LAW OF BANKING AND NEGOTIABLE INSTRUMENTS: Unit-l: short answer

PAPER-II:

LAW OF BANKING AND NEGOTIABLE INSTRUMENTS:

Unit-l:

1. What is the evolution and history of banking in India?

The history of banking in India dates back to the 18th century with the establishment of the Bank of Hindustan in 1770. The modern banking era began with the formation of the Presidency Banks, particularly the Bank of Calcutta in 1806. In 1921, these banks merged to form the Imperial Bank of India, which later became the State Bank of India in 1955. Post-independence, the Indian government aimed to improve financial inclusion and nationalized 14 major commercial banks in 1969, and six more in 1980. The liberalization era in the 1990s saw the emergence of private and foreign banks, leading to greater efficiency, innovation, and competition in the banking sector.

2. What is the structure of the banking system in India?

India’s banking system is broadly divided into two main sectors: scheduled and non-scheduled banks. Scheduled banks include commercial banks (public, private, foreign, and regional rural banks) and cooperative banks. The central bank, Reserve Bank of India (RBI), regulates and supervises the entire banking network. Commercial banks perform core functions like accepting deposits, granting loans, and facilitating payments. Cooperative banks primarily serve rural and agricultural sectors. Regional Rural Banks cater to the credit needs of rural areas. Development finance institutions, like NABARD and SIDBI, support specific sectors. This multi-tier structure ensures financial inclusion, credit flow, and economic stability.

3. What was the idea behind the concept of Social Control on banks?

The concept of Social Control on banks was introduced in 1967 to ensure that banks fulfill the needs of the economy, particularly the priority sectors such as agriculture, small-scale industries, and weaker sections. Before this, banks mostly focused on urban areas and big businesses. Social control aimed to align banking operations with national priorities and development plans. It involved appointing professional and government-nominated directors to bank boards to guide credit allocation policies. Although it was a step toward nationalization, it served as a transitional phase to make banks more socially responsive and reduce the dominance of large industrialists in the banking sector.

4. Why were banks nationalized in India?

Banks in India were nationalized to align the banking sector with the goals of planned economic development. In 1969, 14 large commercial banks were nationalized, followed by six more in 1980. The objectives were to ensure equitable distribution of credit, promote financial inclusion, support rural and agricultural development, and reduce the monopoly of a few industrialists over financial resources. Nationalization helped expand bank branches into rural areas, increased savings, and made institutional credit available to marginalized sectors. It was a major policy step to bring banks under government control and enhance their role in nation-building.

5. What are the arguments for and against nationalization of banks?
Arguments in favour:

  • Promotes financial inclusion
  • Facilitates social and rural development
  • Ensures government control over vital credit institutions
  • Reduces regional and sectoral imbalances in credit flow

Arguments against:

  • Leads to inefficiency and bureaucracy
  • Politicization of lending decisions
  • Reduced competition and innovation
  • Increased burden on taxpayers due to NPAs

While nationalization helped improve access to banking, over time, operational inefficiencies and rising bad loans have led to calls for privatization and reforms.

6. What are the key provisions of the RBI Act, 1935?

The Reserve Bank of India Act, 1935 provides the legal framework for the functioning of the RBI, India’s central bank. It outlines the constitution, powers, and responsibilities of the RBI. Key provisions include:

  • Regulation of currency issuance and monetary policy
  • Maintaining financial stability and public confidence in the system
  • Supervising and regulating banks
  • Managing foreign exchange reserves and external trade policies
  • Acting as banker to the government
    The Act empowers the RBI to regulate the credit system and ensure the country’s financial and economic well-being. Amendments have been made over the years to strengthen its regulatory and supervisory roles.

7. What is the constitution of the RBI Board of Directors and their powers?

The Board of Directors of RBI is composed of:

  • One Governor
  • Up to four Deputy Governors
  • Four directors nominated from local boards
  • Ten government-nominated directors (with experience in various fields)
  • One government representative

The Board is responsible for general superintendence and direction of RBI’s affairs. It frames policies related to banking regulation, monetary operations, financial stability, and currency issuance. The Governor is the chief executive and spokesperson. The Board ensures that the RBI functions in line with government policy and public interest, balancing autonomy and accountability.

8. What are the salient features of the Banking Regulation Act, 1949?

The Banking Regulation Act, 1949 governs the regulation and licensing of banks in India. Key features include:

  • Licensing of banks by RBI
  • Capital and reserve requirements
  • Regulation of management and operations of banks
  • RBI’s powers to inspect and audit banks
  • Restrictions on loans and advances to directors
  • Amalgamation, reconstruction, and winding up procedures
    The Act empowers the RBI to ensure the soundness of the banking sector by supervising its functioning, protecting depositor interests, and maintaining monetary stability.

9. What are CRR and SLR in the Indian banking context?

CRR (Cash Reserve Ratio) is the percentage of a bank’s total deposits that must be maintained with the RBI in cash form. It helps control liquidity in the economy and acts as a safeguard for depositors.
SLR (Statutory Liquidity Ratio) is the minimum percentage of a bank’s net demand and time liabilities (NDTL) that must be held in the form of gold, cash, or approved securities.
CRR and SLR are monetary tools used by the RBI to control inflation, manage liquidity, and ensure financial stability. They influence banks’ lending capacity and interest rates.

10. What is modern banking and the impact of technology on banking in India?

Modern banking in India has been transformed through technological advancements. The introduction of Core Banking Solutions (CBS), ATMs, Internet and Mobile Banking, UPI, NEFT, RTGS, and digital wallets has revolutionized customer experience. Technology has improved operational efficiency, reduced transaction time, enhanced security, and expanded access to banking services. With digitalization, banks offer 24×7 services and reach remote areas through mobile apps and fintech partnerships. Innovations like AI-driven customer service, blockchain, and biometric authentication are shaping the future of banking. The digital push by the government (e.g., Digital India, Jan Dhan Yojana) has accelerated this transformation.

11. What is meant by amalgamation and merger of banks?

Amalgamation and merger refer to the combining of two or more banks into a single entity. Amalgamation involves the absorption of one bank by another, while merger implies mutual consolidation. The objectives include improving financial health, achieving economies of scale, expanding outreach, and reducing NPAs. In India, RBI regulates such restructuring under Section 44A of the Banking Regulation Act, 1949. Recent examples include the merger of several public sector banks like Bank of Baroda with Vijaya and Dena Bank. These steps aim to create strong, competitive banks with global capabilities and better governance.

12. What is the procedure for winding up of banks in India?

Winding up of banks refers to the process of legally closing a bank’s operations due to insolvency, financial mismanagement, or RBI’s direction. The RBI can apply to the High Court for the winding up of a bank under the Banking Regulation Act, 1949. The process involves appointment of a liquidator, repayment to depositors, and disposal of assets. The Deposit Insurance and Credit Guarantee Corporation (DICGC) ensures limited protection (up to ₹5 lakh per depositor) in such cases. The Insolvency and Bankruptcy Code (IBC), 2016, applies mainly to non-banking financial companies (NBFCs), while banks follow RBI-directed closure procedures.

13. What are the different types of banks in India?

Banks in India are classified based on ownership and function:

  • Public Sector Banks (PSBs): Owned by the government (e.g., SBI, PNB)
  • Private Sector Banks: Owned by private entities (e.g., HDFC, ICICI)
  • Foreign Banks: Operate in India with foreign headquarters (e.g., Citibank)
  • Regional Rural Banks (RRBs): Provide rural banking
  • Cooperative Banks: Operate on a cooperative model
  • Small Finance Banks and Payment Banks: Provide focused financial services
    This diversified banking ecosystem supports the financial needs of varied sectors across rural and urban India.

14. What are financial institutions and how do they differ from banks?

Financial Institutions (FIs) are specialized organizations that provide financial services but may not accept public deposits like banks. Examples include NABARD, SIDBI, EXIM Bank, and NHB. They mainly provide long-term capital for development in agriculture, small-scale industries, exports, and housing. Banks, in contrast, offer a wide range of retail and commercial banking services, including accepting deposits and providing short-to-medium term credit. FIs work as instruments for policy implementation, whereas banks are more market-driven and offer day-to-day banking facilities.

15. What are the functions of commercial banks in India?

Commercial banks perform key roles in the economy:

  • Accepting various types of deposits
  • Providing loans and advances (personal, business, industrial)
  • Facilitating payments and settlements (cheques, drafts, RTGS, UPI)
  • Issuing credit/debit cards and internet banking services
  • Offering foreign exchange and trade finance
  • Safeguarding valuables in lockers
    Their dual function of accepting deposits and lending funds enables capital formation and supports business, industry, and personal finance needs.

