BANKING LAW

MODULE:3

Principles of Lending
Lending is a core function of banks and financial institutions, crucial for
economic growth and development. The principles of lending guide banks in
making sound lending decisions to ensure the safety of funds and maximize
returns. Here are the key principles of lending:

 Safety: The primary principle of lending is safety, ensuring that the funds
lent are secure and the likelihood of repayment is high. Banks assess the
creditworthiness of borrowers based on their financial stability, credit
history, and ability to repay the loan.
 Liquidity: Banks must ensure that they maintain sufficient liquidity to
meet depositors' demands for withdrawals. While lending, banks need to
consider the maturity profile of their assets and liabilities to maintain
liquidity.
 Profitability: Lending should be profitable for banks, generating interest
income that exceeds the cost of funds and operational expenses. Banks
assess the risk-return trade-off of lending to ensure profitability.
 Diversification: Banks should diversify their loan portfolio to minimize
risk. Diversification involves lending to a variety of sectors, industries,
and types of borrowers to reduce the impact of defaults in any single
segment.
 Prudence: Lending decisions should be made prudently, considering
factors such as the purpose of the loan, the borrower's repayment
capacity, and the economic environment. Banks should avoid excessive
risk-taking in lending practices.
 Compliance: Banks must comply with regulatory requirements and
lending guidelines issued by regulatory authorities. Compliance ensures
that lending practices are transparent, fair, and in line with regulatory
standards.
  Relationship Banking: Establishing long-term relationships with
borrowers is essential for effective lending. Relationship banking
involves understanding the borrower's needs, providing personalized
services, and maintaining communication to ensure timely repayments.
 Documentation: Proper documentation is essential for lending
transactions. Banks should maintain accurate records of loan agreements,
collateral documents, and borrower information to enforce legal rights in
case of default.
 Monitoring and Control: Banks should continuously monitor the
performance of loans and implement effective control measures to
identify and mitigate risks. Monitoring includes assessing changes in the
borrower's financial condition and taking timely action to address
potential issues.
 Recovery: In cases of default, banks should have a robust recovery
mechanism in place to recover outstanding loans. Recovery involves legal
action, asset seizure, or restructuring of loans to minimize losses.

What is Priority Sector Lending?

Priority sector lending (PSL) is lending to those sectors of the economy which
may not otherwise receive timely and adequate credit. This role is assigned by
the RBI to the banks for providing a specified portion of the bank lending to a
few specific sectors. This is essentially meant for an all-round development of
the economy as opposed to focusing only on the financial sector.

Categories of Priority Sectors

The Reserve Bank of India (RBI) has classified the following eight categories of
priority sectors in India:
 Agriculture
 Micro, Small and Medium Enterprises (MSMEs)
 Export Credit
 Education
 Housing
  Social Infrastructure
 Renewable Energy
 Others

Activities Covered Under Priority Sector Lending in India

The activities covered under priority sector lending typically include:

 Agriculture: Loans provided for farming activities, including crop

cultivation, animal husbandry, fisheries, and other allied agricultural
activities.
 Micro, Small, and Medium Enterprises (MSMEs): Credit extended to
micro, small, and medium enterprises. It includes loans for starting new
businesses, working capital requirements, and expansion purposes.
 Education: Loans granted for education-related expenses, including
tuition fees, purchase of books, payment for educational courses, and
other educational purposes.
 Housing: Lending for housing finance, including loans for the purchase,
construction, or renovation of residential properties.
 Export Credit: Financing provided to exporters to facilitate international
trade. It includes pre-shipment and post-shipment credit, export working
capital, and other export-related financial services.
 Renewable Energy: Loans extended for renewable energy projects such
as solar power, wind power, biomass, and other clean energy initiatives.
 Healthcare: Credit support for healthcare infrastructure development,
including funding for hospitals, clinics, medical equipment, and
healthcare services.
 Social Infrastructure: Financing for social infrastructure projects such
as schools, colleges, vocational training centers, and other community
development initiatives.
 Loans to Weaker Sections: Special focus on providing credit to
marginalized and economically weaker sections of society. It includes
Scheduled Castes, Scheduled Tribes, and Other Backward Classes.
Weaker Sections under the Priority Sector
Priority sector loans to the following borrowers are treated under the Weaker
Sections category

 Small and Marginal Farmers.

 Artisans, village and cottage industries where individual credit limits do
not exceed Rs 1 lakh.
 Beneficiaries under Government Sponsored Schemes such as the National
Rural Livelihoods Mission (NRLM), National Urban Livelihood Mission
(NULM) and Self Employment Scheme for Rehabilitation of Manual
Scavengers (SRMS)
 Scheduled Castes and Scheduled Tribes.
 Beneficiaries of the Differential Rate of Interest (DRI) scheme.
 Self-Help Groups.
 Distressed farmers are indebted to non-institutional lenders.
 Distressed persons other than farmers, with loan amounts not exceeding
Rs 1 lakh per borrower to prepay their debt to non-institutional lenders.
 Individual women beneficiaries up to Rs 1 lakh per borrower.
 Persons with disabilities.
 Minority communities may be notified by the Government of India from
time to time
 Overdraft availed by PMJDY account holders as per limits and conditions
prescribed by the Department of Financial Services, Ministry of Finance
from time to time may be classified under Weaker Sections.
 In States, where one of the minority communities notified is found to be
in majority, the above covers only the other notified minorities.
 These States and Union Territories are Punjab, Meghalaya, Mizoram,
Nagaland, Lakshadweep and Jammu & Kashmir.

NATURE OF SECURITIES AND RISKS INVOLVED

In banking law, the term “securities” refers to financial instruments that can be
bought, sold, or traded in financial markets. These instruments represent
ownership interests, debt obligations, or other rights and are often used as
collateral for loans and other financial transactions. Securities can take various
forms, such as stocks, bonds, derivatives, and other financial instruments.
Securities play a significant role in the banking and financial industry, and
banking law regulates various aspects of their issuance, trading, and use as
collateral.

Securities
In banking law, “securities” in the context of a secured loan typically refer to
financial assets that are pledged as collateral to secure the loan. These securities
provide the lender with a form of assurance that, in the event the borrower
defaults on the loan, the lender can take possession of the pledged securities and
sell them to recover the outstanding loan amount.

ATTRIBUTES OF GOOD SECURITY ARE AS FOLLOWS:

Title of the security:

Clear and well-documented ownership is a requirement for good security. A

borrower should have a clear title to the security, and the title should be
undisputed. The borrower should prove with evidence that he has complete
ownership of the security and that he is authorised to use it as security.

Non-encumbrance:

The security should be free from liabilities or encumbrance. There shouldn’t be

any disputes, liens, or third-party claims involving the collateral. To prevent
difficulties during enforcement, the collateral must have a clear legal title.

Marketability:

The collateral should be marketable and easily convertible into cash through a
sale. Marketable collateral ensures that the lender can quickly recover the
outstanding loan amount by selling the collateral in the event of default.
Value:

It is considered to be good security if the cost of the security can be easily

ascertained. Good security should have sufficient value to cover the loan
amount and potential interest in case of default.

 Stability of value:
o Collateral with stable value is preferable. The security should not be
liable to wide price fluctuation. The value of security needs to be
reasonably constant. Bankers must also ensure that the security’s value
does not fluctuate drastically over a short period. While market swings
can affect the value of any asset, less variable collateral offers the lender
greater predictability.

 Storability:
 The security should be easy to store. Security should be such that they
satisfy the requirement of easy storage and do not require special storage
facilities. Goods should not be risky to store, such as inflammable
articles. Goods which require a special storage facility are not preferable
as it infers additional expenses to the banker.

 Transferability:
 The transfer of security should be simple and unrestricted. It is preferable
to have collateral that can be quickly transferred into the lender’s
ownership in the event of default. This characteristic enables the lender to
realise the value of the collateral without facing any legal issues.

 Durability:
 Security should be reasonably durable. Vegetables, fruits, and other
perishable commodities that require extra efforts to keep in the same
condition are also not preferred and are not good security. The goods
which are durable like metal, jewellery is preferred.
Transportable:

Transporting security should be easy and simple. Security should be able to be

shifted from one location to another with no difficulty. Securities which are
easily transportable at less cost are preferable over those that are difficult and
expensive to transport. They can be shifted from one market to another for easy
disposal.

