BANKING THEORY LAW

AND PRACTICE
 CENTRAL BANK
• A central bank is a financial institution given
privileged control over the production and
distribution of money and credit for a nation or
a group of nations.
• In modern economies , the central bank is
usually responsible for the formulation of
monetary policy and the regulation of member
banks.
 CENTRAL BANK
• In contrast to a commercial bank, a central bank possesses a
monopoly base in the state , and also generally controls the
printing of the national currency which serves as the state’s
legal tender.

• Its goals are to stabilize the nation’s currency, keep

unemployment low, and prevent inflation.

• The central bank of India is the Reserve Bank of India (RBI).

 FACTS ABOUT RBI
• The RBI logo was inspired from the East India Company
Double Mohur.
• It was formed on April 1, 1935 as a private entity, but it is a
government entity now. Nationalization of the central bank
did not happen till 1949.
• RBI was also the central bank for 2 other countries of
Pakistan till June 1948 and of Burma (Myanmar) till 1947.
NATURE OF CENTRAL BANKING

• The central bank does not aim at profits but aims at

national welfare.
• It is basically concerned in achieving monetary stability,
full employment and economic growth.
• The central bank does not compete with member banks.
• The central bank has special relationship with
government and with commercial banks.
NATURE OF CENTRAL BANKING

• The central bank is generally free from

political influence.
• The central bank is apex body of the banking
structure of the country.
• The central bank should have overall control
over the financial system.
FUNCTIONS OF CENTRAL BANK

• Controlling the nation’s entire money supply

the government’s banker and the banker’s
bank (“lender of last resort”) managing the
country’s foreign exchange and gold reserves
and the government bonds regulating and
supervising the banking industry.
 FUNCTIONS OF CENTRAL BANK
• Eight major functions of central bank in an economy are as
follows:
1. Bank of issue.
2. Banker, Agent & Advisor to government.
3. Custodian of cash reserves.
4. Custodian of foreign balances.
5. Lender of last resort.
6. Clearing house.
7. Controller of credit, and
8. Protection of depositors interest
 1.BANK ISSUE

Central bank now - a - days has the monopoly of note issue in

every country. The currency notes printed & issued by the central
bank are declared unlimited legal tender throughout the country.
Main objects of the system of currency regulation:
 People’s confidence in the currency is maintained.
 Its supply is adjusted to demand in the economy.
 The system aims of uniformity, elasticity, safety & security. The
system of note issue has been varying from time to time.
 2.BANKER, AGENT & ADVISOR

Central bank, everywhere performs the functions of banker, agent and

advisor to the government.
 As banker to the government, it makes and receive payments on
behalf of the government. It advances short term loans to the
government to tide over difficulties.
 It floats public loans & manager the public debts on behalf of the
government.
 The central bank also acts as an agent to the government where
general exchange control is in force
 3.CUSTODIAN OF CASH RESERVES

