Second Edition

Elements of
BANKING AND
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INSURANCE
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JYOTSNA SETHI
NISHWAN BHATIA
 Elements of
Banking and Insurance
SECOND EDITION

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JYOTSNA SETHI
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Associate Professor
Department of Commerce
Jesus and Mary College
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University of Delhi

NISHWAN BHATIA
Associate Professor
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Department of Commerce
Jesus and Mary College
University of Delhi
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New Delhi-110001
2012
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ELEMENTS OF BANKING AND INSURANCE, Second Edition

Jyotsna Sethi and Nishwan Bhatia

© 2012 by PHI Learning Private Limited, New Delhi. All rights reserved. No part
of this book may be reproduced in any form, by mimeograph or any other means,
without permission in writing from the publisher.

ISBN-978-81-203-4657-4

The export rights of this book are vested solely with the publisher.

Sixth Printing (Second Edition)   October, 2012

Published by Asoke K. Ghosh, PHI Learning Private Limited, M-97, Connaught

Circus, New Delhi-110001 and Printed by Rajkamal Electric Press, Plot No. 2,
Phase IV, HSIDC, Kundli-131028, Sonepat, Haryana.
 By the Grace of Guru

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We dedicate our work
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The Academic Fraternity
and
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Our Inquisitive Students
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Contents

Preface xi

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Preface to the First Edition xiii
Abbreviations xv
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1. Introduction to Banking Business
1.1 Brief History 2
1.2 Business of Banking 6
1–15

1.3 Banker Customer Relationship 10

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1.4 Bank Deposits 13
Key Terms 15
Review Questions 15
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2. Structure of Commercial Banks in India and

Apex Banking Institution 16–44
2.1 Structure of Indian Banking System 17
2.2 Reserve Bank of India 18
2.3 Commercial Banks 22
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2.4 Public Sector Banks 24

2.5 Private Sector Banks 25
2.6 Public Sector Banks Vs. Private Sector Banks 27
2.7 Local Area Banks 27
2.8 Indian Banks 28
2.9 Foreign Banks 29
2.10 Indian Banks Vs. Foreign Banks 30
2.11 Regional Rural Banks 31
2.12 Cooperative Banks 33
2.13 Commercial Vs. Cooperative Banks 36
2.14 Apex-Level Banking Institutions 36
2.15 National Bank for Agriculture and
Rural Development (NABARD), 1982 37
2.16 National Housing Bank (NHB) 38
2.17 Small Industries Development Bank of India (SIDBI) 41
2.18 Industrial Development Bank of India Limited 42
2.19 Export Import Bank of India (EXIM Bank) 43
Key Terms 43
Review Questions 44
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3. Banking Sectors 45–63

3.1 Recent Developments in Banking Industry 46
3.2 Banking Sectors 46
3.3 Corporate Banking 46
3.4 Retail Banking 48
3.5 International Banking 50
3.6 Rural Banking 53
3.7 Non-Banking Financial Intermediaries 58
Key Terms 62
Review Questions 63
4. Electronic Banking 64–77
4.1 Meaning of E-banking 65
4.2 Automated Teller Machine 66
4.3 Internet Banking 67
4.4 Electronic Clearing Service (ECS) 68
4.5 Electronic Funds Transfer (EFT) 69

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4.6 Telebanking 70
4.7 Electronic Cheques 70
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4.8 Credit Cards
4.9 Debit Cards
4.10 Smart Card
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4.11 Risks in E-banking 76
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Key Terms 77
Review Questions 77
5. Loans and Advances 78–92
5.1 Principles of Sound Lending 78
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5.2 Methods of Granting Advances 81

5.3 Secured Advances 84
5.4 Modes of Creating Charges 86
Key Terms 92
Review Questions 92
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6. Priority Sector Lending 93–101

6.1 Rationale of Priority Sector 93
6.2 Different Segments of Priority Sector Advances 96
Key Terms 100
Review Questions 101
7. Export Credit 102–111
7.1 Export and Import Finance 102
7.2 RBI Measures to Promote Export Credit 104
7.3 Pre-shipment or Packing Credit 104
7.4 Post-shipment Finance 106
7.5 Export Import Bank of India (EXIM Bank) 107
7.6 Export Credit Guarantee Corporation of India (ECGC) 109
Key Terms 110
Review Questions 111
8. Annual Report and Balance Sheet of a Bank 112–122
8.1 Annual Report 113
8.2 Balance Sheet of a Commercial Bank 114
 Contents vii

8.3 Liabilities and Assets of a Bank 119

Key Terms 122
Review Questions 122
9. Project and Working Capital Finance 123–132
9.1 Project Finance 124
9.2 Project Appraisal 125
9.3 Working Capital 127
Key Terms 131
Review Questions 132
10. Banking Legislation 133–141
10.1 The Reserve Bank of India Act, 1934 134
10.2 The Banking Regulation Act, 1949 138
Key Terms 141
Review Questions 141
11. Banking Sector Reforms and NPAs 142–150

