheque means signing ones name either on the back of a cheque or on its
face or on a slip of paper called the allonge for the purpose of transferring the interest,
right, property or title in the cheque to another person. The person who endorses the
cheque is called the endorser of the cheque and the person to whom the cheque is endorsed
is called the endorsee of the cheque.

Section A (2 Marks Questions)
1. Define a commercial Bank?

2. State any general utility functions of commercial banks?
3. What do you mean by material alteration of a cheque?
4. What is an endorsement?
5. What is a negotiable instrument?
6. How can bearer cheques be transferred?
7. What is a promissory note?
8. What are order cheques?

Section B (5 Marks Questions)
1. Explain the significance of commercial banks? 2. What is Nationalization?
2. Write a brief note on objects of nationalization:
3. What are the achievements made in second phase of nationalization?
4. What are the characteristics of a negotiable instrument?
5. Explain “not negotiable” and “Account Payee” crossing a cheque.
6. Write a note on material alteration of cheques.
7. Explain double crossing of a cheque.
8. Distinguish between general and special crossing.
9. What are the presumptions relating to negotiable instruments?
10. Write a note on MICR.
Section C (14 Marks Questions)

1. Explain the various functions of commercial banks?
2. Explain briefly the Narasimhan Committee Report:
3. Explain the different kinds of endorsements.
4. Explain the types of crossing.
5. Explain in detail the marking of cheques.
6. Explain the essentials of a cheque.
1.16 References:
1. Gordon &Natrajan: Banking Theory Law and Practice, HPH.
2. Maheshwari. S.N.: Banking Law and Practice, Kalyani Publishers
3. Gagendra Naidu, S. K. Poddar , Law and Practice of Banking, VBH.
4. M. Prakash – Banking Regulation & Operations, VBH.
5. Tannan M.L: Banking Law and Practice in India, Wadhwa and company
6. P.SubbaRao ; Bank Management, HPH.

Skill Development
• Conduct a study on the evolution of banking sector in India
• Present the transaction process of negotiable instruments
• Collect the list of nationalised banks and the scale of their operation.

Module - 2
FINANCIAL SYSTEM AND SERVICES
Meaning- Features- function and basic elements of financial system, Classification of Financial
System. Constituents of Financial Markets – Functions of Primary Market and Secondary Market,
Differences between capital and money market, Financial services- Fee and Fund based.
Financial sector reforms in India. Recent mergers of nationalized bank and its impact on
customers and banks.
2.1 Introduction
2.2 Meaning
2.3 Functions of Financial System
2.4 Components of Financial system
2.5 Importance of Indian Financial System
2.6 Financial Markets
2.7 Money Market
2.8 Meaning and Definition
2.9 Features of Money Market
2.10 Functions or Importance of Money Market
2.11 Difference Between Capital and Money Market
2.12 Financial Services
2.13 Features of Financial Services
2.14 Types of Financial Activities
2.15 Financial Sector Reforms in India
2.16 Recent mergers of Nationalized Banks
2.17 Advantages and Disadvantages
2.18 Summary
2.20 References
2.1 Introduction
Economic development of any country depends upon the existence of a well-organized financial
system. It is the financial system which supplies the necessary financial inputs for the production

of goods and services which in turn promote the wellbeing and standard of living of the people
of a country. Thus the financial system is a broader term which brings under its fold the financial
markets and the financial institutions which support the system. The major assets traded in the
financial system are money and monetary assets. The responsibility of a well-organized financial
system is to mobilize savings from public by giving attractive returns and make it available for
productive activities and thus promote economic growth.
2.2 Meaning
The word ‘system ’in the term ‘financial system ’implies a set of complex and closely connected
or intermixed instructions, agents, practices, markets, transactions, claims and liabilities in the
economy. Finance is the study of money, its nature, creation, behavior, regulations and
administration. Therefore, financial system includes all those activities dealing in finance,
organized into a system.
2.3 Functions of Financial System.
1. Providesliquidity : The major function of financial system is the provision of money and
monetary assets for the production of goods and services. There should not be any
shortage of money for productive ventures. The term liquidity refers to cash or money
and other assets which can be converted into cash readily without loss.
2. Mobilization of savings:One of the important activities of the financial system is to

mobilize savings and channelize them into productive activities. The financial system
should offer appropriate incentives to attract savings and make them available for more
productive ventures. Thus, the financial system facilitates the transformation of savings
into investments and consumption.
3. Size transformation function: Generally, the savings of millions of small investors are
in nature of small unit of capital which cannot find any fruitful avenue for investments
unless it is transformed into a perceptible size of credit unit. Banks and other financial

intermediary perform this size transformation function by collecting deposits form vast
majority of small customers and giving them as loan of sizeable quantity.
4. Maturity transformation function: The financial intermediaries accept deposits from

public in different maturities according to their liquidity preference and lend them the
borrowers in different maturities according to their need and promote the economic
activities of a country.
5. Risk transformation function: Small investors hesitate to invest directly to the financial
markets directly because of the risk involved. On the other hand the intermediary collects
this small amount form individuals and distributes them into different avenues of
investments. Moreover, various risk minimizing tools are available in the financial
system like hedging, insurance and derivatives etc.

2.4 Components of financial system / financial concepts

(1) Financial Institutions – Financial institutions are intermediaries of financial markets which
facilitate financial transactions between individuals and financial customers.
It simply refers to an organization (set-up for profit or not for profit) that collects money from
individuals and invests that money in financial assets such as stocks, bonds, bank deposits, loans
etc.
There can be two types of financial institutions:
• Banking Institutions or Depository institutions – These are banks and credit unions that collect
money from the public in return for interest on money deposits and use that money to advance
loans to financial customers.
• Non- Banking Institutions or Non-Depository institutions – These are brokerage firms,

insurance and mutual funds companies that cannot collect money deposits but can sell
financial products to financial customers.
Financial Institutions may be classified into three categories:

• Regulatory – It includes institutions like SEBI, RBI, IRDA etc. which regulate the financial
markets and protect the interests of investors.
• Intermediaries– It includes commercial banks such as SBI, PNB etc. that provide short term
loans and other financial services to individuals and corporate customers.
• Non – Intermediaries– It includes financial institutions like NABARD, IDBI etc. that provide
long-term loans to corporate customers.
(2) Financial Markets – It refers to any marketplace where buyers and sellers participate in
trading of assets such as shares, bonds, currencies and other financial instruments. A financial
market may be further divided into capital market and money market. While the capital market
deals in long term securities having maturity period of more than one year, the money market
deals with short-term debt instruments having maturity period of less than one year.

(3) Financial Assets/Instruments – Financial assets include cash deposits, checks, loans, accounts
receivable, letter of credit, bank notes and all other financial instruments that provide a claim
against a person/financial institution to pay either a specific amount on a certain future date or to
pay the principal amount along with interest.
(4) Financial Services – Financial Services are concerned with the design and delivery of
financial instruments and advisory services to individuals and businesses within the area of
banking and related institutions, personal financial planning, leasing, investment, assets,
insurance etc.
It involves provision of a wide variety of fund/asset based and non-fund based/advisory services
and includes all kinds of institutions which provide intermediate financial assistance and
facilitate financial transactions between individuals and corporate customers.
2.5 Importance of Indian Financial System

• It accelerates the rate and volume of savings through provision of various financial
instruments and efficient mobilization of savings
• It aids in increasing the national output of the country by providing funds to corporate
customers to expand their respective business
• It protects the interests of investors and ensures smooth financial transactions through
regulatory bodies such as RBI, SEBI etc.
• It helps economic development and raising the standard of living of people
• It helps to promote the development of weaker section of the society through rural
development banks and co-operative societies
• It helps corporate customers to make better financial decisions by providing effective
financial as well as advisory services
• It aids in Financial Deepening and Broadening
2.6 Financial markets: Financial markets can be referred to as those centres and arrangements
which facilitate buying and selling of financial assets, claims and services. There is specific place
or location to indicate a financial market. Wherever a financial transaction takes place, it is
deemed to have taken place in financial market. Hence financial markets are widespread

throughout the economic system. Sometimes we can identify a specific geographic location as
financial market as in the case of a stock exchange.
Classification of financial markets
Financial markets may be classified into different categories based on the nature of operations
they carry out. The following chart shows the classification of financial markets.
A) Un Organised Market
This market consists of number of money lenders, indigenous bankers etc. who lend money to
public. They also collect deposits from public. There are also private finance companies, chit
funds whose activities are not fully controlled by RBI. Since these companies are not completely
controlled by RBI or any other regulator, this market is called unorganised sector. RBI has taken
steps to bring these private finance companies and chit funds under its strict control by issuing
non-banking financial companies directions (1998). But still the regulations concerning their
dealings are inadequate and their financial instruments have not been standardized.
B) Organised Market
In the organised market there are standardised rules and regulations governing their dealings. In
organised market there is also a high degree of institutionalisation and instrumentalisation. These
markets are subject to strict supervision and control by the RBI and SEBI. These organised
markets are further classified into the following two types:
1. Capital Market
2. Money Market
1. Capital Market
The capital market is a market for financial assets or financial instruments having a long maturity
period. It deals with securities which have a maturity period of more than a year. E.g. equity
shares, debentures, preference shares etc. It mobilises long term capital for the companies in the
form of subscription. Capital market may be further classified into three as following:
I. Industrial securities Market.
II. Government securities Market.
III. Long term loans Market.
A. Industrial securities market

It is market which deals the securities issued by industrial companies. Industrial securities market
deals in the purchase and sale of equity shares, preference shares, debentures or bonds. It is a
market where industrial companies raise their capital or long term debt in the form of shares and
debentures. This market can be subdivided into two parts. They are as follows:
a) Primary market or New issue Market.
b) Secondary market or stock exchanges.
Primary market
Primary market is a market where the new securities are issued to public. It deals with securities
which are issued to the public for the first time. New issue market helps in capital formation.
There is no specific location where these transactions take place. Wherever these financial
transactions take place it is said to have taken place in new issue market. Hence it is an
arrangement where companies issue their shares and debentures to the public for long term
funds.
Secondary market
Secondary market is a market for secondary sale of securities. In other words, securities which
have already passed though the primary market are bought and sold in this market. Stock
exchanges are a very good example of secondary market. The securities are listed in stock
exchanges and are continuously bought and sold. This market provides continuous and regular
market for securities. The stock exchanges in India are regulated by the provision of the
Securities Contracts (Regulation) Act 1956. Securities and Exchange Board of India was
established by government of India for regulating and controlling stock exchanges in India.
B. Government securities markets

It is a market where securities issued by the government are traded. It is otherwise called as Gilt-
Edged securities market. They are called Gilt-Edged securities since government securities are
secured in nature because of the amount of income source a government has, compared to any
other company. In India government issues both long term as well as short term securities for its
financial needs. Long term government securities are traded in this market and short term
securities are traded in money market. Securities issued by Central and State Governments,

Semi-Government authorities like City Corporations, Port Trusts, State Electricity boards, all
India and state financial institutions and public sector enterprises are dealt in this market.
The major participants in this market are commercial banks, because they hold a very substantial
portion of these securities to satisfy their SLR requirements. The secondary market is very
narrow since most of the institutional investors tend to retain these until maturity.
C. Long term loans market

It is the collection of institutional lenders and borrowers of long term loans. Development banks
and commercial banks play a significant role in this market by supplying long term loans to
corporate customers. This market includes term loans market, mortgages market, and financial
guarantee market.
2.7 Money Market
Money market for short-term loans or financial assets it is market for lending and borrowing of
short term funds. The money market doesn’t refer to a particular place where short funds are
dealt with. It includes all individuals ’institutions and intermediaries dealing with short term
funds. The transactions between borrowers, lenders and middleman take place through
telephone, telegraph, mail and agents.
2.8 Meaning and Definition

Money market is a market for short-term loan or financial assets. It is a market for the lending
and borrowing of short term funds. As the name implies, it does not actually deals with money
but deals with near substitutes for money or near money like trade bills, promissory notes and
government papers drawn for a short period not exceeding one year. These short term
instruments can be converted into cash readily without any loss and at low transaction cost.
Money market is the center for dealing mainly in short – term money assets. It meets the short-
term requirements of borrowers and provides liquidity or cash to lenders. It is the place where
short-term surplus funds at the disposal of financial institutions and individuals are borrowed by

individuals, institutions and also the Government. Definition According to geotterycrowther,
“the money market is the collective name given to the various firms and institutions that deal in
various grades of near money.
2.9 Features of Money Market

The following are the general features of a money market:
1. It is a market purely for short-term funds or financial assets called near money.
2. It deals with financial assets having a maturity period up to one year only.
3. It deals with only those assets which can be converted into cash readily without loss and with
minimum transaction cost.
4. Generally transactions take place through phone i.e., oral communication. Relevant documents
and written communications can be exchanged subsequently. There is no formal place like stock
exchange as in the case of a capital market.
5. Transactions have to be conducted without the help of brokers.
6. The components of a money market are the Central Bank, Commercial Banks, Non-banking
financial companies, discount houses and acceptance house. Commercial banks generally play a
dominant in this market.
Objectives of Money Market

The following are the important objectives of a money market:
1. To provide a parking place for short-term surplus funds.
2. To provide room for overcoming short-term deficits.
3. To enable the Central Bank to influence and regulate liquidity in the economy through its
intervention in this market.
4. To provide a reasonable access to users of Short-term funds to meet their requirements
quickly, adequately and at reasonable costs.
2.10 Functions or importance of Money Market

The money market plays an important role in trade, commerce and financial systems in the
economy in the following ways

