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BANKING LAW
Master in Business Laws
Banking Law
Course No: II
Module No: I - IX
Distance Education Department
National Law School of India University
(Sponsored by the Bar Council of India and Established
by Karnataka Act 22 of 1986)
Nagarbhavi, Bangalore - 560 072
Phone: 3211010 Fax: 080-3217858
E-mail: mbl@nls.ac.in
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CONTENTS
TOPICS
1. Structure and Functions of Commercial Bankers
and Financial Institutions (Module No. I) ................................................................... 3
2. Reserve Bank of India
Structure and Functions (Module No. II) .................................................................... 34
3. Law of Banking Regulations (Module No. III) ............................................................ 65
4. Negotiable Instruments:
Law and Procedure (Module No. IV & V) ................................................................... 119
5. Banker - Customer Relation (Module No. VI) ............................................................ 191
6. Advances, Loans and Securities (Module No.VII & VIII) ......................................... 228
7. Procedural Aspects of Banking Law (Module No. IX) ............................................... 271
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Master in Business Laws
Banking Law
Course No: II
Module No: I
Structure & Functions
Of
Commercial Banks & Financial Institutions
Distance Education Department
National Law School of India University
(Sponsored by the Bar Council of India and Established
by Karnataka Act 22 of 1986)
Nagarbhavi, Bangalore - 560 072
Phone: 3211010 Fax: 080-3217858
E-mail: mbl@nls.ac.in
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MATERIALS PREPARED BY:
1. MR.T.V. MOHANDAS PAI, F.C.A.
2. Prof. N.L. MITRA M.Com., LL.M., Ph.D.
MATERIALS CHECKED BY:
1. MS. ARCHANA KAUL LL.M.
2. Mr. SUPRIO DASGUPTA B.Sc.,LL.B.
MATERIALS EDITED BY;
1. MR. HARIHARA AIYAR LL.M., Former General Manager, SBI
2. Prof. P.C. BEDWA LL.M., Ph.D.
National Law School of India University
Published By:
Distance Education Department
National Law School of India University,
Post Bag No: 7201
Nagarbhavi, Bangalore, 560 072.
Printed At
Sri Vidya Printers, Bangalore Ph. 23445594
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INSTRUCTIONS
Basic Readings
The materials given in this course are calculated to provide exhaustive basic readings on topics and sub-topics
included in the course. Experts in the area have collected the basic information and thoroughly analysed the same
in topics and sub-topics. Lucid/supportive illustrations and leading cases are also provided. Relevant legislative
provisions are also included. Care has been taken to communicate basic information required for decision making
in problems likely to arise in the course-area. The reader is advised to read atleast three times. In the first reading
information provided are to be selected by making marginal notes using markers. The first reading, therefore,
necessarily has to be very slow and extremely systematic. While so reading the reader has to understand the
implications of those informations. In the second reading the reader has to critically analyse the material supplied
and jot down in a separate note book points stated in the material as well as the critical comments on the same. A
third reading shall be necessary to prepare a Check List so that the check list can be used afterwards for solving
problems like a ready reckoner. (The reader is required to purchase a Bare Act and refer to the relevant sections
at every stage.)
Supplementary Reading
Several supplementary readings are suggested in the materials. It is suggested that the reader should register with
a nearby public library like the British Council Library, the American Library, the Max Muller Bhavan, the
National Library, any University Library where externals are registered for the purpose of library reading, any
commercial library or any other public library run by Government or any private institution. Readers in Metropolitan
and other big cities may have these facilities. It is advised that these basic materials be photocopied, if necessary,
and kept in the course file. Supplementary readings are also required to be read more than once and marginal
notes, marking notes, analytical notes and check lists prepared. Any reader requiring any extra readings not
available in his/ her place may request the Course Coordinator to photocopy the material and send it by post for
which charges at the rate of .50 paise per page for photocopying and the postage charge shall be sent either by
M.O. or by Draft in advance. The Course Coordinator shall take prompt action on receiving the request and the
payment.
Case Law
The course material includes some case materials generally based upon decided cases. These cases are to be
studied several times for,
(a) understanding the issues to be decided (b) decisions given on each issue (c) reasoning specified
It is advised that while reading a case the reader should focus first on the facts of the case and make a self analysis
of the facts. Then he/she should refer the check list prepared earlier for appropriate information relating to law
and practice on the facts. Then the student should prepare a list of arguments for and on behalf of the plaintiff/
appellant. Keeping the arguments for the plaintiff/appellant in view of the reader should try to build up counter
arguments on behalf of the defendant/respondent. These exercise can take days. After these exercises are done
one has to prepare the arguments for or against and then decide on the issues. While deciding it may be necessary
often to evolve a guiding principle which also must be clearly spelt out. Subsequently the reader takes up the
decision given in the case by the judge and compare his/her own exercise with the judgment delivered. A few
exercise of this type shall definitely sharpen the logical ability, the analytical skill and the lawyering competence.
Though it is not compulsory, the reader may send his/ her exercises to the Course Coordinator for evaluation. On
receiving such request the Course Coordinator shall get the exercises evaluated by the experts and send the
experts comment to the students. Through these exercises one can build up an effective dialogue with the
experts of the Distance Education Department (DED).
Problems and Responses
After reading the whole module which is divided into several topics and sub-topics the reader has to solve the
problems specified at the end of the module. The module is designed in such a manner that a reader can take
about a weeks time for completing one module in each of the four courses. It is expected that after finishing the
module over a period of a week the student solves these problems from all possible dimensions to the issue. No
time limit is prescribed for solving a problem though it would be ideal if the reader fixes his/her own time limit
for solving the problem - which may be half an hour per problem - and maintain self discipline. While solving the
problems the candidate is advised to use the check list, the notes and the judicial decisions - which he/she has
already prepared. After completing the exercise the student is directed to send the same to Course Coordinator
for evaluation. Though there is no time stipulation for sending these responses a student is required to complete
these exercises before he/she can be given the certificate of completion to appear for final examination.
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STRUCTURE AND FUNCTIONS OF COMMERCIAL
BANKS & FINANCIAL INSTITUTIONS
TOPICS
1. The Evolution in Banking Services & its History in India. ........................................ 7
2. Role & functions of Banking Institutions. ................................................................... 11
3. Structure of Banking Institutions. ................................................................................ 18
4. Financial Institutions & their Functions. ..................................................................... 20
5. Industrial Development Bank. ...................................................................................... 24
6. National Bank for Agricultural & Rural Development. ............................................. 26
7. Unit Trust of India. ........................................................................................................ 27
8. Case Law. ........................................................................................................................ 29
9. List of Statutes. ............................................................................................................... 31
10. Problems. ......................................................................................................................... 32
11. Supplementary Reading ................................................................................................ 33
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SUB-TOPICS
1.1. Introductory Note.
1.2. History of Banking in India
1.3. Bank Nationalisation
1.4. Various types of Banking Services
1.5. Social control measures on bank
1.6. Narasimham Committee Report
1.7. Concluding Remark
1.1. INTRODUCTORY NOTE
In early societies functions of a Bank were done by the
corresponding institutions dealing with loans and advances. The
modern banking and its networking are the products of modern
western civilization which rapidly developed with the advent
of industrialization. Britishers brought with them this modern
concept of banking in India. The Bank of England was started
in 1694, when the Britishers were carrying on a long war with
France. In 1708, the monopoly and the right to issue notes was
given to Bank of England through an Act. Several joint stock
banking companies started operating early in the nineteenth
century. These banks primarily carried on functions which are
presently known as commercial functions like receiving money
on deposits, lending money, transferring money from place to
place and bill discounting. Banking has now presently become
a globally mobile service and it facilitates the capital movement
from one part of the country to another, one part of the globe
from another.
Obviously it is now difficult to understand the banking system
of a nation in isolation. The present Indian banking system is
required to be studied, viewed and reviewed in the context of
global banking trends.
1.2. HISTORY OF BANKING IN INDIA
Early History
Banking in India has a very hoary origin. The Vedic period has
literature which records the giving of loans to others. Banking
was synonymous with money lending. The Manusmrithi speaks
of deposits, pledges, loans and interest rate. Interest could be
legally charged at between two and five per cent per month in
order of class. The maximum amount of interest collectable on
the principal was laid down by the State. Usury was not allowed.
Payment of debt was made a pious obligation on the heir of a
dead person. With the growth of trade and commerce, the
trading community soon evolved a system of money transfer
throughout the country.
The main instrument through which banking and transfer of
funds was carried out was through the inland bills of exchange
or the Hundi. Indian bankers lent money, financed the rulers
and trade, acted as treasurers of the State and also as insurers of
goods. They also acted as money changers due to the differing
coins circulating all over India. Business developed so well
that certain castes or communities traditionally came to regard
banking as their family business. The power and prestige of
these banks rose and fell with the growth and decline of empires.
Jagirs were granted to select banks and some acted as revenue
collectors for local rulers. However, tenets of modern banking
were not practised as acceptance of deposits was not a regular
part of the business.
Modern History
Modern banking in India began with the rise to power of the
British. The British consolidated their power and became the
most powerful force in India after vanquishing Tipu Sultan in
the battle of Srirangapattanam in 1799. The quest for power
by Lord Mornington (Later Marquess of Wellesly). Governor
General of Fort William in Bengal at that time led to a serious
depletion of the resources of the East India Company. This led
to the Company promoting the Bank of Calcutta in 1806 to
raise resources.
The situation prevailing at that time could be known by the
writing of some Britishers, C.N. Cooke, Deputy Secretary and
Treasurer of the Bank of Bengal, writing in his book Banking
in India, has stated that usury prevailed in India more than in
any other country in the nineteenth century. The native money
lender lent to the farmers at 40, 50 and 60 per cent interest.
The European community was relatively better off. He
attributed the very high rates to the riskiness of many of the
lendings and the difficulties in realising them.
Indian businessmen very often acted as lender to the European
businessmen with a rate of interest lower than the market rate.
Till the advent of the three Presidency Banks, the European
Agency Houses acted as bankers. They accepted deposits from
British Officers serving in India and Europeans who had served
in India and had returned to Europe. They financed trade with
such funds and at certain times even helped the Government.
There was a very effective credit network for flow of funds
from one part of India to the other provided by the Indian
banking firms.
As the Agency Houses had prospered they also sought to operate
Banks. Alexander & Company a leading Agency House started
managing the Bank of Hindustan from 1770s. The exact date
of the founding of that bank is not known. The Bengal Bank
and the General Bank of India, too, were started by the other
Agency Houses in Bengal in the eighteenth century. In 1819
the Commercial Bank and in 1824 the Calcutta Bank were
floated by the Agency Houses. None of these banks enjoyed
limited liability nor were they proper joint stock banks. They
were partnership firms with unlimited liability.
The concept of limited liability was not put on the statute books
till the 1860 Companies Act. Till that date Banks had to either
obtain a special Charter from the Crown to operate or had to
operate under unlimited liability.
1. THE EVOLUTION OF BANKING SERVICES AND
ITS HISTORY IN INDIA
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The Bank of Calcutta started in 1806 was the precursor of the
Bank of Bengal. In 1862 the right of note issue was taken
away from the Presidency Banks. The Government also
withdrew their nominees as Directors on their Board. However,
they were given the privilege of managing the Government
treasury at the Presidency Towns and at their branches.
The Bank of Bombay collapsed in 1867 and was put into
voluntary liquidation in early 1868. It was finally wound up in
1872, but the bank was able to meet its liability in full to the
general public.
Subsequently a new bank, aptly called the New Bank of
Bombay, was started in 1867 to commence banking operations.
The Presidency Banks Act of 1876 was passed in order to have
a common law for all the three Banks in order to enable the
government to regulate the working of these Banks. The
Government had earlier withdrawn its shareholding from these
three banks.
The Swadeshi Movement which prompted Indians to start many
new institutions also provided an impetus for starting new banks.
The number of joint stock banks increased remarkably during
the boom of 1906-13. The Peoples Bank of India Ltd., The
Bank of India, The Central Bank of India, Indian Bank Ltd.
and the Bank of Baroda were started during this period. This
boom continued till it was overtaken by the crash of 1913-17,
the first crisis that the Indian joint stock banks experienced.
In 1921 the three Presidency Banks at Calcutta, Bombay and
Madras were merged into the Imperial Bank by the passing of
the Imperial Bank of India Act 1920. This bank did not have
the power of issuing bank notes,but was permitted to manage
the clearing house and hold government balances. With the
passing of the Reserve Bank of India Act of 1934, the Reserve
Bank of India came into being to act as the Central Bank. It
acquired the right to issue notes and acted as the banker to the
Government in place of the Imperial Bank. However, the
Imperial Bank was given the right to act as the agent of the
Reserve Bank of India in places where the Reserve Bank had
no branches.
By the passing of the State Bank of India Act 1955, the Imperial
Bank was taken over and the assets vested in a new bank, the
State Bank of India.
The Reserve Bank was originally a shareholders bank. It was
nationalised by the Reserve Bank Amendment Act 1948,
consequent to the nationalisation of the Bank of England in
1946.
1.3. BANK NATIONALISATION
The major historical event in the history of banking in India
after independence is undoubtedly the nationalisation of 14
major banks on 19th July 1969. The imposition of social control
on the banks in early 1969 was deemed unsuccessful as the
government felt that the Indian commercial banks did not
increase their lending to the priority sectors like agriculture,
small scale industry etc., Nationalisation was deemed as a major
step in achieving the socialistic pattern of society.
The nationalised banks were to increase lending to areas of
importance to the government and to use their resources for
subserving the common good. A detailed scheme of objectives,
regulations, management, etc. was drawn up for these banks.
In 1980 six more private sector banks were nationalised
extending the public domain further over the banking sector.
Nationalisation was a recognition of the potential of the banking
system to promote broader economic objectives. The banks
had to reach out and expand their network so that the concept
of mass banking was given importance over class banking.
Development of credit in the rural area was a prime objective.
The benefits of nationalisation has indeed been impressive. The
branch network of these banks have spread practically all over
the country especially in the rural and previously unbanked
areas. The branch network which was 8262 in June 1969
expanded to over 60000 by 1992 with a major expansion (80%)
in rural areas. The average number of people served by a branch
came down from over 60000 to 11000. The deployment of
credit is more widely spread all over the country as against
only in the advanced states. In 1969 deposits amounted to 13%
of G.D.P and advances to 10%. By 1990 deposits grew to 30%
and advances 25% of G.D.P. Rural deposits as a percentage of
deposits grew from 3% to 15% making for increased
mobilisation of resources from the rural areas. Deposits grew
from a figure of Rs.4669 crores in July 1969 to Rs. 2,75,000
crores on 31.3.1993. 40% of the total credit was directed to the
priority sector. More than 45% of the total deposits was used
by the government to fund its five year plans.
However, this growth did not come without its costs. The
banking system has grown too large and unmanageable.
Customer service has suffered due to increasing costs and lower
productivity. The directed credit program has led to large
overdues affecting the very viability of the banking system.
1.4 VARIOUS TYPES OF BANKING SERVICES
The flow chart given below shows the following types of
banking services.
1. Central Banking Services
2. Commercial Banking Services
3. Specialized Banking Services
4. Non-banking financial services.
1. Central Banking Services : The Central Bank of any
country (i) issues currency & bank notes; (ii) discharges the
treasury functions of the Government, (iii) manages the money
affairs of the nation & regulates the internal and external value
of money, (iv) acts as the bank of the Government and last but
not the least, acts as the bankers bank.
2. Commercial banking services: Commercial banking
services include (i) receiving various types of deposits; (ii)
giving various types of loans, (iii) extending some non-banking
customer services like facilities of locker, rendering services in
paying directly house rent, electricity bill, share-calls, money
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or insurance premium and the like. Commercial bank also
advises on investment re-investment, allotment or transfer of
funds.
3. Specialized banking services : Special banking institutions
are established for definite specialized banking services like
industrial banks to supply industrial long term credit and
working capital; land mortgage bank for granting loans on
equitable mortgage; Rural Credit Banks for generating funds
for extending rural credit; developmental banks to support any
developmental activities. These types of banks accept all types
of deposits but mobilises the amount in its specially focussed
area.
4. Non-Banking Financial Services: Many institutions are
established for carrying on non-banking financial services.
Mutual funds are institutions accepting finances from its
members and investing in long term capital of companies both
directly in the primary market as well as indirectly in the capital
market. Financial institutions acting as portfolio managers
receive funds from the public and manage the funds for or on
behalf of its depositors. This port-folio managers undertake
the responsibility of managing the funds of the principal so as
to generate maximum return.
1.5. SOCIAL CONTROL MEASURES ON BANK
The Indian economy in the 1960s passed though a stressful
phase due to drought and wars. Political uncertainty and popular
discontent too caused concern. The Government veered around
towards ensuring a socialistic pattern of society. The Banking
Regulation Act was amended in 1968 to provide for social
control over the banks. Under these measures the Board of
Directors of the banks were reconstituted so that 51% of their
number was made of persons having special knowledge or
experience in accountancy, agriculture, rural economy, small
scale industry, co-operation, banking, economic laws etc. A
quota was specified for certain categories. The Reserve Bank
of India (RBI) was given powers to reconstitute the Board. A
full time Chairman was to be appointed who was a professional
banker, with prior approval of the RBI. The Government also
acquired power to acquire any bank in case it failed to comply
with any direction issued to it under the Banking Regulation
Act, as regards banking policy.
1.6 THE NARASIMHAM COMMITTEE REPORT:
The 1980s were the decade of private enterprise all over the
world. The collapse of the USSR at the end of the 1980s is the
end of one experiment of socialism. In India the country went
through traumatic moments in 1990, after the heady economic
growth in the 1980s, due to a foreign exchange crisis on account
of large scale external borrowings in the 1980s, that had
weakened the countrys ability to service its debts.
The government felt that there was a need to initiate reform in
the financial system and banks, as the system had developed
weaknesses. A great part of the savings of the community was
pre-empted by the Government in the form of the Cash Reserve
Ratio (CRR) and the Statutory Liquidity Ratio(SLR). Banks
were burdened by a large percentage of non- performing loans.
Customer service had suffered, and out-moded practices were
in vogue. Internal weakness due to bad house-keeping practices
had increased. The Narasimham Committee was set up to
recommend changes in the financial system.
The Narasimham Committee made revolutionary
recommendation emphasising the need for de-regulation and
Commercial Specialised Institutional Non-Banking
Banks Banks Banks Financial Institutions
Land Mortgage
Rural Credit
Industrial Development
Co-operative
Housing Finance
Export Import
Bank of India
Mutual Funds
UTI
Other MF
and LIC,
GIC
Bank &
Can Bank
Private Sector
Non-Banking
Financial Com.
Various Types of Banks and Banking Functions
Central Bank
IFCI
SFCs
IDBI
ICICI
IRBI
NABARD
HDFC
Nationalised State Bank
Banks (20) LIC Of India &
Associate
Bank
Private Banks
Indian Foreign
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liberalisation. Banks were to be allowed to raise capital from
the public. Also no further nationalisation of banks were to be
made. New private sector banks were to be allowed and no
distinction was to be made between private and public sector
banks. Foreign banks were to be allowed freedom to open
branches. The pattern of banking structure should be broadened
with 3-4 large banks on a international level 8-9 large banks on
a national level and the other as local banks. Control over the
banking system should be centralised with the RBI and not split
between the RBI and the department of banking of the
government. A separate body, quasi autonomous, operating
under the aegis of the RBI is to be formed to supervise the
functioning of the banks. The SLR and the CRR should be
reduced to prudent levels. Concessional lending should be
phased out. Deposit interest rates should be raised along with
the reduction of SLR. The capital base of banks should meet
with international norms of capital adequacy; provision was to
be made for bad debts with special tribunals to be formed for
realising bank debts. The appointment of Chief Executive of
banks needs to be de-politicised and banks should be free to
make their own recruitment of employees and officers.
Some of the recommendations made have already been accepted
and put into practice by the government while others are being
considered.
The wheel appears to have come full circle. While
nationalisation has given immense benefits to the country, it
has also exposed the defects in an excess of State control. At
this present point, the future appears to be towards an open
system based on increased private ownership.
1.7. CONCLUDING REMARKS
The banking system in India is likely to undergo a major change.
Restrictions imposed upon foreign banks to establish Indian
branches are going to be gradually withdrawn. The GATT
multilateral treaty emphasised the role of free operations in the
services sector like banking and insurance. As a result, it is
expected that there shall be more openings in the banking sector.
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SUB-TOPICS
2.1. Role and functions of Central Bank
2.2. Advances to priority sectors and the credit guarantee
schemes
2.3. Role & functions of Commercial Banks
2.4. Role & functions of Specialised and Institutional Banks
2.5. Role & functions of non-banking financial institutions
2.1. ROLE AND FUNCTIONS OF CENTRAL BANKS
Central Bank:
Central Bantral Bank is an apex financial authority. The
essential feature of a Central Bank is its discretionary control
over the monetary system of the country. It occupies a pivotal
position in the monetary and banking structure of the country.
Thus it acts as the leader of the money market and in that
capacity, it controls, regulates and supervises the activities of
the Commercial banks. It is recognised as the highest financial
authority and is a symbol of financial sovereignty and stability
of the country. It holds the ultimate resources of the nation
controls the flow of purchasing power and acts as the banker to
the State.
The principles on which a Central Bank operates are different
from the ordinary banking principles to the extent that :
a. The Central Bank unlike an ordinary Bank does not operate
with the motive or objective of making a profit but is
primarily meant to shoulder the responsibility of safe-
guarding the financial and economic stability of the country.
b. The Central Bank being the reservoir of Credit and lender
of last resort cannot look to or rely on other banking
institutions to come to its aid in case of need and has to
therefore keep its assets as liquid as possible so that other
banks and financial institutions can approach it for
accommodation.
c. The credit machinery of the country needs to be stabilised
quite often. This is done by the Central Bank by
manipulating the bank rate and open market operations.
This power is vested only in the Central Bank.
Functions of Central Bank:
The functions of the Central Bank are briefly discussed below.
A Central Bank acts in the following capacities.
(i) As a currency issuing agency;
(ii) As a banker to the State;
(iii) As a bankers bank;
(iv) As the lender of last resort;
(v) As the guardian of the money market through credit control;
(vi) It undertakes exchange control operations and maintains
the external value of the domestic currency and ensures
the stability of the internal value of currency;
(vii)Ensures economic stability and promotes economic
development; and
(viii) Currency printing and management of mints.
[Details of the functions of the Central Bank in India i.e. the
Reserve Bank of India are discussed in the module on RBI.]
2.2 ADVANCES TO PRIORITY SECTORS AND
CREDIT GUARANTEE SCHEMES
One of the major deficiencies in the banking system in the 60s
related to granting of advances. Bulk of the advances were
being directed to the large and medium scale industries and big
and established business houses while agriculture, small scale
industries and exports were not receiving adequate attention, if
not being neglected. The Reserve Banks credit policy of 1967-
68 sought to set right this anomaly in the system by channelising
the flow of credit to the emerging priority sectors of the economy
in the larger interests of the country. Though the emphasis of
the 1967 credit policy was on overall restraint certain
liberalisation was allowed on a selective basis with a view to
enlarge the flow of credit to the areas of agriculture, exports
and small scale industries. The banks were encouraged to
increase their involvement in lending to the priority sectors by
the extension of various relaxations and incentives in the form
of refinance from the RBI at a concessional rate of interest or
on other special terms not available for other bank lendings.
In order to provide an incentive to lending to small borrowers
the RBI set up the Credit Guarantee Corporation of India Ltd.
in 1971. This institution is now named as the Deposit Insurance
and Credit Guarantee Corporation. The main objective of this
Corporation is to administer a comprehensive credit guarantee
scheme for loans by banks to small individual borrowers in the
priority and other neglected sectors. There are various schemes
in operation which provide cover for direct lendings to small
borrowers who without such support would find institutional
credit highly inaccessible.
The recommendations of the Tandon committee, which went
into the working of the special credit schemes of Commercial
Banks with special reference to their employment potential led
the RBI to issue a set of guidelines which emphasised on need-
based assistance to different categories of self-employed
persons. Banks were asked to make efforts to arrange integrated
financial and management assistance to borrowers, taking into
account the totality of their requirements and the viability of
the proposition being financed.
Since 1977-78, export credit has been excluded for the purposes
of computation of the total priority sector advances of banks,
but it has continued to receive preferential treatment in matters,
such as, refinance facilities from the Reserve Bank, concessional
rates of interest on pre-shipment and post-shipment credit to
exporters etc.
2. ROLE AND FUNCTIONS OF BANKING INSTITUTIONS
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The flow of credit to the neglected sectors were boosted by the
directive of the Government of India in November 1974 to
public sector banks whereby, priority sector lending was to reach
a level of not less than one-third of their outstanding credit by
March 1979.
In March 1980, the Government of India took two major
decisions :-
1) To raise the proportion of advances to the priority sectors
by public sector banks from 33 1/3% to 40% by 1985; and
2) The implementation of the 20 point programme to be
actively promoted by banks.
The Reserve Bank also set up a working committee on priority
sector lending and 20 point economic programme to work out
the modalities of implementation of the above decisions of the
government. Based on the recommendations of the working
group, the RBI issued instructions for implementation. Some
of the important instructions were :-
a) Priority sector advances should constitute 40% of aggregate
bank advances by 1985.
b) 40% of priority sector advances to be earmarked for
agriculture and allied activities.
c) Direct advances to weaker sections in agriculture and allied
activities should reach a level of at least 50% of the total
direct lending to agriculture.
d) Advances to rural artisans, village craftsmen and cottage
industries should constitute 12.5% of the total advances to
small scale industries by 1985.
A series of measures taken with the aim of encouraging the
commercial banks to cater to the credit requirements of the
neglected sectors, particularly the weaker sections of the society
led to the formation of the Credit Guarantee Corporation of
India Ltd.
This is a public limited company floated by the Reserve Bank
of India on 14th January 1971.
The Corporation was visualised as an agency to provide a simple
but wide-ranging system of guarantees for loans granted by the
Credit institutions to small and needy borrowers.
The Corporation has introduced several schemes to cater to the
small borrowers in the non-industrial sector like the Small Loans
Guarantee Scheme 1971; the Small Loans (Financial
Corporations) Guarantee Scheme 1971 and the Small Loans
(Service Co-operative Societies) Guarantee Scheme 1971.
After the take over by the Deposit Insurance Corporation in
July 1978 a fourth scheme was introduced by the Deposit
Insurance and Credit Guarantee Corporation of India Ltd.,
known as the Small Loans (Small Scale Industries) Guarantee
scheme 1981. DICGC is the new name given to Deposit
Insurance Corporation after its take over of the Credit Guarantee
Corporation.
In addition to the above, various other schemes were introduced
for the benefit of the priority sectors like the :-
a) National Rural Employment Programme (NREP) which
basically dealt with the problem of unemployment and
underemployment in the rural areas.
b) Rural Landless Employment Guarantee Programme
(RLEGP) more specifically to tackle the problem of
unemployment among the landless and to create durable
assets for strengthening the rural infrastructure.
c) Crop Insurance Scheme - to provide a measure of financial
support to farmers in the event of crop failure as a result of
natural calamities, to support and stimulate production of
cereals, pulses, oilseeds, etc.
d) Self-employment Scheme for Educated Unemployed Youth
(SEEUY)- to encourage educated unemployed youth to
undertake self-employment ventures in industry, services
etc; and
e) Self-employment Programme for Urban Poor (SEPUP) to
provide self employment to the urban poor.
2.3. ROLE AND FUNCTIONS OF COMMERCIAL
BANKS
The following chart shows the Commercial banking system in
India
Scheduled
Representative Offices
State Bank
of India
Associates of
State Bank of
India
Other
Nationalised
Banks
Private Sector
Public Sector
Scheduled
Non scheduled
Foreign Banks
Indian Banks
Commercial Banking system in India
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13
A Scheduled Bank is one which is included in the second
schedule of the RBI Act. A non scheduled Bank is one which is
not included in that schedule.
Utility of Banking Institutions
Banks are extremely useful and indispensable institutions for a
modern community. They are the custodians and distributors
of liquid capital the essential ingredient for commercial and
industrial activities. The utility of banks can be summarised as
follows :-
a) The banks create purchasing power, in the form of bank
notes, cheques, bill, drafts, etc. and economise the use of
metallic money which is very expensive and cumbersome.
b) Banks transfer funds, by bringing lenders and borrowers
together, and by helping funds to move from place to place
and from person to person in a convenient and inexpensive
manner, through the use of cheques, bills and drafts. In
this way, they help trade and industry.
c) The banks encourage the habit of saving among the people
and enable small savings, which otherwise would have been
scattered ineffectively, to be accumulated into large funds
and thus made available for investments of various kinds.
In this way, they promote economic development through
capital formation.
d) By encouraging savings and investment, the banks increase
the productivity of the resources of the country and thus
contribute to general prosperity and welfare by promoting
economic development.
e) The banks agency functions are very useful to the customers
of the bank. They undertake to make payments of various
kinds on behalf of their customers and also make several
types of collections on their behalf.
Thus, banks are useful to both the community in general and
the individual customer in particular.
Role of Banks in the Socio-economic development
Banks play a vital role in the economic development of the
country as explained hereunder :
i) Banks promote capital formation :
In any plan of economic development capital occupies a position
of crucial and strategic importance. Unless there is an adequate
degree of capital formation, economic development is not
possible. Deficiency of capital is a result of inadequate savings
made by the community. The serious handicaps in economic
development arise from capital deficiency. This is where the
banks can play an useful role in making up the deficiency.
The role of banks in economic development is to remove the
deficiency of capital by stimulating savings and investment. A
sound banking system mobilises the small and scattered savings
of the people and makes them available for investment in
productive enterprises. In this connection, the banks perform
two important functions.
a) they attract deposits by offering attractive rates of interest,
thus converting savings which would have remained idle,
into active capital; and
b) they distribute these savings through loans among
enterprises which are connected with economic
development.
ii) Optimum Utilisation of Resources :
In the absence of banks, it would have been very difficult to
mobilise the small savings of the people and distribute these
saving among entrepreneurs. It is through the agency of the
banks that the communitys savings automatically flow into
channels which are productive. The banks exercise a degree of
discrimination which not only ensures their own safety but also
makes for optimum utilisation of the financial resources of the
community.
iii) Financing the priority sectors :
In order to meet additional demands arising out of economic
development, the banking system has undergone changes in its
structure and organisation. The banks and financial institutions
operate in such a manner as to confirm to the priorities of
development and not in terms of return on their capital. The
banks now play a more positive role. Thus, the central bank
does not merely stop at playing a regulatory role i.e., regulation
of bank credit but it also plays a developmental role. It helps to
create a machinery or agency for financial development plans.
It ensures that the available finance is diverted to the right
channels. For successful implementation of the development
programmes, it becomes necessary to make credit facilities
available to high priority sectors and to see that the available
funds are not squandered away in non-essential or non-plan
expenditure.
iv) Banks promote Balanced Regional Development :
By opening branches in backward areas the banks make credit
facilities available there. Also, the funds collected in developed
regions through deposits may be channelised for investment in
the under developed regions of the country. In this way, they
bring about more balanced regional development.
v) Expansion of Credit :
To maintain a high level of economic activity, it is imperative
that credit must expand. In an era of economic developments,
banks create credit more liberally and thereby make funds
available for the development of various projects. Thus, banks
make a valuable contribution to the speed and the level of
economic development in the country.
vi) Banks promote growth with stability :
Banks regulate the rate of investment by influencing the rates
of interest. The primary function of the Reserve Bank of India
was to regulate the issue of bank notes and keep adequate
reserves to ensure monetary stability. Now, it has assumed wider
14
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responsibility to help in the task of economic development. In
addition to regulating currency and controlling credit, the RBI
has been playing a vital role in the financing and supervision of
the development programmes for agriculture, trade, transport
and industry. It has created special funds for promoting
agricultural credit and has created special Institutions for
widening facilities for industrial finance. The other banks too
have cooperated in these areas by opening new branches to tap
the savings of the people and lend them to entrepreneurs.
Thus, banks come to play dominant and useful role in promoting
economic development by mobilising the financial resources
of the community and by making them flow into desired
channels.
In recent years, commercial banks in India have been adopting
the strategy of innovative banking in their business operations.
This implies the application of new techniques, new methods
and novel schemes in the areas of deposit mobilisation,
deployment of credit and bank management. To attract more
deposits, Banks have introduced many attractive saving
schemes such as education deposit plan, perennial pension plan
retirement schemes, loan linked recurring deposit schemes etc.,
Mobile bank branches have also been introduced by a number
of banks. Innovations have also been made in the credit side by
introducing education loan schemes, housing finance, credit
cards, packing credit and post shipment credit for exporters,
consumer credit, which pool the investors funds for investing
in a diversified portfolio of securities so as to spread and reduce
risks.
In addition to various activities like innovative banking,
promoting entrepreneurship, retail banking and rural
development, the commercial banks have promoted various
schemes like advances to priority sectors and credit guarantee
schemes. These are discussed in the role and functions of
specialised banks.
2.4 ROLE AND FUNCTIONS OF SPECIALISED AND
INSTITUTIONAL BANKS
The role and functions of the following institutional banks are
discussed below. The role & functions of many other financial
institutions shall be dealt with at the appropriate place of this
module along with their structure. The few institutional banks
that are discussed below operate under various schemes of the
Government along with other Commercial Banks. Some of
these schemes are given below :
(a) Lead Bank Scheme :
The Lead Bank Scheme, under which the leadbanks play the
role of pace setter for banking and credit development, has had
a special significance for banks as agents of change. It has
imparted a new direction to the branch expansion policy. District
credit planning exercises have made blockwise estimates of
credit needs. The scheme has also focussed the attention of the
banks on the concept of the banking needs of the area. The
scheme has opened up new vistas in the field of rural banking.
The credit plans envisage schemes of credit extension, mainly
for the development of priority sectors and for the benefit of
the weaker sections. In terms of the guidelines issued by the
Reserve Bank of India, the Annual Action Plans (AAP) cover
Integrated Rural Development Programme (IRDP), and the lead
banks have assumed a part of the responsibility for formulating
plans which fit into the Rural Development schemes covering
viable economic activities, and which can be pursued by the
IRDP beneficiaries.
(b) Integrated Rural Development Programme :
The Integrated Rural Development Programme (IRDP) is a
major instrument to alleviate rural poverty. Its objective is to
enable selected families in rural areas to cross the poverty line.
This is achieved by providing productive assets and inputs to
the target groups. The assets are provided through financial
assistance in the form of subsidy by the government and term
credit advanced by financial institutions, primarily by banks.
Commercial banks have been the principle agents of IRDP
implementation through their branch network. Commercial
banks have looked upon the IRDP as an opportunity to take
banking to the rural areas and have made earnest endeavors to
contribute to its success.
(c) Poverty Alleviation Programme :
Presently, the programme is limited to the financing of such
traditional activities as dairy, poultry and village industries
including basket making, carpentry, handlooms etc., where the
scale of production is very small and the technology used in
the production process is primitive. Commercial banks, State
Bank of India, in particular, have taken a number of steps to
enable the borrowers to increase the scale of production and
improve the production processes by offering technical support,
demonstration plots, financial and management consultancy etc.,
and by conducting management appreciation programmes and
organising entrepreneurial development programmes. Some
of the institutional banks operating these schemes are as follows:
1. Co-operative Banks:
Cooperative Banks also played a limited but important role in
the banking system of the country. There are a number of such
banks which include State Cooperative Banks (SCBs), Central
Cooperative Banks (CCB), Primary Cooperative Banks
(PCBs), Land Development Banks (LDBs), Primary
Agricultural Credit Societies (PACs) etc.
a) Primary Co-operative Banks:
Commonly called the Urban Cooperative Banks, they are small
sized Cooperatively organized banking units which operate in
metropolitan, urban and semi- urban centres to cater mainly to
the need of small borrowers. The Reserve Bank is responsible
for licensing of existing/new banks and branches, sanctioning
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15
of credit limits to SCBs on behalf of PCBs for financing the
SSI unit as well as conducting their statutory inspections.
b) Land Development Banks (LDBs):
In the cooperative credit structure the Land Development Banks
i.e., State Land Development Banks (SCDBs) and Primary
Land Development Banks (PLDBs) provide long term credit
for agriculture.
The major sources of funds for the SLDB are the special
development debentures and ordinary debentures. The ordinary
debentures programme of the SLDB is finalised by the
NABARD.
2. Regional Rural Banks
Objectives :
RRBs are primarily organised to develop the rural economy
by providing, for the purpose of development of agriculture,
trade, commerce, industry and other productive activities in the
rural areas, credit and other facilities, particularly the small and
marginal farmers, agricultural labourers, artisans and small
entrepreneurs and for matters connected therewith and incidental
thereto.
Capital Structure:
The authorised capital of each Regional Rural Bank shall be
Rs.5 crores provided that the Central Government may after
consultation with the National Bank and the sponsor Bank,
increase or reduce such authorised capital. Of the capital, 50%
shall be subscribed by the Central Government, 15% by the
concerned State Government and 35% by the sponsor Bank.
Management :
The general superintendence, direction and management of the
affairs and business of a RRB vests in the Board of Directors
who may exercise all the powers and discharge all the functions
which may be exercised or discharged by the RRB.
OPERATIONS :
During the financial year 1991-92 (upto September 1991) while
the number of RRBs remained unchanged at 196, the total
number of districts covered by RRBs increased to 385 as
compared with 380 in the preceding year.
Aggregate deposits of RRBs rose from Rs.4267 crores to
Rs.5141 crores at the end of September 1991 recording a growth
of 20.5%.
Borrowings of RRBs from sponsor Banks NABARD, SIDBI
and other institutions aggregated Rs.1702 crores as at the end
of September 1991 of which Rs.1471 crores were from
NABARD alone.
NABARD also offered assistance to RRBs for setting up
technical, monitoring and evaluation cells for preparation and
evaluation of schemes under project lending.
3. Role and Functions of an EXIM Bank
The EXIM Bank is established by an Act of 1981 for functioning
as the principal Financial Institution for co-ordinating the
working of institutions engaged in financing export and import
of goods and services with a view to promoting Countrys
international trade. The EXIM bank may grant in or outside
India loans and advances either by itself or in participation with
any other bank or financial institutions. It may also grant loans
and advances to scheduled Banks or Financial Institutions;
underwrite issue of stock, shares, bonds or debentures of a
Company engaged in export or import; accept, collect, discount,
purchase, sell or negotiate bills or promissory notes connected
with export or import; grant issue or endorse letters of credit;
finance export or import of machinery or equipment; buy or
sell foreign exchange; undertake surveys techno-economic or
any other study; provide technical administrative or financial
assistance of any kind of export or import; plan, promote or
develop export oriented concerns; collect, compile and
disseminate market and credit informations and do such other
acts and things necessary to discharge the duties and functions
under the Act [Sec 10].
4. Role and Functions of Re-Construction Bank
Industrial Re-Construction Bank is established by the Act of
1984 with a view to function as the principal credit and re-
construction agency for industrial revival. The bank is to act as
the agent of the central or State Govts,RBI, SBI,State co-
operative bank and other public financial institutions. It may
carry on and transact the following functions; granting of loans
and advances to industrial concerns, guaranting or counter-
guaranteeing or providing indemnity, under-writing issues of
stock shares and debentures; providing credit to State level
agencies for granting industrial loans; providing infra-structure
facilities, machineries and other equipments, consultancy and
merchant banking services; transfering or acquiring any
instrument relating to loans and advances; providing managerial
assistance; granting or opening or issues of letters of credit;
and doing such other acts or things as may be incidental to or
consequential upon the powers and duties under the Act.
[Sec.18]
5. National Housing Bank
This specialised bank was established by an Act of 1987 in
order to promote housing finance institutions. The Bank may
promote, establish, support or aid in the promotion of housing
Finance institutions; make loans and advances for housing
finance, purchase stock shares, bonds and debentures; guarantee
the financial obligation of housing finance institutions; draw,
accept, discount negotiable instrument; provide technical and
administrative assistances to housing finance institutions; do
any other business the Central Govt may on the
recommendations of the RBI authorise the institutions to do.
The above discussions about the functions of the specialised
banks are only illustrative.
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Country wise
State wise
NABARD
All India Large scale
Agriculture
VARIOUS DEVELOPMENT BANKS & FINANCIAL INSTITUTIONS AT A GLANCE
AFC
SLDB
RRB
Mutual funds
LIC, GIC including UTI and its subsidiaries
SHCI
CRSIL/ CARE / ICRA
DFHI
EXIM BANK
ECGC
Small Scale
State Level
Industrial Development
Export/Import
Capital Market
NSIC
SIDBI
ICICI
IDBI
IFCI
IRBI
SFC
SIDC
SIIC
Housing > NHB & HB of Commercial Banks (HDFC)
Insurance & Credit guarantee > DICGC
NABARD National Bank for Agriculture and Rural Development
AFC Agriculture Finance Corporation
SLDB State Land Development Bank
RRB Regional Rural Banks
SEBI Securities and Exchange Board of India
SHC Stock Holding Corporation of India
CRISIL Credit Rating Information Service of India
ICRA Investment Information and Credit Rating Agency of India
DFHI Discount and Finance House of India
EXIM BANK Export Import Bank of India
ECGC Export Credit and Guarantee Commission
ICICI Industrial Credit and Investment Corporation of India
IDBI Industrial Development Bank of India
IFCI Industrial Finance Corporation of India
IRBI Industrial Reconstruction Bank of India
NSIC National Small Industries Corporation
SIDBI Small Scale Industrial Development Bank of India
SFC State Finance Corporation
SIDC State Industrial Development Corporations
SIIC State Industrial Investment Corporations
NHB National Housing Bank
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17
Having regard to the nature and range of activities of the
merchant bankers and their responsibilities to SEBI Investors
and Issuers of securities it has been decided to have four
categories of merchant bankers.
Category I : Those authorised to act in the capacity of issue
manager/co-advisor/consultant and portfolio manager to an
issue and underwriter to an issue as mandatorily required.
Category II : Those authorised to act in the capacity of co-
manager, advisor or consultant to an issue or portfolio manager,
and
Category III : Those authorised to act only in the capacity of
advisor or consultant to an issue.
Category IV : Advisors and consultants who provide
consultancy and guidance to certain terms of authorisation have
also been specified for merchant bankers a few of which are
listed below.
a. All Merchant bankers must obtain the authorisation of SEBI
b. SEBI may collect from the merchant bankers an initial
authorisation fee an annual fee and a renewal fee.
c. The Merchant bankers must have a minimum net worth
which is based on the category into which they are
classified.
Category I - 1 Crore
Category II - 50 Lakhs
Category III - 20 Lakhs
Category IV - NIL
d. Lead Manager/Merchant bankers would be responsible for
ensuing timely refunds and allotment of securities to
the investor.
e. The merchant banker shall make available to SEBI such
information documents returns and reports as may be
prescribed and called for.
f. SEBI has already prescribed a code of conduct for merchant
bankers, which they should adere to.
The above terms of authorisation have been framed to make
merchant bankers more responsible and liable and any
negligence on the part of the merchant bankers can be proceed
against legally.
This will ensure that fake companies whose only intention is to
defraud the Public do not have any access to the stock market
and the investing public at large.
2.5 ROLE AND FUNCTIONS OF NON-BANKING
FINANCIAL INSTITUTIONS
Merchant Banking :
In addition to the Commercial banking and specialised banking
activities merchant banking has also grown in stature and gained
an important place in the financial system of the country.
Merchant Bankers are governed by the Securities and Exchange
Board of India (Merchant Bankers) Rules 1992. Merchant
Banker is defined as any person who is engaged in the business
of issue management either by making arrangement regarding
selling, buying or subscribing to securities as Manager,
Consultant, Adviser or rendering corporate advisory service in
relation to such issue management. Public money plays a vital
role in financing a large number of projects both in public and
private sectors. Hundreds of Crores of rupees are tapped from
Capital market every year to finance industrial projects. To
raise the money from the capital market, promoters have to
bank upon merchant bankers who manage the issue.
Role of Merchant Bankers:
Merchant bankers are designated as managers to the issue. They
are specialised agencies whose main business is to attract public
money to Capital issues. They render the following services.
a) Drafting of prospectus and getting it approved from the
stock exchanges.
b) Appointing, assisting in appointing bankers, underwriters,
brokers, advertisers etc.
c) Obtaining the consent of all the agencies involved in public
issue.
d) Holding brokers conference/investors conference.
e) Deciding the pattern of advertising
f) Deciding the branches where applications money should
be collected.
g) Deciding the dates of opening and closing of the issue.
h) Obtaining the daily report of application money collected
at various branches.
i) Obtaining subscription to the issue and
j) After the close of issue, obtaining consent of stock exchange
for deciding basis of allotment etc.
Merchant Bankers charge a heavy fee for rendering the above
mentioned services. The fees are so lucrative that many
nationalised banks which had separate merchant banking
divisions have now opened separate subsidiary companies for
rendering merchant banking services.
DICGC Deposit Insurance and Credit Guarantee Corporation
LIC Life Insurance Corporation of India
GIC General Insurance Corporation of India
UTI Unit Trust of India.
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SUB-TOPICS:
3.1. Structure of a Scheduled Commercial Bank.
3.2. Structure of State Bank of India.
3.3. Structure of EXIM Bank
3.4. Structure and Management of a Nationalised Bank
3.1 STRUCTURE OF A SCHEDULED COMMERCIAL
BANK
The composition of a Board of Directors of a Scheduled Bank
shall consist of a whole time Chairman, or a whole time Director
who shall be the Chairman of the Board of Directors and other
elected and nominated part-time members. Of course in a recent
amendment part time Chairman can also be appointed.
According to Sec.10A of Banking Regulation Act (BRA), 1949
as amended in 1968, not less than 51% of the number of
members shall consist of persons having special knowledge in
one or more of the areas, such as accountancy, agriculture and
rural economics, banking, cooperation, economics, finance, law,
small-scale industries or any other special knowledge which in
the opinion of the Reserved Bank be useful in the banking
company. Atleast two of three members must have special
knowledge of practical experience in agriculture or rural
economy cooperation or small-scale industries.
The Chairman and a Director of the Banking Company
appointed by the RBI shall not be required to hold qualification
shares in the banking Company. The management of the whole
affairs of the banking company shall be entrusted with the whole
time Director who is also the Chairman of the Company subject
to superintendence, control and direction of the Board of
Directors. The Chairman must have special knowledge and
practical experience of working of a banking company or of
the SBI or any subsidiary bank or a financial institution
[Sec.10B(4)]. The RBI has the power to remove the Chairman
or the whole time Director or Chief Executive Officer (whatever
name called) for reasons to be recorded in writing with effect
from such date as may be specified by order. Any person
appointed as a Chairman, Director or Chief Executive Officer
shall hold office during the pleasure of RBI and subject thereto
for a period not exceeding three years as the RBI may specify.
The RBI has the power to appoint Additional Director.
Directors of a Banking company other than the whole time
Directors shall not hold office for a period exceeding 8 years.
A Chairman of a whole time Director removed from office shall
cease to be a Director of a Company and shall not to eligible to
be appointed as a Director either by election or by co-option or
otherwise for a period of four years from the date of such
removal. If the office of a Chairman of a Banking Company is
vacant the RBI may appoint a person qualified under
Sec.10B(4). No Banking Company shall employ a Managing
Agent.
3.2 STRUCTURE OF STATE BANK OF INDIA
A flow chart of the Managment of the SBI is given below
Central Chairman
Two Managing Directors
Board (CB) President of the thirteen Local Boards
Four elected Directors
Comprise Ten other Directors
Local Boards at each local Head Office
Chairman Directors Six one elected Chief
ex-offico of CB from nominated member G.M. of
the area members the local
H. Office
SBI which is still a shareholders bank in which RBI is the
majority shareholder and private shareholders are minority
shareholders. The bank shall be managed by the Central Board
of Directors which shall be guided by the Central Government.
All such directions of the Central Government shall be given
through the RBI. The Central Board shall consist of the
Chairman to be appointed by Central Government in
consultation with the RBI, two Managing Directors appointed
by the Central Government in consultation with RBI, presidents
of the Local boards and four elected members elected by the
shareholders other than by the RBI provided the shareholders
hold more than 25% of the share capital. One Director taken
from the workmen to be appointed by the Central Government,
One Director to be appointed by the Central Government from
the employees not less than two and not more then six Director
to be appointed by the Central Government in consultation with
RBI from persons having the special knowledge of the working
of cooperative institutions and of rural economy or experience
in commerce, industry, banking or finance. One nominated
Director by the Central Government and one nominated Director
by the RBI (sec 19 of the SBI Act). The Chairman, and each
managing Director shall hold office for such term not exceeding
5 years as the Central Government may fix. They may however
be eligible for the appointment. The Central Government has
the right to terminate them by serving notice of not less than 3
months or paying 3 months salary in lieu of the notice within
the time.
The local boards of all local head offices comprise of the
Chairman ex officio and Directors of the Central Board coming
from that are ex officio, six members nominated by the Central
Government in consultation with RBI, one elected member
from the shareholders other than RBI and Chief General
Manager of the area. The Governor of the RBI in consultation
with the Chairman of the SBI shall nominate members of the
3. STRUCTURE OF BANKING INSTITUTIONS
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19
local board. The member of the local board shall hold office
not exceeding 3 years but shall continue in office until the
successor be nominated.
The local boards shall exercise all powers and perform all
functions and duties of the SBI as may be approved by the
Central board. All questions are decided by the majority.
Similarly local boards are also to meet at such place and time
and observe such rules and procedures as may be prescribed
3.3 STRUCTURE OF EXIM BANK
The management of the EXIM, bank is nested in the board
comprising :
(a) A Chairman and Managing Director appointed by the
Central Government
(b) One Director nominated by the RBI
(c) One Director nominated by the Development Bank
(d) One Director nominated by the Export Credit and Guarantee
Corporation.
(e) Not more than 12 Directors nominated by the Central
Government of whom 5 are Government officials, not more
than 3 are from schedule banks and not more than 4 are
persons having special knowledge of professional
experience in export and import of finance.
The Board may constitute such committees either wholly or
partly by Directors and of other persons. The committees meet
at such time and place and shall observe such rules and
procedures and transact such business as may be prescribed.
Directors of a Board hold office for a period not exceeding 6
years. Nominated Directors hold office during the pleasure of
the authority nominating them. Chairman and Managing
Directors hold office for such term not exceeding 5 years but
eligible for the appointment.
3.4 STRUCTURE AND MANAGEMENT OF A
NATIONALISED BANK
Under Sec 9 of the Banking Companies (Acquisition of Transfer
of Undertakings Act 1970 the Central Government was given
the power to make schemes in consultation with the RBI for
the purpose of :
(a) Management by board of Directors, the appointment of
managing Directors, the holding of board meetings and
allied matters.
(b) Meetings of the Board
(c) Appointment of Committees of the Board
(d) Constitution of Regional Consultative Committees and their
Boards.
Nationalised Banks are managed by the Board of Directors
having 15 nominated members including two fulltime Directors
of whom one is the managing Director. The Composition of
the Board is at follows :
(a) Two whole time Directors including the Managing Director,
(b) One Director from the employer, (c) One Director
representing Workmen, (d) One Director representing
depositors, (e) Three Directors representing farmers, workers
and artisans, (f) One Director who is an official of the RBI, (g)
One Director who is the official of the Central Government,
and (h) not more than 5 Directors having knowledge or practical
experience of the working of nationalised Banks. The Directors
hold office during the pleasure of the Central Government for a
period not exceeding 3 years. They may however be re-
appointed. Clause 13 of the scheme provide provisions for
constituting management of the Board. The Board may
constitute advisory committees consisting Directors or partly
with Directors or partly with other persons for advising the
Board on matters refer to them.
The Board has to meet atleast 6 times in a year and once in each
quarter and the head office of the Bank or at such other place as
the Board may decide. All questions are to be decided by
majority votes.
The scheme also provides for appointment of regional
competitive committees for six regions specified by the
Committee. The Committee shall consist of not more than three
persons nominated by the Central Government and two
representatives from each of the State in respective regions.
One representative to be nominated by the Central Government
as desired by the RBI. Meetings of the consultative Committee
shall be presided over by Minister of Finance or his deputy.
The functions of these committees shall be to review banking
developments within the region and recommend on such matters
as may be referred to it by the Central Government and the
RBI.
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SUB-TOPICS
4.1 Introductory Note
4.2 Industrial Finance Corporation of India (IFCI)
4.3 State Financial Corporations (SFC's)
4.4 The Industrial Credit and Investment Corporation of India
(ICICI)
4.1 INTRODUCTORY NOTE
The economic development of a country depends inter alia on
its financial system. In the long run, the larger the proportion
of financial assets to real assets, the greater the scope for
economic growth. Investment is a pre-condition for economic
growth. In order to sustain the growth, continued investment
is a prime importance, Finance is a major input in the growth
process. This is where the financial institution play a vital role.
The major function of financial institutions whether short term
or long term, is to provide the maximum financial convenience
to the public. This is achieved in the following manner.
a) Promoting the overall saving of the economy by widening
the financial system.
b) Distributing the existing savings in a more efficient manner
so that those in greater need from the social and economic
point of view, get priority in allotment; and
c) Creating credit and deposit money and facilitating the
transactions of trade, production and distribution in
furtherance of the economy.
The integrated structure of the financial institution in the country
comprises to 12 institutions at the National level and 44 at the
State level. The structure consists of five All India Development
Banks (AIDBs) four Specialized Financial Institutions (SFIs),
three Investment Institutions, 18 State Financial Corporations
(SFCs) and 26 State Industrial Development Corporations
(SIDCs). The AIDBs are Industrial Development Bank of India
(IDBI), Industrial Finance Corporation of India (IFCI),
Industrial Credit and Investment Corporation of India (ICICI),
Small Industries Development Bank of India (SIDBI) and
Industrial Reconstruction Bank of India (IRBI). The SFIs are
Risk Capital and Technology Finance Corporation Ltd, (RCTC),
Technology Development and Investment Company of India
ltd., (TDICI), SCICI Ltd, and Tourism Finance Corporation of
India Ltd (TFCI).
The investment activities are conducted by Life Insurance
Corporation of India (LIC), Unit Trust of India (UTI), and
General Insurance Corporation of India (GIC) and its
subsidiaries and various Mutual Funds.
Among the All India Development Banks, IDBI, IFCI, ICICI
and IRBI provide assistance to medium and large industries
and SIDBI to the tiny and small sector. They also undertake
promotional and developmental activities. Among the
specialised financial institutions, RCTC and TDIC are involved
in risk capital, venture capital and technology development
financing. SCICI, which was originally set up for financing
shipping, deep sea fishing and allied activities has diversified
its operations to other industrial sectors also. TFCI is engaged
in financing hotels tourism and related projects. Of the
investment institutions, LIC and GIC which primarily take care
of the life and general insurance needs of the society and UTI
which is a mutual fund mobilising the savings of the community
for channelising into productive sectors, are active participants
in providing finance to industry both by way of term loans and
subscription to equity and debentures. The SFCs provide
assistance mainly to small sector and SIDCs to the medium
and large sectors in their respective states besides undertaking
promotional and development activities. The Financial
Institutions, evolved over the years have been instrumental in
providing term finance in the form of loan, underwriting and
direct subscription to equity and debentures and guarantees.
Looking to the emerging needs of the industrial sector they
have also introduced a variety of financial products and services.
4.2 INDUSTRIAL FINANCE CORPORATION OF
INDIA (IFCI)
The need for speedier industrial expansion and for
modernisation and replacement of obsolete machinery in already
established industries paved the way for establishment of the
Industrial Finance Corporation of India in 1948. IFCI was the
first development bank to be established for providing medium
and long term credits to industrial concerns. IFCI was
established under such circumstances where normal banking
accommodation was inappropriate and recourse to capital issue
methods were impracticable.
Capital: The Authorised capital of the IFCI was Rs.10 Crores
it was subsequently raised to 20 crores by the IFCI Act, 1972.
Presently the authorised capital is 250 crores Fifty percent of
the share capital of IFCI is held by the IDBI and the remaining
50% is held by commercial and cooperative banks.
The corporation is authorised to issue bonds and debentures in
the open market within certain limits.
Functions: The following are the major functions of the IFCI :
1) To guarantee loans raised by industrial concerns.
2) To grant loans and advances to or subscribe to the
debentures of industrial concerns.
3) To underwrite the issue of stocks, shares, bonds or
debentures by industrial concerns.
4) To extend guarantee in respect of deferred payments by
importers
5) To subscribe directly to the stock or shares of any industrial
concern.
The IFCI caters to the financial needs of large and medium
sized limited companies in the public and private sectors and
cooperative societies engaged in the manufacture, preservation,
4. FINANCIAL INSTITUTIONS AND THEIR FUNCTIONS
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21
processing, shipping, mining or hotel industry or in generation
and distribution of electricity or any other form of power.
The IFCI provides assistance in all forms-sanction of rupee loans
and foreign currency loans, underwriting of and subscribing to
share and debenture issues, guaranteeing of deferred payments
etc.
However, the corporation cannot compete with the commercial
banks in financing industrial concerns but supplement their work
by granting loans in such amounts and for such periods as are
outside the scope of ordinary commercial banks.
The corporation now functions as a subsidiary of the IDBI under
its supervision, guidance and control.
Before granting loan to any industrial concern applying for
financial aid, the corporation scrutinizes the application
carefully and the following points are evaluated i.e.,
a) the importance of the industry to the national economy;
b) the feasibility of and the cost of the scheme for which
financial aid is required;
c) technical, financial and economic viability;
d) the competence of the management;
e) the nature of the security offered.
f) the adequacy of the supply of technical personnel and raw
materials; and
g) the quality of the product and the countrys requirements
of the product manufactured.
While lending, the corporation requires the security of fixed
assets such as land, buildings, plant and machinery and it does
not normally lend against raw materials or finished products. It
ordinarily requires the personal guarantee of directors and has
the right to appoint two directors to the board of management
of the borrowing concern in order to ensure efficient
management and also to safeguard the interests of the
corporation. In fact, the corporation has the right to take over
the management of a concern or to sell the property mortgaged
in the event of continuous default in the payment of interest
and of the principal advanced to the concern. It obtains periodic
reports from the borrowing concerns and also undertakes
periodic inspection.
In addition to providing assistance by way of project finance
and financial services like equipment leasing, equipment
procurement, buyers and suppliers credit, finance to leasing
and hire purchase concerns etc., IFCI also provides merchant
banking services. It also helps industrialisation through a range
of promotional activities.
The promotional services cover funds support for technical
consultancy, risk capital venture capital, technology
development, tourism and tourism related activities, housing,
development of securities market and investor protection
upgradation of managerial skills, entrepreneurship development,
science and technology, entrepreneurs perks, research etc, and
subsidy support through promotional schemes of IFCI to help
the entrepreneurs and enterprises in the village and small
industries (VSI) sectors.
Operations:
The Cumulative financial assistance sanctioned by the
Corporation since its inception in 1948 upto end March 1993
aggregated 16650-93 crores against which disbursements
amounted to Rs.8650.6 crores. Among the many industries
which have received financial assistance from the corporation
are those which are of high national priority such as fertilizers,
cement, power generation, paper, industrial machinery, etc.
During the year 1992, IFCI introduced one more scheme of
financial service i.e. Installment credit scheme, with a view to
providing an option to borrowers for availing assistance for
acquiring equipment for industrial use. The scheme is flexible
in regard to repayment and has a simplified procedure for
interest payment.
The above scheme is similar to the soft loan scheme introduced
by the Corporation in 1976 which provided financial assistance
to productive units in selected industries i.e. Cement, Cotton,
Textile, Jute, Sugar and certain engineering industries on
concessional term to overcome the backlog in modernisation
replacement and renovation of their plant and equipment so as
to achieve higher and more economic levels of production. The
scheme is administered by IDBI with financial participation by
IFCI and ICICI. The basic criterion for assistance under the
scheme was the weakness of the units on account of
obsolescence of machinery.
The IFCI has also sponsored the Risk Capital Foundation to
provide assistance in the form of interest free personal loans to
new entrepreneurs including technologists and professionals
for meeting a part of the promoters contribution to equity capital.
With the amendments in 1986-87 to the IFCI Act, the area of
operations of the IFCI has been enlarged. The corporation has
been designated as the nodal point to administer the Jute
Modernisation Fund constituted by the Government of India in
order to revitalise and modernize the jute industry.
The IFCI has also been appointed as the agent of the government
for disbursement of loans from the Sugar Development Fund
for rehabilitation and modernization of sugar units. During
1986-87, the IFCI established a Merchant Banking division to
take up assignment of capital restructuring, merger and
amalgamation, loan syndication with other financial institutions
and trusteeship assignments. It also provides guidance to
entrepreneurs in project formulation, resource management etc.
During the same year, IFCI also introduced a promotional
scheme called the scheme of Interest Subsidy for encouraging
Quality Control measures in the small scale sector.
The Investment Information and Credit Rating Agency of India
Ltd., (IICRA), set up by IFCI, commenced operations in
September 1991 and rated 39 instruments by 31st March 1992.
With a view to provide training facilities for workers in the
industry and organisations connected with industrial
development and for retraining and reorientation of workers in
specific industries covering skills and attitudes to adjust to
technological changes, IFCI established, in January 1992, a
national level institute called the Institute of Labour
Development at Jaipur in Rajasthan.
22
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IFCI has been playing the role of a leader by identifying the
varying financial needs of industry and has promoted specialised
institutions to cater to these needs, such as :
Managment Development Institute (MDI)
Risk Capital and Technology Finance Corporation Ltd
(RCTC)
Investment Information and Credit Rating Agency of India
Ltd (ICRA)
Tourism Finance Corporation of India Ltd (TFCI)
Institute of Labour Development (ILD)
IFCI has also co-sponsored national institutions like
Stock Holding Corporation of India (SHCIL)
Entrepreneurship Development Institute of India (EDII)
Over-the-Counter Exchange of India Ltd (OCTCEI)
National Stock Exchange of India Ltd. (NSEIL)
Bio-tech Consortium (India) Ltd.
4.3 STATE FINANCIAL CORPORATIONS (SFCS)
Implementation of programmes for planned industries
development and their success depends, on the availability of
adequate financial resources for a wide variety of projects. Since
the Indian Banking system had confined itself to financing the
working capital requirements of trade and industry, the need to
set up long term financial institutions was greatly felt. This
could ensure adequate flow of assistance in the form of capital
to Industrial projects. However, the IFCI which was set up for
this very purpose could cater only to the corporate sector and
industrial co-operatives.
To reduce the imbalance, it was decided to set up regional
development banks to cater to the needs of the small and
medium enterprises. Thus, the State Financial Corporations
came into existence by an Act of the Parliament passed in 1951
called the State Financial Corporations Act, 1951.
Under the provisions of the Act, SFCs are established by the
respective State Governments for providing term finance to
medium industries operating in 18 different States including
New Delhi
SFCs are under the control of the IDBI and the State
Governments.
SFCs grant financial assistance to public limited Companies,
private limited Companies, partnership firms and proprietary
concerns in the form of loans and advances, subscription to
shares and debentures, underwriting of new issues and guarantee
of loans. They also operate the seed capital scheme on behalf
of IDBI and SIDBI.
The SFCs operating at the State level have grown to be an
integral part of the financial system of the country. They have
been fairly successful in achieving balanced regional socio-
economic growth. they have been instrumental in catalysing
higher investment and generating greater employment
opportunities and widening the ownership base of the industries.
The working group set up by IDBI in 1990-91 to service the
operations of SFCs has made wide-ranging recommendations
for improving the working of SFCs.
4.4 THE INDUSTRIAL CREDIT AND INVESTMENT
CORPORATION OF INDIA (ICICI)
The Company was set up as a Development Finance Institution
on January 5, 1955 under the Indian Companies Act, 1913,
with the support of the Government of India and the active
involvement of the World Bank.
The need for setting up such a finance institution came out
because the existing institutional frame work was not geared to
the job of bringing about a rapid industrial revolution through
private effort. Hence, the basic objective of ICICI at the time
of formation was to assist the countrys industrial development
by providing finance.
ICICI has an unique structure. It is a development agency with
twin objectives i.e. assist in the industrial development of the
country and earn profit for its shareholders.
Capital structure:
The Corporation was registered as a company with an authorised
capital of Rs.25 crores and a subscribed capital of Rs. 5 crores.
Today the capital stands at a whooping Rs.300 crores
(authorised) and a subscribed capital or Rs.171 crores. ICICI
has been meeting its financing requirements through internal
generation of funds and borrowings in the domestic and
international markets. Internal generation of funds by way of
repayment of loans, receipt of interest etc. constitutes a major
source of funding ICICIs resource requirements. ICICI has
been raising rupee resources, within the regulatory framework
of the RBI, mainly by issue of Bonds in the nature of promissory
notes, convertible debentures, equity and loans from institutions
such as Unit Trust of India & Life Insurance Corporation of
India.
In the recent past, however, ICICI has been endeavoring to
diversify its resource base on account of Government policies
encouraging it to seek funds from commercial sources. In this
regard, it has entered the Certificates of Deposit market and
has scrutinised a part of its assets.
Management & Organisation:
ICICI is efficiently managed by a Board of Directors comprising
personalities drawn from such diverse fields as finance and
banking, industry and government service. The day-to-day
affairs are handled by the Managing Director supported by the
senior executives of ICICI.
The organisation is characterised by a high degree of
professionalism, delegation of authority and effective client
servicing through swift communication and computerised data
basis.
Objectives:
The main objects of the company as set out in its Memorandum
of Association are:
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23
To carry on the business of assisting industrial enterprises within
the private sector of the industry in India by -
a) assisting in the creation, expansion and modernisation of
such enterprises;
b) encouraging and promoting the participation of private
capital, both internal and eternal, in such enterprises;
c) encouraging and promoting private ownership of industrial
investments and the expansion of investment markets;
d) providing finance in the form of long or medium term loans
orequity participation;
e) sponsoring and underwriting new issues of shares and
securities;
f) guaranteeing loans from other private investment sources;
g) making funds available for re-investment by revolving
investments as rapidly as possible;
h) providing or assisting in obtaining directly or indirectly,
advice or services in various fields including management,
finance, investment, technology, administration, commerce,
law, economics, labour, accountancy, taxation etc;
i) performing and undertaking activities relating to leasing,
giving on hire or hire purchase, warehousing, bill
marketing, factoring and other related fields.
Operations:
ICICI began its activities in the 1950s predominantly as a
foreign currency lender and gradually diversified its activities
to rupee lending over a period of time with the growth of
indigenous capital goods industry.
Till 1985, term lending to industry was the main form of
financial assistance provided by ICICI. So long as the
corporation received rupee funds at special rates by way of
government guaranteed bonds and lent these funds at fixed rates,
it earned reasonable returns. However, the lending rates
remained constant even as the cost of funds were increasing.
This led to a pressure on the margins thereby forcing the
corporation to expand its non-project financing to other areas
like leasing of industrial equipment, asset credit and deferred
payment financing of sale of industrial equipment.
Non project financing showed a faster growth rate than project
financing and the share of this segment in the annual approvals
rose from a mere 13.6% in 1980 to 42.5% in 1991.
In addition to assistance provided to industries, ICICI also
encourages projects in backward areas and those related to
pollution control. ICICI is in the process of carrying out a
comprehensive study to identify the scope for technological
collaboration between companies in India and suitable agencies
in the industrialised countries for instituting more efficient
pollution control measures.
In order to improve the exportability of Indian products, ICICI
has been providing assistance to existing companies for
technology upgradation, modernization and balancing
equipment out of lines of credit obtained from the World Bank.
The Corporation is also making concerted efforts to develop
programmes for the benefit of export oriented companies by
chalking out an export marketing strategy and helping them
produce internationally acceptable quality of products. The
Corporation provides financial support in the form of grants
from the Productivity Fund and Export Development Fund.
During 1991-92, the ICICI initiated the Export Breakthrough
Service in collaboration with Developing Countries Trade
Agency (DCTA) an agency funded by the British Government.
Under the service, exporters who require market and commercial
information necessary for entering new export markets are
introduced to selected market research consultants. Funds are
also provided towards the cost of market research.
ICICI has also moved into merchant banking activity which
has acquired great significance in the emerging environment
for the financial services industry which is poised for further
growth with the establishment of private sector mutual funds
and opening up of the Indian capital markets for foreign portfolio
investors. A comprehensive exercise to reorganize and position
ICICIs merchant banking activity has been undertaken so that
ICICI as a mature merchant banker, can play its due role in he
emerging financial system.
ICICI is today one of the national level institutions through
which the government of India seeks to operationalize its
industrial development policies pertaining to the corporate
sector. It has been extending its vision far beyond its immediate
function of finding industrial projects. It has been looking at
all sectors of the economy and where ever a need was perceived,
has designed either a new concept or a new instrument or even
a new institution to cater it. In this regard, ICICIs development
activities have encompassed such diverse areas as technology
financing, project promotion, rural development, human
resource development and publications. It has also been a
pioneer in setting up specialized institutions in key sectors like:
HDFC - Housing Development Corporation of India.
SCICI - Shipping Credit and Investment Company of India
Ltd.
CRISIL- Credit Rating Information Services of India Ltd.
TDICI - Technology Development and Information Company
of India Ltd.
OTCEI - Over the Counter Exchange of India.
The company has also offered its expertise to Development
Finance Institutions in developing countries such as Bhutan,
Nepal, Ghana, Sri Lanka and Uganda.
The Company also assists organisations such as Institute of
Financial Management and Research (IFMR) and Indian
Institute of Foreman Training (IIFT) and provides financial
assistance towards conducting Entrepreneurship Development
Programmes (EDP) in various states. ICICI has started a
commercial Bank of its own.
24
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SUB-TOPICS:
5.1 Industrial Development Bank of India.
5.2 Small Industrial Development Bank of India.
5.1 Industrial Development Bank of India
(IDBI)
The need for an effective mechanism to coordinate and integrate
the activities of the different financial agencies brought into
existence the Industrial Development Bank of India.
The IDBI was set up in 1964, under the Industrial Development
Bank of India Act 1964 as a wholly owned subsidiary of the
RBI. Under the Public Financial Institutions Laws (Amendment)
Act 1976 the Ownership of the IDBI was transferred from the
RBI to the Government of India. Also various other
responsibilities of the RBI vis-a-vis the financial institutions
was vested in the IDBI. Thus it was given the status of an
autonomous body.
Today IDBI is regarded as an apex institution in the area of
development banking.
Capital structure & Management:
Authorised capital shall be 1000 crores and the Central
Government by notification in the Official Gazette increase the
paid up capital up to 2000 crores of rupees and any further
issue shall be wholly subscribed by the Central Government.
Management: The general superintendence, direction and
management of the affairs and business of the Development
Bank is vested in a Board of Directors.
The Board shall consist of -
(a) A Chairman and a Managing Director appointed by the
Central Government.
(b) A Deputy Governor of the Reserve Bank nominated by
that bank.
(c) Not more than 20 Directors nominated by the Central
Government.
Of these 20 Directors :
i) 2 Directors shall be officials of the Central Government,
ii) Not more than five Directors shall from Financial
Institutions,
iii) 2 Directors shall be from amongst the employees of the
Development Bank and the Financial Institutions and of
such Directors one shall be from amongst the Officer
employees and the other from amongst the workmen
employees,
iv) Not more than 6 Directors shall be from the State Bank,
the Nationalised Banks and the SFCs (State Financial
Corporations),
v) Not less than five Directors shall be persons who have
special knowledge of, and professional experience in
science, technology, economics, industry, industrial co-
operatives, law, industrial finance, investment, accountancy
marketing or any other matter, the special knowledge of,
and professional experience in, which would, in the opinion
of the Central Government, be useful to the Development
Bank.
Objective of the IDBI :
(1) Establishing an appropriate working relationship among
financial institutions.
(2) Co-ordinating their activities and building a pattern of inter-
institutional cooperation to effectively meet the changing
needs of the industrial structure.
(3) Undertake market and investment research and surveys as
well as techno-economic studies bearing on the
development of the industry.
(4) Providing technical and administrative assistance for the
promotion, management or expansion of industry.
(5) Plan, promote and develop industries to fill vital gaps in
the industrial structure.
(6) Providing refinancing facilities to the IFCI, SFCs and other
financial institutions approved by the government.
(7) Purchasing or underwriting shares and debentures of
industrial concerns.
(8) Guaranteeing deferred payments due from industrial
concerns for loans raised by them.
Operations:
The IDBI Act was amended in 1986 to provide for a
considerable measure of operational flexibility. Now, the Bank
has been empowered to finance and provide assistance to a
diverse range of industrial activities, irrespective of their form
of organisation. These activities include the service sector
industries like health care, information, storage, generation and
distribution of energy and other value additive services.
The scope of business has also been extended to the fields of
consultancy, merchant banking etc.
There are no restrictions as regards the nature and type of
security. There are no maximum or minimum limits prescribed
either for assistance to a unit or the size of the unit itself.
During the year 1991-92, IDBI made a debut in the field of
equipment leasing to widen its range of services offered to
industrial concerns. A venture capital division was also set up
and is expected to give a wider perspective to the concept of
venture capital by providing risk capital assistance for projects
promoted by technocrats and professional entrepreneurs seeking
to introduce an innovative product or service in the Indian
market.
It has also entered into merchant banking activities.
IDBI has also been appointed as the implementing agency for
the Energy Management Consultation and training Project being
financed by the USA of $ 20 million.
5. INDUSTRIAL DEVELOPMENT BANKS
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25
IDBI has also entered into an agreement with the European
community (EC) to function as an intermediary for channelising
foreign currency assistance by way of grant or equity
participation or loan to eligible joint ventures.
The growth of IDBI has been phenomenal in the last few years
to the extent that it is the central co-ordinating agency and is
concerned with the problems and questions relating to the long
and medium term financing of the industry and is now in a
position to adopt and enforce a system of priorities in promoting
future industrial growth.
During the year 1991-92 the privilege given to IDBI of
Exemption from income tax was removed which resulted in
payment of Rs.168.5 crores as taxes comprising of Rs.140 crores
as advance tax and Rs.28.5 crores as interest tax.
5.2 SMALL INDUSTRIAL DEVELOPMENT BANK OF
INDIA (SIDBI)
The Small Industries Development Bank of India (SIDBI) was
set up as the principal financial institution for promotion,
financing and development of industry in the tiny and small
scale sector and to co-ordinate the functions of institutions
engaged in similar activities.
SIDBI is a wholly owned subsidiary of IDBI. It took over the
financing activities relating to small scale sector from IDBI and
commenced operation on April 2, 1990. Since the
commencement of its business, SIDBI has been paying
concentrated attention to the financing and multi-dimensional
growth of industries in the small scale sector with special
emphasis on development of small units in the village, cottage
and tiny sector.
Activities: SIDBIs activities comprise refinancing of term loans
granted by SFCs, SIDCs Banks and other financial institutions,
direct discounting and rediscounting of bills arising out of sale
of machinery and equipments by manufacturers in the small
scale sector on deferred credit and rediscounting of short term
trade bills arising out of sale of products of the small scale sector.
SIDBI also provides assistance for development of marketing
infrastructure, creating new marketing channels for the products
of SSI units and direct assistance for development of Industrial
areas with requisite infrastructure facilities.
SIDBI provides equity type of assistance to special target groups
like new promoters, women and ex-servicemen under National
Equity Fund (NEF), Mahila Udyam Nidhi (MUN) and self
employment scheme for ex-servicemen (SEMFEX). SIDBI
provides resource support to NSIC and SSIDCs for their raw
material supply and marketing of SSI products as well as their
hire-purchase and leasing activities. For promotion,
development and growth of small scale sector, SIDBI extends
technical and related support services.
Operations:
The year 1991-92 saw the introduction by SIDBI of a new
scheme of direct assistance to help widen the supply base of
small scale ancillary units and encouraging the existing units
to undertake technology upgraduation/modernisation for
improving the quality and competitiveness of their products.
A scheme to provide resource support to factoring companies
against their factored debts of small scale industries was also
introduced during the year 1991-92. SIDBI contributed 20%
of the Share Capital of factoring companies promoted by State
Bank of India and Canara Bank. A special refinance scheme
for acquisition of computers including accessories was
introduced during the year for supplementing efforts of SSI
units in improving their productivity and operational efficiency.
SIDBI has identified the need for improving managerial
capabilities of existing entrepreneurs, developing a special cadre
of trained professionals for the sector, promoting rural
entrepreneurship technology upgradation and modernisation of
existing units, strengthening of ancillaries and bringing about
qualitative changes in such direction so as to improve the
competitive strength of the sector. In its supportive role, SIDBI
has also given special attention to tackling the problem of
inadequate marketing infrastructure and delayed payments faced
by SSI units.
In tune with the new SSI policy announced by the Government
of India, SIDBI liberalized the terms and scope of its existing
schemes. Investment limits for tiny units was raised from Rs.2
lakhs to 5 lakhs for the purpose of refinance, independent of
location of the units. Corporate and non-corporate entities and
accredited Non-Governmental Organisations (NGOs) approved
by KVIC (Khadi and Village Industries Commission) were made
eligible for setting up industrial areas/estates in rural areas under
the scheme of assistance for development of Industrial areas/
estates.
During the year 1991-92, SIDBI sanctioned assistance
aggregating Rs.2898.1 crore under all its schemes and disbursed
a sum of Rs.2027.4 crore recording a growth of 20.3% in
sanctions and 10.3% in disbursements over the previous year
1990-91. SIDBI also rediscounted short term bills relating to
SSI units to the tune of Rs.560.7 crores. Assistance sanctioned
under Refinance and Bills Finance schemes (including Direct
Discounting of Bills) accounted for little over 97% of total
sanctions under all schemes and is expected to catalyze
investment of the order of Rs.6700 crores and provide additional
employment opportunities to 17 lakh persons.