 All commercial banks in a country keep a part of their cash balances as

deposits with the central bank, may be on account of convention or
legal compulsion.
 They draw during busy seasons and pay back during slack reasons.
Part of these balances is used for clearing purposes. Other member
banks look it for guardians, help the direction in time to need.
 “ Centralised cash reserves can at least serve as the basis of a large and
more elastic credit structure than if the same amount were scattered
amongst the individual banks
 The centralisation of cash reserves in
conducive to economy in their use and to
increased elasticity and liquidity of the
banking system and of the credit structure as a
whole
 4.CUSTODIAN OF FOREIGN
BALANCES
 After world war 1, central banking have been keeping gold and foreign
currencies as reserve note issue and also meet to adverse balance of payment, if
any, with other countries.
 It is the function of the central bank to maintain the exchange rate fixed by the
government and manage exchange control and other restrictions imposed by
the state. Thus, it becomes a custodian of nation’s reserves of international
currency or foreign balances.
 Under the gold standard or when the country is on the gold standard, the
management of that standard, with a view of securing stability of exchange
rate, is left to the central bank
 5.LENDER OF LAST RESORT
 Central bank is the lender of last resort, for it can give cash to
the member banks to strengthen their cash reserve position by
rediscounting first class bills in case there is a crisis or panic
which develops into ‘ run’ on banks or when there is a seasonal
strain.
 Member banks can also take advances on approved short –
term securities from the central bank to add to their cash
resources at the shortest time.
1. The central bank by acting as the lender of the last resort
assumes the responsibility of meeting all reasonable demands
for accommodation by commercial banks in time of
difficulties and strain.
2. The essential duty of the central bank as the lender of last
resort is to make good a shortage of cash among the
competitive banks.
 6.CLEARING HOUSE
 Central bank also acts as a clearing house for the
settle of accounts of commercial banks. A clearing
house is an organisation where mutual a claims of
banks on one another or offset and a settlement is
made by the payment of the difference.
 Central bank being a banker’s bank keeps the cash
balances of commercial banks and as such it
becomes easier for the member banks to adjust or
settle their claims against one another to through the
central bank.
 7.CONTROLLER OF CREDIT
 The control or adjustment of credit of commercial banks by the central bank is
accepted as it’s most important function. Commercial banks create lot of credit
which sometimes results in inflation.
 “ The control and adjustment of credit is accepted by most economists and
banker’s as the main function of a central bank. It is the function which
embraces the most important questions of central banking policy and the one
through which practically all other functions are united and made to serve a
common purpose”.
 Thus, the control which the central bank exercises over commercial banks as
regards their deposits, it is called controller of credit
 CONTROLLER OF CREDIT
• METHODS
– Bank Rate Policy
– Open market operations
– Cash Reserve Ratio (CRR)
– Statutory Liquidity Ratio (SLR)
– Credit Control Function
– Repo and Reverse Repo Rates
 8.PROTECTION OF DEPOSITORS
INTEREST
 The central bank has to supervise the functioning of commercial banks so as to
protect the interest of the depositors and ensure development of banking on
sound lines.
 The business of banking has, therefore, been recognized as a public service
necessitating legislative safeguards to prevent bank failures.
 Legislation is enacted to enable the central bank to inspect commercial banks in
order to maintain a sound banking system, comprising strong individual units
with adequate financial resources operating under proper management in
conformity with the banking laws and regulations and public and national
interests.
 BANKER AND CUSTOMER

There is no statutory definition for the term

‘banker’ and ‘customer ‘
BANKER
The business of a banker ordinarily consist in
receiving money from or on account of a
customer and repaying the same on demand.
 DEFINITION
• The banking regulation act 1949 does not define the
term “banker” but defines what banking is:
• As per sec5(b) of this act, banking means accepting for
the purpose of lending or investment, of deposits of
money from the public repayable on demand or
otherwise and withdrawable by cheque, draft order or
otherwise.
 CUSTOMER
Customer is a person who has some
sort of account, either deposit or
current account with banker.
 GENERAL RELATIONSHIP
BETWEEN THE BANKER AND
CUSTOMER
Banker and Customer
• According to Section 3 of the Negotiable Instruments Act, the term ‘Banker’
includes any person acting as a banker.
• A banker is one who in the ordinary course of his business honors Cheques
drawn upon him by persons from and for whom he receives money on their
account.
• A customer is a person who has some kind of account, such as deposit or
current with a bank and from this it follows that any person may become a
customer by opening a deposit or current account or having some similar
relation with a bank.
 GENERAL RELATIONSHIP BETWEEN
THE BANKER AND CUSTOMER

• The relationship between a banker and a customer depends on

the type of transaction.
1.Debtor-Creditor relationship
2.Principal and Agent
3.Bailee and Bailor relationship
4.Banker as a Trustee
5.Banker as an Excecutor
6.Banker as an Attorney
 GENERAL RELATIONSHIP BETWEEN
THE BANKER AND CUSTOMER
1.Debtor-Creditor relationship:
• When a customer (debtor) deposits money with a bank (creditor), the customer
becomes a lender and the bank becomes borrower. As such, the relationship is
that of a debtor and creditor. It is a general relationship between banker and his
customer.
2.Principal and Agent:
• Banker acts as an agent of his customer and performs a number of agency
functions e.g the bankers collect cheques on his behalf and makes payment of
various dues of his customer viz. insurance premium.
3.Bailee and Bailor relationship:
•  A bank Function as a bailee when it keeps valuable articles, ornaments, title
deeds, etc. of its customer. The bank takes custody of these things and it is
implied the responsibility of the bank to return these things safely.  Thus the
bank is a bailee and the customer is bailor.
 GENERAL RELATIONSHIP BETWEEN
THE BANKER AND CUSTOMER
4.Banker as a Trustee:
•  A trust is a relation between two persons by virtue of which one of
them (called trustee) holds property vested in him for the benefit of
the other (called beneficiary).
5.Banker as an Excecutor:
• Where a customer appoints a banker as his executor and leaves
property through a will, the banker has to administer the property
according to the terms of the will after the death of such customer. 
6.Banker as an Attorney:
• The customer may grant a special power of attorney to his banker to
transact certain dealings on his behalf. The banker is the attorney of
the customer in such cases. 
 RIGHTS AND OBLIGATIONS OF
BANKERS
Rights
Right of general lien.
Right of set off.
Right of appropriation.
Right to charge interest and
commission
Right to close the accounts
Obligations
To honour cheque.
To maintain secrecy.
To maintain proper books of
records.
To follow customer
instructions.
To give notice before closing
the accounts.
BANKING OMBUDSMAN SCHEME

