UNIT - I

FINANCIAL SERVICES - BANKING AND INSURANCE

INTRODUCTION :

The entire syllabi of Financial Services Banking and Insurance are divided in to FIVE UNITS
for the convenience of students. The basic idea of the syllabi is to acquaint every student
with the introductory aspects of financial services and financial markets. Every student in
banking subject need to understand the structure of Indian financial system. In the syllabi an
attempt is made to familiarize the student with the concept of bank and its functions along
with an introduction to Reserve Bank of India. For the advantage of learners insurance
concept and globalization of insurance are also elaborated. In the last unit certain aspects of
life-insurance along with Non-Life Insurance Products are also analyzed for the benefit of
students.

UNIT-I

This Unit is divided in to six lesions. An attempt is made this unit to familiarize the student
with the subject of financial services, financial system in general and functions of commercial
bank along with an introduction to Reserve Bank and insurance concept in particulars.

LESSON 1 : Explains the meaning of financial service and its structure.

LESSON 2 : Financial System, its structure and Financial Institutions are analyzed.

LESSON 3 : Financial Market and types of markets are elaborated.

LESSON 4 : Functions of Commercial banks and innovations in banking are touched

upon.

LESSON 5 : Introduction to Reserve Bank and its functions are discussed.

LESSON 6 : Meaning of Insurance, globalization of insurance and insurance sector

reforms are touched upon.

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 Lesson No. : 1

FINANCIAL SERVICES AND STRUCTURE OF

FINANCIAL SERVICES
An attempt is made in this lesson to motivate every student to understand clearly about the
concept of financial services, structure of financial services with a chart and importance of financial
services are also discussed.
STRUCTURE
1.1 Introduction
1.2 Concept and Meaning
1.3 Salient features of financial services
1.4 Structure of financial services
1.5 Importance of financial services
1.6 Role of Financial System in economic development
1.7 Summary
1.8 Key Terms
1.9 Model Questions
1.10 Books suggested.

OBJECTIVES :
After reading this lesson you should be able to -
* Explain the concept and meaning of financial services.
* Identify salient features of financial services.
* Classify financial services with help of a chart.
* Describe the importance of financial services.
1.1 INTRODUCTION :
Financial services are considered as an important component of financial system. These services
are provided by specialized in situations. In order to cater to the needs of individual investors and
financial markets these services are being offered. The specialized financial institutions will offer these
services for investment of capital in the area of merchant banking, Insurance and portifolio management.
In a developing country like India, financial services sector will play an important role in the development
of financial system. Financial Services cater to the needs of financial institutions and financial markets.

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An effective functioning of financial system depends to a great deal on the range of financial services
offered by various financial services offered by various financial institutions.
1.2 CONCEPT OF FINANCIAL SERVICES :
The concept explains to us that all such activities which are transacted in financial markets are
called financial services. Financial services, through the net work of elements such as financial institutions,
financial markets and financial instruments serve the financial needs of individuals, institutions and corporate
sectors.
The concept also explains to us that financial services include the service offered by asset
management companies and liability management companies. Asset management companies include
mutual funds, merchant bankers, lease financing companies and portfolio managers. Liability management
companies comprise of the bills discounting and acceptances.
MEANING :
In the financial market corporate firms, industries, Trading concerns and individual investors
need capital for investment in business activities. So these institutions need services of specialized firms
and companies which can offer better services in the area of finance. Services offered by these specialized
firms are called financial services. So any service offered in the nature of finance can be called financial
service to our understanding.
Financial services also mean to provide solutions to the investors and business firms in the area
of mobilization of funds for investment purpose. It also mean offering suggestions to companies and
business firms in the area of capital management.
1.3 SALIENT FEATURES :
Some of the Salient Features of financial services are discussed below: They are -
I. Financial Services are customer based. It is because business firms and institutions who provide
these services will study the needs of various customers while offering these services.
II. Firms which offer these services largely depend upon quality of customer service to ensure
better use of capital for productive investment.
III. Based on the need and understanding of customers these services are offered.
IV. Financial services offered are flexible in nature always depending on market charges.
V. All types of activities which are of financial nature may be regarded as Financial services.
VI. As a result of firms innovations new products and services are emerging in capital market like
merchant banking and Mutual fund services.

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1.4 STRUCTURE OF FINANCIAL SERVICES WITH CHART EXPLAINED BELOW:
Classification of financial services is explained with a chart. The following chart is also called
structural classification of financial services. Financial services can be classified into two types.

Structure or Classification of Financial Services

Insurance and Banking and other

Insurance related Services Financial Services

Life Non-Life Reinsurance Claim Risk

Insurance Insurance Services settlement Management
Services Services services services

Accepted LendingMoney Trading Stock Financial Leasing

of Deposits Services Transmission Service Broking Consultancy and
from Loans and Services - in Services Services Venture
Public Advances Credit and Securities Capital
To Debit Cards Services
Customers & issue & Mutual
Institutions Fund
Services
Classification of financial services as mentioned in the above chart are elaborated below in
detail.
I. INSURANCE AND INSURANCE RELATED SERVICES :
A- LIFE INSURANCE SERVICES – These services form a significant part of financial services,
with the main idea of protecting the life of an individual against premature death or disability and
to provide security for the loss of property, Life Insurance Corporation of India was formed in
January 1956. L.I.C. along with other private insurance companies are extending insurance
services to public and government. Insurance Services provided by Insurance Companies are
useful in sharing the losses of the insured.
B- NON-LIFE INSURANCE SERVICES – Insurance Services are divided into Life Insurance
and Non-Life Insurance Services. The non-life insurance service is the offered by an insurance
company which covers the risk of business activities other than the risk of human life.
C- REINSURANCE SERVICES – Reinsurance service refer to an insurance contract between
two or more companies. While providing this service, the insurance company may allow the
insured to insure the same risk undertaken by him with another insurance company.
D- CLAIM SETTLEMENT SERVICES – The claims settlement service is an important aspect
in insurance services offered to policy holder. The settlement of claim discharges the insurer’s
obligation under the policy agreement with insured. This is an important financial service through
which claim will be settled for payment.

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E- RISK MANAGEMENT SERVICES – No business is free from risk and also investments
involve some form of risk. So some specialized institutions which offer services to customers
against risk management. These services are in the form of advisory services.
II. BANKING AND FINANCIAL SERVICES -
A- ACCEPTANCE OF DEPOSITS – To do banking business commercial banks accepts deposits
from public and pay interest on such deposits. When banks accepts deposits from customers
relationship will arise between bank and customer. Hence bank will have an obligation to extend
services to its customers. These are called customer services offered by a bank.
B- LENDING SERVICES TO CUSTOMERS – Besides customer services banks also provide
lending services by granting various types of loans and advances not only to Bank customers but
also to various institutions including business firms.
C- ISSUE OF DEBIT AND CREDIT CARDS – All commercial banks in the country will offer
Money Transfer services to various customers. A Bank will allow its customer to transfer funds
from one account to other through electronic system. Banks also issue ATM Cards and Credit
Cards to its customers.
D- TRADING SERVICES – Commercial banks also provide another type of service called trading
services like purchase and sale of shares and securities through Demat Account.
E- STOCK BROKING SERVICES – Commercial Bank some times and offer stock broking
services to customers and financial institutions by acting as a buyer broker and Seller’s broker on
behalf of customer for trading of shares in stock exchange market.
F- FINANCIAL CONSULTANCY SERVICES – Commercial banks and specialized companies
will offer financial advisory services in the area of business.
G- LEASING, VENTURE CAPITAL AND MUTUAL FUND SERVICES –
LEASING – One of the major asset financing services prevalent in the industrial sector is
leasing service. A lease is a contract where the owner of an asset (Lessor) grants to another
party (Lessee) the exclusive right to use the asset for an agreed period of time. This type of
service is provided by some industrial firms to other companies.
VENTURE CAPITAL – Venture capital implies long term investment projects with high reward
or with super profits to earn in future. For this purpose some of the companies and firm which
are specialised in the area will offer venture capital services to industries and business firms.
These institutions will supply capital also for taking risk while investing in business.
MUTUAL FUNDS – The efficiency of the financial market largely depends on the existence
of active and efficient financial intermediaries. A mutual fund is a trust that pools the savings of
a number of investors, who share a common financial goal. Mutual funds floated by banks and
companies make investment of such mobilized funds in stock markets and debt markets on
behalf of investors. These are mutual fund services.
1.5 IMPORTANCE OF FINANCIAL SERVICES -
Term lending Institutions and other specialized firms are providing financial services for supply
of funds. These services are required in a developing economy like India because these services also
include capital restructuring of Corporate Companies. The firms which offer these financial services will
also advise public sector companies for portfolio management of funds for profits earning. These services
are also important for risk capital Management. Financial services cover a wide range of activities like
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fund based activities like underwriting of shares and debentures and primary market services like
undertaking of new shares. Financial services also include foreign exchange market activities. These
services include giving guidance to clients in selecting best source of funds for investment. In this way
business firms, industries and Corporate Companies are being benefited from financial services.
1.6 ROLE OF FINANCIAL SYSTEM IN ECONOMIC DEVELOPMENT :
The financial system is the life life of an economy. The economic development of a country is
highly influenced by a well developed and organised financial system. The rate of economic development
largely depends on the proportion of national income saved and invested and the productivity of capital.
Therefore the financial system mobiles savings and make them available for productive and profitable
investment. Mobilisation of savings is done by financial institutions in financial markets through financial
instruments. The major contributors of financial resources are households. The business houses, producers
and government are the main users of funds. The investors require funds for both expansion projects and
working capital requirements.
The financial system provides finance for various sectors which play a vital role in economic
development.
1. Industrial finance is provided for the development of Trade and Industry.
2. Finance is provided to the government to meet the current expenditure as well as development
activities of the nation.
3. Agriculture finance is provided for the conduct of agricultural and allied operations.
4. Development finance is provided to both agriculture and industrial sectors by specialised instutions
and banks.
The Indian financial system performs a major role in the economic development of the country
through savings and investment process. It is, therefore, called as the financial market in India.
1.7 SUMMARY
In a developing economy like India we require mobilization of and investment of capital in various
sectors of economy for rapid development. In India term lending institution, commercial banks and
specialized firms are offering these financial services for capital mobilization and also offering services
like management services. For our understanding we can classify these financial and management
services as follows.
1. Supply of funds for working capital and fixed capital through these services.
2. Restructuring of companies and Industries through these services.
3. Portfolio management services to many corporate companies and banks.
4. Risk capital and venture capital services to many business firms.
In this way the financial services are very essential for overall growth of economy and for the
development of financial system.
1.8 KEY TERMS
1. FINANCIAL SYSTEM - It a net work of financial institution and financial services.
2. FINANCIAL INSTRUMENTS - These instruments includes money market and capital
market instruments.
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 3. FINANCIAL MARKETS - It consists of lenders and borrowers of finance. It is a
market where funds are available for investment as capital.
4. MERCHANT BANKING SERVICES - These services Non-Fund based services.
Merchant banker acts as an intermediatory to transfer capital to investors.
5. MUTUAL FUNDS - These funds are investment institutions. They mobilize funds
from savers and invest them in stock markets.
6. VENTURE CAPITAL SERVICES - It refers to institutional investors who provide
finance to newly started business funds and companies.
1.9 MODEL QUESTIONS
I LONG ANSWER QUESTIONS:
a. Discuss Financial services importance in the context to economic development of a country.
b. Discuss the structure of Indian financial services.
c. Explain the meaning of Financial services and discuss their salient features.
d. What are life insurance services and discuss their importance.
II SHORT ANSWER QUESTIONS:
a. Leasing services concept to explain.
b. Non-Life Insurance services to explain.
c. Mutual fund services advantages.
d. Venture Capital services to explain.
1.10 BOOKS SUGGESTED
1. Dr.A.V.Ranganadhachary - Financial Services – Banking
& Dr. K.Anjaneyulu and Insurance - Kalyani Publishers,
Hyderabad,2009 – Edition.
2. Dr.A.V.Ranganadhachary
& R.R.Paul - Banking and Financial
Systems Kalyani Publishers,
Hyderabd, 2009 – Edition.
3. Sundaram & Varsheney - Banking and Financial
Services Kalyani Publishers, Hyderabad, 2008
– Edition.
4. M.Y.Khan - Indian Financial System
TATA MCGRAW HILL, NEWDELHI–2008-
EDITION.

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 Lesson - 2

FINANCIAL SYSTEM – STRUCTURE OF FINANCIAL

SYSTEM AND FINANCIAL INSTITUTIONS

In this lesson meaning of financial system and its importance in a developing country like India
are explained. Classification of financial system under four groups is discussed. The role of financial
system in the economic development of a country also explained for the advantage of students.
STRUCTURE:
2.1 Introduction
2.2 Meaning of financial system
2.3 Presenting structure of Indian Financial System.
2.4 Financial Institutions role in the system.
2.5 Financial system and economic development.
2.6 Summary
2.7 Important questions in the lesson.
2.8 Glossary
2.9 Additional Readings.
OBJECTIVES :
After studying this lesson you should be able to understand about the following points.
* Components of Financial System
* Financial System Provides finance for Productive investment
* The Structure of Indian Financial system is classified in to 4 parts
* Role of financial system in the economic development of a country
2.1 INTRODUCTION :
The financial system is the life line of the economy, A well developed financial system great by
facilitates over all economic development of a nation. In a developing country like India investment of
capital in the various sectors of the economy is required. Financial system enables all financial institutions
in the country to mobilize savings for investment in financial markets. Financial system supplies finance
to various sectors like agriculture, Industry and for infrastructure development.
2.2 MEANING :
Financial system simply we mean an institutional mechanism to mobilize funds from different
financial institutions. The financial system consists of financial institutions, financial instruments, financial
markets and financial services. The system facilitates transfer of resources from surplus savers to deficit
investors in the economy.

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2.3 STRUCTURE OF INDIAN FINANCIAL SYSTEM :
The financial system in our country comprises of four important components. They are elaborated
with the help of a chart.
I. Financial Institutions
II. Financial Markets
III. Financial Instruments
IV. Financial Services
Financial Institutions : The financial institutions comprise of banking and Non-banking institutions,
development banks, specialised institutions and Non-banking financial intermediaries. All these are called
as financial intermedianes. These are classified into (1) Money market intermediaries and (2) Capital
market intermediaries. Reserve Bank of India, Public Sector banks, Private sector banks, Co-operative
banks and Regional Rural Banks are money market intermediaries. Similarly, Development banks such
as IFCI, IDBI, NABARD, SFCS, SIDBI; Investment institutions such as LIC, GIC, Agriculture Finance
institutions; EXIM bank are functioning as capital market intermediaries.
Financial Markets : These are the markets in which financial assets are created or transferred. Financial
assets represent claims to the payment of money or periodic payment of dividend or interest. These refer
to the institutional tie up for dealing in financial assets and credit instruments such as cash, cheques, bills,
shares, bonds, deposits etc. Financial markets consist of lenders and borrowers of money. Industrial and
Agricultural sectors, service sector, business firms borrows funds from financial markets. The funds that
are borrowed and lend may be either for short or long period.
Financial Services : All activities which are of financial nature are called financial services. These
services are partly fee based and party fund based. The financial services are defined as “activities,
benefits, satisfactions connected with the sale of money that offer to users and customers, financial
related value”. Commercial Banks, merchant banking, mutual funds, Hire purchasing, finance companies,
lease financing companies etc., are extending financial services.
Financial Instruments : These include money market instruments and capital market instruments.
Money market instrument is for short term loans whereas capital market instrument is for long term
loans. Treasury bills, certificate of deposits, Commercial bills and money at call and short notice are
examples of money market instruments. The capital market instruments are Shares, Debentures, Bonds,
Derivative instruments etc.
2.4 FINANCIAL INSTITUTIONS ROLE IN THE FINANCIAL SYSTEM :
The financial institutions are the active players in the financial system. They involve in the
mobilization of funds and in channelising the savings for productive investment. These institutions provide
credit to corporate companies, industries, and Training concerns. They play an important role in the
development of country for the following reasons.
· Supply funds for capital market
· Supply funds for Money Market
· Mobilisation of funds for capital formation
· These institutions are classified as banking and non-banking institutions.
· Intermediary institutions play an important role in the financial system.
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 · Reserve Bank and commercial banks play an active role under the financial system
· These institutions can create money and credit
· L.I.C.
· Investment companies
· Housing Development finance companies and N.H.B.
· Leasing companies
These are the various financial institutions to play an active and catalyst role in the financial
system of the country.
2.5 FINANCIAL SYSTEM AND ECONOMIC DEVELOPMENT :
We have to accept that the economic development of any country depends on well organized
financial system. It is the financial system which provides financial in puts for the production of goods
and services. The system which is well developed and regulated will increase the standard of living of
the people of a country.
In view of the following reasons financial system in a country like ours will play an effective role
for over all growth of the economy.
I. Low Savings
II. Low capital formation
III. Slow investment
IV. Lower infrastructure facilities
V. Low production
VI. Employment generation not encouraging
VII. Low per capita Income of the individual.
A healthy and efficient financial system can constribute to accelerate the growth of various
sectors in the country. It is because the system provides finance through intermediaries for the development
of agricultural sector and industrial sector.
2.6 SUMMARY :
The economic development of a nation can be promoted by the financial system. The financial
system performs the following functions to understand.
A- The system enables financial institutions to transfer financial resources from lenders to borrowers.
B- It provides a channel through which savings flow into capital formation.
The Indian financial system has undergone rapid changes during the last five decades. At
present the financial system in our country is well built and having a net work of financial institutions,
financial markets and financial instruments to mobilize financial resources for overall development of the
Indian economy.

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2.7 IMPORTANT QUESTIONS :
A- LONG ANSWER QUESTIONS
1. Explain importance of financial system in the economic development of a country like India.
2. Discuss the structure of Indian financial system with a chart.
3. Explain the role of financial institutions in a developing country like India.
B- SHORT ANSWER QUESTIONS
1. Financial system concept and meaning
2. Financial instruments to explain
3. Types of financial markets to explain
4. Financial institutions importance
2.8 GLOSSARY :
I. Financial Market – It is the market in which financial assets are created or transferred.
II. Financial Instruments – These instruments are of two types. They are money market and capital
market instruments.
III. Financial Institutions – These institutions deal with money and credit. All banks, non-banking
institutions will come under financial institutions.
2.9 ADDITIONAL READINGS :
I. Sundaram and Varsheney - Banking and Financial Systems Himalaya Publications,
Hyderabad, 2009 Edition.
II. Dr. K.N. Prasad and - Banking and Financial systems
T. Chandra Das S. Chand and Coy, New Delhi, 2009 Edition.

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 Lesson No. 3

FINANCIAL MARKET AND TYPES OF MARKETS

In this lesson definition of Financial Market its importance and classification of financial markets
are elaborated. An attempt is also made to explain the meaning and importance of money market institutions
and capital market institutions for the benefit of students.
STRUCTURE:
3.1 Introduction
3.2 Financial Market Definition
3.3 Importance
3.4 Types of Financial Markets
3.5 Money Market Meaning
3.6 Money Market Institutions
3.7 Capital Market Meaning
3.8 Capital Market Institutions
3.9 Summary
3.10 Glossary
3.11 Model Questions
3.12 Books Suggested

OBJECTIVES:
After carefully following this lesson, you should be able to know about –
* Concept of Financial Market
* Classification of Financial Market
* Money Market Institutions in India
* Capital Market Types.
3.1 INTRODUCTION :
Financial Market is a Center that provide facilities for buying and selling of financial claims and
services. In the market demand will be created for funds by the business firms, agents, brokers, banks
and lenders. In the financial market demand for funds and supply of funds and services will be provided
by various Institutions. Lenders and borrowers in the market are interlinked with communication net
work.

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 Financial market refers to the institutional arrangement for dealing in financial assets and credit
instruments like bills, cheques, bonds, and shares. Business firms, Industries, Marketing Companies, LIC
and Banks actively participate for mobilization of funds in Financial Market.
Financial markets are classified as money markets and capital markets.
3.2 DEFINITION :
A financial market may be defined as the market in which financial assets are created or
transferred. The market refers to the institutional arrangement for dealing in financial assets and credit
instruments such as bills, Government Bonds, Shares and deposits in various banks.
3.3 IMPORTANCE :
Financial markets supply finance to various sectors of the economy like industrial sector, service
sector, Business firms and Corporate Companies for investment of Capital in business activities. In the
market funds are borrowed and lent may be for short period for long period. In the financial market
funds are mobilized in Primary Market and in secondary market also for the development of Industrial
and Service Sectors.
3.4 TYPES OF FINANCIAL MARKETS :
Financial Markets are classified into
1. ORGANISED MARKET
2. UNORGANISED MARKET
1) ORGANISED FINANCIAL MARKET IS DIVIDED INTO
A) MONEY MARKET
B) CAPITAL MARKET
2) Unorganised financial market does not come under the control of Reserve Bank of India.
So markets which are functioning under unorganized sector are not being regulated by
guidelines issued by SEBI and RBI. The unorganised sector consists of indigenous bankers
and money lenders.
3.5 MONEY MARKET MEANING :
Financial markets are functionally divided into (a) Money Market and (b) Capital Market. This
classification is done on the basis of term of credit.
Money Market is a short-term credit market which deals with liquid assets. Liquid assets are
short-term government securities, treasury bills and bills of exchange. So money market always deals in
short-term credit instruments to raise money quickly.
Money Market is the nerve centre of the financial system. Money Market mobilizes savings
from different sources and make them available for investment in business activities.
Functions of Money Market : A well developed money market can perform the following functions
effectively.
(1) It is purely a market for short-term funds. It bridges the gap between the lenders and
borrowers of short-term funds.

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 (2) It provides necessary working capital requirements of agriculture, trade and industry.
(3) It enables the government to raise short-term loans with treasury bill market.
(4) It assists trade and industry by developing a bill market, and acceptance market.
(5) It provides financial assets with a high degree of liquidity.
(6) It is regulated and controlled by Reserve Bank of India.
(7) It helps the central bank in maintaining stability of the value of currency note.
(8) It makes the monetary policy effective.
3.6 MONEY MARKET INSTITUTIONS :
The following are the Money Market Institutions which are playing an active role in mobilization
of short-term funds for investment in business activities.
A) RESERVE BANK OF INDIA – It is considered as Central Bank of the Country. It is the
apex monetary authority of the country. It is considered as Government Bank. It undertakes
major financial operations of the money market. The Reserve Bank is to regulate the monetary
operations and credit system in the money market.
B) COMMERCIAL BANKS – Commercial banks constitute another important part of the
money market. These banks have specialized in providing short-term funds to business
firms in many market. Commercial banks play a key role in providing working capital by
means of cash credit, discounting of bills and promissory notes.
C) CALL MONEY MARKET – This market is considered as an important component of the
money market. Call money represents the amount borrowed by commercial banks from
each other for a short-period to meet their cash reserve needs. The borrower will repay the
principle amount along with interest for the short-period. In the call money market besides
banks LIC, UTI and Co-operative Banks, IDBI, NABARD, are also considered as lenders
and borrowers for short-term funds in the call money market.
D) TREASURY BILL MARKET – Treasury Bills are short-term promissory notes for a
period of 90 days. The Government will borrow money or funds against – Treasury Bills for
short-term financial needs. These bills are issued as a part of public debt operations of Govt.,
of India. They are issued at a discount and therefore do not carry interest payment obligation.
E) COMMERCIAL BILLS MARKET – Commercial bills are nothing but bills of exchange
drawn by the seller on the buyer for the value of goods Bold. Generally these bills are drawn
for 90 days. These bills are considered as liquid assets as they can be discounted in this
market to raise funds. The discounted bills can again be rediscounted in the commercial bill
market at the market - related discount rate. The RBI prescribed the eligibility criteria for
rediscounting commercial bills brought to it. Scheduled commercial banks, select schedule
Co-operative banks, Urban Co-operative banks etc., are approved participents in the market.
3.7 CAPITAL MARKET MEANING :
Capital market refers to all the facilities and institutional arrangements for borrowing and lending
for long term funds or capital market does not deal in capital goods, but it is concerned with the raising of
money capital. It is a market where long term, securities are transacted. It consists of new securities
market and secondary market or stock exchanges.

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 1. Demand for funds comes mainly from manufacturing industries, Government, Corporate
Companies and Private companies – in the Capital Market.
2. Supply of funds in the capital market – Mainly comes from commercial banks, LIC,
Financial Institutions like ICICI, IDBI.
3. So in the Capital market long term capital is supplied for interest to borrowers for
investment as fixed capital in business and also for investment in various sectors of the
economy for development of the economy.
Functions of Capital Markets : Following are the functions and importance of capital markets.
1. Capital markets play an important role in mobilising savings and diverting them as
productive investment. Transferring the financial services from surplus and wasteful
areas to deficit and productive areas. Thus increasing the productivity and prosperity of
the country.
2. The development of capital markets encourage people to save more.
3. The capital market facilitates lending to the businessmen and the government and thus
encourage investment habit among people.
4. The capital markets help investors by advertising security prices, to keep tract of their
investments and channalise them into most profitable level.
5. The capital markets reflect the general economic condition and acclerates the process
of economic growth of the country.
6. The capital markets tend in stabilise the value of stocks and securities and reduce
fluctuations in the prices to the minimum possible extent.
3.8 CAPITAL MARKET INSTITUTIONS :
A brief summary of the structure of Indian Capital Market is explained below.
STRUCTURE OF INDIAN CAPITAL MARKET:
It is divided into FOUR PARTS:
A) GILT-EDGED SECURITIES MARKET:It refers to the market for Government and
non-government securities supported by Reserve Bank. In this market financial transactions
are traded between different types of securities to raise capital.
B) INDUSTRIAL SECURITIES MARKET:
In this market capital is mobilized in the form of shares and debentures issue to public.
This market is divided into TWO PARTS:
1. PRIMARY MARKET OR NEW ISSUES MARKET :
This market supplied fresh capital to the business firms by issuing new shares or debentures.
2. SECONDARY MARKET OR STOCK EXCHANGE :
This market deals with previously issued capital instruments which are bought and sold.

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 Stock exchange is an organization for systematic buying and selling of listed securities. Only
listed securities which can be called shares and debentures are traded on the stock market.
Long term capital is mobilized for business activities in this stock exchange or stock market.
Stock exchange has both Primary and Secondary markets under its control and supervision.
C) DEVELOPMENT BANKS :
Another important part of capital market is the establishment of number of development institutions
which are actively involved in mobilization of capital for investment purpose. These development banks
are also called term-lending institutions.
The Development Banks are as follows:
1. Industrial Development Bank of India – IDBI.
2. Small Industries Development Bank of India – SIDBI.
3. State Finance Corporations – SFCS.
4. Life Insurance Corporation of India – LIC.
5. General Insurance Corporation of India – GIC.
D) FINANCIAL SERVICES:
Financial services also play an important role in capital market. These services are classified as follows:-
1) Merchant banking services.
2) Leasing services.
3) Factoring services.
4) Venture capital services.
5) Mutual Funds investment services.
3.9 SUMMARY :
Financial market mainly deals with financial assets and credit instruments. Financial markets
consist of lenders and borrowers of money for business transactions. Business houses, public limited
companies, private companies and service sector borrow funds from financial markets. Recently many
new financial intermediaries have emerged in Indian Capital Market to accelerate the growth of financial
markets.
NSE : In our country we have National Stock Exchange of India – NSE established in 1993 to bring
reforms in stock exchange markets.
SEBI: As per the recommendations of Narasimham Committee to make all Stock markets to function
more effectively and to have a regulation over stock markets, securities and exchange Board of India
was established in April, 1988.
In a developing country like India there is every need to promote and develop financial markets
in order to mobilize more funds or capital for productive investment in various sectors of the economy.

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3.10 GLOSSARY :
1. ORGANISED MARKET – It is a market where trading activities are systematically Co-
ordinated by the Reserve Bank.
2. UNORGANISED MARKET – In this market indigenous banks and money lenders play an
active role in lending funds. It is called unorganized market because their trading activities are
not regulated and co-ordinated by the Reserve Bank.
3. GOVERNMENT SECURITIES – The term Government securities refers to all government
bonds and treasury bills issued by the Government for the purpose of raising loans in the financial
market.
4. TREASURY BILLS – A treasury bills is a particular type of finance bill or a promissory note
issued by the government to raise short-term loans in the financial market.
5. STOCK EXCHANGE OR MARKET – A stock market is a place where securities (means
shares, debentures and bonds) of various types are openly traded and where one can purchase
and sell these securities for mobilization of funds for business activities.
3.11 MODEL QUESTIONS :
A) LONG ANSWER QUESTIONS :
1. What are financial markets and explain their classification.
2. What is money market and discuss its classification.
(OR) Describe the constituents of Indian Money Market.
3. What is capital market and explain its importance in the Indian Context.
4. What are the constituents of Indian Capital market and explain their role in the financial
market.
SHORT ANSWER QUESTIONS:
1. Financial Market
2. Money Market
3. Capital Market
4. Call Money Market
5. Treasury Bill Market
6. Unorganised Money Market
7. Secondary Market
8. SEBI
3.12 BOOKS SUGGESTED :
1. A.V.Ranganadhachary : Financial Services - Banking and Insurance
and Rudra Saibaba Kalyani Publishers,
and K.Anjaneyulu HYDERABAD-2009.

17
 Lesson - 4

FUNCTIONS OF COMMERCIAL BANKS

INNOVATIONS IN BANKING
In this lesson introduction to banking and recent trends in banking are analysed. An attempt is
also made to motivate every student to understand about functions of commercial banks and innovations
in banking.
STRUCTURE :
4.1 Introduction to banking
4.2 Definitions of bank and meaning of bank
4.3 Functions of a commercial bank
4.4 Innovations in banking
4.5 Summary
4.6 Key Terms used
4.7 Model Questions
4.8 Books suggested
OBJECTIVES :
After reading this lesson, you should be able to understand about.
* Meaning and definition of bank.
* To know about various functions of commercial bank and importance of bank.
* To understand about innovations in banking.
* Describe the Primary functions of bank.
* Narrate the credit creation function of commercial banks.
* Retail banking services.
* To discuss about financial advisory services to customers of bank.
4.1 INTRODUCTION TO BANKING :
In India banking was aged old history. In the past when there are no banks in the Country,
traders used to collect money from the public in order to offer such money to public and small traders for
interest.
The first bank was established in 1157 in Italy as Bank of Venis. Later in 1964 Bank of England
was established in England. In the year 1913 Federal Reserve Bank was established in USA.
In the first half of the 19th Century 3 Presidency Banks were established in India. In 1921 these
3 banks were merged to form as Imperial Bank of India. In July, 1955 after nationalization of Imperial
Bank of India, State Bank of India was established in our Country. Which is considered as largest
Commercial Bank in India.
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4.2 MEANING AND DEFINITIONS OF BANK :
MEANING : A bank is an institution which deals with money and credit. A bank is a financial
institution which creates demand deposits for the purpose of lending to others. A bank is considered as
a financial institution which accepts deposits from the public and make them available to those who are
in need of such funds. Bank provides various types of financial services to its customers.
DEFINITION :
It is difficult to give a precise and general definition of a bank. The word bank has been defined
by several authors in different ways.
For the purpose of our understanding three definitions are discussed below.
I. R.S.SAYERS DEFINITION: “ Bank is an institution which deals with deposits of public and
transferring these deposits from one person to other for the purpose of lending”. Sayers says
banks are not merely traders in money, but also in an important sense manufacturers of money.
II. CROWTHER : An economist defined bank as “Any institution which collects money from
those who have to spare or from those who were saved some money out of their incomes and
lends it to those who require such money as loan”.
III. INDIAN BANKING REGULATION ACT, 1949:
Defines banking as
“A bank means accepting money from public for the purpose of lending or investment of such
money and this money is repayable on demand and withdrawable either by cheque or otherwise by the
public and any institution which does this banking business is called a bank”.
SUMMARY OF THE ABOVE 3 DEFINITIONS:
I. A) According to sayers bank is an institution which deals with deposits of public.
B) Bank transfers these deposits to others for the purpose of lending.
C) Banks are considered as Traders in money because they lend money out of deposits
collected for interest.
II. FROM THE DEFINITION OF CROWTHER IMPORTANT POINTS TO
REMEMBER ARE AS FOLLOWS :
A) Bank means a financial institution.
B) Bank is an institution which mobilizes money from such person who have surplus money
out of their income.
C) Bank is institution which has collected and mobilized money from different persons and
institutions in order to lend such money for interest to those who are in need of it.
III. FROM THE DEFINITION OF INDIAN BANKING REGULATION ACT, 1949, THE
FOLLOWING IMPORTANT POINTS TO UNDERSTAND :
B) Bank is called an institution which accepts money from those persons who are willing to
save and to deposit such money with bank.

19
 C) Bank mobilizes funds or money for the purpose of lending to others and also for investment
purpose. It means bank will invest some of its money I assets in order to earn income.
D) Money which is mobilized from the public will be kept in the form of deposit accounts by
an institution which can be called a bank.
E) There is an obligation on the part of a bank which can be called as liability on the part of
bank to return their money whenever depositors demand.
F) Person or institutions who have deposited money with bank are called customers.
G) Any institution which is involved in the above mentioned activities is called a bank.
H) Any institution which is involved in the above mentioned activities is called a bank that
institution is said to be doing banking business. Hence bank is also called a commercial
bank.
COMMERCIAL BANK FEATURES :
A bank is called a commercial bank because it is involved in doing banking business. A bank
refers to an institution having the following salient features:
i) Bank accepts deposits of the savers.
ii) The deposits are advanced in the form of loans.
iii) A Commercial bank acts as an intermediary between savers and investors.
iv) Bank help for development of Trade and Industry in the country.
v) Bank is a commercial institution so it aims at earning profit.
vi) Bank deals with credit and so it has the ability to create credit for the purpose of lending.
4.3 FUNCTIONS OF COMMERCIAL BANK :
Banks play useful important role in the economic development of a country. Banks have a
control over a large part of the supply in circulation. Banks mobilize the dormant savings of the public in
form of deposits. A Bank accepts deposits of various types and grants loans for a variety of purposes
like Trade, Industry, Agriculture and rural and development.
To our understanding functions of a commercial bank are explained herewith the help of a chart.
These functions are classified into 3 types.

20
 FUNCTIONS OF COMERCIAL BANK

PRIMARY ANCILLIARY NEW BANKING

OR SERVICES
SECONDARY OR INNOVATIONS IN

BANKING SERVICES
OR MODERN FUNCTIONS
Accepting Granting Credit Promoting
Deposits of Loans creation cheque System

Agency Services General Utility

Services
I. PRIMARY FUNCTIONS :
A. Accepting Deposits
B. Granting of Loans
C. Credit Creation
D. Promoting Cheque System
II. ANCILIARY FUNCTION :
A. Agency Functions
B. General Utility functions of services
III. INNOVATIONS IN BANKING OR MODERN FUNCTIONS:
A. Electronic Banking Services
B. Retail Banking services
C. Financial Advisory Services to Customers
4.3 FUNCTIONS OF COMMERCIAL BANKS :
As explained in the chart, functions of a commercial bank are classified into 3 types to our
understanding. These functions are discussed in brief.
I. ACCEPTING DEPOSITS – The first important function of a bank is to accept variety of
deposits from customers such as saving deposit account, recurring deposit account, current
deposit account and fixed deposit account money in fixed deposits is made for a fixed period of
time and cannot be withdrawn before the expiry of that period. High rate of interest is allowed on
fixed desposits. Current deposit accounts are operated by traders or businessmen who want to
make payments almost every day. Generally no intest is allowed on these account balances. The
account holders of current accounts have to pay certain incidential charges to the bank for the

21
 services obtained. Savings deposits account are meant for encouraging thrift and saving habit
among the public. The number of withdrawls and the amount to be withdrawn in a week are
restricted to a given period of time. A nominal rate of interest is allowed on the balance of
savings deposit account. Recurring deposits accounts are created to encourage periodic savings
particularly by the fixed income group. Normally money deposited in these accounts will be for
every month for a stipulated period of 1 year onwards. The amount will be rapid with interest
soon afer the completion of the period. The rate of interest on these deposits is more than
savings deposit account and less than fixed deposit account.
II. GRANTING OR ADVANCING OF LOANS – The second important function of a bank is
advancing of various loans to public. These loans include money at call and short notice, cash
credit, overdraft facility, discounting of bills, term loans, and personal loans including housing
loans to its customers.
III. CREDIT CREATION – A unique function of a bank is to create credit. It means whenever a
bank grants a loan to its customer, it creates an equal amount of bank deposit in the name of
borrower. This process is called credit creation by a bank. The more the capacity of a bank to
sanction loans, the more number of loan accounts can be created in the name of borrowers. This
is all credit creation by a bank to understand.
IV. PROMOTING CHEQUE SYSTEM – Cheque is the most developed credit instrument in the
money market. Banks also create a very useful medium of exchange in the form of cheque.
Through a cheque depositor or customer of a bank direct his bank to make payment to the
payee. In most of the business transactions, cheques are used to set the debts rather than the
use of cash.
II. SECONDARY FUNCTIONS:
In addition to Primary functions commercial banks provide two types of services to customers.
They are
I. AGENCY SERVICES:
On behalf of customers banks provide certain Agency services like
* Remittance of funds on behalf of customers.
* Collection and payment of credit instruments.
* Purchase and sale of securities, bonds and shares on behalf of customers.
* Collection of dividends from shares on behalf of customers.
* Acting as a Trustee on behalf of its customer.
II. GENERAL UTILITY SERVICES :
In addition to agency services, banks provide many general utility services also to customers.
These services are mentioned here.
· Provide locker facility to keep valuables of customers by collecting locker rent.
· Issue of Travellers cheques to customers.
· Issue of letter of credit to Traders, Firms.

22
 · Issue of gift cheques to customers.
· Acting as a reference in order to collect information for customers.
· Banks also deal in the business of foreign currencies by financing foreign trade.
4.4 NEW BANKING SERVICES OR MODERN FUNCTIONS OR INNOVATIONS IN
BANKING :
In addition to primary and secondary functions, commercial banks in the modern global world are
performing new banking services to its customers. These new services are explained below.
After introduction of reforms in banking sector, new technology with core banking facility have
been introduced in banking industry as per the recommendations of C.Rangarajan Committee in July,
1983. Some of the innovations introduced in banking sector are detailed below. Universal banking is the
order of the day. Indian Commercial banks are now resorting to off shore banking.
I. TECHNOLOGY BANKING – INNOVATIONS IN BANKING SERVICES :
It is also called electronic banking. It means the delivery of banking services to a customer by
using electronic delivery channels. Bank transactions relating to a customer will be offered through a
computer by the application of electronic technology. It is any where, any time banking 24 hours in a day
and 7 days in a week.
Let us describe the important aspects electronic banking. Electronic banking comprises of
computersation, telephone banking, automated teller machine, Interent banking etc.
Internet Banking is the latest wave in information technology. Internet banking means any user
with a personal computer and a browser can get connected to his bank’s website to perform any of the
virtual banking functions. It would be a borderless entity permitting anytime, anywhere and any how
banking. Internet banking clients are able to dial into banks and get a number of services through their
desk top computers. The term virtual banking is associated with electronic delivery of services. Virtual
banking means that a customer is not interacting with bank personnel across the counter. Many of the
customers are now using virtual banking which includes credit cards, telephone banking, ATMS and
Electronics clearing services.
Mobile banking is the delivery of bank’s services to customers through cell phone. It takes the
form of SMS banking and wireless application protocall (WAP). Off shore banking is financial
intermediation performed for non-resident borrowers and depositors. Its functions are narrowers but it is
a special category of financial service.
i. To extend better quality of service to customers of bank.
ii. To deliver its services to customers to save time and with low cost of service.
iii. To extend phone banking service or mobile banking services to its customers at any
time at any place.
iv. To enable the customer to use automated teller machine – ATM – services.
v. To provide banking services to customers in unbanked areas through mobile ATM
facility Andhra Bank has introduced this service recently.

23
II. INNOVATIONS IN BANKING ALSO INCLUDE EXTENSION OF RETAIL BANKING
SERVICES TO CUSTOMERS :
A) Telephone and insurance premium payment services on behalf of customer.
B) Facility to customer to open demat account for demating of shares and debentures.
C) Housing Finance facility to customers.
D) Car loan facility to customers.
E) Selling of insurance products to public through bank.
F) Providing consumer product loan.
G) Education loan facility to students.
H) Electronic funds transfer – EFT – Transfer of money from account to other – It is also
called online banking facility.
I) Supply of smaller denomination coins to public through teller machiner – recently introduced
by IOB.
III. FINANCIAL ADVISORY SERVICES TO CUSTOMERS:
Besides retail banking services, banks are providing financial services such as –
A. Helping customers to invest their surplus funds in mutual funds.
B. To help customers to invest their funds in RBI Bonds.
C. To invest funds of various bank customers in bonds of various financial institutions.
D. Providing portifolio management and cash management services to public and firms and companies
in general.
4.5 SUMMARY :
In this lesson, we have studied the functions of banks and also innovations in banking sector. We
have also studied that credit creation is one of the primary functions of the commercial banks. In the
process of accepting deposits and granting loans, bank also create money. Money is created through
lending activity of a bank. Bank deposits are regarded as money. The bank money is as good as cash in
settlement of debts. So banks are manufacturers of money. Bank deposits are of two types. They are
(a) Primary deposits (b) Derivative deposits.
The Indian banking industry is on the threshold of a modernization era with the introduction of
new technology into banking operations. After initiation of reforms, major changes have been taking
place in the Indian commercial banking sector. To cut down the cost of banking services, merger of
banks and electronic banking have been already introduced in banking sector.
All these aspects are discussed in this lesson.
4.6 KEY TERMS USED:
1. PRIMARY DEPOSITS – These deposits are also known as cash deposits. These
deposits are created by banks when cash or cheque is deposited by customers.

24
 2. DERIVATIVE DEPOSITS – These deposits are created by banks when banks lend
money or at the time of granting a loan, these accounts are created in the names of
borrowers.
3. CREDIT CREATION – A unique function of the bank is to create credit. Whenever
a bank grants a loan, it creates an equal amount of deposit. This is also known as
multiple credit creation.
4. ELECTRONIC BANKING – The delivery of bank’s services to a customer at home
by using electronic delivery channels is called electronic banking.
5. ONLINE BANKING (OR) INTERNET BANKING - Customer are provided access
to banks through interest. This is called network banking.
6. ELECTRONIC FUNDS TRANSFER (EFTS) – This is an electronic debit of
customer’s account at the point of goods sales and services – through this system funds
can be transferred from one account to other account.
7. SMART CARD – It is an electronic information carrier system that uses plastic cards.
This card can be used to store personal identification and medical history and Insurance
information of an individual.
4.7 MODEL QUESTIONS:
I. LONG ANSWER QUESTIONS:
A. Describe the functions of commercial banks.
B. Discuss the innovations introduced in banking sector.
C. Define a bank and explain anciliary functions of a bank.
II. SHORT – ANSWER QUESTIONS:
A. Distinguish between primary deposits and derivative deposits.
B. Various types of deposit Accounts to explain.
C. What is credit creation by bank.
D. Differences between ATM Debit card and Credit card.
4.8 BOOKS SUGGESTED :
A.V.Ranganadhachary – Financial Services –
and Banking and Insurance -
R.R. Paul Kalyani Publishers,
HYDERABAD-2009 Edition.

25
 Lesson : 5

RESERVE BANK OF INDIA INTRODUCTION –

FUNCTIONS OF RESERVE BANK – R.B.I. AND
ECONOMIC DEVELOPMENT
In this lesson an introduction to Reserve Bank and its functions are analysed. In the economic
growth of the nation, the role played by Reserve Bank is also touched upon.
STRUCTURE :
5.1 Introduction to Reserve Bank
5.2 Meaning of Reserve Bank
5.3 Objectives and Functions of Reserve Bank
5.4 Monetary Policy and Reserve Bank
5.5 Reserve Bank and Economic Development
5.6 Non-Monetary Functions of R.B.I.
5.7 Summary
5.8 Key terms Used
5.9 Model Questions
5.10 Books suggested

OBJECTIVES :
The Prime Objective of the lesson is to help you to understand regulatory and supervisory
authority of Reserve Bank of India in the banking system. After completing this lesson, you should be
able to review important aspects.
* Introduction to Reserve Bank
* Important functions of Reserve Bank
* Monetary Policy and Reserve Bank of India
* Non-Monetary functions of Reserve Bank
* Reserve Bank Role in Economic Development of a Nation.
5.1 INTRODUCTION :
Today, we could observe there is a Central Bank in each and every country. The Central Bank
plays an important role in the Monetary and bank structure of a nation. It supervises, controls and
26
regulates the activities of banking sector. In olden days, the Central Bank is empowered to issue the
currency notes and to control credit in the country. In every country the Central Bank has the responsibility
of Managing all the economic and monetary affairs.
The first Central Bank in the world was Bike Bank of Sweeden esta blushed in 1656. The
bank of Norway was established in 1817. The Bank of Japan was established in 1882. In every
country it is established with specific objectives.
The Reserve bank of India is our Central Bank. In India the Reserve Bank was established on
April 1, 1935 under R.B.I. Act, 1934, as a private share holders’ Bank. Later it was nationalized on 1st
January, 1949.
So the name of Central Bank differs from country to country. According to De-cock, the
Central Bank being generally recognized as apex of the monetary and banking structure of its country.
5.2 MEANING :
In India the Central Bank of our country which is called Reserve Bank is considered as a
captain of banking industry. It regulates and supervises the entire banking and monetary system of the
country. It performs special functions. It is not a profit seeking institution like commercial banks. The
functions of Reserve Bank are different from a commercial bank. Hence, it is considered as Central
Bank of the country.
5.3 OBJECTIVES AND FUNCTIONS OF RESERVE BANK OF INDIA :
The R.B.I. performs the following objectives and functions :
Objectives : The preamble to the Reserve Bank of India Act, 1934 speaks the objectives of Reserve
Bank as :
1. to regulate the issue of bank notes and the keeping of reserves with a view to securing monetary
stability in India and generally to operate the currency and credit system of the country to its
advantages.
2. to assist the planned process of development of Indian economy.
3. to remain free from political influence and be in successful operation for maintaing financial stability
and credit.
4. to discharge purely central banking functions in the Indian money market i.e., to act as note issue
authority, banker’s bank and banker to government, to promote the growth of economy.
FUNCTIONS :
1. IT ACTS AS A BANK OF NOTE ISSUE
The Reserve Bank has the sole authority to issue currency notes of various denominations in to
circulation under section 22 of R.B.I. Act, 1934. The R.B.I. is having Monopoly Power to issue
currency. All the currency Notes and various denomination coins circulated by Reserve Bank to
all banks in the country are being considered as legal tender money.

27
 The following are the important provisions made under the RBI Act, 1934 regarding the issue of
currency notes by the Reserve Bank :
1. All the notes issued by the RBI are legal tender and are guaranteed by the central government.
2. The issue department of the Bank alone can issue notes of higher denominations.
3. The central government is empowered to demonetise any series of the notes issued by the
RBI.
4. The assets fo the issue department should be completely segregated from those of the Banking
department of the Reserve Bank.
5. No stamp duty is payable by the RBI in respect of notes issued by it.
6. The central government has to circulate rupee coins through the RBI only.
2. SERVING AS A BANKER TO GOVERNMENT –
The Reserve Bank acts as a banker and also as an agent to Central Government and also to
State Governments. The Central and State Governments will conduct their financial operations
through Reserve Bank. The Reserve Bank will grant temporary advances to central and state
governments. Hence it is called banker to Government.
It provides a full range of banking services to state and central government, such as :
1. Maintaing and operating of deposit accounts of the central and state governments.
2. Receipts and collections of payments to the central and state governments.
3. Making payments onbehalf of the central and state governments.
4. Transfer of funds and remittance facilities to the central and state governments.
5. Managing the public debt and the issue of new loans and treasury bills of the central government.
6. The Reserve Bank represents the government of india as member of the I.M.F. and World
Bank.
3. ACTING AS A SUPERVISOR FOR BANK OPERATIONS OF ALL BANKS AND AS
BANKER’S BANK
Reserve Bank will always acts as the leader of all banks in the country. Hence it is considered as
a Captain of banking industry. It helps commercial banks in times of need by granting advances.
All scheduled banks in the country will maintain cash with Reserve Bank. Hence Reserve Bank
is considered as banker’s bank. It also monitors the banking operations of all banks in the
country.
4. ACTS AS A CONTROLLER OF CREDIT –
One of the major functions of Reserve Bank is to regulate and Monitor always money supply in
the economy. The money supply in the economy must be at optimum level, to promote economic
development of the country. For this purpose, Reserve Bank will prepare monetary policy in
order to regulate money supply and credit sanctioned by various banks in the country. It is the
28
 primary function of R.B.I. to supply funds to various sectors of the economy through banks for
balanced regional development of the country.
Credit control measures – In order to control credit Reserve Bank has 2 weapons. There are
called weapons of credit control such as –
I. QUANTITATIVE CREDIT CONTROL WEAPONS OR MEASURES:
A - BANK RATE – It is considered as one of the weapons of Reserve Bank to control and
regulate credit created by banks. Bank rate is the rate at which R.B.I. is prepared to buy or
rediscount bills of exchange or other commercial papers of banks. This is one weapon of
quantitative credit control.
B - OPEN MARKET OPERATIONS – This is another weapon or measure available to the
Reserve Bank. It refers to purchase or sale of commercial paper or bills in the open market by
R.B.I. from banks. So control credit situation this measure will be implemented by R.B.I.
C - VARIATION OF CASH RESERVE RATIO – CRR – This is another weapon of credit
control available to Reserve Bank. Commercial banks in the Country maintain cash reserve
with Reserve Bank. Sometimes to control credit Reserve Bank will change the reserve ratio
of banks. As a result money supply with the banks will be affected. So credit will be regulated.
D - STATUTORY LIQUIDITY RATIO – SLR – This is another credit control weapon to be
used by Reserve Bank in order to regulate volume of credit created by banks in the country.
All scheduled banks in addition to cash reserve, 25 per cent of their net total demand and time
liabilities in the form of cash, gold and Government Securities – RBI has the power to change
the SLR in order to control credit.
The above mentioned weapons or measures are known as quantitative credit control measures.
Besides the above weapons, the Reserve Bank in order to regulate the use of credit, the
following weapons known as selective credit control measures or also known as qualitative credit
control weapons. They are explained below.
II. SELECTIVE CREDIT CONTROL MEASURES:
This measure is a popular technique to be used by Reserve Bank in our Country. To
control inflation and to regulate credit for proper use this weapon is used sometimes.
Selective credit control measures are mentioned below –
A - FIXATION OF MARGIN REQUIREMENTS – The Reserve Bank any prohibit or
caution banks against lending against particular type of securities by prescribing margins. It
means central bank may prescribe margins against secured advances.
B- MORAL PERSUATION – Reserve Bank persuade the banks not to approach bank for
further loans, because such banks already exceeded their limit in borrowing loans and
interest on such loans is over due. If excess money is released in to circulation if may lead
to inflation. So Reserve Bank will persuade banks not to approach for loans in future.

29
 C- DIRECT ACTION AGAINST BANKS – When certain commercial banks pursue an
unsound credit policy or when they borrow excessively, the Reserve Bank may refuse
loans further and sometimes refuse rediscounting facility of bills. In some circumstances
Reserve Bank may charge panel rate of interest on loans from commercial banks. Such a
policy is termed as direct action against banks.
5.4 MONETARY POLICY AND RESERVE BANK :
The Reserve Bank of India is mainly consituted as a apex authority for monetary management.
It primary function is to formulate and administer monetary policy. Monetary policy refers to “the use of
instruments within the control of the central bank to influence the level of aggregate demand for goods
and services by regulation of the money supply and credit.
During the course of planning, the monetary policy of India aimed at the following objectives :
a) To promote savings and top potential savings.
b) To permit growth without any financial impediments.
c) To mobilise savings for capital formation and for growth investment projects.
d) To curb the inflationery spiral. To maintain an appropriate structure of relative prices and general
price stability.
e) To provide extensive credit to cater to the increasing needs of agriculture, trade, industry, commerce
and other productive activities there by promoting overall growth.
f) To provide incentive to investment and, thus, to prepare an investment climate conducive to the
fulfilment of plan objectives.
The monetary policy is basically concerned with the regulation of money supply in the country
and also it is concerned with regulation of interest rates relating to all banks in the country. The Central
government objective is to stabilize the economy with the help of Reserve Bank by framing monetary
policy. The main aim of monetary policy is growth of the economy, to achieve monetary stability in the
economy and also have social Justice. Monetary Policy aims to boost the exports of the country in
order to earn more foreign exchange. Finally Reserve Bank’s monetary policy aim at promoting more
competitive environment and to achieve monetary discipline in the economy for better monetary
management.
5.5 RESERVE BANK AND ECONOMIC DEVELOPMENT:
Besides the normal central banking functions, the Reserve Bank also performs a variety of
Promotional and developmental functions for overall all growth of the economy. Reserve Bank will
play a key role in the developmental Programmes of government.
For rapid development of the economy, Reserve Bank performs a number of developmental
functions as explained below-
1. To economic savings and to supply funds for various sectors of the economy for investment,
Reserve Bank to encourage commercial banks to expand their branches.
2. To promote the process and development of agricultural sector, Reserve Bank will provide
finance through special institutions like NABARD.
30
3. To help and to promote the process of industrialization, Reserve Bank encourages the setting
up of specialized banks which are called development banks in the country.
4. Another developmental functions of Reserve Bank is to encourage export sector in order to
increase exports of the country to earn more foreign exchange reserves. It acts as a custodian
of foreign exchange reserves of the country.
5.6 NON–MONETARY FUNCTIONS :
Role of Reserve Bank in regulating and supervising banks as non-monetary functions explained
below-
The Reserve Bank of India Act, 1934 and Banking Regulations Act, 1949 have given the
R.B.I. wide powers of supervision and control over commercial Banks in the country. To promote
sound banking system, R.B.I. performs certain non-monetary functions such as –
1. The Reserve Bank is empowered to grant licence to a bank to start its banking business.
2. Approval of capital reserves and liquid assets of banks.
3. Reserve Bank is empowered to grant permission to a bank to open its branches.
4. The Reserve Bank is empowered to conduct inspection of commercial banks.
5. The Reserve Bank is having powers to conduct Audit of bank branches.
6. The R.B.I. is playing an active role in making institutional arrangements for providing Training
to the banking personnel to improve their efficiency.
5.7 SUMMARY :
In this lesson we have studied how the Reserve Bank of India performs all the typical functions
of a Central Bank. In addition, Reserve Bank performs a variety of developmental and promotional
functions. The main function of Reserve Bank is to regulate the money market, capital market and to
regulate monetary system of the country which comprises currency, banking and credit systems. The
Reserve Bank plays a key role in the areas of Agricultural Finance, Industrial finance, Export Finance
and Foreign Exchange Management. It also play an important role in promoting banking system for
over all development of the country. The role of Reserve Bank as central Bank of our country is
appreciable.
5.8 KEY TERMS :
1. BANK OF ISSUE – Under section 22 of the R.B.I. Act, the Reserve Bank has the sole right
to issue currency notes of all denominations except one rupee note.
2. MONETARY POLICY – It refers to the policy of Reserve Bank to regulate and control the
volume of money and credit supply.
3. CREDIT CONTROL MEASURES – The Reserve Bank of India has various weapons of
credit control like quantitative and quantitative credit control weapons in order to maintain
monetary stability in the country.
4. BANK RATE – It is the rate at which the Reserve Bank is prepared to buy or rediscount bills
of exchange or commercial papers of the commercial banks.
31
 5. C.R.R. – Commercial banks shall maintain cash reserves with R.B.I. The cash Reserve ratio
can be changed by R.B.I. as and when to control volume of credit.
6. S.L.R. – Scheduled banks will have to maintain in addition to cash Reserve with R.B.I., 25 per
cent of their net total demand and time liabilities in the form of cash, gold, and securities. It is
called statutory liquidity ratio.
5.9 MODEL QUESTIONS :
A- LONG ANSWER QUESTIONS:
1. Discuss the functions of Reserve Bank of India.
2. What are the various weapons of credit control available to R.B.I. and now they are used to
control credit.
3. What is bank rate? What are the effects of changes in bank rate.
4. State the role of Reserve Bank in economic development of a country.
B) SHORT ANSWER QUESTIONS –
1. Explain monetary policy of Reserve Bank.
2. Role of Reserve Bank as Banker’s bank to explain.
3. What are selective credit control measures of R.B.I.
4. Non-monetary functions of Reserve Bank to explain.
5.10 BOOKS SUGGESTED –
1. Maheswari and Paul - Banking and Financial System -
- Himalaya Publications, Hyderabad
2009 Edition.
2. A.V.Ranganadha Chary - Financial Services Banking and
and R. Saibaba Insurance -
Kalyani Publications, Hyderabad, 2009 Edition.

32
 Lesson No: 6

MEANING OF INSURANCE AND RE-INSURANCE,

GLOBALISATION OF INSURANCE AND INSURANCE
SECTOR REFORMS
In this lesson an attempt is Made to explain many aspects relating to insurance, globalization of
insurance and insurance sector reforms.
STRUCTURE:
6.1 Introduction to insurance
6.2 Meaning of Insurance and Re-insurance
6.3 Principles of Insurance
6.4 Kinds of Insurance
6.5 Advantages of insurance and limitations
6.6 Globalisation of Insurance concept
6.7 Benefits of globalization
6.8 Insurance sector reforms and Insurance Laws
6.9 Summary
6.10 Key Terms
6.11 Model Questions
6.12 Books suggested.

OBJECTIVES :
After completing the lesson you should be able to grasp the following points relating to insurance.
* History of Insurance
* Definition of Insurance
* Objectives of Re-insurance
* Insurable interest
* Indemnity
* Subrogation
* Trends in Global Insurance Industry
* Malhotra Committee recommendations of 1993
* Reforms introduced in Insurance Sector in 1990-2000
* IRDA Act, 1993 – features.

33
6.1 INTRODUCTION :
The concept of Insurance is probably as old as of mankind. The concept of insurance is based
on to secure themselves against any loss and disaster existed in men. The idea of insurance is largely a
development of the recent past particularly after industrial revolution. To avert the evil consequences of
fire, blood and loss of life, to have security for life and business, the concept of Insurance was promoted.
Insurance is a form of contract between two parties to make good for a loss or damage.
6.2 MEANING AND DEFINITION OF INSURANCE :
I. MEANING – Every person is exposed to number of risks not only in his life but also with his
business. So he is very much interested to avert such risks. His life and business has to be
protected. Hence the idea of Insurance is based on risk and protection.
II. DEFINITION – The term “insurance is defines as a form of agreement in which one party
agrees in return of a consideration to pay an agreed amount of money to another party to make
good for a loss or damage to property or business or injury to save one by paying some
compensation.”
MEANING AND DEFINITION OF RE-INSURANCE –
MEANING – Re-insurance refers to an insurance contract between two or more companies. In
order to safe guard his interest, a person may insure the same risk undertaken by him
with another insurer. Hence re-insurance means it is the insurance of insurance.
DEFINITION - “It is an arrangement whereby an insurer has accepted an insurance transfer as
a part of the risk to another insurer.”
6.3 PRINCIPLES OF INSURANCE :
Insurance is a contract entered into between two parties. To make the contract valid certain
basic requirements like proposal, acceptance, free consent and consideration are required. Besides these
insurance contract also to fullfil certain fundamental principles which are detailed below:
a) Insurable interest
b) Utmost good faith
c) Indemnity
d) Subrogation
e) Mitigation of loss
a) It is a precondition for a valid contract of Insurance. If insurable interest is not present, the
insurance contract is not valid and cannot be enforced in the Court of Law.
Insurable interest can be defined as the legal right to insure against a financial relationship,
recognised by law, between the insurred and the insurer. The essential features of insurable
interest are : (1) there must be some property right, lift interest which is capable of being insured.
(2) Such property right, life etc., must be the subject matter of insurance. (3) The relationship
between the insured and the insurer must be recognised by law.
b) The insurance contract requires utmost good faith on the part of all the parties concerned. Good
faith refers to absence of fraud on the part of the parties to the contract. In otherwords, a higher
standard of honesty is imposed on parties to an insurance contract rather than an ordinary
commercial contract. This principle has its histrocial roots in marine insurance.
34
 c) Indemnity refers to make good the loss and not more than actual loss suffered by the insured
party. All contracts of Insurance, except life insurance, are the contracts of indemnity. It is
because individual’s life cannot be measured in terms of money. It is an important legal principle,
particularly for property insurance. It has two purposes to prevent the insured from profit from a
loss and to control moral hazards. This principle is not applicable to valued policy loss, life insurance
contracts.
d) It is also known as “Doctrine of Rights Substitution”. It is also called insurer’s right to receive
the benefits due to loss. Under this the insurer settles the claim of the insured and recovers the
same from the third party. The insured is entitled to indemnify but not more than that subrogation
allows the insurer to recoup and profit the insured might make from an insured event.
e) This Principle is based on the point to minimize or decrease the loss. Under this principle, insured
to take all such steps to minimize the loss. It is responsibility of the insured to make a reasonable
effot and take all available precautions to protect the insured property.
Every contract of insurance must satisfy two principles invariably i.e., principle of insurable
interest and principle of utmost good faith. However, life insurance policies are not covered by
idemnity principle. Insurance interest is not measurable. Hence in life insurance there may be
more than one insurance policy.
6.4 KINDS OF INSURANCE :
Non-a-days Insurance has become an integral part of business and human life. Various types of
insurance which are in practice are discussed here. They are three types.
I. On the basis of risk involved – The insurance policies may be classified on the basis of
personal needs, property risks, and liability. The personal insurance needs are based on Life
Insurance Policies and also on personal accident insurance and health insurance.
II. The liability based insurance policies are reinsurance, workmen compensation insurance and
Motor Insurance Policies.
III. On the basis of commercial aspects, the insurance policies are grouped under 3 heads – they
are…
a) General Insurance - Fire and Marine Insurance
b) Life Insurance - Life of person insured
c) Social Insurance - Covers accidents, disablement, old age insurance.
a) General Insurance : Insurance contracts are mainly classified into life insurance and general
insurance (non-life insurance). General insurance contract covers risk of accidents, property damage,
theft, hazards etc. General insurance contracts are for short period and the premium paid is
lumpsumes. General insurance business covers mainly (1) Motor vehicles (2) Fire accident (3)
Marine and Cargo. These contracts are contingent or uncertain and hence may or may not happen.
Therefore every policy need not become a claim. Insured loss is measureable in terms of money.
In case of marine insurance, insurable interest is required only at the time of loss. Average clause
is applicable for payment of claim. All the general insurance companies functioning in India were
nationalised and grouped into four companies as the national insurance company limited, The new
India Assurance company limited, The oriental Insurance company limited, The United India
Insurance Company limited.

35
b) Life Insurance : Among the various insurance contracts life insurance occupies the most important
contract. It is gaining rapid progress and occuping a leading position in the insurance sector. It is a
contract between the insured and the insurer to make good the loss of life that happens to the
former by the later. It is a long period contract and the insured must pay all the premiums periodically.
The liability of the isurer is to pay the sum assured either on death or on maturity which ever is
earlier. Life insurance contract is based on two principles Viz., utmost faith and insurable interest.
Life insurance policy gives financial protection to the dependents of insured family members.
Payment of premium is complusory to keep the policy alive. It acts as a protection to the life and
source of investment.
c) Social Insurance : Social Insurance is an important technique of social security. It is given top
priority by the government as a need for social security, economic security, maintaining standard of
living of the masses keeping in view the changing social scenario. The social insurance has gained
popularity witht he shift of society from agricultural to industrial. It aims to fight against the risk of
disease, old age, industrial accidents, umemployment and evils of poverty. It is made compulsory
for all large industrial undertakings, by the central governments.
6.5 ADVANTAGES OF INSURANCE :
Insurance provides a number of advantages to the common people in the society, traders, business
firms and government. Advantages of Insurance are detailed below:
a) Insurance gives assurance to the insured against risk. The payment of premium by insured to
the insurer to reduce the risk.
b) Insurance helps to distribute the losses of any uncertain events among the large number of
insurers.
c) The insurance company guarantees the insured to compensate the losses if any event happens
in future.
d) Insurance reduces the risk and increases the efficiency in business.
e) Insurance paves the way for expansion of foreign trade because it provides security to exporters
and importers.
f) Insurance encourages common people to go for savings and enable them to save some money
regularly in insurance policies for future risk.
LIMITATIONS OF INSURANCE :
Although insurance provides number of advantages to different people, still it is having the following
limitations – They are….
I. In insurance the loss of one person should be shared by all other policy holders. So return on
investment in insurance is reduced.
II. In insurance after the maturity of the policy, the real value of the money to be received from
the Insurance Company will be very less.
III. In insurance, the insured has to follow number of members, formalities and procedures to
take a policy and also to receive money against the policy.
IV. Insurance business is not attracting rural population and its business confined to urban and
town areas.

36
 Inspite of few limitations, insurance concept has become popular even during 18th century. In
the year 1870 first Indian Life Insurance Company was established in Bombay. Later Bharat Insurance
Company was also established in the year 1896. The Swadeshi movement of 1905-07 gave rise to the
establishment of more Insurance companies in our country. Insurance is gaining momentum. Mankind
is exposed to many serious perils including premature death. So insurance will protect and safeguard
against any peril or unforeseen incident to an individual or to business.
6.6 GLOBALISATION OF INSURANCE SECTOR :
NEW TRENDS IN INSURANCE INDUSTRY OR SECTOR :
Since 1990 onwards many radical changes have taken place across the globe in Insurance
industry. As a result the following trends have been witnessed in insurance sector in many countries
including India.
CENTRALISATION PROCESS –
This process started in India also for merging Insurance and re-insurance companies with insurance
credit rating companies and mergers between small and medium insurance companies also taken place.
TRADITIONAL SERVICES MODERNISED –
With the globalization of Insurance sector, traditional services of insurance company have been
modified, in order to extend better quality services to policy holders.
NEW PRODUCTS –
Due to globalization trend, new insurance products have been introduced in to the Insurance
Market.
FACTORS RESPONSIBLE FOR GLOBALISATION :
The insurance system is believed to have existed during the ancient India with the indication that
Rigveda included the word YOGASHAM – which means insurance. As such insurance is believed to
have its origin from 1000 B.C. Later during 18th century British Insurance Companies opened their
business in India. In the year 1896 Bharat Insurance Company have been setup. In 20th Century
General Insurance Company was set up. Afterwards some more Insurance Companies like New India
Assurance Company Limited and Oriental Insurance Company Limited were also established in Insurance
Sector during 1970s.
The first two decades of the Twentieth Century could see a lot of growth in insurance business.
Everything has changed according to the need of the time. Many changes have been witnessed
in insurance sector after 1991. In India liberalization, privatization and globalization have become the 3
concepts to bring changes in the development of insurance industry.
As a result of these changes in our economy, mergers and integration foreign companies with
Indian Insurance Companies have taken place. Now insurance sector is globalised for better future.
6.7 BENEFITS OF GLOBALISATION :
The globalization of insurance industry has helped the industry to extend its fruits to public in
general and also to Government in particular. The following are some of the benefits –
A- GROWTH IN BUSINESS – As a result of globalization, the insurance sector has witnessed a
rapid growth of insurance business since a decade.

37
B- BENEFIT TO MIDDLE CLASS – In many countries including India, after the introduction
of many new products, middle class families are being encouraged to save their surplus in insurance
policies.
C- STABILITY AND EFFECTIVE MANAGEMENT OF INDUSTRY – As a result of
globalization of Insurance industry, many changes have come in the management of the industry
and also moving towards stability.
D- FREE FLOW OF MANAGERIAL TALENT – Globalization has resulted in free flow of
managerial talent into industry because of mergers and competition from other insurance
companies.
6. 8 INSURANCE SECTOR REFORMS :
Our country felt the need of a comprehensive legislation on Insurance during 1930 and due to
mismanagement of some Insurance companies. So the Government of India introduced Insurance Act,
1938 in order to provide supervision with accountability over the operations of Insurance companies.
REFORMS DURING 1990-2000 – In order to introduce reforms in insurance sector, Malhotra
Committee was constituted in the year 1973. The Committee has reviewed the working of insurance
industry in our country.
MALHOTRA COMMITTEE RECOMMENDATIONS:
a) To permit private companies to enter into insurance industry.
b) Permitting foreign companies to enter into industry for joint venture business.
c) Setting up of an insurance regulatory body to control and supervise the insurance industry and
make the insurance industry an independent one.
The Government respond positively to the above recommendations of the committee and
accordingly Insurance Regulatory and Development Authority Act, 1999 was passed in parliament.
This IRDA has helped to develop the insurance market in India.
INSURANCE LAWS IN 2004 – The introduced Insurance Loans in 2004 as part of insurance
sector reforms. The following are some of the important points relating Insurance Amendments Bill of
2004 are explained here –
a) The bill seeks to increase the investment of Private companies in insurance sector
from 26% to 49%.
b) Bill allows general insurance companies to raise funds from capital market.
c) Bill permits foreign insurers to open their branches in India.
INSURANCE LAWS IN 2008:- To introduce reforms in insurance industry Insurance Law Amendments
Bill of 2008 was introduced in Parliament – Important points of the Bill 2008 are explained below:
a) The bill provides insurance companies to raise new capital through new instruments.
b) The bill enables LIC and general insurance companies as self-regulatory bodies.
c) The bill gives the responsibility of appointing insurance agent by the insurers and IRDA
would regulate their procedure.