SIDBI stepped up its resource support to SSIDCs by providing
Line of Credit during 1991-92 for their raw material
procurement and distribution, marketing and infrastructure
development activities for SSI units. Limits aggregating to
Rs.20.8 crores were sanctioned during the year 1991-92 against
which disbursements amounted to Rs.13.1 crores. An amount
of Rs.5 crores was sanctioned to NSIC to finance its activities
relating to hire-purchase, leasing and supply of raw materials
to SSI units against which disbursements amounted to Rs. 4
crores.
The assets of SIDBI as at end March 1992 stood at Rs.6680
crores comprising outstanding refinance of Rs.4909 crore,
outstanding bills discounted and rediscounted of Rs.1406 crore,
investment in shares and debentures of Rs.160 crore and other
assets of Rs. 205 crore. SIDBI raised resources aggregating
Rs.1168.8 crore of which Rs.362.3 crore were from Overseas
Economic Co-operation fund, Japan, Rs.440 crore from RBI
and Rs.330 crores were loans from IDBI out o SLR market
borrowings and the balance from other sources.
26
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SUB-TOPICS
6.1 Objects
6.2 Capital Structure
6.3 Organisation
6.4 Functions
6.1 OBJECTS
NABARD was set up by an Act of Parliament on July 12, 1982
called the NABARD Act. The objective of setting up this Bank
was to provide, by way of refinance to banks, all kinds of
production and investment credit to agriculture, small scale
industries, artisans, cottage and village industries and other allied
economic activities.
Initially, it was sought to act as a decentralised section of the
RBIs functions in the areas of rural credit. But now, NABARD
has taken over the entire operations of the Agricultural
Refinance and Development Corporation (ARDC) as well as
the refinancing functions of the RBI in relation to the State Co-
operative Banks (SCBs) and Regional Rural Banks (RRBs).
6.2 CAPITAL STRUCTURE
The share capital of NABARD is held by the Reserve Bank of
India jointly with the Government of India in equal proportions.
NABARD draws its funds from the Government of India, the
World Bank and other agencies to meet its long term loan
operation. The Bank has also been authorised to accept deposits
for over a year from the Central, State and local governments,
scheduled banks etc. Its short term operations are met mainly
from funds drawn from the Reserve Bank.
6.3 ORGANISATION
NABARD is managed by a Board of Directors, consisting of a
Chairman, Managing Director, 2 Directors from experts in rural
economics, rural development etc., 3 Directors from out of the
Directors of RBI, 3 Directors with experience in the working
of Cooperative Banks, 5 Directors from among the officials of
the Government of India and State Governments.
All these appointments are made by the Central Government.
6.4 FUNCTIONS
Main functions:
1) To provide by way of refinance, credit to the rural sector
for the promotion of agriculture, small scale industrial units,
cottage and village industries, handicrafts, other rural crafts
and allied productive activities in the rural areas with the
primary aim of promoting integrated rural development and
attaining rural prosperity.
2) To give short term as well as long term loans in a composite
form. It also makes loans to State Governments for a
maximum period of 20 years in order to enable them to
subscribe to the Share Capital of Cooperative Credit
Societies.
3) To provide medium term loans ranging from 1
1
/
2
to 7 years
to State Cooperative Banks (SCBs) and Regional Rural
Banks (RRBs) for agricultural and rural development.
Ancillary functions:
1) Inspection of RRBs and Cooperative societies (other than
primary cooperative Banks).
2) Appraisal and forwarding of applications to the RBI for
opening of new branches of RRBs and Cooperative banks.
3) Calling for information and statements from RRBs and
Cooperative banks with regard to their operations etc. (RRBs
and cooperative banks are required to furnish to NABARD
copies of returns submitted to RBI under the Banking Regulation
Act).
4) Undertaking research and development programmes to
alleviate the problems of agricultural and rural development.
5) Providing training to its own staff as well as the staff of
SCBs, RRBs in order to upgrade the technical skills and
competence of the staff.
6) To assume responsibility from the RBI for Coordinating with
the Government of India, the planning commission and other
relevant agencies concerned with the development of rural
industrialisation and putting into practice the various policies
and procedures meant for rural development.
Resources (Net) Mobilised by NABARD April-March
Resources (Rs. In Crores)
1990-91 1991-92
Reserves and Surplus 63 105
NRC (LTO) Fund 775 915
NRC (Stabilisation) Fund 30 40
Deposits 30 69
Bonds and Debentures` 90 99
Borrowings from Govt. of India 194 127
Borrowings from RBI 560 631
ARDR Scheme 1990 692 31
Other Liabilities 21 58
Total 905 1821
[Source: Report on trend and progress of banking in India 1991-
92 (June-July)].
6. NATIONAL BANK FOR AGRICULTURE AND RURAL
DEVELOPMENT (NABARD)
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27
SUB-TOPICS:
7.1. Objects
7.2. Capital Structure
7.3. Management
7.4. Operations of the Trust
7.5. Pricing policy
7.6. Advantages
7.7. Conclusion
7.1 OBJECTS
The need for establishment of an investment trust to extend
facilities for growing number of small investors in the middle
income groups of the community led to the formation of Unit
Trust of India.
UTI was established by an Act of parliament in 1964, and it
plays an important role in tapping the savings of the small
investors through sale of units and channelising them into
corporate investments.
The primary objective of the Trust is -
(a) tapping and mobilising the savings of the middle and low
income groups; and
(b) to enable them to share the benefits and prosperity of the
rapidly growing industrialisation in the country.
The Unit Trust achieves its objectives by-
(1) selling units of the Trust among as many investors as
possible in different parts of the country;
(2) by investing the sale proceeds of the units and also the initial
capital fund of Rs.5 crores in industrial and corporate
securities; and
(3) by paying dividends to those who have bought the units of
the Trust.
7.2 CAPITAL STRUCTURE
The initial capital of the UTI was 5 crores which was subscribed
fully by the Reserve Bank of India (Rs.2.5 crores), the Life
Insurance Corporation (Rs. 75 lakhs), the State Bank of India
(Rs. 75 lakhs) and Scheduled banks and other financial
institutions (Rs. 1 Crore).
7.3 MANAGEMENT
The general superintendence, direction and management of the
affairs and business of the Trust is vested in a Board of Trustees,
consisting of a Chairman and nine other Trustees. The Chairman
shall be appointed by the Reserve Bank of India, four trustees
to be nominated by the RBI out of which at least 3 shall be
persons having special knowledge of, or experience in
commerce, industry, banking finance and investment, one trustee
nominated by LIC and one by State Bank, two trustees to be
elected by the contributing institutions and one executive trustee
to be appointed by the Reserve Bank of India.
7.4 OPERATIONS OF THE TRUST
In 28 years of operations upto 1991-92, the Unit Trust of India
has done remarkably well in the area of fund mobilisation and
assistance to industries by way of investments. During the year
1991-92, the total number of unit holders was a phenomenal
20 million and the total investible funds available as at end
June 1992 aggregated Rs. 30550.8 crores.
The Government has also assisted the growth of the Trust by
giving many tax incentives to investors who buy the units issued
by the Trust.
Unit Trust of India has introduced many new kinds of units
suitable for different types of investors. Eight new units were
introduced during the year 1991-92 i.e. the Deferred Income
unit scheme 1991, the Unit growth scheme 5000 Master Equity
Plan 1992, Master plus, Growing monthly Income Unit Scheme
(GMIS) 91, GMIS 91-II, GMIS-92 and Mastergain.
The Trust has built up a portfolio of investments which is
balanced between the fixed income bearing securities and
variable income bearing securities. The main objective of the
Trusts investment policy is to secure maximum income
consistent with safety of capital. The bulk of the investible funds
have been invested in companies which are on regular dividend
paying basis. Barring investments in bonds of public
corporations, the Trusts funds have been invested in financial,
public utility and manufacturing enterprises.
The Trust has now floated its own Bank, UTI Bank Ltd.
7.5 PRICING POLICY
The sale and repurchase prices of the units of the Unit Trust
are fixed according to the rules framed by the Trust. The sale or
the repurchase price is worked out by obtaining the basic value
of the units. This is done by dividing the value of all the assets
of the trust less current liabilities by the number of units deemed
to be in issue. Normal charges like brokerage, commission,
stamp duties etc., are added or subtracted as the case may be
and the final figure is rounded off to the nearest five paise.
7.6 ADVANTAGES
1. Investments in these units is safe, since the risk is spread
over a wide range of securities (fixed income bearing and
variable income bearing)
7. UNIT TRUST OF INDIA (UTI)
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2. Units holders are assured of a regular and steady income.
3. Dividents are exempt from Income tax under section 80L.
4. Liquidity is high as the investor can encash the units
whenever he wants. The units can also be sold back to the
Trust under the repurchase facility offered by the Trust.
7.7 CONCLUSION
The Unit Trust of India plays an important role in tapping the
savings of the small investors through sale of units and
channelising them into corporate investments. The trust being
a public sector enterprise has created confidence among the
general public. Additionally, the tax concessions provided by
the Government has added to its growth. So also, the benefits
of liquidity and safety of capital over the years, the trust has
extended its operations to other areas like assistance to corporate
sector by way of term loans, bills rediscounting, equipment
leasing and hire-purchase financing.
During the year 1991-92, UTI, in association with the Bank of
Ceylon and others, promoted the Unit Trust management of Sri
Lanka and also provided technical and management support in
designing and marketing of its schemes. UTI also signed a
Memorandum of Understanding with Alliance Capital
Management Ltd. of United States to jointly set up an asset
management company.
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29
8. CASE LAW
Sajjan Bank Pvt. Ltd. v RBI (30 Comp. Cases,146)
The petitioner, a banking company which was in existence at
the commencement of the Banking Companies Act, 1949,
applied to Reserve Bank on Sept.14, 1949, under section 22 of
that Act for a licence to carry on banking business. Officers of
the Reserve Bank inspected the banking company under section
22 of the Act in July, 1952, but as the inspection revealed defects
in the method of keeping accounts and contravention of certain
provisions of the Act, the Reserve Bank kept in abeyance
consideration of the question of issuing a licence. A fresh
inspection carried out by the Reserve Bank under section 35 in
September 1956, four years later,also revealed certain defects.
The Reserve bank not being satisfied that the affairs of the
banking company were being conducted in the interests of the
depositors, directed the banking company to show cause against
the refusal of the licence and after considering the
representations of the banking company,declined to grant the
licence. Aggrieved by the refusal,the petitioner applied to the
High Court for the issue of a writ of Certiorari quashing the
order refusing the grant of the licence.
Three conditions were raised in the writ petition: (i) that Section
22 of the Banking Companies Act was unconstitutional in so
far as it proceeded to restrict the fundamental right of the
petitioner to carry on its business,namely the banking
business;(ii) even if the provisions of the Sec 22 of the Act be
held to be in accordance with the constitution,the action of the
respondent was arbitrary;and (iii) in any event the procedure
adopted by the respondent was illegal and in that,after an
inspection under section 35,it could only proceed to act under
Section 35(4) and not refuse the licence altogether.
The court held that the provisions of Section 22 of the Banking
Companies Act prescribed only a system of licensing with a
view of regulating the banking business and was not repugnant
to the provisions of Article 19(1)(g) of the Constitution.
The provisions in Section 22 investing the Reserve Bank with
the power to grant, refuse to grant or cancel, a licence did not
amount to an excessive delegation of legislative power. There
was sufficient legislative guidance for the granting of licence
embodied in the provisions of the Act, and of Section 22 in
particular, and delegation of the power, having been made to
non-political body statutorily concerned with the credit structure
of the country, the restriction imposed in the regulation of the
banking business was nothing but reasonable. The power that
was given to the Reserve Bank under the Act was a wide range
of administrative discretion which it was peculiarly competent
to undertake, and the determination whether the conditions
which were required before the licence could be given or refused
exist, was peculiarly within its competence as an expert statutory
body. The legislature having prescribed the nature of a real
banking institution in this country, it could not be said that there
was any excessive delegation of power.
The provisions of Sec.35 (4) which empowered the Central
Government to prohibit a banking company from continuing
its business on the report of the Reserve Bank after inspection
under Section 35, related to a banking company to which a
licence has already been granted. It was open to the Reserve
Bank to consider the defects revealed in an inspection under
S.35 for disposing of an application for the grant of a licence
under Sec.22.
Finally the court held that the jurisdiction of the Reserve Bank
to refuse to grant a licence to the petitioner was properly
exercised. The powers vested in it under Section 22 of the
Banking Companies Act are not ones invested with a mere
officer of the bank. The standards for the exercise of the power
have been laid down in Section 22 itself. The Reserve Bank is
a non-political body concerned with the finances of the country.
When a power is given to such a body under a statute which
prescribes the regulations of a banking company, it can be
assumed that such power would be exercised so that geniune
banking concerns could be allowed to function as a bank, while
institutions masquerading as banks or those run on unsound
lines or which would affect the interests of the public could be
weeded out. The nature of the power and its exercise after the
investigation prescribed by the statute invested it with a quasi
judicial character. Such a power cannot be said to be an arbitrary
one.
In re Supreme Court of India Ltd. v. Official Liquidator
and Others (37, Comp. Cases. 392.)
Five appeals arose out the order of the learned Company Judge
in misfeasance proceedings against the Directors and Officers
of a banking company by name The Supreme Bank of India
Ltd., taken on an application of the official liquidator during
the course of its winding up proceedings.
On appeal the High Court held that though both Section 196 of
the Companies Act, 1913 & Section 45B of the Banking
Companies Act, 1949, provide for public examination of a
Director or an officer of a company as to promotion, formation
or the conduct of the business of the company or as to his
conduct and dealings as Director or Manager or other officer,
Sec. 196 of the Companies Act enables the liquidator to make
such an application for public examination only when he is of
opinion that fraud had been committed by a Director, while
under Section 45G of the Banking Companies Act, all that is
necessary for the liquidator to make such an application, is that
he should be of opinion that any loss had been caused to the
banking company by any Act or omission of the Director,
whether or not any fraud has been committed by such Act or
Omission.
The duties of the Directors were summarised by the court in
the following terms:
1. The Directors are not bound to give continuous attention
to the affairs of the bank and their duty is of an intermittent
nature to be performed at the periodical Board Meetings
and the Meetings of Sub-committees of the Board. They
are not bound to check the cash of the bank or the books of
account to detect shortage of cash or manipulation of bank
balances;
30
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2. To begin with, the Directors are entitled to trust the
Managing Director and other officers of the Bank to perform
their duties honestly. They are entitled to continue to repose
such trust until there are grounds for suspicion;
3. Once there was any ground for suspecting the honesty,
competence or skill of the Managing Director or other
officers of the bank, the Directors are bound to exercise
such reasonable care as an ordinary prudent man would do
in his own case, in order to avert losses to the company.
Even after such ground for suspicion if they shut their eyes
and do not take any effective steps to prevent losses
resulting from their wilful neglect, they would make
themselves liable for the resulting losses;
4. Until there is such ground for suspicion, the directors are
not liable for losses due to the mistake, negligence or
dishonesty of the managing director and other officers of
the company, although such losses could have been averted
if the directors had taken care; and
5. The crucial question in such cases is, therefore, whether
there were any circumstances arousing the suspicion of the
directors and, if so, when should their suspicions have been
aroused.
Sardar Gulab Singh v. Punjab Zamindara Bank Ltd. (AIR
1942 Lah.47)
The plaintiff Managing Director of the company brought a suit
against the company for a declaration that he was the managing
director of the company and for injunction restraining the
company from preventing him from discharging his duties. The
trial court decreed both the declaration and the injunction prayed
for. On appeal the learned Senior Subordinate Judge dismissed
the suit. On second appeal the High Court allowed the appeal
as regards the declaration, but dismissed it with regard to the
injunction. Both parties filed appeals. The plaintiff against the
decision allowing him an injunction and the defendants against
the decision granting the plaintiff declaration.
The Court held that even if the memorandum and articles of
association of a company are held not to constitute a contract
in themselves, an implied contract may be proved by the acts
of the parties on the terms set out in the articles of association
of the company. Where in pursuance of certain articles acted
upon by the company a shareholder was appointed Managing
Director and acted as Managing Director for 11 years and was
remunerated in accordance with the terms set out in the articles,
the articles constituted an implied contract between the company
and the share-holder so as to entitle him to the declaration that
he was the managing director of the company.
With regard to the second point, whether Sardar Gulab Singh
is entitled to an injunction, the court held that it would not be
proper to issue an injunction. In this connection the court
observed that the position of the company and that of Sardar
Gulab Singh as managing director was that of master and
servant. With great respect we do not think that this is correct.
A Director or Managing Director is in no way a servant of the
company, he is the agent of the company for carrying on its
business. But we agree that the same principles which have
been held to apply to the issue of an injunction at the instance
of a dismissed servant ought also to apply in the case of a
dismissed agent. It would be contrary to public policy to impose
upon an unwilling principal an agent whom he does not wish
to employ, especially as there is nothing to prevent an agent
whose contract of agency has been wrongfully broken from
bringing an action for damages.
Andhra Bank Ltd. v. Bonu Narasamma [(1988) 63
Com.Cas.p.328]
In this case an appeal arose out of a suit filed for recovery of
Rs.2,87,681.85 with interest and in default of payment for the
sale of the scheduled properties to realise the suit debt. The
learned counsel for the appellant contended that the levy of
interest by A.P.Bank is linked with and based upon the rate of
interest fixed by the Reserve Bank and the question of charging
penal or unconscionable interest does not arise and in any event
such contention does not survive in view of S.21A of the
Banking Regulation Act. On the other hand learned counsel
for the respondents seeking to sustain the judgements of the
courts contended that the levy of such exorbitant interest by a
nationalised bank is unconstitutional as it is beyond the
legislative competence of Parliament and is in breach of Art.14
of the constitution.
The High Court held that the provisions of Sec.21 A of the
Banking Regulation Act, 1949, declaring that the rates of interest
charged by banking companies shall not be subject to scrutiny
by the courts from the point of view of excessiveness are within
the legislative competence of parliament under entry 45 of list
I of Sch.VII of the Constitution of India, which pertains to
banking. The charging of interest is interwined with banking
business and the element of interest is ingrained in the veins of
all dealings in society. The bank is a dealer in credit. Section
21A strives to safeguard the levy of interst and quantum of
interest charged and Section 21A is essentially concerned with
the banking operation and therefore, within the legislative
competence of Parliament.
The Court further held that Sec. 21A does not violate the
provisions of Art.14 of the Constitution. The modalities and
the quantum of interest is uniform in all the banks as regulated
by the Reserve Bank. The charging of interest is tied up with
the interest fixed by the Reserve Bank. The Reserve Bank is
entrusted with diverse powers for regulating the banking
business in the country and the Reserve Bank taking stock of
the prevalent economic growth, cost of living, index, purchasing
and paying capacity and other factors fixes the rate of interest
chargeable by the banks. Banking Companies are bound to
adhere to the guidelines and directions given by the Reserve
Bank. The rate of interest chargeable by the banks is rooted in
the rate of interest fixed by the Reserve Bank and as a sequel of
the decision of the experts, apparently with a view to having a
uniform rate of interest in all banking companies throughout
the country at all times and situations, The jurisdiction of Civil
Courts is taken away.
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31
9. LIST OF STATUTES
The readers are requested to purchase the following Acts for
better understanding of the laws and practice.
1. Reserve Bank of India Act, 1934
2. Banking Regulation Act, 1949
3. Banking Companies (Acquisition and Transfer of
Undertakings) Act, 1970 and Act of 1980
4. State Bank of India Act, 1955
5. Nationalised Banks (Management and Miscellaneous
Provisions) Scheme, 1970 and Scheme of 1980,
6. Export-Import Bank of India Act, 1981
7. Industrial Development Bank of India, 1964
8. Industrial Insurance and Credit Guarantee Corporation Act,
1961
9. Deposit Insurance and Credit Guarantee Corporation Act,
1961
10. Industrial Reconstruction Bank of India Act, 1984
11. National Bank for Agriculture and Rural Development Act,
1981
12. National Housing Bank Act, 1987
13. Regional Rural Banks Act, 1976
14. State Financial Corporations Act, 1951
32
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10. PROBLEMS
1. Critically examine the functional and structural relation
between NABARD and RRB.
2. Evaluate the Composition of the Board of Directors both
at the central and local level in so far as maintaining the
operation of efficiency of the State Bank of India.
3. State Bank of India has a distinct role in the banking services
in India. Critically examine the statement.
4. Examine the role of commercial bank in building directly
and indirectly the industrial capital.
5. How far it is justified to attribute government's interference
in the functioning of financial institutions as the cause of
operational inefficiency? Explain your answer with
reference to actual functioning of one financial institution.
6. Compare the management and organisation structure of
IDBI, ICICI and IFC. What is the functional relation
between these three institutions, if any. Do you think
functional commercial competition or better institutional
cooperation will be more beneficial for building up better
industrial climate ?
7. Critically examine the branch banking policy in India. What
alternate do you suggest ?
8. State Bank of India performs part of the RBI function.
Critically examine the statement indicating the function, if
any, done by the SBI on behalf of RBI.
9. Name some of the important Mutual Fund Organisation, in
India and critically look at law and practice relating to
mutual Fund.
10. In recent times many of the Commercial banks indulge more
in non-banking functions than the conventional banking
operations. Critically examine the statement indicating the
non-banking functions undertaken by the commercial
banks.
11. Compare and contrast the management and an organisation
structure of a nationalised bank and a private bank. Do
you think the nationalization of Commercial banks brought
inefficiency and corrupt practice in banking operation ?
Justify your answer with reference to functioning of
Commercial banks in the light of the Report of Narasimham
Committtee.
[Note: Specify Your Name, I.D. No. and address while sending answer papers]
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33
11. SUPPLEMENTARY READING
1. Mark Hapgvod, Paget's Law of Banking, 10th edn., 1989, Butterworths London & Edinburg.
2. Saravanavel. P., Banking Theory Law & Practice, 1st edn., 1987, Margham Publications, Madras.
3. Sheldon & Fidler's, Practice & Law of Banking, 11th edn. (Rep.), 1984, Macdonald & Evans Ltd., Plymouth.
4. Suneja H.R., Practice & Law of Banking, Ist edn., 1990, Himalaya Publishing House, New Delhi.
5. Sundaram & Varshney, Banking Theory, Law & Practice, 8th edn. (revised), 1990, Sultan Chand & Sons, New Delhi.
6. Tannan M.L., Banking Law & Practice in India, 18th edn., 1989, Orient Law House, New Delhi.
34
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Master in Business Laws
Banking Law
Course No: II
Module No: II
Reserve Bank of India
Structure and Functions
Distance Education Department
National Law School of India University
(Sponsored by the Bar Council of India and Established
by Karnataka Act 22 of 1986)
Nagarbhavi, Bangalore - 560 072
Phone: 3211010 Fax: 080-3217858
E-mail: mbl@nls.ac.in
(Sys 4) - D:\shinu\lawschool\books\module\contract law
35
Materials Prepared By :
1. Mr. K.D. Zachariah, LL.M.
2. Mr. N. L. Mitra, M.Com., LL.M., Ph.D.
Materials Checked By :
1. Mr. V. Vijaykumar, M.A., LL.M., M.Phil.
2. Mr. T. Devidas. LL.M.
3. Ms Archana Kaul, LL.M.
4. Ms Pooja Kaushik, M.A, (Eco)
Materials Edited By :
1. Mr. P.C. Bedwa LL.M., Ph.D.
2. Mr. Sunderajan, A.C.A.
3. Mr. Harihara Ayyar, LL.M., Former General Manager, SBI
Distance Education Department
National Law School of India University
Post Bag No : 7201
Nagarbhavi, Bangalore 560 072.
India
36
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INSTRUCTIONS
Basic Readings
The materials given in this course are calculated to provide exhaustive basic readings on topics and sub-topics
included in the course. Experts in the area have collected the basic information and thoroughly analysed the same
in topics and sub-topics. Lucid/supportive illustrations and leading cases are also provided. Relevant legislative
provisions are also included. Care has been taken to communicate basic information required for decision making
in problems likely to arise in the course-area. The reader is advised to read atleast three times. In the first reading
information provided are to be selected by making marginal notes using markers. The first reading, therefore,
necessarily has to be very slow and extremely systematic. While so reading the reader has to understand the
implications of those informations. In the second reading the reader has to critically analyse the material supplied
and jot down in a separate note book points stated in the material as well as the critical comments on the same. A
third reading shall be necessary to prepare a Check List so that the check list can be used afterwards for solving
problems like a ready reckoner. (The reader is required to purchase a Bare Act and refer to the relevant sections
at every stage.)
Supplementary Reading
Several supplementary readings are suggested in the materials. It is suggested that the reader should register with
a nearby public library like the British Council Library, the American Library, the Max Muller Bhavan, the
National Library, any University Library where externals are registered for the purpose of library reading, any
commercial library or any other public library run by Government or any private institution. Readers in Metropolitan
and other big cities may have these facilities. It is advised that these basic materials be photocopied, if necessary,
and kept in the course file. Supplementary readings are also required to be read more than once and marginal
notes, marking notes, analytical notes and check lists prepared. Any reader requiring any extra readings not
available in his/ her place may request the Course Coordinator to photocopy the material and send it by post for
which charges at the rate of .50 paise per page for photocopying and the postage charge shall be sent either by
M.O. or by Draft in advance. The Course Coordinator shall take prompt action on receiving the request and the
payment.
Case Law
The course material includes some case materials generally based upon decided cases. These cases are to be
studied several times for,
(a) understanding the issues to be decided (b) decisions given on each issue (c) reasoning specified
It is advised that while reading a case the reader should focus first on the facts of the case and make a self analysis
of the facts. Then he/she should refer the check list prepared earlier for appropriate information relating to law
and practice on the facts. Then the student should prepare a list of arguments for and on behalf of the plaintiff/
appellant. Keeping the arguments for the plaintiff/appellant in view of the reader should try to build up counter
arguments on behalf of the defendant/respondent. These exercise can take days. After these exercises are done
one has to prepare the arguments for or against and then decide on the issues. While deciding it may be necessary
often to evolve a guiding principle which also must be clearly spelt out. Subsequently the reader takes up the
decision given in the case by the judge and compare his/her own exercise with the judgment delivered. A few
exercise of this type shall definitely sharpen the logical ability, the analytical skill and the lawyering competence.
Though it is not compulsory, the reader may send his/ her exercises to the Course Coordinator for evaluation. On
receiving such request the Course Coordinator shall get the exercises evaluated by the experts and send the
experts comment to the students. Through these exercises one can build up an effective dialogue with the
experts of the Distance Education Department (DED).
Problems and Responses
After reading the whole module which is divided into several topics and sub-topics the reader has to solve the
problems specified at the end of the module. The module is designed in such a manner that a reader can take
about a weeks time for completing one module in each of the four courses. It is expected that after finishing the
module over a period of a week the student solves these problems from all possible dimensions to the issue. No
time limit is prescribed for solving a problem though it would be ideal if the reader fixes his/her own time limit
for solving the problem - which may be half an hour per problem - and maintain self discipline. While solving the
problems the candidate is advised to use the check list, the notes and the judicial decisions - which he/she has
already prepared. After completing the exercise the student is directed to send the same to Course Coordinator
for evaluation. Though there is no time stipulation for sending these responses a student is required to complete
these exercises before he/she can be given the certificate of completion to appear for final examination.
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37
RESERVE BANK OF INDIA : STRUCTURE
AND FUNCTIONS
TOPICS
1. Organisation ................................................................................................................... 38
2. Functions ......................................................................................................................... 43
3. Issue & Management of Currency................................................................................ 45
4. Banker to the Government ............................................................................................ 47
5. Bankers Bank ................................................................................................................ 49
6. Monetary Control ........................................................................................................... 50
7. Custodian of Foreign Exchange .................................................................................... 54
8. Promotional Functions................................................................................................... 59
9. Case Law......................................................................................................................... 60
10. Problems.......................................................................................................................... 63
11. Bibliography ................................................................................................................... 65
38
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1. ORGANISATION
SUB-TOPICS
1.1 Introduction
1.2 Organisational Model
1.3 Central Board
1.4 Local Boards
1.5 Critical Remarks
1.1 INTRODUCTION
Central Banking as a concept is of fairly recent origin. Though
some Latin American countries had a central banking system
in the 19th century, this system really became popular in the
early 20th Century. Generally speaking, a Central Bank is
considered as the leader of the money market, but several
economists emphasize different roles for the Central Bank. For
example, according to Whawtrey,R.G, the essential
characteristic of a Central Bank is its function as the lender of
last resort. According to Kische & Elkin, the main function of
the Central Bank is to maintain the stability of the monetary
standard. On the other hand, Shaw,W.R. lays emphasis on
credit control as the major function of Central Bank. The Bank
of England founded in 1694 is perhaps the oldest Central
Banking institution which provides finance for the government.
The first attempt at Central Banking in India dates back to
General Bank in Bengal & Bihar estd. in January, 1773 at the
instance of Warren Hastings, the then Governor of Bengal. But
this experiment was very short lived. Three Presidency Banks
were established and started functioning in 1866. Alongwith
their commercial functions they undertook some functions on
behalf of the Government also. These Presidency Banks were
amalgamated in 1921 to form the Imperial Bank of India which
was primarily a commercial bank but used to perform certain
central banking functions as well. In 1926 the Royal
Commission on Indian Currency & Finance (Milton Young
Commission) recommended the dichotomy to be ended & the
establishment of a Reserve Bank of India as its Central Bank.
A Bill was introduced in the Legislative Assembly in 1927,
which was later dropped. In the meantime during 1930-31
consideration for constitutional reforms in the country started
being debated. Ultimately, the Reserve Bank of India Act was
passed in 1934, part of which came into operation in 1935 &
the remaining part in 1937. It took over the management of the
currency from the Central Government and of carrying on the
business of banking in accordance with the provisions of the
Act. As stated in the preamble to the Act, the Bank has the
responsibilities of (i) regulating the issue of Bank notes; (ii)
keeping of reserves with a view to securing the monetary
stability in India; and (iii) generally to operate the currency and
credit system of the country to its advantage.
As provided in Section 3(2) of the Act, the Bank is a body
corporate having perpetual succession and common seal and
shall sue and be sued in its name. The whole capital of the
Bank of Rs.5.00 crores is at present held by the Central
Government. The Bank has its Central Office in Bombay and
other offices in Bombay, Calcutta, Delhi and Madras and
branches in most of the State capitals and departments at a few
other important places. The matters of policy relating to
banking, monetary management, exchange control, inspection
and supervision of banks, credit control, and economic and
financial matters are formulated at the Central Office of the
Bank at Bombay. The basic function of note issue and general
banking business are discharged by the issue department and
banking department at the local offices/ branches.
1.2. ORGANISATIONAL MODEL
The Reserve Bank of India (RBI) was originally constituted as
a shareholders bank with a share capital of 5 crores divided
into 5 lakh fully paid-up shares of Rs. 100/- each. Only 2,300
shares were held by the Federal Government. The whole
country was divided into 5 areas for the operation of the Bank,
viz., Bombay, Calcutta, Madras, Delhi & Rangoon*. (* closed
since 1947). In 1948, RBI was nationalised by the Reserve
Bank (Transfer to Public Ownership) Act, 1948, and the entire
share capital was acquired by the Central Government.
With the introduction of the Constitution of India in 1950, RBI
was put under entry 38 List I, VII Schedule U/Art.246, thereby
subjecting RBI to the legislative power of the Parliament.
Accordingly, the Act was amended several times by the
Parliament to virtually touch every section. There were some
extremely important amendments which will be discussed
alongwith the concerned subject. It will suffice to give the
following outline of the organisational set-up of RBI as it stands
today.
The RBI was initially designed on the pattern of Bank of
England, theoretically subordinate to the Treasury. The
Governor, 4 Deputy Governors, all Directors of the Central
Board & the Local Boards are either appointed or nominated
by the Central Government. The Governor & the Deputy
Governor are whole time officials and hold office for such term
not exceeding 5 years as may be fixed by Central Government
and are eligible for re-appointment [S.8(4).] They may however
be removed from their office by the Central Government at
anytime. This legal provision has made RBI an almost
subordinate agency of the Ministry of Finance, Government of
India.
There are several models of Central Banking. The dominating
models are :
1) Bank of England, which is in theory as stated earlier
subordinate to the Treasury but in practice has a relationship
of co-operation rather than subordination (Sheldon, p.8).
This model can be called the functionally independent
model.
2) Federal Reserve System, USA - This system can be said to
be both functionally & statutorily independent.
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39
3) Deutsche Bundesbank, Germany - This can be said to be
constitutionally & functionally independent. The Central
Bank Council & the Directorate are headed by the President
& Vice President of the Deutsche Bundesbank. The
President & Vice President of this Bank are appointed by
the President of Germany on recommendation of the
Bundesrat (upper House of Parliament). The Bundesbank
is independent of the instructions of the Federal
Government. In order to maintain cooperation between
the Central Bank & the Federal Government, the
government is required under the Constitution to consult
the President of Bundesbank on all matters of basic
monetary policy. There is an autonomous Central Bank
council in whose meetings the Federal government may
take part but cannot participate in the voting.
The operational efficiency of an organisation predominantly
depends upon the organisation structure of the institution.
Several issues are important while determining this
organisational structure. The organisation of RBI was modelled
on the pattern of Bank of England as being subordinate to the
Central Government at a time when imperial power wanted to
have a positive & definite power centralisation. Continuation
of the same structure in a democratic set-up may be examined
in view of the need for a strong monetary system. This requires
an autonomous institution to cooperate with the Central
Government for laying down a strong monetary system. But
the organisational structure of RBI is entirely subordinated to
the Central Government. The Governor, 4 Deputy Governors
and all the Directors of the Central Board and Local Boards are
appointed/nominated by the Central Government (CG) and hold
office during the pleasure of Central Government. In England
a legal prescription of subordination to the treasury is replaced
by close cooperation through establishment of sound
conventions. In India on the other hand, this led to super control,
so much so that even a Deputy Secretary of the Ministry of
Finance became more powerful than the Governor of the RBI.
This is very unscientific and injurious to the nations economy.
As for example, RBI cant refuse to supply any quantity of
money to the government, against Government securities. As
a result, it is unable to maintain the value of money and
effectively manage the monetary affairs of the country, which
is its primary consideration u/s.3 of RBI Act.
The Constitution of India is not merely a political document,
but it also contains the financial aspiration of the country.
Therefore, the responsibility of the leader of the Bank in the
national economy is enormous, which in no way is any less
important than the resource distribution work of the Finance
Commission of the country. As a matter of fact, the present
statutory provision has not merely created an atmosphere of
dependenatia, but has also made the Central Bank (i.e. RBI)
gradually weaker. Since the system of governance could not
build up a strong convention of autonomy and an institution of
co-operation with the Central Government, it may be necessary
to review the organisational structure in the light of experience
of other constitutional institutions.
ORGANISATION CHART OF RBI [SS 8 & 9 OF THE Act]
W.T. GOVERNOR
CENTRAL BOARD
4 DG 10 DIR 4 DIR 1 GO
W.T. NOMINATED BY FROM LBS
C G
CENTRAL OFFICE
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
Note : The Department names are given below
LOCAL BOARDS
DELHI BOMBAY CALCUTTA MADRAS
NOTE : Each Local Board consists of 5 Members, appointed by the CG, One of whom
is elected as Chairman
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Abbreviations used above :
WT Whole Time DG Deputy Governor
DIR Director CG Central Government
LB Local Board GO Government official
Departments in the Central Office
1. Secretariat 2. Banking operations &
development
3. Industrial Credit 4. Agricultural Credit
5. Rural Planning & Credit 6. Exchange Control
7. Currency management 8. Expenditure & budgetary
control
9. Govt. accounts 10. Economic analysis &
policy
11. Credit planning cell 12. Statistical analysis &
Computer
13. Management Service 14. Administration &
Personnel
15. Legal Services 16. Inspection
17. Premises 18. 3 Bankers Training
Colleges, one each at
Bombay, Pune & Madras.
1.3 CENTRAL BOARD & ITS FUNCTIONS
Constitution
The general superintendence and direction of the affairs and
business of the Bank are entrusted to a Central Board of
Directors under Section 7 of the Act. However, the Board has
to abide by any directions that may be given by the Central
Government after consultation with the Governor of the Bank.
Such directions can be given from time to time in public interest.
The Central Board shall consist of the Governor, not more than
4 Deputy Governors to be appointed by the Central Government
and other directors to be nominated by the Central Government
as under :
i) four directors to be nominated by Central Government, one
each from the Local Boards constituted under Section 9.
ii) ten directors to be nominated by Central Government.
iii) one Government official to be nominated by the Central
Government.
The Governor and Deputy Governors are wholetime officials
of the Bank. A Deputy Governor and a Government official
nominated as above [under Section 8(1)(d)] may attend any
meeting of the Central Board and participate in deliberations
but do not have voting rights.
The Governor and Deputy Governors hold office for a term
fixed by the Central Government at the time of appointment,
not exceeding 5 years and are eligible for reappointment. The
Government official nominated under Section 8(1)(d) shall hold
office at the pleasure of the Government. The directors
nominated from the Local Board shall continue during their
membership of the Local Boards. The other directors shall hold
office for 4 years and thereafter until their successors are
nominated. The B R Act prescribes certain qualifications
(Chartered Accountant, Lawyer, Cooperator, etc.) for the
Directors of commercial banks, where as there are no such
qualifications specified for appointment to the Board of
Directors.
Under Section 11, the Central Government may remove from
office the Governor or a Deputy Governor or any other director
or any member of the Local Board. Central Government has
also the power under Section 30 to supercede the Central Board,
if the Bank fails to carry out any of the obligations imposed on
it by or under the Act. In such a case, the general
superintendence and direction of the affairs of the Bank shall
be entrusted to any other agency determined by the Central
Government. A full report of the circumstances leading to such
action has to be laid before the parliament at the earliest and in
any case within 3 months.
Powers
The Central Board has wide powers and may exercise all powers
and do all acts and things which may be exercised or done by
the Bank subject to any directions issued by the Central
Government in public interest after consultation with the
Governor. Further, the Governor or in his absence, the Deputy
Governor nominated by him in this behalf shall also have powers
of general superintendence and direction of the affairs and
business of the Bank, and may exercise all the powers and
functions of the Bank unless otherwise provided in the
regulations made by the Central Board.
Meetings
Meetings of the Central Board have to be held at least six times
a year and at least once in a quarter. The Governor or a Deputy
Governor duly authorised shall preside over such meetings and
he shall have casting vote (or second vote) in the event of
equality of votes.
Regulations
Under Section 58 of the Act, the Central Board has the power
to make regulations for giving effect to the provisions of the
Act. Such regulations are to be made after previous sanction
of the Central Government. These regulations are also required
to be laid before both the Houses of the Parliament.
Functions
For practical convenience the Board delegated some of its
functions by means of statutory regulations to a Committee
called the Committee of the Central Board consisting of the
Governor, Deputy Governors and such other Directors as may
be present at the relevant time in the area where the meeting is
to be held. The Committee meets once a week, generally on
Wednesday at the office of the Bank in which the Governor has
his Head Quarters for the time being, to attend to the current
business of the Bank, approval of the Banks weekly accounts
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41
pertaining to the issue and the banking departments. This
Committee is assisted by two sub-committees : one for dealing
with staff and related matters & the other for looking after
matters relating to building projects. Of course, the role of
these sub-committees is purely advisory in nature.
Special Provisions
The Reserve Bank is exempted from income-tax and super-tax
on its profits or gains under Section 48 of the Reserve Bank of
India Act. Further Section 57 provides that the Bank shall not
be placed under liquidation except by an order of the Central
Government and in such manner as it may direct.
Administrative set-up
The Governor has the power of general superintendence and
direction of the affairs of the Bank and may exercise all powers
of the Bank unless otherwise provided in the regulations made
by the Central Board. The Deputy Governors, Executive
Directors and other officers in different grades assist the
Governor. The delegation of powers to different grades of
officers is governed by the Reserve Bank of India General
Regulations, 1949, which are statutory regulations made under
Section 58 of the Act. The officers and other staff are governed
by the Reserve Bank of India (Staff) Regulations, 1948. These
regulations are not statutory. As held by the Supreme Court in
V.T. Khanzode Vs. Reserve Bank, (AIR 1982 SC 917) besides
making statutory regulations under Section 58 of the Act, Bank
could also lay down service conditions of the staff
administratively under Section 7(2) of the Act.
Establishments
The Central office [Head Quarters (H.Qrs.)] of the Bank is
located at Bombay. Formulation of policies concerning banking,
money management, inspection & supervision of Banks,
extension of banking & credit facilities, management of foreign
exchange and rendering of advice to the Central Government -
all these functions are carried out from the Head Quarters.
Besides these the Central office has various departments as
mentioned before in p.5.
The department of banking operations & development
includes Public Accounts Division (PAD), Public Debt Office
(PDO), Deposit Accounts Division (DAD) & Securities
Division (SD). The Head Quarters of the department of non
banking companies is located in Calcutta.
1.4 LOCAL BOARDS AND ITS FUNCTIONS
Constitution
Section 9 of the Act provides for four regional Local Boards
consisting of 5 members each appointed by the Central
Government to represent, as far as possible, territorial and
economic interest and the interests of co-operative and
indigenous banks. The Local Boards have their headquarters
at Bombay, Calcutta, Delhi and Madras. The Local Board has
a Chairman elected from the members. The members of the
Local Boards hold office for 4 years and thereafter until their
successors are nominated. They are also eligible for
reappointment.
Functions
The function of the Local Board is to advise the Central Board
on matters generally or specially referred to it by the Central
Board and also to perform any duties delegated to it by the
Central Board. The advice of the Local Boards is sought on
various matters of local importance, for eg. applications for
opening new branches of commercial banks, opening of offices
in India by foreign banks, directions to be given to the banks
on basis of inspection, granting of license to commercial banks,
etc.. In 1976, financial powers were also delegated to the Local
Boards enabling them to take final decisions in matters relating
to purchase of land, buildings, etc. within the limits fixed by
the Central Board.
Disqualifications
There are certain disqualifications under Section 10 applicable
to Directors of both Central Board and Local Boards. Thus (i)
a person who is a salaried government official; (ii) an
adjudicated insolvent or one who has suspended payment or
has compounded with his creditors; (iii) a person of unsound
mind ; (iv) an officer or employee of any bank or (v) a director
of a banking company or co-operative bank is disqualified to
be a director.
However, this stipulation prohibiting a director from being a
government employee or salaried government official is not
applicable to the Governor, Deputy Governor and the Director
nominated under Section 8(1)(d).
1.5 CRITICAL REMARKS
The efficiency of a Central Banking system is to be judged by
its ability to maintain price stability inside and ouside the
country. Factors affecting this efficiency are (i) the strength of
autonomous decision making power for leading the whole
banking system with the basic objective of money management;
(ii) quick information flow and capability of immediate
assessment of the situation; & (iii) adequate power of system
corrections.
(i) An empirical understanding of the men in the management
of RBI can clearly show the political overtone in the
management structure of the RBI. Appointments to various
senior positions of RBIs management are mere executive
functions of the Ministry of Finance of Government of
India. Instances of appointing persons to the highest post
in the Reserve Bank not having adequate experience in
banking are not unknown. Political considerations often
dominate while constituting Central & Local boards. Such
appointments do not require any legislative or judicial
scrutiny. There is complete lack of transparency in the
constitution & appointment of this highest administrative
setup in the RBI. As such, in designing the monetary policy,
42
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regulating & controlling it, the RBI does not have functional
autonomy to the extent required by the leader of a countrys
banking system.
(ii) The RBI Act, 1934, has provisions for information flow in
accordance with the technological standard of 1934. In
most of the cases today, there is a time lag of 4-6 weeks in
between the happening of an incident & submission of the
information to the RBI. These provisions (Secs.26-28 &
31) breed inefficiency and incapacity. In order to effectively
play the role of the leader of the banking system, the Central
Bank must have complete information of all transactions
taking place in the realm of banking within the quickest
possible time. It is unfortunate that sufficient steps are yet
to be taken with this end in view.
(iii) Of course RBI has the power of delicensing any commercial
bank. This is an extreme step. RBI should have other
intermediary power as well, including imposition of fine or
taking disciplinary action or removing from service any person
or any employee who is found negligent.
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43
2. FUNCTIONS
SUB- TOPICS
2.1 Introductory note
2.2 Outline of various types of functions
3.3 Concluding remarks
2.1 INTRODUCTORY NOTE
It has already been pointed out that RBI has been constituted as
Central Bank of the country. Classical functions of the Central
bank are the following:
a) Banker to the Government: Reserve Bank of India is the
banker of the Central & State Governments as such it has
treasury functions. It collects money for & on behalf of
the Government and meets the expenses, whereas in the
case of Central Government it may demand any quantity
of money and the RBI is obliged to meet the demand. In
case of State governments the RBI extends a time credit
facility up to a maximum limit which is required to be set
off against future collections.
b) Currency Function: RBI is the sole authority for the issue
of the currency. Of course one rupee coins & notes &
subsidiary coins are issued by the government of India,
they are put into circulation only through RBI.
c) Credit Control & Money Management : RBI regulates the
value of money & controls the credit system through
manipulation of cash reserve ratio, bank rate, open market
buying & selling of securities & statutory liquidity ratio.
d) Bankers Bank : RBI is the apex bank regulating,
controlling & creating opportunities for ordinary
commercial banks to function efficiently. It also gives
constant advice about the various goals of lending,
borrowing & other banking functions. It also monitors the
banking functions of the institutions of commercial banks
& institutional banks.
e) Leadership in institutional banking : RBI provides
leadership to all institutional banking such as NABAD
Rural Bank, IBRD, IFC in industrial banking, National
Housing banking so on & so forth. These banks look
forward to RBI for their policies on loans & advances.
f) Ordinary Commercial Banking Function : RBI carryout
ordinary commercial banking functions for the commercial
banks and the government which many central banks of
other countries do not do. These functions include bill
discounting, giving loans & advances to financial
institutions, dealing with foreign exchange & the like.
Table I
Functions of RBI
Central Banking Ordinary Banking
System Function
Currency Banker Credit Bankers Special Bills Lending Institutional Foreign Other
Management to Govt & Monetary Bank Rural discounting & Borrowing banking & Exchange Banking
(Secs.22-29) (Sec.20, Control Credit (Ss.17&18 of Industrial dealing functions
21A & 21B) Secs. 18 & 42 (National RBI Act) finance (Ss.39&40) (Chapter
RBI Act., Ss.17, Bank for 38 of
18,20,21 & 24 Agriculture and RBI Act)
of the B.R. Act) Rural Development
S.54 of the RBI Act)
Licensing of Banks Banks of the Bankers Supervisors of the
(S.22 of B.R. Act) (Ss.11, 17, 18 & 24 of Banks (Ss.9,19,21,& 22
B.R. Act) of the BR Act)
2.2 OUTLINE OF THE FUNCTIONS
The following table gives the outline of the functions of the
Reserve Bank of India :
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2.3 CONCLUDING REMARKS
Different functions of the RBI are discussed hereafter in
subsequent topics. In this topic a broad outline is only given.
It may be pointed out in this connection that many central banks
like BUNDS Bank in Germany, Federal Reserve System in
USA, Bank of England, Bank of Mexico & many others do not
carry on any ordinary commercial banking function. From that
Table II
RESERVE BANK OF INDIA
CREDIT CONTROL
By Traditional Measures (quantitative) By Non-Traditional
(qualitative or Selective)
Interest Liquidity Ratio Open Market operations Cash Reserve Ratio Direct Action
System Sec.24(A) Sec. 42, RBI Act (Sec.58(B) of
B.R. Act Sec.18(1), 24(2A) RBI Act)
(a) (ii), B.R. Act)
Bank Rate Rate of Interest Publicity
(Sec.49 [(Sec.21(e) of (Sec.45(E) of RBI
RBI Act 1949 (BRA)] Act)
1934)
Moral Susasion advice,
request & persuasion With
the Commercial Banks
by Central Bank
Directives by the Central
Bank (Sec.21(2) BRA Secs.35A
& 45 K of RBI Act)
Fixation of Marginal Requirement on
secured Loans
(Sec.21(2) (b) of BRA)
Regulation of Consumer
Credit instalment credit system
point of view functions of RBI are multifarious. Some of the
commercial banking functions are being exclusively done by
RBI. As for e.g., RBI exclusively deals with foreign exchange,
of course it may specially permit branches of some other
commercial banks to deal with foreign exchange for or on its
behalf. Thus other commercial banks doing this particular job
at the instance of RBI do it as the agent of RBI.
Effecting on Credit
creating capacity of
Commercial Banks
(Sec.36(1) BRA
Sec.18(3) RBI Act)
Changes in the Prices
of Government securities
(Sec. 17(4A) of RBI Act)
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45
SUB- TOPICS
3.1 Currency authority
3.2 Legal tender
3.3 Rupee coin & small coins
3.4 Management of currency
3.5 Refund of notes
3.1 CURRENCY AUTHORITY
Reserve Bank is the sole authority under Section 22 of the RBI
Act, 1934 for the issue and management of currency in India.
Section 3(1) of the Act mentions that taking over of the
management of currency is one of the purposes of constituting
the Reserve Bank. Until the currency function was taken over
by the RBI,, it was under the Controller of Currency in the
Central Government. Although the Central Government issues
one rupee notes, coins and small coins, they are put into
circulation only through the Reserve Bank. To protect the
monopoly of the Reserve Bank for issue of bank notes, section
31(1) of the Act prohibits anybody other than the Reserve Bank
(and the Government of India when expressly authorised) from
issuing bills, hundies and notes payable to bearer on demand
except for drawing on a persons account with a banker, shroff
or agent. Sub-Section (2) of Section 31 further prohibits
specifically the making or issue of a bearer promissory note by
any other person.
Under Section 24 of the Act, the Reserve Bank may issue notes
of denominations varying from two rupees to ten thousand
rupees, as decided by the Central Government based on the
recommendations made by the Central Board of the Reserve
Bank. The design, form and material of these notes has to be
approved by the Central Government on the recommendation
of the Central Board. Further, printing, circulation or issue of
notes of certain denominations may be discontinued, if so
decided by the Central Government as per the recommendations
of RBIs Central Board.
3.2 LEGAL TENDER
Under Section 26 of the Act, every bank note shall be legal
tender at any place in India in payment or on account for the
amount expressed therein. This is guaranteed by the Central
Government. Sub-Section (2) of Section 26 provides that the
Central Government is empowered to notify on the
recommendation of the Central Board of the Bank, that any
series of bank notes of any denomination shall cease to be legal
tender as specified in the notification. Under this provision
certain high denomination notes were demonetised by the
Government in 1946 and also in 1978. This was done to check
unaccounted money, tax evasion and illicit transfer of money
for financing transactions harmful to the national economy.
Reserve Bank is exempted under Section 29 of the Act from
payment of stamp duty in respect of the bank notes issued by it.
The notes issued by the Reserve Bank are referred to as bank
notes in the Act to distinguish them from the notes issued by
the Central Government.
Initially at the time of taking over the management of currency,
the Reserve Bank issued the currency notes of the Central
Government until the bank notes were ready. Now those
currency notes of the Central Government are no longer legal
tender. (Reserve Bank of India, Functions and Working, (Fourth
Edn.) 1983, P.10.)
3.3 RUPEE COINS AND SMALL COINS
One rupee coins and other coins of lower value are issued by
the Central Government under the Indian Coinage Act, 1906.
The one rupee note is governed by the Currency Ordinance of
1940. One rupee notes are treated as rupee coins for all purposes
of the RBI Act. The Central Government is responsible for
minting and supplying these coins to the Bank. The Bank acts
only as an agent of the Central Government in the distribution
and issue of coins as also for with-drawing and remitting them
back to Government. Under Section 38 of the Act, the Central
Government is bound to put into circulation one rupee coins
through the Reserve Bank only. The Central Government has
to supply coins to the Bank on demand under Section 39 of the
Act for exchange with bank notes/currency notes. It is the duty
of the Bank to exchange for currency notes or bank notes of
two rupees or upwards, currency notes or bank notes of lower
value or other coins which are legal tender under the Indian
Coinage Act, 1906. If the Central Government fails to supply
such coins to the Reserve Bank on demand, the Bank is released
from the statutory obligation to supply them to the public.
3.4 MANAGEMENT OF CURRENCY
The matters relating to management of currency are handled
by the Department of Currency Management at the Central
Office in Bombay and the Issue Departments at the Regional
Offices of the Reserve Bank. Under Section 23 of the Act, the
Issue Department has to be separate and wholly distinct from
the Banking Department. However, in practice, such distinction
between the Issue Department and Banking Department has
little economic significance (RBI, 1983, p.14).
At the Regional Offices of the Reserve Bank, the Issue
Department provides facilities of exchange. The Banking
Department, through which the currencies are issued, draws on
the local Issue Department for its requirement of currency. The
currency requirements at other centres are met through currency
chests maintained by the Reserve Bank with banks and treasuries
which act as agents of the Reserve Bank. The currency chest is
a receptacle in which new and reissuable notes, as also rupee
3. ISSUE & MANAGEMENT OF CURRENCY
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coins are kept. Currency notes and coins withdrawn from
circulation are also deposited in the chest. The balances in the
chest are the property of the Reserve Bank.
The bank notes are fully covered by approved assets. The assets
of the Issue Department are mentioned in Section 33 and the
liabilities in Section 34 of the Act. The assets consisting of
gold coin, gold bullion, foreign securities, rupee coin and rupee
securities should not be less than the total of liabilities, namely
the total amount of currency notes/bank notes for the time being
in circulation. There is no limit or ceiling on the amount of
notes that can be issued at any time.
3.5 REFUND OF NOTES
Under Section 27 of the Act, Reserve Bank has a duty not to
reissue bank notes which are torn, defaced or excessively soiled.
This is to ensure the quality of the notes in circulation. Section
28 stipulates that no person shall have a right to recover from
the Central Government or the Reserve Bank, the value of any
lost, stolen, mutilated or imperfect currency note or bank note.
However, as a matter of grace, the value of such currency notes
or bank notes may be refunded in certain circumstances and
conditions. The conditions for refund are prescribed in the
Reserve Bank of India (Note Refund) Rules framed under the
proviso to Section 28. Refund is available from the Reserve
Bank and also from authorised branches of commercial banks.
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47
SUB-TOPICS
4.1 Bank of the Central Government
4.2 Business of State Government
4.3 Ways & means advances
4.4 Public debt
4.5 Adviser to Government
4.6 Agents of the bank
4.1 BANK OF THE CENTRAL GOVERNMENT
The Reserve Bank is the banker to the Central and State
Governments. Under Section 20 of the Act, it is obligatory for
the Reserve Bank to undertake the banking business of the
Central Government, namely acceptance of deposits, making
payments upto the amounts standing to the credit of its account
and also carrying out exchange, remittance and other banking
operations. The Bank also has to manage the public debt of the
Central Government. In turn the Central Government has a
duty to entrust the Reserve Bank with all its money, remittance,
exchange and banking transactions in India and deposit free of
interest all its cash balance with the Bank. As the Reserve Bank
has branches only in a limited number of places, it is open to
the Central Government to carry on money transactions and
hold requisite balances at places where the Reserve Bank or its
agents have no place of business. It is also obligatory for the
Central Government to entrust the management of its public
debt and issue of any new loans to the Reserve Bank. The
terms and conditions of transaction of Government business
including public debt as above are governed by agreement
between the Reserve Bank and the Government. In a case where
the Reserve Bank and the Government fail to reach an
agreement, the Government is empowered to decide the
conditions. Under sub-section (4) of section 20 any agreement
made under this section has to be laid before the Parliament.
4.2 BUSINESS OF STATE GOVERNMENT
The transaction of the business of State Government is not
obligatory unlike in the case of Central Government. However,
under Section 21A, by agreement with Government of any State,
Bank may undertake -
(a all its money, remittance and banking transactions in India
including in particular, the deposit, free of interest, of all
its cash balances with the Bank; and
(b) the management of the public debt and the issue of any
new loans by that State.
Such agreements are also required to be placed before the
Parliament.
4.3 WAYS AND MEANS ADVANCES
Section 17(5) of the Reserve Bank of India Act authorises the
Reserve Bank to make ways and means advances to the Central
and State Governments. Such advances are repayable not later
than 3 months from the date of making the advances. There
are temporary advances to meet the immediate needs when there
is interval between expenditure and the flow of receipt of
revenue. The rate of interest and amount that may be advanced
is regulated by agreements between the Central and State
Governments. State Governments often resort to taking
advances in excess of the limits prescribed by the agreement
with them, which take the form of overdraft. The Government
transactions are carried out all over the country with the Reserve
Bank, State Bank of India, other agency banks and treasuries
and the accounts are maintained at the Central Accounts Section
of the Reserve Bank at Nagpur.
The Reserve Bank closely monitors the utilisation of ways and
means advances by States and has the authority to suspend
payments on account of a State, the accounts of which shows
overdraft for more than a specified number of working days
(RBI, 1983, pp.27-31).
4.4 PUBLIC DEBT
The management of public debt concerns with the raising of
finance by the Government. Under the provisions of the Public
Debt Act, 1944, the management of public debt is with the
Reserve Bank. Sections 20, 21 and 21A of the Reserve Bank
of India Act also confer powers for the management of public
debt and issue of new loans for the Central and State
Governments. For raising public loans Government issues
securities in various forms, namely
i) stocks transferable by registration in the books of the
Reserve Bank.
ii) promissory notes payable to order and
iii) bearer bonds payable to bearer. Government may
also prescribe any other forms as provided in Section
2 of the Public Debt Act.
The public debt functions are carried out through the Public
Debt Office operating at the local branch offices of the Reserve
Bank. The long term objectives of public debt management is
to ensure adequate finance for the Government and avoid
recourse to short term borrowings from the Reserve Bank as
far as possible. Treasury bills are the main instruments of short
term borrowing by the Central Government. As an agent of the
Government, the Reserve Bank issues treasury bills at a discount
which can be rediscounted with the Bank at any time before
maturity. However, the Union Finance Minister has proposed
in the 1994-95 budget to phase out the Central governments
access to unlimited ad hoc treasury bills over a period of three
years by 1997-98. This has been done to bring in greater
financial discipline in the governments expenditure. The budget
deficit is to be limited to two-thirds of 1% of the GDP (Gross
Domestic Product), the deficit should be Rs. 6000 crores for
the financial year 1994-95. A cushion has been provided as the
government can borrow upto Rs 9,000 crs. for a maximum
4. BANKER TO THE GOVERNMENT
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period of 10 working days at any time during the year. If the
govt. fails to abide by this principle, the RBI will be free to sell
the Treasury bills in the open market so as to reduce the ad hoc
treasury bills in its custody. The government will then have to
find other ways of borrowing, from the market, domestic or
foreign. The Reserve Bank also advises the Central and State
Governments regarding the time, quantum and other aspects of
issue of new loans.
4.5 ADVISER TO GOVERNMENT
Apart from its relations with the Government as banker and
customer, and in the management of public debt, the Reserve
Bank also functions as an adviser to Government in banking
and financial matters. As the fiscal policies of the Government
have a major impact on the monetary and credit system which
the Bank regulates, coordination with the Government is
necessary.
4.6 AGENTS OF THE BANK
Reserve Banks function as banker to the Government is
discharged in the Public Accounts Departments of the local or
branch offices. At other places, government business is handled
by its agents. Under Section 45 of the Reserve Bank of India
Act, National Bank, State Bank of India and its associate banks
or nationalised banks may be appointed as agents for specified
purposes by the RBI.
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5. BANKERS BANK
SUB-TOPICS
5.1 Lender of last resort
5.2 Clearing Houses of Banks
5.1 LENDER OF LAST RESORT
Section 17 of the Reserve Bank of India Act specifies the several
kinds of business which the Bank may transact. Under sub-section
(1), Reserve Bank may accept deposits without interest from the
Central Government, State Governments, local authorities, banks
and any other persons and also undertake collection of money on
their behalf. Accordingly, it maintains apart from Government
accounts, the accounts of banks, financial institutions, foreign
central banks and international financial institutions. Thus, the
Reserve Bank is the banker of banks.
The Bank also makes loans and advances to banks when necessary,
under various provisions of the Reserve Bank of India Act. When
difficulties arise, Reserve Bank is a lender of last resort for banks.
The availability of credit from the Bank is dependent on the
prevailing credit policy. Section 17 authorises the Reserve Bank
to give financial accommodation to scheduled banks, State Co-
operative Banks and financial institutions. Rediscount facilities
are available under various provisions of section 17(2) of the Act
for financing commercial or trade transactions, agricultural
operations or marketing of crops, production or marketing
activities of cottage and small scale industries etc. For this purpose
the documents eligible for purchase or rediscount are bills of
exchange and promissory notes drawn on and payable in India
bearing two or more good signatures, one of which has to be that
of a scheduled bank, or state co-operative bank or a State Financial
Corporation as stipulated.
Loans and advances are also available under other provisions
of Section 17, namely 17(3A), 17(3B), 17(4)(a) to (d), to
scheduled banks and state co-operative banks against securities
for financing exports, commercial or trade transactions,
agricultural operations, marketing crops, etc. Further, loans
and advances in foreign currency for financing international
trade are available under Section 17(12B). In addition to the
provisions under Section 17 for transaction in normal times,
Section 18 gives emergency powers to purchase, sell or discount
bills of exchange or promissory notes which are not eligible
for purchase or discount under Section 17 and also to make
certain loans and advances to State Co-operative banks and co-
operative societies recommended by them or any other person.
5.2 CLEARING HOUSES OF BANKS
Apart from being the banker to banks as above, the Reserve
Bank also manages the clearing houses of banks at most centres
where it has offices or branches. Under Section 58(2)(p) of the
Act, Reserve Bank is empowered to frame regulations for
regulating the clearing houses for banks including Post Office
Savings Banks. However, no such rules have been framed so
far and the clearing houses continue to work under their own
rules which are adopted by consent of members. (See, RBI,
Uniform Regulations and Rules for Banks Clearing Houses).
The Managers of the local offices of Reserve Bank are the ex-
officio Presidents of the clearing houses. The Reserve Bank is
an ordinary member of the clearing houses like other banks for
clearance of cheques and other instruments. At other places
clearing houses are managed by the State Bank or its associate
banks.
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6. MONETARY CONTROL
SUB-TOPICS
6.1 Introduction
6.2 Bank rate
6.3 Open market operations
6.4 Cash reserve
6.5 Statutory Liquidity Ratio
6.6 Interest rate
6.7 Selective Credit Control
6.8 Regulation of non-banking institution
6.9 Directions
6.10 Un-incorporated bodies.
6.1 INTRODUCTION
Monetary Control is the main function of the Reserve Bank, as
it is the Central Bank of the country. Formulating and
administering monetary policy involves using of instruments
within its control to influence the level of aggregate demand
for goods and services by regulation of the total money supply
and credit. The Reserve Bank exercises monetary regulation
by influencing the availability and cost of credit by exercising
different types of controls. General or quantitative controls are
the instruments of Bank rate, reserve requirements and open
market operations. These methods affect the total money supply.
The other types of controls called selective credit control
envisage the increase or decrease of margins upto which the
commercial banks can finance sensitive commodities like
foodgrains, edible oils, cotton, pulses,etc. It exercises control
over the direction of credit, namely the flow of credit to a
particular commodity or sector of the economy. Control over
interest rates on acceptance of deposits by non-banking
institution also forms a part of monetary control.
6.2 BANK RATE
Bank rate is defined in Section 49 of the RBI Act as the standard
rate at which the Bank is prepared to buy or re-discount bills of
exchange or other commercial paper eligible for purchase under
the Act. In India Bank Rate has been changed frequently to
effect change in the cost of funds available from Central Bank
to banks and financial institutions. In actual practice, due to
the absence of a genuine bill market, the rate on advance by
Reserve Bank has become important and that rate has been
commonly treated as the equivalent of Bank rate.
The effectiveness of bank rate as an instrument of monetary
control depends on the extent of operation in the money market
and also on how far the commercial banks resort to borrowing
from Reserve Bank. Money market is the centre for dealings
in monetary assets of short term nature. In Indian conditions,
raising or lowering of the bank rate is of little operative
significance as there is no well developed bill market. However,
it is an important indicator of changes in the direction of the
credit policy of the Reserve Bank as it is usually offered along
with the other control measures of the RBI as a package.
6.3 OPEN MARKET OPERATIONS
Section 17(8)of the Reserve Bank of India Act authorises the
Reserve Bank to engage in the purchase and sale of securities
of any maturity of the Central Government and the State
Governments. Securities of local authorities like the State
Electricity Boards, Water Supply and Sewerage Boards,
Housing Boards, etc may also be purchased as specified by the
Central Government on the recommendation of the Central
Board of the Reserve Bank. A security which is fully guaranteed
by the Government or the authority concerned as to the principal
and interest is deemed to be a security of such Government or
authority. Reserve Bank is also authorised to purchase and sell
commercial bills of short-term maturity under Section 17(2) of
the Act.
Open market operations are used by a Central Bank to alter the
liquidity position of banks by dealing directly in the market
instead of indirectly influencing it by variation of cost of credit.
Reserve Bank can influence the resources or cash base of
commercial banks by purchase and sale of Government
securities in the open market. Open market operations can be
carried out by purchase and sale of a variety of assets such as
Government securities, commercial bills of exchange, foreign
exchange, gold and even company shares. In actual practice
they are confined to the buying and selling of Government
securities (RBI, 1983, p80). When securities are purchased from
the open market, the reserves of the banks with the Reserve
Bank increases and they can acordingly expand credit. Similarly
selling of Government securities has the effect of contraction
of credit and reduction in supply of money. The market for
Government securities being very narrow, namely public debt
being held by a few institutions and their operations being
limited, the potency of this instrument of monetary control is
reduced to that extent. Now these operations are used more to
assist Government in its borrowing than as an instrument to
influence the cost of credit. (Tannan, 1987 p 56).
6.4 CASH RESERVE
Section 42 of the Reserve Bank of India Act and Section 18 of
the Banking Regulation Act deal with cash reserves to be kept
with the Reserve Bank by scheduled banks and non-scheduled
banks respectively. Scheduled bank, as defined in Section
2(e) of the Reserve Bank of India Act means a bank included in
the second schedule of the Act.
Under Sub-section (6) of Section 42, a bank operating in India
may be included in the Second Schedule by the Reserve Bank
on the following conditions :
(i) The aggregate value of paid-up capital and reserves
is not less than Rs. 5 lakhs;
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(ii) Satisfies the Reserve Bank that its affairs are not being
conducted in a manner detrimental to the interests of
its depositors; and
(iii) Is a State Co-operative Bank or a company or an
institution notified by the Central Government in this
behalf or a company, corporation incorporated under
any law in force in any place outside India.
The Bank is also empowered to direct exclusion of any
scheduled bank from the Second Schedule if its paid up capital
and reserve fall below the stipulated minimum, or its affairs
are conducted in a manner detrimental to the interests of
depositors (as found by the Bank after making an inspection of
the Bank under Section 35 of the Banking Regulation Act) or it
goes into liquidation or otherwise ceases to carry on banking
business. The Bank may defer the making of such direction on
an application from the scheduled bank concerned and give
time, subject to suitable conditions, to increase capital and
reserve or to remove the defects in the conduct of its affairs.
Scheduled banks have to maintain under sub-section (1) of
Section 42, an average daily balance of not less than 3% of the
total demand and time liabilities in India of such banks. Further,
the Reserve Bank is empowered to increase the rate of cash
reserve by notification in the official Gazette upto 20% of the
total demand and time liabilities. Liabilities for this purpose
is defined in clause (c) of the explanation to Section 42(1).
The paid up capital, reserves and any credit balance in the profit
and loss account of the bank as also any loan from the RBI, the
Industrial Development Bank of India, Exim Bank and certain
other financial institutions is specially excluded from Liability.
Similarly in the case of State Co-operative Banks certain
liabilities like loans from State Government and in the case of
Regional Rural Banks, loans from Sponsor Banks are excluded.
Further, under sub-section (1C), the Bank may specify from
time to time whether any transaction or transactions shall be
regarded as liability of a scheduled bank for the purpose of
cash reserve or not and in case of any doubt, the decision of the
Bank shall be final.
Sub-Section (1A) of Section 42 empowers the Bank to direct
scheduled banks to maintain a specified additional average daily
balance from any specified date. Such additional balance is
calculated with reference to the excess of the total of the demand
and time liabilities of a bank as shown in its return under sub-
section (2) Section 42 over the total of the demand and time
liabilities at the close of business over the date specified in the
notification. The additional balance should not be more than
such excess and the total cash reserve should not in any case
exceed twenty percent of the banks total demand and time
liabilities.
Where any scheduled bank maintains additional balance as
required under sub-section (1) or (1A), interest is payable at
the rates determined by the Bank. However, no interest is
payable in respect of any balance in excess of the requirement.
Every scheduled bank has to send to the Reserve Bank a return
under Section 42(2) showing the amount of its demand and
time liabilities and the amount of its borrowings from banks in
India classifying them as demand and time liabilities and other
details of its holdings, advances and investments, at the close
of business on each alternate Friday. Such returns have to be
sent not later than seven days after the date to which it relates.
Scheduled banks have also to submit another return as at the
close of business on the last Friday of every month (where it is
not an alternate Friday) under sub-section (2) giving the details
as required in fortnightly returns. However, in practice, it is
found that these returns are not properly compiled and submitted
in time on account of the very large network of branches.
In cases where the cash reserve falls short of the requirement
under sub-section (1) and (1A), such scheduled banks are not
entitled to interest on the reserve maintained and are also liable
to pay panel interest on the short fall initially at the rate of 3%
above Bank rate and thereafter at the rate of 5% above Bank
rate. Continued default will make every director, manager or
secretary of the scheduled bank who is knowingly and willingly
a party to the default punishable with fine. Further, the Bank is
also empowered to prohibit the scheduled bank from receiving
fresh deposits if the default persists. Default in complying with
such prohibition is also punishable with fine. Sub-section (4)
provides for penalty for failure to comply with the provisions
of sub-section (2) regarding returns. Sub-section (5) provides
for realisation of penalties imposed by issuing demand notice
to the scheduled bank. If the amount is not paid within 14
days, Reserve Bank may apply to the principal Civil Court for
a direction to levy the fine. The Court making such direction
shall issue a certificate specifying the sum payable which is
enforceable like a decree in a suit. If the Bank is satisfied that
the defaulting bank had sufficient cause for the default it may
not demand payment of penal interest or penalty.
The requirement of cash reserve under Section 18 of Banking
Regulation Act for non-scheduled banks is also at least 3% of
the total demand and time liabilities in India. Such cash reserve
may be maintained with the bank itself or by way of balance in
a current account with the Reserve Bank or by way of net
balance in current accounts (with State Bank, its subsidiaries
or nationalised banks) or in one or more of the aforesaid ways.
The bank has to submit a return to the Reserve Bank before
20th of every month; a return showing the amount so held on
alternate Fridays during a month with particulars of its demand
and time liabilities in India on such Fridays.
6.5 STATUTORY LIQUIDITY RATIO (SLR)
Banks are required under Section 24(1) of the Banking
Regulation Act, 1949 to maintain in India liquid assets in cash,
gold or unencumbered approved securities amounting to 20%
of its total demand and time liabilities. Approved security, as
defined in Section 5(a) of the Act means securities in which a
trustee may invest money under Clauses (a), (b), (bb), (c) or (d)
of Section 20 of the Indian Trusts Act, 1882 and certain other
securities authorised by the Central Government.
Unencumbered approved securities include approved
securities lodged with another institution for an advance or any
other credit arrangement to the extent to which such securities
have not been drawn against.
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This provision enabled banks to liquidate their Government
security holdings, to offset the impact of variable cash reserve
requirements. Hence, sub-section (2A) to section 24 was
introduced in 1962 to require all banks to maintain a minimum
amount of liquid assets of not less than 25% of their demand
and time liabilities in India, excluding the cash balances to be
maintained under Section 42 of the Reserve Bank of India Act
in the case of scheduled banks and that under Section 18 of the
Banking Regulation Act in the case of non-scheduled banks.
The Reserve Bank is empowered to increase it up to 40 per
cent. The balances maintained by scheduled banks on their
own in excess of the requirement of cash reserve ratio under
Section 42 of the Reserve Bank of India Act or any balances in
current account with State Bank or any notified bank are counted
for the purpose of statutory liquidity ratio. Deposits of foreign
banks with Reserve Bank under Section 11(2) of the Banking
Regulation Act and any cash balances of non-scheduled banks
with themselves or in current account with Reserve Bank, State
Bank or any notified bank in excess of the requirements under
Section 18 of the Banking Regulation Act and any balances
maintained by a Regional Rural Bank with its sponsor bank are
also counted as liquid assets. The percentage of liquid assets
maintainable by a Regional Rural Bank may be varied by the
Reserve Bank by notification.
Banks have to submit a monthly return to the Reserve Bank
under sub-section (3) of Section 24 for ensuring compliance
with the requirements of liquidity ratio. Sub-section (4) provides
for payment of panel interest by defaulting banks, which is 3
per cent above Bank rate initially and liable to be increased to
5% above Bank rate for continued default. When Reserve Bank
is satisfied that the defaulting bank had sufficient cause for its
default, penal interest may be waived. The penalty is payable
within 14 days of demand by notice failing which the Reserve
Bank may obtain a direction and a certificate from the principal
Civil Court which may be enforced in the manner of a decree
from a civil court. In case of default even after increased penal
interest becomes payable, Section 24(7) provides for
punishment with fine.
6.6 INTEREST RATE
Reserve Bank exercises direct control over the lending rates of
banks by influencing cost of bank credit by increase or decrease
in the lending rates rather than the Bank rate. The relevant
statutory provisions are sections 21 and 35A of the Banking
Regulation Act. Under Section 21, Reserve Bank is empowered
to issue direction to banks in public interest or in the interests
of depositors or banking policy. Such direction may, among
other things, stipulate the rate of interest and other terms and
conditions on which advances may be made. Further, Section
35A authorises the Reserve Bank to issue directions to banks
when it is satisfied that it is necessary to do so, in the public
interest, in the interest of banking policy, to prevent the affairs
of the banks being conducted in a manner detrimental to the
interest of the depositors and also to secure proper management
of the banks. Under these provisions namely Section 21 and
35A, Reserve Bank has issued direction regarding interest rates
on both deposits and advances of banks. Section 21A of the
Banking Regulation Act stipulates that notwithstanding the
Usurious Loans Act, or any other law for the time being in
force in any State relating to indebtedness the transaction
between a bank and its debtor shall not be reopened by any
court on the ground that the rate of interest charged by such
bank is excessive. The Reserve Bank can accordingly fix the
lending rate or the maximum or minimum lending rates.
However, this has no bearing on the courts jurisdiction to give
relief to an aggrieved party when it is established that a bank
has charged interest in excess of limit prescribed by the Reserve
Bank. (H.P. Krishna Reddy v. Canara Bank, AIR 1985 Kant
285; see also Bank of India v. Karnam Renga Rao AIR 1986
Kant 246 regarding compounding of interest on agricultural
loans and Jameela Beevi v. SBT, (1992) 74 Comp. Cas 736
regarding Reserve Banks power to regulate interest rate.)
6.7 SELECTIVE CREDIT CONTROL
Selective Credit Control refers to regulation of distribution
or direction of bank resources to certain sectors of the economy.
This is done in terms of the broad national policies for achieving
developmental goals. Selective Credit Control is used by the
Reserve Bank along with general credit control. The provision
of Sections 21 and 35A of the Banking Regulations Act
empower the Reserve Bank here also. The wide powers
conferred under these provisions enable the Reserve Bank to
determine the policy in relation to advances to be followed by
banks. The directions may, apart from rate of interest, deal
with the following aspects of advances:
(i) The purpose of advances, for example, to prevent hoarding
of sensitive commodities like foodgrains, pulses, edible oils,
etc;.
(ii) Margins to be maintained in case of secured advances and
(iii) Maximum amount of advances or other financial
accommodation to a single borrower.
Such direction may be given to banks generally or to a
specific bank.
Selective credit control is exercised by Reserve Bank by
stipulating (i) minimum margins for lending against selected
commodities (ii) ceilings on the levels of credit and (iii) rates
of interest on stipulated commodities. The first two control the
quantum of credit and the last, the cost of credit. By judicious
use of these instruments, it is possible to regulate the availability
of credit to different sectors of the economy.
6.8 REGULATION OF NON-BANKING
INSTITUTIONS
The fast growth of non-banking institutions in the country and
their accepting deposits from the public at very high rates of
interest raised the question of regulating their activities. As
credit from the banking sector was under the control of the
Reserve Bank, the non-banking institutions had a ready market
and many unhealthy practices developed in course of time.
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Hence control over the acceptance of deposits by non-banking
institutions was conceived as an adjunct to monetary and credit
policy and also with a view to protecting the interests of
depositors. Chapter III-B of the Reserve bank of India Act was
introduced in 1964 by an amendment of the Act conferring
powers on the Reserve Bank to regulate the acceptance of
deposits by non-banking institutions. Chapter III-C of the Act
which was introduced in 1984 seeks to regulate the acceptance
of deposits by unincorporated bodies. The Prize Chits and
Money Circulation Schemes (Banning) Act, 1978 and the Chit
Funds Act, 1982, were enacted pursuant to the recommendations
of a study group appointed by the Reserve Bank in 1974 to
examine the then existing statutory provisions and the directions
thereunder to suggest further regulatory measures. This statute
on prize chits and money circulation schemes is administered
by the States and Union territories but the rules are required to
be framed in consultation with the Reserve Bank. Further, the
Bank has an advisory role for the winding up of the existing
prize chits and money circulation schemes and generally on
the implementation of the Act. The Chit Funds Act is also
administered by the State Governments and the Reserve Bank
has only advisory role in the framing of rules, giving exemption
from the provisions of the Act and generally on question of
policy.