1. Development of Trade and Industry: Money market is an important source of financing trade
and industry through bills, commercial papers, etc. It influences availability of finance both –
national and international trade.
2. Development of Capital Market: The short-term rates of interest and the conditions that
prevail in the money market influence the long-term interest as well as the resource
mobilization in capital market.
3. Smooth Functioning of Commercial Banks: The money market provides the commercial
banks with facilities for temporarily employing their surplus funds in easily realisable assets.
It also enables commercial banks to meet their statutory requirements of Cash Reserve Ratio
(CRR) and Statutory Liquidity Ratio (SLR) by utilising the money market mechanism.
4. Effective Central Bank Control: A developed money market helps the effective functioning
of a central bank. It facilities effective implementation of the monetary policy of a central
bank. The central bank, through the money market, pumps new money into the economy in
slump and siphons the excess cash off in boom. The central bank, thus, regulates the flow of
money so as to promote economic growth with stability.
5. Formulation of Suitable Monetary Policy: Conditions prevailing in a money market serve as

a true indicator of the monetary state of an economy. Hence, it serves as a guide to the
Government in formulating and revising the monetary policy then and there depending upon
the monetary conditions prevailing in the market.
6. Non-Inflationary Source of Finance to Government: It offers to the Government to raise

short-term funds through the treasury bills floated in the market. In the absence of a
developed money market, the Government would be forced to print and issue more money or
borrow from the central bank. Both ways would lead to an increase in prices and the
consequent inflationary trend in the economy.
2.11 Difference between Capital and Money Market
Basis Money Market Capital Market

A random course of financial A kind of financial market where the
institutions, bill brokers, money company or government securities are
dealers, banks, etc., wherein generated and patronised for the
Meaning
dealing on short-term financial intention of establishing long-term
tools are being settled is finance to coincide the capital necessary
referred to as Money Market. is called as Capital Market.
Nature of
Informal Formal
Market
Commercial Papers, Treasury Bonds, Debentures, Shares, Asset

Financial Tools Certificate of Deposit, Bills, Securitization, Retained Earnings, Euro
Trade Credit, etc., Issues, etc.,
Commercial bank, bill brokers,

The stock exchange, Commercial banks,
non-financial institutions, the
Organizations non-banking organisations like insurance
central bank, acceptance
companies etc.,
houses, and so on.
Risk Factor Low High
Liquidity High Low
To achieve short term credit To achieve long term credit requirements

Purpose
requirements of the trade. of the trade.
Time Horizon Within a year More than a year
Rises liquidity of capitals in the Mobilization of Economies in the

Merit
market. market.

Return on
Less High
Investment
2.12 Financial Service

Financial Services may be simply defined as services offered by financial and banking
institutions like loan, insurance, etc.
Financial Services are concerned with the design and delivery of financial instruments and
advisory services to individuals and businesses within the area of banking and related
institutions, personal financial planning, investment, real assets, insurance etc.
It involves provision of a wide variety of fund/asset based and non-fund based/advisory services
and includes all kinds of institutions which provide intermediate financial assistance and
facilitate financial transactions of both individuals and corporate customers.
2.13 Features of Financial Services

• Financial services are Intangible
• Financial services are customer oriented
• The production and delivery of a service are simultaneous functions therefor are
inseparable
• They are perishable in nature and cannot be stored
• They are dynamic in nature as a financial service varies with the changing requirements of
the customer and the socio-economic environment. – must be dynamic socio economic
changes, disposable income
• They are proactive in nature and help to visualize the expectations of the market
• They acts as link between the investor and borrower
• They aid in distribution of risks
2.14 Types of Financial Activities
Fund based

1. Leasing : A lease may be defined as a contractual arrangement / transaction in which a party
owning an asset / equipment (lessor) provides the asset for use to another / transfer the right to
use the equipment to the user (lessee) over a certain / for an agreed period of time for
consideration Parties in leasing:
LESSOR: Lessor is the owner of the asset that is being leased.

LESSEE: Lessee is the receiver of the services of the asset under a lease contract.
2. Hire purchase. It is defined as a kind of transaction in which the goods are let on hire with an
option to the hirer to purchase them with the following stipulations:
Payment to be made in instalments over a specified period. The possession is delivered to the
hirer at the time of entering in to the contract The property in the goods passes to the hirer on
payment of the last instalment
3. Factoring
It in agreement between bankers, sellers and buyers undertakes the task of providing services
like account receivables, maintaining book of accounts, bills receivables etc
4. Mutual fund: it is financial services which collects small amount of money from the investors
and invest these amount in diversified portfolio and returns the benefits to the investors. A
mutual fund is a type of financial vehicle made up of a pool of money collected from many
investors to invest in securities such as stocks, bonds, money market instruments, and other
assets. Mutual funds are operated by professional money managers, who allocate the fund's
assets and attempt to produce capital gains or income for the fund's investors. A mutual fund's
portfolio is structured and maintained to match the investment objectives stated in its prospectus.

Mutual funds give small or individual investors access to professionally managed portfolios of
equities, bonds and other securities. Each shareholder,
therefore, participates proportionally in the gains or losses of the fund. Mutual funds invest in a
vast number of securities, and performance is usually tracked as the change in the total market
cap of the fund—derived by the aggregating performance of the underlying investments.
5. Bills discounting: selling the bills at discount to receive the cash benefits before the date
mentioned in the instruments like cheque, promissory notes etc.Bill Discounting is a discount/fee
which a bank takes from a seller to release funds before the credit period ends. This bill is then
presented to seller's customer and full amount is collected. Bill Discounting is mostly applicable
in scenarios when a buyer buys goods from the seller and the payment is to be made through
letter of credit
6. Housing finance: it is a financial service to provide housing loan for the purpose of
construction of house or purchasing flat. The Housing Finance Company is yet another form of
non-banking financial company which is engaged in the principal business of financing of
acquisition or construction of houses that includes the development of plots of lands for the
construction of new houses.
7. Venture capital: It is an equity form of risky capital to provide for unproven entrepreneurs and
unproven technology. provide to start-up companies and small businesses that are believed to
have long- Venture capital is financing that investors term growth potential. Venture capital
generally comes from well-off investors, investment banks and any other financial institutions.
However, it does not always take a monetary form; it can also be provided in the form of
technical or managerial
expertise.

8. Consumer credit: it is the loan facility to buy capital and durable products.
Fee based
1. Portfolio management: it is a service to be provided for the investor to guide them in investing
their money in order to get investment benefits. Portfolio believed in a principle that money to be
invested in different securities to reduce risk and to increase the return.
2. Corporate counselling: it is service to guide the entrepreneurs or promoters
in doing right things or doing things right. This service conducts SWOT analysis and provides
valuable suggestion to enterprise regarding what to start, where to start and whom to target in the
market.
3. Credit rating : It means measuring credit worthiness of the companies before they issue any
instruments or stocks to the public. In other words rating is a quantified assessment of the
creditworthiness of a borrower in. A credit general terms or with respect to a particular debt or
financial obligation. A credit rating can be assigned to any entity that seeks to borrow money—
an individual, corporation, state or provincial authority, or sovereign government. CRISIL,
CARE, ICRA are the main credit rating agencies in India.
4. Restructuring: It is a service to guide the corporate to have optimum capital structure to

reduce the burden of cost of debt and to increase the productivity. In other words Restructuring is
an action taken by a company to significantly modify the financial and operational aspects of the
company, usually when the business is facing financial pressures. Restructuring is a type of
corporate action taken that involves significantly modifying the debt, operations or structure of a
company as a way of limiting financial harm and improving the business. When a company is

having trouble making payments on its debt ,it will and adjust the terms of the debt in a debt
restructuring, creating a way to pay off bondholders.
5. Letter of credit A letter of credit, or "credit letter" is a letter from a bank guaranteeing that a
buyer's payment to a seller will be received on time and for the correct amount. In the event that
the buyer is unable to make a payment on the purchase, the bank will be required to cover the
full or remaining amount of the purchase. Due to the nature of international dealings, including
factors such as distance, differing laws in each country, and difficulty in knowing each party
personally, the use of letters of credit has become a very important aspect of international trade.
6. Merchant banking: A merchant bank is a company that conducts underwriting, loan services,
financial advising, and fundraising services for large corporations and high net worth individuals.
Unlike retail or commercial banks, merchant banks do not provide services to the general public.
They do not provide regular banking services like checking accounts and do not take deposits.
These banks are experts in international trade, which makes them specialists in dealing with
multinational corporations. Some of the largest merchant banks in the world include J.P.
Morgan, Goldman Sachs, and Citigroup.
7. Stock broking :
A stockbroker is a professional who executes buy and sell orders for stocks and other securities
on behalf of clients. A stockbroker may also be known as a registered representative, investment
adviser or simply, broker. Stockbrokers are usually associated with a brokerage firm and handle
transactions for retail and institutional customers alike. Stockbrokers often receive commissions
for their services, but individual compensation can vary greatly depending on where they are
employed. Brokerage firms and broker-dealers are also sometimes referred to as stockbrokers
themselves. The most commonly referenced stockbroker firms are discount brokers.

2.15 Financial sector reforms in India
1. Digitization
2. Enhanced Mobile Banking
3. UPI (Unified Payments Interface)
4. Block Chain
5. Artificial Intelligence Robots
6. The rise of Fintech Companies
7. Digital-Only Banks
8. Cloud Banking
9. Biometrics
10. Wearables
1. Digitization - In India, it all began not earlier than the 1980s when the banking sector
introduced the use of information technology to perform basic functions likes customer service,
book-keeping, and auditing. Soon, Core Banking Solutions were adopted to enhance customer
experience. However, the transformation began in the 1990s during the time of liberalization,
when the Indian economy exposed itself to the global market. The banking sector opened itself
for private and international banks which is the prime reason for technological changes in the
banking sector. Today, banks and financial institutions have benefitted in many ways by
adopting newer technologies. The shift from conventional to convenience banking is incredible.
Modern trends in banking system make it easier, simpler, paperless, signatureless and branchless
with various features like IMPS (Immediate Payment Service), RTGS (Real Time Gross
Settlement), NEFT (National Electronic Funds Transfer), Online Banking, and Telebanking.
Digitization has created the comfort of “anywhere and anytime banking.” It has resulted in the
reduced cost of various banking procedures, improved revenue generation, and reduced human
error. Along with increased customer satisfaction, it has enabled the customers creating
personalized solutions for their investment plans and improve the overall banking experience.
2. Enhanced Mobile Banking – Mobile banking is one of the most dominant current trends in
banking systems. As per the definition, it is the use of a smartphone to perform various banking

procedures like checking account balance, fund transfer, and bill payments, without the need of
visiting the branch. This trend has taken over the traditional banking systems. In the coming
years, mobile banking is expected to become even more efficient and effortless to keep up with
the customer demands. Mobile banking future trends hint at the acquisition of IoT and Voice-
Enabled Payment Services to become the reality of tomorrow. These voice-enabled services can
be found in smart televisions, smart cars, smart homes, and smart everything. Top industry
leaders are collaborating to adopt IoT-connected networks to create mobile banking technologies
that require users’ voice to operate.
3. UPI (Unified Payments Interface)- UPI or Unified Payments Interface has changed the way
payments are made. It is a real-time payment system that enables instant inter-bank transactions
with the use of a mobile platform. In India, this payment system is considered the future of retail
banking. It is one of the fastest and most secure payment gateways that is developed by National
Payments Corporation of India and regulated by the Reserve Bank of India. The year 2016 saw
the launch of this revolutionary transactions system. This system makes funds transfer available
24 hours, 365 days unlike other internet banking systems. There are approximately 39 apps and
more than 50 banks supporting the transaction system. In the post-demonetization India, this
system played a significant role. In the future, with the help of UPI, banking is expected to
become more “open.”
4. Block Chain - Blockchain is the new kid on the block and the latest buzzword. The technology
that works on the principles of computer science, data structures and cryptography and is the
core component of cryptocurrency, is said to be the future of banking and financial services
globally. Blockchain uses technology to create blocks to process, verify and record transactions,
without the ability to modify it.
NITI Aayog is creating IndiaChain, India’s largest blockchain network, which is expected to
revolutionize several industries, reduce the chances of fraud, enhance transparency, speed up the
transaction process, lower human intervention and create an unhackable database. Several
aspects of banking and financial services like payments, clearance and settlement systems, stock
exchanges and share markets, trade finance, and lending are predicted to be impacted. With its
strenuous design, blockchain technology is a force to be reckoned with.