 Convertible Assets:
 Assets that can be easily converted to cash, such as marketable securities,
are preferred as collateral due to their liquidity.

 Maintainability:
 Collateral that is relatively easy to maintain, such as real estate or
financial assets, is preferable. Maintaining the collateral ensures that its
value is preserved until the loan is repaid.

Kinds of securities

1.Land/Real Estate

Real property such as land, homes, commercial buildings, or other real estate
assets can serve as collateral for secured loans. Mortgages are a common
example of secured loans where the property being financed serves as collateral.
In the past, banks were very hesitant to accept land and buildings as security;
but, over time, this prejudice has changed, and land and buildings as security
have become an accepted collateral in most advances. It is currently a standard
form of security that banks accept. The advantages and disadvantages of this
form of security cannot be universally applied to all lands and it depends on the
nature of the land offered.

Advantages:
  The value of land increases over a period of time.
 Under the SARFAESI Act of 2002, the mortgaged property may be
securitized without court intervention

Disadvantages:

 Difficulty in valuation: Real estate valuation can be challenging at times

because it depends on a number of variables, including location, property
condition, size, and more.
 Ascertaining the title of the owner is time-consuming: The borrower must
be the owner of the property being mortgaged in order for the banker to
obtain a legal title. In India, where the law of inheritance is governed by
the personal laws of different religions, determining whether the borrower
has a legitimate title or not takes time.
 Not readily realisable: Due to the absence of a ready market, the land is
not easily and speedily realisable. It can take months to sell, and if the
market is unfavourable, it might sell for less money than was planned.
 Creating a charge is costly: The security may be pledged as collateral
either through a legal mortgage or through an equitable mortgage. Since a
legal mortgage’s remedies prevail over an equitable mortgage’s, the
former is preferable. However, there are costs associated with completing
a legal mortgage, such as stamp duty, as well as several formalities which
make it a costly affair.

2.Stocks and Shares :

These can be divided into equity shares and preference shares. Preference
shares are those which enjoy preference both with regard to the payment of
dividends and the repayment of capital on the other hand equity shares that are
not preference shares.

Advantages

 Ascertaining the value of stocks and shares is easy.

 Stocks and shares typically have stable values and are not prone to
significant fluctuations.
  The formalities for using stocks and shares as collateral are quite
minimal.
 Ascertaining the title of a share is easier compared to that of real estate.
 Creating a charge of this is less expensive than real estate. Compared to
real estate, the cost of creating a charge is less.
 They generate money in the form of dividends that can be applied to the
loan account.
 They are more trustworthy as they are tangible securities.
 Such securities are released with relatively little expenditure and
formality.

Disadvantages:-

 They must be appropriately guarded because they are easy to realise and
thus prone to fraud.
 Partly paid shares have the following demerits:
 The calls may need to be paid by the banker.
 Prices for partially paid shares change drastically.
 Due to the limited market for such shares, they are not readily realisable.

3.Debentures

Debentures are a type of long-term debt instrument issued by corporations,

governments, and other entities to raise capital. They are essentially loans taken
out by these entities from investors, who purchase the debentures with the
understanding that they will receive interest payments and the principal amount
back at maturity.

Advantages

 Selling of debenture is easy.

 Price of the debentures is not subject to violent fluctuations.
 Cost of transfer is very less.
 Bearer debentures are completely negotiable.
 They are given priority over shares and are often backed by a charge
against the company’s assets.
 Disadvantages

 The debentures’ marketability and pricing would be affected if interest

wasn’t paid on a regular basis.
 If a charge against a company’s property is not registered, the subsequent
charges will take precedence.
 Companies that lack the ability to borrow money may issue debentures.

4.Goods :

Using goods as security for a loan involves pledging tangible assets owned by a
borrower as collateral to secure the loan. Goods can include physical products,
inventory, equipment, and other movable assets that have value.

Advantages

 Unlike other forms of security, goods can be quickly traded since there is
a ready market for them.
 It is simple to determine the value of goods.
 Since advances on products are typically granted for short periods of
time, the banker’s risk is significantly minimised.
 Creating a charge against the security is generally less expensive and
requires fewer formalities, with the exception of a few states where the
stamp fee is high.
 When a banker does business with reputable and established clients, they
obtain a good title to the items.

Disadvantages

 The value of the banker’s security may be diminished over time as a

result of certain items’ propensity to expire or deteriorate in quality.
 There could be a chance that the borrower will commit fraud or act
dishonestly.
 The value of certain collateral, especially electronic consumer goods, can
change significantly, making their valuation challenging. Even for
essential items with multiple variations, unless the banker is an expert,
 valuation can be misleading. Selling large quantities quickly might be
tough and might not yield the anticipated price.
 It might be difficult for the banker to store the goods.
 Transporting goods from one place to another is costly and time-
consuming.
 In cases where goods are stored in a warehouse, the warehouse keeper
holds a lien on the goods for any outstanding charges. Consequently, the
banker needs to regularly confirm that all fees are appropriately settled.

5.Life Policies

Using life insurance policies as security for a loan involves pledging the
policy’s cash value or death benefit to secure a loan. The policy serves as
tangible security and is held by the bank. If the borrower defaults on payment,
the security can be promptly converted into cash by surrendering the policy to
the insurance company.

Advantages

 Realisation of policy is easy.

 There are very few formalities involved in assigning the policy in the
banker’s benefit, and the banker is given a perfect title.
 The surrender value increases with the length of time the policy have
been in effect.
 If the borrower doesn’t make their payments as agreed, the security can
be realised right away by surrendering the policy to the insurance
provider.
 The policy acts as concrete collateral and is under the control of the bank.
The banker’s responsibility primarily involves ensuring the consistent
payment of premiums.

Disadvantages

 If the premium is not paid regularly, the policy lapses, and reviving the
policy is complicated.
 All the requirements of valid assignment should be fulfilled without
which the banker cannot acquire complete benefit of the policy. If the
policy contains any clause against the assignment need to be taken into
notice.
  The policy deposited should be a valid insurance contract and should
have fulfilled all the requirements of a valid insurance contract. Failing to
fulfil any of the requirements of the insurance will render the policy void.
 The policy may contain special clauses, which may restrict the liability of
the insurer.
 Special precautions need to be taken while accepting policy under
Married Women Property Act.
 Banker should always make sure that the policy deposited is original and
there are no encumbrances on the policy.

6.Fixed Deposit

A Fixed Deposit (FD), also known as a Term Deposit or Time Deposit, is a

financial arrangement where an individual deposits a specific sum of money
with a bank or financial institution for a predetermined period at a fixed interest
rate. A person receives the initial deposit amount plus any accumulated interest
at the maturity date.

Banks commonly allow depositors to use their deposits as collateral for

borrowing. This collateral is highly valuable, as the deposited funds are already
held by the bank. This eliminates concerns related to assessing value, verifying
ownership, or managing storage and associated expenses.

Debt recovery
 Debt recovery’ according to the Black Law Dictionary refers to legal
procedures and approaches used to reclaim money loaned to someone
else. In simpler terms, it involves legitimate methods to retrieve extended
funds, with or without interest.

 Initially, India’s insolvency laws were limited to the Presidency Towns

Insolvency Acts of 1909 (applicable to Kolkata, Chennai, and Mumbai)
and the Provincial Insolvency Act of 1920 (covering the rest of India).
These Acts primarily focused on individual insolvency and didn’t include
corporations.
 Recognizing the need for comprehensive insolvency and bankruptcy
laws, the legislature made several attempts to address debt recovery
challenges. Critical legislations include the Securitization and
Reconstruction of Financial Assets and Enforcement of Security Interest
Act, 2002 (SARFAESI), the Recovery of Debt Due to Banks and
Financial Institutions Act, 1993 (DRT Act), and the Sick Industrial
Companies Act, 1985. These laws aimed to provide a framework for
resolving insolvency and debt recovery effectively.

 In India, the issue of non-performing assets and debt recovery has been a
significant concern for banks, financial institutions, and corporate debtors
alike. To address this challenge, the country has established a robust legal
framework for debt recovery, aiming to ensure the efficient and
expeditious adjudication of debt recovery matters.

 When a borrower defaults on loan payments, banks and financial

institutions initiate the debt recovery process. The first step typically
involves sending a legal notice to the debtor, informing them of the
outstanding debts and demanding repayment. Many loan agreements
include an arbitration clause, allowing disputes to be resolved through
alternative dispute resolution services rather than lengthy court
proceedings.

 In cases of dishonest misappropriation or misappropriation of property,

the banks or financial institutions can take legal action and file recovery
proceedings against the defaulters. The legal process for recovery of
loans involves approaching the appropriate legal forum, such as the Debt
Recovery Tribunal (DRT) or the Debts Recovery Appellate Tribunal
(DRAT), depending on the amount and nature of the debt.

 Secured creditors, who have collateral properties or immovable property

as security, may have a faster recovery process compared to unsecured
creditors, who lack such security. The Recovery of Debts Due to Banks
and Financial Institutions Act, along with the Insolvency and Bankruptcy
 Code, provides a legal framework for the recovery of money from
defaulters, including corporate debtors and individuals.

 The Debt Recovery Tribunals and Debt Recovery Appellate Tribunals

play a crucial role in handling debt recovery matters. A financial creditor,
such as a bank or financial institution, may initiate proceedings by
submitting a recovery application to the relevant Debt Recovery Tribunal.
The Tribunal then examines the case and can pass a judgment for debt
recovery in favor of the creditor.

Methods of Debt Recovery in India

Negotiated Settlement
Creditors can directly negotiate with the debtor to reach a settlement wherein
the debtor agrees to repay the outstanding debt either in a lump sum or through
installments.

Legal Notice
Creditors can send a legal notice to the debtor, demanding repayment of the debt
within a specified period. The notice serves as a formal communication, putting
the debtor on notice of the creditor’s intention to initiate legal proceedings if the
debt remains unpaid.

Civil Suit
Creditors can file a civil suit in the appropriate court to recover the debt. This
involves initiating a formal legal process, presenting evidence, and seeking a
judgment from the court to enforce the repayment of the debt. In civil remedy,
the aggrieved party can initiate a civil suit by sending a legal notice to the
debtor. The notice serves as a formal communication demanding payment of
debts due or seeking compensation for damages caused. If the debtor fails to
comply with the notice, the aggrieved party can proceed with filing a civil
lawsuit in the appropriate court. The court will then adjudicate the matter,
considering the evidence and legal arguments presented by both parties and
make a decision regarding debt recovery or compensation.

Summary Suit
For smaller debts not exceeding a certain threshold, creditors can opt for a
summary suit under Order 37 of the Civil Procedure Code (CPC). This
expedites the legal process by providing a shorter timeframe for the debtor to
respond, and if the debtor fails to appear, the court can presume the creditor’s
claims as valid and proceed with judgment.

Debt Recovery Tribunals (DRTs)

DRTs are specialized forums established under the Recovery of Debts Due to
Banks and Financial Institutions Act, 1993. They handle cases related to the
recovery of debts from borrowers and provide a quicker resolution compared to
civil courts.

SARFAESI Act
Securitization and Reconstruction of Financial Assets and Enforcement of
Security Interest (SARFAESI) Act enables banks and financial institutions to
take possession and sell the secured assets of defaulting borrowers without the
intervention of a court, subject to certain conditions.

Insolvency and Bankruptcy Code (IBC)

In cases where the debtor is unable to repay the debt, creditors can initiate
insolvency proceedings under the IBC. This allows for the resolution and
recovery of debts through the corporate insolvency resolution process or
liquidation, depending on the circumstances.

Recovery of debts under the DRT Act and SARFAESI Act as it

provides for the banks and Financial Institutions to proceed
without the intervention of courts.
 1. RDDBFI Act, 1993 (“Recover of Debts due to Banks and Financial
Institutions”)
Prior to ratification of the RDDBFI Act, banks and FI’s faced significant
difficulties in recovering debts from borrowers because the courts were
overburdened with a large number of regular cases, preventing the courts from
giving priority to bank and financial institution recovery matters.

“The Government of India formed a committee headed by Mr T. Tiwari in 1981,

and this committee proposed a quasi-judicial setup exclusively for banks and
financial institutions, which, by using a summary procedure, can quickly
dispose-off recovery cases filed by banks and financial institutions against
borrowers. In 1991, a committee chaired by Mr.Narasimham backed the Mr T.
Tiwari Committee's findings and proposed the formation of quasi-judicial debt
collection agencies to expedite debt recovery. As a result, the Government of
India adopted the RDDBFI Act. Through the enactment of RDDBFI Act, quasi-
judicial bodies, i.e., the DRT (Debt Recovery Tribunal) and DRAT (Debt
Recovery Appellate Tribunal) were established, and a system for debt collection
was established.

The first DRT was established in Calcutta on 27th April 1994.”[i]Presently there
are 39 DRT’s and 5 DRAT in India.

Constitutionality of Act
The Act's constitutionality was contested in the case of “Union of India &Anr.
vs. Delhi High Court Bar Association &Ors.”[ii] The Act's constitutionality was
challenged on the grounds that it was irrational, violated Article 14 of the
Constitution, and exceeded the legislative competence of Parliament.

The Supreme Court ruled that “while Articles 323A and 323B specifically
enable the legislature to enact laws for the establishment of tribunals, the power
of the parliament to enact a law constituting a tribunal such as a banking
tribunal is not taken away in relation to the matter specified therein.” It was
observed that, in exercising its legislative competence, the parliament can offer
a mechanism for recovering payments owed to banks and financial institutions,
therefore upholding the Act's legitimacy.

Pecuniary Jurisdiction
For any debts worth more thansum of Rs. 20 Lakhs, an application for the
recovery of debt can be made to thetribunal. Banks and FI’s can use the
standard remedy and approach Civil Courts, for smaller sums.

Jurisdiction of Tribunal
Section 17 of the RDDBFI Act gives the tribunal jurisdiction, power, and
authority to entertain and decide applications from secured creditors for
recovery of debts owed to such secured creditors. The DRT and DRAT's
jurisdictional powers and authority are structured in such a way that civil courts
do not directly intervene on the principal issue on which DRTs must rule.
Furthermore, section 17A gives DRAT overall superintendence and control, as
well as appellate jurisdiction over DRT.

Section 18 of the Act prohibits all other Courts from hearing debt related
matters, with the exception of the Supreme Court and High Court, whose power
is derived from Articles 226 and 227 of the Indian Constitution. The basic line is
that only the High Court and the Supreme Court may grant redress against a
DRAT verdict.

While the DRT procedure was intended to relieve the burden on lower courts,
the lower courts do play a part in the DRT process since the judicial powers
placed on the DRT and DRAT under the RDDBFI Act are extremely limited. In
the case of “Standard Chartered Bank vs. DharmindarBhoi and others”[iii], the
Supreme Court emphasised in its decision that the DRT and DRAT can only
adjudicate on topics within their scope as established in section 17 of this Act.
For example, DRTs and DRATs do not have authority over property succession
rights, monitoring and enforcing KYC rules, or issuing receipts.Thus, disputes
on such topics necessitate decisions from civil courts, which have greater
authority than DRTs and DRATs.

Application to Tribunal
Under section 19, “the bank or financial institution for the recovery of any debt
can file an application to the tribunal within the local limits of whose
jurisdiction:

a) The branch or any other office of the bank or financial institution is

maintaining an account in which debt claimed is outstanding, for the time
being; or
b) The defendant, or each of the defendants where there are more than one,
at the time of making the application, actually and voluntarily resides, or
carries on business, or personally works for gain; or
c) Any of the defendants, where there are more than one, at the time of
making the application, actually and voluntarily resides, or carries on
business, or personally works for gain; or
d) The cause of action, wholly or in part, arises”[iv]

Right to Appeal
Under Section 20, an appeal to the order of tribunal may lie to the appellate
tribunal i.e, the DRAT by the aggrieved person within period of 30 days from
date on which the copy of order made by the DRT is received by borrower. Such
appeal shall only be entertained on the submission of 50% of amount of the debt
by the borrower which can be reduced to 25% by the tribunal but cannot be
waived.

2. SARFAESI Act, 2002(“Securitisation and Reconstruction of

Financial Assets and Enforcement of Security Interest”)
Even after the RDDBFI Act was passed, issues such as a lack of liquidity, an
asset-liability mismatch, and long-term asset blockage continued. Banks were
unable to recover their dues to the level predicted even after the establishment
of DRTs.
“To overcome those gaps, the federal government formed different committees,
such as the Narasimham Committee I (1991) and the Narasimham Committee II
(1998) and Andhyarujina Committee constituted under the chairmanship of Sri
T.R. Andhyarujina, to investigate banking sector reforms. These committees
evaluated the need for changes to the legal framework and the creation of new
securitization legislation that permits banks and financial institutions to take
control of assets and sell them without the need for judicial intervention. In the
year Finally, the SARFAESI ACT was approved in 2002.”[v]

Object of the Act

“The Securitisation and Reconstruction of Financial Assets and Enforcement of
Security Interest Act, 2002”, was enacted to regulatesecuritization and
reconstruction of financial assets, as well as the enforcement of security
interests created in favour of secured creditors.

The Act specifies three possible techniques for recovering NPAs:

a) Securitization
b) Asset Reconstruction; and
c) Enforcing security without the intervention of the court.

Constitutionality of Act
In the case of “Mardia Chemicals Ltd. Vs Union of India”[vi],constitutionality
of SARFAESI was challenged, namely “Sections 13, 15, 17, and 34”, on the
grounds that they are excessive and arbitrary.The Supreme Court in its
judgement upheld the constitutionality of SARFAESI.

Pecuniary Jurisdiction
“The provisions of SARFEASI Act applies to NPA loan accounts of value
exceeding Rs. 1 Lakh and the NPA loan account is more than a twentieth of
principle and interest. Such NPAs should be backed by securities charged to the
banks by way of hypothecation, mortgage or assignment and the secured
assets.”[vii]

Recovery Process under SARFAESI

On the account of the borrowers failure of due payment of loan, bank declares
the loan account as NPA andsend notice to the borrower under Section 13(2).
On receiving such NPA notice from bank, the borrower has 60 days to discharge
his liabilities. In case borrower fails to do so, the secured creditor proceeds
under Section 13(4) of the Act for the enforcement of Security Interest.

“The secured creditor may take one or more recourse mentioned in under
section 13(4) namely,

i. To take possession of the secured assets of the borrower including the

right to transfer by way of lease, assignment or sale for releasing the
secured asset. When it comes to taking possession of the property, there
are two things like taking symbolic possession and taking actual
possession

ii. To take over the management of the business of the borrower including
the right to transfer by way of lease, assignment or sale for releasing the
secured asset.

iii. Appoint the manager, to manage the secured asset whose possession has
been taken

iv. Requiring money from any person who has acquired any of the secured
assets from the borrower and from whom any money is due to the
borrower, to pay to the secured creditor, by notice in writing”.
The Secured creditor under Section 14 may request by writing to the
jurisdictional Chief Metropolitan Magistrate or District Magistrate to take
possession thereof. Such Magistrate may then take control of the asset and
deliver it to the secured creditor. And may use or cause the use of such force as
he deems necessary.

Remedy to Aggrieved Borrower

“Any individual who is aggrieved by any measure taken under section 13(4) by
the secured creditor may file an application with the tribunal within 45 days of
the date such measures were adopted under Section 17 of the Act. If the tribunal
concludes, after reviewing, that the measures under section 13(4) are in
violation of the Act, it may declare the measures invalid and return the
borrower's possession of the secured asset.”[ix]

Right to Appeal
Any Individual aggrieved by the order of DRT may approach the DRAT under
Section 18 of the act provided that no appeal shall lie unless the borrower has
deposited 50% of the amount of debt owed by the borrower.

RDDBFI and SARFAESI Complimentary

In the case of“Transcore Vs. UOI”[x], it was held that RDDBFI Act, 2016 and
SARFAESI Act are complementary to each other. The withdrawal of an action
pending before the tribunal under RDDBFI, 1993 is not a prerequisite for
resorting to SARFAESI. The SARFAESI Act of 2002 is an extra remedy that is
not inconsistent with the DRT Act of 1993, and hence the theory of election
does not apply.

Module:4

Nature of Banking Frauds

Bank fraud is a purposeful act of omission or conduct by any person in the
course of a banking transaction or in the bank’s books of accounts, which results
in unlawful temporary gain to any individual or otherwise, with or without any
monetary loss to the bank. The losses incurred by banks as a consequence of
fraud are equal to the combined losses incurred as a consequence of offences
such as robbery, dacoity, burglary, and theft. Unauthorized credit facilitates are
extended for illegal gratification such as cash credit allowed against pledge of
goods, hypothecation of goods against bills, or against book debts.

“‘Fraud’ denotes a false statement made knowingly or without trust in its truth,
or recklessly careless, whether true or untrue,” according to Lord Herschell. In
the case of Derry v. Peek (1889), he had opined that a false statement made by
someone who does not believe it to be genuine is referred to as a fraudulent
misrepresentation.

Pledging of fictitious items, inflating the value of goods, hypothecating

commodities to several banks, fraudulent removal of goods with the knowledge
and connivance of or ignorance of bank employees, and pledging of goods
belonging to a third party are all common methods of operation of bank frauds.
Goods hypothecated to a bank are found to contain obsolete stocks packed in
between good stocks and cases of shortage in weight are not uncommon.

Components of a bank fraud

Any fraud conducted by a bank employee or in conjunction with a borrower has
two key components, namely,

1. First, there is the subjective intention, and

2. There is the objective opportunity.
In a bank, conditions must be constructed such that a person who wants to
commit fraud does not have the chance to do so. An examination of instances
surrounding banking frauds reveals the following four primary aspects that are
responsible for the commission of bank frauds:
  Active participation of the personnel, both managerial and clerical, either
independently or in collusion with outsiders.
 Failure of bank employees to adhere to properly set out instructions and
procedures.
 External elements defrauding banks by forging or manipulating checks,
drafts, and other financial instruments.
 There has been increasing cooperation of business people, senior bank
executives, public servants, and powerful politicians to cheat banks by
bending the rules, flouting laws, and tossing banking standards to the
wind.

Classification of frauds
The RBI’s Master Directions on Frauds – Classification and Reporting by
commercial banks and select FIs (Updated as on July 03, 2017) provides
different categories of offences that constitute fraud, putting specific reliance on
the Indian Penal Code, 1860. The classifications are provided hereunder:

 Misappropriation and criminal breach of trust.

 Fraudulent encashment through forged instruments, manipulation of
books of account or through fictitious accounts, and conversion of
property.
 Unauthorised credit facilities extended for reward or for illegal
gratification.
 Negligence and cash shortages.
 Cheating and forgery.
 Irregularities in foreign exchange transactions.
 Any other type of fraud not coming under the specific heads as above.

Types of Bank Fraud

Bank fraud is a serious crime that can cost banks and customers significant
amounts of money. It can come in many forms, from small-scale scams to large-
scale operations that involve millions of dollars. The most common types of
bank fraud include the following:

1. Accounting fraud
 Accounting fraud is when a financial institution misrepresents its
financial position by either omitting important information or deliberately
misrepresenting it. This type of fraud can involve manipulating the
financial statements of a bank to make it appear more profitable than it is.
It can also involve the misappropriation of funds from a bank’s accounts.

2. Bill discounting fraud

 Bill discounting fraud occurs when a bank accepts bills that are not
backed by adequate collateral. This type of fraud can lead to losses for the
bank if the person or entity that issued the bill does not pay it back. It can
also involve the sale of a bill at a discount, which can result in the bank
losing money.

3. Cheque kiting
 Cheque kiting is a form of fraud which involves taking advantage of the
time gap between the writing and clearing of a cheque. A criminal will
write a cheque for an amount of money that they know is not in the
account, then deposit it into another account. Once the cheque has been
accepted, the criminal will withdraw the funds from the other account
before the original cheque bounces due to a lack of funds. This is a form
of fraud which involves the use of forged or fraudulent documents.

4. Forged or fraudulent documents

 Forged or fraudulent documents are documents which have been
created, altered, or tampered with to deceive or defraud someone.
For example, a criminal might use a forged or fraudulent document
to open a bank account in someone else’s name and deposit a
 cheque they know will not clear. This is a form of cheque kiting
which is illegal and can lead to criminal charges.

5. Forgery and altered cheques

 Forgery and altered cheques, as well as fraudulent loan applications, are
two very serious offences. Making minor changes to a document or
cheque to defraud someone is illegal and punishable by law.

 Altered cheques are commonly used in fraud, as they are easy to alter and
difficult to detect. For instance, a person can add or delete numbers,
change the name of the recipient, or even change the date and amount.
Altered cheques can be used to obtain money or goods that the
perpetrator is not entitled to, and can also be used to commit identity
theft.

6. Fraudulent loan applications

 Fraudulent loan applications are another form of fraud. This type of crime
involves submitting false or incomplete information on a loan application
to obtain a loan that the perpetrator is not qualified for. It can also involve
creating fake documents or providing false information about income,
assets, or other financial information.

7. Empty ATM envelope deposits

 Empty ATM envelope deposits have become an interesting area of
concern when it comes to fraud. It is a process wherein criminals deposit
empty ATM envelopes into ATMs to create fake deposits to launder
money. This is done by taking advantage of the fact that many banks do
not take the time to verify the contents of an ATM deposit, and thus they
can be used to hide illegal activities.

8. Identity theft or impersonation

 Identity theft or impersonation is a serious crime and a growing problem
in today’s world. It involves someone stealing another person’s personal
 information such as their name, address, bank account number, Social
Security Number (USA) or National Insurance Number (UK), driver’s
license number, or credit card information and using it to commit fraud or
other crimes.

 Identity theft or impersonation can occur in several ways. One way is for
someone to gain access to a person’s personal information by hacking
into their computer or stealing their wallet. Another way is for someone
to use the stolen information to open new accounts or to make purchases
in the victim’s name.

9. Money laundering
 Money laundering is a process of concealing the sources of illegally
obtained money, involving the transfer of funds from one financial
institution to another, or the use of false identities to hide the origin of the
money. Money launderers may also attempt to disguise the movement of
funds by using shell companies, overseas bank accounts, or anonymous
online wallets.

 This type of fraud is often perpetrated by organised crime groups or

individuals who have access to someone else’s card information. Money
laundering can lead to loss of funds, as well as increased scrutiny from
law enforcement and financial regulators.

10.Payment card fraud

 Payment card fraud is the illegal use of debit or credit cards. Making it a
global problem that affects people who use credit and debit cards. It
occurs when someone steals a cardholder’s information and uses it to
make unauthorised purchases.
 Payment card fraud can be perpetrated in a variety of ways, from stealing
physical cards to hacking into online accounts. Regardless of how it is
done, the result is the same – financial loss for the cardholder.

11.Phishing or Internet fraud

 Phishing or Internet fraud is a type of fraud that involves the use of
deceptive techniques, such as sending emails, texts, or pop-up messages,
to obtain sensitive personal or financial information from unsuspecting
victims. The goal of phishing is typically to steal money or data or to
access private accounts, such as bank accounts.

 Criminals use fake websites, emails, or text messages to deceive victims

into providing personal information, such as credit card numbers, bank
account numbers, and passwords. The criminals then use this information
to steal money from the victims’ accounts or to commit other types of
fraud.

12.Prime bank fraud

 Prime bank fraud is a type of fraudulent investment scheme, in which
perpetrators create fictitious “prime banks” to lure investors into
investing in non-existent financial instruments or products. The
perpetrators may also use false documents such as fake bank statements,
forged signature cards, false financial records, fraudulent statements,
false testimonials and other fabricated documents to convince investors
that their money is being invested in a legitimate venture. The fraudsters
promise high returns in a short time.

13.Rogue traders
 Rogue traders are individuals or entities that engage in securities fraud
and other illegal activities to make a profit. They often use deceptive
tactics to manipulate the market and take advantage of unsuspecting
investors. Rogue traders can also be brokers or investment advisers who
provide false information to their clients to generate commissions or fees.
 14.Stolen cheque
 Stolen cheque fraud is a type of financial fraud in which a person illegally
obtains and uses a cheque belonging to someone else. The fraudster then
attempts to cash the cheque or deposit it into their account. Common
methods of committing this type of fraud include stealing cheques from
mailboxes, stealing chequebooks from homes, and taking advantage of
the elderly.

15.Wire transfer fraud

 Wire transfer fraud is a type of fraud involving the transfer of money
through wire transfer services. It generally involves a thief or fraudster
using stolen personal information to gain unauthorised access to a bank
account and initiate a wire transfer of funds from that account to another
account, usually owned by the thief or an accomplice.

Other types of bank fraud

Other types of bank fraud include the following:

 Credit card fraud

 Check Kiting
 Account Takeover
 Counterfeiting

Legal Regime to Control Banking Frauds

The legal regime to control banking frauds in India is governed by various laws
and regulations that aim to prevent, detect, and prosecute fraudulent activities in
the banking sector. These laws provide a framework for banks and financial
institutions to follow in order to safeguard their operations and protect the
interests of depositors and the financial system as a whole. Here are some key
aspects of the legal regime:

Prevention of Money Laundering Act, 2002 (PMLA):

Objective: The PMLA aims to prevent money laundering and provide for the
confiscation of proceeds of crime derived from money laundering.
Key Provisions:
 Requires banks and financial institutions to maintain records of all
transactions and report suspicious transactions to the Financial
Intelligence Unit-India (FIU-IND).
 Mandates the appointment of a Money Laundering Officer (MLO) in
every banking company, financial institution, and intermediary to ensure
compliance with the provisions of the Act.
 Provides for the attachment and confiscation of proceeds of crime and
properties involved in money laundering.
 Empowers the Enforcement Directorate (ED) to conduct investigations
and take enforcement actions against offenders.
Significance: The PMLA strengthens the regulatory framework to combat
money laundering and financial fraud, thereby enhancing the credibility of the
banking sector.

Banking Regulation Act, 1949:

Objective: The Banking Regulation Act provides for the regulation and
supervision of banking companies by the Reserve Bank of India (RBI).
Key Provisions:
 Empowers the RBI to issue directions to banks on various matters,
including fraud prevention and detection.
 Requires banks to maintain books of accounts and other records in such
manner as may be prescribed by the RBI.
 Provides for the appointment of banking inspectors by the RBI to inspect
the books and accounts of banks.
Significance: The Banking Regulation Act ensures the stability and soundness
of the banking sector by regulating banking operations and promoting
transparency and accountability.

Securitization and Reconstruction of Financial Assets and Enforcement of

Security Interests Act, 2002 (SARFAESI Act):
Objective: The SARFAESI Act empowers banks and financial institutions to
enforce their security interests without the intervention of courts.
Key Provisions:
 Allows banks to issue notices to defaulting borrowers demanding
repayment of the debt.
 Enables banks to take possession of and sell secured assets without the
intervention of courts.
 Provides for the establishment of Asset Reconstruction Companies
(ARCs) to acquire and manage non-performing assets.
Significance: The SARFAESI Act expedites the recovery of debts due to banks
and financial institutions, thereby reducing the burden of non-performing assets
on the banking system.

Indian Penal Code (IPC):

Objective: The IPC contains provisions that can be used to prosecute
individuals involved in banking fraud.
Key Provisions:
 Section 420 deals with cheating and dishonestly inducing delivery of
property, which is often applicable in cases of banking fraud.
 Section 467 deals with forgery of valuable security or will, which is
relevant in cases where documents are forged to commit banking fraud.
Significance: The IPC provides a legal framework to prosecute and deter
individuals from engaging in fraudulent activities in the banking sector.

Debt Recovery Tribunals (DRTs):

Objective: DRTs were established to adjudicate debt recovery proceedings and
provide a forum for banks to recover debts from defaulting borrowers.
Key Provisions:
 Banks and financial institutions can file applications before DRTs for the
recovery of debts.
 DRTs adjudicate the applications and pass orders for the recovery of
debts.
 Once orders are passed, banks can initiate execution proceedings to
recover the debts.
Significance: DRTs provide a specialized forum for the expeditious recovery of
debts due to banks and financial institutions, reducing the burden on regular
courts.

Specialized Agencies:
Objective: Specialized agencies such as the CBI and the ED play a crucial role
in investigating and prosecuting banking fraud cases.
Key Functions:
 Investigate complex and high-profile cases of banking fraud.
 Work closely with banks, regulatory authorities, and other law
enforcement agencies to uncover and prosecute fraudulent activities.
Significance: Specialized agencies enhance the effectiveness of the legal regime
by investigating and prosecuting banking fraud cases, deterring potential
offenders, and maintaining the integrity of the banking system.

Regulatory Oversight:
Objective: Regulatory bodies like the RBI and SEBI provide regulatory
oversight to ensure compliance with laws and regulations related to banking
fraud prevention.
Key Functions:
 Issue guidelines and directives to banks on fraud prevention and
detection.
  Conduct regular inspections and audits of banks to ensure compliance
with regulations.
Significance: Regulatory oversight ensures the stability and integrity of the
banking sector by promoting transparency, accountability, and adherence to best
practices.

Role and responsibility of RBI to tackle the problems of banking

frauds
The Reserve Bank of India (RBI) plays a crucial role in tackling the problems of
banking frauds through its regulatory and supervisory functions. Here are the
key roles and responsibilities of the RBI in this regard:

 Regulatory Framework: The RBI is responsible for formulating and

implementing the regulatory framework for banks and financial
institutions in India. It issues guidelines, circulars, and directives to banks
on fraud prevention, detection, and reporting.
 Licensing and Supervision: The RBI is responsible for licensing and
regulating banks in India. It conducts regular inspections and audits of
banks to assess their compliance with regulatory requirements, including
those related to fraud prevention and detection.
 Fraud Monitoring and Reporting: The RBI requires banks to establish
robust systems and processes for monitoring and reporting of frauds.
Banks are required to report all fraud cases to the RBI and take necessary
action to prevent recurrence.
 Guidance and Training: The RBI provides guidance and training to
banks and their employees on fraud prevention and detection. It conducts
workshops, seminars, and training programs to enhance the skills and
awareness of bank staff in dealing with frauds.
 Coordination with Law Enforcement Agencies: The RBI coordinates
with law enforcement agencies such as the Central Bureau of
Investigation (CBI) and the Enforcement Directorate (ED) in
investigating and prosecuting banking fraud cases. It provides necessary
support and information to facilitate timely action against fraudsters.
  International Cooperation: The RBI collaborates with international
organizations and regulatory bodies to share information and best
practices in combating banking frauds. It participates in international
forums and working groups to address cross-border frauds and money
laundering activities.
 Policy Development: The RBI continuously reviews and updates its
policies and regulations to address emerging risks and vulnerabilities in
the banking sector. It takes proactive measures to strengthen the legal and
regulatory framework for fraud prevention and detection.
 Consumer Protection: The RBI is also responsible for protecting the
interests of bank customers. It issues guidelines to banks on fair practices,
transparency, and grievance redressal mechanisms to ensure that
customers are not victimized by fraudulent activities.

Recent Trends in Banking: Automatic Teller Machine and

Internet Banking, Smart Cards, Credit Cards.

Recent trends in banking have seen a significant shift towards digitalization and
the adoption of technology to enhance customer experience and operational
efficiency.

1. Automatic Teller Machines (ATMs):

 Enhanced Features: ATMs now offer a range of advanced features
beyond basic cash withdrawal and deposit. These include bill payments,
fund transfers, check deposits, and mobile recharges.
 Biometric Authentication: Some ATMs are equipped with biometric
authentication systems, such as fingerprint or iris scanning, to enhance
security and prevent unauthorized access.
 Contactless Transactions: Contactless ATMs allow customers to
withdraw cash or perform transactions using their mobile phones or
contactless cards, reducing the need for physical contact with the ATM.
 Integration with Mobile Banking: ATMs are increasingly integrated
with mobile banking apps, allowing customers to pre-stage transactions
 on their mobile devices and complete them at the ATM for added
convenience.

2. Internet Banking:
 Mobile Banking Apps: Banks are focusing on developing user-friendly
mobile banking apps that offer a wide range of services, including
account management, bill payments, fund transfers, and transaction
tracking.
 Enhanced Security Features: Internet banking platforms are
incorporating advanced security features such as two-factor
authentication, biometric login, and encryption to protect customer data
and prevent fraud.
 AI Integration: Artificial intelligence is being used to enhance internet
banking services by providing personalized recommendations, automated
customer support, and real-time fraud detection.

3. Smart Cards:
 Contactless Payment Technology: Smart cards with contactless
payment technology allow customers to make transactions by simply
tapping their card on a POS terminal, providing a faster and more
convenient payment experience.
 Biometric Authentication: Some smart cards now feature biometric
authentication, such as fingerprint scanning, to enhance security and
prevent unauthorized use.
 Integration with Mobile Wallets: Smart cards can be linked to mobile
wallets, allowing customers to make payments using their smartphones,
further reducing the need for physical cards.
4. Credit Cards:
 Rewards Programs: Credit card issuers are offering rewards programs
that allow customers to earn points, miles, or cashback on their purchases,
encouraging card usage and customer loyalty.
 Enhanced Security Features: Credit cards now come with advanced
security features such as tokenization, which replaces sensitive card
information with a unique token, making transactions more secure.
  Fraud Detection Algorithms: Credit card companies use fraud detection
algorithms to monitor transactions in real-time and detect any suspicious
activity, helping to prevent fraudulent transactions.

Module:5

Role of RBI
Role and Function of Reserve Bank of India

1. Monetary Management
 The development and implementation of monetary policy and ensuring
monetary stability in India are two of the RBI's most crucial
responsibilities. It makes use of the credit and monetary systems for its
benefit.

2. Supervision and Regulation of Banking and Non-Banking Financial

Institutions
 The RBI serves to protect the interests of depositors through an effective
regulatory framework. keeping a close check on how banking operations
are being conducted and the bank's solvency, as well as preserving overall
financial stability through a variety of policy actions.

3. Regulation of Foreign Exchange Market, Government Securities

Market, and Money Market
 The RBI is in charge of regulating the Indian foreign exchange market.
Through the provisions of the FEMA Act 1999, RBI monitors and
controls the foreign exchange market.
 The central and state governments' trade securities are governed by the
RBI. The RBI Act of 1934 gives it the authority to regulate this.
 The RBI has the authority to regulate short-term and highly liquid debt
securities under the terms of the RBI Act of 1934.
4. Foreign Exchange Reserve Management
 The RBI is in charge of looking after India's foreign exchange reserves.
The RBI Act of 1934 contains legal provisions relating to the
administration of foreign exchange reserves.
 The RBI is allowed to invest these foreign exchange reserves in the
following instruments under the RBI Act of 1934:
o Place a deposit with international banks.
o With overseas commercial banks, make a deposit.
o Instruments of Debt

5. Bankers to the Central and State Governments

 The RBI serves as the government's banker. The RBI is in charge of
receiving and disbursing funds on behalf of the various government
agencies. The Central and State Governments' Consolidated Funds,
Contingency Funds, and Public Accounts are all maintained by the
RBI.As a lender to the government, the RBI also extends loans to the
union and federal governments.

6. Advisor to the Government

 The RBI provides financial and banking-related advice to the government
as and when requested.

7. Central and State Governments' Debt Manager

 The primary goals of the debt management strategy are to reduce
borrowing costs and even out the debt's maturity structure. On behalf of
the federal government and state governments, the RBI manages the
nation's debt and issues fresh loans.

8. Banker to Bank
 In order to maintain their SLR and CRR, banks open current accounts
with the RBI. The RBI serves as a central banker for all of the individual
banks and facilitates the settlement of money transfers between banks.
 The RBI gives banks emergency loans and short-term credit for certain
needs.

9. Issuer of Currency
 The RBI is in charge of the printing and overall administration of the
national currency, with the aim of releasing a sufficient quantity of
authentic notes and maintaining the flow of the economy.

10.Developmental Role
 The RBI's role in economic development includes setting up
organizations to construct financial infrastructure, ensuring credit to the
economy's productive sector, and increasing access to accessible financial
systems.

Branch Opening
Branch opening in banking refers to the process of establishing a new physical
location where customers can access banking services. This process involves
several steps and considerations, including regulatory requirements, market
analysis, and operational planning. Branch opening is an important strategic
decision for banks, as it allows them to expand their reach and serve customers
in new locations. However, it also involves costs and risks that need to be
carefully evaluated.

 Market Analysis: Before opening a new branch, banks conduct a

thorough analysis of the market to assess the demand for banking services
in the area. This includes studying demographic trends, competitor
analysis, and potential customer base.
 Regulatory Requirements: Banks need to comply with regulatory
requirements set by the Reserve Bank of India (RBI) and other regulatory
bodies for opening a new branch. This includes obtaining necessary
approvals and licenses, as well as meeting capital adequacy and other
regulatory norms.
  Operational Planning: Banks need to plan the operational aspects of the
new branch, including staffing, technology infrastructure, and product
offerings. This involves identifying the right location, hiring and training
staff, and ensuring that the branch is equipped to offer a full range of
banking services.
 Cost-Benefit Analysis: Banks conduct a cost-benefit analysis to evaluate
the financial viability of opening a new branch. This involves estimating
the costs associated with setting up and operating the branch, as well as
the potential revenue generation from new customers and increased
business.
 Risk Assessment: Opening a new branch involves certain risks, such as
competition, regulatory changes, and economic downturns. Banks need to
assess these risks and develop strategies to mitigate them.

Banking Inspection
Bank inspection is a regulatory process conducted by the Reserve Bank of India
(RBI) to assess the financial health, operational efficiency, and compliance of
banks with regulatory requirements. The primary objective of bank inspection is
to ensure the stability and integrity of the banking system and to protect the
interests of depositors and other stakeholders.

Key aspects of bank inspection include:

 Risk Assessment: Inspectors evaluate the bank's risk management

practices, including credit risk, market risk, liquidity risk, and operational
risk. They assess the adequacy of the bank's risk management framework
and its ability to identify, measure, monitor, and control risks.
 Compliance: Inspectors review the bank's compliance with regulatory
requirements, including capital adequacy, liquidity requirements, and
prudential norms. They ensure that the bank is following the guidelines
and directives issued by the RBI and other regulatory bodies.
 Governance and Controls: Inspectors assess the bank's corporate
governance structure, including the effectiveness of its board of directors
and management. They review the bank's internal controls, policies, and
 procedures to ensure that they are adequate and effective in mitigating
risks.
 Asset Quality: Inspectors review the quality of the bank's assets,
including its loan portfolio and investments. They assess the adequacy of
loan loss provisions and the bank's ability to recover loans.
 Financial Performance: Inspectors evaluate the bank's financial
performance, including its profitability, capital adequacy, and asset-
liability management. They assess the bank's ability to generate income
and maintain adequate capital levels.
 Reporting and Disclosure: Inspectors review the bank's financial
reporting and disclosure practices to ensure that they are accurate,
transparent, and in compliance with regulatory requirements.

Fixation of Interest Rate

The fixation of interest rates in banking is a complex process influenced by
various factors, including the monetary policy of the Reserve Bank of India
(RBI), market forces, inflation, and the cost of funds for banks. Here's a brief
overview of how interest rates are typically determined:

 Monetary Policy: The RBI's monetary policy plays a significant role in

determining interest rates in the economy. The RBI sets the repo rate,
which is the rate at which it lends money to commercial banks. Changes
in the repo rate affect the cost of funds for banks and, consequently, the
interest rates they offer on loans and deposits.
 Market Forces: Interest rates are also influenced by market forces, such
as demand and supply dynamics for credit and deposits. When there is
high demand for credit and limited supply of funds, interest rates tend to
rise. Conversely, when there is low demand for credit and excess liquidity
in the system, interest rates tend to fall.
 Inflation: Inflation has a direct impact on interest rates. High inflation
erodes the purchasing power of money, leading to higher interest rates to
compensate for the loss in value. The RBI often considers inflation
targeting while setting interest rates to maintain price stability in the
economy.
  Cost of Funds: The cost of funds for banks, including the interest rates
they pay on deposits and borrowings, also influences the interest rates
they charge on loans. Banks aim to maintain a spread between their cost
of funds and the interest rates they charge to cover operating expenses
and generate profits.
 Regulatory Environment: Regulatory factors, such as the RBI's
guidelines on interest rate ceilings and floors, also play a role in
determining interest rates. Banks are required to adhere to these
guidelines while setting interest rates on loans and deposits.

Emerging Trends in Indian banking system

1. Digital Transformation:
 Banks are leveraging digital technologies such as cloud computing, big
data analytics, and robotic process automation (RPA) to streamline
operations and enhance customer experience.
 Digital transformation is not just about adopting new technologies but
also about reimagining business processes and organizational culture to
become more agile and customer-centric.

2. Fintech Collaboration:
 Collaboration between banks and fintech firms is becoming increasingly
common, leading to the development of innovative solutions in areas
such as payments, lending, and wealth management.
 Banks are partnering with fintechs to tap into their expertise in areas such
as AI, blockchain, and cybersecurity, helping them stay competitive in a
rapidly evolving market.

3. Data Analytics and AI:

 Banks are using advanced analytics and AI to gain deeper insights into
customer behavior, improve risk management, and personalize offerings.
 AI-powered chatbots are being used to enhance customer service,
providing instant responses to queries and improving customer
satisfaction.
4. Open Banking:
 Open banking is enabling banks to share customer data securely with
third-party providers, leading to the development of new products and
services.
 APIs (Application Programming Interfaces) are playing a key role in
enabling secure data sharing and fostering innovation in the banking
sector.

5. Blockchain and Cryptocurrency:

 Blockchain technology is being explored for applications beyond
cryptocurrencies, such as trade finance, supply chain management, and
identity verification.
 Some banks are exploring the use of cryptocurrencies for cross-border
payments and remittances, although regulatory uncertainties remain a
challenge.

6. Regulatory Reforms:
 Regulatory reforms such as the IBC and Basel III norms are aimed at
strengthening the banking sector's resilience and improving risk
management practices.
 The implementation of these reforms is expected to enhance transparency,
accountability, and governance standards in the banking sector.

7. Focus on Financial Inclusion:

 Banks are expanding their reach to underserved and unbanked
populations through initiatives such as no-frills accounts, mobile banking,
and Aadhaar-based services.
 Financial inclusion initiatives are not just about expanding access to
banking services but also about promoting financial literacy and
empowerment among marginalized communities.
 8. Green Banking:
 Green banking is gaining prominence as banks increasingly focus on
sustainability and environmental conservation.
 Banks are financing green projects such as renewable energy, energy-
efficient infrastructure, and sustainable agriculture, contributing to the
transition to a greener economy.

CRR and SLR

CRR – Meaning

As mentioned above, CRR stands for Cash Reserve Ratio. It is a compulsory

reserve that the central bank of the country – The Reserve Bank of India (RBI),
must maintain. Every commercial bank is obligated to maintain CRR, which is a
specified percentage of their net demand and time liabilities.
Commercial banks must maintain the CRR in the form of cash balances with the
RBI. These banks are not allowed to use the money for economic or commercial
purposes.
Essentially, CRR represents the minimum percentage of deposits that a
commercial bank must keep as a cash reserve with the RBI. The RBI uses CRR
to maintain liquidity and cash flow in the economy.

SLR – Meaning

SLR stands for Statutory Liquidity Ratio. It is an obligatory reserve that

commercial banks must maintain. Commercial banks may maintain this reserve
requirement in the form of approved securities per a specific percentage of the
net demand and time liabilities.
SLR can also be defined as a tool used to maintain the stability of the banks by
restricting the credit facility they offer to their customers. Banks usually hold
more than the required SLR, per RBI norms stating that they must maintain a
certain amount of money as liquid assets. This helps banks fulfil their
depositors' demands as and when they arise.

What is the difference between CRR and SLR?

The following are the key differences between CRR and SLR:

Parameters CRR SLR

Meaning It is a percentage of money that It is a proportion of liquid

a bank has to keep with the assets per a percentage of time
RBI. and demand liabilities.

Form Maintained in the form of cash. Maintained in the form of cash,

gold and government-approved
securities.

Uses Regulates the flow of money in Ensures the solvency of banks.

the economy.

Reserved Reserved with the RBI. Reserved with commercial

With banks.

National Regulates the liquidity of cash Maintains the credit growth of

Impact in the country. the country.

Mergers and Acquisitions: Amalgamation of Banking Companies

With the rapidly advancing technology and an increase in competitions between

corporations, Mergers and Acquisitions (“M&A”) are the immediate choice and
an effective strategy to penetrate new markets. This approach is often employed
by corporations with an aim to extend their business into a new domain and
prevail over their unviable state.
Banks being the underpinning foundation of our economy, are frequently
encouraged to merge in order to expand globally and create harmony, which in
turn benefits the affluence of our country through enhanced flow of monies. In
the present day, the Indian banking industry is considered to be growing swiftly
and has altered itself into a dynamic industry. A new dimension is accelerated in
the sector through mergers and acquisitions and has enabled banks to achieve a
high ranking, tossing huge value to the shareholders.

Guidelines for merger/amalgamation of private sector banks

On April 21, 2016, the Reserve Bank of India ("RBI") issued master directions
streamlining the process of mergers of private sector banks ("Guidelines"). The
proposed merger of two banking companies or of a banking company with a
non-banking financial company is governed by these Guidelines. Additionally,
these Guidelines would be applicable to public sector banks, as appropriate.
According to the Guidelines, under the terms of Section 44A of the Banking
Regulation Act of 1949, RBI has the discretionary authority to authorize the
voluntary merger of two banking entities.
These powers do not apply to the voluntary merger of a banking company with
a non-banking company, which is governed by Sections 232 to 234 of the
Companies Act of 2013, under which the National Company Law Tribunal
(“Tribunal”) must approve the merger's plan.

Approval by board of directors

Boards of the banks play a vital role in the amalgamation process as the
decision of amalgamation must be ratified by two-third majority of the total
board members and not just of those present and voting.

Amalgamation between two banking companies

According to Section 44A of the Banking Regulation Act of 1949, no banking
company may merge with another banking company unless a scheme outlining
the terms of the merger has been presented in draft form to the shareholders of
each of the relevant banking companies separately and approved by a resolution
passed by a majority of the shareholders of each of the aforementioned
companies present in person or by proxy at a meeting of shareholders.
Prior to the shareholders’ approval, the boards of directors of the two banking
companies must accept the draft scheme. The following factors should be taken
into account while considering such approval:
 The value of the proposed merged company's assets, liabilities, and
reserves, and if the proposed incorporation will result in an increase in the
asset value;
 The type of compensation the merging banking company will provide to
the shareholders of the merged company;
 Whether the required amount of due diligence has been done with regard
to the proposed merger;
 Whether the swap ratio has been determined by independent valuers and
whether such swap ratio is fair and appropriate.
 The shareholding structure of the two banking companies and if, as a
result of the merger and the swap ratio, any person's, entity's, or group's
ownership of shares in the merged banking company will violate RBI’s
policies;
 The planned modifications to the board of directors' composition and
whether the resulting membership of the board would be in compliance
with the RBI Guidelines; and
 The impact on the viability and the capital adequacy ratio of the
amalgamating banking company.
If such a scheme is adopted by the required number of shareholders, it must be
presented to the RBI for approval, which if granted, will be binding on the
relevant banking companies.

Amalgamation of an NBFC with a banking company

In the event its proposed to merge an NBFC with a banking company, the
banking company should procure RBI’s permission after its board has
authorized the proposed merger but before it is filed to the Tribunal for
approval.
With respect to the approval of the scheme, in addition to the considerations
listed above, the board should also consider the following aspects:
1. Determine whether any RBI/SEBI regulations have been violated or are
likely to be violated by the NBFC, and if so, ensure that they are
complied with, before the scheme is approved;
2. Whether “Know Your Customer” norms are complied with by the NBFC
for all its accounts which will become accounts of the banking company;
3. Whether the NBFC has used credit facilities from banks or financial
institutions, and if so, whether the loan agreements require the NBFC to
obtain the consent of the bank or financial institution concerned for the
proposed merger.

Information and documents to be furnished

Along with the application of scheme of amalgamation, following are few of the
documents/ information required to be submitted:

 Draft scheme of amalgamation approved by the shareholders of the

banking companies;
 Certificates authorized by each of the officials present at the meeting of
shareholders;
 Certificates from the concerned officers of the banking companies listing
the names of shareholders who gave written notice to the banking
company at or before the meeting that they opposed the amalgamation
plan, along with the amount of shares held by each shareholder;
 Details of the proposed CEO of the banking company after
amalgamation;
 Annual reports of each of the banking companies for the three financial
years preceding the date of such amalgamation;
 Such other information, documents or explanations as RBI may required
during the application process.
Reasons for M&As in banks
The following are the reasons for the mergers in banks:

1. Merger of weaker banks

The objective of combining weaker banks with stronger banks has been
supported in order to stabilize weak banks and diversify risk management. By
joining forces with a more powerful bank, the weaker ones can maintain its
presence and avoid going out of business completely.

2. Synergies and Economies of scale

Due to the synergies created by the combined client bases of the two banks, the
amalgamated product will be more profitable and provide improved customer
satisfaction. The merged bank will have superior business portfolio, risk
management plans, and market capitalization. It also benefits from economies
of scale and lower costs through better utilization of available resources.

3. Financial liquidity and economies of scale

A merger increases liquidity, ensures direct access to cash resources, and assists
in the disposition of surplus and obsolete assets. It aids to pool the resources of
the individual banks and use them in an effective and efficient manner. After the
merger, the banks will be better equipped to fund massive projects that they
previously wouldn't be able to do so on their own, making the funding
procedure for those projects swift and simple.

4. Technology advancement
With the advent of the internet, banks can now offer services with the touch of a
screen, allowing them to utilize the latest technologies. Through the merger,
banks work together and make use of cutting-edge technology to deliver better
services and support the expansion of the banking industry.

5. Skill & Talent

When two banks merge or are acquired by one another, staff and expertise are
also amalgamated, creating a larger talent pool that gives the merged entity an
advantage over its competitors.

History of mergers and acquisitions

The Indian banking sector has witnessed a few mergers with the primary motive
to ensure growth, expand and diversify within the sector. For example, inter-
alia, Punjab National Bank acquired New Bank of India in 1993, Bank of
Madura Ltd merged into ICICI Bank Ltd in 2001 and Bhartiya Mahila Bank
merged into State Bank of India in 2017.
In August 2019, Government of India announced the -merger of 10 Public
Sector Banks (“PSBs”) to 4. In accordance with RBI’s press release dated 28th
March 2020, the said mergers were to take effect from 1st April, 2020.

ANCHOR BANK BANKS MERGED

Punjab National Bank United Bank of India and Oriental Bank
of Commerce
Indian Bank Allahabad bank
Canara Bank Syndicate Bank
Union Bank of India Andhra Bank and Corporation Bank
Bank of Baroda Dena Bank and Dena Bank and Vijaya Bank
Vijaya Bank
State Bank of India State Bank of Bikaner and Jaipur

-State Bank of Hyderabad

-State Bank of Mysore

-State Bank of Patiala

-State Bank of Travancore

-Bharatiya Mahila Bank

**

 Bank of Baroda was merged with Vijaya Bank and Dena Bank. The
merger took effect on 1 April 2019.
 SBI’s associate banks and Bharatiya Mahila Bank were merged with the
State Bank of India in 2017.

Impact of the mergers

 The merger, which saw 27 public sector banks consolidated and reduced
to 12, had a principal objective to establish next generation banks and
achieve a trillion-dollar economy in the years to come. This merger
undoubtedly has positive and synergistic effects on the banking industry,
which would have an impact on the effectiveness, workforce, and clients
of the banks.
 The government's consolidation strategy aims to create larger banks that
can compete with both domestic and international financial institutions.
Following the mergers, SBI currently has a 22% market share among all
banks, and PNB, the second-largest public-sector bank, has a market
share of roughly 8%.
  With the merger of Punjab National Bank, United Bank of India, and
Oriental Bank of Commerce, the country's second-largest nationalized
bank in terms of revenue and branch network will be created. The
resulting synergy will yield a next-generation bank that is competitive on
a global scale.

Objectives of PSB Amalgamation

The Government of India announced the mergers with the following objectives:

 Increase operational effectiveness to reduce financing costs

 Establishment of banks with a significant national presence and global
reach
 Unlocking potential through mergers and the development of new banks
 Repositioning PSBs in order to create a $5 trillion economy
 Increased ability to take on more credit and risk
 Improvement in delivery of services