Sections 45J, 45K and 45L of the Act empower the Reserve
Bank to regulate acceptance of deposits by non-banking
institutions. Deposit as defined in Section 45I(bb) includes
any receipt of money by way of deposit or loan or any other
form except those specifically excluded. The excluded
categories are :-
i) amounts raised by way of share capital.
ii) share capital brought in by partners.
iii amounts received from banks and financial institutions.
iv) amounts received in ordinary course of business by way of
security deposit, dealership deposit,earnest money and
advance for orders of goods and services;and
v) subscriptions to chits.
Non-banking institution as defined in Section 45I(e) means a
company, corporation or co-operative society. Financial
institution as defined in Clause (c) of Section 45-I means any
non-banking institution which carries on the types of business
specified therein.
Section 45J, provides for the Reserve Bank to regulate or
prohibit in public interest issue of prospectus or advertisement
soliciting deposits from the public. Section 45K provides for
collection of information from non-banking institution regarding
deposits and also for issuing directions on matters relating to
receipt of deposits including rates of interest and period of the
deposit. On failure to comply with such directions, acceptance
of deposits may be prohibited.
Under 45L, Reserve Bank may call for information from
financial institutions and give direction relating to the conduct
of the business of financial institutions. Non-banking
institutions have a duty to furnish statements, information and
particulars as called for by the Reserve Bank. There is also
provision under Section 45N for inspection of non-banking
institutions by the Reserve Bank. Further soliciting of deposits
on behalf of a non-banking institution by unauthorised persons
is prohibited. According to Section 45Q, Chapter III B shall
over ride the provisions of other laws. With the amendment to
Companies Act, 1956 introducing Section 58A (See also,
Companies acceptance of Deposit Rules, 1975. For a detailed
discussion, see, Ramaiya, (1988, pp 231-47), regarding
prohibition of prize chits, See AIR 1981 SC 504) the Central
Government is empowered to exercise control over acceptance
of deposits by non-banking non-financial companies and over
advertisements for acceptance of deposits by all clauses of
companies.
6.9 DIRECTIONS
Under the authority of Section 45J, 45K and 45L, the Reserve
Bank has issued the Non-Banking Financial Companies
(Reserve Bank Directions 1977, the Miscellaneous Non-
Banking Companies (Reserve Bank) Directions, 1977 and the
Residuary Non-Banking Companies ( Reserve Bank)
Directions, 1987. These directions are applicable to financial
companies or other non-banking companies as specified in the
directions. These directions impose several restrictions on rate
of interest, period of deposit, maintenance of assets etc. which
are modified from time to time. (See Peerless General Finance
& Investment Company Ltd. v. RBI AIR 1992 SC 1033).
6.10 UNINCORPORATED BODIES
Chapter III C of the Reserve Bank of India Act prohibits
acceptance of deposits by individuals, firms or unincorporated
bodies from more than the number of depositors specified
therein. (See, (1993) 77 Comp. Cas (Part II) p.197).
Accordingly an individual may not accept deposits from more
than 25 persons excluding relatives of the individual. In the
case of firms the ceiling is twentyfive depositors per partner
and two hundred and fifty depositors in all excluding relatives
of partners. In the case of unincorporated associations also the
limit is twenty five depositors per individual and two hundred
and fifty depositors in total excluding relatives of the individuals
forming the association. Relatives for this purpose are defined
in the Explanation to Section 45 S(2). However, any period
not exceeding 6 months in any account relating to mutual
dealings in the ordinary course of trade or business shall not be
deemed to be a depositor on account of such balance.
Under Section 45 T an authorised officer of the Bank or of the
State Government may obtain a warrant from the court for search
of any place where documents regarding acceptance of deposits
in contravention of the provisions of Section 45 S are believed
to be kept. The Bank has no powers to regulate interest rate or
impose other conditions regarding acceptance of deposits by
unincorporated bodies. However, acceptance of deposits from
more depositors than specified being in contravention of the
provisions of the Act, the Bank can initiate prosecution under
Section 58 B read with Section 58 E of the Act.
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SUB-TOPICS
7.1 Introduction
7.2 Restrictions on dealings in Foreign Exchange
7.3 Authorised dealers & Money changers
7.4 Blocked Accounts
7.5 Import & Export of currency
7.6 Payment for exported goods
7.7 Export & Transfer of Securities
7.8 Appointment of agents
7.9 Establishment of place of business
7.10 Employment of Foreign nationals
7.11 Information & Returns
7.12 Inspection
7.13 Issue of directions
7.14 Rupee Convertibility
7.1 INTRODUCTION
Regulation and conservation of foreign exchange is a major
function of the Reserve Bank under the Foreign Exchange
Regulation Act (FERA), 1973. As observed by the Supreme
Court in Life Insurance Corporation of India vs. Escorts
Ltd., (AIR 1986 SC 1370), it is the custodian general of
foreign exchange.
According to the Preamble, the Act provides for regulation of
certain payments, dealings in foreign exchange and securities,
transactions indirectly affecting foreign exchange and the import
and export of bullion and currency, for the conservation of
foreign exchange resources of the country and the proper
utilisation thereof in the interests of the economic development
of the country. Regulation of foreign exchange was introduced
in India under the Defence of India Rules, 1939 which was
replaced by the Foreign Exchange Regulation Act, 1947 and
later by the Foreign Exchange Regulation Act, 1973 which is
currently in force.
Although the Reserve Bank is the main agency for
administration of FERA, the task of enforcement is left to the
Directorate of Enforcement constituted under Section 3 of the
Act. The Central Government is vested with several powers
under the Act including the power to give general or special
direction to the Reserve Bank under Section 73. The Bank is
obliged to comply with such direction in the discharge of its
functions under the Act. The Act imposes certain restrictions
on dealings in foreign exchange, import and export of currency
and payment for exported goods. Holding of immovable
property outside India by residents of India and in India by non
residents, appointment of non-residents as agents and
establishment of place of business in India by non-residents
are some of the other major areas of control.
7.2 RESTRICTIONS ON DEALINGS IN FOREIGN
EXCHANGE
Under Section 8 of the Act, the previous general or special
permission of the Reserve Bank is necessary for any person,
other than an authorised dealer in India to purchase or otherwise
acquire, borrow, sell, lend, exchange or otherwise transfer any
foreign exchange with any person not being an authorised dealer.
Foreign exchange as defined in Section 2(h) means foreign
currency and includes all deposits, credits and balances payable
in any foreign currency and any drafts, travellers cheques, letters
of credit and bills of exchange, expressed or drawn in Indian
currency but payable in any foreign country. However, letters
of credit can be drawn in foreign currency too. It also includes
any instrument payable, at the option of its drawee or holder or
any other party thereto, either in Indian currency or in foreign
currency or partly in one and partly in the other. These
restrictions apply also to persons resident in India, as defined
in Clause (p) of Section 2 of the Act, other than authorised
dealers in respect of their dealings outside India. This does
not, however, apply to the purchase or sale of foreign currency
in India between any person and a money changer. Conversion
of foreign currency into Indian currency or vice versa, has to
be done at the rates of exchange for the time being determined
and authorised by the Reserve Bank. For conversion at other
rate, previous general or special permission of the Reserve Bank
is necessary. This applies to authorised dealers and money
changers as well.
Section 9(1)(a) prohibits any person in or resident in India from
making any payment to or to the credit of any person resident
outside India except with the general or special exemption of
the Reserve Bank. (Release of foreign exchange under Sections
8 and 9 should not be discriminatory See, Pranab K. Ray v.
RBI (AIR 1993 Cal.50). Such exemption may be granted with
or without conditions. Similar prohibition also extends to
making and receipt of payments of various types mentioned in
Clauses (b) to (g) of Section 9(1). Under Sub-section (3) of
Section 9, remittance of any amount from any foreign country
into India should be through an authorised dealer unless general
or special exemption is granted by the Reserve Bank, with or
without conditions.
7.3 AUTHORISED DEALERS AND MONEY
CHANGERS
Under Section 6 of the Act, Reserve Bank is empowered to
authorise any person to deal in foreign exchange. Persons so
authorised are called authorised dealers as defined in Section
2(b). Such authorisation may be granted subject to conditions
and may be for, (i) dealings in all foreign currencies or restricted
to specified foreign currencies; (ii) transactions of all
descriptions in foreign currencies or restricted to specified
transactions; (iii) a specified period or within specified periods.
Authorised dealers are generally scheduled banks. However,
7. CUSTODIAN OF FOREIGN EXCHANGE
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Reserve Bank has given restricted licence to Industrial
Development Bank of India and Exim Bank to undertake certain
specified functions. [Exchange Control Manual, 3rd Edn., 1987
Vol. I para 1.4 (Note)]. The Reserve Bank may revoke the
authorisation or licence of any authorised dealer (i) in public
interest or (ii) for non-compliance of the conditions stipulated
or for violation of the provisions of the Act or of any rule,
notification, direction or order made thereunder. Before
revoking an authorisation, except when it is in the public interest
to do so, the authorised dealer has to be given a reasonable
opportunity for making a representation in the matter.
An authorised dealer has to function within the terms of his
authorisation and has to comply with any general or special
directions or instructions as may be given by Reserve Bank
from time to time.
Section 7 of the Act empowers the Reserve Bank to authorise
any person to deal in foreign currency. Persons so authorised
are called money changers. The authorisation given to money
changers may be (i) for all foreign currencies or in respect of
specified foreign currencies, (ii) for all transactions in foreign
currencies or for specified transactions and also may be, (iii)
for operating at a specified place and for a specified time or
within specified amounts. Money changer licences have been
given to certain established firms, hotels and other organisations.
There are full fledged money changers who buy and sell
foreign currency and restricted money changers who only buy
foreign currency and surrender it to authorised dealers. It is
open to the Reserve Bank to impose any conditions while
granting licence to money changers. The Bank is also
empowered to give direction to money changers as also to
revoke the authorisation given to money changers, as in the
case of authorised dealers under Section 6.
7.4 BLOCKED ACCOUNTS
Section 10 of the Act deals with blocked accounts. (Regarding
ordinary Non-resident Accounts, Non-Resident External
Accounts, Foreign Currency Non-Resident Accounts (FCNR),
(Exchange Control Manual, 3rd Edn., 1987 Vol I Chapters 28
& 29). A blocked account is an account opened as a blocked
account at any office or branch of a a bank in India authorised
by the Reserve Bank in this behalf or an account blocked by an
order of the Reserve Bank. While granting exemption to any
person under Section 9 in respect of payment of any sum to a
non-resident, Reserve Bank may stipulate a condition that the
payment be made to a blocked account. In such cases, the
payment shall be made to a blocked account in the name of that
person in the manner as directed by the Reserve Bank by a
special or general order. The crediting of a blocked account as
directed by the Reserve Bank would give a valid discharge to
the person making the payment to the extent of the sum credited.
Withdrawal of any amount from such blocked account is
permissible only with the general or special permission of the
Reserve Bank.
7.5 IMPORT AND EXPORT OF CURRENCY
Import or export of foreign exchange or Indian currency to or
from India is also subject to restrictions imposed under Section
13. General or special permission of the Reserve Bank is
necessary to take or send out of India any Indian currency or
foreign exchange other than foreign exchange obtained from
an authorised dealer or a money changer.
Acquisition of Foreign Exchange
Section 14 authorises the Central Government to order by a
notification in the official Gazette, every person in or resident
in India to sell foreign exchange to the Reserve Bank or to
persons authorised by the Reserve Bank for this purpose. The
sale should be at a price not less than the rate of exchange for
the time being authorised by the Reserve Bank. Such order
may also be made to persons entitled to assign any right to
receive foreign exchange. However, this does not apply to
foreign exchange acquired from an authorised dealer or money
changer and retained with the permission of the Reserve Bank
for any purpose.
Duty of Persons Entitled to Receive Foreign Exchange
Under Section 16(1) of the Act, general or special permission
of the Reserve Bank is necessary for any person having a right
to receive foreign exchange or a rupee-payment from a non-
resident, to do or refrain from doing anything which has the
effect of delaying such payment or ceasing such payment in
whole or part. If any person fails to comply with this provision,
the Reserve Bank is empowered to give suitable directions for
ensuring the receipt of the foreign exchange or payment.
7.6 PAYMENT FOR EXPORTED GOODS
Section 18(1) empowers the Central Government to stipulate
that before exporting any goods from India, the exporter
furnishes to the prescribed authority a declaration in the
prescribed form.(See Govt. Notification dated 1-1-1974 as
amended from time to time, GR, PP and VP/COD Forms
prescribed. Declaration value on some conditions. Ref.
Exchange Control Manual, 3rd Edn. 1987, Vol.I, Chapter II).
The authority prescribed under the Foreign Exchange
Regulation Rules, 1974 is the local Collector of Customs or, in
the case of export through post, the local postal authorities.
Such declaration shall mention the full export value of the goods
or the expected export value thereof and affirm that the full
export value of the goods, has been or will, within the prescribed
period, be paid in the prescribed manner. Such notification
may be in respect of all goods or any goods or any class of
goods as specified therein. It is also open to the Central
Government to direct that in respect of any goods specified,
the exporter shall not sell the goods at a value lesser than the
expected export value already declared, except with the
permission of the Reserve Bank. An application for such
permission shall not be refused without giving a reasonable
opportunity to the exporter for making a representation in the
matter. Rejection of such applications have to be communicated
to the exporter within 20 days of receipt thereof failing which
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permission from the Reserve Bank shall be presumed. The
period taken by Reserve Bank for giving opportunity to the
exporter to be heard shall not be counted for this purpose.
Permission of the Reserve Bank is also necessary under Section
18(2) for :
(i) payment of goods other than in the prescribed manner;
(ii) delayed payment beyond the prescribed period or
(iii) where proceeds of sale of the goods exported do not
represent full export value of goods subject to any
deduction permitted by the Reserve Bank.
The Reserve Bank may give suitable direction under sub-section
(4) to exporters who fail to realise payments within the
prescribed period, for securing payment (where goods are
already sold) or for sale of goods and payment therefore or
reimport of goods to India as circumstances permit. The time
limit for the purpose may also be specified. Such direction
may also require that the goods, the right to receive the payment
therefore or any other right to enforce payment be transferred
or assigned to the Central Government or a person specified in
the directions.
Where the value of the goods as specified in the declaration
under sub-section (1) is less than the full export value or the
expected export value in the opinion of the Reserve Bank, the
Reserve Bank may intervene under sub-section (6). Thus the
person holding the shipping documents may be ordered to retain
the possession thereof until the exporter has arranged for the
Reserve Bank or its nominee to receive on behalf of the exporter,
the full export value of the goods in the prescribed manner.
Further, the exporter may be required under sub-section (7) to
exhibit the contract with the foreign buyers or any other evidence
to show that the full export value or the expected export value
of the goods has been or will be paid within the prescribed
period and in the prescribed manner.
Section 18(9) empowers the Reserve Bank to issue general or
special orders from time to time for ensuring that the full export
value of goods are received without delay. Such orders may be
in respect of exports of goods to any destination, any class of
export transactions, any class of goods or exporters. These
orders may provide that the exporter shall, prior to export,
comply with certain conditions. Such conditions may be
regarding -
i) registration of contract as specified in the order;
ii) payment to be covered by letter of credit/firm orders
or other document;
iii) certification of the export value declared by a
specified authority;
iv) prior approval of the declaration under sub-section
(1) by the Reserve Bank.
The prior approval as above may be given or withheld or may
be given subject to any condition. However, before withholding
any approval, the exporter has to be given an opportunity to
make a representation in the matter.
The general or special permission of the Bank is required under
Section 18A to take any goods from India to any place on lease,
hire or other arrangement other than sale, the provisions of
Section 18 apply to such cases also in terms of sub-section (2)
of Section 18A.
7.7 EXPORT AND TRANSFER OF SECURITIES
General or special permission of the Reserve Bank is necessary
under Section 19 for the following transactions :
(i) Taking or sending any security to any place outside
India;
(ii) Transfer of any security or creation or transfer of any
interest in a security to or in favour of any non-
resident;
(iii) Issuing in India or outside, any security which is
registered or to be registered in India to a non-resident;
(iv) Acquiring, holding or disposing of any foreign
security.
When the holder of a security is the nominee of a non-resident,
general or special permission of the Reserve Bank is necessary
before he recognises or gives effect to the substitution of another
person as the person from whom he directly receives
instructions. For enforcing this provision, Reserve Bank may
require all transferors and transferees of securities to declare
that the transferee is not a non-resident.
The mere offer of shares to a person by itself does not create
any interest in the shares in favour of the person to whom the
offer is made. Although such offer as observed by the Supreme
Court, (AIR 1981 SC 1298 at 1348) creates fresh rights, such
right is either to accept the offer or to renounce it and it does
not create any interest in the shares in respect of which the
offer is made. Permission of the Reserve Bank is necessary
under sub-section (4) for registering transfer of securities where
the transfer is suspected to involve contravention of Section
19. Further, recording an address outside India in respect of
issue or transfer of security also requires such permission.
Exemption is given for substitution of address in certain cases.
This provision is binding on any registering authority
notwithstanding any other law.
Transfer of any share, bond or debenture of a company registered
in India made by a non-resident or foreign national to a resident
shall be valid only if such transfer is confirmed by the Reserve
Bank on the application of transferor or transferee. It is open
to the Reserve Bank to exempt any transfer or class of transfers
from the operation of this provision in public interest by giving
general or special permission. Any suitable conditions may be
stipulated in this behalf.
Bearer Securities
Section 22 of the Act restricts the issue of bearer securities.
Any person in India and any resident outside India requires the
permission of the Reserve Bank to create or issue any bearer
certificate or coupon or alter any document to become a bearer
certificate or coupon.
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Gifts and Settlements
Settlement or gift of any property to a non-resident (at the time
of such settlement) without the general or special permission
of the Reserve Bank is prohibited under Section 24. However,
settlement or gift without such permission is not invalid. Further,
it is open to the Reserve Bank to exclude any territories from
the operation of this section by notification.
Holding of Immovable Property outside India
Persons resident in India are prohibited under Section 25 from
acquiring, holding or disposing of (by sale, mortgage, lease,
gift, settlement or otherwise) any immovable property situated
outside India except with the general or special permission of
the Reserve Bank. This provision does not apply to (i) a lease
for a period of upto five years and (ii) nationals of foreign states.
General or special permission of the Reserve Bank is necessary
under Section 26 for a resident to give guarantee in respect of
any debt or other obligation or liability of a resident which is
due or owing to a non-resident or the debt, obligation or liability
of a non-resident.
7.8 APPOINTMENT OF AGENTS
Under Section 28, the following persons require the general or
special permission of the Reserve Bank to act or accept
appointment as agent in India of any person or company in the
trading or commercial transactions of such person or company.
(i) Non-resident (whether citizen of India or not);
(ii) Person who is not a citizen of India but is resident in
India;
(iii) Company which is not incorporated under the Indian
Laws or any branch thereof.
Acting or appointment as agent without such permission is void.
Agent includes any person or company (including its branch)
who or which buys any goods with a view to selling such goods
before any processing thereof. A banking company is excluded
from the operation of this Section. (Banking Companies being
subject to restrictions under B.R. Act).
The Reserve Bank may conduct an inquiry before deciding on
an application for permission under Section 28. It is also open
to the Bank to allow the application imposing any conditions
or to reject it. However, before rejecting any application the
affected party should be allowed to make a representation.
On rejection of an application for permission, acting or
appointment as such agent is void after ninety days of receipt
of the order or such other later date specified in the order.
7.9 ESTABLISHMENT OF PLACE OF BUSINESS
Non residents and other persons referred to in Section 28 require
the general or special permission of the Reserve Bank under
Section 29(1) for various transactions as under :
(i) To establish or carry on in India a place of business
for carrying on trading, commercial or industrial
activity;
(ii) Acquiring the whole or any part of any undertaking
in India of any person or a company carrying on trade,
commerce or industry, or purchasing the shares of
such company in India.
Further, under Sub-section (1A) of Section 29, a company other
than a banking company, in which non-resident interest is more
than 40% requires the general or special permission of the
Reserve Bank to carry on any activity relating to agriculture or
plantation in India. This restriction extends to acquisition by
such company of the whole or any part of any undertaking in
India of any person or company carrying on any activity relating
to agriculture or plantation or purchasing the shares in such
company.
In Life Insurance Corporation vs. Escorts,(AIR 1986 SC
1370) the Supreme Court held that permission under Section
29(1) need not be previous permission in the context of purchase
of shares of an Indian Company by non-resident companies.
The court clarified that ex-post facto permission can also be
granted. However, Reserve Bank is not bound to give ex-post
facto permission when it is found that business has been started
or shares have been purchased without its previous permission.
Where oblique motives are suspected, permission can be refused
and action can be initiated to punish the offender. It is also
open to grant ex-post facto permission subject to conditions,
for instance, that the purchaser shall not be entitled to
repatriation benefits.
In another case (AIR 1981 SC 1298) where the Reserve Bank
granted permission to a company to carry on its business subject
to dilution of non-resident interest in its equity capital to a level
not exceeding 40% within a period of one year, the Supreme
Court held that the permission would cease automatically if
such dilution was not carried out within the stipulated period
or any extended period. Hence the continuance of business
after the stipulated period would be illegal unless the condition
of dilution of non-resident equity was duly complied with.
7.10 EMPLOYMENT OF FOREIGN NATIONALS
Foreign nationals have to obtain prior permission of the Reserve
Bank under section 30 of the Act to practice any profession or
to carry on any occupation, trade or business in India, if they
desire to acquire any exchange intended for remittance out of
India from the earnings of such profession, occupation, trade
or business. In order to obtain such permission, foreign nationals
have to apply to the Reserve Bank in the prescribed form and
manner. After making such enquiry as it deems fit, the Reserve
Bank may allow the applications with or without conditions or
may reject it after giving the applicant an opportunity for
representation.
Acquisition of Immovable Property in India
Section 31 of FERA makes it mandatory for (i) persons who
are not citizens of India; and (ii) companies which are not
incorporated under any Indian law - to obtain prior general or
special permission of the Reserve Bank to acquire or hold or
transfer immovable property situated in India. This does not
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apply to banking companies and also to lease transactions for a
period of upto 5 years. Any person requiring a special
permission in this regard, has to apply to the Reserve Bank.
On receipt of such application RBI may conduct suitable inquiry
and thereafter either allow it with or without conditions or reject
it. As in other cases discussed earlier, before rejecting any
application, the applicant has to be given an opportunity to
represent his case. It further provided that unless such
application is rejected within 90 days, grant of permission shall
be presumed. The period spent by the Reserve Bank in giving
the applicant an opportunity to be heard shall not be counted
for the purpose. The Reserve Bank has no duty to give a hearing,
to any person other than the applicant. (AIR Manual 4th Edn.
Vol 19,p 543)
7.11 INFORMATION AND RETURNS
Persons owning foreign exchange, foreign securities or
immovable properties held outside India have to submit returns
thereof to the Reserve Bank, if so directed by the Central
Government under Section 33 of the Act. Further, the Reserve
Bank, Central Government and certain offices of enforcement
are empowered to call for any information, or require production
of any book or document in the possession of any person for
examination. The Reserve Bank has also issued directions
regarding various returns to be submitted by authorised dealers
and others which are detailed in the Exchange Control Manual.
7.12 INSPECTION OF AUTHORISED DEALERS AND
MONEY CHANGERS
Under Section 43 of the Act, a duly authorised officer of the
Reserve Bank may inspect the books, accounts and other
documents of an authorised dealer. Similar powers of inspection
are also vested on the officers of Enforcement. The authorised
dealer has to produce all the requisite books and documents
and also furnish any statement or information relating to the
affairs of the authorised dealer as may be required. The
inspecting officer may also examine the authorised dealer, his
agent, or any partner direct or other officer on oath in relation
to its business. Failure to comply with the requirements of the
inspecting officer would amount to contravention of the
provisions of the Act. These provisions apply to money
changers also.
7.13 ISSUE OF DIRECTIONS AND EXCHANGE
CONTROL MANUAL
Reserve Bank is authorised under Section 73 to issue directions
to authorised dealers, money changers and other persons for
the purpose of securing compliance with the provisions of the
Act and of any rules, directions or orders made thereunder. The
directions of a standing nature made to authorised dealers,
money changers, shipping and airlines companies etc. are
contained in the Exchange Control Manual published by the
Reserve Bank.
As observed by the Supreme Court, in Escorts case, (AIR 1986
SC 1370) this Manual is a compendium of various statutory
direction, administrative instruction, advisory opinion,
comments, notes, explanation, suggestion etc. Amendments to
the directions are communicated in the form of circulars to
authorised dealers or the other persons concerned. Section 73A
provides for penalty for contravention of the direction of the
Reserve Bank or for failure to file returns.
7.14 RUPEE CONVERTIBILITY
Currency of a nation is fully convertible when the holder is
free to convert any amount of his/her national currency into
any other foreign currency. Indian Rupee is not totally
convertible because citizens of the country cannot convert their
rupee currency in any foreign currency without obtaining an
approval from the RBI. But Indian rupee is made freely
convertible in Balancing of Payment (BOP) account and in
current account of the business establishments. As such, under
this provision foreign currencies are avilable freely against
Indian rupee to commerical establishments for import of goods
and services as well as for foreign business trips, students,
scholars and researchers.
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SUB-TOPIC
8.1 A brief account of promotional functions
8.1 A BRIEF ACCOUNT OF PROMOTIONAL
FUNCTIONS
Apart from the key central banking and regulatory functions,
the Reserve Bank also undertakes several promotional functions.
In the past the Bank has promoted several financial institutions
with a view to achieving economic growth of the country
according to the guidelines and policies of the Central
Government.
The Reserve Bank has undertaken the task of building up the
co-operative credit structure in the country for making credit
available to the rural sector which was neglected by the
commercial banks. Steps were also taken to rationalise the
policies adopted by the cooperative credit institutions. State
governments were persuaded to establish state co-operative
banks in states where they were not existing. Amalgamations
of central co-operative banks were encouraged with a view to
establishing a strong central bank for each district. Bank had
also an active role in the reorganisation of primary societies by
helping the state governments to formulate the norms of
viability. Bank has also appointed several study teams and
8. PROMOTIONAL FUNCTIONS
committees with a view to strengthening the co-operative credit
structure and also contributed to research and training in
agricultural and rural credit. The erstwhile Agricultural
Refinance and Development Corporation and the National Bank
for Agriculture and Rural Development were established with
the active support and assistance of the Reserve Bank. So is
the case of Regional Rural Banks.
The Bank has also had a promotional role in other areas of
development as under:
i) Establishment of bill market scheme.
ii) Establishment of institutions for industrial credit like
Industrial Development Bank of India, Industrial
Reconstruction Corporation of India Ltd., Unit Trust of
India etc.
iii) Formulation of credit guarantee schemes for small scale
industries and the establishment of Deposit Insurance and
Credit Guarantee Corporation.
iv) Formulation of export bills credit scheme and various other
schemes for promotion of export credit facilities and the
establishment of the Export Import Bank of India.
Reserve Bank has also promoted several institutions for training
and research in banking and related subjects. (SeeRBI, 1983,
pp 172-77 & pp 244-77; See also Tannan, 1987, p 54)
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9. CASE LAW
Bank of India v. Karnam Ranga Rao & others AIR 1986
Kant 242.
A suit was instituted by the Bank of India (the bank) which is
the appellant for the recovery of Rs.30,564/- which was due
and outstanding from the defendants 1 and 2 out of the loan of
Rs.10,000/- granted to them for raising sugarcane crop.
Defendant 3 guaranteed repayment of the loan by executing a
letter of guarantee. The documents suggested that defendants
1 and 2 were liable to pay interest at the rate of 4 percent above
the rate prescribed by the RBI subject to the minimum of 13
per cent with quarterly rates. However the Bank has charged
only half yearly rates and also claimed at the same rate in the
suit.
Defendants admitted the loan taken, but denied their liability to
pay interest with quarterly rates on the ground that the loan
was for agricultural purpose & the Bank by the settled practice
has no right to charge periodical compound interest. They also
prayed for grant of instalments to repay the loan in five equal
annual instalments.
The following issues were framed by the trial court on the basis
of the pleadings namely,
i) Whether the plaintiff was not entitled to charge
compound interest ?
ii) Whether the defendants are entitled for five equal
instalments?
The trial court after considering the contentions urged and the
documents produced held:
It has been well settled now that for agricultural loans in
India, the conception of quarterly rate basis i.e., charging of
compound interest does not apply. That being so, the plaintiff
would not be entitled to charge compound interest on the loan
amount advanced to the defendants 1 & 2....
With that conclusion, the court directed the Bank to submit a
revised statement of accounts charging simple interest on the
amount due. Accordingly, the Bank submitted a revised
statement determining Rs.19,851.66 as the sum due from the
defendants. The Court then decreed the suit for the said amount
with future interest at 6 per cent payable in two annual
instalments.
The question raised by this appeal relates to the right of the
Bank to charge compound interest on agricultural advances.
The essential question to be decided by the court was whether
the Bank was justified in charging interest with half yearly rates
on the agricultural loan amount due and outstanding from the
defendants.
The court stated that in the present case, although the terms of
the loan advanced to the respondents authorised the bank to
charge interest with quarterly rates, the bank however, has
charged interest only with half-yearly rates. The Counsel for
the Appellant while justifying the interest charged with half
yearly rates also contended that the directives of the Reserve
Bank impose no constrain on commercial banks from charging
interest with periodical rates, quarterly or half yearly. On the
contrary according to counsel it will be obligatory for banks to
charge interest with quarterly or longer rates. In order to support
his contention he depended upon the circulars/directives issued
by the Reserve Bank relating to charging of interest on
agricultural advances.
The court held that the circulars/directives of the Reserve Bank
direct that the agricultural advances should not be treated at
par with the commercial loans in the matter of application of
the system of compounding interest. The farmers do not have
any regular source of income other than sale proceeds of their
crops is an acknowledged fact. They get income generally only
once a year. They are, therefore, not in a position to pay interest
at usual fixed intervals like monthly, quarterly and half yearly.
Banks should not charge compound interest on current dues.
Banks should not also charge interest with monthly, quarterly
or half yearly rates overdue agricultural loans.
H.P. Krishna Reddy v. Canara Bank AIR 1985 Kant.228.
The appellant was defendant against whom the respondent
Canara Bank (the Bank) instituted the suit for recovery of a
sum of Rs.23,940.97 with current interest at 13 per cent per
annum on the following averments :-
On June 19, 1969 the defendant availed of a loan of Rs.15,500/
- on the security of immovable properties with the deposit of
title deeds so as to create an equitable mortgage in favour of
the Bank. In order to ensure prompt repayment of the loan the
defendant also executed on Demand Promissory Note for a sum
of Rs.15,500/- in favour of the Bank. On October 14, 1969,
the defendant again availed of another loan of Rs.10,500/- by
extending the said security & on executing another Promissory
Note for a sum of Rs.10,500/-. The defendant also hypothecated
his crops and live-stock by executing necessary agreements.
In all, the defendant had taken Rs.26,000/- as loan from the
Bank.
The loan was not repaid as agreed on March 31, 1972. The
defendant was found to owe the bank a sum of Rs.23,940.97
including interest at the rate of 13 per cent per annum. The
defendant admitted the creation of equitable mortgage by
deposit of title deeds of his property as security for the loan
taken from the bank and also the execution of the Promissory
notes, but denied the liability to pay interest at the rest of 13 per
cent per annum. He also disputed the liability of charging higher
rate of interest and the validity of the suit claim without
furnishing the details of the aggregate interest charged.
The trial court framed the following issues :
1) Whether the plaintiff has paid Rs.15,500/- to the defendant
on the transaction of equitable mortgage of A schedule
properties ?
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61
2) Whether the plaintiff has paid Rs.10,500/- on the
hypothecation of C & D Schedule properties ?
3) Whether the plaintiff is entitled to claim interest at 13 per
cent ?
4) Whether the accounts furnished by the plaintiff are correct?
5) Whether the defendant was liable only upto a sum of
Rs.6,537.53 on both these transactions as on 17.12.1971 ?
After considering the evidence, the trial court determined all
the above said issues in favour of the bank and finally decreed
the suit in favour of the Bank.
The trial court held that the defendant should pay to the plaintiff
a sum of Rs.23,940.97 together with costs and current interest
at 13 percent per annum from April 1, 1972 to the date of decree
and at 6 per cent per annum from the date of decree till payment,
within a period of six months, failing which the amount due
shall be recovered from such mortgaged properties & balance
if any shall be recovered personally from the defendant.
On appeal two points arose for consideration before the High
Court :
(1) Whether the court below was justified in awarding interest
from April 1, 1972 to the date of the decree at 13 percent
per annum on Rs.23,940-97; and
(2) Whether the Bank is entitled to recover interest with
quarterly rates?
After hearing both sides the High Court observed that in a suit
for recovery of money due under equitable mortgage and
Promissory Note, the plaintiff bank has claimed interest at the
rate of 13 per cent with quarterly rates as per rules of business,
trade, usage and custom. But no evidence has been produced
in proof of such trade practice, usage or custom. It produced a
circular of the RBI issued on 17-8-1978 which in turn made a
reference to an earlier circular dated 5-10-1974, which makes
it clear that the banks have been precluded from receiving
interest with quarterly rates on agricultural advances. The High
Court held that under S.21A which was introduced in Banking
Regulation Act by Banking Laws (Amendment) Act, 1983,
the courts cannot exercise jurisdiction under the Usurious Loans
Act or any other law relating to indebtedness for the purpose of
giving relief to any party. This appears to be the intent of the
Legislature in enacting the Amendment Act, 1983. S.21 A has,
however, no bearing on the jurisdiction of courts to give relief
to an aggrieved party when it is established that the Bank in a
particular case has charged interest in excess of the limit
prescribed by the RBI. Section 46(4) of the Banking Regulation
Act confers power on the Reserve Bank to impose penalty for
contravention of its order, rule, or direction. If, in any case, it
is proved that the Bank has charged interest in violation of the
direction of RBI, the court could give relief to the aggrieved
party notwithstanding S.21A of the Banking Regulation Act.
The interest charged beyond the rate prescribed by the Reserve
Bank would be illegal & void. Therefore the claim of the Bank
on quarterly rates on agricultural loans cannot be allowed.
The High Court allowed the appeal & modified the decree of
the court below. The High Court stated that the Bank shall re-
calculate the interest on the advance given to the appellant at
varied rates, but without quarterly rates and file a memo before
this court. The Bank is entitled to 13 percent interest per annum
from April 1, 1972 till the date of decree and thereafter at 6 per
cent per annum till the date of realisation. The Bank should
also give adjustment to payment, if any, made by the appellant
after filing the suit.
Y. Jameela Beevi v. State Bank of Travancore (1992) 74 Comp.
Cases 736.
The appellants under agreements obtained a loan from the
respondent bank on the basis of a packing credit facility granted
for the purpose of enabling export of cashewnuts. The
agreements, in accordance with a Reserve Bank circular,
provided that if export was made within 180 days of obtaining
the loan, the rate of interest would be only 11% ; and that if the
time was exceeded, the normal rate of 16% interest had to be
paid. The trial court awarded interest to the bank at 16 percent.
On appeal, the question before the High Court was whether the
trial court was justified in awarding 16% interest or whether
11% alone ought to have been allowed.
The Court held that concessions in the matter of interest are
given in obedience to circulars issued by the RBI from time to
time. The Circular directed concessional rate of interest only
in cases where export was made within 180 days. In other
cases, the banks were authorised to levy the normal rate of 16%.
On the facts, the award of interest at 16% was justified.
Pranab Kumar Ray & another v. Reserve Bank of India AIR
1993 Cal.50.
A writ petition challenging the validity of the decision of the
RBI rejecting the request of the petitioner to release foreign
exchange for his son for prosecuting LL.B(Hons) course at the
University of Leeds in United Kingdom.
The issue involved was whether the disclosure of the policy
guidelines contained in the book of Instructions of the RBI
relating to release of Foreign exchange for LL.B Course leading
to Honours degree at Cambridge/Oxford Universities only
justified the action of the RBI.
The Court held that the classification made by RBI in favour of
the Oxford and Cambridge Universities Vis-a-Vis other
Universities of the same country is quite unreasonable and
discriminatory and violative of Art.14 of the Constitution and
accordingly, illegal & void. It must be examined whether there
is any rational & proximate nexus between the object of FERA
and the condition imposed by the RBI in this particular case.
The object of FERA was to conserve & direct to the best uses,
the limited supplies of the countrys foreign exchange and to
control transaction in-foreign exchange, securities & gold. The
whole idea was to see that the countrys foreign exchange
resources were not wasted under any circumstances and were
properly utilised to advance the national interest. In the instant
writ application, the above principle has no rational or proximate
nexus. Here the Foreign exchange has been asked to be utilised
properly for the advancement of national interest by way of
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prosecution of studies in the University of Leeds and not for
wasting the Foreign exchange for any other purpose. The
authorities are working against the best interests of the country.
V.T. Khanzode & others v. Reserve Bank of India & others
AIR 1982 SC 917.
The decision of the Reserve Bank of India introducing Common
seniority and intergroup mobility amongst different grades of
officers belonging to Group I (Section A), Group II and Group
III was challenged. That decision was contained in
Administrative circular and also in office order and had been
acted upon in the draft combined seniority list of officers in
Grade B and in Grades C, D, E and F.
The contention of the petitioners was that the aforesaid circular,
office order and combined seniority list are violative of their
fundamental rights under Arts. 14 and 16 of the Constitution
and are also ultra vires the power, jurisdiction and competence
of the Reserve Bank of India, being without the authority of
law and in contravention of the provisions of the Reserve Bank
of India Act 1934.
Upholding the decision of RBI, the Supreme Court observed
that this system of grouping had many drawbacks bearing on
the promotional opportunities of offficers in the various groups.
To mention but a few, the drawbacks were (i) Unequal size of
one group as compared to another (ii) Uneven expansion in
one group as compared to another, and (iii) Earlier confirmations
of officers in one group as compared to those in another. Various
Departments of the Reserve Bank were grouped and regrouped
from time to time. Such adjustments in the administrative affair
of the Bank are a necessary sequel to the growing demands of
new situations which are bound to arise in any developing
economy. The group system has never been a closed or static
chapter and it is wrong to think that the officers of the various
groups were kept in quarantine. The group system has been a
continuous process of trial and error and the scheme of
intergroup mobility has emerged as the best solution out of the
experience of the past. Combined seniority has been
recommended by two special committees, whose reports reflect
the expertise and objectivity which was brought to bear on their
sensitive task. It is clear that intergroup mobility and common
seniority are a safe and sound solution to the conflicting
demands of officers belonging to Group I on one hand and those
of Groups II and III on the other. No scheme governing service
matters can be fool-proof and some section or the other of
employees is bound to feel aggrieved on the score of its
expectations being falsified or remaining to be fulfilled. But
the fact that the scheme does not satisfy the expectations of
every employee does not render it arbitrary, irrational, perverse
or malafide. Combined seniority has emerged as the most
acceptable solution as a matter of administrative, historical &
functional necessity.
Peerless General Finance & Investment Co. Ltd v. Reserve
Bank of India AIR 1992 SC 1033.
In this case Residuary Non-Banking Companies (Reserve Bank)
Directions of 1987 issued by Reserve Bank of India under Secs
45-K(3) 45-J, & 45(2) of the Reserve Bank of India Act, 1934
providing for manner in which the deposits received by the
residuary non-banking companies are to be deposited by them
and manner in which such deposits are to be disclosed in balance
sheet or books of accounts of the Company, were challenged.
The Court held that the Reserve Bank was authorised to issue
the impugned directions of 1987. A very wide power is given
to the Reserve Bank of India to issue directions in respect of
any matters relating to or connected with the receipt of deposits.
It cannot be considered as a power restricted or limited to receipt
of deposits. It cannot be said that under this power the Reserve
Bank would only be competent to stipulate that deposits cannot
be received beyond a certain limit or that the receipt of deposits
may be linked with the capital of the Company. Such an
interpretation would be violating the language of S.45K(3)
which furnishes wide powers to the Reserve Bank to give any
directions in respect of any matters relating to or connected
with the receipt of deposits. The Reserve Bank under this
provision is entitled to give directions with regard to the manner
in which the deposits are to be invested and also the manner in
which such deposits are to be disclosed in the balance sheet or
books of accounts of the Company. The directions of 1987 are
fully covered under S.45k(3) of the Act which gives power to
the Reserve Bank to issue such directions.
Srinivasa Enterprises & Others v. Union of India etc AIR
1981 SC 504.
The Prize Chits Money Circulation Schemes (Banning Act)
1978 (Act 43 of 1978) was challenged on the ground that
Categories exempted under Sec.11 of the said Act spell out
discriminatory treatment & therefore violative of Art.14 of the
Constitution.
The Court stated that a bare reading of Sec.11 makes it clear
that the exempted categories do not possess the vices of private
prize chits. For one thing, what are exempted are prize chits
and money circulation schemes promoted by or controlled by
the State-Governments, the Central Government or the State
Bank of India or the Reserve Bank of India. Even Rural Banks
and Co-operatives covered by Sec.11, are subject to public
control. Likewise, Charitable and educational institutions are
exempted only if they are notified by the State Government in
consultation with the Reserve Bank. There are enough
arguments to justify the different classification of these items
and their exemption cannot be called in question on the ground
of violation of Art. 14. Reasonable classification wins
absolution from the charge of discrimination if the differentia
has a nexus with the statutory object.
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63
10. PROBLEMS
1. Paul Foundation Ltd. indented to import from a German
firm some raw materials for its fibre glass factory at Kanpur
and kept 200% deposit with the Bank of Karad as per the
guidelines of RBI. After the arrival of goods, the Company
asked the Bank of karad to pay for the same which was
done. Then, the Company asked for refund of the balance
amount. But, in the meanwhile, the Bank was put under a
liquidator and the liquidator refused to pay the balance on
the plea that the unutilised portion was part of the general
assets of the bank available for distribution in the winding
up. The Company files a suit for the refund of the money.
Decide. Give reasons and refer to cases already decided on
the issue, if any.
2a. Has any person got a right to get refund for soiled and
mutilated notes ? If not, is any amount payable at all in
respect of such notes ?
(Ans: Section 28 RBI Act, RBI (Note Refund) Rules, 1975)
2b. Are bank notes promissory notes ? If so, why are they not
stamped ?
(Ans: Section 4 NI Act, Section 29, RBI Act)
2c. Does the Reserve Bank pay interest for money kept in
deposit with it ? Are there any provisions for commercial
banks to get loans from Reserve Bank ?
3. Who manages public debt of the Government ? What are
the obligations of Reserve Bank in the matter ?
(Ans: Sections 20, 21A, RBI Act, and also see Public Debt
Act, 1944)
4a. What are the restrictions on acceptance of deposits by
individuals and firms ? What is RBIs role?
(Clue: Chapter III C RBI Act, Sections 45R, 45S & 45T of
RBI Act)
4b. Does the RBI control acceptance of deposits by companies?
What are the methods of control ?
(Clue: Sections 45J, 45L & 45 N of RBI Act; Section 58A
of Companies Act 1956; Companies (Acceptance of
Deposits) Amendment Rules, 1987; and notifications given
by Department of Financial Companies, RBI, Calcutta)
4c. What is the extent of Government control over acceptance
of deposits by companies ?
(Clue: As above)
[Specify your name, ID No. and address while sending answer papers]
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11. BIBLIOGRAPHY
LIST OF BOOKS AND CASES REFERRED
1. RBI, Reserve Bank of India - functions and working, 4th Edn., 1983.
2. RBI, Exchange Control Manual, 3rd Edn., 1987.
3. Tannan M.L. "Banking law and Practice in India, 18th Edn., 1989. Orient Law House, New Delhi.
4. A. Ramaiya, Guide of Companies Act, 11th Edn., 1988, Wadhwa and Co., Nagpur.
5. RBI, Uniform Regulations and Rules for Banks Clearing Houses.
6. AIR Manual, 4th Edn., Vol.19.
7. RBI General Regulations, 1949.
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65
Master in Business Laws
Banking Law
Course No: II
Module No: III
LAW OF BANKING REGULATIONS
Distance Education Department
National Law School of India University
(Sponsored by the Bar Council of India and Established
by Karnataka Act 22 of 1986)
Nagarbhavi, Bangalore - 560 072
Phone: 3211010 Fax: 080-3217858
E-mail: mbl@nls.ac.in
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Materials Prepared By:
1. Mr. Harihar Aiyyar LL.M. General Manager (Retd) SBI.
Materials Checked By:
1. Ms. Archana Kaul LL.M.
2. Ms. Sudha Peri LL.M.
Materials Edited By:
1. Prof. N.L. Mitra M.Com., LL.M., Ph.D.
2. Prof. P.C. Bedwa LL.M., Ph.D.
National Law School of India University
Published By:
Distance Education Department
National Law School of India University
Post Bag No: 7201
Nagarbhavi, Bangalore, 560 072
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67
LAW OF BANKING REGULATIONS
TOPICS
1. Regulation of Banking Operations ............................................................................... 68
2. Licensing of Banking Activities .................................................................................... 78
3. Capital, Reserve and Liquid Asset Requirements ...................................................... 82
4. Restrictions on Loans and Advances ............................................................................ 88
5. Regulation on Managerial Organs ............................................................................... 92
6. Amalgamation and Reconstruction .............................................................................. 96
7. Accounts and Audit ........................................................................................................ 101
8. Powers of Reserve Bank ................................................................................................ 104
9. Other Powers of Central Government ......................................................................... 107
10. Winding up of Banking Companies.............................................................................. 111
11. Case Law......................................................................................................................... 115
12. Problems.......................................................................................................................... 117
13. Supplementary Readings ............................................................................................... 118
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SUB-TOPICS
1.1 Introduction
1.2 Social control and its mechanism
1.3 Narasimham Committee Report : A brief outline
1.4 Concluding remarks
1.1 INTRODUCTION
The preamble to the Banking Companies Act,1949 (name of
the Act changed to Banking Regulation Act with effect from
1.3.1966)states that the Act was passed to consolidate and
amend the law relating to banking.The need for the consolidation
was felt owing to the absence of measures to safegaurd the
interests of the depositors,and the abuse of powers by persons
who controlled some of the banks.
The Act is regulatory, meant to regulate the functioning of the
banking companies and corporations. It is not a legislation to
codify the law relating to Banking.
Section 2 of the Act states that the provisions of this Act shall
be in addition to, and not, save as hereinafter expressly provided,
in derogation of the Companies Act 1956 and any other law for
the time being in force.
The years 1968, 1969 and 1980 witnessed three major events :-
(i) Social control on banking companies imposed through Act
58 of 1968. This was an amending Act to the Banking
Regulations Act 1949 and it came into effect from 01.02.69.
(ii) The nationalisation of 14 major Banks with effect from
19.07.69 by the Banking Companies (Acquisition and
Transfer of Undertakings) Act, 1970.
(iii) Further nationalisation of 6 major Banks under the Banking
Companies (Acquisition and Transfer of Undertakings) Act,
1980.
1.2 SOCIAL CONTROL AND ITS MECHANISM
The Preamble of Act 58 of 1968 states An act further to amend
the Banking Regulation Act, 1949, so as to provide for the
extension of social control over banks and for matters connected
therewith or incidental thereto.
The political situation prevailing in and around 1967 led to the
expression social control in relation to banks and banking
companies. Mismanagement of the banks coupled with the
allegations that a large chunk of the bank loans were sanctioned
to the large and medium scale industries, and big and established
business and industrial houses in which the management had
vested interest compelled the government to effect these social
control measures. In addition, complaints that sectors such as
small scale industries, agriculture and exports were neglected
by the commercial banks also led the government in this
direction. Allegations that the bank directors, who were mostly
industrialists directed the Bank credit to companies in which
they had substantial interests, and that they influenced the banks
to grant such advances in an indiscrete manner compelled the
government to bring in social control measures.
The government at that point of time and particularly, Shri
Morarjee Desai who was then the Dy. Prime Minister of India
holding charge of the Finance Ministry had no intention to
nationalise the Banks. But at the same time the government
wanted to impose such restrictions and controls over the banking
industry, which would determine the priorities of lending and
investment and those that would evolve appropriate guidelines
for the management and promote a reorientation of the decision
making machinery of the banks. The government also did not
desire to leave any opportunity in the hands of the management
and directors to mismanage the affairs of banks.
The proposals evolved to achieve these goals were termed as
social control.
The Deputy Prime Minister made a statement in the Lok Sabha
on 14.12.1967, declaring the views of the government and how
the government proposed to impose the social control. The
two steps taken in this direction were _
1. setting up of a National Credit Council (N.C.C) and
2. introducing legislative control on the banks by suitable
amendments to the Banking Regulation Act.
The National Credit Council now stands dissolved since the
nationalisation of the banks.
Towards achieving the second goal, the government passed Act
58 of 1968 which introduced radical amendments to certain
provisions of the Banking Regulation Act. The Preamble to
the amending Act states to provide for the extension of social
control over the Banks.
The mechanism to achieve the social control, by introducing
additional controls and instructions can be summarised as under:
I. Section 10 A to the Banking Regulation Act states that the
Board of directors was to include persons with professional
or other experience. This amendment was aimed to reduce
the predominance of the industrialists as Directors of a bank.
Not less than 51% of the total number of members of the
Board of Directors of the banking company shall consist
of persons, who_
a) shall have special knowledge of, or practical
experience in respect of one or more of the following
matters, viz,
1. accountancy 2. agriculture and rural economy 3. banking
4. co-operation 5. economics 6. finance 7. law 8. small scale
industry 9. any other matter the special knowledge of and
practical experience in which would in the opinion of the
Reserve Bank of India, be useful to the banking company.
The Proviso to the Section lays down that out of the aforesaid
number of directors, not less than two shall be persons having
1. REGULATION OF BANKING OPERATIONS
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69
special knowledge or practical experience in respect of
agriculture or rural economy, co-operation or small scale
industry; and
b) shall not -
1) have substantial interest in or be connected with, whether
as employee or manager, or managing agent of any
company, not being a company registered under the
Companies Act or any firm which carries on any trade,
commerce or industry and which in either case, is not a
small scale industrial concern or
2) be proprietors of any trading, commercial or industrial
concern not been of a small scale industrial concern.
By Act No I of 1984 further restrictions were imposed restricting
the tenure of office of a director for a period of eight years,
other than that of the Chairman or whole time Director. This
amendment also restricts the appointment as a director of a
person who was removed from the position of a Chairman or
whole time Director of a Bank. Such persons who have been
removed by the Reserve Bank of India cannot be co-opted or
elected as director of a Bank for a period of 4 years from their
date of removal.
The added sub-section 2A also made provisions for the
reconstitution of the Board so that the provision of Section 10A
is complied with at all times.
The new sub section also confers sweeping powers to the
Reserve Bank of India to reconstitute the Board.
II. Section 10B of the amended Act lays down for the
management of the affairs of a banking company by a whole-
time Chairman, who has special knowledge of and practical
experience in the working of a bank, or is a specialist in finance,
economics or business administration.
The effect of this new section is to curb the encroachment of
industrialists over experts.
III. Section 20 of the Act places restrictions on loans and
advances by a banking company to its directors or to a company
or a firm in which a director is substantially interested or to an
individual for whom a director is a guarantor.
IV. Additional powers were conferred on the Reserve Bank of
India to enforce and supervise the social control
V. Punishment for the following was provided -
a) obstructing any person from entering or leaving a bank ;
b) holding demonstrations within the bank;and
c) acting to undermine the depositors confidence in a bank.
VI. Special powers of Central Government to acquire
undertakings of a banking company when it is satisfied on a
report from the Reserve Bank of India that the banking company
has committed certain defaults and that it is necessary to do so.
As already stated the prime reason to introduce the social control
measures was that there were complaints that the Indian
commercial banks were directing their advances to large and
medium scale industries and big business houses and that the
sectors demanding priority such as agriculture, small scale
industries and exports were not securing their due share. Hence
the Banking Regulation Act was amended.
Steps were initiated in 1969 to amend the Banking Regulation
Act to impose social controls with a view to remedy the basic
weakness of the Indian banking system and to ensure that the
banks would cater to the needs of the neglected sectors of
economy. It was felt that the social control measures had not
changed the position substantially as there were still complaints
that the commercial banks were continuing to direct their
advances to large and medium scale industries.
On 19th July 1969 14 major Banks, each having a deposit of
more than 50 crores were nationalised and taken over as
undertakings of the Government of India. This revolutionary
measure did not merely signify a change of the ownership of
the Banks, but it was the beginning of a co-ordinated endeavour
to use an important part of the financial mechanism for the
countrys economic development.
The critics of nationalisation argued that the social control on
banks should have been given a fair chance and trial for its
success. It was also argued that in line with the performance of
other public sector undertakings, inefficiency and nepotism
would creep in the banking industry.
On 15th April 1980 six more Banks having demand and time
liabilities of not less than Rs.200 crores were nationalised. The
undertakings of these Banks were transferred to six
corresponding new banks under the Banking Companies
(Acquisition and Transfer of Undertakings) Act of 1980.
The Nationalised banks have definitely functioned to achieve
the goal of economic development.
The Reserve Bank of India and the Government of India
acquired draconian powers under the Acts. However the
concept of mass banking - a change from class banking, the
directed lending policy, and subsidised bank lending over a
period of time has resulted in many of these banks making
losses, and becoming inefficient and incompetent. To
camouflage the public, the asset classifications became illusory.
The Reserve Bank of India and the government under the
dictates of the I.M.F and the World Bank brought in the
prudential norms of asset classification as some of the
nationalised banks became weak and sick and merger of the
weaker and stronger banks started.
1.3 NARASIMHAM COMMITTEE REPORT :
A BRIEF OUTLINE
The social control measures should be analysed with reference
to the recent economic changes. A high power committee under
the chairmanship of Shri.M.Narasimham was constituted to
recommend ways and means.
The terms of reference of the Committee were as follows :-
i) to examine the existing structure of the financial system and
its various components and to make recommendations for
improving the efficiency and effectiveness of the system
70
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with particular reference to the economy of operations,
accountability and profitability of the commercial banks
and financial institutions ;
ii) to make recommendations for improving and modernising
the organisational systems and procedures as well as
managerial policies ;
iii) to make recommendations for infusing greater competitive
vitality into the system so as to enable the banks and
financial institutions to respond more effectively to the
emerging credit needs of the economy;
iv) to examine the cost, composition and adequacy of the
capital structure of the various financial institutions and to
make suitable recommendations in this regard ;
v) to review the relative roles of the different types of financial
institutions and to make suitable recommendations in this
regard ;
vi) to review the existing supervisory arrangements relating
to the various entities in the financial sector, in particular
the commercial banks and the term lending institutions and
to make recommendations for ensuring appropriate and
effective supervision ;
vii) to review the existing legislative framework and to suggest
necessary amendments for implementing the
recommendations that may require legislative change ; and
viii)to make recommendations on any other subject matter as
the Committee may consider germane to the subject of
enquiry or any related matter which may be specifically
referred to the Committee by the government of India.
The Committee submitted the summary of its Report on
November 8, 1991 and its main Report on November 16, 1991
to government. The full text of the summary of the Report is
reproduced below :
1. The Committees approach to the issue of financial sector
reform is to ensure that the financial services industry
operates on the basis of operational flexibility and functional
autonomy with a view to enhancing efficiency, productivity
and profitability. A vibrant and competitive financial
system is also necessary to sustain the ongoing reform in
the structural aspects of the real economy. We believe that
ensuring the integrity and autonomy of operations of banks
and DFIs is by far the more relevant issue at present than
the question of their ownership.
2. The Indian banking and financial system has made
commendable progress in extending its geographical spread
and functional reach. The spread of the banking system
has been a major factor in promoting financial
intermediation in the economy and in the growth of financial
savings. The credit reach also has been extensive and
banking system now caters to several million borrowers
especially in agriculture and small industry. The DFIs have
established themselves as a major institutional support for
investment in the private sector. The last decade has
witnessed considerable diversification of money and capital
markets. New financial services and instruments have
appeared on the scene.
3. Despite this commendable progress serious problems have
emerged as reflected in a decline of the profitability of the
banking sector. The major factors responsible for these
are : (a) directed investments ; and (b) directed credit
programmes. In both these cases, rates of interest that were
available to banks were less than the market related rates
or what they could have secured from alternate deployment
of funds. There has been a deterioration in the quality of
the loan portfolio which in turn has come in the way of
banks income generation and enhancement of their capital
funds. Inadequacy of capital has been accompanied by
inadequacy of loan loss provisions. The accounting and
disclosure practices also do not always reflect the true state
of affairs of banks and financial institutions. The erosion
of profitability of banks has also emanated from the side of
expenditure as a result of fast and massive expansion of
branches, many of which are unremunerative especially in
the rural areas, a considerable degree of overmanning
especially in the urban and metropolitan centres and
inadequate progress in updating work technology. Both
management weaknesses and trade union pressures have
contributed to this. There have also been weaknesses in
the internal organisational structure of the banks, lack of
sufficient delegation of authority and inadequate internal
controls and deterioration in what is termed housekeeping
such as balancing of books and reconciliation of inter-
branch and inter-bank entries. The DFIs also suffer from
the degree of portfolio contamination. This is more
pronounced in the case of SFCs. Being smaller institutions
the internal organisational problems of the DFIs have been
less acute than those of the banks. However, both banks
and the DFIs have suffered from excessive administrative
and political interference in individual credit decision
making and internal management. The deterioration in the
financial health of the system has reached a point where
unless remedial measures are taken soon, it could further
erode the real value of and return on the savings entrusted
to them and even have an adverse impact on depositor and
investor confidence. This diagnosis of the problem
indicates the lines of solution which the Committee
proposes with a view as much to improving the health of
the system as for making it an integral part of the ongoing
process of economic reforms.
4. The Committee is of the view that the SLR instrument
should be deployed in conformity with the original intention
of regarding it as a prudential requirement for financing
the public sector. In line with Governments decision to
reduce the fiscal deficit to a level consistent with macro-
economic stability, the Committee recommends that the
SLR be brought down in a phased manner to 25 per cent
over a period of about five years, starting with some
reduction in the current year itself.
5. As regards the cash reserve ratio [CRR], the Reserve Bank
should have the flexibility to operate this instrument to serve
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71
its monetary policy objectives. The Committee believes
that given the Governments resolve to reduce the fiscal
deficit, the occassion for the use of cash reserve ratio to
control the secondary expansion of credit should also be
less. The Committee accordingly proposes that the Reserve
Bank consider progressively reducing the cash reserve ratio
from its present high level. With the deregulation of interest
rates there would be more scope for the use of open market
operations by the Reserve Bank with correspondingly less
emphasis on variations in the cash reserve ratio.
6. The Committee proposes that the interest rates paid to banks
on their SLR investments and on CRR in respect of
impounded deposits above the basic minimum should be
increased. As discussed later, the rates on SLR investments
should be progressively market related while that on cash
reserve requirement above the basic minimum should be
broadly relating to the banks average cost of deposits.
However, during the present regime of administered interest
rates, this rate may be fixed at the level of the banks one
year deposit rate.
7. With respect to directed credit programmes, the Committee
is of the view that they have played a useful purpose in
extending the reach of the banking system to cover sectors
which were neglected hitherto. Despite considerable
unproductive lending there is evidence that the contribution
of bank credit to growth of agriculture and small industry
has made an impact. This calls for some re-examination
of the present relevance of directed credit programmes at
least in respect of those who are able to stand on their own
feet and to whom the directed credit programmes with the
element of interest concessionality that has accompanied it
has become a source of economic rent. The Committee
recognises that in the last two decades banking and credit
policies have been deployed with a redistributive objective.
However, the Committee believes that the pursuit of such
objectives should use the instrumentality of the fiscal rather
than the credit system. Accordingly, the Committee
proposes that the directed credit programmes should be
phased out. This process of phasing out would also
recognise the need that for some time it would be necessary
for a measure of special credit support through direction.
The Committee therefore, proposes that the priority sector
be redefined to comprise the small and marginal farmer,
the tiny sector of industry, small business and transport
operators, village and cottage industries, rural artisan, and
other weaker sections. This credit target for this redefined
priority sector should henceforth be fixed at 10 per cent of
aggregate credit which would be broadly in line with the
credit flows to these sectors at present. The Committee
also proposes that a review may be undertaken at the end
of three years to see if directed credit programmes need to
be continued. As regards medium and large farmers, and
the larger among small industries, including transport
operators, etc., who would not now constitute part of the
redefined priority sector, the Committee proposes that to
further encourage banks to provide credit to these erstwhile
constituents of the priority sector, the Reserve Bank and
other refinancing agencies institute a preferential refinance
scheme in terms of which incremental credit to these sectors
would be eligible for preferential refinance subject to
normal eligibility criteria.
8. The Committee is of the view that the present structure of
administered interest rates is highly complex and rigid. This
is so in spite of the recent moves towards deregulation.
The Committee proposes that interest rates be further
deregulated so as to reflect emerging market conditions.
At the same time, the Committee believes that a reasonable
degree of macro-economic balance through a reduction in
the fiscal deficit is necessary for successful deregulation
of interest rates. Premature moves to market determined
interest rates could, as experience abroad has shown, pose
the danger of excessive bank lending at high nominal rates
to borrowers of dubious credit-worthiness, eventually
creating acute problems for both the banks as well as the
borrowers. Accordingly, the Committee recommends that
for the present, interest rates on the bank deposits may
continue to be regulated, the ceilings on such rates being
raised as the SLR is reduced progressively as suggested by
us earlier. Similarly, the interest rate on Government
borrowing may also be gradually brought in line with
market-determined rates which would be facilitated by the
reduction in SLR. Meanwhile, the Committee would
recommend that concessional interest rates would bear a
broad relationship to the Bank rate which should be used
as an anchor to signal the Reserve Banks monetary policy
stance. It would be desirable to provide for what may be
called a prime rate, which would be the floor of the lending
rates of banks and DFIs. The spreads between the bank
rate, the bank deposit rates, the Government borrowing rates
and the prime rate may be determined by the RBI broadly
in accordance with the criteria suggested by the
Chakravarthy Committee so as to ensure that the real rates
of interest remain positive.
9. The inadequacy of capital in the banking system is a cause
for concern. While progress towards BIS norms is
desirable, the Committee recognises that this will have to
be phased over time. The Committee suggests that the
banks and financial institutions should achieve a minimum
4 per cent capital adequacy ratio in relation to risk weighted
assets by March 1993, of which Tier 1 capital should not
be less than 2 percent. The BIS standards of 8 per cent
should be achieved over the period of the following 3 years,
that is, by March 1996. For those banks with an
international presence it would be necessary to reach these
figures even earlier.
10. The Committee believes that in respect of those banks
whose operations have been profitable and which enjoy a
good reputation in the markets, they could straight-away
approach the capital market for enhancement of their
capital. The Committee, therefore, recommends that in
respect of such banks, issue of fresh capital to the public
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through the capital market should be permitted. Subscribers
to each issues could include mutual funds, profitable public
sector undertakings and employees of the institutions
besides the general public. In respect of other banks, the
Government could meet the shortfall in their capital
requirements by direct subscription to capital or by
providing a loan which could be treated as subordinate debt.
11. Before arriving at the capital adequacy ratio for each bank,
it is necessary that the assets of the banks be evaluated on
the basis of their realisable values. The Committee proposes
that the banks and financial institutions adopt uniform
accounting practices particularly in regard to income
recognition and provisioning against doubtful debts. There
is need also for adopting sound practices in regard to
valuation of investments on the lines suggested by the
Ghosh Committee on Final Accounts.
12. In regard to income recognition the Committee recommends
that in respect of banks and financial institutions which are
following the accrual system of accounting, no income
should be recognised in the accounts in respect of non-
performing assets. An asset would be considered non-
performing if interest on such asset remains past due for a
period exceeding 180 days at the balance sheet date. The
Committee further recommends that banks and financial
institutions be given a period of three years to move towards
the above norms in a phased manner beginning with the
current year.
13. For the purpose of provisioning, the Committee
recommends that, using the health code classification which
is already in vogue in banks and financial institutions, the
assets should be classified into four categories namely,
Standard, Sub-standard, Doubtful and Loss Assets. In
regard to Sub-Standard Assets, a general provision should
be created equal to 10 per cent of the total outstandings
under this category. In respect of Doubtful Debts, provision
should be created to the extent of 100 percent of the security
shortfall. In respect of the secured portion of some Doubtful
Debts, further provision should be created, ranging from
20 percent to 50 percent, depending on the period for which
such assets remain the doubtful category. Loss Assets
should either be fully written off or provision be created to
the extent of 100 percent. The Committee is of the view
that a period of 4 years should be given to the banks and
financial institutions to conform to these provisioning
requirements. The movement towards these norms should
be done in a phased manner beginning with the current
year. However, it is necessary for banks and financial
institutions to ensure that in respect of doubtful debts 100
per cent of the security shortfall is fully provided for in the
shortest possible time.
14. The Committee believes that the balance sheets of banks
and financial institutions should be made transparent and
full disclosures made in the balance sheets as recommended
by the International Accounting Standards Committee. This
should be done in a phased manner commencing with the
current year. The Reserve Bank, however, may defer
implementation of such parts of the standards as it considers
appropriate during the transitional period until the norms
regarding income recognition and provisioning are fully
implemented.
15. The Committee suggests that the criteria recommended for
non-performing assets and provisioning requirements be
given due recognition by the tax authorities. For this
purpose, the Committee recommends that the guidelines
to be issued by the Reserve Bank of India under Section 43
D of the Income Tax Act should be in line with our
recommendations for determination of non-performing
assets. Also, the specific provisions made by the banks
and institutions in line with our recommendations should
be made permissible deductions under the Income Tax Act.
The Committee further suggests that in regard to general
provisions, instead of deductions under Section 36(1) (viia)
being restricted to 5 per cent of the total income and 2 per
cent of the aggregate average advances by rural branches,
it should be restricted to 0.5 per cent of the aggregate
average non-agricultural advances and 2 per cent of the
aggregate average non-agricultural advances and 2 percent
of the aggregate average advances by rural branches. This
exemption should also be available to banks having
operations outside India in respect of their Indian assets, in
addition to the deductions available under Section
36(1)(viii).
16. Banks, at present, experience considerable difficulties in
recoveries of loans and enforcement of security charged to
them. The delays that characterise our legal system have
resulted in the blocking of a significant portion of the funds
of banks and DFIs in unproductive assets, the value of
which deteriorate with the passage of time. The Committee,
therefore, considers that there is urgent need to work out a
suitable mechanism through which the dues to the credit
institutions could be realised without delay and strongly
recommends that Special Tribunals on the pattern
recommended by the Tiwari Committee on the subject to
set up to speed up the process of recovery. The introduction
of legislation for this purpose is long overdue and should
be proceeded with immediately.
17. While the reform of accounting practices and the creation
of Special Tribunals are essential, the Committee believes
that an arrangement has to be worked out under which part
at least of the bad and doubtful debts of the banks and
financial institutions are taken off the balance sheet so that
the banks could recycle the funds realized through this
process into more productive assets. For this purpose, the
Committee proposes for establishment, if necessary by
special legislation, of an Assets Reconstruction Fund (ARF)
which could take over from the banks and financial
institutions a portion of the bad and doubtful debts at a
discount, the level of discount being determined by
independent auditors on the basis of clearly stipulated
guidelines. The ARF should be provided with special
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73
powers of recovery somewhat broader than those contained
in Sections 29-32 of the State Financial Corporations Act
1951. The capital of the ARF should be subscribed by the
public sector banks and financial institutions.
18. It is necessary to ensure that the bad and doubtful debts of
the banks and financial institutions are transferred to the
ARF in a phased manner to ensure smooth and effective
functioning of the ARF. To begin with all consortium
accounts where more than one bank or institution is
involved should be transferred to the ARF. The number of
such accounts will not be large but the amounts involved
are substantial to make a difference to the balance sheet of
banks. Gradually, depending on the progress achieved by
the ARF, other bad and doubtful debts could be transferred
over time. Meanwhile banks and institutions should pursue
recovery through the Special Tribunals. Based on the
valuation given in respect of each asset by a panel of at
least two independent auditors, the ARF would issue bonds
to the concerned institution carrying an interest rate equal
to the Government bond rate and repayable over a period
of 5 years. These bonds will need to be guaranteed by the
Government of India and should be treated as qualifying
for SLR purposes. The advantage to banks of this
arrangement would be that their bad and doubtful debts
would be off their books though at a price but they would
have in substitution of these advances bonds upto the
discounted value with a certainty of interest income which
would be an obviously important aspect from the point of
view of income recognition, and further by making these
bond holdings eligible for SLR purposes, banks fresh
resources could become available for normal lending
purposes. We wish to emphasise that this proposal should
be regarded as an emergency measure and not as a
continuing source of relief to the banks and DFIs. It should
be made clear to the banks and financial institutions that
once their books are cleaned up through this process, they
should take normal care and pay due commercial attention
in loan appraisals and supervision and take adequate
provisions for assets of doubtful realisable value.
19. Selling these assets to the Fund at a discount would
obviously mean an obligation on the banks/DFIs to write
off these losses which many of them are in no position to
do now, given their weak capital position. We propose
that to enable the banks to finance the write off represented
by the extent of the discount, the Government of India
would, where necessary, provide, as mentioned earlier a
subordinated loan counting for capital. As far as the
Government of India itself is concerned, we believe that
the rupee counterpart of any external assistance that would
be available for financial sector reform could be used to
provide this type of capital to the banks and DFIs.
20. The ARF would be expected to deal with those assets which
are in the process of recovery. In respect of sick units which
are under nursing or rehabilitation programmes, it is
necessary to work out a similar arrangement to ensure
smooth decision making and implementation in respect of
such nursing programmes. The Committee recommends
that in respect of all such consortium accounts which are
under a nursing programme or in respect of which
rehabilitation programmes are in the process of being
worked out, the concerned lead financial institution and/or
lead commercial bank should take over the term loan and
working capital dues respectively from other participating
institutions and banks. Such acquisitions should be at a
discount based on the realisable value of the assets assessed
by a panel of at least two independent auditors as in the
case of transfer of assets to ARF.
21. In regard to the structure of the banking system, the
Committee is of the view that the system should evolve
towards a broad pattern consisting of :
(a) 3 or 4 large banks (including the State Bank of India)
which could become international in character ;
(b) 8 to 10 national banks with a network of branches
throughout the country engaged in universal
banking ;
(c) local banks whose operations would be generally
confined to a specific region ; and
(d) rural banks (including RRBs) whose operations would
be confined to the rural areas and whose business
would be predominantly engaged in financing of
agriculture and allied activities.
The Committee is of the view that the move towards this
revised system should be market driven and based on
profitability considerations and brought about through a
process of mergers and acquisitions.
22. The Committee is of the view that the structure of rural
credit will have to combine the local character of the RRBs
and the resources skills and organisational/managerial
abilities of the commercial banks. With this end in view
the Committee recommends that each public sector bank
should set up one or more rural banking subsidiaries,
depending on the size and administrative convenience of
each sponsor bank, to take over all its rural branches and,
where appropriate, swap its rural branches with those of
other banks. Such rural banking subsidiaries should be
treated on par with RRBs in regard to CRR/SLR
requirements and refinance facilities from NABARD and
sponsor banks. The 10 per cent target for directed credit
which we have recommended as a transitional meausure
should be calculated on the basis of the combined totals of
the parent banks and their subsidiaries. The Committee
proposes, that while RRBs should be allowed to engage in
all types of banking business, their focus should continue
to be to lend to the target groups to maintain at a minimum
the present level of their lending to these groups. With a
view to improving the viability of their operations, the
Committee proposes that the interest rate structure of the
RRBs should be in line with those of the commercial banks.
The Committee would leave the option open to the RRBs
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and their sponsor banks as to whether the RRBs should
retain identity so that their focus on lending to the target
groups is not diffused or where both the RRBs and the
sponsor banks wish to do so they could be merged with the
sponsor banks and the sponsor banks in such cases should
take over as 100 per cent subsidiaries by buying out the
shares from other agencies at a token price, and eventually
merge them with the rural banking subsidiaries which we
have proposed. For those RRBs that retain their identity
and whose viability would need to be improved, we propose
that instead of investing in Government bonds as part of
their SLR requirements, they could place the amounts
stipulated under SLR as deposits with NABARD or some
special federal type of agency that might be set up for this
purpose. This would also be consistent with the statutory
requirements in this regard and NABARD or this agency
could pay interest on such balances by investing or
deploying these funds to the best advantage on their behalf
and thus help to augment the income of the RRBs.
23. The Committee proposes that Government should indicate
that there would be no further nationalisation of banks.
Such an assurance will remove the existing disincentive
for the more dynamic among the private banks to grow.
The Committee also recommends that there should not be
any difference in treatment between the public sector and
the private sector banks. The Committee would propose
that there be no bar to new banks in the private sector being
set up provided they conform to the start-up capital and
other requirements as may be prescribed by the Reserve
Bank and the maintenance of prudential norms with regard
to accounting, provisioning and other aspects of operations.
This in conjunction with the relevant statutory requirements
governing their operations would provide adequate
safeguards against misuse of banks resources to the
detriment of the depositors interests.
24. The Committee recommends that branch licensing be
abolished and the matter of opening branches or closing of
branches (other than rural branches for the present) be left
to the commercial judgement of the individual banks.
25. The Committee also believes that, consistent with other
aspects of Government policy dealing with foreign
investment, the policy with regard to allowing foreign banks
to open offices in India either as branches or, where the
Reserve Bank considers it appropriate, as subsidiaries,
should be more liberal, subject to the maintenance of
minimum assigned capital as may be prescribed by the
Reserve Bank and the statutory requirement of the
reciprocity. Joint ventures between foreign banks and
Indian banks could also be permitted, particularly in regard
to merchant and investment banking, leasing and other
newer forms of financial services.
26. Foreign banks when permitted to operate in India should
be subjected to the same requirements as are applicable to
domestic banks. If, in view of certain constraints such as
absence of branch network, the foreign banks are unable
to fulfil certain requirements such as directed credit (of 10
per cent of aggregate credit) the Reserve Bank should work
out alternative methods with a view to ensuring a level
playing field.
27. The Committee is of the view that the foreign operations of
Indian banks need to be rationalised. In line with the
structure of the banking system visualised above, there
would seem to be scope for one or more of the large banks,
in addition to the SBI, to have operations abroad in major
international financial centres and in regions with strong
Indian ethnic presence. Pending the evolution of a few
Indian banks with an international character, the Committee
recommends as an interim measure that those Indian banks
with the largest presence abroad and strong financial
position could jointly set up one or more subsidiaries to
take over their existing branches abroad. The SBI
operations abroad can continue and indeed be strengthened
in the course of time. The Government may also consider
the larger banks increasing their presence abroad by taking
over existing small banks incorporated abroad as a means
of expanding their international operations.
28. The Committee believes that the internal organisation of
banks be best left to the judgment of the managements of
individual banks, depending upon the size of the bank, its
branch spread and range of functions. However, for the
medium and large national banks the Committee proposes
a three-tier structure in terms of head office, a zonal office
and branches. In the case of very large banks, a four-tier
organisation, as is the case with the State Bank, with head
office, zonal office, regional office and branches may be
appropriate. Local banks may not need an intermediate
tier between the branch and the central office.
29. The Committee endorses the view of the Rangarajan
Committee on Computerisation that there is urgent need
for a far greater use of computerised system than at present.
Computerisation has to be recognised as an indispensable
tool for improvement in customer service, the institution
and operation of better control systems, greater efficiency
in information technology and the betterment of the work
environment for employees. These are essential
requirments for banks to function effectively and profitably
in the increasingly complex and competitive environment
which is fast developing in the financial services segment
of the economy.
30. Consistent with the Committees view that the integrity
and internal autonomy of banks and DFIs is far more
important than the question of ownership, the Committee
makes the following recommendations regarding
recruitment of officers and staff and appointments of chief
executives and constitution of the boards of the institutions:
31. The Committee recommends that instead of having a
common recruitment system for officers individual banks
should be free to make their own recruitment. Thus there
is no need for setting up a Banking Service Commission
for centralised recuritment of officers nor for their
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75
recruitment, as at present, through Banking Service
Recruitment Boards (BSRBs). This will provide scope for
the banks to scout for talent and impart new skills to their
personnel. The Committee, however, predicates this
recommendation on the assumption that the banks will set
up objective, fair and impartial recruitment procedures and,
wherever appropriate, they could voluntarily come together
to have a joint recruitment system. As regards clerical
grades, the present system of recruitment through BSRBs
may continue but we would urge that the appointment of
the Chairmen of these Boards should be totally left to the
coordinating banks.
32. The Committee believes that there has to be a recognition
on the part of managements and trade unions that the system
cannot hope to be competitive internally and be in step with
the wide-ranging innovations taking place abroad without
a radical change in work technology and culture and greater
flexibility in personnel policies. We have been reassured
to know that organised labour is as much convinced of the
importance of enhancing the viability of the banking
industry and providing efficient customer service. It is
equally incumbent on management of banks to adapt
forward looking personnel policies which would help to
create a satisfying work environment.
