Unit I - INTRODUCTION TO BANKS

Origin of the word bank

• Banks-German (which means Joint stock fund)

• Banco-Italian (which means Heap of money)
• Bancus /Banque-French (which means Bench a place where valuables are kept)
• Bank- English (common meaning prevalent today i.e., as an institution accepting
money as deposit for lending)
Definitions:

• Walter Leaf defines a bank as “A person or corporation which holds itself out to receive
from public deposits payable on demand or cheque”.
Definition by Indian Banking Regulation Act 1949;

 Section 5(1)(c)- defines the term Banking company as “any company which transacts
the business of banking in India”
 Section 5(1)(b)- defines the term Banking as “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”.
 Section 6- defines various subsidiary services such as collection of cheques, drafts and
bills, remittance of funds, acceptance of safe custody deposits etc that are performed by
a bank.
 Section 7- requires that every banking company should use as a part of its name, the
term ‘bank’, ‘banker’ or ‘banking company’

Essential characteristics of bank-

 Banking institution must accept deposits of money from the public. (Mahalaxmi Bank
Ltd Vs Registrar of Companies).
 Deposits can be accepted on various accounts.
 Deposits accepted from depositors should be repaid on demand or after expiry of a
specified period or must be utilized for the purpose of lending or investment in
securities.
 Banking should be the main part of the business of a bank.
 A bank should also perform subsidiary services along with its primary function of
accepting deposits and lending money.
 Using the term ‘bank’, ‘banker’ or ‘banking company’ as part of the name
Need or importance of Bank

 Banks offer attractive interest rates on the savings of the people and encourages the
habit of thrift and saving.
 Banks help in the process of capital formation.
 Banks provide safety and security to the surplus money of depositors.
 Banks provide convenient and economical means of payment, transfer of funds.
 Banks help trad, commerce, industry and agriculture by meeting their financial
requirements.
 Banks serve as the best financial intermediaries between the savers and investors.
 Banks deposits are risk free investment for the depositors.
 Banks also participate in social banking.
Functions of banks

The commercial banks serve as the king pin of the financial system of the country. They render many
valuable services. The important functions of the Commercial banks are:
They can be divided two categories:

1. Primary functions
2. Secondary functions
3. Modern banking functions

1. Primary Functions of Commercial Banks:

The primary functions of the commercial banks include the following,

1. Acceptance of Deposits
2. Lending of funds
3. Investment of funds on securities
4. Creation of money

1. Acceptance of deposits
The most important activity of a commercial bank is to mobilize deposits from the public.
People who have surplus income and savings find it convenient to deposit the amounts
with banks. Depending upon the nature of deposits, funds deposited with bank also earn
interest. Thus, deposits with the bank grow along with the interest earned. If the rate of
interest is higher, customers will also come forward to deposit more funds with the bank.
There is also safety of funds deposited with the bank. Deposits are classified into two-
Time deposits and Demand deposits.
a. Time Deposits:
These are deposits repayable after a certain fixed period. These deposits are not
withdrawable by cheque, drafts or by other means. It includes the following:

i. Fixed Deposits:
The deposits can be withdrawn only after expiry of certain period say 3 years, 5 years
or 10 years. The banker allows a high rate of interest depending on upon the amount
and period of time. Banks accept deposits even for 15 days or one month etc. In
times of urgent need for money, the bank allows premature closure of fixed
deposits by paying interest at reduced rate. Depositors can also avail loans against
Fixed deposits. The FDR cannot be transferred to other person. The rate of interest
and other terms and conditions regulating fixed deposits are determined by the
Reserve Bank of India for all commercial banks.
ii. Recurring deposits:
In recurring deposit, the customer opens an account and deposits a certain sum of
money every month. After a certain period, say 1 year, 3 years or 5 years, the
accumulated amount along with interest is paid to the customer. It is very helpful to
the middle and weaker section of the people.

iii. Cash certificates:

Cash certificates are issued to the public for a long period of time. It attracts the
people because its maturity value is in multiples of the sum invested. It is an
attractive and high yielding investment for those who can keep the funds for a long
[Link] certificates are generally issued at discount to face value. It means a
cash certificate of Rs.1,00,000 payable after 10 years can be purchased now say
for Rs.20,000/-
b. Demand deposits:
These are the deposits which may be withdrawn by the depositor at any time without
previous notice. It is withdrawable by cheque /draft. It includes the following:
i. Savings deposits:
The savings deposit promotes thrift among people the saving deposit can only be
held by individuals and non-profit institutions. The rate of interest paid on saving
deposits is lower than that of time deposits. The savings account holder gets the
advantage of liquidity (as in current a/c) and small income in the form of interests.
But there are some restrictions on withdrawals. Presently interest on SB
accounts is determined by RBI
ii. Current Account Deposits:
These accounts are maintained by the people who need to have a liquid balance.
Current account offershigh liquidity. No interest is paid on current deposits and
there is no restriction on withdrawals from the current account. These
accounts are generally in the case of business firms, institutions and co-operative
bodies. Nowadays, banks aredesigning and offering various investment schemes
fordepositof money. These schemes vary from bank to bank.
2. Lending of funds:
The next important function of a commercial bank is to grant loans and advances. Such
loans and advances are given to members of the public and to the business community at a
higher rate of interest than allowed by banks on various deposit accounts. The
commercial banks provide loans and advances in various forms. They are given
below:
a. Overdraft:
This facility is given to holders of current accounts only. This is an arrangement
with the bankers where by the customer is allowed to draw money over and above the
balance in his/her account. This facility of overdrawing his account is generally pre-
arranged with the banker up to certain limit. It is a short-term temporary fund facility
from bank and the bank will charge interest over the amount overdrawn. This facility
is generally available to business firms and companies.
b. Cash credit:
Cash credit is an arrangement whereby the bank allows the borrower to draw
amounts up to a specified limit. The amount is credited to the account of the
customer. The customer can withdraw this amount as and when he requires. Interest is
charged on the amount actually withdrawn. Cash credit is granted as per agreed
terms and conditions with the customers. Under this arrangement, the customer
opens an account and the sanctioned amount is credited with that account. The
customer can operate that account within the sanctioned limits as and when required.
On the basis of operation, the period of credit facility may be extended further.
c. Discounting of Bills:
Discounting of Bills may be another form of bank credit. Banks provide short-term
finance by discounting bills that is, making payment of the amount before the due
date of the bills after deducting a certain rate of discount. The party gets the funds
without waiting for the date of maturity of the bills. In case any bill is dishonored on
the due date, the bank can recover the amount from the customer.
D. Loans and Advances

A loan is granted for the specific time period. Generally commercial grant
short term loans. But term loans, that is, loan for more than a year may also be granted.
The borrower may withdraw the entire amount in lump sum or in installments.
Loans are [Link] be repaid
either in lump sumor in installments.

It includes both demand and term loans, direct loans, and advances given to all types
of customers, mainly to businessmen and investors against personal security or
goods of movable or immovable nature. The loan amount is paid in cash or by credit to
customer accounts which the customer can draw at any time.

E. Other Advances: Housing Loan, educational Loan Scheme, loans against

Shares/Securities, loans against Savings Certificates (NSC, FDR, KVP), consumer Loans and
Advances
3. Investment of funds on securities: Investment of surplus funds on securities is one of
the important functions of commercial banks. Commercial banks invest a considerable
amount of their funds in Government and industrial securities.

4. Creation of Money or Creation of Credit: Commercial banks would not have become so
prominent, as they are today, if they merely borrow and lend money. They do something
more than this. That is, they manufacture or create money. Ask they manufacture money, they
are called manufacturers of money.

SECONDARY FUNCTIONS OF COMMERCIAL BANKS

The secondary functions of the banks consist of Agency functions and General utility functions.

A. Agency Functions:
(i) Collection of cheques, dividends, interests:
As an agent the bank collects cheques, drafts, promissory notes, interest, dividends etc.
on behalf of its customers and credit the amounts to their accounts.
(ii) Payment of rent, insurance premiums:
The bank makes the payments such as rent, insurance premiums, subscriptions,
on standing instructions until further notice.
(iii) Dealing in foreign exchange:
As an agent the commercial banks purchase and sell foreign exchange as well for
customers as per RBI Exchange Control Regulations.
(iv) Purchase and sale of securities:
Commercial banks undertake the purchase and sale of different securities such as
shares, debentures bonds etc. on behalf of their customers.
(v) Act as trustee, executor, attorney, etc:
ThebanksactasexecutorsofWill,trusteesandattorneys. It is safe to appoint a bank as
a trustee than to appoint an individual. Acting as attorneys of their customers, they
receive payments and sign transfer deeds of the properties of their customers.
(vi) Preparations of Income-Tax returns:
They prepare income-tax returns and provide advices on tax matters for their
customers.
B. General Utility Services:
• Safety Locker facility: Safekeeping of important documents, valuables like jewels
are one of the oldest service provided be commercial banks.
• Issue “Travelers Cheques”: Banks issue travellers cheques to help carry money
safely while travelling within India or abroad. Thus, the customers can travel
without fear, theft, loss of money.
• Letters of Credit: Letter of credit is a payment document provided by the buyer’s
banker in favour of seller. The letter of credit is an important method of payment in
international trade.
  Banker also acts as a referee for his customer.
 Banker collects trade related information for his customer.
 Banker collects statistics and important information of all the sectors (insurance,
industry, technology, banking) and publishes same in the magazines for the benefit
of students, and general public.

Modern services
 Issue of debit and Credit cards
 Gift Cheques
 Consultancy services
 Tax consultancy services
 Underwriting of shares
 Factoring services
 Core Banking Solution (CBS)
 No-Frills account
 Demat account
 Net banking
 Mobile banking
 Lock-box services and night safe services
 Insurance

RELATIONSHIP BETWEEN A BANKER AND A CUSTOMER

The relationship between a banker and the customer may be divided into two types. They are:
1. General relationship
2. Special relationship
General relationship between a banker and customer
The general relationship between a banker and the customer may be sub-divided into:
1. Primary general relationship and
2. Subsidiary general relationship

1. Primary general relationship between a banker and customer

The various features of primary general relationship between a banker and the customer are:
1. Commencement of primary general relationship: The primary general relationship between a
banker and a customer starts from the time the customer opens the bank account by
depositing money.
2. Contractual primary general relationship:
The primary general relationship between a banker and a customer arises from a contract
between the two. So, it is a contractual relationship. As it is a contractual relationship, it is
governed by the various terms of agreement between the two parties.
3. Nature of primary general relationship:
• The primary general relationship between a banker and a customer is that
of a debtor and creditor. When a banker receives a deposit of money from
a customer, he is neither a Bailee, nor a trustee, nor an agent, but only a debtor.
• Banker is not a Bailee or depositor of customer’s money:
• Banker is not a trustee of customer’smoney:
• Banker is not an agent in respect of customer’s money:
4. Banker is only a debtor in respect of customer’s money:
When a banker accepts deposits of money from a customer, he is only a debtor of the
customer in respect of that money, because the money ceases to be the money of the customer
and becomes the absolute property of the banker. As the owner of the money, the banker can
deal with the money in any way he likes. His only obligation to the customer is that he should
return to the customer in an amount equal to the amount deposited together with interest, if
any, on demand or otherwise. So, the banker is just a debtor, and the customer is a creditor, when
he accepts and has the deposits of the customer.

Unique features of debtor and creditor relationship of Banker and Customer

a) Banker is a privileged, honoured or dignified debtor:
No doubt, a banker is a debtor, when he holds his customer’s deposit. But he is a
privileged, honored or dignified debtor. He is privileged debtor for the following
reasons:

• Banker borrowing from a customer is nothing but a debt. It is given a dignified

name “deposit”.
• Generally, for borrowing money, a debtor goes to the creditor. But, in this case of a bank
deposit, the creditor (that is, the depositor) goes to the debtor (that is, the banker) for
giving the amount (that is, the deposit).
• Banker has to repay the deposit only when there is an express demand in writing by the
customer for the repayment of the money.
• A banker cannot be asked by the customer to repay the deposit at any place other than the
one where the deposit is kept.
• A banker can be asked to repay the deposit only on a working day and only during
working hours.
• A banker is not required to give any security to the customer for the deposit accepted for
the money borrowed.
• A banker, as a debtor of the customer in respect of the deposits of money by the customer,
has the right to set off or combine two or more accounts of the customer maintained in the
same name and in the same capacity.
• The law of limitation which is applicable to all debts, lays down that a debt will become
Time – barred after the expiry of three years from the date of the debt.
• In the case of a banking that (that is, Bank deposit), the debtor (means banker) cannot
close the account of his creditor (means customer) without prior notice to the customer.
Subsidiary General relationship between banker and customer:

Besides the primary debtor and creditor relationship, the banker and the customer can also enter
into subsidiary relationships like that of a Bailee and Bailor ; Trustee and Beneficiary; Agent
and Principal by special agreements or arrangements.
Features of subsidiary general relationship
a. Customer is only a general creditor of the banker: It is true that the customer is the creditor
of the Bank, when he has some deposit in the bank. But he cannot be a secured creditor of
the banker,becausehedoesnotgetanychargeonanyassetofthe banker. He cannot be even
preferential creditor of the banker, as he does not get priority of the claim over the other
creditors of the bank in the event of liquidation of the bank. He’s just an ordinary, general
or unsecured creditor of the banker.
b. Demand for repayment of deposits is necessary: For the repayment of the deposit due
from the banker to the customer, and express demand for repayment is required to be made
by the customer. In other words, the banker is not bound to repay the customer's deposit
unless he is called upon by the customer to repay the deposit.
c. Customer can demand repayment of deposits whenever he wants: The customer of a
bank can demand to repay the deposit at any time whenever he wants and the
banker is bound to repay the same by honouring the customer’s cheques.
d. Customer’s demand for repayment of deposits should be made at proper place: Demand
for the repayment of bank deposit should be made by the customer at the proper place,
should be made at the same branch of the bank where the deposit is kept by the customer.
This point was supported by many authorities on banking law and court decisions.
e. Customers demand for repayment of deposits should be made on a working day
and during business hours.
f. Customers demand for repayment of deposits should be made in proper form

1. Bailee and Bailor relationship:

When a banker accepts valuables and documents from a customer for safe custody he becomes a
Bailee, and the customer becomes a Bailor.
As a Bailee, the banker owes some duties and liabilities to the customer. They
are:
a. He is required to safeguard the safe-custody deposits of the customer in his hands
with reasonablecare.
b. If he fails to take reasonable care in the preservation of the safe-custody deposits,
and the customer suffers a loss as a consequence, he becomes liable to compensate the
customer for the loss.
In this context, it should be noted that the banker is liable only for the losses arising out of his
negligence, and not for those losses arising out of reasons beyond his control, such as fire,
burglary, etc. This is because, bankers only a Bailee, and not an insurer, of the safe custody deposit
left with him.
c. He is required to hand over the safe custody deposit to the depositor, whenever
he demands them back.
 2. Trustee and beneficiary relationship:
A banker becomes the trustee of his customer, when he is entrusted with some trust work for
instance, when a customer deposit a certain sum of money with the banker with specific
instructions to use the same for specific purpose, the banker becomes a trustee of the
customer in respect of that money until that purpose is fulfilled.
When money is paid into a bank with special instructions to retain the money till further
instructions, the banker becomes a trustee for that money.
When a banker is appointed as trustee for the customer's property ,he becomes a trustee of the
customer.
As a trustee, the banker owes some duties. They are:
a. He is required to deal with the trust money or property in accordance with the
terms of the trustdeed.
b. He is required to give a detailed account of the administration of the trust property to
the beneficiary.
c. He is bound to hand over the profit earned from the use of the trust property to the
beneficiary (The customer or somebody else) who is entitled to the benefits of the trust
property.

3. Agent and Principal Relationship:

When a banker undertakes agency services, such as collection of cheques, drafts and bills,
collection of interests and dividends on securities, payment of premium and subscriptions, purchase
and sale of securities, etc. for a customer, he becomes the agent and the customer becomes the
principal.

As an agent, the banker owes someduties to the customer. They are;

(a) He is required to act in accordance with the instructions of the principal, i.e ., the
customer.
(b) He is bound to return to the customer all the incomes which he earns as an agent of the
customer.

SPECIAL RELATIONSHIP BETWEEN A BANKER AND A CUSTOMER

Meaning of Special Relationship:

Special Relationship between a banker and a customer refers to the special obligations and rights
of the banker against the customer and vice versa. In other words, it means the mutual
obligations and rights of the banker and the customer arising out of their general debtor and
creditorrelationship.

Various features of Special Relationship:

The various special features of relationship between a banker and a customer can be discussed under
three heads. They are:
 1. Banker’s obligations.

2. Banker’s rights.
3. Banker’s obligations coupled with his rights or banker’s rights coupled with his obligations.

I. BANKER’S OBLIGATION TO HONOUR HIS CUSTOMER’S CHEQUES.

When a current account is opened by a banker in the name of a customer, there is an obligation
on the banker to honour the customer’s cheques as long as there are sufficient funds available in the
customer’s account for meeting the cheques.

Nature of Banker’s obligation to honour cheques:

The current deposits accepted byabanker from acustomerarethe debts due from the banker to the
customer. These debts are repayable by the banker to the customer on demand as per the
contract entered into between them. So, whenever the customer depends the repayment of his
deposits by issuing cheques, there is a contractual obligation on the banker to honour his customer’s
cheques and repay his deposits.

Banker’s obligation to honour cheques is subject to certain conditions:

(a) Sufficient funds must be available:

The banker must have sufficient funds of the customer to pay his cheques. The funds to the
credit ofthe customer’s account must be sufficient to pay the amount of the cheque presented by
the customer for payment. If the banker does not have sufficient funds of the customer,he can
dishonor the cheque issued by the customer. In this context, it should be noted that

When the funds of the customer lying in the hands of the banker are not sufficient to pay the
cheque in full, the banker need not make a part payment for that cheque to the extent of the balance
available. He can just dishonor that cheque.
For the purpose of determining the sufficiency of funds in the customer’s account, only the funds in
the particular current account (i.e the current account on which the cheque is drawn) should be
considered. The funds held by the customer in another current account should not be taken into
account.
The balance to the credit of the customer’s current account held in another branch of the bank
should not be taken into account. The amount of overdraft granted by the banker to the customer
under an overdraft arrangement should be taken into account for the purpose of determining the
sufficiency of funds in the drawer’s account.
(B) Funds must beproperly applicable to the payment of the cheque:
The funds of the customer in the hands of the banker must be available for the payment of
the customer’s cheque. For instance, the funds in the hands of the banker to the credit of
a trust account are applicable only for the purposes covered by the trust, and not for other
purposes. Similarly, if the banker has received a notice of the assignment of the
customer’s credit balance to a third party, then the funds assigned will not be
available for the payment of the customer’s cheque. So also, if certain funds in the
customer’s account are earmarked by the customer for some specific purpose then
those funds will not be available for the payment of the customer’s cheque.

(C) Banker must be duly required to pay the cheque:

The banker must be duly required to pay the customer’s cheque. The bank should pay
the cheque only if it is complete and is in order ( i.e properly drawn satisfying all the
legal requirements) and is presented within areasonable time after its date of issue. A
cheque must be presented for payment within six months from its date of issue,
otherwise it becomes stale and invalid. If a cheque is not properly drawn, the banker
need not honour that cheque. Similarly if a cheque is not presented before it becomes
stale, it need not be paid by the banker. If a cheque is presented for payment before the
date of payment mentioned on its face (i.e if the cheque is post dated) the banker is
not required to pay that cheque.
Again, if a cheque is presented outside business hours, the banker is not required to honour
the same.
(D) There must be no legal bar preventing the payment of cheque: There must not
be any legal bar preventing the banker from paying the customer’s cheque. If there is a
garnishee order issued by a court attaching the funds of the customer in particular
account, a cheque drawn against that garnished account should not be paid by the
banker. Similarly, if there is any order issued by the income tax authorities attaching the
customer’s funds in an account, a cheque drawn by the customer against such an
account should be honoured bythe banker.

Banker’s obligation to honour cheques extends even to cheques drawn against overdraft or
cash credit sanctioned:
The obligation of a banker to honour his customer’s cheques applies not only to cheques
drawn against the customer’s credit balance or deposits, but also to cheques drawn against
the amount of overdraft or cash credit agreed upon.
If a cheque or cheques drawn by a customer against insufficient balances have been
honoured by the banker in the past, then, such a practice (i.e honouring the cheques drawn
against insufficient balances) should not be discontinued by the banker without giving
reasonable prior notice to the customer warning him that further cheques issued by
him against insufficient balances without previous overdraft arrangement will not be
paid. This is because, in such a case, an implied agreement to grant overdraft is presumed.
Banker’s obligation to honour cheques does not apply to cheques drawn against uncleared
cheques or bills:

A banker is obliged to honour his customer’s cheques drawn against the credit balance or
deposits in his account and also against the overdrafts agreed upon or implied. But he is
not bound to honour the customer’s cheques drawn against the chequesorbills deposited
for collection until and unless those cheques or bills are collected and credited to the
customer’s account. This is because, first, the bank must have reasonable time for
collecting the cheques or bills and crediting the proceeds to the customer’s account.
Secondly there is no certainty that those cheques or bills will be realised. So if cheques
 are drawn by a customer against uncleared cheques or bills ( i.e cheques or bills deposited
by the customer for the collection but not yet collected and credited to the customer’s
account) the banker can return such cheques unpaid with the remark.

Banker’s obligation to honour cheques does not apply to domiciled bills of exchange:
The obligation of a banker to honour the cheques of his customer does not apply to
domiciled bills of exchange i.e bills of exchange accepted by the customer and made
payableby the banker. So, a banker need not pay the domiciled bills of exchange.
Dishonour of customer’s cheques:
Though a banker is obliged to honour his customer’s cheques he can dishonour the
cheques issued by a customer under certain circumstances, such as insufficiency of
funds in the customer’s account, irregularity in the cheque, presentation of a cheque after
it becomes stale, presentation of a post-dated cheque before its due date, attachment of
the funds in the customers account by a garnishee order, etc.

Wrongful dishonor ofa cheque anditsconsequences:

Dishonour of a cheque by a banker without any justifiable reason is called
wrongful dishonour of a cheque.
Though a banker can dishonour a customer’s cheques under certain circumstances,
wrongful or unjustified dishonour of the customer’s cheques lands the banker in
trouble. If a banker, without any justifiable reason, dishonours his customer’s
cheques, he becomes liable to compensate the customer for any damage or loss caused to
the customer. The customer can claim damages from the banker for wrongful
dishonour of his cheque on the ground of breach of contract by the bank.
Damages or compensation forwrongful dishonor of cheques:

Damages or compensation payable by a banker to his customer for the wrongful dishonor
of his cheque maybe divided into 4 kinds. They are,

A. General damages for breach of contract.

B. Special damages for pecuniary loss or financial loss.
C. General damages for defamatory statement and
D. Vindictive damages.

A. General damages for breach of contract:

(i) Damages for breach of contract are damages payable by a banker to a customer for
causing annoyance and or damage to the credit (i.e., reputation) of the customer as
a result of the wrongful dishonour of his cheque.
(ii) The amount ofgeneral damages which the banker is required to pay to his customer
for the breach of contract does not depend even upon the actual monetary loss
suffered by the customer, because the term “loss or damage” used in Section 31 of
Indian Negotiable Instruments Act of 1881 is not limited to the actual monetary
loss only, but also includes loss of credit or injury to reputation.
 (iii) In fact, the amount of general damages payable by the bankers to his customer for
the breach of the contract depends mainly on the injury caused to the credit or
reputation of the customer by the wrongful dishonour of the cheque.
(iv) The amount of general damages awarded by the court may be ordinary or nominal
(i.e., small) or special (i.e., large) depending upon the circumstances of each case.
(v) When a suit is filed in a court of law by a customer of a bank claiming damages for
the wrongful dishonour of his cheque, the court determines the amount of general
damages after carefully assessing the injury or damage caused to the customer’s
credit or reputation by the wrongful dishonour of his cheque.
(vi) A trader customer (i.e., a customer who is a trader or a commercial agent or a
manufacturer) can get substantial general damages for the wrongful dishonour of
the cheque issued by him without proving the actual damage to his credit.
(vii) Similarly, a trustee can get substantial general damages for the wrongful dishonour
of a cheque issued by him against the account which he holds as a trustee without
proving the loss of the credit.
(viii) A non-trader customer (i.e., a customer who is not a trader or a commercial agent or a
manufacturer) can ordinarily get only nominal general damages for the wrongful
dishonour ofhis cheque. He can get substantial general damages of if he proves
that his credit or reputation has suffered on account of the wrongful dishonour of his
cheque by the banker, because injury to the credit or reputation of a non-trader
customeris not presumed.
B. Special damage for financial loss:
Special damages also refer to the damages payable by a banker to his customer for the
actual financial loss (i.e., loss of profit of income) suffered by the customer as a direct result
of the wrongful dishonour of his cheque by the banker.
C. Substantial general damages for defamatory statement:
When a cheque is dishonoured by a banker, he, usually, gives the reason for the
dishonour on a slip of paper attached to the dishonoured cheque. If the answer given by the
banker is defamatory (i.e., humiliating) to the customer, the customer, whether he is a
trader-customer or a non-trader customer, can claim from the banker substantial general
damages even without proving the actual damage to his credit or reputation.

The substantial general damages payable by the banker to the customer for defamatory
statement is commensurate with the nature and the volume of business transactions
carried on by the customer and his standing in business.
D. Vindictive damages:
If the dishonor of a customer’s cheque is willful, the banker becomes liable to pay
vindictive damages.
 2. BANKERS OBLIGATION TO MAINTAIN THE SECRECY OF
THE CUSTOMER’S ACCOUNT:

For a long time, the obligation to observe the secrecy of the customer’s account vested
on the banker only as a matter of practice. But, later on, it was given legal recognition by
many court judgements.

Meaning of banker’s obligation to maintain secrecy:

A banker’s obligation to maintain the secrecy of his customer’s account means that he
should not disclose to any outsider the details concerning the customer’s account, such as the
amounts deposited, cheques, drafts and bills deposited for collection, the parties from whom
the cheques drafts and bills are received, the cheques issued, the parties to whom the cheques
are issued, the bank in the account, the overdraft, loan or any other advances granted, the securities
deposited by the customer against the advance, etc. In short, it means that the banker should
not disclose the state of the customer’s account to any outsider.

Idea behind banker’s obligation to maintain secrecy:

The relationship between a banker and a customer is confidential or private in
character. If the private character of the relationship (i.e., transactions between the banker and
the customer) is revealed to any outsider, it may affect the reputation and the business of the
customer adversely. So, an obligation is imposed on the banker to observe the secrecy of his
customer’s account.
Nature of banker’s obligation of secrecy:

The banker’s obligation to observe the secrecy of the customer’s account is contractual
in nature. It’s one of the implied terms of the contract on which the banker and customer
relationship is built. Today, the obligation is not only implied, but also legally imposed. It may
be noted that the duty of the banker to maintain secrecy of the customer’s account is not a
statutory duty. The banker’s obligation of secrecy applies not only to information derived by
the banker from the customer himself or from his account, but also to information that may
come into the banker’s possession in his capacity as a banker.

Again, the banker’s obligation to observe the secrecy of the customer’s account exists
not only during the currency of the account (i.e., when the account is in operation), but continues
even after the account is closed and even after the death of the customer.

Exception to banker’s obligation to observe secrecy:

The banker’s obligation to observe secrecy of his customer's account is not absolute
but qualified that means, disclosure is permitted in some cases.
1. When there is an Express consent of the customer:
A banker is justified in disclosing the state of his customer's account to a third party, when
there is an express consent of the customer for such disclosure.
2. When there is an implied consent of the customer:
A banker is justified in disclosing the state of his customer’s account to an outsider even
when there is an implied consent of the customer for such disclosure.
3. When he is compelled by the law of the country:
A banker can disclose the state of his customer’s account to public authorities when is
compelled by the laws of a country under section 285 of the income-tax act of 1961, every
banker is required to furnish to the income-tax authorities the names, the addresses and the
amounts of interest paid to depositors who get more than Rs.10,000 as interests during any
accounting year.
4. When he is under a public duty to disclose:
A banker is justified in disclosing the state of his customer’s account when he is
under a public duty to disclose.
5. When his own interest requires disclosure:
A banker in justified in disclosing the state of his customer’s account when his own
interest requires disclosure.
6. When an enquiry is received from a fellow banker:
Bankers have the practice of exchanging information amongst themselves about
customers because of common courtesy. So, when an enquiry is received by a banker
from a fellow banker about the state of a customer account, the banker can answer that
enquiry as a matter of common courtesy.

Precautions to be taken by a banker in answering an enquiry:

While answering an enquiry a banker should bear in mind the following points:
(a) He should not be negligent in giving information.
(b) The information should be given confidentially.
(c) The information should be given honestly.
(d) In answering any enquiry about a customer, the banker should depend only on facts as
disclosed by the customer's account, and not on rumours regarding the credit of the customer
that are afloat in the market. (Again, he is not expected to make further enquiries in order to
furnish the information.)
(e) The information should be given in the most general manner. The actual details of
the customer's account should not be disclosed.

Consequences of unjustified disclosure:

Disclosure of the state of a customer’s account by a banker to an outsider, except and
reasonable and proper grounds as stated earlier, is regarded as unjustified disclosure.
 II BANKER'S RIGHTS

The banker has certain rights. The various rights of a banker are:
1. BANKER'S RIGHTS OF GENERAL LIEN
Lien is the right of a person to retain the property, in his possession, belonging to
another, until the debt due from the owner of that property is repaid.
Types of lien: Lien is of two types, viz., (1) Particular lien, special lien or conventional lien
and (2) General lien.
Particular Lien:

A particular lien is the right of a creditor to retain a particular property (i.e., property, in respect of
which the debt is incurred) until the particular debt (i.e., the debt incurred in respect of the property
retained) is repaid. It is enjoyed by Craftsman, Mechanics, public carriers, bailees and others who
have expanded time, labour and money on the property retained. For instance, a tailor has a
particular lien on the clothes stitched by him for a customer for the tailoring charges due from the
customer. Similarly, a watch repairer has a particular lien on the watch repaired by him for a
customer for the repair charges due from the customer. A Goldsmith has a particular lien on
the ornaments made by him for a customer for the making charges do from the customer.

General Lien:

A general lien is the right of a creditor to retain any property until the general balance (i.e., All the
debts due from the owner of the property) is repaid. It is enjoyed by the bankers, factors, (i.e.,
Mercantileagents, attorneys of high courts and policy brokers and by those who obtain it by special
agreement.

Differences between Particular Lien and General Lien:

The main differences between a particular lien and a general lien are:

1. In the case of a particular lien, a creditor can retain only a particular property (i.e., the
Property in respect of which the debt is incurred). On the other hand, in the case of a general
lien, a creditor can retain any property of his debtor.
2. In case of a particular lien, a creditor can retain the property of his debtor only for the non-
payment of a particular debt (I.e., a debt incurred in respect of the property retained). on the
other hand, in the case of a general lien, a creditor can retain the property of his debtor not only
for the non-payment of a particular debt but also for any other debt due from his debtor.
3. Particularly in is enjoyed by any person who has expended time, Labour and money on the
property retained. But a general lien is enjoyed by only a few persons, such asbankers,factors,
wharfingers,attorneysofHighCourtand policy brokers, and by those who obtain it by special
agreement.
4. To a creditor, a general lien is more valuable than a particular lien.
 Bankers' general lien:

Bankers General Lin is the right of a banker to retain the goods and securities entrusted to him as a banker
by customer in respectofthegeneral balance (I.e., all the debts) due from the customer.

Objective of Banker's General Lien:

The object of banker's general lean is to ensure the safety of the banker's funds by serving as a
protection against the loss that may arise on a loan and overdraft or any other advanced granted to
a customer.

Conferring of General Lien on a Banker:

General Lien is conferred on bankers by custom or usage of trade. The general lien of bankers has also
been confirmed by legal decisions.

Nature of Banker's General Lien:

Generally, Lien is only a possessory lien. So, it empowers the processor of the securities (i.e., the
creditor) only to retain the securities, but not to sell them. However, a bankers general Lien
empowers the banker not only to retain the securities, but also to sell them without getting any
order from the court, as in the case of a pledge. So, a banker's general lien is considered as an implied
pledge.

Circumstances under which a banker cannot exercise his right of general lien or exceptions to
bankers right of General Lien:

A banker cannot exercise his right of general lien in the following cases:

1. No lien on deposits of money:

In the past, banker could exercise his general lien on the funds deposited by the customers with
him, (I.e., the banker) In his capacity as a banker. This view was accepted by many authorities. For
instance, according to Sir John Paget, customers, money is subject to banker's lien. However,
today a banker has no lien on the money deposited by the customer. This is because the money
deposited into a bank by a customer ceases to be the money of the customer.

2. No lienon safe-custody deposits:

A banker cannot exercise his right of general lien on securities deposited with him, only for safe
custody.

3. No lien on money deposited for a specific purpose:

A banker cannot exercise his general lien on money deposited with him for a specific purpose.

4. No lien on bills, promissory notes etc deposited for a special purpose:

A banker has no general lean on bills of exchange, promissory notes, cheques and other documents
entrusted to him for a specific purpose.
5. No Lien on securities left with him inadvertently:

A banker has no general lien on securities left with him by a customer. Inadvertently, (I.e., by
mistake) because in this case the possession of the securities has not been obtained by the banker
lawfully.

6. No lien on securities obtained by force:

A banker cannot exercise his general lien on securities obtained from the customer through the use
of force.

7. No lean on Securties left cover alone, which is not granted

8. No lien on securities received for sale

9. No lien on securities furnished to cover a specific debt

2. Banker’s right of set-off or banker’s right to combine accounts:

Meaning of bankers right of set-off:

Right of set-off is the right of a debtor to adjust the amount due to him from a creditor against the
amount payable by him to the creditor to determine the net balance payable by one to the other.

It is the right of a banker to come by or adjust the debit and credit balances of two or
more similar accounts held by a customer in the same name and in the same capacity.

The idea behind the bankers right to set- off is to enable the banker to reduce thenetamount
dueto him from a customer,and thereby, ensure the safety of hisfunds.

This right is given to the banker by law to help him ascertain the net amount due to or due from
the customer under certain circumstances. The circumstances or the occasions on which a
banker gets the right of automatic set-off are as follows:
1. On death of the customer.
2. On the insolvency of the customer.
3. On the insanity of the customer.
4. On the receipt of a garnishee order attaching the customer’s
account.
5. Onthereceiptofanoticeofassignmentofthecustomer’scredit balance.
6. On the receipt of a notice of second charge over the security of the customer already
charged to the banker.

Scope of Bankers right of set-off:

When a banker gets the right of set-off, he can set-off or combine:
• The debit and credit balances in the two or more current accounts maintained
by the customer at the same branch of the bank.
 • The debit balance (ie. overdraft) in the current account and credit balance in the savings
bank account maintained by the customer at the same branch.
• The debit balance in the current account and the credit balance in the fixed deposit
account maintained by the customerat thesame branch.
3. Banker’s right to charge compound interest
When a banker grants van advance to a customer,he becomes the creditor of the customer.
When he becomes the creditor of the customer, the banker has an implied right to charge
interestonthe customer by virtue of banking custom. Besides the implied right providedbythe
bankingcustom,inpractice,everybankerenters
intoanexpressagreementwiththecustomerandgetstherightto charge interest on the amount
due to him from the customer.
4. Banker’s right to charge incidental charges on unremunerative accounts
Incidental charges may take the form of service charges, ledger folio charges, processing charges,
appraisal charges, handling charges, standing instruction charges, penal charges, stop payment
charges, etc.

A banker has an implied right to charge incidental charges on the customerformeetingthecosts

involvedinkeepingtheiraccounts. Incidental charges are levied in the case of unremunerative
current accounts (i.e., those current accounts the credit balances of which are so small that they
cannot be employed profitably by the banker), overdrawn current accounts and credit cash
accounts.

5. Banker’s right to levy commitment charges

In the case of an overdraft as well as a cash credit, the banker is required to keep at the disposal of
the borrower the full amount of the overdraft or the cash credit sanctioned. But he can charge
interestonly ontheamountactually overdrawnorwithdrawnbythe borrower. On account ofthese
features, abankeris likely tosuffer lossofinterest,incasetheoverdraftorthecashcreditsanctioned
is not utilised by the borrower in full. So, to protect himself against the loss of interest and to
discourage the borrowers from borrowing more than their requirements’ general, a clause
known as commitment charge clause is included in an overdraft as well as in a cash credit
arrangement.
6) Bankers right to charge commission
As a banker renders certain services for a customer, he has an implied right to collect from the
customer a reasonable commission for his services.
7) Bankers rightnottoprovidebooksofaccountsunder banker’s books of evidence act of 1891
Before the passing of the bankers books of evidence act of 1891 a banker could be called upon bya
court to produce his original books of accounts such as the day books, cash books, ledger, etc.
before the court even in a legal proceeding towhich thebankerwas not aparty. This caused great
hardship to bankers, as they have to continuously work on their book [Link]
bankerswassoughttoberemovedby the Bankers Books Evidence Act of 1891.
 III. Banker’s obligation couple with his rights or banker’s obligations coupled with hisrights
There are certain cases in which a banker has obligations coupled with his rights or banker’s
obligations coupled with his rights. Such cases are:
1. Banker’s obligations and right regarding appropriation of payments
When a customer owes several distinct debts to a banker and makes a payment which is insufficient
to discharge all the debts simultaneously, a question arises as to which debt the payment should
be appropriated or applied.
Banker’sobligationregardingappropriationofpayments:
The general rule regarding the appropriation of payments is that the party who makes the payment,
ie. The debtor, has the right to appropriate the payment to any debt or account which he likes. If
such a specific appropriation is madeby thecustomerat the time making the payment, the banker
is obliged to appropriate the payment in accordance with the customer’s instructions. In India, the
debtor’srightandthecreditor’sobligationregarding appropriation of payments is incorporated in
Section 59 of the Indian Contract Act, 1872.

Banker Right Regarding Appropriation of Payments :

As per the general rule, if the debtor fails to make any specific appropriation of the payment
made by him at the time of making the payment, the creditor can appropriate of apply the payment
to any debt, even to a time-barred debt.
2. Banker’s obligations and rights when a customer’s account is attached by a garnishee order
When a debtor fails to pay the amount due from him to his creditor, and when the creditor knows
thatsome money is due to his debtor from another party (i.e., the debtor of his debtor),he may apply
to the court for the issue of garnishee order on the debtor of his debtor attaching the amount due
from him(i.e., the debtor of his debtor) to his debtor (i.e., preventing the debtor of his debtor from
paying the amount due from him to his debtor) and directing him to pay the same to the judgment
creditor.

Meaning of Garnisheeorder:
It is said that the word “garnishee” is derived from the Latin term “garnire” which means “to
warm”. So,agarnisheeorder is anorder issued by a court at the instance (i.e., request) of a
judgement creditor (i.e., the creditor who has applied to the court for the issue of the garnishee
order) to the garnishee (i.e., judgement debtor’s debtor) warning him (i.e., the garnishee) not to
pay the money owed by him to the judgment debtor (i.e., the party who owes money to the
judgement creditor) until the claim of the judgement creditor is disposed of.

How is a Garnishee order issued?

A garnishee order is issued in two stages.
First, a preliminaryorder called theordernisi is issued, Theterm ’nisi’means‘unless’.So,theorder
nisi warms the garnishee not to pay the funds of the judgement debtor lying in his hands to the
[Link] words, it attaches the funds of the
judgement debtor lying in the hands of the garnishee and restrains the garnishee from paying the
same to the judgement debtor until the claim of the judgement creditor is disposedof.
 Debts attached by a garnishee order:

Amount attached to a garnishee order:

The amount garnished(i.e., the amount attached) by a garnishee order depends upon the terms of the
garnishee order.

Serving of a garnishee Order on a banker:

As the banker holds the funds or deposits of the customer, and as some of his customers may be
indebted to others, he (i.e., the banker) may be served with garnishee orders.
3. Applicability of the law of limitation to bank deposits and advances:
In the context of the study of the special relationship between a banker and his customer, it is
necessary to have some idea about the applicability oftheLawofLimitationtobankdepositsandbank
advances.
Under Article 22 of Part II of the Schedule to the Indian Limitation Act1863,adebtbecomestime-
barred,andbecomesbadifit isnot repaid within three years after it is contracted. As such, no legal
action can be taken by a creditor against debtor for the recovery of the amount due from the debtor
after the expiry of three years from the date ofdebt.

Types of banks in India

Indian banking system is classified into two-
1. Unorganised banking sector
2. Organised banking sector

Unorganised banking sector includes

1. Indigenous bankers and
2. Money lenders

Indigenous bankers: Indigenous bankers have been operating in India since very
ancient times. They operate mainly in small, semi-urban areas and rural areas.
Indigenous bankers are known by different names in different parts of the country.
In Maharashtra they are known as shroffs; in West Bengal they are known as seths and
buniyas; in Uttar Pradesh they are known as Sahukar’s; in Punjab they are known as
Mahajan’s; in Tamil Nadu they are known as chettiars.
Indigenous bankers are individual who perform the function of lending money to the
needy and sometimes accepting deposits.

Features of indigenous bankers

• Indigenous bankers have been working in India from very ancient times
• Indigenous banking business is conducted on Indigenous lines and not on modern
commercial lines.
• Indigenous banking business is confined to small towns, semi-urban areas and rural
areas.
• Indigenous banking business is conducted by people of all the castes. Indigenous
bankers are known by different names in different parts of the country.
• Acceptance of deposit is one of the features of indigenous banking.
• Dealing in Hundi is essential business of indigenous banking.
• They combine banking business with non-banking business that is trading.
• They are practically unconnected with the modern banking sector.
• They maintain their business accounts in vernacular language.
• They lend money both for short term and long-term purpose against any security. They
lend mainly towards trade, commerce and Industry and they also finance agriculture.
• They charge high rate of interest.
• There is unhealthy competition between the indigenous bankers themselves.

Money Lenders
Money lenders also existed since ancient times, they generally operate in villages.
Person who lend their own money mainly for consumption or other domestic purpose
are called money lenders they do not accept deposit from public but they lend their own
funds. They are called money lenders and not bankers. Money lenders do not deal in
hundis. The rate of interest charged by indigenous bankers are less than those charged
by money lenders. Money lenders do not insist on securities for their advances.

Organised banking sector is classified into

1. Reserve Bank of India
2. Commercial Banks
3. Development Banks
4. Regional Rural Banks
5. Co-operative Banks
6. NABARD
7. Foreign Exchange Banks
8. Land Development Banks

1. Reserve Bank of India

RBI is the Central Bank of the country. It was established in 1935 under the Reserve
Bank of India Act, 1934. It performs the functions of a Central bank like issue of
currency notes, banker to the Government, bankers bank, controller of credit, monetary
management, foreign exchange management. It also performs many promotional and
many other regulatory functions like encouraging agricultural finance, industrial
finance, export finance, controlling non-banking finance companies.

2. Commercial banks
• Commercial banks accept deposits from the public and lend money. They also perform
many agencies services and general utility services. Commercial banks play important
 role in deciding the best business initiatives, expanding existing businesses, developing
a new markets and clients, and creating new products for ecommerce, the Internet,
international markets and consumers. Commercial banks in India fall under the
following category:
a) Public sector or Private sector banks. b) Scheduled or Non-Scheduled banks
• Public Sector Banks - these are banks that are owned by central government directly
or through Reserve Bank of India.
Private Sector Banks- these are owned by private promoters. This list includes Indian
private sector banks and foreign banks (A banking company which is incorporated
outside India)

• Scheduled and Non-scheduled banks

Scheduled banks are those banks that are included in the second schedule of the Reserve
Bank of India Act. All the public sector banks are scheduled banks. Scheduled banks
have access to remittance facilities of RBI, participate in its clearing house activities
and borrow from RBI against approved securities.
Non-Scheduled banks are those banks which are not included in the second schedule of
RBI Act.

3. Development banks
A Development Bank is a financial institution which provides all types of financial
assistance like loans medium term and long-term loans, extending technical and
managerial consultancy, underwriting of securities, extending guarantee etc. Important
development banks are- The Industrial Finance Corporation of India, The Industrial
Credit and Investment Corporation of India (ICICI), Industrial Development Banks of
India (IDBI).

4. Regional Rural banks (RRBs)

RRBs Originated from the 20-point program initiated by the Central government in
1975. In 1976 the RRB Act was passed. Regional Rural Banks were established for
granting loans and advances to small and marginal farmers and agricultural laborers.
Financial assistance was also given to Co-operative Societies, artisans, small
entrepreneurs and persons engaged in petty trade or small business.

5. Co-operative banks
Co-operative banks are formed for the purpose of promoting economic interest of a
well-defined group of people. These banks are government backed financial institution
work on the principle of cooperation, self-help and mutual help.
Co-operative banks have 3 tier structure.
a). Primary Agricultural Credit Societies at village level,
b). Central Co-operative Banks at district level and
c). State Co-operative Banks at the State level.
The Central Co-operative banks accept deposit from the public and lend money to other
Co-operative banks and Co-operative societies. They perform all the functions of
 commercial banks like, providing remittance facilities, granting loans to customers etc.
At the State level apex Co-operative banks function as a federation of Central Co-
operative banks. They provide loans to Central Co-operative banks and participate in
clearing house activities for the cheques that are presented by Central Co-operative
banks for collection.

6. National Bank for Agricultural and Rural Development (NABARD)

NABARD was set up in 1982 after passing the NABARD Act, 1981 by the Central
Government. It was set up to improve the delivery channel of rural credit through
refinancing all the financial institutions provide rural finance. Function of NABARD
are,
• Provides refinance for the loans granted by specific institutions
• It has the power to inspect RRBs.
• The application for opening a new branch by RRBs should be forwarded to RBI
through NABARD.
• It has association with the World Bank and other international institutions in project
implementation for rural and Agro related activities
• Linking Self-help group and non-government organization to banks in the delivery of
rural credit
• NABARD has been linking up with self-help group and banking sector in promoting
microfinance to the farmers and others in rural areas

7. Foreign Exchange banks: These banks finance exports and imports of a country.
International trade involves foreign exchange. These banks help in smooth flow of
international trade. Functions of foreign exchange banks are,
a) Collection of bills of exchange drawn by the exporter on the importer.
b) Accepting Bills of exchange on behalf of importer
c) Issue of letter of credit to the importer for buying goods from foreign country
d) Purchase and sale of foreign currencies.
e) Buying or discounting export and import bills
f) Providing international trade information to exporters or importers.

8. Land Development banks: Land development banks are co-operative institutions

engaged in providing long term loan facility to agriculturist. These banks were also
called as ‘Land Mortgage Banks’. LDBs provide long term loan for – purchase of
equipment’s like pump sets, tractors, digging of new wells or borewells, purchase
additional land, construction of tank or tube wells.

Reserve bank of India

The RBI was set up on the basis of the recommendation of the Hilton Young
Commission. Reserve Bank of India Act was passed in 1934 and the bank began
functioning from 1st April 1935. Ownership of the bank was passed into the hands of
Government of India with effect from 1st January 1949. RBI is India’s Central bank and
 regulatory body and is responsible for the issues and supply of the Indian rupee and the
regulation of the Indian banking system. It also manages the country’s main payment
systems and works to promote its economic development.
Functions of RBI

Following are the important functions of RBI

1. Monetary Functions
2. Supervisory Function
3. Promotional and Developmental Function

Monetary or Central banking function

a) Issue of currency notes

b) Acting as a banker to the Government
c) Acting as a banker to other banks
d) Control of credit
e) Control of foreign exchange operations

a) Issue of currency notes: Section 22 of RBI Act 1934, gives sole right to RBI to issue
currency notes. All the currency notes from ₹5, ₹10, ₹20, ₹50, ₹100, ₹200, ₹500, ₹1000
and ₹2000 are issued by RBI and they carry the signature of Reserve Bank of India
Governor. RBI has a separate department called the Issue Department for issue of
currency notes. Gold coins, foreign securities, rupee coins, Indian Government
securities and eligible bills are kept as reserves in issue department. RBI also has
currency chests. Currency chest is place where the RBI stocks the money meant for
banks and ATMs.
Advantages of currency chests

• Banks can draw funds as per requirement and deposit funds when found surplus.
• Exchange old and mutilated notes for new notes and coins.
• Cash remitted to currency chests by banks can be also useful for maintaining CRR.

b) Acting as a Banker to the Government

RBI acts as a banker to the Central and State Government. As a banker to the Government
the RBI acts in three capacities:

• RBI as a banker
• RBI as a financial agent
• RBI as a financial adviser

RBI as a banker

• Accepts deposits from Government, opens accounts in their names and keeps their cash
balances.
• Collects money on behalf of the Government
 • Makes payment on behalf of the Government
• Arranges for transfer of funds
• Makes arrangement for supply of foreign exchange to the Government
• Maintains currency chests
• Grants short term credit to central and state Government without security
• RBI also grants long term loans to central Government at the time of emergencies
RBI as a Financial agent

• RBI Acts as agent of Central and State Governments.

• It manages the public debts of the central and state Governments.
• As an agent of the Government of India, the RBI represents the Government of India
in the International monetary institutions.
RBI as financial adviser

• Advises central and state government on all financial and economic matters
• Advices the government on matters of international finance
• Collects information through research and statistics department
Functions of RBI as a banker to the Government

As a banker to the government the RBI renders the following functions

• Collects taxes and makes payment on behalf of the government

• Accepts the deposits from the government
• Collect cheques and drafts deposited in the government accounts.
• Provides short term loans to the government
• Provides the foreign exchange resources to the government.
• Maintains the accounts of various government departments
• Maintains currency chests in treasuries at some important places for the convenience
of the government.
• Advises government on their borrowing programs.
• Maintains and operates central governments IMF accounts.

3. Acting as a Bankers bank:

RBI acts as a banker to all scheduled banks. RBI as a banker to banks performs the
following functions

• Provides financial assistance to commercial banks at the time of financial needs

• Helps commercial banks in maintaining liquidity of their financial resources
• Enables the commercial banks to carry out their activities with the minimum cash
reserves.
• RBI can exercise full control over the commercial banks as it is a lender of last resort.
 • enables smooth and seamless clearing and settlement of interbank obligations
• Provides an efficient means of funds transfer for banks.
• Enables banks to maintain their accounts with Reserve Bank for statutory reserve
requirement and maintenance of transactions.
• Helps in maintaining Cash Reserve Ratio
4. Control of credit

Control of credit is one of the most important functions of RBI. The Reserve Bank performs
this task with the twin objectives of checking inflation and providing sufficient credit for the
economic development of the country. RBI employees two weapons to control credit by virtue
of power given to it by RBI Act, 1934 and Banking Regulation Act, 1949.

1. Quantitative weapon
2. Qualitative weapon
Quantitative weapons: The main quantitative weapons used by Reserve Bank are;

• Bank rate policy

• Open market operations
• Cash reserve ratio
• Statutory liquidity ratio
Bank rate policy: Bank rate is the rate at which the Reserve Bank purchases or rediscounts
specified bills or commercial papers. By raising or lowering the Bank rate the Reserve Bank
can influence the cost and supply of bank credit and control the level of economic activities
and the general price level in the country. In India Bank rate policy alone cannot achieve the
desired result on its own. It is required to be supplemented by other measures of credit control,
like open market operations, variable cash reserve requirement and selective credit controls.

Open market operations: Reserve Bank of India engages in the purchases and sales of
securities of Central and State government and also securities of local authorities as specified
by Central government. Objectives of open market operations

• To assist the government in borrowing program

• To maintain the prices of government securities stable
• To support the Bank rate policy
• To control credit
• To offset the seasonal changes in the supply of money in the money market
Cash Reserve Ratio

As per Reserve Bank of India Act 1934, every scheduled bank is required to keep with the
Reserve Bank of India cash reserves called statutory cash reserve equivalent to 4% of its Net
Demand and Time Liabilities (NDTL). Banks Do not earn returns on money parked as CRR.
Cash Reserve Ratio (CRR) is the share of a bank’s total deposit that is mandated by the Reserve
Bank of India (RBI) to be maintained with the latter as reserves in the form of liquid cash. The
percentage of cash required to be kept in reserves as against the bank’s total deposits is called
as CRR.

Objective of CRR are;

The Cash Reserve Ratio serves as one of the reference rates when determining the base rate.
Base rate means the minimum lending rate below which a bank is not allowed to lend funds.
The base rate is determined by the Reserve Bank of India (RBI). Another objective of CRR is
to keep inflation under control. During high inflation in the economy, RBI raises the CRR to
reduce the amount of money left with banks to sanction loans. It squeezes the money flow in
the economy, reducing investments and bringing down inflation.

Statutory liquidity ratio

Section 24 of Indian Banking Regulation Act, 1949 requires every commercial bank to
maintain a certain percentage of its total time and demand liabilities in liquid assets such as
cash in hand, cash reserves with the Reserve Bank, balances, with other banks in current
accounts, gold and Government securities. This portion off liquid assets required to be
maintained by commercial banks to their total time and demand deposits is called Statutory
Liquidity Ratio. Banks earn returns on money parked as SLR. SLR helps the Reserve Bank of
India to reduce the lendable funds in the hands of commercial banks and to check bank credit
to a certain extent in times of inflation. An increase in this ratio constricts the ability of the
bank to inject money into the economy.

Objective of SLR are;

• SLR ensures that there is solvency in commercial banks and assures that banks invest
in Government securities. RBI raises SLR to control the bank credit during the time of
inflation. It reduces SLR at the time of recession to increase bank credit.

Qualitative weapon

Qualitative credit control is also referred as selective credit control. Objectives of selective
credit control is-

• To restrict bank credit for non-essential and anti-social activities and to bring down the
price level in the country.
• To divert the flow of credit into pre-determined priority sectors like exports trade, small
industries and agriculture.

Forms of qualitative credit controls are

• Issuing of directives
• Regulation of margin requirements
• Differential rates of interest
• Prior credit authorisation scheme
• Moral suasion
Issuing directives

RBI is empowered to issue directives to all the banks regarding-

• Purpose for which advances may or may not be granted

• Maximum amount of advances that can be granted to individuals, firm, company
• Margin to be maintained on secured loans
• Rate of interest to be charged on advances

Regulation of margin requirement: RBI fixes high margin for borrowers whose needs for
credit are not urgent and whose activities are likely to aggravate the price situation and lower
margin for those whose credit needs are urgent and whose activities are not likely to aggravate
the price situation.

Differential rates of interest (DRI): This scheme was launched to provide credit access to
low-income groups. The loan scheme enables banks to lend to weaker section of the society at
a concessional interest rate.

Prior credit authorisation scheme: Under this scheme commercial banks are required to
obtain the RBI’s prior authorisation for sanctioning any fresh credit beyond the authorised
limits.

Moral suasion: Under this system RBI persuades the commercial banks to follow a particular
line of action either by calling meeting of the representatives or by sending circular letters to
the banks.

5. Control of foreign exchange operations

RBI has set up a separate department called Exchange Control Department. The Department
has powers to regulate the foreign exchange business of the country. The entire business of
purchase and sale of foreign exchange is being conducted and managed by the department. RBI
ensures that the foreign exchange reserves of the country are utilised only for approved
purposes and the limited foreign exchange reserves of the country are conserved for the future.

Supervisory functions of RBI

Supervisory functions of RBI include Exercising powers relating to licensing, branch

expansion, liquidity management, amalgamation, reconstruction, and liquidation of
commercial banks and cooperative banks. RBI also has power to conduct Inspection of
commercial banks and cooperative banks.

Promotional and development functions

Promotional and development functions of RBI includes;

1. Promotion of financial institutions for granting rural credit

2. Promotion of special financial institution for provision of industrial finance.
3. Extension of banking facilities to unbanked semi-urban and rural areas and promotion
of banking habit
4. Collection and publication of statistics of financial and economic matters.