5. Artificial Intelligence Robots - Several private and nationalized banks in India have started to
adopt chatbots or Artificial intelligence robots for assistance in customer support services. For
now, the use of this technology is at a nascent stage and evolution of these chatbots is not too far
away. Usage of chatbots is among the many emerging trends in the Indian banking sector that is
expected to grow.
More chatbots with the higher level of intelligence are forecasted to be adopted by the banks and
financial institutions for improved customer interaction personalized solutions. The technology
will alleviate the chances of human error and create accurate solutions for the customers. Also, it
can recognize fraudulent behavior, collate surveys and feedback and assist in financial decisions.
6. The rise of Fintech Companies - Previously, banks considered Fintech companies a disrupting
force. However, with the changing trends in the financial services sector in India, fintech
companies have become an important part of the sector. The industry has emerged as a
significant part of the ecosystem. With the use of financial technology, these companies aim to
surpass the traditional methods of finance. In the past few decades, massive investment has been
made in these companies and it has emerged into a multi-billion-dollar industry globally.Fintech
companies and fintech apps have changed the way financial solutions are provided to the
customers. Besides easy access to financial services, fintech companies have led to a massive
improvement in services, customer experience, and reduced the price paid. In India, the dynamic
transformation has been brought upon by several important elements like fintech startups,
established financial institutions, initiatives like “Start-Up India” by Government of India,
incubators, investors, and accelerators. According to a report by National Association of
Software and Services Companies (NASSCOM), the fintech services market is expected to grow
by 1.7 times into an $8 billion market by 2020.
7. Digital-Only Banks - It is a recent trend in the Indian financial system and cannot be ignored.
With the entire banking and financial services industry jumping to digital channels, digital-only
bankshave emerged to create paperless and branchless banking systems. This is a new breed of
banking institutions that are overtaking the traditional models rapidly. These banks provide
banking facilities only through various IT platforms that can be accessed on mobile, computers,
and tablets. It provides most of the basic services in the most simplified manner and gives access

to real-time data. The growing popularity of these banks is said to be a real threat to traditional
banks.
ICICI Pockets is India’s first digital-only bank. These banks are attractive to the customers
because of their cost-effective operating models. At the same time, though virtually, they provide
high-speed banking services at very low transaction fees. In today’s fast lane life, these banks
suit the customer needs because they alleviate the need of visiting the bank and standing in a
queue.
8. Cloud Banking - Cloud technology has taken the world by storm. It seems the technology will
soon find its way in the banking and financial services sector in India. Cloud computing will
improve and organize banking and financial activities. Use of cloud-based technology means
improved flexibility and scalability, increased efficiency, easier integration of newer
technologies and applications, faster services and solutions, and improved data security. In
addition, the banks will not have to invest in expensive hardware and software as updating the
information is easier on cloud-based models.
9. Biometrics - Essentially for security reasons, a Biometric Authentication system is changing

the national identity policies and the impact is expected to be widespread. Banking and financial
services are just one of the many other industries that will be experiencing the impact. With a
combination of encryption technology and OTPs, biometric authentication is forecasted to create
a highly-secure database protecting it from leaks and hackers attempts. Financial services in
India are exploring the potential of this powerful technology to ensure sophisticated security to
customers’ account and capital.
10. Wearables - With smartwatch technology, the banking and financial services technology is
aiming to create wearables for retail banking customers and provide more control and easy
access to the data. Wearables have changed the way we perform daily activities. Therefore, this
technology is anticipated to be the future retail banking trend by providing major banking
services with just a click on a user-friendly interface on their wearable device.

2.16 Recent mergers of nationalized bank
Background:
The announcement of the mega-merger of the ten big public sector banks (PSBs) into four was
made by Union Finance Minister Nirmala Sitharaman in August 2019. The merger was under the
Bank Consolidation plan among other major initiatives and steps with the aim to boost India’s
economic growth. The Union Cabinet under the chairmanship of PM Narendra Modi gave its
official approval to the merger plan in early March 2020.
The government made this announcement in early March with the purpose of creating stronger
banks in the public sector. Though the central government announced the plan but RBI has been
given the charge for the successful implementation of the plan.
The branches of the state-run banks will work as the branches of the banks in which they have
amalgamated. This decision by GOI has been taken under Section 7 of RBI that gives the power
to the government to make rulings on RBI functioning in the interest of the public.
Details of 10 State-Run Banks Amalgamation:

As per the consolidation scheme, the details of 10 state-run banks into 4 are mentioned below-
• United Bank of India and Oriental Bank of Commerce will merge into Punjab National Bank
• Syndicate Bank will merge into Canara Bank
• Allahabad Bank into Indian Bank
• Corporation and Andhra Banks will be merged in Union Bank of India
The major objectives of the merger are:

• To help India make a USD 5 trillion economy
• Reducing the lending cost
• Enhancing the capacity in order to increase credit
• To bring next-generation technology for the banking sector
• Banks that have strong national and international reach
• To improve the ability to raise market resources.

2.17 The advantages of merger are:
• It reduces the cost of operation
• The merger helps in financial inclusion and broadening the geographical reach of the
banking operation
• NPA and risk management are benefited
• Merger leads to availability of a bigger scale of expertise and that helps in minimising the
scope of inefficiency which is more in small banks
• The disparity in wages for bank staff members will get reduced. Service conditions get
uniform
• Merger sees a bigger capital base and higher liquidity and that reduces the government's
burden of recapitalising the public sector banks time and again
• Redundant posts and designations can be abolished which will lead to financial savings
The disadvantages of merger:

• Many banks have a regional audience to cater to and merger destroys the idea of
decentralisation.
• Larger banks might be more vulnerable to global economic crises while the smaller ones
can survive
• Merger sees the stronger banks coming under pressure because of the weaker banks.
• Merger could only give a temporary relief but not real remedies to problems like bad loans
and bad governance in public sector banks
• Coping with staffers' disappointment could be another challenge for the governing board of
the new bank. This could lead to employment issues.
2.18 Summary
Meaning of Financial System

The word ‘system ’in the term ‘financial system ’implies a set of complex and closely connected
or intermixed instructions, agents, practices, markets, transactions, claims and liabilities in the
economy. Finance is the study of money, its nature, creation, behavior, regulations and

administration. Therefore, financial system includes all those activities dealing in finance,
organized into a system.
Importance of Indian Financial System

• It accelerates the rate and volume of savings through provision of various financial
instruments and efficient mobilization of savings
• It aids in increasing the national output of the country by providing funds to corporate
customers to expand their respective business
• It protects the interests of investors and ensures smooth financial transactions through
regulatory bodies such as RBI, SEBI etc.
• It helps economic development and raising the standard of living of people
• It helps to promote the development of weaker section of the society through rural
development banks and co-operative societies
• It helps corporate customers to make better financial decisions by providing effective
financial as well as advisory services
• It aids in Financial Deepening and Broadening
Financial markets: Financial markets can be referred to as those centres and arrangements
which facilitate buying and selling of financial assets, claims and services. There is specific place
or location to indicate a financial market. Wherever a financial transaction takes place, it is
deemed to have taken place in financial market. Hence financial markets are widespread
throughout the economic system. Sometimes we can identify a specific geographic location as
financial market as in the case of a stock exchange.
Capital Market
The capital market is a market for financial assets or financial instruments having a long maturity
period. It deals with securities which have a maturity period of more than a year. E.g. equity
shares, debentures, preference shares etc. It mobilises long term capital for the companies in the
form of subscription.
Money market

is a market for short-term loan or financial assets. It is a market for the lending and borrowing of
short term funds. As the name implies, it does not actually deals with money but deals with near
substitutes for money or near money like trade bills, promissory notes and government papers
drawn for a short period not exceeding one year. These short term instruments can be converted
into cash readily without any loss and at low transaction cost.
Financial Service
Financial Services may be simply defined as services offered by financial and banking
institutions like loan, insurance, etc.
Financial Services are concerned with the design and delivery of financial instruments and
advisory services to individuals and businesses within the area of banking and related
institutions, personal financial planning, investment, real assets, insurance etc.
The advantages of merger are:
banking operation
uniform

decentralisation.
can survive

Financial sector reforms in India

1. Digitization
2. Enhanced Mobile Banking
3. UPI (Unified Payments Interface)
4. Block Chain
5. Artificial Intelligence Robots
6. The rise of Fintech Companies
7. Digital-Only Banks
8. Cloud Banking
9. Biometrics
10. Wearables
The advantages of merger are:

banking operation
uniform

decentralisation.
can survive

Section A
1. What is Financial System
2. What is a Capital market
3. What is Primary Market
4. What is Secondary Market
5. What is Organised Market
6. What is a Money Market
7. What do you mean by Financial Service
8. What is Fee based Financial Service
9. What is Fund based Financial Service
Section B
1. Write the function of Financial system

2. Write the Importance of Financial System
3. Write the features of Money Market
4. Write the objectives of Money Market
5. What are the advantages of Merger
6. What are the disadvantages of Merger

7. Explain the differences between capital and money market
Section C
1. Explain the components of Indian Financial System

2. Explain the Functions or Importance of Money Market
2.20 References
1. Gordon &Natrajan: Banking sTheory Law and Practice, HPH.
Skill Development
• Analyse different types of instruments traded in capital markets
• Conduct a study on the evolution of stock exchange in India
• Collect the list of financial instruments present in India

Chapter 3
FINANCIAL INSTITUTIONS
 Evolution of Banking and Non-Banking Financial Institutions
 Constitution, Objectives & Functions of IDBI, SFCs, SIDCs, LIC, EXIM Bank.
 Mutual Funds – Features and Types.
3.1 Introduction to banking and non-banking financial institutions

3.2 Constitution, Objectives & Functions of IDBI
3.3 Constitution, Objectives & Functions of SFCs

3.4 Constitution, Objectives & Functions of SIDCs
3.5 Constitution, Objectives & Functions of LIC
3.6 Constitution, Objectives & Functions of EXIM Bank
3.7 Mutual Funds-Meaning types
3.8 Mutual funds advantages and disadvantages

3.1 Introduction to banking financial institutions
A bank is a financial institution that provides banking and other financial services to their
customers. A bank is generally understood as an institution which provides fundamental banking
services such as accepting deposits and providing loans. There are also nonbanking institutions
that provide certain banking services without meeting the legal definition of a bank. Banks are a
subset of the financial services industry. A banking system also referred as a system provided by
the bank which offers cash management services for customers, reporting the transactions of
their accounts and portfolios, throughout the day. The banking system in India should not only
be hassle free but it should be able to meet the new challenges posed by the technology and any
other external and internal factors. For the past three decades, India’s banking system has several
outstanding achievements to its credit. The Banks are the main participants of the financial
system in India. The Banking sector offers several facilities and opportunities to their customers.
All the banks safeguards the money and valuables and provide loans, credit, and payment
services, such as checking accounts, money orders, and cashier’s cheques. The banks also offer
investment and insurance products. As a variety of models for cooperation and integration
among finance industries have emerged, some of the traditional distinctions between banks,
insurance companies, and securities firms have diminished. In spite of these changes, banks
continue to maintain and perform their primary role is accepting deposits and lending funds from
these deposits.
3.1.1 History and evolution of banking in India
There are three different phases in the history of banking in India.
I. Pre-Nationalization Era.
II. Nationalization Stage.

III. Post Liberalization Era.
I. Pre-Nationalization Era:
In India the business of banking and credit was practices even in very early times. The
remittance of money through Hundies, an indigenous credit instrument, was very popular.
The hundies were issued by bankers known as Shroffs, Sahukars, Shahus or Mahajans in
different parts of the country. The modern type of banking, however, was developed by the
Agency Houses of Calcutta and Bombay after the establishment of Rule by the East India
Company in 18th and 19th centuries.
During the early part of the 19th Century, ht volume of foreign trade was relatively small.
Later on as the trade expanded, the need for banks of the European type was felt and the
government of the East India Company took interest in having its own bank. The
government of Bengal took the initiative and the first presidency bank, the Bank of
Calcutta (Bank of Bengal) was established in 180. In 1840, the Bank of Bombay and IN
1843, the Bank of Madras was also set up.
These three banks also known as “Presidency Bank”. The Presidency Banks had their
branches in important trading centers but mostly lacked in uniformity in their operational
policies. In 1899, the Government proposed to amalgamate these three banks in to one so
that it could also function as a Central Bank, but the Presidency Banks did not favour the
idea. However, the conditions obtaining during world war period (1914- 1918) emphasized
the need for a unified banking institution, as a result of which the Imperial Bank was set up
in1921. The Imperial Bank of India acted like a Central bank and as a banker for other
banks.
The RBI (Reserve Bank of India) was established in 1935 as the Central Bank of the
Country. In 1949, the Banking Regulation act was passed and the RBI was nationalized and
acquired extensive regulatory powers over the commercial banks. In 1950, the Indian
Banking system comprised of the RBI, the Imperial Bank of India, Cooperative banks,
Exchange banks and Indian Joint Stock banks.

II. Nationalization Stage.
After Independence, in 1951, the All India Rural Credit survey, committee of
Direction with Shri. A. D. Gorwala as Chairman recommended amalgamation of
the Imperial Bank of India and ten others banks into a newly established bank
called the State Bank of India (SBI). The Government of India accepted the
recommendations of the committee and introduced the State Bank of India bill in
the Lok Sabha on 16thApril 1955 and it was passed by Parliament and got the
president’s assent on 8th May 1955. The Act came into force on 1st July 1955, and
the Imperial Bank of India was nationalized in 1955 as the State Bank of India.
The main objective of establishing SBI by nationalizing the Imperial Bank of India
was “to extend banking facilities on a large scale more particularly in the rural and
semi-urban areas and to diverse other public purposes.” In 1959, the SBI
(Subsidiary Bank) act was proposed and the following eight state-associated banks
were taken over by the SBI as its subsidiaries.
Name of the Bank Subsidiary with effect from
1. State Bank of Hyderabad 1st October 1959
2. State Bank of Bikaner 1st January 1960
3. State Bank of Jaipur 1st January 1960
4. State Bank of Saurashtra 1st May 1960
5. State Bank of Patiala 1st April 1960
6. State Bank of Mysore 1st March 1960
7. State Bank of Indore 1st January 1968
8. State Bank of Travancore 1st January 1960

III. Post Liberalization Era.
Post-Liberalization Era—Thrust on Quality and Profitability: By the beginning of
1990, the social banking goals set for the banking industry made most of the public
sector resulted in the presumption that there was no need to look at the fundamental
financial strength of this bank. Consequently they remained undercapitalized.
Revamping this structure of the banking industry was of extreme importance, as the
health of the financial sector in particular and the economy was a whole would be
reflected by its performance.
The need for restructuring the banking industry was felt greater with the initiation
of the real sector reform process in 1992. The reforms have enhanced the
opportunities and challenges for the real sector making them operate in a borderless
global market place. However, to harness the benefits of globalization, there should
be an efficient financial sector to support the structural reforms taking place in the
real economy. Hence, along with the reforms of the real sector, the banking sector
reformation was also addressed.
The causes for the lackluster performance of banks, formed the elements of the
banking sector reforms. Some of the factors that led to the dismal performance of
banks were.
 Regulated interest rate structure.
 Lack of focus on profitability.
 Lack of transparency in the bank’s balance sheet.
 Lack of competition.
 Excessive regulation on organization structure and managerial resource.
 Excessive support from government.