38
6. 9 SUMMARY
Insurance is a method of securing protection against future calamities and uncertainties. The
history of Insurance is as old as the history of mankind.
The Insurance has become an integral part of business and human life. Various kinds of insurance
policies are based on risks involved, commercial aspects, and sum assured for the policy. So depending
on the type of policy, insurance premium to be paid is fixed.
Reinsurance refers to an insurance contract between two or more companies.
Insurance is an integral part of financial services. The globalization impact during 1999-2000 on
insurance sector enabled Private and foreign companies to enter into insurance sector for the issue of
new insurance products to policy holders. Insurance helps all policyholders in sharing losses. So insurance
is a risk-sharing pla for the future.
6.10 KEY TERMS :
INSURABLE INTEREST – For a valid contract of insurance between insurer and insured, insurable
interest is the base for issue of Insurance Policy.
UTMOST GOOD FAITH – The insurance contract is based an mutual faith of insurer and insured
which is called utmost good faith.
PROXIMATE CAUSE – It is a latin word which means for immediate cause. While determining the
liability of the insurer, the proximate cause for loss is considered.
INSURER – The party who agrees to pay the money as premium. Insurer is a risk bearer.
INSURED OR ASSURED – The party who seeks protection against a risk and who agrees to pay
premium is called insured. The insured receives money from insurer.
SUM ASSURED – It is nothing but insured amount it is called also face value of the policy.
MARKET ENVIRONMENT – It refers to changes occurred in insurance industry. Due to globalization
market environment in insurance sector is totally changed.
IRDA ACT, 1999 – Insurance Regulatory and Development Authority Act was passed in 1999 in
Parliament in order to regulate and supervise the activities of business of insurance companies.
6.11 MODEL QUESTIONS –
I LONG ANSWER QUESTIONS.
A. Explain the meaning of insurance and discuss the principles of insurance.
B. Discuss the advantages and limitations of insurance.
C. Explain the concept of globalization of insurance and what are the benefits of globalization.
D. Explain the impact of reforms introduced in insurance sector the growth of insurance market.
II SHORT FOR ANSWER QUESTIONS
A. Define insurance and Re-insurance.
B. What is insurable interest.

39
C. Distinguish between insurer and insured.
D. What is subrogation.
E. Malhotra Committee on insurance sector reforms.
6.12 BOOKS SUGGESTED -
1. A.V.Ranganadhachaya and - Financial Services
K.Anjaneyulu Banking and Insurance, Kalyani Publishers,
Hyderabad – 2010 Edition.
2. Maheswari and Paul - Banking and Financial Systems
- Kalyani Publishes, Hyderabad-2010 Edition.

40
 UNIT - II

As a student of banking, one should familiarize with frame work of banking systems one has
to understand about the functioning of different banks in our country.

LESSON 7 : Types of banking systems and banking sector reforms along with
prudential norms are discussed.

LESSON 8 : Innovation in Banking and Electronic Banking Offshore Banking explained

in detail.

LESSON 9 : Regional Rural Bank concept and functions and co-operative Bank
meaning and features are elaborated.

LESSON 10 : Priority Sector Advances and Micro Finance in India discussed.

LESSON 11 : Indigenous Bankers - Role of Indigenous Bankers in Economy is

explained.

LESSON 12 : NABARD functions, Development Bank concept and functions are

explained.

41
 Lesson No. : 7

BANKING SYSTEMS – BANKING SECTOR REFORMS

AND PRUDENTIAL NORMS FOR BANKS
The objectives of the present lesson is to explain about types of banking systems, introduction to
banking sector reforms and Narasimham Committee recommendations are also discussed along with
prudential norms for banks as suggested by Narasimham Committee in 1991.
STRUCTURE
7.1 Introduction
7.2 Different concepts of banking systems.
7.3 Branch bank system advantages and disadvantages.
7.4 Unit banking system advantages and disadvantages.
7.5 Structure of commercial banking system in India elaborated with chart.
7.6 Banking sector reforms in India and Narasimham Committee recommendations relating
to 1991 and 1998.
7.7 Prudential Norms suggested for banks.
7.8 Meaning of NPAs
7.9 Causes for Non-Performing Assets
7.10 Summary
7.11 Key Terms
7.12 Model Questions
7.13 Books suggested.

OBJECTIVES
After reading this lesson you should be able to understand about….
* Different banking systems.
* Structure of Indian banking system.
* Banking sector reforms and Narasimham Committee report issued in November, 1991.
* Prudential norms required for banks as suggested by Narasimham Committee.
7.1 INTRODUCTION :
Different countries adopt different banking systems. Various types of banking systems which
are popular are…
a) Branch banking
b) Unit banking
c) Group banking
42
 d) Chain banking
e) Deposit banking
f) Mixed banking system
Each banking system has its own merits and demerits. The structure of commercial banking system
comprises of public sector and private sector works, scheduled and non-scheduled banks, foreign banks,
Regional Rural banks and development banks. This lesson is devoted to describe the measures undertaken
to liberalize banking sector. The measures introduced in banking sector are the outcome of the
recommendations of Narasimham Committee on financial sector in 1991. The developments that have
taken place in the banking sector because of reforms measures are discussed here. In order to restore
the financial health of commercial banks in India and the balance sheets of all banks are to reflect the
actual financial position of a bank, certain prudential norms are necessary for banks to follow. It means
classification of assets and provisioning for bad debts on prudential basis is required as suggested by the
committee.
7.2 DIFFERENT TYPES OF BANKING SYSTEMS :
Each country adopts its own banking system according to its economic conditions. Various types
of banking systems are mentioned here.
A- BRANCH BANKING SYSTEM – Under branch banking system, a big bank as a single
institution and under single ownership operates through a net work of many branches all over the
country. This is called branch banking system. In the process of evolution, banking organisation
developed in the form of branch banking with a network of branches spread throught out the
length & breath of the country.
B- UNIT BANKING SYSTEM - Under this system an individual bank operates its banking
activities through a single office. It is quite contrary to branch banking system in the area of
operation and size. The area of operation is restricted to a limited place. An independent unit
bank is a corporation that operates one office and that is not related to other banks either in
ownership or control.
C- GROUP BANKING – It refers to the system of banking in which two or more banks are
directly controlled by a corporation of under a business trust. The holding company may be a
banking company or a non-banking company. Each bank maintains its separate identity by the
whole business is managed by the holding company.
D- CHAIN BANKING – It is another form of group banking. It refers to the system in which two
or more banks are brought under common control by a single person or group of persons through
stock ownership or otherwise. This system combines the merits of branch banking and unit
banking systems.
E- DEPOSIT BANKING - Commercial banks generally do deposit banking under this banking
system, banks mobilize financial resources from savers by opening deposit accounts for short
periods mostly less than 3 years. The funds so mobilised are lent to trade, commerce and industry
for short periods in the form of overdraft cash credit and bill discounted etc., Thus the system of
banking accpeting deposits and lending for short periods is called deposit banking.
F- MIXED BANKING – Under this system – banks provide short term and long term loans to
industry. Banks raise funds by floating shares and bonds from Public. Mixed banks accept both
short term and long term deposits and provides funds for both short term and long term credits to
industry. Thus they minimise risks involved in investment banking. It is therefore is a mixture of
deposits investment banking.
43
7.3 BRANCH BANKING SYSTEM ADVANTAGES AND DISADVANTAGES :
On the basis of organization and scale of operations, banking systems can be divided into two.
They are Branch banking system and unit banking system.
The banking system of England offers the best example for branch banking. System. The big
five banks in England control about seventy five per cent of the banking operations in England. In the
same way India also adopted branch banking system for conducting bank operations. So banking business
is performed by branch banking system only in India.
ADVANTAGES –
The following are the advantages of branch banking system.
1. Economies of large scale operations – under branch banking the bank with a number of branches
can have a huge financial resources and can enjoy the benefits of large scale operations like
division of labour can be introduced in all branches. Under branch banking highly trained and
experienced staff can be appointed to increase the efficiency of management of a branch.
2. Spreading of risk – Under branch banking diversification of risk is possible. The losses of one
branch may be offset by the profits earned by other branches.
3. With minimum cash reserves – Under branch banking a branch of any bank can keep minimum
cash reserves. In times of need resources can be transferred from one branch to other branch.
4. Diversification of Deposits and Assets – This is one added advantage in branch banking system
because of wider geographical coverage of branches.
5. Uniform interest rates – Under branch banking system, mobility of capital increases uniform
interest rates prevails in all branches of a particular bank.
6. Banking facilities in unbanked areas – under branch banking facilities can be offered to backward
and unbanked areas by opening new branches.
DISADVANTAGES –
The following are the main disadvantages and also can be called as limitations of branch banking
system.
1. Problem of management – under branch banking supervision and management problems may
arise because of number of branches.
2. No independent decision making – Under branch banking independent decisions cannot be taken
at branch level. So delay in administration of certain matters.
3. Inefficient branches – under this system uneconomical and inefficient branches may continue to
operate.
7.4 UNIT BANKING SYSTEM ADVANTAGES AND DISADVANTAGES :
Under unit banking system, one individual bank operates and controlled by a single office. So the
area of banking operations is smaller under this banking system. Branches will not opened under this
system unlike in the case of branch banking. The unit banking system had its origin in America under
Federal banking laws.

44
ADVANTAGES –
Unit banking system has the following advantages.
1. Local development – This system encourages local development. Funds are not transferred to
other areas under this system local area branch can concentrate on the development of particular
local area.
2. Easy management – The management and supervision of a unit bank is much easier and more
effective.
3. Promotes regional balance – under this system there is no transfer of funds from rural and
backward areas to other centres. Hence this concept reduces regional imbalances.
4. No protection to inefficient branches – under this banking system no protection to weak branches
and inefficient and unprofitable branches will be eliminated.
DISADVANTAGES –
1. Under this system banking operations are highly localized so no diversification of risks.
2. Under unit banking system very few branches will function, so banks restrict their ability to face
financial crisis.
3. A unit bank has no branches at other places. As a result transfer of funds from one unit bank to
other is not possible in case of any difficulty.
BANKING SYSTEM SUITABLE TO INDIA :
In India still about 70 per cent of the population lives in rural areas. Large volume of savings are
dormant in small villages. So mobilize those savings and to make them available for investment branch
net work of various banks is absolutely necessary in India. Through branch banking system only expansion
of branches of different banks in unbanked areas is possible. So for a developing country like India,
branch banking system is adoptable. Unit banking system is not suitable to our country.
7.5 STRUCTURE OF COMMERCIAL BANKING SYSTEM IN INDIA :
The origin and growth of commercial banking in India makes an interesting reading. Its origin
began in India in 1770 with the establishment of first joint stock bank called Bank of Hindustan in Kolkata.
Another major development in the history of Indian banking was the establishment of State Bank of India
as a commercial bank in July 1955 by nationalizing Imperial Bank of India.
Indian Commercial Banks are operating in both rural and urban areas.
The banking structure in India comprises of public and private Sector banks, scheduled and non-
scheduled banks, private banks and also foreign banks functioning in our country. There regional banks
operating in rural India. The local area banks are functioning in rural and semi-urban areas. Foreign
banks are confined to cities and ports located places.
Nearly 80% of the total banking business is covered by 28 public sector banks with a branch net
work of 70% earning a profit of 76%. The new private sector banks such as ICICI Bank, Axis Bank,
RRB’s have a wide spread branch network forming 22% of the total branches earning 6% of the profits.
There are 52 urban co-operative banks and 16 state Co-operative banks are also working as scheduled
banks. The old private sector banks are with a branch network of 7.5% earning about 9.8% of the total
profits.

45
 The structure of Indian commercial banking is shown in the following chart.
COMMERCIAL BANKING STRUCTURE
Reserve Bank of India
(is also called Central Bank)

Public Sector Private Foreign RRBs Development

Banks (28) Sector(29) Banks(29) (133) Banks

SBI and its Nationalised Scheduled Non-scheduled

Associate Banks (20) Banks(87) Banks (29)
Banks (8)

7.6 BANKING SECTOR REFORMS IN INDIA :

Indian banking made rapid changes in the post nationalization period. Banking sector has made
remarkable progress in branch expansion of banks after July, 1969. Despite this commendable
achievement, there had been a decline in productivity and efficiency of banks and profitability of some
banks have been reduced. In the light of these undesirable developments in the banking sector, the
Government of India set up Narasimham Committee in 1991 to suggest various measures to reform the
banking industry.
NARASIMHAM COMMITTEE IN 1991 :
The Government of India under the chairmanship of
Sri M. Narasimham, former governor of R.B.I. along with 9 members constituted a committee to examine
the structure and functioning of financial system of India and to suggest reforms of financial sector.
The committee submitted its report in November 1991. Recommendations of the committee are
mentioned here :
Objectives of the Committee :
1. To examine the existing structure of the financial system and its different components.
2. To make recommendations for improving the efficiency and effectiveness of the system with
special reference to economy of operations, accountability, profitability and competitiveness in the
system.
3. To review the existing supervisory arrangements relating to the various entities in the financial
sector and make recommendations for ensuring appropriate and effective supervision.

46
4. To review the existing legislative frame work and to suggest necessary amendments for implementing
the recommendations.
The main object of the committee is to examine the financial health of the Public sector banks
and other financial institutions and also to study the existing structure of financial system. The
recommendations of the committee can be grouped under 3 heads.
I. Relating to commercial banks
II. Relating to financial institutions.
III. Relating to money and capital markets.
BANKING SECTOR REFORMS –
The committee recommended the following reforms in banking sector for its healthy growth.
1. The Government should stop the practice of using statutory liquidity ratio as a measure for
mobilizing resource to meet deficit.
2. The Structure of interest rates be deregulated according to market forces.
3. To increase the efficiency of banks, some of the public sector banks be merged to reduce
the number of banks.
4. Reserve Bank should be alone to regulate banking system but not Ministry of Finance.
5. Banks and financial institutions should achieve a minimum of 4 percent capital adequacy
ratio.
6. Present branch licensing policy of RBI be abolished.
COMMITTEE FOR BANKING SECTOR REFORMS IN 1998 :
The Government of India once again appointed a committee in 1998 under the chairmanship of
Sri M. Narasimham to recommend reforms in the Indian banking sector. The committee submitted its
report to government in April, 1998.
The important recommendations are as follows -
1. To close unhealthy banks and merger of weak banks with strong banks.
2. Private Banks should be allowed to enter into baking industry.
3. When non-performing Assets (NPAs) are more in a weak bank, bank should not invests
resources in risky business.
4. Modernization and computerization of Bank branches to extend better quality customer services.
7.7 PRUDENTIAL NORMS FOR BANKS :
The Narasimham Committee in its report in 1991 recommended certain prudential norms for
classification of assets and Provision for bad debts be made very cautiously basing on norms. The
committee suggested that income on loans should be recognized on recovery basis. Assets of a bank be
classified as standard and sub-standard. And for sub-standard assets 20 to 50 percent provision be
made. The committee also suggested that every bank should created Asset Reconstruction Fund.
These are some of the Prudential norms as recommended by the Committee in its report in 1991.

47
 NON-PERFORMING ASSETS (NPA)
Introduction :
Granting of credit for economic activities is the prime duty of banking. A part from raising
resources through fresh deposits, borrowings and recycling of funds received back from borrowers
constitute a major part of funding credit dispensation activity. Lending is generally encouraged because
it has the effect of funds being transferred from the system to productive purposes, which results into
economic growth. However lending also carries a risk called credit risk, which arises from the failure of
borrower. Non-recovery of loans along with interest forms a major hurdle in the process of credit cycle.
Thus, these loan losses affect the bank profitability on a large scale. Though complete elimination of such
losses is not possible, but banks can always aim to keep the losses at a low level.
Non-performing Assets (NPA) has emerged since over a decade as an alarming threat to the
banking industry in our country sending distressing signals on the sustainability and endurability of the
affected banks. The positive results of the chain of measures affected under banking reforms by the
Government of India and RBI in terms of the two Narasimhan Committee Reports in this contemporary
period have been neutralized by the ill effects of this surging threat. Despite various correctional steps
administered to solve and end this problem, concrete results are eluding. It is a sweeping and all pervasive
virus confronted universally on banking and financial institutions. The severity of the problem is however
actually suffered by National Banks, followed by the SBI group, and the all India Financial Institutions.
7.8 Meaning of NPAs
An assets is classified as Non-performing Assets (NPA) if due in the form of principal and
interest are not paid by the borrower for a period of 180 days. However with effect from March 2004,
default status would be given to borrower if dues are not paid for 90 days. If any advance or credit
facilities granted by banks to a borrower becomes non-performing, then the bank will have to treat all the
advances / credit facilities granted to that borrower as non-performing without having any regard to the
fact that there may still exist certain advances / credit facilities having performing status.
Though the term NPA connotes a financial asset of a commercial bank, which has stopped
earning an expected reasonable return, it is also a reflection of the productivity of the unit, firm, concern,
industry and nation where that asset is idling. Viewed with this perspective, the NPA is a result of an
environment that prevents it from performing up to expected levels.
The definition of NPAs in Indian context is certainly more liberal with two quarters norm being
applied for classification of such assets. The RBI is moving over to one-quarter norm from 2004 onwards.
Magnitude of NPAs
In India, the NPAs that are considered to be at higher levels than those in other countries have of
late, attracted the attention of public. The Indian Banking system had acquired a large quantum of NPAs,
which can be termed as legacy NPAs.
A distinction is often made between Gross NPA and Net NPA. Net NPA is obtained by deducting
items like interest due but not recovered, part payment received and keep in suspense account etc., from
Gross NPA.
Dealing with NPA is involves two sets of policies
1. Relating to existing NPAs
2. To reduce fresh NPA generation.

48
 As far as old NPAs are concerned, a bank can remove it on its own or sell the assets to AMC to
clean up its balance sheet. For preventing fresh NPAs, the bank itself should adopt proper policies.
7.9 Causes for Non Performing Assets
A strong banking sector is important for a flourishing economy. The failure of the banking sector
may have an adverse impact on other sectors. The Indian banking system, which was operating in a
closed economy, now faces the challenges of an open economy.
On one hand a protected environment ensured that banks never needed to develop sophisticated
treasury operations and Assets Liability Management skills.
On the other hand a combination of directed lending and social banking relegated profitability and
competitiveness to the background. The net result was unsustainable NPAs and consequently a higher
effective cost of banking services.
One of the main causes of NPAs into banking sector is the directed loans system under which
commercial banks are required a prescribed percentage of their credit (40%) to priority sectors. As of
today nearly 7 percent of Gross NPAs are locked up in ‘hard-core’ doubtful and loss assets, accumulated
over the years.
The problem India faces is not lack of strict prudential norms but
i) The legal impediments and time consuming nature of asset disposal proposal.
ii) Postponement of problem in order to show higher earnings.
iii) Manipulation of debtors using political influence.
Macro Perspective Behind NPAs
A lot of practical problems have been found in Indian banks, especially in public sector banks.
For examples, the government of India had given a massive wavier of Rs. 15,000 Crs. under the Prime
Minister ship of Mr.V.P.Singh, for rural debt during 1989-90. This was not a unique incident in India and
left a negative impression on the payer of the loan.
Poverty elevation programs like IRDP, RREP, SUME, SEPUP, JRY, PMRY etc., failed on
various grounds in meeting their objectives. The huge amoung of loan granted under these schemes were
totally unrecoverable by banks due to political manipulations, misuse of funds and non-reliability of target
audience of these sections. Loans given by banks are their assets and as repayment of several of the
loans were poor, the quality of these assets were steadily deteriorating. Credit allocation became ‘Lon
Melas’, loan proposal evaluations were slack and as a result repayment were very poor.
There are several reasons for an account become NPA.
* Internal factors
* External factors
Internal Factors :
1. Funds borrowed for a particular purpose but not use for the said purpose.
2. Project not completed in time.
3. Poor recovery of receivables.
4. Excess capacities created on non-economic costs.
49
5. In-ability of the corporated to raise capital through the issue of equity or other debt instrument
from capital markets.
6. Business failures.
7. Diversion of funds for expansion / modernization / setting up new projects / helping or promoting
sister concerns.
8. Willful defaults, sophoning of funds, fraud, disputes, management disputes, mis-appropriation etc.,
9. Deficiencies on the part of the bank viz. in credit appraisal, monitoring and follow-ups, delay in
settlement of payments / subsidiaries by government bodies etc.,
External factors :
1. Sluggish legal system
Long legal tangles
Changes that had taken place in labour laws
Lack of sincere effort.
2. Scarcity of raw material, power and other resources.
3. Industrial recession.
4. Shortage of raw material, raw material / input price escalation, power shortage, industrial recession,
excess capacity, natural calamities like floods, accidents.
5. Failures, non payment / over dues in other countries, recession in other countries, externalization
problems, adverse exchange rates etc.
6. Government policies like excise duty changes, Import duty changes etc.,
Causes for an Account becoming NPA
Those Attributable to Borrower
Causes Attributable to Banks
Other Causes
a) Failure to bring in Required capital
b) Too ambitious project
c) Longer gestation period
d) Unwanted Expenses
e) Over trading
f) Imbalances of inventories
g) Lack of proper planning
h) Dependence on single customers
i) Lack of expertise
j) Improve working Capital Mgmt.
k) Mis management

50
l) Lack of expertise
m) Poor Quality Management
n) Heavy borrowings
o) Poor Credit Collection
p) Lack of Quality control
a) Wrong selection of borrower
b) Poor Credit appraisal
c) Unhelpful in supervision
d) Tough stand on issues
e) Too inflexible attitude
f) Systems overloaded
g) Non inspection of units
h) Lack of motivation
i) Delay in sanction
j) Lack of trained staff
k) Lack of delegation of work
l) Sudden credit squeeze by banks
m) Lack of commitment to recovery
n) Lack of technical, personnel & zeal to
a) Lack of Infrastructure
b) Fast chaning technology
d) Un helpful attitude of Government
e) Increase in material cost
f) Government policies
g) Credit policies
h) Taxation laws
i) Civil commotion
j) Political hostility
k) Sluggish legal system
l) Changes related to Banking amendment act.
7.10 SUMMARY :
In this lesson we have discussed various types of banking systems. Each country adopts its own
banking system to perform its banking operations. India witnessed a number of bank failures during
1950’s when there were small banks operating in our country. In the process of revolution in banking
industry after 1969, we are moving forward towards branch banking system. Branch banking system is
more suitable to Indian conditions. A comparison between unit banking and branch banking is essentially
a comparison between small scale and large scale operations. A bank having more branches always
enjoys more advantages when compares to a unit bank.
We have also analyzed points relating to banking sector reforms in this lesson. To address the
issue relating to financial system and to enable the system to play an active role in mobilizing resources

51
for productive investment, a high level committee was constituted under the guidance of Sri M. Narsimham
to examine all aspects relating to structure, organization, functions and procedures of the financial system
in order to introduce reforms in financial sector.
7.11 KEY TERMS
Financial System - It consists of financial institutions, financial markets, financial instruments
and financial services. It is the life time of the Economy.
Banking structure - It included various types of commercial banks functioning in the country.
Banking sector reforms - It means to introduce innovative changes in the system for healthy
performance.
Prudential Norms - In order to generate more income from various assets of a bank, certain
Principles have to be followed which are called norms.
Capital adequacy - It is the ratio of Capital funds in relation to deposits or assets of bank.
7.12 MODEL QUESTIONS :
A Essay type questions.
1. Explain the advantages and disadvantages of branch banking system.
2. Distinguish between unit and branch banking concepts and which system is suitable to India.
3. Discuss the major recommendations of Narasimham Committee on banking sector reforms.
B Short Answer questions.
1. Unit Banking system
2. Branch Banking system
3. Chain Banking
4. Mixed Banking
5. Capital adequacy ratio
6. Prudential norms for banks.
7.13 BOOKS SUGGESTED :
1. Sundaram and varshney - Banking Theory and Practice
2. Vasant Desai - Indian Banking System
3. A.V.Ranganadhachary - Financial Services
And Saibaba Banking Insurance

52
 Lesson No. : 8

INNOVATIONS IN BANKING

STRUCTURE
8.1 Introduction
8.2 Diversification in Banking
8.3 E-Commerce
8.4 Internet Banking
8.5 Steps to do Net Banking
8.6 ATM
8.7 Credit Cards / Debit Cards
8.8 Difference between Credit Cards and Debit Cards
8.9 Off - Shore Banking
8.10 Summary
8.11 Self Assesment Question
8.12 Further Readings

8.1 Introduction :
Commercial banks have found in course of time that traditional lending operations have not been
bringing adequate profits. This is mainly because of narrow lending margins, regulated interest rates, loan
defaults and rescheduling. In their search for new profitable avenues of business, international banks
since 1981, have started diversifying into bond and capital market operations. In India too this trend is
evident. Some of the leading banks in India have been trying to diversify their business in such areas as
merchant banking, leasing, mutual funds. housing finance, consumer credit cards etc. A few banks have
set up subsidiaries to undertake merchant banking, leasing and mutual funds business. Such diversification
of business caused blurring of boundaries between money capital and banking markets.
8.2 Diversification in Banking :
The Government of India issued guidelines to the banks under Section 6 of the Banking Regulation
Act permitting and encouraging them to diversity their function.
1. Merchant Banking and Underwriting : Commercial banks have now setup merchant banking
division and are underwriting new issues, especially conclusion of deferred payment agreements
between Indian industrial in the and foreign firms. Formerly, banks provided merchant banking
services only to a few known companies. But now, they have floated separate subsidiaries and
offer wider services to a large clientele.

53
2. Mutual Funds : Some banks have now been permitted to float subsidiaries such as mutual funds
(at one time, mutual fund operations were a monopoly of Unit Trust of India). In all, seven public
sector banks have set up mutual funds and have floated as many as 30 schemes so far.
iii) Hire - Purchase Credit : Hire-Purchase means purchase of goods on the basis installments.
Hire-Purchase credit or installment credit refers to term loans provided for the purchase of consumer
goods, services and some items producer goods. These loans are repaid in installment during the
specified period. In India, here-purchase finance is provided by the retail and wholesale traders,
specialized here-purchase finance companies, commercial banks, and financial institutions.
iv) Venture Capital Funds : One public sector bank subsidiary and one foreign bank have launched
venture capital funds (VCF). The purpose of VCF is to provide equity capital for pilot plants,
attempting commercial application of indigenous technology and adaptation of previously, imported
technology to domestic conditions. The Government of India has issued detailed guidelines and
procedures for the establishment of VCF, management structure, size and investment of the fund
etc.
v) Factoring Service : Finally, some public sector banks have set-up separate subsidiaries exclusively
for undertaking factoring services. Factoring is a new type of service which banks can provide. It
is device by which book debts are quickly realized through outright sale of account receivables to
a financial intermediary (or a bank’s subsidiary) called for ‘factor’. The RBI has already accepted
factoring in principle and banks are permitted float subsidiaries to take up factoring.
vi) Technology upgradation : In the last decade or so, the Indian banking industry has made great
strides in technology up gradation. For instance, electronic funds transfer (EFT) is available in all
major cities of the country. RBI is now considering a proposal to commence national electronic
funds transfer with a view to extending benefits of EFT to all locations in the country.
8.3 E-Commerce :
The propelling force towards inspiration - E-Banking is the emergence of Electronic Commerce
(E-Commerce). The genesis of E-Commerce lies in the upcoming knowledge - based Industrial Revolution
in the new era of the Information Age - which is characterized by the extensive use of global communication
networks facilitated by the development of the Internet and the Information super highways.
E-Commerce essentially is the paperless exchange of business information spread through
computer devices such as Electronic Data Inter change (EDI), E-Mail, Electronic Bulleting - in short, the
tools such as Internet and extranets created under the network - based technologies are employed.
E-Commerce is an innovative approach to commerce is an innovative approach to commercial
exploitation by moving the business organizations to a fully electronic environment of the Information
Age, in conducting the business through networks. Under the E-Commerce, it is velocity of information
processing and dissemination that plays a major role in determining the speed and growth of business
transactions. So far, electronic data interchange (EDI), is the major application in conducting electronic
commerce. The EDI is used to electronically transmit business documents such as purchase orders,
invoices, shipping vouchers, receiving advices and allied business correspondence among the trading
partners. E-Commerce is a boon the to new business era in streamlining procedures, efficiency and
improving productivity.
In short, EDI and E-Commerce in the upcoming century will radically change the mode and
methods of conducting business and commerce world over. Business communities in the developing
countries have to be ready to face the emerging challenges and grab the opportunities by acquiring
necessary skills and knowledge.

54
 When the business and commerce tend to be the electronics modes, banking can never remain
isolated. When E-Commerce refers to carrying on business transaction electronically, it covers any form
of business. Hence, E-banking implies performing basic banking transactions by the customers round the
clock globally through electronic media. Modern banking is more information based, speedy and boundary
less due to the impact of E-Revolution. Modern banks have to be well-versed in information Technology,
its users and application Banking divisions have to be based on E-Banking is knowledge - based and
mostly scientific in using electronic devices to become internet working organizations, banking has to be
E-Banking in the new century.
Today’s banking is virtual banking. Virtual banking denotes the provision of banking and other
related services through the extensive use of IT, without direct resource to the bank by the customers.
The salient features of virtual banking are deliver banking services to the customers. The principle types
of virtual banking services include Automated Teller Machines (ATM’s), shared cards, stored value
cards, phone banking, home banking, internet banking. Thus, the practice of banking has undergone a
significant transformation due to the adoption of banking.
8.4 Internet Banking :
Internet banking is the latest wave in information technology. It is another electronic delivery
channel. In simple terms internet banking means any user with a personal computer and a browser can
get connected to his bank’s Website to be perform any of the virtual banking functions (electronic delivery
of services). There is no human operator present in a remote location to respond to his needs in telelphone
banking. The bank has a centralized database that is web-enabled all the services that the bank has
permitted on the internet are displayed in menu. Any service can be selected and further interaction is
dictated by the nature of service. The traditional branch model of bank is now giving place to an alternative
delivery channel with ATM network once the branch offices of bank are interconnected through Satellite
links, there would no physical identify for any branch. It would a borderless entity permitting anytime, any
where and anyhow banking.
The basic goal of banks is to create connectivity between each and every branch of the bank.
The network which connects the various locations and gives connectivity to the central office within the
organization is called intranet. These networks are limited to organizations for which they are set up.
These intranets can be connected to other intranets forming internet.
Internet based online banking service is to aid dissemination and sharing of information in a
closed group aiding better and faster flow. Intranet eliminates duplication of databases and inconsistencies
thereof. There is centralized data which the users can download and find out what they want. SWIFT is
a live example of intranet application. The contribution of Indian banks to SWIFT is negligible.
With electronic banking, clients are able to dial into banks and get host of requests serviced
through their desktop computers. For the client, it means direct and immediate access to his account in
the bank, without having to physically visit the branch. They can transmit message, all from their homes
or offices. For banks, the administration cost are lesser.
The quality, range and price of these electronic services decides a bank’s competitive position in
industry. Technology banking helps banks in four major ways: (1) to handle a greatly expanded customer
base (2) to reduce the real cost of handling payments (3) to liberate banks from the traditional constraints
on time and place and (4) to introduce new products and services.
8.5 Steps to do Net Banking :
The procedure for transacting net banking Business is as follows :

55
Step 1 : Tye the website address of you bank in the address bar of one’s browser and the bank
website appears on the screen.
Step 2 : Go the net banking login icon on the Right hand top of the bank, website screen and click on
“login”. Now a new window pops up, which is the login screen for net banking.
Step 3 : Enter the customer ID number and password in the relevant boxes on the Login screen.
Step 4 : Click ‘ok’ now, one will be ready to transact the business.
Step 5 : There be links to proceed further, For e.g. Consumer Banking Depository Services etc. If
one has to transact regular banking business then he has to click on consumer banking. For
Demat details, one has to click on Depository Services.
Step 6 : For further Assistance, one has to click the help menu in the net banking area.
8.6 ATM
ATM means Automated Teller Machine. This machine is designed to perform the most important
function of bank, i.e. provision of cash facilities. ATM is operated by plastic card with its special features.
The plastic card is replacing cheque, personal attendance of the customer, banking hours restrictions and
paper based verification. These are debit cards. ATMs are used as spring board for Electronic Fund
Transfer (FFT). Point or Sale (POS) has taken many functions performed by cashiers - ATM itself can
provide information about customer’s account and also receive instructions from customers - ATM
cardholders. An ATM is an EFT terminal capable of handling bills. It may be on-line or off-line. The on-
line the facilities are confined to that particular ATM assigned. Any customer possessing ATM card
issued by the Shared Payment Network System (network of ATMs) can go to any ATM linked to SPNs
and perform his transactions.
ATMs are established in important places by a bank in cities and important towns. The Indian
Railways gave a mandate 3 to 10 leading banks to host ATMs at Railway stations.
Banks in India realized the need for ATM inter-change deals to keep their overheads under
check. Under ATM inter-change, customers of one bank are offered unlimited free access to other
bank’s ATM network.
Indian banks are moving in the direction of shared ATM’s. A group of 5 nationalised banks led by
the Bank of India launched cash shared ATM network ‘Cash Tree’. Others are Indian Bank, Syndicate
Bank, United Bank of India and Union Bank of India. Similarly, Andhra Bank ties up with IDBI bank for
creating a shared ATM Network. The State Bank of India and associates tied up with three major private
sector banks - ICICI, HDFC and UTI Banks. This would create the largest domestic ATM network. The
SBI - ICICI Bank tie up will give access to the combined network of 3973 ATMs spread over 600
centers in the country.
ATM usage in India is growing at 300 per cent and still the ATM density in relation to population
stands at a mere 4 ATMs per million population (by the beginning of 2002) as against 60 for China, 731
for USA and 1132 for Japan.
The essential difference between the Credit Card and ATM Card is that the former offers
facility as the name suggest, whereas the latter in a networked environment allows the account of the
cardholder to be directly debited.
8.7 Credit Cards / Debit Cards :
The Credit Card holder is empowered to spend wherever and whenever he wants with his
Credit Card within the limits fixed by his bank. Credit Card is a post paid card.
56
 Debit Card, on the other hand, is a prepaid card with some stored value. Every time a person
uses this card, the business house gets money transferred to its account from the bank of the buyer. The
Buyers account is debited with the exact amount of purchases.
An individual has to open an account with the issuing bank which gives a debit card with a
Personal identification Number (PIN). When he makes a purchase, he enters his PIN on shop’s PIN
Pad. When the card is striped through the electronic terminal, it dials the acquiring bank system - either
Master Card or VISA that validates the PIN and finds out from the issuing bank whether to accept or
decline the transactions. The customer can never overspend because the system rejects any transaction
which exceeds the balance in his account. The bank never faces a default because the amount spend is
debited immediately from the customer’s account.
Smart Card, It looks very much like a traditional credit card with one major exception. There is
a micro-processor unit or chips added to the current magnetics stripes. The micro processor or chip is
capable of holding lot of information. They hold a large amount of personal information from medical and
health history to personal banking and personal preferences. Smart card combines the features of both
credit as well as debit card. It can be used to buy goods and services, pay bills, access information and
perform many other functions. There is Relationship based smart card which is an extension of the
existing card. It provides additional services which include access to multiple accounts such as debit,
credit, investment or store value for E-Cash, like payment, balance enquiry.
8.8 Difference between Credit Card and Debit Card :
a) The credit card is a pay later product, whereas a debit card is ‘pay now product’.
b) In the case of credit card the holder can avail of credit for 30 to 45 days, whereas in a debit card
the customer’s account is debited immediately.
c) No sophisticated telecommunication system is required in a credit card business. The debit card
programme requires installation of sophisticated communication network.
d) Opening a bank account and marinating a required amount are not essential in a credit card. A
bank account and keeping a required amount to the extent or transaction are essential in a debit
card system.
e) Possibility of risk of fraud is high in a credit card. The risk is minized through Personal Identification
Number (PIN) in debit card programme.
8.9 Off-Shore Banking :
The banking confined primarily to non-resident lenders and borrowers is called off shore banking.
In other words, it is a kind of financial intermediation performed purely for non-resident depositors and
borrowers. The main advantages for an off shore banking centre is the minium regulations and Government
control in addition to low taxes. In recent years, many of shore banking centers have come up, either to
serve worldwide in the case of primary centers or to serve limited area as in the case of booking, funding
and collections centers.
Off shore banking generally refers to carrying out banking business by Indian banks abroad. But
due to IT revolution, the banking business is become either web-enabled or increasing its reliance on
common networks. So, banks are able the SWIFT network. SWIFT is the Society for World wide
Interbank Financial Telecommunication Network and it is used for the transmission and receipt of all
international financial messages by member banks and financial institutions.

57
 Again, off-shore banking is also carried out by establishing corresponding arrangements with
major banks, spread over all the important countries. Moreover banks maintain NOSTRO accounts in
foreign currencies, to facilitate cross-boards transactions effectively. The variety of services generally
offered under this category are :
i) issue of documentary and other letters of credit
ii) issue of guarantees on behalf of customers
iii) dealing in treasury - based derivative products
iv) dealing in forward contracts and interest rate swaps.
8.10 Summary :
Business world today is getting closer and compact. E-Banking is a major step towards building
a global village. The internet and world wide web (W W W) offer unlimited opportunities to transform
the conduct of banking business in due of time. Banking transactions on Internet can be convenient, easy,
speedy and widespread. With electronic banking approach, a local bank can become global overnight.
Now E-Banking is gigantic. It calls the widom to execute. E-banking characterizes smart banking.
E-Banking captures the benefits of E-Commerce for successful E-Banking. Bankers need to develop a
coherent perspective of the role of network technologies and advancement of their internal EFT -
departments with a competitive introspection of their banking business.
8.11 Self Assessment Questions
1. Short Questions
1. Electronic Banking
2. Credit Cards
3. Debit Cards
4. E-Commerce
II. Essay Questions
1. What is ATM? What are its benefits to bank customers?
2. Describe innovations in commercial Banking in India.
3. What is net Banking? Explain the Steps to do Net Banking
8.12 Further Readings :
1. Mithani & Gordon - Banking and Financial Systems
2. Vasant Desai - Indian Banking

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 Lesson No. : 9

REGIONAL RURAL BANK – CONCEPT AND ITS

FUNCTIONS – CO-OPERATIVE BANKING –
STRUCTURE OF CO-OPERATIVE BANKING SYSTEM

An attempt is made in this lesson to familarise the student with origin and concept of Regional
Rural Bank, its functions and problems of RRB’s and also meaning of co-operative bank, its functions
are discussed in detail.
STRUCTURE :
9.1 Introduction to RRBs.
9.2 Meaning and origin of RRBs and objectives
9.3 Functions of RRBs.
9.4 Problems faced by RRBs and remedial measures.
9.5 Introduction to co-operative Banking
9.6 Meaning of Co-operative Bank
9.7 Differences between Co-operative and Commercial Banks
9.8 Structure of Co-operative Banking system
9.9 Weaknesses of Co-operative Banking
9.10 Suggestions for improvement of co-operative system
9.11 Summary
9.12 Key words used
9.13 Model questions
9.14 Books suggested.

OBJECTIVES :
After completing this lesson you should be able to come to know about…..
* Analyse the concept and need of the rural banking.
* Multiagency approach.
* Functions of RRBs.
* Meaning and History of Co-operative banking in India.
* Structure of Co-operative Credit Institutions.
* Differences between Co-operative and commercial banks.
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9.1 INTRODUCTION TO REGIONAL RURAL BANKS :
A country like India which lives in villages requires the extension of banking facilities to rural
areas. The Reserve Bank appointed the All India Rural Credit Survey Committee to evaluate the co-
operative credit structure and make recommendations for strengthening rural credit structure. The
committee realized that co-operatives have miserably failed to provide meaningful credit to rural farmers.
So the government appointed a committee under the chairmanship of Sri M. Narasimham to examine
the need for another agency for rural development. The government accepted this recommendation and
an ordinance was issued in September, 1975 for the establishment of Regional Rural Banks in the country.
Accordingly RRB Act was passed in parliament in 1975 for the establishment Regional Rural Banks.
The main objective of these RRBs is to strengthen the rural economy by extending credit to agriculture,
trace and other productive activities particularly in rural areas.
9.2 MEANING AND ORIGIN :
The Banking Commission in 1969 under the chairmanship of R.G. Saraiya recommended the
setting up of rural bank as the commercial banks are not in a position to cater to the needs of rural people.
A regional rural bank is also a scheduled commercial bank. This bank grants loans and advances only to
small and marginal farmers and to rural artisans. Every RRB is sponsored by a particular public sector
bank for banking operations. The main purpose of these Regional Rural Banks is to develop the rural
economy by providing credit and other facilities to agriculture, Trade commerce and industry and such
other productive activities.
During 1970s, the Government of India announced 20-Point economic programme. One of the
important points of the programme was the liquidation of rural indebtedness of marginal and small farmers
in rural areas.
The Nominal capital of Regional Rural Bank will be Rs.5 crores and the subscribed and paid up
capital would be Rs.1 crore. of which the central govt., will contribute 50%, the maining 50% will be
contributed by the state govt., and the sponsoring bank @ 15% and 35% respectively. The shares in
Regional Rural Banks will be treated as trustee securities.
Objectives of Regional Rural Banks : The main objectives of the Regional Rural Banks are summarised
as under.
1. To provide credit and other facilities to small farmers, agricultural labourers and other weaker
sections of the rural India.
2. To provide employment opportunities
3. To fulfill the rural business aims and social responsibilities.
4. To develop rural economic activities particularly agriculture sector.
5. To protect the rural masses from the clutches of money lenders in taking credit.
6. To provide liberal credit to meet the increasing needs of suppressed and depressed class of people
in rural areas.
9.3 FUNCTIONS – The RRBs Perform The Following Functions as mentioned here –
1. To provide credit facilities to agricultural sector, particularly to small and marginal farmers and
agricultural labourers.
2. These banks to promote the welfare of economically backward sections of the society.

60
 3. They help rural artisans and small entrepreneurs in rural areas by extending credit facilities.
4. These banks also mobilize deposits from rural people.
5. They help small business units and village level societies by providing credit.
6. To develop rural economy, these banks supply credit for the establishment of small industries in
villages.
9. 4 A – PROBLEMS OF RRBs and Remedial measures :
1. The Main problem of RRBs is recovery of loan amount from borrowers. So over dues against
loans increasing.
2. Many RRBs are running in losses because of overhead expenditure and reduced lending rates
of interest.
3. It has been observed that the efficiency of bank staff provided by sponsor bank is low and
inadequate man power.
4. These banks are facing competition from other commercial banks in banking business.
5. Lower interest rates, credit facilities available only to certain sections of society etc., are the
hurdles for their earning capacity.
6. Lack of adequate infrastructure facilities and experienced staff in rural areas.
7. Regional Rural Banks are facing the problem of delayed decision making as they are being
controlled by many agencies.
8. They are facing problems to secure deposits because rich farmers are not served by them.
Remedial measures for the problems of RRBs :
1. The unique role of RRBs in providing credit facilities to weaker sections in the village must be
preserved. The RRBs should be as rural banks of the rural poor.
2. The state Govt., should also take keen interest in the development and growth of RRBs.
3. There should be a clear cut planning for the scope of the activities of RRBs Co-operatives and
commercial banks in the rural areas as they are the competitors.
4. Local staff may be appointed in RRBs as far as possible inorder to strengthen the local stand.
5. The RRBs should strongly be linked with the sponsoring scheduled commercial banks and the
Reserve Bank of India.
6. Participation of local people in the equity share capital of the RRBs should be allowed and
encouraged.
7. The RRBs must strengthen effective credit system by way of credit apprisal, monitoring the
progress of loans and their efficient recovery.
8. The credit policy of the RRBs should be based on the group approach of financing of rural
activities.
9. The RRBs may relax their procedures for lending and make them easy for the village borrowers.
10. The RRBs should increase their consumption of loans to the villagers and weakers sections.
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B- EVALUATION OF RRBs BY NARASIMHAM COMMITTEE –
In 1991 the Narasimham Committee has evaluated the functioning of RRBs in the country. The
Committee felt that these banks have fared well in their objectives but loans recovery position is not
satisfactory. Hence many of these banks incurring losses, the committee observed. These banks are not
financial viable, on account of low earning capacity of these banks in rural areas.
9.5 INTRODUCTION TO CO-OPERATIVE BANKING –
The Co-operative movement was started in India in 1940 to relieve the farmers from the clutches
of the money lenders and to provide adequate credit at low interest rates. In India agricultural credit is
available mostly from indigenous bankers, Co-operative societies and land development banks. Co-operative
Banking concept is based on equality for some common purpose of all members. Basing on the equality
and for the promotion of the economic interest Co-operative society is formed.
The Co-operative society or institution has a three tier structure, such A. Primary Co-operative
credit societies. B. Co-operative banks. C. State Co-operative Banks.
9.6 MEANING OF CO-OPERATIVE BANK AND ITS NEED :
Co-operative Bank is an institution established on Co-operative basis for mutual help of members
and dealing in ordinary Banking business.
The Co-operative credit movement was launched in India in 1904. The Co-operative Credit
Societies Act, 1904 has ushered in Co-operative Credit system in our country. D.R.GADGIL Considered
Co-operative Banking as a great instrument to help the poor to improve their economic conditions through
self – help. Co-operative Banking system in India consists of rural and urban Co-operative Banks.
9.7 Differences between Co-operative banks and commercial Banks.
In the organised sector of the Indian money market, Co-operative Banks and commercial Banks
do exist and perform the functions of banking. But there are certain differences in performing banking
functions. The differences are -
1. Co-operative Banks are governed by Co-operative Societies Act, 1980 and Commercial Banks
are governed by Banking Regulation Act, 1949.
2. Co-operative Banks mostly supply credit to agriculturists in rural areas but commercial Banks
supply long term credit to industry, Trade commerce including priority sectors.
3. Co-operative Banks offer slightly higher rate of interest to depositors but commercial Banks
offer less rate of interest to depositors.
4. In Co-operative Banks members will have voting powers in commercial banks depositors do not
have such voting powers.
5. Co-operative Banking does not operate on large scale but commercial Banks do have large
branch banking network for its operations.
9.8 STRUCTURE OF CO-OPERATIVE BANKING IN INDIA :
In India Co-operative banking system represents a three - tier structure consisting as.
1. PRIMARY AGRICULTURAL CREDIT SOCIETIES (PACS) :
These are at the base of the Co-operative credit structure of the country. In rural areas these
PACS cater to the short, medium term credit needs of the farmers. These societies supply credit
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 directly to farmers in villages. These societies raise funds by way of share capital, membership
fee and deposits from members and non-members. These PACS borrow funds from District
Central Co-operative Banks.
2. DISTRICT CENTRAL CO-OPERATIVE BANKS (DCB)
For every district DCB is established. All Primary Agricultural Credit Societies will be members of
District Central Co-operative Bank. Individuals also won be members the District Co-operative
Bank. These Banks also accept deposits from public. These Banks mobilize funds share capital from
members of public, loans and advances from commercial banks and also from State Co-operative
Bank. These banks provides financial assistance to Primary Co-operative Societies. These banks
grant loans to members, small traders and provide remittance facilities to Primary Co-operative
Societies besides supervising their functioning.
3. STATE CO-OPERATIVE CENTRAL BANK (SCB)
In every state there will be a State Co-operative Central Bank. All the District Co-operative Banks
will be its members. The Reserve Bank contributes nearly 50 percent of the working capital of the
State Co-operative Banks. These Banks occupy a unique position in the Co-operative credit structure
because of their FOUR important functions. They are elaborated below.
1. These banks participate in rural finance through Reserve Bank which supplies Credit to these
State Co-operative Banks.
2. These State Level Banks supply surplus funds to district level banks to enable them to finance
rural credit.
3. These State Level Banks finance, control and supervise the Central Co-operative Banks and
also through them Primary Credit Societies.
4. These State Level banks provide 75 percent of its funds for agricultural purposes for short
period.
Besides the three tier structure we could also observe the under mentioned banks functioning in
our country to supply credit to farmers.
A. LAND DEVELOPMENT BANK –
Farmers need long-term credit also besides short-term loans. Long-term credit is required to buy
equipment like pump sets, Tractors, seeds, menures besides for reclamation of land and for
digging of new bore wells for agricultural purpose. In order to meet these long-term needs of
agriculturists, long-term credit is supplied by these land development banks. The working capital
of these banks is derived from share capital, deposits from members, issue of debentures and
borrowings from other banks. These banks sanction loans against 50 per cent of the value of
land mortgaged with these banks by farmers.
B . NON-AGRICULTURAL CREDIT CO-OPERATIVE SOCIETIES
In rural areas and taluk level members form in to the one group establish Co-operative marketing
societies only for the marketing of agricultural products. Several cottage and small industries
also organize these Co-operative credit societies to help among themselves for procurement and
transportation of products.
9. 9 WEEKNESSES OF CO-OPERATIVE BANKING IN INDIA :
Various Committees and commissions who have studies and reviewed the working of Co-operative
Banking system have pointed out a member of draw backs in the syste. The major draw backs are
mentioned below nor our understanding.
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 1. According to survey 55 per cent of rural households are still not covered under the Co-operative
credit system in India.
2. The all India rural credit review committee pointed out that primary credit societies in villages
are financially weak and hence unable to meet the credit needs of rural farmers.
3. The Banking commission, 1972 has pointed out that in rural areas majority of borrowers are
unable to provide the required security for the loan amount.
‘4. It has been pointed out that many PACS are running at loss in rural areas. And not in a position
to supply credit.
5. A serious problem pointed out by many commissions is overdue loans of Co-operative institutions
and so bad debts are increasing considerably year by year.
9.10 SUGGESTIONS FOR EFFECTIVE CO-OPERATIVE BANKING SYSTEM –
We suggest the following points for effective functioning of Co-operative Banks in our country.
They are –
1. The financial resources of the Co-operative should be strengthened.
2. The Primary Co-operative credit societies at rural level should be more viable economically
strong to supply credit to small farmers.
3. The liability of the members of the Primary Co-operative Societies be limited to their investment
of share capital.
4. Loans sanctioned to formers at rural level should be for productive purposes only.
5. Agricultural inputs like fertilizers, seeds, pumpsets should be supplied by Co-operatives Societies
in rural areas.
6. Credit facility and marketing of agricultural products should be integrated for the benefit of rural
farmers.
9.11 SUMMARY :
Regional Rural Banks are considered as low cost institutions aim at providing alternative credit facilities
to rural population especially to low income group of rural farmers. These banks extend credit facilities
to small and marginal farmers. Regional rural Bank is also authorized to carry on and transact Banking
business Just as that of commercial Bank. In June 1977, the RBI had appointed a committee known as
Dantawala Committee to review the working RRBs in India. The committee had the following findings in
its report submitted in February, 1978.
A. The RRBs should function as intermediary banks to bridge the credit gap.
B . The Commercial Banks to Co-ordinate with RRBs to supply credit in rural areas.
C. The RRBs should be allowed to provide full working facilities in rural areas.
D. The Procedures for sanction of loans be simplified.
More credit is necessary for farmers of India. Rural credit that is being supplied by commercial
Banks to rural farmers, artisans is not sufficient. So Co-operative credit is more easily accessible to the
rural population through Co-operative Banking system in our country. These Co-operative Banks at
various levels have been working to supply small credit to small farmers and others for agriculture
purpose.
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9.12 KEY WORDS USED :
Regional Rural Bank - A Bank that extends Banking facilities to rural areas.
Regional disparities - Uneven development between different regions in the country
Viability of a bank - Financial soundness of as work for the supply of funds.
Co-operative Banking - To mobilize savings to encourage the habit of thrift and self - help.
9. 13 MODEL QUESTIONS :
ESSAY QUSTIONS –
1. What are the main functions of regional Rural Banks and explain their role in the supply of credit
needs of rural sector.
2. Discuss the problems of RRBs and give your suggestions to solve them.
3. Describe the structure of Co-operative Banking system in the country.
4. Explain the weaknesses of Co-operative Banking and suggestions for improvement.
SHORT ANSWER QUSTIONS :
1. Meaning of Regional Rural Bank
2. Concept of Co-operative banking
3. Dantawala Committee findings on RRBs in brief.
4. What are land Development Bank.
5. Non – agricultural Co-operative Societies to explain.
9.14 BOOKS SUGGESTED.
Vasant Desai - Indian Banking.
A.V. Ranganadhachari - Banking and Financial system.

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 Lesson No. : 10

PRIORITY SECTOR ADVANCE & MICRO FINANCE

STRUCTURE
10.1 Introduction
10.2 Meaning and Definitions of Micro Finance
10.3 Micro Finance Services
10.4 Scope of Micro Finance
10.5 Features of Micro Finance
10.6 Micro Financial Service Providers
10.7 Approaches of Micro Financing
10.8 Priority Sector Advances
10.9 Summary
10.10 Self Assessment Question
10.11 Further Readings

OBJECTIVE :
After Studying this lesson you should be able to understand the following points
* Micro Finance Meaning
* Scope and Features of Micro Finance
* Different approaches of Micro Finance
* Priority Sector

10.1 Introduction :
Over the years, Micro Finance (MF) as a financial service innovation is fast emerging as an
important method of bettering the loet of the poor and the downtrodden. In fact, micro finance has
become a subject of interest in the recent past especially in the context of reaching the poorest families
in a more effective way. For a country like India, where substantial number of population is poor, access
to credit facility is not only necessary but also indipensable for optimizing their contribution to the growth
of national economy.
The existing rural credit system in India has failed to live up to the expectations of development
of the poorer sections of the society. Empirical evidences bear sufficient testimony to this. Further, the
banking system too has failed to deliver when it comes to meeting the needs of the weaker sections of
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the society especially the women. Therefore, an effective credit delivery mechanism, which could ensure
credit delivery in a sustainable manner, has become necessity. Such a mechanism would ultimately work
for the removal of poverty and the development of women in the society.
Credit for poverty alleviation depends on the productive use of capital that is made available to
the poor. It is the lack of efficient use of capital that keeps the poor in perpetual poverty trap. It is in this
context that the role of micro financing assumes significance. Micro financing through intervention,
enhances the capacity to generate income, savings, investment and employment. Micro Finance program
offers the surest ways by which to make best use of the scare development funds to achieve the objectives
of poverty alleviation. Micro Finance interventions commonly happen through Self Help Groups (SHGs)
10.2 MEANING AND DEFINITIONS OF MICRO FINANCE
Micro Finance - Meaning :
Finance provided to benefit the low income women and men is called ‘micro finance’. Micro
finance is not simply a banking activity, it is a development tool.
Micro Finance - Definition :
According to the ‘High Power Task Force in Micro Finance’ set up by the NABARD, micro
finance is defined as provision of thrift, credit and other financial services and products very small
amount to the poor in rural, semi-urban or urban areas for enabling them to raise their income levels and
improve living standards. The emphasis of support under MF is on the poor in ‘pre-micro enterprises’
state for building up their capacities to handle large resource. No specific limit for ‘small’ amount of
financial services is envisaged.
According to the Task Force, it will not be correct to equate Micro Finance merely as credit for
micro-enterprises while the poor also need savings, consumption loans, housing loans and insurance
services.
10.3 MICRO FINANCIAL SERVICES :
Micro financial services refer to the provision of financial to low income clients including the
self-employed. In the context of micro finance, financial services include savings as well as credit. It also
includes insurance and payment services, such as group formation, development of self-confidence and
training in financial literacy and management capabilities among members of a group. MFIs can be either
Non-Government Organizations (NGOs), Savings and Loan Co-operatives, Credit Unions, Banks of
Non-Bank Financial Institutions.
Thus, Micro Financial Services include both financial intermediation and social intermediation.
Micro finance activities usually involve the following :
* Small loans, typically for working capital.
* Informal approach of borrowers and investments.
* Collateral substitutes such as group guarantees or compulsory savings.
* Access to repeat and larger loans based on repayment performance.
* Streamlined loan disbursement and monitoring.
* Secure savings products.

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 Some MFIs provide enterprise development services such as skill training and marketing and
social services such as literacy training and health care.
10.4 Scope of Micro Finance :
Micro finance approach attempts to overcome the defects of the earlier approaches through
sustained credit innovations. MFIs deftly balance the dual task of social and financial intermediation. An
ideal micro finance system aims at balancing both social and financial intermediation, by ensuring credit
access to poor people and yet making it sustainable for the lending institution. The balancing between
social intermediation and financial intermediation is necessary, for overcoming the vulnerability imposed
by continual reliance on subsidies (finance as charity), by establishing a market based system (finance as
business), that can operate on its own. Effective and sustainable micro financing system requires good
social intermediation and prudent financial intermediation.
10.5 Features of Micro Finance :
The innovative features of micro finance are as follows :
1. Micro character : Micro finance is characterized by small size of savings, small size of loans,
shorter repayment period, small repayment dues, micro enterprises and small risk.
2. Size of loan : Loan are micro in nature or very small in size.
3. Target users : The target users of micro financial services include micro entrepreneurs and poor
people belonging to vulnerable section.
4. Poor oriented : Micro finance activities are aimed at helping the poor in improving their lot.
Micro credit programmes extend small loans to people, especially in rural areas, too poor to quality
for traditional bank loans. It is a popular measure in the ongoing struggle against poverty.
5. Utilization : The use of funds is for enterprise promotion / income generation. But it can also be
used for consumption and for promotion of health and education of the family members.
6. Terms and conditions : Terms and conditions for micro credit loans are flexible and easy to
understand, and suited to the local conditions of the community.
7. Flexibility : MFIs provide financial services similar to traditional system but with greater flexibility
at a more afforable price, making the micro financial services more attractive to a large number of
low income people.
8. Harnessing local resources : Micro finance activities are designed to tap the local capital in a
significant manner. The idea is to deliver credit and other related services, to the poor and women
out of their own savings.
9. Financial Sustainability : Micro finance activities are aimed at helping the poor to build financially
self sufficient collateral free, subsidy free, customer friendly and locally merged institutions.
10. Strengthening Financial System : Micro financial services provides the wherewith to make the
existing financial system stronger. For instance, existing format financial institutions like commercial
banks, credit unuon networks and state owned financial institutions can be strengthened by micro
finance activities Intact, the supplemental micro finance activities help expands the formal financial
system, for both savings and credit operations. Besides they too have the potential to increase their
profitability.

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10.6 Micro Financial Service Provides :
Financial services are essential for the development of rural areas. The users of financial services
are heterogeneous and include farm households, plantation, petty business, agri-business, non-farm micro
enterprises and dairy enterprises, who demand short term working capital as well as long term investment
loan and loan for consumption purposes. The financial system consists of many institutions, instruments
and markets including format, semi-formal arrangements and institutions.
Formal Financial Institutions :
They are chartered by the government and are subject to banking regulations and supervision.
They include public and private banks, insurance firms and finance companies. When these institutions
serve smaller business or farmers, there is potential for them to move into the micro finance sector. In
rural areas formal financial institutions include, commercial banks, postal savings system, development
banks and specialized savings banks and regional rural banks.
Semi - Formal Institutions :
They are not regulated by banking authorities but are usually licensed and supervised by other
government agencies. Examples are credit unions are cooperative banks, which are often supervised by
a bureau in charge of cooperative. NGOs are considered part of semi-formal sector because they are
often legally registered entities, that are subject to some form of supervision on reporting requirements.
These financial institutions, which vary greatly in size, typically serve midrange clients associated by a
profession or geographic location and emphasize deposit mobilization. The design of their loan and savings
products often borrows characteristics from both sectors. In many countries semi-formal institutions
often receive donor or government support through technical assistance or subsidies for their operations.
Informal Financial Intermediaries :
They operate outside the structure of government regulation and supervision. They 6 include
local money lenders, pawn brokers and SHGs. These institutions concentrate on the informal sector on
loans and deposits for small firms and households. Often loans are granted without formal collateral on
the basis of familiarity with borrowers. Social sanctions within a family a village or a religious community
substitute for legal enforcement. Credit terms and typically adapted to the client’s situation. The total
amount lent as well as the number and the number and the frequency of installments is fitted to the
borrower’s expected cash flow. Little or paperwork is involved in applying for a loan.
Communal and savings club, mutual aid societies, Rotating, Savings and Credit Associations
(ROSCAS), input suppliers, store keepers, traders, farmers, agent lender, money lenders, friends and
relative comprise a heterogeneous category referred to as informal finance.
10.7 Approaches of Micro Financing :
The various models of micro financial services attempt to explain the role of micro finance, in the
realm of development and growth of poor and the rural people.
1. Basic Self - help Group (SHG) Approach
This approach is linked to the self-help groups who come into direct contact with the lending
agencies. Members under the basic SHG model generally are women, and they are mobilized and
organized into self-help groups (SHGs). The size of the SHGs is neither too large, as exceeding 20
nor too small as less than 10. Besides performing savings and loan activity, SHGs serve as a forum
for the poor rural women to,
* Voice their opinions / views and take decisions
69
 * Interact with one another on group issues
* Share their experiences
* Exchange ideas and raise their voice on various social issues,
* Initiate collective action on a wide range of social, personal and economic issues
Each SHG selects its own leader, secretary and treasurer and holds regular meetings, (9 weekly
/ fortnightly monthly). Capacity building inputs are provided to the SHGs by the NGOs, so that they
become capable of functioning as grass roots units in an independent and effective manner, serving the
diverse needs of their members. Savings activity, which permits accumulation of capital at the grassroots,
is a compulsory feature of the SHG activities. The amount of money to be saved is fixed by the group
members themselves. In some groups optional savings system also exists.
After a period of one or two months of consistent savings (say 6 months), or from the very next
month of formation of group, the SHGs start rotating their savings in the form of small internal loans for
micro enterprise activity and other purposes including consumption, as may be decided by members.
Most of the decision making function such as interest rates to be charged for internal loans, the repayment
schedule. fine in the case of default, the lead time for loan sanctioning and specific purposes for which
loans will be given etc., are left to the decision of the group.
Only those SHGs that have performed well in rotating internal savings, in the form of small
interest loans are assisted with external funds through linkages with banks and other financial intermediaries.
The NGOs act as promoters and catalysts, facilitating the establishment of the micro finance system that
is capable of bringing economic, social political and personal empowerment to the poor clients.
2. The Federated Self - Help Group (SHG) Approach
Under this approach, several SHGs are brought together under a single umbrella to form a Federation.
A major benefit of this approach is that it helps to overcome the limitations of individuals SHGs.
Federation are usually registered under the Societies Registration Act. In some cases, there is a
distinct three - tier structure - the SHG which is the basic unit, the cluster as the intermediate unit,
and an apex body, or a federation that represents the entire membership. At the cluster level, each
SHG participates directly in the representatives body, with two members from each SHG attending
the monthly cluster meetings. Information from the groups to the federations and vice versa is
channelled through the cluster level representative body.
3. Rural Industries Promotion SHG framework :
This approach attempts to facilitate the delivery of a total package of service to members in SHGs.
The establishment of a structure, which manages typical industrial activity, like a private limited
company for, by and of women from SHGs is the key objective.
4. The Pure / Adapted Grameen Replicator Approach :
The basic unit in this model comprises the joint Liability groups or the Solidarity Groups consisting
of five members. The group is provided initial training of one week, covering various topics relating
to credit management, after which it is subjected to Group Recognition Test. The group becomes
eligible to borrow from the MFL, after which it is subjected to Group Recognition Test. The group
becomes eligible to borrow from the MFI, when the group comes out successful in the test.
Members pay a one-time membership fee of Rs.10/- and seven groups constitute a Centre. Meetings
are normally held weekly and members have to contribute a certain amount. Usually 5 percent of

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 all loans disbursed to a group is deducted as Group Tax and deposited in the Group fund account.
In addition, members also contribute some amount of voluntary savings.
This type of model generally offers a combination of loan products to its members, depending on
the purpose such as general loans, seasonal loans, housing loan etc. Interest rate of 15-24 percent
is charged on the loans, which are repaid in a year. Members are also eligible to avail repeat loans,
subjects to their good repayment record and performance.
5. The Urban Co-operative Banking Model :
Savings groups, under this model, comprise 10 to 50 members, whose deposits range from 10 to 25
rupees per month. Deposits are collected from the homes of the women by bank staff (savings
mobilisers). When assessing the loan application of a member, greater emphasis is placed on her
financial behaviour, as demonstrated by her ability to save regularly, rather than on collateral or
other forms of security.
6. The Co-operative Solidarity Group Model :
Under this mode, women organize themselves into neighbourhood loan groups of 5-15 members.
These solidarity group comprise of women who are residents of the same area, and have lived
there for period of more than five years.
The credit programme organizers conduct orientation meetings for the group before they are
formally registered. Prior to initial sanction of loans, there is an assessment of the applicant’s
poverty status, type of business in order to determine its size and nature, ownership of the enterprise
and also resident status among other things. Loans to members are recommended by the group
and approved by the organizer. Prior to the first loans, the groups are registered, members become
shareholders, and acquire share holding, according to the amount that they want to borrow.
7. The Co-operative Networking framework the thrift Co-operative are the primary entitles in this
micro finance system, usually from the same village. The Women’s Men’s Thrift co-operative
(WTCs/MTCs) are divided into smaller groups of 10-15 members to facilitate better monitoring of
thrift and loan payments. Each group nominates a leader from among the members who is responsible
for convening group meetings, collecting savings and monitoring loan repayments. Some of these
WTCs/MTCs have registered themselves under the APMACS Act, 1995 which gives them greater
autonomy and flexibility to operate as compared to the earlier Cooperative Act.
All the members of the primary cooperatives constitute the General Body and adopt a uniform
set of bye laws. A set of geographically contiguous cooperatives federate to form an association of
Women’s / Men’s Thrift Cooperatives (AWTCs / AMTCs). The Chairperson and Managing Director of
each participating Cooperative are members of the General Body of the Association.
10.8 Priority Sector Advances :
The concept of priority sector was evolved with the introduction of social control over banks and
nationalization of banks. In order to divert the flow of funds to the hitherto neglected sectors of the
economy, the Reserve Bank of India has included following in the priority sector.
1. Agriculture and allied activities
2. Small-scale industries
3. Small road and water transport operators
4. Retail trade,

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 5. Small business
6. Professional and self-employed persons
7. Education
8. Housing finance to weaker sections, and
9. Consumption loan
10. Micro-Credit.
The targets for priority sector credit are fixed from time. Banks were required to provide 40 per
cent of the total credit to the priority sector by March 1985 and 25 per cent of the priority sector advance
to then weaker sections.
Direct finance to agriculture was to be provided at least 15% of the total credit by March 1985
and 16% by March 1986.
Lending under DRI schemes was to be at least 1% of net credit.
The Narsimham Committee on Financial Systems (1991), has made recommendations to redefine
the priority sector to include the small and marginal farmers, the tiny sector of industry small business
operators, village and cottage industries, rural artisans and other weaker sections. Over the time, the
definition of priority sector advance has been widened to cover commercial the definition of priority
sector advance has been widened to cover commercial bank’s investment in special bonds issued by the
financial institutions like National Housing Bank (NHB) or exclusive financing of the priority sector. The
scope of Priority sector lending is expanded to include financing of activities relating to setting up to
agricultural clinics and agricultural business centers. In case of foreign banks operating in India, their
advances to export sector are treated as priority sector advances.
10.9 Summary :
The Micro finance, an innovative financial approach has been introduced to cater to the credit
requirements of a large segment of the population. Who are poor and who remain outside the banking
fold. It has been recognized as an effective tool to meet the felt need of the poor, so as to improve their
economic as well as social status. In fact, micro-finance is the provision of a broad range of financial
services such as deposits, loans, payment services, money transfers, insurance and pension to the poor
and low income households and their micro - enterprises.
10.10 Self assessment Question :
I. Short Questions
1. Meaning of Micro Finance
2. Scope of Micro Finance
3. What are the Micro Financial Service?
II. Essay Questions
1. What is Micro Finance? Explain its Features
2. Explain about Micro Financial service providers
3. What are the different approaches of Micro Financing?
10.11 Further Readings :
1. Mithani & Gordon - Banking and Financial Systems.
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 Lesson No. : 11

INDIGENOUS BANKERS

STRUCTURE
11.1 Introduction
11.2 Meaning and Definitions of Indigenous Banking
11.3 Functions of Indigenous Bankers
11.4 Features of Indigenous Bankers
11.5 Drawbacks of Indigenous Banker
11.6 Suggestions for Reforms
11.7 Indigenous Banks and the Banking commission (1972)
11.8 Indigenous Bankers and the Reserve Bank
11.9 Summary
11.10 Self Assessment Question
11.11 Further Readings

OBJECTIVE :
After completing this lesson, you should be able to understand about
* Indigenous Bankers
* Types of Indigenous Bankers
* Defects of Indigenous Bankers and their solutions
* Steps taken by RBI in case of Indigenous Bankers

11.1 Introduction :
The Banking Systems has a significant role to play in the rapid growth of the economy through
planed efforts. Indigenous banking had it role in the growth of the economy to a great extent in case of
rural areas. In the credit system, the indigenous bankers had played their own important role. Indigenous
banking is an unorganized sector of banking. The Indigenous bankers were not at all modern in their
money lending operations. Through the money market of India coming of Indigenous bankers they
lacked the unified control and as a result different rates of interested prevailed.
11.2 Meaning and Definition of Indigenous Banking :
Indigenous bankers constitute constitutes banking system of India. They have been carrying on
their age-old banking operations in different parts of the country under different names. These bankers
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are called chattier. Mahukans, Marwaris and seths. According to the Indian central banking Enquiry
committee, an indigenous banker or bank is defined as an individual or private firm which receives
deposits, deals in bundies or engage itself in lending money.
These banks can be divided into three categories
i) Those who deal only in banking business
ii) Those who combined banking business with trade.
iii) Those who deal mainly in trade and also have limited banking business.
Definition :
According to the Indian Central Banking Enquiry Committee, an indigenous banker is defined as,
“as individual or private firm receiving deposits and dealing in hundis or lending money.
In the rural money market of the country, among the different types of indigenous bankers, the
Multani bankers occupy a strategic position. This is because Multani bankers grant unsecured loans
against hundis to the traders. It has been observed that, on an average, a Multani bankers deal with at
least 300 parties everyday.
11.3 Functions of Indigenous Bankers :
Indigenous bankers render the following services, in the money market :
a) They accept deposits on current and fixed accounts
b) They buy and sell hundis for remitting funds.
c) They accept valuables of their clients for safe custody.
d) They finance inland trade (retail wholesale), including the movement of agricultural commodities
like cotton, sugar, oilseeds, etc. But they do not give direct loans to farmers.
e) They give loans to artisans and small urban traders against collateral security or personal security.
f) In recent years, they are also providing working capital to the small industrialists.
11.4 Features of Indigenous Bankers :
Indigenous bankers have the following distinguished features when compared to a modern bankers:
a) Indigenous bankers accept deposits and deal in hundis. Modern bankers do not deal in hundis,
but in bills of exchange.
b) Indigenous bankers use their own capital for conducting their lending activities. Deposits a
small part of their working capital which a modern banker relies largely on deposits for his
business.
c) Operations of indigenous bankers are free form formalities and delays. The business hours are
flexible. A modern banker deals in a formal way only.
d) In comparison with a modern banker, indigenous banking establishment are small and economical.
As against modern joint-stock commercial bank the business of indigenous bankers is carried
on as a family concern with their own working capital.