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11.1 Rationale of Banking Sector Reforms 142
11.2 Non-Performing Assets (NPA) 147
Key Terms ta
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Review Questions
12. Practical Banking
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151–161
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12.1 Cheque 152
12.2 Magnetic Ink Character Reading (MICR)
Cheques/Drafts 153
12.3 Core Banking Solution (CBS) System 153
12.4 Essential Features of a Cheque 154
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12.5 Bank Drafts/Pay Order, Banker’s Cheque 155

12.6 Banking Ombudsman Scheme, 2006 159
Key Terms 161
Review Questions 161
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13. Risk Management: An Overview 162–178

13.1 Importance of Risk Management 163
13.2 The Concept of Risk 164
13.3 Meaning of Business Risks 166
13.4 Nature of Business Risks 166
13.5 Causes of Business Risks 167
13.6 Types of Business Risks 168
13.7 Methods of Handling Risks 172
12.8 Enterprise Risk Management 175
Key Terms 177
Review Questions 178
14. Introduction to Insurance 179–202
14.1 Characteristics of Insurance 180
14.2 Insurance: Purpose and Need 181
14.3 Benefits of Insurance 183
14.4 Functions of Insurance 184
14.5 Importance of Insurance 185
14.6 Principles of Insurance 186
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14.7 Nature of Insurance Contract 190

14.8 Types of Insurance Contracts 191
14.9 Fundamentals of Insurability 192
14.10 Insurance Contract Vs. Wagering Agreement 192
14.11 Assurance Vs. Insurance 193
14.12 Gambling Vs. Insurance 194
14.13 Classification of Insurance 195
Illustrations 197
Insurance Terminologies 198
Key Terms 201
Review Questions 202
15. Life Insurance 203–229
15.1 Essential Features of Life Assurance 204
15.2 Advantages of Life Assurance 206
15.3 Types of Life Insurance Plans 207
Key Terms 228

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Review Questions 228
16. Fire Insurance 230–240
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16.1 Scope of Fire Insurance

16.3 Types of Fire Policies

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16.2 Fire Insurance: Underlying Principles
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16.4 Assignment of Fire Policy 238
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16.5 Settlement of Claims 238
Illustrations 239
Key Terms 240
Review Questions 240
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17. Marine Insurance 241–255

17.1 The Scope of Marine Insurance 242
17.2 Marine Insurance Contracts 243
17.3 Fundamental Principles of Marine Insurance 244
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17.4 Marine Insurance Policies 248

17.5 Types of Marine Losses 250
17.6 Important Clauses of Marine Insurance 252
Illustrations 254
Key Terms 254
Review Questions 255
18. Motor Vehicle Insurance 256–263
18.1 Taxonomy of Motor Vehicles 257
18.2 Kinds of Motor Vehicle Insurance Policies 258
18.3 Servicing of Motor Vehicle Insurance 260
18.4 Claims Settlement Under Motor Vehicle Insurance 262
Key Terms 263
Review Questions 263
19. Health Insurance 264–274
19.1 Types of Health Insurance Policies 266
19.2 Health Insurance Schemes in India 272
Key Terms 273
Review Questions 273
 Contents ix

20. Miscellaneous Insurance 275–286

20.1 Fidelity Guarantee Insurance 276
20.2 Property Insurance 277
20.3 Building Insurance 277
20.4 Earthquake Insurance 278
20.5 Flood Insurance 278
20.6 Burglary Insurance 279
20.7 Cattle Insurance 280
20.8 Engineering Insurance 282
20.9 Liability Insurance 285
20.10 Crop Insurance 285
Key Terms 285
Review Questions 286
21. Reinsurance 287–295
21.1 Characteristics of Reinsurance 288
21.2 Types of Reinsurance 288

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21.3 Reinsurance Vs. Double Insurance 290
21.4 Over Insurance 291

Key Terms
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21.5 Essentials of A Reinsurance Programme
21.6 Important Terms Concerning Reinsurance
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Review Questions 295
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22. Insurance Pricing 296–311
22.1 Pricing Objectives 297
22.2 Life Insurance Pricing Elements 298
22.3 Insurance Rating Methods 299
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22.4 Calculation of Premium 301

22.5 Methods of Loading 307
22.6 Classification of Expenses 308
22.7 Payment of Premium 308
22.8 Rate Making 309
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Key Terms 310

Review Questions 311
23. Underwriting 312–321
23.1 Purposes and Principles of Underwriting 313
23.2 The Underwriting Process 313
23.3 Methods of Rate Determination 316
23.4 Types of Underwriters 318
23.5 Role of Agents in Underwriting 320
Key Terms 321
Review Questions 321
24. Policy Servicing and Claims Settlement 322–345
24.1 Insurance Documents 323
24.2 Nomination and Assignment: A Comparison 327
24.3 Alterations 330
24.4 Revival 332
24.5 Policy Loans 332
24.6 Surrender Value and Paid-Up Value 333
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24.7 Issue of Duplicate Policy 335

24.8 Lost Policies 336
24.9 Claims Settlement in Life Insurance 336
24.10 Improvements in Policy Servicing 343
Key Terms 344
Review Questions 345
25. Channels of Distribution 346–363
25.1 Insurance Intermediaries and their Functioning 347
25.2 Bancassurance 356
Key Terms 362
Review Questions 362
26. Legal Framework 364–423
26.1 The Indian Contract Act, 1872 365
26.2 The Consumer Protection Act, 1986 374
26.3 The General Insurance Business (Nationalization)
Act, 1972 381

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26.4 Life Insurance Corporation Act, 1956 388
26.5 The Insurance Regulatory and Development

Key Terms
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Authority Act, 1999
26.6 The Insurance Act, 1938
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Review Questions 422
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27. Indian Insurance Industry: Transition and Prospects 424–448
27.1 Insurance in India: Historical Background 425
27.2 Reforms in the Indian Insurance Sector 427
27.3 Liberalization: Meaning and Implications 429
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27.4 Future Trends in the Indian Insurance Industry 431

27.5 Macro Insurance: The Indian Perspective 434
27.6 Major Players in Indian Insurance Industry 435
Key Terms 447
Review Questions 448
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Appendix A: Public Sector Banks 449–450

State Bank of India and its Subsidiaries 449
Nationalized Banks 449
Appendix B: Foreign Banks in India 451–452
Appendix C: Private Sector Banks 453–454
Old Private Sector Banks 453
New Private Sector Banks 454
Appendix D: Cooperative Banks 455–456
Appendix E: Cases 457–460
Case 1 Banker’s Right of General Lien 457
Case 2 Dishonour of Cheques 458
Case 3 Banker’s Right of Appropriation 458
Case 4 Relative Rights of Unpaid Seller and
the Banker Hypothecatee 460
Bibliography 461–464
Index 465–472
Preface

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We are indeed thankful to our dear students and esteemed
colleagues for the overwhelming response to our book Elements of
Banking and Insurance, as is evident from five reprints in a short
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span of time. It has also been included in the reading list of some
of the top universities of the country. The appreciation and
feedback received by the book has encouraged us to enlarge, revise
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and update it.
The present second edition includes many more and wide-
ranging aspects of banking and insurance, including the role and
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functions of the apex banking institutions such as National Bank

for Agriculture and Rural Development (NABARD), Small
Industries Development Bank of India (SIDBI), and National
Housing Bank (NHB). A new chapter on Practical Banking has
been added to make the students familiar with magnetic ink
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character reader (MICR), core banking solution (CBS), bouncing of

cheques, and banking ombudsman. The recent trends in the
insurance industry have been well-incorporated with information
on new private players and policies being offered. Discussions on
various aspects of insurance are further elaborated.
We ardently hope that the reader will find the second edition
even more useful. We look forward to receiving valuable comments
and suggestions from students as well as faculties to further
improve and enhance the contents of the book.

Jyotsna Sethi
Nishwan Bhatia

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Preface to the First Edition

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The financial sector constitutes one of the major components of the
services sector and within the financial sector Banking and
Insurance have a significant role to play. There has been a
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manifold increase in the demand for banking services along with a
commensurate increase in insurance services to cover various
commercial and personal risks arising out of increasing
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complexities of modern life.
The past few years have witnessed myriad institutional and
structural changes paving the way for the entry of a number of
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private and foreign players in these fields. These, in turn, have

thrown up numerous opportunities as well as challenges for
banking and insurance companies.
The present book is an attempt to describe the role of banking
and insurance sectors in the current era of globalization,
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privatization and liberalization. Besides, the strides made in the

field of information technology in recent years, have significantly
impacted the operating environment resulting in increased
competitive pressures and changing customer demands. A corollary
of this is the increased employment opportunities in these sectors,
directly or indirectly.
Many universities have exhibited great foresight by introducing
the subjects of Banking and Insurance at the undergraduate level.
Delhi University in particular, has offered an Application Course
in Banking and Insurance for the third year students of B.A.
(restructured) programme. The subject of Insurance has also been
offered as a discipline course for the B.A. (restructured)
programme.
We hope that the lucid style of the text presentation which has
been supported with suitable tables, figures and illustrations will
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xiv Preface to the First Edition

prove useful to our students in the understanding of these subjects

as well as help them to keep abreast of the current developments
taking place in these areas. It is also expected that this text will
aid fellow teachers in clarifying certain theoretical and conceptual
issues as well as provide useful insight to professionals in the
fields of banking and insurance.
Despite our best efforts, we acknowledge our human
limitations and possible errors. We, therefore, invite constructive
suggestions as they would be instrumental in further improving
our work.
We are deeply indebted to our families whose support and
understanding helped bring this effort to fruition.

Jyotsna Sethi

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Nishwan Bhatia

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