Meaning of Non-Banking Financial Institutions
A Non-Banking Financial Company (NBFC) is a company registered under the Companies Act,
1956 engaged in the business of loans and advances, acquisition of
shares/stocks/bonds/debentures/securities issued by Government or local authority or other
marketable securities of a like nature, leasing, hire-purchase, insurance business, chit business
but does not include any institution whose principal business is that of agriculture activity,
industrial activity, purchase or sale of any goods (other than securities) or providing any services
and sale/purchase/construction of immovable property. A non-banking institution which is a
company and has principal business of receiving deposits under any scheme or arrangement in
one lump sum or in installments by way of contributions or in any other manner, is also a non-
banking financial company (Residuary non-banking company).
3.2 Constitution, Objectives & Functions of IDBI
Introduction
Industrial Development Bank of India (IDBI) established under Industrial Development Bank of
India Act, 1964, is the principal financial institution for providing credit and other facilities for
developing industries and assisting development institutions.
Till 1976, IDBI was a subsidiary bank of RBI. In 1976 it was separated from RBI and the
ownership was transferred to Government of India. IDBI is the tenth largest bank in the world in
terms of development. The National Stock Exchange (NSE), the National Securities Depository
Services Ltd. (NSDL), Stock Holding Corporation of India (SHCIL) are some of the Institutions
which has been built by IDBI.

3.2.1 Constitution
IDBI consist of a Board of Directors, consisting of a chairman and Managing Director

appointed by the Government of India, a Deputy Governor of the RBI nominated by that
bank and 20 other Directors are nominated by the Central Government.
The board had constituted an Executive Committee consisting of 10 Directors, including

the Chairman and Managing Director. The executive committee is empowered to sanction
financial assistance The Head office of IDBI is located in Mumbai. The bank has five
regional offices, one each in Kolkata, Guwahati, New Delhi, Chennai and Mumbai.
Besides the bank have 21 branch offices
3.2.2 Objectives of IDBI
The main objectives of IDBI is to serve as the apex institution for term finance for
industry in India. Its objectives include:
1. Co-ordination, regulation and supervision of the working of other financial

institutions such as IFCI , ICICI, UTI, LIC, Commercial Banks and SFCs.
2. Supplementing the resources of other financial institutions and there by widening
the scope of their assistance.
3. Planning, promotion and development of key industries
and diversification of industrial growth.
4. Devising and enforcing a system of industrial growth that conforms to national
priorities

3.2.3 Functions of IDBI
The IDBI has been established to perform the following functions-
1. To grant loans and advances to IFCI, SFCs or any other financial institution by way of
refinancing of loans granted by such institutions which are repayable within 25 year.
2. To grant loans and advances to scheduled banks or state co-operative banks by way of
refinancing of loans granted by such institutions which are repayable in 15 years.
3. To grant loans and advances to IFCI, SFCs, other institutions, scheduled banks, state
co-operative banks by way of refinancing of loans granted by such institution to
industrial concerns for exports.
4. To discount or re-discount bills of industrial concerns.
5. To underwrite or to subscribe to shares or debentures of industrial concerns.
6. To subscribe to or purchase stock, shares, bonds and debentures of other financial
institutions.
7. To grant line of credit or loans and advances to other financial institutions such as IFCI,
SFCs, etc.
8. To grant loans to any industrial concern.
9. To guarantee deferred payment due from any industrial concern.
10. To guarantee loans raised by industrial concerns in the market or from institutions.
11. To provide consultancy and merchant banking services in or outside India.
12. To provide technical, legal, marketing and administrative assistance

13. Planning, promoting and developing industries to fill up gaps in the industrial structure.
14. To act as trustee for the holders of debentures or other securities.
3.3 Constitution, Objectives & Functions of SFCs

Introduction The State Finance Corporations (SFCs) are the integral part of institutional
finance structure in the country. SFC promotes small and medium industries of the states.
Besides, SFCs are helpful in ensuring balanced regional development, higher investment,
more employment generation and broad ownership of industries.
At present there are 18 state finance corporations (out of which 17 SFCs were established
under SFC Act 1951). Tamil Nadu Industrial Investment Corporation Ltd. established
under Company Act, 1949, is also working as state finance corporation.
3.3.1 Constitution
The State Finance Corporations management is vested in a Board of ten directors. The
State Government appoints the managing director generally in consultation with the
Reserve Bank and nominates three other directors. The insurance companies, scheduled
banks, investment trusts, co-operative banks and other financial institutions elect three
directors. Thus the majority of the directors are nominated by the government institutions
3.3.2 Functions
1. The SFCs grant loans mainly for acquisition of fixed assets like land, building, plant
and machinery.
2. The SFCs provide financial assistance to industrial units whose paid-up capital and
reserves do not exceed Rs. 3cr (or such higher limit up to Rs. 30cr as may be
specified by the central government).
3. The SFCs underwrite new stocks, shares, debentures etc., of industrial concerns.

4. The SFCs provide guarantee loans raised in the capital market by scheduled banks,
industrial concerns, and state co-operative banks to be repayable within 20 years
3.4 Constitution, Objectives & Functions of SIDCs

Introduction
In many state governments, for the promotion of small scale industries, a separate
corporation has been set up which is known as Small Industries Development Corporation.
They undertake all kinds of activities for the promotion of small scale industries. Right
from the stage of installation, to the stage of commencing production, these Corporations
help small scale industries (SSI) in many ways.
In short, they provide infrastructure facilities to small scale industries. Due to the
assistance provided by SIDCO, many backward areas in most of the states have been
developed. So, SIDCO has also been responsible in spreading the industrial activity
throughout several states.
3.4.1 Objectives of SIDCs
1. The main objective of SIDCs is to stimulate the growth of industries in the small scale
sector
2. To provide infrastructure facilities like roads, drainage, electricity, water supply, etc is one
of the primary objective of SIDCs.
3. To Promote industrial estates which will provide industrial sheds of different sizes with all
basic infrastructure facilities.
4. To Provide technical assistance through training facilities to the entrepreneurs.
5. To Promote skilled labor through the setting up of industrial training institutes.
3.4.2. Functions of SIDCs
1. 1 It evolve a national policy for the development of small-scale industries

2. It co-ordinate the policies and programmes of various State Governments

3. It maintain a proper liaison with the related Central Ministries, Planning Commission,
State Governments, Financial Institutions etc
4. It co-ordinate the programmes for the development of industrial estates.
5. It reserve items for production by small-scale industries
6. It collects data on consumer items imported and then, encourage the setting of
industrial units to produce these items by giving coordinated assistance,
7. It renders required support for the development of ancillary units, and

8. It encourages small-scale industries to actively participate in Government Stores
Purchase Program by giving them necessary guidance, market advice, and assistance.
9. It makes provision to technical services for improving technical process, production
planning, selecting appropriate machinery, and preparing factory lay-out and design.
3.5 Constitution, Objectives & Functions of LIC
3.5.1 Objectives of LIC
1.To assure full protection to the policy holder.
2. To encourage & mobilize public savings.
3. Effective utilization of those savings in different forms of investments for national &
economic development.
4. To create liquidity position in public.
5. To motivate saving habits in public.
6. Provisions for old age and tax concession
3.5.2 Functions of LIC
1. The main function of LIC is to collect the savings of the people through a life insurance
policy and invest that money in various financial markets.

2. One of the main functions of LIC is to invest fund into government securities so as to protect
the capital of the people who have given their money to LIC.
3. LIC has to issue an insurance policy at affordable rates to people.
4. LIC provides direct loans to industries at lower interest rates. The rate of interest is as low as
12% for the entire tenure.
5. It is one of the major stakeholders in many of the blue-chip companies in the Indian stock
market.
6. It also provides refinancing activities through SFCs in different states and cities.
7. It also invests in the various corporates via bonds and securities, thus supports corporate
funding in an indirect way.
8. It also gives loan to the various national projects which are important for economic growth.
9. It provides financial supports to socially-oriented projects like electrification, sewage, and
water channelizing, etc
10. It also gives a housing loan at reasonable rates.
11. It is the main channel between savings and investment for the people in India
3.6 Constitution, Objectives & Functions of EXIM Bank
Introduction
For a long time, the need for a separate institution for export finance was not felt in the country
due to the closed market conditions and India’s limited share in world export. It is only during
the 1980s, the need to increase India’s export was felt, owing to increased foreign debts, which
compelled India to go for an Apex institution and the Export Import Bank (Exim Bank) was set
up in 1982.
3.6.1 Objectives
1. To ensure and integrated and co-ordinated approach in solving the allied problems
encountered by exporters in India
2. To pay specific attention to the exports of capital goods
3. Export projection
4. To facilitate and encourage joint ventures and export of technical services and
international and merchant banking
5. To extend buyers’ credit and lines of credit.
6. To tap domestic and foreign markets for resources for undertaking development and
financial activities in the export sector
3.6.2 Functions
1. Finance for exports and Imports: Exim bank helps by providing finance for exports
and imports of goods as well as services from India. One of the major export policies
adopted by government of India is the export of value added items.
2. Finance on deferred basis: Exim bank provides finance on deferred basis for
importing capital equipment and other machinery. The cost of capital equipment in
foreign countries will be more and the Indian importer cannot afford to pay lump sum
payment in foreign exchange
3. Lease Finance: It provides lease finance for importing capital equipment.
Under cross border leasing, the lessor may be in a foreign country, while the lessee
will be in India. The Exim bank helps the Indian lessee in obtaining the capital
equipment on lease by making the lease payment in terms of foreign exchange
4. Finance to export projects: Export projects in Third World countries are financed.
India has taken up various export projects in Third World countries, such as railway
project in Tanzania. Similarly, projects on some of the oil wells in Kuwait and Iraq
taken up by Oil and Natural Gas Commission (ONGC) are also financed by Exim
bank
5. Line of credit: The Exim bank provides line of credit to foreign importers so that
exports from India can increase. Under line of credit, exim bank will provide finance
to the Central bank of the borrowing country which in turn will provide to the
commercial bank and ultimately the credit will reach the importer.
6. Refinance in foreign exchange: The Exim bank obtains bulk loan in foreign
currencies in the foreign exchange market and provides refinance to the financial
institutions, providing export finance. Different types of exporters may require
different foreign currencies and these are obtained by the Exim bank at a competitive
interest rate and are given to commercial banks for lending to exporters.

7. Contribution to Equity fund: The Exim bank also contributes to the
shares, debentures of Indian companies involved in exports. Export companies while
raising capital, may issue shares which may be partly financed by Exim bank. The
bank may extend this facility as a temporary finance as it will not retain the shares
permanently.
8. Consultancy Services: The Exim bank also provides technical, administrative and
other assistance to exporters. Export projects are analyzed by the Exim bank from the
point of view of technical, managerial, marketing and financial feasibility.
3.7 Mutual funds
A Mutual Fund is a collective investment vehicle formed with the specific objective of raising
money from a large number of individuals and investing it according to a pre-specified objective,
with the benefits accrued to be shared among the investors on a pro-rata basis in proportion to
their investment. According to Encyclopedia Americana, “Mutual funds are open end investment
companies that invest shareholders’ money in portfolio or securities. They are open ended in that
they normally offer new shares to the public on a continuing basis and promise to redeem
outstanding shares on any business day.”
3.7.1 Types of Mutual Funds

I. Functional Classification
1. Open-ended schemes: In case of open-ended schemes, the mutual fund continuously offers to
sell and repurchase its units at net asset value (NAV) or NAV-related prices. Unlike close-ended
schemes, open-ended ones do not have to be listed on the stock exchange and can also offer
repurchase soon after allotment. Investors can enter and exit the scheme any time during the life
of the fund.
2. Close-ended schemes: Close-ended schemes have a fixed corpus and a stipulated maturity
period ranging between 2 to 5 years. Investors can invest in the scheme when it is launched. The
scheme remains open for a period not exceeding 45 days. Investors in close-ended schemes can
buy units only from the market, once initial subscriptions are over and thereafter the units are
listed on the stock exchanges where they dm be bought and sold.