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 e) Indigenous bankers provide finance to the traders, artisans, as well as the small industrialists,
but give no direct loans to the agriculturists, indigenous bankers do not have any formal banking
education. They conduct business on the basis of their experience.
f) Indigenous bankers maintain simple accounts in the vernacular.
g) Indigenous bankers have a through knowledge about the family history of their customers and
all details regarding their business and financial outstanding.
h) Indigenous bankers are keen on maintain their business reputation unlike non-professional money
lenders. They have a high sense of responsibility and profit motive. As such they command
prestige and great confident among the trade circles and the borrowers.
i) Unlike a modern banker, indigenous bankers lend on the mortgage of land houses etc. They
also draw and discounts, hundis darshini or muddati (i.e) demand or usance bill). The discounting
rate charged by them is called the bazaar rate.
j) A majority of indigenous bankers combine banking business with trading and speculative activity,
based on a common capital fund employed them. However, Multains of Mumbai and Chettiaes
of Chennai stick to banking business only.
11.5 Drawbacks of indigenous banker :
There are, however, certain defects in indigenous banking in India :
a) Indigenous banker combine non-banking activities along with banking business and commission
agency. Many of them undertake speculative activities.
b) Most of them maintain traditional system of accounts in their own language.
c) They do not pay the required attention to deposit banking.
d) They have failed to tap and mobilies rural savings effectively.
e) They are unorganized.
f) They hardly make any distinction between the purpose of borrowing and short-term and long-
term finance.
g) They have no regular contact with the commercial banks.
h) They adopt a traditional accounting system in the vernacular.
i) As compared to the organised financial agencies, they charge very high rates of interest for
loans.
j) They keep info mail business relations.
k) Bulk of their business is based on cash transactions rather than on hundis.
l) The majority of them are conservations in approach and attitude. Despite these drawbacks, the
role of indigenous bankers in India cannot be underestimated.
11.6 Suggestions for Reforms :
To improve the functioning of indigenous banking in the country, the following suggestions have
been made :

75
 a) Indigenous bankers should be linked with the Reserve Bank of India. “Such indigenous bankers
as are engaged in banking or are prepared to shed their business other than banking should
eligible to be placed on the approval list of the Reserve Bank, in same manner as joint-stock
banks”.
b) Licensing should be introduced for indigenous banking.
c) Their activities should be linked with general banking. For the reason, commercial banks might
discounts their hundis more easily.
d) The benefits of the Bankers Book Evidence Act might be extended to the indigenous bankers
as well.
e) The indigenous bankers should themselves reform their operational methods in consonance
with modern banking.
f) They should develop bill-broking business like bill brokers in the London money market.
g) They should adopt modern methods of book-keeping.
h) They should be members of an association
i) The Reserve Bank should supervise and inspect the conduct of indigenous bankers.
11.7 Indigenous Banks and the Banking commission (1972) :
The banking commission in its report (1972), however, suggested that the best way to control the
business of indigenous bankers should be through commercial banks, where the former are qualified to
avail themselves of the discounting facilities with the latter.
a) To keep away from any trading activity.

b) To put in his “own” capital of not less then Rs. 1 lakh. Discounting facilities should be fixed as
a given multiple of “owned funds”.
c) To maintain regular books of account and get them duly audited
d) To furnish a summary statement of business on a prescribed form annually to the Reserve
Bank.
e) He should not be a member of an associated.
11.8 Indigenous Bankers and the Reserve Bank :
Sometime back, the Reserve Bank of India had tried to link up indigenous banking with organized
sector by insisting on the following conditions to be fulfilled by the indigenous bankers.
i) The indigenous bankers should register themselves as Banking companies under the banking
companies Act and function accordingly.
ii) They should :
a) maintain proper accounts
b) stop carrying out activities other than banking

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 c) Submit themselves for inspection and supervision.
Since the indigenous bankers did not comply with these rules, the Reserve Bank could not
integrate them with the organized sector.
11.9 Summary :
Anyway in the interest of economic development of the country, indigenous banks should change
their attitude, consider organizational change form themselves into corporate bodies, become more
professional and formal their operations and acquire a degree of sophistication. Indigenous banking has
a positive and perspective role to play in the Indian money market.
11.10 Self Assessment Questions :
I. Short Answer Question :
1. What are the features of Indigenous bankers?
2. What are the defects of indigenous bankers?
II. Essay Questions
1. Describe the functions and working of indigenous bankers. What are the recommendations of
the Bank Commission of 1972 to link them with the Reserve Bank of India?
2. What is Indigenous Banking? What are the defects of indigenous bankers?
3. What are indigenous bankers and explain their importance and functions?
4. Narrate the role of Indigenous bankers in the Indian Money Market.
11.11 Further Readings :
1. Ranganadha Chary A.V. & R.R. Paul - Banking and Financial Systems
2. Vasnat Desai - Indian Banking

77
 Lesson No. 12

NABARD- FUNCTIONS AND ACHIEVEMENTS

DEVELOPMENT BANKING MEANING – ITS
FEATURES DEVELOPMENT BANKS FUNCTIONING

As a student of banking, one should familiarize with NABARD and its functions. In the same
way you should be able to understand about Development Banking features, types of Development
Banks and their functioning which are discussed in detail in this lesson.
STRUCTURE
12.1 Introduction to NABARD and Development Banking.
12.2 Functions of NABARD.
12.3 Organisation and working of NABARD.
12.4 Achievements of NABARD.
12.5 Meaning of Development Banking.
12.6 Features of a Development Bank.
12.7 Functions of Development Banks.
12.8 Structure of Development Banks in India.
12.9 Summary
12.10 Key Terms
12.11 Model Questions
12.12 Books suggested.

OBJECTIVES –
After completing this lesson, you should be able to explain….
* Meaning of NABARD and Development Bank.
* The functions of NABARD and Development Bank.
* Working of NABARD.
* Structure of Development Banking.
* Importance of Development Financial Institutions.

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12.1 INTRODUCTION
A- NATIONAL BANK FOR AGRICULTURE AND RURAL DEVELOPMENT-
NABARD
Indian actually lives in villages where majority of its population is directly depending upon agriculture
sector for their lively-hood. They carry on agricultural operations with insufficient funds and
traditional activities. So their earnings are always hand to mouth. The govt. of india has been
embarking upon rural development for the upliftment of standard of living of rural development
for the upliftrement of standard of living of rural masses. Towards this end various incentive
schemes and liberalised rural credit facilities have been initiated. The National Bank for Agriculture
and Rural Development (NABARD) is essentially a development bank for promoting agriculture
and rural development.
With the increasing role of institutional credit for the integrated rural development of the country,
a need was felt for a single broad based organization which would not only extend financial
assistance to various credit institutions of the rural areas but also provide guidance in the formulation
and implementation of rural development programmes. In 1981 the Reserve Bank constituted a
committee to review arrangement for institutional credit for agriculture and rural development in
the country, has recommended the establishment of the National Bank for Agriculture and Rural
Development. The recommendation was accepted by the government and consequently
NABARD came in to existence on July 12, 1982.
Features & Objectives of NABARD :
1. NABARD is the apex bank at the rural level which is the leader of the total rural credit system
in India.
2. It provides refinance to institutions that in turn provide credit for rural economic activities.
3. It will monitor the activities of Co-operative banks, Land Development Bank, Regional Rural
Banks, Co-operative socieities at the rural areas.
4. It will also handle the financial requirements of weaker sections in setting up of small industries,
petty traders cottage industries artisans etc.
5. It will be responsible for the development, policy planning, trading and other related matters
regarding rural credit.
6. It will also provide direct finance to institutions directed by the central government.
B DEVELOPMENT BANK :
Economic development of a country requires easy availability of adequate financial resources to
meet long-term capital needs of agriculture and industry. These banks not only provide long term
finance but also have a development role to play through promoting investment. These banks
are specialized financial institutions. These banks are also called development – Oriented banks.
12.2 FUNCTIONS OF NABARD :
Important functions of National Bank for Agriculture and Rural development are discussed below
1. The main function of NABARD is to provide refinance for institutions providing finance for
developmental activities in rural areas.
2. It functions as an apex institution on behalf of Reserve Bank of India with regard to rural credit.
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 3. It provides medium term loans to State Co-operative Banks and RRBs for agricultural and rural
development.
4. Another important function is to inspect Regional Rural Banks and Co-operative Societies
regularly.
5. It co-ordinates the government, the planning commission, and State governments in the area of
rural development for preparation of credit plan of action.
6. It provides long term loans to state government upto 20 years for subscribing to the share capital
of co-operative Banks in the country.
12.3 ORGANISATION AND WORKING OF NABARD :
A- ORGANISATION – The NABARD is managed by a Board of Directors headed by a Chairman
and 13 Directors representing Reserve Bank, Government of India, State Governments, Co-
operative Banks, all these officials are appointed by Government of India. It has now taken over
the functions of Agricultural Department, Rural Planning Credit Cell of Reserve Bank of India.
B- WORKING OF NABARD – It has sanctioned Rs. 5685 Crores upto 2008 to State Co-operative
Banks for financing of seasonal agricultural operations in the country. It also provided minimum
and long term credit to the tune of Rs. 1218 Crores to agricultural sector upto 2008. It also
successfully with the World Bank regarding NABARD credit project to obtain a loan for
agricultural sector development. During 1986-87, it provided refinance credit under IRDP
amounting to Rs. 379 Crores. From 1998 onwards, NABARD introduced certain policy changes
and schemes in the area of farm credit, National Oil seeds development programme and refinance
facility for agriculture product marketing loan scheme.
12.4 ACHIEVEMENTS OF NABARD:
NABARD is a single integrated organization which looks after the credit requirements of all
types of agricultural and rural development activities.
1. It provides short-term credit facilities for production, procurement and marketing activities of
weavers co-operatives.
2. It also provides assistance to production and marketing activities of industrial co-operative societies.
3. During 2007-2008 it sanctioned a total credit of Rs. 13,130 Crores to State Co-operative Banks
and RRBs in the country.
4. Southern region accounted for the highest share in financial assistance from NABARD to the
extent of Rs.525 Crores.
5. It also provides financial help to non-agricultural activities with a view to promote integrated
rural development in the country.
6. Every year NABARD provides financial assistance to a number of banks for research and
development in the area of rural development.
12.5 MEANING OF DEVELOPMENT BANKING:
Development banking in India is of recent origin. It is a post-independence concept. In Germany
and Japan development banks were established in the beginning of 19th century. In India the first
development bank was established in 1948 known as Industrial Finance Corporation of India. The

80
concept of development banking is based on the philosophy of development of industrial sector and
agricultural sector with adequate financial resources supplied by various development banks in the country.
Fundamentally, a development bank is a term lending institution. It is a financial institution concerned
with providing all types of financial assistance to business units, in the forms of loans, underwriting,
investment and guarantee operations and promotional activities - economic development in general and
industrial development in particular.
Development bank is a multi purpose financial institution with a broad out look of industrial
development. Development bank is a development oriented bank.
12. 6 FEATURES OF A DEVELOPMENT BANK :
A development bank must possess the following features –
1. It is a specialised financial institution.
2. It provides medium and long term finance to business units.
3. It does not accept deposits like a commercial bank.
4. It aims at promoting the saving and investment habit in the community.
5. It is a term lending institution and multi purpose financial institution.
6. Its motive is to serve public interest rather than to make profits.
7. It is a multi-faceted financial institution.
8. It works in the general interest of the nation.
9. It provides assistance and help to public and private sector units.
10.It encourages new and small entrepreneurs and seeks balanced regional development.
12.7 FUNCTIONS OF DEVELOPMENT BANKS :
These banks are expected to formulate their lending policies in accordance with socio economic
objectives of the country. They perform the following functions in general.
1. Provide medium term and long term loans to industries.
2. To act as under writers for the issue of shares and debentures of industrial units.
3. To give guarantee to the loans raised by industries and government.
4. These banks directly invest their funds in shares and bonds issued by government and Reserve
Bank of India.
5. These banks encourage starting of new units and also prepare project reports for industries.
6. They provide advice on technical and managerial problems of units.
12. 8 STRUCTURE OF DEVELOPMENT BANKS IN INDIA :
Development banks in India have developed in the post-independence period. The structure of
Indian development banks can be divided into three broad categories. They are –
I. Industrial Development Banks at state level and central level which are mentioned here –
81
 State finance Corporations under 1951 Act.
State Industrial Development Corporations - 1955 Act.
National Small Scale Industries Corporation – 1955.
Industrial Finance Corporation of India – 1948.
Industrial Credit and Investment Corporation of India – 1955.
Industrial Development Bank of India – 1964.
II. Agricultural Development Banks –
NABARD
State Co/operative and Agricultural and Rural Development Banks.
Primary Agricultural and Rural Development Banks.
III. Export Import Development Bank to promote foreign trade in order to earn more foreign
exchange reserves.
EXIM BANK – Export Import Bank of India.
12.9 SUMMARY :
NABARD is a single integrated organization which looks after the credit needs of all types of
agricultural and rural development activities in the country. It operates as an apex institution dealing with
policy, planning and operational aspects of rural credit. It is considered as a refinancing agency providing
financial support to banks for increasing their credit facilities in rural areas for rural development.
Development Banks provide long term finance to agriculture and industrial sectors of the economy.
These banks play a development role in promoting investment in various industries. These banks provide
risk capital and underwrite new issue of shares and also give guarantee for term loans. These banks
make arrangement for foreign exchange loans for foreign trade.

12.10 KEY TERMS USED:

Short Term Credit - It is provided for reasonal Agricultural operations.
Medium Term Credit - For agricultural operations and to convert short term
loans this type of credit is provided.
Long term Credit - Loans granted to State Governments for over
15 to 20 years by banks.
SIDBI - Small industries development Bank of India
Established in 1989 to promote and finance
Small Scale Industries.
EXIM BANK - Export Import Bank of India to promote foreign trade
and to extend financial assistance to exporters and
Importers.

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12.11 MODEL QUESTIONS :
Long Answer Questions
1. Discuss the functions of NABARD and also explain its achievements.
2. What is meant by multi-agency approach to rural credit and role of NABARD in achieving the
goal.
3. Explain the features and functions of a Development Bank.
4. Discuss the structure of Development Banks in India.
Short Answer Questions
1. What is a Development Bank and its features to explain.
2. Meaning of rural credit and rural development.
3. Multi-Agency approach to explain.
4. Organisation of NABARD.
12.12 BOOKS SUGGESTED:
Vasant Desai - Indian Banking.
A.V.Ranganadha Chary - Banking and financial
and R. Saibaba systems.

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 UNIT - III

In this unit features of banker – customer relationship, important aspects of Negotiable

Instruments Act, 1881 are elaborated. Types of looms and advances are also explained.

LESSON 13 : Meaning of banker and customer, different types of relationship between

banker-customer are discussed.

LESSON 14 : Different types of bank accounts, banker special Customer and

precautions bankers to take are explained.

LESSON 15 : Negotiable Instruments Act-1881, Cheque definition and types and

crossing of cheque are analyzed.

LESSON 16 : Meaning of Paying banker and collecting banker and their duties are
narrated.

LESSON 17 : Types of looms and advances, principles of sound lending are explained.

LESSON 18 : Credit appraisal - Modes of creating a charge also explained in detail.

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 Lesson No.: 13

BANKER AND CUSTOMER – RELATIONSHIP AND

CUSTOMER ACCOUNT OPENING

STRUCTURE :
13.1 Banker And Customer- Definition
13.2 Relationship Between Banker And Customer
13.3 Bank Account Opening Procedure
13.4 Special Types Of Bank Customers And Precautions For Bank While Opening Account
13.5 Summary
13.6 Self Assessment Questions
13.7 Suggested Readings
13.8 Key Terms
OBJECTIVE :
The objectives of the present unit are to facilitate your understanding about –
* the meaning of banker/bank and the customer
* the dimensions of relationship between the banker and the customer
* Special types of customers and
* procedure of opening bank account and precautions while opening account by customer.
13.1 BANKER AND CUSTOMER – DEFINITION AND MEANING
In India, a banking company is defined as a company which is engaged in the business of banking.
The Banking Regulation Act, Section 5(b) defines banking thus, “accepting for the purpose of lending or
investment of deposits of money from the public payable on demand or otherwise, and withdrawable by
cheque, draft, order or otherwise”. In addition, a banker can undertake other business enumerated in
Section6 of the Act.
In England there is no statutory definition for the term banker. However leading authors defined
banking in the following way.
HERBERT L. HART defines banker thus, “A banker is one who in the ordinary course of
business honors cheques drawn upon him by persons from and for whom he receives money on current
account”. The two basic ingredients according to this definition are (a) the receipt of deposits and (b)
honoring of cheques drawn by persons who have deposited the money with the banker in the current
account.
According to Sir John Paget, “It is fair deduction that no person or body of persons, corporate or
otherwise, can be banker who does not (1) take deposit accounts (2) take current account (3) issue and

85
pay cheques and (4) collect cheques crossed or uncrossed for his customers”. Here Paget described
the functions to be performed by a banker. Further, banking should be main business to a banker.
From the above definitions it is clear that an essential feature of a banker is that he must accept
deposits from the public. The banker uses the deposits for the purposes of lending or investment. Borrowing
and lending money should be the main function of a banker. A person who lends money from his own
resources is not a banker. He is only a money lender. However, in India law does not prohibit a money
lender calling himself a banker. In fact they are “Self styled bankers”.
CUSTOMER :
The term “Customer” has not yet been statutorily defined. In common parlance the term customer
means a person who has an account with the bank. Old banking experts used to lay emphasis on the
duration for which a person maintained an account with the bank. For example, according to John Paget,
“to constitute a customer there must be some recognizable course of habit of dealing in the nature of
regular banking business. It is difficult to reconcile the idea of single transaction with that of a customer”.
Thus, according to the view, a person does not become a customer simply by opening an account with
bank. He should be in the habit of dealing with the bank i.e., there should be some measure of continuity
in his dealing with the bank.
Duration Theory: The above view point, popularly known as “duration theory”, has not been
rejected. In the case of Commissioner of Taxation. v. English Scottish and Australian Bank, Lord
Dunedin observed, “The word customer signifies a relationship in which duration is not of essence. A
person, whose money has been accepted by the bank on the footing that the bank undertakes to honor
cheques up to the amount standing to his credit, is a customer of the bank irrespective of whether his
connection is of lo9ng or short standing”.
The above view was also confirmed by the Kerala High Court in the case of Central Bank of India
Ltd., Bombay v. Gopinathan Nair and others. Their Lordship observed:
“Broadly speaking, a customer is person who has the habit of resorting to the same place or person
to do business. So far as the banking transactions are concerned he is a person whose money has been
accepted on the footing that the banker will honor his cheques up-to the amount standing to his credit,
irrespective of his connection being of short or long standing”.
Thus, in order to constitute customer, a person should satisfy two conditions:
(i) He should have an account with the bank, whether fixed, savings or current.
(ii) The dealings should be of a banking nature. These dealings have to be distinguished from other
dealings which are of a casual nature e.g. occasionally getting a cheque encashed or purchasing
stamps or depositing valuables for safe custody.
13.2 RELATIONSHIP BETWEEN BANKER AND CUSTOMER :
1. Debtor and Creditor: When a customer deposits money with his bank, the customer becomes a
lender and the bank becomes a borrower. The money handed over to the bank is a debt. The
relationship between the banker and the customer is that of a debtor and a creditor. When the
bank lends money to the customer, the customer is the borrower and the bank is the lender. The
relationship between the banker and the customer is therefore that of a creditor and a debtor.
2. Trustee and Beneficiary: If a customer keeps certain valuables or securities with the bank for
safe-keeping or deposits a certain amount of money for a specific purpose, the banker, besides
becoming a bailee, is also a trustee. In the case of Subramanyan Pillai and Others vs. Palai

86
 Central Bank Ltd., (AIR 1962 Ker. 210), certain persons deposited Rs. 2,000 each in the bank as
guarantee money to purchase cars. The bank failed before they could get the vehicle. The court
was of the view that the bank should act as a trustee and that the money should be refunded from
the bank’s asset on the basis of preferential debts. A trustee holds money or assets and performs
certain functions for the benefit of other person called beneficiary.
In another case, a customer remitted money with instructions to purchase shares/stocks of a
company. The bank bought shares in parts, but before completing the rest of the purchase, it
failed. It was held that the bank stood in the position of a trustee to the remitter and was entitled
to the refund of the unspent balance of amount.
3. Bailor–Bailee: When a customer deposits certain valuables, bonds, securities or other
documents with the bank, for their safe custody, the bank, besides becoming a trustee as discussed
earlier, also becomes a bailee and the customer is the bailor. According to the terms of Section 148
of the Indian Contract Act, 1872, the bank becomes custodian of the securities of the customer and
hence as a bailee is liable for any loss caused to the bailor due to negligence. The finder of lost
goods (Section 71 Indian Contract Act) should return any increase in goods/animals to the true
owner. Under Section 164 (Indian Contract Act), the finder has to take care of such goods as an
ordinary prudent man. These are examples of bailee-bailor relationship
4. Principal and agent: One of the ancillary services rendered by the bank is remittance, collection
of cheques, bills, etc. on behalf of the customers. It further undertakes to pay regularly, electricity
bills, telephone bills, insurance premium, club fees, etc. In all such cases, the bank acts as an
agent, his principal being the customer.
The relationship of agency, however, terminates on the death, insolvency and lunacy of the customer
or on completion of the work assigned. In the case of remittances, although the relation is that of
agency in the case of Traders Bank Ltd vs. S. Kalyan Singh (AIR 1953), Punjab p. 195, the High
Court has held that the relation is that of debtor-creditor.
5. Lessor and lessee: The banks provide safe deposit lockers to the customers who hire them
on lease basis. The relationship therefore, is that of lessor and lessee. In certain banks, this
relationship is termed as licensor and licensee. The bank leases out the space for the use of
clients. The bank is not responsible for any loss that arises to the lessee in this form of transaction
except due to negligence of that bank.
6. Indemnifier and indemnified: A contract by which one party promises to save the other from
loss caused to him by the conduct of the promisor himself or the conduct of any other person is
called a contract of indemnity – Section 124 (Indian Contract Act, 1872). In the case of banking,
this relationship happens in transactions of issue of duplicate demand draft, fixed deposit receipt
etc. The underlying point in these cases is that either party will compensate the other of any loss
arising from the wrong/excess payment.
13.3 PROCEDURE FOR OPENING OF CURRENT AND SAVINGS ACCOUNTS :
Following formalities are required to be completed before a current or a savings account is
opened in a bank:
1. Application on the prescribed form: The person desiring to open a current or a savings account
with the bank has to make application in the prescribed form. The applicant is required to give
his name, address and occupation in the form. He has also to declare that he shall comply with
the bank rules in force from time to time for the conduct of the account.

87
 2. Photographs: As per the recent directives of the Reserve Bank the applicant is required to
submit two photographs- One to be pasted on the application form and the other on specimen
signature sheet.
3. Introduction or reference: The applicant is also required to furnish in the application form the
names of the referees from whom the banker may make enquiries regarding the character,
integrity and respectability of the applicant. In most cases the introduction is done by the customer
of the bank or some person known to the bank by signing on the application form. The person so
signing on the application form. The person so signing gives his account number (if any) with the
bank or his address.
In case a banker opens an account without proper introduction the banker is Deprived of statutory
protection available to a collecting banker under Section 131 of the Negotiable Instrument Act.
According to this section a banker who Collects a cheque, bill of exchange etc., for a customer
in good faith and without negligence will not be liable for wrongful conversion of funds on account
of any defect in customer’s title to those instruments.
4. Specimen Signature: Even customer is required to supply to his banker with one or more specimens
of his signature. These signatures are taken on cards which are indexed and filed in an alphabetical
order.
5. Mandate for an operation of the account by an agent: In case a customer desires to get his
account operated upon by another person, the bank will obtain a mandate in writing to that effect
as well as the specimen signature of the person in whose favor the mandate is given.
6. Opening the account: After observance of these formalities the bank opens an account in the
name of the applicant. The applicant is required to deposit alternative minimum amount ranging
from Rs. 100 to Rs. 1,000 in a Savings Bank Account and Rs. 5,000 to Rs. 20,000 in case of
Current Account. As a measure of promoting Financial inclusion the banker may also allow a
‘no frill account’ i.e. opening an account 9savings A/c) without minimum amount. The bank then
provides the customer with:
(a) a pay-in-slip book,
(b) a cheque book,
(c) a pass book.
Pay-in slip book: With a view to facilitate the receipt of credit items paid in by a customer, the
bank supplies him pay-in-slips either loose or in book form.
Cheque book: To facilitate withdrawals and payments to third parties by the customer, the bank
also supplies a cheque book to the customer.
Pass book: Pass book is an authenticated copy of the customer’s account with the bank. It is
written by the bank and records all dealings between the bank and the customer. In the computerized
banking e-pass books or transaction sheets serve this purpose.
13.4 SPECIAL TYPES OF BANK CUSTOMERS AND THE PRECAUTIONS FOR BANK
WHILE OPENING ACCOUNT :
Opening of a bank account is a special type of contract. Different types of individuals and
institutions open a bank account. In this chapter are discussed special features of certain types of
customers and the precautions which a bank has to take when dealing with such customers.

88
 1. Minors: According to Indian Law, a person is a minor until he completes his eighteenth year. If
he is under the guardianship of Court of Wards, he continues to be a minor until he completes his 21st
year, In England a person who does not complete his 21st year is called an infant.

According to Indian Contracts Act, a minor has no capacity to contract. Agreements entered
into by a minor are void, and as such cannot be enforced in courts of law. But agreements entered into
by a minor either for necessaries or for the minor’s benefit are valid contracts and are enforceable in a
court of law.
Precaution: The Banker should take the following precautions before opening an account in the
name of a minor. The banker may open a savings bank account in the name of a minor to be operated by
the natural guardian or the guardian appointed by the court. A savings bank account can be opened in
the name of a minor and operated by a minor provided he has completed 14 years of age. The bank
should record the date of birth of the minor as supplied by the minor or his guardian. If the father of a
Hindu minor dies, his mother becomes natural guardian. If the mother also dies during the minority of the
boy either testamentary guardian or the guardian appointed by the court will operate the account. The
banker may return the balance amounts to such guardian. If the minor dies the guardian will draw the
amounts.
The banker runs no risk in dealing with a minor as long as his account is in credit. However, the
fact that a contract with a minor is avoid, it is advisable to open the account in the name of his guardian.
This will enable the banker to recover the amount of the overdraft which he might have allowed by
mistake. Otherwise, not only the amount advanced to a minor becomes irrevocable, but also any securities
pledged by him must be returned. A guarantee given by a third party in respect of a debt contracted by
a minor is of no avail, on the ground that where the principal debtor is not liable, the surety can not be held
liable.
Minor as agent: A minor can act as agent of another person competent to contract, provided he
is duly authorized. For instance, minor son may make contracts besides endorsing cheques and bills on
behalf of his father. He can even borrow on behalf of his father, if he has a distinct authority to do so.
Minor as partner: There is nothing to prevent a minor from becoming a partner in a firm and
transacting business on its behalf. However, he cannot be held liable for any debts of the partnership
incurred before he attains majority. On the other hand, unless he expressly repudiates the contract of
partnership within six months of his attaining majority, it is presumed that he has ratified the partnership
agreement. After that he will become liable for the debts incurred by the partnership firm and is already
eligible for profits on par with other partners.
2. Lunatics: Under Section 12 of the Indian Contract Act, persons of unsound mind are disqualified
from entering into contracts. But the disqualification does not apply to contracts entering into by lunatics
during periods of sanity or which are ratified during such periods. According to Indian Law, contracts
with persons of unsound mind are not only avoidable but void. Consequently, no banker would knowingly
open an account in the name of a person of unsound mind because that would easily involve him in the
difficulty of choosing between the risk of unjustifiably dishonoring the customer’s cheques on the one
hand and of being held to have debited his account without adequate authority on the other. When a
banker comes to know of his customer’s lunacy, all operations on his account should be suspended until
the receipt of an order from the court or the definite proof of the customer’s sanity.
3. Drunkards: If a person who is a party to a contract can prove that at the time of entering into
the contract he was incapable, from the effect of liquor, or understanding the contract and of forming a
rational judgment as to its effects upon his interest which fact which fact was known to the other party,
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he may have the contract set aside by the court. If a customer tenders, when drunk, a cheques for which
he demands payment, the banker would be advised to have a witness to the signature and the payment of
the amount.
4. Married woman: According to Indian Contract Act, a married woman is competent to enter into
contracts, to acquire and sell property, to lend and borrow money, etc. In another words she has all the
rights which a man has. A current account may be opened in the name of a married woman. A married
woman has power to draw cheques and give sufficient discharge her if she does not have a separate
property. Even if she has separate property, the property may be so settled upon her that she is entitled
to the income as it falls due but may not touch the corpus or the anticipated income. A married woman
cannot make her husband liable except for necessaries of life.
A banker should be careful while granting, loans or allowing overdrafts. This is essential because
the husband’s liability for wife’s debts arises only under the following circumstances:
1. Where the husband has given his consent or authority.
2. Where the debt is incurred for the purchase of necessities of life, in case the
husband defaults in providing the same to his wife.
It is clear from the above that the husband is not liable for all the debts made by his wife. The
banker can recover the amount only from the personal assets of the married woman. Therefore, the
banker should examine her own assets and satisfy himself whether they are sufficient to cover the
amount of the loan.
A banker will have to keep the following points in his mind while granting a loan or an overdraft
to a married woman:
1. The husband of a married woman is not liable for debts contracted by her except in so far as they
are for necessaries of life in case the husband defaults in supplying the same to her. So the banker
should not lend money to a married woman simply because her husband had sufficient property.
2. If she does not have separate property, there will not be sufficient security for overdrafts granted
to her. It may be difficult to recover money from her.
3. If she has separate property (Streedhan), the banker must find out the nature of her right to that
property. She may not have the right to sell the property, although she may enjoy the income there
from.
4. If a married woman applies for loan, the banker must examine whether there is any undue influence
exercised by her husband. She should be apprised of her liability for the loan she contracts. She
may be advised to consult her lawyer.
5. If there is a joint account in the names of husband and wife and if there is clause to the effect that
in the event of the death of one party, the balance should vest in the survivor, the banker’s position
will be safe.
5. Pardanashin woman: A pardanashin woman is one who, by the custom of the country or the
usage of the particular community to which she belongs, is obliged to observe complete seclusion. A
contract with a pardanashin lady is presumed to have been induced by undue influence and, therefore, a
banker has to be extra-cautious while dealing with her. In order that lady may not set aside any contract
on the ground of undue influence, the banker will have to prove that:
(a) the terms of the contract are fair and reasonable;
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 (b) the transaction is real and bonafide;
(c) the lady had an independent advice in the matter;
(d) the deed was explained to her; and
(e) she understood it and its effects on her interest in full.
The identity of such a lady is not possible to determine and, therefore, usually the banks refuse to
open an account in her name.
6. Illiterate persons: An illiterate person may open an account with a bank. The banker
should take the following steps:
(i) Thumb impression: The left hand thumb impression of the depositor should be obtained on the
account opening form and the specimen signature sheet in the presence of an authorized
supervising official.
(ii) Identification mark: Where possible, brief details of one or two identification marks of the
depositor should be noted on the account opening form and the specimen signature sheet under
authentication of an authorized official.
(iii) Photograph: Two copies of the passport photograph of the depositor should be obtained and got
renewed every three years. One copy of the photograph will be pasted on the account opening
form and another on the specimen signature sheet.
(iv) General: Implications and conditions for operation of the account should be explained to the
depositor by an authorized official. He should also append a certificate to the effect that he had
done so on the account opening form. Withdrawals from the account should generally be
allowed only when the person comes personally and produces his or her pass book.
7. Joint Accounts: When an account is opened in the names of two or more persons, who are
not partners in a firm or who are not joint trustees, it is called a joint account. When a joint account is
opened the banker should obtain a comprehensive mandate. The mandate should cover all points because
the right to draw cheques conferred upon a person does not automatically confer upon him the right to
deal in securities, to contract debts, or to deal in bills of exchange. If one of the joint account holders
obtains an overdraft, the others do not have liability. So it is necessary that definite instructions should be
obtained on the following matters.
Issuing of Cheques: It should be clearly specified in the mandate as to who is authorized to
draw cheques. If there is nothing stated in the mandate, all the joint customers must sign the cheques.
Although the right to draw cheques may be conferred on one or more of the parties, any one of the joint
account holders can countermand a cheque. In this case, the right to sign the cheques conferred on one
of the parties is deemed to be temporarily withdrawn.
If a third party, not being a joint account holder, is authorized to draw cheques, the arrangement
must be approved by all the parties. Similarly, if a power of attorney is given to a third party, not being a
joint account holder, the power of attorney must be signed by all the parties.
Death of Joint account holder : If one of the Joint account customer dies, according to English Law,
the survivors can continue to transact the business relating to the joint account. But according to Indian
law, the surviving joint customers along with the heir of the deceased joint customer must transact the
business. Clear instructions must be included in the mandate given to the banker.
Joint Debts: The right to draw cheques given to a joint customer is limited to the credit balance available
in the bank account. If cheques are drawn in excess of the amount, all the joint customers become
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indebted to the bank. But the right to draw cheques does not extend to contract debts. So the banker
must ascertain whether the person who has the right to draw cheques has also the power to overdraw
the account.
Joint and Several Liability: According to Indian Law, joint liability means joint and several liabilities. If
one of the joint customers dies, and if the account is overdrawn by that time, the banker must stop that
account and open a fresh account in order to make the estate of the deceased customer liable for the
debt. Otherwise, the banker would lose his right to recover the amount from the estate of the deceased
party on account of the operation of the rule in Clayton’s case.
Safe custody deposits: If joint account holders deposit valuables for safe custody with the bank, no one
of them can take delivery of them. The banker should return the securities only on the requisition of all
the joint customers. Similarly, no one of the joint customer can stand surety on behalf of all the joint
customers. No single joint customer can pledge the fixed property of the joint parties without a power of
attorney granted to him. When shares or valuables belonging to the joint parties are sold by the banker,
the sale proceeds should be handed over to the joint holders and legal representatives of the deceased
party or reimbursed in accordance with their instructions.
Death insanity or bankruptcy of a joint customer: When the banker is duly informed of the death of
one of the joint customers, the banker should not thereafter honor cheques presented for payment.
Similarly, when a notice is given to him of the insanity or bankruptcy of one of the joint customers the
banker should not honor cheques subsequently presented. The balance should be paid only to the legal
representative of the deceased or insane customer and to the other joint customers.
Garnishee order: If the banker receives a Garnishee order in respect of one of the joint account holders
asking him not to make any payment out of the joint account, he should inform the Court that it is a joint
account and request the Court to withdraw the Garnishee order
Trust Accounts: If the joint account relates to a Trust, but the banker is not informed of the same, the
banker need not take cognizance of the fact. After he comes to know that it is trust account, he should
be careful to see that it is not overdrawn at any time.
Joint account in the name of Husband and Wife: The position in the case of a joint account in the
name of husband and wife is different. Where an account is opened by the husband for his convenience,
the balance cannot be claimed by the widow but has to be brought to the estate of the deceased. But
where the intention of the husband by opening a joint account was to make a provision for his wife in
case of his untimely death, the widow would receive the money. Further in a Madras case it has been
held that under the law at present prevailing in India, a deposit standing in the name of Hindu husband and
his wife and payable to either of survivor, must be presumed to belong to the husband, in the absence of
any evidence to the contrary.
8. Partnerships: The Indian Partnership Act, 1932 defines partnership as “the relation between the
persons who have agreed to share the profits of the business carried on by all, or by any one of them
acting for all”. Persons who have entered into partnership agreement are individually called partners.
All the partners are collectively called a ‘firm’.
Essentially Features of Partnership: The following are the essential features of a partnership firm.
1. The existence of written or implied agreement to do lawful business.
2. To share profits.
3. Dual role of every partner as principal and agent.
4. Partner’s implied authority to bind all other partners by his conduct in the ordinary course of the
business.
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 5. The maximum number of partners is 20 and the minimum number is 2 in the case of banking firms,
the maximum number of partners is 10.
Partner’s Implied Authority: Partner’s implied authority in a firm is a most significant feature.
Each partner is the accredited agent of the firm. A transaction entered into by him is binding on the firm
if the transaction is related to its normal business. A power to do what is usual does not include a power
to do what is unusual, however, urgent. This implied authority of a partner to blind the firm does not
extend to guarantees.
In view of the above uncertain conditions about eh partners in the firm, the banker should take
certain extraordinary precautions while dealing with a partnership firm.
Precautions: A banker should take the following precautions before opening an account in the name of
the firm.
1. Opening of Account in the name of a firm: The account must always be opened in the name of the
firm but not in the name of individual partner or names of partners. If an account is opened in the name
of any individual partner, his co-partners are not liable in respect of transactions therein.
2. Signature by all partners on the Account Opening Form: Though any one of the partners is
entitled to open the account, the banker in his own interest shall ask all the partners to sign on the account
opening form.
The right of drawing cheques given to a partner may be withdrawn by others at any time. When
the banker is notified of withdrawal of such right, he should not honor cheques presented subsequently.
Any partner can countermand a cheque issued in the name of the firm.
3 Death of a partner: When a partner dies, the partnership comes to an end. The legal heir of the
deceased partner does not automatically become the partner of the firm. the legal heir has only the right
to recover the money due to him from the partnership firm. The banker may continue the bank account
if by the date of the death of the partner there is a credit balance in the account. Bit if here is a debit
balance, the banker must stop the account and start a fresh account. the banker thus will secure for
himself the right of recover the amount from the estate of the deceased partner also.
4 Bankruptcy of a partner: partnership also comes to an end when one of the partners becomes
bankrupt. The banker should not honor cheques drawn by the bankrupt partner, unless it bears the
signatures of the other partners as well. The banker may continue the bank account in so far as it may
be necessary o wind up the affairs of the firm, which is dissolved owing to the bankruptcy of a partner.
In such a case, the assets of the partnership may be transferred to one of the partners, who acts as a
trustee of such assets. There is the danger of the banker being held guilty of negligence unless he acts
with utmost care and caution in such cases.
5. Insanity of a partner: A partnership is not dissolved when one of the partners becomes insane, but
it becomes as sufficient reason for the dissolution of the firm. The relations of the insane partner may file
a petition in the court for ordering the dissolution of the firm.
6 Retirement of a partner: When a partner retires from the partnership firm, he must notify the same to
the banker. Otherwise, he also becomes liable for the debts incurred by the receipt of retirement notice,
if the partnership is indebted to the bank, the bank must stop the account and start a fresh account. In
this case, the retiring partner also will be liable for the debt owing by the partnership firm at the date of

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retirement. If the partnership assets had been given as security for the advance granted to the firm, the
bank account may be continued on the basis that transactions are being continued for the purpose of
winding it up.
9. Joint stock companies:
1. The banker should examine the certificate of incorporation, Memorandum of Association and
Articles of Association of the company, before opening an account. He should obtain copies of
the latest documents as amended uptodate and note carefully the provisions relating to capital,
objects, liability, name, borrowing powers, powers and duties of directors and other rules and
regulations.
2. In the case of a public company, he must inspect its certificat5e of commencement of business and
satisfy himself that the company has been authorized to commence business.
3. If the banker has any doubt, he should inspect the company’s file in the office of the Registrar of
Companies.
4. H should receive a copy of the Board’s resolution appointing him as the company’s banker stating
the mode of operation and naming the person authorized to operate upon the account. This resolution
is to be signed by the Chairman and countersigned by the Secretary of the company.
5. He should obtain specimen signatures of those persons who are authorized to operate upon the
account.
6. He should note the first directors of the Company.
7. In case of existing companies, he should ask for copies of Annual accounts and reports for some
previous years.
8. In the case of a private company, all the precautions mentioned above should be taken by a banker.
But the certificate of commencement of business need not be examined. In dealing with a private
company, he must be on his guard. he should not grant any accommodation without any security.
He should be more careful, if the business is recently converted into a private company.
Opening an Overdraft account: The banker should take the following steps before an overdraft
account in the name of a registered company.
1. He should go through the Memorandum and Articles of Association for the borrowing powers and
restrictions thereon particularly in a non-trading company. All trading companies have an implied
power to borrow to such an extent as is reasonable and accessory for the carrying out of their
declared objects.
2. He should note any limitations placed by the Articles on the borrowing powers to be exercised by
the directors.
3. He must also know the powers of directors to mortgage the company’s assets and the regulations
controlling the signing and endorsing of cheques and bills.
4. He need not enquire into the purpose of the advance. If it is misapplied, it cannot be avoided,
provided the banker acted bonafide and without knowing about the intended misapplication.
5. He should get a certificate by the Chairman or director or the secretary of the company, stating
that the proposed advances are within the powers of directors.
6. He should insist on a separate resolution of the Board whenever the company wants to borrow.
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 7. He should see that any charge created by the company in favor of the bank is filed with the
Registrar within 30 days of its creation. He should inspect the register of charges and ascertain
whether there are any prior encumbrances.
10. Joint hindu family firms : A business carried on by a Joint Hindu Family is governed by the
provisions of Hindu Law. A banker should know well the laws and customs relating to succession and
transfer of right among Hindus before granting any financial accommodation to such a family. Following
points are worth mentioning in this respect.
1. The business of the family is run by the eldest member in the family. He is called as the Karta.
2. The Karta has an implied power to contract debts, pledge the property of family for purposes
which are beneficial for the family or for discharge of lawful ancestral debts from the family.
3. The burden of proof that the loan was taken by the karta for purposes beneficial to the family lies
on the banker. In order to protect itself from such a liability it will be safe for the banker to ask for
signatures of all adult male members of the family on the document charging joint family estate in
favor of the banker.
4. A trading Hindu Undivided Family may appoint some person as Manager who holds out as its
accredited representative. He may be a person other than the karta because there may be more
than one manager particularly when business is done at more than one place.
5. A manager has wider powers than the Karta. He has all the powers required for carrying on the
family business. He can pledge credit or property of the family for the purposes of family business.
He can also bind all members including minor for negotiable instruments executed by him. However,
the family will not be bound by his immoral or speculative transactions.
6. All members of the family are liable for all acts done by the Karta in the ordinary course of the
family business. However, except karta no other member is personally liable. The other members
are liable only to the extent of their share in the property of the Joint Hindu Family. But in those
cases where each member has also made a contracting party, each one of them is personally liable
except a minor member. Such members are liable only when contracts are ratified by them on
attaining majority.
11. Non trading institutions and other associations: In case a society or an institution such as a
school, a hospital wants to open an account in its name, the banker should take the following precautions:
(i) The society must be incorporated: The society, be it a club, school or any institution, must
be registered as a corporate body under the Societies Registration Act or the Companies Act or the Co-
operative Societies Act. In the absence of any such registration, the society will have no legal existence
and will have no contracting powers. The banker will not be in a position to sue neither them nor their
individual members for any loan or overdraft sanctioned to them. However, where an account is opened
in the personal name of any member for the society, e.g. “Sai Chandra account Gymkhana Club”, such
a member can be held personally responsible for any overdraft sanctioned to such club or society.
(ii) Copies of memorandum and articles of association must be obtained: The banker
should obtain a copy each of the Memorandum of Association and Articles of Association of the society.
The former will tell the banker about the broad objectives of the society while latter will acquaint it with
the rules, by-laws regarding the internal management of the society and the powers and functions of the
persons managing the affairs of the society.
(iii) Resolution of the managing committee: The banker should also call for a duly certified
copy resolution passed by the managing Committee of the society authorizing the opening of the society’s
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account with banker. The resolution should also state the names of persons who should be entitled to
operate the account on behalf of the society.
In the event of death, lunacy, of the person entitled to operate the account, the banker should stop
operation of the account till the managing committee communicates the appointment of a new person in
his place.
(iv) Power to borrow: As stated earlier a non-trading organization has no implied power to
borrow. Such power must be given by its memorandum. The banker should see the memorandum and
the articles of the society to find out the extent of society’s and office bearers’ power to borrow and
create charge on the assets of the society and the procedure to be followed for such borrowings and the
purposes for which money can be borrowed.
(v) No mixing of personal account with the society: In case an office bearer of the society
has also his personal account with the society, the banker should see that the society money does not find
its way into the personal account of the office bearer otherwise the banker may be held liable by the
society for wrongful conversion of funds.
12. Trustees: A trustee is a person in whom confidence is reposed. he is given control of an
estate, usually of the deceased, for the benefit of certain person. The person reposing the trust is called
author of the trust. The person for whose benefit the trust is created is called beneficiary. The document
creating the trust is called the trust deed.
A banker should take the following precautions while having business dealings with the trustees:
(i) The banker should thoroughly study the trust deed. The trust contains the names of the trustee,
their powers, the details of the trust property and other terms.
(ii) In case of several trustees, ll trustees must act jointly unless the trust deed provides for delegation
of powers to some of the trustees.
(iii) In case an account is opened for two or more trustees, the bank should obtain clear instructions
as regards the person or persons who shall sign the cheques or other instruments. In the absence
of such instructions all trustees must sign on each occasion.
(iv) In the case of death or retirement of one or more of the trustees, the powers of surviving or
remaining trustees will depend on the provisions of the trust deed.
(v) In the event of death or retirement of all the trustees, the new trustees may be appointed by the
court.
(vi) The insolvency of one or more trustees does not in any way affect trust property since it cannot
be utilized for payment of the personal debt of the trustee.
(vii) The banker should not knowingly permit the misuse of trust funds, otherwise it can be held liable
to the beneficiaries of the trust. For example, in a case, where the banker who had knowledge
of the trust character of an account allowed the customer to transfer funds standing to the credit
of the trust account to his personal account which was overdrawn, it was held that the banker
was liable to pay the money to the account to which it really belonged.
(viii)In case of charitable trust, the banker should examine the registration certificate issued by the
charity commissioner or such other authority as may be prescribed by the State Government
concerned under the Public Trust Act.

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 13. Executors and administrators : Executors and Administrators, both are persons appointed
to settle the accounts of a person after his death. Executor is appointed by the deceased himself, before
his death. The person appointing him called ‘testator’. The executor has to act according to the directions
given in the ‘will’. However, he must get the official confirmation of the will, technically called as
‘probate’, from the court.
The ‘Administrator’ is appointed by Court in those cases where the deceased has not given the
name of Executor in his ‘will’ or person named as executor has died or refuses to act. He disposes of the
assets and makes payment of the liabilities of the deceased as per the directions given in the will or in its
absence in the letter of Administration issued by the Court appointing him as Administrator.
The Banker should observe the following precautions while dealing with Executors or
Administrators.
(i) The bank should examine the ‘Letter of Probate’ (i.e. official confirmation of the will) in case of
Executors and Letter of Administration in case of Administrators to acquaint itself with the powers
and functions of the executors or the administrators.
(ii) An account in the following style may be opened in the name of executors or administrators.
“ABC executors (or administrators) of the estate of X, the deceased’.
(iii) In case of joint executors or administrators, the banker should get clear instructions, from them
regarding the executors, administrators who will operate the account.
(iv) The executors may borrow money for discharging some urgent obligations of the deceased. The
executors or administrators are personally liable for such loans unless the banker has given loan
on the specific asset of the deceased. In case of joint executors or administrators the power to
mortgage or pledge is available to all of them jointly. Moreover, they cannot exercise such power
if the probate or letter of administration specifically forbids it.
13.5 SUMMARY :
A banker or a bank is a person or company carrying on the business of receiving money and
collecting drafts for customers, subject to the delegation of honoring cheques drawn upon them from
time to time by the customers to the extent of the amounts available on their accounts. Accordingly the
essential function of a banker is the acceptance of deposits of funds withdrawable on demand. A
customer is a person or corporate body who opens an account or negotiates an advance on current or
loan account. Mere opening of an account will constitute a person as a customer of a bank, irrespective
of whether the connection is of long or short standing.
The general view is that the banker-customer relationship is mainly that of a debtor and a creditor
with certain special features: However, today the range of banking services is more extensive and
indeed is expanding all the time. So, other relationships will arise besides that of debtor and creditor. For
instance, the relationship of principal and agent when the customer instructs his bank to buy or sell stocks
on his behalf and when items are held in safe-custody the relationship is that of bailer and bailee. Where
the bank’s executorships service takes on the administration of a deceased’s estate, the relationship is
that of trustee and beneficiary. When the bank has sold property in mortgage and has a surplus to pass
to the subsequent mortgagee. Obviously, the relationship with the customer in that situation is that of a
mortgagor with a mortgagee on the customer. So relationships depend on the nature of transaction and
changes from customer to customer.
Before opening an account, the banker should obtain references from respectable parties about
the proposed customer’s integrity and respectability. Every person who is competent to contract can
open an account with a bank provided the bank is satisfied regarding his bonafides and is willing to enter
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into necessary business relations with him. But there are certain types of persons e.g. minors, lunatics,
married woman etc., whose capacity to enter into valid contracts is subject to certain legal restrictions.
13.6 SELF ASSESSMENT QUESTIONS :
1. What do you mean by banker and customer? Explain the relationship between banker and customer.
2. Who are the special customers of a bank? How should the banker deal with them.
3. Who is a minor? Can the banker open an account in the name of a minor? What precautions a
banker should take?
4. How a banker should deal with the accounts of (a) Married Woman (b) Drunkards (c) Lunatics.
Short Notes:
1. Define customer
13.7 BOOKS FOR FURTHER READING :
1. Sethi and Bhatia, Elements of Banking and Insurance, Prentice Hall of India, New Delhi.
2. Maheswari & Paul, Banking Theory Law & Practice, kalyani publishers, Ludhiana.
3. K.C. Sekhar et.al., Banking Theory and practice, Vikas publishing House Pvt Ltd., Mumbai.
13.8 KEY TERMS :
Current Account: A deposit Account mainly to serve business undertakings without any limits as to
number of deposits or withdrawals. Such Accounts are generally without interest on balances.
Bailment: Delivery of goods from one party (bailor) to the other (bailee) to be returned or otherwise
disposed of after the accomplishment of purpose.

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 Lesson No.: 14
PASS BOOK, NEGOTIABLE INSTRUMENTS,
TYPES OF BANK ACCOUNTS AND CUSTOMERS

STRUCTURE :
14. 1 Pass Book And Its Features
14.2 Entries In The Pass Book-the Leagalities
14.3 Cheque Book And Cheque
14.4 Types Of Bank Accounts
14.5 The Negotiable Instruments – Types And Features
14.6 Types Of Bank Customers
14.7 Summary
14.8 Self Assessment Questions And Short Notes
14.9 Suggested Readings
14.10 Key Terms

OBJECTIVE :
* The Unit is designed and presented in a way to make you understand
* the features of pass book and the legalities of entries in the pass book,
* the negotiable instruments types and features.
14.1 PASS BOOK AND ITS FEATURES :
Every customer with savings bank or current A/C transacts with the bank very frequently by
depositing money or cheques/drafts and also withdraws cash. The banker maintains a note of all the
customer’s transactions and gives a copy of the Customer’s Account to the customer in the form of a
small Account Bank, and now in the Computerized Banking in the form of a periodical statement sheets
which serve the purpose of a pass book. Thus a Bank pass Book is a small account book which the
banker issues to his customer to enable him examine the position of his account with the banker and
includes the computerized bank statements also.
According to John Paget, the proper function of a pass book is to constitute a conclusive,
unquestionable record of the transactions between the banker and the customer. But the legal decisions
indicate that the entries in the pass book are only prima facie evidence and not conclusive evidence. The
pass book is subject to contentions and corrections for wrong entries.

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Features of the pass book :
There are certain main features of pass book. Pass book is the record of the transactions by the
customer through his account. It is prepared and entered by the Banker. Pass book is not conclusive
proof and it is subject to corrections for wrong entries if any. It consists of Debit, Credit and Balance
entries. Debit for Cash and cheque withdrawals and credit for deposit of cash and cheques. Pass book
contains the identity of the customer along with address.
14.2 ENTRIES IN THE PASS BOOK-THE LEAGALITIES :
Entries in the pass book are only prima facie evidence, and not conclusive evidence. The banker
should endeavor to correct any wrong entry in the pass book immediately upon detection. As observed
by Sheldon, the longer the item remains uncorrected, the weaker the banker’s chance of recovering
money wrongly credited.
The legal position of entries in the pass book is explained in the following discussion. where a customer
issues a cheque depending upon a wrong entry of high balance by the banker in the pass book. If a
customer issues a cheque relying on an erroneous high balance shown by the pass book, the banker is not
entitled to dishonour it. If he dishonors such a cheque, he will be held liable for damages, as has been
held in Holland Vs Manchester and Liverpool District Banking Co. However, this does not mean
that a customer can hold the banker liable for dishonoring cheques issued. He law protects the banker in
that a customer is not allowed to take fraudulent advantage of an incorrect entry in the pass book, as has
been held in Rhind Vs Commercial Bank of Scotland.
If the customer receives a larger amount and spends more relying on an erroneous balance
shown in the pass book in Skyring Vs Greenwood, the decision was in favor of an army officer who
received a larger amount erroneously. The customer was held entitled to assume that he had performed
his banker duty, and having himself spent the overpaid money on that assumption was held not liable to
refund to the banker. The same principle was upheld in Holt Vs Markham. Hence, it is important for
a banker to remember that, if relying on an erroneous balance shown in the pass book, an ordinary
customer spent more money than he would otherwise have spent, the banker cannot reclaim it from the
customer.
There is a conflict of judicial opinions as regards the effect of entries favorable to the banker in
the pass book. In a general manner, it may be stated that the banker has no right to withhold money
which he has received from a customer, even though the customer may not have pointed out the omission
in his pass book.
Omission of entries in the pass book by the banker and not pointed out by the customer. .
Sometimes there may be entries in the pas book favorable to the banker. The banker may
commit omission of deposit entry in the pass book and it is not pointed out by the customer. In such a
case the banker has no right legally to withhold money he has received to the credit of the customer. It
was held in the case of Chatterton Vs. London and Country Bank that the omission of entry by the
banker understanding the balance to the customer’s credit is binding on the banker. Even though the
customer returns the pass book after tick marks against the wrong entries it is not a binding
acknowledgement. The banker is still liable.
But as held in the case of Essa Esmail vs. Indian Bank Limited, if a customer signs a confirmation
slip supplied to him by his banker the account would be taken as settled between the banker and the
customer. This the signed acknowledgement by the customer is the conclusive proof of the accuracy of
the pass book even though the erroneous entries are omitted or committed in favor of the banker.

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 Regarding the payment by the banker against the cheques where the customer’s signature is
forged.
The banker is liable and answerable for the payment of cheques where the customer’s signature
is found forged. It does not stand against the customer even though the signed confirmation slip is taken
from the customer as was need in Allahabad Bank Limited Vs. Kul Bhushan and others.
The instances above help to know that the banker should show utmost care in making entries in
the pass book of a customer. And it is not correct to consider the pass book a conclusive proof of the
customer’s account with the bank.
14.3 CHEQUE BOOK AND CHEQUE
Cheque- characteristic features of a cheque.
For the convenience of the customer a bundle of cheques are issued to the customer in a book
form with individual leaves consecutively numbered. Section 6 defines a cheque as “a bill of exchange
drawn on a specified banker and not expressed to be payable otherwise than on demand”. A cheque is
also, therefore, a bill of exchange with two additional qualifications:
It is always drawn on a specified banker.
It is always payable on demand.
Thus, all cheques are bills of exchange but all bills are not cheques.For the convenience of the
customer a bundle of cheques are issued to the customer in a book form with individual leaves consecutively
numbered.
Characteristic features of cheque :
The following are the essential features of a cheque.
It is an instrument in writing: A cheque should always be in a written form. Oral orders cannot make
a cheque, even if they are powerful with strong support and proofs.
Cheque should be an unconditional order: a cheque is an order to pay, but the word ‘order’ need not
be used in writing a cheque. Cheque should be an unconditional order. If any condition is attached to the
cheque, it automatically loses its identity as cheque. According to the negotiable instruments act, to
honor a cheque if banker is asked to do some thing additional, it becomes a conditional order. If the order
is conditional, the instrument cannot be defined as cheque.
Cheque is always drawn on a specified banker: In this regard cheque totally differs from other
negotiable instruments such as bill of exchange and promissory note which can be drawn on any person.
It is a common practice among banks to issue cheques with the name and address of the bank printed on
the top of the cheque. This restricts the use of cheque on anybody except on the banker specified.
Payment of certain sum of money: Cheque is an order to pay certain sum of money. A cheque cannot
be used to draw other things such as securities, documents etc. from the bank and such instrument
cannot be regarded as cheque. It is also important to understand that the sum of money to be paid is also
certain.
Amount of the Cheque: It is very important that the drawer of the cheque should mention the amount
very clearly both in figures and words. The drawer writes the amount he wishes on the face of the
cheque usually in the space provided for it.

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Payee must be certain: A cheque can be considered valid only when the payee is certain. Payee is the
one to whom the amount mentioned in the instrument is to be paid. Bank should know to whom the
amount is directed to pay. If payee is not certain, cheque is not considered as valid cheque. In this
context Sir John Paget says “a cheque is one is which there is a drawer, a drawee banker and a payee or
bearer….” Thus drawer should mention certain person to whom it should be paid.
Payable on demand: A cheque is always payable on demand. This is an important and essential
feature of the cheque and it differs from other instruments. Cheque is such an instrument where time is
not mentioned, it is payable on demand.
Signature of the drawer: A cheque to be regarded as a valid cheque, should be signed by the drawer.
The signature should match the specimen signature he has submitted to the banker at the time of opening
of an account. Even if it differs minutely banker need not honor the cheque.
Drawing of cheques: Cheque differs from other instruments drastically that a cheque can be drawn by
a customer of a bank only on his banker. Thus to draw a cheque there should be relationship between
banker and customer as banker and depositor and the customer should have only the current account or
savings account to draw cheques.
Form of cheque: there is no provision in the Negotiable Instruments Act with regard to the form, size,
material to be used, language etc. to be used in writing a cheque. ‘Cheque can be an instrument in
writing’ is the only condition laid by the Act. Thus cheque can be written with any instrument, in any
language known to the banker and customer on any material. Banker cannot dishonour a cheque because
it is not written on a paper. But it is a common practice among banks in any country to provide printed
cheques with name and address of banks with blanks to write particulars.
The Negotiable Instruments Act merely states that the cheque must be in writing. Cheque in printing
form is not a legal presumption. But in view of the safety, security and to guard against alterations and
fraud printed form of cheque is desirable. Cheque in printed form is desirable for the following
reasons.
The printed form ensures that all the legal requirements of a cheque are met. The customer is
saved from the trouble of drafting each cheque in conformity with the requirements of law.
It makes forgery difficult because the forger will first have to obtain the cheque book of the
customer before he can think of forging his signature.
The alternations are easier to detect when printed forms are used than when ordinary slips of
paper are used.
Where the drawer’s signature is not legible, the banker can know the name of the drawer by
referring to cheque book re cords.
The customer can countermand a cheque by simply intimating the number of the cheque to the
banker.
The counterfoils of the cheque book serve as record of the various payments made by the
customer by means of such cheques.
14.4 TYPES OF BANK ACCOUNTS
Accounts are one of the important sources of bank’s funds. The major functions of a bank are
to mobilize deposits from the public and to invest and/or lend these deposits to individuals, forms and
corporate institutions. In order to attract customers the banks offer attractive facilities to different types
of deposit account holders.
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Types of Deposits:
Deposits are normally classified as demand deposits and time deposits. The main differences
between the two are listed here:

Demand Deposits Time Deposits

1. Payable on Demand 1. Repaid after expiry of the Deposit Period.

2. Low interest rates or no interest. 2. High interest rates, which vary according to period.
3. It includes current, savings, overdue 3. Time deposits from 7 days to 120
deposits and unclaimed deposits. months period with or without reinvestment plans.
4. Interest is paid on half yearly basis 4. Interest is paid on quarterly rests and
on saving accounts. is cumulative every quarter.

Demand Deposit Accounts:

Demand deposits are classified into current accounts and savings accounts. The features can be
elaborated as under:
Current Deposit Accounts: Current deposit accounts are opened to meet the transactions of business
and trade and hence are not entitled to any interest from the bank. On the contrary, the bank could levy
charges for maintaining the accounts in the form of per page fees, per cheques leaf debit charges,
minimum balance fees etc. The minimum balance could differ from bank to bank. There are no restrictions
on the number of transactions per day but the customer has to pay cheques leaf charges at the time of
issue of cheques books by the bank. Current account is meant, normally for trading or business transactions
where every transaction made is only through cheque.
Saving Deposit Accounts: Its purpose is to inculcate a habit of saving. It is opened by individuals/
trusts, etc. Interest is paid at a rate as determined by RBI. At present, it is 3.5 per cent per annum on the
minimum balance in between 10th and last day of the month. The bank’s customers can withdraw
amounts either by cheques or withdrawal form. Interest paid is on a half yearly basis. Nomination
facility is available. In the case of frequent return of cheques due to insufficient funds, the bank can
impose a penalty and ultimately close the account after due notice o the customer. The numbers of
withdrawals are restricted by each bank and the minimum balance to be maintained could vary between
Rs. 100 and Rs. 25,000.
Time or Term Deposit Accounts: Term deposit accounts are classified under various schemes as:
(i) Fixed Deposits (with simple interest payable every 6 months).
(ii) Monthly Interest Deposits (interest payable monthly).
(iii) Quarterly Interest Deposits (interest is payable every quarter).
(iv) Short-term Deposits (period of deposit less than a Year).
(v) Reinvestment Deposit Scheme (interest is not paid out but reinvested by the bank.the interest is
capitalized).
(vi) Recurring Deposit Scheme (deposits are credited in equal installments on monthly basis by the
customer).

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 Banks may vary the payment terms in combination with annuity, interest payment being partial or
full or flexible in nature etc., and offer variety of deposit products to suit the needs of the customers.
Fixed Deposit Account:
They are also known as time liabilities or term deposits. These are deposits which are made with
the bank for a fixed period specified in advance. The bank need not maintain cash reserves against these
deposits and, therefore, the bank offers higher rates of interest on such deposits. These deposits generally
constitute more than half of the deposits with the banks.
Opening and operation of fixed deposit account :
The depositor has to fill in an application form wherein he mentions the amount of deposit, the
period for which deposit is to be made and the name/names in which the fixed deposit receipt is to be
issued. In case of a deposit in joint names, the banker also takes the instructions regarding payment of
money on maturity of the deposit, i.e., whether payable jointly or payable to either or survivor, etc. The
banker also takes the specimen signatures of the depositor(s). A Fixed Deposit Receipt is then issued to
the depositor acknowledging receipt of the sum of money mentioned therein. It also contains the rate of
interest and the date on which the deposit will fall due for payment.
Recurring Deposits or Cumulative Deposit Accounts:
The objective of the Recurring deposit scheme is to develop a regular habit of savings in the
depositor. The rate of interest varies according to the period for which deposit has been made. It is
almost equal to that of the fixed deposits. A depositor opening a recurring deposit account has to deposit
a fixed amount (usually in multiples of Rs. 100 or Rs. 1,000) every month for a period selected by him.
The period ranges from 1 to 10 years. The installment has to be paid before the last working day
of that month. In case, the depositor wants to transfer his account from one branch to another, he can
get it done without payment of any charge for such transfer.
Dormant Accounts:
Dormant Accounts are those accounts which are without any customer created transaction for
a long time. The law has not prescribed any period after which an account should be treated as a
Dormant Account because of absence of any transactions by the customer in his account. Every bank
has its only policy in this respect.
There may be several reasons for an account becoming a Dormant Account. The depositor
might have moved from one place to another without notifying the banker about his change of address.
He may have misplaced his pass book and forgotten about the existence of an account with a particular
bank. In some cases the depositor might have died without bank’s knowledge.
In case of active accounts, there is some measure of control because of periodic review by the
customer of his account. In case of current accounts, the Bank submits statements of account to the
customer at regular intervals. It is presumed that the customer must have gone through the account and
checked about its accuracy. in case of an active account, the customer is asked to submit his Pass Book
from time to time to the bank so that the bank may pass necessary entries in it. Thus, in case of an active
account, the chances of fraud being committed by the bank’s employees are much less since the accounts
are subject to constant check by the customers. However, no such controls are available in case of
Dormant Accounts can easily be manipulated by cheats. One method of controlling fraud in case of
Dormant Accounts is to transfer all of them into one Ledger. This Ledger should list all the depositors
having Dormant Accounts with the bank with the amount shown against each account. The signature
cards for Dormant Accounts should also be removed from the active file and should be placed in a
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Locker under dual control. The card reference of such transfers should be kept in the active file. The
card should show the name of each depositor and the date on which the account was transferred to
Dormant Account Ledger. In case of each depositor whose account has been taken as a Dormant
Account wants to operate such an account, the entry must be initialed by a responsible official before the
account is permitted to be operated upon. The officer concerned should also initial the control sheet
when such entries are made.
14.5 THE NEGOTIABLE INSTRUMENTS – TYPES AND FEATURES:
Meaning and types of Negotiable instruments: According to Section 13 of the negotiable Instruments
Act 1881, a negotiable instrument means “a promissory note, bill of exchange or cheque, payable either
to order or to bearer whether the words “order” or “bearer” appear on the instrument or not”. The term
negotiable instrument means a written document which creates a right in favor of some and which is
freely transferable. Free negotiability is an important characteristic of a negotiable instrument.
Due to specific features and their significance in trade and commerce, a special Act was passed
to govern negotiable instruments called Negotiable Instruments Act 1881. The Act was passed in 1881
and came into force from 1st March 1982. it has been amended by “The Banking Public Financial
Institutions and Negotiable Instruments Laws (Amendment) Act 1988” with effect from 30th December
1988.
The negotiable Instruments Act deals with negotiable instruments and also the law that governs
the negotiable instruments, Section13 of Negotiable Instruments Act specified that negotiable instruments
covered by the Act are promissory Notes, Bills of Exchange and Cheques. Thus according to the Act
these three are negotiable instruments, with which banker deals regularly in his banking functions and
services.
The Negotiable Instruments Act 1881 consists of XVII Chapters and 142 Sections.
The Act recognizes only three types of instruments- a promissory note, a bill of exchange and a
cheque as negotiable instruments. But it does not exclude the possibility of other instruments, which
satisfy the Characteristics of negotiability being included in the list.
The conditions are:
1. the instrument should be freely transferable (by delivery or by endorsement and delivery) by the
custom of the trade, and
2. the person who obtains in good faith and for value gets it free from all defects, and thus, is entitled
to recover the money of the instrument in his own name.
Hence, documents such as Dividend Warrants, Port Trust or Improvement Trust Debentures,
Railway Boards payable to bearer or Railway Receipts are considered equivalent to negotiable instruments.
But Money orders and postal orders, deposit receipts, share certificates, bills of lading, dock warrants
etc., are, however, not negotiable instruments. Though, they are transferable by delivery and endorsement
they are not able to give better title to the bonafide transferee for value than what the transferor has.
Features or characteristics of Negotiable instruments: Following are the essential
characteristics of a negotiable instrument:
Negotiability: The property in a negotiable instrument is freely transferable. In case of order instruments,
it is transferable by endorsement and delivery. Incase of bearer instruments it is transferable by mere
delivery.

