What are the main Functions of the Central Bank?

Central Banks differ from country to country in their structure and organization , in their policies and techniques. But their functions are very similar. The Ce ntral Bank renders the following important functions in almost all countries: (i) Issuing of notes and regulating the volume of currency (ii) Acts as banker to the government (iii) Acts as banker to the banks (iv) Acts as custodian of Nation's reserves (v) Acts as the lender of last resort (vi) Functions as National Clearing House (vii) Acts as controller of credit (viii) Publishes economic statistics and other information (ix) Development functions (x) Supervises the activities of financial institutions. The Central Bank is legally empowered to issue currency notes. The Central Bank is charged with the responsibility of maintaining price stability, inflation lev el, i.e., the domestic value of its money as well as its external value. The sup ply of money consists of the legal lender money and the bank money. The Central Bank has the monopoly power of the note issue to regulate the supply of legal tender money. This enables it to impart elasticity to the currency sys tem and to maintain stability in the circulation of money. In Hong Kong the responsibility of issuing currency notes has been entrusted wit h a private sector bank, viz. Hong Kong and Shanghai Banking Corporation (HSBC). By the function of note issue the central bank achieves the following merits: (a) Enhance the public confidence on the monetary system. (b) Maintaining uniformity in the monetary system throughout the country. (c) Flexibility in the monetary system. By the function of note issue the Centra l Bank can maintain the circulation of the economy at desired level. (d) Credit creation can be effectively controlled. The sole right of note issue enables the Central Bank to regulate the creation of credit by commercial banks and adjust the supply of money to the demand for it. (e) Maintaining the internal and external value of money. The Central Bank follows different systems of note issue according to the curren cy regulations. The different systems of currency are, (a) Fixed fiduciary system (b) Minimum fiduciary system (c) Proportional Reserve system (d) Foreign exchange reserve system (i) Minimum Reserve system Whatever may be the system three basic principles are to be followed. They are ( i) Uniformity (ii) Security and (iii) elasticity. The currency issued must be un iform and a single authority must be vested with the power of note issue to achi eve uniformity. There must be security for the currency without any dangers of over-issue. Publi c must have confidence in the currency, which to some extent, depends upon the g old and foreign exchange reserves it holds. At the same time the currency supply must be elastic. The Central Bank must be able to expand or to contract the supply of currency ac cording to the changing needs from time to time. (ii) Banker to the Government: The Central Bank acts as the banker, financial agent and advisor to the governme nt. The surplus money of the government is kept with the Central Bank. It lends money to both central and state governments. It helps the government to tide ove r the time gap between their expenditure and collection of taxes. The Central Bank is usually required to make temporary advances to the governmen t in anticipation of collection of revenues. These advances are known as "ways an d means advances" in India and are made for short periods. The Central Bank also undertakes to provide the government with necessary foreign exchange for making payments abroad. It is necessary that there should be close co-operation between the Central Bank

and the government. The government is the ultimate authority for laying down th e broad monetary policies of the country and Central Bank is the institution for carrying out of such policies. The Central Bank as a fiscal agent to the government accepts loans and manages p ublic debts, receives taxes and other payments from the public. The government bo nds and treasury bills are issued by the Central Bank on behalf of the governmen ts As the financial adviser, the Central Bank provides valuable advice to the gover nment on important financial matters like, foreign exchange policy, commercial p olicy, rising of funds from market, etc. (iii) Banker to the banks: The Central Bank Acts as the bankers' bank. As such it performs the following fun ctions: Custodian of cash reserves of commercial banks: The commercial banks of the coun try are required to keep a certain percentage of their deposits with the Central Bank. It secures the advantage of centralized cash reserves. In India the Centr al Bank is authorized to vary these reserve requirements within certain limits. Such cash reserves with the Central Bank have the following advantages: (a) The centralization of cash reserve is a source of great strength to the bank ing system of the country as it strengthens the confidence of the public (b) Centralized reserves can be used effectively and quickly in times of emergen cy. (c) This ensures liquidity and imparts economy in the credit structure of the co untry. (d) These reserves promote liquidity of commercial banks as they enable the Cent ral Bank to undertake rediscounting of bills on a more extensive scale for the p urpose of meeting the requirements of the money market. (e) The Central Bank can control credit by varying the cash reserves that commer cial banks should keep with it. (iv) Act as custodian of National reserves: Central Bank is the custodian of nation's gold and foreign exchange reserves. Pr eviously, to some extent, the value of a currency depends upon the gold reserves or foreign exchange reserves held as the backing for the currency. As such, it is the responsibility of the Central Bank to maintain sufficient reserves and to prevent their depletion. The Central Bank manipulates the bank rates and takes other steps to conserve th e reserves of gold and foreign exchange. Some Central Banks have absolute powers to control the foreign exchange reserves and to license the various uses to whi ch the foreign exchange is put to use. In modern times, the foreign exchange con trol has become the essential function of the Central Bank. (v) Acts as Lender of last resort: The Central Bank acts as the lender of last resort and as the bank of rediscount . Rediscounting can be defined as conversion of bank credit into Central Bank Cr edit. The commercial banks approach the Central Bank for its financial needs as it is the lender of the last resort or the ultimate source of finance. It lends to the commercial banks by rediscounting the eligible bills. The redisc ounting facilities given by the Central Bank impart elasticity and liquidity to the entire credit structure of the country. It helps the commercial banks in a b ig way to prevent them from bank failures. But its assistance is limited only to the banks which suffer from technical inso lvency and not to those unsound and really insolvent banks. Moreover, a commercial bank is not entitled to financial accommodation simply bec ause it has eligible paper or approved securities. Unless it is conducting its b usiness according to sound banking principles, the Central Bank refuses accommoda tion. Thus, the Central Bank is able to control credit while discharging the function of lender of last resort. The Central Bank is also regarded as performing the fu nction of last resort when it grants accommodation to the government in times of monetary stringency. (vi) Functions as National clearing house:

The Central Bank acts as the national clearing house. The maintenance of account s by all commercial banks with the Central Bank en-ables it to settle inter-bank indebtedness. A clearing house is an institution where interbank claims, i.e., claims of banks against one another are settled. The net balances or differences called the cle aring balances are settled by mere transfers between their respective accounts a t the Central Bank. The clearing houses facilitate expeditious and economical settlement of inter-ban k claims. The Central Bank acts as a bank of clearance, settlement and transfer a nd establishes clearing houses in the important cities and towns in the country. They are housed in the premises of the Central Bank administered by it or at th eir Agent banks. Clearing houses are established in the important cities and towns of a country b y the respective local banks. If the Central Bank has no offices of its own, the clearing houses are housed in the premises of the agents of the Central Bank. Technique of Clearance The technique of settling the inter-bank indebtedness is simple. The clearing ho use operates as follows. The representatives of various member banks of a cleari ng house meet at the clearing house at a particular time. Every representative delivers to others the cheque and other claims which his ba nk holds against them. Similarly, he receives from others the claims which they hold against his banks. Cheques dishonored are returned to the concerned represen tatives. The amount receivable and payable are added. The net clearing balances of banks are settled by debtor banks by issuing cheque s against their accounts with the central bank in favour of creditor banks. Thus , the inter-bank claims are settled by mere book entries in the accounts maintai ned with the central bank. These days the payment system operates more efficientl y through computerized operations. Advantages of Clearing House Central Banks' function of clearing house provides the following advantages: (a) Clearing houses reduce the cost involved in the collection of cheques and cl aims. (b) They avoid the delay in the clearing of cheques. (c) They ensure convenience and economy in the settlement (d) They minimise the risk involved in the realisation of cheques. (e) They minimise the necessity of holding large cash balances by commercial ban ks. (f) They can be used as a common platform for the discussion of the problems of member banks. (g) They promote co-operation among member banks. (h) Central Banks also get information about the liquidity position of commercia l banks. (i) Clearing houses offer valuable data to know the trends in the operations of commercial banks. (vii) Act as the controller of credit: The Central Bank functions as the control ler of credit in the country. According to De Kick, this function is considered as the most important function of the Central Bank. The credit creation by the c ommercial banks has a direct impact on the economy. If the banks expand the credit limits that leads to inflation and if they unduly contract credit it leads to deflation. Thus, the central bank is empowered to c ontrol the credit creation of the commercial banks. The commonly used methods of credit control are, (a) Bank Rate Policy (b) Open Market Operations (c) Variation of cash reserves (d) Credit rationing (e) Variation of margin requirements (f) Regulation of consumer's credit (g) Moral suasion (h) Direct action

(i) Selective credit control By adopting these methods, the Central Bank controls both the quantity and quali ty of credit created by the banks. Publishes economic statistics and other information: The Central Bank regularly collects and publishes the statistics regarding variou s economic activities of the government, banking system, etc. Further it provide s useful information regarding government policies. Development functions: The Central Bank Acts as the catalyst of economic growth of the country. It acts as an agency of economic growth. It renders various developmental functions suc h as (i) Provision of credit facilities to agricultural industry and other priority s ectors through commercial banks and co-operative banks. (ii) Expansion of banking facilities in the country. (iii) Maintaining price stability in the country. (iv) Mitigating the effects of trade cycles by its effective monetary policies, etc. The responsibility of the Central Bank is increasing every day and its functions are expanding. The well-administered central banking functions are necessary fo r all the countries especially for the developing countries to maintain price sta bility and economic growth. However, the developmental role of Reserve Bank of India was gradually branched out into separate development financial institutions, such as IDBI and NABARD an d investment institutions like UTI over a period of time. Forms and Functions of Modern Banking 1. Modern Banking Measures of the Money Supply, Functions and Types of Financial Institutions, And Modern E-Banking 2. Measuring the Money SupplyTo understand Modern Banking, an understanding of w hat constitutes the Money Supply , the money available in the economy, is needed . The Money Supply is divided into two distinct categories: M1 Assets that can b e easily accessed and immediately used to purchase goods and services. These are referred to as Liquid Assets. Money deposited in Checking Accounts meets this c riteria because checks represent Demand Deposits , as they are paid On Demand for the cash in the account. M2 All of M1 and assets that cannot be used directly as cash but can easily be converted to cash. Money Market Mutual Funds are example s of this because they can be used as collateral against certain types of checks . Savings accounts also fall into this category. 3. Functions of Financial InstitutionsFinancial Institutions utilize the Money S upply to perform many roles including: Storing Money Saving Money Loans Mortgage s Credit Cards Conveying Interest (Simple and Compound) Earning a Profit 4. Storing MoneyOne of the basic functions of a bank is to provide a safe, and c onvenient, storage location for valuables, chiefly money. Vaults are generally f ireproof and nearly impenetrable. Banks are insured against losses due to theft. 5. Saving MoneyBanks offer a variety of means of saving money such as: Savings A ccounts Checking Accounts Money Market Accounts Certificates of Deposit Banks ge nerally pay interest, an amount paid for the use of your money, on these account s. 6. LoansBanks offer loans , money given out for a period of time in exchange for fees and interest charges. Banks are limited in the total amount of loans that they issue because of the Fractional Reserve System . This is the idea that bank s must keep a certain percentage of the value of loans that they issue on hand i n the form of deposits. 7. MortgagesMortgages are specific types of loans used to buy real estate. They generally come in term lengths of 15, 25, or 30 years. A key determining factor in determining the interest rate and the term on the mortgage is the borrowers C reditworthiness. That is a reflection of the likelihood that the borrower will b e able to repay the loan and not default , or fail to repay the loan. 8. Credit CardsCredit Cards are cards that allow their holders to make purchases of goods and services in exchange for the credit cards provider immediately payi