3. Interval scheme: Interval scheme combines the features of open-ended and close-ended
schemes. They are open for sale or redemption during predetermined intervals at NAV related
prices.
II. Portfolio Classification

1. Income funds: The aim of income funds is to provide safety of investments and regular
income to investors. Such schemes invest predominantly in income-bearing instruments like
bonds, debentures, government securities, and commercial paper. The return as well as the
risk are lower in income funds as compared to growth funds.
2. Growth funds: The main objective of growth funds is capital appreciation over the medium-
to-long- term. They invest most of the corpus in equity shares with significant growth
potential and they offer higher return to investors in the long-term. They assume the risks
associated with equity investments. There is no guarantee or assurance of returns. These
schemes are usually close-ended and listed on stock exchanges.
3. Balanced funds: The aim of balanced scheme is to provide both capital appreciation and
regular income. They divide their investment between equity shares and fixed nice bearing
instruments in such a proportion that, the portfolio is balanced. The portfolio of such funds
usually comprises of companies with good profit and dividend track records. Their exposure
to risk is moderate and they offer a reasonable rate of return.
4. Money market mutual funds: They specialize in investing in short-term money market
instruments like treasury bills, and certificate of deposits. The objective of such funds is high
liquidity with low rate of return.
III. Geographical Classification

1. Domestic funds: Funds which mobilise resources from a particular geographical locality
like a country or region are domestic funds. The market is limited and confined to the
boundaries of a nation in which the fund operates. They can invest only in the securities
which are issued and traded in the domestic financial markets.

2. Offshore funds: Offshore funds attract foreign capital for investment in ‘the country of
the issuing company. They facilitate cross-border fund flow which leads to an increase in
foreign currency and foreign exchange reserves. Such mutual funds can invest in
securities of foreign companies.
IV. Other Classification

1. Sectorial: These funds invest in specific core sectors like energy, telecommunications,
IT, construction, transportation, and financial services. Some of these newly opened-up
sectors offer good investment potential.
2. Tax saving schemes: Tax-saving schemes are designed on the basis of tax policy with
special tax incentives to investors. Mutual funds have introduced a number of taxsaving
schemes. These are close--ended schemes and investments are made for ten years,
although investors can avail of encashment facilities after 3 years. These schemes
contain various options like income, growth or capital application.
3. Equity-linked savings scheme (ELSS): In order to encourage investors to invest in
equity market, the government has given tax-concessions through special schemes.
Investment in these schemes entitles the investor to claim an income tax rebate, but
these schemes carry a lock-in period before the end of which funds cannot be
withdrawn
4. Special schemes: Mutual funds have launched special schemes to cater to the special
needs of investors. UTI has launched special schemes such as Children’s Gift Growth
Fund, 1986, Housing Unit Scheme, 1992, and Venture Capital Funds.
5. Gilt funds: Mutual funds which deal exclusively in gilts are called gilt funds. With a
view to creating a wider investor base for government securities, the Reserve Bank of
India encouraged setting up of gilt funds. These funds are provided liquidity support by
the Reserve Bank.
6. Load funds: Mutual funds incur certain expenses such as brokerage, marketing
expenses, and communication expenses. These expenses are known as ‘load’ and are
recovered by the fund when it sells the units to investors or repurchases the units from
withholders.

7. Index funds: An index fund is a mutual fund which invests in securities in the index on
which it is based BSE Sensex or S&P CNX Nifty. It invests only in those shares which
comprise the market index and in exactly the same proportion as the
companies/weightage in the index so that the value of such index funds varies with the
market index.
3.7.2 Benefits of Mutual Funds

An investor can invest directly in individual securities or indirectly through a financial
intermediary. Globally, mutual funds have established themselves as the means of
investment for the retail investor.
1. Professional management: An average investor lacks the knowledge of capital

market operations and does not have large resources to reap the benefits of
investment. Hence, he requires the help of an expert. It, is not only expensive to ‘hire
the services’ of an expert but it is more difficult to identify a real expert. Mutual
funds are managed by professional managers who have the requisite skills and
experience to analyse the performance and prospects of companies. They make
possible an organised investment strategy, which is hardly possible for an individual
investor.

2. Portfolio diversification: An investor undertakes risk if he invests all his funds in a
single scrip. Mutual funds invest in a number of companies across various industries
and sectors. This diversification reduces the riskiness of the investments.
3. Reduction in transaction costs: Compared to direct investing in the capital market,

investing through the funds is relatively less expensive as the benefit of economies of
scale is passed on to the investors.
4. Liquidity: Often, investors cannot sell the securities held easily, while in case of
mutual funds, they can easily encash their investment by selling their units to the fund
if it is an open-ended scheme or selling them on a stock exchange if it is a close-
ended scheme.
5. Convenience: Investing in mutual fund reduces paperwork, saves time and makes
investment easy.
7. Flexibility: Mutual funds offer a family of schemes, and investors have the option of
transferring their holdings from one scheme to the other.
8. Tax benefits Mutual fund investors now enjoy income-tax benefits. Dividends
received from mutual funds’ debt schemes are tax exempt to the overall limit of Rs
9,000 allowed under section 80L of the Income Tax Act.
9. Transparency Mutual funds transparently declare their portfolio every month. Thus
an investor knows where his/her money is being deployed and in case they are not
happy with the portfolio they can withdraw at a short notice.
10. Stability to the stock market Mutual funds have a large amount of funds which
provide them economies of scale by which they can absorb any losses in the stock
market and continue investing in the stock market. In addition, mutual funds increase
liquidity in the money and capital market.

11. Equity research Mutual funds can afford information and data required for
investments as they have large amount of funds and equity research teams available
with them.
3.7.3 Disadvantages of mutual funds
1. Costs to manage the mutual fund
The salary of the market analysts and fund manager comes from the investors. Total fund
management charge is one of the first parameters to consider when choosing a mutual
fund. Higher management fees do not guarantee better fund performance.
2. Lock-in periods
Many mutual funds have long-term lock-in periods, ranging from five to eight years.
Exiting such funds before maturity can be an expensive affair. A specific portion of the
fund is always kept in cash to pay out an investor who wants to exit the fund. This portion
cannot earn interest for investors.
3. Fluctuating returns: Mutual funds do not offer fixed guaranteed returns in that you
should always be prepared for any eventuality including depreciation in the value of your
mutual fund. In other words, mutual funds entail a wide range of price fluctuations.
Professional management of a fund by a team of experts does not insulate you from bad
performance of your fund.
-------------------------------------------------------------------------------------------------------------------

REFERENCES
1. E Gardon& K Natarajan: Financial Markets & Services, HPH.
2. Vasant Desai : Financial Markets & Financial Services , Himalaya Publishing House.
3. K.Nanje Gowda, Financial Markets & Financial Services , VBH.
4. V.A. Avadhani : Financial Services in India, HPH.
5. Meir Kohn: Financial Institutions and Markets, Tata Mc Graw Hill 6. R.M Srivastava / D.
Nigam; Dynamics of Financial Markets & Institutions in India, Excel Books.
7. L M Bhole: Financial Institutions and Markets, Tata Mc Graw Hill 8. Dr. K.

Venkataramanappa, SHB Publications
Skill development
 Visit LIC and collect various services list provided by them

 Collect all nationalized banks list in India
 Analyze impact of recent mergers of nationalized banks in India
 Visit Karnataka State Financial Institution and collect various schemes introduced by
them for industrial development
2 marks Questions
1. Define bank
2. Define non bank
3. What are mutual funds?
4. What is index fund?
5. Expand IDBI, SFCs, SIDCs

Five marks questions
1. Explain their differences between banking and non banking financial institutions.
2. Explain function of IDBI
3. Explain advantages of Mutual funds
10 marks questions.
1. Explain objectives and functions of IDBI

2. Explain objectives and functions of SFCs
3. Explain objectives and functions of LIC
4. Explain objectives and functions of SIDCs
5. Explain objectives and functions of EXIM bank
6. Explain different types of mutual funds
7. Explain History and evolution of banking in India

Chapter 4 : REGULATORY INSTITUTIONS
4.1 Reserve Bank of India (RBI)

4.1.1 Evolution
4.1.2 Organization
4.1.3 Objectives
4.1.4 Roles and Functions.
4.2 Monetary policies.
4.3 The Securities Exchange Board of India (SEBI)
4.4 Organization – Objectives,
4.5 Powers and functions of SEBI, BSE and NSE in Indian economy.

4.Reserve Bank of India (RBI)
4.1.1 Evolution of the Reserve Bank of India

The origins of the Reserve Bank of India (RBI) can be traced to 1926, when the Royal
Commission on Indian Currency and Finance – also known as the Hilton Young Commission –
recommended the creation of a central bank for India to separate the control of currency and
credit from the Government and to augment banking facilities throughout the country. The
Reserve Bank of India Act of 1934 established the Reserve Bank and set in motion a series of
actions culminating in the start of operations in 1935. Since then, the Reserve Bank's role and
functions have evolved, as the nature of the Indian economy and financial sector changed.
Though started as a private shareholders' bank, the Reserve Bank was nationalised in 1949.
The Preamble to the Reserve Bank of India Act, 1934, under which it was constituted, specifies
its objective as “to regulate the issue of Bank notes and the keeping of reserves with a view to
securing monetary stability in India and generally to operate the currency and credit system of
the country to its advantage”. The primary role of the RBI, as the Act suggests, is monetary
stability, that is, to sustain confidence in the value of the country's money or preserve the
purchasing power of the currency. Ultimately, this means low and stable expectations of
inflation, whether that inflation stems from domestic sources or from changes in the value of the
currency, from supply constraints or demand pressures. In addition, the RBI has two other
important mandates; inclusive growth and development, as well as financial stability.
In a country where a large section of the society is still poor, inclusive growth assumes great
significance. Access to finance is essential for poverty alleviation and reducing income
inequality. One of the core functions of the RBI, therefore, is to promote financial inclusion that
leads to inclusive growth. As the central bank of a developing country, the responsibilities of the
RBI also include the development of financial markets and institutions. Broadening and
deepening of financial markets and increasing their liquidity and resilience, so that they can help
allocate and absorb the risks entailed in financing India's growth is a key objective of the RBI.

History of RBI
History of any institution aims at documenting, collating, compiling and presenting a

comprehensive, authentic and objective study of the working of that institution, the events, the
policies, the institutional development of the organisation. The institutional history of the central
bank reflects, in some ways, the monetary history of the country, bringing down to concrete and
human terms the policies, the considerations, the mistakes, the thought processes, the decision
making and the broader canvas of political economy of the times.
The history of Reserve Bank of India thus not only traces the evolution of the central banking in
India but also serves as a work of reference and an important contribution to the literature on
monetary, central banking and development history of India. We have so far published four
volumes of our history.
Volume 1
The Reserve Bank of India was set up on April 1, 1935. It is one of the few central banks to
document its institutional history. So far, it has brought out four volumes of its history. Volume
1, covering the period from 1935 to 1951, was published in 1970. It details the initiatives taken
to put in place a central bank for India and covers the formative years of the Reserve Bank. It
highlights the challenges faced by the Reserve Bank and the Government during World War II
and the post-independence era.
Volume 2
Volume 2, covering the period from 1951 to 1967 was published in 1998. This period heralded
an era of planned economic development in India. This volume captures the initiatives taken to
strengthen, modify and develop the economic and financial structure of the country. Apart from

the Reserve Bank’s role as the monetary authority, it highlights the endeavour to establish an
institutional infrastructure for agricultural and long-term industrial credit in India. This volume
succinctly covers the external payment problems faced by the country and the rupee devaluation
of 1966.
Volume 3
On March 18, 2006, Hon’ble Prime Minister, Dr. Manmohan Singh released the third volume of
the Reserve Bank’s history covering the period from 1967 to 1981. An important event of this
period was nationalisation of fourteen banks in 1969, leading to spread of banking in country’s
hinterland. The issues of safety and prudence in banking also gained prominence. Internationally,
the abandonment of the Bretton Woods system in 1971 posed serious challenges for the
developing countries including India. The volume also deals with the matters of co-ordination
between the Reserve Bank and the Government.
Volume 4
Volume 4 of the Reserve Bank’s history was also released by Dr. Manmohan Singh, Hon’ble
Prime Minister of India on August 17, 2013. It covers the eventful 16 years from 1981 to 1997
and is published in two parts, Part A and Part B, which ideally should be read in continuum. Part
A focusses on the transformation of the Indian economy from a regime of restrictions to
progressive liberalisation. The 1980s were characterised by an expansionary fiscal policy
accompanied by automatic monetisation of budgetary deficit that strained the conduct of
monetary policy. Similarly, a highly regulated banking system impaired efficiency. The domestic
macroeconomic imbalances combined with deteriorating external conditions triggered the
balance of payments (BoP) crisis of 1991. Subsequent reforms ushered in far reaching changes
not only in the economy but also in central banking. Part B of the volume captures the
implementation of structural and financial sector reforms: fiscal correction and phasing out of
automatic monetisation; development of government securities market; and greater integration

among money, securities and foreign exchange markets. It also covers the transformation in
banking with liberalisation and improvement in credit delivery. At the same time, the Reserve
Bank had to contend with a securities scam which led to the introduction of better control
systems and strengthening of the payment and settlement systems.
Origins of the Reserve Bank of India
1926: The Royal Commission on Indian Currency and Finance recommended creation of a
central bank for India.
1927: A bill to give effect to the above recommendation was introduced in the Legislative
Assembly, but was later withdrawn due to lack of agreement among various sections of people.
1933: The White Paper on Indian Constitutional Reforms recommended the creation of a
Reserve Bank. A fresh bill was introduced in the Legislative Assembly.
1934: The Bill was passed and received the Governor General’s assent
1935: The Reserve Bank commenced operations as India’s central bank on April 1 as a private
shareholders’ bank with a paid up capital of rupees five crore (rupees fifty million).
1942: The Reserve Bank ceased to be the currency issuing authority of Burma (now Myanmar).
1947: The Reserve Bank stopped acting as banker to the Government of Burma.
1948: The Reserve Bank stopped rendering central banking services to Pakistan.
1949: The Government of India nationalised the Reserve Bank under the Reserve Bank (Transfer
of Public Ownership) Act, 1948.
Objectives of the Reserve Bank of India
The Reserve Bank of India Act, 1934 sets out the objectives of the Reserve Bank:

“to regulate the issue of Bank notes and keeping of reserves with a view to securing monetary
stability in India and generally to operate the currency and credit system of the country to its
advantage; to have a modern monetary policy framework to meet the challenge of an
increasingly complex economy, to maintain price stability while keeping in mind the objective of
growth.”
The formulation, framework and institutional architecture of monetary policy in India have
evolved around these objectives – maintaining price stability, ensuring adequate flow of credit to
sustain the growth momentum, and securing financial stability.
The responsibility for ensuring financial stability has entailed the vesting of extensive powers in
and operational objectives for the Reserve Bank for regulation and supervision of the financial
system and its constituents, the money, debt and foreign exchange segments of the financial
markets in India and the payment and settlement system. The endeavour of the Reserve Bank has
been to develop a robust, efficient and diversified financial system so as to anchor financial
stability and to facilitate effective transmission of monetary policy. In addition, the Reserve
Bank pursues operational objectives in the context of its core function of issuance of bank notes
and currency management as well as its agency functions such as banker to Government (Centre
and States) and management of public debt; banker to the banking system including regulation of
bank reserves and the lender of the last resort.
The specific features of the Indian economy, including its socio-economic characteristics, make
it necessary for the Reserve Bank to operate with multiple objectives. Regulation, supervision
and development of the financial system remain within the legitimate ambit of monetary policy
broadly interpreted in India. The role of communication policy, therefore, lies in articulating the
hierarchy of objectives in a given context in a transparent manner, emphasising a consultative
approach as well as autonomy in policy operations and harmony with other elements of
macroeconomic policies.