33. The Committee recommends that the various guidelines
and directives issued by the Government or the Reserve
Bank in regard to internal administration of the banks should
be reviewed to examine their continuing relevance in the
context of the need to ensure the independence and
autonomy of banks. Such guidelines which relate to matters
of internal administration such as creation and
categorisation of posts, promotion procedures and similar
matters should be rescinded.
34. The Committee believes that the Indian banking system, at
present, is over regulated and over-administered.
Supervision should be based on evolving prudential norms
and regulations which should be adhered to rather than
excessive control over administrative and other aspects of
bank organisation and functioning. The Committee would
also like to place greater emphasis on internal audit and
internal inspection systems of banks. The inspection by
the supervisory authorities should be based essentially on
the internal audit and inspection reports. Their main
concern should be to ensure that audit and inspection
machinery (which will cover the credit appraisal system
and its observance) is adequate and conforms to well laid
down norms.
35. The Committee is firmly of the opinion that the duality of
control over the banking system between the Reserve Bank
and the Banking Division of the Ministry of finance should
end and that the Reserve Bank should be the primary agency
for the regulation of the banking system. The supervisory
function over the banks and other financial institutions, the
Committee believes, should be hived off to a separate
authority to operate as a quasi autonomous body under the
aegis of the Reserve Bank but which would be separate
from other central banking functions of the Reserve Bank.
The Committee recognises that as long as the Government
has proprietory interest in banks and financial institutions,
it would be appropriate for the Ministry of Finance to deal
with other Government departments and Parliament and
discharge its other statutory obligations but not to engage
in direct regulatory functions.
36. Central to the issue of flexibility of operations and autonomy
of internal functioning is the question of depoliticising the
appointment of the chief executive (CMD) of the banks
and the boards of the banks and ensuring security of tenure
for the CMD. The Committee believes that professionalism
and integrity should be the prime considerations in
determining such appointments and while the formal
appointments have to be made by Government, they should
be based on a convention of accepting the recommendations
of a group of eminent persons who could be invited by the
Governor of the Reserve Bank to make recommendations
for such appointments. As regards the boards of public
sector banks and institutions, as long as Government owns
the banks, it would be necessary to have a Government
director to take care of proprietorial concerns but we
believe that there is no need for the Reserve Bank to have
a representative on the boards.
37. As regards development financial institutions,the main issue
with regard to their operations are to ensure operational
flexibility, a measure of competition and adequate internal
autonomy in matters of loan sanctioning and internal
administration. The Committee proposes that the system
recommended for commercial banks in the matter of
appointment of chief executives and boards should also
apply to DFIs. The present system of consortium lending
has been perceived as operating like a cartel. The
Committee believes that consortium lending should be
dispensed with and, in its place, a system of syndication or
participation in lending, at the instance not only, as now, of
the lenders but also of the borrowers, should be introduced.
The Committee also believes that commercial banks should
be encouraged to provide term finance to industry, while at
the same time, the DFIs should increasingly engage in
providing core working capital. This will help to enhance
healthy competition between banks and DFIs. The
Committee proposes that the present system of cross holding
of equity and cross representation on the boards of the DFIs
should be done away with. The Committee welcomes the
removal of the tax concession enjoyed by IDBI as an
important step in ensuring equality of treatment between
various DFIs. As a further measure of enhancing
competition and ensuring a level playing field, the
Committee proposes that the IDBI should retain only its
apex and refinancing role and that its direct lending function
be transferred to a separate institution which could be
incoporated as a company. The infected portion of the DFIs
portfolio should be handed over to the ARF on the same
terms and conditions as would apply to commercial banks.
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38. In the case of state level institutions, it is necessary to
distance them from the State Governments and ensure that
they function on business principles based on prudential
norms and have a management set-up suited for this
purpose. We propose that an action plan on these lines be
worked out and implemented over the next 3 years.
39. As regards the role of DFIs in corporate take-overs, the
Committee believes that DFIs should lend support to
existing managements who have a record of conducting
the affairs of the company in a manner beneficial to all
concerned, including the shareholders, unless in their
opinion the prospective new management is likely to
promote the interests of the company better. In doing so
we would expect the institutions to exercise their individual
professional judgement.
40. The DFIs should seek to obtain their resources from the
market on competitive terms and their privileged access to
concessional finance through the SLR and other
arrangements should gradually be phased out over a period
of three years.
41. The last decade had witnessed a considerable growth in
capital market operations with the emergence of new
instruments and new institutions. The capital market,
however, is tightly controlled by the Government whose
prior approval is invariably required for a new issue in the
market, the terms of the issue and its pricing. The process
of setting up Securities and Exchange Board of India (SEBI)
for over-seeing the operations of the market is still not
complete with the legislation for this purpose yet to be
enacted. We believe the present restrictive environment is
neither in tune with the new economic reforms nor
conducive to the growth of the capital market itself.
42. The committee strongly favours substantial and speedy
liberalisation of the capital market. Prior approval of any
agency _ either Government or SEBI _ for any issue in the
market should be dispensed with. The issuer should be
free to decide on the nature of the instrument, its terms and
its pricing. We would recommend in this context, that the
SEBI formulate a set of prudential guidelines designed to
protect the interests of investor, to replace the extant
restrictive guidelines issued by the Controller of Capital
Issues (CCI). In view of the above, the office of the CCI
will cease to have relevance. In the Committees view,
SEBI should not become a controlling authority substituting
the CCI, but should function more as a market regulator to
see that the market is operated on the basis of well laid
down principles and conventions. The capital market
should be gradually opened up to foreign portfolio
investment and simultaneously efforts should be initiated
to improve the depth of the market by facilitating issue of
new types of equities and innovative debt instruments.
Towards facilitating securitisation of debt, which could
increase the flow of instruments, appropriate amendments
will need to be carried out in the Stamp Acts.
43. In the last decade several new institutions have appeared
on the financial scene. Merchant banks, mutual funds,
leasing companies, venture capital companies and factoring
companies have now joined hire purchase companies in
expanding the range of financial services available.
However, the regulatory framework for these new set of
institutions has still to be developed.
44. The Committee recommends that the supervision of these
institutions which form an integral part of the financial
system should come within the purview of the new agency
to be set up for this prupose under the aegis of the RBI.
The control of these institutions should be principally
confined to off-site supervision with the on-site supervision
being resorted to cases which call for active intervention.
The SEBI which is charged with the responsibility of
ensuring orderly functioning of the market should have
jurisdiction over these institutions to the extent their
activities impinge on market operations. In regard to mutual
funds there is a good case for enacting new legislation on
the lines obtaining in several countries with a view to
providing an appropriate legal framework for their
constitution and functioning. The present guidelines with
regard to venture capital companies are unduly restrictive,
and affecting the growth of this business and need to be
reviewed and amended.
45. As in the case of the banks and financial institutions there
is need to lay down prudential norms and guidelines
governing the functioning of these institutions. These
prudential guidelines should relate, among other things, to
capital adequacy, debt equity ratio, income recognition
provisioning against doubtful debts, adherence to sound
accounting and assets. The eligibility criteria for entry,
growth and exit should also be clearly stipulated so that
the growth of these institutions takes place on proper lines.
46. The Committee would like to emphasise that a proper
sequencing of reforms is essential. Deregulation of interest
rates can only follow success in controlling fiscal deficits.
Asset reconstruction, institution of capital adequacy and
establishment of prudential norms with a good supervisory
machinery have to be proceeded with in a phased manner
over the next 3 to 5 years but, we believe, it is important
that the process must begin in the current year itself.
47. The above set of proposals would necessitate certain
amendments in existing laws which the Government should
undertake expeditiously.
48. The committees approach thus seeks to consolidate the
gains made in the Indian financial sector while improving
the quality of the portfolio, providing greater operational
flexibility and most importantly greater autonomy in the
internal operations of the banks and financial institutions
so as to nurture a healthy, competitive and vibrant financial
sector. This will, above all else, require depoliticisation of
appointments, implying at the same time a self-denial by
Government and the perception that it has distanced itself
from the internal decision making of the banks and the
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77
financial institutions. The proposed deregulation of the
financial sector and the measures aimed at improving its
health and competitive vitality would, in the Committees
view, be consistent with the steps being taken to open up
the Indian economy, enable the Indian financial sector to
forge closer links with the global financial markets, and
enhance Indias ability to take competitive advantage of
the increasing international opportunities for Indian trade,
industry and finance.
1.4 CONCLUDING REMARKS
In the economy of every country, Commercial Banks have
a very significant role to play. These institutions are the players
in the money market. It is therefore necessary for the Central
Bank of the country to have regulations on these Commercial
Banks, which have been already narrated in the module on RBI.
Over and above these regulations by the Central Bank which
contains
(a) restrictions on loans and advances ; (See S.20 of B.R. Act)
(b) maintenance of percentage of liquid assets ; (See S.24 of
B.R.Act)
(c) maintaining reserve fund and cash reserve ; (See Ss. 17
and 18)
(d) Licensing of banking companies ; (See S. 22)
The Central Govt also has certain regulatory functions. This
module contains all these regulatory requirements excepting
those which relate to the money market discussed in the module
of RBI.
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SUB TOPICS
2.1 General provisions about Licensing
2.2 RBI Guidelines
2.1 GENERAL PROVISIONS ABOUT LICENSING
Section 22 of the Banking Regulation Act deals with the
Licensing provisions of Banking Companies
1) Save as hereinafter provided, no company shall carry on
banking business in India unless it holds a licence issued
in that behalf by the Reserve Bank, and any such licence
may be issued subject to such conditions as the Reserve
Bank may think fit to impose.
2) Every banking company in existnece on the commencement
of this Act, before the expiry of six months from such
commencement, and every other company before
commencing banking business in India, shall apply in
writing to the Reserve Bank for a licence under this section:
Provided that in the case of a banking company in existence
on the commencement of this Act, nothing in sub-section
(1) shall be deemed to prohibit the company from carrying
on banking business until it is granted a licence in pursuance
of this section or is by notice in writing informed by the
Reserve Bank that a licence cannot be granted to it :
Provided further that the Reserve Bank shall not give a
notice as aforesaid to a banking company in existence at
the commencement of this Act before the expiry of the three
years referred to in sub-section (1) of section 11 or of such
further period as the Reserve Bank may under that sub-
section think fit to allow.
3) Before granting any license under this section, the Reserve
Bank may require to be satisfied by an inspection of the
books of the company or otherwise that the following
conditions are fulfilled, namely :-
a) that the company is or will be in a position to pay its
present or future depositors in full as their claims
accrue ;
b) that the affairs of the company are not being, or are
not likely to be, conducted in a manner detrimental
to the interests of its present or future depositors ;
c) that the general character of the proposed
management of the company will not be prejudicial
to the public interest or the interest of its depositors ;
d) that the company has adequate capital structure and
earning prospects;
e) that the public interest will be served by the grant of
a licence to the company to carry on banking business
in India ;
f) that having regard to the banking facilities available
in the proposed principal area of operations of the
company, the potential scope for expansion of banks
already in existence in the area and other relevant
factors the grant of licence would not be prejudicial
to the operational and consolidation of the banking
system consistent with monetary stability and
economic growth ;
g) any other condition, the fulfilment of which would, in
the opinion of the Reserve Bank, be necessary to
ensure that the carrying on of banking business in
India by the company will not be prejudicial to the
public interest or the interests of the depositors.
3A) Before granting any licence under this section to a company
incorporated outside India, the Reserve Bank may require
to be satisfied by an inspection of the books of the company
or otherwise that the conditions specified in sub-section
(3) are fulfilled and that the carrying on of the banking
business by such company in India will be in the public
interest and that the Government or law of the country in
which it is incorporated does not discriminate in any way
against banking companies registered in India and that the
company complies with all the provisions of this Act
applicable to banking companies incorporated outside India.
4) The Reserve Bank may cancel a licence granted to a banking
company under this section _
i) if the company ceases to carry on banking business
in India ; or
ii) if the company at any time fails to comply with any
of the conditions imposed upon it under sub-section
(1) or
iii) if at any time, any of the conditions referred to in
sub-section (3) and sub-section (3-A) is not fulfilled:
Provided that before cancelling a licence under clause (ii)
or clause (iii) of this sub-section on the ground that the
banking company has failed to comply with or has failed
to fulfil any of the conditions referred to therein, the Reserve
Bank, unless it is of opinion that the delay will be prejudicial
to the interests of the companys depositors or the public,
shall grant to the company on such terms as it may specify,
an opportunity of taking the necessary steps for complying
with or fulfilling such condition.
5) Any banking company aggrieved by the decision of the
Reserve Bank cancelling a licence under this section may,
within 30 days from the date on which such decision is
communicated to it, appeal to the Central Government.
6) The decision of the Central Government where an appeal
has been preferred to it under Sub-section (5) or of the
Reserve Bank where no such appeal has been preferred
shall be final.
This section originated with the demand for licensing of foreign
banks doing business in India and was also recommended by
the Indian Central Banking Enquiry Committee, mainly with
the object of prohibiting the entry of banks started in countries
2. LICENSING OF BANKING ACTIVITIES
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79
which discriminated against banks started in India. The above
section, however, introduces a comprehensive system of
licensing of banks incorporated in India is dependent upon the
maintenance of a satisfactory financial condition coupled with
the additional qualification in case of foreign banks, vide sub-
section (3A) which has been inserted by the Banking Laws
(Amendment) Act, 1983 (1 of 1984) on the basis of existing
clause (c) of sub-section (3), that the countries of their origin
do not discriminate in any way against banks registered in India.
It also provides for the issue of conditional licence. Laws of
certain foreign countries such as Switzerland, U.S.A and
Sweden have almost similar provisions. The requirements under
this section may be classified under following three heads :
(a) necessity of licensing and mode of applying for it ;
(b) conditions for granting of licences and compliance with
further condition;
(c) cancellation of licences and appeals from such orders.
No banking company can commence or carry on banking
business in India until it holds a licence granted to it by the
Reserve Bank for the purpose. In the case of banking companies
to be started, before granting a licence to them the Reserve
Bank may require to be satisfied whether the conditions given
in sub-section (3) of section 22 are fulfilled. By the Banking
Laws (Amendment) Act, 1983 clauses (c) to (g) have been
substituted for existing clause (c) w.e.f. 15.2.1984, so as to widen
the scope of the matters which the Reserve Bank may consider
before granting a licence. It amy be added that while a banking
company whose licence is cancelled by the Reserve Bank has
the right to appeal to the Central Government whose decision
is to be regarded as final, no such appeal can be preferred by a
new banking company whose application for licence is turned
down.
In Sajjan Bank (P) Ltd, Vs. Reserve Bank (30 Comp.Cas. 146),
it has been held that the provisions of Section 22 of the Banking
Regulation Act, 1949 prescribe only a system of licensing,
having for its object the regulation of the business of banking
and does not violate fundamental right of any person to carry
on the business of banking. It was also laid down that the powers
vested in the Reserve Bank of India under Section 22 of the
Banking Companies Act, 1949 are not vested with a mere officer
of the Reserve Bank.
Restrictions on opening and transfer of Branches :- Under the
provisions of Section 23, the Reserve Bank has been empowered
to control the opening of new and transfer of existing places of
business of banking companies as follows
1) without obtaining prior permission of the Reserve Bank _
a) no banking company shall open a new place of
business in India or change otherwise than within the
same city, town or village, the location of an existing
place of business situated in India; and
b) no banking company incorporated in India shall open
a new place of business outside India or change,
otherwise than within the same city, town or village
in any country or area outside India, the location of
an existing place of business situated in that country
or area :
Provided that nothing in this sub-section shall apply to the
opening for a period not exceeding one month of a temporary
place of business within a city, town or village or the environs
thereof within which the banking company already has a place
of business, for the purpose of affording banking facilities to
the public on the occasion of an exhibition, a conference or a
mela or any other like occasion.
2) Before granting any permission under this section, the
Reserve Bank may require to be satisfied by an inspection
under section 35 as to the financial condition and history
of the company, the general character of its management,
the adequacy of its capital structure and earning prospects
and that public interest will be served by the opening or, as
the case may be, change of location, of the place of business.
3) The Reserve Bank may grant permission under sub-section
(1) subject to such conditions as it may think fit to impose
either generally or with reference to any particular case.
4) Where, in the opinion of the Reserve Bank, a banking
company has, at any time, failed to comply with any of the
conditions imposed on it under this section, the Reserve
Bank may, by order in writing and after affording reasonable
opportunity to the banking company for showing cause
against the action proposed to be taken against it, revoke
any permission granted under this section.
4A) Any regional rural bank requiring the permission of the
Reserve Bank under this Section shall forward its
application to the Reserve Bank through the National Bank
which shall give its comments on the merits of the
application and send it to the Reserve Bank ;
Provided that the regional rural bank shall also send an advance
copy of the application directly to the Reserve Bank.
5) For the purposes of this section place of business includes
any sub-office, pay-office, sub-pay ofice and any place of
business at which deposits are received, cheques cashed or
moneys lent.
The need for the permission for the opening of a new branch
was first brought into operation by Banking Companies
(Restriction of Branches) Act, 1946. Explanation to section
does not serve to define the words place of business, unless
the money aid was lent at that place. Similarly the words
cheques cashed apply to cheques drawn on the bank at the
place in question. The restrictions imposed by the section are
not applicable to change of location of a place of business in
the same city or village, in which a place of business is already
existing. It is also provided that a banking company may without
the previous permission of the Reserve Bank open a new place
of business, for a period not exceeding a month for the purpose
of affording exhibition, or a fair, if such temporary place of
business is located with the environs of a city, town or village
in which the banking company already has a place of business.
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Originally the section did not impose any restriction on the
opening of branches of Indian banks outside India. It was,
however, subsequently felt that the maintenance of a satisfactory
financial position, and the observance of sound banking
traditions by foreign branches of Indian banks were of vital
importance not only to the banking prestige abroad but also in
the larger interests of the country, so it is now necessary for
Indian banks to obtain permission of the Reserve Bank before
opening branches in foreign countries. Besides, banks have to
submit a monthly statement regarding the assets and liabilities
of their branches in each foreign country.
After nationalisation the entry of new private Banks was
externally prohibited.
However on the basis of the liberalisation of our economy the
Reserve Bank of India have brought our guidelines on 22.1.1993
for floating new private sector banks.
2.2 RBI GUIDELINES ON ENTRY OF NEW PRIVATE
BANKS
For well over decades, after the nationalisation of 14 larger
banks in 1969, no bank has been allowed to be set up in the
private sector. Progressively, over this period, the public sector
banks have expanded their branch net work considerably and
catered to the socio-economic needs of large masses of the
population, especially the weaker section and those in the rural
area. The public sector banks now have 91 per cent of the total
bank branches and handle 86 per cent of the total banking
business in the country. While recognising the importance and
the role of public sector banks, there is increasing recognition
of the need to introduce greater competititon which can lead to
higher productivity and efficiency of the banking system. A
stage has now been reached when new private sector banks
may be allowed to be set up.
It is necesary that while permitting the entry of new private
sector banks the following considerations have to be kept in
view :
(a) they sub-serve the underlying goals of financial sector
reforms which are to provide competitive, efficient and low
cost financial intermediation services for the society at large;
(b) they are financially viable;
(c) they should result in upgradation of technology in the
banking sector;
(d) they should avoid the shortcomings such as unfair
preemption and concentration of credit, monopolisation of
economic power, cross holdings with industrial groups etc.
which beset the private sector banks prior to nationalisation;
(e) freedom of entry in the banking sector may have to be
managed carefully and judiciously.
Based on these consideration, the Reserve Bank has formulated
the following guidelines for establishment of new banks in the
private sector :-
a) Such a bank shall be registered as a public limited company
under the Companies Act, 1956 ;
b) The RBI may, on merits, grant licence under the Banking
Regulation act, 1949 for such a bank. The bank may also
be included in the Second Schedule of the Reserve Bank
of India Act, 1934 at the appropriate time. The decision of
the RBI in these matters shall be final ;
c) The bank will be governed by the provisions of the Banking
Regulation Act, 1949 in regard to its authorised, subscribed
and paid-up capital. The minimum paid-up capital for such
a bank shall be determined by the RBI and will also be
subject to other applicable regulations ;
d) The shares of the bank should be listed on stock exchanges;
e) To avoid concentration of the headquarters of new banks
in metropolitan cities and other overbanked areas, while
granting a licence preference may be given to those the
headquarters of which are proposed to be located in a centre
which does not have the headquarters of any other bank ;
f) Voting rights of an individual shareholder shall be governed
by the ceiling of 1 per cent of the total voting rights as
stipulated by Section 12(2) of the Banking Regulation Act.
However, exemption from this ceiling may be granted under
section 53 of the said Act, to public financial institutions;
g) The new bank shall not be allowed to have as a director
any person who is a director of any other banking company,
or of companies which among themselves are entitled to
exercise voting rights in excess of twenty per cent of the
total voting rights of all the shareholders of the banking
company, as laid down in the Banking Regulation Act,
1949;
h) The bank will be governed by the provisions of the Reserve
Bank of India Act, 1934, the Banking Regulation Act, 1949
and other relevant statutes, in regard to its management
set-up, liquidity requirements and the scope of its activities.
The directives, instructions, guidelines and advices given
by the RBI shall be applicable to such a bank as in the case
of other banks. It would be ensured that a new bank would
concentrate on core banking activities initially;
i) Such a bank shall be subject to prudential norms in respect
of banking operations, accounting policies and other
policies as are laid down by RBI. The bank will have to
achieve capital adequacy of 8 per cent of the risk weighted
assets from the very beginning. Similarly, norms for income
recognition, asset classification, and provisioning for bad
and doubtful advances will also be applicable to it from
the beginning. So will be the single borrower and group
borrowers exposure limits that will be inforced from time
to time ;
j) The bank shall have to observe priority sector lending
targets applicable to other domestic banks. However, in
recognition of the fact that new entrants may require some
time to lend to all categories of the priority sector, some
modification in the composition of the priority sector
lending may be considered by the RBI for an initial period
of three years
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81
k) Such a bank will also have to comply with such directions
of the RBI as is applicable to existing banks in the matter
of export credit. As a facilitation of this it may be issued
an authorised dealers licence to deal in foreign exchange,
when applied for ;
l) A new bank shall not be allowed to set up a subsidiary or
mutual fund for at least three years after its establishment.
The holding of such a bank in the equity of other companies
shall be governed by the existing provisions applicable to
other banks viz . _
i) 30 percent of the banks or the investee companys
capital funds, whichever is less, as set up under
the Banking Regulation Act, 1949, and
ii) 1.5 per cent of the banks incremental deposits during
a year as per RBI guidelines.
The aggregate of such investments in the subsidiaries and
Mutual Fund (if and when set up) and portfolio investments in
other companies shall not exceed 20 percent of the banks own
paid-up capital and reserves.
m) In regard to branch opening, it shall be governed by the
existing policy that banks are free to open branches at
various centres including urban/metropolitan centres
without the prior approval of the RBI once they satisfy the
capital adequacy and prudential accounting norms.
However, to avoid over concentration of their branches in
metropolitan areas and cities, a new bank will be required
to open rural and semi urban branches also, as may be laid
down by RBI.
n) Such a bank shall have to lay down its loan policy within
the several policy guidelines of RBI. While doing so, it
shall specifically provide prudential norms covering related
party transactions.
o) Such a bank shall make full use of modern infrastructural
facilities in office equipments, computer,
telecommunications, etc, in order to provide good customer
service. The bank should have a high powered customer
grievances cell to handle customer complaints ;
p) Such other conditions as RBI may prescribe from time to
time.
In Terms of the Narasimham Committee Recommendations,
the nationalised Banks, under the directions of the RBI and the
government are now aiming at the closure or merger of unviable
branches.
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SUB TOPICS
3.1 Introduction
3.2 Capital Requirements
3.3 Reserves and Liquid Assets
3.4 Concluding Remarks
3.1 INTRODUCTION
The Banking Regulation Act contains requirements as to
minimum paid up capital (Sec.11), regulation of paid up capital,
subscribed capital and authorised capital (Sec.12), and
prohibition charge on unpaid capital (Sec.14). The Act also
contains prescriptions on reserve fund (Sec.17), Cash reserve
(Sec.18), prohibition of floating charge on asset and assets to
be kept in India (Sec.25).
At the outset a few observations on the concept of capital are
needed to make the terminological content of the word Capital
clear.
Until the acceptance of the Basle Accord, the term Capital
referred to the owned funds of a bank comprising paid up capital
and disclosed free reserves. It served mainly two purposes viz.,
(a) reflecting the owners stake in the enterprise and acting as a
disincentive to them to take up higher risk-investments and (b)
serving as a buffer to absorb adverse effects on a bank of various
risks. Till the Basle Accord, the capital requirements for a bank
differed from one country to another. Virtually, every country
had laid down a minimum capital requirement, but the size of
the amount varied. In addition, certain countries had stipulated
that the banks should maintain an appropriate relationship
between capital on the one hand and total assets, risk assets or
liabilities on the other. Furthermore, some countries, such as
Japan, did not formally prescribe capital adequacy. Others like
the United States, had attempted at judgemental assessment.
Developments in the early eighties had emphasised the need to
strengthen the capital base of banks and to adopt a uniform
standard to assess adequacy among countries. During that
period, there was a general deterioration in the asset portfolio
of major international banks particularly to the debt problems
of the developing countries. Notwithstanding the adverse trend,
banks continued to acquire still high-risk assets to retain their
market share. This tendency had further contaminated their
asset portfolios because of the increased competition both
among banks and between banks and pseudo-banking entities
following world wide lineralisation of financial services sector.
Consequently, the leverage ratios of banks had scaled
unsustainable levels. Furthermore, the difference in capital
requirements for different domestic markets had resulted in
competitive inequalities. Such inequalities in the context of
globalisation of the transactions following widespread
application of new communication and computer technology
and the trend towards liberalisation of international capital
transactions had resulted in major banks attempting to take
greater risks to protect their market shares.
To counteract the trend and to restore health to the system,
authorities in some countries had attempted to strengthen banks
by prescribing simple leverage ratios and in some others, by
laying down on balance sheet risk-asset ratios. These attempts
had proved inadequate because the stipulation of simple leverage
ratios had discouraged banks from holding low-risk assets while
the prescription of on-balance sheet risk-asset ratios had
encouraged them to substitute off-balance sheet exposure for
conventional assets. A more sophisticated and realistic yardstick
was required to measure the adequacy of capital. Also
international co-ordination was considered necessary to prevent
banks taking advantage of differences in national capital
definitions and requirements thereby exposing themselves to
greater risks. In this situation, supervisors in major industrial
countries were naturally prepared to sacrifice elements of their
own capital adequacy requirements in the interest of reaching a
multi-lateral agreement.
One of the notable developments in the banking regulatory
framework in the recent years relates to the stipulation of capital
requirements. Banking supervisors world over have
unanimously agreed on the method for assessing adequacy of
capital as also on the need of harmonise such requirement at
the international level, at least in respect of internationally active
banks. The agreement is known technically as the International
Covergence of Capital, Measurement and Capital Standards,
and popularly as The Basle Accord. The Accord has become
the reference point for policy action among nations. For
example, the Solvency Ratio and Own Funds requirements of
the European Community, which will become effective in 1993,
are based on the norms contained in the Accord. In India, the
Committee on the financial system under the Chairmanship of
Shri. M. Narasimham has not only recommended the adoption
of the Basle Accord but also laid down a time-frame for
compliance. Against this backdrop, an attempt is made to briefly
recapitulate the Basle Accord and its implications to Indian
banks having overseas branches.
The Basle Accord
The new method of assessing adequacy of capital is based on a
system of risk-weighted capital ratio for the banks. The Basle
Banking Supervisory Committee had worked on this since 1987,
and had recommended it for the banks in G-10 countries. The
authorities of these countries had endorsed the recommendations
in July 1989. The new ratio has the following advantages :
i) providing a fairer basis for international comparision
between banking systems with structural differences ;
ii) allowing off-balance sheet exposures to be incorporated
more easily into the measure ; and
iii) non-detering banks from holding liquid or other assets with
low risk.
Capital : New Definition
For supervisory purposes, the Basle Accord has defined capital
in two tiers. The Core Tier 1, Capital comprises fully paid-up
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capital and disclosed reserves and corresponds to the traditional
measure of capital. The Accord has also recognised the
supplementary or Tier II Capital consisting of undisclosed
reserves, revaluation reserves, general provisions, hybrid debt,
capital instruments and subordinated term debt. Besides, the
national authorities are left with the discretion to include/exclude
any items, in the light of their national accounting and
supervisory regulations. This is an improvement over the
conventional definition of capital. However, Tier 1 Capital is
granted greater importance due to certain well recognised facts.
This is the only element common to the banking system the
world over; it is wholly visible in the published account; and it
has a crucial bearing on the profit margins and the banks ability
to compete. Aslo, the strengthening of the Core Capial would
facilitate a progressive enhancement in the quality as well as
the level of the total capital resources maintained by the banks.
Thus, the maximum permissible size of Tier II Capital is limited
to the actual size of Tier I Capital.
Assets and Risk Weighting
For risk-weighting, assets are classified into five broad classes,
each class carrying different weights ranging from 0 percent to
100 percent. The risk-weights attached to a specific assets is
based mainly on the perceived riskiness of the assets. Obviously,
this method has certain caveats. The weighting is not a substitute
for commercial judgement. Further, the risk-weights capture
only credit-risk and hence exclude other risks such as investment
risk, interest rate risk, exchange risk and concentration risk.
Weighting also differs in respect of county exposure.
Industrialised debtor countries, for instance, carry a lower
weight implying thereby that such exposure is safer than that in
respect of LDCs. As for the banks claim on public sector
enterprises, the Accord has allowed discretion to each national
supervisory authority to determine the appropriate weights in
factors. On other assets (both on-and-off balance sheet assets),
the Accord has enumerated each item and has prescribed
different ratios ranging from 20 per cent to 100 per cent.
The Targets
The Accord has provided for a minimum risk-weighted capital/
asset ratio of 8 per cent to be achieved by G-10 countries by the
end of 1992. A transitional minimum ratio of 7.25 per cent
was also stipulated for the end of 1990.
Capital adequacy
Prevailing capital requirements for banks in India are rather
complex. The State Bank of India Act, 1955 prescribes the
capital structure for the State Bank of India (SBI). According
to the provisions in this Act, the authorised capital of SBI is Rs.
1,000 Crores; the actual paid-up captial is Rs.200 Crores. The
issued capital of each of the seven Associate Banks of SBI was
fixed by SBI with the approval of the Reserve Bank of India
(RBI). The capital structure of the nationalised banks is laid
down by the Banking Companies (Acquisition and Transfer of
Undertakings) Act, 1979/80. According to these Acts, the paid-
up capital of these banks are equal to their respective paid-up
capital at the time of their nationalisation. In the case of a foreign
bank, the aggregate value of its paid-up capital and reserves
should not be less than Rs. 15 lakhs and this level is raised to
Rs.20 lakhs if it has a place or places of business in Bombay
and/or Calcutta. The absolute minimum requirement for an
Indian private sector bank, as laid down in the Banking
Regulation Act, 1949, is Rs. 5 lakhs. (Rs. 10 lakhs if it has
offices in more than one State and/or has office(s) in Bombay
and/or Calcutta).
The Committee on the financial system under the Chairmanship
of Shri.M. Narasimham has recognised that the Indian banking
system has inadequately capitalised and the situation is a cause
of concern. It has, therefore, suggested that the banks should
achieve a minimum of 4 per cent capital adequacy ratio in
relation to risk-weighted assets by March 1993. The standards
by the Basle Accord should be achieved by March 1996. For
these banks with an international presence, it would be necessary
to reach these figures even earlier.
3.2 CAPITAL REQUIREMENTS
Section 11 of the Banking Regulation Act, lays down the
requirements regarding the minimum standard of paid-up capital
and reserves as a condition for the commencement of business.
These conditions apply to the banking companies wherever
incorporated, but companies in existence at the time of the
commencement of the Act were given a period of three years
or such further period not exceeding one year as the Reserve
Bank of India extended to comply with the provisions contained
in Section 11, which are shown for easy reference in a tabular
form.
Under the provisions of sub-sections (i) and (ii) of Section 12 it
has been laid down that no banking company shall carry on
business in any State of India, unless (a) the subscribed capital
of the company is not less than half of its authorised capital,
and the paid-up capital is not less than half of its subscribed
capital, provided that when capital is increased this proportion
may be permitted to be secured within a period to be determined
by the Reserve Bank not exceeding two years from the date of
increase; and (b) its share capital does not comprise shares other
than ordinary shares, provided that preference shares, if any,
issued before 1st July 1944 will not operate as a disqualification.
These provisions deal with the minimum ratios between
authorised, subscribed and paid-up capital of a banking
company. The need for these provisions arose from the fact
that the management of some banks used to mislead members
of the public by displaying large figures of authorised capital,
while only a small portion of their capital might have been
subscribed, a still smaller portion might have been called-up.
By calling only a small amount of the subscribed capital the
promoters of banking companies were able to persuade persons
with small means to go in for much larger number of shares
than they could afford to purchase.
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Requirements of Aggregate Value of Paid-up Capital and
Reserve
Aggregate Value of Paid-up
Capital and Reserve
I. Incorporated in India Rupees
A. (i) For a banking company incorporated in India
having places of business in more than one state .. 5,00,000
(ii) If any such place or places of business is or are
situated in the city of Bombay or Calcutta or both.. 10,00,000
B. If all places of business in one State but none of which
in Bombay city or Calcutta :
(i) For principal place of business in one state .. 1,00,000
(except in City of Bombay and Calcutta)
plus
(ii) For each other place of business in the same .. 10,000
district
(iii) For each place of business situated outside that
district .. 25,000
Subject to a total of .. 5,00,000
(iv) For having only one place of business 50,000
C. If all places of business in one State :
(i) One or more of which is/are in the city of
Bombay or Calcutta .. 5,00,000
plus
(ii) In respect of each place of business situated
outside the city of Bombay or Calcutta .. 25,000
Subject to a total of .. 10,00,000
II. Incorporated outside India
(i) If it has no place of business in Bombay city or .. 15,00,000
Calcutta
(ii) If it has a place of business in Bombay city or
Calcutta or both .. 20,00,000
Note :- Banking companies incorporated outside India have to
deposit the amount required as above either in cash or in
unencumbered approved securities or partly in cash and partly
in such securities with the Reserve Bank.
If a place of business situated in a State other than that in which
the principal place of business of a banking company is situated
and the distance is less than twenty-five miles between these
two places, they will be considered as places of business in
one State.
Place of Business means any office, sub-office, sub-pay office
and any place of business at which deposits are received,
cheques cashed and moneys lent.
Commission on the sale of shares
Section 13 prohibits a banking company from paying out
directly or indirectly by way of commission, brokerage, disocunt
or remuneration in any form in respect of shares issued by it,
any amount exceeding in the aggregate two and half per cent of
the paid-up value of the said shares. Section 76 and 79 of the
Companies Act, 1956 provide for higher percentage of
Commission. The present provisions of the Banking Regulation
Act alter the effect of the provisions of the Companies Act 1956,
so far as banking companies are concerned and to the extent of
commission that can be paid.
Prohibition of charge on Unpaid Capital
No banking company shall create any charge upon its unpaid
capital, and any such charge, if created, shall be invalid (Section
14). It is unusual for banks in India to create any charge on
their future assets. Unpaid capital of a company constitutes its
future asset. However, the provision of this section is based
upon the salutary principle that all the creditors of a banking
company should participate in the future assets which should
not be realised for the benefit of one or more preferred creditors.
The Companies Act, 1956 permits the creation of a charge by a
company on its uncalled capital provided the instrument creating
the said charge is registered with the Registrar of Companies
within 30 days from the date of its creation (Section 125 of the
Companies Act, 1956).
Section 14A prohibits every banking company from creating a
floating charge on its undertaking or any property or any part
thereof unless the creation of such a floating charge is certified
in writing by the Reserve Bank as not being detrimental to the
interests of the depositors of such company. The floating charge
if created without obtaining the Reserve Banks certificate is
invalid.
Restrictions on holding of shares in other Companies
Section 19 lays down that :
Restriction on nature of subsidiary companies -
(1) A banking company shall not form any subsidiary company
except a subsidiary company formed for one or more of
the following purposes, namely:-
(a) the undertaking of any business which, under clauses
(a) to (o) of sub-section (1) of Section 6, is permissible
for a banking company to undertake;
(b) with the previous permission in writing of the Reserve
Bank, the carrying on of the business of banking
exclusively outside India ;
(c) the undertaking of such other business, which the
Reserve Bank may, with the prior approval of the
Central Government, consider to be conducive to the
spread of banking in India or to be otherwise useful
or necessary in the public interest;
Explanation :- For the purposes of Section 8, a banking company
shall not be deemed, by reason of its forming or having a
subsidiary company, to be engaged indirectly, in the business
carried on by such subsidiary company.
(2) Save as provided in sub-section (1), no banking company
shall hold shares in any company, whether as pledgee,
mortgagee or absolute owner, of an amount exceeding thirty
per cent of the paid-up share capital of that company or
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85
thirty per cent of its own paid-up share capital and reserves,
whichever is less :
Provided that any banking company which is on the date of
commencement of this Act holding any shares in contravention
of the provisions of this sub-section shall not be liable to any
penalty therefor if it reports the matter without delay to the
Reserve Bank and if it brings its holding of shares into
conformity with the said provisions within such period, not
exceeding two years, as the Reserve Bank may think fit to allow.
(3) Save as provided in sub-section (1) and notwithstanding
anything contained in sub-section (2), a banking company
shall not, after the expiry of one year from the date of the
commencement of this Act, hold shares, whether as pledgee,
mortgagee or absolute owner, in any company in the
management of which any managing director or manager
of the banking company is in any manner concerned or
interested.
This section restricts the scope of formation of subsidiary
companies by a banking company, as well as the holding of
shares in other companies. A banking company may form a
subsidiary company for the purposes referred to in this section,
as well as for other purposes subject to the previous permission
in writing of the Reserve Bank. Sub section (1) has been
substituted by the Banking Laws (Amendment) Act, 1983, w.e.f.
15.2.1984 so as to amplify, in pursuance of the recommendation
of the Banking Commission, the scope of the said section with
a view to enlarging the purposes for which a banking company
can form subsidiaries. A banking company would now be
permitted to form subsidiaries for carrying on one or more kinds
of business which it is permitted to engage in under clauses (a)
to (o) of Section 6(1) of the Banking Regulation Act, 1949.
Prior to the amendment a banking company was not permitted
to form subsidiaries except for undertaking and executing trusts,
administration of estates as executors and for doing banking
business outside India.
It appears, however, that the definition of a subsidiary company
as given in the Companies Act, 1956 excludes the case of a
company holding shares as security, when the ordinary business
of the company so holding shares includes the lending of money.
It may be noted that a company, even though it is not
incorporated under the Companies Act, will be regarded as
subsidiary company within the meaning of that Act, if the
holding banking company incorporated under the Banking
Regulation Act and/or the Companies Act, is interested in it in
such a way that it controls the composition of the Board of
Directors of such a Company.
Under Section 4 of the Companies Act, 1956, a company is
deemed to be a subsidiary of another, if and only if _
(a) that other controls the composition of its Board of
Directors ; or
(b) that other holds more than half in nominal value of
its equity share capital; or
(c) the first mentioned company is subsidiary of any
company which is that others subsidiary.
As regards the second restriction mentioned in Section 19 of
the Banking Regulation Act, it is clear that a banking company
can hold shares in any company (i.e., a company liable to be
wound up under the Companies Act) to the extent of thirty per
cent of the paid-up share capital of the latter, but this should
not exceed thirty per cent of the paid-up share capital and reserve
of the former. Thus, it would appear that a banking company
may hold shares of a foreign company, exceeding thirty per
cent if that company does not operate in India, but such holding
must not exceed fifty per cent as to the close of an accounting
period. The main object of the provision as laid down under
this section is, that a banking company may not enter into non-
banking business by means of a subsidiary company or any
other company in which it is to be largely interested. The
restriction regarding the holding of shares seems to apply only
when the shares are held as pledgee, mortgagee or owner, and
not when they are held as trustee, custodian or agent, or
otherwise than a pledgee, mortgagee or owner.
If on the date of commencement of this Act, a banking company
holds shares beyond the limit stated in the sub-section, provided
it forthwith reports the matter to the Reserve Bank of India, it
can dispose off the excess holding within such period (not
exceeding two years as the Reserve Bank may permit) to comply
with the provisions of Section 19(1). Sub section (3) of the
same section absolutely prohibits the holding after the expiry
of one year from the date of the commencement of the Act of
shares as pledgee, mortgagee or owner, in any company in the
management of which a managing director or manager of the
banking company in question is concerned or interested. This
prohibition, however, does not apply to the shares in a subsidiary
company permitted under sub-section (1) of Section 19. It does
not appear to be quite clear whether the period of one year
referred to above, is automatically allowed to every banking
company or is the maximum period of concession that can be
allowed by the Reserve Bank. It may be observed that the word
concerned or interested appears to have rather wide
meaning. Probably it will be interpreted with reference to
Section 295 and other provisions contained in Sections 297,
299, 300, 301 and 302 of the Companies Act, 1956.
A critique on capital adequacy position of some Nationalised
Banks:
In this context an academic exercise is attempted to assess the
prevailing position of capital in nine Indian banks having
overseas branches vis-a-vis the requirements of the Basle
Accord as also of the Narasimham Committee for 1993. The
nine banks are Bank of India, Bank of Baroda, Bharat Overseas
Bank, Canara Bank, Indian Bank, Indian Overseas Bank, SBI,
Syndicate Bank and UCO Bank. This exercise presents the
position at end-March 1991. Since the published balance sheets
of these banks do not conform to the details of assets as
enumerated in the Basle Accord, available data are treated to
conform broadly to the classification of the Accord. Thus, cash
on hand, balances with other banks and money at call and short-
notice are taken as cash and equivalent having no risk. Total
investments, contra-items and contingent liabilities were allotted
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50 per cent risk-weight (each). All other assets are given 100
per cent risk-weight.
Aggregate Picture
As on March 31, 1991, the combined owned funds, i.e., paid-
up capital and disclosed reserves of these nine banks aggregated
to Rs. 3,859 crores. Their total assets amounted to Rs. 1,63,994
crores. The risk unadjusted capital asset ratio, therefore, worked
out to Rs. 2.35 percent. On the other hand the risk weighted
assets (including contra-items and contingency liabilities)
totalled Rs. 1,53,172 crores. The capital/risk-weighted alset
ratio stood higher at 2.52 per cent because of the complete
exclusion of cash and equivalent, and one half of investments,
contra-items, and contingent liabilities from the denominator.
While considering Tier I norm of the Basle Accord, therefore,
there was a deficit of 1.48 per cent of Rs. 2,267 crores in respect
of the required capital of these Banks. According to the
prescription of Narasimham Committee, however, the banks
have fulfilled their Tier I needs (2.0 per cent) but fell short of
total capital adequacy by 1.48 percentage points (Rs. 2,267
crores).
Disaggregated position
Bank-wise, the position varied widely. Only three banks, viz.,
Canara Bank, Indian Overseas Bank, and UCO Bank, have
fulfilled the Tier I Capital requirement of the Basle Accord.
The shortfall in respect of other banks ranged from Rs. 5 crores
(Bharat Overseas Bank) to Rs. 1,507 crores (SBI); in percentage
terms, the shortfall ranged from 1.46 per cent (Bank of India)
to 2.41 per cent (Syndicate Bank).
The norms of the Narasimham Committee (2.0 per cent Tier I
Capital) was met by six banks. Only three banks, viz., SBI,
Bank of Baroda, and Syndicate Bank, have fallen short of the
target.
Caveats
It should be reiterated that these computations are illustrative
and at best are indicative of the direction and possible dimension,
the precise amount could be different. The position by end
March 1994 will also depend upon other factors such as the
growth in the balance sheets, contingent liabilities, extent of
asset contamination, etc., of these banks. Again, the role of the
injection of substantial funds by the Government to augment
the capital of weak banks needs to be remembered.
Available options : Tier I capital
Available options to cover the shortfall are rather limited. Tier
I capital refers to purely owned funds consisting paid-up capital
and disclosed reserves. The scope for additional allocation of
operating surplus to reserves is limited because of the
diminishing profitability of the banks. There could also be a
greater need to make larger provision for loan losses from the
available meagre surplus. The scope of augmenting paid-up
capital by the government is also limited since the present
emphasis is on curtailing expenditure as much as possible.
Notional augmentation through issue of special securities, as
had been done hitherto in this context, would hardly serve any
useful purpose. Perhaps, fresh capital could be issued to the
public. Response will, however, depend naturally upon the track
record of the issuer.
Recognising this, the Narasimham Committee has
recommended that in respect of banks which have had a
consistent record of profitability and enjoy a good reputation
in the market, it should be possible to tap the capital market by
issuing fresh capital to the public. Mutual funds, insurance
companies and profitable public sector companies could
subscribe to such equity, besides employees of the banks and
the general public. In respect of other banks, it may be necessary
for the government to supplement the capital by direct
subscription. In this context, it should be remembered that the
paid-up capital of all the nationalised banks have almost reached
their respective authorised levels. hence, legislative measures
may have to be taken to increase the capital structure of these
banks if additional capital funds are to be injected.
Holding company
We could also conceive the establishment of a new holding
company with adequate capital to take care of these banks.
According to the stipulations of the Basle Accord, the Tier I
capital needs of the proposed holding company, as at end-March
1991 would be around Rs. 6,130 crores, as per our estimates.
In the present context of economy measures, perhaps, RBI alone
may be in a position to contribute this amount. In due course,
however, these could be professionally managed. Similarly,
officials for posting to the foreign branches should undergo a
stringent process of selection procedure establishing their
efficiency. Necessary safeguards ought to be built in the
procedure to provide representation to all the participant banks
as also to discourage any possible brain-drain.
Tier II Capital
The components of supplementary capital of Tier II capital are
undisclosed reserves, revaluation reserves, general
provisions,hybrid debt instruments,and subordinate term debt.
Hitherto, the actual financial position of the banks is not fully
clearly reported.With the implementation of new accounting
policies and procedures as well as the adoption of new formats
for the final accounts, it should be possible to effect greater
transparency to the financial status of the reporting banks. Once
these changes are effected, perhaps, the banks could fully satisfy
the needs of Tier II Capital. In cases where shortfalls are noticed,
one could think of issuing subordinate term debts.
CONCLUSION
Indian banks operating abroad need to subject themselves to
the capital regulatory requirements as laid down in the Basle
Accord. It is true that the requirements of the Accord are stiff
for Indian situation. Recommendations made by the
Narasimham Committee in this context are very reasonable,
practicable and achievable. This could be considered as the
transitory provisions and intensive attempts should be made to
attain the BIS standards at the earliest. A precondition in this
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87
regard, as noted by the Narasimham Committee, is that the
Indian banks should have their assets revalued on a more
realistic basis and on the basis of their realisable value. Then
alone a clearer picture would emerge facilitating appropriate
action.
3.3 RESERVES AND LIQUID ASSETS
Provisions relating to the building up of reserves are relatively
simple. Indian banks are statutorily required to build up reserves
by transferring sums equivalent to not less than 20 per cent (25
per cent since 1974 as per RBIs advice) of their annual disclosed
profit. Foreign banks need to maintain 20 per cent of their
annual profits in respect of their Indian operations with RBI
either in cash or in unencumbered approved securities. Since
some of these banks have often complied with provision by
transferring securities in their investment portfolio (which
enabled them to remit the entire profit), they are required, since
1989, to retain in a separate account, 20 per cent of the profits
of their Indian operations as disclosed in their annual accounts
every year. This reserve is permanent in nature and forms part
of owned funds of these banks [ See Sec.17].
Every Banking Company shall maintain a cash reserve with
itself or by way of balance in a current account with the Reserve
Bank or by way of net balance partly with itself and partly with
Reserve Bank, a sum equivalent to atleast three percent of the
total of its demand and time liabilities in India as on the last
Friday of the second preceding fortnight and shall submit to
the Reserve Bank before the 20th day of every month a return
to that effect. This is known as CRR or Cash Reserve Ratio.
As has already been stated the RBI instructs the banking
companies to keep a certain CRR. This type of manipulation of
CRR is done for regulating the money market.
3.4 CONCLUDING REMARKS
Adequate capital and sufficient liquidity are the two hall marks
of success of commercial banks. If the liquidity goes higher
capital remains under-utilised. In fact one of the strongest
criticism of commercial banking in India is that loans and
advances are costlier because of high rate of interest. The interest
rate is high because a big part of the capital is required to be
locked up on account of CRR and SLR. It means that a part of
the capital has to work for the total capital. Liquidity is required
for having confidence on the monetary system and banking
institution. Certain percentage of cash keeps up the thickness
of monetary flow. But keeping reserve higher than that is
counter- productive. Generally speaking this step is used also
for checking the inflation. But theoretically checking flow of
money may lead to stagflation instead of controlling inflation.
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SUB TOPICS
4.1 Tandon Committee Report on Bank Credit
4.2 Chore Committee Report on Cash Credit
4.3 Restrictions on loans and advances
4.4 Concluding Remarks
4.1 TANDON COMMITTEE
1. The study group to frame guidelines for follow-up of bank
credit set up by the Reserve Bank of India (RBI) in July
1974, submitted its report in August 1975. The main
recommendations of the Group relate to :-
i. Norms for inventory and receivables ;
ii. approach to lending ;
iii. style of credit ;
iv. information system; and
v. bill finance
2. The guidelines are to be followed in regard to conduct of
advances to borrowers enjoying aggregate limits in excess
of Rs.10 lacs.
3. The norms for inventory and receivables are applicable to
all industrial borrowers including small-scale industries
with aggregate Working Capital limits from the banking
system in excess of Rs. 10 lacs. In respect of Industries for
which norms have not been suggested, the purpose and
spirit behind the norms should be kept in view. The
deviations from norms should be for known specific
circumstances and situations and allowed for agreed period
which should be relatively small.
4. The purpose of bank credit is only to supplement the
borrowers resources in carrying a reasonable level of
current assets in relation to production requirements.
5. The Working Capital Gap has been defined as the
difference between current assets and current liabilities
other than bank finance.
6. The level of current assets for this purpose should be in
conformity with the norms laid down for inventory and
receivables.
7. The study Group has recommended three alternative
methods for determining the maximum finance that could
be extended for meeting Working Capital requirements.
8. Under the I method, 25% of the Working Capital Gap
should be financed out of long term resources. The
maximum bank finance permissible under this Method
would, therefore, be 75% of the Working Capital Gap.
9. In the II Method, the borrower will have to provide a
minimum of 25% of total current assets from long term
funds; this will give a Current Ratio of at least 1.33:1.
10. In the III Method, the borrowers contribution from long
term funds will be to the extent of the entire core current
assets, as defined, and a minimum of 25% of the balance
current assets, thus strengthening the Current Ratio further.
(It has been decided not to implement this for the time
being).
11. The excess borrowings arising out of (i) excess current
assets levels and (ii) shortfall in the maintenance of Net
Working Capital should be converted into a Working
Capital Term Loan with a specific repayment schedule.
12. The Cash Credit limit can be bifurcated into _
i. a loan, comprising the minimum level of borrowing
which the borrower expects to use throughout the
year; and
ii. a Demand Cash Credit to take care of fluctuating
requirements, both being reviewed annually.
13. Receivables should be financed by way of bills.
14. In order to ensure that borrowers do not use the Cash Credit
facility in an unplanned manner, the financing should be
placed on a quarterly budgeting-reporting system.
15. The actual drawings in the Cash Credit account will be
determined by the borrowers inflow and outflow of funds,
as reflected in the quarterly funds flow statement.
4.2 CHORE COMMITTEE REPORT
1. Reserve Bank of India (RBI) appointed in March 1979, a
Working Group to review the system of Cash Credit in all
its aspects, particularly with reference to the unutilised gap
under sanctioned limits. The Group submitted its Final
Report in August 1979.
2. The major recommendations of the Working Group relate
to :
i. method of lending : II Method to be applied
straightaway to all borrowers with Working Capital
limits of Rs.50 lacs and above ;
ii. information system ;
iii. drawee bill system ; and
iv. follow-up of review/renewal of limits.
3. The information system would apply to all borrowers with
Working Capital Limits of Rs. 50 lacs and over.
4. All Working Capital limits of Rs. 10 lacs and over from the
banking system must be renewed at least once a year.
5. Wherever feasible, separate limits for peak and normal non-
peak level requirements should be fixed.
6. Ad-hoc or temporary limits should be granted under very
exceptional circumstances only and should entail additional
interest of 1% per annum.
7. 50% of the Cash Credit limit against raw materials to
manufacturing units should be granted by way of drawee
bills only.
4. RESTRICTIONS ON LOANS AND ADVANCES
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4.3 RESTRICTIONS ON LOANS AND ADVANCES
Sections 20, 20A and 21 of the Banking Regulation Act deal
with restrictions on loans and advances. The sections read -
Section 20 of the Act, laying down the restrictions on loans
and advances has been wholly amended from 1.2.1969. It is
applicable to the State Bank of India and the 20 nationalised
banks. Under the old section only a secured loan or advance
could be made to a director of a Banking Company or to the
firms or private companies, in which the director was interested
as partner, director or managing agent. A secured loan or
advance is defined in Section 5(n) of the Act which reads :-
5(n) :- Secured loan or advance means a loan or advance made
on the security of assets the market value of which is not at any
time less than the amount of such loan or advance; and
`unsecured loan or advance means a loan or advance not so
secured.
Section 20 as amended by the Amending Act 58 of 1968 is
much wider in scope; it is the pivot of the so called social control
over Banks. It prohibits a banking company from entering into
any commitment from granting any loan, secured or unsecured,
to any of its directors or to any firm or company or its subsidiary
or holding company in which a director is interested or even to
any individual for whom a director stands as a guarantor with
whom a director is a co partner in a firm.
1) Notwithstanding anything to the contrary contained in
Section 77 of the Companies Act, 1956, no banking
company shall,
(a) grant any loans or advances on the security of its own
shares ;
(b) enter into any commitment for granting any loan or
advance to or in behalf of -
(i) any of its directors; or
(ii) any firm in which any of its directors is interested as
partner, manager, employee or guarantor ; or
(iii) any company (not being a subsidiary of the banking
company or a company registered under Section 25
of the Companies Act, 1956, or a Government
Company) of which, or the subsidiary or the holding
company of which any of the directors of the banking
company is a director, managing agent, manager,
employee or guarantor or in which he holds
substantial interest; or
(iv) any individual in respect of whom any of its directors
is a partner or guarantor.
2) Where any loan or advance granted by a banking company
is such that a commitment for granting it could not have
been made if clause (b) of sub section (1) had been in force
on the date on which the loan or advance was made, or is
granted by a banking company after the commencement of
Section 5 of the Banking Laws (Amendment) Act, 1968,
but in pursuance of a commitment entered into before such
commencement, steps shall be taken to recover the amounts
due to the banking company on account of the loan or
advance together with interest, if any, due thereon within
the period stipulated at the time of the grant of the loan or
advance, or where no such period has been stipulated,
before the expiry of one year from the commencement of
the said Section 5:
Provided that the Reserve Bank may, in any case, on an
application in writing made to it by the banking company in
this behalf, extend the period for the recovery of the loan or
advance until such date, not being a date beyond the period of
three years from the commencement of the said Section 5, and
subject to such terms and conditions, as the Reserve Bank may
deem fit :
Provided further that this sub-section shall not apply if and when
the director concerned vacates the office of the director of the
banking company, whether by death, retirement, resignation or
otherwise.
3) No loan or advance, referred to in sub-section(2), or any
part thereof shall be remitted without the previous approval
of the Reserve Bank, and any remission without such
approval shall be void and of no effect.
4) Where any loan or advance referred to in sub-section (2),
payable by any person, has not been repaid to the banking
company within the period specified in that sub-section,
then, such person shall, if he is a director of such banking
company on the date of the expiry of the said period, be
deemed to have vacated his office as such on the said date.
Explanation : In this section _
(a) loans or advance shall not include any transaction
which the Reserve Bank may, having regard to the
nature of the transaction, the period within which,
and the manner and circumstances in which, any
amount due on account of the transaction is likely to
be realised, the interest of the depositors and other
relevant considerations, specify by general or special
order as not being a loan or advance for the purpose
of the section ;
(b) director includes a member of any board or
committee in India constituted by a banking company
for the purpose of managing, or for the purpose of
advising it in regard to the management of, all or any
of its affairs.
5) If any question arises whether any transaction is a loan or
advance for the purposes of this section, it shall be referred
to the Reserve Bank, whose decision thereon shall be final.
In clause (b) of sub-section (1), the words enter into
commitment for granting a loan or advance appear.
Committing is one step before granting. If a banker committs
to grant a loan, he will, as his reputation stands, in all probability
grant it. But the reason for drawing the line appears in sub
Section (2). There may be a loan violating sub section (1), the
commitment for which would have been entered before the date
on which the new section came into force (i.e. 1.2.1969) but
would have been granted till that date ; in such a case the banking
company can grant loan, but sub-section (2) requires the
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Banking company to recover the loan within its stipulated period
or if there is no such period within one year from 1.2.1969, or
requires the director concerned to vacate his office. If either
the advance is recovered or the director vacates within the said
period, he shall on the expiry of the period be deemed to be not
a director.
Clause (b) of Sub-section (1) is clear and speaks for itself in all
its sub-clauses except that sub-clause (iv) is somewhat confusing
when it refers to any individual in respect of whom any of its
directors is a partner. A question may be asked : how could
one individual to be a partner in respect of another ? The
sub-clause perhaps intends to refer to an individual who is a
partner of a director in a firm. In any event, it would be safe for
banking companies to read the sub-clause in this sense.
A question may arise whether a loan can be granted to a Hindu
Undivided Family of which a director is a co-parcener or
member. The Section is silent on this and on its strict
construction such a loan would not fall within its mischief.
Explanation (a) sub-section 4, to the Section is more exception
than an explanation. It can even be called a legal fiction.
Although it uses the word transaction, it in effect refers to a
loan or advance, since it talks of an amount due and period
within which it becomes due or is likely to be realised. The
explanation provides to the effect that a loan or advance shall
not be deemed to be a loan or advance for the purpose of the
Reserve Bank so desires by an order, general or special and
also provides that considerations induced it to pass such an order.
On such an order being passed, the disastrous effects of sub
sections 2 and 4 will be suspended. The Reserve Bank did
issue an order on 1.2.1969 specifying that for the purpose of
S.20, loans and advances shall not include (i) loans or advances
against Government securities, Life Insurance policies or fixed
deposits, and (ii) loans or advances to Agricultural finance
Corporation Ltd.
Sec. 20-A : Restrictions on power to remit debts
1) Notwithstanding anything to the contrary contained in
Section 293 of the Companies Act, 1956, a banking
company shall not, except with the prior approval of the
Reserve Bank, remit in whole or in part any debt due to it
by:-
(a) any of its directors, or
(b) any firm or company in which any of its directors is
interested as director, partner, managing agent or
guarantor, or
(c) any individual if any of its directors is his partner or
guarantor.
2) Any remission made in contravention of the provisions of
sub-section(1) shall be void and of no effect.
Sec. 21: Power of Reserve Bank to control advances by
banking companies
(1) Where the Reserve Bank is satisfied that it is necessary or
expedient in the public interest or in the interest of
depositors or banking policy so to do, it may determine the
policy in relation to advances to be followed by banking
companies generally or by any banking company in
particular, and when the policy has been so determined, all
banking companies or the banking company concerned, as
the case may be, shall be bound to follow the policy as so
determined.
(2) Without prejudice to the generality of the power vested in
the Reserve Bank under sub-section (1), the Reserve Bank
may give directions to banking companies, either generally
or to any banking company or group of banking companies
in particular as to :-
(a) the purposes for which the advance may or may not
be made,
(b) the margins to be maintained in respect of secured
advances,
(c) the maximum amount of advances or other financial
accomodation which, having regard to the paid-up
capital, reserves and deposits of a banking company
and other relevant considerations, may be made by
that banking company to any one company, firm,
association of persons or individual,
(d) the maximum amount up to which, having regard to
the considerations referred to in clause (c), guarantees
may be given by a banking company on behalf of
any one company, firm, association of persons or
individual, and
(e) the rate of interest and other terms and conditions in
which advances or other financial accomodation may
be made or guarantees may be given.
(3) Every banking company shall be bound to comply with
any directions given to it under this section.
When a nationalised bank charges a particular rate of interest
in pursuance of Reserve Banks direction it would be a special
circumstance justifying the said interest otherwise the bank
would have violated Section 21 attracting penalty provided in
Section 46. Indian Bank v. V.A.B.Gurukal, [AIR 1982 Mad
296.]
The Banking Laws (Amendment)Act, 1983 (1 of 1984) has
inserted a new section 21A w.e.f. 15.2.1984, so as to provide
that the rates of interest charged by banking companies to the
debtors shall not be re-opened in a court. The section reads as
under :
21-A: Rates of interest charged by banking companies not
to be subject to scrutiny of courts - Notwithstanding anything
contained in the Usurious Loans Act, 1918 (10 of 1918), or
any law relating to indebtedness in force in any State, a
transaction between a banking company and its debtor shall
not be reopened by any Court on the ground that the rate of
interest charged by the banking company in respect of such
transaction is excessive.
In Bank of India v. Karnam Ranga Rao and others, [(1988) 64
Comp.Cas, 477] the Karnataka High Court has held that Section
21-A is a restraint on the power of the court to re-open any
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account maintained by a bank relating to transactions with its
customers on the ground that the rate of interest charged, in the
opinion of the court, is excessive and unreasonable. However,
if it is proved that the interest charged by the banks on loans
advanced is not in conformity with the rates prescribed by the
Reserve Bank, the court can disallow such excess interest and
give relief to the party notwithstanding the provisions of section
21-A.
4.4 CONCLUDING REMARKS
Commercial banks keep the monetary system of a country
mobile. Through loans and advances it keeps the investment
line, maintains the productivity and keeps up the productivity.
But regulation of loans or advances is extremely necessary to
maintain an overall economic stability. Banking Regulation
Act provides this regulatory mechanism.
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SUB TOPICS
5.1 General Regulatory Outline
5.2 Wholetime Chairman
5.3 Additional Directors
5.4 Concluding Remarks
5.1 GENERAL REGULATORY OUTLINE
The powers of the Reserve Bank of India over the Management
of Banks is very wide. The Reserve Bank of India has been
armed with Draconian powers under the Banking Regulation
Act 1949 as amended from time to time. These powers are
spread over in a number of sections of the Act.
Section 10A :- This Section was introduced to subserve the
purpose of social control. The Section prescribes the nature
and composition of the Board of Directors who are responsible
for the management of Banking company. Sub sections 5,6,7
& 8 of Section 10 A read _
Sub-section(5). Where the Reserve Bank is of opinion that the
composition of the Board of Directors of a banking company is
such that it does not fulfil the requirements of sub-section(2) it
may, after giving to such banking company a reasonable
opportunity of being heard, by an order in writing, direct the
banking company to so re-constitute its Board of Directors as
to ensure that the said requirements are fulfilled and, if within
two months from the date of receipt of that order, the banking
comapny does not comply with the directions made by the
Reserve Bank, that Bank may, after determining, by lots drawn
in such manner as may be prescribed, the person who ought to
be removed from the membership of the Board of Directors,
remove such person from the office of the director of such
banking company and with a view to complying with the
provisions of sub-section(2), appoint a suitable person as a
member of the Board of directors in the place of the person so
removed whereupon the person so appointed shall be deemed
to have been duly elected by the banking company as its director;
Sub-section(6). Every appointment, removal or reconstitution
duly made, and every election duly held, under this section shall
be final and shall not be called into question in any court ;
Sub-section(7). Every director elected, or, as the case may be,
appointed under this section shall hold the office until the date
upto which his predecessor would have held office, if the
election had not been held, or, as the case may be, the
appointment had not been made;
Sub-section(8). No act or proceeding of the Board of directors
of a banking company shall be invalid by reason only of any
defect in the composition thereof or on the ground that it is
subsequently discovered that any of its members did not fulfil
the requirements of this section.
5.2 WHOLETIME CHAIRMAN
10 B: Banking Companies to be managed by Whole-time
Chairman
(1) Notwithstanding anything contained in any law for the time
being in force or in any contract to the contrary, every
banking company in existence on the commencement of
Section 3 of the Banking Laws (Amendment) Act, 1968,
or which comes into existence thereafter shall have one of
its directors as chairman of its Board of Directors who shall
be entrusted with the management of the whole of the affairs
of the banking company :
Provided that the chairman shall exercise his powers subject
to the superintendence, control and direction of the Board
of Directors:
Provided further that nothing in this sub-section shall apply
to a banking company in existence on the commencement
of the said section for a period of three months from such
commencement.
(2) Every Chairman of the Board of Directors of a banking
company shall be in the whole-time employment of such
company and shall hold the office for such period, not
exceeding five years, as the Board of Directors may fix,
but shall, subject to the provisions of this section, be eligible
for re-election or re-appointment:
Provided that nothing in this sub-section shall be construed
as prohibiting a chairman from being a director of a
subsidiary of the banking comapny or a director of a
company registered under Section 25 of the Companies
Act, 1956.
(3) Every person holding office on the commencement of
Section 3 of the Banking Laws (Amendment) Act, 1968,
as managing director of a banking company shall _
(a) if there is a chairman of its Board of Directors, vacate
office on such commencement, or
(b) if there is no chairman of its Board of Directors, vacate
office on the date on which the chairman of its Board
of Directors is elected or appointed in accordance with
the provisions of this section.
(4) Every chairman of the Board of Directors of a banking
company shall be a person who has special knowledge and
practical experience of _
(a) the working of a banking company, or of the State
Bank of India or any subsidiary bank or a financial
institution, or
(b) financial, economic or business administration :
Provided that a person shall be disqualified for being a chairman,
if he _
(a) is a director of any company other than a company
referred to in the proviso to sub-section (2), or
(b) is a partner of any firm which carries on any trade,
business or industry, or
(c) has substantial interest in any other company or firm,
or
5. REGULATION ON MANAGERIAL ORGANS
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(d) is a director, manager, managing agent, partner or
proprietor of any trading, commercial or industrial
concern, or
(e) is engaged in any other business or vocation.
(5) A Chairman of the Board of Directors of a banking
company may, by writing under his hand addressed to the
company, resign his office.
(5-A) A Chairman of the Board of Directors whose term of
office has come to an end, either by reason of his resignation
or by reason of expiry of the period of his office, shall,
subject to the approval of the Reserve Bank, continue in
office until his successor assumes office.
(6) Without prejudice to the provisions of Section 36-AA, where
the Reserve Bank is of opinion that any person who is, or
has been elected to be, the Chairman of the Board of
Directors of the banking company is not a fit and proper
person to hold such office, it may, after giving to such person
and to the banking company, a reasonable opportunity of
being heard, by order in writing, require the banking
company to elect or appoint any other person as the
chairman of its Board of Directors and if, within a period
of two months from the date of receipt of such order, the
banking company fails to elect or appoint a suitable person
as the chairman of its Board of Directors, the Reserve Bank
may, by order, remove the first mentioned person from the
office of the chairman of the Board of Directors of the
banking company and appoint a suitable person in his place
whereupon the person so appointed shall be deemed to have
been duly elected or appointed, as the case may be, as the
chairman of the Board of Directors of such banking
company and any person elected or appointed as chairman
under this sub-section shall hold office for the residue of
the period of office of the person in whose place he has
been so elected or appointed.
(7) The banking company and any person against whom an
order of removal is made under sub-section (6) may, within
thirty days from the date of communication to it or to him
of the order, prefer an appeal to the Central Government
and the decision of the Central Government thereon, and
subject thereto, the order made by the Reserve Bank under
sub-section (6), shall be final and shall not be called into
question in any court.
(8 Notwithstanding anything contained in this section, the
Reserve Bank may, if in its opinion it is necessary in the
public interest so to do, permit the chairman to undertake
such part-time honorary work as is not likely to interfere
with his duties as such chairman.
(9) Notwithstanding anything contained in this section, where
a person appointed as chairman dies or resigns or is by
infirmity or otherwise rendered incapable of carrying out
his duties or is absent on leave or otherwise in circumstances
not involving the vacation of his office, the banking
company may, with the approval of the Reserve Bank, make
suitable arrangements for carrying out the duties of
chairman for a total period not exceeding four months.
10-BB : Power of Reserve Bank to appoint Chairman of a
banking company
1) Where the office of the chairman of a banking company is
vacant, the Reserve Bank may, if it is of opinion that the
continuation of such vacancy is likely to adversely affect
the interests of banking company, appoint a person, eligible
under sub-section (4) of Section 10-B to be so appointed,
to be the Chairman of the banking company and where the
person so appointed is not a director of such banking
company, he shall, so long as he holds the office of the
chairman, be deemed to be a director of the banking
company.
2) The Chairman so appointed by the Reserve Bank shall be
in the whole-time employment of the banking company
and shall hold office for such period not exceeding three
years, as the Reserve Bank may specify, but shall, subject
to other provisions of this Act, be eligible for reappointment.
3) The Chairman so appointed by the Reserve Bank shall draw
from the banking company such pay and allowances as the
Reserve Bank may determine and may be removed from
office only by the Reserve Bank.
4) Save as otherwise provided in this section, the provisions
of Section 10-B, shall as far as may be, apply to the
Chairman appointed by the Reserve Bank under sub-section
(1) as they apply to a chairman appointed by a banking
company.
10-D : Provisions of Section 10-A and 10-B to override all
other laws, contracts, ect.
Any appointment or removal of a director or chairman in
pursuance of Section 10-A or Section 10 - B or Section 10BB
shall have effect and any such person shall not be entitled to
claim any compensation for the loss or termination of office,
notwithstanding anything contained in any law or in any
contract, memorandum or articles of association.
Under the above provisions the Reserve Bank of India is vested
with powers to do and undo the composition of Board of
Directors and Chairman of any Bank.
Section 35B: Amendments of provisions relating to
appointments of managing Directors, etc., to be subject to
previous approval of the Reserve Bank-
(1) In the Case of the banking company _
(a) no amendment of any provision relating to the
maximum permissible number of Directors or the
appointment or reappointment or termination of
appointment or remuneration of a chairman, a
managing director or any other director, whole-time
or otherwise or of a manager or a chief executive
officer by whatever name called, whether that
provision be contained in the companys
memorandum or articles of association, or in an
agreement entered into by it, or in any resolution
passed by the Company in general meeting or by its
Board of Directors shall have effect unless approved
by the Reserve Bank ;
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(b) no appointment or reappointment or termination of
appointment of a chairman, a managing or a whole
time Director, manager or chief executive officer by
whatever name called, shall have effect unless such
appointment is made with the previous approval of
the Reserve Bank.
Explanation : For the purposes of this sub-section, any provision
conferring any benefit or providing any amenity or perquisite,
in whatever form, whether during or after the termination of
the term of office of the chairman or the manager or the chief
executive officer by whatever name called or the managing
Director, or any other Director, whole-time or otherwise, shall
be deemed to be a provision relating to his remuneration.
(2) Nothing contained in Sections 262 and 269, the proviso to
sub-section(3) of Section 309, Sections 310 and 311, the proviso
to Section 387, and Section 388 (in so far as Section 388 makes
the provisions of Sections 269, 310 and 311 apply in relation to
the manager of a company) of the Companies Act, 1956, shall
apply to any matter in respect of which the approval of the
Reserve Bank has to be obtained under sub-section (1).
2-A : Nothing contained in Section 198 of the Companies Act,
1956 (1 of 1956) shall apply to a banking company and the
provisions of sub-section(1) of Section 309 and of Section 387
of that Act shall, in so far as they are applicable to a banking
company, have effect as if no reference had been made in the
said provisions to Section 198 of that Act.
(3) No act done by a person as chairman or a managing or
wholetime director or a director not liable to retire by rotation
or a manager or a chief execuive officer by whatever name
called, shall be deemed to be invalid on the ground that it is
subsequently discovered that his appointment or reappointment
had not taken effect by reason of any of the provisions of this
Act; but nothing in this sub-section shall be construed as
rendering valid any act done by such person after his
appointment or reappointment has been shown to the banking
company not to have had effect.
Decisions of Reserve Bank are subjective. They cannot be
challenged as violative of the prinicples of natural justice. [E.A.
Poyya Vs. Reserve Bank of India, AIR 1966 Ker 6.]
Sections 35B (1)(b) is not violative of Article 19(1) of the
Constitution. [ E.A. Poyya Vs. Reserve Bank of India, AIR
1966 Ker 6.]
Part II A of the Banking Regulation Act inserted by Act 55 of
1963 deals with control over management. These powers are
explained in sections 36 AA, 36AB and 36AC of the Act which
reads:
36AA: Power of Reserve Bank to remove managerial and
other persons from office
(1) Where the Reserve Bank is satisfied that in the public
interest or for preventing the affairs of a banking company
being conducted in a manner detrimental to the interests of
the depositors or for securing a proper management of any
banking company it is necessary so to do, the Reserve Bank
may, for reasons to be recorded in writing, by order, remove
from office, with effect form such date as may be specified
in the order, any chairman, director, chief executive officer
(by whatever name called) or other officer or employee of
the banking company.
(2) No order under sub-section (1) shall be made unless the
chairman, director or chief executive officer or other officer
or employee concerned has been given a reasonable
opportunity of making a representation to the Reserve Bank
against the proposed order :
Provided that if, in the opinion of the Reserve Bank, any delay
would be detrimental to the interests of the banking company
or its depositors, the Reserve Bank may, at the time of giving
the opportunity aforesaid or at any time thereafter, by order
direct that, pending the consideration of the representation
aforesaid, if any, the chairman or, as the case may be, director
or chief executive officer or other officer or employee, shall
not with effect from the date of such order _
(a) act as such chairman or director or chief executive
officer or other officer or employee of the banking
company ;
(b) in any way, whether directly or indirectly, be
concerned with, or take part in the management of
the banking company.
(3) (a) Any person against whom an order of removal has
been made under sub-section (1) may, within thirty
days from the date of communication to him of the
order, prefer an appeal to the Central Government.
(b) The decision of the Central Government on such
appeal, and subject thereto, the order made by the
Reserve Bank under sub-section (1) shall be final and
shall not be called into question in any court.
(4) Where any order is made in respect of a chairman, director
or chief executive officer or other officer or employee of a
banking company under sub-section (1), he shall cease to
be a chairman or, as the case may be, a director, chief
executive officer or other officer or employee of the banking
company and shall not, in any way, whether directly, or
indirectly be concerned with, or take part in the management
of, any banking company for such period not exceeding
five years as may be specified in the order.
(5) If any person in respect of whom an order is made by the
Reserve Bank under sub-section (1) or under the proviso
to sub-section (2) contravenes the provisions of this section,
he shall be punishable with fine which may extend to two
hundred and fifty rupees for each day during which such
contravention continues.
(6) Where an order under sub-section(1) has been made, the
Reserve Bank, may, by order in writing, appoint a suitable
person in place of the chairman or director or chief executive
officer or other officer or employee who has been removed
from his office under that sub-section, with effect from such
date as may be specified in the order.
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(7) Any person appointed as chairman, director or chief
executive officer or other officer or employee under this
section, shall _
(a) hold office during the pleasure of the Reserve Bank
and subject thereto for a period not exceeding three
years or such further period not exceeding three years
at a time as the Reserve Bank may specify:
(b) not incur any obligation or liability by reason only of
his being a chairman, director or chief executive
officer or other officer or employee or for anything
done or omitted to be done in good faith in the
execution of the duties of his office or in relation
thereto.
(8) Notwithstanding anything contained in any law or in any
contract, memorandum or articles of association, on the
removal of a person from office under this section, that
person shall not be entitled to claim any compensation for
the loss or termination of office.
5.3 ADDITIONAL DIRECTORS
36AB : Power of Reserve Bank to appoint additional
directors
(1) If the Reserve Bank is of opinion that in the interest of
banking policy or in the public interest or in the interests of
the banking company or its depositors it is necessary so to
do, it may, from time to time by order in writing, appoint,
with effect from such date as may be specified in the order,
one or more persons to hold office as additional directors
of the banking company :
(2) Any person appointed as additional director in pursuance
of this section-
(a) shall hold office during the pleasure of the Reserve Bank
and subject thereto for a period not exceeding three years
or such further periods not exceeding three years at a time
as the Reserve Bank may specify ;
(b) shall not incur any obligation or liability by reason only of
his being a director or for anything done or omitted to be
done in good faith in the execution of the duties of his office
or in relation thereto; and
(c) shall not be required to hold qualification-shares in the
banking company.
(3) For the purpose of reckoning any proportion of the total
number of directors of the banking company, any additional
director appointed under this section shall not be taken into
account.
36-AC: Part II-A to override other laws
Any appointment or removal of a director, chief executive officer
or other officer or employee in pursuance of Section 36-AA or
Section 36-AB shall have effect notwithstanding anything to
the contrary contained in the Companies Act, 1956, or any
other law for the time being in force or in any contract or any
other instrument.
The powers conferred are Draconian. Many of these also cannot
be challenged in a court. The Act has saved the applicability of
the other laws through many of these sections. The Reserve
Bank of India have exercised some of these powers. There are
cases when these powers were exercised under political
pressures on the Reserve Bank which is only an extended arm
of the government.