ng for the good or service, and the card holder promising to pay back the amount of the purchase to the card provider over a period of time, and with interest. The amount of credit available to a card holder is often a reflection of their c reditworthiness. 9. Simple and Compound InterestBanks earn income through the interest that they charge on their lending. As we have already established, Interest is the price p aid to use borrowed money. In can take two forms: Simple Interest paid on an ann ualized basis as a percentage of the value of the loan or deposit know as the Pr incipal . Compound Interest paid annually on the total principal, and the accumu lated interest from previous time periods. 10. Earning a ProfitBanks exist to earn money the same as any other business. Th ey do this through charging interest on their lending and through charging vario us fees for their services. 11. Modern E-CommerceModern Banks utilize electronic formats to complete many of their functions. These electronic formats can include: Automated Teller Machine s (ATMs) Debit Cards Home Banking Automatic Clearing Houses (ACHs) Stored Value Cards 12. ATMsATMs replace human bank tellers in performing basic banking functions su ch as: Deposits Withdrawals Account Inquiries Key advantages of ATMs include: 24 hour availability. Elimination of labor costs. Convenience of location. 13. Debit CardsDebit cards are used to electronically withdraw funds directly fr om the cardholders accounts. Most debit cards require a Personal Identification Number (PIN) to be used to verify the transaction. 14. Home BankingHome banking is the process of completing financial transactions from your own home as opposed to utilizing a branch of a bank. Actions can incl ude: Make Account Inquiries Transfer Money Pay Bills Apply for Loans Direct Depo sit 15. Automatic Clearing Houses (ACHs)ACHs facilitate the payment of bills without the need to write a check. An ACH can be used to create automatic monthly bill payments so that the payer does not have to initiate the payment of the bill. Be nefits Include: Postal Savings No Forgotten Payments Time Savings 16. Stored Value CardsStored Value Cards are used in a manner very similar to a Debit Card. The card is Loaded, or credited, with a set value. That value can th en be used to make purchases. Examples of this concept include: Prepaid Calling Cards Store Gift Cards ACCESS Cards Economic Development and the Evolving Importance of Banks and Stock Markets Submitted by Asli Demirg-Kunt on Thu, 2012-01-19 11:55 How should the relative importance of banks and stock markets change as countrie s develop? Is there an optimal financial structurein other words, should the mix ture of financial institutions and markets change to reflect the evolving needs of economies as they develop? Previous research has found that both the operation of banks and the functioning of securities markets influence economic development (Demirguc-Kunt and Maksimo vic, 1998; Levine and Zervos, 1998), suggesting that banks provide different ser vices to the economy from those provided by securities markets. Indeed, banks ge nerally have a comparative advantage in financing shorter term, lower risk, well collateralized investments, while arms length markets are relatively better sui ted in designing custom financing for more novel, longer run and higher risk pro jects. However, economic theory also emphasizes the importance of financial structure, i.e., the mixture of financial institutions and markets operating in an economy. For example, Allen and Gales (2000) theory of financial structure and their comp arative analyses of Germany, Japan, the United Kingdom, and the United States su ggest that (1) banks and markets provide different financial services; (2) econo mies at different stages of economic development require different mixtures of t hese financial services to operate effectively; and (3) if an economys actual mix ture of banks and markets differs from the optimal structure, the financial system will not provide the appropriate blend of financial services, with adverse effe cts on economic activity. Empirical research, however, has been largely unsuccessful at clarifying the evo

lving importance of banks and markets during the process of economic development . In our earlier research Ross Levine and I show that banks and securities marke ts tend to become more developed as economies grow and that securities markets t end to develop more rapidly than banks (Demirguc-Kunt and Levine, 2001). Thus, f inancial systems generally become more market-based during the process of econom ic development. But this pattern could simply reflect supply side factors, such that securities markets grow more rapidly than banks as economies expand, with n o implication that firms and households change their relative demand for the ser vices provided by banks and markets respectively. In a recent paper with Erik Feyen and Ross Levine, we try to evaluate empiricall y the changing importance of banks and securities markets as economies develop. In particular, we focus on assessing whether economies increase their demand for the types of services provided by securities markets relative to the services p rovided by banks as countries grow. We do this by testing whether the economic d evelopment returns to improvements to both bank and securities market development change as economies grow. At a more exploratory level, we also examine whether e ach level of economic development is associated with an optimal financial structur e, such that deviations from this optimum are associated with lower levels of ec onomic activity. We use data on 72 countries, over the period from 1980 through 2008, and we aggregate the data in 5-year averages (data permitting), so that we have a maximum of six observations per country. We use several measures of bank and securities market development, including standard indicators such as bank c redit to the private sector as a share of gross domestic product (GDP), the valu e of stock market transactions relative to GDP, and the capitalization of equity and private domestic bond markets relative to GDP. The primary methodological contribution of this paper is using quantile regressi ons to assess how the sensitivities of economic activity to both bank and securi ties market development evolve as countries grow. Ordinary least squares (OLS) r egressions provide information on the association between, for example, economic development and bank development for the average country, the country at the aver age level of economic development. But quantile regressions provide information on the relationship between economic activity and bank development at each perce ntile of the distribution of economic development. Thus, we assess how the assoc iations between economic development and both bank and securities market develop ment change during the process of economic development. Figure 1 illustrates our findings. In Figure 1 the graph on the left side plots the coefficients from quantile regressions for each of the 5th to 95th percentil es of Log Real GDP per capita, where the dependent variable is Log Real GDP per capita and the main regressor is Private credit and we also control for Stock va lue traded. A circle indicates each coefficient estimate. Quantile coefficients for private credit and securities market activity The left axis provides information on the values of the coefficient estimates. T hus, the estimated coefficient, indicated by a circle, depicts the sensitivity of Log Real GDP per capita associated with a change in Private credit at each perce ntile of economic development. The graph also plots the actual value of Private credit at each percentile. A triangle indicates these actual values, where the s cale is provided on the right axis. The triangles provide the average quantity of Private credit at each percentile of economic development. In the graph on the r ight, we provide similar information on the relationship between economic activi ty and Stock value traded. In both figures, the horizontal dotted line is the OL S estimate of the coefficient on the financial development indicator. The solid lines are the estimated linear relationship between the sensitivity coefficients and log GDP per capital. In terms of bank development, Figure 1 shows that as Log Real GDP per capita ris es, two things happen: (1) Private credit rises (triangles) and (2) the marginal increase in Log Real GDP per capita associated with an increase in Private cred it falls (circles). Put differently, quantities rise and sensitivities fall. Thi s relationship is also statistically significant: as economic activity increases , there is a significant reduction in the sensitivity of Log Real GDP per capita

to an increase in Private credit. The results are different for securities market development. As Log Real GDP per capita rises, (1) Stock value traded rises and (2) the marginal increase in Log Real GDP per capita associated with an increase in Stock value traded also rise s. That is, quantities and sensitivities rise. This effect is also statistically significant: the sensitivity of economic activity to Stock value traded increas es as Log Real GDP per capita rises. These results suggest that the relationship between bank development and economi c activity differs from that between securities market development and economic activity. As economies develop, the marginal increase in economic activity assoc iated with an increase in bank development falls, while the marginal boost to ec onomic activity associated with an increase in securities market development ris es. These results suggest that the demand for the services provided by securitie s markets increases relative to the demand for those provided by banks as econom ies develop. We also conduct a preliminary examination of whether deviations of a countrys act ual financial structure from our estimate of the countrys optimum are associated with lower levels of economic activity. To estimate the optimal mixture of banks and markets for each level of economic development, we first regress a measure of financial structure (such as the ratio of bank to securities market developme nt) on GDP per capita for the sample of high-income OECD countries, while contro lling for key institutional, geographic, and structural traits. The maintained h ypothesis is that conditional on these traits, the high-income OECD countries pr ovide information on how the optimal financial structure varies with economic de velopment. We then use the coefficients from this regression to compute the esti mated optimal financial structure for each country-year observation for all coun tries. Next, we compute the Financial structure gap, which equals the natural lo garithm of the absolute value of the difference between the actual and the estim ated optimal financial structure, controlling for systematic variation in the pr ediction errors. The Financial structure gap measures deviations of actual finan cial structure from the estimated optimum, where larger values indicate bigger d eviations, regardless of whether the deviations arise because the country is too b ank-based or too market-based. We find that deviations of an economys actual financial structure from its estima ted optimumi.e., increases in the Financial structure gapare associated with a red uction in economic output. Even when controlling for bank development, securitie s market development, country characteristics, and country fixed effects, there is a negative relationship between the Financial structure gap and economic acti vity. Although we do not identify a causal impact of financial structure on econ omic development, these results are consistent with the view that the mixture of banks and marketsand not just the level of bank and market developmentis importan t for understanding economic development. Why is this relevant for policy? This research suggests that we expect the optim al mixture of institutions and markets to change as economies develop. So, the c osts of policy and institutional impediments to the evolution of the financial s ystem can be significant. We dont know enough to target a given financial structu re for a particular country. However, if we do see that market or bank developme nt is too skewed compared to what we would expect, these findings give us a reas on to dig much deeper. We can try to find out if taxes, regulations, legal imped iments or other distortions are leading to excessive reliance on banks or market s. Hence this research can justify a more focused, in-depth investigation of par ticular characteristics of the financial system that might be hindering economic progress. INVESTMENT POLICY OF BANKS The nancial position of a commercial bank is re ected in its balance sheet. The bal ancesheet is a statement of the assets and liabilities of the bank. The assets o f the bank aredistributed in accordance with certain guiding principles. These p rinciples underline theinvestment policy of the bank. They are discussed below:

 Liquidity: In the context of the balance sheet of a bank the term liquidity has twointerpre tations. First, it refers to the ability of the bank to honour the claims of the depositors. Second, it connotes the ability of the bank to convert its non-cash assetsinto cash easily and without loss.It is a well known fact that a bank deal s in funds belonging to the public. Hence,the bank should always be on its guard in handling these funds. The bank shouldalways have enough cash to meet the dem ands of the depositors. In fact, the successof a bank depends to a considerable extent upon the degree of con dence it can instillin the minds of its depositors. If the depositors lose con dence in the integrity of their bank, the very existenc e of the bank will be at stake. So, the bank should always be prepared to meet t he claims of the depositors by having enough cash. Among thevarious items on the assets side of the balance sheet, cash on hand represents themost liquid asset. Next comes cash with other banks and the central bank. The orderof liquidity go es on descending.Liquidity also means the ability of the bank to convert its non -cash assets intocash easily and without loss. The bank cannot have all its asse ts in the form of cash because each is an idle asset which does not fetch any re turn to the bank. So some of the assets of the bank, money at call and short not ice, bills discounted, etc. could bemade liquid easily and without loss. Pro tability: A commercial bank by de nition, is a pro t hunting institution. The bank has to earn pro t to earn income to pay salaries to the staff, interest to thedepositors, div idend to the shareholders and to meet the day-to-day expenditure.Since cash is t he least pro table asset to the bank, there is no point in keeping all theassets i n the form of cash on hand. The bank has got to earn income. Hence, someof the i tems on the assets side are pro t yielding assets. They include money at calland s hort notice, bills discounted, investments, loans and advances, etc. Loans andad vances, though the least liquid asset, constitute the most pro table asset to the bank. Much of the income of the bank accrues by way of interest charged on loans and advances. But, the bank has to be highly discreet while advancing loans.3. Safety or Security: Apart from liquidity and pro tability, the bank should lookto the principle of saf ety of its funds also for its smooth working. While advancing loans, it is neces sary that the bank should consider the three C s of credit character,capacity and the collateral of the borrower. The bank cannot afford to invest its fundsreckle ssly without considering the principle of safety. The loans and investmentsmade by the bank should be adequately secured. For this purpose, the bank should always insist on security of the borrower. Of late, somehow or other the banks h avenot been paying adequate importance to safety, particularly in India.4. Diversity: The bank should invest its funds in such a way as to secure for itself an adequa te and permanent return. And while investing its funds, the bank shouldnot keep all its eggs in the same basket. Diversi cation of investment is necessaryto avoid the dangerous consequences of investing in one or two channels. If the bank inv est its funds in different types of securities or makes loans and advancesto dif ferent objectives and enterprises, it shall ensure for itself a regular ow of inc ome.5. Saleability of Securities: Further, the bank should invest its funds in such typesof securities as can be e asily marketed at a time of emergency. The bank cannot afford to invest its fund s in very long term securities or those securities which areunsaleable. It is ne cessary for the bank to invest its funds in government or in rst class securities or in debentures of reputed rms. It should also advance loans against stocks whi ch can be easily sold.6. Stability in the Value of Investments: The bank should invest its funds in thosestocks and securities the prices of whi ch are more or less stable. The bank cannot afford to invest its funds in securi

ties, the prices of which are subject to frequent uctuations.7. Principles of Tax-Exemption of Investments: Finally, the investment policy of a bank should be based on the principle of tax exemption of investments. The bankshould invest in those government securities which are exempted from income andother taxes. This will help the bank to increa se its pro ts.Of late, there has been a controversy regarding the relative importa nce of thevarious principles in uencing the investment policy of a bank particular ly between liquidity and pro tability. It is interesting to examine this controver sy.Let us examine what happens if the bank sticks to the principle of liquidity only. It istrue that if the bank pays importance to liquidity, it can easily mee t the demands of thedepositors. The bank should have adequate cash to meet the c laims of the depositors. It is true that a successful banking business calls for installing con dence in the minds of the depositors. But, it should be noted that accepting deposits is not the only function of a bank. Moreover, the bank canno t afford to forget the fact that it has to earn income topay salaries to the sta ff, interest to the depositors, dividend to the shareholders and meet the day-to -day expenditure. If the bank keeps all its resources in liquid form, it will no t be able to earn even a rupee. But pro tability is a must for the bank. Though c ash on hand is the most liquid asset, it is the least pro table asset as well. Cas h is an idle asset.Hence, the banker cannot concentrate on liquidity only.If the bank attaches importance to pro tability only, it would be equallydisastrous to t he very survival of a bank. It is true that a bank needs income tomeet its expen diture and pay returns to the depositors and shareholders. The bankcannot underm ine the interests of the depositors. If the bank lends out all its funds, it will be left with no cash at all to meet the claims of the depositors. It sho uld benoted that the bank should have cash to honour the obligations of the depo sitors.Otherwise, there will be a run on the bank. A run on the bank would be suic idal tothe very existence of the bank. Loans and advances, though the most pro tab le asset,constitute the least liquid asset.It follows from the above that the ch oice is between liquidity and pro tability.The constant tug of war between liquidi ty and pro tability is the feature of the assetsside. According to Crowther, liqui dity and pro tability are opposing or con ictingconsiderations. The secret of succes sful banking lies in striking a balance betweenthe two. Promote Commercial Virtues: The businessmen are more afraid of a banker thana preacher. The businessmen shou ld have certain business qualities like industry,forethought, honesty and punctu ality. These qualities are called commercial virtueswhich are essential for rapid economic progress. The banker is in a better positionto promote commercial virtu es. Banks are called public conservators of commercialvirtues. Ful llment of Socio-economic Objectives: In recent years, commercial banks,particularly in developing countries, have bee n called upon to help achieve certainsocio-economic objectives laid down by the state. For example, nationalised bank inIndia have framed special innovative sch emes of credit to help small agriculturists,self-employed persons and retailers through loans and advances at concessionalrates of interest. Banking is thus use d to achieve the national policy objectives of reducing inequalities of income a nd wealth, removal of poverty and elimination of unemployment in the country.Thu s, banks in a developing country have to play a dynamic role. Economic developme nt places heavy demand on the resources and ingenuity of the banking system. It has to respondto the multifarious economic needs of a developing country. Tradit ional views and methodsmay have to be discarded. An Institution, such as the bank ing system, which touches andshould touch the lives of millions, has necessarily to be inspired by a larger social purposeand has to subserve national prioritie s and objectives. A well-developed banking systemprovides a rm and durable foundat ion for the economic development of the country. Conclusion From the above discussion, undoubtedly, we can say that, commercial banks form t he most important part of nancial intermediaries. It accepts deposits from the ge