• It is a quasi judicial authority.

• It is an expeditious and inexpensive forum for
bank customers for resolution of complaints
relating to certain services rendered by banks.
• Also helps by offering information and
guidance on banking matters.
Introduction Under section 35 A of banking
regulation act, 1949 by RBI with
effect from 1995.
Latest Amendment banking ombudsman scheme 2006(july
1,2017)
Number 22
Banks covered All scheduled commercial banks,
regional rural banks, scheduled primary
co-operative banks
Cost Nil
Compensation limit amount arising or 20L (lowest)
 EXAMPLE OF COMPLAINTS
• Non payment or delay in payment of cheques, bills, drafts,
payment of inward remittances.
• Non-adherence to prescribe working hours.
• Levying of charges without adequate prior notice.
• Forced closure, refusal to closure or delay in closure of
accounts .
• Non-disbursement or delay in disbursement of pension, any
fees
 GENERAL PRECAUTIONS FOR
OPENING ACCOUNT
• Application form
• Specimen Signature
• Interview
• Account in cash
• Mandate in writing
• Verification of Documents
• Pay-in-slip Book, Cheque Book and Pass Book
• Passport Size Photograph
• KYC Regulations
• Letter of Introduction
1. Application Forms
• These application forms contain the rules and regulations of the bank
along with the terms and conditions of the deposit
• Different bankers have different printed application forms.
2. Specimen Signature
• Every new customer is expected to give three or more specimen signature.
• They are obtained on cards which are filed alphabetically for ready
reference.
3. Interview
• At the time of opening of new accounts, it is always advisable to have an
interview with the new customer.
• It reduces the chances of any fraud at later stage.
4. Account in cash
• It is a common practice among bankers to allow a new party to open an
account only in cash.
• On the other hand, if the account is opened by depositing a cheque, the
risks are greater to the banker.
5. Mandate in Writing
• The mandate contains the agreement between the two regarding the
operation of the account, the specimen signatures of the authorised
persons and the powers delegated to the authorised persons.
6. Verification of Document
• If the new party happens to be a corporate body, it is essential that the
banker should verify some of the important documents like MOA, AOA,
Bye-law copy, etc.
7. Pay-in-slip Book, Cheque Book and Pass Book
• Pay-in-slip Book : The pay-in-slip is a document which is used for depositing
cash or cheque or bill into the account.
• Cheque Book : A cheque book is used for the purpose of withdrawing money. It
normally contains 10 to 20 blank forms.
• Pass Book : A customer is also supplied with a pass book which reflects the
customer’s account in the banker’s ledger.
8. Passport size Photograph
• Banks insist upon the prospective customers to affix their passport size
photographs on the application forms at the time of opening the accounts.
• This is to prevent impersonation and for easy identification.
9. KYC Regulation
• All banks have been directed by the RBI to get complete identity of their
customers under “ Know Your Customer ” norms.
10. Letter of Introduction
• It is always advisable on the part of a banker to allow the prospective
customer to open an account only with a proper introduction.
• A letter of introduction always protects a banker in the following
ways:
1. Protection against fraud
2. Protection against inadvertent overdraft
3. Protection against an undischarged bankrupt
4. Protection against negligence under Sec.131 of the
Negotiable Instrument Act
5. Protection against giving incorrect information to fellow
bankers.
 KYC NORMS
What is KYC?
• The meaning of KYC is 'Know Your Customer' or 'Know
Your Client'.
• It is a process through which a business verifies the identity of
its clients and assesses potential risks of illegal intentions for
the business relationship.
• The term KYC is also used to refer to the bank regulations and
anti-money laundering (AML) regulations which govern these
activities.
• This process has been declared compulsory for every bank or
financial institution in India by the Reserve Bank of India
(RBI). RBI has made this a mandatory process so as to prevent
any misuse of the services provided by the banks or financial
institutions.
 OBJECTIVES OF KYC
The aim of implementation of KYC norms is to prevent
banks from being used, intentionally or unintentionally,
for money laundering or other criminal activities.

The main objectives of Know Your Customer norms

are to:
• Stop money laundering,
• Terrorist financing and,
• Understand the customer and avoid future risks
REQUIRED DOCUMENTS FOR FILING
KYC
• An identity proof with photograph and an address proof are usually the two
basic, mandatory, KYC documents required for establishing one's identity
at the time of opening of savings bank account, mutual fund, insurance,
etc.
• Six documents have been notified by the Government of India as
‘Officially Valid Documents’ (OVDs) for the purpose of producing proof
of identity. These are
• Passport
• Driving Licence
• Voters’ Identity Card
• PAN Card
• Aadhaar Card
• NREGA Job Card
 KYC NORMS BY RESERVE BANK OF
INDIA
The implementation of KYC norms for every new bank account was made
compulsory by RBI in the year 2002, which came into force from 1st July
2005. Know Your Customer norms were made mandatory with the objective
to restrict money laundering and to stop terrorist financing. In 2002, when
the KYC guidelines were introduced, their proper implementation was not
made possible. In order to reach their goal, RBI asked the banks to adopt
some measures for the existing bank accounts also. Some of these are
• Public Notices were published in the national newspapers.
• Identification was made compulsory for zonal customers.
• The customers who didn't follow the norms were forwarded with
individual notices.
• To ensure proper documentation, a final notice was given within 7 days
from that particular day in the newspapers.
• Guidelines regarding Know Your Customer are
issued by the RBI through Banking Regulation
Act, 1949 Section 35A along with Prevention
of Money Laundering (Maintenance of
Records) Rules, 2005. If there would be any
kind violation of the KYC norms by any bank,
it would be subject to penalty under the Bank
Regulation Act, 1949.
VARIOUS TYPES OF BANK DEPOSITS
 SAVINGS DEPOSIT
• his type of account is suitable for people who have a definite income
and are looking to save money. For example, the people who get salaries
or the people who work as labourers. 
• This type of account can be opened with a minimum initial deposit.
Money can be deposited at any time in this account.
• Withdrawals can be made either by signing a withdrawal form or by
issuing a cheque or by using an ATM card. A minimum balance has to
be maintained in the account as prescribed by the bank.
• Interest is allowed on the balance of deposit in the account.
 CURRENT DEPOSIT
• Majority of customers particularly business class, government
departments, public bodies keep their money in current accounts.
• In this account money can be deposited and withdrawn from bank at
any time during banking hours.
• Generally, interest/profit is not paid on this account and bank deducts
its service charges from the account.
• Now a day, some banks are offering interest/profit on a particular
amount kept in these accounts.
• It is also called running and active account.
 FIXED DEPOSIT
• In the fixed deposit account, money is deposited for a fixed period of time.
• High rate of interest/profit is paid on this deposit.
• The period is fixed at the time of opening a bank account. This period of
deposit may range from 15 days to three years or more during which no
withdrawal is allowed. 
• However, on request, the depositor can encash the amount before its maturity.
In that case, banks give lower interest than what was agreed upon.
• Banks also grant a loan on the security of the fixed deposit receipt.
 RECURRING DEPOSIT
• While opening the account a person has to agree to deposit a fixed amount once
in a month for a certain period.
• The total deposit along with the interest therein is payable on maturity.
However, the depositor can also be allowed to close the account before its
maturity and get back the money along with the interest till that period.
• The account can be opened by a person individually, or jointly with another, or
by the guardian in the name of a minor.
• The rate of interest allowed on the deposits is higher than that on a savings
bank deposit but lower than the rate allowed on a fixed deposit for the same
period.
 NEGOTIABLE INSTRUMENTS ACT

Meaning
• The word Negotiable mean transferable by delivery
• The word instruments mean a written document by which
a right is created in favour of same person.
Thus the term Negotiable instruments mean a written
document transferable by delivery.
Definition
According to section 13(1) of the Negotiable Instruments
Act, A Negotiable Instrument means a Promissory note, Bills
of exchange or cheque payable either to order or to bearer.
Negotiable Instruments Act ,1881
• Originally published: 9 December 1881
• Enacted by: Imperial Legislative Council (India)
• Commenced: 1 March 1882

It is covered under two heads that are;

i) Negotiable Instruments by Statue
ii)Negotiable Instruments by Usage
 TYPES OF NEGOTIABLE
INSTRUMENTS
i) Negotiable Instruments by Statue
🔸Promissory note
🔸Bills of Exchange
🔸Cheques

ii)Negotiable Instruments by Usage

🔸 Delivery orders
🔸Custom receipts
NEGOTIABLE INSTRUMENTS BY STATUE

Promissory Notes: Sec 4

Promissory note is a signed document of written
promise to pay a stated sum to a specified person or to
the bearer at a specified date or on demand.
i.e. It contains a promise by the debtor to the creditor
to pay a certain sum of money.
Bills of Exchange: Sec 5
Bills of exchange is a binding agreement by one party to pay a
fixed amount of cash to another party as of a predetermined date
or on demand.
🔸Its used primarily in International trade.
🔸The person who draws it is called Drawer(creditor)
🔸The person on whom its drawn is called drawee (debtor) or
acceptor
Cheque
According to sec. 6 of the Act a cheque is an order by the customer of the
bank directing his banker to pay on demand, the specified amount, to or to the
order of the person named therein or to the bearer.
And it includes the electronic image of a truncated cheque and a cheque in
the electronic form.
Requirements of Negotiable Instruments
🔹It must be in writing.
🔸It must be signed by the maker or drawer.
🔹It must be an unconditional promise or order to pay.
🔸It must be for a fixed amount in money.
🔹It must be payable on demand or at a definite time.
🔸It must be payable to order or bearer, unless it is a check.
 ENDORSEMENT
Meaning
• The act of a person who is a holder of a negotiable instrument in signing
his or her name on the back of that instrument, thereby transferring title
or ownership is an endorsement.
• An endorsement may be in favour of another individual or legal entity.
• An endorsement provides a transfer of the property to that other
individual or legal entity.
• The person to whom the instrument is endorsed is called the endorsee.
The person making the endorsement is the endorser.
 DEFINITION
• According to Section15 of the Negotiable
Instruments Act 1881,When the maker or holder
of a negotiable instrument signs the same,
otherwise than as such maker, for the purpose of
negotiation on the back or face thereof or on a
slip of paper annexed thereto, or so signs for the
same purpose a stamped paper intended to be
completed as a negotiable instrument, he is said
to endorse the same, and is called the “endorser”.
TYPES OF ENDORSEMENT
1. Blank endorsement
2. Special Endorsement
3. Restrictive endorsement
4. Partial endorsement
5. Conditional endorsement
 BLANK ENDORSEMENT
• An endorsement is said to be blank or general
when the endorser puts his signature only on
the instrument and does not write the name of
anyone to whom or to whose order the
payment is to be made.
 SPECIAL ENDORSEMENT
• An endorsement is 'special' or in 'full' if the endorser,
in addition to his signature also mention the name of
the person to whom or to whose order the payment is
to be made.
• There is direction added by endorse to the person
specified called the endorsee, of the instrument who
now becomes its payee.
 RESTRICTIVE ENDORSEMENT

• Restrictive endorsement seeks to put an end

the principal characteristics of a Negotiable
Instrument and seals its further negotiability.
• This may sound a little unusual, but the
endorsee is very much within his rights if he
so signs that its subsequent transfer is
restricted.
 CONDITIONAL ENDORSEMENT

• The endorser of a negotiable instrument may,

by express words in the endorsement, exclude
his own liability thereon, or make such
liability or the right of the endorsee to receive
the amount due thereon depend upon the
happening of a specified event, although such
event may never happen.
 PARTIAL ENDORSEMENT
• An endorsement partial is one which allows
transferring to the endorsee a part only of the
amount payable on the instrument. This does
not operate as a negotiation of the instrument.