Various departments in RBI
Consumer Education and Protection Department
Corporate Strategy and Budget Department
Department of Regulation
Department of Supervision
Department of Communication
Department of Currency Management
Department of Economic and Policy Research
Department of External Investments and Operations
Department of Government and Bank Accounts
Department of Information Technology
Department of Payment and Settlement Systems
Department of Statistics and Information Management
Enforcement Department
Financial Inclusion and Development Department

Financial Markets Operation Department
Financial Markets Regulation Department
Financial Stability Unit
Foreign Exchange Department
Human Resource Management Department
Inspection Department
Internal Debt Management Department
International Department
Legal Department
Monetary Policy Department
Premises Department
Rajbhasha Department
Risk Monitoring Department
Secretary's Department
Central Vigilance Cell

4.1.2 Organizational Structure of The Reserve Bank of India
Originally, the Reserve Bank was constituted as a shareholders bank, based on the model
of leading foreign central banks of those days. The bank’s fully paid-up share capital was
Rs 5 crores divided into shares of Rs. 100 each. The entire share capital was owned by
private individual with exception of shares of nominal value of Rs. 2,20,000/- which were
allotted to the Central Govt, for issue to directions of the Central Board of the Bank.
Seeking to obtain the minimum shares qualification.* 11 The shares capital of the bank
has remained unchanged until today. The Reserve Bank also had a Reserve fund of Rs.
150 crores in 1982. It was nationalised in January 1949 and since then it is functioning as
the State-owned bank and acting as the premier institution in India’s banking structure
The provisions relating to organization of the Reserve Bank of India are being vested in
the Boards, which comprises of:
A. Central Board
B. Local Boards
A. Central Board The Central Board of Directors is the leading governing body of the
bank. It is entrusted with the responsibility of general superintendence and direction
of the affairs and business of the Reserve Bank. The Central Board of Directors
consists of 20 members as fallows.
(i) One Governor and four Deputy Governors They are appointed by the Government of
India for a period of five years. Their salaries, allowances and other perquisites are
determined by the central Board of Directors in consultation with the Government
ofIndia.13
(ii) Four Directors Nominated from the Local Boards There are four local Boards of
Directors in addition to the Central Board of Directors. They are located at Bombay,
Calcutta, Madras and New Delhi. The Govt of India nominates one member each from
these local Boards. The tenure of these directors is also for a period of five years.

(iii) Ten other Directors ' The ten other directors of the Central Board of Directors are also
nominated by the Government of India. Their tenure is four years
(iv) One Government Official The Government of India also appoints one Government
Official to attend the meetings of the Central Board of Directors. This official can
continue for any number of years with the consent of the Government, but he does not
enjoy the right to vote in the meetings of the Central Board
B. Local Boards
The Reserve Bank of India is divided into four regions: the Western, the Eastern, the
Northern and the Southern areas. For each of these regions, there is a Local Board, with
headquarters in Bombay, Calcutta, New Delhi and Chennai. Each Local Board consists of
five members appointed by the Central Government for four year. They represent
territorial and economic interests and the interests of co-operative and indigenous banks
in their respective areas. In each local Board, a chairman is elected from amongst their
members. Managers in-charge of the Reserve Bank's offices in Bombay, Calcutta,
Chennai and New Delhi are ex-officio Secretaries of the respective Local Boards at these
places.
4.1.3 Aims and Objectives

1) to regulate the issue of banknotes and the keeping of reserves with a view to securing
monetary stability in India and generally to operate the currency and credit system of the
country to its advantage; and
2) that it is essential to have a modern monetary policy framework to meet the challenge of
an increasingly complex economy and the primary objective of the monetary policy is to
maintain price stability while keeping in mind the 5 objective of growth.
4.1.4 Functions of RBI

1) Issue Functions - Legal Background Right to issue bank notes is one of the key central
banking functions the RBI is 9 mandated to do . Section 22 of the RBI Act confers the RBI

with the sole right to issue bank notes in India. The issue of bank notes shall be conducted
by a department called the Issue Department, which shall be separated and kept wholly
distinct from the Banking Department . The RBI Act enables the RBI to recommend to
Central Government the denomination 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 or other denominations not
exceeding ten thousand rupees .
Right to issue bank notes is one of the key central banking functions the RBI is mandated to
do . Section 22 of the RBI Act confers the RBI with the sole right to issue bank notes in
India. The issue of bank notes shall be conducted by a department called the Issue
Department, which shall be separated and kept wholly distinct from the Banking
Department . The RBI Act enables the RBI to recommend to Central Government the
denomination 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 or other denominations not exceeding ten thousand
rupees . The design, form and material of bank notes shall be that approved by the Central
Government on the recommendations of Central Board of the RBI .Every bank note shall be
a legal tender at any place in India, however, 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 . Another important function is exchange of mutilated or torn notes, which
under the RBI Act is not a matter of right, but a matter of grace . The bank notes that are
being issued by the RBI are exempt from payment of stamp duty .
2) Banker’s Bank:
As bankers’ bank, the RBI holds a part of the cash reserves of commercial banks and lends
them funds for short periods. All banks are required to maintain a certain percentage (lying
between 3 per cent and 15 per cent) of their total liabilities. The main objective of changing
this cash reserve ratio by the RBI is to control credit.

The RBI provides financial assistance to commercial banks and State cooperative banks
through rediscounting of bills of exchange. As the RBI meets the need of funds of
commercial banks, the RBI functions as the Tender of the last resort
3) Banker to the Government:

The RBI acts as the banker to the government of India and State Governments (except
Jammu and Kashmir). As such it transacts all banking business of these Governments
(i) Accepts and pays money on behalf of the Government.
(ii) It carries out exchange remittances and other banking operations.
4) Controller of Credit:
The RBI controls the total supply of money and bank credit to sub serve the country’s
interest. The RBI controls credit to ensure price and exchange rate stability.
To achieve this, the RBI uses all types of credit control instruments, quantitative, qualitative
and selective. The most extensively used credit instrument of the RBI is the bank rate. The
RBI also relies greatly on the selective methods of credit control. This function is so
important that it requires special treatment.
5) Exchange Management and Control:

One of the essential central banking functions performed by the Bank is that of maintaining
the external value of rupee. The external stability of the currency is closely related to its
internal stability the inherent economic strength of the country and the way it conducts its
economic and monetary affairs.
Domestic, fiscal and monetary policies have, therefore, an important role in maintaining the
external value of the currency. Reserve Bank of India has a very important role to play in this
area.
6) Custodian of Cash Reserves of Commercial Banks:

The commercial banks hold deposits in the Reserve Bank and the latter has the custody of
the cash reserves of the commercial banks.

7) Custodian of Country’s Foreign Currency Reserves:
The Reserve Bank has the custody of the country’s reserves of international currency, and
this enables the Reserve Bank to deal with crisis connected with adverse balance of
payments position. The powers and responsibilities with respect to external trades and
payments, development and maintenance of foreign exchange market in India are
conferred on the RBI under the provisions of the Foreign Exchange Management Act,
1999 ('FEMA'). Section 10 of the FEMA empowers the RBI to authorize any person to be
known as authorized person to deal in foreign exchange or in foreign securities, as an
authorized dealer, money changer or off-shore banking unit or in any other manner as it
deems fit. Similarly, it empowers the RBI to revoke an authorization issued to an
authorized dealer in public interest, or if the authorized person has failed to comply with
the conditions subject to which the authorization was granted or has contravened any of
the provisions of the FEMA or any rule, regulation, notification, direction or order issued
by the RBI. However, the revocation of an authorization may be done by the RBI after
following the prescribed procedure in the FEMA or the Regulations made thereunder.
Section 13 of the FEMA details out the contraventions and penalties, and the RBI has
been empowered with the power to compound such contraventions under Section 15 of
the FEMA.
8) Payment and Settlement Functions

Legal Background The Parliament of India enacted the Payment and Settlement Systems
Act, 2007 ('PSS Act, 2007') with an objective to provide for the regulation and supervision
of payment systems in India and to designate the Reserve Bank of India as the authority for
that purpose and for matters connected therewith or incidental thereto . Under Section 4 of
the PSS Act, 2007, no person shall commence or operate a payment system except with an
authorization issued by the RBI. Similarly, under Section 8 of the PSS Act, 2007, RBI has
the power to revoke the authorization granted to any person if it contravenes any of the
provisions of the PSS Act or does not comply with regulations or fails to comply with the
orders or directions issued by the RBI or operates the payment system contrary to the
conditions subject to which the authorization was issued.

4.2 Monetary Policies
Meaning : Monetary policy is the macroeconomic policy laid down by the central bank. It
involves management of money supply and interest rate and is the demand side economic
policy used by the government of a country to achieve macroeconomic objectives like
inflation, consumption, growth and liquidity.
In other words Monetary policy, the demand side of economic policy, refers to the
actions undertaken by a nation's central bank to control money supply to
achieve macroeconomic goals that promote sustainable economic growth.
4.2.1 Tools of monetary policies
I. Quantitative Tools
1. Cash Reserve Ratio (CRR)
CRR is a certain minimum amount of deposit that the commercial banks have to hold
as reserves with the central bank. CRR is set according to the guidelines of the central
bank of a country.
Example: When someone deposits Rs 100 with a bank, it increases the deposits of
the bank by Rs 100. If the CRR is 9%, then the bank will have to hold additional Rs 9
with the central bank. This means that the commercial bank will be able to use only
Rs 91 for investments and/or lending or credit purpose.
2. Statutory Liquidity ratio:

Every bank must have a specified portion of their Net Demand and Time Liabilities
(NDTL) in the form of cash, gold, or other liquid assets by the day’s end. The ratio of
these liquid assets to the demand and time liabilities is called the Statutory Liquidity
Ratio (SLR). The Reserve Bank of India has the authority to increase this ratio by up
to 40%. An increase in the ratio constricts the ability of the bank to inject money into
the economy.
3. Repo rate :
Repo rate is the rate at which the central bank of a country (Reserve Bank of India in
case of India) lends money to commercial banks in the event of any shortfall of funds.
Repo rate is used by monetary authorities to control inflation.
4. Reverse repo rate

Reverse repo rate is the rate at which the central bank of a country (Reserve Bank of
India in case of India) borrows money from commercial banks within the country. It
is a monetary policy instrument which can be used to control the money supply in the
country.
5. Base or Bank Rate:

Base rate is the minimum rate set by the Reserve Bank of India below which banks
are not allowed to lend to its customers.
Description: Base rate is decided in order to enhance transparency in the credit

market and ensure that banks pass on the lower cost of fund to their customers. Loan
pricing will be done by adding base rate and a suitable spread depending on the credit
risk premium.
6. Open market operation

It is the sale and purchase of government securities and treasury bills by RBI or the
central bank of the country. The objective of OMO is to regulate the money supply in the
economy. It takes place When the RBI wants to increase the money supply in the
economy, it purchases the government securities from the market and it sells government
securities to suck out liquidity from the system.
II. Qualitative tools
Unlike quantitative tools which have a direct effect on the entire economy’s money
supply, qualitative tools are selective tools that have an effect in the money supply of a
specific sector of the economy.
1. Margin requirements – The RBI prescribes a certain margin against collateral,

which in turn impacts the borrowing habit of customers. When the margin
requirements are raised by the RBI, customers will be able to borrow less.
2. Moral suasion – By way of persuasion, the RBI convinces banks to keep money in
government securities, rather than certain sectors.
3. Selective credit control – Controlling credit by not lending to selective industries or
speculative businesses
4.5 The Securities Exchange Board of India (SEBI)

SEBI is a statutory regulatory body established on the 12th of April, 1992. It monitors and
regulates the Indian capital and securities market while ensuring to protect the interests of
the investors formulating regulations and guidelines to be adhered to. The head office of
SEBI is in Bandra Kurla Complex, Mumbai.
4.5.1 Structure of SEBI
SEBI has a corporate framework comprising various departments each managed by a

department head. There are about 20+ departments under SEBI. Some of these
departments are corporation finance, economic and policy analysis, debt and hybrid

securities, enforcement, human resources, investment management, commodity
derivatives market regulation, legal affairs, and more.
The hierarchical structure of SEBI consists of the following members:
1) The chairman of SEBI is nominated by the Union Government of India.