16. What is social banking and why is it important?

Social banking refers to banking activities aimed at promoting social and economic welfare rather than just profitability. Initiatives include priority sector lending, Jan Dhan Yojana, Self Help Groups (SHG)-bank linkage, and financial inclusion drives. The aim is to bring banking services to the underprivileged, including rural populations, small farmers, artisans, and weaker sections. Social banking helps bridge the gap between urban and rural financial access and supports inclusive growth by aligning with government schemes and poverty alleviation programs.

17. What is the role of RBI in regulating the banking sector?

The Reserve Bank of India (RBI) is the apex regulatory authority for banks in India. Its functions include:

  • Licensing and supervision of banks
  • Formulating and implementing monetary policy
  • Regulating CRR and SLR
  • Issuing currency
  • Acting as banker to the government
  • Ensuring price and financial stability
    RBI uses tools like repo rate, reverse repo, open market operations, and moral suasion to maintain liquidity and control inflation. Its oversight ensures public confidence and the smooth functioning of the banking system.

18. What is the impact of bank privatization in India?

Privatization of banks aims to improve efficiency, competitiveness, and customer service. After liberalization in 1991, private banks like HDFC and ICICI emerged as strong competitors to public banks. Privatized banks tend to adopt advanced technology, have professional management, and provide better returns on assets. However, concerns remain about job security, rural outreach, and financial inclusion. Recent government initiatives have hinted at privatizing certain public sector banks to reduce the fiscal burden and promote efficient governance.

19. How does technology impact banking in India today?

Technology has revolutionized banking in India with innovations like Core Banking Solutions (CBS), Internet Banking, Mobile Banking, UPI, NEFT, RTGS, and digital wallets. These developments offer 24/7 access, faster transactions, enhanced security, and convenience. Customers can now open accounts, transfer funds, apply for loans, and invest digitally. Banks are also using AI, chatbots, and blockchain for fraud detection and smart contracts. Technology bridges the urban-rural gap and strengthens financial inclusion under initiatives like Digital India and Aadhaar-linked banking.

20. What are the challenges faced by Indian banks today?

Indian banks face several challenges, including:

  • Non-Performing Assets (NPAs) affecting profitability
  • Cybersecurity threats due to digitization
  • Regulatory compliance burden
  • Public trust issues after scams
  • Competition from fintech and digital-only banks
    To overcome these, banks are adopting robust credit appraisal systems, focusing on asset quality, improving customer service, and investing in technology and training. Strengthening corporate governance and enhancing transparency are also key steps toward building a resilient banking sector.

21. What are Non-Performing Assets (NPAs)?

NPAs are loans or advances where the principal or interest payment is overdue for 90 days or more. High NPAs indicate poor loan recovery and affect bank profitability. NPAs are classified into substandard, doubtful, and loss assets. Major reasons include willful defaults, economic downturns, and poor credit assessment. Banks use tools like SARFAESI Act, Asset Reconstruction Companies, and Insolvency and Bankruptcy Code (IBC) for recovery. Managing NPAs is crucial for the financial health of banks and the broader economy.

22. What is the role of the DICGC in the banking system?

The Deposit Insurance and Credit Guarantee Corporation (DICGC) is a subsidiary of the RBI that provides insurance on bank deposits. In the event of bank failure, DICGC insures each depositor up to ₹5 lakh for both principal and interest. It covers all commercial and cooperative banks in India. The objective is to instill depositor confidence and financial system stability. It plays a vital role during the liquidation of banks or in crisis situations like those involving PMC Bank or Yes Bank.

23. What is financial inclusion and how is it promoted in India?

Financial inclusion means providing affordable financial services (like banking, credit, insurance) to the unbanked and underprivileged sections of society. India promotes it through:

  • PM Jan Dhan Yojana: zero-balance bank accounts
  • Direct Benefit Transfers (DBT)
  • UPI and mobile wallets
  • Bank Mitra and BC models
  • Small Finance and Payment Banks
    Financial inclusion empowers people economically, reduces poverty, and integrates more citizens into the formal financial system.

24. What are Payment Banks and their role in Indian banking?

Payment Banks are niche banks introduced by the RBI to promote financial inclusion. They can accept deposits (up to ₹2 lakh per customer), offer remittance services, and issue debit cards but cannot give loans or issue credit cards. Examples include Airtel Payments Bank and India Post Payments Bank. They use technology and widespread reach (especially in rural areas) to provide basic banking services. These banks help bring the unbanked population into the formal financial system and promote cashless transactions.

25. What is the role of NABARD in the Indian financial system?

National Bank for Agriculture and Rural Development (NABARD) is a key development bank focused on rural and agricultural development. It refinances loans given by cooperative and regional rural banks for agriculture, irrigation, dairy, and cottage industries. NABARD also promotes financial inclusion, SHGs, rural infrastructure, and climate-resilient farming practices. It acts as a bridge between policy-making and grassroots implementation, ensuring that rural credit is accessible, affordable, and effective.

25. What is the role of NABARD in the Indian financial system?

The National Bank for Agriculture and Rural Development (NABARD) is India’s apex development bank for rural and agricultural sectors. Established in 1982, it refinances loans extended by cooperative banks, Regional Rural Banks (RRBs), and other institutions for agriculture and rural development. NABARD supports projects in irrigation, rural infrastructure, micro-finance, dairy, and rural entrepreneurship. It also promotes Self Help Groups (SHGs) and financial literacy. NABARD plays a pivotal role in policy formulation and ensures that rural credit is timely, affordable, and productive, thereby aiding inclusive growth and rural development.

26. What is the difference between Scheduled and Non-Scheduled Banks?

Scheduled Banks are listed under the Second Schedule of the RBI Act, 1934, and fulfill certain conditions like maintaining CRR with the RBI. They include public sector banks, private banks, foreign banks, and cooperative banks. These banks enjoy privileges like access to the RBI’s financial assistance and clearinghouse facilities.
Non-Scheduled Banks are not listed in the Second Schedule and do not meet the required criteria. They are typically smaller in scale, operate in limited areas, and are not entitled to RBI support. Scheduled banks are considered more stable and regulated than non-scheduled ones.

27. What is Priority Sector Lending (PSL) and why is it important?

Priority Sector Lending (PSL) is a policy mandated by the RBI requiring banks to allocate a specific portion of their credit to sectors deemed vital for economic development, such as agriculture, micro and small enterprises, education, housing, and weaker sections. As per RBI norms, commercial banks must allocate 40% of their Adjusted Net Bank Credit (ANBC) to the priority sector. PSL ensures credit access to marginalized groups and helps in achieving inclusive growth, reducing regional disparities, and supporting employment generation in underdeveloped areas.

28. What is the Basel Norms and how do they apply to Indian banks?

The Basel Norms are international banking regulations developed by the Basel Committee on Banking Supervision to ensure financial stability and risk management. They consist of Basel I, II, and III standards, focusing on capital adequacy, stress testing, and market liquidity. Indian banks are required by the RBI to comply with Basel III norms, which mandate maintaining a minimum Capital to Risk-weighted Assets Ratio (CRAR), leverage ratio, and capital buffers. These norms improve risk management, protect depositors, and reduce the chances of bank failures, especially during financial crises.

29. What is a Bank Ombudsman and what services does it provide?

The Banking Ombudsman is a quasi-judicial authority created by the RBI under the Banking Ombudsman Scheme to address customer grievances against banks. It handles complaints related to delays in services, ATM issues, credit/debit card problems, non-adherence to RBI instructions, and unfair practices. Customers can file a complaint online or in writing without any cost. The Ombudsman provides a simple, fast, and cost-effective platform for dispute resolution. It helps improve customer satisfaction and enhances the accountability of banks in their dealings.

30. What is financial literacy and why is it important for banking?

Financial literacy is the ability to understand and effectively use financial products and services like banking, credit, savings, insurance, and investments. In the context of banking, financial literacy empowers individuals to make informed decisions, avoid debt traps, use digital payment systems safely, and plan for the future. The RBI and banks run financial literacy programs, especially in rural areas, to spread awareness about banking rights, fraud prevention, and financial inclusion schemes like Jan Dhan Yojana. A financially literate population strengthens the economy and promotes responsible banking behavior.

Unit-II

1. Who is a banker?

A banker is a person or institution that is licensed to accept deposits, offer loans, and provide related financial services. In India, banks operate under the Banking Regulation Act, 1949. A banker typically offers services like deposit accounts, withdrawal facilities, credit facilities, remittance services, investment advisory, etc. The Reserve Bank of India (RBI) acts as the central regulator of banking services. A banker enters into a legal relationship with its customers, and their rights and duties are governed by contracts and prevailing banking laws.

2. Who is a customer in banking law?

A customer is a person or entity that maintains an account with a bank and avails banking services. The relationship starts once an individual opens an account and the bank accepts it. A customer can be an individual, firm, company, trust, or any legal entity. Even a person without an account may be considered a customer if they avail specific services like demand drafts, currency exchange, or lockers. The banker-customer relationship is contractual and includes rights, obligations, and liabilities defined by law and banking practices.

3. What is the general relationship between a banker and a customer?

The general relationship between a banker and a customer is primarily that of debtor and creditor. When a customer deposits money, the bank becomes the debtor and the customer the creditor. When a loan is given, the roles reverse. This relationship is fiduciary and involves trust, honesty, and mutual understanding. Apart from debtor-creditor, the relationship can also be agent-principal, trustee-beneficiary, or bailee-bailor, depending on the nature of the transaction (e.g., safe custody, cheque collection, or power of attorney).

4. How is the banker a debtor and the customer a creditor?

When a customer deposits money in a bank, the bank owes that money to the customer, thus becoming a debtor, and the customer becomes a creditor. However, the bank need not return the money unless a demand is made (such as withdrawal or cheque presentation). This relationship is not like a usual loan, as the money is repayable on demand, and the bank can use the money in the meantime for lending or investments.

5. When does the banker act as an agent for the customer?

A banker acts as an agent when it performs certain tasks on behalf of the customer, such as collecting cheques, paying bills, receiving dividends, making payments, or acting on instructions like standing orders. In these cases, the customer is the principal and the banker the agent. The bank has a duty to act honestly, in good faith, and with due care while executing these instructions. The agency relationship is created by the conduct of the parties and is governed by the Indian Contract Act.

6. What is the trustee-beneficiary relationship between banker and customer?

A banker becomes a trustee when it holds money or securities on behalf of the customer for a specific purpose (e.g., for safekeeping or investment). In this case, the customer is the beneficiary. The bank must use those funds only for the designated purpose and cannot treat them as general deposits. Such a fiduciary relationship imposes a duty of loyalty and care on the bank, and misuse of funds can lead to legal consequences.

7. What is the bailor-bailee relationship in banking?

Under the bailor-bailee relationship, the customer (bailor) hands over movable goods (like documents, valuables) to the bank (bailee) for safekeeping. For instance, when a customer uses a locker service or deposits valuables in the bank’s custody, the bank is bound to take reasonable care of those items. The bailment is governed by the Indian Contract Act. If the bank fails in its duty of care and the items are lost or damaged, it can be held liable for breach of duty.

8. What is the lessor-lessee relationship in banking?

In case of locker services, the bank acts as the lessor and the customer as the lessee. The bank leases a safe deposit locker to the customer for rent. The relationship is not that of bailment since the bank does not have knowledge or custody of the contents inside the locker. The bank must provide reasonable security and access, and cannot open the locker without due process. Recent court rulings have emphasized the bank’s responsibility to maintain and monitor lockers properly.

9. What are multifarious transactions between banker and customer?

Multifarious transactions include all services beyond deposits and withdrawals, such as:

  • Cheque collection and payments
  • Loan disbursement
  • Issuing demand drafts, guarantees, or letters of credit
  • Foreign exchange dealings
  • Safe custody services
  • Investment advisory
    These transactions create varying legal relationships, such as agent-principal, trustee-beneficiary, or creditor-debtor. Each transaction is governed by banking norms, statutory laws, and contractual obligations. The bank must maintain integrity, accuracy, and transparency in all such dealings.

10. What are the rights of a customer in relation to a bank?

Customers enjoy several rights, including:

  • Right to deposit and withdraw money
  • Right to receive fair treatment
  • Right to know interest rates, fees, and charges
  • Right to confidentiality
  • Right to receive bank statements
  • Right to redressal of grievances
    These rights are protected by RBI guidelines and consumer laws. Customers also have the right to close an account, claim compensation for service deficiencies, and move complaints to the Banking Ombudsman if not resolved by the bank.

11. What are the rights of a banker in relation to a customer?

A banker has the following rights:

  • Right of lien: To retain goods/securities until dues are paid
  • Right of set-off: To adjust credit against debit balances
  • Right to charge interest and commission
  • Right to close the account after notice
  • Right to refuse payment in case of insufficient funds
    These rights are subject to legal limitations and must be exercised fairly. A banker cannot disclose customer information except in legal or public interest situations.

12. What is a banker’s obligation to honour cheques?

The banker must honour a customer’s cheque if:

  • The account has sufficient funds
  • The cheque is properly drawn and signed
  • There is no legal bar (e.g., stop payment or court order)
    Failure to honour valid cheques without justification can make the bank liable for damages. However, if the cheque is forged, post-dated, or irregular, the bank has the right to refuse payment. The obligation arises from the contractual duty to pay money on demand.

13. What is overdraft and how does it work?

An overdraft is a facility where a customer is allowed to withdraw more money than what is available in their current account, up to a sanctioned limit. It is a form of short-term credit provided by banks, mainly to current account holders. The customer pays interest only on the amount used. It can be secured (against collateral) or unsecured. Overdrafts are useful for managing cash flow and meeting urgent financial needs. The bank can recall the facility at any time.

14. What is banker’s general lien?

A banker’s general lien is the right to retain a customer’s securities, goods, or documents in its possession until the outstanding dues are cleared. It arises from Section 171 of the Indian Contract Act, 1872. This right is general because it applies to all debts, not just those related to the specific item held. However, it cannot be exercised if the goods were given for a specific purpose (e.g., safe custody). It acts as security for the bank’s claims against the customer.

15. What is the difference between lien and implied pledge?

A lien is the right to retain possession of goods until dues are paid but not to sell them, whereas an implied pledge gives the right to both retain and sell the goods if payment is not made. Banks may claim implied pledge if securities are given with the intention of securing a loan. For example, when a customer pledges fixed deposit receipts for an overdraft, the bank may realize the amount by selling them upon default.

16. What is a banker’s duty to maintain secrecy of customer accounts?

A banker is legally obligated to keep customer account details confidential. This duty arises from contract, professional ethics, and common law. However, exceptions exist where disclosure is required:

  • Under a court order or law
  • For public interest
  • With the customer’s consent
  • To credit bureaus (as per RBI norms)
    Violation can result in liability for breach of trust. Confidentiality builds trust and safeguards the privacy of financial information.

17. How can the banker-customer relationship be terminated?

The relationship can be terminated in several ways:

  • By mutual agreement (e.g., closure of account)
  • By death, insolvency, or lunacy of the customer
  • By termination by the bank with reasonable notice
  • By legal proceedings such as garnishee orders
  • By transfer of account to another bank
    The bank must follow fair procedures and settle all outstanding transactions before formally ending the relationship.

18. Who are special types of customers in banking?

Special types of customers include:

  • Minors: Cannot enter binding contracts
  • Joint Account Holders: Need joint operations mandate
  • Partnership Firms: Require firm authorization and partnership deed
  • Hindu Undivided Families (HUF): Managed by the Karta
  • Trusts and NGOs: Must submit trust deeds and resolutions
  • Unincorporated Bodies: Like clubs and societies need by-laws
  • Corporations: Require board resolutions and proper documents
  • NRIs and Foreigners: Subject to FEMA rules and KYC norms
    Banks must exercise extra diligence while dealing with such accounts.

19. What are current accounts and their features?

Current accounts are designed for businesses and professionals needing frequent transactions. Key features include:

  • No interest on deposits
  • Unlimited withdrawals and deposits
  • Overdraft facilities
  • Cheque book and digital banking services
    These accounts are ideal for high-volume, day-to-day financial operations. Banks charge maintenance fees and require a minimum balance. Current accounts offer liquidity and flexibility but are not meant for savings.

20. What are savings accounts and their benefits?

Savings accounts are meant for individuals to deposit surplus funds and earn interest. Features include:

  • Moderate interest on deposits
  • Limited number of free withdrawals
  • ATM/debit cards, mobile banking, UPI access
  • Encourages saving habits
    There may be restrictions on transactions to promote saving. These accounts are suitable for salaried individuals, pensioners, and students. Banks may offer different variants like zero-balance or salary accounts based on customer profiles.

21. What is the legal capacity of a minor to open a bank account?

A minor (below 18 years of age) generally cannot enter into a legally binding contract. However, banks allow minors to open accounts with certain restrictions. A minor above 10 years may open a self-operated savings account with limited facilities. For younger minors, a guardian-operated account is permitted. Minors cannot be granted overdraft, loans, or credit cards. On attaining majority, the account must be regularized with updated KYC documents. Banks must exercise caution to protect both the minor’s interest and their legal position under the Indian Contract Act, 1872.

22. How are joint accounts managed by banks?

A joint account is opened by two or more individuals together. The operational mode must be clearly defined — for example, “either or survivor”, “jointly”, or “former or survivor”. All account holders must comply with KYC norms. Joint accounts offer flexibility, but all parties share rights and liabilities. In case of death of one account holder, the survivor(s) can operate the account based on the mandate. Banks must follow strict documentation to avoid future disputes. Proper nomination is also recommended in such accounts.