5.4 CONCLUDING REMARKS
RBI has general regulatory power on the management of the
banking companies in general and Nationalised Banks in
particular. The Central Government has also some controlling
functions. It has been found over the years that the Central
Government having two powers, namely, power in the role of
ownership and power in the role of a controller and the Reserve
Bank having its own powers and control, often may have
conflicting interests. The ownership interest of the Government
and the controlling interest of the RBI may conflict. In most of
these conflict interest situations RBI fails to have its say. This
has weakened the management of the Nationalised Banks.
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SUB TOPIC
6.1 GENERAL PROVISIONS ON CONTROL OVER
AMALGAMATION
6.1 CONTROL OVER AMALGAMATION AND
SCHEMES OF RECONSTRUCTION
The Procedure for amalgamation of banking companies is
contained in Section 44 A of the Banking Regulations Act. The
Section reads -
44A : Procedure for amalgamation of banking companies
(1) Notwithstanding anything contained in any law for the time
being in force, no bankng company shall be amalgamated
with another banking company, unless a scheme containing
the terms of such amalgamation has been placed in draft
before the shareholders of each of the banking companies
concerned separately, and approved by a resolution passed
by a majority in number representing two-thirds in value
of the shareholders of each of the said companies, present
either or by proxy at a meeting called for the purpose.
(2) Notice of every such meeting as is referred to in sub-section
(1) shall be given to every shareholder of each of the
banking companies concerned in accordance with the
relevant articles of association, indicating the time, place
and object of the meeting, and shall also be published at
least once a week for three consecutive weeks in not less
than two newspapers which circulate in the locality or
localities where the registered offices of the banking
companies concerned are situated, one of such newspapers
being in a language commonly understood in the locality
or localities.
(3) Any shareholder, who has voted against the scheme of
amalgamation at the meeting or has given notice in writing
at or prior to the meeting to the company concerned or to
the presiding officer of the meeting that he dissents from
the scheme of amalgamation, shall be entitled, in the event
of the scheme being sanctioned by the Reserve Bank, to
claim from the banking company concerned, in respect of
the shares held by him in that company, their value as
determined by the Reserve Bank when sanctioning the
scheme and such determination by the Reserve Bank as to
the value of the shares to be paid to the dissenting
shareholder shall be final for all purposes.
(4) If the scheme of amalgamation is approved by the requisite
majority of shareholders in accordance with the provisions
of this section, it shall be submitted to the Reserve Bank
for sanction and shall, if sanctioned by the Reserve Bank
by an order in writing passed in this behalf, be binding on
the banking companies concerned and also on all the
shareholders thereof.
(5) x x x x x x
(6) On the sanctioning of a scheme of amalgamation by the
Reserve Bank, the property of the amalgamated banking
company shall, by virtue of the order of saction, be
transferred to and vest in, and the liabilities of the said
company shall, by virtue of the said order be transferred
to, and become the liabilities of, the banking company
which under the scheme of amalgamation is to acquire the
business of the amalgamated banking company, subject in
all cases to the provisions of the scheme as sanctioned.
(6A) Where a scheme of amalgamation is sanctioned by the
Reserve Bank under the provisions of this section, the
Reserve Bank may, by a further order in writing, direct
that on such date as may be specified therein the banking
company (hereinafter in this section referred as the
amalgamated banking company) which by reason of the
amalgamation will cease to function, shall stand dissolved
and any such direction shall take effect notwithstanding
anything to the contrary contained in any other law.
(6B)Where the Reserve Bank directs a dissolution of the
amalgamated banking company, it shall transmit a copy of
the order directing such dissolution to the Registrar before
whom the banking company has been registered and on
receipt of such order the Registrar shall strike off the name
of the Company.
(6C) An order under sub-section (4), whether made before or
after the commencement of Section 19 of the Banking Laws
(Miscellaneous Provisions) Act, 1963 shall be conclusive
evidence that all the requirements of this section relating
to amalgamation have been complied with, and the copy
of the said order certified in writing by an officer of the
Reserve Bank to be a true copy of such order and the copy
of the scheme certified in the like manner to be a true copy
thereof shall, in all legal proceedings (whether in appeal or
otherwise and whether instituted before or after the
commencement of the said section 19), be admitted as
evidence to the same extent as the original order and the
original scheme.
(7) Nothing in the foregoing provisions of this section shall
affect the power of the Central Government to provide for
the amalgamation of two or more banking companies under
Section 396 of the Companies Act, 1956; Provided that no
such power shall be exercised by the Central Government
except after consultation with the Reserve Bank.
From the above section it can be seen that -
1) A scheme of amalgamation containing its terms to be
approved by a majority of shareholders of both the banks.
The majority of the shareholders should represent two thirds
of the value of shareholders. It should be approved in a
general meeting convened specially for the purpose ;
2) Sub section (2) of the section provides for the issue of notice
to the share holders of both the banks ;
6. AMALGAMATION AND RECONSTRUCTION
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3) Shareholders who dissent the amalgamators or who vote
against it will be entitled to receive the value of their shares
as decided by the Reserve Bank of India ;
4) When the scheme of amalgamation is approved by the
requisite majority of the shareholders, the scheme should
be submitted to the Reserve Bank of India in writing, it
shall be binding on both the banks and their shareholders;
5) As per sub-section (6) the assets and liabilities of the
transferor bank shall vest in the transferee bank subject to
the provisions of the scheme as sanctioned by the Reserve
Bank of India;
6) In terms of Sub-section (6A), the Reserve Bank will fix a
date from which the transferor or the amalgamated bank
will be dissolved and will cease to function;
(8) Sub-section (6B), provides for the issue of notice to the
Registrar of Companies by the Reserve Bank of India for
striking off the name of the transferor bank;
(9) An order passed by the Reserve Bank of India under sub-
section (4) shall be conclusive evidence that all the
requirements of this section relating to amalgamation has
been complied with;
(10)Sub-section (7) arms the Central Government with powers
to amalgamate two or more banking companies under
section 356 of the Companies Act. The proviso to the sub-
section provides for consultation by the Central
Government with the Reserve Bank of India.
Section 44B of the Act lays down -
Restriction on compromise or arrangement between banking
company and creditors - (1) Notwithstanding anything contained
in any law for the time being in force, no High Court shall
sanction a compromise or arrangement between a banking
company and its creditors or any class of them or between such
company and its members or any class of them or sanction any
modification in any such compromise or arrangement unless
the compromise or arrangement or modification, as the case
may be, is certified by the Reserve Bank in writing as not being
incapable of being worked and as not being detrimental to the
interests of the depositors of such banking company.
(2) Where an application under Section 391 of the Companies
Act, 1956, is made in respect of a banking company, the
High Court may direct the Reserve Bank to make an inquiry
in relation to the affairs of the banking company and the
conduct of its directors and when such a direction is given,
the Reserve Bank shall make such enquiry and submit its
report to the High Court.
(3) Where an application under Section 391 of the Companies
Act, 1956, is made in respect of a banking company,the
High Court may direct the Reserve Bank to make an inquiry
in relation to the affairs of the Banking company and the
conduct of its directors and when such a direction is given,
the Reserve Bank shall make such inquiry and submit its
report to the High Court.
Section 45 of the Banking Regulation Act empowers Reserve
Bank of India to apply to the Central Government for
supervision of business by a banking company and to prepare
scheme of reconstitution or amalgamation.
The section reads _
Power of Reserve Bank to apply to Central Government
for suspension of business by a banking company and to
prepare scheme of reconstitution or amalgamation -
(1) Notwithstanding anything contained in the foregoing
provisions of this part or in any other law of any agreement
or other instrument, for the time being in force, where it
appears to the Reserve Bank that there is good reason so to
do, the Reserve Bank may apply to the Central government
for an order of moratorium in respect of a banking company.
(2) The Central Government, after considering the application
made by the Reserve Bank under sub-section (1), may make
an order or moratorium staying the commencement or
continuance of all actions and proceedings against the
company for a fixed period of time on such terms and
conditions as it thinks fit and proper and may from time to
time extend the period so however that the total period of
moratorium shall not exceed six months.
(3) Except as otherwise provided by any directions given by
the Central Government in the order made by it under sub-
section (2) or at any time thereafter, the banking company
shall not during the period of moratorium make any
payment to any depositors or discharge any liabilities or
obligations to any other creditors.
4) During the period of moratorium, if the Reserve Bank is
satisfied that-
(a) in the public interst or
(b) in the interests of the depositors or
(c) in order to secure the proper management of the banking
company or
(d in the interests of the banking system of the country as a
whole, - it is necessary so to do, the Reserve Bank may
prepare a Scheme -
(i) for the reconstruction of the banking company or
(ii) for the amalgamation of the banking company with
any other banking institution (in this section referred
to as the transferee bank)
5) The schemes aforesaid may contain provisions for all or
any of the following matters, namely -
(a) the constitution, name and registered office, the
capital, assets powers, rights, interests, authorities and
privileges, the laibilities, duties and obligations of the
banking company on its reconstruction or, as the case
may be, of the transferee bank;
(b) in the case of amalgamation of the banking company,
the transfer to the transferee bank of the business,
properties, assets and liabilities of the banking
company on such terms and conditions as may be
specified in the scheme ;
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(c) any change in the Board of Directors, or the appointment
of a new Board of Directors, of the banking company on
its reconstruction, or as the case may be, of the transferee
bank and the authority by whom, the manner in which, and
the other terms and conditions, on which, such change or
appointment shall be made and in the case of appointment
of a new Board of Directors or of any director, the period
for which such appointment shall be made ;
(d) the alteration of the memorandum and articles of association
of the banking company on its reconstruction or, as the
case may be, the transferee bank, for the purpose of altering
the capital thereof or for such other purposes as may be
necessary to give effect to the reconstruction or
amalgamation;
(e) subject to the provisions of the scheme, the continuation
by or against the banking company on its reconstruction,
or as the case may be, the transferee bank, of any actions
or proceedings pending against the banking company
immediately before the date of the order of moratorium;
(f) the reduction of the interest or rights which the members,
depositors and other creditors have in or against the banking
company before its reconstruction or amalgamation to such
extent as the Reserve Bank considers necessary in the public
interest or in the interest of the members, depositors and
other creditors or for the maintenance of the business of
the banking company;
(g) the payment in cash or otherwise to depositors and other
creditors in full satisfaction of their claim _
(i) in respect of their interest or rights in or against the
banking company before its reconstruction or
amalgamation ; or
(ii) where their interests or rights aforesaid in or against
the banking company has or have been reduced under
clause (f), in respect of such interest or rights as so
reduced ;
(h) the allotment to the members of the banking company for
shares held by them therein before its reconstruction or
amalgamation whether their interest in such shares has been
reduced under clause (f) or not, of shares in the banking
company on its reconstruction or, as the case may be, in
the transferee bank and where any members claim payment
in cash and not allotment of shares, or where it is not
possible to allot shares to any members, the payment in
cash to those members in full satisfaction of their claim _
(i) in respect of their interest in shares in the banking
company before its reconstruction or amalgamation ;
or
(ii) where such interest has been reduced under clause
(f) in respect of their interest in shares as so reduced;
(i) the continuance of the services of all the employees
of the banking company (excepting such of them as
not being workmen specifically mentioned in the
scheme) in the banking company itself on its
reconstruction or, as the case may be, in the transferee
bank at the same remuneration and on the same terms
and conditions of service, which they were getting or
as the case may be, by which they were being
governed, immediately before the date of the order
of the moratorium :
Provided that the scheme shall contain a provision that -
i) the banking company shall pay or grant not later than the
expiry of the period of three years from the date on which
the scheme is sanctioned by the Central Government, to
the said employees the same remuneration and the same
terms and conditions of service as are, at the time of such
payment or grant, applicable to employees of corresponding
rank or status of a comparable banking company to be
determined for this purpose by the Reserve Bank whose
determination in this respect shall be final;
ii) the transferee bank shall pay or grant not later than the
expiry of the aforesaid period of three years, to the said
employees the same remuneration and the same terms and
conditions of service as are, at the time of such payment or
grant, applicable to the other employees of corresponding
rank or status of the transferee bank subject to the
qualifications and experience of the said employees of the
transferee bank:
Provided further that if in any case under clause (ii) of the first
proviso any doubt or difference arises as to the said employees
are the same as or equivalent to the qualifications and experience
of the other employees of corresponding rank or status of the
transferee bank, the doubt or difference shall be referred, before
the expiry of a period of three years from the date of payment
or grant mentioned in that clause to the Reserve Bank whose
decision thereon shall be final;
(j) notwithstanding anything contained in clause (i) where any
of the employees of the banking company not being
workmen within the meaning of the Industrial Disputes
Act, 1947 are specifically mentioned in the scheme under
clause (i), or where any employees of the banking company
or, as the case may be, the transferee bank at any time before
the expiry of one month next following the date on which
the scheme is sanctioned by the Central Government,
intimated their intention of not becoming employees of the
banking company on its reconstruction or, as the case may
be, of the transferee bank, the payment to such employees
of compensation, if any, to which they are entitled under
the Industrial Disputes Act, 1947, and such pension,
gratuity, provident fund and other retirement benefits
ordinarily admissible to them under the rules or
authorisations of the banking company immediately before
the date of the order of moratorium;
(k) any other terms and conditions for the reconstruction or
amalgamation of the banking company ;
(l) such incidental, consequential and supplemental
matters as are necessary to secure that the
reconstruction or amalgamation shall be fuly and
effectively carried out.
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99
6) (a) A copy of the scheme prepared by the Reserve Bank
shall be sent in draft to the banking company and
also to the transferee bank and any other banking
company concerned in the amalgamtion, for
suggestions and objections, if any, within such period
as the Reserve Bank may specify for this purpose ;
(b) The Reserve Bank may make such modifications, if
any, in the draft scheme as it may consider necessary
in the light of the suggestions and objections received
from the banking company and also from the
transferee bank, and any other banking company
concerned in the amalgamation and from any
members, depositors or other creditors of each of
those companies and the transferee bank.
7) The Scheme shall thereafter be placed before the Central
Government for its sanction and the Central Government
may sanction the scheme without any modifications or with
such modifications as it may consider necessary; and the
scheme as sanctioned by the Central Government shall
come into force on such date as the Central Government
may specify in this behalf;
Provided that different dates may be specified for different
provisions of the scheme.
7A) the sanction accorded by the Central Government under
sub-section (7) whether before or after the commencement
of Section 21 of the Banking Laws (Miscellaneous
Provisions) Act, 1963, shall be conclusive evidence that
all the requirements of this Section relating to the
reconstruction, or, as the case may be, amalgamation have
been complied with and a copy of the sanctioned scheme
certified in writing by an officer of the Central Governmet
to be true copy thereof, shall, in all legal proceedings
(whether in appeal or otherwise and whether instituted
before or after the commencement of the said Section 21),
be admitted as evidence to the same extent as the original
scheme.
8) On and from the date of the coming into operation of the
scheme or any provision thereof, the scheme or such
provision shall be binding on the banking company or, as
the case may be, on the transferee bank and any other
banking company concerned in the amalgamation and also
on all the members, depositors and other creditors and
employees of each of those companies and of the transferee
bank, and on any other person having any right or liability
in relation to any of those companies or the transferee bank
including the trustees or other persons managing, or
connected in any other manner with, any provident fund or
other fund maintained by any of those companies or the
transferee bank.
9) On and from the date of the coming into operation of, or as
the case may be, the date specified in this behalf in the
scheme, shall be substituted; the properties and assets of
the banking company shall, by virtue of and to the extent
provided in the scheme, stand transferred to, and vest in,
and the liabilities of the banking company shall, by virtue
of and to the extent provided in the scheme, stand
transferred to, and become the liabilities of, the transferee
bank.
10) If any difficulty arises in giving effect to the provisions of
the scheme, the Central Government may by order do
anything not inconsistent with such provisions which
appears to it necessary or expedient for the purpose of
removing the difficulty.
11) Copies of the scheme or of any order made under sub-
section(10) shall be laid before both Houses of Parliament,
as soon as may be, after the scheme has been sanctioned
by the Central Government, or, as the case may be, the
order has been made.
12) Where the scheme is a scheme for amalgamation of the
banking company, any business acquired by the transferee
bank under the scheme or under any provision thereof shall,
after the coming into operation of the scheme or such
provision, be carried on by the transferee bank in
accordance with the law governing the transferee bank,
subject to such modifications in that law or such exemptions
of the transferee bank from the operation of any provisions
thereof as the Central Government on the recommendation
of the Reserve Bank may, by notification in the Offical
Gazette, make for the purpose of giving full effect to the
scheme :
Provided that no such modification or exemption shall be made
so as to have effect for a period of more than seven years from
the date of the acquistion of such business.
13) Nothing in this section shall be deemed to prevent the
amalgamation with a banking institution by a single scheme
of several banking companies in respect of each of which
an order of moratorium has been made under this section.
14) The provisions of this section and of any scheme made
under it shall have effect notwithstanding anything to the
contrary contained in any other provisions of this Act or in
any of the law or any agreement, award or other instrument
for the time being in force.
15) In this section, banking institution means any banking
company and includes the State Bank of India or a
subsidiary bank or a corresponding new bank.
Explanation - References in this section to the terms and
conditions of service as applicable to an employee shall not be
construed as extending to the rank and status of such employee.
The guarantee under clause (i) of Section 45(5) of the Act does
not cover merely the remuneration; it covers the terms and
conditions of service as well, it would be a gross denial of the
guarantee if the employee is not given the rank and status which
he had in the transferor bank. It is not open to the transferee
bank to fit an employee of the transferor bank performing
the duties of a clerk into a subordinate cadre manned by
employees performing duties which are not clerical, but of
peons, watchmen, sweepers and the like. [State Bank of
Travancore Vs. Elias Elias, (1970) 2 SCC 761: (1970) 2 LLJ
424.]
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The word experience includes the quality of service, efficiency
of organisation, and the range and the volume of business
transacted. [State Bank of Travancore Vs. General Secretary,
(1978)2 LLJ 305:50 Com Cas 412 : 1978 Lab IC 1343.]
Framing of Scheme of amalgamation and giving a direction
under clause (f) of sub-section (5) cannot be treated as an
insolvency. [Simon Thomas Vs. State Bank, 1976 KLT 554
(FB).]
No notice is required to be given to the employee before his
name is included in the schedule of the scheme of amalgamation.
Reserve Bank need not pass speaking order. [Piare Lal Vs.
State Bank of India, 1973 Lab IC 761.]
The period of three years provided in section (45)(5)(i), (ii)
proviso cannot be meant to cover up the deficiencies of the
transferor bank and level up to the disparity between it and the
transferee bank. [State Bank of Travancore Vs. General
Secretary, (1978) 2 LLJ 305:50 Com Cas 412 : 1978 Lab IC
1343.]
To protect the interests of the depositors and to ensure stability
of the banking institutions there have been a number of
amalgamation of weaker banks with stronger banks. Instances
in which a Bank has been fully wound up or liquidated has not
been there in the last three decades.
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101
7. ACCOUNTS AND AUDIT
SUB TOPIC
7.1 General Control over Accounts and Audit
7.1 GENERAL CONTROL OVER ACCOUNTS AND
AUDIT
Section 29 of the Banking Regulation Act deals with Accounts
and Balance Sheet of a Banking company. The Section reads -
(1) At the expiration of each calendar year or at the expiration
of a period of twelve months ending with such date as the
Central Government may, by notification in the Official
Gazette, specify in this behalf, every banking company
incorporated in India, in respect of all business transacted
by it, and every banking company incorporated outside
India, in respect of all business transacted through its
branches in India, shall prepare with reference to that year
or period, as the case may be, a balance sheet and profit
and loss account as on the last working day of the year or
the period, as the case may be, in the Forms set out in the
Third Schedule or as near thereto as circumstances admit.
Provided that with a view to facilitating the transition from one
period of accounting to another period of accounting under this
sub-section, the Central Government may, by order published
in the Official Gazette, make such provisions as it considers
necessary or expedient for the preparation of, or for other matters
relating to, the balance sheet or profit and loss account in respect
of the concerned year or period, as the case may be.
Note:- Consequent to the amendment made in the Income-Tax
Act, 1961, every assessee shall follow the uniform Accounting
year beginning as on the 1st of April every year. Accordingly,
Banking companies are required to prepare their balance sheet
and the corrected Financial statements beginning April 1 of
every year. Hence the section has to be read in lieu of what is
stated above in this note.
(2) The balance sheet and profit and loss account shall be
signed-
(a) in the case of a banking company incorporated in
India, by the manager or the principal officer of the
company and where there are more than three
directors of the company, by at least three of those
directors, or where there are not more than three
directors, by all directors, and
(b) in the case of a banking company incorporated outside
India by the manager or agent of the principal office
of the company in India.
(3) Notwithstanding that the balance sheet of a banking
company is under sub-section (I) required to be prepared
in a form other than the form set out in Part I of Schedule
VI to the Companies Act, 1956, the requirements of that
Act relating to the balance sheet and profit and loss account
of a company shall, in so far as they are not inconsistent
with this Act, apply to the balance sheet or profit and loss
account, as the case may be, of a banking company.
(3-A) Notwithstanding anything to the contrary contained in
sub-section (3) of section 210 of the Companies Act, 1956
(1 of 1956), the period to which the profit and loss account
relates shall, in the case of a banking company, be the period
ending with the last working day of the year immediately
preceding the year in which the annual general meeting is
held.
Explanation - In Sub-section (3-A), year means the year or,
as the case may be, the period referred to in sub-section (1).
The third schedule prescribed in the section has undergone a
great change from the Accounting year ending March 1993,
particularly those relating to the classification of assets.
Section 30 of the Banking Regulation Act deals with Audit,
and Sections 31, 32, 33, 34 and 34A deal with the related
provisions -
The sections read -
Section 30 Audit-
The balance sheet and profit and loss account prepared in
accordance with section 29 shall be audited by a person duly
qualified under any law for the time being in force to be an
auditor of companies.
(1A) Notwithstanding anything contained in any law for the
time being in force or in any contract to the contrary, every
banking company shall, before appointing, reappointing
or removing any auditor, or auditors obtain the previous
approval of the Reserve Bank.
(1B) Without prejudice to anything contained in the Companies
Act, 1956, or any other law for the time being in force,
where the Reserve Bank is of opinion that it is necessary in
the public interest or in the interests of the banking company
or its depositors to do so, it may at any time, by order direct
that a special audit of the banking companys accounts, for
any such transaction or class of transactions or for such
period or periods as may be specified in the order, shall be
conducted and may by the same or a different order either
appoint a person duly qualified under any law for the time
being in force to be an auditor of companies or direct the
auditor of the banking company himself to conduct such
special audit, and the auditor shall comply with such
directions and make a report of such audit to the Reserve
Bank and forward a copy thereof to the company.
(1C) The auditor shall have the powers of, exercise the functions
vested in, and discharge the duties and be subject to the
liabilities and penalties imposed on, auditors of companies
by Section 227 of the Companies Act, 1956 and auditors,
if any, appointed by the law establishing, constituting or
forming the banking company concerned.
(3) In addition to the matters which under the aforesaid Act
the auditor is required to state in his report, he shall, in the
case of a banking company incorporated in India, state in
his report -
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(a) whether or not the information and explanations required
by him have been found to be satisfactory ;
(b) whether or not the transactions of the company which have
come to his notice have been within the powers of the
Company;
(c) whether or not the returns received from branch offices of
the company have been found adequate for the purposes
of his audit ;
(d) whether the profit and loss account shows a true balance of
profit and loss for the period covered by such account ;
(e) any other matter which he considers should be brought to
the notice of the shareholders of the company.
Section 31: Submission of returns
The accounts and balance sheet referred to in Section 29 together
with the auditors report shall be published in the prescribed
manner and three copies thereof shall be furnished as returns to
the Reserve Bank within three months from the end of the period
to which they refer :
Provided that the Reserve Bank may in any case extend the
said period of three months for the furnishing of such returns
by a further period not exceeding three months:
Provided further that a regional rural bank shall furnish returns
also to the National Bank.
Section 32: (1) copies of balance sheets and accounts to be
sent to Registrar
Where a banking company in any year furnished its accounts
and balance sheet in accordance with the provisions of Section
31, it shall at the same time send to the registrar three copies of
such accounts and balance sheet and of the auditors report,
and where such copies are so sent, it shall not be necessary to
file with the registrar, in the case of public company, copies of
accounts and balance-sheet and of the auditors report, and, in
the case of a private company, copies of the balance sheet and
of the auditors report as required by sub-section (1) of Section
220 with the same fee and shall be dealt within all respects as if
they were filed in accordance with that section.
(2) When in pursuance of sub-section (2) of Section 27 the
Reserve Bank requires any additional statement or information
in connection with the balance sheet and accounts furnished
under Section 31, the banking company shall, when supplying
each statement or information, send a copy thereof to the
registrar.
Section 33 : Display of audited balance sheets by companies
incorporated outside India
Every banking company incorporated [outside India] shall, not
later than the first Monday in August of any year in which it
carries on business, display in a conspicuous place in its
principal office and in every branch office [in India] a copy of
its last audited balance sheet and profit and loss account prepared
under Section 29, shall keep the copy so displayed until replaced
by a copy of the subsequent balance sheet and profit and loss
account so prepared, and every such banking company shall
display in like manner copies of its complete audited balance
sheet and profit and loss account relating to its banking business
as soon as they are available, and shall keep the copies so
displayed until copies of such subsequent accounts are available.
Section 34 : Accounting provisions of the Act not
retrospective
Nothing in this Act shall apply to the preparation of accounts
by a banking company and the audit and submission thereof in
respect of any accounting year which has expired prior to the
commencement of this Act, and notwithstanding the other
provisions of this Act, such accounts shall be prepared, audited
and submitted in accordance with the law in force immediately
before the commencement of this Act.
Section 34-A : Production of documents of confidential nature
(1) Notwithstanding anything contained in Section 11 of the
Industrial Disputes Act. 1947, or other law for the time
being in force, no banking company shall, in any proceeding
under the said Act or in any appeal or other proceeding
arising therefrom or connected therewith, be compelled by
any authority before which such proceeding is pending to
produce, or give inspection of, any of its books of account
or other document or furnish or disclose any statement or
information, when the banking company claims that such
document, statement or inspection of such document or the
furnishing of disclosure of such statement or information
would involve disclosure of information relating to -
(a) any reserves not shown in its published balance-sheet;
or
(b) any particulars not shown therein in respect of
provisions made for bad and doubtful debts and other
usual or necessary provisions.
(2) If any such proceeding in relation to any banking company
other than the Reserve Bank of India, any question arises
as to whether any amount out of the reserves or provisions
referred to in sub-section (1) should be taken into account
by the authority before which such proceeding is pending
the authority, may, if it so thinks fit, refer the question to
the Reserve Bank and the Reserve Bank shall, after taking
into account principles of sound banking and all relevant
circumstances concerning the banking company, furnish
to the authority a certificate stating that the authority shall
not take into account any amount as such Reserves and
provisions of the banking company or may take them into
account only to the extent of the amount specified by it in
the certificate, and the certificate of the Reserve Bank on
such question shall be final and shall not be called in
question in any such proceeding.
(3) For the purposes of this section banking company
includes the Reserve Bank, the Development Bank, the
Exim Bank, the Reconstruction Bank, the National Housing
Bank, the national Bank, the Small Industries Bank, the
State Bank of India, a corresponding new bank a regional
rural bank and a subsidiary bank.
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103
Section 35: Inspection
(1) Notwithstanding anything to the contrary contained in
Section 235 of the Companies Act, 1956, the Reserve Bank
at any time may, and on being directed so to do by the
Central Government shall, cause an inspection to be made
by one or more of its officers of any banking company and
its books and accounts; and the Reserve Bank shall supply
to the banking company a copy of its report on such
inspection.
1-A : (a) Notwithstanding to the contrary contained in any law
for the time being in force and without prejudice to
the provisions of sub-section (1), the Reserve Bank,
at any time, may also cause a scrutiny to be made by
any one or more of its officers, of the affairs of any
banking company and its books and accounts; and
(b) a copy of the report of the scrutiny shall be furnished
to the banking company if the banking company
makes a request for the same or if any adverse action
is contemplated against the banking company on the
basis of the scrutiny.
(2) It shall be the duty of every director or other officer or
employee of the banking company to produce to any officer
making an inspection under sub-section (1) or a scrutiny
under sub-section (1A) all such books, accounts and other
documents in his custody or power to furnish him with any
statements and information relating to the affairs of the
banking company as the said officer may require of him
within such time as the said officer may specify.
(3) any person making an inspection under sub-section (1) or
a scrutiny under sub-section (1A) may examine on oath
any director or other officer or employee of the banking
company in relation to its business, and may administer an
oath accordingly.
(4) The Reserve Bank shall, if it has been directed by the
Central Government to cause an inspection to be made,
and may, in any other case, report to the Central Government
on any inspection or scrutiny made under this section, and
the Central Government, if it is of opinion after considering
the report that the affairs of the banking company are being
conducted to the detriment of the interest of the depositors,
may, after giving such opportunity to the banking company
to make a representation in connection with the report as,
in the opinion of the Central government, seems reasonable,
by order in writing -
(a) prohibit the banking company from receiving fresh
deposits;
(b) direct the Reserve Bank to apply under Section 38
for the winding up of the banking company;
Provided that the Central Government may defer, for such
period as it may think fit, the passing of an order under this
sub-section, or cancel or modify any such order upon such
terms and conditions as it may think fit to impose.
(5) The Central Government may, after giving reasonable notice
to the banking company, publish the report submitted by the
Reserve Bank or such portion thereof as may appear necessary.
Explanation: For the purposes of this section, the expression
banking company shall include -
i) in the case of a banking company incorporated outside
India, all its branches in India; and
ii) in the case of a banking company incorporated in
India -
a) all its subsidiaries formed for the purpose of carrying on
the business of banking exclusively outside India; and
b) all its branches whether situated in India or outside India.
(6) the powers exercisable by the Reserve Bank under this
section in relation to regional rural banks may without
prejudice to the exercise of such powers by the Reserve
Bank in relation to any regional rural bank whenever it
considers necessary so to do to be exercised by the national
Bank in relation to the regional rural banks as if every
reference therein to the Reserve Bank included also a
reference to the National Bank.
Sub-section (4) of section 35 relates to Bank for which licence
has already been given. [Sajjan Bank (P) Ltd. Vs. Reserve
Bank of India, AIR 1961 Mad 8.]
It is open to the Reserve Bank to consider the defects or
improvements revealed in an application under Section 35 for
disposing of the application for licence as there is nothing in
the Act to prohibit it from taking into consideration all relevant
facts. [Sajjan Bank (P) Ltd Vs. Reserve Bank of India, AIR
1961 Mad 8].
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8 OTHER POWERS OF R.B.I.
The other powers, which are specifically enacted are detailed
in the following sections of the Banking Regulations Act. These
are -
1) Section 35A of the Banking Regulations Act, 1949 deals
with the Power of Reserve Bank to give directions. The
section reads -
35A : Power of the Reserve Bank to give directions
(1) Where the Reserve Bank is satisfied that -
(a) in the public interest; or
(aa) in the interest of banking policy; or
(b) to prevent the affairs of any banking company being
conducted in a manner detrimental to the interests of
the depositors or in a manner prejudicial to the
interests of the banking company; or
(c) to secure the proper management of any banking
company generally;
It may be required to issue directions to banking companies
generally or to any banking company in particular, RBI from
time to time, issues such directions as it deems fit, and the
banking companies or the banking company, as the case may
be, shall be bound to comply with such directions.
(2) The Reserve Bank may, on representation made to it or on
its own motion, modify or cancel any direction issued under
sub-section (I), and in so modifying or cancelling any
direction may impose such conditions as it thinks fit, subject
to which the modification or cancellation shall have effect.
The Reserve Bank is entitled to give directions to bankers under
Section 20(3) of the Foreign Exchange Regulation Act, 1947
blocking certain accounts. Section 20(3) does not contemplate
the issue of a prior notice before taking such action under that
section. [Mohamed Ayisha Nachiyar Vs. Deputy Director,
Enforcement, (1976) 46 Com Cas 653 (Mad)]
Directions by Reserve Bank cannot prevent payment of higher
bonus in terms of the agreement. [American Express
International Banking Corp. Vs. S.Sundaram, (1978) I SCC
101: 1978 SCC (L & S) 34.]
2) Section 36: Further powers and functions of Reserve
Bank.
The Reserve Bank may -
(a) caution or prohibit companies generally or any banking
company in particular against entering into any particular
transaction or class of transactions, and generally give
advice to any banking company;
(b) on a request by the companies concerned and subject to
the provisions of Section 44A, assist, as intermediary or
otherwise, in proposals for the amalgamation of such
banking companies;
(c) give assistance to any banking company by means of the
grant of a loan or advance to it under clause (3) of sub-
section (1) of Section 18 of the Reserve Bank of India Act,
1934;
(d) at any time, if it is satisfied that in the public interest or in
the interest of banking policy or for preventing the affairs
of the banking company being conducted in a manner
detrimental to the interests of the banking company or its
depositors it is necessary so to do, by order in writing and
on such terms and conditions as may be specified therein-
(i) require the banking company to call a meeting of its
directors for the purpose of considering any matter
relating to or arising out of the banking company, or
require an officer of the banking company to discuss
any such matter with an officer of the Reserve Bank;
(ii) depute one or more of its officers to watch the
proceedings at any meeting of the Board of Directors
of the banking company or of any committee or of
any other body constituted by it; require the banking
company to give an opportunity to the officers so
deputed to be heard at such meetings and also require
such officers to send a report to such proceedings to
the Reserve Bank;
(iii) require the Board of Directors of the banking
company or any committee or any other body
constituted by it to give in writing to any officer
specified by the Reserve Bank in this behalf at this
usual address all notices of, and other communications
relating to, any meeting of the Board, committee or
other body constituted by it;
(iv) appoint one or more of its officers to observe the
manner in which the affairs of the banking company
or of its offices or branches are being conducted and
make a report thereon;
(v) require the banking company to make, within such
time as may be specified in the order, such changes
in the management as the Reserve Bank may consider
necessary.
II. The Reserve Bank shall make an annual report to the Central
Government on the trend and progress of banking in the country,
with particular reference to its activities under clause (2) of
Section 17 of the Reserve Bank of India Act, 1934, including
in such report its suggestions, if any, for the strengthening of
banking business throughout the country.
III. The Reserve Bank may appoint such staff at such places as
it considers necessary for the scrutiny of the returns, statements
and information furnished by banking companies under this
Act, and generally to ensure that efficient performance of its
functions under this Act.
Section 45(P): RBI to tender advice in winding up
proceedings
Where in any proceeding for the winding up of a banking
company in which any person other than the Reserve Bank has
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105
been appointed as the official liquidator and the High court has
directed the official liquidator to obtain the advice of the Reserve
Bank on any matter (which it is hereby empowered to do), it
shall be lawful for the Reserve Bank to examine the record of
any such proceeding and tender such advice on the matter as it
may think fit.
Sections 45(Q) and 45(R) lay down :-
Section 45(Q): Power to inspect
(1) The Reserve Bank shall, on being directed so to do by the
Central Government or by the High court, cause an
inspection to be made by one or more of its officers of a
banking company which is being wound up and its books
and accounts.
(2) On such inspection, the Reserve Bank shall submit its report
to the Central Government and the High Court.
(3) If the Central government, on consideration of the report
of the Reserve Bank, is of opinion that there has been a
substantial irregularity in the winding up proceedings, it
may bring such irregularity to the notice of the High court
for such action as the High Court may think fit.
(4) On receipt of the report of the Reserve Bank under sub-
section (2) or on any irregularity being brought to its notice
by the Central government under sub-section (3), the High
court may, if it deems fit, after giving notice to and hearing
the Central Government in regard to the report, give such
directions as it may consider necessary.
45(R): Power to call for returns and information
The Reserve Bank may, at any time by a notice in writing,
require the liquidator of a banking company to furnish it, within
such time as may be specified in the notice or such further time
as the Reserve Bank may allow, any statement or information
relating to or connected with the winding up of the banking
company; and it shall be the duty of every liquidator to comply
with such requirements.
Explanation :
For the purposes of this section and Section 45Q, a banking
company working under a compromise or arrangement but
prohibited from receiving fresh deposits, shall, as far as may
be, deemed to be a banking company which is being wound up.
Section 47: Cognizance of offences
No court shall take cognizance of any offence punishable under
sub-setion (5) of Section 36AA or Section 46 except upon
complaint in writing made by an officer of the Reserve Bank
or, as the case may be, the National Bank generally or specially
authorised in writing in this behalf by the Reserve Bank or, as
the case may be, the National Bank and no court other than that
of a Metropolitan Magistrate or a Judicial Magistrate of the
first class or any court superior thereto shall try any such offence.
47A : Power of Reserve Bank to impose penalty
(1) notwithstanding anything contained in Section 46, if a
contravention or default of the nature referred to in sub-section
(3) or sub-section (4) of Section 46, as the case may be, is made
by a banking company, then, the Reserve Bank may impose on
such banking company -
(a) where the contravention is of the nature referred to
in sub-section (3) of Section 46, a penalty not
exceeding twice the amount of the deposits in respect
of which such contravention was made;
(b) where the contravention or default is of the nature
referred to in Sub-section (4) of Section 46, a penalty
not exceeding two thousand rupees; and where such
contravention or default is a continuing one, a further
penalty which may extend to one hundred rupees for
every day, after the first, during which the
contravention or default continues.
(2) for the purpose of adjudging the penalty under sub-section
(1), the Reserve Bank shall hold an inquiry in the prescribed
manner after giving the banking company a reasonable
opportunity of being heard.
(3) While holding an inquiry under this section, the Reserve
Bank shall have power to summon and enforce the
attendance of any person to give evidence or to produce
any document or any other thing which, in the opinion of
the Reserve Bank, may be useful for, or relevant to, the
subject matter of the enquiry.
(4) No complaint shall be filed against any banking company
in any court of law in respect of any contravention or default
in respect of which any penalty has been imposed by the
Reserve Bank under this section.
(5) Any penalty imposed by the Reserve Bank under this section
shall be payable within a period of fourteen days from the
date on which notice issued by the Reserve Bank demanding
payment of the sum is served on the banking company and
in the event of failure of the banking company to pay the
sum within such period, may be levied on a direction made
by the principal civil court having jurisdiction in the area
where the registered office of the banking company is
situated; or, in the case of a banking company incorporated
outside India, where its principal place of business in India
is situated:
Provided that no such direction shall be made except on an
application made to the Court by the Reserve Bank or any
officer authorised by that Bank in this behalf.
(6) The court which makes a direction under Sub-section (5)
shall issue a certificate specifying the sum payable by the
banking company and every such certificate shall be
enforceable in the same manner as it were a decree made
by the court in a civil suit.
(7) Where any complaint has been filed against any banking
company in any court in respect of the contravention or
default of the nature referred to in sub-section (4) of Section
46, then, no proceedings for the imposition of any penalty
on the banking company shall be taken under this section.
Sections 49A, 49B and 49C deal with the following:
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49A : Restriction on acceptance of deposits withdrawable
by cheque
No person other than a banking company, the Reserve Bank,
the State Bank of India or any other banking institution, firm or
other person notified by the Central Government in this behalf
on the recommendation of the Reserve Bank shall accept from
the public deposits of money withdrawable by cheque:
Provided that nothing contained in this section shall apply to
any savings bank scheme run by the Government.
49B : Change of name by a banking Company
Notwithstanding anything contained in Section 21 of the
Companies Act 1956, the Central Government shall not signify
its approval to the change of name of any banking company
unless the Reserve Bank certifies in writing that it has no
objection to such change.
49C : Alteration of memorandum of a banking company
Notwithstanding anything contained in the Companies Act,
1956, no application for the confirmation of the alteration of
the memorandum of a banking company shall be maintainable
unless the Reserve Bank certifies that there is no objection to
such alteration.
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107
Section 36AE: Power of Central Government to acquire
undertakings of banking companies in the following cases
(1) If upon receipt of a report from the Reserve Bank, the
Central Government is satisfied that a banking company -
(a) has, on more than one occassion, failed to comply
with the directions given to it in writing under Section
21 or Section 35-A, in so far as such directions relate
to banking policy, or
(b) is being managed in a manner detrimental to the
interest of its depositors,
and that -
(i) in the interests of the depositors of such banking
company, or
(ii) in the interest of banking policy, or
(iii) for the better provision of credit generally or of credit
to any particular section of the community or in any
particular area;
It is necessary to acquire the undertaking of such banking
company, the Central Government, may, after such consultation
with the Reserve Bank as it thinks fit, by notified order, acquire
the undertaking of such company (hereinafter referred to as the
acquired bank) with effect from such date as may be specified
in this behalf by the Central Government (hereinafter referred
to as the appointed day) :
Provided that no undertaking of any banking company shall be
so acquired unless such banking company has been given a
reasonable opportunity of showing cause against the proposed
action.
Explanation - In this part,
(a) notiified order means an order published in the
Official Gazette;
(b) undertaking, in relation to a banking company
incorporated outside India, means the undertaking of
the company in India.
(2) Subject to the other provisions contained in this Part, on
the appointed day, the undertaking of the acquired bank
and all the assets and liabilities of the acquired bank shall
stand transferred to, and vest in, the Central Government.
(3) The undertaking of the acquired bank and its assets and
liabilities shall be deemed to include all rights, powers,
authorities and privileges and all property, whether
movable, or immovable, including in particular, cash
balances, reserve funds, investments, deposits and all other
interests and right in, or arising out of such property as
may be in the possession of, or held by, the acquired bank
immediately before the appointed day and all books,
accounts and documents relating thereto, and shall also be
deemed to include all debts, liabilities and obligations, of
whatever kind, then existing of the acquired bank.
(4) Notwithstanding anything contained in sub-section (2), the
Central Government may, if it is satisfied that the
undertaking of the acquired bank and its assets and liabilities
should, instead of vesting in the Central Government, or
continuing to so vest in a company established under any
scheme made under this Part or in any corporation
(hereinafter in this part and in the Fifth Schedule referred
to as the transferee bank) that government may, by order,
direct that the said undertaking, including the assets and
liabilities thereof, shall vest in the transferee bank either
on the publication of the notified order or on such other
date as may be specified in this behalf by the Central
Government.
(5) Where the undertaking of the acquired bank and the assets
and liabilities thereof vest in the transferee bank under sub-
section(4), the transferee bank, shall, on and from the date
of such vesting, be deemed to have become and trasferee
of the acquired bank and all the rights and liabilities in
relation to the acquired bank shall, on and from the date of
such vesting, be deemed to have been the rights and
liabilities of the transferee bank.
(6) Unless otherwise expressly provided by or under this Part,
all contracts, deeds, bonds, agreements, powers of attorney,
grants of legal representation and other instruments of
whatever nature subsisting or having effect immediately
before the appointed day and to which the acquired bank is
a party or which are in favour of the acquired bank shall be
of full force and effect against or in favour of the Central
Government, or as the case may be, of the transferee bank,
and may be enforced or acted upon as fully and effectually
as if in the place of the acquired bank the Central
Government or the transferee bank had been a party thereto
or as if they had been issued in favour of the Central
Government or the transferee bank, as the case may be.
(7) If, on the appointed day, any suit, or other proceeding of
whatever nature is pending by or against the acquired bank,
the same shall not abate, be discontinued or be, in anyway,
prejudicially affected by reason of the transfer of the
undertaking of the acquired bank or of anything contained
in this Part, but the suit, appeal or other proceeding may be
continued, prosecuted and enforced by or against the
Central Government or the transferee bank, as the case may
be.
36AF : Power of the Central government to make scheme
(1) The Central Government may, after consultation with the
Reserve Bank, make a scheme for carrying out the purposes
of this Part in relation to any acquired bank.
(2) In particular, and without prejudice to the generality of the
foregoing power, the said scheme may provide for all or
any of the following matters namely :-
9. OTHER POWERS OF THE CENTRAL GOVERNMENT
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(a) the Corporation, or the company incorporated for the
purpose, to which the undertaking including the
property, assets and liabilities of the acquired bank
may be transferred, and the capital, constitution, name
and office thereof.
(b) the constitution of the first Board of management (by
whatever name called) of the transferee bank, and all
such matters in connection therewith or incidental
thereto as the Central Government may consider to
be necessary or expedient ;
(c) the continuance of the services of all the employees
of the acquired bank (excepting such of them as, not
being workmen within the meaning of the Industrial
Disputes Act, 1947, are specifically mentioned in the
scheme) in the Central Government or in the
transferee bank, as the case may be, on the same terms
and conditions so far as may be, as are specified in
clauses (i) and (j) of sub-section (5) of Section 45;
(d) the continuance of the right of any person who, on
the appointed day, is entitled to or in receipt of,
pension or other superannuation or compassionate
allowance or benefit, from the acquired bank or any
provident, pension or other fund or any authority
administering such fund, to be paid by, and to receive
from, the Central Government or the transferee bank,
as the case may be, or any provident fund, pension or
other fund or any authority administering such fund,
the same pension, allowance or the benefit so long as
he observes the conditions on which the pension,
allowance or benefit was granted, and if any question
arises whether he has so observed such conditions,
the question shall be determined by the Central
Government and the decision of the Central
Government thereon shall be final;
(e) the manner of payment of compensation payable in
accordance with the provisions of this Part to the
shareholders of the acquired bank, or where the
acquired bank is a banking company incorporated
outside India, to the acquired bank in full satisfaction
of their, or as the case may be, its, claims ;
(f) the provision, if any, for completing the effectual
transfer to the Central Government or the transferee
bank of any asset or any laibility which forms part of
the undertaking of the acquired bank in any country
outside India;
(g) such incidental, consequential and supplemental
matters as may be necessary to secure that the transfer
of the business, property, assets and liabilities of the
acquired bank to the Central Government or transferee
bank, as the case may be, is effectual and complete.
(3) The Central government may, after consultation with the
Reserve Bank, by notification in the Official Gazette, and
to, amend or vary any scheme made under this section.
(4) Every scheme under this section shall be published in the
Official Gazette.
(5) Copies of every scheme made under this section shall be
laid before each House of Parliament as soon as may be
after it is made.
(6) The provisions of this Part and to any scheme made
thereunder shall have effect notwithstanding anything to
the contrary contained in any other provisions of this Act
or in any other law or any agreement, award or other
instrument for the time being in force.
(7) Every scheme made under this section shall be binding on
the Central Government or, as the case may be, on the
transferee bank and also on all members, creditors,
depositors and employees of the acquired bank and of the
transferee bank and on any other person having any right,
liaibility, power or function in relation to, or in connection
with, the acquired bank or the transferee bank, as the case
may be.
36AG: Compensation to be given to shareholders of the
acquired bank
(1) Every person who, immediately before the appointed day,
is registered as a holder of shares in the acquired bank or,
where the acquired bank is a banking company incorporated
outside India, the acquired bank, shall be given by the
Central Government, or the transferee bank, as the case
may be, such compensation in respect of the transfer of the
undertaking of the acquired bank as is determined in
accordance with the principles contained in the Fifth
Schedule.
(2) Nothing contained in sub-section (1) shall affect the rights
inter se between the holder of any share in the acquired
bank and any other person who may have any interest in
such shares and such other persons shall be entitled to
enforce his interest against the compensation awarded to
the holder of such share, but not against the Central
Government, or the transferee bank.
(3) The amount of compensation to be given in accordance
with the principles contained in the Fifth schedule shall be
determined in the first instance by the Central Government,
or the transferee bank, as the case may be, in consultation
with the Reserve Bank, and shall be offered by it to all
those to whom compensation is payable under sub-section
(1) in full satisfaction thereof.
(4) If the amount of compensation offered in terms of sub-
section (3) is not acceptable to any person to whom the
compensation is payable, such person may, before such days
as may be notified by the Central Government in the Official
Gazette, requrest the Central Government in writing, to have
the matter referred to the Tribuanl constituted under Section
36AH.
(5) If, before the date notified under sub-section (4), the Central
Government receives requests, in terms of that sub-section,
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109
from not less than one-fourth in number of the share holders
holding not less than one fourth in value of the paid up
share capital of the acquired bank, or, when the acquired
bank is a company incorporated outside India, from the
acquired bank, the Central Government shall have the
matter referred to the Tribunal for decision.
(6) If, before the date notified under sub-section (4), the Central
Government does not receive requests as provided in that
sub-section, the amount of compensation offered under sub-
section (3), and where a reference has been made to the
Tribunal, the amount determined by it, shall be the
compensation payable under sub-section (1) and shall be
final and binding on all parties concerned.
36AH: Constitution of the Tribunal
(1) The Central Government may, for the purpose of this Part,
constitute a Tribunal which shall consist of a chairman and
two other members.
(2) The Chairman shall be a person who is, or has been, a judge
of a High Court or of the supreme court, and, of the two
other members, one shall be a person, who, in the opinion
of the Central Government, has had experience of
commercial banking and the other shall be a person who is
a chartered accountant within the meaning of the Chartered
Accountants Act, 1949.
(3) If, for any reason, a vacancy occurs in the office of the
Chairman or any other member of the Tribunal, the Central
Government may fill the vacancy by appointing another
person thereto in accordance with the provisions of sub-
section (2), and any proceeding may be continued before
the Tribunal, so constituted, from the stage at which the
vacancy occured.
(4) The Tribunal may, for the purpose of determining any
compensation payable under this Part, choose one or more
persons having special knowledge or experience of any
relevant matter to assist in the determination of such
compensation.
36AI: Tribunal to have powers of a civil court
(1) The Tribunal shall have the powers of a civil court, while
trying a suit, under the Code of Civil Procedure,,1908, in
respect of the following matters namely:
(a) summoning and enforcing the attendance of any
person and examining him on oath ;
(b) requiring the discovery and production of documents;
(c) receiving evidence on affidavits ;
(d) issuing commissions for the examination of witnesses
or documents.
(2) Notwithstanding anything contained in sub-section (1), or
in any other law for the time being in force, the Tribunal
shall not compel the Central Government or the Reserve
Bank:
(a) to produce any books of account or other documents which
the Central Government, or the Reserve Bank, claims to be
of a confidential nature;
(b) to make any such books or documents part of the record of
the proceedings before the Tribunal; or
(c) to give inspection of any such books or documents to any
party before it or to any other person.
36AJ: Procedure of the Tribunal
(1) The Tribunal shall have the power to regulate its own
procedure.
(2) The Tribunal may hold the whole or any part of its inquiry
in camera.
(3) Any clerical or arithmetical error in any order of the Tribunal
or any error arising therein from any accidental slip or
omission may, at any time, be corrected by the Tribunal
either of its own motion or on the application of any of the
parties.
Section 45Y: Power of Central Government to make rules
for the preservation of records
The Central government may, after consultation with the
Reserve Bank and by notification in the Official Gazette, make
rules specifying the periods for which
(a) a banking company shall preserve its books, accounts
and other documents; and
(b) a banking company shall preserve and keep with itself
different instruments paid by it.
Section 52: Power of Central Government to make Rules
(1) The Central Government may, after consultation with the
Reserve Bank, make rules to provide for all matters for
which provision is necessary or expedient for the purpose
of giving effect to the provisions of this Act and all such
rules shall be published in the Official Gazette.
(2) In particular, and without prejudice to the generality of the
foregoing power, such rules may provide for the details to
be included in the returns required by this Act and the
manner in which such returns shall be submitted and the
form in which the official liquidator may file lists of debtors
to the Court having jurisdiction under Part III or Part IIIA
and the particulars which such lists may contain and any
other matter which has to be, or may be, prescribed.
(3) The Central Government may, by rules made under this
section annul, alter or add to, all or any of the provisions of
the Fourth Schedule.
(4) Every rule made by the Central government under this Act
shall be laid, as soon as may be after it is made, before
each House of Parliament, while it is in session, for a total
period of thirty days which may be comprised in one session
or in two more successive sessions, and if, before the expiry
of the session immediately following the session or the
successive sessions aforesaid, both Houses agree in making
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any modification in the rule or both Houses agree that the
rule should not be made, the rule shall thereafter have effect
only in such modified form or be of no effect, as the case
may be; so however, that any such modification or
annulment shall be without prejudice to the validity or
anything previously done under that rule.
Section 53: Power to exempt in certain cases
The Central Government may, on the recommendation of the
Reserve Bank, declare, by notification in the Official Gazette,
that any or all the provisions of this Act shall not apply to any
banking Company or institution or to any class of banking
companies either generally or for such period as may be
specified.
Section 54: Protection of action taken under Act
(1) No suit or other legal proceeding shall lie against the Central
Government, the Reserve Bank or any officer for anything
which is in good faith done or intended to be done in
pursuance of this Act.
(2) Save as otherwise expressly provided by or under this Act,
no suit or other legal proceeding shall lie against the Central
Government, the Reserve Bank or any officer for any
damage caused or likely to be caused by anything in good
faith or intend to be done in pursuance of this Act.
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111
Sections 38 to 44 of the Banking Regulation Act deal with the
provisions relating to the winding up of a Banking Company
by Court.
Section 38: Winding up by High Court
1) Notwithstanding anything contained in Section 391, Section
392, Section 433 and Section 583 of the Companies Act,
1956, but without prejudice to its powers under sub-section
(1) of Section 37 of this Act, the High Court shall order
the winding up of a banking company -
(a) if the banking company is unable to pay its debts; or
(b) if an application for its winding up has been made by
the Reserve Bank under Section 37 or this section.
2) The Reserve Bank shall make an application under this
Section for the winding up of a banking company, if it is
directed so to do by an order under clause (b) of sub-section
(4) of Section 35.
3) The Reserve Bank may make an application under this
section for the winding up of a banking company -
(a) if the banking company, -
(i) has failed to comply with the requirements specified in
Section 11; or
(ii) has by reason of the provisions of Section 22 become
disentitled to carry on banking business in India ; or
(iii) has been prohibited from receiving fresh deposits by an
order under clause (a) of sub-section (4) of Section 35 or
under clause (b) of sub-section (3A) of Section 42 of the
Reserve Bank of India Act, 1934; or
(iv) having failed to comply with any requirement of this Act
other than the requirements laid down in Section 11, has
continued such failure, or, having contravened any
provision of this Act has continued such contravention
beyond such period or periods as may be specified in that
behalf by the Reserve Bank from time to time, after notice
in writing of such failure or contravention has been
conveyed to the banking company; or
(b) if in the opinion of the Reserve Bank -
(i) a compromise or arrangement sanctioned by a Court in
respect of the banking company cannot be worked
satisfactorily with or without modifications; or
(ii) the returns, statements or information furnished to it under
or in pursuance of the provisions of this Act disclose that
the banking company is unable to pay its debts; or
(iii) the continuance of the banking company is prejudicial to
the interests of its depositors.
4) without prejudice to the provisions contained in Section
434 of the Companies Act, 1956, a banking company shall
be deemed to be unable to pay its debts if it has refused to
meet any lawful demand made at any of its offices or
branches within two working days, if such demand is made
at a place where there is an office, branch or agency of the
Reserve Bank, or within five working days, if such demand
is made elsewhere, and if the Reserve Bank certifies in
writing that the banking company is unable to pay its debts.
5) A copy of every application made by the Reserve Bank
under sub-section (1) shall be sent by the Reserve Bank to
the registrar.
On application by Reserve Bank under section 38(1), the court
must order winding up. [Reserve Bank of India Vs. Palai
Central Bank, AIR 1961 Ker 268.]
Satisfaction of Reserve Bank under clause (b) of sub-section
(3) is subjective and is not amenable to judicial review.
The word debt in sub-section (1) does not mean banking debt,
[Dwarka Das Vs. Dharam Chand, AIR 1954 Cal 583.]
Sub-section (1) does not preclude the court from taking action
suo motto. [Parfulla Chandra sinha Vs. Chhota Nagpur
Banking Association, AIR 1965 Pat 502.]
Commencement of proceedings for liquidation does not bring
about companys dissolution. [K.V.S.V. Vassan Bros. vs.
Official Liquidator, AIR 1952 Tra-Co. 170.]
From the above section it may be noted that -
The High Court has to order the winding up-
a) if the Bank is unable to pay its debts or
b) if the company is under a moratorium and the Reserve
Bank applied to the High Court for the winding up of
the Bank on the ground that its affairs are conducted
in a manner detrimental to the interests of the
depositors. A Banking Company if it has refused to
meet any lawful demand made at any of its offices
within two days of the Demand and the Reserve Bank
certifies that the Bank is unable to pay its debts, then
the Bank is deemed to be unable to pay its debts.
Other prerequisites are :-
1) there should be a direction from the Central government,
2) An Inspection of the Banking company by the Reserve
Bank, before the order of the Government.
The grounds on which the Reserve Bank of India may apply
for winding up are-
1) the Banking company has failed to comply with the
provisions as to the minimum paid up capital and Reserves
as laid down in Section 11 of the Act;
2) the Banking Company is disentitled to carry on business
of Banking for want of licence under Section 22;
3) the Banking Company has been prohibited by the Reserve
Bank of India and the Central Government from accepting
fresh deposits ;
4) the Banking Company has failed to comply with any
requirement of the Banking Regulation Act, and continues
to do so even after the Reserve Bank of India calls up to do
so by issuing notices;
10. WINDING UP OF BANKING COMPANIES
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5) the Reserve Bank is of the opinion that a compromise or
arrangement sanctioned by the court cannot be worked out
satisfactorily;
6) the Reserve Bank is satisfied from the Returns furnished
by the Banking Company that it is unable to pay its debts
or its continuance is prejudicial to the interests of its
depositors.
The most important judicial pronouncement in the last 3 decades
is the case relating to the winding up of the [Reserve Bank of
India vs. Palai Central Bank Ltd [AIR 1961 Kerala 268].
From the decision it may be noted that _
1) the court must order the winding up on an application by
the Reserve Bank of India under Section 38(1).
2) the satisfaction of the Reserve Bank of India under clause
(b) of Sub-section 3) is subjective and cannot be challenged
in a court of law.
Section 38A : Court Liquidator
(1) there shall be attached to every High Court a Court
liquidator to be appointed by the Central Government for
the purpose of conducting all proceedings for the winding
up of banking companies and performing such other duties
in reference thereto as the High Court may impose.
(2) x x x
(3) x x x
(4) Where having regard to the number of banking companies
wound up and other circumstances of the case, the Central
Government is of opinion that it is not necessary or
expedient to attach for the time being a court liquidator to
a high court, it may, from time to time, by notification in
the Official Gazette, direct that this section shall not have
effect in relation to that High Court.
Section 39 prescribes that the Reserve Bank of India, State Bank
of India or others to be the official liquidator.
Section 39: Reserve Bank to be Official Liquidator
(1) Notwithstanding anything contained in Section 38A of this
Act or in Section 448 or Section 449 of the Companies Act,
1956, where in any proceeding for the winding up by the High
Court of a banking company, an application is made by the
Reserve Bank in this behalf, the Reserve Bank, the State Bank
of India or any other bank notified by the Central Government
in this behalf or any individual, as stated in such application
shall be appointed as the official liquidator of the banking
company in such proceeding and the liquidator, if any,
functioning in such proceeding shall vacate office upon such
appointment.
(2) Subject to such directions as may be made by the High
Court the remuneration of the official liquidator appointed under
this section, the cost and expenses of his establishment and the
cost and expenses of the winding up shall be met out of the
assets of the banking company which is being wound up,and
notwithstanding anything to the contrary containd in any other
law for the time being in force,no fees shall be payable to the
Central Government,out of the assets of the banking company.
The provisions of the Indian Companies Act are applicable to
the liquidators appointed under the Banking Regulation Act.
Section 39A: Application of Companies Act to liquidators
(1) All the provisions of the Companies Act, 1956, relating to
a liquidator, in so far as they are not inconsistent with this
Act, shall apply to or in relation to a liquidator appointed
under Section 38A or Section 39.
(2) Any reference to the Official liquidator in this Part and
Part IIIA shall be construed as including a reference to any
liquidator of a banking company.
Section 41 of the Act deals with the preliminary report by the
Official Liquidator within 2 months from the date of the winding
up order, on the assets and liabilities of the Banking Company.
The section reads -
Notwithstanding anything to the contrary contained in, Section
455 of the Companies Act, 1956, where a winding up order has
been made in respect of a banking company whether before or
after the commencement of the Banking Companies (Second
Amendment) Act, 1960, the official liquidator shall submit a
preliminary report to the High Court within two months from
the date of the winding up order has been made before such
commencement, within two months from such commencement,
giving the information required by that section so far as it is
available to him and also stating the amount of assets of the
banking company in cash which are in his custody or under his
control on the date of the report and the amount of its assets
which are likely to be collected in cash before the expiry of that
period of two months in order that such assets may be applied
speedily towards the making of preferential payments under
Section 530 of the Companies Act, 1956, and in the discharge,
as far as possible, of the liabilities and obligations of the banking
company to its depositors and other creditors in accordance
with the provisions hereinafter contained; and the official
liquidator shall make for the purposes aforesaid every endeavour
to collect in cash as much of the assets of the banking company
as practicable.
Section 41A deals with the notice of preferential claimants and
secured and unsecured creditors. The Section reads -
(1) Within fifteen days from the date of the winding up order
of a banking company or where the winding up order has
been made before the commencement of the Banking
Companies (Second Amendment) Act, 1960, within one
month from such commencement, the official liquidator
shall, for the purpose of making an estimate of the debts
and liabilities of the banking company (other than its
liabilities and obligations to its depositors), by notice served
in such manner as the Reserve Nank may direct, call upon-
(a) every claimant entitled to preferential payment under
Section 530 of the Companies Act, 1856, and
(b) every secured and every unsecured creditor, to send
the official liquidator within one month from the date
of the service of the notice a statement of the amount
claimed by him.
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113
(2) Every notice under sub-setion (1) sent to a claimant having
a claim under section 530 of the Companies Act, 1956,
shall state that if a statement of the claim is not sent to the
official liquidator before the expiry of the period of one
month from the date of the service, the claim shall not be
treated as a claim entitled to be paid under Section 530 of
the Companies Act, 1956, in priority to all other debts but
shall be treated as an ordinary debt due by the banking
company.
(3) Every notice under sub-section (1) sent to a secured creditor
shall require him to value his security before the expiry of
the period of one month from the date of the service of the
notice and shall state that if a statement of the claim together
with the valuation of the security is not sent to the official
liquidator before the expiry of the said period, then, the
official liquidator shall himself value the security and such
valuation shall be binding on the creditor.
(4) If a claimant fails to comply with the notice sent to him
under sub-section (I), his claim will not be entitled to be
paid under Section 530 of the Companies Act, 1956, in
priority to all other debts but shall be treated as an ordinary
debt due by the banking company; and if a secured creditor
fails to comply with the notice sent to him under sub-section
(1), the official liquidator shall himself value the security
and such valuation shall be binding on the creditor.
Section 42 deals with the power to dispense with meetings of
creditors etc. The Section reads -
Notwithstanding anything to the contrary contained in Section
460 of the Companies Act, 1956, the High Court may, in the
proceedings for winding up a banking company, dispense with
any meetings of creditors or contributories if it considers that
no object will be secured thereby sufficient to justify the delay
and expense.
Section 43 lays down the Depositors credits to be deemed
proved. The Section reads -
In any proceeding for the winding up a banking company,
every depositor of the banking company shall be deemed to
have filed his claim for the amount shown in the books of the
banking company as standing to his credit notwithstanding
anything to the contrary contained in Section 474 of the
companies Act, 1956, the High Court shall presume such claims
to have been proved, unless the official liquidator shows that
there is reason for doubting its correctness.
Section 43A deals with Preferential payment to Depositors.
The Section reads-
(1) in every proceeding for the winding up of a banking
company where a winding up order has been made, whether
before or after the commencement of the Banking
companies (Second Amendment) Act, 1960, within three
months from the date of the winding up order or where the
winding up order has been made before such
commencement, within three months therefrom, the
preferential payments referred to in section 530 of the
companies Act, 1956, in respect of which statements of
claims have been sent within one month from the date of
service of the notice referred to in Section 41A, shall be
made by the official liquidator or adequate provision for
such payments shall be made by him.
(2) After the preferential payments as aforesaid have been made
or adequate provision has been made in respect thereof,
there shall be paid within the aforesaid period of three
months -
a) in the first place, to every depositor in the savings
bank account of the banking company a sum of two
hundered and fifty rupees or the balance at his credit,
whichever is less; and thereafter,
b) in the next place, to every other depositor of the
banking company a sum of two hundred and fifty
rupees or the balance at his credit, whichever is less.
In priority to all other debts from out of the remaining assets of
the banking company available for payment to general creditors:
Provided that the sum total of the amounts paid under clause
(a) and clause(b) to any person who in his own name (and not
jointly with any other person) is a depositor in the savings bank
account of the banking company and also a depositor in any
other account, shall not exceed the sum of two hundred and
fifty rupees.
(3) Where within the aforesaid period of three months full
payment cannot be made of the amount required to be paid
under Clause (a) or Clause (b) of sub-section (2) with the
assets in cash, the official liquidator shall pay within that
period to every depositor under clause (a) or, as the case
may be, clause (b) of that sub-section on a pro rata basis so
much of the amount due to the depositor under the clause
as the official liquidator is able to pay with those assets;
and shall pay the rest of that amount to every such depositor
as and when sufficient assets are collected by the official
liquidator in cash.
(4) After payments have been made first to depositors in the
savings bank account and then to the other depositors in
accordance with the foregoing provisions, the remaining
assets of the banking company available for payment to
general creditors shall be utilised for payment on a pro rata
basis of the debts of the general creditors and of the further
sums, if any, due to the depositors, and after making
adequate provision for payment on a pro rata basis as
aforesaid of the debts of the general creditors, the official
liquidator shall as and when the assets of the company are
collected in cash make payment on a pro rata bais as
aforesaid, of the further sums, if any, which may remain
due to the depositors referred to in clause (a) and clause
(b) of sub-section (2).
(5) In order to enable the official liquidator to have in his
custody or under his control in cash as much of the assets
of the banking company as possible, the securities given to
every secured creditor may be redeemed by the official
liquidator -
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a) Where the amount due to the creditor is more than
the value of the securities as assessed by him or,as
the case may be,as assessed by the official liquidator,
on payment of such value; and
b) where the amount due to the creditor is equal to or
less than the value of the securities as so assessed, on
payment of the amount due;
provided that where the official liquidator is not
satisfied with the valuation made by the creditor,he
may apply to the High Court for making a valuation.
(6) When any claimant,creditor or depositor to whom any
payment is to be made in accordance with the provisions
of this section,cannot be found or is not readily
traceable,adequate provision shall be made by the official
liquidator for such payment.
(7) For the purpose of this section, the payments specified in
each of the following clauses shall be treated as payments
of a different class, namely:-
a) payments to preferential claimants under Section 53
of the Companies Act, 1956;
b) payments under clause (a) of sub-section(2) of the
depositors in the savings bank account;
c) payments under clause (b) of sub-section (2)to the
other depositors;
d) payments to the general creditors and payments to
the depositors in addition to those specified in clause
(a) and clause (b) of sub-section (2).
(8) The payments of each different class specified in sub-
section (7) shall rank equally among themselves and be
paid in full unless the assets are insufficient to meet them,
in which case they shall abate in equal proportion.
(9) Nothing containd in sub-sections (2),(3),(4),(7) and (8)shall
apply to a banking company in respect of the depositors of
which the Deposit Insurance Corporation is liable under
section 16 of the Deposit Insurance Corporation Act, 1961.
(10)After preferential payments referred to in sub section
(1)have been made or adequate provision has been made
in respect thereof, the remaining assets of the banking
company referred to in sub-section (9) available for
payment to general creditors and of the sums due to the
depositors;
Provided that where any amount in respect of any deposit is to
be paid by the liquidator to the Deposit Insurance Corporation
under Section 21 of the Deposit Insurance Corporation Act,
1961, only the balance, if any, left after making the said payment
shall be payable to the depositors.
No banking company shall be wound up voluntarily unless the
Reserve Bank of India certifies that the Company is able to pay
in full all its Debts. The provision and the powers of the High
Court in voluntary winding up is contained in Section 44 of the
Banking Regulation Act which reads -
(1) Notwithstanding anything to the contrary contained in
Section 484 of the Companies Act, 1956, no banking
company may be voluntarily wound up unless the Reserve
Bank certifies in writing that the company is able to pay in
full all its debts to its creditors as they accrue.
(2) The High Court may, in any case where a banking company
is being wound up voluntarily, make an order that the
voluntary winding up shall continue, but subject to the
supervision of the court.
(3) Without prejudice to the provisions contained in Sections
441 and 521 of the Companies Act, 1956, the High Court
may of its own motion and shall on the application of the
Reserve Bank, order the winding up of a banking company
by the High Court in any of the following cases, namely _
(a) Where the banking company is being wound up
voluntarily and at any stage during the voluntary
winding up proceedings the company is able to meet
its debts as they accrue ; or
(b) Where the banking company is being wound up
voluntarily or is being wound up subject to the
supervision of the Court and the High Court is
satisfied that the voluntary winding up or winding
up subject to the supervision of the Court cannot be
continued without detriment to the interests of the
depositors.
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115
11. CASE LAW
In the matter of Travancore National & Quilon Bank Ltd,
(in Liquidation) G. Samuel - Applicant. v. Cyril gill and
John Stanley Goodwin - Official Liquidators - Respondents
[AIR 1941 Madras p.622-625]
In this case question of set off was raised. The Travancore
National and Quilon Bank hereinafter called the bank, lent a
sum of Rs.2000 to the applicant Mr. G. Samuel, on a promissory
note dated 7th October 1936. The bank was not willing to lend
this sum to him without security. His mother-in-law Mrs. G.P.
Sathanansham Srinivasan offered to give the necessary security.
On the date of the loan, she had a sum of Rs.4300 in fixed
deposit covered by the fixed deposit receipt bearing the same
date. She gave that amount as security. In her affidavit Mrs.
Srinivasan stated that she gave the said security on the definite
understanding that the bank should adjust the amount due by
Mr. Samuel from and out of the money due to her under the
said deposit at the time of maturity. The terms on which she
gave the loan were reduced to writing and were evidenced by a
letter written by Mrs. Srinivasan to the bank.
It appeared from the affidavit of the Official Liquidator that
along with the said letter a duly receipted fixed deposit receipt
in blank was also lodged with the bank. The fixed deposit was
for a period of two years and on the date when the bank went
into liquidation it had not matured. Mr. Samuel has not paid
anything towards the promissory note, but he claims that he is
entitled to have the amount due by the bank to Mrs. Srinivasan
set off against the amount due by him. Mrs. Srinivasan had
also filed an affidavit stating that she is willing to have the
amount set off.
The question involved was not whether she is willing, but
whether a set off can be allowed in law. Mrs. Srinivasan had
not personally undertaken to repay the debt except giving
security as aforesaid. There were no mutual dealings in this
case, which would entitle the applicant to claim a set off under
S.229, Companies Act, under which in the winding up of an
insolvent company the same rules should prevail and be
observed as are in force for the time being under the law of
insolvency with respect to the estate of person adjudged
insolvent.
It was contended on behalf of the applicant that on the facts it
must be found in this case that there was an agreement to set
off the amount of fixed deposit against the debt due by the
applicant. From the terms of the letter given by Mrs. Srinivasan
the bank was authorized to set off the whole or any portion of
the said deposit and interest accrued thereon. Of course it
confers a right on the bank to set off, if the bank so chose to do.
The Court observed that from the terms of the letter it appears
that the fixed deposit amount was given as security with the
intention that the amount when realized may be appropriated
by the bank towards the debt if they so chose to do. It is one
thing to say that the bank has a right to set off but another thing
to say that the applicant has got a right to set off and there was
an agreement to set off. It was open to the bank to give up the
security if they liked. The Court therefore was of the opinion
that no set off can be allowed in this case but the equity of the
case demands that the bank should adjust the dividend payable
under the deposit towards the amount due and recover only the
balance.
Singheshwar Mandal, Appellant v. Smt. Gita Devi and
another, Respondents [AIR 1975 Patna 81 p.81]
This appeal was by defendant No.1. A money suit was filed
against him by the plaintiff-respondent for recovery of a sum
of Rs. 1541 & 15 annas on the basis of a handnote admitedly
executed by him for a sum of Rs.1133/11 annas in favour of
Dhir Narain Chand, the father of the plaintiff. It was stated in
the plaint, inter alia, that the plaintiffs father had expressed his
desire in presence of the defendant second party that the amount
in respect of this loan would go to the plaintiff alone to which
the defendant second party expressly consented. The defendant
second party were the two widows of Dhir Narain Chand
aforesaid.
Defendant No.1 contested the suit on various grounds, inter
alia, that the plaintiff being not the holder of the handnote in
question, she had no right to institute the suit in question. The
trial court accepted the defence and dismissed the suit but on
appeal, however, the learned Additional Subordinate Judge
decreed the same. Now the second appeal had been filed by
defendant No.1. The learned Additional Subordinate Judge
has overcome this plea of the appellant on the gound that the
plaintiff was an heir of Dhir Nair Chand who had every right to
make arrangement and partition the assets among his heirs. On
referring to the evidence and the circumstances on the record,
he has held that the plaintiffs father did make such an
arrangement according to which this debt was made realisable
by the plaintiff alone.
The Court of appeal below has committed an apparent error of
Law in decreeing the suit. Under the provisions of Section 78
of the Negotiable Instruments Act, payment of the amount due
on a promissory note etc. in order to discharge the maker or
acceptor thereof must be made to the holder of the instrument
or if the same is endorsed then to the endorsee as provided
under Section 82(c) of the Act which is not the case here. The
provisions of the Negotiable Instruments Act are very specific.
The Court held that in this case the handnote in question was
not endorsed in favour of the plaintiff nor does the recital in
any way indicate the intention of the creditor for the payment
of the ultimate dues by the debtor to the plaintiff. The term
Holder has been defined in Section 8 of the Negotiable
Instruments Act, according to which the holder of a promissory
note, inter alia, means a person entitled in his own name to the
possession thereof and to receive or recover the amount due
thereon from the parties thereto. Admittedly, therefore, the
plaintiff does not answer any of the descriptions mentioned
above and the defendant was not bound to make the payment
to her of the dues in question and as such the plaintiff has no
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right to institute the suit. It is not a case either of any transfer of
this debt or claim which under the provisions of the Transfer of
Prperty Act would be an actionable claim by the father to
the plaintiff. In view of the provisions of Section 130 of the
Transfer of Property Act the transfer of an actionable claim has
to be effected only by the execution of an instrument in writing
signed by the transferor or his duly authorised agent and only
thereafter the rights and remedies of the transferor is transferred.
Additional Subordinate Judge, therefore, was not right in
referring to any other mode of supposed arrangement by the
father of the plaintiff and the different members of the family
which did not answer this requirement of law.
The Court allowed the appeal, and set aside the judgement and
decree of the court of appeal and restored the order of dismissal
of the suit passed by the trial court.
State Bank of India, Petitioner vs. Vathi Samba Murthy,
Respondent. [AIR 1988 Orissa 50]
In this case a civil revision petition was filed against the appellate
judgement confirming the decision of the trial court. The case
of the plaintiff was that the defendant drew Rs.2000/- on the
basis of a cheque from his personal account although he had no
funds available in that account for which the overdrawal was
permitted. In spite of demand, the same not having been repaid,
the suit was filed for recovery of Rs.2000/- as principal amount
and Rs.979.39 paisa towards interest.
The contention of the defendant was that he had two accounts
in the bank. One current account was in his own name and the
other current account was in the name of the partnership firm
of which he was a partner. His case was that in the partnership
account there was enough money and the amount was really
intended to be drawn from that account and there was no
necessity for permitting the overdrawal from his own account
where there was no money.
The trial court applied the principle decided in the case reported
in 1967 SC 1058 (Chandradhar Goswami v. Gauhati Bank
Limited) and held that in absence of the original ledger account
no decree can be granted. The appellate court found as a fact
that the money was given from the personal account. But it
confirmed the dismissal of the suit. It is not disputed by the
defendant in this Court that the amount has been drawn by him
from his personal account, and that he issued the cheque where
no sufficient fund was available. He only stated that the money
should have been adjusted from the partnership account.
The Court held for withdrawal of money from an account any
cheque cannot be issued. It is only the cheque relating to that
account wherefrom money is to be drawn is to be issued. Cheque
of one account cannot be used in respect of another account
even though the same person may be having two accounts.
Accordingly, having drawn money from his personal account
where sufficient funds were not available to honour the cheque,
the defendant shall have the liability of pay back the amount
since it is not a gift by the bank. Both the courts went wrong in
law in dismissing the suit in respect of the principle amount of
Rs.2000/- drawn by the defendant.
There is no material on record that the defendant requested for
overdrawal. There is no general agreement that in absence of
request also, overdrawal may be permitted. If there was no
money available, the banker should have dishonored the cheque
unless specifically requested by the defendant for permitting
overdrawal. If the banker of his own permitted overdrawal, he
has no right to claim interest. However, a person getting benefit
is required to compensate for the benefit rendered to him. In
the absence of any statutory provision relating to payment of
interest on overdrawals, it is a matter for the court to consider
the reasonable rate at which interest can be granted.
It is a common knowledge that business of a banker is to advance
loans and there are varying types of interest in respect of
different types of loans. Similarly for receiving deposits the
bankers give interest of different rates in respect of different
types of deposits. Therefore, the defendant should compensate
the bank for the benefit rendered to him by paying interest at
the rate of 7% from the date of drawal till the payment is made
on the amount of Rs.2000/-.
The court allowed the revision petition, set aside the decisions
of both the courts and decreed the suit partly to the extent of
Rs.2000/- towards principal amount and interest at the rate of
7% from the date of drawal till the date of recovery or payment.