2) Two officers from the Union Finance Ministry will be a part of this structure.
3) One member will be appointed from the Reserve Bank of India.
4) Five other members will be nominated by the Union Government of India.
4.5.2 Objectives of SEBI
The statutory objectives of the SEBI enshrined in the SEBI Act are fourfold-
1) Protection of investors interests in securities Promotion of the

development of the securities market.
2) Regulation of the securities market.
3) To reduce insider trading.
4.5.3Functions of SEBI
1. Registering and regulating the working of stock brokers, sub-brokers, share

transfer agents, bankers to an issue, trustees of trust deeds, registrars to an issue,
merchant bankers, underwriters, portfolio managers, investment advisers and such
other intermediaries who may be associated with securities market in any manner.
2. Registering and regulating the working of the depositories, participants,
custodians of securities, foreign institutional investors, credit rating agencies and
such other intermediaries as the board may, by notification, specify in the behalf.
3. Registering and regulating the working of venture capital funds and collective
investment schemes, including mutual funds.

4. Promoting and regulating self-regulatory organizations.
5. Prohibiting fraudulent and unfair trade practices relating to securities markets.
6. Promoting investors education and training of intermediaries of securities
markets.
7. Prohibiting insider trading in securities.
8. Regulating substantial acquisition of shares and takeover of companies.
9. Calling for information from, undertaking inspection, conducting inquiries and
audits of the stock exchanges, mutual funds, other persons associated with the
securities market, intermediaries and self-regulatory organizations in the
securities market
10. Performing such functions and exercising such powers under the provisions of the
Securities Contracts Act, 1956, as may be delegated to it by the Central
Government.
11. Levying fees or other charges for carrying out the purposes of this section.
12. Conduction research for the above purposes.
13. Calling from or furnishing to any such agencies, as may be specified by the board,
such information as may be considered necessary by it for the efficient discharge
of its functions.
4.6 BSE and NSE in Indian economy.
4.6.1 Bombay Stock Exchange:
Established in 1875, BSE (formerly known as Bombay Stock Exchange), is Asia's first &
the Fastest Stock Exchange in world with the speed of 6 micro seconds and one of India's
leading exchange groups. Over the past 143 years, BSE has facilitated the growth of the
Indian corporate sector by providing it an efficient capital-raising platform. Popularly
known as BSE, the bourse was established as ‘The Native Share & Stock Brokers'

Association’ in 1875. In 2017 BSE become the 1st listed stock exchange of India.
Today BSE provides an efficient and transparent market for trading in equity, currencies,
debt instruments, derivatives, mutual funds. BSE SME is India’s largest SME platform
which has listed over 250 companies and continues to grow at a steady pace. BSE StAR
MF is India’s largest online mutual fund platform which process over 27 lakh
transactions per month and adds almost 2 lakh new SIPs ever month. BSE Bond, the
transparent and efficient electronic book mechanism process for private placement of
debt securities, is the market leader with more than Rs 2.09 lakh crore of fund raising
from 530 issuances. (F.Y. 2017-2018).
Keeping in line with the vision of Shri Narendra Modi, Hon’be Prime Minister of Inida,
BSE has launched India INX, India's 1st international exchange, located at GIFT CITY
IFSC in Ahmedabad.
Indian Clearing Corporation Limited, a wholly owned subsidiary of BSE, acts as the
central counterparty to all trades executed on the BSE trading platform and provides full
novation, guaranteeing the settlement of all bonafide trades executed.
BSE Institute Ltd, another fully owned subsidiary of BSE runs one of the most respected
capital market educational institutes in the country.
BSE has also launched BSE Sammaan, the CSR exchange, is a 1st of its kind initiative
which aims to connect corporate with verified NGOs.
BSE's popular equity index - the S&P BSE SENSEX - is India's most widely tracked
stock market benchmark index. It is traded internationally on the EUREX as well as
leading exchanges of the BRCS nations (Brazil, Russia, China and South Africa)

CSR (Corporate Social Responsibility)
Corporate Social Responsibility (CSR) in BSE is aligned with its tradition of creating wealth in
the community with a three pronged focus on Education, Health and the Environment. Besides
funding charitable causes for the elderly and the physically challenged, BSE has been supporting
the rehabilitation and restoration efforts in earthquake-hit communities of Gujarat. BSE has been
awarded the Golden Peacock Global - CSR Award for its initiatives in Corporate Social
Responsibility (CSR) by the World Council of Corporate Governance.
4.6.2 National Stock Exchange
The National Stock Exchange of India Ltd. (NSE) is the leading stock exchange in India and the
second largest in the world by nos. of trades in equity shares from January to June 2018,
according to World Federation of Exchanges (WFE) report.
NSE launched electronic screen-based trading in 1994, derivatives trading (in the form of index
futures) and internet trading in 2000, which were each the first of its kind in India.
NSE has a fully-integrated business model comprising our exchange listings, trading services,
clearing and settlement services, indices, market data feeds, technology solutions and financial
education offerings. NSE also oversees compliance by trading and clearing members and listed
companies with the rules and regulations of the exchange.
NSE is a pioneer in technology and ensures the reliability and performance of its systems
through a culture of innovation and investment in technology. NSE believes that the scale and
breadth of its products and services, sustained leadership positions across multiple asset classes
in India and globally enable it to be highly reactive to market demands and changes and deliver

innovation in both trading and non-trading businesses to provide high-quality data and services
to market participants and clients.
Mr. Vikram Limaye is the Managing Director and CEO of NSE.
References
1. Gurusamy, Financial Markets and Institutions, 3rd edition, Tata McGraw Hill.
2. Srivastava RM : Management of Financial Institutions, HPH
3. Saunders, Financial Markets and Institutions, 3rd edition, Tata McGraw Hill.
4. Bharat Kulkarni; Commodity Markets and Derivatives, Excel Books
5. Khan, Indian Financial Systems, 6th edition, Tata McGraw Hill
6. The Federal Reserve and the Financial Crisis, Lectures by Ben S.Bernanke, 2013
7. Fundamentals of Central Banking – Lessons from the Crisis, Group of Thirty, 2015
8. The Evolution of Central Banking, Charles Goodhart, 1988
9. Statement by Dr. Raghuram Rajan on taking office on September 4, 2013, R
SKILL DEVELOPMENT
 Collection of CRR Level of last 10 years
 Visit the stock exchanges and know the process.
 Collect IPO certificates of Indian companies
 Collect the name of 30 BSE SENSEX and NSE 50 companies
Two-mark questions
1. What do you mean by monetary policies?
2. Define CRR
3. Expand BSE and NSE
4. Who is the present chairman of SEBI?
5. What is meant by bank rate?

6. Define Open market operations
Five marks questions.

1. Write a note on BSE
2. Write a note on NSE
3. Explain structures of SEBI
4. Explain objectives of RBI
Ten marks questions
1. Explain history and evolution of RBI

2. Explain different functions of RBI
3. What are monetary policies of RBI? Explain monetary policies of RBI
4. Explain Objectives and Functions of SEBI
5. Organizational Structure of The Reserve Bank of India

Chapter 5.
BRANCH OPERATION AND CORE BANKING
5.1 Introduction and evolution of bank management –

5.1.2 Technological impact in banking operation
5.1.3 Recent trends in Indian Banks
5.1.4 Total branch computerization
5.2 Concept of Centralized banking
5.2.1 Opportunities, challenges and implementation,
CardlessATM service,
AI-Driven Predictive Banking Artificial intelligence for fraud detection.
5.1 Bank management: Accepting deposits, clearing checks, paying interest on pre-defined
rates and making loans; a bank can be defined by such activities. Besides being an intermediary
in financial transactions, a bank can provide other financial services to its customers. All these
tasks and services are coordinated by a system called Banking Management System.
Bank management governs various concerns associated with bank in order to maximize profits.
The concerns broadly include liquidity management, asset management, liability management
and capital management.
The Origin of Banking Management System

The need for a system, which could ensure quality services to customers had always been there.
The need for such system becomes really indispensable when many banking activities are
monitored by the government. Banks that deal with banking activities on a larger scale are the
ones usually have to comply with the rules set by the government.
It requires a bank management system. The system has proved effective in coordinating among
the customers, the government and the banks. It gives us a system in which the government is
allowed to play an important role with its control over the banking system. And, the bank can
also offer quality services to the customers.
Evolution of Banking Management System
Modern banking system caters to a wide range of financial services. Banking management
system can be traced back to the Roman Empire where banking management system was
practiced. But, the system wasn’t systematic. And, it didn’t have a framework as modern banking
system does. So, banking management system evolved gradually in each and every sector of the
banking sector.
5.1.2 Technological impact in banking operation
Positive impact of technology on banking sector :-
1. The biggest revolution came in banks is Digitization.

2. Banking process is faster than before and more reliable. Maintenance and retrieval of
documents and records have become much faster and easier.
3. Computerized banking also improves the core banking system. With CBS (core banking
system) all branches have access to common centralized data and are interconnected.
4. With the innovation of MICR cheque processing system, the processing of cheques
becomes more faster and efficient h than before.

5. USSD (Unstructured supplementary service data) was launched by Government, so
people with no internet-connectivity too can access their bank accounts without visiting
the branch.
6. With increasing internet reach, Internet Banking was developed and now offered by
almost every bank. Through this, every transaction details and inquiries can be performed
online without visiting the bank.
7. It offered more transparency in transactions.
8. The scope of frauds in banks is being minimized through the use of passwords, double
authentication in online banking
9. Technology also leads to competition among the banks which eventually provides better
services to people.
10. With introduction of mobile banking, one can access their bank from anywhere-anytime.
Everything is one quick tap away.

11. To facilitates better services, Banks have introduced Automated Banking Services
Solution like Cash Deposit Machine, Cheque Deposit Machine, Passbook Printing
Machine through these service have become easier.
Negative impact of technology on banking sector:-
1. The biggest negative impact of technology is loss of Jobs as automation has replaced
number of jobs in banking sector.
2. Through technology comes the threat of Cyber Attack, a loophole in the system, millions
of data can be lost in the blink of an eye.
3. These technologies consumes less time, it also sometimes makes people careless-which
causes loss of personal details as happened last year in 2016,many debit cards details of
big banks were compromised.
5.1.3 Recent IT Trends of Indian banks:-

The banking industry is going through a period of rapid change to meet competition, challenges
of technology and the demand of end user. Clearly technology is a key differentiator in the
performance of banks. Banks need to look at innovation not just for product but for process also.
Today, technology is not only changing the environment but also the relationship with
customers. Technology has not broken barriers but has also brought about superior products and
channels. This has brought customer relationship into greater focus. It is also viewed as an
instrument of cost reduction and effective communication with people and institutions associated
with the banking business. The RBI has assigned priority to the up gradation of technological
infrastructure in financial system. Technology has opened new products and services, new
market and efficient delivery channels for banking industry. IT also provides the framework for
banking industry to meet challenges in the present competitive environment. IT enables to cut
the cost of global fund transfer.
Some of the recent IT devices described as below:-
1. Electronic Payment and Settlement System
The most common media of receipts and payment through banks are negotiable instruments like
cheques. These instruments could be used in place of cash. The inter bank cheques could be
realized through clearing house systems. Initially there was a manual system of clearing but the
growing volume of banking transaction emerged into the necessity of automating the clearing
process.
2. Use of MICR Technology
MICR overcomes the limitation of clearing the cheques within banking hours and thus enables
the customer to get the credit quickly. These are machine – readable codes added at the bottom
of every cheque leaf which helped in bank and branch-wise sorting of cheques for smooth
delivery to the respective banks on whom they are drawn. This no doubt helped in speeding up
the clearing process, but physical delivery of cheques continued even under this partial
automation.
3. CTS (Cheque Truncation System)
Truncation means stopping the flow of the physical cheques issued by a drawer to the drawee
branch. The physical instrument is truncated at some point on route to the drawee branch and an
electronic image of the cheque is sent to the drawee branch along with the relevant information
like the MICR fields, date of presentation, presenting banks etc. This would eliminate the need to
move the physical instruments across branches, except in exceptional circumstances, resulting in
an effective reduction in the time required for payment of cheques, the associated cost of transit
and delays in processing etc., thus speeding up the process of collection or realization of
cheques.
4. Electronic Clearing Services (ECS)
The ECS was the first version of “Electronic Payments” in India. It is a mode of electronic funds
transfer from one bank account to another bank account using the mechanism of clearing house.
It is very useful in case of bulk transfers from one account to many accounts or vice-versa. The
beneficiary has to maintain an account with the one of the bank at ECS Centre.
There are two types of ECS (Electronic Clearing Service)
ECS – Credit – ECS Credit clearing operates on the principle of ‘single debit multiple
credits’ and is used for transactions like payment of salary, dividend, pension, interest
etc.
ECS – Debit – ECS Debit clearing service operates on the principle of ‘single credit
multiple debits’ and is used by utility service providers for collection of electricity bills,
telephone bills and other charges and also by banks for collections of principle and
interest repayments.
5. Electronic Fund Transfer

(EFT) – EFT was a nationwide retail electronic funds transfer mechanism between the
networked branches of banks. NEFT provided for integration with the Structured Financial
Messaging Solution (SFMS) of the Indian Financial Network (INFINET). The NEFT uses
SFMS for EFT message creation and transmission from the branch to the bank’s gateway and
to the NEFT Centre, thereby considerably enhancing the security in the transfer of funds.
6. Real Time Gross Settlement (RTGS)
RTGS system is a funds transfer mechanism where transfer of money takes place from one
bank to another on a ‘real time’ and on ‘gross basis’. This is the fastest possible money
transfer system through the banking channel. Settlement in ‘real time’ means payment
transaction is not subjected to any waiting period. The transactions are settled as soon as they
are processed. “Gross settlement” means the transaction is settled on one to one basis without
bunching with any other transaction.
7. Core Banking Solutions (CBS) –
Computerization of bank branches had started with installation of simple computers to
automate the functioning of branches, especially at high traffic branches. Core Banking
Solutions is the networking of the branches of a bank, so as to enable the customers to
operate their accounts from any bank branch, regardless of which branch he opened the
account with. The networking of branches under CBS enables centralized data management
and aids in the implementation of internet and mobile banking. Besides, CBS helps in
bringing the complete operations of banks under a single technological platform.
8. Development of Distribution Channels.