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Title: The holder in due course is not in any way affected by the defective title of the transferor or any
party. The term holder in due course means a holder who has accepted a negotiable instrument for
value, in good faith and before maturity.
Recovery: The holder in due course is entitled to sue on the instrument in his own name. He need not
give any notice of transfer to the person liable for payment on the instrument.
Presumptions: A negotiable instrument is always subject to certain presumptions. They will be applicable
unless contrary is proved.
The presumptions are: that every negotiable instrument was drawn, accepted and endorsed made or
transferred for consideration; that the date it bears is the date on which it was made; that it was accepted
within a reasonable time after being made and before maturity; that every transaction was made before
maturity; that the endorsements were made in the same order in which the appear; that the lost instrument
was duly signed and stamped; that every holder of a negotiable instrument is a holder in due course
unless it is proved that the holder has taken it from the true owner either without his free consent or
without consideration; that in a suit upon a dishonored instrument, the court shall, on proof of the protest,
presume that it was dishonored until this fact is disproved.
A negotiable instrument, therefore, means not only that the instrument is transferable by
endorsement or by delivery but also that the holder in due course of the instrument shall acquire a good
title to it. And a negotiable instrument will not be rendered invalid merely because of the obvious or
intelligible mistakes or omissions in the written words if the intentions are clear.
Meaning of and differences among Promissory Note, Bill of Exchange and Cheque :
Promissory Note, bill of exchange and Cheque are the negotiable instruments under law.
Promissory Note: Section 4 or the Act defines a ‘promissory note’ as an “instrument in writing (not
being a bank note or a currency note) containing an unconditional undertaking, signed by the maker, to
pay a certain sum of money only to or to the order of, certain person, or to the bearer of the instrument.
The Act gives an exhaustive definition of a promissory note and categorically excludes certain instruments
which do not comply with the requirements mentioned in the section. To determine, whether a particular
document is a promissory note or not, regard shall be had to the intention of the parties rather than to its
mere form.
Features of a promissory note:
Following are the essential features of a promissory note:
It is an instrument in writing: A mere verbal promise to pay is not a promissory note.
The promise should be in writing. The writing may be in ink or pencil, or printing, engraving or
lithographing.
It is a promise to pay :
There must be an express undertaking or promise to pay. The use of the word ‘promise’ in the
instrument is not necessary. A mere acknowledgement of the debt is not sufficient. Bank notes, and
currency notes, though are similar to promissory notes in every respect, have been expressly excluded.
They are considered as money and not merely securities for money. A currency note is a note issued by
the Government containing a promise to pay to the bearer a certain sum of money on demand.
It should be both in form and intent :
Before a document can be treated as a Promissory Note, it should be Promissory Note both in
form and intent. If indebtedness is acknowledged in a document in a defined sum of money payable on
demand that is enough to make a document a promissory Note and the document need not necessarily
say that the debtor promises to repay the amount. In a case Surjit Singh and others V. Ram Ratan
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Sharma the Assam High Court held that an acknowledgment of a receipt of amount does not take away
the character of the document as a promissory note if other conditions are satisfied.
The Undertaking to pay is unconditional :
The payment should not depend upon contingencies which may or may not happen, because
uncertainty badly affects the business and commerce. But, when an instrument is payable on the happening
of an event which is bound to happen, there is no uncertainty, and therefore, it is a pronote. Similarly, an
undertaking to pay money at a particular place or after a specified time, is unconditional and the document
is a pronote.
It should be signed by the maker: The person who promises to pay must sign the instrument even
though it might have been written by the promissory himself. There are no restrictions regarding the
form or place of signatures in the instrument. It may be in any part of the instrument. It may be in pencil
or ink, a thumb mark or initials. The pronote can be signed by the authorized agent of the maker but the
gent must expressly state as to on whose behalf he is signing otherwise he himself may be held liable as
a maker.
The maker must be certain: The note itself must show clearly who the person is agreeing to undertake
the liability to pay the amount.
The payee must be certain. The promissory note must point out with certainty the person to
whom the promise has been made. The payee may be ascertained by name or by designation.
The promise should be to pay money and money only: Money means legal tender money and not
old and rare coins. A promise to deliver paddy either in the alternative or in addition to money does not
constitute a promissory note.
Amount should be certain: One of the important characteristics of a promissory note is certainty
– not only regarding the person to whom or by whom payment is to be made but also regarding the
amount.
Other formalities: The other formalities regarding number, place, date, consideration etc., though
usually found given in the promissory notes but are not essential in law. The date of instrument is not
material unless the amount is made payable at a certain time after date. But a promissory note must be
properly stamped as required by the Indian Stamps Act.
Bill of exchange: Section 5 of the Negotiable Instruments Act defines a Bill of Exchange as. “an
instruments in writing containing an unconditional order, signed by the maker, directing a certain person to
pay a certain sum of money only to, or to the order of a certain person or to the bearer of the instrument”.
A bill of exchange, therefore, is a written acknowledgement of the debt, written by the creditor and
accepted by the debtor. There are usually three parties to a bill of exchange – drawer, acceptor or
drawee and payee. Drawer himself may be the payee.
Essential Features:
The essential features of a bill of exchange may be summarized s follows:
It must be in writing.
It must be signed by the drawer.
The drawer, drawee and payee must be certain.
The sum payable must also be certain.
It should be properly stamped.
It must contain and express order to pay money and money alone.

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 The order must be unconditional. In other words, the payment of the bill should not be dependent
on the happening of a contingency or the fulfillment of a condition.
Classification of Bills:
Bills can be classified as follows:
Inland and Foreign Bills.
Time and Demand Bills.
Trade and Accommodation Bills.
Inland and Foreign Bills:
Section II and 12 of the Negotiable Instruments Act deal with these bills.
Inland bill: A bill is termed as an inland bill if:
it is drawn in India on a person residing in India whether payable in or outside India, or
it is drawn in India on a person residing outside India but payable in India.
Foreign bill:
A bill which is not an inland bill is a foreign bill. Thus, following are foreign bills:
A bill drawn in India on a person residing outside India and made payable outside India.
A bill drawn outside India and made payable in India.
A bill drawn outside India on any person residing outside India.
A bill drawn outside India on a person residing in India.
A bill drawn outside India and made payable outside India.
Bills in Sets (sections 132 and 133): Foreign bills are generally drawn in sets of three, and each
set is termed as a ‘via’. The practice of drawing a bill in parts is called drawing a bill ‘in a set’. Each part
is dispatched by a separate means of conveyance so that there may be no delay on account of miscarriage
in the transit. All these parts form only one bill, the stamp is affixed on one part only and only one part of
the whole set is required to be accepted and paid. If this is done, the other parts become in operative. On
each part there is a reference of the other two parts.
Sections 132 and 133 provide the following rules for a bill in sets:
1. A bill of exchange may be drawn in parts, each part being numbered and containing a provision
that it shall continue payable only so long as the others remain unpaid. All parts make one bill and
the entire bill is extinguished i.e. when payment is made on one part, the other parts will become in
operative 9Section 132).
2. The drawer should sing and deliver all the parts but the acceptance is to be conveyed only on one
of the parts (Section 132).
3. As between holders in due course of the different parts of the same bill he who first acquired title
to any one part is entitled to the other parts and is also entitled to claim the money represented by
the bill (section 133).
Usance: Time fixed for the payment of bills drawn in one country and payable in another is called
usance. Length of usance differs according to the custom in force in each country.

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Time and Demand Bills:
Time Bill: A bill payable after a fixed time is termed as a time bill. A bill payable ‘after date’ is
a time bill.
Demand Bill: a bill payable at sight or on demand is termed as a demand bill.
Trade and Accommodation Bills :
Trade Bill: a bill drawn and accepted for a genuine trade transaction is termed as ‘trade bill’
Accommodation Bill; A bill drawn and accepted not for a genuine trade transaction but only to
provide financial help to some party is termed as an ‘accommodation bill’.
In form and all other respects an accommodation bill is quite similar to an ordinary bill of exchange.
There is nothing on the face of the accommodation bill to distinguish it from an ordinary trade bill.
Cheque:
Section 6 defines a cheques as “a bill of exchange drawn on a specified banker and not expressed
to be payable otherwise than on demand” A cheque also includes the electronic image of a truncated
cheque and a cheque in the electronic form. A cheque is also, therefore, a bill of exchange with two
additional qualifications:
It is always on a specified banker
It is always payable on demand
Thus, all cheques are bills of exchange but all bills are not cheques.
These three negotiable instruments differ in their features.

Bill of Exchange Promissory Note

1. It is an order to pay certain sum of money It is a promise to pay certain sum of Money
2. There are three parties to a bill of ex- There are two parties Maker and Payee
Change, drawer, drawee and payee
3. Liability is that of the drawee who accepts Liability is that of the maker who signs the note
4. Acceptance is necessary for a bil Acceptance is not necessary
5. A bill can be drawn and payable to bearer It cannot be made payable to bearer
(It is not payable on demand)
6. Some times it is drawn in sets It is not the case with promissory note
7. A bill of exchange can be accepted It can never be conditional
Conditionally
8. Notice of dishonour is required Not necessary

Differences between Bills of Exchange and Cheques: Bill of exchange and cheque are negotiable
instruments under law and possess several similarities,. Cheques resemble bills of exchange on several
issues. But there are some differences between cheques and bills because ‘all cheques are bills of
exchange but all bills of exchange are not cheques’ (Chalmer). Differences between bills of exchange
and cheques can be in the following way.

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 Cheques Bills of Exchange

1. All cheques are bills of exchange All bills of exchange are not cheques
2. Cheques are always drawn on a Bills can be drawn on any person
Specified banker
3. Cheques should be drawn on a Bills need not be drawn in a fixed printed
Printed form supplied by the Banks. form
4. Cheques are drawn against the funds Bills are drawn in the process of trade,
Held by bank drawer administration etc. to facilitate Flow of funds
5. Drawee need not accept cheque Drawee should accept the bill of Exchange
6. A cheque is paid on demand It is drawn for a specified period and it
Immediately is entitled to 3 grace days for payment
7. A cheque can be crossed There is no such facility for bill of Exchange
8. Liability of the drawer extends Delay in presentation will discharge
to six months the bill
9. There is no stamp duty on cheque A bill attracts stamp duty
10. Statutory protection under Negotiable There is no such statutory protection
Instrument Act is available
11. It is not protested on dishonour It is usually protested and noted for Dishonour
12. Notice of dishonour is not Notice of dishonour must be sent to
necessary hold the party liable
13. A cheque can be countermanded Bill of exchange can not be counter-manded
14. Cheque is never drawn in sets Some types of bills are always drawn in Sets

14.6 TYPES OF BANK CUSTOMERS

Opening of a bank account is a special type of contract. Different types of individuals and
institutions open a bank account. Special features of certain types of customers and the precautions
which a bank has to take when dealing with such customers are discussed in the following paragraphs.
1. Minors: According to Indian Law, a person is a minor until he completes his eighteenth year. If
he is under the guardianship of Court of Wards, he continues to be a minor until he completes his 21st
year, In England a person who does not complete his 21st year is called an infant.
According to Indian Contracts Act, a minor has no capacity to contract. Agreements entered
into by a minor are void, and as such cannot be enforced in courts of law. But agreements entered into
by a minor either for necessaries or for the minor’s benefit are valid contracts and are enforceable in a
court of law.
Precaution: The Banker should take the following precautions before opening an account in the name
of a minor. The banker may open a savings bank account in the name of a minor to be operated by the
natural guardian or the guardian appointed by the court. A savings bank account can be opened in the
name of a minor and operated by a minor provided he has completed 14 years of age. The bank should

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record the date of birth of the minor as supplied by the minor or his guardian. If the father of a Hindu
minor dies, his mother becomes natural guardian. If the mother also dies during the minority of the boy
either testamentary guardian or the guardian appointed by the court will operate the account. The
banker may return the balance amounts to such guardian. If the minor dies the guardian will draw the
amounts.
The banker runs no risk in dealing with a minor as long as his account is in credit. However, the
fact that a contract with a minor is avoid, it is advisable to open the account in the name of his guardian.
This will enable the banker to recover the amount of the overdraft which he might have allowed by
mistake. Otherwise, not only the amount advanced to a minor becomes irrevocable, but also any securities
pledged by him must be returned. A guarantee given by a third party in respect of a debt contracted by
a minor is of no avail, on the ground that where the principal debtor is not liable, the surety can not be held
liable.
Minor as agent: A minor can act as agent of another person competent to contract, provided he
is duly authorized. For instance, minor son may make contracts besides endorsing cheques and bills on
behalf of his father. He can even borrow on behalf of his father, if he has a distinct authority to do so.
Minor as partner: There is nothing to prevent a minor from becoming a partner in a firm and
transacting business on its behalf. However, he cannot be held liable for any debts of the partnership
incurred before he attains majority. On the other hand, unless he expressly repudiates the contract of
partnership within six months of his attaining majority, it is presumed that he has ratified the partnership
agreement. After that he will become liable for the debts incurred by the partnership firm and is already
eligible for profits on par with other partners.
2. Lunatics: Under Section 12 of the Indian Contract Act, persons of unsound mind are disqualified
from entering into contracts. But the disqualification does not apply to contracts entering into by lunatics
during periods of sanity or which are ratified during such periods. According to Indian Law, contracts
with persons of unsound mind are not only avoidable but void. Consequently, no banker would knowingly
open an account in the name of a person of unsound mind because that would easily involve him in the
difficulty of choosing between the risk of unjustifiably dishonoring the customer’s cheques on the one
hand and of being held to have debited his account without adequate authority on the other. When a
banker comes to know of his customer’s lunacy, all operations on his account should be suspended until
the receipt of an order from the court or the definite proof of the customer’s sanity.
3. Drunkards: If a person who is a party to a contract can prove that at the time of entering into
the contract he was incapable, from the effect of liquor, or understanding the contract and of forming a
rational judgment as to its effects upon his interest which fact which fact was known to the other party,
he may have the contract set aside by the court. If a customer tenders, when drunk, a cheques for which
he demands payment, the banker would be advised to have a witness to the signature and the payment of
the amount.
4. Married woman: According to Indian Contract Act, a married woman is competent to enter into
contracts, to acquire and sell property, to lend and borrow money, etc. In another words she has all the
rights which a man has. A current account may be opened in the name of a married woman. A married
woman has power to draw cheques and give sufficient discharge her if she does not have a separate
property. Even if she has separate property, the property may be so settled upon her that she is entitled
to the income as it falls due but may not touch the corpus or the anticipated income. A married woman
cannot make her husband liable except for necessaries of life.
A banker should be careful while granting, loans or allowing overdrafts. This is essential because
the husband’s liability for wife’s debts arises only under the following circumstances:

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 1. Where the husband has given his consent or authority.
2. Where the debt is incurred for the purchase of necessities of life, in case the husband defaults in
providing the same to his wife.
It is clear from the above that the husband is not liable for all the debts made by his wife. The
banker can recover the amount only from the personal assets of the married woman. Therefore, the
banker should examine her own assets and satisfy himself whether they are sufficient to cover the
amount of the loan.
A banker will have to keep the following points in his mind while granting a loan or an overdraft
to a married woman:
1. The husband of a married woman is not liable for debts contracted by her except in so far as they
are for necessaries of life in case the husband defaults in supplying the same to her. So the banker
should not lend money to a married woman simply because her husband had sufficient property.
2. If she does not have separate property, there will not be sufficient security for overdrafts granted
to her. It may be difficult to recover money from her.
3. If she has separate property (Streedhan), the banker must find out the nature of her right to that
property. She may not have the right to sell the property, although she may enjoy the income there
from.
4. If a married woman applies for loan, the banker must examine whether there is any undue influence
exercised by her husband. She should be apprised of her liability for the loan she contracts. She
may be advised to consult her lawyer.
5. If there is a joint account in the names of husband and wife and if there is clause to the effect that
in the event of the death of one party, the balance should vest in the survivor, the banker’s position
will be safe.
5. Pardanashin woman: A pardanashin woman is one who, by the custom of the country or the
usage of the particular community to which she belongs, is obliged to observe complete seclusion. A
contract with a pardanashin lady is presumed to have been induced by undue influence and, therefore, a
banker has to be extra-cautious while dealing with her. In order that lady may not set aside any contract
on the ground of undue influence, the banker will have to prove that:
(a) the terms of the contract are fair and reasonable;
(b) the transaction is real and bonafide;
(c) the lady had an independent advice in the matter;
(d) the deed was explained to her; and
(e) she understood it and its effects on her interest in full.
The identity of such a lady is not possible to determine and, therefore, usually the banks refuse to
open an account in her name.
6. Illiterate persons: An illiterate person may open an account with a bank. The banker
should take the following steps:
(i) Thumb impression: The left hand thumb impression of the depositor should be obtained on the
account opening form and the specimen signature sheet in the presence of an authorized supervising
official.
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 (ii) Identification mark: Where possible, brief details of one or two identification marks of the depositor
should be noted on the account opening form and the specimen signature sheet under authentication
of an authorized official.
(iii) Photograph: Two copies of the passport photograph of the depositor should be obtained and got
renewed every three years. One copy of the photograph will be pasted on the account opening
form and another on the specimen signature sheet.
(iv) General: Implications and conditions for operation of the account should be explained to the
depositor by an authorized official. He should also append a certificate to the effect that he had
done so on the account opening form. Withdrawals from the account should generally be allowed
only when the person comes personally and produces his or her pass book.
7. Joint Accounts: When an account is opened in the names of two or more persons, who are
not partners in a firm or who are not joint trustees, it is called a joint account. When a joint account is
opened the banker should obtain a comprehensive mandate. The mandate should cover all points because
the right to draw cheques conferred upon a person does not automatically confer upon him the right to
deal in securities, to contract debts, or to deal in bills of exchange. If one of the joint account holders
obtains an overdraft, the others do not have liability. So it is necessary that definite instructions should be
obtained on the following matters.
Issuing of Cheques: It should be clearly specified in the mandate as to who is authorized to draw
cheques. If there is nothing stated in the mandate, all the joint customers must sign the cheques. Although
the right to draw cheques may be conferred on one or more of the parties, any one of the joint account
holders can countermand a cheque. In this case, the right to sign the cheques conferred on one of the
parties is deemed to be temporarily withdrawn.
If a third party, not being a joint account holder, is authorized to draw cheques, the arrangement
must be approved by all the parties. Similarly, if a power of attorney is given to a third party, not being a
joint account holder, the power of attorney must be signed by all the parties.
Death of Joint account holder: If one of the Joint account customer dies, according to English Law, the
survivors can continue to transact the business relating to the joint account. But according to Indian law,
the surviving joint customers along with the heir of the deceased joint customer must transact the business.
Clear instructions must be included in the mandate given to the banker.
Joint Debts: The right to draw cheques given to a joint customer is limited to the credit balance available
in the bank account. If cheques are drawn in excess of the amount, all the joint customers become
indebted to the bank. But the right to draw cheques does not extend to contract debts. So the banker
must ascertain whether the person who has the right to draw cheques has also the power to overdraw
the account.
Joint and Several Liability: According to Indian Law, joint liability means joint and several liabilities. If
one of the joint customers dies, and if the account is overdrawn by that time, the banker must stop that
account and open a fresh account in order to make the estate of the deceased customer liable for the
debt. Otherwise, the banker would lose his right to recover the amount from the estate of the deceased
party on account of the operation of the rule in Clayton’s case.
Safe custody deposits: If joint account holders deposit valuables for safe custody with the bank, no one
of them can take delivery of them. The banker should return the securities only on the requisition of all
the joint customers. Similarly, no one of the joint customer can stand surety on behalf of all the joint
customers. No single joint customer can pledge the fixed property of the joint parties without a power of
attorney granted to him. When shares or valuables belonging to the joint parties are sold by the banker,

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the sale proceeds should be handed over to the joint holders and legal representatives of the deceased
party or reimbursed in accordance with their instructions.
Death insanity or bankruptcy of a joint customer: When the banker is duly informed of the death of
one of the joint customers, the banker should not thereafter honor cheques presented for payment.
Similarly, when a notice is given to him of the insanity or bankruptcy of one of the joint customers the
banker should not honor cheques subsequently presented. The balance should be paid only to the legal
representative of the deceased or insane customer and to the other joint customers.
Garnishee order: If the banker receives a Garnishee order in respect of one of the joint account
holders asking him not to make any payment out of the joint account, he should inform the Court that it is
a joint account and request the Court to withdraw the Garnishee order
Trust Accounts: If the joint account relates to a Trust, but the banker is not informed of the same, the
banker need not take cognizance of the fact. After he comes to know that it is trust account, he should
be careful to see that it is not overdrawn at any time.
Joint account in the name of Husband and Wife: The position in the case of a joint account in the
name of husband and wife is different. Where an account is opened by the husband for his convenience,
the balance cannot be claimed by the widow but has to be brought to the estate of the deceased. But
where the intention of the husband by opening a joint account was to make a provision for his wife in
case of his untimely death, the widow would receive the money. Further in a Madras case it has been
held that under the law at present prevailing in India, a deposit standing in the name of Hindu husband and
his wife and payable to either of survivor, must be presumed to belong to the husband, in the absence of
any evidence to the contrary.
8. Partnerships: The Indian Partnership Act, 1932 defines partnership as “the relation between
the persons who have agreed to share the profits of the business carried on by all, or by any one of them
acting for all”. Persons who have entered into partnership agreement are individually called partners.
All the partners are collectively called a ‘firm’.
Essentially Features of Partnership: The following are the essential features of a partnership firm.
1. The existence of written or implied agreement to do lawful business.
2. To share profits.
3. Dual role of every partner as principal and agent.
4. Partner’s implied authority to bind all other partners by his conduct in the ordinary course of the
business.
5. The maximum number of partners is 20 and the minimum number is 2 in the case of banking firms,
the maximum number of partners is 10.
Partner’s Implied Authority: Partner’s implied authority in a firm is a most significant feature. Each
partner is the accredited agent of the firm. A transaction entered into by him is binding on the firm if the
transaction is related to its normal business. A power to do what is usual does not include a power to do
what is unusual, however, urgent. This implied authority of a partner to blind the firm does not extend to
guarantees.
In view of the above uncertain conditions about eh partners in the firm, the banker should take
certain extraordinary precautions while dealing with a partnership firm.

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Precautions: A banker should take the following precautions before opening an account in the name of
the firm.
1. Opening of Account in the name of a firm: The account must always be opened in the name of
the firm but not in the name of individual partner or names of partners. If an account is opened in
the name of any individual partner, his co-partners are not liable in respect of transactions therein.
2. Signature by all partners on the Account Opening Form: Though any one of the partners is
entitled to open the account, the banker in his own interest shall ask all the partners to sign on the
account opening form.
The right of drawing cheques given to a partner may be withdrawn by others at any time. When
the banker is notified of withdrawal of such right, he should not honor cheques presented
subsequently. Any partner can countermand a cheque issued in the name of the firm.
3. Death of a partner: When a partner dies, the partnership comes to an end. The legal heir of the
deceased partner does not automatically become the partner of the firm. the legal heir has only the
right to recover the money due to him from the partnership firm. The banker may continue the
bank account if by the date of the death of the partner there is a credit balance in the account. Bit
if here is a debit balance, the banker must stop the account and start a fresh account. the banker
thus will secure for himself the right of recover the amount from the estate of the deceased partner
also.
4. Bankruptcy of a partner: partnership also comes to an end when one of the partners becomes
bankrupt. The banker should not honor cheques drawn by the bankrupt partner, unless it bears the
signatures of the other partners as well. The banker may continue the bank account in so far as it
may be necessary o wind up the affairs of the firm, which is dissolved owing to the bankruptcy of
a partner. In such a case, the assets of the partnership may be transferred to one of the partners,
who acts as a trustee of such assets. There is the danger of the banker being held guilty of
negligence unless he acts with utmost care and caution in such cases.
5. Insanity of a partner: A partnership is not dissolved when one of the partners becomes insane,
but it becomes as sufficient reason for the dissolution of the firm. The relations of the insane
partner may file a petition in the court for ordering the dissolution of the firm.
6. Retirement of a partner: When a partner retires from the partnership firm, he must notify the
same to the banker. Otherwise, he also becomes liable for the debts incurred by the receipt of
retirement notice, if the partnership is indebted to the bank, the bank must stop the account and
start a fresh account. In this case, the retiring partner also will be liable for the debt owing by the
partnership firm at the date of retirement. If the partnership assets had been given as security for
the advance granted to the firm, the bank account may be continued on the basis that transactions
are being continued for the purpose of winding it up.
9. Joint stock companies:
1. The banker should examine the certificate of incorporation, Memorandum of Association and
Articles of Association of the company, before opening an account. He should obtain copies of
the latest documents as amended up-to-date and note carefully the provisions relating to capital,
objects, liability, name, borrowing powers, powers and duties of directors and other rules and
regulations.
2. In the case of a public company, he must inspect its certificat5e of commencement of business and
satisfy himself that the company has been authorized to commence business.

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 3. If the banker has any doubt, he should inspect the company’s file in the office of the Registrar of
Companies.
4. He should receive a copy of the Board’s resolution appointing him as the company’s banker stating
the mode of operation and naming the person authorized to operate upon the account. This resolution
is to be signed by the Chairman and countersigned by the Secretary of the company.
5. He should obtain specimen signatures of those persons who are authorized to operate upon the
account.
6. He should note the first directors of the Company.
7. In case of existing companies, he should ask for copies of Annual accounts and reports for some
previous years.
8. In the case of a private company, all the precautions mentioned above should be taken by a banker.
But the certificate of commencement of business need not be examined. In dealing with a private
company, he must be on his guard. he should not grant any accommodation without any security.
He should be more careful, if the business is recently converted into a private company.
Opening an Overdraft account: The banker should take the following steps before an overdraft
account in the name of a registered company.
1. He should go through the Memorandum and Articles of Association for the borrowing powers and
restrictions thereon particularly in a non-trading company. All trading companies have an implied
power to borrow to such an extent as is reasonable and accessory for the carrying out of their
declared objects.
2. He should note any limitations placed by the Articles on the borrowing powers to be exercised by
the directors.
3. He must also know the powers of directors to mortgage the company’s assets and the regulations
controlling the signing and endorsing of cheques and bills.
4. He need not enquire into the purpose of the advance. If it is misapplied, it cannot be avoided,
provided the banker acted bonafide and without knowing about the intended misapplication.
5. He should get a certificate by the Chairman or director or the secretary of the company, stating
that the proposed advances are within the powers of directors.
6. He should insist on a separate resolution of the Board whenever the company wants to borrow.
7. He should see that any charge created by the company in favor of the bank is filed with the
Registrar within 30 days of its creation. He should inspect the register of charges and ascertain
whether there are any prior encumbrances.
10. Joint Hindu family firms: A business carried on by a Joint Hindu Family is governed by the
provisions of Hindu Law. A banker should know well the laws and customs relating to succession and
transfer of right among Hindus before granting any financial accommodation to such a family. Following
points are worth mentioning in this respect.
1. The business of the family is run by the eldest member in the family. He is called as the Karta.
2. The Karta has an implied power to contract debts, pledge the property of family for purposes
which are beneficial for the family or for discharge of lawful ancestral debts from the family.
3. The burden of proof that the loan was taken by the karta for purposes beneficial to the family lies
on the banker. In order to protect itself from such a liability it will be safe for the banker to ask for
signatures of all adult male members of the family on the document charging joint family estate in
favor of the banker.
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 4. A trading Hindu Undivided Family may appoint some person as Manager who holds out as its
accredited representative. He may be a person other than the karta because there may be more
than one manager particularly when business is done at more than one place.
5. A manager has wider powers than the Karta. He has all the powers required for carrying on the
family business. He can pledge credit or property of the family for the purposes of family business.
He can also bind all members including minor for negotiable instruments executed by him. However,
the family will not be bound by his immoral or speculative transactions.
6. All members of the family are liable for all acts done by the Karta in the ordinary course of the
family business. However, except karta no other member is personally liable. The other members
are liable only to the extent of their share in the property of the Joint Hindu Family. But in those
cases where each member has also made a contracting party, each one of them is personally liable
except a minor member. Such members are liable only when contracts are ratified by them on
attaining majority.
11. Non trading institutions and other associations: In case a society or an institution such as a
school, a hospital wants to open an account in its name, the banker should take the following precautions:
(i) The society must be incorporated: The society, be it a club, school or any institution, must be
registered as a corporate body under the Societies Registration Act or the Companies Act or the
Co-operative Societies Act. In the absence of any such registration, the society will have no
legal existence and will have no contracting powers. The banker will not be in a position to sue
neither them nor their individual members for any loan or overdraft sanctioned to them. However,
where an account is opened in the personal name of any member for the society, e.g. “Sai
Chandra account Gymkhana Club”, such a member can be held personally responsible for any
overdraft sanctioned to such club or society.
(ii) Copies of memorandum and articles of association must be obtained: The banker should
obtain a copy each of the Memorandum of Association and Articles of Association of the society.
The former will tell the banker about the broad objectives of the society while latter will acquaint
it with the rules, by-laws regarding the internal management of the society and the powers and
functions of the persons managing the affairs of the society.
(iii) Resolution of the managing committee: The banker should also call for a duly certified copy
resolution passed by the managing Committee of the society authorizing the opening of the
society’s account with banker. The resolution should also state the names of persons who
should be entitled to operate the account on behalf of the society.
In the event of death, lunacy, of the person entitled to operate the account, the banker should
stop operation of the account till the managing committee communicates the appointment of a
new person in his place.
(iv) Power to borrow: As stated earlier a non-trading organization has no implied power to borrow.
Such power must be given by its memorandum. The banker should see the memorandum and
the articles of the society to find out the extent of society’s and office bearers’ power to borrow
and create charge on the assets of the society and the procedure to be followed for such borrowings
and the purposes for which money can be borrowed.
(v) No mixing of personal account with the society: In case an office bearer of the society has
also his personal account with the society, the banker should see that the society money does not
find its way into the personal account of the office bearer otherwise the banker may be held
liable by the society for wrongful conversion of funds.
12. Trustees: A trustee is a person in whom confidence is reposed. He is given control of an
estate, usually of the deceased, for the benefit of certain person. The person reposing the trust is called
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author of the trust. The person for whose benefit the trust is created is called beneficiary. The document
creating the trust is called the trust deed.
A banker should take the following precautions while having business dealings with the trustees:
(i) The banker should thoroughly study the trust deed. The trust contains the names of the trustee,
their powers, the details of the trust property and other terms.
(ii) In case of several trustees, all trustees must act jointly unless the trust deed provides for delegation
of powers to some of the trustees.
(iii) In case an account is opened for two or more trustees, the bank should obtain clear instructions
as regards the person or persons who shall sign the cheques or other instruments. In the absence
of such instructions all trustees must sign on each occasion.
(iv) In the case of death or retirement of one or more of the trustees, the powers of surviving or
remaining trustees will depend on the provisions of the trust deed.
(v) In the event of death or retirement of all the trustees, the new trustees may be appointed by the
court.
(vi) The insolvency of one or more trustees does not in any way affect trust property since it cannot
be utilized for payment of the personal debt of the trustee.
(vii)The banker should not knowingly permit the misuse of trust funds, otherwise it can be held liable
to the beneficiaries of the trust. For example, in a case, where the banker who had knowledge of
the trust character of an account allowed the customer to transfer funds standing to the credit of
the trust account to his personal account which was overdrawn, it was held that the banker was
liable to pay the money to the account to which it really belonged.
(viii) In case of charitable trust, the banker should examine the registration certificate issued by the
charity commissioner or such other authority as may be prescribed by the State Government
concerned under the Public Trust Act.
13. Executors and administrators: Executors and Administrators, both are persons appointed
to settle the accounts of a person after his death. Executor is appointed by the deceased himself, before
his death. The person appointing him called ‘testator’. The executor has to act according to the directions
given in the ‘will’. However, he must get the official confirmation of the will, technically called as
‘probate’, from the court.
The ‘Administrator’ is appointed by Court in those cases where the deceased has not given the
name of Executor in his ‘will’ or person named as executor has died or refuses to act. He disposes of the
assets and makes payment of the liabilities of the deceased as per the directions given in the will or in its
absence in the letter of Administration issued by the Court appointing him as Administrator.
Precautions:
(i) The bank should examine the ‘Letter of Probate’ (i.e. official confirmation of the will) in case of
Executors and Letter of Administration in case of Administrators to acquaint itself with the
powers and functions of the executors or the administrators.
(ii) An account in the following style may be opened in the name of executors or administrators.
“ABC executors (or administrators) of the estate of X, the deceased’.
(iii) In case of joint executors or administrators, the banker should get clear instructions, from them
regarding the executors, administrators who will operate the account.
(iv) The executors may borrow money for discharging some urgent obligations of the deceased.
The executors or administrators are personally liable for such loans unless the banker has given

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 loan on the specific asset of the deceased. In case of joint executors or administrators the
power to mortgage or pledge is available to all of them jointly. Moreover, they cannot exercise
such power if the probate or letter of administration specifically forbids it.
14.7 SUMMARY :
Every customer who transacts with a bank should have a record of the transactions. Pass Book
is a small account book or record of the transactions. Pass Book is not a conclusive proof but it is the
prima facie evidence. It is subject to corrections for wrong entries if any. Sometimes the banker is liable
and sometimes the customer is liable legally for wrong entries in the pass book.
There are different types of Bank accounts. These include savings deposit accounts, current
deposit accounts and term deposit accounts. The Bank customers are different types which include
individuals and institutions. These are minors, married women, illiterate persons lunatics, drunkards, joint
hindu family, trusts, companies, non trading institutions and associations, administrators and executors
etc.The Banker has to take necessary precautions in opening and dealing with the accounts of different
customers.
The Negotiable Instruments Act of 1881, as amended from time to time contains the provisions
governing the negotiable instruments. Legally there are three types of Negotiable Instruments. These
include (a) Promissory Note (b) Bills of Exchange and (c) Cheques. Negotiability and transferability is
the chief characteristic feature of the Negotiable Instrument. Though these three instruments though
bear similarities, there are differences among Promissory Notes, Bills of Exchange and Cheques.
14.8 SELF ASSESSMENT QUESTIONS AND SHORT NOTES:
1. Explain different types of customer Accounts and their characteristics
2. What are negotiable instruments? Explain the features of Negotiable Instruments.
3. Differentiate between (a) Promissory Note and Bill of exchange (b) Bill of Exchange and cheque.
4. Briefly explain different types of customers and the precautions to be taken by the banker while
opening the Account.
Short Notes (i) Holder in due course ii) Promissory Note
14.9 SUGGESTED READINGS:
K.C Sekhar & Sekhar, Banking Theory and Practice, Vikas publishing House private Ltd, New Delhi.
Indian Institute of Banking and Finance, Principles and Practice of Banking, Macmillan, Mumbai.
Dr. G. Satya Devi, Financial Services – Banking & Insurance, S. Chand & Co., New Delhi.
14.10 KEY TERMS:
Current Deposit Accounts: Current deposit accounts are opened to meet the transactions of business
and trade and hence are not entitled to any interest from the bank.
Trustee: A trustee is a person in whom confidence is reposed. He is given control of an estate, usually
of the deceased, for the benefit of certain person.
Pardanashin woman: A pardanashin woman is one who, by the custom of the country or the usage of
the particular community to which she belongs, is obliged to observe complete seclusion.
Garnishee order: Monetary judgment by the court against defendant by ordering third party (garnishee)
to pay money owed by the defendant(judgment debtor) to the plaintiff(judgment creditor).This is so
when there is default in debt repayment.

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 Lesson No. : 15

CHEQUE-MEANING, TYPES AND CROSSING

STRUCTURE :
15.1 Cheque-meaning
15.2 Types And Features Of Cheques
15.3 Dishonor Of Cheques By Bank And Consequences
15.4 Crossing Of Cheques And Types Of Crossing
15.5 Summary
15.6 Self Assessment Questions
15.7 Suggested Readings
15.8 Key Terms

OBJECTIVE :
The lesson is designed to enable you understand the meaning and types of cheque.Inaddition you
can also understand what is crossing of cheque and types of crossing after a thorough reading of the
lesson.
15.1 CHEQUE -MEANING
Section 6 of the Negotiable Instruments Act defines a cheque as “a bill of exchange drawn on a
specified banker and not expressed to be payable otherwise than on demand” A cheque also includes the
electronic image of a truncated cheque and a cheque in the electronic form. A cheque is also, therefore,
a bill of exchange with two additional qualifications:
It is always drawn on a specified banker
It is always payable on demand
15.2. CHEQUES – TYPES AND FEATURES:
A cheque is used to draw money from the deposit account or to make payments. Cheque is
given negotiability by the Negotiable Instrument Act of 1881.
1. “:Cheque is a bill of exchange drawn on a specified banker and not expressed to be Payable
otherwise than on demand” – Section 6, Negotiable Instrument Act 1881.
2. A cheque is defined as “A bill of exchange drawn on a banker payable on demand”, - The Bills of
Exchange Act 1882, USA.
Cheque is an instrument drawn on a banker for payment. If banker honors the cheque he makes
payment to the customer across the counter by giving him the amount in cash. Depending on the nature
of payment, cheques can be classified into two types 1. Open Cheques and 2. Crossed cheques.
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1. Open cheque: Open cheque is not a crossed cheque. It is an ordinary cheque drawn by a customer
and he presents it to the banker for payment. The person who presents an open cheque can get cash
directly from the banker. There is no need to have an account with the bank for a person to get payment
for the open cheque. This is also called a bearer cheque.
2. Crosed cheque: A crossed cheque is a cheque on which the drawer of the cheques draws two
parallel lines. Such cheques are not payable directly but the amount is credited to the account of the
payee. Thus to encash a crossed cheque payee should have a bank account in any bank.
There are Banker’s cheques also. Banker’s cheques are drawn by a banker on the banker himself.
Banker’s cheques are issued on behalf of customers and others to facilitate local payment. Such cheques
are not transferable and are payable at par locally. Banker’s cheques are only an additional facility
offered to the customer for making some local payments. Banker’s cheques were introduced on the
recommendation of a working group (Talwar Committee) on customer service in banks. State Bank of
India is the first bank to offer such facility.
Features of cheques:
All cheques are bills of exchange but all bills are not cheques. A cheque must have all the features of
a bill of exchange and some more besides. Hence, all cheques are bills of exchange, but not all bills of
exchange are cheques. So all the features of a bill of exchange must be present in a cheque, with
necessary modifications. The essential features of a cheque are described below:
A cheque is an instrument in writing: Oral orders do not come under the definition of a cheque. The
writing may be done by means of a pen, pencil, and typewriter or it may be in printed characters.
However, banks should discourage writing with a lead pencil, as it is very easy to make unauthorized
alterations, which are difficult to detect.
It is an unconditional order: The cheque must be an unconditional order. There should not be any
conditions attached to payment. The word ‘order’ need not be used for the purpose of conveying the
order. The order relating to payment may be conveyed by the word ‘Pay’ or words ‘Please pay”. The
order to pay should be unconditional. In Section 5, the term ‘unconditional’ has been explained to some
extent. An order is not unconditional if the order to pay is with condition that payment should be made on
the happening of a specified event which is bound to happen. For instance, if it is stated that the payment
shall be made on X’s attaining majority, or on his grandfather’s death, it is not an unconditional order. On
the other hand, if the payment is to be made on X marrying Miss Y, it is a conditional order, because X
may not marry Miss Y. An order to pay from a particular fund is not an unconditional order.
It should be drawn on a specified banker: A cheque must be drawn on a specified banker. Order on
individuals or institutions that are not bankers do not come within the definition of a cheque.
A cheque must be an order to pay a certain sum of money: The order must be for the payment of
a certain sum of money. In other words, it must not relate to the payment of a certain quantity of articles.
Further, the amount to be paid must be certain.
It is always payable on demand: A cheque should not be expressed to be payable otherwise than on
demand. It is not necessary to use the words, ‘on demand’. If the drawer of the cheque orders the bank
to pay, without specifying the time of payment, it means that the payment is to be made on demand.
The payee must be certain: The person to whom the payment is to be made must be certain. A
cheque may be made payable to a certain person, or order or bearer. The term ‘person’ refers to
‘person’ in the legal sense of the term, and a cheque can be paid to a person, company, local authority,
club, association etc.

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 A cheque is not invalid merely on the ground that it is ante-dated or post-dated, or that it bears a
date of a public holiday. A cheque not dated at all is also valid. Any holder of the cheque, including the
banker, may insert a date. Nevertheless, bankers generally return undated cheques. According to the
decision in Dalton Vs Grifiths, a banker is not bound to honor undated cheques. An ante-dated cheque
is one which bears a date earlier than the date of issue. A banker cannot refuse payment of a cheque
merely on the ground that it is ante-dated.
A post-dated cheque is one which bears a date later than the date of issue. A post-dated cheque
is a negotiable instrument. An example may make the point clear ‘A’ gives ‘B’ a post-dated cheque.
Before the due date ‘B’, gives it to ‘C’ in payment of a debt. ‘C’ takes the cheque in good faith. ‘A’
stops payment of the cheque because of ‘B’s failure to fulfill his contract. However, ‘C’ acquires a good
title to the cheque and when the due date arrives, he can sue ‘A’ for the amount.
15.3 DISHONOUR OF CHEQUES – CONSEQUENCES OF WRONGFUL DISHONOUR:
Dishonor of cheques: The Banking Regulation Act, 1949, defines banking as, “accepting for the
purpose of lending or investment, of deposits of money from the public, repayable on demand or otherwise
and withdrawable by cheque, draft, order or otherwise”. According to Hart, ‘a banker is one who in the
ordinary course of his business, honors cheques drawn upon him by persons from and for whom he
receives money on current accounts”.
A banker must honor the customer’s cheque drawn on him provided:
(a) he has sufficient funds of the customer. (b) the funds are properly applicable to the payment
of such cheque, (c) banker has been duly required to pay, (d) the cheque has been presented within a
reasonable time after the apparent date of its issue, (e) no prohibitory order of the court or any other
competent authority e.g. tax authority etc., is standing against the accounts of the customer.
A banker can dishonor a cheque under the following circumstances.
1) Countermanding of cheque: Drawer of the cheque has right to countermand the cheque.
Countermanding of cheque means instructing the banker to stop payment of a particular cheque
issued by him.
2) Death of customer: Banker stops payment of cheques of a customer when he receives notice of
death. Banker should not honor cheques, because on the death of the customer, the amount in the
balance of the customer’s account will be passed to the nominee or his legal representatives.
3) Insolvency of the customer: When banker receives the notice of insolvency of the customer to
stop further payments and he dishonors the cheques.
4) Insanity of the customer: Cheques drawn by the customer when he became insane are not
valid. Therefore, when the banker receives the notice of insanity of the customer from authorized
persons, he should stop payments.
5) Garnishee order: If banker receives Garnishee order or any such court orders, he should not
honor cheques drawn against the customer’s account.
6) Notice of Assignment: Assignment means transfer of ownership of an article by means of a
written and registered document under the provisions of the Transfer of Property Act.
7) Breach of Trust: In case of trust accounts, if the banker gets the information of the breach of
trust, he can reject the payments by dishonoring cheques.
8) Other reasons: Banker can dishonor cheques when:
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 a) the funds in the account of customer are not sufficient to honor cheques. b) If cheque is not
presented in proper form. c) Cheque is not presented in the office where the drawer has account. d)
Cheque is stale or mutilated or with material alteration. e) Endorsement is irregular. f) Signature is
forged etc.
When a banker dishonors a cheque, he returns the cheque with a note giving the reason of dishonor
on a slip called ‘return memo’ or ‘cheque returned slip’. It is not a legal obligation of the banker to give
the reason of dishonor in a written form to the customer. But it is necessary to inform the customer about
the reason of dishonor, if not the customer may be in confusion. Banker should be careful in giving
reason for dishonor. If by mistake he gives wrong reason and if it cause loss or damage to the customer,
he (drawer) can file a case in the court and claim for damages.
Consequences of wrongful Dishonor: In case a bank wrongfully fails to honor a customer’s cheque, it
can be held liable by the customer to pay him the damages. The damages will be not only for the
pecuniary loss that the customer might have suffered but also for loss to his reputation. From this point
of view customers can be divided into two categories. (i) Traders and (ii) Non-traders. In case of a
trader customer, the loss to the reputation of the customer in the event of wrongful dishonor of a cheque,
is presumed and he is entitled to claim besides ordinary damages, substantial damages for loss of reputation
even without proving the special loss. In the case of New Central Hall v. United Commercial Bank
Limited, the Madras High Court it is held.
“In cases where a cheque issued by a trader customer is wrongfully dishonored even special
damages could be awarded without proof of special loss or damage. In the above case a number of
cheques issued by a customer were dishonored because the clerk of the bank forgot to give credit to the
customer of the amount deposited by him.
It should he noted the amount of damages claimed by the customer need not depend on the
amount of the cheque. As a matter of fact reverse is true. It means, the smaller is the amount of cheque
dishonored, the greater will be the amount of damages. This is because it is presumed that dishonor of a
cheque of a smaller amount will result in a greater loss to the credit of the customer. In the case of a non-
trader customer, the loss to the reputation of the customer in the event of wrongful dishonor of a cheque,
is not presumed but will have to be proved by the customer. Such a customer is, therefore, entitled to get
only ordinary damages. He can claim substantial damages for loss of reputation only when he proves
this as a special loss.
15.4 CROSSING OF CHEQUES AND TYPES OF CROSSING:
Crossing of cheques: A cheque may be an ‘open cheque’ or a ‘crossed cheque’. The former may be
presented across, the counter for payment; the later will have to be presented through another banker.
The Negotiable Instruments Act, 1881 recognizes ‘crossing’ of cheques. A crossing is a direction to the
paying banker that the cheque should be paid only to a banker and if the name of the banker is mentioned
in the crossing, only to that banker. In other words, the holder of a crossed cheque is not entitled to cash
the cheque across the counter. This ensures the safety of payment by means of cheques.
A cheque is said to be crossed when two transverse parallel lines with or without any words are
drawn across its face. A crossing is a direction to the paying banker to pay the money generally to a
banker or a particular banker s the case may be, and not to be holder at the counter. Crossing may be
written, stamped, printed or perforated. Crossing of a cheque does not amount to material alteration so
as to discharge.
The objective of crossing is security and protection to the true owner, since payment of such a
cheque has to be made through a banker. It can, therefore, be easily detected to whose use the money
has been received. Cheques are crossed in order to avoid losses arising from open cheques falling into
the hands of wrong persons. Crossing helps in detection of fraud.
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 Crossing of a cheque does not affect its negotiability. Crossed cheques are negotiable by delivery
in case they are payable to bearer and by endorsement and delivery where they are payable to order.
Holder of a crossed cheque, who has no account in any bank, can obtain payment by endorsing it in favor
of some person who has got an account in a bank.
Types of Crossing:
There are different types of crossing. These are mainly 1. General Crossing 2.Special Crossing
3. Restrictive Crossing.
1. General Crossing: According to Section 123 of the Act where a cheque bears across its face two
transverse parallel lines with or without any words, it is called ‘general crossing’. Words such as ‘and
company’ or any other abbreviation, e.g. ‘& Co.,’ may be written in between these two transverse
parallel lines, either with or without words ‘not negotiable’. Absence of these words would not affect the
validity of the crossing. In this case, the banker upon whom the cheque is drawn will make the payment
only some other banker.
_____________________________________
& CO.
______________________________________
Not Negotiable
______________________________________
Under Rupees Eight
Thousand only
_______________________________________
The addition of the words ‘& Co.’ in a crossing does not have nay legal significance. But the
addition of words ‘not negotiable’ has significant legal effect. Of course, these words do not take away
the characteristics of transferability of the instrument, but they very much restrict it. This is because a
transferee of a cheque bearing words ‘not negotiable’ will not get a better title than that of the transferor.
In other words, if the transferor’s title is defective, the title of the holder will also be defective even if he
happens to be a holder in due course.
2 Special Crossing: Where a cheque bears across its face an addition of the name of a banker with or
without the words ‘not negotiable’, it shall be deemed to be a special crossing (sec. 124). When a
cheque has been specially crossed, the banker upon whom it has been drawn will make the payment only
to that banker in whose favor it has been crossed.
____________________________________
Central Bank of India
____________________________________
Central Bank of India
Not Negotiable
____________________________________
3. Restrictive Crossing: Besides the above two types of statutory crossing, the practice of crossing
cheques with the words “account payee” or “account payee only” has sprung up. Such a crossing is
termed as ‘restrictive crossing’.
Restrictive crossing is only a direction to the collecting banker that the proceeds are to be credited
only to the account of payee named in the cheque. In case the collecting banker allows the proceeds to
be credited to some other account, it may be held liable for wrongful conversion of funds.

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 __________________________________
A/C Payee only
Central Bank of India
__________________________________
A/C Payee only
A/C Payee
__________________________________
A/C payee
Not Negotiable
__________________________________
It is to be noted that the basic ingredient of crossing, “the two transverse parallel lines” across
the face of the cheque, must be present in order to constitute any cheque as a crossed cheque. The
cheque will not be taken as a crossed cheque if this has not been done.
Crossing can be made by –
The drawer: The drawer can make general, special or restrictive crossing on a cheque before
issuing it.
The holder: (i) Where a cheque is uncrossed, the holder may cross it generally or specially.
Where a cheque is crossed generally the holder may cross it specially.
Where a cheque is crossed generally or specially the holder may add the words ‘not negotiable’.
The banker: Where a cheque is crossed specially, the banker to whom it is crossed may again
cross it specially to another banker to work as its agent for collection (Sec. 125). It is to be noted that a
cheque can be specially crossed only once except where the second crossing is to a banker as agent for
collection. It is necessary to specify in the second special crossing that the banker in whose favor it is
made.
Double Crossing:
When a cheque bears two separate special crossing, it is said to have been doubly crossed.
According to Section 127 “where a cheque is crossed specially to more than one banker, except when
crossed to an agent for the purpose of collection, the banker on whom it is drawn shall refuse payment
thereon”. Thus, a paying banker shall pay a cheque doubly crossed only when the second banker is
acting only as the agent of the first collecting banker and this has been made clear on the instrument.
Such crossing may be done in those cases where the banker in whose favor the cheque has been
specially crossed does not have a branch at the place where the cheque is to be paid.
_________________________________
Indian Bank
To
Central Bank of India
As Agent for collection
_________________________________
In all other cases the paying banker should refuse to pay a cheque bearing double crossing.
Liability of the paying banker on crossed cheques:
The paying banker should make payment of a crossed cheque only through the collecting banker. In
case of special crossing the payment of cheque should be done only to the banker whose name has been
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mentioned between the two transverse parallel lines. In case the paying banker makes payment of a
crossed cheque in contravention of the above rules, its liability will be as follows:
The paying banker will have to reimburse the true owner for any loss that he might suffer on
account of payment being made to a wrong person.
The paying banker shall not be entitled to debit his customer’s account with the amount of
payment in case payment has been made to a wrong person since it has not followed the mandate of the
customer. Such payment will not be taken as a payment made in due course (Sec. 126).
Opening of Crossing:
Cancellation of crossing of a cheque is called opening of crossing. The cancellation can be done
only by the drawer of the cheque. The drawer after cancellation of crossing will put his signature and
write ‘Pay Cash’ on the cheque.
Obliterating a Crossing:
Section 89 provides protection to a collecting banker of a cheque whose crossing is obliterated or
erased by dishonest persons. In case of such cheques the paying bank shall be discharged from its
liability if the cheque does not appear to be a crossed one or obliteration of crossing is not apparent at the
time of its presentation for payment, and the payment has been made in due course as required under
Section 10.
15.5 SUMMARY :
Every customer who transacts with a bank should have a record of the transactions. Pass Book is
a small account book or record of the transactions. Pass Book is net a conclusive proof but it is the prima
facie evidence. It is subject to corrections for wrong entries if any. Sometimes the banker is liable and
sometimes the customer is liable legally for wrong entries in the pass book. The cheque book is a bundle
of leaves which can be drawn by the customer of the bank who has money deposited to his credit for the
collection or payment of money on demand.
A cheque is a bill of exchange drawn on a specified banker and not expressed to be payable otherwise
than on demand. The main features of a cheque are: it is an instrument in writing, it is an unconditional
order, drawn on a specified banker, it is an order to pay a certain sum of money, payable on demand, the
payee must be certain. Though not inevitable it is desirable to use printed cheque.Cheque may be
dishonored. But a banker is liable for wrongful dishonor. A cheque may be ‘open cheque’ or crossed
cheque. An open cheque can be presented across the counter for payment even to the bearer. A crossed
cheque will have to be presented through a banker and paid through the account of the customer. The
main objective of crossing is security and protection to the true owner. A cheque is said to be crossed
when two transverse parallel lines, with or without any words, are drawn across its face. Crossing of
cheque does not affect its transferability. There are different types of crossing which are especially two.
They are General Crossing and Special Crossing. Crossing may also be restrictive crossing. When a
cheque bears two separate crossing, it is called double crossing, cancellation of crossing is called opening
crossing. The drawer of the cheque can open the cheque by cancellation of crossing by his signature.
15.6 SELF ASSESSMENT QUESTIONS & SHORT NOTES:
1) Define Cheque. Explain the essential characteristic features of Cheques.
2) What is Crossing/ explain different types of crossing a Cheque.
Short Notes (i) Holder in due course 9ii) Promissory Note (iii) Double Crossing (iv) Special Crossing
(v) Pass Book and its features.
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15.7 SUGGESTED READINGS :
K.C Sekhar & Sekhar, Banking Theory and Practice, Vikas publishing House private Ltd, New Delhi.
Indian Institute of Banking and Finance, Principles and Practice of Banking, Macmillan, Mumbai.
Dr. G. Satya Devi, Financial Services – Banking & Insurance, S. Chand & Co., New Delhi.
15.8 KEY TERMS :
Holder in due course: Holder in due course is any person who for valuable consideration becomes the
possessor of a negotiable instrument payable to bearer or the endorsee or payee thereof before the
amount mentioned in the document becomes payable.
Order Instrument and Bearer Instrument: Order instrument is transferable by endorsement and
delivery. A bearer instrument is transferable by mere delivery.
Truncated Cheque: ‘A truncated cheque’ means a cheque which is truncated during the course of a
clearing cycle, either by the clearing house or by the bank whether paying or receiving payment,
immediately on generation of an electronic image for transmission, substituting the further physical
movement of the cheque in writing.
Cheque in electronic form or Image: ‘A cheque in the electronic form’ means a cheque which
contains the exact mirror image of a paper cheque, and is generated, written and signed in a secure
system ensuring the minimum safety standards with the use of digital signature (with or without biometrics
signature) and asymmetric crypto system.
Endorsement: The term ‘Endorsement’ of a negotiable instrument means writing of a person’s name
on the back of instrument for the purpose of negotiation. According to Section 15, when the maker or
holder of a negotiable instrument signs his name, otherwise than such maker, for the purpose of negotiation,
on the back or face thereof or on a slip of paper annexed thereto he is said to have indorsed the instrument.

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 Lesson No. : 16

PAYING BANKER AND COLLECTING BANKER –

MEANING AND DUTIES

STRUCTURE:
16.1 Introduction
16.2 Paying Banker And Collecting Banker – The Meaning
16.3 Duties Or Responsibilities Of A Paying Banker
16.4 Duties And Obligations Of A Collecting Banker
16.5 Summary
16.6 Self-assessment Questions
16.7 Further Readings
16.8 Key Terms
OBJECTIVE:
After a thorough reading of the present guideline you will know
(a) the meaning of the paying Banker and collecting Banker
(b) the duties and responsibilities of a paying Banker and the collecting Banker.
16.1 INTRODUCTION:
According to the Banking regulation Act, 1949 the basic business of a banker is accepting deposits
of money from the public for the purpose of lending or investment. And these deposits are repayable on
demand or otherwise and withdrawable by cheque, draft, order or otherwise. Besides the may also
agree to collect cheques of its customers on their behalf. Thus, the Banker stands in the relation of a
paying banker and collecting banker to the customer.
16.2 PAYING BANKER AND COLLECTING BANKER – THE MEANING:
(a) Paying Banker: Money deposited will always belong to the customer and the bank will be bound
to return its equivalent to the customer or to any person to his order on demand. According to
Hart, “a banker is one who in the ordinary course of his business, honors cheques drawn upon him
by persons from and for whom he receives money on current accounts”. Thus, it is the prime
duty of a banker to honor the cheques of its customers. Section 31 of the Negotiable Instruments
Act provides “the drawee of a cheque having sufficient funds of the drawer in his hands, properly
applicable to the payment of such cheque must pay the cheque when duly required so to do, and
in default of such payment, must compensate the drawer for any loss or damage cause by such
default”. Thus a banker should be very cautious both at the time of honoring as well as dishonoring
his customer’s cheques.
(b) Collecting Banker: When a banker undertakes to collect cheques and bills, he is called “collecting
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 banker”. No doubt a banker is under no legal obligation to collect cheques and bills on behalf of its
customers. But every modern bank collects cheques and bills on behalf of its customers in order
to provide a service to them. This service of collection of cheques on behalf of its customers has
become an accepted part of bankers functions due to greater use of crossed cheques, which are
payable through a banker only. Dr. H.L. Hart has observed in this connection that, as his customer’s
agent in this matter, the banker is bound to use reasonable skill, care and diligence in presenting
and securing payment of the drafts entrusted to him for collection and placing the proceeds to his
customer’s account, or in taking other steps as may be proper to secure the customer’s interests.
The banker is thus both a paying banker and collecting banker. The liabilities, duties or precautions
of a banker mainly from these two angles are discussed.
16.3 DUTIES OR RESPONSIBILITIES OF A PAYING BANKER:
While making payment of his customer’s cheques the banker should observe certain precautions
or duties. This is in order to protect his self interests as well as the interests of the customers. The
implied duties or obligations of a paying banker depend upon certain important conditions.
1. Ensure the cheque must be in the proper form: The cheque should be in proper form. The
negotiable Instruments Act does not give the form of a cheque but most banks in India provide in
their rules of operating accounts that the cheque must be drawn in the printed forms supplied by
the banks and the banks reserve the right of dishonoring a cheque in case it is not in the prescribed
form. In such cases bank may not honor a cheque which is not in the prescribed form.
2. Verify the branch on which the cheque is drawn: The banker should verify whether the
cheque is drawn on it or on some other branch of the same bank. A banker has to honor cheques
which are drawn on it only but not on any other bank or branch. The drawer must be the banker’s
customer. Further there must be sufficient credit balance in the account of the customer. Otherwise
the banker may dishonor the cheque.
3. Verify whether cheque is open or crossed: The most important precaution that a banker
should take is about crossed cheques. A banker has to verify whether the cheque is open or
crossed. He should not pay cash across the counter in respect of crossed cheques. If the cheque
is a crossed one, he should see whether it is a general crossing or special crossing. If it is a general
crossing, the holder must be asked to present the cheque through some banker. It should be paid
to a banker. If the cheque bears a special crossing, the banker should pay only to the bank whose
name is ‘mentioned in the crossing. If it is a open cheque, a banker can pay cash to the payee or
the holder across the counter. If the banker pays against the instructions as indicated above, he is
liable to pay the amount to the true owner for any loss sustained. Further, a banker loses statutory
protection in case of forged endorsement. In Madras Bank Limited vs. South India match factory
Limited, a cheque was issued by a purchaser in favor of the official liquidator of a company
towards the purchase price of certain properties. The bank paid the amount of the crossed cheque
to the liquidator across the counter. The Liquidator mis-appropriated the amount. In a suit filed,
the court held that the “banker committed breach of statutory duty and was negligent in paying
direct to the liquidator over the counter and hence was not entitled to legal protection”.
4. Observe the cheque must not be stage or post dated: Generally a cheque is considered as
stale when it has been in circulation for more than six months and bankers return such cheques for
the drawer’s confirmation. A stale cheque or out of date cheque is one which has been in circulation
for an unreasonably long period. In case a cheque is post dated i.e., it bears a date which is yet to
come, the bank should honor it only on or after the date mentioned on the cheque e.g. if a cheque
is drawn on 1st January and bears the date of 15th March, the cheque is post-dated and it should be
honored by the banker, not earlier than 15th March.

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5. Confirm the drawer’s signature must correspond with the specimen signature: Signature
of the drawer on the cheque must correspond with the specimen signature obtained by the banker
at the time of opening the account. The question of negligence on the part of the customer, such
as leaving the cheque book carelessly, would afford no defence to the bank where the signature
(or, where two persons are authorized to operate on the account, both the signatures or one of the
signatures) to the cheque is not genuine, as was held in Bihta Co-operative Development and Cane
Marketing Union Vs. Bank of Bihar and Another.
6. Ensure the amount and mentioned both in figures and words are the same: The banker
should see that the amount mentioned both in figures and words in the cheque are the same. In
case they differ, the amount stated in words may be taken as correct and the banker may make the
payment. Usually in such cases also, though not correct, the banker returns the cheque for reference
to the drawer. In case the amount has been stated in words only and not in figures the banker
should pay the cheque. But where in amount has been mentioned in figures only, not in words, the
banker should return the cheque.
7. Careful about mutilated cheques: A cheque is mutilated when it has been cut or torn, or when a
part of it is missing. Mutilation may be accidental or intentional. When it is accidental, the banker
should get the drawer’s conformation before honoring it. In the latter case, the banker should
refuse payment. Otherwise, the drawer can refuse to be debited with such a cheque. Hence the
banker should return such a cheque market ‘mutilated cheque’ or ‘mutilation requires confirmation’.
8. Assure material alterations are confirmed by the drawer: Material alterations make a cheque
void. Hence a banker honoring a cheque with material alterations is not allowed to debit his
customer’s account. Or else, he should make sure that material alterations are confirmed by the
drawer. This includes alteration of the date, the crossing, the place of payment, the amount and
the name of the payee. In case the cheque is signed by more than one person, material alterations
should be confirmed by the signature of all the persons. When either party to a joint account has
authority to sign cheques alone, the signature of one is sufficient, a paying banker honoring a
cheque which has been materially altered, without the drawer’s confirmation, cannot debit the
drawer’s account. However, this general rule is subject to one important qualification. A banker
is justified in honoring a cheque that bears a non-apparent alteration. Further, if the drawer has, by
his own negligence, facilitated the alteration, he may be precluded from denying that the alteration
was made without his authority, as has been held in London Joint Stock Bank Limited, Vs
Macmillan and Arthur. Here, the drawer facilitated alteration of the amount by leaving blank
spaces before and after the amount. He was charged with negligence, and precluded from denying
that the alteration was made without his authority.
9. Confirm that the cheque is properly endorsed (in other words that the endorsement is
regular): The cheque may be bearer cheque or order cheque.
In the case of a bearer cheque, endorsement is not legally necessary. In the case of an order
cheque, endorsement is necessary. A cheque originally expressed to be payable to bearer always
remains a bearer cheque. An order cheque may be made payable to the bearer by an endorsement
in blank.
10. The paying banker must follow the directions contained in the crossing: A paying banker
has to honor his customer’s cheques according to the directions contained in the crossing. Where
a cheque is crossed generally, the banker upon whom it is drawn shall not pay it otherwise than to
a banker. Where the cheque is crossed specially, payment shall be made only to the banker to
whom it is crossed, or his agent for collection. The addition of the words ‘not negotiable’, ‘account
payee’ etc does not materially affect the position of the paying banker.
11. Make payment only during banking hours: The banker should make payment of only such cheque
which has been presented to it for payment during its banking hours. Any payment of cheque
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 which was presented after banking hours will not be taken as a payment in due course and the
banker will not be entitled to debit the customer’s account. The customer may countermand the
payment or some similar event had happened.
12. Verify the branch on which the cheque is drawn: The banker should verify whether the cheque is
drawn on it or on some other branch of the same bank. A banker has to honor cheques which are
drawn on it only but not on any other bank or branch. The drawer must be the banker’s customer.
Further there must be sufficient credit balance in the account of the customer. Otherwise the
banker may dishonor the cheque.
16.4 DUTIES AND OBLIGATIONS OF A COLLECTING BANKER:
In the process of collecting cheques a banker acts as either (i) holder for value or
(ii) an agent of the customer. When a banker becomes a holder for value his rights are the same
as of other holder for value. In other words, he will be entitled to receive the amount of the cheque from
the drawee in his own right and in case of dishonor from one or all of the endorsers. When the banker
undertakes to collect the cheque of a customer without becoming a holder for value or a holder in due
course, he acts as customer’s agent. The banker must act with care and diligence in acting as the agent
of the customer. The collecting banker acting as an agent of his customer does not possess title to the
cheque better than the customer. If the customer’s title is defective and if it is collected the banker
becomes liable for conversion.
The collecting banker has to act in diligence in good faith and without negligence.
The following are the duties or obligations of the collecting banker.
1. Examination of cheques and endorsement: As an agent of the customer, the collecting banker
is bound to show reasonable care and diligence in the collection of cheques. He must exercise
reasonable care in examining cheques, in presenting them for payment, in obtaining payment and in
crediting his customer’s account. If the customer suffers any loss through the negligence of the
banker in any of those matters, the banker is liable to the customer to the extent of the loss. This
fact was decided in Forman. Vs. Bank of England.
2. Presentation of cheques for collection: The collecting banker must present the cheques received
for payment within a reasonable time to the drawee-bank. According to banking practices, if the
collecting and paying banks are in the same place, the collecting bank should present the cheques
by the next day. In case they are at different places, the cheques must be dispatched for collection
by the next day. If the collecting banker fails to present the cheque within a reasonable time and
in the meanwhile the drawer’s bank fails, the cheque will be dishonored. As a result, the customer
will suffer. The collecting banker can be held liable to pay the loss to the customer on account of
lack of proper diligence.
3. Information to the customer about collection: It is the duty of the collecting banker, to inform
the customer about the amount collected and credited to his account. The collecting bank must
follow the instructions of the customer in this regard.
4. Serve notice of dishonor: When a cheque is dishonored, the collecting banker must give notice
of dishonor to the customer. This is usually done by returning the cheque to the customer with a
covering letter. This notice of dishonor will enable the customer to recover the amount from the
parties liable thereon. In case the banker fails to serve the notice of dishonor to the customer, he
will be liable for damages to the customer.
5. Precautions to avoid conversion charge: the collecting banker has responsibility to work in
the interest of the owner of the cheque. If the customer is not the true owner of the cheque, the
collecting banker cannot get a better title as he is only an agent. So if a collecting banker collects
a cheque received from a customer who has no title on the cheque, he will be held liable to the true
owner on the charge of conversion.
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16.6 SUMMARY :
The basic business of the banker is collecting deposits which will be repayable or withdrawable by
the customer through cheques etc. The banker also undertakes to collect cheques of its customers on
their behalf. Thus the banker acts as both as a paying banker as well as the collecting banker. In both
the capacities the banker should act in good faith and with diligence without negligence. As a paying
banker and collecting banker he has specific duties or obligations to be performed. The banker should
take necessary precautions and perform certain obligations. Indeligence and negligence of his prescribed
or customary duties make the banker liable for loss or damages incurred by the customer.
16.7 SELF-ASSESSMENT QUESTIONS:
1. Who is a Paying Banker? Explain the Duties of a Paying Banker.
2. Explain the role and duties of a Collecting Banker.
Short Notes:
(a) Conversion
(b) Payment in Due course
(c) Holder For Value
16.8 FURTHER READINGS:
1. K.C. Sekhar and Lekshmy Sekhar, Banking Theory and Practice, Vikas publishing House pvt
Limited, Mumbai.
2. Maheswari and Maheswari, Banking Law and Practice, Kalyani Publishers, Ludhiana.
3. Indian Institute of Banking & Finance, Principles and Practice of Banking, Macmillan, Mumbai.
16.9 KEY TERMS :
1. Payment in due course : “Payment in due course means payment in accordance with the apparent
tenor of the instrument, in good faith and without negligence to any person in possession thereof. And it
must be under circumstances which do not afford a reasonable ground for believing that he is not entitled
to receive payment of the amount therein mentioned”.
2. Draft : Draft is an order to pay money drawn by one office of the Bank upon another office of the
same bank for a sum of money payable to order on demand.
3. Stale cheque : A cheque which is presented for payment after the expiry of a fixed period (generally
3 or 6 months depending on individual banks) from the date it is drawn. It is also known as ‘out of date
cheque”.
4. Conversion : Conversion is unauthorized interference with another person’s property. It is inconsistent
with the owner’s right of possession. If the customer has no title or defective title to the cheque, the
collecting banker could not have good title. In such a case the collecting banker who collects the cheque
will be held liable for ‘conversion’ i.e., illegally interfering with the right of the true owner of the cheque.
In such a case actually the banker cannot undertake collection of cheques. But Section 131 of the
Negotiable Instruments Act provides protection to the collecting banker it he receives payment of a
crossed cheque or draft on behalf of his customers if he acts in good faith and without negligence.
5. Holder for Value : A banker becomes holder for value of a cheque (i) when a Banker pays the
amount of a cheque drawn on another bank before collection or (ii) when the collecting banker permits
the customer to draw the amount of the cheque paid in, even before it is cleared or (iii) where he
receives a cheque in specific reduction of the amount due from the customer or (iv) where the banker
has a lien on the cheque. As holder for value the banker is entitled to receive the amount of the cheque
from the drawee in his own right.
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 Lesson No. : 17

LOANS AND ADVANCES-TYPES AND

PRINCIPLES OF SOUND LENDING

STRUCTURE:
17.1 Introduction
17.2 Typess Of Bank Loans And Advances
17.3 Principles Of Sound Lending
17.4 Summary
17.5 Self Assessment Questions And Short Notes
17.6 Suggested Readings
17.7 Key Terms

OBJECTIVE:
A thorough reading of this lesson makes you understand
(a) the concept of loans and advances by banks
(b) the principles of bank lending
(c) different methods of banking advances and their dimensions
17.1 INTRODUCTION :
Banks collect deposits for the purpose of granting loans and advances. A major portion of the
banks funds are used for the purpose of granting loans and advances, which is the primary function of
banks. There are different methods of loans and advances granted by the banks. The loans and advances
stand as the major item on the assets side of the balance sheet of a bank. Therefore quality of this Asset
(Loans & Advances) is very important. Lending money by the bank involves risks. Hence, the banks
have to take some precautions and observe sound principles of lending goods and securities. This helps
to control Non-Performing Assets (NPAs).
17.2 TYPES OF BANK LOANS AND ADVANCES :
In India the Banking loans and Advances can be classified into Loans, Cash credit, Over Draft,
and Bills discounting and purchasing, Issue of Letters of Credit by banks is also a method of granting
advances. These methods of advances- under the heads- A. Loans, B. Cash Credit, C. Cash Credit, D.
Bills Discounting and Purchasing and E. Letters of Credit - are detailed below.
A. Loans: In the case of a loan the bank makes a lump sum payment to the borrower or credits his
deposit account with the money advanced. It is with or without security. It is given for a fixed period at
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an agreed rate of interest. Repayment may be made in installments or at the expiry of a certain period.
The customer has to pay interest on the total amounts advanced whether he withdraws the money from
his account (credited with the loan)or not. The rate of interest charged by a bank in the case of loans is
usually lower than in case of cash credits and overdrafts. Because, it involves lower cost of maintenance
on account of not frequent operation of the account. Further, the bank gets interest on the total amount
sanctioned whether the customer withdraws the whole money or not.
Types of Loans: Loans can broadly be categorized on the basis of the period sanctioned or on the basis
of the purpose of the loan. On basis of period, they can be short-term, medium-term or long-term loan or
a bridge loan. They can be composite or consumption loans depending on their purpose.
Short-term loans: Short-term loans are loans which are granted for a period not exceeding one year.
These are advanced to meet the working capital requirements.
Term-loans: Medium and long-term loans are usually called term loans. These loans are extended for
periods ranging from one year to about eight or ten years on the security of existing industrial assets or
the assets purchased with the loan. Term loans are used for purchase of capital assets for establishment
of new industrial units, for expansion, modernization or diversification. The loans an element of risk as
they are intended to be repaid out of the future profits over a period of years.
Bridge loans: Bridge loans are essentially short-term loans that are granted pending disbursement of
sanctioned term loans. Bridge loans help borrowers to meet their urgent and critical needs during the
period when formalities for availing of the term loans sanctioned are being fulfilled.
Composite loans: If a loan is taken for buying capital assets as well as for meeting working capital
requirements, it is called a composite loan.
Consumption loans: Banks used to focus on loans for productive purposes, but during the recent past
banks have increasingly started giving loans for consumption purposes like education, medical needs and
automobiles.
Loans or Advances may be Secured or Unsecured. A Secured Advance is one which is one which is
made against the security of either assets or against personal security. Assets as security are tangible
securities or impersonal securities. Personal securities are called intangible securities which include
Promissory Notes, Bills of Exchange, Personal Security of Guarantor. Loans may be Term loans or
Demand loans. A demand loan is short term loan payable on demand.
Loans as a method of advances have the following advantages and disadvantages or limitations.
Advantages of Loan System:
1. Financial discipline for the borrower: In case of loan system, the time and amount of repayment
of installments is fixed in advance. The system therefore encourages a greater degree of financial
discipline on the borrower.
2. Periodic review of loan account: The banker gets an opportunity to review the loan account as
and when a loan is granted or renewed. The banker may discontinue or refuse unsatisfactory loan
account.
3. Simple and profitable: The banker charges interest on the total amount sanctioned as a loan to
the borrower irrespective of the withdrawals by the borrower. Thus, there is no loss of interest to
the banker. Moreover the operation of the system is comparatively simple as compared to a cash-
credit system.

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Limitations of Loan System:
1. Inflexibility: The system is inflexible in the sense that every time a loan is required the banker has
to negotiate with the borrower. In order to avoid this difficulty, the borrower may get a larger loan
sanctioned to him as compared to his requirements.
2. More formalities: Sanctioning of the loan requires more documentation as compared to a cash-
credit system.
3. Frequent renewals: Though the loan is sanctioned only for a fixed period but in practice they are
continuously renewed period after period. The review of the loan accounts generally becomes
‘casually’ in this process.
B. Cash Credit: Cash credit is the most favored method for availing credit in India. Under this system
the banker fixes a credit limit on an annual basis, and the customer is at liberty to withdraw any amount
within the cash credit limit as and when he needs. Thus, the cash credit account is an active and running
account to which deposits and withdrawals may be affected frequently. Cash credit arrangements are
usually made against the security of commodities hypothecated or pledged with the bank.
The Cash Credit method has certain advantages and limitations which are listed below:
Advantages:
1. Flexibility: In case of a cash credit system, the customer need not borrow at once the whole of
the amount he is likely to require but draw such amounts as and when required. He can put back
any surplus amount which he may find with him for the time being. Interest has to be paid by the
customer on the amount actually drawn at any time and not on the full amount of the credit
allowed.
2. Convenience: Banks have to maintain only one account for all transactions of the customer and
hence repetitive documentation can be avoided. Thus, the system is quite convenient to operate.
Limitations:
1. Misutilisation of the credit limits: Cash credit limits are fixed once a year. Hence, it gives rise
to the tendency of fixing a higher limit than the amount of funds required by the customer throughout
the year. In times of credit shortage the customer may misutilise the normally unutilized credit
gap.
2. No verification of end-use of funds: In case of this system the banker lays greater emphasis on
the security offered rather the end use of funds. As a result the funds are diverted to other
purposes without banker’s knowledge.
3. Lack of proper management: In case of this system it is not, the banker but the borrower who
decides when and how much he will borrow. In other words utilization of credit limits depends
upon the discretion of the borrower. This may result in idle funds with the banker.
C. Overdraft: An overdraft is a short-term credit facility. It is given to a current account holder. The
customer may be allowed to overdraw his current account, if he requires temporary accommodation.
This arrangement, like cash credit, is advantageous from the customer’s point of view. He is required to
pay interest on the actual amount used by him. A cash credit differs from an overdraft. The cash credit
is used for long terms by commercial and industrial concerns doing regular business. The overdraft bank
credit is to be made use of occasionally and for shorter durations.

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D. Bill Discounting and Purchasing: Another short-term facility for providing working capital is
through discounting and purchasing of bills. Bills are considered highly liquid security and, therefore, they
are highly favored especially by the conservative banks.
Trade bills are negotiable money market instruments and the intermediaries at a discount buy
these before their maturity. Bill discounting is a source of short-term trade finance. Bills discounting and
purchasing is used as a medium of financing the current trade and is not used for financing capital
purposes.
The banks discount and purchase bills of their customers. In such a case the customers gets
immediate finance from the bank and has not to wait till the bank collects the payment of the bill. The
term ‘purchasing of bill’ is used in respect of ‘demand bills’, while the term ‘discounting of bills’ is used
in respect of ‘usance bill’. In both the cases the bank immediately credits the account of the customer
with the amount of the bill less its charges. In case of ‘purchasing of bill’ the charges are less because
the bank can Collect the payment immediately by presenting it before the drawee for payment. In both
the cases of discounting and purchasing of bills, the bank is granting advance to the customers and,
therefore ‘bills discounted and purchased’ are shown as advances by a bank in its balance sheet. There
are certain advantages to the Banks in granting advances through Bill discounting and purchasing.
The advantages are as below:
1. Certainty of payment: The banker is almost certain of getting the payment of bills on the due
dates. This is because the drawee in order to maintain his credit will see that the bill is paid on
maturity. In case the drawee refuses to honor the bill, the banker can get the payment from the
customer for whom he has discounted the bill.
2. Safety of funds: The funds of the banker are safe because of double security. The drawee is
liable to pay the bill and ion the event of his inability to meet the bill, the banker can recover the
money with all expenses from the customer.
3. Employment of funds for a definite period: Since the bills are drawn for a definite period, the
banker by making a judicious selection of bills can invest his surplus funds for the period he
considers appropriate.
4. Refinance facility: The banker can obtain refinance facility from the approved financial institutions
of the country in respect of bills discounted and purchased by him. Thus, bills discounted are as
good as liquid assets.
5. No fluctuations in prices: Bills are better than other securities because they do not fluctuate in
their value while other securities such as goods or property are affected by fluctuations in their
market prices.
6. Higher yield: The discounting of bills gives a higher rate of return than loans and cash credits
even when the rate of interest is uniform. This is because in case of discounting the bills, the bank
charges interest known as discount, right at the time of discounting the bill by deducting the amount
from the value of the bill. While in case of loans and cash credits, interest is charged only after the
expiry of a period.
E. Issue of Letters of Credit: Banks Issue Letters of Credit to the buyer of goods or raw material as
an arrangement of short term finance. A letter of credit is a document issued by the bank at the request
of the buyer of goods. It is a binding document from the bank in order to guarantee that the payment for
goods will be transferred to the seller. In order for the payment to occur, the seller has to present the
bank with necessary documents as per terms.

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 While sanctioning the letter of credit limits for the purchase of raw materials, the banker has to
collect the following particulars:
i. Value of raw materials consumed in the ensuing year as projected
ii. Value of raw materials that are purchased on credit out of the above
iii. Time taken for advising the letter of credit to the beneficiary
iv. Time for shipment and the consignment to reach the customer’s destination
v. Credit period (usance period) agreed between the beneficiary and the customer
vi. Credit period projected and reckoned for calculation of the Maximum Permissible Bank Finance
(MPBF) while sanctioning the funded limits to the borrower customer.
A banker should ensure that the stocks procured through the L/C are taken under hypothecation
and are not included in the stocks declared as security for the fund based limits granted to the customer.
If the L/C limit is sanctioned for purchase of capital goods, the same is taken under a hypothecation
charge by the banker.
17.3 PRINCIPLES OF BANK LENDING:
Banks lend money collected from the public. They deal with others money which is to be repaid
on demand. The loans and advances involve the risk of Non-payment and bad debts. Therefore for a
sound banking operations the banks should be prudent, conservative and careful in granting advances.
Banks have to follow certain principles of lending and observe some considerations in granting loans and
advances.
The principles or considerations of sound lending are briefed below:
1. Liquidity: Liquidity implies the ability to produce cash on demand, and the banker must be able to
meet the liabilities whenever they are demanded. Banks accept customer’s money, a substantial
part of which is repayable on demand. So a banker must ensure that the money he invests or lends
should be repaid in the stipulated period, so that his obligation to pay his depositors is not affected.
2. Safety : Safety first is the most important principle of good lending. The banker is a custodian of
public funds and lends money which has been entrusted to his care by the depositor and which is
to be repaid in accordance with the tenure of the deposit. The banker must, take utmost care in
ensuring that the business, for which a loan is sought, is a sound and the borrower is capable of
repaying the loan it out successfully.
3. Profitability: The bank earns its profits mainly through advances. It cannot ignore the consideration
of profitability while making advances. It has to see that the funds remain fairly, safe and also give
a reasonable return. The bank keeps in its investment portfolio three types of investments – liquid,
semi-liquid and income earning investment. It has to maintain them in optimum proportions to
assure profitability.
4. Purpose : Loans for undesirable and speculative purposes cannot be granted. Although the earnings
on such business activities may be higher, even then a bank cannot resort to these loans.
5. Social Responsibility: Principle of social responsibility has been gaining more importance. While
granting loans and Advances Banks should not only consider the Borrower’s ability to repay and
the economic viability of the project. The project which will help in rural upliftment, import substitution
or equitable distribution of income has to be preferred in comparison to other projects. Similarly

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 loans for productive purposes should be given in priority to loans for unproductive purposes. The
principle of social responsibility does not, however mean that attention should not be paid to other
principles. But the interests of the larger public, future generations and sustainability of mother
earth should be safeguarded. Social Banking and Green banking is the Answer. Banks should
restrain from granting loans and advances to polluting industries that emit carbons.
6. Borrower considerations: The banker while selecting his borrower should have a clear appraisal
about the three C’s – Character, Capital Character denotes integrity of the borrower i.e. he should
have willingness to repay the money borrowed. Capacity denotes his ability to manage his business.
Capital denotes his financial soundness. No banker will like to lend money to a person who does
not put money from his own resources.
7. Security: Security is now considered to be a secondary consideration while advancing loans.
However, this aspect cannot be completely overlooked since it is a safeguard for unexpected
defaults in repayments by the borrower. There may be cases where there is no security except
the personal security. The security and its adequacy alone should not form the sole consideration
for judging the suitability of a loan. But, the security, if accepted, must be adequate and readily
marketable, easy to handle and free encumbrances.
8. Diversification of Risks: The banker should not grant advances to only a few and similar business
houses, undertakings, industries or regions. It should be ensured that the advances are diversified.
The Banker should not keep all the eggs in one basket. Banker should always try and spread risk
by granting loans to borrowers from different trades, industries, sectors and regions, so that risks
arising from change in government policies, natural calamities or technological breakthroughs and
so forth do not put his position in risk.
Since 1991 with banking sector reforms, liberalization and privatization the principles of commercial
viability, efficiency, prudence and profitability have been receiving much attention of commercial banks.
It is because of increasing competition and emphasis on survival. But none of the principles should be
considered in isolation while granting loans. A judicious and objective consideration of the principles is
essential for sound lending by banks.
17.4 SUMMARY :
The primary function of banks is granting loans and advances. Bank grants loans and advances out
of the public money collected through deposits. There are different methods or forms of banking advances.
These include loans (Demand loan and Term Loans, secured and Unsecured loans), cash credit, overdraft,
Bill discounting and purchasing, Issue of Letters of Credit (LIC) etc. Bank lending involves different
risks. Banks have to take certain precautions and follow the principles of sound lending to minimize the
risks associated. Different principles of sound lending are safety, liquidity, profitability, security, purpose,
social responsibility, dispersal of risks etc.
17.5 SELF ASSESSMENT QUESTIONS AND SHORT NOTES:
1. Explain the principles/considerations of sound bank lending.
2. Give a brief account of the methods or forms of Bank loans and Advances.
3. What is Bill discounting and purchasing? Explain the advantages/merits of Banks advances
through discounting and purchasing of bills.

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Short Notes:
Cash Credit
Overdraft
Letter of Credit
Principle of Social Responsibility
17.6 SUGGESTED READINGS:
1. K.C. Sekhar and Lekshmy Shekar, Banking Theory and practice, Vikas publishing House Pvt.
Ltd., New Delhi.
2 Ranganadhachary and R.R. Paul, Banking and Financial System, kalyani publishers, New Delhi.
3. Mithani, D.M., Currency and Banking, Himalaya publishing House, Bombay.
17.7 KEY TERMS
NPAs : An Asset (loans and Advances) becomes a Non-Performing Asset (NPA) when it ceases to
generate income for the ban. Banks classify an account as an NPA if the interest charged during any
quarter is not serviced fully within ninety days from the end of the quarter.
Green Banking: Banking according to the cannon of social responsibility and restraining from granting
loans and advances to pollutant industries and those industries and those industries that emit carbons etc.
Social Banking: Banking or granting loans and advances for the social uplift and welfare of the unreached
people, poor and down trodden.
Term Loans : Medium and Long term loans
Bridge Loans : Bridge loans are the short term loans to meet the urgent and critical needs of the
borrowers during the period when formalities for availing of the term loans sanctioned are being fulfilled.
Hypothecation: In the case of hypothecation possession of goods of the borrower is given to the bank
that grants credit. The bank can check the stock of goods whenever it desires. Loan is granted by the
bank against hypothecation of goods only to those borrowers with integrity.
Pledge : In the case of pledge, the goods are placed in the custody of the bank with its name on the
godown. The borrower has not right to deal with the goods.

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 Lesson No: 18

CREDIT APPRAISAL – MODES OF CREATING

A CHARGE

STRUCTURE :
18.1 Introduction
18.2 Credit Appraisal – The Concept And Aspects Involved
18.3 Modes Of Creating A Charge
18.4 Summary
18.5 Self Assessment Questions
18.6 Suggested Readings
18.7 Key Terms
OBJECTIVE :
The lesson is designed to make you understand the credit appraisal by the banker and the modes of
creating change on security offered by the borrower against the loans and advances. A reading of this
lesson enables you explain the process as aspects involved in credit appraisal and the methods and
implications of different modes of creating charge on securities offered.
18.1 INTRODUCTION:
The expression ‘credit’ refers to short-term loans and advances as well to medium-/long-term loans
and off balance sheet transactions. Management includes, within its preview, pre-sanction appraisal,
sanction, documentation, disbursement and post-lending supervision and control. In the highly competitive
and deregulated environment, banks and financial institutions have to evolve better systems and procedures
to manage the credit needs of their highly demanding customers, particularly in the corporate and retail
sectors. The developments of the past decade have totally changed the credit management perspectives
in banks. The ‘Credit management’ involves among other things. Appraisal, credit decision-making and
loan review mechanism. Several risks affect credit decisions. The main risks are credit risk, market risk
(mainly liquidity risk and interest rate risk) and operational risk. Credit risk is defined as the possibility of
losses associated with a diminution in the credit quality of borrowers or counter parties.
‘Prevention is better than cure’ is the popular adage. Therefore, to guard against the risks involved in
extending credit proper credit appraisal, to judge the soundness of the borrower and the project to which
credit is granted is very important. Similarly, to ensure the recovery of the loan extended and safety of
money lent banks may emphasize on security for the loan granted. The banker exercises different
modes of charge against the securities offered by the borrower to the banker to fall back upon.
18.2 CREDIT APPRAISAL – THE CONCEPT AND ASPECTS INVOLVED:
Credit is extended by the banks for working capital finance or as term loans. The proposal or
project for which the credit is extended should be appraised regarding its viability and feasibility besides
the strength and soundness of the borrower. Credit Appraisal is the pre-sanction evaluation or assessment

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of the credit proposal or project. The project report which is prepared by the borrower has to be
appraised. Project appraisal is a prerequisite for funding. Though the project may appear to be most
desirable on paper its viability from the point of view of technical viability, financial feasibility, market
potential, management appraisal, environmental and ecological implications, etc. have to be systematically
reviewed and assessed.
The General Appraisals:
Technical Appraisal: Technical feasibility analysis is primarily conducted to ensure that the project is
technically sound. It examines the project idea/concept, the manufacturing processes, plant and machinery
as well as other equipment and know-how, etc. proposed to be used.
Financial Appraisal: An assessment of total financial requirements including those for fixed capital,
working capital as well as establishment costs, etc. has to be made. The sources from of the funds and
cost of funds have to be identified. Only if the project is able to service debt and satisfy return expectations
it will be considered financially viable.
Market Appraisal: Market appraisal helps to assess the market potential of the proposed product/
service. Realistic estimate of market demand, competition (both direct and from substitutes), export
potential has to be made.
Management Appraisal: The character or willingness of the borrower the reputation good-will, vigor
and enthusiasm are all very important aspects for the success of the venture. The educational, technical
qualifications and experience of the borrower/managerial team are other important factors which have
to be kept in mind.
Environment Appraisal: Environmental and ecological appraisal has become a very important part of
project appraisal. Any damage to the environment as a result of technology used or waste/effluents not
being managed properly needs to be examined. When the above feasibility parameters produce a positive
result only then the funding agencies will consider grant of finance for the project. It is the spirit of
Green banking.
A project is considered viable when the cash flow generated from the project is adequate enough to
service the funding arranged by the project owners. The financing institution has to satisfy itself on all
the above accounts-in other words that there is market demand for the proposed goods/services to be
manufactured/supplied, availability of technical know-how for the manufacturing process, economical
cost of the product, sources of finance, whether the project will be self-sustaining, and the competency
of the management to manage the enterprise.
In the credit appraisal process, the decision maker makes an attempt to find the answer to two
important questions. First, whether the entrepreneur requires funds, also what are his credentials? If the
answer is the first question is positive, the second question is all about the extent of his requirements and
the ways in which the requirements can be met. Due to non-performing asset norms, credit appraisal
techniques are increasingly focused on the assessment of repayment capacity of the borrowers, which in
turn depends on their cash generating ability.
Working Capital Finance: Commercial Banks mostly lend working capital or short term credit. Working
capital is the amount of funds required by an enterprise to finance its day-today business operations. It
is that part of the total capital which is employed in short-term assets such as raw-materials, accounts
receivable, inventory, etc. The major sources of working capital funds for investment in current assets
are; trade credits/unsecured loans/bank borrowings/ etc. The conditions of commercial banks for lending
on a short-term basis are rigorous. A customer has to satisfy his bank about his character, capacity,
capital and collateral, in brief he has to establish his credit worthiness. If the overall appraisal is satisfactory,

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the bank will finance only the residual gap in the customers’ resources, after taking into consideration the
expected availability from all other sources of funds.
It must be emphasized that the assessment of the working capital requirements of a firm must be
preceded by a detailed appraisal of the past and future viability of the firm’s planning, operations and
financial position. It is implicit that the firm will have to submit an acceptable business plan, in the form
of projected financial statements, to the bank. Thereafter, the assessment of working capital needs is
made based on the past trends, the end use of funds and the estimated requirement of additional funds as
revealed by the firm’s business plan or the cash budget, in cases of those firms which have a marked
seasonality of operations.
For extending working capital credit the commercial banks should assess the working capital
requirements of a firm. The following methods are generally followed for assessing working capital
requirement of a firm.
Turnover method: Under this, the working capital is assessed as minimum 25 per cent of the sales
turnover, which is financed by way of bank finance at minimum of 20 per cent and the borrower’s
contribution at 5 per cent of the projected sales.
Traditional method: This method takes the length of the operating cycle and the size of the sales into
account. The level of working capital would be the sum total of anticipated current assets and also
reasonable level of other assets.
Cash budget method: As per this method, monthly cash inflow and outflow statement is prepared and
the gap between the two becomes the basis for sanction of credit limit.
18.3 MODES OF CREATING CHARGE:
Types of Charge and Nature of Security

Type of charge Nature of security

Lien Goods and securities

Pledge or hypothecation Movable properties
Assignment Book debts
Mortgage Immovable property

The modes of creating charge and the features and legalities involved are discussed below:
PLEDGE : Pledge is the bailment of goods as security for payment of a debt or performance of a
promise. When a borrower secures a loan through a pledge, he is called a pawner or pledger, and the
bank is called the pawnee or pledge. To complete a contract of pledge, delivery of the goods to the
banker is necessary. Delivery of the title documents relating to the goods, or the key of the godown
where the goods are stored, may be sufficient to create a valid pledge. Strictly speaking, where no
possession is given, it is known as ‘hypothecation’. It has been observed in Shatzadi Begum Saheba and
others Vs Girdharilal Sanghi and others that there are three essential features of a pledge, namely:
(i) there must be a bailment of goods, i.e. delivery of goods;
(ii) the bailment must be by way of security
(iii) the security must be for payment of a debt or performance of a promise.

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 A pledge gives the pledge no right of ownership. But, he gets a special interest to retain possession
even against the true owner until the payment of the debt, and any other expenses incurred in respect of
the possession or preservation of the goods. In case of a pledge, a special interest and not the special
property is transferred to the pledge who is impliedly authorized to sell the goods pledged in case of
default. The banker may redeliver, for a specific purpose, the goods pledged with him It has been held
in Mercantile Bank of India Limited Vs, Central Bank of India Limited, that the pledge is not lost by such
redelivery.
In case of default by the pledger, the banker has the right either to
(a) File a civil suit against the pledger and retain the goods as additional security; or
(b) Sell the goods. In case of sale, banker must give due notice of sale to the borrower before making
a sale.
This right is not limited by the law of limitation. Banker’s right of pledge prevails over any other
dues including government dues except worker’s wages. Banker must take good care of goods and
return them after the payment is made along with accretion, if any.
HYPOTHECATION: The term ‘Hypothecation’ means a charge in or upon any movable property,
existing or future created by a borrower in favor of a secured creditor, without delivery of possession of
the movable property to such creditor. Hypothecation differs from pledge because goods remain in the
possession of the borrower. Hypothecation is a charge made on movable property in favor of a secured
creditor without delivery or possession. Charge is created only in movable goods like stocks, machinery
and vehicles. It is a convenient device in the circumstances in which the transfer of possession is either
inconvenient or impracticable such as buses and taxies. The agreement is entered into through a deed of
hypothecation. The bank cannot take possession of goods without the consent of the borrower, but after
taking possession, the banker is free to exercise the right of a pledge, and sell the assets without intervention
of the court.
In a case Delhi High Court has concluded that hypothecation is virtually pledge because ‘the
borrower is in actual possession (of the asset) but the constructive possession is still of the bank because
according to the deed of hypothecation, the borrower holds the actual physical possession, not in his own
right as an owner of the goods but as the agent of the bank”. M/s Gopal Singh Hira Singh v. Punjab
National Bank (1976) A.I.R. Delhi 115.
LIEN : Lien means the right of the creditor to retain the goods and securities owned by the debtor until
the debt due from him is repaid. The creditor gets only the right to retain the goods and not the right to
sell. A banker, therefore, can retain all securities etc., in his possession till all his claims against the
concerned person are satisfied. The right of general lien is applicable in respect of all amounts which are
due from the debtor such as security handed over to the banker for a machinery loan after its repayment
can also be used by the banker in respect of any other advance outstanding in his name.
MORTGAGE: Mortgage is a transfer of interest in immoveable property to secure an advance or loan.
According to Section 58(a) of the transfer of property Act, a mortgage is the ‘transfer of an interest in
specific immovable property for the purpose of securing the payment of money advanced or to be
advanced by way of loan, existing or future debt or the performance of an engagement which may give
rise to a pecuniary liability”. The transferor is called a mortgagor and the transferee a mortgages. The
principal money and the interest of which payment is secured for the time being are called the mortgage
money and the instrument (if any) by which the transfer is effected is called the mortgage deed. The
term immovable property includes land, buildings and similar other assets.

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 The main characteristics of mortgage are:
1. Mortgage relates only to immovable properties.
2. The object of mortgaging the property is to give security for the loan to be taken or already taken
for performance of an engagement giving rise to the pecuniary liability.
3. The mortgagor does not transfer the ownership of the property to the mortgagee. He transfer only
some of his right as an owner e.g. He cannot sell the property without the consent of the mortgagee.
ASSIGNMENT: Assignment means transfer of an existing or future right, property or a debt by one
person to another person. The transferor is known as the assignor and the transferee as assignee.
Usually assignments are made of actionable claims e.g. book debts, insurance claims etc.
Assignment may be: Legal or (ii) Equitable.
A legal assignment is one where:
(a) assignment deed is in writing duly signed by the assignor,
(b) the transfer of actionable claim is absolute, and
(c) the assignee informs the assignor’s debtor about the assignment and also gets the balance confirmed
from him.
An equitable assignment is one which does not fulfil all the above requirements. For example,
where a debtor, issues an order in favour of his creditor, on his debtor asking him to pay such funds to his
creditor, it will result in creation of an equitable charge of the creditor over such funds. On assignment
of property the assignee gets absolute control over it and no other creditors of the debtor can have
priority over the assignee’s claim. The power of allorney created in favour of creditor cannot be revoked
if the creditor himself has interest in such power.
18.4 SUMMARY:
The basic business of banking is collecting Deposits and lending money. Different types of loans and
advances are granted by banks. Mostly banks lend credit for working capital finance. No doubt, long
term credit is also offered by bank though to a less extend. While extending credit banks have to look for
safety, security and liquidity besides the character, credit worthiness and capability of the borrower.
Therefore, before extending credit, credit appraisal is very important. In the credit appraisal process the
banker has to assess the extent of credit requirement, the feasibility of the project, borrower’s credentials,
etc.
Bank extends credit both secured and unsecured. In view of the safety of bank’s money loans are
granted against security. No doubt banks extend credit without security also. Security helps the banker
to fall back upon in times of borrower’s failure to repay the loan. Bankers create charge on security in
their favour. Charge on an asset makes the asset available to the banker when needed in realization of
the advances made by him in the event of non repayment. There are different modes of creating charge
on assets. These include: 1. Lien, 2. Pledge, 3. Hypothecation, 4. Mortgage and 5. Assignment.
18.5 SELF ASSESSMENT QUESTIONS:
1. What do you understand by credit appraisal? Explain the various parameters used in credit appraisal.
2. What is charge? Explain different modes of creating charge.

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Short Notes:
Project Appraisal
General Appraisal
Working capital
18.6 SUGGESTED READINGS:
1. Vasant Desai, Indian Banking-nature and problems, Himalaya publishing House, Mumbai.
2. Dr. C. Satya Devi, Financial Services-Banking & Insurance, S. Chand & Co., new Delhi.
3. K.K. Jindal, Banking & Financial Institutions, Skylark publications, New Delhi.
18.7 KEY TERMS:
Operating cycle: The acquisition of raw materials and the final cash realization always Involves a
certain time gap. The period between the materials ordering stage to conversion of sales into cash is
referred as the operating cycle.
Working capital : Working capital is the excess of current assets over current liabilities. Current
assets include cash and bank balances, receivables, inventory, prepaid expenses, etc. Current liabilities
are the debts of the firms which have to be repaid during the current accounting period. These include
creditors, outstanding expenses, short-term borrowings, advances received against sales, taxes and dividends
payable, etc.
Gross working capital: The sum total of current assets.

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 UNIT - IV

LESSON 19 : Features, structure and growth of Indian Money Market and Indian
capital market and their functions are also discussed in detail.

LESSON 20 : NBFC meaning and functions of NBFC are touched upon.

LESSON 21 : Stock Exchange functions and SEBI functions also explained in detail.

LESSON 22 : This lesson elaborates meaning of financial services classification.

LESSON 23 : Importance of merchant banking and mutual funds services also

discussed.

LESSON 24 : Meaning of venture capital, depository system and features of loan

syndication are touched upon.

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 Lesson No: 19

MONEY MARKET-STRUCTURE AND FEATURES

STRUCTURE:
19.1 Introduction
19.2 Meaning Of Financial Market
19.3 Money Market – The Concept
19.4 Structure And Composition Of Money Market
19.5 Bill Market And Rbi
19.6 Reforms Of The Indian Money Market
19.7 Summary
19.8 Self Assessment Questions And Short Notes
19.9 Suggested Readings
19.10 Key Terms

OBJECTIVE:
After reading this unit, you should be able to: describe the Money Market in its structure and
composition, explain the characteristics and weaknesses of the Money Market and understand the Reforms
of the Indian Money Market
19.1 INTRODUCTION:
Financial system includes all those activities dealing in finance organized into a system. The
economic development of any country depends on the presence of a well organized financial system.
The financial system of any country comprises of four important components. These are: (i) Financial
institutions (ii) Financial Markets (iii) Financial instruments and (iv) Financial services. The efficient and
well orders functioning of the financial system relies heavily upon the range of financial services offered,
the efficiency of financial institutions and the effective functioning of financial markets.
19.2 MEANING OF FINANCIAL MARKET:
Financial markets are the centers or arrangements that provide facilities for buying and selling
of financial claims and services. Financial market refers to a place or Mechanism, where funds or
savings are transferred from surplus units to deficit units. These markets can be broadly divided into
Money market and Capital market. Money markets deal with short-term claims or financial assets
(less than a year), while capital market deals with long-term claims or financial assets. There is another
classification of financial markets, i.e., Primary market and Secondary market. While primary market
takes care of new issue securities, secondary market deals with securities which are already issued and
available in the market.

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19.3 MONEY MARKET – THE CONCEPT:
The RBI defines “Money market is the centre for dealing mainly of short term character in
money assets; it meets the short term requirements of borrowers and provides liquidity or cash to the
lenders. It is the place where short term surplus investible funds are at the disposal”.
According to V. Padia “Money market is a whole sale market for highly liquid low risk and short
term instruments to be traded on, whose prices vary moderately”. Money Market, like any other market,
is concerned with the supply of and the demand for investible funds. Essentially, it is a reservoir of short-
term funds. A money market provides a mechanism by which short-term funds are sent out and borrowed.
It is through this market that a large part of the financial transactions of a country of the world is cleared.
It is the place where a bid is made for short-term investible funds at the disposal of financial and other
institutions by borrowers comprising institutions, individuals and the government itself: Such a market is
composed of commercial and other types of banks and agencies (e.g. indigenous bankers) catering to
the short-term capital requirements in different sectors of the country’s economy, ancillary institutions,
such as discount houses, and acceptance houses, and the central bank of the country as the apex institution
of the money market.
19.4 STRUCTURE AND COMPOSITION OF MONEY MARKET:
You can grasp the structure of Money Market through the following chart. Basically the Indian
Money Market is divided into (i) Organized sector and
(ii) Unorganized sector.
Indian Money Market
_____________________!_________________________________
Organized sector unorganized sector
| | — Indigenous Bankers
Central Bank (RBI) | — Money Lenders
|
Commercial Banks
| - - Public Sector Banks
| — Private & Foreign Banks
|— Cooperative Banks and
!— other institutions
(i) Organized Money Market: The Organized Money Market is the work of institutions headed by the
RBI. It comprises of the Reserve Bank of India (Central Bank), Commercial Banks and Financial
Institutions. The Organized Money Market is under total control of the RBI which applies qualitative as
well as quantitative controls to regulate the supply of money to various sectors of the economy.
(ii) Unorganized Money Market: This sector of the money market mainly consists of Indigenous
banker and money lenders. These do not follow rules and regulations of the Government. Thus this
sector of the Money Market is outside the regulatory frame work of the RBI.

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 The Money Market also consists of the institutions like Discount houses and Accepting houses.
The players in the organized Money market are as below.
A. Central Bank:
The Central Bank is the apex monetary authority of the country. The main function of the Central
Bank is to regulate the monetary mechanism comprising of the currency, banking and credit systems.
Another important function of the central bank is to conduct the banking and financial operations of the
government. The functions of a Central Bank are (i) Issue of Currency Notes (ii) Government Banker
(iii) Banter’s Bank.
B. Commercial Banks:
Commercial banks constitute another important segment of the money market. These banks are
concerned with accepting deposits of money from the public at large, repayable, on demand or otherwise,
and withdrawable by cheques, draft, order or otherwise and employing the deposits so pooled in the form
of loans and investment to meet the financial needs of business and other classes of society. Like other
financial Intermediaries, commercial banks act as mobilizers of public savings, for their productive
utilization. The provision of short-term loan by means of cash credit, discounting bills, promissory notes
and there debt instruments distinguishes commercial banks from other financial intermediaries.
C. Indigenous financial Agencies:
Indigenous financial agencies occupy an important position in the Indian money market. They
comprise money lenders and indigenous bankers. The Indian Central Banking Enquiry Committee defined
an indigenous banker as ‘any individual or private from receiving deposits and dealing in hundis or lending
money and money lenders as “those whose primary business is not banking but money lending”. It is
difficult to draw a defining line between money lenders and indigenous bankers. Methods of business of
these money lenders vary from place to place and from money lender to money lender. Generally, loans
are given on personal security and even without any written agreement.
D. Discount houses:
Discount houses are specialized firms which transact the bulk of the total discount business and
very popular. These agencies are concerned with the discounting of trade bills. After having discounted
the bills, they arrange them according to their maturity and sell them to commercial banks after one
month. The organization of the discount houses is extremely simple, and the number of their employees
is quite small, although they turn over huge sums of money every day. The discount houses borrow at
call from banks and other financial institutions. In this way, they provide a means whereby the banks are
able to reduce to a minimum the amount of money they must keep unemployed to meet the calls upon
them by their, customers for cash, and at the same time earn interest on the surplus funds which they
may have at nay given time. The money borrowed by discount houses is mainly invested in Treasury
Bills, Commercial Bills.
E. Accepting houses:
Another important constituent of the Market is Accepting Houses again popular in London Money
Market. They borrow short period loans from the banks with a view to lending them out to the money
market. Acceptance credit is the basic business of these houses which has been described as fundamentally
a three-month operation. These houses finance exports from and imports. The other activities traditionally
financed by the Accepting Houses include normal banking facilities for customers, including the foreign
banks which regulate open credits with them. They also advise on the shipping and insurance problems
arising out of the financing of trade.

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16.5.1 Instruments of Money Market:
The money market is composed of different sub-markets and instruments as explained below:
(a) Government securities: The term government securities encompass all bonds and treasury bills
issued by the government for the purpose of raising public loans. These securities are usually
referred to as gilt-edged securities as repayments of principal as well as interest are totally secured
being first charge on the nation’s purse. Depending upon the issuing body, such securities could be
bifurcated into five types: 1. Central Government securities, 2. State Government securities’ 3.
Securities guaranteed by Central Government or Central Government Financial Institutions like
IDBI, ICICI, IFCI etc. 4. Securities Guaranteed by the State Government or state institutions like
state electricity boards and housing boards. 5. Treasury bills issued by RBI. Government securities
could be held in three forms viz., 1. Stock Certificates 2. Promissory Notes and 3. Bearer Bonds.
(b) Treasury Bills: A treasury bills is a particular kind of finance bill or a promissory note issued by
the Government of the country to raise short-term funds. Unlike commercial bills, financial bills
are not backed by transactions in goods. These bills are highly liquid and virtually risk free as they
are backed by a guarantee from the government. Treasury bills popularly known as T-bills do not
carry any coupon rate. They are issued at a discount. There are here types of treasury bills which
are marketed in India; the 91 day treasury bills, and 364day treasury bills and the 182 day treasury
bills.
The market for the 182 day treasury bills and 364 day treasury bills is of quite recent origin while
the 91 day bills are in force since long time back and they serve two purposes. First, they replenish
government cash balances. Second, they provide a medium for investing temporary surpluses to State
Governments, semi government departments, and foreign central bank. The important features of treasury
bills are, high liquidity, absence of risk of default, ready availability, assured yield, low transaction cost,
eligibility for inclusion in the SLR, and negligible capital depreciation.
The creation of 91 day treasury bills is closely related to and it essentially reflects the volume and
changes in the Government budgetary deficit. As a result, the bulk of these bills is purchased and held by
the RBI. Consequently, the market in treasury bills has remained narrow and inactive. Apart from the
RBI, the treasury bills are also purchased by commercial banks, State Governments and other approved
bodies. With a view to widening the short-term money market, and to providing more outlets for temporary
surplus funds, the authorities in India, introduced, in November, 1986, a major financial innovation in the
form of a new money market instrument. The 182 day treasury bill can also be regarded as a new fiscal
instrument. The maturity period of the new treasury bill, as its name itself makes clear, is 182 days, i.e.,
it is exactly twice the maturity period of the other old treasury bill. The new bill has become a handy
instrument for banks, financial institutions, corporate finance managers, and so on to invest their short-
term liquid funds. The bills are normally issued at a discount to face value for a minimum of Rs. 1 lakh
and multiples thereof.
The new treasury bills can be purchased by any person resident in India, including individuals, firms,
companies, banks, and financial institutions. But unlike the 91 day treasury bills, they cannot be purchased
by the State Government and provident funds. It is also to be noted that the RBI does not purchase these
bills at all. An important favorable feature of the new bills is that attractive rate of return available on it.
This yield is freely determined by the market forces.
(c) Commercial Paper (CP): In the USA, Commercial paper has been in vogue since early 19th
century. However, elsewhere it is only a post-1980 phenomenon. RBI introduced the concept of
commercial paper, in January 1990. Commercial paper is defined as a short term money market
instrument issued by way of a promissory note for fixed maturity. It is totally unsecured and
substitutes working capital finance for companies for a short period. Commercial papers are
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 short-term usance promissory notes with fixed maturity issued mostly by the leading, nationally
reputed, credit worthy, and highly rated large corporations.
On the recommendations of Vaghul Working Group Commercial Paper is introduced in the Indian
money market in January 1990. Commercial papers are issued by corporate entities to raise resources
for their short-term needs instead of borrowing from banks. It is a certificate evidencing an unsecured
corporate debt to short-maturity. It represents a promise by the borrowing company to repay loan at a
specified date.
The paper is a usance promissory note. It is therefore negotiable by endorsement and delivery.
A company desiring to mobilize working capital through the issue of C.P. has to send an application to
R.B.I. through a bank or the leader of the consortium banks. The application should be accompanied by
a certificate from Credit rating agency. After the R.B.I. grants permission, C.P. issue has to be completed
within 2 weeks.
The primary advantages of the introduction of C.P. are to enable corporate companies to float their
own short term paper for raising funds on competitive terms. The advantage to investors is that they can
deploy their funds at higher rates of interest. The important sources for the supply of funds in the market
are the all-India financial institutions such as LIC, GIC and its subsidiaries; UTI and mutual funds and
financial institutions.
(d) Certificates of Deposits (CDs): CDs are deposit receipts issued by banks against deposits kept
by individuals, companies, PSUs. and other institutions. The R.B.I. introduced the Certificates of
Deposits Scheme in June 1989, C.Ds. can be issued only by scheduled commercial banks excluding
RRBs. All India financial institutions like the IDBI, ICICI and IFC are permitted to issue CDs with
a maturity period of more than 1 year up to 3 years with an initial aggregate limit of Rs. 1,000 crore
( raised to Rs. 1,350 crore in May 1992). The Industrial reconstruction Bank of India is also
permitted to issue CDs up to a limit of Rs. 100 crore with effect from July 29, 1992.
Certificate of Deposit (CDs) is defined as short term deposit procured by a bank by way of a
usance promissory note having a short maturity of note less than three months and not more than one
year. CDs are bank deposit accounts which are transferable from one party to another. They are
marketable or negotiable short term instrument in bearer form and are known as Negotiable Certificates
of Deposit (NCDs) also. Liquidity and marketability are said to be the hall marks of CDs. CDs are also
virtually risk less in terms of default of payment of interest and principal. The maturity period of CDs
varies between 2 weeks to 5 years. The more common period is 3 months to 1 year; and the most
common period is 3 months or 90 days. CDs are quite flexible in respect of maturity period.
Since the beginning of 1980’s the possibility of introducing CDs in India was being seriously
assessed. Tambe Working Group studies in 1982 on its feasibility and recommended against it. The
Vaghul Working Group studied the matter again five years later (1987) and was in favor of introducing
CDs. Ultimately, the RBI formulated and launched in June 1989 a scheme permitting banks to issue CDs
“With a view to further widen the range of money market instruments and to give investors greater
flexibility in the deployment of their short-term surplus funds. Although the scheme of CDs has been in
operation for quite some time, it has yet to gain ground and its usage has remained confined to only a few
corporations and banks. Banks are in need of exploring the use of innovative means such as CDs to
maintain their share in the funds market. Given such favorable supply and demand factors, and given the
support of the RBI and institutions like DFHI, the markets for CDs seem to have a good potential for
growth in the coming years.
(e) Call and Notice Money Market: The Call and Notice Market constitutes the core of the Indian
Money Market. Call money represents the amount borrowed by commercial banks from each
other for short periods to meet their cash reserve requirements. Those banks whose cash reserves
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 decline below the statutory requirement borrow from such banks which have surplus cash reserves.
Funds are thus borrowed and lent for one day (call) and for a period up to 14 days (notice) without
any collateral security. Deposit receipt is issued to the lender who on recalling the funds discharges
the receipt. The borrowing bank will repay not only the principal but also interest.
Scheduled Commercial banks, Cooperative Banks, LIC, UTI and DFHI are the participants in
this market. While commercial and cooperative banks and DFHI are permitted to act as both borrowers
and lenders, LIC and UTI are allowed to operate only as lenders. With effect from May 2, 1990, GIC.
IDBI and NABARD are permitted to participate as lenders. In January 1991, the RBI allowed Indian
Bank Mutual Fund and PNB, Mutual Fund to enter into this market as lenders.
19.5 BILL MARKET AND RBI:
Bill Market refers to the market for short-term bills generally of three months maturity. A bill is
a promise to pay a specified amount by the borrower (drawer) to the creditor (drawee). Bills are of
three types: (a) bills of exchange or commercial bills used to finance trace; (b) finance bills or promissory
notes; and (c) treasury bills used to meet temporary financial needs to the government. These bills may
be bought and sold in the discount market which consists of commercial, banks, discount houses and
other institutions. The bill market plays an important role in the banking and monetary system of the
country.
The bill market scheme was introduced by the Reserve Bank of India in January 1952. Before 1952,
the practice was that the banks could secure additional cash from the Reserve Bank only by selling
government securities to it. But, according to the bill market scheme, a bank can grant loans to its
customers against their promissory notes and can further use the same promissory notes to borrow from
the Reserve Bank. Thus the bill market scheme aimed at widening the loan window of the Reserve
Bank for the banks by allowing them to borrow even against their ordinary commercial credit after its
conversion into eligible bills. Initially, the bill market scheme was introduced on an experimental basis. it
was restricted to the scheduled banks with deposits of Rs. 10 crore and above. Later on the scope of the
scheme was broadened from time to time by making more banks eligible to borrow under the scheme.
The bill market scheme introduced in 1952 was in fact a pseudo bill market scheme. Its objective
was not to develop a genuine bill market, but to provide extended financial accommodation to banks by
the Reserve Bank. Dissatisfied with the old bill market scheme, in February 1970, the Reserve Bank of
India constituted a Study Group under the chairmanship of Dahejia to go into the question of enlarging the
use of bills of exchange as an instrument of credit and the creation of genuine bill market in India. The
Dahejia Committee report brought out the abuses of cash system and suggested the use of bill financing
for the supervision of the funds lent by the commercial bank. On the recommendations of the report of
the study group, the Reserve Bank introduced the New Bill Market Scheme in November 1970 under
Section 17 (2) of the Reserve Bank of India Act. A developed bill market makes the monetary system of
the country more elastic and will also make the monetary control measures, as adopted by the Reserve
Bank, more effective.
A developed bill market is useful to the borrowers, creditors and to financial and monetary system as
a whole. The existence of a well organized bill market is essential for the proper and efficient working
of money market. Unfortunately, in spite of the serious efforts made by the Reserve Bank of India, the
bill market in India has not yet been fully developed.
19.6 REFORMS OF THE INDIAN MONEY MARKET:
The development and strength of the Indian Money Market lies in the presence of a Central
Bank (RBI), developed and reformed Banking system, integrated structure of interest rates, availability
of financial assets and resources, existence of specialized institutions, absence of discrimination against
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foreign firms, integrated structure of the markets etc. Despite these strengths, the Indian Money Market
is loosely organized. It is inadequately developed and suffers from a number of problems or defects.
The weaknesses of the Indian Money Market which characterize it as inadequately developed
include-
(a) Existence of incoherent organized and unorganized sectors
(b) Predominance of unorganized sector
(c) Shortage of capital funds
(d) Deregulated and Diversified interest rates
(e) Absence of Integrated all India Money Market
(f) Lack of well organized Bill Market
(g) Unhealthy competition among constituents
(h) There are no discount houses in Indian Money Market
(i) Absence of innovative instruments
In view of the deficiencies in the Indian Money Market, a number of Reforms are contemplated.
In this direction different committees have been constituted by the Government of India and the RBI.
Based on the recommendations various measures have been initiated.
Sukhamoy Chakravarthi Committee was constituted in 1982 and submitted its report on 10th April
1985. The major recommendations of the committee are that the
• Secondary market for bills should be developed.
• Treasury bills should be issued at flexible discount rate.
• Ceiling on inter bank call money interest rates should be removed.
• More institutions should participate in call market.
In, 1986, the Reserve Bank of India set up a Working Group under the chairmanship of Mr.
N.Vaghul to examine the possibilities of enlarging the scope of money market instruments. The Working
Group submitted its Report in January, 1987. It has made a number of recommendations for activating
and developing the Indian money market.
The government also appointed a high level committee (Narasimham Committee) to examine the
financial system. The committee submitted its report in November 1991 which included also reforms to
be introduced into the money market.
The Reserve Bank of India has initiated measures to implement the reform recommendations
of the Working Group during 1987-2006.
(i) In order to attract additional funds into rediscount market, the ceiling on the bill rediscounting rate
has been raised from 11.5% to 12.5%.
(ii) Access to bill rediscounting market has been increased by selectively increasing the number of
participants in the market.

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(iii) 182 Day Treasury Bills have been introduced in 1987. In 1992-93, 364 Day Treasury Bills were
introduced. Like 182 Day Treasury Bills, 364 Day Bills can be held by commercial banks for
meeting Statutory Ratio.
(iv) Total deregulation of money market interest rates with effect from May 1, 1989 is a significant
step taken by RBI towards the activation of money market.
(v) Certificates of Deposits (CDs) were introduced in June 1989 to give investors greater flexibility in
employment of their short-term funds.
(vi) Another money market instrument, Commercial Paper (CP), was introduced in 1990-91 to provide
flexibility to the borrowers.
(vii) Since July 1987, the Credit Authorization Scheme (CAS) has been liberalized to allow for greater
access to credit.
(viii) In April 1988, the Discount and Finance House of Indian Limited (DFHI) was established with a
view to increasing the liquidity of money market instruments.
(ix) In 1991, the scheduled commercial banks and their subsidiaries were permitted to set up Money
Market Mutual Fund (MMMF) which would provide additional short-term avenue to investors.
19.6.1 Measures or suggestions to improve Indian Money market: In a view of the various defects
in the Indian money market, the following suggestions have been made for its proper development:
1. The activities of the indigenous banks should be brought under the effective control of the Reserve
Bank of India.
2. Banking facilities should be expanded especially in the unbanked and neglected areas.
3. More innovative instruments suitable to satisfy the Indian investor’s priorities should be designed
and introduced.
4. Variations in the interest rates should be reduced.
5. It is important to relax the rigid conditions and rules imposed on unorganized sector to develop
relationship between organized and unorganized sectors.
6. Discounting and rediscounting facilities should be expanded in a big way to develop the bill market
in the country
19.7 SUMMARY:
Financial Markets refer to a mechanism where funds or savings are transferred from surplus
units to deficit units. Money Market and Capital Market are the constituents of Financial Markets.
Money Market refers to institutional arrangements which deal with short term funds. Capital Market
deals in long term credit. The structure of the Money Market includes organized sector and unorganized
sector. The organized sector includes the Central Bank and Commercial Banks and other institutions.
Unorganized Money Market consists of Indigenous bankers and money lenders who are largely
unregulated.
The Indian Money Market is less developed and largely dominated by the unorganized sector.
Money Market is a short term credit market which deals with relatively liquid and quickly
marketable instruments such as Government securities, call market, treasury bills, bills of exchange,
commercial paper and certificates of deposits. In view of the inherent deficiencies in Indian Money

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Market a number of committees like Sukhomoy Chakravarthi Committee and Vaghul Working Group
were constituted and reforms were initiated on the basis of expert recommendations still various measures
of integration, regulation and innovation are to be introduced to develop and further strengthen the
money market.
19.8 SELF ASSESSMENT QUESTIONS AND SHORT NOTES:
1. Define Money Market and explain the structure of Money Market in India.
2. Is Indian Money Market developed? Explain its structure and problems
3. What are the defects of Indian Money Market? Explain the measures for improvement.
4. Give an account of the Money Market Reforms in India.
19.9 SHORT NOTES:
Financial system
Financial Market
Money Market
Bill Market
Certificates of Deposits (CDs)
Bill Market and RB
19.10 SUGGESTED READINGS:
1. M.Y. Khan, Indian Finance System
2. L.M. Bhole, Financial Institutions and Markets, Tata Mc Graw Hill, New Delhi
KEY TERMS:
1. Financial Market; Financial Market refers to a place or mechanism where funds or savings are
transferred from surplus units to deficit units
2. Financial Institutions: Financial institutions are business concerns that play the role of mobilizers and
depositories of savings and as purveyors of credit.
3. Financial Services; Financial Services include the services offered by both types of companies –
Asset Management companies and liability management companies.
4. Financial Instruments: Financial Instruments or Financial Assets are the commodities (securities)
that are traded or dealt in a financial market.
5. Usance : Time fixed for the payment of bills drawn in one country payable in other country is called
usance.
6. Discount House: Discount House is a financial institution which specialized in discounting bills of
exchange.
7. Asset Management Companies (AMCs): These are leasing companies, mutual funds etc.
8. Liability management Companies (LMCs): These include Bill discounting houses and accepting
houses.
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 Lesson No: 20

INDIAN CAPITAL MARKET-FEATURES

AND REFORMS

STRUCTURE:
20.1 Capital Market – Meaning And Significance
20.2 Indian Capital Market – Composition
20.3 Primary And Secondary Markets
20.4 Capital Market Reforms In India
20.5 Summary
20.6 Self Assessment Questions And Short Notes
20.7 Suggested Readings
20.8 Key Terms

OBJECTIVE :
A study of this Unit helps you to understand the meaning, composition and constituents of Capital
Market besides, the reforms in Indian Capital Market. Moreover, you can also understand the composition
and role of primary and secondary markets.
20.1 CAPITAL MARKET – MEANING AND SIGNIFICANCE :
The financial market can be broadly grouped into two categories viz: (a) Capital market, (b)
Money Market. Long term financial instruments such as Shares, preference and equity, bonds and
debentures; are traded in the Capital Market. ‘Capital Market’ refers to the arrangements for facilitating
the borrowing and the lending of long-term funds.
A capital market may be defined as an organized mechanism for effective and efficient transfer
of money-capital or financial resources from the investing parties, i.e., individuals or institutional savers
to the entrepreneurs engaged in industry or commerce in the business either be in the private or public
sectors of an economy (Shashi K. Gupta).
Capital market refers to that market in which long-term funds are borrowed and lent. It refers
to the institutional arrangement which facilitate the borrowing and lending of long-term funds. Thus, the
emphasis is on markets for long-term debt and equity claims, stocks, bonds etc.
According to W.H. Husband and J.C. Dockerbay, “the capital market is used to designate activities
in long-term credit, which is characterized mainly by securities of investment type”. Arun K. Data Gupta
writes that “the Capital Market is a complex of institutions, investment and practices which established
link between the demand for and supply of different types of capital funds”. Capital market is an
essential pre-requisite for industrial and commercial development of a country. The money market
caters to the short-term needs only. The long term capital needs are met by the capital market. The
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capital market facilitates the movement of capital to the point of highest yield. Thus a capital market
strives for (i) the mobilization or concentration of national savings or economic development, and (ii) the
mobilization and import of foreign capital and investment to augment the deficit in the required financial
resources so as maintain the expected rate of economic growth.
The major functions performed by a capital market include (i) Mobilization of financial resources
on a national-wide scale, (ii) Securing the foreign capital and know-how to fill up the deficit in the
required resources for economic growth at a faster rate. (iii) Effective allocation of the mobilized
financial resources, by directing the same to projects yielding highest yield or to the projects needed to
promote balanced economic development.
20.2 INDIAN CAPITAL MARKET – COMPOSITION:
Capital Market consists of (a) The Gilt Edged Market and (b) Industrial Securities Market,
Government and Semi Government securities which are stable in value and are backed by Reserve Bank
of India are traded in the gilt- edged market. The Industrial Securities Market reefers to the market for
shares and debentures of existing and new companies. The Industrial Securities market is further divided
into two categories viz. (a) Primary Market and (b) Secondary Market. Primary Market refers to raising
of capital in the form of fresh public issue of shares, debentures or bonds of private and public companies.
The securities so issued in primary market i.e. existing financial instruments of existing companies are
traded in secondary markets.
The abolition of Monopolies and Restrictive Trade Practices (MRTP) Act, clearance for mergers
and acquisitions the relaxation of Foreign Exchange Regulation Act (FERA), abolition of Controller of
Capital Issues (CCI) and establishment of Securities and Exchange Board of India (SEBI), pre-pricing
of issues are some of the major capital market reforms formulated by the Government of India.
The capital market in India is composed of organized and unorganized sectors. In the organized
sector of capital market demand for long-term capital comes from corporate institutions. The sources of
supply of funds comprise individual investors, corporate and institutional investors, investment intermediaries,
financial institutions, commercial banks and government.
In India, even the organized sector of capital market was ill developed till recently because of the
following reasons:
Agriculture was the main occupation which did not lend itself to the floatation of securities
The foreign business houses hampered the growth of securities market.
Managing agency system also accounted for ill-development of capital market as managing
agents performed both activities of promotion and marketing securities.
The investment habit of individuals.
Restrictions imposed on the investment pattern of various financial institutions.
The unorganized sector of the capital market consists of indigenous bankers and private money-
lenders. The main demand in the unorganized capital market comes from the agriculturists, private
individuals for consumption rather than production and even small traders.
There are three main components of the capital market. These are (a) New issues market (b)
Stock market and (c) Financial institutions. The new issue market represents the primary market where
new securities, i.e., shares or bonds that have never been previously issued, are offered. Both the new
companies and the existing ones can raise capital on the new issue market. Stock market represents the
secondary market where existing securities (shares and debentures) are traded,. Stock exchange provides
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an organized mechanism for purchase and sale of existing securities. By now, we have 23 stock exchange
in our country.
Financial institutions are the most active constituent of the Indian capital market. Such
organizations provide medium and long-term loans on easy installments to big business houses. Such
institutions help in promoting new companies; expansion and development of existing companies and
meting the financial requirement of companies during economic depression.
The need for establishing financial institutions was felt in many countries immediately after the
second World War in order to re-establish their war shattered economies. In underdeveloped countries,
the need for such institutions was much more due to large number of organizational and financial problems
inherent in the process of industrialization.
The main special institutions that are most active constituents of the Indian Capital Market are:
The Industrial Finance Corporation of India (IFCI), State Financial Development Corporations (SFCs),
Unit Trust of India (UTI), Life Insurance Corporation of India (LIC) etc.
Commercial banks are also important constituents of capital market but their operations in India have
been mainly limited to the purchase and sale of government securities. However, in recent years,
commercial banks have also been increasingly participating in term lending through subscribing to the
shares and debentures of special financial institutions. Many commercial banks have also set up separate
merchant banking divisions and their financial subsidiaries to provide a variety of financial services.
20.3 PRIMARY AND SECONDARY MARKETS:
Capital markets could be broadly classified into primary and secondary markets. Primary markets
are those in which new debt/share capital is raised directly from the public/banks/institutions. Secondary
markets, on the other hand, refer to the stock exchanges, where shares and debt instruments are actively
traded.
1. Primary or New issue market:
Primary market is generally referred to the market of new issues. Primary market operations include
new issues of shares by new and existing companies, right issues to existing shareholders, public
offers and issue of debt instruments such as debentures, bonds etc. There is no element of trading in
primary market operations and investors apply through applications and subscribe directly to equity
or debt of a company. The investors benefit by way of dividend and or capital appreciation.
The following are the market intermediaries associated with the primary market:
1) Merchant banker
2) Registrar to the issue
3) Underwriter broker to the issue
4) Adviser to the issue
It is through these agencies that a company reaches its prospective investors. SEBI plays a crucial
role in regulation of primary market. There has been tremendous growth in the sphere of new issue
activity in India in the 1980s and 1990s. The total amount of capital raised during 1961 was only Rs. 74.0
crores which increased to Rs. 87.7 crores during 1971 and to Rs.301.1 crore during 1981. Subsequently
the liberalization of industrial and new capital issue policies in 1984-85 gave a real shot in the arm to the
securities market. Further the relaxation of norms relating to foreign investments and incentives provided
by the government helped to sustain the impetus of growth in the market.
A number of new instruments have been introduced in the securities market resulting into and
upsurge in the new issue market. The (Harshad Mehta) securities scam during 1991 caused a temporary
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set back to the growing new issue market in India. But the 1991 new economic policy and the setting up
of Securities and Exchange Board of India to promote investor protection the setting up of the Over-the
Counter Exchange of Indian (OTCEI) which began its operations in 1991 permitting smaller companies
to raise capital, gave a boost. During the year 1993, there has been a tremendous growth in the new
issue activity resulting into Rs. 19,825 crores of capital raised by non-government public limited companies
in India.
In 1994-95 and 1995-96, the new issues market remained subdued due to number of reasons,
including political uncertainty. The downward trend in primary markets continued in the year 1996-97.
The capital raised through new issues during the period of April to December 1996, was down to Rs.
10,369.21 crore from Rs. 14,151.1 crore raised in the corresponding period of the previous year. The
down trend in the capital market continued in 1997-98 also despite the fact that SEBI took a number of
measures designed to boost investor confidence. The primary market remained depressed with substantial
decline in number of issues and amount raised. Capital raised through new issues during 1997-98 registered
a steep decline to Rs. 4,570 crore from Rs. 14,276 crore in 1996-97. The number of issues also fell
substantially to 141 in 1997-98 from 882 in 1996-97 and 1726 in 1995-96.
Most of the resources mobilization from primary market in 1999-2000 has been by the private
sector. A number of initiatives were taken of further rationalize the Initial Public Offer (IPO) norms
during the year 2000-2001. Despite these initiatives, the year witnessed a noticeable decline in resource
mobilization from the primary market. During April-December, 2000, 2000, resource mobilization through
public and rights issues registered a significant decline by 25.9 per cent to Rs. 4,240 crore through 124
issues from Rs. 5,723 crore through 60 issues during the corresponding period of 1999-2000.
The downtrend continued in 2001-2002 and 2003. But the volume of public issues rose by
roughly five times to a level of Rs. 35,859 crore in 2004. Out of which equity issuance amounted to Rs.
33,475 crore. It was the highest ever level of public equity issuance in India’s history. A major development
in the Indian primary market has been the introduction of “Screen based book building”. In 2005, Rs.
30,325 crore of resources were raised on the primary market of which Rs. 9,918 crore were made up by
55 companies which were listed for the first time (IPOs). The primary capital market has remained
upbeat during the year 2006-07. But later on due to Global financial crisis the primary market experienced
shocks of decline.
2. Secondary Market :
It is a market place which provides liquidity to the scrips already issued in the primary market.
Thus, the growth of secondary market is dependent upon primary market. More the number of companies
entering the primary market, the greater is the volume of trade at the secondary market. Trading activities
in the secondary market are done through recognized stock-exchanges which are 23 in number including
over the counter exchange of India and National Stock Exchange of India and National Stock exchange
of India.
Secondary market operations involve buying and selling of securities on the stock exchanges
though its members. The companies hitting the primary market are mandatorily required to list their
shares on one or more stock exchanges in India including a regional Stock Exchange. Listing of scrips
provides liquidity and offers an opportunity to the investors to buy or sell the scrips. The following
intermediaries are involved in secondary market. 1) Broker member of Stock Exchange-Buyers broker
and seller’s broker. 2) Portfolio manager, 3) Investment adviser, 4) Transfer agent. SEBI issues several
guidelines on the regulation of secondary market, conduct and registration of brokers and portfolio
managers.
SEBI has taken several measures to control and regulate the secondary market in India. These
are expansion of stock exchanges and their integration, improvement in trading system and settlement
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procedures, registration of brokers and sub-brokers, prohibition on insider trading, bringing greater
transparency in trading activities, eligibility norms etc. Over the Counter Exchange of India (OTCEI)
and National Stock Exchange (NSC) are other two important land marks in Indian Stock Market.
Stock Exchanges –the all of secondary market in capital market
The Stock Exchange is an organized market for purchase and sale of listed industrial and financial
securities. The securities, traded on stock exchanges include shares and debentures of public limits
companies, Government securities, etc. According to the Securities, contracts (Regulation) Act, 1956,
“Stock Exchange is an association, organization or body of individual, whether incorporated or not,
established for the purpose of assisting, regulating and controlling business in buying selling and dealing
securities. Stock market refers to the market provided by different stock exchanges to the securities
which include share, debenture, bond and other government securities admitted to dealings at competitive
open prices.
Though the unorganized stock market existed in Calcutta since 1830, the first organized stock
exchange was set up at Bombay in 1877 under the name of ‘Native stock and Share Brokers Association’.
The next stock exchange which emerged in the country was ‘Ahmedabad Share and Stock Brokers
Association’ which was founded in 1894. The third stock exchange was set up at Calcutta in the year
1908.
There are 23 recognized stock exchanges in India. In terms of legal structure, the stock exchanges
in India could be segregated into two broad groups – nineteen stock exchanges which were set up as
companies, and the 3 stock exchanges which were Associations of Persons (AOPs), viz., Bombay Stock
Exchange (BSE), Ahmedabad Stock Exchange (ASE) and Madhya Pradesh Stock Exchange (MPSE).
The nineteen stock exchanges which have been functioning as companies include: the Stock Exchanges
of Bangalore, Bhubaneswar, Calcutta, Cochin, Coimbatore, Delhi, Guwahati, Hyderabad, Interconnected
SE, Jaipur, Ludhiana, Madras, Magadh, Pune, Saurashtra, Kutch, Uttar Pradesh, Vadodara, National
Stock Exchange (NSE) and Over the Counter Exchange of India (OTCEI). Apart from NSE, all stock
exchanges, whether established as corporate bodies or as AOPs, were non-profit making organizations.
Differences between Primary Market and Secondary Market

PRIMARY MARKET SECONDARY MARKET

1. Primary market is known as new issue Market Secondary market is known as stock exchange
2. Every new issue is a separate process Stock exchanges if once they are
and ends with allotment established, work continuously.
3. Primary market deals with new securities Secondary market deals with securities which have
been issued Previously
4. It contributes additional funds to the Corporate sector does not get any additional funds
Corporate sector through secondary market
5. New issue market is wide spread and it It is located in a particular area and a building.
does not belong to a particular area. Example: Bombay Stock exchange, Dalal street
6. Prices of securities fixed by the company Prices are fixed on the basis of
at par or with premium; on the basis of its market forces.
goodwill and credit rating
7. To go for new issue company should get Only when stock exchange accepts to list the shares
Approval of SEBI of a particular Company, they can be trades in
Stock exchange
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20.4 CAPITAL MARKET REFORMS IN INDIA:
20.4.1 Introduction: The number of stock exchanges increased from 8 to 18 by the end of 1991, the
number of active stock brokers surged to about 3000 at present from about 1250 a decade ago and the
number of listed companies increased from 4744 in 1986 to 6500 in 1991. Further, the number of
shareholders has also risen sharply from about 10 lakhs to about 120 lakhs during the 1980-1991, catapulting
the nation to the third largest shareholding population nation in the world; next only to US and Japan.
Such a spectacular growth of the stock market during the last decade is tribute to the entrepreneurial
class availing of funds provided by the market in one hand and emergence of a growing community of
investors willing to take direct investment risk in exchange of a prospect of higher earnings on the other.
However, the Capital Market is unable to serve the investors to their satisfaction. This is because
of the problems or weaknesses inherent in the capital market in general and the stock market is particular.
Some of the important problems then existing are discussed below.
20.4.2 Problems of Capital/Stock Market:
The Indian Stock Markets have not been able to develop the requisite degree of liquidity in all the
listed securities. In this context, the Pherwani Committee (1991) adversely commented on the
poor liquidity of both equity and debenture scrips.
Lack of transparency of transactions is another major shortcoming of stock market in India. An
investor is hardly allowed to know the actual rate of transaction without indicating the quantum
of brokerage.
Longer settlement period poses another serious problem to the investors. An investor who has
sold shares through his broker used to get payment only after four to five weeks.
Another problem that the small investors face relates to odd lot holding of shares. The problems
in disposing of the odd lots holding are many. Moreover, the odd lots are traded only once in a
week and not much attention is given to their disposal or buying.
One of the inter-market trading problems faced by the investors is the mismatch between primary
market development and secondary market trading arrangements. While the primary market is
nation wide, the secondary market arrangements have remained localized and fragmented.
Equally problematic practice during last few years is associated with delaying not only allotments
but subsequently not returning shares lodged with them.
Certain companies also follow deceptive process to manipulate share prices.
Another disconcerting development observed is the deceptive publicity made by the underwriters,
merchant bankers, and others in making tall claims regarding the performance of the company
not mentioned in the prospectus.
The practice of insider trading against the interests of the ordinary investors.
20.4.3 Capital Market Reform Measures
The Government has initiated reforms in economic financial and trade policies in 1991. Privatization,
liberalization and globalization stand the spirit of the Indian Economic policy. Perwani Committee suggested
the reforms of Indian Capital Market to be in tune with economic reforms, privatization and globalization.
A well organized and well regulated capital market facilitates sustainable development of the
economy by providing long term funds in exchange for financial assets to investors. Indian capital
market is one of the oldest and largest capital markets of the world. A package of reforms consisting of
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measures to liberalize, regulate and develop the securities market is being implemented since early 1990s.
This is to mitigate the problems and strengthen the capital market innovative initiatives like establishment
of SEBI, screen-based trading and establishment of I.T backed NSE, depository services, rolling
settlements, internet trading and derivatives trading are some of the reform measures.
The reform measures or important development in the Indian Capital Market as announced by
the Government of India are as follows:
Reform Measures from 1991-1996:
Setting up Securities and Exchange Board of India (SEBI) with autonomous power as a regulatory
authority over various constituents of the capital market.
Launching of Over the Counter Exchange of India (OTCEI) a second-tier bourse permitting smaller
companies to raise funds.
Comptroller of Capital Issues (CCI) abolished and free pricing introduced.
Insider trading made an offence.
Guidelines for disclosures and investor’s protection issued.
New guidelines issued for preferential offers, rights and bonus shares.
Minimum subscription for public issue has been raised.
Proportionate allotment of shares for all public issues cleared by SEBI after January 1, 1994 has
been made mandatory.
Capital adequacy norms for brokers announced: For brokers belonging to BSE and CSE minimum
deposit required is Rs. 5 lakhs each, for Delhi and Ahmedabad Rs. 3.5 lakhs etc; for remaining
stock exchanges Rs. 2 lakh each.
Rules relating to portfolio managers and mutual funds announced. A number of private sector
mutual funds launched schemes to mobilize funds for investment.
Relaxation in the provisions of Foreign Exchange Regulation Act, 1973 (FERA) and MRTP Act,
1969.
National Stock Exchange (NSE) began on line scrip less trading in India.
Abolition of licensing system.
Promoters required to subscribe to at least 25 per cent of the equity in each class of instrument
when more than one instruments is offered to the public.
Clearance for financial institutions and banks for their capital issues has been made mandatory.
Full convertibility of rupee on trade as well as on current account announced.
Foreign Equity Investments of Multi-National Corporations (MNCs) increased to 51 per cent of
equity capital in their subsidiary companies in India.
Reform Measures from April 1996 to March 2002:
The process of capital market reforms was carried forward during 1996-2002. A number of
reforms, both in the primary as well as secondary markets for equity, debt and foreign institutional
investment were made. The following are some of the important reforms made during this period:
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 The Depositories Act, 1996 was enacted in July 1996 and SEBI (Depositories and Participants)
Regulations, 1996 notified.
To provide greater flexibility, SEBI gave up vetting of public issue documents.
To encourage the development of debt market, debt issues not accompanied by an equity component
permitted to be sold entirely by the ‘book-building’ process subject to Section 19(2) (b) of the
Securities Contracts (Regulation) Rules.
Uniform good-bad delivery norms and procedure for time bound resolution of bad deliveries, through
bad Delivery cells, prescribed.
Several restrictions including limits on the size of issues proposed to be listed on OTCEI removed,
and listing criteria for OTCEI relaxed.
The promoter’s contribution for public issues has been made uniform at 20 per cent irrespective of
the issue size.
The SEBI (Registrars to an Issue and Share transfer Agents) Rules and Regulations, 1993 have
been amended to provide for an arm’s length relationship between the Issuer and the registrar.
Only body corporate are now allowed to act as merchant bankers.
SEBI regulations enabling companies to buy-back their shares have been framed.
Introduction of rolling settlement in respect of demat securities.
Compulsory trading of shares in dematerialized form in specified scrips by institutional investors.
Companies have been given freedom to determine the par value of shares issued by them.
Insurance Regulatory and Development Authority (IRDA) Bill passed by Parliament in December,
1999.
SEBI accepted a system envisaging the use of existing infrastructure of stock exchanges for
marketing initial public offers (IPOs).
Investors can now place buy/sell orders through the internet.
The SEBI Committee on Venture Capital, set up in July 1999, examined the impediments to the
growth of Venture Capital Funds and suggested several measures to facilitate the growth of venture
capital Activity in India.
Introduction of derivatives trading in June 2000.
Compulsory trading of shares of all companies listed in stock exchanges in demat form with effect
from 2nd January 2002.
Notification about the establishment of the Investor Education and protection Fund with effect
from October 1, 2002.
20.5 SUMMARY:
Capital market is the market for financial assets that have long or indefinite maturity. It is an
arrangement of institutions that provide long term capital. Capital market can be divided into two parts:
one, covering the market for corporate securities and the other, covering the market for gilt-edged securities
(securities issued by the Central Government, State Governments and Quasi-Government bodies). Capital
market may also be divided into two segments: i) The Primary market ii) The Secondary market. New
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issues are made in the primary market, outstanding issued are traded in the secondary market. When a
company wishes to raise capital by issuing securities, it goes to the primary market and raises long term
funds by issuing financial securities. The primary market facilitates the formation of capital. There are
three ways in which a company may raise capital in the primary market: public issue, rights issue and
private placement. Public issue involves sale of securities to members of the public. Rights issue is a
method of raising further capital from existing shareholders. Private placement is the method of selling
securities privately to a selective group of investors. The secondary market consists of the Stock Exchanges
and OTC Exchange of India. SEBI has been empowered to oversee the functioning of the securities
market and the operations of the intermediaries.
20.6 SELF ASSESSMENT QUESTIONS AND SHORT NOTES:
1. Define Capital Market. Explain the composition and constituents of the Capital Market.
2. What is Primary Market? Give an account of the growth trends in Indian Primary Market.
3. Critically explain the Capital Market Reforms in India.
4. What are NBFCs? Explain the role of NBFCs in capital market.
Short Notes:
1. Primary or New Issues Market 2. Stock Exchanges
20.7 SUGGESTED READINGS:
1. L.M. Bhole., Financial Institutions and Markets, Tata Mc Graw Hill, New Delhi
2. M.Y. Khan, Indian Financial System, Tata Mc Graw Hill, New Delhi
3. Shashi K. Gupta and Agarwal, Financial Services, Kalyani publishers, Ludhiana
4. Rao, K.C., Indian Capital Market, APH publishing company, New Delhi.
20.8 KEY TERMS:
Initial Public Offer (IPO): where a company goes for Public Issue of shares and securities for the first
time.
Rights Issue: Issuing or selling additional shares to existing share holders.
Seasoned Equity Offerings (SEO): Selling of Shares to the public by a listed company.
Placement through Private Route: This is also known as preferential issue. A mechanism, where the
shares and securities can be placed with a few wholesale buyers of securities without incurring the
overheads of the public issue.
Screen based book building: Securities are auctioned through an anonymous screen based system and
the price at which securities are sold is discovered on the screen. This eliminates the delays, risks and
implementation difficulties associated with traditional procedures.
Insider Trading: It is a trading in security or commodity on the basis of inside information i.e., information
about the organization which is available to the people belonging to that organization.
Full Convertibility: Full involves removing most of the exchange and trade controls, refers to the
freedom to convert local financial assets into foreign financial assets and vice versa at market, determined
rates of exchange and allowing free competitive price mechanism to work in international trade and
finance.
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Offer for sale: In the primary market under offer for sale method the company sells the entire issue of
shares through intermediary agency of issue or merchant banker to the public.
Book Building: Book building is a process of fixing price for an issue of securities on a feedback from
potential investors based upon their perception about a company. It involves selling an issue step-wise to
investors at an acceptable price with the help of a few intermediaries/merchant bankers who are called
book-runners. Under book-building process, the issue price is not determined in advance.
Scrip: It is a document or certificate like share certificate which shows that the holder has subscribed
money to a company and which entitles him to receive dividends.
Rolling Settlement: It is a settlement of trade or transaction in which trades executed during a day are
settled on a daily basis.
Dematerialization (Demat): A process by which the physical share certificates of an investor are taken
back by the company or registrar to the issue and actually destroyed. The securities are credited in the
electronic form in the electronic holdings of that investor.
Listing of securities: Means permission to quote shares and debentures officially on the trading floor
of the stock exchange.
Financial Intermediaries: Financial intermediaries intermediate between savers and investors. They
lend money as well as mobilize savings.

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 Lesson No: 21

NBFC AND STOCK EXCHANGE

STRUCTURE:
21.1 Introduction
21.2 NBFC – Meaning
21.3 Stock Exchange- Meaning And Stock Exchange Inindia
21.4 Functions Of Stock Exchanges
21.5 On Line Trading
21.6 National Sock Exchange (Nse)
21.7 Summary
21.8 Self Assessment Questions
21.9 Suggested Readings
21.10 Key Terms

OBJECTIVE:
The guideline is designed to enable you understand
1. The concept of Non-Banking Financial Company (NBFC) and Stock Exchange
2. Online trading and the dimensions of National Stock Exchange
21.1 INTRODUCTION:
NBFCs are a group of financial institutions other than commercial and co-operative banks. These
companies raise deposits and in a way compete with commercial banking sector. Non-Banking Finance
Companies (NBFCs) are an integral part of the financial sector. These are more active in developed
countries. It has been observed by the World Development Report of 1989 has brought out that banks
in developing countries hold a bigger share of all financial assets (48%) than they do industrialized
countries (37%),
21.2 NBFC – MEANING:
In order to identify a non-banking finance company, the RBI considers both the assets and the
income pattern as evidenced from the last audited balance sheet of the company.
A company will be treated as NBFC if its financial assets are more than 50% of its total assets
(netted off by intangible assets) and income from financial assets should be more than 50 of the gross
income. Any company which carries on the business of an NBFC as its principal business as defined u/
s 451C read with section 451F of RBI Act 1934 is to be treated as an NBFC.

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 Any company which carries on the principal business of agricultural activities, industrial activities,
trading in commodities, dealing in immovable properties etc., is not a financial institution. Since the term
principal business has not been defined in law, RBI has decided the description of principal business for
the purpose of identification of an NBFC. An NBFC requires compulsory registration with the apex
bank to commence or carry on the financial business.
21.3 STOCK EXCHANGE – MEANING AND STOCK EXCHANGES IN INDIA:
Stock Exchanges are the most perfect type of market for securities whether of government and
semi-government bodies or other public bodies as also for shares and debentures issued by the joint-
stock companies. In the stock market, purchase and sales of shares and debentures are issued by the
joint-stock companies. In the stock market, purchase and sales of shares are making in conditions of
free competition. Government securities are traded out side the trading ring in the form of over the
counter sales or purchase. The bargains that are struck in the grading ring by the member of the stock
exchanges are at the fairest prices determined by the basic laws of supply and demand.
The stock exchange is an organized market for purchase and sale of listed industrial and financial
securities. The securities, traded on stock exchanges include shares and debentures of public limited
companies, Government securities, etc. According to the Securities, Contract s (Regulation) Act, 1956,
“Stock Exchange is an association, organization or body of individual whether incorporated or not,
established for the purpose of assisting, regulating and controlling business in buying selling and dealing
securities are at Coimbatore and Meerut. A stock exchange has also been set up at Gangtok, Sikkim
early in 1986.
The recognition accorded to stock exchanges is normally valid for a period of 5 years or a
shorter period as prescribed. It is renewed after the expiry of the period, subject to a satisfactory
performance of the exchange during this period. The stock exchanges located at Mumbai, Kolkatta,
Chennai, Ahmedabad, Delhi, Hyderabad, Madhya Pradesh and Bangalore have been granted permanent
recognition. The Bombay Stock Exchange is the principal stock exchange in the country accounting for
nearly 70 per cent of the aggregate market capitalization of the listed companies.
The stock exchanges operate under the rules, bye-laws and regulations duly approved by
government and constitute an organized market for securities. The Indian Stock Exchanges are regulated
by the Ministry of Finance, the Securities and Exchange Board of India (SEBI) and the Governing
Boards of the Stock Exchanges within the legal frame work provided by the Securities Contracts
(Regulation) Act, 1956 and the Securities and Exchange Board of India Act 1992.
21.4 FUNCTIONS OF STOCK EXCHANGES:
A stock market is a place where securities (shares, debentures and bonds) of various a types are
openly traded and where one can purchase and sell securities easily. These securities are infecting
documentary evidence of ownership to claim upon the assets of the issuing company. These securities
are also not fixed in value which is determined at the time of their buying and selling. A stock market is
a place where enormous capital is raised which is generally required to operate the industrial and commercial
enterprises of a country. it provides important unity for trading in newly issued securities and facilitate
capital mobilization. It provides ready market and liquidity to the various types of securities listed thereon.
The stock market also ensures efficient allocation of available capital resources to the diverse
users in the economy. It also acts as a barometer which can easily measure and detect the incipient
symptoms of an economic boom or decline well in advance before such an eventually actually occurs.
The important characteristic of price movement in securities provides this coverage to the stock market.
For an individual investor, stock exchange is a place where money can be made or lost very quickly.

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 Therefore, the role of stock exchange in India cannot be over-emphasized. It provides a well
regulated market and mechanism for dealing in shares, stocks, debentures, bonds and gilt-edged securities.
The stock exchanges play a very important role in the following ways.
21.5 ON LINE TRADING:
On line trading is fully automated screen based trading conforming to the international standards,
the screen based on-line trading involves no trading floors nor dealers use the telephone to arrange
money market deals. The on line trading operates with all market participants stationed at their offices
and making use of computer terminals to enter orders, to receive the current market status, the trades
executed and other market related information. The system provides complete transparency of operations.
21.6 NATIONAL STOCK EXCHANGE (NSE):
In the fast-changing economic scenario, a need was felt for a countrywide screen-based on-line
trading bourse conforming to international standards. It was the high-powered committee, on the
establishment of new stock exchanges, headed by the former UTI Chairman, M J Pherwani that first
mooted the idea of a National Stock Exchange in June 1991. The recommendation of the Committee
was in the backdrop of fragmented secondary markets in the country operating through distantly located
monopolistic exchanges.
The National Stock Exchange of India was incorporated in November, 1992 with an equity capital
of Rs. 25 crores and promoted among others by IDBI, ICICI, LIC, GIC and its subsidiaries, commercial
banks including State Bank of India and other institutions including SBI Capital Market Limited.
The establishment of the National Stock Exchange of India Limited (NSE) was a step towards
professionalisation of the capital market as also to provide nationwide securities trading facilities to
investors. Providing trading facilities for investors and bringing Indian financial markets inline with
international markets was another reason to set up the NSE.
MAIN OBJECTIVES OF NSE:
a) To establish a nationwide trading facility for equities, debt instruments and hybrids.
b) To ensure equal access to investors all over the country through an appropriate communication
network.
c) To provide a fair, efficient and transparent securities market to investors using electronic trading
system.
d) To enable shorter settlement system.
e) To meet the current international standards of securities markets.
The NSE is a stock exchange with a difference. Besides the traditional retail market for equities,
debentures, etc., traded under the capital market, the NSE is operating for the first time in the country,
screen-based trading facility for the Wholesale Debt Market (WDM). WDM is a facility for institutions
and bodies corporate to enter into high-value transactions in instruments such an government securities,
treasury bills, public sector units bonds, commercial papers, certificates of deposit, etc., On the EDM
segment, there are two types of entities, viz., Trading members and Participants.
The NSE market is a fully-automated screen-based trading system. There is no trading floor as is
prevalent in the traditional stock exchanges, nor do dealers use the telephone to arrange money market
deals. Rather, the market operates with all market participants stationed at their offices and making use
of computer terminals, to enter orders, to receive the current market status, the trades executed and
other market-related information.
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 The identity of the Trading Member placing the order is not disclosed in the NSE computer
trading system. By enabling Trading members and participants to hide their identity, it allows placing
large orders into the system by the big players, without fear of large orders influencing the price of the
market.
The system provides complete transparency of trading operations. Investors can see prices of
traded securities and know whether their orders have been placed into the system, the rate at which their
deal has taken place, the counterparty and the time at which the trade was executed.
For a member (only corporate) on NSE it is required that it should have minimum net worth of Rs.
10 crores and minimum market capitalization of Rs. 50 crores. It has two kinds of trading members to
participating trading members, who trade only on their own behalf and intermediary trading members
who trade on behalf of their clients.
At NSE three kinds of margins are imposed ie., daily margins, margins which depend on market
fluctuations and Adhoc margins, which are adjusted against the exposure of the members.
It has three mutually exclusive segments comprising of wholesale debt market, capital market and
futures and options trading. Debt market was activated in early 1994 and the share trading on November
3, 1994.
BENEFITS OF NSE:
TO TRADING MEMBERS
• They can provide efficient service to their clients.
• Their back office load is reduced considerably as the system generates details of trade undertaken.
• There will be no need to occupy office premises near the Exchange unlike at present, and thus
can lead to reduced establishment cost.
• The system will assure ‘best price’ to participants in the market.
• Settlement will be quick and efficient.
TO INVESTORS
• The investor is assured of the best price in the market.
• Price and brokerage are separately shown on contract notes.
• Date and time of trade are indicated.
• The system is better monitored and regulated ensuring a fair deal to investors.
• Safely of securities is enhanced in a depository and there will be no problems of bad delivery,
loss, theft or forgery.
TO ISSUERS
• By a single listing they can provide nationwide access to their investors.
• As a result their listing costs are reduced considerably.
• Issues will have high visibility.

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 The general trend all over the world has been the merger of stock exchanges and reduction in
their numbers. The rapid strides in communication technology have obviated the need to set up several
city-based exchanges.
The establishment of the NSE in India is thus a step in the right direction. The NSE has been
consciously encouraging multiple memberships in order to give access to members of the other stock
exchanges to the NSE market. Gradually, with its reach spreading, the national network could thus
effectively integrate the markets in the country.
21.7 SUMMARY:
Financial institutions are business organizations that act as mobilizes and depositories of savings,
and as purveyors of credit or finance. They also provide various financial services to the community.
Financial institutions are classified into Banking and Non-Banking Financial institutions, LIC, UTI, and
IDBI are the examples of NBFCs.
Stock Exchange is an integral part of the capital market. Stock Exchange is a market where
stocks, shares and other securities are bought and sold. There are 23 recognized stock exchanges in the
country.
Marketing of securities on the stock market can be done only through members of the stock
exchange. The trading is done on the floor of the house and involves floor brokers, dealers etc. To
encourage stock exchange reforms and to provide nationwide stock trading facilities and also electronic
clearing and settlements, the National Stock Exchange was set up in 1993. The NSE is expected to
serve as a model exchange for online trading.
21.8 SELF ASSESSMENT QUESTIONS:
1. Explain NBFC and the functions of NBFC.
2. Define stock exchange. Explain the functions of Stock Exchange.
3. Explain the objective, constitution of functioning of National Stock Exchange of India.
Short Notes:
NBFC
Online Trading
21.9 SUGGESTED READINGS:
1. Gordon, E and Natarajan. K. Financial Markets & Services, Himalaya Publishing House, Mumbai.
2. L.M. Bhole, Financial Institutions and Markets, Tata Mc Graw Hill, New Delhi.
3. M.V. Khan, Indian Financial System, Tata Mc Graw Hill, New Delhi.
21.10 KEY WORDS:
Hybrid securities: Securities with mixed characteristics of Equity and debt.

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 Lesson No: 22

FINANCIAL INTEMEDIARIES AND SERVICES

STRUCTURE :
22.1 Financial Intermediaries – Meaning
22.2 Economice Basis Of Financial Intermediation
22.3 Advantages Or Services Of Financial Intermediaries
22.4 Concept And Scope Of Financial Services
22.5 Summary
22.6 Self-assessment Questions
22.7 Suggested Readings
22.8 Key Terms

OBJECTIVE:
A thorough reading of the lesson helps you understand explain
a) the meaning of financial intermediaries and services
b) the economic basis of financial intermediation
c) services rendered or advantages of FIs, to the lenders and borrowers
d) the concept And Scope of Financial Services
22.1 FINANCIAL INTERMEDIARIES – MEANING:
Financial Intermediaries (FIs) are institutions or firms that mediate or stand between ultimate
lender and ultimate borrowers or between those with budget surpluses and those who wish to run budget
deficits. The examples are banks, insurance companies, provident funds, etc. The central function of all
FIs is to collect surplus (savings) and to lend them on to deficit spenders.
The FIs are leaders in securities.What they buy are primary securities; what they sell are
secondary securities. By absorbing primary securities in their asset portfolios and producing securities to
finance them, they virtually transmute primary securities into secondary securities. The essence and the
success of financial intermediation lie in this asset transformation. They alone are able o produce securities
that are, in general, far more acceptable to surplus units. There are broadly two types of financial
intermediaries. These are 1.Banking Financial Intermediaries and 2. Non-Banking Financial Intermediaries.
Non- banking financial intermediaries are a group of financial institutions other than commercial and
cooperative banks.
22.2 ECONOMIC BASIS OF FINANCIAL INTERMEDIATION:
The true economic basis of financial intermediation lies in the economies of scale in portfolio
management and in the law of large numbers. This is explained below

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1 Law of large numbers: Banks, insurance companies unit trusts, and all other FIs operate on the
assumption, supported by statistical law if large numbers, that not all the creditors will put forward their
claims for cash at the same time. Add to this the facts that if some creditors are withdrawing cash, some
other (whether old or new) are paying in cash. Besides, FIs receive regularly interest payments on loans
and investments made and repayments of loans due. Fortified by this knowledge, banks keep in cash
only a small fraction of even their demand liabilities and invest or lend the rest. for the same reason, unit
trusts can also afford to keep most of their funds (liabilities) invested in securities and yet offer to buy
back all the units the unit holders like to sell at any time. Life insurance companies also operate on the
actuarial fact that a determinable fraction of lives insured will actually expire in a normal year, so that
they need to keep only an estimated fraction of their total life funds in cash and near-cash and the rest of
them can be invested to long-term basis. Thus FIs can afford to manufacture liabilities (secondary
securities) that are far more liquid than the primary securities they buy as earning assets.
2. Economies of Scale in portfolio Management; The average size of the asset portfolios of banks,
insurance companies and other organized-sector FIs is quite large in value. So, there FIs can reap
several economies of scale in portfolio management, which improve significantly their net rates of return
from their asset holdings. These economies accrue in the following main forms:
a) Reproduction of risk through portfolio diversification: Lending/investing is always risky. It
carries risk of default and of capital loss on marketable assets. One common way of reducing risk is
through pooling of independent risks by placing funds into diversified portfolio. Thereby what the investor
may lose in a few directions may more than make up in other directions. But for adequate diversification,
the size of the portfolio must be reasonably large; otherwise the cost of portfolio management will become
excessively high. An average wealth owner cannot afford the degree of portfolio diversification and the
resulting reduction of risk an average FI can. Then a large FI can schedule maturities of its loans to
match anticipated outflows and thereby safeguard its liquidity.
b) Professional management: The large size of the asset portfolios to be managed allows FIs to employ
professional managers, who are well-versed in the complexities of modern finance, in monitoring their
loans and investments, in analyzing consequences of market and other developments of the health of
their businesses. Individual wealth owners cannot afford the cost of professional management and other
support staff. They do not in general have the expertise, time, or even the desire to manage financial
asset portfolios comprising of primary securities.
c) Indivisibilities and market imperfections: Some loans and investments are of very large size
individually. An average household wealth-owner cannot handle them. In certain cases even FIs have to
come together in consortia, pool their resources, and spread their risks to finance them. The per rupee
administration cost of large loans borne by FIs is quite low.
In certain cases, such as purchase of treasury bills or placement of call funds, only sums above
a certain minimum amount too large for an average householder are accepted by the borrower to save
transactions costs. Thus, FIs with large asset portfolios can earn interest even on very short-term funds
and construct the maturity structure of their assets as desired. Small asset holders cannot do so.
d) Other cost economies: Because of the large volume of business, the fixed cost of establishment,
cost of information and various transactions costs are lower per unit of transaction to a FI than to an
average household wealth-owner.
22.3 ADVANTAGES OR SERVICES OF FINANCIAL INTERMEDIARIES:
Financial intermediaries are advantageous or render services both to the lenders and borrowers.
Advantages or Services:

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i) To lenders
1. Low risk: Other things being the same, lenders are interested in minimizing all kinds of risk of
capital and interest loss on loans or financial investments they make. These risks may arise in the form
of risk of default or risk of capital loss on stock-market assets. Such risks on secondary securities are far
less than on primary securities for individual lenders.
Government regulation of the organization and working of major FIs help in reducing risks of their
creditors. Any strengthening of the financial system that goes to inspire public confidence in it reduces
further any psychological risk suffered by lenders.
2. Greater Liquidity: FIs offer much greater liquidity on their secondary securities to their
lenders. Units of the UTI can be sold back to it. Savings embodied in life insurance policies are not
equally liquid, but loans can always be arranged against them from banks or the LIC itself. Primary
securities do not carry any of these features, because primary borrowers need funds for agreed periods
to finance their expenditures. FIs can offer much greater liquidity to their creditors, and yet lend on a
much longer term to their debtors.
3. Convenience: secondary securities sold by FIs can be easily bought, held and sold. The
information cost and transaction cost involved are very low. Banks run branches in all urban areas and
several semi-urban and rural areas. The deposits they sell are standardized and information about them
easily available. So the choice about bank deposits, life insurance policies, UTI units is not as difficult as
about corporate equities (primary securities). Much, however, depends on the quality of customer service
provided by the FIs, which in the case of public sector FIs in India is deplorably poor.
This has hampered greatly the growth of financial intermediation in the country.
4. Other Services: each of the FIs specializes in selling special kinds of secondary securities
and other services associated with them. Thus banks specialize in selling deposits with particular features.
In addition, they transfer funds, collect cheques for their clients, offer safe-deposit values and most
important of all, are the dominant lender. All these and several other services attract the public to banks
and induce it to hold deposits with them. The UTI sells units (shares0 of a balanced asset portfolio of
marketable corporate securities to the investing public. The LIC collects long-term savings of the public
by selling life insurance. These other services can be had only when particular kinds of secondary
securities carrying them are bought.
ii) To borrowers
1) FIs have big pools of funds, so that big individual demands for funds can be satisfied only by the
FIs.
2) There is much greater certainty of the availability of funds with the FIs at all times.
3) The rate of interest charged by the FIs is generally lower than that charged by other lenders.
4) Regulated FIs do not fleece small borrowers in the manner money lenders do. On the contrary, as
a matter of official policy, banks and other official lending agencies are required to give small
borrowers preferential treatment both in the grant of credit and in the rate of interest charged by
them.
22.4 CONCEPT AND SCOPE OF FINANCIAL SERVICES:
Financial Services in general refer to the activities of mobilizing savings from surplus units and
allocating the same for various capital requirements. Financial services transform savings into investments.
The activities of financial services are associated with mobilization of savings through various means and
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allocating them to different investment channels. Financial services are also called financial mediation
because they mediate between surplus sector and deficit sector. Banking, Insurance, Merchant Banking,
Mutual Funds etc., are financial services.
The classification of financial services which can be broadly grouped into Banking and Non-
Banking services can be presented as below.
Financial Services

Banking Non-Banking

Long Term Short Term Funded Non-Funded Other

DFIs Commercial Banks |Leasing Merchant Banking MF
|V.C.F.s Insurance
|Loan Syndication
Credit-
Rating
| Factoring
The financial services are supported by a systematic mechanism and other associated services
in the financial system. Financial services are trading with money and money related functions. The
financial system consisting of individuals, institutions or corporate entities is designed to offer finance
related services called financial services. If the mechanism of the financial system works with efficiency,
the financial services offer several advantages. Financial services are significant because (a) they
provide safe and attractive modes of saving and encourage public and firms to save (b) financial services
directly contribute towards capital formation, the most essential economic input in any country (c)
Financial services are responsible to build a strong financial system in the country which is the base for
economic development (d) financial services facilitate development of trade, industry, exports and other
services.
In the environment of liberalisation, privatization and globalization the ambit of financial services
have been increasing with the addition of new and innovative services. These services are increasing in
quantity and quality with increasing number of players and instruments.
22.5 SUMMARY:
The focus of the lesson is financial intermediation and Services. Financial Intermediaries (FIs)
are institutions or firms that mediate or stand between ultimate lender and ultimate borrowers or between
those with budget surpluses and those who wish to run budget deficits. These are 1. Banking Financial
Intermediaries and 2. Non-Banking Financial Intermediaries. Non- banking financial intermediaries are
a group of financial institutions other than commercial and cooperative banks. The true economic basis
of financial intermediation lies in the economies of scale in portfolio management and in the law of large
numbers. Financial intermediaries are advantageous or render services both to the lenders and borrowers.
Financial Services in general refer to the activities of mobilizing savings from surplus units and allocating
the same for various capital requirements. Banking, Insurance, Merchant Banking, Mutual Funds etc.,
are financial services.

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22.6 SELF-ASSESSMENT QUESTIONS:
1. What are Financial Intermediaries? Explain the economic basis of financial Intermediation.
2. Give an account of the Advantages or Services rendered by Financial Intermediaries.
3. Short Notes:
(a) Financial intermediation
(b) Financial Services
22.7 SUGGESTED READINGS:
1. L.M. Bhole (2004), Financial Institutions and Markets, Tata Mc Graw Hill, New Delhi
2. Khan M.Y., Indian Financial system, Tata Mc Graw Hill, New Delhi
3. Machiraju H.., Indian Financial system, Vikas publishing House, New Delhi
4. Srivastava, R.M. & Nigam Divya, Management of Indian Financial Institutions, Himalaya publishing
House, Mumbai.
22.8 KEY TERMS:
Leasing: A contractual agreement whereby the lessor grants the lessee the right to use his Asset for a
fixed period in return for the periodic rentals (lease).
Factoring: The selling of a company’s accounts receivable, at a discount, to a factor who then assumes
credit risk and receives cash as the debtors settle their accounts. This helps liquidity of the selling entity.

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 Lesson No: 23

MERCHANT BANKERS AND MUTUAL FUNDS

STRUCTURE:
23.1 Merchant Banker – The Meaning
23.2 Banker And Merchant Banker
23.3 Spectrum Of Merchant Banking Services
23.4 Mutual Fund – The Concept
23.5 Constitution And Management Of Mutual Fund
23.6 Types Of Mutual Funds
23.7 Summary
23.8 Self-assessment Questions
23.9 Suggested Readings
23.10 Key Terms

OBJECTIVE:
A study of this Guideline help you understand. 1. The merchant Bankers and their services and 2.
The Mutual Funds and types of Mutual Funds
23.1 MERCHANT BANKER – THE MEANING:
Merchant banking stands for providing various service relating to capital market and finance to
corporate sector. This includes not only the activities for the above purpose in the country but at times
arranging funds from outside the country. In India the merchant banking business started in the year
1967, when Grind lays Bank established their Merchant Banking Division.
The Merchant Bankers also provide consultancy to the corporate sector on the issues like finance,
capital structure and investment, mergers, takeover and amalgamation, establishing coordination between
the government and the corporate sector.
In fact the merchant banker should be able to provide guidance to entrepreneurs on all matters
from the stage of conception of a project in his mind till it goes into commercial production. As per
Securities and Exchange Board of India(SEBI) rules, a merchant banker means any person who is
engaged in the business of issue management either by making arrangement regarding selling, buying or
subscribing to securities or acting as manager, consultant or rendering corporate advisory services in
relation to such issues. This SEBI definition however is for a limited purpose.
Whenever a business concern needs funds from the capital market it would usually approach the
Merchant Banker rather than banks or financial institutions.

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23.2 BANKER AND MERCHANT BANKER:
A Banker has funds with him which he mobilizes through deposits and borrowing or other ways
and then deploys or lends these funds, whereas a merchant banker does not have any fund in his own
kitty but he has the expertise and access to various sources of funds as per needs of the client.
The bankers find merchant banking activity to be highly remunerative because of:
- Deposits on short term basis.
- The business helps to improve their profits and profitability.
- The business also helps to get good corporate clients.
They are extending the merchant banking services through: (a) Merchant Banking Divisions
established by them, (b) Merchant Banking subsidiaries established by them.
23.3 SPECTRUM OF MERCHANT BANKING SERVICES:
* Project counseling
* Loan syndications
* Technology tie-ups
* Raising of funds from capital market
* Raising of funds through new instruments
* Portfolio management Mutual funds
* Bought-out deals
* Rehabilitation of sick units
* OTC market operations
* Mergers and amalgamations
The prime function of a merchant banker or an investment banker is marketing of corporate and
other securities. In the process, he performs a number of services concerning various aspects of marketing,
viz., origination, underwriting, and distribution, of securities. During the regime of Controller of Capital
Issues in India, when new issues were priced at a significant discount to their market prices, the merchant
banker’s job was limited to ensuring press coverage and dispatching subscription forms to every corner
of the country. Now, merchant bankers are being forced to design innovative instruments and perform a
number of other services both for the issuing companies as well as the investors. The functions or
services performed by merchant banks, in India, today include
1. Project promotion services.
2. Project finance.
3. Management and marketing of new issues.
4. Underwriting of new issues.
5. Syndication of credit.
6. Leasing services.
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 7. Corporate advisory services.
8. Providing venture capital.
9. Operating mutual funds and off shore funds.
10.Investment management or portfolio management services.
11. Bought out deals.
12.Providing assistance for technical and financial collaborations and joint Ventures.
13.Management of and dealing in commercial paper.
14.Investment services for non-resident Indians.
15.Servicing of issues etc.
The large variety of functions performed by most of the merchant bankers can be studied under the
following heads.
I. CORPORATE COUNSELLING:
This service is, usually, provided free of charge to a corporate unit. Merchant bankers render
advice to corporate enterprises from time to time in order to improve performance and build better
image/reputation among investors and to increase the market value of its equity shares. Counseling is
provided in the form of opinions, suggestions and detailed analysis of corporate laws as applicable to the
business unit.
II. PROJECT COUNSELLING:
Project counseling broadly covers the study of the project and providing advisory services on the
project viability and procedural steps to be followed for its implementation. Sometimes, merchant banks
also encourage and guide Indian entrepreneurs to make investment in Indian projects in India and joint
ventures overseas by offering all possible help in project appraisal and implementation.
III. CAPITAL RESTRUCTURING SERVICES:
Merchant banks render different capital restructuring services to the corporate a unit depending
upon the circumstances a particular unit is facing.
IV. PORTFOLIO MANAGEMENT:
Merchant banks offer services not only to the companies issuing the securities but also to the
investors. They advise their clients, mostly institutional investors, regarding investment decisions as to
the quantum of amount of security and the type of security in which to invest. Merchant banks render
necessary services to the investors by advising on the optimum investment mix. Merchant bankers even
undertake the function of purchase and sale of securities for their clients so as to provide them portfolio
management services. Some merchant bankers are managing mutual funds and off share funds also. In
order to attract foreign capital resources for being invested in India, Union Government has offered
various incentives to Non-Resident Indians (NRIs) persons of Indian Origin Resident Abroad (PIORA).
Merchant banks provide special services on this account to encourage the NRIs to invest their savings in
Indian industry.
V. ISSUE MANAGEMENT:
In the past, the functions of a merchant banker had been mainly confined to the management of new
public issues of corporate securities by the newly formed companies, existing companies (further issues)
and foreign companies in dilution of equity as required under FERA. In this capacity, the merchant bank
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usually acts as a sponsor of issues. They obtain consent of the Controller of Capital Issues (CCI) now,
SEBI and provide a number of other services to ensure success in the marketing of securities. If
debentures are to be issued, it advises on the type of debentures, whether convertible or non convertible,
whether redeemable or non-redeemable or whether linked with equity or preference shares etc. merchant
banks also performs the function of taking a decision as to the size and timing, of the public issue in the
light of prevailing market conditions, press coverage, underwriting support from brokers institutional
underwriters etc.
VI. LOAN /CREDIT SYNDICATION:
Merchant bankers provide specialized services in preparation of project, loan applications for
raising short-term as well as long-term credit from various banks and financial institutions for financing
the project or meeting the working capital requirements.
VII. ARRANGING WORKING CAPITAL FINANCE:
Earlier Working capital finance was not considered to be a merchant bank activity but used to be
a part of the commercial bank’s function. But some banks like Canara Bank, Grind lays Bank and
Central Bank of India have started including working capital finance as one of the merchant banking
service area. Finance for working capital is provided usually for new ventures or for existing companies
through issue of debentures.
VIII. BILL DISCOUNTING AND ACCEPTANCE CREDIT:
In foreign countries, acceptance credit and bill discounting function is another important area
which is recognized as a merchant banking activity. But in India this facility is not provided to the
corporate units by the merchant bankers. The need for such services was recognized when Banking
Commission 1972, in its report had recommended the establishment of acceptance and discount house in
India following the development of bill market. Indian merchant bankers have still to formulate the
practices and procedure so that efficient services could be offered in acceptance and bill discounting.
IX. LEASE FINANCE:
Many merchant bankers also provide leasing and finance facilities to their customers. Leasing is
an arrangement that provides a firm with the use and control over assets without buying and owning the
same. It is a form of renting assets. Merchant bankers assist their clients by providing finance for the
acquisition of asset taken on lease.
X. VENTURE CAPITAL:
Many merchant bankers maintain venture capital funds to assist the entrepreneurs who lack
capital to be risked. Capital funds may be provided for unproven ideas, products technology-oriented or
start-up funs. Venture capital has emerged as a new merchant banking activity. It is a form of equity
financing especially designed for funding high risk and high reward projects.
XI. PUBLIC DEPOSITS:
Merchant bankers also help companies in raising finance by way of public deposits.
XII. SPECIALISED SERVICES:
In addition to the basic activities involving marketing of securities, merchant banks also provide
corporate advisory services on issues like mergers and amalgamation, takeovers, tax matters, recruitment
of executives and cost and management audit etc. Many merchant bankers have also started making of
bought out deals of shares and debentures. The activities of the merchant bankers are increasing with
the change in the money market.
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23.4 MUTUAL FUND – THE CONCEPT:
Mutual funds are vehicles for collective investment that pool the savings of many investors for
investment in securities, according to stated investment objective and the profits are shared equally
among its participants in proportion to their holding. Mutual fund could be defined as a non-depository,
non-banking financial intermediary. It brings together the investors who have surplus money to invest
and corporate entities that need the money for their industrial projects. The fund collects money from the
members and invests them in diversified portfolio of financial assets with a view to reducing risk, and
maximizing income and capital appreciation for distribution to its members. They enjoy collectively the
benefits of expertise in investments by the specialists in trust which no single individual by himself could
enjoy.
In India, Unit Trust of India (UTI) came into existence in 1964 and pioneered the concept of
“units”. However, the first Mutual Fund Scheme in the real sense was in 1986 when UTI launched
“Master shares”. UTI has the dominant position among mutual funds.
23.5 CONSTITUTION AND MANAGEMENT OF MUTUAL FUND:
Mutual Fund is set up under the Indian Trust Act. Initially, the management of mutual funds was
vested with Board of Trustees consisting of members from sponsoring bank and two outside members.
Now, the management of the funds has been handed over to an Asset Management Company (AMC).
The AMC will be a specialized agency for the asset management of the mutual funds and o provide
efficient service to various unit holders of the fund. They will keep an-arm’s-length relationship with the
Board of Trustees.
The function of the Board of trustees is to collect, manage and disburse what is due to unit
holders. The AMC’s function is resource mobilization and fund management. The function of the
custodian is to take physical delivery of the securities acquired from the funds. Prior permission of RBI
is required for every scheme launched by any MF. In order to maintain liquidity and regular growth of
the investments, MF invests the funds collected under the schemes in various capital market instruments
like government and other trustee securities, shares and debentures of public limited companies and
bonds of public sector undertakings. MF should not undertake direct or indirect lending, portfolio/fund
management, underwriting, bill discounting etc.
MF should not invest or hold more than 5 per cent of issued share capital or debenture of any
company. In case more than one scheme is operated by a MF, such lending should not exceed 15 per
cent of the paid-up capital or debenture stock of a company. Further, MF should not invest more than 15
percent of a scheme’s funds in a particular industry, e.g. cement, steel, paper etc., but his restriction is not
applicable to a scheme which has been floated for investment in one or more specified industries and a
declaration has been made to that effect.
MF should not enter into short sales/purchases of securities. Separate account of each scheme
should be maintained by segregating the assets under each scheme. For the benefit of the concerned
subscribers, the fund should disclose Net Assets Value of each of the schemes.
23.6 TYPES OF MUTUAL FUNDS:
Mutual funds could be classified in many ways based on structure, objectives of investment,
pattern of investments and returns, etc.
Based on structure, mutual funds could be classified as:
1) Open-Ended Schemes
2) Close-Ended Schemes
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 3) Interval Schemes
Based on the investment objective, the classification could be:
A) Growth Funds
B) Income Funds
C) Balanced Schemes
D) Money Market Schemes
E) Other Special Schemes
Different funds under structural basis are explained below.
1) OPEN-ENDED FUNDS:
Under open-ended scheme, the mutual fund will announce daily purchase and sale price of the
Units of the scheme. If investors want to buy the Units today, they can buy the same at the sale price.
May be, after six months, if investor decides to sell the units, they can sell at the purchase price announced
by the mutual fund on that date. Thus, the mutual fund offers instant liquidity for investment under open-
ended scheme by taking responsibility of purchasing back the Units. There is no limit to the size of the
funds. Investors can invest as and when they like. The purchase price is determined on the basis of Net
Asset Value (NAV). NAV is the market value of the fund’s assets divided by the number of outstanding
Shares/Units of the fund.
2) CLOSE ENDED FUNDS:
Under close-ended schemes, there is no repurchase facility. However, the Units are listed in the
stock market and investors can sell and buy Units like any other securities in the market. The scheme
has a specific life (say 10 years or 5 years) and at the end of the period, the mutual fund sells securities
bought under the scheme and disburses the proceeds to Unit holders. When the stock market was doing
well, many of the schemes have attracted investors and there was also active secondary market. But
they lost the fancy of the investors after couple of stock market failures. Today, the close-ended scheme
is virtually dead and only a very few schemes of this nature floated during the last few months. These
funds are fixed in size as regards the crops of the fund and the number of shares. In close-ended funds,
no fresh Units are created after the original offer of the scheme expires. The Shares/Units of these
funds are not redeemable at their NAV during their life as are in the case of open-ended funds. The
Shares of such funds are traded in the secondary market on stock exchanges at market prices that they
may be above or below their NAV.
3) INTERVAL FUNDS:
Interval Funds combine then features of open-ended close-ended schemes. They are open for
sale or redemption during pre-determined intervals at NAV related prices.
Different funds classified under investment objective are explained below.
A) GROWTH FUNDS:
The aim of growth funds is to provide capital appreciation over the medium to long-term. Such
schemes normally invest a majority of their corpus in equities. It has been proven that returns from
stocks, have out performed most other kind of investments held over the long term. Growth schemes are
ideal for investors having a long-term seeking growth over a period of time.

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B) INCOME FUNDS:
The aim of income funds is to provide regular and steady income to investors. Such schemes
generally invest in fixed income securities such as bonds, corporate debentures and Governments securities.
Income funds are ideal for capital stability and regular income.
C) BALANCED FUNDS:
The aim of balanced funds to provide both growth and regular income. Such schemes periodically
distribute a part of their earning and invest both in equities and fixed income securities in the proportion
indicated in their offer documents. In a rising stock market, the NAV of these schemes may not normally
keep pace, or fall equally when the market falls. These are ideal for investors looking for a combination
of income and moderate growth.
D) MONEY MARKET FUNDS:
The aim of money market funds is to provide easy liquidity, preservation of capital and moderate
income. These schemes generally invest in safer short-term instruments such as treasury bills, certificates
of deposit, commercial paper and inter-bank call money. Returns on these schemes may fluctuate
depending upon the interest rates prevailing in the market. These are ideal for Corporate and individual
investors as means to park their surplus funds for short periods.
E) OTHER SPECIAL FUNDS:
LOAD FUNDS:
A Load Fund is one that charges commission for entry or exit. That is, each time you buy or sell
Units in the, a commission will be payable. Typically entry and exit loads range from 1% to 2%. It could
be worth paying the load, if the fund has a good performance history.
NO-LOAD FUNDS:
A No-Load Funds is one that do not charge a commission for entry or exit. That is, no commission
is payable on purchase or sale of Units in the fund. The advantage of a no load fund is that the entire
corpus is put to work.
TAX SAVING SCHEMES:
These schemes offer tax rebates to the investors under specific provisions of the Indian Income
Tax laws as the government offers tax incentives for investment in specified avenues. Investments
made in Equity Linked Savings Schemes and pension Schemes are allowed as deduction under the
Income Tax Act, 1961.
INDUSTRY SPECIFIC SCHEMES:
Industry Specific Schemes invest only in the industries specified in the offer document. The
investment of these funds is limited to specific industries like Info Tech, FMCG, Pharmaceuticals, etc.
INDEX SCHEMES:
Index Funds attempt to replicate the performance of a particular index such as the BSE Sensex or
the NSE 50.
SECTORAL SCHEMES:
Sectoral Funds are those, which invest exclusively in a specified industry (like Pharma fund or IT
fund) or a group of industries or various segments such as ‘A’ Group shares or initial public offerings.
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23.7 SUMMARY:
This lesson deals with Merchant Banking and Mutual Funds. Merchant banking stands for providing
various service relating to capital market and finance to corporate sector. In India the merchant banking
business started in the year 1967, when Grind lays Bank established their Merchant Banking Division. A
Banker has funds with him which he mobilizes through deposits and borrowing or other ways and then
deploys or lends these funds, whereas a merchant banker does not have any fund in his own kitty but he
has the expertise and access to various sources of funds as per needs of the client. The prime function
of a merchant banker or an investment banker is marketing of corporate and other securities. In the
process, he performs a number of services concerning various aspects of marketing, viz., origination,
underwriting, and distribution, of securities. Now, merchant bankers are being forced to design innovative
instruments and perform a number of other services both for the issuing companies as well as the
investors.
Mutual funds are vehicles for collective investment that pool the savings of many investors for
investment in securities, according to stated investment objective and the profits are shared equally
among its participants in proportion to their holding. Mutual fund could be defined as a non-depository,
non-banking financial intermediary. Mutual funds could be classified in many ways based on structure,
objectives of investment, pattern of investments and returns.
23.8 SELF ASSESSMENT QUESTIONS:
1. What is Merchant Banking? Give an account of the Merchant Banking services.
2. Explain the concept of Mutual Fund. Enumerate the types of Mutual Funds.
Short Notes:
1. Open ended Funds
2. Close ended Funds
3.Grouth Fund vs Income Fund
23.9 SUGGESTED READINGS:
1. Shashi K .Gupta et.al, Financial Services,Kalyani Publishers,Ludhiana
2. Pezullo Mary Ann, Marketing Financial Services, AmericanBankers Association, The Indian
Institute of Bankers.
23.10 KEY WORDS:
Mutual Fund : A mechanism for pooling the resources by issuing units to the investors and investing
funds in securities in accordance with objectives as disclosed in offer document.
Closed-Ended Mutual Funds : A mutual fund with limited capitalization and a fixed number of units
traded at a stock exchange
Diversification : An investment strategy to reduce risks by investing in securities, common stocks
debentures or bonds of several companies.
Gilt Fund : A mutual funds specifically launched to invest in government gilt securities.
Credit Risk : The danger that the issuer of a corporate bond will experience about financial difficulties
causing deterioration in credit worthiness, perhaps even a default.

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 LESSON NO: 24

VENTURE CAPITAL, FACTORING AND

DEPOSITORY SERVICES

STRUCTURE:
24.1 Introduction
24.2 Venture Capital – Concept, Nature And Role
24.2.1. Nature And Role Of Venture Capital
24.2.2. Characteristics Of Venture Capital Investment
24.2.3. Origin And Development Of Venture Capital In India
24.2.4. Methods Of Venture Capital Financing
24.2.5. Advantages Of Venture Capital
24.3 Factoring – Meaning
24.3.1. Process Of Factoring
24.3.2. Characteristics Of Factoring
24.3.3. Types Of Factoring
24.3.4. Advantages Of Factoring
24.3.5. Disadvantages Of Factoring
24.4 Depository – Meaning And Objective
24.4.1. Constituents Of Depository
24.4.2. Dematerialisation Of Shares And Securities
24.4.3. Advantages Of The Depository System
24.5 Summary
24.6 Self Assessment Questions
24.7 Further Readings
24.8 Key Terms

OBJECTIVES:
A thorough reading of the lesson helps you understand the financial services with a focus on
venture capital services, Factoring services and Depository services.

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24.1 INTRODUCTION:
In the Financial system there has been a growing presence of financial services. Financial
services are provided by the banking and non-banking financial companies. Financial services include
‘the activities, benefits and satisfactions, connected with the sale of money, that offer to users and
customers financial related value’. Financial intermediaries provide a whole range of financial services.
These include commercial banks, Merchant bankers, specialized institutions and specialized financial
institutions. Financial services can be broadly classified into two categories. These include (1) Asset or
fund based services and (2) Fee based or advisory services venture capital, factoring, leasing etc., come
under asset or fund based services whereas merchant banking, corporate counseling, credit rating, stock
broking and depositories come under fee based or advisory services. In this lesson venture capital,
factoring and depository services are explained.
24.2 VENTURE CAPITAL – CONCEPT, NATURE AND ROLE:
Venture capital is a source of long-term financing for new industrial enterprises. It is essentially
a concept of American origin. Venture capital refers to the risk capital supplied to growing private
companies and it takes the form of share capital in the business firms. Venture capital refers to the
commitment of capital for the formation and setting up of firms particularly those specializing in new
ideas or new technologies. Thus, it is not merely an injection of funds into a new firm but also a simultaneous
input of skills needed to set up the firm, design its marketing strategy, organize and manage it. In Western
countries like the USA and UK, venture capital concept is used in the above sense. In our country
venture capital finance for high technology and funds to turn research and development into commercial
production.
The Venture Capital is defined as the organized financing of relatively new enterprises to achieve
substantial capital gains. Such young companies are chosen because of their potential for considerable
growth due to advanced technology, new products or services, or other valued innovations. A high level
of risk is implied by the term ‘Venture Capital’ and is implicit in this type of investment. Venture capital
implies long term investment generally in high risk industrial projects with high reward possibilities.
24.2.1. Nature and Role:
Venture Capital is associated with successive stages of the firms’ development. There are
broadly four stages of a firm’s development, viz., development of an idea, start-up, fledgling and
establishment. The first stage of development of a firm is development of an idea for the new product or
service and to establish a business plan. The start-up stage is the second stage of the firm’s development.
At this stage, the entrepreneur sets up the enterprise to carry into effect the business plan and venture
capitalist supplies start-up finance. In the third phase, the firm, having made some headway, will need a
large amount of fledgling finance from the venture capitalist. In the last stage of the firm’s development,
when it stabilizes itself, it may need, in some cases, establishment finance to exploit opportunities of
scale.
Venture capital provides finance as well as skills to new enterprises and new ventures or existing
ones based on high-technology innovations. It provides seed capital funds to finance innovations even in
the pre-start stage. The venture capitalist is expected to perform not only the role of a financier but also
a broad spectrum of spectrum of specialist services, including technical, commercial, managerial, financial
and entrepreneurial. The venture capitalist also assists the entrepreneurs in locating, interviewing and
employing outstanding corporate achievers to professionalize the firm.
24.2.3. Characteristics of Venture Capital Investment:
The main characteristics of venture capital investment are noted as under:

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1. Venture capital is generally invested in equity instruments.
2. Venture capital Investment is generally made in new enterprises using new technology to produce
new products in expectation of higher gains or spe- ctacular return.
3. Venture capital investors are not directly involved in the management of the enterprise but manage
their own portfolio of investments.
4. Venture capital investor does not interfere in the management of the enterprise but keeps in close
contact with the promoter/entrepreneur to protect and enhance his investment.
5. Venture capitalists, due to continuing involvement in the client after making investments, differs in
approach from stock market investor (who buys or sells at will) on one hand and the banker or
lender (who cares for return of investment with interest) on the other hand.
6. Venture capital investment is illiquid i.e. not subject to repayment on demand as is the case with an
overdraft or following a loan repayment schedule. The investment realized only on enlistment of
security or it is lost if enterprise is liquidated for unsuccessful working.
24.2.4. Origin and Development of Venture Capital in India:
The origin of venture capital in USA is traceable to the post World War-II period when the
investors in organized form came forward to invest their funds in new ventures based on new technology
providing very high returns, growth and prosperity. The origin of venture capital in UK is also traced
back to the nineteenth
Century when European merchant bankers and investors were helping the growth of industry in
USA and in their dominions like South Africa, India and elsewhere.
The need for Venture capital in India was first highlighted by the Committee on Development of
Small and Medium Entrepreneurs under the chairmanship of R.S. Bhatt, popularly known as R.S. Bhatt
committee, in 1972 by spotlighting on the problems of new entrepreneurs and technologists in setting up
industries. Soon after, in1975 the concept of Venture capital was introduced in India by the all India
financial institutions with the inauguration of Risk Capital Foundation (RCF) sponsored by the Industrial
Finance Corporation of India (IFCI) to supplement ‘promoters’ equity’ with a view to encouraging
technologists and professionals to Promote new industries. During 1976, the Seed capital Scheme was
introduced by IDBI. Till 1984, the concept of venture capital was known in the form of “Risk Capital”
and “Seed Capital”.
The announcement of Technology Policy Statement in 1983 made by the Central Government
setting guidelines towards technological self-reliance through comercialisation and exploitation of
technologies developed in the country had established the need for Venture Capital. In addition IFCI and
IDBI, the Industrial Credit and Investment Corporation of India limited (ICICI) also took decision in 1984
to allocate funds for providing assistance in the form of Venture capital to economic activities having risk
but also profit potential. ICICI launched a Venture Capital Scheme in 1986 to encourage new technocrats
in the private sector in new fields of high technology with inherent high risk.
The Venture Capital Fund was created by the Central Government which became Operational
with effect from 1.4.1986 and is administered by Industrial Development Bank of India. In 1988, ICICI
sponsored company viz. Technology Development and Information Company of India Limited (TDICI)
was founded and Venture Capital operations of ICICI were taken over by it with effect from July 1,
1988. In November, 1988 Central Government announced guidelines for the establishment and functioning
of venture capital activities. These guidelines allowed the private sector to operate in the venture capital
financing industry.
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 In 1988, Risk Capital Foundation (RCF) sponsored by IFCI was converted into Risk Capital and
Technology Finance Corporation Limited (RCTFC) which took over the Schemes of financing technology
development and managing venture capital fund. During the year 1989, UTI sponsored “Venture Capital
Unit Scheme” known as VECAUS.
After the Government Guidelines of November 1988, many new venture Capital funds were sponsored
viz. ANZ Grindlays Bank, a foreign bank, had also set up in 1987, the first private venture capital fund
known as India investment Fund and Subsequently came out with the Second India Investment Fund in
1989. Other Venture capital funds which were established during this period include Canbank Venture
APIDC Venture Capital Limited (APIDC-VCL) in October 1990, Gujarat Venture Finance limited (GVFL)
in November 1990, Indus Venture Capital Management Limited (IVCML) in October 1991, SIDBI
Venture Capital Fund (SIDBI-VCF) in April 1994 etc. Capital Association (IVCA).
There were 20 Venture Capital Companies in India both in private and public sector in 1994. These
companies assisted 350 projects to the tune of Rs. 250 crore upto 1993-94. out of the 350 projects
assisted 62% belongs to new entrepreneurs. At the end of 1996, according to the Venture Capital
Association of India, 14 of Its members had set up 17 funds. In the year 2000, SEBI registered 13 more
VC funds and their number increased to 32. In 2003 there were 43 domestic VCFs and six foreign VCFs
registered with SEBI.
24.2.5. Methods of venture Capital Financing:
Venture Capital is available in four forms in India:
1. Equity Participation
2. Conventional Loan
3. Conditional Loan
4. Income Notes.
1. Equity participation: Venture Capital Firms participate in equity through direct purchase of shares
but their stake does not exceed 49%. These shares are retained by them till the assisted projects making
profit. These Shares are sold either to the promoter at negotiated price under buy back agreement or to
the public in the secondary market at a profit.
2. Conventional Loan : Under this form of assistance, a lower fixed rate of Interest is charged till the
assisted units become commercially operational. The loan has to be repaid according to a predetermined
schedule of repayment as per terms of loan agreement.
3. Conditional Loan: Under this form of finance, an interest free loan is provided during the implementation
period but it has to pay royalty on sales. The loan has to be repaid according to a pre determined
schedule as soon as the company is able to generate sales and income.
4. Income Notes: It is a combination of conventional and conditional loans. Both interest and royalty
are payable at much lower rates than in case of conditional loans.
At present, several venture capital firms are incorporated in India and they are promoted either
by all India Financial Institutions like IDBI, ICICI, IFCI, State level financial institutions, public sector
banks or promoted by
Foreign banks/private sector or financial institutions like Indus venture capital fund

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 24.2.6. Advantages of Venture Capital: Venture Capital is advantageous to the promoters,
investing public and the economy in general. The following are the advantages of venture capital.
1. Venture capital makes significant contribution to technological innovations And promotion of
entrepreneurship.
2. It is economy oriented as it helps the industrialization of the country, help in technological
development, generate employment and help to develop entrepreneurial skills. It is also investor
oriented as benefits the investors when they are invited to invest only after organization starts
earning profit, when risk is low and growth is healthy.
3. The investing public will be able to reduce risk significantly against unscrupulous management, if
the public invest in venture fund who in turn will invest in equity of new business.
4. The venture funds equipped with necessary skills will be able to analyze the Prospects of the
business and create awareness among promoters.
5. The venture fund having representatives on the Board of Directors of the Company would
ensure that the affairs of the business are conducted prudently.
6. Venture Capital provides a solid capital base for future growth by injecting Long-term equity
financing.
7. Venture fund assistance would eliminate the efforts of public issue leaving entrepreneur to
concentrate upon activities of business.
8. Assistance from venture fund does not require costs of public issue of equity Shares.
9. The venture capitalists act as business partners who share the rewards as well as the risks.
10. Venture Capitalists provide strategic, operational tactical and financial Advice based on past
experience with other companies.
11. Venture capital institutional set-up reduces the time lag between a technological innovation and
its commercial exploitation.
12. Once venture capital funds start earning profits, it will be very easy for them to raise resources
from primary capital market in the form of equity and debts
13. Business will take-off with the help of finance from venture funds and this Would help in increasing
productivity, better capacity utilization etc.
14. The economy with well developed venture capital network induces the entry of large number of
technocrats in industry, resulting in faster industrial development.
15. A venture capital firm serves as an intermediary between investors looking for high returns for
their money and entrepreneurs in search of needed capital for their start ups.
24.3 FACTORING – MEANING:
Factoring refers to management of receivables of a company by a financial intermediary (factor)
for a fee. The need for factoring arose on account of the inordinate delays faced by suppliers for
realizing their bills from their customer. Factoring could be with or without recourse to the supplier, on
whose behalf this service is undertaken.

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 The purchase of book debts is central to the function of factoring, permitting the factor to provide
basic services such as
i) administration of the seller’s sales ledger
ii) provision of prepayment against the debt purchased
iii) collection of the debts purchased
iv) covering the credit risks involved.
Factoring is different from forfaiting and bills discounting.
Factoring, is a Financial Service which is rendered by a ‘factor’, who deal in realising the book
debts, bills receivables manages sundry debts and sales registers of commercial and trading firms in the
capacity of an agent for a commission.
Forfaiting is the process of purchasing trade bills or promissory notes by a bank or financial institutions
without re-course to the seller.
Bill Discounting is a source of short term trade financing by discounting bills receivable. It is also
known as acceptance credit where one party accepts the liabilities of trade.
Reserve Bank of India has constituted in January, 1988 a Study Group under the chairmanship of
Sri. C.S. Kalyansundram to examine the feasibility and mechanism of stating factoring organization in
India. The Group submitted the report in January 1989.
The study group had gone into its various functional formalities, implication and importance for
promoting factoring in the country with involvement of commercial banks and non-banking financial
intermediaries like merchant banks, etc. The report of the study group on factoring and recommendation
made therein were accepted by RBI.
Thus factoring is a financial service which is rendered by the specialized persons known as
“Factors”, who deal in realizing the book debts, bills receivable, managing sundry debtors and sales
registers of the commercial and trading firms in the capacity of agent for a commission. Such commission
is known as “commercial charge”. Factoring helps in realization of credit sales of trading firms.
Parties to Factoring Contract:
There are three parties involved generally in a factoring contract, viz.,
1) Buyer of goods who has to pay for goods bought on credit terms.
2) Seller of goods who has to realize credit sales from buyer.
3) ‘Factor’ who acts as agent in realizing credit sales from buyer and passes on the realized sum to
seller after deducting his commission.
24.3.1. Process of factoring: Credit sales generate the factoring business in ordinary course of business
dealings. Realization of credit sales is the main function of factoring services. Once sale transaction is
completed the factor steps in and takes course to realize the sales. Various activities undertaken by the
three parties (the buyer, the seller and the factor) in a factoring transaction are as under:
1) The Buyer:
a) Buyer negotiates terms of purchasing plant and machinery or other material with the seller.

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 b) Buyer receives delivery of goods with invoice and instructions by the seller to make payment to
the factor on due dates;
c) Buyer makes payment to the factor in time or gets extension of time or in the case of default is
subject to legal process at the hands of factor.
2) The Seller
a) Enters into Memorandum of Understanding (MSU) with the buyer in the form of letter exchanged
between them or agreement entered into between them;
b) Sells goods on credit to the buyer as per MOU’
c) Delivers copies of invoice, delivery challan, MOU, instructions to make payment to factor given
to buyer;
d) Seller receives 80% or more payment in advance from factor on selling the receivables from the
buyer to him;
e) Seller receives balance payment from factor after deduction of factor’s services charges, etc.
3) The Factor
a) the factor enters into agreement with seller for rendering factor services to it;
b) On receipt on copies of sales documents as referred to above makes payment to the seller of the
80% of the price of the debt;
c) The factor receives payment from the buyer on due dates and remits the money to seller after
usual deductions.
d) The factor also ensures that the following conditions should be met to give full effect to the
factoring arrangements;
i) The invoice, bills or other documents drawn by seller should contain a clause that these payments
arising out of the transaction as referred to or mentioned therein might be factored;
ii) The seller should confirm in writing to factor that all the payments arising out of these bills are
free from any encumberances, charges, lien, pledge, hypothecation or mortgage or right of self-
off or counter-claim from another, etc;
iii) The seller should execute a deed of assignment in favor of factor to enable the latter to recover
the payment at the time of after default;
iv) The seller should confirm by a letter of confirmation that all conditions sell-buy contract between
the buyer and him have been complied with and transaction is complete;
v) The seller should procure a letter of waiver from the bank in favour of the factor in case the
bank has a charge over the assets sold out to buyer and the sale proceeds are to be deposited in
the account of bank.
24.3.2. Characteristics of Factoring:
The main characterisitics of factoring are noted below:
1) Assignment of debt in favour of factor

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 2) Setting out the conditions with which the factor will have no recourse to the supplier on non-
payment from the customer and what circumstances the factor will turn to recourse to the supplier.
3) Setting out details of the payment to the factor for his service known as service charge or
commercial charge which is usually a percentage on turnover.
4) Setting out details of the interest to be allowed to the factor on the accounts where credit has
been allowed/to be allowed to the supplier. The rate of interest is to vary depending upon the
money market conditions and is commonly fixed at 2 ½% to 4% per cent per annum above the
base rate so as to give better margin to at factor.
5) Setting the limit of any overdraft by the supplier and the rate of interest to be charged by the
factor on such overdrafts.
6) Specify the condition that the amount to be paid by the factor to the supplier should be net of the
service charge.
7) Specify the percentage or the amount of the invoice value to be received from the factory by the
supplier. Usually, about 80% of the invoice value of the amount is provided by the factor to the
supplier.
8) Setting out special terms for the factor to handle accounts of different customers.
24.3.3 Types of Factoring:
The type of factoring services varies on the basis of the nature of transactions between the client
and the factor, the nature and volume of client’s business, the nature of factor’s security etc. Factoring
can be classified into the following types.
1) Full service factoring or without recourse factoring
2) With Recourse Factoring
3) Maturity Factoring
4) Bulk Factoring
5) Invoice Factoring
6) Agency Factoring
7) International Factoring
1) Full Service Factoring: Under this type, a factor provides all kinds of services. Thus, a factor
provides finance, administers the sales ledger, collects the debts at his risk and renders consultancy
service. This type of factoring is a standard one,. If the debtors fail to repay the debts, the entire
responsibility falls on the shoulders of the factor since he assumes the credit risk also. This type of
factoring is also called ‘Without Recourse’ Factoring.
2) With recourse factoring: Under this type, the factor does not assume the credit risk. If the debtors
do not repay their dues in time and if their debts are outstanding beyond a fixed period, say 60 to 90 days
from the due date, such debts are automatically assigned back to the client. The client has to take up the
work of collection of overdue account by himself. If the client wants the factor to go on with the
collection work of overdue accounts, the client has to pay extra charges called ‘Reassuring Charges’.
3) Maturity factoring: Under this type, the factor does not provide immediate cash payment to the
client at the time of assignment of debts. He undertakes to pay cash as and when collections are made
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from the debtors. The entire amount collected less factoring fees is paid to the client immediately. It is
also called ‘collection factoring’.
4) Bulk Factoring: Under this type, the factor provides finance after disclosing the fact of assignment
of debts to the debtors concerned. This type of factoring is resorted to when the factor is not fully
satisfied with the financial condition of the client. The work relating to sales ledger administration, credit
control, collection work etc., has to be done by the client himself. This is otherwise called as “Disclosed
Factoring” or “Notified Factoring”.
5) Invoice factoring: Under this type, the factor simply provides finance against invoices without
undertaking any other functions. All works connected with sales administration, collection of dues etc.
have to be done by the client himself. The debtors are not at all notified and hence they are not aware of
the financing arrangement. This type of factoring is very confidential in nature and hence it is called
‘Confidential Invoice Discounting’ or ‘Undisclosed Factoring’.
6) Agency Factoring: Under this type, the factor and the client share the work between themselves as
follows:
(i) The client has to look after the sales ledger administration and collection work and
(ii) The factor has to provide finance and assume the credit risk for a commission.
7) International Factoring: Under this type, the services of a factor in a domestic business are simply
extended to international business. Factoring is done purely on the basis of the invoice prepared by the
exporter. Thus, the exporter is able to get immediate cash to the extent of 80% of the export invoice
under international factoring. International factoring is facilitated with the help of export factors and
import factors.
8) Suppliers Guarantee Factoring: Generally, goods are sold through wholesaler, retailers, retailers or
through middlemen. In such cases, the factor guarantees the supplier of goods against invoices raised by
the supplier upon another supplier. The bills are assigned in favour of the factor who guarantees payment
of those bills. This enables the supplier to earn profits without much financial involvement.
9) Limited factoring: Under this type, the factor does not take up all the invoices of a client. He
discounts only selected invoices on merit basis and converts credit bills into cash in respect of those bills
only.
10) Buyer based factoring: Under this type, the buyer approaches a factor to discount his bills. Thus,
the initiative for factoring comes from the buyers end. The approved buyers of a company approach a
factor for discounting their bills to the company in question. In such cases, the claims on such buyers are
paid by discounting the bills without recourse to the seller and the seller also gets ready cash. This facility
is available only to reputed credit worthy buyers and hence it is also called selected Buyer Based Factoring.
11) Seller based factoring: Under this type, the seller, instead of discounting his bills, sells all his accounts
receivables to the factor, after invoicing the customers. The seller’s job is over as soon as he prepares
the invoices. Thereafter, all the documents connected with the sale are handed over to the factor who
takes over the remaining functions. This facility is extended to reputed and credit worthy sellers and
hence it is also called ‘Selected Seller Based factoring’.
24.3.4. Advantages of Factoring: Factoring offers a number of advantages to the clients. Some
of the important advantages are:

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1) Immediate cash inflow: The major benefit of the factoring service is that the clients will be able
to convert their trade debts into cash upto 80% immediately as soon as the credit sales are over.
They need not wait for months together to get cash for recycling.
2) Collection of debts at less cost: Debt collection work is completely taken up by the factoring
organization, leaving the client to concentrate on production alone. This is an important service
rendered by a factor to his client. The cost of collection is also cut down as a result of the
professional expertise of a factor.
3) ‘Credit risk’ Service: Once the factoring relationship is established, the client need not bother
about the loss due to bad debts. The factor assumes the risk of default in payment by customers
and thus, the client is assured of complete realization of his book debts.
4) Expertised ‘Sales Ledger Management’: Administration of sales ledger is purely an accounting
function which can be performed efficiently only by a few. It requires a specialized knowledge
which the client may not possess. The client can receive services like maintenance of accounting
records, monthly sales analysis, overdue invoice analysis and customer payment statement from
the factor.
5) Consultancy Service: Factors are professionals in offering management services like consultancy.
They collect information regarding the credit worthiness of the customers of their clients, ascertain
their track record, quality of portfolio turnover, average size of inventory etc., and pass on the
same to their clients. It helps the clients avoid poor quality and risky customers.
6) Economy in Servicing: Factors are able to render services at low service charges because their
overhead cost is spread over a number of clients. Factoring is a cheap source of finance to the
client because the interest rate is charged only on the amount actually provided to the client.
7) Off-Balance Sheet Financing: Factoring is an off-balance sheet means of financing. When the
factor purchases the book debts of the client, these debts no longer exist on the current asset side
of the balance sheet. It leads to reduction in debts and less collection problems.
8) Trade Benefits: Factoring enables the supplier to concentrate on production and materials
management without bothering about the financial management. Factoring enables clients to offer
longer credit facilities to their customers and thus to attract more business. Thus many trade
benefits are available under factoring.
24.3.5. Disadvantages of Factoring:
1) Image of the client may suffer as engaging a factor agency is not considered a good sign of
efficient management.
2) Factoring may not be of much use where companies have nation-wide network of branches.
3) Financial evaluation may not be accurate.
4) If the client has cheaper means of finance and credit (where goods are sold against advance
payment), factoring may not be useful.
24.4 DEPOSITORY – MEANING AND OBJECTIVE:
One of the biggest problems faced by the Indian capital market has been the manual and paper
based settlement system. The system of physical delivery of scrips poses many problems for the purchaser
as well as the seller in the form of delayed settlement, long settlement periods, high level of failed trade,
high cost of transactions, bad deliveries etc. Moreover, the old manual system of settlement and transfer
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has almost failed to handle the growing volume of paper that has loaded the market. Thus to eliminate
paperwork facilitate scrip less trading and electronic book entry of the transfer of securities shorten
settlement periods, and to improve liquidity in the stock market, it was found necessary to replace the old
system of transfer and settlement with the new and modern system of depositories. Accordingly the
Government of India enacted the Depositories Act in 1990 for the orderly growth and development of the
Indian Capital Market. A major reform of the Indian stock markets has been the introduction of the
depository system and scripless trading mechanism, since 1996. The essential part of scripless trading is
the dematerialization of share certificates through depositories.
It is a system whereby the transfer and settlement of scrips take place not through the traditional
method of transfer deeds and physical delivery of scrips but through the modern system of effecting
transfer of ownership of securities by means of book entry on the ledgers or the depository without the
physical movement of scrips. The new system thus eliminates paper work, facilitates automatic and
transparent trading in scrips, shortens the settlement period and ultimately contributes to the liquidity of
investment in securities. This system is also known as ‘scripless trading system’.
24.4.1. Constituents of Depository system: There are essentially four players or constituents in the
depository system:
(i) The Depository Participant (DP)
(ii) The Beneficial Owner/Investor
(iii) The issuer
(iv) The Depository
1. The Depository Participants (DP): A DP is an agent of the depository. If an investor wants to
avail the services offered by the depository, the investor has to open an account with a DP. DP
functions as a bridge between the depository and the beneficial owners. He maintains the ownership
records of every beneficial owner in book entry form. Both the depository and the participant’s
have to be registered with the securities and exchange board of India. The investors can select
any DP to open a demat account. While selecting a DP the investor should take into account cost,
convenience and benefits comforts derived from the DP. A depository participant is an intermediary
between the investor and the depository.
2. The Beneficial Owner: Beneficial owner means a person whose name is recorded as such with
a depository. A beneficial owner is the real owner of the securities who has lodged his securities
with the depository in the form of book entry. He has all the rights and liabilities associated with
the securities.
3. The Issuer: The issuer is the company which issues the security. It maintains a register for
recording the names of the registered owners of securities, the depositories. The issuer sends a
list of shareholders who opt for the depository system.
4. The Depository: A depository is a firm wherein the securities of an investor are held in electronic
form in the same way a bank holds money. The depository based settlement system is also called
‘book entry transfer settlement’. The depository acts as a defect owner of the securities lodged
with it for the limited purpose of transfer of ownership. It functions as a custodian of securities of
its clients. With increase in the number of transactions in the stock market, it had become difficult
for the investors to hold share certificates and debt instruments in bulk. But now, depository
institutions handle this job. At present there are two depositories in India.

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 (a) National Securities Depository Limited (NSDL)
(b) Central depository Services (India) Limited (CDSL).
24. 4.2. Dematerialization of shares and securities:
The essential part of scrip- less trading is the dematerialization of share and security certificates
through depositories. Dematerialization is the process wherein share certificates or other securities held
in physical form are converted into electronic form and credited to demat account of an investor opened
with a depository participant. The demat account offers a number of benefits to the investor as he is not
required to keep the shares or other securities in safe custody eliminating the risk of fire, theft, loss in
transit, delay in transfer, bad delivery, fake or forged shares etc. Several initiatives have been taken by
SEBI to promote dematerialized or paperless trading, which can go a long way in eliminating the risks of
bad delivery and forged shares. It introduced compulsory trading of shares in dematerialized form in
specified scrips by institutional investors with effect from January 15, 1998. Subsequently, SEBI has
made compulsory trading of shares of all the companies listed in stock exchanges in demat form with
effect from 2nd January 2002. Hence, if the investor wants to trade in respect of the companies which
have established connectivity with national Securities Depository Limited (NSDL) and Central Depository
Services (India) Limited (CDSL), he may have to open a beneficiary account with a depository participant
of his choice. The procedure of opening a demat account with DP is similar to opening an account with
a bank.
Dematerialization (Demat) offers the following advantages:
1. Reduction in brokerage.
2. Clarity in the title of ownership of securities at all times.
3. Ready acceptance of securities for pledge and hypothecation.
4. Easy receipt of public issue allotment.
5. Quick receipt of corporate benefits like rights and bonus.
24.4.3. Advantages of Depository system:
The depository system Takes away many problems and weaknesses of the hitherto existing system of
trading in shares and securities. It contributes to the highly efficient capital market operations and settlement
for securities trading. The Depository system is advantageous to the investors, Issuing companies and
also the economy of a country.
A. Advantages to the investors:
(i) Immediate transfer of funds and securities: But in Depository system, purchase of securities in
physical form requires registration with registrar which takes three to four months. The investors might
loose an opportunity to earn gain by selling the securities during the transfer period. Moreover, they are
always exposed to the risk of loss in transit. Once the securities are credited to the investors account on
payout, he becomes the legal owner of the securities. There is no need to send it to the company
registrar for registration.
Elimination of all risks associated with physical certificates: An investor is always exposed to
risk of theft of stock mutilation of certificates, loss in transit or loss of certificates during movement
through or from the registrars etc. While dealing in physical securities an investor has to incur costs for
obtaining duplicate certificate and advertisement etc. Such problems are not faced under depository
system.
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(ii) No stamp duty: No stamp duty is payable by the investors for getting the equity shares and units of
mutual funds transferred under the depository system. In case of physical shares, stamp duty of 0.5% is
payable on transfer of shares.
(iii) Minimized chances of fraud, theft and counterfeiting of securities: Holding of securities in
electronic form minimizes the chance of theft. DPs can affect debit or credit to demat only after
receiving valid instruction slip from the client. Thus the risk of frauds, theft and also counterfeiting of
securities is minimized.
B. Advantages to the Issuer:
(a) The costs of registration and transfer of shares get reduced which were earlier incurred by the
issuer company.
(b) There is saving in costs involved at the time of public issues.
(c) It is easy to attract foreign investors without incurring any costs of issuance in overseas market.
Reduction in the cost of registry and transfer, which are presently undertaken by the issuer.
C. Advantages to the Intermediaries:
(i) Faster settlement.
(ii) Less risk of bad delivery.
(iii) Reduced chances of forgery, counterfeit certificates, loss in transit, theft, etc.
D. Advantages to the economy:
(i) An economy can earn foreign exchange because investors invest their money in offshore
funds with the help of depository.
(ii) It has become easy for an investor to invest in shares because number of depository participants
is providing dematerialization of shares services. This has led to the development of capital
market.
(iii) The concept of DP has created tough competition among various Issuers. This has led to
international competitiveness. For India to survive in this competition, it will have to raise
Indian Capital Market to global standards.
24.5 SUMMARY:
The Unit covers three distinct financial services viz., Venture Capital, Factoring and Depository.
All the three facilitate in financing trade and industry.
Venture capital implies long term investment generally in high risks industrial projects with high
reward possibilities. Venture capital financing refers to the commitment of capital as shareholding for
the formulation and setting up of small firms specializing in a new firm. It is not just providing finance but
also includes a simultaneous input of skill needed to set up the firm, design its marketing strategy and
organize and managing it. Venture capitalists finance the project at different stages. These include seed
finance (ideas stage), start up finance (implementation stage), additional finance (Fledging stage) and
establishment Finance (establishment stage).
Factoring is a service rendered by the Factor’, who deals in realizing the book debts, bills
receivable, managing sundry debtors and sales registers of a firm, in the capacity of an agent for a

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commission. There are three parties to a Factoring contract: buyer of goods, who has to pay for goods
bought on credit terms, seller of goods, who has to realize credit sales from buyer and the factor, who
acts as an agent and realizes the sales from the buyer.
Forfaiting denotes the purchase of trade bills or promissory notes by bank or financial institution,
without recourses to seller. Bill Discounting is a source of short-term trade finance. It is so known as
acceptance credit, where one party accepts liability of trade towards third party.
The Depository is a facility of capital market operations which ensures scripless trading through
electronic form i.e. dematerialization. Depository stem replaces the old manual system of settlement and
transfer of shares and securities. Thus quick settlement, transfers and liquidity are ensured.
24.6 SELF-ASSESSMENT QUESTIONS:
1. What is Venture Capital? Explain different stages of venture capital financing.
2. What is ‘scripless trading’? Discuss various players or constituents in the depository system.
3. What is depository? Explain the advantages of depository.
4. What is factoring? Explain the Advantages and disadvantages of Factoring.
5. Give an account of the characteristics and mechanism (process) of Factoring.
Short Notes:
a. Dematerialization b. Differentiate between Factoring, c. Forfaiting and Discounting of Bills.
24.7 SUGGESTED READINGS:
1. Mishra Ashim Kumar, venture Capital Financing. Shipra publication, New Delhi, 1996.
2. Verma, J.C., Venture Capital Financing in India, Sage publications India (P) Ltd., new Delhi, 1997.
3. Pandey, I.M., Venture Capital in India, Prentice Hall of India, New Delhi, 1996.
4. Shashi K. Gupta and Aggarwal, Financial Services, Kalyani publishers, New Delhi.
24.8 KEY TERMS:
Start up : The stage at which a business is being formed or the earliest stage At which venture capitalist
provides funds to an enterprise.
Up-front cost : Start up cost in the beginning of a new project.
Dematerialization (Demat): Dematerialization is a process by which the paper certificates of an
investor are taken back by the company/registrar and actually destroyed and an equivalent number of
securities are credited in electronic holdings of that investor. The depository works as an aid to
dematerialize securities and eliminate paper from the market.
Forfaiting : Forfaiting is the process of purchasing trade bills or promissory notes by banks or financial
institutions without recourse to the seller.
Bills Discounting : Buying of the trade bills or Bills receivable by the intermediary like banks at a
discount before their maturity. Trade Bills are negotiable instruments and they can be discounted as a
source of short term trade finance

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 UNIT - V

The Objective of this units is to Introduce the concept of Insurance in India Life Insurance
and Non-Life Insurance and explain about surrender of policy and claim settlement of policies.

LESSON 25 : Life Insurance meaning and explained about different types of insurance.

LESSON 26 : Insurance Policy - Issue procedure, sum assured and nomination facility
procedure explained in detail.

LESSON 27 : Discussed about lapse of policy and revival of policy

LESSON 28 : Policy assignment, loan on policy bond and policy settlement procedure
also explained.

LESSON 29 : Non-life Insurance and regulation of insurance discussed.

LESSON 30 : Discussed about health social and rural insurance.

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 Lesson No: 25

LIFE INSURANCE – MEANING AND TYPES

STRUCTURE :
25.1 Introduction
25.2 Life Insurance – Meaning
25.3 Principles Or Features Of Life Insurance Contract
25.4 Types Of Life Insurance Policies
25.5 Types Of Insurance
25.6 Summary
25.7 Self Assessment Questions
25.8 Suggested Readings
25.9 Key Terms

OBJECTIVE :
The presentation of this lesson helps you understand the concept of life insurance and different
types of insurance.
25.1 INTRODUCTION:
We all are exposed to various risks in our daily life. Nobody can predict or foresee the calamity
he may suffer in future. It is possible to take precautions against such events, but the possibility of such
happenings can not be completely ruled out. One can increase life expectancy by proper health and
medical care, however death will still happen risks can be reduced but not eliminated. A risk involves
loss. A person exposed to some risk may incur a loss. It will be better if a device or system is developed
to provide help to those who happen to suffer a loss. Such a device is ‘insurance’.
Insurance is a co-operative device which spreads, the loss caused by a particular risk to some
persons, over a number of persons who are exposed to, same or similar risk and who agree to ‘insure’
against that risk. According to Encyclopedia Britannica, “Insurance may be defined as a social device
whereby a large group of individuals, through a system of equitable contributions, may reduce or eliminate
measurable risk of economic loss common to all members of the group”.
According to Justice Tindall, “Insurance is a contract in which a sum of money is paid to the
assured in consideration of insurer’s incurring the risk of paying a large sum upon a given contingency”.
In the words of E.W. Patterson, “Insurance is a contract by which one party, for a consideration called
premium, assumes a particular risk of the other party and promises to pay to him or his nominee a certain
or ascertainable sum of amount on a specified contingency”. The person who seeks protection against
a risk is known as ‘insured’. The person who provides protection is ‘insurer’ (i.e. insurance company).
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The document containing terms and conditions of contract in called ‘policy’ or ‘insurance policy’. The
consideration from the insured is called premium.
The concept of insurance is based on two basic principles:
(a) Principle of Co-operation: Insurance can be described as highest degree of Co-operation.
(b) Principle of Probability: Without premium, co-operation is not possible and premium can not be
determined without applying theory of probability. The occurrence of risk in each type of insurance
can be estimated with the help of theory of probability. The probability tells about the chances and
amount of loss.
25.2 LIFE INSURANCE – MEANING:
The subject matter of life insurance is human life. The insured is promised by the insurance
company that during the tenure of insurance in case of his death, his nominee will be paid the insurance
amount. According to section 2(ii) of Insurance Act 1938, “Life insurance is the business of effecting
contracts of insurance upon human life including any contract, whereby the payment of money is assured
on death except death by accident on the happening of any contingency dependent on human life and any
contract which is subject to the payment of premium for a term dependent on human life. In case he
survives the term of the policy, he will be paid an amount as per terms of the policy.
Life insurance is a contract by which the insurer in consideration of the payment of premium
undertakes to pay a certain sum of money either on the death of the insured or on the expiry of a fixed
period. The premium may be paid in a single payment or in some equal installments. Life insurance
contract is not a contract of indemnity. Therefore a definite sum is paid at the death or on maturity of the
policy. Life insurance is one of the long term insurance businesses that directly deal with the risk of the
insurers’ life (death).
25.3 PRINCIPLES OR FEATURES OF LIFE INSURANCE CONTRACT:
The following are the important legal principles or features of the life insurance contract.
1. General Contract: Life insurance is a contract between the insured and the insurance company.
Therefore it should contain all the essential features of a valid contract according to Indian Contracts
Act. The features of a valid contract are:
a. A valid contract should have a definite offer by one person and acceptance of the same by the
other person to whom it is made.
b. Parties to the contract should be competent.
c. Both the parties should have free consent.
d. Both the parties should have consideration. In life insurance premium is the consideration for
the insurer and the risk cover is consideration to the insured.
e. The object of the contract should be legal.
2. Insurable Interest: In life insurance, the insured should have insurable interest in the life to be
insured. In the absence of insurable interest, it becomes void. The insurable interest must exist at
the time of the contract of insurance. Insurable interest is the pecuniary interest and the loss
should be monetary loss. Insurable interest can be in two ways; insurable interest in own life and
insurable interest in others life. Insurable interest may arise due to business relationship or may be
in family relation.

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 a. An individual always has an insurable interest in his own life up to any amount. This is unlimited
because the loss cannot be measured in terms of money.
b. Husband is presumed to have insurable interest in his wife’s life and vice versa. This is stressed
in the Griffith vs. Flemming Case.
c. A person has insurable interest in the life of relatives whose lives depend on him.
3. Utmost Good faith (Uberrimae Fedai): Contracts of insurance are based on mutual trust and
faith. It is a contract which requires Uberrimae Fedai i.e. utmost good faith. In accordance with
this principle, the insured must make full disclosures regarding the material facts. The material
facts in such contracts are those, which are relevant for the insurer to evaluate the risk of the
insured e.g. nature of the risk and character of the insured. However, there is no obligation to
disclose which are of public knowledge, which is contained in the documents, can not be noticed in
survey etc. A non-disclosure, concealment, mis-representation, or fraudulent representation will
make the contract either void or voidable at the option of the insured.
4. Suicide: The life policy usually contains a clause that no payment shall be made if the insured
commits suicide. A policy in India cannot be avoided on the ground of suicide unless there is a
specific clause to that effect in the policy. All life policies issued by Life Insurance Companies
contain suicide clause. According to this clause if the assured commits suicide with in one year of
the commencement of the risk under the policy will not be allowed to claim the insurance amount.
5. Assignment and Nomination: Assignment means transfer of rights. It is a method by which any
living person who is entitled to transfer the interest in the property conveys it to another living
person. The person who transfer the property is called Assignor and to whom the property is
transferred is called the Assignee. When assignment is executed, all rights to the title are immediately
transferred to the Assignee and he becomes the owner of the policy subject to the lawful conditions
made in the assignment. An interest in life insurance policy can be assigned freely.
25.4 TYPES OF LIFE INSURANCE POLICIES :
Life insurance is a contract whereby the insurer, in consideration of a premium, undertakes to
pay a certain sum of money either on the death of the insured or on the expiry of a certain number of
years. Companies have devised different policies as per the suitability of persons taking up those policies.
Various life insurance policies can be broadly classified as:
1. On the basis of duration of policy;
2. On the basis of method of paying premium; and
3. On the basis of participation in profits
1. On the Basis of Duration of Policy:
(i) Whole life policies.
(ii) Endowment policies.
(i) Whole Life Policies:
This policy is also called ‘Ordinary Life Policy’. Under this policy the premium is paid throughout
the life of the insured. The payment of the policy is made only after the death of the insured. The insured
will have to pay premium even at the old age when he is not earning anything. The rate of premium is the
lowest under this policy. The following are the whole life policies:

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 (a) Ordinary whole life policy.
(b) Limited payment whole life policy.
(c) Single premium whole life policy.
(d) Convertible whole life policy.
Under ordinary whole life policy the premium is payable throughout the life time of the assured
and the policy money shall be payable after the death of the assured. Under limited payment whole life
policy, the assured is required to pay premium for a fixed period of time or up to the attainment of certain
age or till death. In single premium whole life policy the premium is to be paid in one single installment.
In convertible whole life policy there is a provision of getting this policy converted into endowment policy.
(ii) Endowment Policies:
This policy is taken up for a specific period called ‘endowment policy period’. The policy will
mature at the expiry of a specific period or at the attainment of particular age or on the death of the
insured, whichever is earlier. If a policy is taken up for 10 years, it will mature after 10 years or on the
death of the insured if death occurs earlier. This policy is preferred to whole life policy. The rate of
premium under this policy is little more than in the first policy. There are different types of endowment
policies. Some of the popular policies are:
(a) Pure endowment policy: It provides for payment of the sum assured at the end of a specified term
of years or at the event of death which is earlier.
(b) Ordinary endowment policy: It is a combination of term insurance and pure endowment. It provides
both the family protection and the investment. It is taken for a specified term of years. The sum
assured is payable on the death or at the end of the period.
There are several other types of endowment policies such as joint life endowment policy, double
endowment policy, fixed term endowment policy, educational annuity policy, marriage endowment policy
etc.
(2) On the basis of Method of Paying Premium:
On the basis of payment of premium, the policies may be as follows:
(a) Single premium policy: In this policy the whole premium is paid in the beginning. Such a policy can
suit only a person who has enough money to pay the whole premium at one time. The amount of
premium at one time. The amount of premium will be less as compared to the aggregate premium
paid on annual basis because the insurer can earn additional amount on premium received. This
policy is not taken by more people because they want to pay premium in small amounts at regular
intervals.
(b) Level premium policy: under this policy regular and equal premium is paid at definite intervals. The
amount of premium can be conveniently paid at regular periods. The equal amounts of premium
can be paid monthly, quarterly, half yearly or yearly. The period is decided on the convenience of
the insured.
(3.) On the Basis of Participation in Profits:
The policies on the basis of profits may be without profits and with profits.
(a) Without profit policies: under these policies the insured gets the amount of policy at the time of its
maturity or his nominees are paid the face value of the policy after death. There is no bonus or
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 profit added to the amount of the policy. The rate of premium is generally low on such policies.
These policies are also called non-participating policies.
(b) With profit policies: These are also called participating policies. The holders of these policies are
entitled to share the profit of the insurer. The amount of bonus depends on the profit after deducting
provision for taxes. The policy holders get bonus only if there is profit, in case there are losses
then no bonus will be declared by the company. The amount of bonus is linked to the profitability
of the insurer.
(iii) The Basis of number of Lives Insured:
On the basis of lives insured, these can be classified as single life policy and joint life policy.
(a) Single life policy: Under single life policy only one person is insured. It is not necessary that the
policy should be issued on one’s own life; it may be on others life, but the fact is that only one life
is insured.
(b) Joint life policy: This policy insures two or more lives and the policy amount is payable on the first
death. This is beneficial to husband and wife and partners of a firm.
25.5 TYPES OF INSURANCE:
Insurance can be classified into two broad categories:
Life Insurance; Life insurance is a contract whereby the insurer in consideration of a premium paid
either as lump sum or as periodical installments, undertakes to pay, either on the death of the insured or
on the expiry of specified number of years whichever is earlier, an annuity or a specified amount. For
example, whole-life plans, endowment assurance plans, pension plans, unit linked plan.
Non-Life Insurance: Non-life insurance is a contract whereby the insurer in consideration of a premium
paid by the insured agrees to indemnify him for the financial loss suffered by him, due to an adverse even
which is covered by the terms of the policy.
Non-life insurance may be classified further into 1. General Insurance and 2. Miscellaneous
insurance. Again, depending on the subject-matter, there are four kinds of General insurance:
1. General Insurance:
Marine insurance: Marine insurance is a contract of insurance under which the insurer undertakes to
indemnify the insured, in the manner and to the extent thereby agreed, against marine losses incidental to
marine adventure. For example, loss or damages to the ship, cargo, freight, vessels or any other subject
of a marine adventure. Accordingly, there are various types of marine policies like voyage policies,
valued policies, hull insurance, time policies, cargo insurance, freight insurance, etc.
Fire insurance: Fire insurance is a contract under which the insurer agrees to indemnify the insured, in
return for payment of a premium in lump sum or by installments, losses suffered by him due to destruction
of or damage to the insured property, caused by fire during an agreed period of time.
Personal accident insurance: Personal accident insurance is a contract under which the insurer
undertakes to pay a specified amount of money on the death or disability of the insured on account of an
accident.
Motor vehicle insurance: Under this type of Insurance a personal or commercial vehicle is insured
against loss or damage to the vehicle due to accident or theft, personal injury or death of the owner or
passenger due to accident or damages payable to third parties by the owner of the vehicle for accidents.

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2. Miscellaneous Insurance:
Non-Life Insurance, in addition to general insurance includes other miscellaneous insurance.
Some of the types of miscellaneous insurance are discussed here:
Fidelity guarantee insurance: This is the type of contract of insurance and also a contract of
guarantee to which general principles of insurance apply. Fidelity guarantee does not mean the guarantee
of the employee’s honesty. But it guarantees the employer for any damages or loss resulting from the
employee’s dishonesty or disloyalty.
Crop insurance: a contract of crop insurance is a contract to provide a measure of financial support to
farmers in the event of a crop failure due to drought or floods.
Burglary insurance: A burglary policy provides protection against loss or damage caused by theft, larceny,
burglary, housebreaking and acts of such nature.
Cattle insurance: Cattle insurance is a contract of insurance whereby a sum of money is secured to the
insured in the event of death of animals like bulls, buffaloes, cows and heifers.
Cash in transit insurance: This type of insurance compensates the insured against loss of money or cash
stolen from his business premises or while it is being carried from or to the bank.
The following chart portrays the classification of insurance.
Types of insurance

Life insurance Non-life insurance

General insurance Miscellaneous insurance

* Marine insurance * Fidelity guarantee insurance
* Fire insurance * Crop insurance
* Personal accident insurance * Burglary insurance
* Motor vehicle insurance * Cattle insurance
* Cash in transit insurance

25.6 SUMMARY:
The lesson explains the concept of life insurance principles and types of life insurance policies
besides the broad types of insurance. Life insurance is a contract that pledges payment of an amount to
the person assured (or his nominee) on the occurrence of the event insured against. The contract is valid
for payment of the insured amount during:
• The date of maturity, or specified dates at periodic intervals, or
• Unfortunate death, if it occurs earlier.
Among other things, the contract also provides for the payment of a premium Periodically, to the
insurer, by the policy holder. Life insurance is advantageous to the policy holder (insured) in a number
of ways. It is an aid to saving and thrift. It provides liquidity as loans can be raised against the policy as
security. Tax exemptions and savings can be availed under section 80 c of the Income Tax Act.
The main principles are features of the life insurance contract are:
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 1. It is a general contract
2. It involves insurable interest
3. It is in utmost good faith
4. The policy can be assigned
5. It cannot be paid against suicide of the policy holder.
There are different types of life insurance policies. These are broadly whole life policies and
endowment policies, single premium policies and level premium policies, single life policies and joint life
policies.
If we take the insurance in general there are different types of insurance. These include life
insurance and Non-life insurance. General insurance is the most significant in the Non-life insurance
category. The general insurance includes Marine insurance, Fire insurance, personal accident insurance
and Motor vehicle insurance.
25.7 SELF ASSESSMENT QUESTIONS:
1. What is life insurance? Explain the legal principles or features of life insurance.
2. Give an account of the different types of life insurance policies.
3. What is Insurance? Explain different types of insurance.
Short Notes:
Uberrimae Fedai
Insurable Interest
Surrender value
Endowment policy
25.8 SUGGESTED READINGS:
1. Palande, P.S. et.al, Insurance in India: Changing Policies and Emerging opportunities, Sage publication,
New Delhi.
2. Jyotsna Sethi and Nishwan Bhatia, Elements of Banking and Insurance, Prentice Hall of India
Limited, New Delhi.
25.9 KEY TERMS:
Surrender value : Surrender value is the amount paid to the insured by the Insurer at the time of
surrendering the policy.
Indemnity : Compensation for the actual loss not exceeding the amount of Policy.

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 Lesson No: 26

INSURANCE POLICY – ISSUE PROCEDURE, SUM

ASSURED AND NOMINATION FACILITY

STRUCTURE:
26.1 Insurance Policy – A Conceptual Focus
26.2 Procedure For Issue Of Life Insurance Policy
26.3 Sum Assured-meaning
26.4 Nomination-the Concept And Meaning
26.5 Mode Of Nomination
26.6 Change Or Cancellation Of Nomination
26.7 Who Can Be A Nominee?
26.8 Summary
26.9 Self Assessment Questions
26.10 Suggested Readings
26.11 Key Terms

OBJECTIVE :
After reading the lesson thoroughly you can understand the procedure for the issue of Insurance
Policy and the concept of Sum Assured. You can be in a position to explain the Nomination facility of an
insurance policy and the issues and intricacies involved in Nomination of a policy.
26.1 INSURANCE POLICY – A CONCEPTUAL FOCUS:
The Insurance Act, 1938, defines life insurance business as the business of effecting contracts
of insurance upon human life, including any contract whereby the payment of money is assured on death
(except death by accident only) or the happening of any event insured by the contract. In other words,
a life insurance contract is a contract in which the insurer in consideration of a certain premium either in
lump sum or other periodical payments, agrees to pay to the assured or to the person for whose benefits
the policy is taken, an agreed sum of money on the death of the insured or on the expiry of a specified
period of time, whichever is earlier. Thus, under a whole-life assurance, the policy money is payable at
the death of the assured and under an endowment policy, the money is payable on the maturity of the
policy or on his death, in case if that occurs earlier. In case of life insurance the payment is certain.
Insurance policy is a contract document between the insured and the insurer. Life insurance deals
with the risk of the insured’s life. Life insurance is a contract is not a contract of indemnity. Therefore,
a definite sum is paid at the death or maturity of the policy.
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 The types of insurance policies are mentioned in the earlier chapter. However, for a recap the
types of policies are stated here. There are different types of Insurance Policies to cater to the needs of
different customers. These include whole life insurance policy, limited payment life policy. Convertible
whole life policy, endowment policy. Term or short period insurance policies. The document setting out
the contract for Life Insurance is called ‘POLICY’ and the ‘Policy’ contains the conditions upon which
the assurance is granted. The ‘Policies’ are now printed in Schedule form an account of many advantages.
The matter on the face of the policy can be divided into six sections as follows.
1. Heading 2. Preamble 3. Operative Clause 4. Proviso 5. Schedule and 6. Attestation.
The conditions and privileges are printed on the back of the ‘Policy’ and some blank space is left
on the back to facilitate subsequent endorsements to be placed thereon such nomination/assignment etc.
26.2 PROCEDURE FOR ISSUE OF LIFE INSURANCE POLI CY:
Life insurance policies of different types are the products of life insurance business. Life insurance
products have customarily been marketed through insurance agents and these insurance agents have
proved to be highly successful s means of distribution of insurance products. Insurance companies insist
on forming an efficient, well trained team of agents who would be able to draw the attention of their
prospective clients towards their own and their family’s financial security and propose suitable policies
for their requirements. The intensified use of the electronic media has altered the manner in which the
agents interact with their clients. Insurance agents may also be able to get many new customers through
referrals. The insurance companies obviously rely on their agents for the growth of their business. The
success of the insurance agent in affecting an insurance policy would depend on the personal qualities of
the agent like confidence, discipline, willingness to work hard, problem-solving ability, communicative
skills, leadership qualities, etc.
Though international insurance players look at internet as the best distribution channel and are
spending huge amounts on developing business strategies with the use of internet hoping that it will bring
in huge cost savings. They cannot undermine the contribution of the traditional agent in ensuring regular
business. The traditional agent will continue to dominate the insurance scene because the generally
complex insurance products require personal meetings and discussions with the prospective customers.
Moreover, the reason for buying insurance itself has undergone a radical change. Earlier, premature
death used to be the main motivation behind life insurance. But today, the risk of ‘living too long without
visible means of support’ is the real motivator. Consequently, people cautiously plan their retirement
savings and wealth management products, for which they have to depend on the advice of insurance
agents. In fact, the agent’s role has widened.
Procedure in Brief:
The procedure for issue of an insurance policy must be systematic with database of the policy
holder. Because legalities are involved as insurance is a contract between the insurer and the insured. A
contract of insurance has to be in the document form. Thus, the first step in the process of issue of
insurance policy involves the written proposal made by the potential insured (also known as the proposer)
in a prescribed application form issued by insurance companies. After selecting a policy, the proposer is
required to provide information about income, age and health. Where the terms of the policy so require,
the agent also sends the insured’s medical examination report in confidence, to the insurance company.
Normally, the agent or the development officer does preliminary underwriting. The agent or the development
officer, as the case may be, sends a report to the company, giving details about the financial position of
the proposer besides defining the need and adequacy of insurance for the proposer. The information
gathered by the agent/development officer from his personal sources or inquiries is also included in the
report along with the information supplied by the proposer. The insurance company then conducts a
detailed scrutiny of the documents that are submitted to it.
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Proposal Form – the extract of Material information:
Proposal form issued by the company is used for making an application for the requisite insurance
policy. The proposal form contains queries intended to extract all material information. In marine cargo
insurance, proposal forms are not generally required. Instead, a questionnaire or a declaration form, duly
completed may be asked for. In fire insurance, the procedure varies among the companies. Generally,
proposal forms are used only in cases involving simple risks and are not required in cases of large
industrial risks. For such cases, inspection of the risk is essentially undertaken before acceptance of the
proposal. In miscellaneous insurance, proposal forms are essentially required and they include a declaration,
in accordance with the general principles of good faith.
Proposal forms generally contain the following items:
(i) Name of the proposer (in full)
(ii) Address of the proposer
(iii) Profession, occupation or business of the proposer
(iv) Particulars of previous and present insurance
(v) Loss experience
(vi) Sum insured
(vii) Other sections-signature, date, place, etc.
The proposal form must be accompanied with – (i) a valid proof of age, and (ii) medical report.
The significance of these documents is discussed hereinafter.
Age is the main basis of calculation of premium on life insurance policies. Since, old age people
have high probability of dying than the younger ones; premium is calculated on the basis of age groups.
In other words, the rate of premium varies with the age of the life assured at the time of taking out a
policy.
Where the age of the insured is high or the first level examination carries some adverse remarks,
the insurer may refer the proposal for a thorough medical examination, particularly when the amount of
insurance is also very high. According to section 45 of the Insurance Act, 1938, the policy shall be
declared void and all claims in respect of it shall cease in case of any untrue or incorrect statement
contained in the proposal, personal statement, declaration and other documents or in the case of concealment
of any material information. After a thorough scrutiny and satisfaction of the insurer the policy is issued.
Initially the insurance company issues the first premium receipt after the insured has paid the
first installment of premium. This receipt is an acknowledgement of the proposal and contains all the
particulars of the policy. And finally a Policy Bond is issued. A policy form/bond is an evidence of the
contract of insurance. Different policy forms are used for different classes of insurance. A policy bond
must be duly executed and stamped in compliance with provisions of the Indian Stamp Act, 1899.
26.3 SUM ASSURED – MEANING:
Life insurance is a contract by which the insurer, in consideration for the payment of premium,
undertakes to pay a certain sum of money either on the death of the insured or on the expiry of a fixed
period. Life insurance contract is not a contract of indemnity. Therefore, a definite sum is paid at the
death or on the maturity of the policy.
Sum assured simply means the minimum amount payable to insured person or his nominee when
the situation of claim arises or the policy matures.
Sum assured is the amount of cover provided on an insurance policy. This amount is paid out in
the event of a valid claim. It is usually used in reference to life insurance and critical illness policies.
Thus the sum assured is the amount or cover one has or the amount the policy will pay out when one dies.
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 Amount of sum assured depends on the profile of a person taking insurance. It is determined at
the option of the insured depending upon the factors like 1. Age of the insured 2. Income of insured 3.
dependents of insured 4. future requirements of the family of insured etc.
Sum assured in general shall be such that the family of assured can leave in same conditions with
the help of the amount received in case of death of insured person. As a thumb rule sum assured shall be
at least 8 to 10 times of the annual income of the insured.
26.4 NOMINATION – THE CONCEPT AND MEANING:
There are two ways by which a policy holder can ensure that on the claim arising by death, the
policy moneys could be paid without requiring production of a succession certificate or letters of
administration. The two methods are to make either an assignment or a nomination.
Nomination is the process whereby a person so named in the policy becomes entitled to receive
the policy amount in the event of the death of the policyholder. Section 39 of the Insurance Act, 1938
governs nomination of an insurance policy. Accordingly, nomination may be done at the time of
commencement of the policy by giving particulars of the nominee in the proposal form. It may even be
done later by giving notice in a prescribed form to the insurer and endorsing it on the policy bond.
The policy holder can similarly change nomination any number of times during the term of the
policy. The right to nominate, vests only with a policyholder; that too on a policy covering his own life.
Nomination notified to the insurance company should be registered by it in its records. Nomination does
not confer any right on the nominee if the policyholder is alive but if he dies before the policy expires, the
nominee would be legally recognized as the person entitled to the payment of the policy amount. Death
of the nominee would lead to automatic revocation of the nomination. Nomination, however, is not
allowed in the case of children’s policies, until the child attains majority. In case of other policies where
the nominee is a minor, an appointee has to be appointed to receive the policy amount in the event of the
policyholder’s death. No nomination is allowed under a policy financed from HUF funds.
26.5 MODE OF NOMINATION:
“Nomination” is a provision according to the Section 39 of Insurance Act, 1938. The effect of
‘Nomination’ is that the nominee is statutorily recognized as a payee who can give a valid discharge to
the Life Insurance Corporation for payment of policy money. Nomination is a right conferred to the
‘holder of a policy of Life Assurance on his own life” to appoint a person or persons to receive the policy
moneys in the event of the policy becoming a claim by the assureds death during the term of the policy.
Nomination does not take away from the life assured the power of disposal, with the result that the policy,
not with standing its nomination, remains the property of the life assured at his absolute disposal during
his life time, the moneys payable under the policy in the event of the policy becoming a claim by reason
of the assureds death.
Therefore the ‘Nomination’ may be cancelled or changed in favor of another person by the Life
Assured whenever he likes and this he can do without the concurrence or consent of the nominee.
In view of the above effect of the nomination, payment of policy moneys will be paid to the assured
himself inspite of the nomination. Likewise, if the assured dies after the date of maturity but before
receiving the policy moneys, it the heirs of the assured who would be paid the money but not the nominee.
“Nomination’ is effective only in India and similar enactments exist in Pakistan, Fiji and Ceylon.
The nomination may be affected by mentioning the name or names persons as nominees in the
proposal form itself in which case it will be incorporated in the text of the policy. If it is not done in the
proposal and nomination is intended to be done after the issue of the policy, the same could be done by
endorsement on the policy itself. If there is no blank space in the policy the said endorsement can be
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done on a piece of paper and pasted on the policy. After effecting such endorsement the policy containing
such endorsement should be send to LIC for registration. Only when it is registered in the books of the
Corporation, the nomination will be valid. In other words, if nomination endorsed on the policy, but not
communicated and registered policy moneys would be paid to the heirs of the assured and not to the
person endorsed as nominee.
26.6 CHANGE OR CANCELLATION OF NOMINATION:
Nomination once affected on the policy can be cancelled or changed in favor of another person
by the assured. Such change can be affected by an endorsement on the policy mentioning the name of
the person now nominated specifically mentioning in lieu of ‘so and so’ already nominated. The policy
with such endorsement of change of nomination should be forwarded to LIC along with a separate
‘Notice’ addressed to LIC for registration of the change or cancellation. Such notice is to be given by the
insured himself or his duly authorized agent. Notice given by the nominee will not be valid.
Cancellation of Nomination by will: For nomination to be cancelled by ‘will’ the cancellation may
be either by express words or implied. Eg. By a gift of the policy moneys to another party. A will
purporting to provide for the bequest of the estate generally to any party other then the nominee would
not tent amount to cancellation or change of nomination. It is important, therefore that for a ‘will’ to
cancel a nomination there must be either by an express clause therein canceling the nomination specifically
or else there must be bequest of the same policy by full identification to a party other then the nominee.
26.7 WHO CAN BE A NOMINEE?
(i) Any person can be nominated: He need not be related to the assured according to the provisions
of Insurance Act. However, if a stranger is nominated, to safe guard the provisions of Section
30 of Indian contract according to which there should exist insurable interest in the beneficiary,
enquiry should be made so as to ascertain the purpose of insurance. This in other words is to
safe guard against the possible Moral Hazard.
(ii) Several Nominees: Where there are more on nominee, the policy moneys shall be payable to the
nominees/nominee who survives the assured. This means that the nomination specifying shares
amongst several nominees is not valid.
(iii) Nomination under Joint Life Policy: A nomination under a Joint life policy can only be a Joint
Nomination and would be useful only if both the lives assured die simultaneously in a common
calamity.
(iv) Nomination in favor of Wife & Children ‘as a Clause’: The question of the validity of nomination
in favor of wife and children ‘as a clause’ is not free from doubt since the expression ‘wife and
children’ is vague. It would mean that such wife and/or children as would be in existence at the
death of the assured. It is necessary to have proof for the same and the only proof that so & so
is wife/child is to be obtained from court. Where such nomination is contemplated better course
will be to mention the names of existing wife and children.
(v) Successive Nominees: Where it is stipulated that the policy moneys should be paid to ‘Nominee’A’
failing him Nominee ‘B’ failing him Nominee ‘C’ etc., such nomination would in fact, be in favor
of one individual only in the order mentioned.
(vi) Nomination in Favor of Minor: If a minor is nominated, even in case of death of the assured
during the term of the policy, the policy moneys will not be paid to the minor nominee during the
period of minority is., until the nominee attains majority, the amount will be held up with LIC. To
obviate this difficult by the same Section 39 of Insurance Act, 1938, an “Appointee’ to receive
the policy moneys in the event of the death of the life assured during the minority of the nominee
can be appointed either by stating so while ensuring appropriate question in the proposal or by an
endorsement on the policy, duly registered with LIC. Such appointed will have authority only to
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 receive the policy moneys, but do not have powers like a guardian. This provision is valid in India
and Fiji but not in Pakistan and Ceylon.
26.8 SUMMARY:
The lesson focused on the concept of Insurance Policy, sum assured and nomination facility and
its facets. The procedure for issuing an insurance policy is also simply explained. It could be understood
that an insurance policy is a contract between the insured and the insurer. It is for a specified sum
assured in the case of life insurance and critical care illness. Sum assured is to amount of cover
provided on an insurance policy. This amount is paid out in the event of a valid claim and is usually used
in reference to life insurance and critical care illness. The sum assured generally depends upon the
factors like the age, income, number of dependents and future requirement of the insured.
In the issue of a policy the Insurance agents play an intermediary role between the insured and
the insurer. The proposal form containing the material information of the intending policy holder or the
proposer is submitted to the insurer upon scrutiny and satisfaction of the insurer and on payment of the
first premium amount, the first Premium Receipt and then the Policy Bond is issued.
Section 39 of the Insurance Act 1938 governs the nomination of an insurance policy. Nomination
is the process whereby a person so named in the policy becomes entitled to receive the policy amount in
the event of death of the policyholder. Nomination is a facility in the case of life insurance policy. The
nomination can be affected by mentioning the name or the names of the persons as nominees in the
proposal form itself in which case it is incorporated in the text of the policy. Otherwise nomination can
be made subsequently when the policy is in operation. Nomination can be cancelled or changed in favor
of other person.
26.9 SELF ASSESSMENT QUESTIONS:
1. What is an Insurance Policy? Explain the procedure involved in the Issue of an Insurance Policy.
2. What is Nomination of an Insurance Policy? Explain various facets of nomination.
Short Notes:
Sum Assured
Nomination in favor of Minor
Cancellation of Nomination
26.10 SUGGESTED READINGS:
1. R.M. Ray, Life Insurance in India – Its history, law, practice and problems, books google.co.in.
2. H. Sadhak, Life Insurance in India: Opportunities, Challenges and Strategies, books.google.co.in.
3. Dr. C. Satyavathi Devi, Financial Services, Banking & Insurance, S. Chand & Company, New
Delhi.
26.11 KEY TERMS:
Assignment : An Assignment is an instrument whereby the beneficial interest, title and right under a
policy is transferred either absolutely or or conditionally by one person to another person.
Insured : The person whose life is covered by a policy of insurance.
Proposal Form : Prescribed form issued by the insurance company duly executed for securing an
insurance policy.
Consideration : Price for which the Promise of the other is bought and the promise thus obtained is
legally enforceable.
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 Lesson No: 27

SURRENDER VALUE, LAPSE AND

REVIVAL OF POLICY

STRUCTURE :
27.1 Surrender Value
27.2 Approaches To Surrender Value
27.3 Determination of Surrender Value
27.4 Modes of Settlement
27.5 Lapse And Revival of The Policy
27.6 Types of Revival
27.7 Summary
27.8 Self Assessment Questions
27.9 Suggested Reaadings
27.10 Key Terms

OBJECTIVE :
After going through you can understand the concepts of surrender value, lapse and revival of
policy. You will be able to explain the implications and the issues involved in policy surrender, lapse and
revival.
27.1 SURRENDER VALUE:
Under the contract of Insurance policy the insurer pays the premium till the end of stipulated
period as per the terms and conditions. The insurer pools up the premiums paid and adds bonus to pay
the sum assured plus bonus at the end of the policy period or on the unfortunate death of the insured. But
sometimes the policy holder may surrender the policy and discontinue the insurance contract. It may be
out of need or inability to pay the premium. Then the policy holder gets some amount. Thus, surrender
value is the cash value of the policy that is payable by the insurance company if the policy contract is
voluntarily terminated before the expiry of the term of the policy by the insured. LIC of India allows
surrender of the policy only after premiums have been paid for at least three years. According to Sub
Section (1) of Sec. 113 of Insurance Act 1938, a policy of insurance under which premiums have been
paid for at least 3 consecutive years and a policy issued by a Provident Society, Premium where under
have been paid for at least 5 years, will be eligible for surrender value, to which will be added cash value
of Bonus, if any. The surrender value is the amount paid to the insured by the insurer at the time of
surrendering the policy. In general the insurance company does not pay surrender value if the policy
lapses within two or three years of its issue. The reason is that the company may incur loss because to
launch a policy it involves initial expenditure.
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 If the policy holder, so desires, can reinstate the surrendered life policy within six months from
the date of surrender. However, for reinstatement of the surrendered policy the surrender value received
must be repaid with cumulative interest at 10.5 per cent and certificate of evidence of health (Medical
certification) should be produced.
27.2 APPROACHES TO SURRENDER VALUE:
On surrender of the policy the insurer does not pay all the reserves of premium and bonus or
profits accumulated in the name of the policy holder. The expenses incurred or associated with policy
launching, maintenance and surrender are deducted in calculating surrender value. Otherwise the insurer
has to lose. There are two approaches in the determination of surrender value. These are 1. Accumulation
Approach and 2. Savings Approach.
1. Accumulation Approach: Under accumulation approach, net premium is considered for
calculation of surrender value. After surrender of the policy, the insurer need not pay the amount
of claims. Therefore he can pay the accumulated reserve after making a small amount of deductions
to meet expenses. This method considers the reserve as the basis of surrender values. The
reserve is calculated on gross premium. So the expenses are to be deducted from the reserve.
The reserve consists of premium paid and interest earned. From this amount the insurer deducts
overall expenses.
2. Saving Approach: If the policy holder continues to hold it and pay premium, the insurer is
responsible to pay the claims if they arise at any time. But when the policy is surrendered, the
insurer need not pay the sum insured by the policy holder. He is relieved from that responsibility.
He is in a position to save something due to non-payment of claims. Thus he can return thee
surrender value to the policy holder. Under this method, the surrender value is paid in lieu of the
claim amount. But surrender of policy curtails future income to the insurer. To that extent it is a
burden to him and also incurs loss at the time of surrender. Surrender value will be paid partly at
the time of surrender. At the time of maturity or death of the policy holder, the balance will be paid.
27.3 DETERMINATION OF SURRENDER VALUE:
The method of calculating surrender value varies from company to company but generally, it is
restricted to the amount of premiums paid up to the time of surrender, along with attached bonuses, if
any. Surrender value would also depend upon the remaining duration of the policy and duration of the
policy that has already elapsed on the date of surrender. Duration elapsed under the policy is the time
gap between date of surrender and date of commencement of the policy as rounded off to the nearest
‘half-year’. The final calculation of the surrender value is based on the appropriate surrender value
factor per Rs. 100 paid-up value, in relation to the plan, duration elapsed and original term of the policy.
The paid-up value too is proportional to the number of years the premium has been paid but the paid-up
value is much more than the surrender value. If the policy is turned into paid-up, the amount receivable
would be much more than the surrender value. Moreover, no further premiums would be payable by the
insured. However, the amount would not be payable by the insurer immediately. Rather payment would
become due only on the maturity of the policy or on the death of the insured during the term of the policy.
Surrender Value (SV) =
Paid-up value (inclusive of vested bonus, if any) x Surrender Value Factor
____________________________________________________________
100
Where,

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 Paid-up Value = Number of years’ premium paid x Sum assured
_____________________________________________________
Number of years’ premium payable
For example , if the sum assured for a policy is Rs. 5,00,000, plan and term of the policy is
endowment policy (with profits), for 20 years; mode of payment of premium is half-yearly; the date of
commencement of the policy is 01.01.1994; due date of last premium paid is 01.03.2006; the date of
calculation of surrender value is 1.3.2006 and accumulated vested bonus is Rs. 3,85,000, then the surrender
value and the paid-up value in respect of the policy would be calculated as follows:
Number of years’ premium paid (N) = (01.01.2006 – 01.01.1994)
= 12 years
Term of the policy (T)= 20 years
12
Paid-up Value (PV) =____ X 5, 00,000 = Rs. 3, 00,000
20
Bonus = Rs. 3, 85,000
Then
Paid-up value (including vested bonus)
= Paid-up Value + Vested bonus
= Rs. 3, 00,000 + Rs. 3, 85,000 = Rs. 6, 85,000
And,
Paid-up Value X SV Factor
Surrender Value = ______________________
100
27.4 MODES OF SETTLEMENT :
The surrender value may be paid or settled in favor of the insured in different modes. These are as
below:
(a) Surrender value may be paid in the form of cash. This is advantageous to the policy holder.
(b) Net value of surrender may be used for payment of single premium for purchase of another new
term insurance. Total amount assured will be paid on the event of death of the policy holder. This
is not useful to the policy holder because he will not get any cash.
(c) Surrender value may be used for the payment of future premium. Thus the policy will continue up
to a period where the surrender value is adequate to pay the premium. The premium is continued
until the surrender value is completely exhausted. If the policy holder dies, he will get full amount.
(d) The policy holder can purchase annuity by using the surrender value.
27.5 LAPSE AND REVIVAL OF THE POLICY:
A Life Insurance policy stays valid only when the policy holder pays the premium regularly. Due
to different reasons, the policy holder may not pay the premium for sometime. In such a case the

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Insurance Company sends reminders for premium payment. If the premium is not paid the policy
automatically stands lapsed or out of current. Generally a policy lapses it the installment of premium is
not paid within the grace period. The grace period is usually 15 days in the case of monthly payments
and not less than 30 days in the case of other modes.
Lapse is the period from the date of the first unpaid premium. If the policy lapses the policy
holder can revive the policy by giving a new life to the policy. Lapsed policy can be revived during the life
time of the life time of the life assured but before the maturity date.
Revival is giving new life to the lapsed policy. But it is a fresh contract (Novatio) which gives the
right to the insurer to impose fresh terms and conditions.
27.6 TYPES OF REVIVAL:
There are different ways or modes to get the policy revived. These are as follows.
1. Ordinary Revival
2. Special Revival
3. Revival by installments
4. Loan cum Revival
5. Survival benefit cum Revival
1. Ordinary Revival: Where the policy is revived within 6 months from the date when the first
unpaid premium became actually due, the policy is revived as ordinary revival on payment of
delayed premiums along with interest. The rate of interest would depend on the date of
commencement of the policy. The policy holder is not required to submit a personal statement
regarding health in this case. Where the revival of the policy is done on non-medical basis, the
amount to be revived cannot exceed the prescribed limit for non-medical assurance and where it is
done on medical basis the required medical requirements, varying with the amount to be revived
must be fulfilled. For revival of a policy on Non Medical basis it should inter-alia be seen that not
only does the ‘amount to be revived’ (i.e. sum Assured less the paid up value as on the date of
lapse) not exceed the prescribed limit, but also that no other policy or policies on the life of the
assured issued on Non-medical basis are in force for a total assurance exceeding the limit.
2. Special Revival: Revival of the policy if the period of lapse is from 6 months to 3 years is called
special revival. This done generally after production satisfactory evidence of good health. Other
conditions should also be satisfied for special revival. These are 1. the policy should not have
acquired surrender value on the date of lapse and 2. the policy should not have been revived
earlier.
3. Revival by installments: In the case of policy lapse for more than one year, the policy may be
revived on payment of installments with interest. But there should not be any loan on the policy
4. Loan cum Revival: In the case loan cum revival the lapsed policy is deemed to be in force as on
date and a loan is granted for an eligible amount. The installments, along with interest which are
due to the date, are deducted from the loan amount. The remaining amount of loan is paid to the
policy holder. Thus the policy is revived and comes to force.
5. Survival Benefit payment cum Revival: This mode of revival is applicable in the case of
money back policies. If the money back policy stands lapsed the policy can be revived through the
money paid back by the insured. From the amount of money to be paid back to the insured the due
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 installments will be deducted along with interest and the balance amount will be paid back to the
policy holder i.e. insured. Thus the lapse policy is revived.
27.7 SUMMARY:
The lesson focused on the concept of surrender value, policy lapse and Revival of the policy.
Generally the insured pays the premium on the policy till the end of the policy period to get the sum
assured. But if needed the policy may be surrendered intermittently where by the insurance company
pays some amount of money for which the insured is eligible for payment on the occasion of surrender of
the policy is called Surrender value. There are two approaches to thee determination of Surrender
Value. These are 1. Accumulation approach 2. Savings approach. On surrender of the policy the insurer
does not pay all the reserves of premium, bonus or profits accumulated on the policy. The expenses
associated with the policy are deducted.
Sometimes due to the non-payment of the due installments the policy stands out of force. This is
called lapse of the policy. A lapsed policy can be revived by giving a new life to the policy. This is called
revival. On revival the lapsed policy comes into force. There are different types of revival. These
include 1. Ordinary revival which may be on medical basis or non-medical basis, 2. Special revival 3.
revival by installments 4. Loan cum revival and 5. Survival benefit payment cum revival.
27.8 SELF ASSESSMENT QUESTIONS:
1. What is Surrender Value? Explain the approaches to surrender Value.
2. What is revival? Explain the modes or types of revival of policy.
Short Notes:
Lapse
Surrender Value
27.9 SUGGESTED READINGS:
1. R.M. Ray, Life Insurance in India – its History, Law, Practice and problems, Mc Graw Hill Publishers,
new Delhi
2. H. Sadhak, Life Insurance in India: Opportunities, Challenges and Strategies, Unique publishers,
Mumbai
3. Jean Francois Outerville, theory and practice of Insurance books, Google.co.in.
27.10 KEY TERMS:
Grace period : The period allowed after the due date for payment of the Premium and during which the
policy remains in force.
Premium : The amount of money or consideration paid periodically to the Insurance company for any
insurance coverage.
Money back Policy : A policy that provides for periodic payments of partial Survival benefits during the
term of the policy so long as the Policy holder is alive.

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 Lesson No: 28

POLICY ASSIGNMENT, LOAN ON POLICY BOND

AND POLICY SETTLEMENT PROCEDURE

STRUCTURE:
28.1 Assignment – Meaaning
28.2 Kinds Of Assignment
28.3 Essential Conditions Of Policy Assignment
28.4 Loan On Policy Bond
28.5 Procedure Of Policy Settlement
28.6 Summary
28.7 Self Assessment Questions
28.8 Suggested Readings
28.9 Key Terms

OBJECTIVE:
A thorough reading of the lesson helps you understand the concept and significance of policy
assignment. In addition you can learn how loan can be raised on Policy Bond you will also be able to
explain the procedure of policy settlement.
28.1 ASSIGNMENT-MEANING:
The claim on a life insurance policy arises either on Maturity or on the death of a policy holder.
In the case of the death the policy money could be paid only on the production of a succession certificate
or a letter of administration. But, without the need for such documents, a policy holder can ensure the
payment of claim by two methods. These methods are 1. Nomination and 2. Assignment.
Nomination is the process whereby a person so named in the policy becomes entitled to receive
the policy amount in the event of the death of the policy holder. Section 39 of the Insurance Act, 1938
governs nomination of an insurance policy.
An assignment of a policy may be defined as an instrument whereby the beneficial interest, title
and right under a policy is transferred either absolutely or conditionally by one person to another person.
Thus, it is a method by which one living person who is entitled to transferable interest in a policy conveys
it to another living person or to himself and another living person/s. The assignor forgoes all his rights,
title and interest in the policy to the assignee immediately on execution of assignment in favor of the
assignee. Section 38 of the Insurance Act, 1938 governs assignment of a life insurance policy. The
assignor, being a major, either by endorsement on the policy or by a separate duly stamped Deed, can
make assignment. This may be done out of feelings of love affection or emotions or even for financial
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consideration. Assignment must be made in writing under the signature of the assignor, which should be
witnessed by a person. Notice of assignment is required to be submitted to the insurance company.
28.2 KINDS OF ASSIGNMENT:
Assignment is of two types. It may be 1. Absolute or 2. Conditional.
1. Absolute Assignment: Absolute assignment is full and irreversible assignment. An assignment
once legally made cannot be cancelled. If necessary, it can be done only by another legally valid
assignment. The assignor’s rights, title and beneficial interest that he has in the policy gets transferred
to the assignee without any possibility of reversion. Absolute assignment is usually done for
valuable consideration. In case of absolute assignment the assignee however, has the right to
reassign the policy. He also has a right to sue under thee policy. Assignment of the policy results
in automatic cancellation of a prior nomination unless of course, the policy is assigned to the
insurer for loan, etc.
The basic difference is under conditional assignment, if the assignee dies, the benefit under
the policy goes back to the policy holder or to his nominee, if the policy holder has died. On the
other hand, the policy benefits get passed on to the legal representatives of the deceased assignee
in case of absolute assignment.
2. Conditional Assignment: Under conditional assignment, the assignor and the assignee may
agree to suspend or revoke the assignment, either wholly or partially, on the happening of a specified
event provided the event does not depend on the will of the assignor. Conditional assignment is
typically effected out of feelings of natural love and affection and not for monetary consideration.
Under conditional assignment the policy will revert to the assured in the event of his surviving the
maturity date or on the death of the assignee. These assignments are generally executed in favor
of wife and/or children of life assured.
28.3 ESSENTIAL CONDITIONS OF POLICY ASSIGNMENT:
For the validity of the Life Insurance Policy Assignment the following essential conditions are to be
satisfied.
(i) The assignor must have an absolute right and title i.e., assignable interest in it at the time of
execution.
(ii) The assignor must be a major and competent to contract
(iii) The assignee must not be subject to any legal disqualification
(iv) The assignment must be supported by valuable consideration except when consideration is natural
love and affection n exist among kith and kin.
(v) The assignment must not be opposed to any law for the time being in force in the country.
(vi) The assignment must be in writing and must specifically set forth the fact of transfer of policy of
the assignor’s title and interest in it is in favor of the assignee.
(vii) The assignor must affix his signature to the assignment
(viii) The assignor’s signature to the assignment must be attested by at least one witness.
28.4 LOAN ON POLICY BOND:
Insurance is a contract between the insurer and the insured. As evidence the insurance company
i.e. the insurer issues a policy bond. An insurance policy bond is an evidence of the contract of insurance.
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A policy bond is duly executed and stamped in compliance with the provisions of the Indian Stamp Act
1899. On maturity of the policy or death of the insured, the insurance company pays the sum assured
and the bonus accrued on the policy subject to conditions.
When the policy is in operation the policy holder can get loan against the policy bond either from
the life insurance company or the financial institutions like banks. The Insurance Company thus offers
the services to customers by providing loans besides insuring the life.
28.4.1 Procedure and salient features of loan on policy bond: The insurance companies offer loans
on certain policies. Some insurance plans are not eligible for loan. For example, loans are not available
against plans for children plans, special plans like Jeevan Griha; deferred annuity/pension plans and
money back plans. For initiating loan on policy bond, an application on a prescribed form, duly completed
is required to be submitted by the policyholder to the insurance company along with the policy bond. The
loan amount however, is calculated on the basis of the policy’s surrender value. The maximum loan
amount granted by the insurance companies may vary. For instance, LIC of India grants a maximum
loan amount of up to 90 per cent under a policy. However, in case of paid-up policies, it is 85 per cent of
the surrender value of the policy including cash value of bonus.
The rate of interest charged on loans taken on insurance policies and the terms and conditions
of repayment too vary from company to company and from time to time. For instance, LIC of India
provides for a minimum repayment of Rs. 50 followed by multiples of Rs. 10. Moreover, loan is granted
for a minimum period of six months from the fate of its payment.
If claim on the policy accrues due to maturity of the policy or death of the policy holder within
six months from the date of loan, interest will be charged only upto the date of maturity or death, as the
case may be. The amount of loan plus interest thereon, if any, is deducted from the claim amount payable
by the insurance company, if the loan amount is not repaid during the term of the policy and the claimant
would be paid only the balance amount. LIC of India provides for charging of interest on compound
interest basis in case if the interest is not paid regularly, every half-year. If the premiums are not paid
regularly, that is, if the policy is not kept in force, there is a possibility that the loan amount along with
accrued interest would exceed the surrender value inviting action of foreclosure against the policy.
28.4.2 Advantages of loan on Policy Bond: The facility of loans as policy bonds is advantageous to
the insurance company as well as policy holders in the following ways.
(a) Loan facility on policy bond is a customer service offered to the policy holder.
(b) It is easy to obtain loan on policy bond.
(c) It is convenient to raise loan on policy bond. It does not involve any documentation and procedural
complexities.
(d) Repayment is not burden some as in the case of bank loans because the loan on policy bond can be
realized on maturity through the proceeds of the policy.
(e) The loan facility on policy bond attracts customers and improves market base.
(f) The LIC can generate additional resources through interest on loans.
(g) Default risk or credit risk is not involved in the case of loan on policy bond as only 85 to 90 per cent
of the surrender value of the policy is granted as loan.
28.5 PROCEDURE OF POLICY SETTLEMENT:
Claim settlement on Life Insurance Policy is end of the policy contract. There are different
requirements for settlement of claims on policy.
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 The life insurance claims can be classified into two categories: (i) maturity claims, and (ii)
Death claims. The procedure involved in settlement of claims in these cases is as follows:
(i) Maturity claims: Payment of maturity claims is made in accordance with the terms and conditions
of the policy. Life insurance policies are generally endowment policies including money back
policies. These policies have predetermined date of maturity, which is shown in the policy bond.
The amount payable at the time of maturity includes sum assured and bonuses payable on the
policy. The branch office of the insurance company that services the policy generally send intimations
regarding the maturity claims in advance through claim intimation letter along with the required
discharge voucher to be executed by the assured. If no intimation is received from the concerned
branch office, the policyholder may contact the office, mentioning the policy number. Where the
policy document is either not available or is lost, the settlement of claim can be on the basis of an
indemnity bond from the policyholder. For large amounts a reliable surety of sound financial
means may also be asked for.
The following documents are needed in the case of maturity claims:
1. Original policy bond
2. Age proof, if the age was not admitted earlier
3. Assignment deed, if any
4. Discharge form duly completed and executed
Procedure for settlement of maturity claims: After the duly completed, stamped discharge form is
received along with the policy documents, the insurance company settles the claim by issuing an account
payee/crossed/order cheque. In the case of money back plans where periodical survival benefits are
paid in installments, the policy document will be returned to the policy holder after due endorsements are
made on the policy document and in policy records. If the discharge form is lost, say, in transit, the
insurance company can issue a duplicate discharge form. Policy bond and discharge form are not
required for survival benefit payment of up to Rs. 60,000.
If the assured is lunatic or mentally unstable: If the assured or the person authorized to sign the
discharge form becomes mentally unstable, a court certificate issued under the Indian Lunacy Act,
appointing a person to act as his/her guardian would be required to be presented.
If the assured is adjudged insolvent: In case if the assured has been adjudged insolvent by a court of
law after the issue of the policy but before the maturity of the policy, the official assignee appointed by
the court will have to be informed by the insurance company about the date of maturity and other details
of the policy. But, in this case, the official assignee will be required to send a notice along with a certified
copy of the court’s order declaring the assured as insolvent and appointing him as the assignee.
If the assured is reporter dead: Where the life assured is reported to have died before the date of
maturity, the claim is settled as death claim but if he is reported to have died after the date of maturity the
claim is settled by the insurance company as a maturity claim and paid to the legal heirs. The Indian
Evidence Act provides that death may be presumed, if a person is not heard of for a continuous period of
seven years by those who would have heard of him if he were alive. In this case the premiums are paid
until presumption of death on receiving a decree of presumption of death from a court of law or else the
payment would be made after obtaining the court decree as per the status of the policy as on the date
when the premiums stopped.
In the case of HUF: As per the law relating of HUF, all income earned in respect of the property of
HUF, shall belong to HUF. As such where policies are taken on the lives of members of HUF and
220
premiums there under are paid out of HUF funds, insurance amount when due would belong to HUF and
it becomes a part of assets of HUF. However, under policies effected by the family members on their
own lives and where premiums are paid out of their own separate income, policy moneys when due
become the part of the estate of the lives assured.
In case of non-resident claimants: Payments of claims to non-resident claimants are governed by the
foreign exchange control regulations.
Wife and children as dependents: Section 6 of the Married Women’s property Act, 1874, (MWP
ACT) provides that a policy of insurance effected by any married man on his own life, and expressed on
the face of it to be for the benefit of his wife, or of his wife and children, or any of them shall ensure and
be deemed to be a trust for the benefit of his wife, or of his wife and children. Section 6 thus not only
provides for a simple method by which a married man can make a settlement for the benefit of his
dependents without the formality of a deed of settlement but operates to give the beneficiaries under
such a policy certain statutory privileges.
Lapsation of policy and death of insured: No claim is legally acceptable in respect of a lapsed policy
or if the life assured dies within 3 years from the date of commencement of the policy except where
premiums are paid for at least 3 years before the premiums stopped. Here, the nominee is paid a
proportionate paid-up value on the policy.
But if a minimum of 2 years’ premiums are paid and life assured dies within 3 months from the
date of first unpaid premium, then full sum assured is payable along with payment of bonus, subject to
reclamation of the premium already fallen due in addition to the premium that falls during the policy
anniversary.
If the life assured dies any time between 3 and 6 months from first unpaid premium, only an
amount equal to 59 per cent of the basic sum assured is payable. However, in this case neither any bonus
is paid and nor are any arrears of premium allowed to be received. And if the life assured dies any time
between 6 months and 1 year from first unpaid premium, only notional paid-up value is paid.
(ii)Death claims: Death claim arises in cases where the insured dies before the expiry of the
term of the policy. However, suicidal death is not eligible for claim. The insurer has to be informed
about 6the death of the life assured in writing. The insurer may be intimated by the nominee or his
representative; the assignee or his representative; a nearest relative of the life assured; the employer and
the agent of the deceased insured or development officer. Particulars like policy number, name of the
life3 assured, the date of death, the cause of death and the relationship of the informant to the deceased
are to be mentioned. The intimation must be made by a concerned person who shall also be required to
confirm the identity of the deceased person as the life assured under the policy.
The insurer may even get the necessary information from other sources like obituary columns, or
newspaper reports in case of accidents or air crashes. The action towards settlement of the claim can
be initiated as soon as the information reaches the insurance office without waiting for the intimation of
the claim to be received. However, identity of the deceased insured person must of course be established.
Death claims are categorized into following two types:
1. Non-early death claims: It arises in cases where the death of the life assured occurs after 3 years
from the date of commencement of policy or the date of last revival/reinstatement of the policy. If the
policy is operative till the date of death of the life assured by regular payment of premiums, full sum
assured becomes payable along with bonus (in case of with profits policy). The following documents are
required to be submitted for the settlement of the death claim:
a. Policy document (policy bond)
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 b. Death certificate from the appropriate authority
c. A legal evidence of title where the claimant is neither an assignee nor a nominee
d. Abridged claim form
e. Discharge form duly signed
f. Assignment/reassignment deed, if any
g. Age proof only where age is not already admitted
Once the above documents are received and if they are found in order, claim is settled by making
the payment to the person entitled thereto.
2. Early death claims: It arises in cases where the death of life assured occurs within 3 years from
commencement of the policy. The following documents, duly completed are required to be submitted for
the settlement of the death claim:
1. Statement from the medical attendants who last treated the deceased life assured
2. Certificate of the treatment issued by the hospital authorities where the deceased was last treated
3. Certificate issued by the employer where the deceased was an employee
4. Certificate of the burial/cremation signed by a responsible person who attended the funeral of the
deceased
The documents that must be tendered for settlement of death claims would depend upon the
cause of the death, and thus vary with each case as discussed hereinafter.
1. Cases of accidental death must first be reported to the police and an FIR (first information report),
police inquest report (PIR), and post-mortem report (PMR) if conducted, are required to be
submitted.
2. Where death takes place within 2 years from date of commencement of the policy, an investigation
is conducted to establish the authenticity of the claim and accordingly the accidental benefits are
settled.
3. In case of murder of the life assured, FIR and the report that a legal case was initiated against the
accused are necessary. In such cases the settlement of the claim will be withheld until the decision
of the case.
4. In case of death due to an air crash, a certificate issued by airline authorities certifying that the
assured was a passenger on the plane would be needed.
5. In case of death caused by a ship-accident, a certified extract from the logbook of the ship would
be required.
6. In case of sudden heart failures, the doctor’s certificate must be attached.
7. In case of defence personnel, a certificate from the commanding officer of the unit is obligatory.
8. Where a court enquiry is ordered, the report of the enquiry should be obtained.
The death claim amount is payable to the nominee or the assignee as the case may be. In the
absence of assignment or nomination of the policy, a legal evidence of title such as succession certificate
or letters of administration or probate of the will would be mandatory to be entitled to the claim. The
assignee is entitled to the payment in the case of absolute assignment. But if the absolute assignee dies,
then the benefit goes to the estate of the assignee and in case if the conditional assignee dies, the right of
claims gets passed back to the assured.

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 The intimation claim must be made within a maximum of 3 years from the death. Otherwise, the
same becomes time barred and the claimant must accordingly be informed. In case if the death occurred
within 3 years from the date of commencement or revival of the policy, the insurance company is required
to conduct investigations without knowledge of the claimant, on receiving the claim forms. Sometimes,
insurers may grant concessions while settling the claims. That is, under certain plans payment of full sum
assured is made by the insurer after deduction of unpaid premiums with interest till the date of death and
in the event of the death of the life assured within a period of six months or one year from the date of the
first unpaid premium.
The insurance companies may decline death claims in cases where the material information is
fraudulently concealed. But an opportunity is given to the claimant to make a representation for
consideration, and by the review committees of the zonal office and the central office. Thee final
decision is based on the merits of each case.
28.6 SUMMARY :
This lesson covers the aspects of policy assignment, loan on policy bond and policy settlement
procedure. Assignment and nomination are the two methods where a policy holder can ensure payment
of policy claim without the need for succession certificate or letter of administration in the case of policy
holder’s death. Assignment is a method of transferring the rights of the insured under a policy to another
policy or assignee. The assignment should be in writing. There are two types of assignment. These are
1. Absolute assignment and 2.Conditional assignment.
As an evidence of the insurance contract the insurance company issues a policy bond in the
name of the insured. When the policy is in operation, the policy holder can get loan against the policy.
The amount of loan on policy bond may be between 85 to 90 per cent of the Surrender Value of the
policy. Loan facility on policy bond is an additional service.
The insurance policy claim is settled by the insurer on the maturity of the policy or on the death
of the insured. This is subject to various conditions.
28.7 SELF ASSESSMENT QUESTIONS:
1. What is Assignment? Explain the types and features of Assignment of a policy.
2. Explain the procedure and features of loan on policy Bond.
3. Give an account of the procedure of Policy Settlement in case of maturity claims.
4. Explain the procedure of policy claim settlement in case of Death of insured.
Short Notes:
Assignment vs. Nomination
28.9 SUGGESTED READINGS:
1. L.M. Bhole, Financial Institutions and Markets, the mc Graw Hill, New Delhi, 2008.
2. Shashi k. Gupta and Nisha Aggarwal, financial services, Kalyani publishers, Ludhiana, 2007.
28.10 KEY TERMS :
Surrender Value : The amount of money that a policyholder can withdraw on his Surrendering his right
under a policy before its maturity and Terminating the contract of insurance.
Policy Bond : Policy contract, duly executed and containing the terms and Conditions of the contract.
Paid-up Value : The reduced amount payable by the insurer in the event of discontinuation of
payment of premiums after premiums are paid for the first three years.

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 Lesson No: 29

NON-LIFE INSURANCE AND REGULATION

OF INSURANCE

STRUCTURE :
29.1 Non-life Insurance – The Concept And Types
29.2 Fire Insurance – Definition And Meaning
29.3 Types Of Fire Insurance Policies
29.4 Principles Underlying Fire Insurance
29.5 Marine Insurance – Meaning
29.6 Marine Insurance – Scope
29.7 Basic Principles Of Marine Insurance
29.8 Types Of Marine Losses
29.9 Clauses Of Marine Insurance
29.10 Types Of Marine Insurance Policies
29.11 Insurance Act Of 1938 And Regulation Of Insurance
29.12 Summary
29.13 Self-assessment Questions
29.14 Suggested Readings
29.15 Key Terms

OBJECTIVE :
The reading of the lesson helps you understand what is non-life insurance you could explain
different types of non-life or general insurance and their salient features and purpose. In addition, the
lesson enables you understand the regulation of insurance and the relevant provisions of the Acts for
insurance regulation in India.
29.1 N0N-LIFE INSURANCE – CONCEPT AND TYPES:
Insurance can be classified into two broad categories:
Life Insurance: Life insurance is a contract whereby the insurer in consideration of a premium
paid either as lump sum or as periodical installments, undertakes to pay, either on the death of the insured
or on the expiry of specified number of years whichever is earlier, an annuity or a specified amount. For
example, whole-life plans, endowment assurance plans, pension plans, unit linked plan.

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 Non-life insurance: Non-life insurance is a contract whereby the insurer in consideration of a
premium paid by the insured agrees to indemnify him for the financial loss suffered by him due to an
adverse event which is covered by the terms of the policy.
Non-life insurance may be classified further into 1. General insurance and 2. Miscellaneous
insurance.
1. General Insurance: Depending on the subject-matter, there are four kinds of general insurance.
Marine Insurance: Marine insurance is a contract of insurance under which the insurer undertakes to
indemnify the insured, in the manner and to the extent thereby agreed, against marine losses incidental to
marine adventure. For example, loss or damages to the ship, cargo, freight, vessels or any other subject
of a marine adventure. Accordingly, there are various types of marine policies like voyage policies,
valued policies, hull insurance, time policies, cargo insurance, freight insurance, etc.
Fire insurance: Fire insurance is a contract under which the insurer agrees to indemnify the insured, in
return for payment of a premium in lump sum or by installments, losses suffered by him due to destruction
of or damage to the insured property, caused by fire during an agreed period of time.
Personal accident insurance: Personal accident insurance is a contract under which the insurer
undertakes to pay a specified amount of money on the death or disability of the insured on account of an
accident.
Motor vehicle insurance: Under this type of insurance a personal or commercial vehicle is insured
against loss or damage to the vehicle due to accident or theft, personal injury or death of the owner or
passenger due top accident or damages payable to third parties by the owner of the vehicle for accidents.
2. Miscellaneous Insurance: Non-life insurance, in addition to general insurance includes other
miscellaneous insurance. Some of the types of miscellaneous insurance are discussed here under:
Fidelity guarantee insurance: This is the type of contract of insurance and also a Contract of guarantee
to which general principles of insurance apply. Fidelity guarantee does not mean the guarantee of the
employee’s honesty. But it guarantees the employer for any damages or loss resulting from the employee’s
dishonesty or disloyalty.
Crop insurance: A contract of crop insurance is a contract to provide a measure of financial support
to farmers in the event of a crop failure due to drought or floods.
Burglary insurance: A burglary policy provides protection against loss or damage caused by theft,
larceny, burglary, house breaking and acts of such nature.
Cattle insurance: Cattle insurance is a contract of insurance whereby a sum of money is secured to the
insured in the event of death of animals like bulls, buffaloes, cows and heifers.
Cash in transit insurance: This type of insurance compensates the insured against loss of
money or cash stolen from his business premises or while it is being carried from or to the bank.
29.2 FIRE INSURANCE – DEFINITION AND MEANING:
Under the provisions of the Insurance Act, 1938, Fire insurance is defined as the business of
effecting, otherwise than incidentally to some other class of insurance business, contracts of insurance
against loss by or incidental to fire or other occurrence customarily included among the risks insured
against in fire insurance policies.
Under a contract of fire insurance the insurer, in consideration of a sum of money paid by the
insured either in lump sum or in fixed installments, accepts to indemnify the insured against the
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consequences of fire, or the loss or injury as arising there from during a fixed period and up to a certain
sum. Fire insurance thus, is a contract of indemnity wherein the insurer undertakes to indemnify the
insured against financial loss or damage to property caused directly as a result of fire anytime during an
agreed period of time. The contract contained in the policy-document of the fire insurance is usually for
a period of one year. Thereafter, the contract may be renewed every year. The term fire in a contract
of fire insurance means the production of light and heat by combustion. Combustion occurs only at the
actual ignition point. However, fire caused by earthquakes, riots, civil tumult, alien enemy, insurgence,
etc. are not covered by way of fire policies.
There are different types of fire insurance policies that are commonly offered.These include:
1 Specific policy: A specific policy is one where the insurer undertakes to make good the loss only up
to the amount specified in the policy, regardless of the actual value of the property.
2 Valued policy: A valued policy is usually taken where it is not easy to ascertain the value of the
property. For example, it is not easy to determine the value of works of art, antiques, pictures, sculptures,
etc. The value of such articles or valuable possessions is declared by the insured and is mentioned in the
policy. In the case of total loss in the valued policy the insurer undertakes to pay the value of the property
as mentioned in the policy, or the declared value, irrespective of its actual or market value.
3 Average policy: Under an average policy the insured is penalized for under insurance of the property.
This kind of fire policy contains an average clause. The average clause, applies only in cases of under
insurance and partial loss that is, where it is proved that the loss suffered by the insured is less than the
sum insured. But where there is total loss or the loss is more than the sum insured, the insured amount
will be paid. For example, if a property, which is worth of Rs. 4,00,000 is insured for Rs. 3,00,000 and the
actual loss as a result of fire is Rs, 2,00,000, then the liability of the insurer in settlement of claim to be
paid will be calculated as follows:
Amount insured
Amount of claim = __________________________ X Actual loss
Actual value of property
3,00,000
Then ______________ X 2,00,000 = Rs. 1,50,000
4,00,000
4. Floating policy: A floating policy is taken to cover loss on goods, which are lying in different places
and the stock of which is almost continuously fluctuating. In such cases, the owner usually prefers to
take out only one floating policy, against one premium, instead of separate specific policies for all his
goods, some of which may be in stores or warehouses, others in railway stations, shops, etc. Under the
floating policy the insured is required to declare only the total value of the risk and not separate values in
separate risks.
5. Reinstatement or replacement policy: This policy is issued to cover damages/losses suffered in
respect of buildings; plant and machinery; furniture, fixtures and fittings, etc. Under this policy, instead of
paying compensation to the insured for the property destroyed, the insurer undertakes to pay the cost of
reinstating or replacing the property.
6 Comprehensive policy: Comprehensive policy is also termed as all insurance policies. This is because
it provides protection not only against the risk of fire but also consequential risks caused by fire coalescing
with the risk against burglary, riot, civil commotion, theft, damage from pest, lightning.
7 Consequential loss policy: Under this policy the insurer undertakes to indemnify the insured for the
financial loss or loss of profits, suffered due to dislocation of his business as a consequence of fire. That
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is why consequential loss policy is also known as loss of profit policy. Loss of goods or property damaged,
loss of net profits, interruption in business after fire, outstanding expenses (interest on debenture, salaries,
rent on building, etc.) and prepaid expenses are some examples of losses covered under the policy.
8. Declaration policy: Declaration policy is taken in respect of stock of inventory of the policy holder.
Since the levels of stock, which are subject to frequent fluctuations in value or in volume, present a
special problem for insurance, the businessman takes a policy for a maximum amount considered to be at
risk and the premium is paid accordingly.
9. Adjustable policy: The adjustable policy is granted to remove the disadvantages of declaration
policy. This policy covers the fluctuating stock of the insured businessman allowing him the freedom to
vary at his option. The premium varies with the variation of the stock. The insured is liable to inform the
insurer about every variation in the stock immediately.
29.4 PRINCIPLES UNDERLYING FIRE INSURANCE:
The following underlying essential principles for a valid contract of fire insurance:
Principle of indemnity: The purpose of this principle is to put the insured, to the extent possible, in the
same financial position after the suffering of the loss that he was in, immediately before the loss occurred.
The insured can recover only the amount of actual loss subject to the sum assured.
Principle of insurable interest: In fire insurance, the insurable interest must exist both at the time of
affecting the insurance as well as at the time of the loss. The insurable interest may be legal or equitable
and may arise under a contract of purchase or sale. However, the extent to which a person would be
allowed to get the property insured is limited to the extent of his/her financial stake in that property.
Principle of good faith: All contracts of fire insurance are contracts of uberrimae fidei, that is, a
contract based on unconditional good faith. This principle requires the insured to make full and detailed
disclosure of all material facts that may have a bearing on the decision of the insurer to accept or reject
the proposal and in determining the rates of premium to be charged.
Principle of cause proxima: In a fire insurance contract, only losses resulting from fire or some other
related cause, being the proximate cause of loss are covered.
Principles of subrogation: All fire insurance contracts are based on the principle of subrogation whereby
the insurer, after paying compensation to the insured, becomes entitled to claim all the rights of the
insured against third parties who may be proved to be responsible, directly or indirectly, for that loss.
Principle of contribution: Fire insurance contracts are also governed by the principle of contribution,
which pro vides that where the subject-matter has been insured with more than one insurer, each insurer
has to meet the loss only ratably. If he has paid more than his share of loss, he is entitled to recover the
excess a mount paid by him from his co-insurers.
29.5 MARINE INSURANCE – MEANING:
Marine Insurance Act, 1963, defines a contract as an agreement whereby the insurer undertakes
to indemnify the assured, in the manner and to the extent thereby agreed, against losses incidental to
marine adventure. Marine insurance contracts may also be defined to cover loss or damage to vessels,
cargo or freight.
The document containing the contract of marine insurance as entered into, between the insurer
and the assured is called a marine policy or sea policy. The consideration for the policy is called the
premium. The insurer in marine insurance is known as the underwriter. The insurable property may
include any ship, goods or other movable exposed to nautical perils.
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 Nautical/maritime/marine perils, also called as perils of the sea, mean all those perils that are
consequential or incidental to sea journey. Perils of the sea include collisions, war perils, captures,
jettisons, barratry, etc. and any other perils which are either of the like kind or may be designated by the
policy. The term perils of the sea refer only to inadvertent, unpremeditated accidents or casualties of the
sea. Marine Insurance in its modern form was introduced by the Britishers in 1710 for the first time with
the establishment of the Sun Insurance office Limited in Kolkata.
29.6 MARINE INSURANCE – SCOPE:
Though limited in its scope earlier, with the passage of time and entry of different public sector
and private sector players in the Marine insurance business the scope of Marine Insurance has widened.
Though the expression generally applies to the risks associated with the transportation of goods by sea,
the scope of marine insurance extends to a mixture of broad property coverage, divided between land
risks (inland marine) and sea risks (ocean marine). Ocean marine insurance refers not only to the
insurance of ships but also includes the insurance of hulls, the cargo and liabilities likely to be faced by
ship owners and operators. The scope of marine insurance covers the following four categories:
Hull Insurance: Hull insurance involving the insurance of ships including vessel-machinery insurance
refers to the marine insurance policy whereby insured is indemnified for losses as a result of loss or
damage to the ship.
Cargo Insurance: Goods and commodities transported by sea is the subject-matter of cargo insurance.
It covers the multitude of risks associated with the trans-shipment of goods by sea or air in international
trade.
Freight Insurance: Freight may be referred to as the charges paid for the conveyance of goods or the
fee charged for the carriage of goods in the vessel. Freight may be received in advance or after the
goods reach the destination. Where the freight is received in advance, no risk is involved, but in case if
freight is to be paid later, there is always the fear that the goods will not reach the destination port safely.
In case if the vessel is destroyed in route, the freight would also be lost along with the vessel. That is
why, it is a normal practice to buy freight insurance policy along with every hull insurance policy.
Liability Insurance: Liability insurance, also known as protection and indemnity insurance (P&I), is
designed to provide protection to the vessel-owners against liabilities for damages to docks, cargo, illness
or injury to the passengers or crew, and the consequent fines and penalties payable by the ship owner.
29. 7 BASIC PRINCIPLES OF MARINE INSURANCE:
The following are the basic underlying principles of Marine Insurance.
(i) Valid contract: A marine insurance policy is a contract between the insured and the marine insurance
company, also known as underwriter. In order to be legally enforceable, the policy must comply with all
the essentials of a valid contract, that is, offer, acceptance, agreement, competent parties, free consent,
lawful consideration and legal object.
(ii) Insurable interest: The insured must be an insurable interest in the subject-matter of insurance.
This is required to be established at the time of occurrence of the loss. Thus, it is not compulsory that
insurable interest must exist at the time of affecting the contract of insurance.
(iii)Utmost good faith: Marine insurance is a contract of uberrimae fidei or a contract of utmost good
faith. The insured must disclose all such relevant facts to the insurer, which are likely to affect his
inclination or willingness to undertake the risk. According to section 19 of the Marine Insurance Act
1963, if any party does not observe utmost good faith, the other party may avoid the contract.

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(iv)Contract of Indemnity: Marine insurance contracts of indemnity wherein the underwriter agrees
to indemnify the insured against losses by sea risks to the extent of the amount insured. The insured in
return for this undertaking pays an agreed amount known as the premium.
(v)Subrogation: Marine insurance contracts are based on the principles of subrogation and contribution.
According to the principle of subrogation, after compensating the insured’s loss on agreed basis, the
insurer steps into the shoes of the insured and becomes entitled to all the rights and remedies available to
the insured against third persons.
(vi)Contribution: The principle of contribution also applies in such cases of marine insurance, where the
subject matter has been insured with more than one insurer. Each insurer contributes to the loss
proportionately and meets only the ratable proportion of the actual loss. If he has paid more than his
share of loss, he is entitled to recover the excess amount paid from other co-insurers of the policy.
(vii) Warranty: A warranty means a stipulation or condition, the Breach of which entitled the insurers to
completely avoid the policy. The principle of warranty applies even though the breach arises through
circumstances beyond the control of the warrantor. Warranties are of two kinds – Express and Implied.
These are:
Express warranties: These are warranties expressly included in or written upon the policy or contained
in some document referred to in the policy.
Implied warranties: These are warranties, which are implied in every marine insurance contract except
when they are expressly excluded.
Some of the implied warranties are explained as follows:
Seaworthiness of the ship: A voyage policy includes a warranty of seaworthiness by the insured
ensuring that the ship concerned is fit for the voyage.
Non-deviation warranty: In the case of a voyage policy where a voyage is contemplated between any
two given ports there is an implied warranty of non-deviation on the part of the insured, by which the
insured is supposed to give an undertaking that he shall take the usual route taken by navigators, and
shall not deviate there from except in cases where it is excusable by the law.
29.8 TYPES OF MARINE LOSSES:
The losses covered under marine insurance policies can be classified into the following two
types.
Total Loss: A total loss occurs where the subject-matter of insurance ceases to be in its original form or
where it is completely devastated and is thus absolutely lost to its owner. A total loss may either be an
actual total loss or a constructive total loss. Actual total loss can occur in any form. It may mean
physical destruction, e.g. loss due to fire, ship found missing, etc. or it may imply loss of shape or
character of the subject-matter. Irreversible deprivation of ownership of goods or vessel is yet another
form of total loss. A constructive total loss occurs when the subject-matter of insurance/property insured
is not absolutely destroyed but it is so severely damaged that the cost of repairing it or attempting to
recover it is likely to far exceed the value of the property. In such a case, it is preferable to simply
abandon the destroyed property.
Partial Loss: In marine insurance, a partial loss of vessel or cargo is called an average. A partial loss
occurs when the subject-matter of insurance is partially destroyed or damaged. Partial loss may further
be classified into-general average and particular average. Average, in marine insurance means loss and
particular average means partial loss while general average refers to the sacrifices made during extreme

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conditions for the purpose of rescuing the ship and the cargo from being damaged. The general average
clause in a marine insurance policy requires the insurers of various interests to willingly share the cost of
losses. Typical example of general average is the act of jettison, which means throwing part of the
cargo or equipment of the vessel overboard to lighten the load and save the vessel. The owner of the
jettisoned goods is entitled to a general average, i.e., the loss is shared by the vessel-owners and the
cargo-owners, proportionately.
Particular average refers to the loss that occurs as a result of damage fortuitously caused by the
perils insured for. The loss arising thus is borne by the underwriter who insured the item that is damaged,
e.g., if a ship is damaged due to bad weather the loss incurred is a particular average loss. A particular
average is a partial loss that is to be borne by only a particular party. An example of particular average
is damage to the vessel and cargo on the vessel caused by fire. Marine insurance policies do not cover
losses or damages resulting from strikes, riots, civil commotions, war etc.
29.9 CLAUSES OF MARINE INSURANCE:
In accordance with the terms and conditions of the insurance contract, some of clauses of
marine insurance are explained below. Depending upon the clause the scope of indemnity changes. The
following are the important clauses which can be incorporated in a marine insurance policy.
(i)Valuation clause: This clause states the value of the subject matter of insurance as agreed upon and
settled between both the insurance contracts.
(ii) Assignment clause: If the assignment clause is included, the policy can be easily assignable. The
policy can be assigned to anyone who may acquire an insurable interest in the subject matter. Cargo
policy is freely assignable. But in case of hull insurance, the policy cannot be assigned freely. To assign
hull insurance, the policy holder should get consent of the insurer.
(iii) Deviation and touch clauses: Once the policy is taken with a particular route from the port of
departure, to the port of destination, the policy holder is expected to follow it without a charge. If the
route is deviated, the insurer is not liable for any loss.
iv) Warehouse to warehouse clause: In general, the risk covers from the time of loading at the port of
destination till it is unloaded at the port of destination. Some times for some types of goods in some
localities, the risk may be beyond these two ports. To cover such risks of inland, warehouse to warehouse
clause will be included. Under such policy the risk commences from the specified place, usually the
warehouse of the exporter till the final destination, which may be the warehouse of the importer.
v) Jettison clause: Jettison denotes an act of throwing overboard a part of the ship’s cargo in order to
reduce the weight of the vessel to save other goods. Under this clause, all interested parties collectively
compensate the loss suffered by owner(s) of jettisoned goods as a result of such acts.
vi) Continuous clause: With this clause the vessel is allowed to continue and complete its voyage even
after the policy period has run out. This clause is generally incorporated in a time policy. The insured is
required to give a prior notice for this and deposit a monthly pro-rata premium.
vi) Sue and labor clause: The sue and labor clause authorizes the insured to take all possible steps to
prevent or mitigate the loss or to protect the insured subject-matter in the event of danger. The insured
is entitled to recover the expenses that may have been incurred for this purpose from the insurer.
vii)Inchmaree clause: This clause covers the loss or damage caused to the ship or machinery as a
result of negligence of the master of the ship or due to explosives or underlying defect in the machinery
or the hull.

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viii) Touch and stay clause: Under this clause, the ship is allowed to touch and stay only at such ports
and in such order as has been specified in the policy. Any departure from the route mentioned in the
policy or the ordinary trade route followed will be considered as deviation.
ix) Barratry clause: This clause covers losses incurred by the ship owner or the cargo owner due to
willful conduct of the master or crew of the ship.
x) Running down clause: This clause is used in hull insurance to cover the risk of damage arising out
of collision between two ships holding insurer liable to pay compensation to the owner of the damaged
ship.
xi) Lost or not lost clause: This clause is used in marine insurance under which the insurer is liable to
pay even if the insured loss has occurred prior to the effective date of the insurance. However, the
insurer is not liable where the policy holder had knowledge about the loss at the time when the insurance
was bought.
xii) At and from clause: This clause, usually used in voyage policies, covers the subject-matter insured
while it is lying at the port of departure and until they reach the final port of destination.
xiv) Free of capture and seizure policy: Under this clause, the insurer is relieved from the liability of
indemnifying the insured for the loss arising due to the capture and seizure of the vessel. Thee insured
can insure such an abnormal risk. It is covered under the war risks policy.
Xv) Waiver clause: Waiver clause is included in the policy to see that no act of the insured or the insurer
shall be taken to imply that either the insured intends to forego the compensation or that the insurer
accepts the act as abandonment of the policy. The clause safeguards the interests of the insured.
29.10 TYPES OF MARINE INSURANCE POLICIES:
Depending upon the needs of trade and industry there different marine insurance policies to
cover different types of risks. The various types of Marine Insurance Policies are explained below:
i) Voyage Policy: The voyage policy is issued to cover cargo insurance. It is issued to cover risks
involved in a particular transit from one point to another. The insurance cover ceases upon the ship
reaching the town of destination. The risks covered by this policy are determined by the places covered
in the specific trip.
ii) Time Policy: The purpose of this policy is to give specified period of time, say, for example, noon, 1st
Feb, 2010 to noon, 1ast Feb, 2011. This is usually taken for one year. The policy also provides cover
while the vessel is under construction. Time policies are common in the case of hull insurance.
iii) Mixed Policy: Voyage and time policy also called mixed policy is a combination of voyage and time
policy. This policy covers the risk during a particular voyage for a specified period. Chennai to Singapore
for a period of one year.
iv) Valued policy: This policy specifies the agreed value of the subject-matter insured, which may not
necessarily be the actual value of the subject-matter. This agreed value is referred to as the insured
value. Once the value has been agreed, it cannot be recommenced except where an evidence of deceitful
purpose is established; otherwise it remains binding on both parties. These policies are not very common.
V) Unvalued Policy: Unvalued policy does not specify the value of the subject matter insured at the
time of taking the policy. It is left to be valued when the loss takes place. Thus it is also called open
policy or insurable policy. Unvalued policies are not popular and are also not common in marine insurance.

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vi) Floating Policy: Floating policy gives description of insurance in general terms. The policy just
mentions the amount for which the insurance is taken for each shipment. It leaves other details such as
name of the ship etc. to be given in the other declaration. The declaration should be made by the policy
holder by endorsing the policy. Floating policies are suitable where it is difficult to know by what ship the
goods are to be shipped and the details of the goods shipped. Usually cargo owners who make regular
shipments of cargos prefer this policy. All the shipments are automatically covered as soon as declarations
are made. Floating policies are popular in large scale international trade.
vii) Blanket Policy: Blanket policy covers losses in a particular time and place. The policy is taken for
all the shipments over is comprehensive and the period to be covered by the policy and the premium will
be paid at once at the time of taking policy. This covered all the risks for the given period. If actual cover
of risk is less than the total amount of insurance, the premium related to excess amount is returned to the
policy holder. If the amount of shipments is greater than the insured sum, additional premium is charged.
viii) Wagering policy: This policy, although void in law, is issued without requiring the policyholder to
establish any insurable interest in the subject-matter of insurance.
ix) Construction risk or Builder’s risk Policy: This is designed to cover the risks incidental to the
building of a vessel usually giving cover from the time of laying the keel to the completion of trails and
handing over the vessel to the owners.
x) Open cover or Annual Policy: An open cover is an agreement between the assured and his
underwriters whereby the assured agrees to declare, and the underwriter to accept, all shipments being
covered by the annual/open cover policy during the specified time-period. The open cover policy is to
provide marine insurance in advance with an added benefit of an all time cover. This policy is most
popular amongst regular importers and exporters who prefer some kind of blanket insurance and also
want to avoid the effects of rapidly fluctuating rates. Where a business involves regular dispatch of
goods throughout the year, and the quantity can be reasonably estimated in advance, policy can be
obtained on the basis of estimated annual dispatches.
xi) Declaration Policy: A declaration policy is issued as a substitute to annual policy. This policy is
taken for a fixed amount such that each dispatch that is to be insured for transportation risks is declared,
in accordance with the insurance contract and accounted until the sum insured is exhausted. The policy
can be extended for additional amount.
xii) Port risk Policy: This policy provides cover for a specified period to a ship/cargo-owner against the
risks likely to be suffered due to the ship/cargo being on a port in contrast to voyage risks.
xiii) Duty Policy: The custom duty policy is that wherein the insured is entitled to be paid the actual
amount of loss of custom duty as a consequence of loss or damage to the consignment. The policy must
be taken before the vessel reaches the port of destination.
29.11 INSURANCE ACT OF 1938 AND REGULATION OF INSURANCE:
29.11.1 BACKGROUND AND NEED FOR REGULATION :
During British rule in India, insurance was started in a very insignificant way. Therefore the
rulers never felt for a need of regulation of Insurance. Along with other business enterprises and banking
institutions insurance was also governed by the Companies Act 1881. During 1900 to 1915, the freedom
movement became very intensive. The policy makers and experts in the insurance sector expressed that
the Companies Act is inadequate to regulate insurance companies. Insurance is also one of the financial
services. It is a dealer of public savings. Thus it is also a sensitive business like banking and depends on
public confidence for its survival and development. It is easy for the insurer to cheat the policy holders
as it deals with all long duration transactions. The insurance sector’s business depends on the trust of
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general public that it is able to gain. Public trust will be more if the business is well regulated either by the
government or by powerful authority with a strong legal backing.
With this idea the British Indian Government passed two Acts to regulate the insurance business
in 1912. Provident Insurance Societies Act 1912 and Indian Life Insurance Act 1912. These two Acts
were based on English Insurance Act. But these two Acts were confined to only life insurance business
and the non life business was left. All the attempts were of less use because the needs are many.
Several people and experts demanded for a separate Act.
29.11.2. INSURANCE ACT OF 1938:
Life Insurance is governed by the Insurance Act of 1938 and the Life Insurance Corporation Act
1956. The insurance Act 1938 was enacted with a view to establish closer supervision and control on
matters of funds, expenditure and general management of insurance business. The LIC Act 1956 gives
broadly the pattern of its organization and observational aspects.
The Government of India understood the need to introduce a comprehensive new insurance Act.
For this purpose the Government appointed a committee in 1935. The committee submitted its report
with several recommendations. Accepting the recommendations the government introduced a Bill in the
Parliament in 1937. After much debate and discussion, Insurance Act 1938 was passed.
29.11.3. THE SALIENT FEATURES OF THE ACT:
a) Controller of Insurance: The Act provides for the appointment of controller of Insurance means the
officer appointed by the Central Government u/s 2B to exercise all the powers, discharge the functions
and performs the duties of the authority under this Act or the Life Insurance Corporation Act, 1956, or
the General Insurance Business (Nationalization) Act, 1972, or the Insurance Regulatory and Development
Authority Act, 1999.
b) Capital and Deposits: Prior to the passing of the Act, any person can start insurance business with
Rs. 25,000 capital. The Act of 1938 insisted that it should be Rs. 50,000 excluding deposits to be made
before registration and also preliminary expenses to be paid by the company.
c) Registration: The insurance business established before passing the Act should get the certificate of
Registration from the office of the Controller of Insurance within 3 months of the commencement of the
Act. No new business or no new insurer shall start insurance business without obtaining the certificate
of Registration from the Controller of Insurance. If the insurer fails to observe and follow the provisions
given in Section 7 or 8, the Controller can cancel the registration.
d)Prohibition of Insurance business by certain persons: Unless otherwise provided by the Act, no
person shall, after the commencement of the Insurance (Amendment) Act, of 1938 as amended in 1950,
begin to carry on any class of insurance business in India and no insurer carrying on any class of insurance
business in India shall after the expiry of one year from such commencement, continue to carry on any
such business unless he is a public company a society registered under the Cooperative Societies Act,
1912.
e) Renewal of Registration: An insurer who has been granted a certificate of registration under Section
3 shall have the registration renewed annually for each year.
f) Separation of Accounts and Funds: Where the insurer carries on business of more than one of the
following classes, namely, life insurance, fire insurance, marine insurance or miscellaneous insurance, he
shall keep a separate account of all receipts and payments in respect of each such class of insurances
business.

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g) Preparation of Accounts and Balance Sheet: Every insurer, in respect of all insurance business
transacted by him, and in the case of any other insurer in respect of the insurance business transacted by
him in India, shall at the expiration of each financial year prepare, with reference to that year, a balance
sheet and a profit and loss account, in the prescribed form and in accordance with the regulations of the
Act.
h)Audit: The balance sheet, profit and loss account, revenue account and profit and loss appropriation
account of every insurer, in respect of his insurance business, shall, unless subject t to audit under the
Indian Companies Act, 1913, be audited annually by an auditor.
i)Register of policies and Register of claims: According to Section 14 of the Act, every insurer, shall
maintain a register or record of policies, in which shall be entered, in respect of every policy issued by the
insurer, the name and address of the policy holder, the date when the policy was effected and a record of
any transfer, assignment or nomination of which the insurer has notice, and a register or record of claims.
j)Furnishing Reports: Every insurer shall furnish to the authority a certified copy of every report on the
affairs of the concern.
k)Abstract of proceedings of General Meetings: Every insurer, shall furnish to the authority a certified
copy of the minutes of the proceedings of every general meeting, as entered in the minutes-book of the
insurer within thirty days from the holding of the meeting to which it relates.
l)Investment of Assets: Every insurer shall invest and at all times keep invested, assets equivalent to not
less than the sum of the amount of his liabilities to holders of life insurance policies in India on account of
matured claims, and the amount required to meet the liability on policies of life insurance maturing for
payment in India.
m)Prohibition of Loans: According to the Provisions of Sec. 29. No insurer shall grant loans or
temporary advances either on hypothecation of property or on personal security or otherwise, except
loans on life policies issued by him within their surrender value, to any director, manager, managing agent,
actuary, auditor or officer of the insurer if a company.
n)Insurance Business in Rural or Social Sector: Sec. 32 B of the Act provides that every insurer
shall, after the commencement of the IRDA Act, 1999, undertake such percentages of life insurance
business and general insurance business in the rural or social sector. Every insurer, as required by the
provisions u/s 32C shall, provide life insurance or general insurance policies to the persons residing in the
rural sector, workers in the unorganized or informal sector or for economically vulnerable or backward
classes of the society.
o) Investigation and inspection: The authority may at any time, by order in writing, direct any person
specified in the order, to investigate the affairs of any insurer and to report to the authority on any
investigation made by such investigating authority.
p)Prohibition of Payment of Commission for Procuring Business: No person shall after the expiry of
six months from the commencement of this Act, pay or contract to pay any remuneration or reward
whether by way of commission or otherwise for procuring insurance business in India to nay person
except an insurance agent or an intermediary or insurance intermediary.
q)Licensing of Insurance Agents or Intermediaries: The authority or an officer authorized by him in
this behalf shall, issue to any person making any application in the manner determined by the regulations,
a license to act as an insurance agent for the purpose of soliciting or procuring insurance business. A
license issued immediately before the commencement of the IRDA Act, 1999, shall be deemed to have
been issued in accordance with the regulations which provide for such license.

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r)Establishment of Tariff Advisory Committee: With effect from the commencement of the Insurance
(Amendment) Act, 1968, there shall be established a committee, to be called the Tariff Advisory Committee
to control and regulate the rates, advantages, terms and conditions that may be offered by insurers in
respect of general insurance business.
s)Licensing of Surveyors and Loss Assessors: No person shall act as a surveyor or loss assessor in
respect of general insurance business after the expiry of a period of one year from the commencement
of the Insurance (Amendment) Act, 1968, unless he holds a valid license issued to him by the authority.
Every person who intends to act as a surveyor or loss assessor after one year from the commencement
of the Insurance (Amendment) Act, 1968, but before the commencement of the IRDA Act, 1999, shall
make an application to the authority within such time, in such form, in such manner and on payment of
such fee, as may be prescribed.
29.11.4. REGULATION OF INSURANCE BUSINESS – THE MACHINERY:
Life Insurance Corporation Act, 1956: Life Insurance in India was in private sector till 1956. On
January 19th 1956 the Government of India nationalized the life insurance business in India. In June 1956,
a Bill was passed in the Parliament and the Life Insurance Act 1956 was passed facilitating the
establishment of Life Insurance Corporation of India. Since then the life insurance is regulated by the
Life Insurance Act. The Act eliminated the private ownership of life insurance business. The Act gave
necessary provisions relating to the establishment of LIC and its constitution. It described the capital
structure and details of its functions and services. The Act gives powers and duties of LIC and its
management.
General Insurance Business (Nationalization) Act, 1972: Though Life Insurance was brought under
the fold of government ownership and management, General Insurance was in private sector. By passing
the General Insurance Business (Nationalization) Act 1972, the General insurance business was completely
transferred to the government ownership and management. The Act empowered the central government
to establish general Insurance Corporation of India under the Companies Act. Its objective was controlling
and carrying on the business of general insurance. Its initial capital was decided at Rs. 75 crores. The
Act was amended after passing Insurance regulatory and Development Act.
Malhotra Committee: The Government of India constituted a high power committee headed by Sri.
R.N. Malhotra, former governor of the Reserve bank of India in April 1993. The committee was entrusted
with the responsibility of examining and studying the structure of insurance sector and recommend ways
and methods to make it more efficient and competitive. The committee submitted its report in January
1994 with a series of recommendations. The prominent recommendation stressed by the committee was
establishment of a strong and effective Insurance Regulatory Authority which should be a statutory and
autonomous body on the lines of SEBI. After a lengthy discussion and further studies, finally in December
1998, the Bill was introduced along with the recommendations of the standing committee on Finance and
finally the Act came into force in 1999.
Provisions of the Act: The Act empowered the central government to establish Insurance regulatory
and Development Authority. It should be a body corporation having perpetual succession and a common
seal with power subject to the provisions of the Act. The authority can establish its branches anywhere
in India. Authority is managed by a Board headed by Chairperson appointed by the Central Government.
The insurance Regulatory and Development Authority empowered to make necessary amendments to
the Insurance Act 1938, Life Insurance Corporation Act 1956 and General Insurance Business
(Nationalization) Act 1972. Consequently the recommended amendments were made in respective
Acts.
Insurance Regulatory and Development Authority (IRDA) Act 1999: Insurance Regulatory and
Development Authority (IRDA) Act 1999 was passed to make the insurance regulation more efficient
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and to develop the insurance sector according to the fast changing global economic changes especially
against the liberalization and globalization. The Act empowered the Government to establish an Authority
to protect the interests of the insurance policy holders. Its purpose is regulated, promote and ensure
orderly growth of insurance industry.
Owing to the nationalization of the insurance sector there were no private insurance companies
operating in India till 1999, when the Government of India introduced the Insurance Regulatory and
Development Authority Act, thereby deregulating the insurance sector and allowing private companies
into the insurance. Further, foreign investment was also allowed and capped at 26 per cent holding in the
Indian insurance companies. Thus, the objective of the IRDA Act, 1999, was to provide for the establishment
of an authority to protect the interests of holders of insurance policies, to regulate, promote and ensure
orderly growth of the insurance industry and for matters connected therewith or incidental thereto and
further to amend the Insurance Act, 1938, the Life Insurance Corporation Act, 1956 and the General
Insurance Business (Nationalization) Act, 1972.
29.12 SUMMARY :
The present lesson is a mixed bag which deals in details with the Non life Insurance consisting of
health, Fire and Marine Insurance. And also elaborates the Insurance Act of 1938 and the regulation
machinery of Insurance business in India. Conceptually the non-life insurance is also known as General
Insurance. Non-life insurance is a contract whereby the insurer in consideration for a premium paid by
the insured agrees to indemnify him for the financial loss suffered by him due to an adverse event which
is covered by the terms of the policy. There are different kinds of Non-life or general insurance. These
include Health Insurance, Fire Insurance, Marine Insurance, Personal Accident Insurance, and Motor
Vehicle Insurance etc.
For the purpose of control and supervision and also to protect the insured by regulating the
activities of the insurance business, regulation of insurance business is important. Though some regulatory
measures exist even before, the Insurance Act of 1938 is an important beginning. The main objective of
the Act is to regulate all types of insurance business on sound principles. The other legislative initiations
for regulation of insurance business are Life insurance Corporation Act 1956, General Insurance Business
(Nationalization) Act 1972 and the Insurance Regulatory Development Authority (IRDA) Act 1999. The
main objective of the IRDA is to make the insurance regulation more efficient, to protect the interests of
the policy holders. It is also to regulate, promote and ensure orderly growth of insurance industry.
29.13 SELF ASSESSMENT QUESTIONS:
1. What is Non-life Insurance? Explain different kinds of Non-life insurance.
2. Define Fire Insurance. Explain the underlying principles of fire insurance.
3. Elucidate different types of Fire Insurance policies.
4. What is Marine insurance? Explain different kinds of Marine insurance policies.
5. Give an account of the Regulation of Insurance in India.
Short Notes:
Total loss Vs. Partial loss
Voyage policy
Floating policy

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 Comprehensive policy
Causa proxima
Principle of indemnity
29.14 SUGGESTED READINGS:
1. OECD, Insurance regulation and Supervision in Asia, Organization of Economic Cooperation and
Development 1999.
2. William Zartman, Fire Insurance, Yale readings in Insurance, London.
3. Shashi K. Gupta and Aggarwal, Financial Services, kalyani publishers, Ludhiana.
4. John Duer, The law and practice of Marine Insurance, books, google.co.in.
5. Dr. C. Satya Devi, Financial Services, S.Chand&co, New Delhi.
29.15 KEY TERMS:
All risk insurance : A generic term for insurance that covers all risks except Those explicitly excluded.
Marine Perils : Also called Perils of the sea or Nautical or maritime Perils. These are the accidents or
casualties that are con-Sequential or incidental to sea journey.
Ocean Marine Insurance: Insurance to protect against losses in respect of or Damages to goods or
vessel at sea.
Jettison : An act of throwing overboard ship’s cargo to reduce theVessels weight.
Barratry : Losses due to deliberate
Inchmaree : Damages due to negligence of the master of the ship or due to explosives or underlying
defect in machinery or the hull.
Consequential loss : loss due to interruptions or dislocation of business as a Result of fire
Average clause : Condition defining insurer’s liability in case of under Insurance and partial loss.
Indemnity : Compensation for the actual loss not exceeding the amount of policy
Subrogation : A principle of law providing that once insurer has paid for a loss, the insurer receives the
policy holder’s rights to recover from any third party who caused the loss.
Pecuniary value : Value in terms of Money
Marine adventure : The insurable property exposed to marine perils.

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 Lesson No: 30

HEALTH, SOCIAL AND RURAL INSURANCE

STRUCTURE :
30.1 Health Insurance – The Concept
30.2 Types Of Health Insuraance Policies
30.3 Health Insurance Schemes In India
30.4 Feature And Advantages Of Health Insuraance
30.5 Social And Rural Insurance – Concept And The Need
30.6 Insurance Business In Rural And Social Sector – Statutory
30.7 Componeents And Features Of Rural Insurance
30.8 Features And Advantages Of Social And Rural Insurance
30.9 Summary
30.10 Self Assessment Questions
30.11 Suggested Readings
30.12 Key Terms

OBJECTIVE :
The objective of the lesson is to enable you understand the concepts of health, social and rural
insurance. In addition, a reading of this lesson makes you understand the features and advantages of the
health, social and rural insurance. It also enables you explain the need for health, social and rural
insurance.
30.1 HEALTH INSURANCE – THE CONCEPT:
In view of the increase in the cost of health care and treatment, health insurance is becoming
increasingly essential in today’s world. A majority of private hospitals are beyond the reach of a normal
middle class family. A health insurance policy is a contract between an insurer and an individual or a
group, in which the insurer undertakes to provide specified health insurance benefit to the insured in
consideration of a fixed price called premium payable either in a lump sum or in installments. Health
insurance usually provides either direct payment or reimbursements for expenses associated with illnesses
and injuries.
Rising public consciousness for better health care and general yearning for better medicines and
related health services has further contributed to the increasing demand for health insurance cover.
Human beings, in general, are facing serious health problems due to aggravation of environmental pollution.
Lifestyle changes have also lead to the spread of many diseases like AIDS endangering human life.
Government policies and regulations in the form of taxation benefits have also helped in promoting health
insurance.
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30.2 TYPES OF HEALTH INSURANCE POLICIES:
The following are the fundamental Health policies issued by the insurance companies aiming at
meeting the requirements of the general public:
Individual mediclaim or hospitalization benefit policy: An individual mediclaim or hospitalization
benefit policy provides reimbursement (in Indian currency) of medical expenses incurred towards
hospitalization (anywhere within India) in cases of sudden illness or accident and extends to pre-
hospitalization of 30 days and post-hospitalization of 60 days. The cover also includes domiciliary
hospitalization, which implies that a patient may get the medical treatment at home in cases where he/she
is unfit to be moved to the hospital or where there is no accommodation in the specialist hospital on the
condition that the treatment was for a period not less than three days.
Bhavishya arogya policy: This policy provides lifetime hospitalization and domiciliary hospitalization
benefits to the insured, as a result of an accident or sickness, after the age of retirement, in consideration
of his paying premiums up-to that age to the insurer. The mode of premium payment can be either in
lump sum or in equated annual installments.
Hospital cash daily allowance policy: Under this policy, the insurer undertakes to pay a daily allowance
for every completed day of hospitalization in the event of insured person(s) being hospitalized due to
sickness or accident. The number of days of hospitalization as well as the amount of daily allowance,
which can be Rs. 500, Rs. 1000 or Rs. 2000 per day, shall be selected by the insured. The maximum
number of days of hospitalization for which payment can be claimed under a specific policy is fixed up at
30/60 days. However, in case of ICU admission up to a maximum period of 7 days, double the agreed
sum becomes payable.
Critical illness policy: This policy is designed to provide financial assistance in the event of the insured
contracting any of the critical illnesses covered under the policy like first heart attack, bypass surgery,
stroke, cancer, kidney failure, any major organ transplantation, multiple sclerosis, aorta graft surgery,
primary pulmonary arterial hypertension and paralysis.
Health guard: Health guard policy offers cashless benefit and medical reimbursement for hospitalization
expenses to the insured. Under this policy, the member/insured can avail of the cashless facility at
various networked hospitals across India. The member may choose any other hospital besides the
empanelled ones. In this case, the expenses incurred by him would be reimbursed within 14 working
days from the date of submission of all the relevant documents. The policy covers relevant medical
expenses incurred 60 days before and 90 days after hospitalization. Moreover the policy offers a cumulative
bonus of 5 per cent to the sum assured against every claims free year.
Health shield: This is a medical insurance policy that is available to people in the age group of 90 days
to 75 years, designed to cover all hospitalization expenses incurred on any sickness or accident provided
that hospitalization is for a minimum period of 48 hours. The policy makes provision for the payment of
pre-hospitalization expenses for 30 days and post-hospitalization expenses for 60 days. A single health
shield insurance policy covering the spouse, dependent children and dependent parents can be taken, and
the policy also offers a family discount of 10 per cent in case if three persons or more are insured.
Jan arogya bima policy: This policy is quite similar to the individual mediclaim policy except that the
cumulative bonus and mediclaim check up benefits are not included. The plan is designed to provide
insurance benefit to the lower income segment of the society. As such it covers the expenses of
hospitalization and domiciliary hospitalization up to Rs. 5,000 per person p.a. without any inner limits, for
a meager premium of Rs. 70 per adult and only Rs. 50 per dependent son/daughter aged not more than
25 years. The policy is available to persons in the age group of 5 years to 70 years.

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Overseas mediclaim policy: The overseas medical claim insurance policy is particularly tailored to
protect persons undertaking genuine overseas trips for business/holidays, studies or employment (sponsored
by an Indian employer). The exceptional benefit of the policy is that premium is payable in Indian
currency while claims abroad, are payable in foreign currency. The policy covers expenses for medical
treatment taken by the insured person outside India as a direct result of an accident or bodily injury or
illness/disease contracted during an overseas journey.
Mediclaim Policy: This policy provides for cashless hospitalization in India for the treatment of disease
or accidental injury (not specifically excluded) suffered during the period. The payment of claim is made
through Third Party Administrators (TPA) been empanelled by the Company to provide hassle free
admission and discharge in the Network hospital without making any payment. The reimbursement of
hospitalization claims will also be made through the TPA. A family package cover can be taken covering
proposer, spouse, dependents and two dependent children with a 10% discount in premium. Group
policies can be issued to specified groups and group discount can be provided group size is more than 100
members. Premium up to Rs. 15,000 paid by cheque for this policy is entitled for deduction under section
80D of the Income Tax Act.
30.3 HEALTH INSURANCE SCHEMES IN INDIA:
The various health insurance schemes in India can be broadly classified into the following:
Employer-administered health schemes: Employer-administered health schemes and the
reimbursement of health expenses by employers are important instruments of health assurance in India.
Several public sector undertakings, big industrial organizations and also defence services run their own
dispensary and hospitals for the benefit of their employees.
Government-based schemes: The central, state and local governments in India manage, finance and
operate a vast network of hospitals, primary health centers, community health centers, dispensaries and
specialty facilities that provide medical services throughout the country either free of cost or at a very
nominal rate. The Employees State Insurance Corporation (ESIC), a wholly government-owned enterprise,
manages the Employees State Insurance Scheme (ESIS). It is an insurance system that offers both the
cash and the medical benefits. Voluntary and charitable organizations play a major role in creating
awareness. Some of them also link up with key health insurers.
Market-based schemes: Besides the public sector GIC and LIC, there are many private insurance
companies like Bajaj Allianz, ICICI, oriental Insurance and Royal Sundaram that offer a variety of health
insurance policies. Some of the existing health insurance schemes currently available are individual/
family/group insurance schemes.
30.4 FEATURES AND ADVANTAGES OF HEALTH INSURANCE:
The following are the salient features and advantages of health insurance features of Health Insurance:
1. Health insurance policy is a contract like any other insurance policy whereby the insurer undertakes
to provide insurance benefit for health care and treatment.
2. The premium may be paid in lump sum or installments but mostly in lump sum.
3. Health insurance provides either direct payment or reimbursement for expenses associated with
illness and injuries.
4. The health insurance may be for a single individual or a family group.
5. Health insurance is not applicable to pre-existing critical illness for which treatment is recommended
before the start of the policy.
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6. Hospitalization in cases of accidents due to drunken driving are not covered.
7. Treatment in cases of birth defects, congenital anomalies, hereditary diseases, officially
acknowledged epidemics etc., are not covered under health insurance.
8. Sometimes critical illness diagnosed within the first go days from the start of the policy period are
not covered.
9. Under health insurance policies bonus or cumulative discount of 5 per cent is offered against every
claim free year.
10. For encouraging and promoting health insurance, the premium paid towards the health insurance
up to the maximum limit of Rs. 15,000 are totally exempted under Section 80D of Income Tax Act.
11. Health insurance generally does not cover the treatment based on non-allopathic medicines and
use of intoxicating drugs and alcohol.
Advantages of Health Insurance:
1. In view of the increase in the cost of health care and treatment health insurance is very essential
in today’s world.
2. Due to the increasing cost of the corporate health care health insurance helps top bring the private
hospitals within the reach of the normal middle class families.
3. The rural poor can be assured health and corporate treatment through the government supported
health insurance.
4. The workers in the industrial sector who are generally inflicted with occupational diseases and
hazards can be provided with medical facilities and treatment without financial encumbrance and
burden to the worker. Employee State Insurance Corporation (ESI) is an illustration.
5. Premiums under the health insurance policy are exempt from income tax under Section 80D of IT
Act. Thus Health Insurance is a tax saving device.
30.5 SOCIAL AND RURAL INSURANCE – CONCEPT AND THE NEED:
India is a welfare state and lives in villages. The socially and economically oppressed sections of
the society live in villages. 70 per cent of India’s population lives in villages. But the Indian Insurance
sector confined its business and services to urban areas, to the educated employees, trade and business
and industrial organizations. Agriculture which is the dominant activity in rural areas is a gamble in the
monsoon and risky. Therefore, the agriculture and allied activities are risky and low income generating
with wider fluctuations. As a result the rural insurance and agriculture insurance are left untouched. In
a country like India the need for social and rural insurance is very much. The rural insurance consists of
crop insurance, cattle insurance, life and property insurance, micro insurance. The potential and scope
for development is also much.
Social Insurance means offering insurance facilities to the social sector. Social sector includes
unorganized sector, informal sector, economically backward classes and other categories of persons both
in rural and urban areas.
30.6 INSURANCE BUSINESS IN RURAL AND SOCIAL SECTOR-THE STATUTORY
EMPHASIS:
Insurance Business in Rural/Social Sector: The Insurance Act, 1938 requires all insurers to
undertake certain percentage of their insurance business including insurance for crops, in the rural social
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sector as specified by the IRDA. Also they should provide life/general insurance services in the form of
policies to
(i) the persons residing in the rural sector;
(ii) working in the unorganized sector;
(iii) economically weaker/backward classes of society
(iv ) to other categories as specified by the IRDA.
In terms of Section 32 B and Section 32C, every insurance company shall discharge the obligations
to provide life insurance or general insurance policies to the persons residing in the rural sectors workers
in the unorganized or informal sector or for economically vulnerable or backward classes of society and
other categories of persons as may be specified by regulations made by the authority and such insurance
policies shall include insurance for crops. The Regulatory Authority has issued the IRDA (Obligations of
Insurer to Rural or Social Sector) Regulations, 2000.
Rural sector has been defined as any place which as per the latest census has
(i) a population of not more than five thousand;
(ii) a density of population is not more than 400 persons per sq. km.;
(iii) at least seventy-five percent of the male working population is engaged in agriculture.
“Social sector” includes unorganized sector, informal sector, economically vulnerable or backward
classes and other categories, both in rural and urban areas. “Unorganized sector” includes self-employed
workers such as agricultural laborers, bidi workers, carpenters, construction workers, fishermen, handicraft
artisans, khadi workers, lady tailors etc. “Economically vulnerable or backward classes” mean persons
living below the poverty line.
Every insurer carrying on insurance business shall undertake to perform certain percentage of
Social and Rural insurance.
30.7 COMPONENTS AND FEATURES OF RURAL INSURANCE:
As stated earlier the rural sector is composed of sub sectors like primary and secondary activities
in which the rural population is involved. The main activity is agriculture and includes other rural based
economic activities. The rural insurance encompasses such activities. The rural insurance consists of
various components. These are –
1. Agriculture Insurance
2. Crop Insurance
3. Cattle & Live Stock Insurance
4. Property insurance
5. Flood Insurance
6. Personal Insurance
7. Micro Insurance etc.

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1. Agriculture Insurance: India is an agrarian economy. Different agricultural products – food
and non food items are produced across the states. Different climatic conditions are suitable for the
production different agricultural produce. But the agricultural produce is subjected to vagaries of mansoon
and uncertain climatic conditions. To protect the farmer against the loss of produce through agriculture
insurance assumes lot of significance in a country like India. Because, Indian farmers are with average
land holdings and natural calamities such as draught, floods, cyclones etc., are common. Moreover, there
are many risks in Agriculture. The risks are very frequent crop failures, low produce, uncertainty in
getting the final produce, plant diseases, market and price fluctuations etc.
2. Crop Insurance: Crop insurance is the most important component of rural insurance. Due to
high risk and uncertainty, the insurance companies never approached agricultural sector. To encourage
the concept of insurance cover to protect the farmers from risk of losses the Government of India
launched crop insurance scheme during 1985-86. The General Insurance Corporation was entrusted
with the task of administering the scheme on behalf of the government. The insurance charges and
claims in respect of crops insured in any state are shared between the state and the central government.
For this purpose two funds are created, Central Crop Insurance Fund and Crop Insurance Fund, by
central and state governments respectively. For this purpose the General Insurance Corporation maintains
close contracts with the state governments, Reserve Bank of India, NABARD, State Cooperative Banks,
RRBs and other such agencies. In 1985, the General Insurance Corporation introduced comprehensive
Crop Insurance Scheme to cover different crops in India. Later it was changed into National Agricultural
Insurance Scheme. In India, crop insurance falls under the Rashtriya Krihi Bima Yojana, which was
introduced in 1999. The basic purpose of this scheme is to offer financial support to the farmers facing
loss due to a natural disaster; to refurbish credit eligibility of farmers, who have suffered losses due to
crop failure and to support and stimulate production of pulses and oilseeds in the country. The crops
covered under the scheme include rice, wheat, millets, oil seeds, pulses, cotton, sugarcane and potato.
The scheme is carried out in areas as defined through a notification by the Union Ministry of Agriculture.
The problem with crop insurance in our country is that rural India, where it is needed most, is still not
aware of it. A lot needs to be done on the front of crop insurance in India.
3. Cattle and live stock Insurance: Cattle insurance is a contract whereby the insurer undertakes
to pay an agreed sum of money to the assured in the event of death of animals like bulls, buffaloes, cows
and heifers in consideration of a predetermined premium amount. The risk of permanent total disability
of the animal is also covered under the policy on payment of extra premium. The policy provides
indemnity only in cases where death is caused by
1. Accident, which may be a result of fire, lightning, flood, inundation, storm, hurricane, earthquake,
cyclone, tornado, tempest and famine
2. Diseases cropping up or contracted during the period of the policy
3. Surgical operations
4. Strikes and riots
In the event of death of animals, the policy is agreed-value policy; hence claim will be settled for
100 per cent of the sum assured. For this purpose, valuation of insurance is based on the market value
of cattle, which is examined by veterinary doctors. The sum insured will not exceed 100 per cent of
market value. Cattle raring is one of the subsidiary activity of Indian Farmers. Therefore it was not able
to develop as an organized industry. Cattle and livestock insurance was recommended by several scholars
to save the farmers from the sudden loss but it is not materialized.
Only when the General Insurance was nationalized in 1972, the concept of cattle and livestock
insurance was brought into the picture. Cattle and live stock insurance covers a wide range of domestic
animals such as cattle, sheep, goats, horses, pony, pigs, camels, duck, chicks, rabbits, elephants, dogs etc.
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Insurance policies differ from one category of animals to other. At present all these insurance schemes
are governed by the General Insurance Corporation.
4. Property Insurance: Property insurance provides insurance against fidelity, burglary and insolvency.
Property insurance covers loss of property due to burglary, theft or housebreaking or any other criminal
act. Under Rural Insurance the property Insurance covers the following
Agricultural Pump sets insurance: This policy indemnifies the insured against unexpected damages to
the pump sets. The damage may be due to mechanical, electrical breakdown, fire and lightening left and
burglary.
Bullock Cart Insurance: This Insurance policy is designed to indemnify the loss to the carts driven by
animals. The scheme is called Animal Driven Cart Insurance.
Hut Insurance: In 1988 a scheme was introduced to provide insurance cover against loss due to fire for
huts of landless laborers, small farmers, artisans and other poor families in rural areas. The scheme
provides compensation to the hut and also to the belongings. Cost of premium is borne by the Central
Government. Hut Insurance policy indemnifies the insured against all accidental losses due to fire,
earthquake, cyclone, floods, civil disturbances, war etc. the maximum sum insured is Rs. 6,000/-.
5. Flood Insurance: Floods and other natural disasters like cyclones and Tsunamis cause damage
of Agriculture, crop property, houses and lives. The damage is devastating in the coastal and rural areas.
The non-life insurance companies and the Government provides insurance against the losses caused by
such disasters.
6. Personal Insurance: Personal insurance was introduced under different schemes, such as
Janatha Personal Accident. Individual group and Gramin Personal Accident – Individual and group
under the Janatha Personal Accident individual. Rs. 15,000/- is paid at the death due to accident and Rs.
7, 5000/- paid at the loss of a limb. People between 10 years to 65 years are covered under this policy.
Janatha Personal Accident (Group) covers persons of 10 years to 65 years of age and are paid Rs.
15,000/- at the time of death and Rs. 7,500/- for injury. Gramin Personal Accident (Individual), Gramin
personal Accident (Group) provides the same benefits such as pay Rs. 6,000/- at death and Rs. 3,000/-
they have any injury.
7. Micro insurance: Micro Insurance signifies insurance for small amounts targeted at the rural
people and women against a negligible premium. It is a component of Micro finance. The Micro finance
became popular with the development of Micro Credit Programmes through Self Help Groups (SHGs).
Insurance Regulatory Development Authority introduced the concept of micro insurance to cover small
and segmented enterprises. This helps to develop insurance awareness in the remote corner of the
country ie., Rural areas. The General Insurance Corporation and its four subsidiaries – National Insurance
Company limited, The New India Assurance Company limited, oriental Insurance Co. Ltd and United
India Insurance Co. Ltd have taken the responsibility of rural insurance programmes under micro insurance.
30.8 ADVANTAGES OF SOCIAL RURAL INSURANCE:
The social and rural insurance schemes ensure socio-economic advantages to the socially backward
people and rural poor. The advantages are as below.
1. Unorganized and informal sector is characterized with ignorance and illiteracy of the workers who
need an economic support to themselves and their families. Social insurance serves this purpose.
2. Economically and socially backward people are with meager means and cannot support the
insurance policies on par with the elite and urban and forward people. Therefore social and rural
insurance subsidized and supported by the Government.
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3. The agriculture is a gamble in the mansoon. The agriculturist incurs loss of produce and investment
due to climatic changes. Floods, cyclones, damage due to rodents and pests and other unforeseen
circumstances. The rural and agriculture insurance helps to guard against such losses.
4. Cattle rearing is an important subsidiary activity of the agriculturist and rural poor. Due to the
seasonality of agriculture, the rural people depend upon cattle and livestock for their livelihood.
Cattle and livestock insurance helps to protect against the loss, disability and death of cattle.
5. The Agriculturist generally sustains losses due to price fluctuations in the market. The agriculture
insurance makes good such losses.
6. The rural people and the agriculturist are susceptible to snake bites etc. The Janata personal
Insurance Schemes provide economic support to the family of the deceased.
7. The schemes like micro insurance not only provide a social security but also create a sense of
thrift, foresight and awareness of the insurance philosophy and spirit.
8. The property insurance like Agricultural pump set insurance, Bullock cart insurance , hut insurance
etc., are highly advantageous because the loss of such valuable property cannot be easily secured
by the agriculturist with meager incomes.
9. The rural insurance helps to relieve the rural people from the rural indebtedness by guarding
against the economic losses.
10. The social and rural insurance provides a security net for the poor, aged, women and downtrodden.
30.9 SUMMARY:
This lesson focused on the health, Social and Rural insurance. Healthy citizens make healthy
India. ‘Health is wealth’ is the popular adage. But due to a number of reasons like modern life style,
pollution and environment problems today risk of health and illness has been on the increase. The
ordinary people could not be able to meet the sky rocketing cost of treatment in corporate private super
specialty hospitals. Here comes the need for Health insurance. A number of health insurance schemes
are in operation which is supported by the Government, employers and individual beneficiaries. The non-
life insurance companies, both in the public sector and private sector, operate a number of health insurance
policies. As the health insurance provides the insured the expenditure for treatment and clinical tests for
unforeseen illness or diseases, it acts as a guard against severe illness treatment expenditure. It also
brings the costly treatment of diseases within the reach of the insured.
India is an agrarian rural economy. The rural poor and farmers with small holdings and dominant
in the villages. Moreover, because agriculture is a seasonal activity, the rural poor and also the agriculturist
earn their livelihood by rearing the cattle as their subsidiary activity. And as mechanization is not highly
prevalent, the agriculturists still carry their operations with the help of cattle in the neck and corner of the
country. Moreover, the agriculturist and the rural poor are subjected to losses due to uncertainties and
calamilities like floods, cyclones etc., besides the fluctuations in prices of agricultural produce. Due to all
these reasons there is an inevitable need for social and rural insurance for the social and rural sector in
India. The Insurance Act and the IRDA also statutorily emphasizes the need for such insurance. The
rural insurance consists of Agriculture insurance, crop insurance, cattle & livestock insurance, personal
insurance, property insurance, flood insurance, micro insurance etc. All these schemes of social and
rural insurance stand to guard the agriculturist and the rural poor against the losses.

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30.10 SELF ASSESSMENT QUESTIONS :
1. What is Health Insurance? Explain different type of Health Insurance Policies.
2. What is Social Insurance? Explain the advantages and disadvantages of Social Insurance.
3. Explain the concept of Rural Insurance and its significance.
4. Elucidate the components of Rural Insurance.
Short Notes :
Mediclaim
Crop insurance
Micro Insurance
Property Insurance
30.11 SUGGESTED READINGS :
1. Dr. C. Satya Devi, Financial Services – Banking Insurance, S. Chand, New Delhi.
2. Sethi and Bhatia, Elements of Banking and Insurance, prentice Hall of India Ltd, New Delhi
3. William S. Stevens, health Insurance: Current Issues and background, Avive Ron, New York
4. Palaride, P.S. et.al., Insurance in India: Changing Policies and Emerging opportunities, Sage
publications, New Delhi
5. Issac M. Rubinew, Social Insurance, Books, Google.co.in
6. Aviva Ron et.al., health Insurance in developing countries: the Social Security approach 1990,
books.google,co.in
30.12 KEY TERMS:
Health Insurance : Insurance providing cover for financial loss associated with Illnesses and injuries
and expenses incurred for the use of Health related services.
Mediclaim : policy providing cover and reimbursing expenses incurred Towards hospitalization.
Domiciliary hospitalization: Treatment administered at home either on advice of the Doctor or due to
non-availability of room in the hospital.
Fidelity Insurance : Fidelity guarantee insurance provides a cover to the insured (employer) against
losses arising through the fraud or embezzlement.
Burglary insurance : Burglary insurance falls under the property insurance. Losses Or damages of
household goods and properties and personal effects due to theft, larceny, robbery, house breaking and
such similar acts are covered by burglary insurance policy.
Larcency : Act of stealing personal property.

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