23. How do banks deal with accounts of partnership firms?

Banks require a partnership deed and account opening resolution signed by all partners. The account is usually operated by one or more authorized partners. All partners are jointly and severally liable for the firm’s debts. If the firm is not registered, the bank may restrict some services. Upon retirement, death, or admission of a new partner, the bank must be informed, and documents must be updated. Lending to partnerships involves assessing the financial credibility of all partners and the nature of the firm’s business.

24. How are accounts of companies or corporations handled by banks?

To open a corporate account, banks require:

  • Certificate of Incorporation
  • Memorandum and Articles of Association (MOA/AOA)
  • Board resolution authorizing signatories
  • PAN and KYC documents

Banks ensure that the signatories act within their delegated authority. Corporates may be offered current accounts, cash credit, overdrafts, and trade finance facilities. The banker must verify that any borrowing or guarantee falls within the powers granted in the company’s MOA and board resolution. Documentation and compliance play a key role in avoiding legal complications.

25. What precautions are taken in opening accounts of Trusts and NGOs?

Banks require the following for trust/NGO accounts:

  • Registered trust deed or constitution
  • PAN card and KYC documents
  • Resolution from trustees/board authorizing account opening
  • List of authorized signatories with identification proof

Such accounts are often used for donations, grants, or welfare schemes. Banks verify the purpose, source of funds, and nature of activities to prevent misuse or money laundering. These accounts usually do not get overdraft or loan facilities unless backed by securities and clear documentation. Monitoring of end-use of funds is also important.

26. How do banks manage accounts of Hindu Undivided Family (HUF)?

A HUF account is opened in the name of the family, operated by the Karta, the eldest male/female member. The HUF declaration and KYC documents of the Karta and coparceners are required. Banks do not generally offer credit facilities unless backed by proper securities. All transactions must be for the benefit of the family, not personal use. In case of death of the Karta, the next senior-most coparcener takes over. Banks must update documents accordingly. It’s essential that the bank verifies HUF legitimacy before opening such accounts.

27. What is a nominee account and how does it work in banking?

A nominee is a person appointed to receive the account balance in case of the account holder’s death. It is a simple and effective way to ensure smooth transfer of funds. A nominee can be appointed at the time of account opening or added later through a form. The nominee does not become the owner of the funds but merely a trustee holding money on behalf of legal heirs. Banks are protected when they release funds to a valid nominee under Section 45ZA of the Banking Regulation Act.

28. How do banks handle accounts of Non-Resident Indians (NRIs)?

Banks in India offer three types of NRI accounts:

  • NRE (Non-Resident External): Repatriable, tax-free, in INR
  • NRO (Non-Resident Ordinary): For Indian income, taxable
  • FCNR (Foreign Currency Non-Resident): In foreign currency

NRIs must provide passport, visa, overseas address proof, and comply with FEMA regulations. Banks must ensure KYC compliance and monitor foreign remittances as per RBI norms. These accounts help NRIs invest, save, and transfer money to/from India legally and securely.

29. What types of bank accounts can a customer open in India?

Customers can open various types of accounts based on their needs:

  • Savings Account: For individuals to save money and earn interest
  • Current Account: For businesses with high transaction needs
  • Fixed Deposit Account: Offers higher interest for fixed tenures
  • Recurring Deposit: Fixed monthly contributions with interest
  • NRI Accounts: For non-resident Indians (NRE, NRO, FCNR)
  • Jan Dhan Account: For financial inclusion, zero-balance option

Each account serves different financial objectives, and banks offer features like debit cards, online access, and interest based on the account type.

30. How are foreigner accounts handled by Indian banks?

Foreigners can open accounts in India subject to RBI guidelines and FEMA regulations. They must provide a valid passport, visa, photograph, and local address proof (temporary or hotel stay proof). Accounts may be savings, current, or fixed deposit types and are subject to transaction monitoring. Foreigners may face restrictions on remittance and repatriation unless approved by the RBI. Banks take extra care in verifying identity and purpose to prevent misuse for illegal activities. Foreign diplomatic missions and international organizations also maintain accounts in India under special permissions.

🔹 1. What are the salient features of the Negotiable Instruments Act, 1881?

The Negotiable Instruments Act, 1881 governs the use of financial instruments such as promissory notes, bills of exchange, and cheques. Its main features include:

  • Definition and legal recognition of negotiable instruments.
  • Presumption of consideration, date, time of acceptance and transfer, which benefits holders.
  • Transferability, i.e., negotiable instruments can be transferred from one person to another by endorsement and delivery or mere delivery.
  • Holder in due course enjoys special rights and is protected even if the title of the previous holder was defective.
  • Summary trial and legal remedies are available in case of dishonour of cheques under Section 138.
  • Digital recognition of truncated cheques after the IT Act, 2000.

The Act simplifies commercial transactions and facilitates smooth functioning of credit systems. It also provides for criminal liability in case of dishonour of cheques.

🔹 2. Define a Negotiable Instrument. What are its characteristics?

A Negotiable Instrument is a written document guaranteeing the payment of a certain amount of money to the bearer or a specific person either on demand or after a fixed time. Under Section 13 of the Act, it includes promissory notes, bills of exchange, and cheques.

Characteristics include:

  • Transferability without much formality.
  • Holder in due course can sue in their own name.
  • Free from previous defects, once in the hands of the holder in due course.
  • Written and signed by the maker or drawer.
  • Certainty of amount and parties involved.
  • Payable in money only.

These features make negotiable instruments highly useful in banking and business transactions.

🔹 3. What are Deemed Negotiable Instruments?

Deemed negotiable instruments are not explicitly defined in the Negotiable Instruments Act, 1881, but are recognized as negotiable due to custom, usage or special statutes. Examples include:

  • Dividend warrants,
  • Share warrants,
  • Bearer debentures,
  • Government promissory notes (as per RBI Act).

They are considered negotiable because they possess the essential attributes of negotiability — free transfer, title without defects, and the right to sue in one’s own name. Courts have recognized them as negotiable even without specific statutory mention. Their treatment as negotiable ensures smoother financial and capital market operations.

🔹 4. Who is a Holder, Holder in Due Course, and Holder for Value?

  • Holder (Sec. 8): A person entitled in their own name to the possession of the instrument and to receive or recover the amount due.
  • Holder in Due Course (Sec. 9): A person who acquires the instrument for value, in good faith, before maturity, and without notice of any defect.
  • Holder for Value: A person who receives the instrument in return for a valuable consideration, whether before or after maturity.

While all holders can claim payment, the holder in due course has stronger rights and protections under law, even if the instrument was previously dishonoured or forged.

🔹 5. What are the types of Cheques under the Negotiable Instruments Act?

Cheques are of various types based on their form and instruction:

  1. Bearer Cheque: Payable to whoever presents it.
  2. Order Cheque: Payable to a specific person whose name is mentioned.
  3. Crossed Cheque: Includes two parallel lines, instructing the bank to credit only to a bank account, not cash.
  4. Post-dated Cheque: Dated for a future day.
  5. Stale Cheque: Presented after 3 months of issue – not valid.
  6. Open Cheque: Can be cashed at the counter without any crossing.

Each type serves specific purposes and includes different levels of security and risk.

🔹 6. Explain the concept and significance of Crossing of Cheques.

Crossing of cheques involves drawing two parallel lines on the face of a cheque, with or without words such as “& Co.” or “Not Negotiable.” It serves as an instruction to the bank to not pay cash, but credit the amount to a bank account only.

Types:

  • General Crossing (Sec. 123): Just two lines, with or without words.
  • Special Crossing (Sec. 124): Includes the name of a specific banker.
  • Restrictive Crossing: Additional words like “A/c payee only.”

Crossing enhances security by reducing the risk of theft or misuse. It ensures traceability and accountability of the payment.

🔹 7. What are Truncated Cheques and how does the IT Act, 2000 relate to them?

A truncated cheque is a cheque where the physical movement is stopped during the clearing cycle and is replaced by an electronic image for processing. As per Section 6 of the Negotiable Instruments Act (amended by the IT Act, 2000), truncated cheques are legally valid.

The Information Technology Act, 2000 enabled the legal recognition of digital documents and e-signatures, which facilitated the processing of truncated cheques. It speeds up cheque clearing, reduces processing costs, and avoids the risk of physical loss.

Banks now use Cheque Truncation System (CTS) for faster and more secure settlements.

🔹 8. What is Endorsement? What are its types?

Endorsement is the signing of a negotiable instrument by the holder to transfer it to another person. It signifies consent to transfer the rights over the instrument.

Types of Endorsement:

  1. Blank Endorsement: Signature without name of endorsee — converts to bearer instrument.
  2. Full Endorsement: Specifies endorsee’s name — becomes order instrument.
  3. Restrictive Endorsement: Limits further negotiation.
  4. Conditional Endorsement: Transfers subject to a condition.
  5. Sans Recourse Endorsement: Endorser excludes personal liability.

Endorsement facilitates the instrument’s circulation in business and defines legal rights and liabilities of the parties.

🔹 9. What is the effect of Endorsement?

Endorsement legally transfers ownership of the negotiable instrument to another person, known as the endorsee. The endorsee then gets the right to:

  • Collect or receive payment,
  • Sue in their own name,
  • Further endorse it.

In case of dishonour, the endorser is liable to the holder unless it is a sans recourse endorsement. The effect also depends on the type of endorsement—blank endorsements make the instrument bearer, whereas full endorsements retain order nature.

Thus, endorsement ensures negotiability and defines the liability chain among parties.

🔹 10. What is the liability and discharge of an Endorser?

An endorser becomes liable to subsequent holders if the instrument is dishonoured, provided proper notice is given. The endorser guarantees that:

  • The instrument is genuine,
  • They have good title,
  • It will be honoured on due presentation.

Discharge of endorser occurs when:

  • The instrument is paid by the maker/drawee.
  • The holder cancels the endorser’s name.
  • The holder fails to give notice of dishonour.

Thus, endorsement creates a liability chain, but the endorser may be discharged upon payment or procedural lapses by the holder.

🔹 11. What leads to discharge from liability in notes, bills, and cheques?

Discharge from liability means the parties are released from the obligation to pay. It can occur by:

  • Payment in due course by maker or acceptor.
  • Cancellation or tearing of instrument by the holder.
  • Release agreement or settlement.
  • Material alteration without consent.
  • Non-presentment or failure to give notice of dishonour.

Once discharged, the instrument becomes non-negotiable and no legal claim can be made against discharged parties.

🔹 12. What is Dishonour of Cheque by a Banker? What are its consequences?

A cheque is dishonoured when the banker refuses to pay on presentation due to insufficient funds, closed account, mismatched signature, etc.

Consequences under Section 138:

  • Criminal offence.
  • Imprisonment up to 2 years or fine up to twice the amount.
  • Civil liability for compensation.

The drawer must receive a legal notice within 30 days of dishonour. If payment isn’t made within 15 days of notice, a complaint can be filed within 30 days.

This provision ensures the reliability of cheques in commercial dealings.

🔹 13. Explain the liability under the Negotiable Instruments Act, 1881.

Liability arises on the drawer, endorser, acceptor, or holder in due course, depending on the instrument and situation. Key liabilities include:

  • Drawer’s liability for dishonour.
  • Endorser’s liability if the instrument is dishonoured after endorsement.
  • Acceptor’s liability in bills of exchange upon acceptance.

Under Section 138, dishonour of cheque leads to criminal liability. Civil remedies are also available under common law or contract law.

Thus, liability ensures accountability and smooth operation of commercial credit instruments.

🔹 14. How can a company and its directors be prosecuted under the Act?

Section 141 of the Negotiable Instruments Act provides for prosecution of companies in case of cheque dishonour. If the offence is committed by a company, every person in charge and responsible for its business, including directors, may be held liable.

Conditions:

  • Company must have issued the cheque.
  • Directors must be in charge of day-to-day affairs.
  • Proper notice must be given to the company and its responsible officers.

However, sleeping directors or those not involved in management cannot be prosecuted unless specific roles are proven.

🔹 15. What is meant by Pecuniary and Territorial Jurisdiction under the Act?

Pecuniary Jurisdiction refers to the monetary limits within which a court can try cases. Cheque bounce cases are usually filed in Magistrate Courts with jurisdiction based on the amount involved.

Territorial Jurisdiction (as per Sec. 142(2), amended by 2015 Act):

  • The court where the payee’s bank is located (where cheque is deposited) has jurisdiction.
  • Earlier, jurisdiction was with the drawer’s bank — changed by Supreme Court and amendment.

Proper jurisdiction is essential for maintainability of the case and prevents dismissal on technical grounds.

Here are Short Questions and Answers (150–200 words) from Q.16 to Q.30 based on Unit-III of the Negotiable Instruments Act, 1881 syllabus:

🔹 16. What is meant by a Promissory Note? What are its essentials?

A promissory note is defined under Section 4 of the Negotiable Instruments Act, 1881, as an instrument in writing (not being a banknote or currency note) containing an unconditional undertaking, signed by the maker, to pay a certain sum of money to, or to the order of, a certain person or to the bearer.

Essentials:

  • Must be in writing.
  • Must contain an unconditional promise to pay.
  • Must be signed by the maker.
  • Parties (maker and payee) must be certain.
  • Amount must be definite.
  • Payable in money only.

Example: “I promise to pay Ram ₹10,000 on demand. — Signed: Shyam”

A promissory note establishes a clear debtor-creditor relationship and is a widely used instrument in credit transactions.

🔹 17. Define a Bill of Exchange and explain its key elements.

As per Section 5 of the Act, a bill of exchange is an instrument in writing containing an unconditional order, signed by the maker (drawer), directing a certain person (drawee) to pay a certain sum of money to, or to the order of, a certain person (payee), or to the bearer.

Key Elements:

  • Written form.
  • Unconditional order to pay.
  • Signed by the drawer.
  • Three parties involved: drawer, drawee, and payee.
  • Payable on demand or after a fixed time.
  • Amount must be certain.

Example: “Pay ₹5,000 to Ram or order — Signed: Shyam (Drawer), Accepted by Mohan (Drawee).”

Bills of exchange are widely used in trade and commerce for deferred payments.

🔹 18. What are the differences between a Promissory Note and a Bill of Exchange?

Aspect Promissory Note Bill of Exchange
Number of Parties Two (maker and payee) Three (drawer, drawee, payee)
Nature Promise to pay Order to pay
Acceptance Not required Required from drawee
Liability Maker is primarily liable Drawer is secondarily liable
Example “I promise to pay Ram ₹5,000” “Pay ₹5,000 to Ram or order”

Both are negotiable instruments, but their structure and roles of parties differ fundamentally.

🔹 19. What are Inland and Foreign Instruments? Explain the distinction.

As per Section 11 and 12 of the Act:

  • An inland instrument is one that is either drawn or made in India and is payable in India or drawn upon someone residing in India.
  • A foreign instrument is one not fulfilling the criteria of an inland instrument.

Differences:

  • Jurisdiction: Indian laws apply to inland; foreign laws may apply to foreign instruments.
  • Noting and Protest: Required for foreign instruments in case of dishonour.
  • Stamping: Different rules may apply.

Example:

  • Inland: A bill drawn and payable in Mumbai.
  • Foreign: A bill drawn in London and payable in Delhi.

Understanding the classification is important for legal treatment, dishonour, and liabilities.

🔹 20. What is meant by the Maturity of Negotiable Instruments?

Maturity refers to the date when a negotiable instrument becomes payable. For demand instruments like cheques, maturity is on the date of presentation.

For time instruments:

  • Maturity is calculated from the date mentioned on the instrument.
  • As per Section 22, maturity is three days after the date on which the instrument is expressed to be payable (called “days of grace”).

Example: If a bill is payable 1 month after date and is dated 1st July, it matures on 4th August.

Knowing maturity helps in determining due date and taking timely legal action in case of default.

🔹 21. What are Ambiguous and Inchoate Instruments?

  • Ambiguous Instrument (Section 17): An instrument that can be interpreted as either a promissory note or bill of exchange. The holder may elect how to treat it.

    Example: An instrument that orders and promises to pay may be treated as either.

  • Inchoate Instrument (Section 20): An incomplete instrument signed and delivered by the maker, leaving some details (e.g., amount) to be filled later. The holder has authority to complete it up to the authorized amount.

Such instruments still hold validity under law but carry potential risk of misuse, so parties must act with care.

🔹 22. What is the presumption of consideration under the Act?

Under Section 118(a) of the Act, there is a legal presumption that every negotiable instrument was made, drawn, accepted, endorsed, or transferred for consideration.

This means:

  • The burden of proof lies on the party denying consideration.
  • It promotes trust and smooth functioning of commercial transactions.

However, this presumption is rebuttable, meaning the opposing party can bring evidence to the contrary.

This legal safeguard protects the holder and facilitates ease of business.

🔹 23. What is the effect of material alteration on a negotiable instrument?

Material alteration means making changes to the instrument that affect its legal character or obligations. Examples include:

  • Changing the date, amount, name, or rate of interest.

Effect:

  • As per Section 87, a material alteration without consent renders the instrument void against the party who did not consent.

However, some alterations with mutual agreement or to correct clerical errors are permitted.

Material alteration is treated seriously as it can lead to fraud and affects the negotiability and enforceability of the instrument.

🔹 24. What is the difference between ‘Noting’ and ‘Protesting’?

  • Noting: Official recording by a notary public when a negotiable instrument is dishonoured.
  • Protesting: A formal certificate issued by the notary after noting, giving reasons for dishonour.

Differences:

  • Noting is a step towards protesting.
  • Noting is optional for inland instruments but compulsory for foreign ones.

Both serve as legal proof of dishonour and are helpful in court proceedings and for claiming damages.

🔹 25. What is the role of the banker in cheque collection?

A collecting banker acts as an agent of the customer to collect payment from the drawee bank. Duties include:

  • Presenting the cheque within a reasonable time.
  • Ensuring the cheque is properly endorsed.
  • Crediting the amount promptly after realization.

Under Section 131, a banker is protected if:

  • The collection was for a customer,
  • There was no negligence,
  • The cheque was crossed.

Thus, collecting bankers must act in good faith and with due care to avoid liability.

🔹 26. When is a banker liable for conversion in collecting cheques?

A banker is liable for conversion when they collect a cheque wrongfully, especially if:

  • The cheque is stolen or fraudulently endorsed.
  • Banker was negligent in verifying endorsement.
  • The banker did not collect for the account of the true owner.

In such cases, the banker is treated as having interfered with someone else’s property.

Section 131 offers protection only if the banker acted without negligence. Otherwise, the banker can be sued for damages.

🔹 27. What are the legal consequences of dishonour of a bill of exchange?

When a bill is dishonoured:

  • The holder must give notice of dishonour to all prior parties.
  • The drawer and endorsers become liable to compensate the holder.
  • The holder may file a suit for recovery.
  • Noting and protest may be required in foreign bills.

The bill can also be renewed, but if action is not taken in time, the right to recover may lapse.

Dishonour affects the creditworthiness of the drawer and may invite legal action.

🔹 28. What is the significance of Section 138 in maintaining cheque credibility?

Section 138 ensures that cheques are treated as reliable payment instruments by imposing criminal liability for dishonour due to insufficient funds.

Key Points:

  • Punishment up to 2 years’ imprisonment or fine up to twice the cheque amount.
  • Legal notice must be sent within 30 days of dishonour.
  • If drawer fails to pay within 15 days, complaint can be filed within 30 days.

This section protects trade and commerce by instilling discipline in financial commitments.

🔹 29. What is the time limit to file a complaint under Section 138?

The complaint must be filed:

  1. Within 30 days from the expiry of 15 days after giving notice to the drawer (i.e., 45 days total from the date of receiving dishonour memo).
  2. The cheque should have been presented within 3 months of issue date.

Delay beyond the limit requires the Magistrate’s satisfaction for condonation.

Strict adherence to the time frame is crucial for maintainability of the complaint.

🔹 30. What is meant by ‘Holder in Due Course’? What are their rights?

As per Section 9, a Holder in Due Course (HDC) is a person who:

  • Acquires the instrument for consideration,
  • Before maturity,
  • In good faith,
  • Without notice of any defect in title.

Rights:

  • Can sue in own name.
  • Is not affected by prior defects.
  • Enjoys better title than the transferor.
  • Can hold prior parties liable in case of dishonour.

HDC is given preferential legal status, ensuring trust and fluidity in negotiable instrument transactions.

Unit-IV

1. Who is a paying banker?

A paying banker is the banker on whom the cheque is drawn and who is responsible for making payment upon its presentation. When a customer issues a cheque, the paying banker must verify the cheque and, if valid, honour the payment. This role requires utmost diligence, as wrongful payment can result in financial loss or legal liability. The banker must ensure the cheque is genuine, properly signed, and the customer has sufficient funds.

2. What are the primary obligations of a paying banker?

The paying banker must:

  • Honour valid cheques if sufficient balance is available
  • Verify the authenticity of the signature
  • Ensure there are no stop-payment instructions or legal restrictions
  • Make the payment in due course
  • Act in good faith and without negligence
    Failing to meet these obligations may lead to breach of contract with the customer and result in damages or loss of reputation.

3. What does “payment in due course” mean?

As per Section 10 of the Negotiable Instruments Act, 1881, “payment in due course” refers to payment made:

  • In accordance with the apparent tenor of the instrument
  • In good faith and without negligence
  • To the rightful holder
    This concept protects the paying banker from liability when payment is made under proper circumstances. It ensures that once a cheque is paid correctly, the banker cannot be made liable even if the cheque was later found to be stolen or forged.

4. When must a paying banker refuse payment of a cheque?

A paying banker must refuse payment when:

  • There are insufficient funds
  • The cheque is post-dated or stale
  • The drawer’s signature is forged
  • Payment has been stopped by the customer
  • The account is frozen due to legal orders (e.g., garnishee, court injunction)
  • The drawer has died or been declared insolvent or insane
    Refusing payment in these cases protects the bank from liability and complies with legal requirements.

5. What are the consequences of wrongful dishonour of cheque by a banker?

If a banker wrongly dishonours a valid cheque, it breaches its contract with the customer. For individuals, this may cause inconvenience, but for businesses, it can damage credit and reputation. The bank may be liable to pay compensation or damages. Courts have held banks accountable for negligent or unjustified dishonour, especially when done without valid reason or due care.

6. What are the limitations on a paying banker’s duty to honour cheques?

The paying banker’s obligation is limited by:

  • Availability of funds in the account
  • Legal instructions such as garnishee orders
  • Validity of the cheque (no alterations or expiry)
  • Mandates like joint signatures or limits of authorization
  • KYC and AML compliance issues
    These checks prevent fraudulent payments and ensure the bank fulfills legal and regulatory duties.

7. What is statutory protection to the paying banker?

Section 85 of the Negotiable Instruments Act grants statutory protection to the paying banker if:

  • The payment is made in due course
  • The cheque bears a forged endorsement but is payable to order
    This protection shields the bank from liability if payment was made honestly and without negligence. However, no protection is available if the signature of the drawer is forged, as the banker is expected to verify the customer’s signature.

8. What are bearer and order cheques in context of paying banker’s protection?

  • Bearer Cheques: The person holding the cheque can encash it. Protection is given under Section 85(2) for payments in due course.
  • Order Cheques: Payable to a specific person; endorsement may be required. Section 85(1) provides protection to the paying banker if the endorsement is forged, provided payment was in due course.
    In both cases, the banker must act in good faith and with diligence.

9. Who is a collecting banker?

A collecting banker is the bank that collects cheques on behalf of its customers. When a cheque is deposited by a customer, the collecting banker presents it to the paying banker and collects the amount for the customer. This banker acts as an agent in the cheque collection process and has certain legal duties and protections under the law.

10. What are the duties of a collecting banker?

The collecting banker must:

  • Act as an agent in collecting the cheque
  • Exercise due diligence in verifying endorsements
  • Present the cheque within a reasonable time
  • Act without negligence
  • Credit the amount to the correct account
    Failure to meet these duties, especially if negligent, can make the banker liable for loss to the true owner of the cheque.

11. What is the doctrine of conversion in banking?

Conversion refers to the wrongful dealing with someone else’s property. In banking, if a collecting banker collects a cheque for someone who is not the rightful owner (e.g., a thief or a fraudster), it is considered conversion. The true owner can sue the bank for compensation. However, banks can claim statutory protection under Section 131 of the Negotiable Instruments Act if they acted in good faith and without negligence.

12. What is statutory protection to the collecting banker?

Section 131 of the Negotiable Instruments Act provides protection to a collecting banker if:

  • The cheque was crossed
  • The collection was for a customer
  • The bank acted in good faith and without negligence
    If these conditions are met, the bank is not liable even if the cheque was stolen or forged. This legal shield encourages banks to facilitate cheque collection while protecting genuine interests.

13. What is meant by “crossed cheque” and its importance to collecting banker?

A crossed cheque is one that has two parallel lines across its face or carries words like “Account Payee.” It is not payable in cash but only into a bank account. This reduces the risk of theft and fraud. Collecting bankers get statutory protection only when collecting crossed cheques, as per Section 131 of the Negotiable Instruments Act, making it essential in protecting banks from liability for conversion.

14. When can a collecting banker be held negligent?

A collecting banker may be considered negligent if it:

  • Opens an account without proper KYC
  • Collects cheques for a non-customer
  • Ignores suspicious endorsements or alterations
  • Fails to verify identity or account legitimacy
    Negligence removes statutory protection under Section 131, and the banker may be liable to the true owner for conversion or breach of duty.

15. What precautions must a collecting banker take during collection?

Precautions include:

  • Ensuring the cheque is crossed and in proper form
  • Verifying customer’s identity and endorsement
  • Collecting only for known customers
  • Avoiding irregular or suspicious cheques
  • Crediting amounts only after cheque clearance
    By following these steps, the banker avoids negligence and secures legal protection.

16. What is the difference between paying banker and collecting banker?

  • Paying Banker: Pays the cheque drawn on it by the customer.
  • Collecting Banker: Collects the cheque on behalf of a customer.
    The paying banker must ensure payment in due course, while the collecting banker must ensure proper collection without negligence. Both roles involve specific responsibilities and statutory protections under the Negotiable Instruments Act.

17. Can a paying banker claim protection in case of forged drawer’s signature?

No. A paying banker cannot claim statutory protection under Section 85 if the drawer’s signature is forged. The bank is expected to know its customer’s signature and is liable for any payment made on a forged cheque. This exception ensures that banks verify signatures diligently.

18. Can a collecting banker collect cheques for a non-customer?

Generally, no. A collecting banker is expected to collect cheques only for existing customers with proper identification and account opening compliance. Collecting cheques for strangers may be considered negligence and can lead to loss of statutory protection under Section 131. It also increases the risk of fraud and legal action for conversion.

19. What happens if a banker collects an open (uncrossed) cheque?

If a banker collects an open cheque, it is not entitled to statutory protection under Section 131. Open cheques are payable in cash and can be presented directly to the paying bank. Collecting such cheques without caution increases the risk of fraud and legal liability. Banks prefer to handle crossed cheques for this reason.

20. What legal remedy does a true owner have against a negligent collecting banker?

If a collecting banker collects a cheque negligently or without due verification, the true owner of the cheque (e.g., whose cheque was stolen) can sue the bank for conversion. The bank may be required to pay damages equal to the amount of the cheque. Statutory protection will not apply if the banker acted in bad faith or was negligent.

21. What is a Stale Cheque, and how should a Paying Banker treat it?

A stale cheque is a cheque that is presented for payment after three months from its date of issue. As per banking norms, paying bankers must not honour stale cheques, even if there are sufficient funds in the account. Honouring such cheques could be considered negligence, and the bank may not get statutory protection under Section 85 of the Negotiable Instruments Act. The cheque should be returned with the reason “cheque stale.” Banks may, however, pay stale cheques only with written confirmation from the drawer.

22. What is a Post-Dated Cheque, and what are the obligations of the Paying Banker?

A post-dated cheque is dated for a future date, meaning it is not payable until that date arrives. A paying banker must not honour a post-dated cheque before the mentioned date, even if funds are available. Doing so amounts to premature payment and can lead to financial and legal consequences. The bank may be liable for damages to the account holder. The banker must check the date carefully before processing any payment to ensure payment in due course.

23. What is a Stop Payment Instruction, and how should a banker handle it?

A stop payment instruction is a request made by the drawer to the banker to not honour a particular cheque. It must be given in writing before the cheque is presented. Once received, the banker must comply, regardless of whether there are sufficient funds. Ignoring the instruction and paying the cheque can lead to a breach of the customer’s trust, and the banker may be liable to compensate for any resulting loss. Such instructions must be properly recorded and acted upon immediately.

24. What is a Forged Cheque, and what is the liability of the Paying Banker?

A forged cheque is one where the drawer’s signature is not genuine. A paying banker has no protection under Section 85 of the Negotiable Instruments Act if it honours a cheque with a forged drawer’s signature. The bank is expected to verify its customer’s signature, and payment of such a cheque is considered unauthorised. The banker must bear the loss and reimburse the amount to the customer. This highlights the importance of signature verification systems and vigilance in cheque processing.

25. What is the relevance of Section 131 of the Negotiable Instruments Act to Collecting Bankers?

Section 131 provides statutory protection to a collecting banker who collects crossed cheques for a customer in good faith and without negligence. Even if the cheque is later found to be stolen or forged, the bank will not be liable if these conditions are met. However, if the banker is negligent — for example, by opening an account without verification or collecting for a non-customer — the protection is lost. This provision encourages banks to offer cheque collection services responsibly.

26. How does endorsement affect the Collecting Banker’s liability?

The collecting banker must ensure that endorsements on the cheque are regular and valid. An irregular, forged, or incomplete endorsement may indicate fraud. Collecting a cheque with a defective endorsement may amount to negligence, leading to the loss of statutory protection under Section 131. The banker is expected to examine the chain of endorsements, especially for “order” cheques. Failure to do so may make the bank liable for conversion or loss to the true owner of the cheque.

27. What is a Demand Draft, and who is the Paying Banker?

A Demand Draft (DD) is a pre-paid negotiable instrument issued by a bank payable to a specified person. Unlike a cheque, it cannot be dishonoured due to insufficient funds since it is prepaid. The paying banker in the case of a DD is the bank branch on which the draft is drawn. The bank must ensure payment is made to the correct person upon proper identification. While generally safe, the banker must still verify authenticity to avoid fraud or duplicate payment.

28. What is a Garnishee Order, and how does it affect the Paying Banker?

A garnishee order is issued by a court directing a bank (garnishee) to freeze or withhold funds belonging to a judgment debtor (customer) to satisfy a creditor’s claim. Upon receiving such an order, the paying banker must stop payment of any cheque drawn by the customer. Ignoring a garnishee order may lead to contempt of court or liability to the creditor. The banker must carefully follow the order and act only as permitted, freezing only the amount specified.

29. Can a banker honour a cheque with material alteration?

No, a cheque that has undergone material alteration (e.g., change in date, amount, payee name) is not valid unless it is authenticated by the drawer’s full signature. If a banker honours a materially altered cheque without proper authentication, it loses statutory protection and may be liable for the amount. The banker must carefully examine all cheques for alterations and seek confirmation if any suspicious changes are noticed. This protects both the customer and the bank from fraud.

30. What happens when a cheque is paid to a wrong person by the Collecting Banker?

If the collecting banker pays a cheque to the wrong person (e.g., a fraudster or someone impersonating the payee), it may be liable for conversion — i.e., wrongful interference with the rightful owner’s property. Statutory protection under Section 131 applies only when the bank acts in good faith and without negligence. If the banker fails to verify the account, endorsements, or payee identity properly, it is considered negligent, and the true owner can claim compensation.

Unit-V

1. What are loans and advances in banking?

Loans and advances are financial products where banks lend money to customers with the expectation of repayment along with interest. Loans are generally for a fixed tenure and repaid in installments, while advances are short-term, repayable on demand (like cash credit or overdraft). They are extended against security or collateral and help individuals, businesses, and institutions meet various financial needs, such as working capital, housing, education, or expansion.

2. What is pledge of stocks and securities?

A pledge is the bailment of goods (like stocks, shares, or bonds) as security for repayment of a loan. The borrower (pledgor) delivers possession of securities to the bank (pledgee), which retains them until the loan is repaid. The bank gets the legal right to sell the pledged securities if the borrower defaults. Unlike a mortgage, ownership remains with the pledgor unless there is a default.

3. What are advances secured by collateral securities?

Collateral securities are additional assets pledged by a borrower, apart from the primary security, to secure a bank loan. These can be shares, debentures, fixed deposits, or property documents. If the primary security is insufficient or fails, the bank can enforce the collateral to recover dues. Banks assess the value and liquidity of the collateral before granting such loans, and appropriate margin requirements are maintained.

4. What are advances against goods?

Banks provide loans against the security of goods, such as agricultural produce, commodities, or manufactured items. The goods may be in the borrower’s or the bank’s possession (under pledge or hypothecation). Proper documentation, insurance, and warehousing arrangements are necessary. Such loans are common in trading and manufacturing sectors to finance working capital needs.

5. How do banks give advances against life insurance policies?

Banks allow loans against life insurance policies with a surrender value. The policy must be assigned in the bank’s favour, and premiums should be regularly paid. The sum assured acts as the security. This is considered a safe loan, especially when the policy is from a reputed insurer like LIC. However, policies like term plans, which have no surrender value, are not eligible.

6. What are documents of title to goods, and how do banks use them?

Documents of title to goods (like bill of lading, warehouse receipt, railway receipt) represent ownership of goods. Banks may grant advances against such documents, treating them as security. By taking possession of these documents, the bank can legally claim the goods in case of default. This form of security is common in export-import and commodity trading finance.

7. What is compromise settlement in loan recovery?

A compromise settlement is a negotiated agreement between a bank and a borrower to settle the loan by accepting a lesser amount than originally due. It is used when recovery through legal means is difficult or expensive. The bank waives part of the dues and recovers the rest in one or more instalments. Such settlements help banks clean up bad loans while offering borrowers a second chance.

8. What is legal action in loan recovery?

When a borrower defaults and informal recovery methods fail, banks initiate legal action. This involves filing a suit in civil court or a Debt Recovery Tribunal (DRT) to recover the dues. The court may issue a decree for repayment and allow seizure and sale of the borrower’s assets. Legal recovery ensures enforceability but is time-consuming and costly.

9. What is the role of Debt Recovery Tribunals (DRTs)?

DRTs were established under the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 to expedite loan recovery over ₹20 lakh. Banks file applications in DRTs to recover dues. DRTs have powers like a civil court and can order attachment, sale of assets, and recovery through recovery officers. Appeals against DRT decisions lie with DRAT (Debt Recovery Appellate Tribunal).

10. What is SARFAESI Act, 2002?

The SARFAESI Act (Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act) empowers banks to recover non-performing assets (NPAs) without court intervention. Banks can take possession of collateral, sell it, and recover dues. The Act applies to secured loans and covers enforcement through notices, auctions, and Asset Reconstruction Companies (ARCs). It is a powerful tool to reduce bad debts.

11. How does SARFAESI help in faster recovery of loans?

Under SARFAESI, banks can issue a 60-day notice to defaulting borrowers. If dues are not cleared, banks can:

  • Take possession of secured assets
  • Sell the assets via auction
  • Appoint a receiver to manage the business
    Since no court order is needed (except in case of objections), it ensures faster resolution and improves asset quality in the banking system.

12. What is appropriation of payments by a banker?

Appropriation of payments refers to the banker’s right to apply received payments towards any outstanding dues when the borrower owes multiple debts. If the borrower specifies which loan the payment should be adjusted against, the bank must follow. If the borrower is silent, the banker can apply the payment at its discretion. It becomes relevant when part payments are made or when different types of loans are involved.

13. What is Clayton’s Rule in banking?

Clayton’s Rule is a common law principle that says the first debit in a running account is discharged by the first credit. It applies in cases of appropriation of payments, particularly in overdraft accounts. This rule is helpful in determining liability where there is a continuous flow of deposits and withdrawals. Courts use this rule to decide which debts are discharged when there is no express direction from the debtor.

14. What is a bank guarantee?

A bank guarantee is a promise by a bank to pay a specified amount to a beneficiary if the applicant (customer) fails to fulfill a contractual obligation. It is a form of contingent liability. Common types include performance guarantees, financial guarantees, and bid bonds. The bank conducts due diligence before issuing such guarantees, which are widely used in infrastructure, trade, and government contracts.

15. How does a bank act as a guarantor?

A bank acts as a guarantor by assuring the performance or payment of its customer to a third party. If the customer defaults, the bank pays on their behalf. The bank evaluates the financial health of the customer before issuing the guarantee and may take margin money or security. Guarantees are usually time-bound and subject to legal and regulatory guidelines.

16. What is a letter of credit (LC)?

A letter of credit is a written undertaking by a bank on behalf of a buyer to pay a seller a specified amount, provided certain conditions (usually involving presentation of shipping documents) are met. LCs are widely used in international trade to ensure trust and guarantee of payment. It reduces risk for exporters and ensures compliance with trade terms.

17. What are the different types of Letters of Credit?

Common types of LCs include:

  • Revocable and Irrevocable LC: Irrevocable LCs cannot be altered without parties’ consent.
  • Confirmed LC: Another bank guarantees payment.
  • Sight LC: Payment made immediately on document presentation.
  • Usance LC: Payment made after a credit period.
  • Back-to-Back LC: Issued against the primary LC to intermediate suppliers.
  • Standby LC: Acts like a guarantee if payment/default occurs.

18. What is the difference between LC and bank guarantee?

  • Letter of Credit: A primary obligation where the bank pays when conditions are met.
  • Bank Guarantee: A secondary obligation, where the bank pays only if the customer fails to perform.
    LCs are used for trade transactions, while bank guarantees are used for contracts and tenders. LCs ensure performance; guarantees cover failures.

19. What is hypothecation in bank advances?

Hypothecation is a charge created on movable assets where the borrower retains possession, but the bank has rights over the asset. Commonly used for loans against vehicles, inventory, or equipment. In case of default, the bank can take possession of the hypothecated goods. It is different from a pledge, where the bank takes possession of the asset at the time of sanction.

20. What are the risk factors in loans and advances?

Banks face risks like:

  • Credit Risk: Non-repayment by the borrower
  • Collateral Risk: Fall in the value of securities
  • Documentation Risk: Incomplete legal documentation
  • Operational Risk: Errors in sanction or disbursement

    To manage these, banks follow due diligence, credit appraisal, and risk assessment procedures. Regular monitoring and audits ensure early detection and resolution of bad loans.

21. What is the difference between secured and unsecured loans?

Secured loans are backed by collateral, such as property, vehicles, or gold. If the borrower defaults, the bank can seize and sell the asset to recover the loan. Unsecured loans, like personal loans or credit cards, are not backed by collateral. These rely solely on the borrower’s creditworthiness and income. Because of the higher risk, unsecured loans usually have higher interest rates. Banks use credit scores, repayment history, and income documents to evaluate eligibility for unsecured loans.

22. What is margin money in bank advances?

Margin money is the borrower’s contribution toward the total value of the asset or security. It represents the difference between the loan amount and the asset’s value. For example, if a borrower wants to buy machinery worth ₹10 lakh and the bank gives 80% financing, the remaining 20% (₹2 lakh) is margin money. It ensures that the borrower has a stake in the transaction and reduces the bank’s risk exposure.

23. What is an equitable mortgage in banking?

An equitable mortgage is created when a borrower deposits title deeds (property ownership documents) with the bank to secure a loan, without executing a formal mortgage deed. It is also called a mortgage by deposit of title deeds. This method is faster and involves fewer legal formalities. The borrower retains possession of the property but cannot sell it without repaying the loan. In case of default, the bank can approach a court or invoke SARFAESI for recovery.

24. How do banks assess creditworthiness of borrowers?

Banks evaluate creditworthiness based on several factors:

  • Credit score (CIBIL or other bureaus)
  • Income and employment stability
  • Existing loan obligations
  • Repayment history
  • Collateral value
    Banks also review bank statements, income tax returns, and business performance (for business loans). A borrower with strong financials and clean credit history is more likely to get favorable loan terms and higher limits.

25. What is restructuring of bank loans?

Loan restructuring refers to modifying the terms of a loan to help a borrower facing financial difficulty. This may include:

  • Extending repayment period
  • Reducing interest rates
  • Granting moratorium on payments
  • Converting unpaid interest into term loans
    Restructuring helps avoid classifying the loan as a Non-Performing Asset (NPA) and gives the borrower time to recover. However, it is done only after thorough assessment and RBI guidelines must be followed.

26. What are Non-Performing Assets (NPAs)?

An NPA is a loan where the borrower fails to pay principal or interest for 90 days or more. NPAs reduce the bank’s profitability and liquidity. They are classified as:

  • Substandard Assets: Up to 12 months overdue
  • Doubtful Assets: Over 12 months overdue
  • Loss Assets: Identified as non-recoverable
    Banks must provision for NPAs, which affects their balance sheets. Tools like DRT and SARFAESI are used for recovery.

27. What is the importance of documentation in loans and advances?

Proper loan documentation is essential to establish the bank’s legal right to recover dues. Important documents include:

  • Loan agreement
  • Sanction letter
  • Hypothecation or mortgage deed
  • Guarantee documents
  • Security receipts
  • Incomplete or incorrect documentation can weaken the bank’s legal position and delay recovery. Documentation ensures enforceability, transparency, and compliance with regulatory norms.

28. How are Letters of Credit settled?

A Letter of Credit (LC) is settled when the beneficiary (seller) submits the required shipping and commercial documents as per LC terms. The bank verifies the documents and, if they comply, makes the payment or accepts the bill of exchange. The buyer reimburses the issuing bank. Settlement can be:

  • At sight (immediate payment)
  • Usance basis (payment after a credit period)
    Banks must act within the LC framework and cannot modify terms unilaterally.

29. What is a revolving Letter of Credit?

A revolving Letter of Credit allows multiple drawings up to a specified limit without issuing a new LC for each transaction. It can be:

  • Time-based: Renewed periodically
  • Value-based: Renewed when a specified amount is drawn
    Revolving LCs are useful in long-term supply contracts involving frequent shipments. They reduce paperwork and ensure continuous supply chain financing.

30. What are standby Letters of Credit (SBLC)?

A Standby Letter of Credit (SBLC) is a guarantee issued by a bank promising payment if the applicant defaults on contractual obligations. It is used in international trade, construction contracts, or loan guarantees. Unlike regular LCs, SBLCs are not intended for payment but act as a safety net. The beneficiary must present proof of default to claim the payment. SBLCs enhance the creditworthiness of the applicant and are governed by UCP 600 or ISP 98 rules.