The major and upcoming channels of distribution in the banking industry, besides
branches are ATMs, internet banking, mobile and telephone banking and card based delivery
systems.
9. Automated Teller Machine (ATM)

ATMs are perhaps most revolutionary aspect of virtual banking. The facility to use ATM is
provided through plastic cards with magnetic strip containing information about the customer

as well as the bank. In today’s world ATM are the most useful tool to ensure the concept of
“Any Time Banking” and “Any Where Banking”.
10. Phone Banking

Customers can now dial up the banks designed telephone number and he by dialling his ID
number will be able to get connectivity to bank’s designated computer. By using Automatic
voice recorder (AVR) for simple queries and transactions and manned phone terminals for
complicated queries and transactions, the customer can actually do entire non-cash relating
banking on telephone: Anywhere, Anytime.
11. Tele Banking
It is another innovation, which provided the facility of 24 hour banking to the customer.
Tele-banking is based on the voice processing facility available on bank computers. The
caller usually a customer calls the bank anytime and can enquire balance in his account or
other transaction history.
12. Internet Banking
Internet banking enables a customer to do banking transactions through the bank’s website
on the internet. It is system of accessing accounts and general information on bank products
and services through a computer while sitting in its office or home. This is also called virtual
banking.
13. Mobile Banking
Mobile banking facility is an extension of internet banking. Mobile banking is a service
provided by a bank or other financial institution that allows its customers to conduct financial
transactions remotely using a mobile device. Unlike the related internet banking it uses
software, usually called an App, provided by the financial institution for the purpose. Mobile
banking is usually available on a 24 hour basis.
5.1.4 Total branch computerization

Computerized banking system is a proven, secure, modular, on-line, real-time, flexible, scalable,
multi-currency. It is user friendly, easy to manage, and easy to operate information system, based
on fully integrated and co-operative components.
5.1.5The four major objectives of computerization in banking are to improve:
(a) Customer service
(b) Housekeeping
(c) Decision-making
(d) Productivity and profitability.
5.1.6 Advantages Computerized banking system
1. Simplicity
Most business owners are not accountants or bookkeepers by trade and find it challenging to
do most accounting tasks. This is where accounting software programs give a business owner
advantages. A wide variety of accounting software programs are consumer friendly. Business
owners can shop around to find a program that is easy to install, learn and use. Many programs
provide prompts for the type of data that should be entered in each section. Once the system is
established with bank accounts, debts and vendors, the business owner only needs to update
information as it comes in.
2. Reliability
Most of the major software programs make using the program simple. The math is accurate
and reliable, so a business owner can accurately determine available funds at any time.
3. Cost-Effectiveness

Hiring an in-house bookkeeper or outsourcing the work to a bookkeeper or accounting firm can
be costly. The software program has an upfront cost and might require contracting a
bookkeeper to set up the accounts and coach the business owner on using the program, but it
quickly becomes cost-effective. The owner doesn't need to pay for anything beyond the
software purchase and setup. Most programs work with operating systems for years and only
occasionally require an inexpensive upgrade.
4. Ability to Collaborate
Many software programs allow business owners to set permissions that give an outside
bookkeeper or accountant access to the data. Business owners can sync information with bank
and credit accounts and import data with a click of a mouse. This allows business owners to
quickly reconcile accounts and import the correct information that needs to be reviewed by key
advisors.
5.1.7 Disadvantages Computerized banking system
1. Potential Fraud
Dependence on computers sometimes leads to bigger problems. With more software data being
housed in the cloud, there are more opportunities for hackers to get your business's financial
data and use it. This puts assets at risk and creates potential liability if hackers use employer
tax identification to open credit cards and business loans. There is also the risk of someone
within the business accessing the information, perhaps pilfering money from daily deposits and
altering the data in the program. Business owners must diligently protect financial information.
2. Technical Issues
When dealing with computers, issues can arise. You may be completing year-end data for your
accountant and experience a power outage. Computers might acquire a virus and fail. There is
also the potential of users incorrectly performing software tasks that they are not familiar with.
If a user tries to do one thing but inadvertently does something else, it might take some work to
undo the error.

3. Incorrect Information
Bookkeeping records are only as good as the data put into the system. Business owners that don't
take the time to establish account categories properly may enter data and generate reports that are
not accurate. Business owners can do a lot to mitigate the disadvantages and potential problems
associated with computerized accounting with proper planning and software integration. Taking
the time to establish it correctly is easier and cheaper than trying to backtrack because when a
problem occurs.
5.2 Concept of Centralized banking
Core Banking Solutions (CBS) or Centralized Banking Solutions is the process which is
completed in a centralized environment i.e. under which the information relating to the
customer’s account (i.e. financial dealings, profession, income, family members etc.) is stored in
the Central Server of the bank (that is available to all the networked branches) instead of the
branch server. Depending upon the size and needs of a bank, it could be for the all the operations
or for limited operations. This task is carried through advanced software by making use of the
services provided by specialized agencies. Due to its benefits, a no. of banks in India in recent
years have taken steps to implement the Core Banking Solutions with a view to build
relationship with the customer based on the information captured and offering to the customer,
the customized financial products according to their need.
5.2.1 Features of Core Banking
1. Customer relationship management features including a 360 degree customer view.
2. The ability to originate new products and customers.
3. Banking analytics including risk analysis, profitability analysis and provisions for capital
reserve allocation and collateral management.
4. Banking finance including general ledger and reporting.

5. Banking channels such as teller systems, side counter applications, mobile banking and online
banking solutions.
6. Best practice workflow process.
7. Content management facilities.
8. Governance and compliance capabilities such as internal controls management and auditing.
9. Security control and audit capabilities.
10. Core banking solutions to help maximize growth, increase productivity and mitigate risk.
5.2.2 Advantages of Core Banking
1. Limited Professional Manpower to be utilized more effectively.
2. Customer can have anywhere, more convenient and easier banking.
3. ATM, Interest Banking, Mobile Banking, Payment Gateways etc. are available.
4. More strong and economical way of management information system.
5. Reduction in branch manpower.
6. Additional manpower can be available for marketing, recovery and personalized banking.
7. Instant information available for decision support.
8. Quick and accurate implementation of policies.
9. Improved Recovery Process causing reduction on recovery costs, NPA provisions.
10. Innovative, redefined or improved processes i.e. Inter Branch Reconciliation causing
reduction in manpower at Head Office.
11. Reduction in software maintenance at branch and Head office.

12. Centralized printing and backup resulting in reduction in capital and revenue expenditure on
printing and backup devices and media at branches.
13. Electronic Transactions with other Financial Institutions.
14. Increased speed in working resulting in more business opportunities and reduction in
penalties and legal expenses.
5.3 Card less ATMs
Cardless ATMs connect to customer bank account using an application instead of their debit
card, letting them withdraw cash with just throughr mobile phone. When customer want to make
a withdrawal at a cardless ATM, the app will generate some sort of verification key, such as a
QR code for the ATM to scan or a numeric code you can punch in. Once they enter that
verification key and their PIN, the ATM will process the transaction and dispense their cash.
Some banks have their own proprietary apps that work with cardless ATMs, while others
connect with popular mobile wallets.
5.4 Banking on Artificial Intelligence
Harnessing cognitive technology with Artificial Intelligence (AI) brings the advantage of
digitization to banks and helps them meet the competition posed by FinTech players. In fact,
about 32% of financial service providers are already using AI technologies like Predictive
Analytics, Voice Recognition, among others, according to a joint research conducted by the
National Business Research Institute and Narrative Science.
Artificial Intelligence is the future of banking as it brings the power of advanced data analytics to
combat fraudulent transactions and improve compliance. AI algorithm accomplishes anti-money
laundering activities in few seconds, which otherwise take hours and days. AI also enables banks
to manage huge volumes of data at record speed to derive valuable insights from it. Features
such as AI bots, digital payment advisers and biometric fraud detection mechanisms lead to

higher quality of services to a wider customer base. All this translates to increased revenue,
reduced costs and boost in profits.
5.4.1 Benefits of AI
1. Enhanced customer experience: Based on past interactions, AI develops a better

understanding of customers and their behavior. This enables banks to customize
financial products and services by adding personalized features and intuitive interactions
to deliver meaningful customer engagement and build strong relationships with its
customers.
2. Prediction of future outcomes and trends: With its power to predict future scenarios
by analyzing past behaviors, AI helps banks predict future outcomes and trends. This
helps banks to identify fraud, detect anti-money laundering pattern and make customer
recommendations. Money launderers, through a series of actions, portray that the source
of their illegal money is legal. With its power of Machine Learning and Cognition, AI
identifies these hidden actions and helps save millions for banks. Similarly, AI is able to
detect suspicious data patterns among humungous volumes of data to carry out fraud
management. Further, with its key recommendation engines, AI studies past to predict
future behavior of data points, which helps banks to successfully up-sell and cross-sell.
3. Cognitive process automation: This feature enables automation of a variety of
information-intensive, costly and error-prone banking services like claims management.
This secures ROI, reduces costs and ensures accurate and quick processing of
services at each step. Cognitive process automation fundamentally automates a set of
tasks that improvises upon their previous iterations through constant machine learning.
4. Realistic interactive interfaces: Chatbots identify the context and emotions in the text
chat and respond to it in the most appropriate way. These cognitive machines enable
banks to save not only time and improve efficiency, but also help banks to save millions
of dollars as a result of cumulative cost savings.

5. Effective decision-making: Cognitive systems that think and respond like human
experts, provide optimal solutions based on available data in real-time. These systems
keep a repository of expert information in its database called knowledge database.
Bankers use these cognitive systems to make strategic decisions.
6. Robotic automation of processes: AI reviews and transforms processes by applying

Robotic Process Automation (RPA). This enables automation of about 80% of repetitive
work processes, allowing knowledge workers to dedicate their time in value-add
operations that require high level of human intervention.
BOOKS FOR REFERENCE
1. Gordon &Natrajan: Banking Theory Law and Practice, HPH.
Skill Development:
 Conduct a small survey on digital banking

 Collect various tools used in recent banking system India
 Analyse Artificial intelligence pros and cons in banking system

Two-mark questions
1. What is digital banking

2. Define core banking
3. Define artificial Intelligence
4. What is the difference between RTGS and NEFT?
5. Expand USSD and CBS
6. How MICR works
7. Define ECS
Five marks questions
1. Explain benefits of artificial intelligence
2. Explain the features of core banking
3. Explain advantages of centralized banking
4. Explain disadvantages of centralized banking
Ten marks questions
1. Explain both positive impact and negative impact of technology on banking
sector
2. Explain some of the IT devices used in banking system.
3. Explain advantages and disadvantages of computerized banking system.

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BANKING AND FINANCIAL

For private circulation only Page 1

Evolution and Role of Commercial Banks – Functions of Commercial Banks, nationalization of

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1.2 Commercial banks

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Functions of Commercial Banks

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2. General Utility Services

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3. Information and other Services

1.4 Nationalization Of Commercial Banks

1.Central Bank of India limited

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1.5 Objects of Nationalization

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More specifically, the important objectives of bank nationalization are:

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There is often a misconception that nationalization is a peculiarly socialistic measure. The

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Nationalized Banks and Branch Expansion

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iii) The mainline of activity of the organization should be the banking

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1.9 Definition and Meaning of Negotiable Instruments:

For private circulation only Page 17

Characteristics of Negotiable Instruments

The chief characteristics of a negotiable instrument are:

For private circulation only Page 18

Types of Negotiable Instruments

Negotiable instruments can be broadly classified into two:

Instruments negotiable by custom or usage includes Government promissory notes, dividend

For private circulation only Page 19

1.10 Bill of Exchange

The Drawer: The person who draws the bill.

For private circulation only Page 20

1.11 Holder and Holder in Due Course Holder of a Negotiable Instrument

In terms of Section 8 of the Negotiable Instruments Act:

For private circulation only Page 21

Holder in Due Course of a Negotiable Instrument

1. is in possession of the instrument as defined in Section 8;

According to Section 29 of the Bills of exchange Act:

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For private circulation only Page 23

For private circulation only Page 24

For private circulation only Page 25

The paying banker is required to pay the amount of a generally

For private circulation only Page 26

Account Payee Crossing

For private circulation only Page 27

Cancelling or opening of crossing

For private circulation only Page 28

For private circulation only Page 29

Effects of Material Alteration:

For private circulation only Page 30

Magnetic Ink Character Recognition (MICR)

The code line contains the following information:

For private circulation only Page 31

4. Sans recourse Endorsement: