MODULE 1
Nature of Banking and Functions of a Banker
Bank
• Banks are a medium through which economic and fiscal policies of the
government are materialized.
• Under Indian law, Banking Regulation Act of India, 1949, “Accepting, for
the purpose of lending or investment, of deposits of money from the
public, repayable on demand or otherwise and withdrawal by cheque,
draft and order or otherwise” (Section 5b).
• The Reserve Bank of India Act, 1934 and the Banking Regulation Act,
1949, governs the banking operations in India
Commercial Banks
• A commercial bank is a profit-seeking financial institution that grants
loans, accepts deposits, and offers basic financial products like savings
accounts and certificates of deposit to individuals and businesses.
• It makes money primarily by providing different types of loans to
customers and charging interest.
Characteristics of Commercial Bank
• Commercial establishment: which deals in debt and money.
• Accepts deposits: fixed, current, saving, recurring deposit.
• Repayment of Accepted Deposits
• Withdrawable by cheques, drafts or otherwise.
• Advancing loans to the public
• Earning profits
Functions of Commercial Banks
Agency Services
• Collection and Payment of Credit Instruments
• Purchase and Sale of Securities
• Collection of Dividends on Shares
• Acts as Correspondent
• Income-tax Consultancy
• Execution of Standing Orders
• Acts as Trustee and Executor
General Utility Services
• Locker Facility
• Traveler's Cheques and Credit Cards
• Letter of Credit
• Collection of Statistics
• Gift Cheques
• Merchant Banking
Creation of credit by banks
• Primary Deposits Primary deposits arise or formed when cash or
cheque is deposited by customers.
• Derivative Deposits Bank deposits also arise when a loan is granted
or when a bank discounts a bill.
• Every loan creates a deposit
• “deposits are the children of loans, and credit is the creation of bank
clerk’s pen.”
Sources of Bank’s Income:
1. Interest on Loans
2. Interest on Investments
3. Discounts
4. Commission, Brokerage, etc
5. others
Employment / Uses of Funds by Banks
• channelized into earning asset
• Asset Management:-allocation of funds into loans and investments
Cash in hand, cash at bank
Investment, loans,
Bank’s earnings assets, vault cash deposits at central bank,
Cash items in process of collecting,
Fixed assets and other current assets.
Earning assets of bank
• Money at call and short notice
• Investment in Government and Semi-Government securities
• Short and medium term loans
• Discounting of bills
Theory of liquidity and profitability
liquidity : Two interpretations
1. bank to honour the claims of the depositors.
2. Ability of the bank to convert its non-cash assets into cash easily and without loss of money and
time
Profitability:
• commercial bank by definition, is a profit hunting institution
• Why ? pay salaries to the staff, interest to the depositors, dividend to the shareholders, meet the
day-to-day expenditure
• cash is the least profitable asset
• profit yielding assets ? money at call and short notice, bills discounted, investments, loans and
advances
• Loans and advances, though the least liquid asset, constitute the most profitable asset to the bank
THEORIES OF LIQUIDITY AND
PROFITABILITY:
• Anticipated Income Theory
• Shiftability Theory
• Liability Management Theory
• Commercial Loan Theory
RIGHTS OF BANKER
1. Right of general lien
2. Right of set-off
3. Right to appropriate payments
4. Right to charge interest
5. Right not to produce books of accounts
6. Right under Garnishi order – order-Nisi and Order-Absolute
7. Right to close accounts
OBLIGATIONS OF BANKERS
1. Obligation to honour the customer’s cheques.
2. Obligation to maintain secrecy of customer’s account.
3. Obligation to receive the cheques and other instruments for
collection.
4. Obligation to honour the cheques of customers across the counter.
5. Obligation to give reasonable notice before closing the customer’s
accounts
Garnishee Order
• issued by a competent court of law addressed to a banker instructing
him to stop or withhold payment of money belonging to a particular
person who has committed a default in satisfying the claim of his
creditors
• Order-Nisi
• Order-Absolute
Know your Customer (KYC)
• customer identification -determine true identity and ownership of accounts,
source of funds, the nature of customer’s business, fairness of operations
• KYC has two components - Identity and Address
The framework of KYC norms mainly incorporates the following four key
elements:
• Customer Acceptance Policy;
• Customer Identification Procedures;
• Monitoring of Transactions; and
• Risk Management.
Law of limitations
• Limitation period for recovery of Debt in India is governed by the
Limitation Act, 1963.
• The Limitation Act, 1963 specifies certain prescribed period within which
any suit appeal or application can be made. A banker is allowed to take
legal action by filing a suit, prefer an appeal and apply for recovery only
when the documents are within the period of limitation.
• If the documents are expired or are time barred, the banker cannot take
any legal course of action to recover the dues. Banks should be careful to
ensure that all legal loan documents held are valid and not time barred.
Banks should ensure that all loan documents are properly executed and
they are within the required limitation period as per the limitation act.
Period of limitation for certain documents
NATURE OF DOCUMENTS LIMITATION PERIOD
A Demand Promissory Note Three years from the date of DP Note.
A Bill of exchange payable at sight or upon presentation Three years when the bill is presented
An Usance Bill of exchange Three years from the due date
Money payable for money lent Three years from the loan was made.
A guarantee Three years from the date of invocation of the guarantee
A mortgage - enforcement of payment of money Twelve years from the date the money sued becomes due
A mortgage - possession of Immovable property Thirty years when the mortgagee becomes entitled to
possession
Limitation Period – Precautions to be
taken by bank:
1. Banks should preserve all the relevant loan documents in a secured
place
2. The documents should be under dual control of authorized persons
3. Banks should not allow any document to become time barred as
per the provisions of Law of Limitation.
4. Banks internal control and monitoring system should be very
effective in the sense that the renewal of documents should be
done well in advance
References
• Neelam C. Gulati, Principles of Banking Management, Excel Books
• https://www.rbi.org.in/