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117
12. PROBLEMS
1. A foreign bank wants to open a branch in India and asks
you to advice them on the procedure to be followed. Give
a detailed notice advising the bank the procedure to be
followed and the RBI regulation/guideline on the same.
2. Prepare a detailed list containing types of information that
have to flow from the Commercial Banks to the Reserve
Bank stating the periodicity of the informations and need.
3. If you are asked to point out three issues on which Banking
Regulation Act requires amendment what issues will you
suggest and why ? What amendment will you suggest ?
4. Make a critical study on the legal provision on CRR and
SLR and how the system worked in the last three decades.
Do you suggest any alteration to the present provision ?
Explain.
5. Examine the obstacles on securitization in India. What
remedies do you suggest for healthy growth of
securitization?
6. If you are required to give an advice to the Ministry of
Finance on the issue of regulating Mutual Funds, what
major issues will you suggest where a regulation is required
to be enacted ? What makes you feel that this area requires
regulation ?
7. If an Indian Bank wants to open a Branch at a place, what
procedure should it follow ? On what consideration the
permission is given ?
8. Many of the financial institutions have already established
their own Bank or are initiating the proposal to establish
their own Bank. What according to you are the reasons for
such development ? Do you think the trend is a healthy
one ? Explain. What legal system must the country build
up to regulate the area ?
9. On what consideration a Private Bank is allowed to be
established and run in India ? What procedure a proposed
private Bank must follow to finally establish itself and
commence business ?
10. Can a State Government establish a Bank ? On what
considerations RBI may refuse permission to such a
proposal ?
[Note: Specify Your Name, I.D. No. and address while sending answer papers]
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1. Gupta, S.N., : The Banking Law in Theory and Practice, 22nd Edn. (1992), Universal Book Traders, New Delhi.
2. Hapgrood, Mark, : Pagets Law of Banking, 10th Edn, (1989), Butterworths, London and Edinburgh.
3. Ramaiaya, A., : A Guide to the Companies Act, 11th Edn. (1992), Wadhwa and Co. Pvt Ltd, Nagpur.
4. Sheldon & Fidlers : Practice & Law of Banking, 11th Edn (1984), Macknald & Evans, Ltd, London and Plymouth.
5. Tannan, M.L., : Banking Law and Practice in India, 18th Edn, (1989), Orient Law House, New Delhi.
13. SUPPLEMENTARY READINGS
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119
Master in Business Laws
Banking Law
Course No: II
Module No: IV & V
Negotiable Instruments:
Law and Procedure
Distance Education Department
National Law School of India University
(Sponsored by the Bar Council of India and Established
by Karnataka Act 22 of 1986)
Nagarbhavi, Bangalore - 560 072
Phone: 3211010 Fax: 080-3217858
E-mail: mbl@nls.ac.in
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Materials Prepared By :
1. Ms. Sudha Peri
2. Prof. N.L. Mitra
Materials Checked By :
1. Prof. P.C. Bedwa
Materials Edited By :
1. Mr. T. Devidas
National Law School of India University
Published By
Distance Education Department
National Law School of India University,
Post Bag No: 7201
Nagarbhavi, Bangalore, 560 072.
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INSTRUCTIONS
Negotiable Instruments form the axis on which the wheels of commerce revolve, and are the most widely need form of
securitization. The Negotiable Instrument Act itself deals with only three types of instruments, cheques, bills of exchange
and promissory notes. But according to sec. 1 of Act, though it also recognises all instruments in local language and
established by usage from the provisions of the Act. Thus negotiable instruments may be said to be of two types: (1)
those created by the statute and (2) those created by usage or practice of the society.
Though negotiable instruments are widely used by all sections of people for varied purposes, actual knowledge about
these instruments is very low. There is a widespread ignorance about the nature and scope of these instruments, the
rules relating to their presentment, acceptance or dishonour etc. An effort has been made in this module to give a
comprehensive sketch of the various aspects of negotiable instruments.
Students are advised to go through the module carefully and to make a check list at the end of every major aspect of
these instruments for easy understanding, and to keep the bare act besides you while going through the module, to
facilitate easy reference. The subject being a very complicated one you should read up atleast one of the basic books
on the subject, apart from this module so as to come to terms with the intricacies of the subject.
N.L. MITRA
Course co-ordinator
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Negotiable Instruments : Law and Procedure
TOPICS
1. Securitization .................................................................................................................. 123
2. Negotiable Instrument ................................................................................................... 127
3. Parties to a Negotiable Instrument ............................................................................... 138
4. Rules relating to Negotiable Instruments .................................................................... 145
5. Presentment .................................................................................................................... 152
6. Special Provisions Relating to Cheques ....................................................................... 157
7. Discharge from Liability................................................................................................ 161
8. Of Notice, Noting and Protest ...................................................................................... 164
9. Presumptions and Estoppels ......................................................................................... 168
10. Offences under the Act .................................................................................................. 172
11. Foreign Instruments....................................................................................................... 177
12. Case Law......................................................................................................................... 185
13. Problems.......................................................................................................................... 188
14. Supplementary Readings ............................................................................................... 190
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1.1 What is Securitisation?
1.2 Procedure
1.3 What assets can be Securitised
1.4 Type of Securities
1.5 Advantages
1.6 Legal Issues
1.7 Role of government
1.8 Creation of international securities
1.1 WHAT IS SECURITISATION
What is Securitisation?
According to Kenneth Cox securitization is a process in which
pools of individual loans or receivables or actionable claims
are packaged, under written and distributed to investors in the
form of securities. It is a process of liquidizing assets appearing
in the balance sheet of a bank or financial institution which
represent long term receivables by issuing markatable securities
there against. It involves conversion into cash flow from a
portfolio of assets in negotiable instruments or assignable debts
which are sold to investors.
Securitization is in vogue in western countries as a very common
method of funding. Mr. B.D. Ushir (Jt. Legal Advisor, IDBI) in
an article gave a clear analysis of such securitisation. A bank
or a financial institution lends money or purchases or discounts
bills. The outstanding loans and bills appear as assets in the
balance sheet. These assets being generally of long term
maturity, the fund invested therein remain locked up. These
loans/bills form portfolio to form a basket or a pool for the
purpose of securitization.
Now, these debts are assigned in writing through a document
(known as security) by which assigner transfers his actionable
claim over the debt to the assignee who will have all rights
such as right to claim the payment of the debt; right to interest;
right to remedies in case the debt is not paid. As such, through
the creation of securities the Bank or financial institutions
liquidizing the long term debts and loans and create funds for
investments.
1.2 PROCEDURE FOR SECURITIZING
Securitizing has several steps involved such as :
(a) Creation of a basket or pool of loans/bills/actionable
claims: The Bank or the financial institution engaged in the
business of louding/bill discounting/having actionable claims,
1. SECURITISATION
creates a portfolio containing a basket or pool of claims fairly
diversified and representative in characer and not necessarily
relate to same industry or from same statistical history. The
package must form an optimal mix so as to ensure marketability
of the instruments created and issued to the investors. Further,
the maturities should also be so selected that they form one
homogenous group or a few homogenous branches. These
loans are backed by collateral securities. The aggregate pool,
therefore, consists of the receivables flowing from the respective
loans and the rights to the various securities which are
commonly in the form of mortgages or charge on the borrower's
assets.
(b) Forming a special purpose vehicle (SPV) : Once the
assets are identified, these are to be passed through a special
purpose vehicle (SPV). It is common for an investment banker
to act as the special purpose vehicle against the sale for a
valuable consideration. On completion of the passing through
transaction, the securitised assets are removed from the balance
sheet of the lending institution (the originator). At this stage it
has to be remembered that the contractual relations under the
loan agreement between the borrowers and the lender (the
originator) continue to subsist even after the passing away of
the securitised loans and bills to SPV. So the originator shall
continue to receive interest and principal amounts from the
borrower which are requested to be passed to the SPV persuant
to the specific covenants under an agreement entered into
between the two.
(3) Splitting into shares or securities : After the securitised
assets are passed to SPV, it divides notionally the whole asset
into small shares or securities and sells these shares/or securities
to investors. These securities are called the Pass Through or
Pay Through Certificate (PTC). PTC's are so structured as to
synchronise, as regards to their maturities, with the maturities
of the securitised loans or bills (receivables) so that cash flowing
from these sources become available to the payment of the PTCs
and their maturities.
PTC holders look to the SPV for payment of interest and the
principal in respect to the PTCs held by them. The SPV will
meet this obligation out of the receivables realised by the lender
(originator) from the borrowers and passed on to the SPV. A
PTC represents a sale of an individual interest to the assets
securitised by the originator and transfered to the SPV. A choice
of appropriate form of the PTC depends on various
considerations such as the incidence of stamp duty,
marketability/transferability aimed at and so on. The whole
process of securitisation happens thus :
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1.3 WHAT ASSETS CAN BE SECURITISED
All types of assets having a reasonably predictable cash flow
can be securitsed. It has been already pointed out that in
constructing a portfolio to be sold down to the SPV, it will be
important to select assets which are homogenous and diversified.
The assets will also need to have statistically predictable cash
flows, levels of arrears and defaults since these will be key
factos for the investors. The following assets are most common
for the purpose of securitisation
(a) Mortgaged properties & loans ;
(b) Housing loans ;
(c) Car loans ;
(d) Credit card receivables ;
(e) Trade receivables/book debts ;
(f) Bills ;
(g) Actionalbe claims.
1.4 TYPES OF SECURITIES
Securities may generally be of two types, viz:
(i) Securities confined to national boundaries and to be
operated within the country, and
(ii) Securities which are operated internationally. These may
be based upon national assets or international assets which
can be securitised.
National Securities are those which are either negotiable
instruments under the NI Act or transferable but not negotiable.
Common examples are bills, pronotes cheques these being
negotiable ; commercial papers - these being transferable but
non-negotiable.
International securities are GDR (Global Depositing Receipts)
or IDR (International Depository Receipts).
1.5 ADVANTAGES
There are several advantages fo securitization, such as:
(1) Liquidification - It creates liquidity in the market against
assets which are generally sleepng or dorument in character
for sometime, as for example, book debt.
(2) Avenue for investment - It creates opportunities for
investment to the people who want to invest to augment
income, assured securities having opportunity for
encashment as and when required.
(3) Mobilises funds for investment - With floating of new
investments against portfolio, for the purpose of using debt
capital for industrial development.
(4) Foreign funds - Foreign funds can be generated through
the creation of a depository of Indian scrips including shares
and debentures. A global or international depositing is
created with which shares, stocks and debentures can be
deposited for the purpose of creating a SPV against which
Pool of assets
1. Loans & Advances belonging to Originator Receive the loan
2. Bills
(Suppose a Bank or a amount
3. Other Receivables
financial institution
4. Debtors
Passed on to the The SPV may be a Bank Passed on to SPV
Special purpose or a financial insti-
vehicle against tutions
consideration
Asset value in the Shares/Securities sold Share/Securities
pool is divided to investors paid of by SPV
notionally into
small share or
security
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GDR or IDR is issued to foreign investors through which
foreign funds are mobilised for investment in India.
(5) Easy transferability - Securities may be listed in the stock
exchange for easy transferability which ensures floating
funds to be canalised for industrial and market development.
1.6 LEGAL ISSUES AND LAWS INVOLVED
All legal issues relating to Securitisation need to be examined
in the light of the provisions of various laws like, the Transfer
of Property Act 1882, the Registration Act, 1908, the Indian
Stamp Act 1899; Income Tax Act 1961; Securities Contracts
(Regulation Act) 1958 and SEBI Act 1992.
(1) Transfer of Property Act, 1881 : Many of the recoverables
are classified debts coming within the definition of
immovable property and hence call for the knowledge on
Transfer of Property Act. As for example, an interest of a
mortgagee is an immovable property. Similarly mortgage-
debt is an immovable property which can be transferred
only by an instrument in writing being registered under
sec 17(1)(6) of the Registration Act. As such, Securitisation
of these type of portfolio involves a transfer of an interest
of a mortgage when the underlying securities happen to be
in the form of a mortgage. There are two levels of transfers.
First the portfolio is transfered to SPV and secondly
individual interest is transfered through PTC to the
investors. All such transfers concern mortgage-debts, and
hence attracting transfer of property.
(2) Registration Act, 1988 : All non-testamentary instruments
creating, declaring, assigning or extinguishing, whether in
present or in future, any right title or interest, whether vested
or contingent, of the vlaue of Rs.100 or above, to or in any
immovable property are required to be compulsorily
registered. [sec 17(1)d]. Securitisation involves creation
and/or declaration of an interest in the immovable property
firstly in favour of SPV and secondly in favour of the
investors.
(3) Negotiable instrument Act, 1872 : Instruments which
are negotiable are covered under the N1 Act. One of the
defects of the NI Act is its restrictive nature. Only if an
instrument is drawn in the form of a pro-note or a bill, can
it be covered under NI Act. With the growing securitization,
there has to be a pressure on the government for
accomodating securities under NI Act. All instruments are
tranferable but not negotiable in the sense that transfer can
be made by delivery.
(4) Indian Stamp Act, 1899 : According to sec 2(10) of the
Indian Stamp Act, conveyance includes conveyance on sale
and other instruments relating to properties, movable or
immovable. A conveyance attracts ad-valorem stamp-duty
under Art 23 of Schedule I of the said Act. Apart from the
above, the securities (PTCs) to be issued to the investors
would also attract stamp duty at two stages, viz(1) on issue
of securities and (2) on transfer of securities by the investors.
(5) The Income Tax Act, 1961 : Income Tax Act has several
provisions relating to transfer of income. As for example,
Ss.60, 160-162, 194A of the Act relate to matters involved
in Securitisation. Sec 60 contemplates a transfer of income
without transfering the assets from which the income was
generated. Ss 160-162 provide for imposition and tax on a
person as a representative assessee for the income received
by him for and on behalf of others.
(6) Security Contracts (Regulations) Act, 1958 and
Securities Exchange Board of India Act, 1992 : All PTCs
are securities under the ambit of the defintion in the above
two statutes. SEBI is empowered to regulate the issue of
and trading in all PTCs. Securitisation is a financial
innovation and hence cuts accross the money management
and credit control functions of the RBI which may regulate
the marketing operations of such securities through direct
and indirect methods and guidelines and also through laying
down the standard of disclosure and accounting practice.
Besides the above legal requirements other facilties like listing
of the instrument at the stock market; insurance coverage for
the investors subscribing to securities without recourse; credit
facilities against defaults by borrowers; availability of
intermediary services also require building up of infra-structure
legal system compatible with the requirement of growth of
securitisation needed in the commercial market. It is therefore
necessary to build up a legal system for encouraging the
Securitisation.
1.7 ROLE OF GOVERNMENT
It is now understood that the present legal environment about
securitisation is inadequate, in-appropriate and unfriendly. It
has been rightly observed by an author (Ushir, B.D., 212) that
unless immediate steps are taken to remove the legal hurdles,
there is a danger of this promising instrument being lost. A
two dimensional government action is necessary, viz.,
(i) removal of all legal barriers; and
(ii) providing appropriate incentives and adequate infra-
structural facilities.
Besides, a suitable regulatory mechanism is necessary to
formalise the commercial practice and negotiability. Some of
these requirements are as follows :
(a) Stamp duty remission : The law relating to Stamp duties
are both Central and State subjects. According to Entry 91
of List I of Seventh Schedule under Article 246 of the
Constitution of India Rates of Stamp duty in respect of
bills of Exchange, promissory notes, cheques, bills of lading
, letter of credit, policies of insurance, transfer of shares,
debentures proxies and receipts, shall be determined by
the Union'. But according to Entry 63 of List II it is stated
that in all other cases the Stamp duty is to be fixed by the
State. Thus, based on the above stipulation if PTC's are
classified on the basis of nature of portfolio and there are
several prescriptions for several class of securities such as
an portfolio relating to mortgage debts or relating to debt,
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In the above process Indian investors are required to put in
their shares, stocks or debentures with a foreign depository to
be created for the purpose of constituting a SPV. The foreign
depository thereafter issues securities called GDR or IDR for
foreign investors against portfolio. Whan a GDR /IDR for
foreign depository releases the Indian papers which goes back
to the Indian investors. GDR/IDR can be listed with the stock
exchanges. The RBI provides a guideline for the issue of this
type of securities and SEBI regulates the creation of these kinds
of securities as well as its dealings in the market.
there will be several confusion. Therefore stamp duty law
for all such securities should be brought under the Central
subjects and the law is simplified. A nominal stamp duty
can be imposed if at all, in order to facilitate securitisation.
If stamp duty is not remitted, market shall in itself create
some duty saving routes which will have two fold danger.
First, the fate of such transactions would always be
uncertain. Second, the states would rush with the
amendments to the stamp laws to bring within their net the
various devices adopted by the market. It is therefore,
necessary to give complete remission on securitisation so
that growth of the market instruments bring more liquidity
which will offset the loss on account of remission of stamp
duty and wide confusion arising out of present law relating
to stamp duty.
(b) Income tax incentives : It is suggested by many market-
friendly economists that securitisation require tax incentives
in the line of sec. 88A of the Income Tax Act.
(c) Development of infra structural facilities : SEBI may
prepare guidelines for listing of such securities and for other
marketing practices. It is necessary for RBI to make
regulations for the management of portfolios with suitable
rules of set off and protection. In US special institutions
were set up in 1970s and 1980s, such as, the Government
National Mortgage Association (GNMA), the Federal
House Loan Mortgage Corporation (FHLMC) based upon
the nature of the portfolio. These institutions took lead
role in popularising securitization. Various tax incentives
can be given institutions for popularising securitisation.
1.8 CREATION OF INTERNATIONAL SECURITIES
Securities may be created for global funding, both by the floating
of equity or through development of securities. The distinction
between the equity participattion and global securitization is
that the former supplies equuity capital which is generally a
long term capital flow, whereas funds to securitization are loan
capital and short term in nature. Generally for the purpose of
floating the securities for the investment of foreign investors,
the following mecahnism is resorted to:
Creation of Institutional Securities
Indian Side Foreign Country
Pooling of repaid to To Foreign Investor
Indian papers llike
Shares
Stocks
Debenture
Debenture-Stock Release of A Foreign Depositing
Depository
Foreign Investor
creating a SPV
Issue of GDR/IDR
Release of
Indian
Investment
into
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2. NEGOTIABLE INSTRUMENT
SUB TOPICS
2.1. Introduction
2.2. Kinds of Negotiable Instruments
2.3. Promissory Note
2.4. Bill of Exchange
2.5. Cheques
2.6. Hundis
2.7 Inland and foreign instruments
2.8 Inchoate Instruments
2.1 INTRODUCTION
The word negotiable might owe its origin to the French word
negoce meaning business, trade or management of affairs.
Blacks Law Dictionary defines the term negotiable as
something which is legally capable of being transferred by
endorsement or delivery, and negotiability is the legal character
of being negotiable.
Instrument on the other hand may be defined as a written
document; or a formal or legal document in writing such as a
contract or a will.
Thus, taken together a negotiable instrument means a written
document capable of being transferred by endorsement or
delivery. Section 13 of the Negotiable Instruments Act, 1882
provides as under:
Negotiable Instrument - A negotiable intrument means a
promissory note, bill of exchange or cheque payable either to
order or to bearer.
Explanation (i) - A promissory note, bill of exchange or cheque
is payable to order which is expressed to be so payable or which
is expressed to be payable to a particular person, and does not
contain words, prohibiting transfer or indicating an intention
that it shall not be transferable.
Explanation (ii) - A promissory note, bill of exchange or cheque
is payable to bearer which is expressed to be so payable or on
which the only or last endorsement is an endorsement in blank.
Explanation (iii) - Where a promissory note, bill of exchange
or cheque, either originally or by endorsement, is expressed to
be payable to the order of a specified person, and not to him or
his order, it is nevertheless payable to him or his order at his
option.
2) A negotiable instrument may be payable to two or more
payees jointly, or it may be made payable in the alternative to
one of two, or one or some of several payees.
A negotiable instrument is an object of rights, i.e., it gives to
the person in lawful possession of such an instrument certain
rights which other instrument do not give him. Further, a
negotiable instrument represents money and possesses the same
characteristics as that of money, namely, (i) it is not tainted by
any defect in title at the source so long as its acquisition is
lawful, i.e., even if the maker of the instrument commits a fraud
or a forgery, a bonafide payee of the instrument is not affected
by such fraud or forgery; (ii) it passes by delivery like cash
does and the person in lawful possession of it can sue on such
instrument in his own name. A negotiable instrument also
embodies some of the basic principles of contract, because it is
either an undertaking or promise or an order to pay money.
Capacity of the parties to such an instrument, their rights and
liabilities etc., are all governed by the basic principles of
contract. A negotiable instrument is one, therefore which when
transferred by delivery or by endorsement and delivery, passes
to the transferee a good title to payment according to its tenor
and irrespective of the title of the transferor, provided he is a
bonafide holder for value without notice of any defect attaching
to the instrument or in the title of the transferor; in other words
the principle 'nemo dat quod non habit' does not apply. It is
this element of negotiability which makes a contract founded
upon paper thus adapted for circulation different in many
particulars from other contracts known to law [Verma, p.2].
Thus in Raephal v. Bank of England [(1855)104 RR 638:25
LJCP 33], some bank notes of the Bank of England were stolen.
The Bank immediately prepared and circulated a list of the stolen
notes. The plaintiff being a money changer in Paris also received
such a list. After a year of his receiving this notice, a man came
to the plaintiff for exchanging a Bank of England note. The
plaintiff having forgotten the year old notice encashed the note,
which was one of the stolen ones. The Bank of England refused
payment to the plaintiff. It was held that the plaintiff, having
taken the note in good faith, was entitled to its payment. He
was no doubt somewhat negligent, but he had acted honestly.
But the principle of 'nemo dat quod non habet' applies only to
negotiable instruments and a holder of an instrument which is
non-negotiable cannot take this defence. For example, in
Whislter v. Forster [143 ER 441], one G fraudulently obtained
a cheque from the defendant Forster. The cheque was made
payable to G or order. G gave the cheque to the plaintiff as
payment for his debt, but forgot to endorse the cheque. Till
then, he had no notice of the fraud but before the plaintiff could
get Gs endorsement on the cheque, he became aware of the
fraud. It was held that the plaintiff could not get a good title.
Erle CJ observed:
According to law merchant, the title of a negotiable instrument
(payable to order) passes by endorsement and delivery. A title
so acquired is good against all the world, provided the instrument
is taken for value and without notice of any fraud. The plaintiffs
title here, therefore, was to be rendered valid by endorsement;
but at the time he obtained the endorsement, he had notice that
the bill had been fraudulently obtained by G from the
defendant.
This brings us to an interesting question, what are the essential
elements or requirements of a negotiable instrument or when
does an instrument become negotiable ? To understand the
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essential characteristics of a negotiable instrument it is important
to keep in mind the resemblance of these instruments to money.
In the words of Parsons, the most characteristic of money as
distinguished from other species of property is the facility and
freedom with which it circulates. Any one taking it, therefore,
in the course of business, need look no further than to the face
of the coin and the possession of the person from whom he
receives it. These are the qualities which every representative
of money must possess in order to answer its purpose
effectively. [Bhashyam, p.66]. In simpler words what
characterizes money is the certainty which it denotes i.e.,
certainty of denomination and of possession. A negotiable
instrument thus should be very certain as to the amount being
promised or ordered to pay. Further since the instrument also
incorporates principles of contract it should also be clear,
unambigous and concise and should also specify the names of
the person to whom it is being made payable as also the person
making the payment. Thus, a negotiable instrument should be
certain as to: (i) persons making the payment; (ii) persons
receiving the payment; (iii) the amount payable; (iv) the time
and place of payment and (v) conditions of liability (if any).
According to Blacks Law Dictionary, for an instrument to be
negotiable within the meaning of Article 3 of U.C.C. it must -
(1) be in writing and signed by the maker or drawer; (2)
containing an unconditional promise or order; (3) to pay a
specified amount; (4) either on demand or at a definite time;
(5) to the bearer of the instrument or to order, and (6) not contain
any other promise, order, obligation or power given by the maker
or drawer except as authorized. Apart from these general
characteristics each kind of negotiable instrument has its own
set of essential requirements, but these will be dealt with at
appropriate places.
Need for Negotiable Instruments
You may now ask a very pertinent question - the law dealing
with negotiable instruments seems to be very complex, so why
should we deal with it ? More importantly why do we need
negotiable instruments in the first place, why cant be do away
with them ?
The answer to the first question is very simple. Negotiable
instruments form the backbone of todays complex commercial
world. Tradesmen prefer to use cheques, drafts, promissory
notes etc., in their day to day transactions, rather than ready
cash. In fact even the common man has become addicted to the
use of cheques and drafts. These instruments are used as a
mode of payment alongwith application forms, for filing of
tenders, for payment of salary....you name a transaction
involving money and you will find a negotiable instrument in
some form or other exchanging hands. It is because of this
widespread popularity and usage of these instruments that an
indepth study of these instruments becomes essential for every
user of these instruments.
Coming to the second question as to the need or necessity for
the existence of these instruments, let us consider the following
hypothetical conversation between two fictitious persons
Ramesh (who is a money-lender) and Suresh (who is a farmer
needing a loan).
Suresh: Mr.Ramesh I want a loan of Rs.50,000/-.
Ramesh: I will be very happy to loan you that amount but
what is the guarantee that you will return the money?
Suresh: I promise you on everything that I hold sacred that I
will return it.
Ramesh: Promises are not enough. I need some security
against the loan.
Suresh: I have two bullocks which I will give you if I cant
pay the money.
Ramesh: But what will I do with the bullocks ? I stay in the
city and will have no use for them.
Suresh: I will tell you what - Ill write on a piece of paper
that in case I fail to pay the money owed to you, my
bullocks should be sold and the money given to you.
Ramesh: That should be perfectly okay. Here is the money.
Suresh: Thank you - and here is my note.
Though the entire episode described above is fictitous, it must
have been situations like these where the consideration or
security being offered was too unwieldly or inconvenient for
the person to carry around, which gave rise to the birth of these
instruments. Try to imagine, you have sold stock worth say $ 1
million and the person wants to pay you in coins or currency.
How will you carry it and how much care will you have to
extend to see that currency is not stolen. And the situation
would have been even worse in the initial stages i.e., before the
advent of paper currency, when gold & silver coins were in
vogue. A person would really need to be a weight lifter to
carry large amounts of such coins, quite apart from the security
problems involved.
It was to overcome the inconveniences of these kinds of
situations that negotiable instruments started being used and
quickly became popular, so much so that within no time they
became the life and blood of the commercial world. Whether
we like it or not negotiable instruments have come to stay and
we cannot simply wish them away.
Negotiation and Indorsement
Negotiable instruments have a characteristic feature of easy
transferability to a third party by a proces called negotiation.
As mentioned earlier a negotiable instrument contains either a
promise or an order to pay A or his order, or to pay B or bearer.
It is this provision for alternative payment i.e. to one or other,
that makes these instruments really negotiable.
Negotiation may take place in one of the following two ways,
viz ;
(i) When th instrument is payable to bearer it is negotiable by
delivery of it to the third party.
(ii) When the instrument is payable to order, then negotiation
can be done by firstly indorsing it and then delivering it
by the holder.
Payable to order means that the maker may not only specify
the person to whom the money is to be paid say a Mr.X, but
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also order that the money be paid to any person Mr.X orders it
to be paid to. So every instrument may have a series of parties
each making the money payable to the next succeeding person
or to his order. For example, a bill may be made by A to pay to
B or his order; B may by indorsing make it payable to C or
his order; C making it payable to D or his order and so on
and so forth. This stream will continue till the bill is ultimately
cashed and the amount realized. It may be possible that an
instrument gets circulated so rapidly that it becomes so covered
with indorsements that there is no place for any more fresh
indorsements. In such a situation it is permissible to attach a
piece of paper called an allonge to the bill, and this allonge can
be used for further indorsements.
The question now arises, what is an indorsement ? An
indorsement in simple words may be defined as the signing
on the instrument for the express purpose of negotiation, and
negotiation takes place when the indorsed instrument is
delivered to any person so as to make him the holder of the
instrument. The person signing the bill is known as the
indorser and the person in whose favour indorsement is made
is known as the indorsee. The same person may take on the
character of both the indorser and the indorsee as for example,
if A indorses a bill in favour of B, and B indorses the bill in
favour of C, then B is an indorsee with respect to A and he is an
indorser with respect to C. Once a bill is indorsed and delivered,
the indorsee not only acquires the property in the instrument
but also the right to further negotiating the instrument to other
persons. What is essentially required in cases of indorsement
is the intention to pass the property in the bill. Nowadays a
question that is becoming increasingly important is, how to
sign an indorsement, because the protection of a banker who
either pays or receives an indorsed instrument is dependent on
the form of the endorsement.
Indorsements are of two kinds, viz :
(i) indorsements in blank ie where the indorser merely signs
his name without specifying as to the identity of the
indorsee; and
(ii) 1indorsement in full ie where the indorser specifies the
person or indorsee to whom or on whose order the payment
is to be made.
An instrument with blank indorsement is negotiable by mere
delivery, just as if it was an instrument payable to the bearer. A
blank indorsement may be converted into a full indorsement
by the holder, by writing above the indorsers signature a
direction to pay to any other person. The advantage of pursuing
such a course of action is that the holder does not incur the
liabilities of an indorser. The holder may also exclude his
liability by indorsing the instrument sans recourse or he may
make his liability conditional. He may also restrict the right of
the indorsee to further negotiate the bill by appropriate wording
of the indorsement, as for example, by saying pay B only or
pay B or C.
The indorsement to be valid must be of the entire bill i.e. you
cannot keep part of the bill and indorse the remaining. You
may indorse the bill in toto or realize it in toto. A partial
indorsement or a transfer to two or more indorsees severally
does not operate as negotiation of the bill; but if the bill has
been partly paid then a note to that effect can be made on the
indorsement and it may then be negotiated for the balance.
Who can indorse ?
An indorsement can be done only by the lawful holder of the
instrument. Every single maker, drawer, payee, indorsee etc or
if there are more then all of them jointly can indorse an
instrument provided he or they are in lawful possession of the
instrument. A stranger i.e. someone who is not a holder cannot
indorse an instrument so as to convey a title to the indorsee.
An agent of the indorser can indorse the instrument provided
he signs as an agent of the indorser and not as an indorser.
The Act deals only with transfer of instruments according to
Law Merchants, does not deal with transfer by operation of
law. An important consequence of negotiation envisaged by
the Law Merchants is that, a person taking an instrument
bonafide and for value acquires a good title to it, regardless of
the defects in the title of the transferor. It is this characteristic
combined with its transferability by delivery like cash, which
determines the negotiability of the instrument. In case of
ordinary transfers, for example, in assignment of a debt, the
transferee gets a right to see in his own name, but he does not
get a better title than what his transferor has. But in case of
negotiable instruments, title of the transferee is dependant upon
the manner of his acquisition of the instrument rather than the
title of the transferor. In this respect they resemble the coin of
the realm which may pass from hand to hand without being
tainted by the title of the transferor.
2.2 KINDS OF NEGOTIABLE INSTRUMENTS
The Act itself deals with only three kinds of negotiable
instruments, viz : promissory notes, bill of exchange and
cheques. But this does not mean that these are not other kinds
of instruments. The Act specifically saves or excludes from its
operation local usages in respect of all instruments in an oriental
language unless an intention is expressed in any such instrument
that it would be governed by the Act (sec.1). But the usage has
to be established by the party alleging its existence, otherwise
it will be governed by the provisions of the Act regardless of
the language it is written in, i.e. a negotiable instrument need
not necessarily be in English it can also be written in the oriental
languages. The basic condition differentiating a negotiable
instrument from a non negotiable one is not the langauge in
which the instrument is written, but is the intention to make a
negotiable instrument for the purpose of recording in writing
to pay money to a specified person at a specified time. Hence,
receipts etc, are not a negotiable instrument even if such receipt
is coupled with a promise to pay. We will now deal with these
various kinds of negotiable instruments alongwith their salient
characteristics and their distinction from one another.
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2.3 PROMISSORY NOTES
Section 4 of the Act defines promissory note as an instrument
in writing containing an unconditional undertaking, signed by
the maker, to pay a certain sum of money only to, or to the
order of a certain person or to the bearer of the instrument."
The essential ingredients of a promissory note are as follows :
(1) It must be in writing and signed by the maker
(2) It must contain an unconditional and definite promise to
pay a certain sum, and nothing more.
(3) It must be payable either on demand or after the efflux of a
fixed or deteminable time in future, as for example after 6
months.
(4) It must be payable to, or to the order of a specified person
named in the note or to the bearer of the note.
(5) Most importantly, an instrument to be regarded as a
promissory note must show a prima facie intention to make
such a note and it must be delivered.
Thus before a document can be treated as a promissory note,
two things have to be ascertained : (a) an acknowledgement of
indebtedness and (b) a promise to pay the debt. The illustrations
appended to the section make the meaning clear, and are being
reproduced below.
(i) I acknowledge myself to be indebted to B for Rs.
1000 to be paid on demand for value received.
(ii) Mr. B, I.O.U. Rs. 1000.
The first is a promissory note whereas the second is not, because
in the second illustration though there is an acknowledgement
of indebtedness there is no corresponding promise to pay. In
Raghunath v. Seetaram [1972 Mys. 344] certain tests to
ascertain whether the given document was a promissory note
or not were laid down. The Court observed :
The controlling element in determining the question whether
an instrument is a promissory note or not is the intention of the
parties in drawing up that instrument as a promissory note. A
document might comply with the terms of this section and yet
it may not be a promissory note. For instance, a mere receipt
even if coupled with a promise to pay is never intended to be a
promissory note, and so a deposit note containing words we
promise to pay the said sum. But a document, does not become
a promissory note merely because the parties intended it to be a
promissory note unless it fulfills the terms of this section.
However, if a promissory not falling under section 4 of the Act
and therefore under section 2(22) of the Indian Stamp Act, 1899,
is attested and not payable to order or bearer it would fall under
section 2(5)(b) and would amount to a bond for the purposes of
the Act. The description of the instrument as a promissory
note, the language of the instrument taken as a whole, the
circumstances under which it came to be executed, the intention
of the parties manifest from the face of the document and the
surrounding circumstances have all a cumulative bearing on a
proper construction of the instrument whether it is a promissory
note or not." There is another requisite for a promissory note
to be valid and that is that the note should be properly stamped
as per the requirements of the Indian Stamp Act, 1899, but in
case of a pro note executed in the State of Jammu & Kashmir
must be affixed with requisite stamps prescribed under the J &
K Stamp Act, [Gulam Nabi v. Lal Mohammed, AIR 1975 J
& K. 50]
Kinds of Promissory notes
Section 4 recognises three kinds of promissory notes :
(1) A note containing a promise to pay a certain sum of money
to a person. Originally this was not considered as a
negotiable instrument in India, but it was perfectly valid
between the parties to the document, and it was capable of
being assigned as an ordinary chose-in-action though not
by negotiation [Udayar v. Muthia 7 MLJ 231] but Act
VIII of 1919 made such instruments also negotiable, unless
in the instrument words like only to are included.
(2) A note containing a promise to pay a certain sum to the
order of a certain person. Such notes are however payable
only to the person named or by his order.
(3) A note containing promise to pay the bearer, but such notes
were declared invalid under the Paper Currency Act and
now under the Reserve Bank of India Act.
There is another special kind of promissory note viz:
Government Promissory notes - These are issued by the
Government (either Central or State), for loans raised by them,
and are made payable to order or a bearer bond payable to the
bearer. Though these notes are in the form of negotiable
instruments, their transfer by indorsement and the liability of
the transferor and the renewal, are now regulated by Public
Debts Act, 1944. A transfer of such promissory notes will not
be valid unless it conveys the full title to the security or if it is
of such a nature as to affect the manner in which the security is
to be held as expressed by the Government.
The definition u/sec.4 specifically excludes the following notes,
viz:
Bank notes - A bank note may be defined as any bill, draft or
note issued by a banker, promising to pay a certain sum to the
bearer on demand, and whic entitles the bearer or holder of the
instrument to the payment of the amount without further
indorsement. In its nature it is like cash and differs from bonds
and other securities which are only evidence of money being
due and are not money itself.
Currency notes - A currency note issued by the Government
incorporates an undertaking by the Government to pay the
bearer of the note on demand the specified sum. Though bank
notes and currency notes satisfy all the requirements of
promissory notes, they are themselves money and legal tender
for the amount represented by them, and hence excluded from
the purview of the Act. Bank notes differ from currency notes
in that they are not issued by the Government & sec.26 of the
Paper Currency Act, 1923, prohibits the issue of these notes in
the country, and only RBI has the right to issue bank notes and
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131
also has the right to issue currency notes for a period fixed by
the Central Government. All provisions which apply to bank
notes would also apply to currency notes.
Drafting of promissory notes
As mentioned earlier a promissory note should incorporate :
(1) the amount to be paid ; (2) date and place of execution ; (3)
the person to whom the money is to be paid ; (4) the date/time
on which it is to be paid ; (5) by whom it is to be paid. Given
below are a few sample promissory notes which are usually
used in the commercial market.
(i) Promissory note for a loan
Rs.5000 Bangalore, March 24th, 1995
In consideration of the loan of Rs.5000 advanced by Mr.Avtar
Singh to me, I promise to repay the said loan of Rs.Five
Thousand with interest at 6 1/2 % annum to Mr. Avtar Singh or
order
Signed
Pratap Singh son of Biswas Singh
resident of 222, 72 cross, 4th main
Rajajinagar, 6th block
Bangalore.
(ii) Promissory note payable on a fixed date or in instalments
Bangalore, 24th March, 1995
Rs.
I, AB, etc., promise to pay to CD etc., or order the sum
of Rs.________________
(in words) on the ............. (or, ......... month after date) (or, in
twelve equal instalments of Rs. ........... each payable on the
first day of every month commencing from the first day of May,
1995)
(Signed) ..................
AB son of ..................
resident of ..................
(iii) Promissory note in the form of a letter
Bangalore
March 24th, 1995
Dear Shri Cd, etc.,
Whereas you have advanced to me today a loan of Rs .........., I
hereby promise to repay the same to you on demand with interest
at ........ percent per mensem.
Yours Sincerely,
Sd. ..............
Ab s/o ................, resident of ..............
(iv) Joint Promissory Note
Whereas we, AB, CD and EF etc., owe Rs .............. to XY, etc,
as detailed below :
1. ..............
2. ..............
We hereby promise to pay on demand (or ............ years after
date) the said sum of Rs. ...... (in words) to the said XY with
interest at ....... percent per annum.
Dated the 24th March, 1995
Place : Bangalore
Sd. AB ..........................
CD ..........................
EF ..........................
Parties to a promissory note
There are in general two parties to a promissory note - the maker
(i.e. the one who acknowledges this indebtedness and expressly
promises to pay) and the payee (ie the person to whom such
payment is to be made). Where a promissory note is made by 2
or more persons we may have 2 or more makers and if it is
made to 2 or more persons than we have joint payees. The
rights and liabilities which attach to such maker and payee will
be dealt with in a later chapter.
2.4 BILL OF EXCHANGE
A bill of exchange has been defined by sec.5 as, an instrument
in writing containing an unconditional order, signed by the
maker, directing a certain person to pay a certain sum of money
only to, or to the order of a certain person or to the bearer of the
instrument.
A promise or order to pay is not conditional within the
meaning of this section and section 4, by reason of the time for
payment of the amount or any instalment thereof being
expressed to be on the lapse of a certain period after the
occurence of a specified event which, according to the ordinary
expectation of mankind is certain to happen, although the time
of its happening may be uncertain.
The sum payable may be certain within the meaning of this
section and section 4, although it includes future interest or is
payable at any indicated rate of exchange, or is according to
the course of exchange, and although the instrument provides
that, on default of payment of an instalment, the balance unpaid
shall become due.
The person to whom it is clear that the direction is given or that
payment is to be made may be a certain person within the
meaning of this section and section 4, although he is misnamed
or designated by designation only.
The above definition is the result of a number of English
decisions on the topic. A brief of exchange (or BOE) is
sometimes called as a draft drawn by a bank on another or by
itself on one of its other branches.
The essential requirements of a BOE may be said to be as
follows:
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(1) Written: An oral BOE can neither be made nor if made
will it be valid. A BOE being a negotiable instrument should
be in writing and executed by the maker.
(2) Order to pay : A BOE must always contain an order to
pay. In whatever form the order be framed it should be
imperative. Thus in Ruff v. Webb [(1974) 5 RR 773], the
plaintiff a servant of the defendant, was dismissed from his
services by the latter. For the wages due to him the defendant
gave him a draft in the following words :
Mr. Nelson will much oblige Mr. Webb by paying to J.Ruff or
order, twenty guineas on his account. It was held that the
paper ... was a bill of exchange, that it was an order by one
person to another to pay money to the plaintiff or his order. It
is quite apparent that the language of the draft was very polite,
but it has been said that the introduction of the terms of
gratitude does not destroy the promise (or order) to pay.
But where no such order to pay can be ascertained from the
language it will not be a BOE. Thus, in Little v. Slackford
[(1882)31 RR 726], the defendant issued a paper to the plaintiff
containing the following words :
Mr. Little, Please to let the bearer have seven pounds, and to
place them to my account, and you will oblige. Yours humble
servant, R. Stackford. It was held that, ...... the paper does not
purport to be a demand draft made by a party having a right to
call on the other to pay. The fair meaning is you will oblige by
doing it.
(3) Unconditional : The order to pay on the BOE must be
unconditional i.e, the payment must be made under all
circumstances and it should not be dependant on any
contingency. The reason for this was explained in Carlos v.
Fancourt [(1794)5 TR 482] as, it would perplex the
commercial transactions of mankind and diminish and narrow
their credit and negotiability if paper securities of this kind were
issued out into the world, encumbered with conditions and
contingencies, and if the person to whom they were offered in
negotaition were obliged to inquire when these uncertain events
would be reduced to certainty. And hence the general rule is
that the bill of exchange ( or note) always implies a personal
general credit not limited to, or appreciable to particular
circumstances and events which cannot be known to the holder
in the general course of negotiation." Thus a BOE payable
only on contingency is void ab initio, but such contingency or
defect should be apparent on the face of it. In such cases, even
the happening of the contingency cannot make the BOE valid.
A BOE is not based on contingency merely because there is an
uncertainty regarding the person having the right to enforce it
under particular circumstances.
4) Payment of money : The BOE must incorporate an order
to pay and the payment should only be in the form of money i.e
payment in cash not in kind. The same condition also applies
to a promissory note. Further, the amount to be paid must be
certain i.e. you cannot have a BOE with words like pay any
amount or little amount or a certain amount etc. The exact
amount to be paid must be stated clearly. In Smith v
Nightingale [(1818)20 RR 694], a promissory note was made
in the following words : I promise to pay to JE ... the sum of
65 with lawful interest for the same, three months after the
date, and also all other sums which may be due to him. It was
held that "the instrument was too indefinite to be considered a
promissory note. It contained a promise to a pay interest for a
sum not specified and not otherwise ascertained than by
reference to the defendants books." It is to be noted that
wherever in an instrument the rate of interest is specifically
mentioned, the interest is to be calculated at that rate from the
due date to date of debt realisation. But where the interest rate
is not specified in the instrument it is to be calculated at the rate
of 18% according to sec.80 of the Act.
5) Time of payment: The BOE must indicate clearly the time
of payment. Thus in Williamson v. Rider [(1962)2 All ER
268 (CA)] a promise to pay on or before December 31, 1956
was held not to be a promissory note payable at a fixed or
determinable future time within the requirement of section 11
of the Bills of Exchange Act because the option to pay at an
earlier date creates an uncertainty or contingency in the time of
payment.
6) Parties : The names or identities of the parties to the BOE
must be certain. A BOE showing ambiguity regarding the
identity of the persons concerned will not be a valid BOE.
7) Stamp duty: A BOE should be affixed with stamps for
required amount as Specified under the Stamp Act, 1899. In
Bank of Bengal v. Radhakissen [3 M.I.A. 19] it was held that
an instrument which is bad as a bill, note or cheque by reason
of the inclusion thereon of a condition or any other stipulation
may be used as evidence of an agreement, if properly stamped.
Drafting of a BOE
The drafting of a BOE or for that matter a promissory note is a
simple matter as no specific format or use of words is prescribed.
The only point to be remembered is that all the essential
requirements should be included, i.e., in case of BOE it should
contain (i) sum to be paid in cahs; (ii) unconditional order to
pay ; (iii) maker or drawer should be certain and (iv) payee and
draweee should be certain. Given below are a few specimens
of BOEs.
(i) BOE payable on demand
Bangalore
March 25, 1995
Rs. ...............
Pay to X,Y, etc., or order (or, pay to XY, etc., or bearer) (or, pay
to my order) on demand (or, at sight) (or, on presentation) the
sum of Rs ........ (in words).
To
Cd, etc (drawee)
Sd. AB (drawer)
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(ii) BOE payable after date (with interest)
Bangalore
25th March, 1995
Rs. ...............
............. days (months) after date pay to XY, etc., or order (or,
pay to XY, etc., or bearer) (or, pay to my order) (or, pay to
bearer) the sum of Rs ........... (in words), with interest at .... per
cent per annum.
To CD, etc AB (drawer)
(drawee)
(iii) BOE where drawer & drawee is the same person
Bangalore
March 25, 1995
Pay self (or, to my order) the sum of Rs. ........(in words) only.
To
(Sd.) AB
(iv) Foreign Bill of Exchange
(Drawn on set of three parts)
First Part
No. .................... Exchange for
Bangalore, March 25, 1995
......... months after sight of this first of exchange (the second
and third of the same date remaining unpaid), pay to CD, etc.,
or to his order ..... pound sterling (in words) (and charge the
same to the account of XY against your letter of credit No.
........ dated ...........).
To
AB, etc. Sd. ............
(drawee) (drawer)
Second part
No. ................. Exchange for
angalore, March 25, 1995
............. months after sight of this second of exchange (the first
and third of the same date remaining unpaid), pay to CD, etc.,
or to his order ...... pounds sterling (in words) (and charge the
same to the account of XY against your letter of credit No. .....
dated .....)
To Ab etc. Sd. .........
(drawee) (drawer)
Third part
No. ................. Exchange for
Bangalore, March 25, 1995
....... months after sight of this third exchange (the first and
second of the same date remaining unpaid), pay to CD, etc., or
to his order ..... pounds sterling ( in words) (and charge the
same to the account of XY against your letter of credit No.
......... dated ..........)
To
AB, etc. Sd.
(drawee) (drawer)
Distinction of a BOE from a promissory note
Though both are negotiable instruments, there exists three basic
distinctions between the two viz :
(i) In a promissory note there are only two parties the maker
and the payee; whereas in a BOE there are three parties viz the
drawer, drawee and payee.
(ii) A promissory note acknowledges an indebtedness of the
maker to the payee; whereas no such acknowledgement of debt
is there in a BOE.
(iii) In a promissory note the maker or executant makes a
promise to repay the debt himsef; where as in a BOE the
executant directs a third party to pay.
Parties to a BOE
As mentioned earlier, there are three parties to a bill of exchange,
namely, the maker or executant of the bill, the drawer who
is ordered to pay and the payee to whom the money is to be
paid on order. The rights and liabilities attaching to each of
these parties will be discussed in detail in a later chapter.
2.5 CHEQUES
Section 6 of the Act defines cheque as a bill of exchange
drawn on a specified banker and not expressed to be payable
otherwise than on demand.
A cheque being a kind of BOE it must fulfill all the requirements
of a BOE. Thus in Bevins v. London & Smith Western Bank
Ltd [(1900)1 KB 270], a company issued a cheque on its
bankers with a receipt appended to it, and ordering the banker
to make the payment provided the receipt form at foot hereof
is duly signed, stamped, and dated. The cheque was held to
be invalid because its payment was made conditional upon
signature of the receipt.
A cheque is always drawn on a banker. The question now arises,
who is a banker ? This question was answered in R. Pillai v. S.
Ayyar [(1920)43 Mad 816]. Here, a District Board had its
funds in the Government Treasury and used to withdraw money
from that fund by issue of orders in form of cheques. One such
unconditional order being issued the question arose as to
whether it was a cheque. It was held that, Treasury is not a
bank. A banker is one who in the ordinary course of his business
honours cheques drawn upon him by persons from and for
whom he receives money on current accounts. Thus, the order
was held not to be a cheque u/sec.6 but a BOE u/sec.5 of the
Act.
Distinction between cheque and BOE
In Ram Charun Mullick v. Luchmee Chand Radakissen [14
ER 215] it was observed, a cheque is a peculiar sort of
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instrument, in many respects resembling a bill of exchange,
but in some entirely different. A cheque does not require
acceptance, in the ordinary course it is never accepted; it is not
intended for circulation, it is given for immediate payment; it is
not entitled to days of grace ..... Citing this passage in Bank
of Baroda v. Punjab National Bank [(1944) AC 177] Lord
Wright made a further contribution to the distinction between
cheques and BOEs and observed : In addition it is to be
noted, a cheque is presented for payment, whereas a bill in the
first instance is presented for acceptance unless it is a bill on
demand. A bill is dishonoured by non-acceptance, this is not
so in the case of a cheque. These essential differences (besides
others) are sufficient to explain why in practice cheques are not
accepted. Acceptance is not necessary to create liability to pay
as between the drawer and the drawee bank. The liability
depends on contractual relationship between the bank and the
drawer, its customer. Other things being equal, in particular if
the customer has sufficient funds or credit available with the
bank, the bank is bound either to pay a cheque or to dishonour
it at once ... It is different in case of an ordinary bill; the drawee
is under no liability on the instrument until he accepts; his
liability on the bill depends on the acceptance of it.
The distinction between a cheque and BOE can be briefly stated
as below :
a) A cheque is always drawn on a bank or banker ; whereas a
BOE is made to a drawer who is merely a definite or
identifiable person.
b) A cheque is payable immediately on demand without days
of grace; whereas a BOE may be payable on demand or a
future fixed date or at sight or at presentment etc.
c) A cheque requires no acceptance apart from prompt
payment; whereas a BOE in the first instance has to be
presented for acceptance.
d) There is no privity of contract between the banker and the
payee and so the later cannot sue the banker on his
dishonouring the cheque without sufficient cause; whereas
since a drawer of BOE accepts the liability to pay he can
be sued by the payee if he dishonours the BOE i.e. there is
a privity of contract between the drawer and payee.
e) A cheque is supposed to be drawn upon funds in the hands
of the banker belonging to the maker i.e. if there are no
funds the cheque cannot be honoured.
f) A cheque is not noted or protested for dishonour unlike a
BOE.
g) In case of crossed cheques a protection is given to the banker
which is unique only to cheques. This will be discussed
later.
Parties to a Cheque
Like in other BOEs a cheque also involves three parties namely;
the executant or maker of the cheque; the drawee who is always
the bank and the payee in whose favour the cheque is made.
2.6 HUNDIS
As observed earlier though the Act itself recognizes only three
kinds of negotiable instruments by name, it also accepts certain
instruments having wide-spread commercial usage. One such
instrument having a popular usage in India is the Hundi. The
word hundi is derived from the Sanskrit word hund meaning
to collect and explains clearly the purpose for which hundis
are use. Hundis have been in use in India long before the advent
of the Act, and a lot of usages attach to them - the usages
themselves differing from locality to locality. Thus for examples
in Murshidabad interest on hundis drawn payable so many days
after sight is allowed [Dhanput Singh v. Maharaja Jugut
Indur, 4 W.R. 85]; in Dacca the usage is for the gumastas (i.e.
munshis or clerks) to draw hundis on their principals without
thereby incurring liability for the defection of their principals
i.e. the gumastas themselves incur no liability [Muree Mohan
v. Krishna Mohun, 17 W.R. 442]; among the shroffs of
Bombay the usage was that a shroff to whom a hundi was sent
for collection by his customer gave him credit for the amount
and then he acquired all the rights of a holder in due course
[Sugan Chand v. Mulchand, 1 Bom 23]; in Punjab there is a
usage that where a hundi is dishonoured and returned,and a
conditional payment is made,the hundi is to be presented again
within four days or else the amount should be refunded
[Surajaml v. Kashiprasad, 1933 Mag 389]; etc,. The names
in the brackets indicate the cases where these customs have
been upheld by the courts as binding on the parties. A hundi
when paid and cancelled is called a Khokha.
Kinds of Hundis
The very fact that usages attaching to a hundi differ from place
to place proves that there are various kinds of hundis each having
its own specific characteristics, i.e. some may be payable on
sight; some after the elapse of a definite period; some are payable
only to a specific person; etc. We will now discuss these various
kinds of hundis in brief.
(i) Darshini hundi - This is a hundi which is payable on
darshan i.e. at sight or presentment. A specimen of darshini
hundi prevalent in Bombay is given below :
Rs. 5000
At Bombay Sheth ......... please accept salutation of the writer
sheth ........ from . ...... we have received here (Rs 5000) five
thousand only from Sheth ......... Please pay to the presenter at
sight and debit the same to our account. Please pay the double
of two thousand five hundred viz, five thousand only, per rules
of the Bombay Shroff Mahajan.
Date Signature
(ii) Mudati or Thavani hundis - These are hundis which
become payable at a certain period after date or sight. Specimen
of mudati or Thavani hundi is given below.
Muddati (or usance) Hundi (Bengal)
May Sri Durga protect us. Obedient servant Sj. Hari Charan
Dass begs with many salutations to inform you, that a hundi
for Rs.1,000 double of Rupees five hundred (Rupees one
thousand only) is issued upon you from this place. The amount
has been deposited hereby Sri. Amarnath Basu. The Muddat is
25 days and the grace is 3 days, i.e, in all 28 days. On the
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receipt of this Hundi, you please accept it and pay the sum to a
person with credit on due date after the Muddat and take receipt
on the back of the Hundi. This is the prayer to your auspicious
feet. Thus ends this Hundi.
10th Ashar 1335 Monday,
Signature
Thavanai Hundi for goods sent (Madras)
Due 19
Rs ....... Place and date
At ........ days after sight please pay to ......... or order the sum of
Rupees ......... only for value received against R/R ........... To
Drawee (Address).
Signature
(iii) Shah Jogi hundi - This is a hundi payable only to a
respectable holder, i.e. a man of worth and substance known in
the bazar [Lall Mal v Kesho Das, 26 All 493]. There has been
a division of opinion on the question, whether a shah jogi hundi
is a negotiable instrument ? Some courts held that it is not a
negotiable instrument since the payee is an indeterminate person;
whereas some other courts held that the word shah is not
indeterminate and vague, and that it may be treated as payable
to the drawee or to several payees. In Daulatram v. Bulakidas
[(1861) 6 B.H.C.R.] the Bombay High Court held that at its
inception it was a hundi that passes from hand to hand by
delivery and requires no indorsement. The same Court in
Champaklal v. Keshrichand [50 Bom 765] held that, the hundi
may pass from hand to hand till it reaches a Shah who, after
making due enquiries to secure himelf presents it to the drawee
for acceptance or payment; then its negotiability ceases. The
drawee before paying has to satisfy himself that the person
demanding payment is a Shah, for the payment is made only on
the responsibility of that person [Ganeshdas v.
Lachminarayan, 18 Bomb 570]. A minor may be the holder
of a Shah Jogi hundi and a payment to him will certainly be
recognised [Ramprasad v. Shrinivas, 1925 Bom 527] Though
a Shah Jogi hundi does not technically fall within the definition
of a negotiable instrument under the Act, it is nevertheless a
negotiable instrument. The Act does not apply to it though
many of the provisions which apply to it are similar to that of
provisions applicable to those of instruments covered under
the Act, though that is because of the mercantile usage and not
by virtue of a Act. Given below is a specimen of a Shah Jogi
Hundi.
Shah Jogi Hundi (Bombay)
At Bombay Sheth ...... Please accept salutations of the writer
Sheth
.................... from ................ We have received Rs. 1,000 from
Sheth ............... Please pay the presenter on demand as per rules
of the Bombay Shroff Mahajan after assuring yourself that the
presenter is a Shah:
Date the 12th Dark day of Bhadrapad Samvat year 1911.
Date Signature
(iv) Jokhmi hundi - This is a hundi drawn against the goods
shipped on the vessel named in the hundi by the consignor on
the consignee of the goods. The drawer of the hundi is enabled
to get funds by negotiating the hundi and at the same time effect
an insurance upon the goods against loss. The buyer of the
hundi is the insurer who pays the insurance money down and is
entitled to recover the money if the vessel arrives safe in port.
If the ship is lost then he does not have a remedy against either
the drawer or drawee, and he has to bear the entire loss, while
the drawer & drawee themselves are protected. This kind of
transaction though similar to an ordinary insurance policy differs
from it in the sense that the position of insurer and insured is
reversed and the insured money is paid before hand. The term
Jokhmi itself means against risk or conditional. This custom
however imposes no liability on the drawee to take up the hundi,
even if he takes possession of the goods consigned to him. The
drawer also escapes liability if the goods against which the hundi
is drawn are totally lost [Jadowji Gopal v. Jetha Shamji, 4
Bom 333]. Given below is a specimen of a `Jokhmi hundi.
Jokhmi Hundi (Bombay)
Welfare. To worshipful ........... of Bombay written by Liladhar
Govindji of Nawanagar whose salutations please accept. To
wit. We have received here from Jadowji Gopalji Rs.4,000
(forty hundred only). In respect thereof this Jokhmi hundi (is
drawn) against goods on Board Ganga Hariprasad (Nakkawa
Boja, owner Mr. Dayalji Morarji being 29 bags of sheeps wool
shipped from Tuna, against which this Jokhmi hundi (is drawn)
after said vessel shall have arrived in a safe and sound manner.
After 8 days thereof, do you be good enough to pay to Shah
looking to his means, station and place.
Date : Signature
(Note . This is generally accompanied by a letter of advice).
(v) Nam Jog Hundi - In contradistintion to Shah Jogi Hundi,
there is what is known as the Nam Jog Hundi, that is a hundi
payabele to the party named in the bill or his order. The bill
may or may not be accompanied by a descriptive role of the
party in whose name it is granted. When there is a descriptive
role, it cannot be indorsed or transferred; but when there is no
such description, it can be indorsed. The alteration of a Nam
Jog into a Shah Jogi hundi is a material alteration and renders
the instrument void. Given below is a sample of such a hundi.
To Chunnilal at Madras worthy of alleulogy. Written from
Calcutta by Ramkumar from whom please accept salutations.
To wit. Please pay on receipt of this Hundi to Ramnath Goenka
according to custom of Hundi, the sum of Rs.1,000 (double of
half the sum of five hundred) for value received.
Date Signature
(vi) Dhani Jog Hundi - Dhani Jog hundi is one payable to
Dhani or owner, i.e., a person who purchases it. It is payable to
any owner, holder or bearer. It is a negotiable instrument payable
to bearer. The word dhani is not equivalent to `bearer in the
sense it is used in the Negotiable Instruments Act. A mere
bearer of a Dhani Jog hundi is not as such entitled to payment.
It is not a negotiable instrument within the meaning of this Act.
Given below is a sample of such a hundi.
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Bow to Shri Ganesh
To Chunilal Murliprasad worshipped and worthy of alleulogy
at Madras blessed by the Goddess of Wealth ....... written from
Calcutta by Ramkumar from whom please accept salutations.
To wit. Pay at once on receipt of this Hundi to Dhani Jog
according to the custom of hundis.
Rs. 1,000 (in words) one thousand, double of half the sum five
hundred on behalf of Chunnilal Prasad of this place for value
received.
Date Signature
(vii) Jowabi Hundi - The transaction known by the name of
Jowabi hundi is as follows :- A person desirous of making a
remittance writes to the payee and delivers the letter to a banker
who either indorses it on to any of his correspondents near the
payees place of residence or negotiates its transfer. On its
arrival, the letter is forwarded to the payee who attends and
gives his receipt in the form of an answer to the letter which is
forwarded by the same channel to the drawer of the order. This,
it will be noticed, is more in the nature of a letter of
recommendation than a bill of exchange. The banker may cancel
the order of payment by advice to his correspondent at any
time before payment, in case the so-called drawer fails in his
promise to provide the banker with the amount of the order.
(viii) Zickri Chit - According to the usage of shroffs in the
case of Marwari hundis, a hundi may be accepted for honour
under what is called Zickri chit. This is a letter of protection
given to a holder by some prior party to the hundi to be used by
him in case the hundi is not accepted. It is generally addressed
to a person in the town where the bill is payable, asking him to
take up the hundi in case of dishonour. Such usage is even now
recognised by the Court, notwithstanding the fact that the
provision of sections 108 and 109 of the Act are not complied
with a specimen of Zickri (Tikry) Chit.(Ajmere)is produced
below.
To good place Dwarka. Letter written to brother Mohal Lal
from Hari Dayal who sends greetings. We had sold hundi for
Rs.65 (sixty-five) from Dwarka on Sanwal Das, by Radha
Krishan favouring Lodhi Pershad, dated 10th day of Bhadon,
Sambat 1911, payable to bona fide person, in the currency ofthe
market, to brother Baldeo Sahai Gopi Nath who informs us
that the hundi is unpaid. If this hundi has been paid, well and
good. If not, please pay this hundi as stated in this letter debiting
the amount to our account and return the hundi unendorsed to
us.
Letter written the 11th day of the latter half of Katak, Sambat
1911.
(Sd.) HARDAYAL (Verma, pp 58-60)
An important point to be remembered in relation to hundis and
other instruments in oriental languages is that if the existance
of a local custom or usage establishing such instrument cannot
be proved, then the provisions of the Act will apply to such
instruments.
2.7 INLAND AND FOREIGN INSTRUMENTS
Sec.11 of the Act which defines inland instrument states as
follows :
A promissory note, bill of exchange or cheque drawn or made
in India and made payable in or drawn upon any person resident
in India shall be deemed to be an inland instrument.
For a negotiable instrument to be treated as an inland instrument
it should fulfill one of the following two requirements, viz
(i) it must be drawn and made payable in India; or
(ii) it must be drawn in India upon some person resident in
India, even though it is made payable in a foreign country.
An inland instrument does not lose its character merely
because it is either indorsed by a foreign national or in a
foreign country because it is in circulation in a foreign
country.
Sec.12 of the Act dealing with foreign instruments states as
under :
Any such instrument not so drawn, made or made payable
shall be deemed to be a foreign instrument.
A foreign bill may be any one of the following viz :
i) It is drawn outside India and is made payable in or drawn
upon any person resident in a country other than India;
ii) A bill drawn outside India and made payable in or drawn
upon any person resident in India;
iii) Bills drawn in India upon persons resident outside India
and made payable outside India.
Foreign bills are generally drawn in a set of three or in parts
numbered and containing a refrence to the other parts (see the
specimen foreign bill given on pg. 23). The reason for the this
is to reduce or remove the danger of loss, especially when such
bills are to be sent to foreign or overseas countries.
An important question which now arises is - what is meant by
'resident' in India? Although the term 'resident' has been defined
both in the Income Tax Act and the Civil Procedure Code, such
definitions would be extremely wide for application of these
sections. So for our purpose, resident would mean or suggest a
permanency of staying at a place (even if not domiciled) as
opposed to a temporary stay or a visit to the country. In case of
companies and firms 'residence' means 'place of business.'
Distinction between inland and foreign bills
The major difference between these two bills is that in case of
inland instruments 'protesting for dishonour' is optional, whereas
foreign bills must be protested if the law of the place where it is
drawn so requires. Secondly, the liabilities of a drawer of a
foreign BOE or maker of foreign promissory note are essentially
regulated by the law of the land where they are drawn and made;
and merely because such note or BOE is negotiable in its own
country will not automatically make it negotiable in another
country, i.e., such negotiability will be governed by the usages
of such other country.
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2.8 INCHOATE INSTRUMENTS
Section 20 of the Act deals with inchoate or blank instruments
and states that, where one person signs and delivers to another
a paper stamped in accordance with the law relating to
negotiable instruments then in force in India, and either wholly
blank or having written thereon an incomplete negotiable
instrument, he thereby gives prima facie authority to the holder
thereof to make or complete, as the case may be, upon it a
negotiable instrument, for any amount specified therein and
not exceeding the amount covered by the stamp. The person
so signing shall be liable upon such instruments, in the capacity
in which he signed the same, to any holder in due course for
such amount : Provided that no person other than a holder in
due course shall recover from the person delivering the
instrument anything in excess of the amount intended by him
to be paid thereunder.
This section imposes a liability upon a person executing a blank
or incomplete negotiable instrument and hence shall be strictly
construed. The object and intent of this section was laid down
in Glenie v. Bruce Smith by Fletcher Molton, L.J., as The
logical order of operations with regard to a bill, is, no doubt,
that the bill should be first filled up, then that it should be signed
by the drawer, then that it should be accepted, then it should be
negotiated, and then that it should be indorsed by the person
who become successively holders; but it is common knowledge
that parties very often vary, in a most substantial manner. The
logical order of those proceedings, and section 20 of the Bills
of Exchange Act is intended to deal with those cases. Very
often in the commercial world, persons having mercantile credit
ie., good business repute, lend it to others by signing their names
on blank papers which is afterwards filled up as a BOE or
promissory note over their signatures making them drawers or
makers. In Montague v. Perkins [(1853)22 LJ (C.P) 187] it
was observed that, By such signatures, they intend to bind
themselves as drawers or makers, acceptors or indorsers, and
the presence of their names on the blank paper purports to be
an authority granted to the holder to fill up the blanks as a
complete negotiable instrument, and when so filled up, such
parties become as absolutely bound in the capacity in which
they signed, as if they had signed them after the bills were written
out, but till the blanks are so filled up the instrument is not a
valid one and no action is maintainable on it. The capacity in
which a party to a blank bill becomes bound (i.e. whether as
drawer or as indorser etc) depends on the mode and place of
signature. For example, if a person signs his name beneath the
word accepted or simply writes his name across the face of
the bill he becomes liable as an acceptor; but if he signs his
name across the back of the blank paper duly stamped and
delivered he becomes liable as indorser. But in no case will
such a person become liable, till he i.e. the person signing
delivers the paper to another.
A person in possession of such a blank bill has a prima facie
authority to fill up the instrument and in this manner he acts as
an agent of the person delivering the blank instrument. So if
the authority of the agent comes to an end before the instrument
is filled, sec.20 becomes inapplicable and no rights attach to
such an instrument except to a holder in due course.
Sec.20 does not give the time within which such an instrument
should be filled up. The corresponding sec.20 in Bills of
Exchange Act in England states that the instrument should be
filled up within a reasonable time, and what is a reasonable
time is a question of fact varying from case to case.
The authority to fill up the blanks is not limited to the person in
possession of the instrument but also extends to those claiming
under him. But this authority does not include the right to stitch
up several signed stamped papers together so as to make one
single instrument [Gokuldas v. Radhakisan, 54 I. C.3], nor
can a person insert a particular place of payment before the
acceptance [Calvent v. Baker, 150 E.R 1492], since this would
amount to material alteration of the instrument. Thus, whenever
a holder exceeds his authority he can derive no benefit from
that instrument. Under the proviso to the section the holder in
such a case is entitled to recover the sum which was intended
to be paid orginally. In Hatch v. Searles [(1854) 2 Sm. & G.
147] it was observed that, as to a bonafide holder, the question
as to the effect of the acceptance or indorsement having been
written on a blank piece of paper can be of no importance unless
he can be fastened with notice of that imperfection. If the holder
has notice of the imperfection, he can be in no better situation
than the person who took it in blank as to any right against the
acceptor or indorser who gave it in blank. Only bonafide
owners are protected under the section, and so if the holder of
the instrument has taken it for betting transactions and realised
the amount on it, the maker is entitled to recover the amount
[Paine v. Bevan, (1914)19 Com.Cas 234].
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SUB TOPICS
3.1 Introduction
3.2 Parties to a promissory note
3.3 Parties to a BOE and cheque
3.4 Holder an Holder in due course
3.5 Indorser
3.6 Parties
3.1 INTRODUCTION
In the earlier chapter we have repetedly used the words maker,
drawer, drawee or indorser etc. We have also tried to briefly
define the terms, but have not gone into the rights and liabilities
which attach to these parties. We would now deal with these
matters in detail.
3.2 PARTIES TO A PROMISSORY NOTE
A promissory note involves only two parties, viz; the maker
and the payee.
Maker ; The person who executes or makes the promissory
note is called as the maker. It is of paramount importance
that the note should clearly indentify the person entering into
the contract. All persons whose names appear as makers are
primarily and unconditionally liable provided the note clearly
shows an unconditional promise to pay the debt or the amount.
Further the maker should put his signature across the bill.
Though the Act itself does not define the word sign, sec.3(56)
of the General Clauses Act, 1897 defines it as: sign with its
grammatical variations and cognate expressions, shall with
reference to a person who is unable to write his name, inlcude
mark with its grammatical variations and cognate expressions.
Signature may thus be briefly defined as the writing of his
name or putting his mark across a bill by a person in order to
authenticate and accept the contract specified in the bill.
Thus by signing the pro note the maker not only executes the
note but also accepts to be bound by its contents. Thus in Block
v. Bell [(1831)1 Mor. & Rob. 149], an instrument in the form
of a promissory note without any signature of the defendant,
but addressed to him in the margin and accepted by him was
allowed to be declared as a note on the ground that the signature
of the defendant though in the form of an acceptance, was an
adoption of the promise contained in the instrument.
When does the liability arise ?
A makers liability arises when :
a) he signs the promissory note and
b) unconditionally promises to pay
Extent of liability
A maker is liable to pay only that amount which accrues to him
as per the terms of the promissory note. His liability is not
dependant on presentment to any other party on payment or
otherwise unless such condition is expressed in the note itself.
Payee : The person in whose favour the promissory note is
made i.e. the person to whom the money is to be paid is known
as the payee. Just as the maker of the note has to be certain, so
also should the payee be. Thus in Obermeyer v. Barmann
[1911 T.P.D. 79] an instrument containing a promise to pay a
certain sum into the bank but not naming the payee, was held
out to be a promissory note. The payee may be either specified
by name or designation [if by the use of the designation an
identification can clearly be made] or the promissory note may
be made payable to a bearer i.e. the person is in possession of
the note lawfully and presents it for payment. If neither of
these conditions are satisfied then the note is not a promissory
note.
Under sec.4, a note may be made payable to alternative payees
i.e. pay to AB or CD. In such a case either AB or CD can
present the note for payment. This is a good way of limiting
your liability to pay to only the persons mentioned in the note
and to no other.
A note may be issued to more than one person making them
joint payees i.e., payable to A,B, C or their order or the majority
of them. Such a note may be sued upon by all of them. Where
the maker executes a note in favour of a fictitous person then
the note will be treated as payable to bearer and a person in
lawful possession can present it for payment. So also a
promissory note with a blank for the payees name may be filled
up by a bonafide holder in his favour and he can claim on the
note.
Rights of a payee
1. Where the note is a promise to pay, the payee can present
the note for payment. If the maker defaults on the payment
then the payee has the right to sue the maker on the note.
2. Where the note is in the form of payable to AB or order,
the payee can:
- present the note for payment.
- sue the maker in case of default
- indorse the note for negotiation an deliver it to the holder.
3.3 PARTIES TO A BOE OR CHEQUE
Both a bill of exchange and a cheque have three parties to them,
viz ; the drawer, the drawee and the payee.
Drawer : Drawer is the maker of the BOE i.e. he is the person
who orders a third person or promises to pay money to another.
He may make the bill payable on sight i.e. to the bearer of the
bill or on his order.
Liability of a drawer
Section 30 of the Act deals with the liability of the drawer and
states that, The drawer of a bill of exchange or cheque is bound
3 PARTIES TO A NEGOTIABLE INSTRUMENT
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in case of dishonour by the drawee or acceptor thereof, to
compensate the holder, provided due notice of dishonour has
been given to, or received by, the drawer as hereinafter
provided.
Though the section itself is simply worded it has resulted in a
lot of confusion especially on the interpretation of the term
dishonour. This is because, a BOE may be dishonoured by
the non-acceptance (sec.91) or it may be dishonoured by non-
payment (sec.92). It is only in the later cases that sec.93
providing for notice to the drawer comes into play. So the
question arises which kind of dishonour has been contemplated
under this section. in Jagjivan v. Ranchoddas [AIR 1954 SC
554] the Supreme Cout laid down the law as, In a bill payable
after sight, there are two distinct stages firstly when it is
presented for acceptance and later when it is presented for
payment, section 61 deals with the later. As observed in Rama
Raviji Jambakar v. Pralhaddas Subkaran [ 20 Bom 133],
presentment for acceptance must always and in every case
precede presentment for payment. But when the bill is payable
on demand both the stages synchronise, and there is only one
presentment which is both for acceptance and for payment.
When the bill is paid, it is really dishonoured for non-acceptance:
The liability of the drawer can thus be studied under the
following situations, viz:
(i) Where the bill is payable on sight or demand
If such a bill is not paid by the drawee when it is presented
then, the drawer becomes immediately liable to pay the
full amount to the payee.
(ii) Where the bill is payable a certain period after sight or
date
If such a bill has not been accepted by the drawee, then the
drawer becomes liable to compensate the payee provided
he has presented the bill for acceptance within a reasonable
time as required u/sec.61 [Miller v. The National Bank
of India, 19 Cal.146]
(iii) Where the bill is payable on or after a fixed date
If the payee presents the bill for acceptance before such a fixed
date and the drawee refuses to accept it, it cannot be said that
the bill has been dishonoured u/sec 91. The position under
sec.55(1) of the English Bills of Exchange Act is somewhat
different in these situations. The section provides that, the
drawer of a bill by drawing it is said to contract, among other
things, that it shall be accepted by the drawee if presented for
acceptance and that if it be dishonoured by any refusal on the
part of the drawee, he will compensate the holder or the other
party compelled to pay it, on requisite proceedings on dishonour
being taken. In Ram Ravjis Jambakars case The Bombay
High Court observed as follows : the several sections in chapter
(sic)61 relating to presentment for payment appear to us to pre-
suppose that the bill has not been already dishonoured by non-
acceptance. When it is dishonoured by non-payment the
provisions of Chapter VIII come into play. It is true that there
is no such explicit declaration of the law upon the subject in the
Indian Act as in section 43, clause (2) of the English Act. But
the whole scope and tenor of chapter VIII of the Indian Act
appear to contemplate the same result as is there declared to
follow from non-acceptance.
The position in these cases appears to be as follows :
(a) Even if the drawee refuses to accept the bill because it was
presented before the due date, the payee can treat it as
dishonoured for non payment and claim compensation
from the drawee after giving due notice to him. The
advantage here is he gets the amount much earlier than
what he would have done ordinarily.
(b) The payee may elect to maintain the status quo, wait till
the due date, present the bill to the drawee for acceptance
and if the drawee again refuses to honour it, then, claim
compensation from the drawer after giving him a due notice.
But in such a case he does not get a fresh cause of action
on non-payment on the due date. The cause of action
remains the same ie dishonoured for non payment.
When does the liability arise ?
The liability of a drawer does not arise till he has been given a
notice of the dishonour by the drawee. The purpose of notice
is to make him aware of the facts. The liability of the drawer is
similar to that of a principal debtor under an implied contract
of indemnity. He does not undertake to fulfil the original
contract but only to compensate for the loss or breach, on
condition that the bill is dishonoured and he is informed of that
fact. Thus in Baijnath v. Ramkumar [AIR 1975 Cal 286]
where a hundi was stolen in transit and presented to the drawee,
who paid it without detecting the forgery of indorsement it was
held that the drawers liability had been discharged and he was
no longer liable. Giving of notice has been treated as so essential
that any laches in giving of it releases the drawer from his
liability, and is necessary in all cases except to those falling
under the exceptions given in sec.98 of the Act.
In general the holder is required to give the notice within a
reasonable time, but if he is unable to do so due to some reason
or fails to do so then, he may take advantage of any notice of
dishonour received by the drawer from any other party liable
on the instrument. That means that if the drawer receives notice
of dishonour from a stranger to the instrument, the drawee
cannot take advantage of that fact.
Liability of drawer of a cheque
The holder of a cheque has no remedy against the drawer, till
he has presented the cheque to the drawee and been refused
payment on it. A cheque is presumed to be paid out of the
funds deposited in the drawers account, so he should be
immediately informed of the dishonour of the cheque so that
he can make inquiries about the state of funds in his account
and secure his funds. Just as in case of other BOEs, a cheque
should be presented within a reasonable time (the maximum
time within which it can be encashed is 6 months from the date
of its making) and the drawer should be informed immediately
on its dishonour. The difference in liability of the drawer of a
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BOEs and of a cheque is that, in the former case if the BOE is
not presented within a reasonable time or the drawer is not
informed of the dishonour of the bill he is discharged from his
liability but in case of cheques the drawer is not discharged
from his liability in such a case unless he can prove that he has
suffered damage due to non presentment or want of notice of
dishonour.
Contract to contrary
The drawers liability may be made subject to the terms of the
contract i.e. he can make stipulations in the contract negating
or limiting his own liability, for example, by use of words sans
recourse or without recourse to me; or if he is the executor
then by stipulating that payment would be out of the assets of
the deceased etc. Similarly he may also waive away the duties
which the holder owes him, as for example, the notice of
dishonour. But where there is no evidence of such contractual
limitations or stipulations, the drawer would be deemed liable
to the fullest extent under the Act, and the right of the holder
against the drawer will not be lost despite the loss of any
collateral security that may have been given to support the
contract.
Drawee : Drawee is the person who is ordered by the drawer
to pay a specified amount to a third person or on his order.
According to sec.33, only a drawee can be an acceptor of a
BOE except in case of need or acceptance for honour. What
does this term acceptor mean ? Every BOE has to be first
presented by the holder to the drawee who may agree to be
bound by the BOE. Once he accepts to be bound by the BOE,
you say that the bill has been honoured by acceptance. Next
comes the presenting of the bill for payment and the holder can
claim payment only from the person who has agreed to be bound
by it. But if the person to whom the bill has been presented for
acceptance, the holder can after giving notice to the drawer
claim compensation from him for dishonour of the bill. In case
of cheques, there is no presentment for acceptance, there is only
a presentment for payment, and if the drawee refuses payment
on the cheque - the holder can claim compensation from the
drawer for dishonour of cheque.
Liability of a drawee
Section 30 only makes the drawer liable in case of dishonour
and does not speak about the liability of the drawee. In a suit
for compensation filed by the holder against the drawer, the
drawee need not even be made a party to the suit. The drawees
liability can be studied under the following two situations viz :
a) When the drawee refuses to accept the bill
In such a case no liability attaches to the drawee since the drawee
becomes liable only when he accepts the BOE and not before.
The holder in such cases can only sue the drawer for
compensation.
b) When the drawee accepts to honour the bill, but later
refuses to pay when it is presented for payment
In such situations, the holder has an option to sue either the
drawer or the drawee or both of them for the bill amount, either
in the same suit or in separate suits [Basant v. Kolahal, 1 All
392], and the drawer himself is not absolved of his responsibility
merely because of a limitation bar against the acceptor
[Ramaswamy v. Sundararajam, 26 Mad 239] or because the
holder has obtained a decree against the drawee which has not
been satisfied. The primary liability on dishonour of a BOE
rests with the drawer and he cannot escape liability because the
holder has chosen to make the drawee liable. The period of
limitation for such suits is 3 years and the period begins to run
from the time of refusal to accept or refusal to pay.
Liability of drawee of a cheque
The drawee in case of a cheque is always the bank. Section 33
dealing with banks liability in case it dishonours a cheques
states as follows :
The drawee of a cheque having sufficient funds of the drawer
in his hands, properly applicable to the payment of such cheque
must pay the cheque when duly required to do so, and in default
of such payment, must compensate the drawer for any loss or
damage caused by such default.
Thus for a bankers liability to arise the following conditions
must be satisfied, viz :
i) The cheque must have been properly made.
ii) It must have been duly presented within a reasonable time.
iii) There must be sufficient funds in the drawers account to
cover the cheque amount.
iv) The banker must have refused to honour the cheque without
a reasonable or just cause.
If all these conditions are satisfied then the bank's liability is
two folds, viz :
a) The holder of the cheque can sue him either separately or
alongwith the drawer, for the cheque amount with interest,
and
b) The drawer is entitled to sue the bank for damages in lieu of
the damage or loss suffered by him. The quantum of
damages awarded in these cases is decided on the principle
that, lesser the amount or value of the dishonoured cheque
greater are the damages awarded; greater the value of the
cheque, lesser are the damages.
The reason for holding the banker liable is because of the
peculiar relationships which exists between banker and
customer, as was well explained by Lord Atkin in Joachimson
v. Swiss Bank Corporation [(1921)3 KB 110 (CA)]. He
observed as follows :
The bank undertakes to receive money and to collect bills for
its customers account. The proceeds so received are not to be
held in trust for the customer, but the bank borrows the proceeds
and undertakes to repay them. The promise to repay is to repay
at the branch of the bank where the account is kept and during
banking hours. It includes a promise to repay any part of the
amount due, against the written order of the customer addressed
to the bank at the branch and as such written order may be
outstanding in the ordinary course of business for two or three
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141
days, it is a term of contract that the bank will not cease to do
business with the customer except upon reasonable notice. The
customer on his part undertakes to exercise reasonable care in
executing his written orders so as not to mislead the bank or
facilitate forgery. I think it is necessarily a term of contract that
the bank is not liable to pay the customer the full amount of his
balance at which the current account is kept.
Thus a banker is entitled to refuse a cheque only when, it is not
drawn up correctly or its legal validity is doubtful; or it is
irregular or undated or unsigned; or if it is required to be stamped
then in case the cheque is unstamped. But wherever the cheque
is properly drawn andpresented at the appropriate place during
appropriate timeing, the banker is honour bound to accept the
cheque for payment, else he becomes guilty of a breach of
contract between himself and the drawer.
Payee : He is the person in whose favour the BOE is in the first
instance made, i.e., he is the person to whom a certain amount
of money is to be paid by the drawee when so ordered by the
drawer. The bill may be made payable to the payee or on his
order, or it might be payable on sight. When the bill is payable
or his order then the payee may indorse the bil in favour of
another person and once he so indorses the bill he ceases to be
the payee. In case the bill is payable on sight the bearer of the
bill in lawful possession becomes the payee. As mentioned
earlier all the parties to the BOE must be clearly identifiable -
any vagueness or ambiguity in the description of the parties
and the bill becomes invalid.
Rights of a payee
(1) A payee has the right to receive money on the bill or cheque
either on presentment or at the fixed time (depending on
the wordings of the bill) provided that :
a) he presents the bill in the proper manner, and
b) within a reasonable time of making of the bill.
(2) He has a right to negotiate the bill further by indorsement,
unless the right is curtailed by specific stipulations made
by the drawer.
(3) He has the right to sue the drawer for compensation if the
bill has been dishonoured for non-acceptance.
(4) He has the right to sue the drawer or the drawee or both for
compensation if the drawee refuses to honour the bill by
payment, after having accepted to do so.
3.4 Holder and Holder in due Course
Section 8 defines the holder of a negotiable instrument as any
person entitled in his own name to the possession thereof and
to receive or recover the amount due thereon from the parties
thereto.
Where the note, bill or cheque is lost or destroyed, its holder is
the person so entitled at the time of such loss or destruction.
The first holder of an instrument is the payee of that instrument
and he is obviously entitled to be in possession of it. The payee
has two options, viz :
a) he can himself present it to the drawee or maker for
payment; or
b) he can transfer the instrument to a third person in satisfaction
of his own debt. Such a transfer can be done either by :
(i) simple delivery in case the instrument is payable to
the bearer ; or
(ii) by indorsement and delivery if the instrument is
payable to order.
When the payee so transfers the instrument he is said to have
negotiated and the person to whom the instrument is delivered
becomes the holder of it. As per sec.14, when an instrument is
transferred to any person so as to constitute that peson the holder
thereof, the instrument is said to be negotiated. Section 2 of
the English Bills of Exchange Act provides that, holder means
the payee or indorsee of a bill or note who is in possession of it
or the bearer thereof. The Indian definition given u/sec.8 is
similar to this definition except for the use of the phrase entitled
in his own name. This phrase originally assumed significance
because of benami transactions and its importance was
highlighted in the case of Sarjio Prasad v. Rampayari Debi
[AIR 1950 Pat 493]. Here, a sum of Rs. 2,459 was advanced
by the plaintiff under a hand note, which was not executed in
his name but in the name of one X who was the benaminder.
On maturity of the note, the plaintiff sued the defendant for
recovery of the amount. The Court rejecting his claim observed
that as he was not entitled to the possession of the note in his
own name he was not the holder. But in the present day context
the significance is somewhat lost because of Benami
Transactions Prohibition Act making benami transactions of
any kind illegal.
To summarise a holdee is a person who :
a) is the bearer of the note or bill ; or
b) is the indorsee under the note or bill.
A holder has the following rights :
i) To present the note or bill for payment
ii) To negotiate the bill by delivery or indorsement unless his
right to do so is restricted.
iii) To claim compensation from the drawer in case the bill or
note is dishonoured by non-acceptance.
iv) To sue either the drawer or the drawee or both in case the
bill is dishonoured by non-payment after the drawees
acceptance of it.
Holder in due course
According to sec.9, holder in due course means any person
who for consideration became the possessor of a promissory
note, bill of exchange or cheque if payable to bearer, or the
payee or indorsee thereof, if payable to order, before the amount
mentioned in it became payable and without having sufficient
cause to believe that any defect existed in the title of the person
from whom he derived his title.
Thus for a person to be considered as a holder in due course the
following conditions will have to be satisfied viz :
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(i) Consideration
Every negotiable instrument consists of a contract between the
parties and should therefore be supported by real and valuable
consideration as defined under sec.2(d) of the Contract Act. A
person in possession of a bil or note without having given any
consideration for it cannot enforce it unless the lack of
consideration falls under the exceptions given under sec. 25 of
Contract Act. For easy negotiability of these instruments the
doctrine of consideration has been simplified in the following
manner, viz :
a) Consideration is always presumed to have been given unless
proved otherwise [Talbot v. Van Boris, (1911)1 KB 854].
b) It is immaterial in case of negotiable instruments to ascertain
as to where or from whom the consideration has moved -
what is essential is that there should be a consideration.
c) Past consideration is treated as good consideration [J.M.S.
Punto v. A.C. Rodrigues, AIR 1976 Goa 8]
d) Once the holder acquires the instrument for good
consideration the liable party will not be allowed to plead
any defect and want of consideration at any earlier stage.
(ii) Before Maturity
It is essential that the holder must have acquired the instrument
before its maturity date before he can be treated as holder in
due course. In Dawn v. Halling [(1825)KB 107 ER 1082] it
was held that, if a bill or a note or cheque be taken after it is
due the person taking it takes at his peril. He can have no better
title to it than the party from whom he takes it, and, therefore,
cannot recover upon it if it turns out that it has been previously
lost or stolen. Section 59 of our Act embodies this principle
in the following words, the holder of a negotiable instrument,
who has acquired it after dishonour, whether by non-acceptance
or non-payment, with notice thereof, or after maturity, has only,
as against the other parties, the right thereon of his transferor.
The question now arises, when does an instrument become
mature ? An instrument matures in the following situations,
viz :
(1) if it is payable on a fixed date or after a fixed time then at
the expiry of the time; and
(2) an instruments payable on demand does not mature as long
as a demand for payment against it is not made. Thus in
Brooks v. mitchell [(1841) 152 ER 7] a promissory note
made in 1824 was received by the defendant in 1838, who
acting in good faith gave value for the note. The plaintiff
sued him for recovery of the note and contended that a bill
or note payable on demand must not be kept locked up for
an unreasonable time. It was held that, a promissory note
payable on demand could not be treated as overdue as long
as payment was not demanded, because it is intended to
be a continuing security. Section 86(3) of the Bills of
Exchange Act provides that where a note payable on
demand is negotiated, it is not deemed to be overdue, for
the purpose of affecting the holder with defects of title of
what he had no notice by reason that it appears that a
reasonable time for presenting it for payment has elapsed
since its issue. But section 36(3) of the same Act also
provides that a BOE payable on demand is deemed to be
overdue. when it appears on the face of it to have been in
circulation for an unreasonable length of time. What is an
unreasonable length of time is a question of fact i.e. it would
vary from case to case.
(iii) Complete and Regular
For a negotiable instrument to be valid it should be complete
and regular in all respects, i.e. it should not contain any patent
(easily visible or indentifiable) defects. An instrument may be
incomplete because the drawers name is not there or it is not
dated and stamped etc. Similarly an improper indorsement can
render the whole instrument irregular [Arab Bank Ltd v. Ross,
(1952)2 QB 216], but a mere spelling mistake in the indorsee's
name will note affect the indorsee and the bill remains valid
[Leonard v. Wilson, [1834]39 RR 855].
(iv) Good faith
Last but not least is the requirement that the holder should have
acted in good faith. The court is required to apply both the
subjective and objective test to ascertain whether the holder
had acted in good faith, i.e. the court has to find out, (i) whether
he had acted honestly ? (subjective test) and (ii) whether he
had acted as a reasonable and careful or prudent man would
have acted in a similar situation ? (objective test)
Rights and privileges of a holder in due course
1. Presumptions (sec 118) Every holder is deemed prima
facie to be a holder in due course, i.e. the burden of proving
his title does not lie on him, and it is the other party who has to
show that the holder has no title to the instrument, or that there
is defect in his title. It is only when he establishes the defect
that burden of proof shifts to the holder who then has to show
he had acquired the bill or note bonafide and in good faith.
2. Privilege against inchoate stamped instruments (sec.20):
In Glenie v. Bruce Smith [(1908)1 KB 263] it was observed
that, the logical order of operations with regard to a bill is, no
doubt, that the bill should be first filled up, then it should be
signed by the drawer, then it should be accepted, then it should
be negotiated, and then it should be indorsed by the persons
who become successively holders; but it is common knowledge
that parties very often vary, in a most substantial manner, the
logical orde of those proceedings, and section 20 is intended to
deal with those cases. For the section to come into operation,
the defendant must have signed the blank instrument and must
have voluntarily parted with it with the intention that it should
be filled up and issued as such.
3. Fictitous drawer or payee [sec 42] : The acceptor of a
BOE cannot allege as against the holder in due course that the
parties to the bill were fictitous, i.e. persons who were either
not in existence or if they did exist they were never intended by
the drawer to have the payment. But where the drawer intends
the payee to have payment then he is not a fictitous payee and
the forgery of his signature will affect the validity of the cheque.
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Thus in North & South Wales Bank v. Macbeth [1908)AC
137], W induced M by fraud to draw a cheque payable to K or
order. W obtained the cheque, forged Ks indorsement and
collected proceeds of the cheque through his bankers. The
collecting banker was held liable as Ks title was derived through
forged indorsement. K was not a fictitous payee because the
drawer intended him to receive the payment. The result would
have been different if the payee was not a real person or was
not intended to have the payment [Chitton v. Attenborough,
(1897)AC 90].
4. Prior defects (sec.58): The person who is liable to pay on
an instrument, can contend that he had lost the instrument or
that it was obtained from him by means of an offence.
5. Indorsee from a holder in due course (sec 53): A holder
who receives an instrument from a holder in due course gets
the rights of the holder in due course, even if he had knowledge
of the prior defects, provided he himself was not a party to
them.
3.5 INDORSER
As mentioned earlier any negotiable instrument can be
negotiated further by the holder in favour of a third person by
the simple method of signing the instrument in favour of a third
person and delivering the instrument to him. This process of
negotiation is known as indorsement and the person who
transfers his right to another is known as the indorser. Section
35 dealing with the liability of an indorser states that, In the
absence of a contract to the contrary, whoever indorsers and
delivers a negotiable instrument before maturity, without, in
such indorsement, expressly excluding or making conditional
his own liability, is bound thereby to every subsequent holder,
in case of dishonour by the drawee, acceptor or maker, to
compensate such holder for any loss or damage caused to him
by such dishonour, provided due notice of dishonour has been
given to, or received by, such indorser as hereinafter provide
person who transfers his right to another is known as the
indorser. Section 35 dealing with the liability of an indorser
states that, "In the absence of a contract to the contrary, whoever
indorsers and delivers a negotiable instrument before maturity,
without, in such indorsement, expressly excluding or making
conditional his own liability, is bound thereby to every
subsequent holder, in case of dishonour by the drawee, acceptor
or maker, to compensate such holder for any loss or damage
caused to him by such dishonour, provided due notice of
dishonour has been given to, or received by, such indorser as
hereinafter provided."
Every indorser after dishonour is liable as upon an instrument
payable on demand.
This liability of an indorser cannot arise unless the indorser
delivers the indorsed instrument to the indorsee, because no
contract on the negotiable instrument is complete without such
a delivery.
Indorser is estopped from denying to a holder in due course the
genuineness and regularity in all respects of the drawers
signature and all previous indorsements (sec.122). Further he
cannot deny that at the time of his indorsement it was a valid
and subsisting bill and that he had then a good title and right to
indorse. According to sec.88, an indorser is bound by his
indorsement notwithstanding any previous alteration of the
instrument.
Extent of liability
An indorsers liability does not come into existence till he has
been given a due notice of the dishonour of the instrument by
the indorsee. If the indorsee fails to give him a notice, then the
indorser should have received a notice from some other person
liable on the instrument.
The indorser is liable to not only pay the amount on the bill but
also to compensate the holder in case the instrument has been
dishonoured. The quantum of compensation will be determined
as per the rules laid down in sec.117.
Section 35 does not deal with the nature or extent of an indorsers
liability on a note payable on demand. In Hemadri v. Seshama
[AIR 1931 Mad.113] it was however held that, the holder of a
promissory note payable on demand indorsed after dishonour
is not entitled to a decree against the indorser (the payee) without
giving him a proper notice of dishonour.
Neither the section nor the Act provides for a situation where
the indorser indorses an instrument after maturity, and the
instruments not dishonoured. This situation usually arises
where the indorser has committed laches in presenting for
payment indorsing the instrument before the due date and
indorses it only after maturity. The English and American law
on this point is very clear and states that, such an indorser is
liable as if he had indorsed an instrument payable on demand,
and his liability is conditional on a presentment for payment
and notice of dishonour in the event of non-payment within a
reasonable time.' It is to be presumed that the same law would
apply in India also.
Just as in the case of drawer, the indorser can also limit his
liability by having a contract to the contrary. He may either
exclude his liability, or limit his liability or make his liability
conditional, or he may in exceptional cases even enlarge his
liability.
Liability of prior indorsers
According to sec.36, every prior party to a negotiable
instrument is liable thereon to a holder in due course until the
instrument is duly satisfied.
The general rule is that as between indorsers their liability is
in the order in which their names appear on the instrument.
But this rule may be rebutted by adducing evidence to show
the real intention of parties. Therefore, a prior indorser may
recover from a later one if he can prove that there was an
agreement to that effect between them. Similarly, if a second
indorser mistakenly puts his name above the name of the first
indorser, then he can recover the amount from the first indorser
if he is required to pay on the bill. This liability of the prior
indorser to the subsequent one continues till the instrument is
duly satisfied, i.e. each party pays the subsequent one.
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3.6 PARTIES
Uptil now we have been talking of the parties to specific kinds
of negotiable instruments, but havent made any mention as to
who actually can be a party to the instrument.
According to sec.26, every person capable of entering into a
contract can become a party to the negotiable instrument. He
may bind himself and be bound by the making, drawing,
acceptance, indorsement, delivery and negotiation of a
promissory note, bill of exchange or cheque.
Minor - According to sec.11 of the Contract Act, every person
is competant to contract who is of the age of majority according
to the law to which he is subject, and who is of sound mind,
and is not disqualified from contracting by any law to which he
is subject.
Obviously therefore a minor or a lunatic cannot be a party to a
negotiable instrument so as to be liable on it. But a negotiable
instrument does not become void merely because a minor is a
party to it. According to sec.26, a minor may draw, indorse,
deliver and negotiate (an) instrument so as to bind all parties
except himself, i.e. the minor's rights under the instrument are
not affected. The law is same for insane persons.
Corporation - The capacity of a corporation to enter into a
contract vide a negotiable instrument, would depend on its
memorandum and articles.
Agent - According to sec.27, a general authority to transact
business or to receive payment or discharge debts on behalf of
the principal, does not give the agent an automatic right to accept
or indorse bills of exchange so as to bind his principal. Further,
an authority to draw BOE does not include the power to indorse
them. Thus, an agent can bind his principal only in the manner
and to the extent he has been authorised. The agent should
furthermore make it clear that he is acting in a representative
character, else he becomes personally liable unless he can show
that the parties induced him to sign in his own name by telling
him that only the principal would be liable.
Partner - A partnership firm can be held liable on a negotiable
instrument drawn by a partneronly when the partner signs the
bill in his capacity as a partner and the name of the firm appears
on the face of the bill. If a bill is not made or drawn in the name
of the firm the other partners can not be make liable on it.
[Rangaraju v. Devichand, AIR 1945 Mad 439]. The signature
of the firm is deemed to be the signature of all its partners be
they working or dormant, based on the principle that every
partner of a firm is entrusted with a general authority to do all
acts beneficial for the firm. Thus in Lona (KA) v. Dada Haji
Ibrahim Hilari & Co. [AIR 1981 Ker. 86], a promissory note
was executed by one of the two partners of the firm using the
words "the promise to pay". The note had been executed on the
letterhead containing the full name and description of the firm.
It was held that both the firm and the second partner were liable
on the pro-note.
Legal representative - According to sec.30, a legal
representative of a deceased person, who signs an instrument
in his own name, becomes personally liable on it, unless he
specifically limits or excludes his liability for examples by use
ofthe words the amount to be paid only from the estate of the
deceased etc.
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SUB TOPICS
4.1 Introduction
4.2 Ambigous instruments
4.3 Rules relating to maturity
4.4 Rules relating to negotiation
4.5 Rules relating to accomodation bill
4.6 Rules relating to interest payment
4.1 INTRODUCTION
In the previous chapters we have dealt with various kinds of
negotiable instruments; the parties to these instruments, their
rights and liabilities; and to a certain extent the rules relating to
ambigous instruments, indorsement etc. In this chapter we will
try to deal in detail with these general rules applicable to all
kinds of negotiable instruments.
4.2 AMBIGOUS INSTRUMENTS
The ambiguity of an instrument may arise in diffeent ways or
may be of different kinds. Thus we may have ambiguity as to
nature of instrument; as to the parties in the instrument; as to
the amount etc. The term ambiguity itself means lack of clarity
or something of which the meaning is not clear.
Sec.17 states that, where an instrument may be construed either
as a promissory note or bill of exchange, the holder may at his
election treat it as either, and the instrument shall be henceforth
treated accordingly.
Thus where on the face of it the nature of instrument is not
clear, the holder has been given a right to treat it either as a note
or a BOE according to his desire. But he may not treat such an
instrument either as a cheque or as a non negotiable instrument.
So also, merely because on the face of the instrument it is written
that it is a BOE, it need not necessarily be one. For example, in
Harsukdas v. Dhirendra Math [(1941)2 Cal.107], an
instrument on which the word hundi was written was in the
following form :
Sixty days after date we promise to pay AB or order the sum
of Rs.1000 only for value received.
Across the document was written Accepted signed by the
maker XY. It was held that the document was not a BOE but
was a promissory note.
Once the holder makes an election [i.e. to treat it as a promissory
note or a BOE] he cannot retract and must abide .by his decision.
Ambigous instrument vis a vis inchoate instrument
(i) In case of ambigous instrument, the holder having made
an election can institute a suit on it, and he is not prevented
from filing a suit thereby because the instrument is
ambigous.
In case of inchoate instruments, the holder merely gets an
authority to fill in the blanks in the instrument, but till the
instrument is filled he cannot sue on it.
(ii) The court gives ambigous instrument favourable
construction so as to make them valid and construes them
as a bill or a note.
An instrument in the form of a bill having neither the name of
the payee nor that of the drawer is an inchoate instrument, even
if it is addressed to a person and has been accepted by him.
Such instruments cannot be treated as ambigous instruments.
Where amount is stated differently in figures and words
According to sec.18, if the amount undertaken or ordered to
be paid is stated differently in figures and in words, the amount
stated in words shall be the amount undertaken or ordered to be
paid.
Ills ; A bill is drawn for five hundred rupees. In the margin is
superscribed Rs.550. The bill is for Rs.500 only. But if there is
ambiguity in the words in the body itself then help can be taken
from the figures in the margin. [Hutley v. Marshall (1873)46
L.T. 186]. Similarly if there is an ommission in the body of the
instrument which is apparent on the face of it, help may be
taken from the figures in the margin. Thus in R.V. Elliot [(1777),
I Leach CC 175] a bill had the words pay fifty and marginal
figures stated 50, The bill was held to be valid for fifty pounds.
4.3 RULES RELATING TO MATURITY
Maturity of an instrument means the day or time at which the
instrument becomes payable. Some instruments are payable
whenever they are presented, some others becme payable only
after the efflux of a fixed period or only on a fixed day. Sections
22-25 deal with the rules determining the time when the
instrument falls due.
But before dealing with these rules, we should clearly
understand the difference between the following words, viz :
At sight, on presentment and on demand - Broadly
speaking `at sight and `on presentment mean `on demand,
but there are technical differences between these phrases.
Instruments payable `on demand may not necessarily be
presented for payment, but instruments payable `at sight or
`on presentment have to be presented before payment can be
demanded on them. Further, though `at sight does mean `on
demand, the period of limitation for bills payable `at sight is
different from bills payable `on demand. In case of former it
is 3 years from the date of presenting the bill, whereas in case
of later it is 3 years from the date of the bill or note [Arts 32, 35
of Limitation Act, 1963].
After sight, after date - The phrase `after sight on a bill
or note should alway be accompanied by the period after which
the bill or note would become payable, as for example, ` 6
months after sight etc. An instrument may be expressed as
being payable `after sight or `after date or `on occurence of a
specified event. In case of the last, the event should be one
which is certain of happening though the exact date or time of
its happening cannot be predicted, as for example, `payable on
the death of Mr.A etc.
4 RULES RELATING TO NEGOTIABLE INSTRUMENTS
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After sight in a promissory note means that payment cannot
be demanded till the bill has been exhibited to the maker;
whereas in case of a BOE after sight means that the sight
must appear in a legal way, i.e, after acceptance if the bill has
been accepted or after noting for non-acceptance or protest for
non-acceptance [Homes v. Kerrison, (1810), 2 Taunt, 323].
Let us now deal with the rules relating to maturity. According
to sec.22, the maturity of a promissory note or bill of exchange
is the date at which it falls due.
Days of grace - Every promissory note or BOE which is not
expressed to be payable on demand, at sight or on presentment
is at maturity on the third day after the day on which it is
expressed to be payable.
Days of grace as the name itself implies is the additional period
or time given to the acceptor of a bill to come up with the
payment. Though it originally started as a gratuitous right, it
slowly became a custom so much so that it came to be treated
as a legal right. Such grace period is allowable on all those
bills or notes which are made payable on a specified day or
after a fixed period or on occurence of some specified event
[Brown v. Marraden (1791)4 T.R. 148]. In Oridge v.
Sherborne [(1843),11 M & Co. 374] it was held that in case of
instruments payable in instalments, it must be presented for
payment on the third day after the day fixed for each instalment,
the days of grace being available for each instalment. The
custom of allowing days of grace has become so imbedded in
the law relating to negotiable instruments that an instrument is
not deemed to have been dishonoured for non-payment before
the expiry of the last date of grace [Kennedy v. Thomas,
(1894)2 Q.B. 759]. Parteies to the instrument may however
limit or exclude the days of grace by express stipulation to that
effect, for example, by saying without grace [Valliappa v.
Subramaniam, 26 M.L.J. 494]. Though days of grace are
statutorily allowed in India, they have been abolished in England
for some time now.
Maturity of bills and notes payable after sight - Section 24
of the Act states that , "In calculating the date at which a
promissory note or bill of exchange, made payable a stated
number of months after date or after sight, or after a certain
event, is at maturity, the period stated shall be held to terminate
on the day of the month which corresponds with the day on
which the instrument is dated, or presented for acceptance or
sight, or noted for non-acceptance, or protested for non-
acceptance, or the event happens, or, where the instrument is a
bill of exchange made payable a stated number of months after
sight and has been accepted for honour, with the day on which
it was so accepted. If the month in which the period would
terminate has no corresponding day, the period shall be held to
terminate on the last day of such month. [Parthasarathy pp. 74-
75].
Ills :- A negotiable instrument dated 29th January 1995 is made
payable one month after date. The instrument is at maturity on
the third day after the 28th February 1995 [ie including days of
grace].
This section incorporates the English law as it was before
amendment by the Bills of Exchange Act, s.65(5) which now
provides that, for calculating maturity from the date of noting
for non-acceptance, and not from the date of acceptance of
honour. According to Chalmers Bills of Exchange, This sub-
section brings the law into line with mercantile understanding,
and gets rid of an inconvenient ruling that maturity was to be
calculated from date of acceptance for honour.
It is thus evident that the Indian law still retains the old English
rule. In case of bills which have not been accepted for honour,
the period of payment terminates on that day of the month which
corresponds with the day of the instrument or the day on which
it has been presented for acceptance or noted for non-acceptance.
The last sentence of sec.24 in effect means that the term month
referes to calendar month rathen the lunar month.
Section 25 of the Act is similar to sec.24 and deals with maturity
of bills or notes payable so many days after date or sight. The
section states that, In calculating the date at which a promissory
note or bill of exchange made payable a certain number of days
after date or after sight or after a certain event is at maturity, the
day of the date, or presentment for acceptance or signt, or of
protest for non-acceptance, or on which the event, happens,
shall be excluded."
If the day of maturity of a note or bill is a public holiday, the
next working day succeeding such public holiday shall be deemd
to be the maturity day of the instrument (sec.25). The
explanation to the section adds that public holidays includes
sunday and other days declared by the Central Government
in the Official Gazzette to be a public holiday.
If a negotiable instrument is paid by the acceptor at or maturity,
the bill is discharged, and no action can then be brought upon
it. But if the payment is made before maturity, the maker or
acceptor can re-issue it, since payment before maturity operates
as a purchase of the instrument. The instrument, under such
circumstances, is not discharged, and the acceptor will be liable
to pay again on the instrument in the hands of a bona fide
transferee for value [Burbridge v. Manners, (1812),3 Camp.
193]. Where a payment is made by the maker or acceptor before
maturity, he must get possession of the instrument, in which
case he can re-issue the instrument so as to make himself and
all subsequent parties liable [Morley v. Culverwell (1840), 7
M. & W.174; Attenborough v. Mackenzie (1856), 25 L.J. Ex.
244]. The re-issue may take place any number of times before
the maturity of the instrument. But the above observation as to
premature payment can only apply to instruments which are
payable on demand, since they cannot be prematurely paid being
due the moment they are presented [Parthasarthy, p. 180].
4.4 RULES RELATING TO NEGOTIATION
Sections 46-60 of the Act deal with negotiation.
Delivery (sec-46):
For the negotiable instrument to be legally binding on the parties
to it, it has to be delivered by the maker and accepted by the
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other party [be it the acceptor, payee, holder or indorsee]. Till
such delivery is effected the instrument is revocable. As
observed by Bovill, C.J. in Abrey v. Crux [(1869)L.R 5 C.P.
42], To constitute a contract there must be a delivery over of
the instrument by the drawer or the indorser for a good
consideration, and as soon as these circumstances take place,
the contract is complete, and it becomes a contract in writing."
The property in the instrument does not pass to the transferee
merely by signing or indorsing the instrument because mere
signature does not constitute a contract. Under sec.46 of the
Act, a cheque is made or completed as soon as it is delivered
either to the payee or to his agent. In Damji Hirji v.
Mohammedali [41 Bom. L.R. 959] it was observed, A person
may sign a promissory note or negotiable instrument in his own
house and keep it there without incurring any obligation to
anyone at all. When such a document is tendered to the payee
and accepted by him there arises a contract between the parties.
The signature on a negotiable instrument becomes necessary
because of the provisions of S.4 of the Negotiable Instrument
Act. It is only a preparation. It does not amount to an offer,
and therefore, does not become any part of the contract.
The delivery of an instrument may be in any one of the following
ways, viz :
Actual delivery - This consists of delivering the instrument
physically or personally by the maker to the payee or to his
agent. There must be an actual change in possession to constitute
actual delivery.
Constructive delivery - Here there is no change in the actual
possession, but the delivery takes place when the maker of the
bill continues to hold possession of the bill as an agent or on
behalf of the payee or the bill is in the possession of the payee's
or indorsee's agent, clerk or servant, who had the bill on behalf
of such payee/indorsee.
Ills :- (i) A holds a bill on his account. He subsequently indorses
it in favour of B and holds the bill as Bs agent.
(ii) A holds a bill as Bs agent. B indorses it in favour of A. A
continues to hold the bill but now on his own account.
Conditional delivery - Wherever an instrument is delivered
conditionally or for a special purpose, oral evidence can be
adduced by the parties to show that the delivery was made and
not for transferring the property in the bill (sec.46). Thus, oral
evidence cannot be used for varying the terms of the contract
but only to show that the writing does not really represent the
contract. In Rajroopram v. Buddoo [1 Hyd. 155] it was
observed that, Delivery of an instrument for a specified
purpose, and on condition that it shall be returned if not applied
for that purpose, constitutes the holder a mere bailee, trustee,
or agent with a limited title and power of negotiating it. Any
subsequent holder with notice of the specific purpose or
condition must apply the instrument accordingly" [emphasis
supplied]. That means, that in case the purpose is not satisfied
or the condition is not fulfilled the true owner of the instrument
is entitled to get it back from the person to whom it was delivered
or anyone else who has taken the bill from such a person and is
aware of the purpose or condition to which the bill is subject.
But a holder in due course who acquires the bill bonafidely
without notice acquires a good title to it and the true owner
cannot compel such holder in due course to return the
instrument.
Negotiation by delivery (sec.47)
According to sec.47, in case of a negotiable instrument which
is payable to bearer, mere delivery of the instrument is sufficient
to transfer the property in the instrument to the person to whom
it is delivered. An indorsement is not necessary for negotiation
of such instruments. A transferor in such cases exonerates
himself from the liability of an endorser of the instrument and
the entire transaction is more in the nature of sale of the
instrument. The transferee therefore gets no right of recovery
against the transferor if per chance the instrument was later
dishonoured, nor can he get back the amount paid by him to the
transferor for failure of consideration. As Lord Kenyon
observed in Fydell v. Clark [(1796)1 Esp. 447], it is extremely
clear that if the holder of a bill sent it to market without indorsing
his name upon it, neither morality nor the law of this country
will compel him to refund the money for which he sold it, if he
did not know at the time he sold it that it was not a good bill.
The important point to note here is that the transferor must
himself be unaware that the bill is bad, because as observed by
Lord Kenyon again in Read v. Hutchinson [(1813)3
Comp.352] if he knew the bill to be bad, it would be like
sending a counterfeit coin for circulation to impose upon the
world instead of the current coin
The exception to the section provides that, in case a negotiable
instrument payable to bearer is delivered on condition that it
will not take effect unless a certain condition is fulfilled, then
negotiation of the instrument does not take effect till such
condition is fullfilled, and no one else who acquires the
instrument with full knowledge of the restrictive condition gets
a good title to it nor can he sue on it. But once again the
exception is not applicable to a bona fide purchaser for good
value.
Negotiable by indorsement (sec 48)
In case of instruments payable to order, negotiation can be done
only by indorsement and subsequent delivery of the instrument.
If the holder of such an instrument merely delivers it without
indorsing it, the transfee only acquires the rights of an assignee
and does not get any of the advantages of negotiability, since
such delivery merely amounts to assignment and not negotiation.
Similarly, if there are more than one payees to a note, an
endorsement and delivery by only one of them, does not amount
to a valid endorsement and does not amount to an effective
negotiation. The other payees can at any time make a fresh and
valid endorsement and negotiation of the same note [Voruganti
v. Venkata, AIR 1953 Mad 840].
Indorsement in blank and its conversion into full
indorsement [Ss.54 and 49]
Even if an instrument has been originally made as being payable
to order, it may be indorsed in blank and delivered to a person.
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Such blank indorsement and delivery converts the instrument
into one which is payable to bearer and it can then be further
transferred by mere delivery as if it was always made payable
to bearer [Peacock v. Rhodes, (1781)2 Doug. 633].
If the holder of such an instrument (i.e. one with a blank
indorsement) wants to convert it into a fully indorsed instrument,
all he has to do is to write above the indorsers signature a
direction to pay the instrument to another person or his order.
The advantage of following this course of action is that though
the holder transfers the instrument to another he does not incur
the responsibility of an indorser[Hirschfeld v Smith, (1866),
L.R. 1 C.P. 340].
Ills: A is the holder of a bill indorsed by B in blank. A writes
over Bs signature the words pay to C or order and delivers
the instrument to C. A is not liable as an indorser, but the writing
operates as an indorsement in full from B to C [Vincent v.
Horlock, (1808)1 camp.442]
If a negotiable instrument, after having been indorsed in blank,
is indorsed in full, the amount of it cannot be claimed from the
indorser in full, except by the person to whom it has been
indorsed in full, or by one who derives title through such person
[sec.55].
Ills: A is the payee holder of a bill. A indorses it in blank and
delivers it to B, who indorses it in full to C or order. C without
indorsement transfers the bill to D. D as the bearer is entitled
to receive payment or to sue the drawer, acceptor or A who
indorsed the bill in blank, but he cannot sue B or C.
Indorsement as already mentioned earlier should be for the
entire amount on the bill. If an indorsement is made for only
part amount of the bill it would not be valid, unless part of the
amount on the bill has already been paid, in which case partial
indorsement will be valid provided a note to the effect that
remaining amount on the bill has already been paid is added to
the indorsement [sec 56].
Effect of indorsement (sec 50)
The indorsement of a negotiable instrument followed by
delivery transfers to the indorsee the property therein with the
right of further negotiation; but the indorsement may, by express
words, restrict or exclude such right, or may merely constitute
the indorsee an agent to indorse the instrument, or to receive its
contents for the indorser or for some other specified person.
[Parthasarthy pp. 135-136].
This secion must be read with sections 46 and 52 in order to be
fully comprehended. The effect of an indorsement can be briefly
said to be as follows
(i) It transfers the property in the instrument to the indorsee.
(ii) It gives the indorsee the right to sue all those parties whose
names appear on the instrument.
(iii) It gives him the right of further negotiation.
An indorser need not give to the indorsee all of the above rights,
he may make what is known as a restrictive indorsement. A
restrictive indorsement may have any one or all of the following
effects, viz :
a) it may prohibit or exclude further negotiation ; or
b) it may constitute the indorsee an agent to indorse the
instrument, or to receive the contents for the indorser; or
c) constitute the indorsee an agent to receive its contents for
some other specified person.
Generally speaking, in case of restrictive indorsement the
relationship between the indorser and indorsee is that of the
principal and agent. The bill, in fact, comes to the end of its
negotiability in such cases and the last indorsee is the person
who can sue upon it. Thus in Rahmat Bi v. Angappa Raja
[(1969)2 MLJ 518], a promissory note was endorsed for
collection. It was held that, "though the endorsement was not
supported by consideration, the endorsee has the locus standi
to file an insolvency petition against the maker of the note on
the basis of non-payment of the note and the endorser may join
as an additional petitioner. The death of the endorser does not
affect the right of an endorsee for colletion to claim payment."
Who may negotiate ? [sec 51]
According to the section the following persons can negotiate a
negotiable instrument, viz :
a) sole maker
b) drawer
c) payee or indorsee
d) all of several joint makers, payees or indorsees.
The need for a maker or drawer indorsing an instrument arises
when the instrument is made or drawn payable to his own order
i.e. pay to myself or order etc. In case a stranger to an
instrument endorses it, it will not be valid and he cannot be
held liable on it, though he may be held liable as guarantor to
the person in immediate relationships with him. In case of
several payees, it is not required that all of them should indorse
on the same date or at the same time, what is required is that
they should all indorse - they may do it at different dates or
times.
A legal representative cannot complete an indorsement made
by the deceased by mere delivery of instrument, because a legal
representative is not an agent of the deceased. Such an
instrument will have legal effect only if it is re-indorsed and
then delivered. He should however take care to see that while
re-indorsing the instrument he excludes his own personal
liability [ sections 57, 29 & 32].
Further, according to sec.52, the person indorsing the instrument
in order to negotiate it may either exclude or limit his liability
to the holder in any one of the three ways, viz :
(i) By expressly excluding his liability, for example by making
the bill as, pay A or order sans recourse etc.
(ii) By making his liability dependant on the happening of a
specified event which may never happen.
(iii) By making the right of an indorsee to receive the amount
of the instrument dependant on the happening of a specified
event which may never happen. The basic difference
between (ii) & (iii) is, that in the later case as the indorsees
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149
rght is dependant on the happening of an event, he is
prevented from suing the prior parties to the bill before the
happening of such event, whereas in the former case he
can do so even before the happening of the event.
Negotiation back," and "Taking up" of a bill
The general rule is that the holder in due course of a negotiable
instrument may sue all prior parties to the instrument. This
rule is, however, subject to an exception the object of which is
to prevent circuity of action. When a bill or note is negotiated
back to a prior party, the prior party is remitted to his former
position and comes within the definiton of a holder. But it is
not necessary that the bill or note should be re-indorsed to him.
He may or may not cancel the indorsements in full subsequent
to that which constituted him the holder, and may further
negotiate the bill or maintain a suit against parties antecedent
to him. Such a transaction is called taking up of the bill.
If the bill, or note, however, is negotiated back to a prior party
by a proper indorsement, the prior party in addition to his rights
of a former holder acquires also the rights of a holder by virtue
of the last indorsement, but he cannot enforce by a suit payment
of the instrument against an intermediate party to whom he was
previously liable by reason of his prior indorsement, for the
law does not permit circuity of action.
Example
A, the holder of a bill indorses it to B. B indorses it to C. C
indorses it to D. D indorses it to A. A by his first indorsement
is liable to B,C and D; and B,C and D are liable to A under the
second indorsement. A, therefore, cannot sue B, C and D but
A may by striking off the indorsements of B,C and D, again
negotiate the bill.
But where an instrument is negotiated back to a prior party, the
holder can enforce payment against all intermediate parties to
whom the holders was not liable as a prior party, as for example,
where the prior indorsement was without recourse. This is
the rule mentioned in the second clause of the section and
illustration (b) to the section is to the same effect [Parthasarthy,
p. 142].
A holder of a negotiable instrument who derives title from a
holder in due course has the rights thereon of that holder in due
course (sec 53).
Ills: A by fraud induces B to make a promissory note in his
favour. A indorses the note to C, who takes it as a holde in due
course. C subsequently indorses the note to A for value. A
cannot sue B on the note.
Thus, in May v. Chapman [(1847)16 M & W. 355], a partner
in a firm fraudulently indorsed a bill to D in payment of a private
debt. F was cognisant of the fraud but was not a party to it. D
endorsed the bill to E, who took it for value and without notice
of fraud. E endorsed it to F. F acquired Es rights. It was held
that, if he had given value to E he could sue all the parties to the
bill, and if he had not given value to E then he could sue all the
parties except E.
Instrument obtained by unlawful means or for unlawful
considerations (sec 58)
When a negotiable instrument has been lost, or has been
obtained from any maker, acceptor or holder thereof by means
of an offence or fraud, or for an unlawful consideration, no
possessor or indorsee who claims through the person who found
or so obtained the instrument is entitled to receive the amount
due thereon from such maker, acceptor or holder, or from any
party prior to such holder, unless such possessor or indorsee is,
or some person through whom he claims was, a holder thereof
in due course [Parthasarthy pp. 146-147].
This section thus deals with two situations, viz :
a) Lost instruments - The rights and duties of the owner of a
lost negotiable instrument are dealt with u/sec.45A and are as
follows -
(1) When a bill or note is lost, the finder acquires no title to it
as against the rightful owner, nor is he entitled to sue the
acceptor or maker in order to enforce payment on it. The
title of the true owner is not affected by the loss of the
instrument, and he is entitled to recover it from the finder.
[Lowell v. Martin (1813),4 Taunt. 799].
(2) If the finder obtains payment on a lost bill or note, the person
who pays it in due course, may be able to get a valid
discharge for it. But the true owner can recover the money
due on the instrument as damages from the finder. [Burn
v. Morris (1834),2 Cr. & W. 579].
(3) If the finder of a lost bill or note, which is payable to bearer
or which is indorsed in blank and is therefore transferable
by mere delivery, negotiates it to a bona fide transferee for
value, the latter acquires a valid title to it, and is entitled
both to retain the instrument as against the rightful owner,
and to compel payment from the parties liable thereon.
(4) If the finder of a lost bill or note, which is payable to order
and is therefore transferable by indorsement and delivery,
forges the indorsement of the loser and negotiates it to a
bona fide transferee for value, the latter acquires no legal
title to it, for a forgery can confer no title; and a payent by
the acceptor or other party liable to a person, claiming under
a forged indorsement, even though made in good faith, will
not exonerate him.
(5) It is advisable that the owner of a lost bill should give notice
of the loss to the parties liable on the bill for they will
thereby be prevented from taking it up without proper
inquiry. Public advertisement of the loss may also be given
if the amount is large.
(6) The party who has lost a bill must make an application to
the drawee for payment at the time it is due, and give notice
of dishonour to all the parties liable, otherwise he will lose
his remedy against the drawer and indorsers.
(7) Under this section the loser can apply for a duplicate of a
lost bill.
In the application of the section, the following points may be
noted:-
(1) The section is confined in its operation to bills only; it
doesnot apply to notes.
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(2) The section applies to bills before they are overdue.
(3) The remedy given to the owner of the lost bill is againt the
drawer alone. The loser may compel the drawer to give
him a duplicate bill upon an undertaking of indemnity, but
no provision is made as to obtaining a fresh acceptance or
fresh indorsements.
(4) Under the section it is only the holder of a lost bill that can
apply for a duplicate. Therefore, if a bill is payable to order
and is transferred for value but without indorsement, the
transferee, if he looses the bill, cannot apply apply for a
duplicate in his own name, for he is not a holder, that is, a
person entitled in his own name to the possessionof the
bill. [Good v. Walker, (1892) 61L.J.Q.B. 736]
[Parthasarthy pp. 126-128].
b) Instruments obtained by means of an offence
(i) Stolen instruments - A person who steals an instrument
cannot enforce payment of it against any person nor can be
retain it against the party from whom he has stolen it. But a
transferee who bonafidely and for good value acquires such a
stolen instrument from the theif gets a good title to it and can
confer a good title on any one acquiring it from him.
(ii) Instruments obtained by fraud - If the maker or acceptor,
when sued on an instrument, proves that it was obtained from
him fraudulently, the person who has so defrauded him is not
entitled to recover anything from him, because fraud vitiates or
negates all agreements and transactions.
The defence available to a person pleading fraud is that of non
est factum or not my document, but to avail of this defence
he must be able to prove;
(1) that he had not been negligent or careless in signing of the
document; and
(2) that he was induced by the plaintiff to sign it.
(iii) Instruments obtained for unlawful consideration -
Wherever the consideration for a bill, note or cheque is unlawful,
the instrument becomes void. The provisions of Contract Act
would apply to ascertain what could be deemed as unlawful
consideration. But a bona fide holder in due course acquires a
good title to the instrument which was originally made, drawn
or negotiated for an unlawful consideration.
(iv) Forged instruments - Forgery can be defined as the
fradulent making or alteration of a writing on a instrument to
the prejudice or detriment of another. The effect of an instrument
with a forged signature is as follows :
i) The forged signature is void ab initio and the property in
the instrument remains with the person who was the holder
at the time of forgery.
ii) The holder of a forged instrument can neither enforce
payment on it nor can he give a valid discharge.
iii) Where the holder has managed to enforce payment despite
the payment, he cannot retain the money and the true owner
may compel him to return the money.
iv) The true owner may sue in tort the person who has received
money for conversion of bill or for money had and received
to his use.
v) A person who has paid money by mistake on a forged
signature, can recover it from the person to whom he has
paid (sec.72 of Contract Act).
vi) The presumption in favour of holder in due course does
not operate in case of forged instruments, because there is
a difference between defect in title (when he is protected)
and an entire absence of title as in case of forgery (where
he can acquire no title).
vii) Forgery cannot be ratified, but a person whose signature
has been forged may by his conduct, be estopped from
denying the genuineness of his signature later on.
viii)In case of forged indorsements, if the instrument was
indorsed in full, the signature of the person to whom or to
whose order the instrument is negotiated must be genuine
for a title to the instrument can only be through his
indorsement. Therefore, in case of an instrument with
forged indorsement, a person claiming under it cannot
acquire the rights of a holder in due course even if he is a
parchaser for good value.
ix) A banker who pays on a forged bill has no recourse against
his customer ie he has to bear the loss personally.
Instruments acquired after dishonour or when overdue
Section 59 which deals with these situations states that, The
holder of a negotiable instrument, who has acquired it after
dishonour, whether by non-acceptance or non-payment, with
notice thereof, or after maturity, has only, as against the other
parties, the rights thereon of his transferor.
Provided that any person who, in good faith and for
consideration, becomes the holder, after maturity, of a
promissory note or BOE made, drawn or accepted without
consideration, for the purpose of enabling some party thereto
to raise money thereon, may recover the amount of the note or
bill from any prior party.
An instrument remains negotiable till its payment or satisfaction
by the maker, drawer or acceptor of the instrument at or after
maturity, but it cannot be negotiated after such payment or
satisfaction [sec 60].
4.5 RULES RELATING TO ACCOMODATION BILL
These are the main class of bills covered under sub-clause (d).
Accomodation instruments are those that are drawn for the
accomodation of the drawer, and he has undertaken to supply
funds to meet them. Though the sub-section only refers to
drawers there is no reason why it should be so restricted.
The Act itself has not defined an 'accomodation bill'. According
to the commercial practice an accomodation bill is one which
is drawn and accepted for the purpose of accomodation of either
the drawer or the drawee or both. Accordingly an accomodation
bill has certain characteristics viz:
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151
1) It is drawn and accepted without any consideration.
2) The object of the bill is to accomodate one or both the
parties, i.e., it essentially creates loan condition between
the parties.
Accomodation bill is in commercial practice created in
following situations: Suppose A requires money and requests
his commercial friend B to support him with a loan. B unable
to provide cash may request A to draw a bill on him (i.e. B).
This bill is known as accomodation bill because this bill has
been drawn for the purpose of accomodating A. A gets the bill
accepted by B and discounts it from C (who may be the bank or
any other third person). On maturity A has to give the money
to B and B has the primary duty to honour the bill.
Legal validity of these bills - Sec. 43 of the Act provides the
general rule about the negotiable instrument made, drawn,
accepted, endorsed and transferred without consideration.
According to this rule such an instrument does not create any
obligation of payment between the parties to the transaction.
But if such a bill is endorsed to a holder for consideration, such
holder and any subsequent holder may recover the amount due
on such instrument from the transferor for consideration or any
prior party thereto. So a bill without consideration is not as
such a legally invalid document. So an accomodation bill is
valid with only the condition that it creates no obligation for
payment between the parties to the transaction. Thus in the above
example, in between A & B, B is not bound to pay on the
instrument to A. But if A discounts the bill with C, A will have
primary liability to see that the bill is honoured by B. That means,
A has to pay his debt to B thereby enabling B to honour the
bill. According to Explanation I of sec. 43, no party for whose
accomodation a negotiable instrument has been made, drawn,
accepted or indorsed, if he has paid the amount thereof, recover
thereon such amount from any person who became a party to
such instrument for his accomodation. Suppose in the above
example, A pays for the bill to C, A cannot realise the money
from B. Suppose B also pays the amount honouring his bill A
cannot realise the amount from C. B alone can realise the amount
from C on the grounds of double payment u/sec. 70 of Contract
Act. In Canara Bank v. Sanjeev Enterprises [AIR 1988 Del
372] it was held that 'the plea of want of failure of consideration
between immediate prior parties cannot be set up against a
holder for consideration or against any subsequent holder
deriving title from him.'
Rights & duties of Parties - As already stated earlier there is
no obligation of payment on the accomodation bill in between
the drawer and drawee, but the primary and secondary liabilities
of the drawee and drawer shall be imposed against a holder for
consideration and all other subsequent holder deriving title
thereafter.
4.6 RULES RELATING TO INTEREST
Sections 78 to 81 deal with the general rules relating to payment
of interest on the bills. These may be briefly stated to be as
follows :
1) Interest should be paid to either the holder of the instrument
or his duly authorized agent. If interest is paid to anyone
else it will not act as a discharge.
2) Similarly, payment of interest will not act as a discharge
unless it is paid either by the maker of the instrument or his
duly authorized agent.
3) Where the instrument itself specifies a rate of interest,
interest will be calculated at that rate from date of instrument
till realization of amount or if a suit has been instituted
then till the date the court directs.
4) When no rate is specified in the instrument, the rate of
interest will be 18% per annum regardless of any agreement
between the parties, from the date at which it ought to have
been paid to the date of realization or such other date as the
court may direct.
5) Any person who is liable to pay on an instrument, and has
been asked by the holder to pay the amount, is entitled to
have the instrument delivered to him on his paying up, or
if it has been lost then he has the right to be indemnified
against any other claims against him on that bill or note.
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5. PRESENTMENT
SUB TOPICS
5.1 Presentment for acceptance
5.2 Presentment for payment
5.3 When Presentment unnecessary
5.4 Bankers Liability
5.1 PRESENTMENT FOR ACCEPTANCE
Section 61 which deals with presentment for acceptance states
as follows :
A BOE payable after sight must, if no time or place is specified
therein for presentment, be presented to the drawee thereof for
acceptance, if he can, after reasonable search be found, by a
person entitled to demand acceptance, within a reasonable time
after it is drawn, and in business hours on a business day. In
default of such presentment no party thereto is liable thereon to
the person making such default.
If the drawee cannot, after reasonable search be found, the bill
is dishonoured.
If the bill is directed to the drawee at a particular place, it must
be presented at that place; and if at the due date for presentment
he cannot, after reasonable search, be found there, the bill is
dishonoured.
Where authorised by agreement or usage, a presentment through
the post office by means of a registered letter is sufficient.
In Jagjivan Mavji v. Ranchoddas [AIR 1954 SC 554] it was
observed, "in a bill payable after sight thee are two distinct
stages, firstly when it is presented for acceptance (section 61)
and later when it is presented for payment (section 64), but
when the bill is payable on demand both the stages synchronise,
and there is only one presentment, which is both for acceptance
and payment." Thus, presentment for acceptance is a rule
applicable only to those BOE which are payable after sight i.e.
those BOE which are not payable on demand. Acceptance as
the term itself implies is an acceptance or agreement by the
drawee of the liability to pay the amount on BOE whenever it
is presented for payment by the drawee. The reason for this
rule may be two fold, viz:
(i) you cannot make a third person (the drawee) liable for a
sum without his consent or knowledge; and
(ii) it gives the drawee time to make arragements for the amount
which he would have to pay after the elapse of the specified
time limit.
Who may present ?
A BOE has to be presented for acceptance only by a person
who is entitled to demand acceptance. According to sec.78, in
case of BOE payable on demand or at sight the person entitled
to receive payment is the person entitled to present it for
acceptance. Generally, it is the holder of a bill who is entitled
to present it for acceptance, and the drawee can acting on the
presumption that the person in possession of a BOE has the
legal title to it also, accept the bill without any risk. In
Greenwood v. Martins Bank [1933 A.C.J.1] it was held that
if the person presenting turns out to be not a rightful holder,
the drawees acceptance will enure to the benefit of the person
really entitled to the bill. By presenting the bill for acceptance,
the holder does not guarantee that the bill or any documents
attached hereto are genuine.
Presentment for acceptance may be made by the holder himself
or through an agent. Generally speaking, it is bankers who are
employed as agents of their customers both for acceptance and
for payment. A banker is expected to use all possible care and
diligence in the discharge of his duty. In Bank of Van Diemans
Land v. Bank of Victoria [(1871) LR 3 PC 526] the extent of
bankers diligence has been stated thus, the duty of the agent is
to obtain acceptance of the bill, if possible, but not to press
unduly an acceptnace in such a way as to lead to a refusal,
provided that the steps for obtaining acceptance or refusal are
taken within the limit of time which wil preserve the right of
the principal against the drawer. A banker is liable to pay
damages if he is negligent in his duty.
Presentment to whom ?
A presentment should be made either to the drawee or to his
duly authorised agent (sec.75). The demand for acceptance
must be made to the authorised person, in clear and unambigious
manner, and as observed in Check v. Ropper [(1804)5 Esp.
175 170 E.R. 777], it is not sufficient to produce a witness who
went to a place described as the drawees house, and there told
by a stranger to the witness that the drawee would not accept
the bill. There has to be some kind of proof to show that (i) the
presentment was made to the drawee himself or to his duly
authorised agent & (ii) that th BOE was actually exhibited to
the drawee for his acceptance. A drawer is entitled to a period
of 48 hrs to decide whether he wants to accept the bill or not
(sec.63).
In case of there being 2 or more joint drawees, the BOE must
be presented to all of them jointly, unless one of them has been
authorised by the rest to accept the bill on behalf of the rest. A
holder is entitled to have the acceptance of all the drawees and
even if one of them refuses he is entitled to treat the bill as
dishonoured and claim compensation from the drawer.
Place and time of presentment
Although in general the law requires that a presentment should
be the drawee himself there is no specific requirement for the
place of presentment, because at that instance he is only required
to receive the bill, unless a specific place is mentioned in the
bill itself when of course that place has to be adhered to.
A bill has to be presented during business hours, though the
phrase business hours itself has not been defined in the Act or
under any other law for that matter, but may be deemed to be
governed by the usual usage or practice of that trade or in that
area. In England the phrase used is during reasonable hours,
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which phrase has been used differently for traders, bankers and
non-traders. For the traders the reasonable hours are usual
business hours and for non traders it is upto bed time. No such
varied interpretation is given in India, and the interpretation of
the phrase business hours will depend on the facts and
circumstances of each case. Similarly, the presentment must
not be made on a public holiday (including Sundays) i.e. it
must be presented only on a working day.
In Mohanlal Malpani v. Loan Company of Assam [AIR 1960
Assam 191] it was held that a bill payable after sight should be
presented for acceptance, without unreasonable delay or the
drawer and other persons liable on the bill will be discharged;
for, they have an interest in having the bill accepted immediately,
in order to shorten the time of payment, and thus put a limit to
the period of their liability. A second reason for presenting
the bill within a reasonable time is that if the holder makes an
inordinate delay in presenting, there is a very real risk of the
drawee becoming insolvent in the meantime. Section 105 of
the Act dealing with reasonable time states that In
determining what is a reasonable time for presentment for
acceptance or payment, for giving notice of dishonour and for
noting, regard shall be had to the nature of the instrument and
the usual course of dealing with respect to similar instruments;
and, in calculating such time, public holidays shall be excluded.
In short, what is a reasonable time will depend on the facts of
each case.
Acceptance of overdue bills
Though the Act does not specifically deal with the effects of
acceptnace of overdue bills, but such an acceptance is not per
se void, because under sec.32 a bill which has been accepted
after maturity is payable to the holder on demand. Under the
English law a bill may be accepted when it is overdue [sec.18(2)]
and it becomes payable on demand[sec.10(2)]. It is thus clear
that under the English law a bill should be presented for
acceptance before maturity, and if it is not so presented the
holder may lose his right of recourse against the drawer and
indorser, except in case of bills coming under sec.39(4). Since
in the Indian Act there is no provision inconsistent with the
above stated principle it may be safely stated that mere
acceptance of an overdue bill will not act as a revival of the
liability of a drawer or indorser who may have been discharged
by reason of non-presentment of bill before maturity.
Presentment of promissory note for sight
Section 62 states as follows :
A promissory note, payable at a certain period after sight, must
be presented to the maker thereof for sight (if he can after
reasonable search be found) by a person entitled to demand
payment, within a reasonable time after it is made and in
business hours on a buisness day. In default of such presentment
no party thereto is liable thereon to the person making such
default.
Just as in case of BOE, even in case of notes, the presentment
should be to the maker or his duly authorised agent, and it must
be within a reasonable time. The holder is required to diligently
search for the maker in order to make a presentment, and if
even after such a search the maker cannot be found, the holder
is discharged from his liability of making a presentment.
Where the holder fails to present the instrument without a
reasonable cause the other parties to the instrument are
discharged from their liability to the defaulter, though such
default does not affect the rights and liabilities of such other
parties. But in the opinion of Bhashyam & Adiga (p.491) such
default of the holder also affects the liabilities of other parties
inter se as these liabilities depend upon these of the maker to
the holder.
5.2 PRESENTMENT FOR PAYMENT
Section 64 dealing with presentment for payment states as
follows :
Promissory notes, bills of exchange and cheques must be
presented for payment to the maker, acceptor or drawee thereof
respectively, by or on behalf of the holder as hereinafter
provided. The default of such presentment, the other parties
thereto are not liable thereon to such holder.
[where authorised by agreement or usage, a presentment through
the post office by means of a registered letter is sufficient].
Exception - where a promissory note is payable on demand
and is not payable at a specified place, no presentment is
necessary in order to charge the maker thereof.
This section lays down the general rule that a negotiable
instrument should be presented for payment at maturity but not
before, and in default of such presentment, all the parties except
the maker and the acceptor are discharged from their liability
to the holder [Chandra Dat v. Chandra Sen, AIR 1934 Oudh
254]. The reason for making this distinction is that there is a
distinction between the liability of the maker and acceptor and
that of the drawer and indorser. The former is an absolute
liability, whereas the later is conditional.
To whom is the presentment to be made ?
As per the section, presentment of notes should be to the maker,
BOE to the acceptor and cheques to the drawee-banker. The
section does not cover all situations because it does not deal
with bills which are not required to be presented for payment
before payment is demanded. Section 75 deals with certain
other persons to whom presentment may be made and states as
under
Presentment for acceptance or payment may be made to the
duly authorised agent of the drawee, maker or acceptor, as the
case may be, or where the drawee, maker or acceptor has died,
to his legal representative, or, where he has been declared an
insolvent, to his assignee.
Under the English Bills of Exchange Act in case of serveral
drawees unless there is a contract to the contrary, the presentment
should be made to all of them. But no such provision has been
made in the Indian Act and it is to be presumed that given a
similar fact situation we will follow the English law.
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Who should make the presentment ?
Just as in case of presentment for acceptnace, presentment for
payment should also be made by the holder or his duly
authorised agent, although the words used in the section, namely
by or on behalf of the holder is also susceptible to the
construction that a presentment may be made even by an
unauthorised person who would be unable to give a valid
discharge. The English law on the other hand explictly states
that presentment should be made by a person who is the holder,
or some one authorised on his behalf. Though the Indian Act
is susceptible to both constructions, care should be taken to
give only that interpretation to the words which would expose
the maker and the acceptor to minimum risk.
Mode of presentment
In Ramuz v. Crowe [(1847)1 Ex. 167], it was observed that
the presentment for payment must be such as would be
sufficient to charge the indorses and other persons collaterally
liable on the bill, and the document itself must be presented so
as to enable the person presenting, to give it up if paid. A
mere registered notice by a pleader demanding payment is not
a good presentment nor is an oral demand for money enough,
though it is not really necessary that the holder should hold the
bill in his hand while demanding payment. What is required is
that the bill should be at hand or easily accessible even if not in
his personal custody. The reason for having the bill accessible
is that the acceptor (or any body) paying the bill has the right
to the possession of the instrument for his own security and as
his voucher and discharge protanto in his account with the
drawer" [per Lord Tenterdon in Hansard v. Robinson, 108
ER 659].
In 1885 the second clause to the section was added whereby
presentment throguh the post office is made valid if agreed to
by the parties or such presentment is in accordance with usage.
An important safeguard made in this regard is that presentment
through post should always be by a registered letter. er. This
safeguard has not been provided for in English law.
Time and place of presentment
Presentment must be made during the usual business hours and
if it is being made to a banker then it should be made within the
banking hours (sec 65).
A note or BOE which is payable at a specified period after date
or sight must be presented for payment after maturity (sec.66).
A note which is payable by instalments should be presented for
payment on the third day after the date fixed for payment of
each instalment; and non-payment on such presentment has the
same effect as non-payment of a note presented after maturity
[sec.67].
In case the note or bill or cheque specifies the place for
presentment, then it must be presented at that particular place
only in order to charge any party to it (sec 68). Sec 69 further
adds that a bill or note made, drawn or accepted as payable at a
specified place must be presented at that place in order to charge
the maker or drawer of the bill or note. But if no place for
presentment has been specified then the bill or note must be
presented for payment either at the place of business (if any) or
the residence of the maker, drawee or acceptor of the bill or
note [sec.70].
What happens if such maker or drawee has no known place of
business or residence ? Sec.71 provides that in such cases
presentment may be made to him in person wherever he can be
found.
Cheques have to be presented at the bank on which it is drawn
so as to charge the drawer, before the relation between the drawer
and his banker gets altered to the prejudice of the drawer
[sec.72]. In case any other person (i.e. apart from the drawer)
is to be charged, then according to sec.73 the cheque must be
presented within a reasonable time after delivery of it by such
person.
Default in presentment
In case the holder makes a default in presentment, the other
parties on the instrument are discharged from their liability to
the holder i.e. the drawers and the indorsers in case of bills and
cheques and indorsers in case of notes. Since their liability is
conditional and is dependant on the presentment of the
instrument the liability is discharged if this condition is not
fulfilled regardless of whether they have actually been
prejudiced by such non-presentment or not.
In case the holder delays the presentment either for acceptance
or payment, such delay is excusable provided it is caused by
circumstances beyond his control i.e, the holder himself has
not been guilty of negligence or misconduct etc resulting in the
delay. After the cause for delay ceases to exist he should make
the presentment within a reasonable time ( sec. 75 A).
5.3 WHEN PRESENTMENT UNNECESSARY
Section 76 provides for situations in which presentment for
payment is unnecessary, and the instrument in such a case is
dishonoured at the due date for presentment. These situations
are as follows :
A) Presentment not necessary
(i) When prevented - Whenever the maker, drawer or acceptor
intentionally prevents the presentment, then the holder need
not present the instrument. The word prevent implies a
positive action of some kind on the part of such maker or
drawer, as for example, by putting obstacles or disabling
the holder in some way.
(ii) When business place closed - If the place of business of
such maker etc is closed on a working day during business
hours the presentment is not necessary, because in such a
case the presumption is that it has been deliberately kept
closed to avoid payment.
(iii) When no person at place of payment - The same rule
applies, if the instrument is payable at a specified place, and
when the holder goes there for presentment there is no person
present who can either authorise payment or refuse it.
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(iv) When the maker etc cannot be found - The holder is
required to search diligently for the maker etc. If the
instrument does not specify a place of payment. If after
due search the maker etc cannot be found either at his place
of business or his usual residence has to be necessarily
excused and the parties to the instrument are liable on it
without the presentment.
B) Waiver of presentment
(i) By agreement before maturity - If the parties to the bill
or note mutually agree then they may do away with the
presentment at maturity. The waiver of presentment must
be by a person entitled to ask for it and not by any third
person. Such waiver is generally embodied in the
instrument itself and may be incorporated any time ie either
at the time of drawing up the instrument or at any
subsequent time but before the maturity of the instrument.
(ii) Waiver may be express or implied
It is not necessary that the maker should expressly (i.e. either
in writing or by words) waive presentment. Sometimes
his actions or conduct may be such that they create an
impression in the holders mind that the bill or note need
not be presented, then he can dispense with the formality
of presentment by inputing implied waiver.
(iii) Waiver by partner and agent
The Waiver as mentioned above has to be by a person who
is entitled to demand presentment, for the simple reason
that neither can one waive away a right which one does not
have nor can he waive away the right of another. A partner
however is entitled to waive presentment on behalf of his
firm, and in case of joint drawees one of them may be
authorised to waive presentment on behalf of others.
(iv) Promise to stranger no waiver
Just as presentment should be made to a person entitled to
demand it, so also when such a person waives his right it
should be to the person entitled to demand payment. A
waiver to a stranger does not in general amount to waiver
though sometimes it may amount to an admission of the
fact that due presentment was made and notice given
[Potter v. Rayworth, 104 ER 432].
(v) Waiver after maturity
Clause (c) of the section refers to waiver after maturity.
Such waiver may be inferred either from a part payment of
the amount due, or by a promise to pay the amount either
in part or in full or the party may expressly waive his right
or take advantage of any default in the presentment for
payment. [Panchicowri v. Satya Dhenu, AIR 1936 Cal
489]. The promise to pay must be both absolute and
unconditional, otherwise it will not operate as a waiver.
Though no specific words or format of waiver has been
laid down, the words used must be such as to clearly
acknowledge the liability and the promise to pay. Such
promise to pay is a prima facie proof of a presentment
having been made.
A waiver can be made only with full knowledge of facts, ie the
drawer or indorser must be aware that the holder has defaulted
in making a presentment. This is because a waiver is a conscious
act and not a merely automatic or formal gesture.
C Presentment excused
i) When no damage to drawer - Where non-presentment of
an instrument by the holder does not result in any loss or
damage to the drawer or indorser, then the presentment
may be excused. The burden of proof in such cases is on
the person who wants to rely on this excuse i.e. usually the
holder. A common example of this is when the drawer draws
the bill without any right to do so or without any reasonable
ground to expect that the drawee will honour it, i.e. when
he commits a fraud or a folly in drawing the bill, and so he
can suffer no loss or injury by want of presentment, which
would naturally be fruitless in such cases [Terry v. Parker,
112 E.R. 192]. The English law in such cases views it
from the relationship between the drawer and drawee,
whereas the Indian law approaches the issue from the point
of view of future or possible results or consequences of
non-presentment, but as such there is not much diffeence
in the substance of the laws.
(ii) Accomodation instruments
If a bill is drawn for the accomodation of the indorser, or if
he indorsed it for the accomodation of the drawer, knowing
at the time that it will not be honoured at its maturity he
also comes within the reason of the applicable to the drawer,
and presentment to charge him is not necessary
[sec.46(2)(d) of Bill of Exchange Act].
D) In case of specific drawers/drawees
i) When drawer and drawee same
In such situations the holder may treat the instrument as a
promissory note and in which case presentment becomes
unnecessary to charge the maker. But where the holder
wants to charge the indorser, then presentment becomes
necessary. Even if the drawee/acceptor becomes insolvent
before maturity, the holder is not excused from presentment
to drawer.
ii) When drawee is fictitous
Presentment in such cases is dispensed with not only against
the drawer but also against all other parties liable on the
instrument, because a demand cannot be made on a person
who does not exist.
iii) When drawee incompetant
If the drawee is legally incompetant to enter into a contract,
presentment against indorsers is not dispensed with,
although presentment against the drawer becomes
unnecessary. The reason for this is that by drawing on an
incompetant person he has committed a fraud on the holder,
and cannot claim to have suffered damage by want of
presentment. If any of the subsequent indorsers are a party
to the fraud then they also become subject to the same rule.
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iv) When drawee dead
It is not very certain as to whether presentment is necessary
in such cases, and if yes - then who should it be made to ?
As per sec.75, presentment to the legal representative may
be made, but the holder cannot be compelled to do so. Since
the present section does not excuse non-presentment on
that ground it is presumed that the holder is bound to present
at the specified place of payment (if any) or place of
business or residence of the deceased if ascertainable after
diligent search by the holder. It is perhaps safer to present
it to the legal representatives of the deceased [Cf. Philpot
v. Briant, 172 E.R. 405].
E) Impossibility of presentment
The section does not excuse non presentment due to
circumstances beyond the control of the holder. Sec. 75A
however excuses delayed presentment in such cases. But there
are certain general circumstances where presentment is excused
in all jurisprudential systems and mercantile law. These
circumstances are referred to in sec.46 of Bill of Exch. Act, for
example in cas eof political disturbance amounting to virtual
interruption and destruction of trade and this includes war;
enemy occupation of the holders contry; riots; insurgence; etc.,
where closing of business house becomes necessary for
protection of life and property.
Similarly certain circumstances might occur in the life of a
holder, for example, sudden grave illness or death of the holder
at the time of maturity of instrument, which would render it
impossible for the holder to make a presentment. In such
situations, the drawee should be informed of the circumstances
at the earliest. Another common excuse for not making
presentment on time is miscarriage or delay in transit where
presentment by post is allowed. But such delay or non
presentment is not excusable if the holder himself was negligent
or in some other way responsible for the non presentment. A
point to remember is that in these cases the presentment is not
wholly excused but only delay in presentment is excused, i.e.
the moment the impediment or obstacle is removed presentment
has to be made.
F) Dishonour by non-acceptance
Finally, presentment for payment becomes totally unnecessary
when the instrument has been dishonoured for acceptance. In
such cases, the holder can directly hold the drawer liable on the
instrument.
5.4 BANKERS LIABILITY
Earlier it has been mentioned that in general bankers act as
agents of their customers where presentment is required both
for acceptance as well as payment. The question arises, what is
the liability of a banker in case of loss or damage to the holder.
Section 77 of the Act dealing with this states as follows
When a bill of exchange, accepted payable at a specified bank,
has been duly presented there for payment and dishonoured, if
the banker so negligently or improperly keeps, deals with or
delivers back such bill as to cause loss to the holder, he must
compensate the holder for such loss.
A banker in performance of his duties is required to take due
care. He has to make payment on an accepted bill provided he
has sufficient funds in the drawers account. This section comes
into play when the banker legitimately refuses payment on a
BOE. Once he refuses payment, he is required to take due care
of the instrument and return it to the holder in the same state as
was given to him. If he cancels the acceptance or any other
portion on the bill and the holder suffers some special damage
due to such cancellation, then the banker becomes liable to him
for such loss or damage suffered, unless he can prove that there
was no want of due care or diligence on his part. But a banker
is not liable if a cancellation has been mistakenly made and he
makes a note on the bill cancelled by mistake. Thus in Raper
v. Birkbeck [104 e.r. 750], the acceptance in a bill was cancelled
by mistake by a drawee in case of need under the wrong
impression that it had been payable at his house. It was held
that prior indorsers were not discharged, as the cancellation
was through a mistake which was indicated by the words
cancelled by mistake. Further, if the bill has been returned to
a wrong party because of the holders negligence, the banker is
not liable so long as he himself had taken due care.
Thus a banker apart from being the drawers agent is also in the
position of a bailee to the holder. Its for this reason that he is
held liable in case he keeps and refuses to deliver the bill
improperly or deals with it in such a negligent manner that the
holder suffers a loss or damage. Actually speaking this provision
really falls within the purview of the law of torts, but the Select
Committee inserted this provision with a recommendation that
it might be retained in this Act till the codification of tort law.
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SUB TOPICS
6.1 Introduction
6.2 Kinds of Crossing
6.3 Payment of Crossed Cheques
6.4 Protection of the Collecting banker
6.1 INTRODUCTION
Crossing is a feature which is unique to cheques and
distinguishes cheques from other negotiable instruments.
Crossing is a usage born of commercial practice. In Bellamy
v. Marjoribanks [155 E.R. 999] it was observed that this
practice originated at the clearing house when the clerks of the
different bankers wh did business there used to write across the
cheques, the name of their employers, so as to enable the clearing
house clerks to make up the accounts. The objective of crossing
a cheque is to introduce or give a direction to the banker that he
is not to pay the cheque across the counter but to pay it only to
another banker. This second banker may be either the drawee
banker or a different one. By paying money to the banker it
becomes easier for the owner of the cheque to detect or find out
as to where the money has gone or for whose use it has been
received. Crossing of a cheque accords a protection or
safeguards to the cheque owner. This is because, even when a
wrongful person secures payment on a crossed cheque it can
be traced because he operates through a banker, i.e., he has to
open an account first (and since he is not the payee, a current
account) with some banker and then pay the cheque into his
account so as to enable the banker to receive payment on his
behalf and credit it to his account. This makes it easy for the
money to be traced to the recipients hand if it is found out later
that he was not entitled to payment on that particular cheque.
6.2 KINDS OF CROSSING
Crossing of a cheque is generally of two kinds, viz:
(1) General crossing and
(2) Special crossing.
But each of these kinds may be several different sub-types.
Apart from these two kinds there are certain other kinds of
crossings also, viz :
(3) Account payee only
(4) Not Negotiable crossing
We will now deal with each of these kinds in detail.
(1) General Crossing
Section 123 defines general crossing as :
where a cheque bears across its face an addition of the words
and company or any abbreviation thereof, between two
parallel transverse lines, or of two parallel transverse lines
simply, either with or without the words Not negotiable, that
addition shall be deemed a crossing, and the cheque shall be
deemed to be crossed generally.
Thus, for a cheque to be treated as being crossed generally, it
should satisfy the following conditions, viz:
(1) two parallel transverse lines on its face;
(2) either with no writing between them or
(3) the words and company; & Co. or Not Negotiable
written between the lines.
Where no words are written the crossing is said to be general.
Drawing of the parallel lines is essential for general crossing.
Some specimens of general corssing are given below.
(1) A/c Payee. Not Negotiable
(2) Under Ten Rupees
(3) Not Negotiable
(4)
2) Special Crossing
Section 124 states as under :
Where a cheque bears across its face an addition of the name
of a banker, either with or without the words Not Negotiable,
that addition shall be deemed a crossing, and the cheque shall
be deemed to be crossed specially, and to be crossed to that
banker.
For a check to be crossed specially therefore the following
conditions should be satisfied.
a) the two transverse parallel lines may or may not be drawn;
b) name of the banker should be written across the cheque;
c) the words Not Negotiable may also be included.
6. SPECIAL PROVISIONS RELATING TO CHEQUES
XY Bank, Ltd
No: Date: 199
Pay..................................................or Bearer.....................
Rupees...................................................... Rs
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Thus it is seen that unlike general crossing, in case of special
crossing the transverse lines are not compulsory though it is
usual to put them. The only thing necessary is that the name of
the bankers should be written across the face of the cheque.
Given below are a few specimens of special crossing.
(l) Indian Bank
George Town
(2) State Bank of India
(3) Bank of India
Not Negotiable
(4) State Bank of India
Nagarabhavi
Remitted for collection
to Bank of India
3) Account payee crossing
Over the last few years a practice commonly used in crossing
of cheques if making them account payee or account payee
only. The Bill of Exchange Act does not provide for such
kind of crossing. An account payee crossing does not restrict
the negotiability of the instrument but merely provides an
additional safeguard against theft or loss. It is not an addition
to the crossing, but merely directs the receiving bank that as
per the drawers wishes the check should be paid to that bank
where the payee (or holder) has an account. If the banker
receives payment of such a cheque on behalf of a third person
(i.e., other than the payee/holder), he would be guilty of
negligence and cannot seek protection under sec.31.
4) Not Negotiable crossing
In the above paras we have mentioned that both general and
special crossing can also contain the words Not Negotiable.
When this phrase is used while crossing the cheque, we call the
crossing a not negotiable crossing. Sec.130 deals with the
concept of not negotiable crossing and states as under:
A person taking a cheque crossed generally or specially,
bearing in either case the words not negotiable, shall not have,
and shall not be capable of giving, a better title to the cheque
than that which the person from whom he took it had.
Previously under both the Indian and the English law a drawer
was entitled to draw or make a non-transferable cheque by
simply omitting the word order or bearer in the instrument.
But according to sec.13 of the present Act, the absence of these
words do not restrain negotiation, nor does the English law
treat the absence of these words as a restraint, hence the only
way in which a person can draw a non-negotiable or non-
transferable check is by crossing it non-negotiable.
This does not mean that a cheque crossed non-negotiable ceases
to be transferable in entirety-what it means is that transfer of
such cheques are not attended by the same important
consequences as in case of ordinary negotiation. Such cheques
are deprived of the main attribute of negotiability, namely, the
transferability free from equities i.e., the transfree gets a good
title only if transferor has one and if there is defect in the
transferors title such defect is passed on to the transferee. But a
transferee of a non-negotiable cheque is left with the second
attribute of negotiability i.e., of transferability by delivery or
indorsement. In case of such cheques there is only a holder
and no holder in due course. Thus in Great Western
Ry.Co.V.London & County Banking Co., [(1901) AC 414],
H by false pretenses obtained from G.W. a cheque crossed &
Co., & not negotiable and took it to a bank who paid it.
G.W filed a suit against the bank for conversion of the cheque.
It was held that the cheque having been obtained by fraud of
the apparent holder who had no title to the cheque, and could
not give to the bank any title to the cheque or the money, and
that the bank was liable for the amount of cheque. Earl Halsbury,
L.C. observed as follows:
It is very important that every one should know that people
who take a cheque which is upon its face not negotiable and
treat it as a negotiable security must recognise the fact that if
they do so they take the risk of the person for whom they
negotiate it having no title to it. In this case, it cannot be
pretended that Huggins had any title to it at all. I do not
understand what additional security is supposed to be given to
a cheque by putting the words not negotiable upon it, if the
fact of its being negotiated can give a title to any one. The
supposed distinction between the cheque itself and the title to
the money obtained or represented by it seems to me to be
absolutely illusory. The language of the statute seems to me to
be clear enough. It would be absolutely defeated by holding
that a fraudulent holder of the cheque could give a title either to
the cheque or to the money.
In the same case, Lord Brampton observed:
The object of section 81 is obvious. It is to afford to the drawer
or the holder of a cheque who is desirous of transmitting it to
another person as much protection as can be reasonably afforded
to it against dishonesty or accidental miscarriage in the course
of its transit, if he will only take the precaution to cross it, with
the addition of the words not negotiable, so as to make it
difficult to get such cheque so crossed cashed until it reaches
the destination.
It is to be remembered that there is a fine distinction between
cheques crossed non negotiable and cheques which are ab
initio non transferable. The former can be transfered from
person to person though the transferee gets no better title than
the transferor; whereas the latter is payable to the payee only
and no one else and any transfer or indorsement of such cheques
are not recognised. A cheque is non-transferable when it is
drawn payable to Mr.X only and having the words bearer
or order struck out.
Crossing of a cheque after issue
Uptil now we have dealt with the crossing of a cheque by the
drawer i.e., before it was issued to the payee or holder. But a
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cheque can be crossed after it has been issued by the drawer,
and sec.125 which deals with such cheques states that:
Where a cheque is uncrossed, the holder may cross it generally
or specially.
Where a cheque is crossed generally, the holder may cross it
specially.
Where a cheque is crossed generally or specially, the holder
may add the words not negotiable.
Where a cheque is crossed specially, the banker to whom it is
crossed may again cross it specially to another banker, his agent,
for collection.
Thus under this section two categories of persons can cross a
cheque or change the nature of an already crossed cheque, viz.,
(i) the holder of the cheque; and
(ii) the collecting banker of the cheque.
Such crossing is allowed on the principle that crossing by
itself does not amount to a material alteration vitiating the
instrument. Certain points however have to be rememberd in
this connection, viz.,
(i) A cheque crossed generally by the drawer can be converted
into a specially crossed cheque by the holder.
(ii) A cheque specially crossed cannot be converted into a
generally crossed cheque by the holder by striking out the
name of the banker, because this will amount to a material
alteration u/sec.87 and will vitiate the cheque.
(iii) If the banker is crossing the cheque then he can do so only
in favour of another bank which is its agent for collection
purposes.
(iv) In case of double crossing by the bank, the banker before
payment should ascertain that the second bank is an agent
of the first.
(v) If an uncrossed cheque is indorsed in favour of the banker,
then the banker can cross it specially to himself ie., in his
favour.
A commercial practice has of late developed of cancelling the
crossing by writing please pay cash within the crossing lines
and signing or initiating it. The cheque is then said to be opened.
This practice has no legal basis and it is not really advisable for
the bank to act on its basis because if the bank does pay the
cash over the counter and it turns out that the payment has not
been made to the true owner of the cheque the banker is not
protected. In view of this, the London Clearing House Bankers
have passed the resolution in the following terms;
That no opening of cheques be recognised unless the full
signature be appended to the alteration and then only when
presented for payment by the drawer or by his known agent.
[Bhashyam, P.725].
6.3 PAYMENT OF CROSSED CHEQUE
A) Payment of crossed cheques
A crossed cheque as mentioned before is a direction to the
banker to pay the money only through another banker. The
banker to whom money should be paid is:
a) In case of general crossing - the banker with whom the
payee holder has an account.
b) In case of special crossing - the bankers in whose favour
the cheque is crossed or the agent of such banker (sec.126).
The objective of crossing a cheque cannot be better stated
than in the words of the preamble to the statute of 19 and
20, Victoria Ch.25 which states that: It would conduce to
the case of commerce, the security of property and the
prevention of crimes, if drawers or holders of drafts on
bankers payable to bearer, or order, on demand, were
enabled effectually to direct the payment of the same to be
made only to, or through some banker.
If a cheque has been specially crossed more than once, then
according to sec.127 the banker on whom it is drawn shall refuse
to pay on it, unless the second banker is an agent of the first
and the second crossing has been done for collection purposes.
B) Payment in due course of crossed cheque:
Once a banker on whom a crossed cheque has been drawn has
paid the amount on it in due course, he can debit the drawer
with the said amount in his accounts with him. The drawer or
any other person cannot hold the banker liable or charge him
for having paid that amount, even if the amount has not been
received by the true owner of the cheque (sec.128). But if the
banker makes the payment contrary to the provisions of sections
10 or 126, then the banker cannot charge the drawer with the
amount if it has not been received by the tue owner, i.e., if a
banker does not pay the money as per the rules and by some
mischance the money is not received by the true owner then he
will be personally liable to the true owner for the amount
(sec.129).
The term true owner itself has not been defined by the Act,
but it is logical to assume that there cannot be two true owners
of a cheque. A holder in due course or the payee of a cheque
will of course be considered as true owners. Similarly if the
cheque has been stolen, the person from whom it is stolen
remains the true owner i.e., the thief merely by virtue of being
in possession does not become the true owner. In short therefore,
a true owner is one in lawful possession of the cheque.
6.4 PROTECTION OF THE COLLECTING BANKER
Since a crossed check can be paid only by bankers and to a
banker, the Act also provides certain protection to the banker
who acts with due care and diligence in collecting the payment
on a crossed cheque. This protection is incorporated under
sec.131 which states as under:
A banker who has in good faith and without negligence
received payment for a customer of a cheque crossed generally
or specially to himself shall not, in case the title to the cheque
proves defective, incur any liability to the true owner of the
cheque by reason only of having received such payment.
Explanation: A banker receives payment of a crosed cheque
for a customer within the meaning of this section not
withstanding that he credits his customers account with the
amount of the cheque before receiving payment thereof.
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For the application of this section the following conditions have
to be satisfied, viz;
l) For a customer
The first requirement is that the banker should have collected
the money on the crossed cheque on behalf of a customer i.e.,
he should not have collected the amount for himself. A customer
may be loosely defined as a person having an account with the
bank. In Taxation Commissioners v.English, Scotish &
Australian Bank [(1920)AC 683] it was thus observed. The
word customer signifies a relationship in which duration is
not of the essence. A person whose money has been accepted
by a bank on the footing that they undertake to honour cheques
up to the amount standing to his credit is a customer of the
bank in the sense of the statute, irrespective of whether his
connection is of short or long standing. There must be an
existing account at the time when the cheque is received for
collection even if it is opened by means of the same cheque and
for the very purpose of collecting it [Ladbroke & Co.V.Todd,
(l9l4) 111LT 43]. One bank may be customer of another bank.
2) As Agent
Secondly, the payment should be received by him as an agent
of the customer, because the protection is accorded only to
situations where the bank has acted mechanically to provide
collection facility. If the banker receives payment as holder of
a cheque then he loses the protection. It is always a question
of fact as to whether the banker had received payment as an
agent or a holder. In Capital and Counties Bank V.Gordon,
London City and Midland Bank V.Gordon[(1903)AC 240],
one Jones, the plaintiffs clerk, stole a number of cheques
payable to the plaintiff, indorsed them to himself and paid them
into his account with both the above banks. In each case the
amount was immediately credited to his account and he was
either permitted to withdraw the money or his overdraft wiped
out before the cheques were cleared. In both cases, the bankers
were held liable because they had received payment not as
agents but as holders for value of the cheques. It was observed
that As between the customer and the bank, there was an
arrangement or course of practice under which the bank allowed
the customer to draw against the amounts of cheques paid in
and credited before they were cleared. But according to the
explanation appended to the section mere crediting of the
amount to the creditors account does not convert the banker
into a holder. To be deemed a holder there must be an express
or implied agreement between the banker and cutomer allowing
the latter to withdraw the money before it has been actually
collected.
3) Crossed Cheque
The protection is available only in case of crossed cheques. In
case of uncrossed cheques, the banker is not protected if the
customers title is defective. Nor can he seek protection of this
section, if he himself crosses the cheque subsequent to receiving
it.
4) Good faith and without negligence
The last requirement is that the banker should have acted in
good faith i.e., bonafidely and without any negligence. If there
is something about the cheque which is suspicious, then the
bqanker is required to make due inquiries,and if he fails to do
so then he will be guilty of negligence. The extent of inquiry
varies from case to case. Sometimes the banking history of the
customer may become the cause of suspicion. Thus in Motor
Traders Guarantee Corpn. V. Midland Bank [(l937) 157
LT 498], a cheque was collected on behalf of a customer who
had misappropriated it by forging an indorsement. The banker
did make some inquiries but not as much as the antecedant
history of the customer whose cheques had been frequently
dishonoured, demanded or required. The bankers were held
guilty of negligence. This does not mean that a banker should
view every new customer suspiciously as a potential criminal.
Thus an enquiry is necessary only when the circumstances
demand or justify it, because as succintly stated by Scrutton LJ
in A.L.Underwood Ltd., v. Barclays Bank [(l924) 1 KB 775],
If banks for fear of offending their customers will not make
inquiries into unusual circumstances, they must take, with the
benefit of not annoying their customers, the risk of liability
because they will not inquire. In Marfani v. Midland Bank
Ltd.[(l968)1 Lloyds Rep 411] Mield J.lay down the following
guidelines in this regard:
(i) That the standard of care is to be denied from the ordinary
practice of bankers. (ii) That the standard of care required of
bankers did not include the duty to subject the account to
microscopic examination. (iii) The bank must not have been
negligent in accepting a new customer and opening a new
account. (iv) The onus lay on the bank to show that it had acted
without negligence. In Indian Overseas Bank v. Industrial
Chain Concern [(1990) ISCC 484] the Supreme Court
emphasised one more point in connection with this duty, i.e.,
while collecting a cheque for a customer the banker is under
an obligation to present it promptly so as to avoid any loss due
to change of circumstances.
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SUB TOPICS
7.1 Introduction
7.2 Kinds of discharge
7.1 INTRODUCTION
Discharge in the legal sense means a release from liability.
Discharge of a negotiable instrument therefore means the release
of liability on that instrument. A differentiation must be made
between the discharge of parties to the instrument and discharge
of the instrument itself. Discharge of an instrument means the
extinguishment of all rights of action on it. In such a situation
the bill ceases to be negotiable and if later reaches the hands of
a holder he acquires no right of action on it. But the discharge
of a party does not automatically result in the discharge of the
instrument. For example, merely because one of the indorsers
has been discharged from his liability on the bill does not mean
that the bill itself has been discharged not does it effect the
liability of the other parties to the bill. Sections 82-90 of the
Act deal with various circumstances when the parties to an
instrument are discharged from their liability.
7.2 KINDS OF DISCHARGE
The following flow chart depicts the various situations in which
the liability in discharged.
A] By act of parties
(i) By cancellation: When the holder or his agent deliberately
cancel a bill and the cancellation is apparent on the face of it,
the bill is discharged and the parties to the bill are released
from their liability. If the cancellation is not apparent then the
instrument remains valid in the hands of a bonafide holder. Thus
in Ingham V.Primrose[141 ER 745], A accepted a bill and
gave it to B for the purpose of getting it discounted and handing
over the proceeds to A.B, having failed to discount it, returned
the bill to A, who tore it in half intending to cancel it, threw the
two pieces into the street. B picked them up and afterwards
pasted the two pieces in such a manner that the bill seemed to
have been folded for safe custody rather than cancelled. B
then put the bill into circulation and it finally reached the plaintiff
a holder in due course. The plaintiff sued A on the basis of the
bill. It was held that A was liable, because the tearing of the
bill into two pieces was not so clearly manifested on the face of
the bill as to indicate to a reasonably careful person that it had
been cancelled. Tearing of the instrument must be such that a
man of ordinary intelligence and caution should at once come
to know that it has been cancelled.
Sec.82(a) deals with a situation where the holder with
deliberation cancels out not the instrument as such, but the name
of the acceptor or indorser. When the name of the acceptor is
cancelled, all other subsequent parties being sureties for the
acceptor are also discharged from their liability i.e., the effect
of cancelling the acceptors name is the same as the effect of
cancelling the instrument itself. But, where the holder cancels
out the name of an indorser then the parties subsequent to the
cancelled indorser stand discharged but those prior to such an
indorser remain liable on the instrument.
(ii) By release: A holder of an instrument can release the
acceptor or indorser from their liability either by a separate
agreement or by an act which has the effect of discharging them.
Effect of release is the same as that of cancelling a name.
(iii) By payment: The most obvious way of discharging the
liability is by making the payment on the bill. Payment acts as
discharge only if it is made in due course as defined in sec.10
which states that:
Payment in due course means payment in accordance with
the apparent tenor of the instrument in good faith and without
negligence to any person in possession thereof under
circumstances which do not afford a reasonable ground for
7. DISCHARGE FROM LIABILITY
we will now discuss each one of these kinds.
Discharge
By act of parties By operation of law Other circumstances
(Sec. 82) (Sec. 83-90).
Cancellation Release Payment Insolvency Merger Lapse of Discharge of
time one of joint drawers etc
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believing that he is not entitled to receive payment of the amount
therein mentioned. Thus payment to be effective must be made
on the maturity of the instrument & payment before maturity
does not act as discharge unless the instrument is cancelled or
on the face of the bill the words paid etc., are prominently
written. Similarly, payment should be .rm 7.5"
made to a person authorised to receive it i.e., the holder in
rightful or lawful possession. Lastly, it should be made in good
faith and without negligence.
B] By Operation of Law
The Act does not make any specific reference to the discharge
of parties by operation of law may be because these situations
are too logical and common place to merit a special mention
i.e., they are situations where it is logical to presume discharge
though no mention is made in the Act iself. These situations
are given below:
i) Due to insolvency: If in an insolvency proceeding, the
maker, acceptor or indorser is discharged by the court he will
be discharged of his liability on the bill.
ii) By merger: Merger as the name implies means joining.
The joining may be of cause of action & of parties. Thus, when
a judgement is obtained against the acceptor maker or indorser,
the debt under the bill is merged with the judgement debt. But
such a merger acts as discharge only when the judgement debt
is paid off i.e., mere obtaining a judgement does not act as a
discharge. Secondly, when the acceptor of a bill becomes the
holder of it also either at or after its maturity in his own right
the bill is discharged.
iii) Lapse of time: If the holder does not file a suit for recovery
of the bill amount till the time prescribed by Limitation Act is
prescribed, his remedy to enforce his right is extinguished. It
is to be noted that his right itself does not get extinguished nor
is the acceptor etc., discharged of his liability but because the
right to enforcement is not there, the acceptor is effectively
discharged unless he wants to pay the time barred debt.
iv) Discharge of one party: In certain exceptional situations
discharge of one of the several joint drawers would release the
remaining also from their liability.
C] Other circumstances
i) Allowing more than 48 hrs for acceptance - If the holder
allows the drawee more than 48 hrs for deciding on whether he
wants to accept it or reject it, then all prior parties who have not
consented to such extended allowance are discharged from their
liability to the holder (sec.83).
ii) Qualified acceptance - The acceptance of a bill should be
unconditional and unqualified. If the holder acquiesces in a
conditional or qualified acceptance from a drawee/indorser then
according to sec.84 the previous parties to the bill are discharged
of their liability.
iii) Delay in presenting cheque - A cheque once issued should
be presented to the banker-drawee within a reasonable time. If
the holder fails to do so and in the meantime something happens
(for ex: failure of the bank) the drawer is discharged of his
liability, provided that he had sufficient balance in the bank to
pay off the cheque if it had been presented at the right time.
Illustration (a) to sec.84 is as follows:
A draws a cheque for Rs.1,000/- and when the cheque ought to
have been presented, he has funds at the bank to meet it. The
bank fails before the cheque is presented. The drawer is
discharged, but the holder can prove against the bank for the
amount of the cheque.
What is a reasonable time depends on the facts and
circumstances of each case. Where the banker and holder are
in the same place, the cheque should be presented the day after
its receipt, as far as possible. But if the holder and banker are
in different places then time for transit has also to be taken into
consideration. A crossed-cheque takes more time to reach the
drawee-banker and therefore, time necessary for clearance is
excluded in determining reasonable time.
iv) Material alteration - Byles on Bills of Exchange has in
relation to effect of alteration observed as follows:
At common law it has been held that a deed, bill of exchange,
promissory note, guarantee, is avoided by an alteration in a
material part, made while it is in the custody of the plaintiff
although that alteration is by a stranger. For a person who has
a custody of an instrument is bound to preserve it in its integrity;
and as it would be avoided by his fraud in altering it himself, so
it shall be avoided by his laches in suffering another to alter it
[Avtar Singh, p.784].
Section 87, 88 & 89 deal with alteration of an instrument and
its effects. For these sections to apply the following conditions
have to be satisfied, viz.,:
a) Intenational - The alteration to the instrument must be
intentional and deliberate i.e., it should not be by mistake or by
accident. Thus in Hongkong and Shanghai Banking Corpn.,
v. Lo Lee Shi [(1928) AC 181 (PC)], the respondent was given
two notes of $ 500 each by her husband. She placed then in the
pockets of her garment and then having forgotten, she washed,
dried, and starched the garments. While proceeding to iron
them she found a wad of paper in the pocket. Subsequently,
the identity of the notes was restored to a certain extent, except
for the numbers on them. When she presented them for payment
the bank refused to pay. The lower courts held the bankers
liable. On appeal, the Privy Council holding the bankers liable
observed, The alternation contemplated is one to which all
parties might assent. It is not reasonable to assume parties
assenting to a part of the document being effected by the
operation of a mouse, by the hot end of a cigarette or by any
other means by which accidental disfigurement can be effected.
It cannot reasonably apply to the ravages of a rat, white-ant or
any other animal pest.
b) Material: For an alteration to act as a discharge it should be
of a material part of the instrument. As observed by Devlin, J
in Qwei Tek Choo v. British Traders and Shippers Ltd.
[(1954) 2 QB 459], One must examine the nature of the
alteration and see whether it goes to the whole or to the essence
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163
of the instrument or not. If it does, and if the forger corrupts
the whole of the instrument or its heart, then the instrument is
destroyed; but if he corrupts merely a limb, the instrument
remains alive, though no doubt defective. Our own Supreme
Court in Loonkaran Sethiya V. Ivan E.John [(1977) I SCC
394] observed as follows:
A material alteration is one which varies the rights, liabilities
or legal position of the parties as ascertained by the deed in its
original state, or otherwise varied the legal effect of the
instrument as originally expressed, or which may otherwise
prejudice the party bound by the deed as originally executed.
Sec.64(2) of the English Bills of Exchange Act, l882 states as
follows:
In particular the following alterations are material, namely,
any alteration of the date, the sum payable, the time of payment,
and where a bill has been accepted generally, the addition of a
place of payment without the acceptors assent.
But an alteration which is neither material nor substantial, as
already mentioned does not act as a discharge. Further the Act
itself permits three kinds of alteration as given below:
i) A person to whom a stamped and signed instrument has
been issued either wholly or partly in blank has an authority
under sec.20 to complete the instrument by filling in the
blanks, even if he exceeds the actual authority vested in
him while completing the instrument.
ii) The holder of an instrument indorsed in blank has an
authority under sec.49 to convert it into an indorsement in
full.
iii) The holder of an uncrossed cheque may cross it, or he may
convert the general crossing on the cheque to a special
crossing under sec.125. Further, a bankers to whom a
cheque has been crossed specially, may again specially cross
it in favour of his agent-banker for collection purposes.
Section 88 further does not apply to the following cases viz;
l) An acceptor or indorser cannot complain of any alteration
which was made before his acceptance or indorsement,
because the section itself reads as, An acceptor or indorser
of a negotiable instrument is bound by his aceptance or
indorsement notwithstanding any previous alteration of the
instrument.
2) Alterations which re made in accordance with the common
or mutual intention of the parties cannot be complained of.
3) A party cannot complain of an alteration to which he has
expressly or impliedly assented.
4) An alteration made before it becomes a negotiable
instrument does not vitiate the instrument.
c) Apparent: Lastly, the alteration should be such as is apparent
on the face of the instrument, otherwise it remains as a valid
security in the hands of a holder in due course. Sec.89 dealing
with this issue states that:
Where a promissory note, bill of exchange or cheque has been
materially altered but does not appear to have been so altered,
or where a cheque is presented for payment which does not at
the time of presentation appear to be crossed or to have had a
crossing which has been obliterated,
payment thereof by a person or banker liable to pay, and paying
the same according to the apparent tenor thereof at the time of
payment and otherwise in due course, shall discharge such
person or banker from all liability thereon; and such payment
shall not be questioned by reason of the instrument having been
altered, or the cheque crossed.
Thus, if a party makes payment on a bill which has been altered
but not noticeably so, the party paying will be discharged by
payment in due course. But the acceptor in such a case will be
liable only for the original and not the altered tenor of the
instrument. Thus in Scholfield V.The Earl of Londesborough
[(1896) AC 514], a bill for 500 was presented for acceptance
with a stamp of much larger amount than necessary and with
spaces left on it. The acceptor wrote his acceptance and handed
the bill to the drawer, who fraudulently filled in the spaces
turning it into a bill for 3,500/- and negotiated it for that value
to a bonafide holder. In an action against the acceptor it was
held that the acceptor was liable only for what he accepted to
pay, namely 500. The acceptor of a bill of exchange is not
under a duty to take precautions against the fraudulent alteration
in the bill after acceptance.
Extinction of debt
Generally speaking, in cases of material alteration, a holder
loses his rights under the bills but the consideration paid by
him for the bill is not extinguished. Though he cannot enforce
the bill he can still sue on the consideration. But sec.87 provides
that wherever an alteration is made by an indorsee, the indorser
will be discharged from his liability to him even in respect of
the consideration. Thus where alteration is introduced by an
unauthorised person i.e., a stranger and not by the indorsee,
then though the instrument is avoided, the indorsee can still
sue his indorser on the consideration paid by him.
v) By negotiation back: When a BOE comes back to the
original acceptor in the regular course of negotiation, and he
becomes the holder of that instrument, it is known as
negotiation back. When this happens at or after maturity, all
liability on the instrument comes to an end (because of the
merger of acceptor and holder into one person). Sec.90 provides
that If a bill of exchange which has been negotiated is, at or
after maturity, held by the acceptor in his own right, all rights
of action thereon are extinguished. The reason for this principle
can be best stated in the words of Best,CJ, in Meale V.Turton
[(1827) 4 Bing l49: 130 ER 725], There is no principle by
which a man can be at the same time plaintiff and defendent.
The only essential condition for application of this section is
that the acceptor must have become the holder in his own right
and not in any other way.
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SUB TOPICS
8.1 Introduction
8.2 Notice of Dishonour
8.3 Noting
8.4 Protest
8.1 INTRODUCTION
As mentioned in the earlier chapters a negotiable instrument
can be dishonoured by the drawee, acceptor or maker either
when it is presented for acceptance or for payment. Sections
91 & 92 of the Act dealing with dishonour state as follows 91.
Dishonour by non-acceptance A bill of exchange is said to
be dishonoured by non-acceptance when the drawee, or one of
the several drawees not being partners, makes default in
acceptance upon being duly required to accept the bill, or where
presentment is excused and the bill is not accepted.
Where the drawee is incompetant to contract or the acceptance
is qualified, the bill may be treated as dishonoured.
92. Dishonour by non-payment A promissory note, bill of
exchange or cheque is said to be dishonoured by non-payment
when the maker of the note, acceptor of the bill or drawee of
the cheque makes default in payment upon being duly required
to pay the same.
When a duly accepted instrument is paid up when presented it
is discharged. In the previous chapter we have seen the various
modes of discharge. We would now study the procdure to be
followed if a negotiable instrument is dishonoured either for
acceptance or payment.
8.2 NOTICE OF DISHONOUR
Once a negotiable instrument has been dishonoured whether
for acceptance or payment a notice of such dishonour has to be
given in accordance with the requirements of sec.93 which states
that :
When a promissory note, bill of exchange or cheque is
dishonoured by non-acceptance or non-payment, the holder
thereof, or some party thereto who remains liable thereon, must
give notice that the instrument has been so dishonoured to all
other parties, whom the holder seeks to make severally liable
thereon, and to some one of several parties whom he seeks to
make jointly liable thereon.
Nothing in this section renders it necessary to give notice to
the maker of the dishonoured promissory note, or the drawee
or acceptor of the dishonoured bill of exchange or cheque.
Thus, notice of dishonour must be given by the holder of the
instrument or any other party who has remained liable on it to
all those persons whom he seeks to charge. If such a notice is
not given the parties to the instrument stand discharged.
Reason of the rule
Why the law requires prompt notice of dishonour is to enable
the drawer of the bill and other indorsers to withdraw their effect
from, or prevent them from reaching, the hands of the drawee
or acceptor, and also to enable such persons to protect their
interest by taking the necessary measures for obtaining payment
from all other parties liable to them. The necessity for such
notice will be apparent from the nature of the contract of the
several persons who become parties to a negotiable instrument,
either as drawers or indorsers. All the contracts raised upon
the bill, it is seen, except those with the acceptor are contracts
of suretyship, that is to say, are contracts of indemnity. Probably
from this, though perhaps from other more strictly mercantile
circumstances, as for the purpose of making other preparations
or modifications in business, notice of dishonour is by the law
merchant made a condition of the liability of the surety. The
contracts of indorsement then between the immediate parties
to them are conditional and are by way of indemnity. It follows
from this last, that there can be no valid claim in respect of the
indorsement where there is no liability in respect of it. And the
two together are the reason why a failure by any indorsee to
give due notice of dishonour not only disables him from
recovering against the immediate indorser, but disables a prior
indorser to him from recovering against his indorser or a prior
indorser to him, the indorseee who has failed to give notice
cannot recover, because he has not fulfilled the condition of his
contract. The others cannot recover, because, as they cannot
be made liable, they do not require to be indemnified. For
example, the indorser to him who has failed to give due notice
is not liable to him, and therefore cannot claim against his own
indorser, and therefore, again, such last indorser cannot claim
against his indorser, and so on.
Sec.94 of the Act deals with the mode in which a notice may be
given and states as follows :
Notice of dishonour may be given to a duly authorised agent
of the person to whom it is required to be given, or, where he
has died, to his legal representative, given, or where he has
been declared an insolvent, to his assignee, may be oral or
written; may, if written, be sent by post, and may be in any
form; but it must inform the party to whom it is given, either in
express terms or by reasonable intendment,that the instrument
has been dishonoured, and in what way, and that he will be
held liable thereon; and it must be given within a reasonable
time after dishonour, at the place of business or (in case such
party has no place of business) at the residence of the party for
whom it is intended.
If the notice is duly directed and sent by post and miscarries
such miscarriage does not render the notice invalid.
Given below are two specimen forms of notice of dishonour.
I hereby give you notice that the undermentioned bill upon
which you are liable as drawer (or indorser) has been
dishonoured by non-payment (or non-acceptance) and that you
8. OF NOTICE, NOTING AND PROTEST
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will be held liable thereon. I have to request immediate payment
of the amount of the said bill Rs.... together with expenses
Rs..... Total Rs......
Particulars of the bill
Amount Rs ..... Date ...... Tenor ....... Due .....
Drawer ............ Acceptor ........ Indorser ......... Payable
at ............ Answer given ...........
Date .............
or
I beg to give you notice that a bill for Rs.170-50/-0, dated 1st
January 1995 drawn by S.Raju upon K. Swami payable 3
months after date and indorsed by you has this day been
dishonoured by non-acceptance (or non-payment) and you will
be held liable thereon.
4th April 1995 Signature of the Holder
Any person who receives a notice of dishonour should give a
further notice of such dishonour within a reasonable time to
parties liable prior to him if he wants them to be charged, unless
such prior parties have also received a due notice by the holder
as per the provisions of sec.93 [sec 95]
When is a notice unnecessary ?
A notice of dishonour is unnecessary in any of the circumstances
mentioned under sec.98, viz :
a) when it is dispensed with by the party entitled to get such a
notice; or
b) when the drawer countermands payment he is not entitled
to receive a notice; or
c) when no damage will occur to the party being charged by
failure of or not giving of such notice; or
d) when the holder is unable to trace the person entitled to a
notice even after a diligent search or the holder is unable to
give a notice for no fault of his; or
e) no notice is needed to charge the drawer in cases where the
drawer himself is an acceptor; or
f) in cases where the promissory note is not negotiable ; and
g) when the party entitled to notice, unconditionally promises
to pay the amount due on the instrument after being made
aware of the facts.
Sec.98 being an exception to the general rule that a holder of
an instrument should give a notice of its dishonour, any person
who wants to rely on it will have to prove that his case fell
under the exceptions specified under the section. Notice means
something more than mere knowledge. [Carter v. Flower,
(1847) 16 M & W. 173] Thus in Re Fenwick Stobart & Co.
[(1902)1 Ch. 507], one man was secretary for two companies,
one of them being the drawer and indorser, and the other the
indorsee of a bill and no notice of the dishonour, it was held
that the knowledge of the secretary was not to be regarded as
equivalent to notice unless it was shown that it was his duty as
regards the indorsee company to communicate his knowledge
to the drawee company.
8.3 NOTING
On a negotiable instrument being dishonoured the holder
acquires an immediate right or recourse against the drawer and
indorser on the instrument. To charge them with liability he
has first to give a notice of dishonour to them as provided for
uunder sec.93. Sec.99 provides for a convenient mode of
authenticating the dishonour of the bill. This section provides
as under : When a promissory note or bill of exchange has
been dishonoured by non-acceptance or non-payment, the
holder may cause such dishonour, to be noted by a notary public
upon the instrument, or upon a paper attached thereto, or partly
upon each.
Such note must be made within a reasonable time after
dishonour, and must specify the date of dishonour, the reason,
if any, assigned for such dishonour, or, if the instrument has not
been expressly dishonoured, the reason why the holder treats it
as dishonoured, and the notarys charges .
A noting is by way of minutes made on the bill or note or
partly on such bill and partly on a separate piece of paper
attached to such bill. A noting should specify the following,
viz :
a) the fact of the bill or note being dishonoured;
b) the date of such dishonour;
c) if some specific reasons have been given for dishonouring
the bill, then such reasons;
d) where the instrument has not been specifically dishonoured,
the reasons for the holder treating the bill or note as being
dishonoured;
e) the notarys charges;
f) a reference to the notarys register; and
g) the notarys initials.
When the holder wants a bill to be noted, he takes it to a notary
public appointed under the Notaries Act, 1952. The Notary
public represents it for acceptance or payment, (as the case may
be) and if the drawee or acceptor still refuses to accept or pay
the bill, he notes the bill giving all the above mentioned
particulars. He also attaches a slip of paper mentioning the
essence or substance of the answer of the drawer or acceptor,
for example, No advice or no effect. The advantage of
following this course of action is that a notary being a person
well versed in the transactions, is better qualified to advise the
holder as to the proper course of action to be followed in
presentment of the bill, and in a trial could be a reliable witness
of the presentment and dishonour of the bill or note. Further in
the words of Bhashyam and Adiga (p.658) noting being so
generally practised, the circumstance of its not having been
done, would tend to render the other parties to the bill or note
suspicions of irregularity and more reluctant to pay; it would
almost certainly raise a prejudice in the minds of jury against
the plaintiff, if upon a trial, the due presentment should be
disputed. Moreover, by the noting, the presentment and
dishonour of the bill may, with ease, at any time, be traced by
reference to the register or protest-book preserved in the notarys
office, if the original should be lost. For this reason, though
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under the Act itself noting has been made optional, it is better
for the holder to get it done for his own benefit. Under Sec.105,
a notary public should do the noting within a reasonable time
of dishonour, as far as possible on the day of dishonour or on
the next business day, unless the delay is caused by
circumstances beyond the control of the holder.
Thus in Rothschild v. Currie [113 E.R. 1045], a bill drawn on
an acceptor in Paris and payable there, the day on which the
protest had to be made was a holiday when the public registry
was closed in consequence of which owing to pressure on the
office the following day, the notary was unable to effect
registration till after post time that day, it was held that a notice
sent the day was good because due diligence had been used.
Advantages of notice
a) Wherever protest is required to be made within a specified
time, it is sufficient if noting is made within that time though
the protest may be drawn up later [sec 104.A]
b) A BOE may be accepted for honour under sec.108, after
noting through protest is not made.
c) A BOE may be paid for honour after noting, and the person
paying need not wait for protest [sec 113] Further, noting
is of the greatest advantage wher the bill is for a large
amount of where legal proceedings are likely to be instituted
or where there are several indorsers whose liability the
holder seeks to secure.
8.4 PROTEST
The noting by a notary public of a dishonoured negotiable
instrument is called as protest. Sec.100 dealing with protest
states as under :
When a promissory note or bill of exchange has been
dishonoured by non-acceptance or non-payment, the holder
may, within a reasonable time, cause such dishonour to be noted
and certified by a notary public such certificate is called a protest.
Protest for better security
When the acceptor of a bill of exchange has become insolvent,
or his credit has been publicly impeached, before the maturity
of the bill, the holder may, within a reasonable time, cause a
notary public to demand better security of the acceptor, and on
its being refused may, within a reasonable time, cause such
facts to be noted and certified as aforesaid. Such certificate is
called a protest for better security.
The advantages of protest are similar to those of noting, and
the requiring of protest in case of foreign bills is to provide the
foreign drawer or indorser with an authentic and satisfactory
evidence of dishonour, because otherwise such foreign indorser
or drawer would have great difficulty in making inquiries about
the dishonour and would have to rely on the representations
made by the holder in that regard.
Procedure
The procedure to be followed for protest is the same as that for
noting. Chitty in his Chitty on Bills [cf Bhashyam, p.659] has
given a further procedure in case of protest in the following
words :
The next step for the notary to take is to draw the protest which
is a formal declaraton - on production of the bill itself if it can
be obtained; otherwise, on a copy thereof, - that it has been
presented for payment, and how that payment was refused and
why, and that the holder intends to recover all damages and
expenses which he or his principal or any other party to the bill
may sustain on account of its non-payment. The usual practice
is to enter a minute of the demand of payment, and of the
dishonor of the bill, together with a copy of the same in notarial
register of the notary, and afterwards to draw up the formal
protest, dating it of the day when the bill was presented for
payment; and the instrument so drawn up is as much an original
as if it has been drawn up at the time of presentment,and is
equally admissible in our Courts. Similar procedure is to be
followed in case of dishonour by non-acceptance.
According to the second part of sec.100, a protest may also be
made for demanding better security. This may be done when
the acceptor of a BOE becomes insolvent or his credit is publicly
impeached before maturity of the instrument, or the acceptor
of the bill absconds before that date. The procedure to be
followed by the holder is similar to that in case of noting or
protest, i.e, he employs a notary public to make the demand on
the acceptor and if refused, protest is made and the prior parties
are given a due notice of it. Only the holder is entitled to make
a protest for better security, but on the other hand the acceptor
is not bound to give such security. The holder cannot as a matter
of course compel the drawer or indorser to give such security,
nor does he get an immediate right of recourse against them i.e.
he has to wait till the date of maturity before taking action. A
holder is not required under the Act to adopt this procedure,
and failure on his part to do so does not in any way discharge
the parties to the instrument of their liability. The basic
advantage of adopting this procedure is that after protest the
bill may be accepted for honour and enables the drawer and
indorsers of the bill to make arrangements for the payment of
the bill by other means. But a notary, before drawing up a
protest for better security should make full and complete
inquiries and satisfy himself that the acceptor has indeed
become a bankrupt or an insolvent or has suspended payment
within the meaning of the Act. After the bill becomes due and
payment is not made on it, another protest must be made for
non-payment.
Though the section itself does not mention it, a protest should
be made in the place where the bill is dishonoured as far as
possible, except in cases where the bill is returned dishonured
through post, in which case protest should be made at the place
of return. This atleast is the law laid down in sec.51(6) of the
English Bills of Exchange Act.
Contents of protest
According to sec.101 a protest should contain the following
ingredients, viz:
i) Instrument or transcript - A protest should contain either
the actual instrument itself or a literal transcript of it, for
purposes of identification and to later prevent any questions
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being raised regarding the instrument being dishonoured
and protested.
ii) Names of parties - The names of both the person making
the protest as also the person on whom the demand for
acceptance or payment have to be mentioned.
iii) Reason of dishonour, etc - In cases where the drawee or
acceptor have given reasons for dishonouring the instrument
for acceptance or payment, such reasons must also be
recorded.
iv) Time of demand and dishonour - It is important that the
time of both demand and dishonour should be mentioned
in the notarial certificate, else it would be difficult to know
from the protest whether the bill was duly dishonoured or
not. This is also necessary because the formal protest itself
may be extended at any time after the date of noting.
Similarly, place of dishonour is important in ascertaining
whether there has been a dishonour in law, because if a bill
was payable only at a specified place, the certificate will
be defective unless it states the place of presentment and
demand.
v) Signature and seal - It is logical to assume that for a
certificate to be valid the notary public has to affix his
signature on it. Though the section itself does not lay any
stress on the use of notorial seal it is the usual practice
for the notary public to affix both his seal and signature.
Absence of seal may result in admission of the protest as
evidence in a foreign court and so it is prudent for the holder
to insist that the notarial seal should also be affixed. It
would be well to mention that a form of protest should
conform to the law of the country where it is being made.
Thus, in an action on a bill drawn in England and accepted
by a French house, it was held that it was sufficient if it
was proved that such note of dishonour and protest as was
required by the law of France was given, even though the
parties between whom this was decided (i.e the indorsee
and payee) were domiciled in England [Rouquett v.
Overmann, (1875) L.R. 10 Q.B. 525]
vi) Acceptance for honour - This clause is slightly redundant
now after the amendments to sections 108 and 109, allowing
acceptance for honour and payment for honour to be made
without the notarys intervention.
vii) Demand by notarys clerk or by post - This clause was
added by Act 11 of 1885, and allows a demand to be made
by the notary either through his clerk or by a registered
post if the custom or usage allows such a demand or there
is a specific agreement in this regard.
viii)Mistakes in protest - Absence of any one of the above
ingredients will render the protest invalid. But a small or
trivial mistake, for example, a mistake in the Christian
name of the parties, or a spelling mistake, or an incorrect
date of the bill wrongly inserted, will not render the protest
invalid provided such a mistake does not mislead the other
party.
ix) Stamp for protest - For a protest to be legally valid it
must be duly stamped ie it should be on a One Rupee Stamp
Paper [Art 50 of Indian Stamp Act, 1899] or on such stamp
as may be prescribed under some other relevant statute.
Notice of protest
According to sec.102, whenever notes and bills are required to
be protested, notice of protest must be given instead of notice
of dishonour, for example, in case of foreign bills all those parties
whom the holder wants to charge with liability are entitled to
insist on being served with a notice of protest. But the section
is not clear on whether along with the notice a copy of protest
should also be sent or not. The English law on this issue was
however settled in Goodman v. Harvey [111 E.R. 1011]
wherein it was held that in giving notice of dishonour to the
drawer of a foreign bill resident abroad, it is sufficient to inform
him that the bill had been protested, without actually sending
him a copy of the protest. It is to be presumed that the same
rule of law would apply in India also.
Since the rules governing the giving of notice of protest are the
same as those governing notice of dishonour, therefore a notice
of protest may be waived in the same way as dishonour, either
by expressly dispensing with such notice or by a subsequent
promise to pay the amount of the money due under the
instrument, because as Lord Ellenborough observed in Gibbon
v. Coggen [170 E.R. 1124], By the promise to pay, he admits
his liability; he admits the existence of everything which is
necessary to render him liable. When called upon for payment
of the bill, he ought to have objected that there was no protest.
Instead of that he promises to pay it. I must therefore presume
that he had due notice, and that a protest was regularly drawn
up by a notary. So also any other circumstance whch would
result in dispensing with the notice of dishonour would also act
as a dispensing of a notice of protest. In India, unlike England,
notice of protest may be given either by the holder or by the
notary who makes the protest.
Place of protest
Sec.103 which deals with a situation where a bill has been
protested for non-acceptance, states as under :
All bills of exchange drawn payable at some other place than
the place mentioned as the residence of the drawee, and which
are dishonoured by non-acceptance, may, without further
presentment to the drawee, be protested for non-pament in the
place specified for payment, unless paid before or at maturity.
Under the English law protest must be made at the place of
dishonour. According to sec.103, where a bill payable at a
place different from the drawees residence, is dishonoured by
non-acceptance, there is no need for the holder to make a
demand for payment. He can straightaway protest for non-
payment at the place specified for payment, unless the bill has
been paid up before or at maturity. The basic difference between
the English and Indian law is that in England protest has to be
made at the place where the bill is made payable, whereas in
India protesting at the specified place is left to the option of the
holder.
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SUB TOPICS
9.1 Definitional aspects
9.2 Presumptions under the Act
9.3 Estoppel under the Act
9.1 DEFINITIONAL ASPECTS
Before dealing with presumptions and estoppels under the
Negotiable Instruments Act it would be better if we first try to
understand the meaning and scope of these words.
Presumptions
A presumption is an inference of the existence of some fact,
which is accepted without evidence because this fact follows
logically from some other fact which has already been proved
or is assumed to exist. When a fact is presumed it does not
mean that it has been actually proved, it is just assumed to have
been proved. It is a rule laid down for reasons of administrative
convenience rather than anything else, because it saves a lot of
time and energy when the judge presumes certain facts without
requiring them to be proved in the regular manner i.e. by
adducing evidence, examination and cross examination of
witnesses etc. Sec.4 of the Indian Evidence Act, 1872 classifies
presumptions under the following categories, viz :-
(1) Presumption of fact;
(2) Presumption of law; and
(3) Conclusive proof
(1) Presumptions of fact (or may presume)
These are inferences which may be naturally or logically drawn
from the experience and observation of the course of nature,
constitution of human mind, the springe of human action, the
usages and habits of society and ordinary course of human
affairs. They are akin to may presume [Syad Akbar v. St. of
Karnataka, AIR 1979 SC 1848]. As the phrase may presume
itself suggests, it is not obligatory on the part of the court to
presume these facts i.e. it is left to the discretion of the court to
decide whether they want particular fact to be proved in the
usual course or whether they want to presume its existence.
(2) Presumptions of law (or shall presume)
These are artificial presumptions of inferences or propositions
established by law. In case of acts which the court shall
presume no discretion has been left to the court, and it is bound
to presume the existence of that fact till evidence is given by
the interested party to rebut or refute or disprove it. The
difference between may presume and shall presume can be
stated in the following words:
Whenever it is provided by this Act that the court may presume
a fact, it may either regard such fact as proved, unless and until
it is disproved, or may call for proof of it. In such a case, the
presumption is not a hard and fast presumptionm incapable of
rebuttal.
Under this Act the term shall presume a fact means court shall
regard such fact as proved, unless and until it is disproved. In
such cases a Court has no option but to take the fact as proved
until evidence is given to disprove it, and the party interested in
disproving it must produce such evidence if he can. The
presumption is not conclusive but rebuttable [Dayal, p.26].
(3) Conclusive proof
One fact is said to be the conclusive proof of another, when, on
the proof of the first fact the court regards the other as
automatically proved and does not allow evidence to be given
to rebut or contradict it. This generally applies to those cass
where the court feels that it would be against governmental or
societal interest to keep the dispute open for further debate or
discussion on it. Thus, presumptions of conclusive proof are
those to disprove which the court does not allow any evidence.
They are inferences, which law lays down in an absolutely
peremptory tone and which cannot be overruled or
contradicted by any evidence howsoever strong. This is
obviously the strongest of presumptions.
Estoppel
Sec.115 of the Evidence Act defines estoppel as :
When one has, by his declaration, act or omission, intentionally
caused or permitted another person to believe, a thing to be
true and to act upon such belief, neither he nor his representative
shall be allowed, in any suit or proceeding between himself
and such person or his representative, to deny the truth of that
thing.
Estoppel is an evidentiary rule based on the principles of justice,
equity and good conscience, because it would be unjust for a
person to suffer loss or damage because of some course of action
which he has undertaken merely on the strength or basis of a
representation made by another.
In Dhipan Singh v. Jugal Kishore [AIR 1952 SC 145] the
essentials of estoppel have been stated as under, viz :
(1) There must be a representation of an existing fact as distinct
from a mere promise defuture made by one party to the
other;
(2) The other party, believing it, must have been induced to
act on the faith of it; and
(3) He must have so acted to his detriment.
Thus, not only should the person have acted on representation
but he must also have suffered a loss or detriment because of
the act. If he profits from the fact or gains an advantage due to
the act he cannot take the defense of this rule of estoppel.
9.2 PRESUMPTIONS UNDER THE ACT
Presumptions relating to negotiable instruments are dealt with
under sections 118 and 119,which state as under :
Sec. 118. Presumptions as to negotiate instruments - until
the contrary is proved, the following presumptions shall be
made:-
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169
(a) of consideration - that every negotiable instrument was
made or drawn for consideration, and that every such
instrument, when it has been accepted, indorsed, negotiated
or transferred, was accepted, indorsed, negotiated or
transferred, for consideration;
(b) as to date - that every negotiable instrument bearing a date
was made or drawn on such date ;
(c) as to time of acceptance - that every accepted bill of
exchange was accepted within a reasonable time after its
date and before its maturity ;
(d) as to time of transfer - that every transfer of a negotiable
instrument was made before its maturity ;
(e) as to order of indorsement - that the indorsements
appearing upon a negotiable instrument were made in the
order in which they appear thereon;
(f) as to stamp that - a lost promissory note, bill of exchange
or cheque was duly stamped;
(g) that holder is a holder in due course - that the holder of
a negotiable instrument is a holder in due course : provided
that, where the instrument has been obtained from its lawful
owner, or from any person in lawful custody thereof, by
means of an offence or fraud, or has been obtained from
the maker or acceptor thereof by means of an offence or
fraud, or for unlawful consideration, the burden of proving
that the holder is a holder in due course lies upon him.
Sec. 119. Presumption on proof of protest - In a suit upon an
instrument which has been dishonoured, the Court shall, on
proof of the protest, presume the fact of dishonour, unless and
until such fact is disproved.
Thus all the presumptions under the Act are of the nature of
shall presume ie the court has to accept them as proved unless
they are specifically disproved. Referring to sec.118 on Official
Receiver v. Abdul Shakoor [AIR 1965 SC 920] it was observed
that this section is essentially a product of English law, and the
special rules of evidence laid down in this section have been
intended to apply only as between the parties to the instrument
or those claiming under them. Before the presumptions under
this section can be drawn it would first have to be proved and
admitted that the negotiable instrument itself was duly drawn
and executed. In Visvonata Raghunath Audi v. Mariano
Colaco [AIR 1976 GDD 60] it was observed that there is no
presumption about execution of a negotiable instrument and in
case of a denial by the opposite side the party basing its claim
on such instrument must fully prove its execution. Here, the
alleged executants of a hundi had in their written statement
denied their signature and thumb mark on the document. It
was held that the burden of proving the signature and the thumb
mark was on the plaintiff and on the facts on record the execution
of the hundi was not proved. Let us now consider each of those
presumptions in slightly more detail.
a) As to consideration - Under the Common Law, any person
who seeks to enforce a contract has to prove that he had
paid some consideration. For trade purpose, this rule was
relaxed in respect of negotiable instruments by the usage
and practice, and now every such instrument is presumed
to be honest and supported by consideration. Even before
the coming into force of this Act, this particular usage
gained a statutory recognition as is evident from illustration
(c) to sec 114 of the Evidence Act giving the courts a
discretion to the courts to presume that consideration for a
particular bill or note had been exchanged. The
presumption is only relating to the fact that a consideration
must have passed hands but it does not apply to the actual
quantum of consideration which has to be separately
proved. In Marasamma v. Veeraju [AIR 1935 Mad 769]
Varadacharass J., observed : Any presumption as to
quantum of consideration as distinguished from the mere
existence of consideration, has to be drawn, not by virtue
of section 118, Negotiable Instruments Act, or even under
section 114, Evidence Act, but only from the recitals, it
has long been established that being prima facie evidence
against the parties to the instrument, they may operate to
shift on to the party pleading the contrary, the burden of
rebutting the inference raised by them. But the weight due
to recitals may vary according to circumstances and in
particular circumstances the burden of rebutting them may
become very light, especially when the court is not satisfied
that the transaction was honest and bona fide. So also
the presumption against consideration does not apply to a
criminal cases and the prosecution has to prove that
consideration was in fact paid [Sakhawat v. Emperor, 59
I.C. 198].
b) As to discharge - If the maker of a note pleads discharge,
the onus to prove such discharge is on him. This onus is
particularly heavy if the payee produces the note bearing
no marks or signs of discharge. It must be remembered
that when the entire evidence has been taken the question
of presumption is not of much importance [Marasamma
v. Veerarajan, AIR 1935 Mad 769]. This particular view
appears to be in accured with the verb and the Sentintia
legis (the letter and spirit of law).
c) As to date - Though a date as such does not form an
essential part of the negotiable instruments, whenever such
an instrument is dated the presumption is that it has been
or drawn on that date. Even where an instrument has been
indorsed in the blank and the indorsee fills up the blank
left with reference to the date, this presumption would still
apply. In Kirmany v. Aga Ali [AIR 1928 Mad 919] it was
observed that if a promissory note is proved to be genuine,
and it bears the date and place of exeuction, the presumption
is that it was executed at the place and on the date it shows,
and the onus lies on the party pleading a different place
and date to prove it.
d) As to time of acceptance - In general a bill of exchange is
prima facie deemed to have been accepted before its
maturity or due date and within a reasonable time from its
issue. There is no presumption as to the actual date of
acceptance of the bill. This presumption becomes
applicable when the acceptance is not dated; if the
acceptance bears a date, it will prima facie be taken as
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evidence of the date on which it was made [Glossop v.
Jacob, 171 E.R. 404], but evidence can be given to show
that it was accepted on a different date [Kirmani v. Aga
Ali, AIR 1928 Mad 919].
e) As to time of transfer - In Lewis v. Parker [111 E.R.
999] it was observed that except where indorsement bears
a date after the maturity of the bill, every indorsement is
prima facie deemed to have been effected before the bill
was overdue. Since there is no actual presumption
regarding the exact date of negotiation, surrounding
circumstances or even a very strong suspicion falling just
short of direct evidence may be used to rebut the prima
faice presumption in the clause.
f) As to order of indorsement - In case of two or more
indorsements on a negotiable instrument, each indorsement
is presumed to have been made in the order in which it
appears in the instrument.
g) As to stamp on lost bills, etc - In case a negotiable
instrument is lost or destroyed the presumption is that
particular instrument had been duly stamped and cancelled.
h) As to holder being a holder in due course - A holder (as
defined in Sec.8) is presumed to be a holder in due course,
for instance, an indorsee from the payee must be presumed
until the contrary is shown to have been a holder in due
course and he is unaffected by the failure of consideration
as between the drawer and the payee. [Sakharam v. Gulab
Chand 16 Bomb. L.R. 743] The holder in such cases has
to prove that he had not only given consideration, but that
when he gave it he did not have sufficient cause to believe
that there was some defect in the transferors title. In Jones
v. Gordon [37 L.T. 477] Lord Blackburn made the
following observation : I take it to be perfectly clear that
when a bill of exchange is on the face of it a good bill, and
there is nothing on the face of it to show the contrary, it
prima facie imports value; prima facie a bill of exchange is
a good bill of exchange, and it is necessary to show the
contrary. But then, I think it is clear both upon the
authorities, and also, as it seems to me, upon good sense,
that when it is shown that a bill of exchange was a fraudulent
one, or an illegal one or a stolen one, in any one of those
cases it being known that the person who holds it was a
party to that fraud, to that illegality, or to that theft, and
therefore could not sue upon it himself, the presumption is
so strong that he would part with it to somebody who could
sue for him that shifts the burden. I should be unwilling to
say precisely whether it shifts the onus upon him to show
that he gave value bona fide so that, although he gave
value he must give some affirmative evidence to show that
he was doing it honestly, or that the onus of proving that he
is dishonest, or that he had notice of things that were
dishonest, remains on the other side, although he is bound
to prove value. The language of the quotation from Baron
Parke would seem to show that the onus as to both shifted;
but I do not think that it has ever been decided. I have no
doubt that in proving value, it may be proved that he himself
took the bill under such circumstances, that although he
gave value, he could not sue upon it. It is to be remembered
that it is only when an offence like fraud, illegality etc. is
proved in the first instance that the burden is shifted. If the
allegong is merely as to absence of consideration between
the original parties, there is no automatic presumption as
to absence of consideration and the defendant has to prove
the allegation.
i) Other presumptions - Apart from specific presumptions
laid down in sec.118 there are a couple of other
presumptions drawn in case of negotiable instruments. For
example, unless a contrary intention appears from the face
of a bill, the holder may treat it as an inland bill. Similarly,
when a bill leaves the hands of the party who has signed it
as maker, drawer or indorser etc; the presumption is that
there was a valid and unconditional delivery and this
presumption is conclusive in the hands of a holder in due
course.
k) On proof of protest - This presumption laid down in
sec.119 does not arise unless there is a proper protest
according to the provisions given under sections 99,100
and 101. Thus in Veerappa Chetty v. Vellayan [10 L.W.
39] it was observed that a mere entry of Noted for non-
payment without date of dishonour or certificate of protest
is not a proper protest, and the presumption under the
section does not apply. This presumption is only regarding
the fact of dishonour, and does not extend as an evidence
of notice or of other collateral facts such as the lack of
funds of the drawer in the hands of the drawee etc. Though
in general a protest operates as prima facie evidence of
dishonour it is open to rebuttal by the other side.
9.3 ESTOPPEL UNDER THE ACT
Sections 120, 121 and 122 deal with estoppels relating to
negotiable instruments and states as under :
120 Estoppel against denying original validity of instrument
No maker of a promissory note, and no drawer of a bill of
exchange or cheque and no acceptor of a bill of exchange for
the honour of the drawer shall, in a suit thereon by a holder in
due course be permitted to deny the validity of the instrument
as originally made or drawn.
121. Estoppel against denying capacity of payee to indorsee
No maker of a promissory note and no acceptor of a bill of
exchange [payable to order], shall, in a suit thereon by a holder
in due course, be permitted to deny the payees capacity, at the
date of the note or bill, to indorse the same.
122. Estoppel against denying signature or capacity of prior
party
No indorser of a negotiable instrument shall, in a suit thereon
by a subsequent holder, be permitted to deny the signature or
capacity to contract of any prior party to the instrument.
Thus, the Act deals with the following estoppels, viz :
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171
a) As to original validity - An estoppel u/sec 120 becomes
applicable only if the instrument is duly stamped. Speaking
of estoppels in relation to negotiable instruments, Mr.
Caspersz says : The situation of parties to a commercial
instrument is no doubt to be regarded as one of contract,
the parties having agreed that the instrument is to be funded
upon certain facts. When therefore the position of one by
acting on that agreement is altered, the other ought not to
be allowed to deny it. The resemblance to estoppel by
representation is however an artificial one, since there is
no representation beyond what is in the contract itself.
[cf. Bhashyam p,716].
This section is wider in its scope than the provision in the
Evidence Act; because estoppel under this section precludes
both the drawer and the acceptor to honour from denying the
validity of the instrument as originally drawn, and any
circumstance which might vitiate the contract between the
original parties to the bill cannot be set up by persons mentioned
in the section, such as, fraud, coercion, want of consideration,
etc.
This section does not prevent the drawer of a BOE or the maker
of a note from taking the plea in a suit by the holder in due
course, that he had never drawn or made the instrument and
that his name to it had been forged i.e. in short the plea of non
est factum (not my document); or the plea that the note he
had executed was not for a simple unconditional loan but was
based on certain conditions previously agreed upon, and that
those conditions had not been fulfilled [See Bachan Singh v.
Dharam Arth Bank, 1933 Lah. 456].
(i) Estoppel against acceptor for honour - An acceptor for
honour of the drawer is bound by all the estoppels which
bind the drawer, and so even he is estopped from denying
the validity of the original bill. It is not very clear whether
the acceptor for honour of the drawer can set up the plea
for forgery of the name of the drawer for whose honour he
accepted it ? The English authors unanimously agree that
an acceptor for honour cannot set up this plea. The
American authors however seen to be divided on this issue,
some [Daniels in particular] claiming that an acceptor for
honour cannot set up this plea, but others like Parsons etc.
take a contrary view. Under sec.117 of the Indian Evidence
Act, an acceptor can always show that the signature of the
drawer is a forgery, i.e. there is no estoppel against the
drawer in this regard and so an acceptor for honour is also
not estopped from taking the plea that the drawers signature
is a forgery.
(ii) As to acceptors estoppel - An acceptance of a BOE does
not amount to an admission of the drawers signature and
an acceptor can always show even against a holder in due
course that the drawers signature was a forgery (sec.117
of Evidence Act). This principle is directly in conflict with
the English law. In addition to this estoppel an acceptor
under the English law is bound by certain other estoppels
as against a holder in due course : (a) the existence of a
drawer and his capacity and authority to draw the bill, (b)
the capacity of the drawer to indorse in the case of a bill
payable to his order, and (c) the existence and capacity of
the payee. Even under the Indian law an acceptor cannot
deny the existence of the drawer i.e. he cannot plead that
the drawer is a fictitous person, though this conclusion is
more by way of being an inference. Due to sec.117 of the
Evidence Act he can not also deny the authority or capacity
of the drawer but this again is only an interference.
b) As to capacity of payee to indorse - When a person makes
a promissory note, he agrees to pay the amount to the payee
named in the note, and by that act he acknowledges the
payees capacity to receive the money. So in a suit by holder
in due course he cannot take the plea that the payee was an
infant or was insane etc., that is he cannot question the
legal capacity of the payee to indorsee the note. The same
rule applies to the acceptor of a BOE, who by the very act
of acceptance also accepts all that is essential for the validity
or existence of the bill and one such essential factor is the
capacity of the payee named in the bill. In Alcock v. Alcock
[133 ER 1144] it was observed that the case may be
different if the insolvency or the insanity happened after
the making of the note or the indorsing of the bill; for in
such cases, the indorsement by such a person is a mere
nullity and can confer no title on the indorsee, and an
acceptor is not justified in making payments to anyone
whose title is affected by it.
This estoppel applies only to capacity of the payee, and the
maker or acceptor cannot be held to admit the genuineness of
the indorsement of the payee, for he cannot be expected to know
his handwriting; nor does an acceptance admit the agency to
indorse which must be proved by the holder in order to recover
against the acceptor or maker [Robinson v. Garrow, 129 ER
183].
c) Estoppel relating to prior parties - Under sec.122 an
indorser cannot deny either the signature or the capacity
of prior parties to the instrument, because when he indorses
he admits the genuineness of the prior indorsement and
represents that the signature of both the drawer and acceptor
are genuine. He also contracts that the original parties to
the bill or note had the capacity to bind themselves, and so
did the subsequent indorsers (but those prior to him) had
the competance to indorse. Keeping in mind this principle
the indorsee is estopped from denying their signature or
capacity in any suit.
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10 OFFENCES UNDER THE ACT
SUB TOPICS
10.1 Wrongful dishonour
10.2 Cheating
10.3 Forgery
10.4 Criminal prosecution under N.I. Act, 1881
10.1 WRONGFUL DISHONOUR
A Cheque is said to have been dishonoured when the payee
presents it for payment and the banker refuses to do so. A
bankers refusal may arise for either one of the following
reasons, viz :
a) The funds in the drawers account standing with him are
insufficient to cover the cheque amount; or
b) The presentment is wrongful, for example, when it is made
prematurely or after banking hours or after the elapse of
reasonable time, etc; or
c) The cheque has been improperly drawn or made; or
d) The banker entertains reasonable suspicion on the validity
of a transaction and wants to conduct an enquiry; or
e) For some other just or reasonable cause; or
f) For no reasonable cause but the dishonour is due to the
malice, spite or negligence etc., on the part of the banker.
In situations (a) to (e) above the dishonour of a cheque by a
banker is treated as a valid dishonour and the drawer of the
cheque is not entitled to any compensation from the banker;
i.e. the banker acquires no liability on a valid or rightful
dishonour of cheques. It is situation (f) which amounts to a
wrongful dishonour of a cheque that a liability attaches to the
banker.
Sec.31 of the Act states that the drawee of a cheque having
sufficient funds of the drawer in his hands, properly applicable
to the payment of such cheques must pay the cheque when duly
required to do so, and in default of such payment, must
compensate the drawer for any loss or damage caused by such
default. A banker thus has a statutory obligation to honour
the cheques drawn by the customers provided the other requisite
conditions are fulfilled. In Kesharichand Jaisukhlal v.
Shillong Banking Corp Ltd. [AIR 1965 SC 1711] it was
observed that when the banker commits mistake in the account
books which produces incorrect balance of the customers
account and consequently the cheque is dishonoured, the banker
will be liable for the wrongful dishonour. When the money is
deposited in the bank, the relationship that is constituted between
the customer and banker is one of debtor and creditor and that
the banker though entitled to use the money deposited with
him without being called upon to account for such user, his
only liability is to return the amount in accordance with the
terms agreed upon between him and the customer.
Liability of the banker
In case of wrongful dishonour of cheques the liability of bankers
is two-fold (i) to compensate the drawer for the actual loss or
damage suffered by him and (2) to compensate him for the loss
of his social status or reputation caused by the dishonour. The
second clause is of more importance to traders and businessmen
rather than ordinary persons. In New Central Hall v. United
Commercial Bank Ltd [AIR 1959 Mad 153] it was held tat
In cases where a cheque issued by a trade customer is
wrongfully dishonoured even special damages could be awarded
without proof of special loss or damage. The fact that such
dishonour took place due to a mistake of the bank is no excuse
nor can the offer of the bank to write and apologise to the payees
of such dishonoured cheques affect the liability of the bank to
pay damages for their wrongful act. The most important point
to be noted in this regard is that the liability of the banker is
only towards the drawer and not towards the payee. This is
because as between the banker and drawer there is a contract
and further the banker stands in a fiduciary relation with respect
to his customer both of these giving rise to a liability in case of
breach. But as between the banker and payee there is no privity
of contract and in case a cheque is dishonoured a payees
recourse is against the drawer alone. He cannot sue the banker.
In case of a non-trader customer, dishonour of a cheque rarely
leads to loss of status or reputation, and hence in such cases
only nominal damages are awarded. Thus, in Evans v. London
and Provincial Bank (1854)9 Ex. 354] a cheque was drawn
by a wife on her husbands behalf payable to the mess steward
of a shop on which he was serving, and the cheque was
dishonoured. It was held that there was no actual damage due
to such dishonour and so damages of only one shilling were
awarded. In Jogendra Math Chakrawarthi v. New Bengal
Bank Ltd. [AIR 1939 Cal. 63] it was observed where the
banker, being bound to honour his customers cheques, has failed
to do so, he will be liable in damages. If special damage,
naturally ensuing from the dishonour is proved, it will be
properly taken into account in assessing the amount of the
damages. If the customer to be a trader, the court may properly
award substantial damages, in the absence of proof of special
damage. In other cases, the customer will be entitled to such
damages as will reasonably compensate him for the injury
which, from the nature of the case, he has sustained. All loss
flowing from the dishonour of a cheque may be taken into
account in estimating the damages.
Quantum of damages
The general rule followed by the courts in awarding damages
is that damages are awarded for forseeable and actual loss
suffered and the quantum of damages is usually based on the
principle of restitutio in intgegram i.e., restoring the person
to the position he would have been in if he had not suffered a
damage. But in case of dishonour of a tradesmans cheque the
damages awarded are inversely proportional to the amount on
the cheque. Thus smaller the amount of the dishonoured
cheque, greater are the damages paid. The reason behind this
rule is very simple a businessmans loss of reputaton or status
or good will is once again inversely proportional to the amount
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173
of the cheque. For example, if a well known businessman issues
a check for a petty amount of say Rs.100 and the banker
wrongfully dishonour the cheque. People would immediately
start saying - Oh! what kind of bussinessman is he ? He does
not even have Rs.100 in his account. He must be going
bankrupt. That is, the damage to his goodwill or reputation
may in some cases be irreparable. But, if a cheque for say Rs.5
lakhs is dishonoured, people would be more understanding -
Oh! it was such a big amount. May be due to some reason he
lacked sufficient funds. See in this case damage to his reputation
is not really substantial. Hence the rule that smaller the amount
greater will be the damages; greater the amount lesser will be
the damages.
10.2 CHEATING
Cheating being an offence is defined under sec.415 of the
Indian Penal Code as follows :
Whenever, by deceiving any person, fraudently or dishonestly
induces the person so decieved to deliver any property to any
person, or to consent that any person shall retain any property,
or intentionally induces the person so deceived to do or to omit
to do anything which he would not do or omit if he were not so
deceived, and which act or omission causes or is likely to cause
damage or harm to that person in body, mind, reputation or
property, is said to cheat.
Explanation A dishonest concealment of fact is a deception
within the meanng of this section.
Illustrations
(i) A having knowledge that there are not sufficient funds in
his account, draws a cheque in favour of B. The cheque is
dishonoured. A cheats.
(ii) A issues cheques without having account(s) with any banker
with a dishonest intention to deceive. The cheques are
dishonoured. A cheats.
In Ram Das v. ST. of UP [AIR 1974 SC 1811] the Supreme
Court enumerated the essential ingredients of the offence of
cheating as follows :
(i) There should be a fraudulent or dishonest inducement of a
person by deceiving him.
(ii) (a) The person so deceived should be induced to delive
any property to any person, or to consent that any
person shall retain any property; or
(b) the person so deceived should be intentionally
induced to do or omit to do anything which he would
not do or omit if he were not so deceived.
(ii) In cases covered by item (ii) (b), the act or omission should
be one which causes or is likely to cause damage or harm
to the person induced in body, mind, reputation or property.
Whenever a cheque issued with dishonest intentions is
dishonoured, the drawer of the cheque can be proceeded against
under sections 417 & 420 of IPC by the payee or holder in due
course of the cheque. In Keshavji Madhavji v. Emperor [AIR
1930 Bom 179] it was observed that it was for the prosecution
to establish facts which point prima facie to the conclusion
that the failure to meet the cheque was not accidental but a
consequence expected and therefore, intended by the accused.
It will then be for the accused to establish any facts that may be
in his favour which are specially within his knowledge and as
to which the prosecution could not be expected to have any
information. A mere allegation that a cheque issued by the
accused to the complainant had been dishonoured is not
sufficient to establish the offence of cheating u/sec.415 IPC
[Raman Behan Roy v. Emperor, AIR 1924 Cal 215]. In
Baijnath Sahay v. Emperor [AIR 1933 Pat 183] it was
observed that the act of drawing a cheque implied at least three
elements : (a) that the drawer has an account with the bank in
question ; (b) that he has authority to draw on it for the amount
shown on the cheque ; (c) that the cheque as drawn, is valid
order for the payment of the amount, or that the present state of
affairs is such that in the ordinary course of events, the cheque
will on future presentment be honoured. Drawing of a cheque
does not imply a representation that the drawer already had the
money in the bank to the amount shown on the cheque, for he
may either have authority to overdraw, or have an honest
intention of paying in the necessary money before the cheque
can be presented [Kumar Sain v. Emperor, AIR 1939 Lah
95] Thus mere dishonour for lack of funds does not amount to
cheating; for cheating to be established a mental element to
deceive is necessary. In State of Kerala v. A. Pareed Pillai
[AIR 1973 SC 326] it was observed : To hold a person guilty
of the offence of cheating it has to be shown that his intention
was dishonest at the time of making the promise. Such a
dishonest intention cannot be inferred from the mere fact that
he could not subsequently fulfil the promise.
In Raghunathan v. Balasubramanyam [1967 Ker LT 232],
the defendant gave a post dated cheque as payment against goods
supplied by the plaintiff. The cheque was dishonoured on
maturity and the plaintiff filed a case u/sec.415 IPC. It was
held that: A post-dated cheque in payment of goods already
received is mere promise to pay on a future date and a broken
promise to pay on a future date and a broken promise is not a
criminal offence, though it may amount in certain business
relations to discreditable behaviour. It is well settled that a
mere breach of contract cannot give rise to a criminal
prosecution. The distinction between a case of mere breach of
contract and one of cheating, therefore, depends upon the
intention of he accused at the time of the alleged inducement.
In the instant case, there was no misrepresentation and there
was no consequent parting with the goods believing such
misrepresentation. The dishonest intention which is the
gravement of the offence of cheating is absent. In the
circumstances, the order of acquittal is proper.
In K.P. Shadil v. Kandoth [1988 3 Crimes 600 (Ker)] it was
ovserved that where a person issues a cheque to another and it
is dishonoured, and it appears that the failure to meet payment
is not accidental, the presumption is that the drawer knew that
the cheque would be dishonoured and he is guilty of cheating
under section 420 of IPC. Thus, what is important to establish
this offence is the mental element of deceit or mens rea.
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Cheating by personation
Sec.416 of IPC defines cheating by personation as follows :
A person is said to cheat by personation if he cheats by
pretending to be some other person, or by knowingly
substituting one person for another, or representing that he or
any other person is a person other than he or such other person
really is.
Explanation The offence is committed whether the individual
personated is a real or imaginary person.
Illustraion
a) A cheats by pretending to be a certain rich banker of the
same name. A cheats by personation.
b) A cheats by pretending to be B, a person who is already
dead. A cheats by personation.
The personation referred to in this section may be either by
words or by conduct. The section does not intend to punish all
cases of personation, but only those cases where the personation
has been used for the purpose of cheating somebody. This
offence u/sec.416 IPC owes its gravity to te fact that it affects
not only the person deceived but also the person personated.
Offence of cheating by personation is punishable under sec.419
IPC whereas general cheating is punishable under sctions 417
and 420. Explaining the distinction between these two sections
it was observed in re Anilesh Chandra [AIR 1951 Assam
122] where in pursuance of the deception, no property passes,
the offence is one of the cheating punishable under Section
417 IPC, but where in pursuance of the deception, property is
delivered, the offence is punishable under section 420.
10.3 FORGERY UNDER THE ACT
Sec.470 of IPC states that a false document made wholly or
in part by forgery is designated a forged document. Sec.471
further observes that the use as genuine of a forged document
has to be with an intent dishonest or fraudulent. A mere
erroneous belief and persistence in a wrong or perverse opinion
cannot be said to be offence tainted with a dishonest or
fraudulent intent [M.Vaghul, (MD), Bank of India Bombay
v. State of Maharashtra, (1988)1 Bank CLR 224 (Bom)].
Sec 463 IPC defines forgery as :
Whoever makes any false document or part of a document
with intent to cause damage or injury, to the public or to any
person, or to support any claim or title, or to cause any person
to part with property, or to enter into any express or implied
contract, or with intent to commit fraud or that fraud may be
committed, commits forgery.
Sec. 464. Making a false document A person is said to make,
a false document
Firstly - Who dishonestly or fruadulently makes, signs, seals
or executes a document or part of a document, or makes any
mark denoting the execution of a document, with the intention
of causing it to be believed that such document or part of the
document was made, signed, sealed or executed by or by the
authority of a person by whom or by whose authority he knows
it was not made, signed, sealed or executed, or at a time at
which he knows that it was not made, signed, sealed or executed;
or
Secondly - Who, without lawful authority, dishonestly or
fraudently, by cancellation or otherwise, alters a document in
any material part thereof, after it has been made or executed
either by himself or by any other person, whether such person
be living or dead at the time of such alteration; or
Thirdly - Who dishonestly or fraudulently causes any person
to sign, seal, execute or alter a document, knowing that such
person by reason of unsoundness of mind or intoxication cannot,
or that by reason of deception practised upon him, he does not
know the contents of the document or the nature of the alteration.
Explanation 1 - A mans signature of his own name may
amount to forgery.
Explanation 2 - The making of a false document in the name
of a fictitous person, intending it to be believed that the
document was made by a real person, or in the name of a
deceased person, intending it to be believed that the document
was made by the person in his lifetime, may amount to forgery.
Illustrations
(1) A picks up a cheque on a banker signed by B, payable to
bearer, but without any sum having been inserted in the
cheque. A fraudulently fills up the cheque by inserting the
sum of Rs.10,000/-. A commits forgery.
(2) A draws a BOE on himself in the name of B without Bs
authority, intending to discount it as a genuine bill with a
banker and intending to take up the bill on its maturity.
Here, as A draws the bill with intent to deceive the banker
by leading him to suppose that he had the authority of B,
and thereby to discount the bill. A is guilty of forgery.
(3) A endorses a government promissory note and makes it
payable to Z or his order and signing the endorsement. B
dishonestly erases the words Pay to Z or his order thereby
converting the special endorsement into a blank
endorsement B commits forgery.
(4) A signs his own name to a bill of exchange, intending that
it may be believed that the bill was drawn by another person
of the same name. A has committed forgery.
(5) A draws a bill of exchange upon a fictitous person, and
fraudulently accepts the bill in the name of such fictitous
person with an intent to negotiate it. A commits forgery.
Bankers liability for payment made on forged cheques
(1) Banker Customer Relationship - As observed earlier the
relationship between a banker and his customer is that of a debtor
and creditor. When a cheque with a forged signature is
presented, the banker has no authority to make payments on it,
and if he does make such payment he would be acting contrary
to the law and would be liable to the customer for the said
amount. A bank in such cases can escape liability only if it can
show that the customer is not entitled to make a claim on account
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of adoption, estoppel or ratification. The rule of law in this
regard can be stated as follows :
When a cheque duly signed by a customer is presented before
a bank with whom he has an account there is a mandate on the
bank to pay the amount covered by the cheque. However, if
the signature on the cheque is not genuine, there is no mandate
on the bank to pay. The bank when it makes payment on such
a cheque, cannot resist the claims of the customer with the
defence of negligence on his pat such as leaving the cheque
book carelessly so that third parties could easily get hold of it.
This is becase a document in cheque form, on which the
customers name as drawer is forged, is a mere nullity. The
bank can succeed only when it establishes adoption or estoppel
[Awasthi, p.279]
(2) Whether a customer is estopped from disputing the
debits shown in the pass book, where the pass book is
returned without any comment and whether such a conduct
would constitute a stated and settled account? - Before
answering this question it is necessary to examine two other
related querries, namely - does a customer owe a duty to the
bank to inform it about the correctness or otherwise of the entries
made in the pass book within a reasonable time; and whether a
failure to so inform the bank would constitute negligence on
his part to the extent of disentitling him from recovering the
amount paid by the bank on the forged check ? There is a duty
of some kind imposed on the customer to inform the bank within
a reasonable time about any irregularities or mis-statements in
the pass book entries. But merely because he fails to do so,
negligence cannot be automatically attributed to him, nor can it
be presumed that there was a breach of duty by the customer to
the bank. Because the duty imposed on the customer in this
regard is neither a statutory duty nor one inferred from usage
or trade practice, but is more in the nature of being a rule of
administrative convenience. A customer should not by his
conduct facilitate payment of money on forged cheques. In the
absence of corroborating circumstances, a mere negligence on
the customers part will not disentitle him from suing the bank
for the amount. The bank cannot furter take the defuse of
`acquuiescence on the part of the customer, because to sustain
such a plea it is essential to prove that the customer against
whom the plea is raised, had remained silent about the matter
even after becoming aware of the true facts. Thus, in Tali Hing
Cotton Mill Ltd v. Liu Chong Bank Ltd [(1985)2 All ER
947] The Court rejected the plea of implied terms, indirect
constructive notice, and estoppel by negligence, and held that
the company was not under any breach of duty owned by it to
the bank and as such mere silence, omission or failure to act is
not a sufficient ground to establish a case in favour of the bank
to non-suit its customer.
Unless the bank is able to satisfy the Court of either an express
condition in the contract with its customer or an unequivocal
ratification it will not be possible to save the bank