neral public andextends loans to the households, rms and the government. Banks fo rm a signi cant part of theinfrastructure essential for breaking vicious circle of poverty and promoting economic growth and a party can borrow. Margin requirement is a good tool to reduce the degree a ndextent of speculation in commodity market and stock exchanges. 2. Regulation of Consumer Credit: During the Second World War an acute scarcity of goods was felt in the U.S.A., a nd the position was worsened by the system of bank credit to consumers to enable them to buy durable and semi-durable consumer goods throughinstalment buying. T he Federal Reserve Banks of the U.S.A., were authorised to regulatethe terms and conditions under which consumer credit was extended by commercial banks. The re straints under these regulations were two-fold: (a) They limited the amount of c redit that might be granted for the purchase of any article listed in the regula tions; and(b) they limited the time that might be agreed upon for repaying the o bligation. Supposea buyer was required to make a down-payment of one-third of th e purchase price of a carand the balance to be paid in 15 monthly instalments. U nder the regulations restrainingconsumer credit, the down-payment was made large r and the time allowed was madeshorter. The result was a reduction in the amount of credit extended for the purchaseof cars and the time it was allowed to run; and the ultimate result was the restriction,in the demand for consumer goods at a time when there was a shortage in supply andwhen there was a necessity for res triction on consumer spending. This measure was asuccess in America in controlli ng in ationary pressures there. In the past-war period, it has been extensively a dopted in all those countries where the system of consumer credit is common. Rationing of Credit: Rationing of credit, as a tool of selective credit control,originated in England in the closing years of the 18th century. Rationing of credit implies two thing s. First, it means that the central bank xes a limit upon itsrediscounting facili ties for any particular bank. Second, it means that the central bank xes the quot a of every af liated bank for nancial accommodation from thecentral bank.Rationing of credit occupies an important place in Russian Economic Planning.The central b ank of the Russian Federation allocates the available funds amongdifferent banks in accordance with a de nite credit plan formulated by the PlanningCommission.But the criticism of rationing of credit is that it comes into con ict with the funct ionof the central bank as a lender of the last resort. When the central bank act s as a lender of the last resort it cannot deny accommodation to any bank throug h it has borrowed in excess of its quota. Moreover, this method proves effective only whenthe demand for credit exceeds the supply of it. Control through Directives: In the post-war period, most central banks have beenvested with the direct power of controlling bank advances either by statute or bymutual consent between the central bank and commercial banks. For instance, theBanking Regulation Act of In dia in 1949 speci cally empowered the Reserve Bankof India to give directions to c ommercial banks in respect of their lending policies,the purposes for which adva nces may or may not be made and the margins to bemaintained in respect of secure d loans. In England, the commercial banks have been asked to submit to the Capital Issue Committee all loan applications inexc ess of 50,000. There is no uniformity in the use of directives to control bankad vances. On the one extreme, the central bank may express concern over credit dev elopments; the concern may be combined with mild threat to avoid increase ordecr ease in the existing level of bank loans. On the extreme, there can be a clear a ndopen threat to the commercial banks nancing certain types of activities. Moral Suation: This is a form of control through directive. In a period of depression,the centr al bank may persuade commercial banks to expand their loans andadvances, to acce

pt inferior types of securities which they may not normally accept, x lower margin s and in general provide favourable conditions to stimulate bankcredit and inves tment. In a period of in ationary pressure, the central bank maypersuade commercia l banks not to apply for further accommodation or not to use theaccommodation al ready obtained for nancing speculative or non-essential activities lest in ationary pressure should be further worsened. The Bank of England hasused this method wi th a fair measure of success. But this has been mainly because of a high degree of co-operation which it always gets from the commercial banks. Direct Action: Direct action or control is one of the extensively used methods of selective con trol, by almost all banks at sometime or the other. In a broad sense, it include s the other methods of selective credit controls. But more speci cally, direct act ion refers to controls and directions which the central bank may enforce on all banks or any bank in particular concerning lending and investment. The ReserveBa nk of India issued a directive in 1958 to the entire banking system to refrain f romexcessive lending against commodities in general and forbidding commercial ba nksgranting loans in excess of Rs. 50,000 to individual parties against paddy an d wheat.There is no doubt about the effectiveness of such direct action but then the element of force associated with direct action is resented by the commercia l banks. Publicity: Under this method, the central bank gives wide publicity regarding theprobable c redit control policy it may resort to by publishing facts and gures about the var ious economic and monetary condition of the economy. The central bank brings out this publicity in its bulletins, periodicals, reports etc. Limitations of Selective Credit Controls (a) The selective controls embrace the commercial banks only and hence the nonbanking nancial institutions are not covered by these controls.(b) It is very dif c ult to control the ultimate use of credit by the borrowers.(c) It is rather dif cu lt to draw a line of distinction between the productive andunproductive uses of credit.(d) It is quite possible that the banks themselves through manipulations advance loansfor unproductive purposes.(e) Selective controls do not have much s cope under a system of unit banking.(f) Development of alternative methods of bu siness nancing has reduced theimportance of selective controls. From the above discussion, we arrive at the conclusion that the two types of cre dit control measures, quantitative as well as qualitative, are not rivals, but, on the contrary,they supplement each other. For successful monetary management, the central bank shouldcombine the two methods of credit control in appropriate proportions. In fact, a judiciousand a skilful combination of general and select ive credit control measures is the right policyto follow for the central bank of a country. It must, however, be pointed out that the variousmethods, whether qu antitative or qualitative, cannot ensure perfect credit control in aneconomy in view of the several limitations from which they suffer, and other complexitiesin volved in the situation. Conclusion To conclude, the central bank of a country acts as the leader of the money marke t, supervising,controlling and regulating the activities of commercial banks and other nancial institutions.It acts as a bank of issue and is in close touch with the government, as banker, agent andadviser to the latter A number of banks have started evening branches, Sunday branches for the bene t of their customers. Apart from the quantitative increases in deposits, there has b eenan impressive qualitative shift. The number of small account holders with the banks has been increasing day-by-day. Aggregate deposits are composed to time d epositsand demand deposits. Earlier there was predominance of demand deposits. N owthere is predominance of time deposits. The ratio of time deposits to total de

posits has been increasing. Credit Expansion: The expansion of bank credit has also been more spectacularin the post-bank nati onalisation period. Bank credits had increased from Rs. 4,700crores in 1970-71 t o Rs. 4,43,180 crores in 1999-2000. At present, banks are alsomeeting the credit requirements of industry, trade and agriculture on a much largerscale than befo re. Credit is the pillar of development. Bank credit has its crucialimportance i n the context of development and growth with social justice. Investment in Government Securities: The nationalised banks are expectedto provide nance for economic plans of the cou ntry through the purchase of government securities. There has been a signi cant in crease in the investment of the banks in government and other approved securitie s in recent years. The investmentsincreased from Rs. 1,727 crores in 1970 to 74, 370 crores in 1995. Advances to Priority Sectors: An important change after the nationalisationof banks is the expansion of advanc es to the priority sectors. One of the mainobjectives of nationalisation of bank s to extend credit facilities to the borrowers inthe so far neglected sectors of the economy. To achieve this, the banks formulatedvarious schemes to provide cr edit to the small borrowers in the priority sectors, likeagriculture, small-scal e industry, road and water transport, retail trade and small business. The total credit provided by banks to the priority sectors has increasedfrom Rs. 440 cror es in 1969 to Rs. 91,300 crores in March 1998. As a result, advancesto priority sectors as percentage of total credit increased from 15% in 1969 to 42%in 1998. The bank lending to priority sector was, however, not uniform in all states.It w as quite low in many backward states like U.P., Bihar and Rajasthan. Underthe ne w banking policy stress is laid on the weaker and under-privileged groups inthe priority sector weaker sections refer to all persons who became suppressed,depress ed and oppressed because of socio-political, socio-economic or socio-religiousre asons. The concept of pro tability has been substituted by social purposes withregar d to lending to weaker sections of the society. Quantitatively, banks have donew ell in priority lending. But overdues and bad debts have been a serious problemf aced by banks in respect of advances made to the weaker sections of the society. There is always the problem of ensuring the effective end use of the loans given tothe priority sectors.7. Social Banking -Poverty Alleviation Programmes: Commercial banks, especiallythe nationalised banks have been participating in th e poverty alleviation programme launched by the government.

(a) Differential Interest Scheme: With a view to provide bank credit to the weakersections of the society at a con cessional rate the government introduced theDifferential interest rates scheme fro m April 1972. Under this scheme, thepublic sector banks have been providing loan s at 4% rate of interest to the weakersections of the society. The scheme has sh own notable progress. The number of accounts was 2 million and the advances outs tanding were Rs. 640 crores at theend of March 1996.(b) Integrated Rural Development Programme (IRDP): This is a pioneering andambitious programme to rectify imbalances in rural econo my and also for all-round progress and prosperity of the rural masses. Under thi s programme banks has assisted nearly 1.8 million bene ciaries during 1997-98 and disbursed atotal amount of Rs. 1990 crores as loan. Out of the bene ciaries, over 1 million belonged to scheduled castes and scheduled tribes and 0.7 million were women.Other important scheme introduced by the government of India and implemen tedthrough the banking system includes (a) self-employment scheme for educated y

outh,(b) self-employment programme for urban poor, and (c) credit to minoritycom munities.8. Growing Importance of Small Customers: The importance of small customersto banks has been growing. Most of the deposits in recent years have come frompeople with small income. Similarly, commercial b anks lending to small customers has assumed greater importance. Thus banking sys tem in India has turned fromclass-banking to mass-banking. 9. Innovative Banking: In recent years, commercial banks in India have been adoptingthe strategy of inno vative banking in their business operations. Innovative banking implies the appli cation of new techniques, new methods and novel schemesin the areas of deposit m obilisation, deployment or credit and bank management.Mechanisation and computer isation processes are being introduced in the day-to-day working of the banks. 10. Diversi cation in Banking: The changes which have been taking place in India since1969 have necessitated ba nking companies to give up their conservative and traditionalsystem of banking a nd take to new and progressive functions. The government had beenencouraging com mercial banks to diversiy their functions. As a result, commercial banks have se t up merchant banking divisions and are underwriting new issues, especiallyprefe rence shares and debentures. There are now eight commercial banks which haveset up mutual funds also. Commercial banks have started lending directly or indirect lyfor housing. Venture capital fund is also started by one public sector bank. S tate Bank of India and Canara Bank have set-up subsidiaries exclusively for unde rtaking factoringservices. In future all commercial banks can be expected to diver sify their functionsand adopt new technologies. 11.Globalisation: The liberalisation of the economy, in ow of considerable foreigninvestments, frequ ency in exports etc., have introduced an element of globalisationin the Indian b anking system. 8. Credit Cards Now-a-days some banks are issuing credit cards. The system of issuing credit car ds originatedin the U.S.A. Credit cards have become very popular in the U.S.A. C redit cards are issued inthe name of companies to be used by designated executiv es. They are also issued in the nameof individuals to be charged to the companys account or to the personal account.The credit card system is utilised by big com panies, super rich and highly paid executivesin our country. But credit cards ar e not accepted by all establishments in the country. Inour country only luxury h otels, airlines, shops and other establishments dealing in costlyand luxury good s or providing costly services accept credit cards provided, they havearrangemen ts with the issuing bank. Advantages of Credit Cards Credit card holders enjoy certain privileges and advantages. They are:1. Credit cards enable persons to purchase goods and services on credit in establishmentsw hich accept them. They enjoy credit facility without paying interest for above f ourto six weeks.2. Carrying a credit card is more convenient and safer than carr ying cash or cheque book.3. The credit card gives the traveller peace of mind as it takes care of all his needs.4. Credit card is a safer and convenient method of payment.5. A credit card holder will be recognised as a man of sound nancial s tanding.6. The issuing bank or concern will debit the credit card holder or cust omers account once in month after receiving details about purchases. Limitations or Drawbacks of Credit Cards The following are the limitations or disadvantages:1. Credit cards cannot be use d for making purchases in all business establishments.2. Issuing bank will place a limit on the expenditure by the credit card holder.3. Credit card system will

increase indebtedness among the card holders. For example,indebtedness has incr eased tremendously on account of the credit card system in theU.S.A.Inspite of t he limitations, credit cards have become popular instrument in recent yearsin mo st of the countries in the world. The future commerce is e-commerce. Credit card sfacilitate e-commerce. Conclusion It is thus clear that in India, there are different kinds of banks, viz., indige nous bankers,money-lenders, co-operative banks, NABARD, land development banks, regional rural banks, commercial banks including the State Bank of India and its subsidiaries and foreign-exchange banks. Overall these institutions, there is t he Reserve Bank of India which is the central bank of the country Disclosure at the will of Customer: The banker can disclose the state of affairs of the customers account when the cu stomer gives his consent to disclose the accounts. The auditor of the organizati on can fully examine the customers account when an express consent is given by hi m. Similarly when a customer gives the name of guarantor, the guarantor can exam ine the accounts of the customer which the banker should furnish. When banker ac ts as a reference, he can disclose the accounts of the customer. (d) To Protect his Own Interest: Whenever the banker is required to protect his owninterest, if he discloses the details of a customers account, it must be a reasonableand proper occasion. For e xample, if the banker is to recover his own money from aparticular customer, he may give the details to his lawyers. (e) To Protect Public Interest: The Banking Commission (1972) opined as follows: When banks are required to give out information regarding their customers in the interestof the public, the inf ormation should relate to nancial aspect of the customers. Thefollowing are insta nces of such cases:(i) Where considerable amounts are received from other countr ies.(ii) In case the bank thinks that the customer is carrying on such activitie s which arenot congenial in the interest of the nation.(iii) In case the banker thinks that the customer is trying to break the provisions of the law on the bas is of his records.(iv) When the Government calls upon the bank to give informati on regarding aparticular customer and when the bank feels that a particular cust omer hascommitted an offence. 3. Obligation to Receive Cheques and Other Instruments for Collection Basically, the business of banking, as it is known today, comprises acceptance o f moneyon deposit account and payment of cheques. It also includes collection of cheques. It mayrightly be contended that anyone who does not perform these esse ntial services is not a banker. Whenever a banker is entrusted with the job of c ollection of cheques, they must becollected as speedily as possible through the accepted channels. Failure to exercise propercare and employ the recognised rout e for collection may make the bank liable for any losswhich the customer may sus tain. 4. Obligation to Give Reasonable Notice before Closing the Account According to law, a debtor and a creditor may terminate the relationship without notice bythe debtor paying off the balance or the creditor recalling the debt. It is not so simple betweena banker and a customer for the obvious reason that t he banker is under an obligation to honour his customers cheques. If this obligat ion could be terminated by the banker withoutnotice, the customer might be faced with an embarrassing situation. Reasonable time must be granted to enable him t o make alternative arrangements. Where any customer becomesa nuisance through ov erdrawing without arrangement or issuing post-dated cheques etc., itis advisable to close his account. But reasonable time has to be given to enable him to make alternative arrangements if he so desires. If a bank abruptly closes the custom ers account, itmight affect his credit, giving cause for an action against the b ank for damages. Obligations of Customers

Customers are under the obligations to ful l certain duties while dealing with ban ks. Suchobligations are as under:(a) Not to draw cheques without suf cient balance . (b) To draw cheques in such a manner so as to avoid any change of alternation.(c ) To pay reasonable charges for services rendered.(d) To make a demand on the ba nker for repayment of deposit.So far we have discussed the primary and special r elationship between the banker andthe customer. This relationship starts right f rom the moment an account is opened and itcomes to an end immediately on closure of the account. The relationship stands establishedas soon as the agreement or contract is entered into. This relationship is shown in thefollowing chart. General RelationshipSecondaryDebtor and creditor AgentTrustee BaileeSpecial Rel ationshipRightsObligationsLienSet-off AppropriatepaymentChargeinterestGarnisheeo rder CloseaccountsMaintainsecrecyCollection of chequesIssue noticePrimaryBanker obligationsCustomersobligationsTo honour customerschequesRELATIONSHIP BETWEEN BAN KER AND CUSTOMER Conclusion To conclude, it is rightly said that the relationship between a banker and its c ustomer is thatof a bailee and bailor. As a bailee, the banker is bound to take as much care of the goods bailed to him as a man of ordinary prudence would, und er similar circumstances, take of his own goods of the same bulk, quality and value as the goods bailed. However, in t he absenceof any special contract, the bailee gets protection and is not held re sponsible for the loss,distruction or deterioration of the thing bailed, if he h as taken the amount of care of it 194 Banking (d) Small Loans (Co-operative Banks) Guarantee Scheme, 1984; (e) Small Loans(Cooperative Credit Societies) Guarantee Scheme, 1982; (2) Credit Guarantee Scheme forsmall-scale industries, 1981. Nomination Facility The Banking Laws (Amendment) Act, 1983, inserted a new Part III B in the Banking Regulation Act, 1949 to give effect to some of the recommendations of the Bankin gCommission. Newly inserted Section 45ZA and the rules framed thereunder in 1985 providefor the facility of nomination by depositors in banks as follows:(a) A d epositor may nominate, in the prescribed manner, person to whom, in the event of the death of the depositor, the amount to his credit may be paid by the banking company.(b) In case of a joint account, all the depositors together may nominate a person towhom, in the event of death of all the joint depositors, the amount of their credit may be paid by the banking company. Thus, the nominees right to r eceive deposit money arises only after the death of all the depositors. There ca nnot be more thanone nominee in respect of a joint account.(c) Nomination facili ty is available to all types of deposit accounts, including theaccounts opened f or credit of pension.(d) Nomination can be made in favour of individuals only an d not associations, societies,trusts or any organisation or their of ce-bearers.(e ) In the case of a deposit made in the name of a minor, the nomination shall be made by a person lawfully entitled to act on behalf of the minor.(f) The nominee can be a minor. The depositor may, while making the nomination,appoint another individual not being a minor, to receive the amount of the deposit on behalf of the nominee in the event of death of the depositor, or as the case may be, all t he depositors during the minority of the nominee.(g) In case Safe Deposit Locker s in joint names without survivorship bene t, nominationcan be made in favour of m ore than one person. A minor is not accepted as a nomineein case of safe deposit lockers.(h) In case of death of a sole depositor/all the joint depositors, the name of the nomineecan be substituted at his written request in the deposit acco unt/receipts includingoverdue deposits.(i) The nomination may be varied or cance lled by the depositor in the prescribed manner.In case of a joint account, varia tion or cancellation of a subsisting nomination can bemade by all the surviving depositors acting together.On making payment under the provisions of this Sectio n, the banking company shall befully discharged from its liability in respect of

the deposit. The right or claim of any otherperson against the nominee, to whom any payment is made under this section, shall not be affected by such payment. No other person shall be able to get notice of his cla im to suchdeposits to the banking company. Nor shall the banking company be boun d by such noticeeven through expressly given to it. Non-Resident Account The non-resident account is de ned as the accounts maintained with banks in India b ypersons, companies, rms, banks etc., resident or situated outside India. When the account opens in the name of persons, rms, companies or associations it is refer red to as Private Non-Resident Account. While in the case of banks such accounts a re called as Non-Resident Accounts. It should be noted that a non-resident means a citizen of India who is living outside India in the following cases:(a) Taking up employment outside India.(b) Carrying on business outside India. Recent Development There are no major policy changes in the regulations governing Foreign Currency Non-Resident Accounts (FCNRA) and Non-Resident (External) Rupee Accounts [NR (E) RA]except for the conversion rate to be applied for such remittances to NRE A/C s which is covered under the head of Liberalized Exchange Rate Management System (LERMS). The budget for 1992-93 has cited two more facilities to Non-Resident I ndians (NRIs) which are given below:1. Gold Import Scheme: The NRIs and returning Indians are permitted to import gold up to 5 kg. on the p ayment of duty of Rs. 440 per 10 gms in Foreign Exchange.The duty was reduced to Rs. 220 per 10 gms subsequently. Each NRI coming fromabroad will be able to bri ng into India a maximum of 5 kg. of gold provided theperson concerned had spent at least six months abroad. NRIs can avail themselvesof the facility once in six months.2. New Deposit Scheme: (With Flexible Deposit Rates): This scheme was effectivefrom June 15, 1992. This scheme covers the following:(a) Authorised Dealers (ADs) can open these account s with fresh foreign inwardremittances or transfers from existing NRE/FCNR accou nts.(b) The deposit can be accepted for a minimum period of six months and maxim umperiod of three years.(c) The deposit will not be included in the net demand a nd time liabilities (NTL) of the banks and hence these are free from reserve req uirements.(d) Principal and interest are not repatriable.(e) Once these deposits are withdrawn, these bene ts cannot be extended even if thedeposit is redeposited in other banks. 3. Home Loan Account Scheme: The Home Loan Account Scheme which has beenin operation since July 1, 1989, has now been extended to select housing nancecompanies and Apex Co-operative Housing Finance Societies. Under this schememore than 12 lakh accounts have been opened by the end of November 1997. Theamount of deposits collected was about Rs. 100 c rores. Conclusion To conclude, it is rightly said that the relationship between a bank and a custo mer beginswhen the customer opens an account with the bank. For the attraction o f customers the banks offer different types of facilities. In order to avoid mea ningless competition amongseveral banks the Reserve Bank of India has been given the power to x deposit interest rates. For this purpose, the RBI issues directiv es from time to time.Here, it is made clear that all the accounts are opened wit h the bank with the cash money by the customer and that is why, in other words, these are known as Deposit Accounts.Under Section 6 of the Banking Regulation Act 1949, the most important function of amodern bank is to accept deposit of money from the public. The banks have, therefore,introduced different types of account s with various facilities and privileges

INTRODUCTION A banker receives deposits on current and savings accounts from his customers. T hecustomers are allowed to withdraw the amount from time to time needed by them throughcheques or withdrawal slips from the account. The amounts deposited and w ithdrawn byeach customer from time to time are entered in a separate account ope ned in the name of the customer in the ledger account of the banker. Similarly, the transactions are entered in a book and handed over to the customer for his r eference and information. The entries madein the book also stand as evidence of the transactions between the banker and the customer.This book is known as Pass B ook. Meaning of Pass Book Pass book is an important book in the operation of a bank account. It contains a copy of the customers ledger account as it appears in the bankers books. It is an exact extract orcopy of the customers account in the banks ledger, as on a partic ular date. It is, in otherwords, a record of dealings between the customer and t he bank. It is written by the bankfrom its own records. It is supplied by the ba nk to its customer free of charge. It is meant for the information of the custom er. It indicates to him the state of his account in the bank. The customer sends i t periodically to the bank so that upto date entries may berecorded by the bank. As it passes periodically between the banker and the customer, it is called a Pa ss Book. Every entry made in pass book is signed by a responsible of cialof the ban k. Some big banks supply periodical statements of account in place of thepass bo ok. In case of foreign accounts, some banks make use of photography to save the labour of writing statements of accounts. The photostat copies of the customers a ccount are sent to the customers for their approval. Object or Purpose of Pass Book The object of a pass book is to inform the customer from time to time the status of his account as it appears on the books of the bank. It supplies evidence in favour of the customer in theevent of the litigation or dispute with the bank. I n this way, it protects the customer against the carelessness or fraud of the ba nk. The pass book also enables the customer to preparebank reconciliation stateme nt for the purpose of nding out the causes of difference between the balance as sh own by his cash book and the bank pass book Legal Position of Entries in the Pass Book It is dif cult to de ne precisely the decisive legal effects of entries shown in the pass book.When it is issued to customer and if he does not raise any objection, obviously it becomesaccount stated or settled account between him and the banker. B ut there has been acon ict of opinion regarding conclusiveness of the pass book re garding entries made therein.Sir John Paget is of the view that the proper functi on of a pass book is to constitute aconclusive, unquestionable record of the tra nsactions between banker and customer, andit should be recognised as such. He cit es Daveyness. Vs Noble case in support of his view.In this case, it was stated t hat on delivery of the pass book to the customer, he examines it and if there ap pears an error or omission, sends it back for recti cation or if not, his silencei s regarded as an admission that the entries are correct. In Vagliana Brothers Vs Bank of England, also it was held that the return of a balanced pass book by the customer without comments amounts to settlement of account. So, the return of pa ss book by the customerrenders as a stated and settled account as on the particu lar date of balancing.But the legal position both in England and in India is qui te different. According to recent judicial decisions in England and India, the entries in the pass book cannot be regarded asa conclusive proof of their accura cy and as settled account. Any entry in the pass book isopen to comparison and v eri cation by customer. The customer can legitimately questionthe entries at any t ime whenever he notices them. The banker is bound to make the suitablecorrection s. The entries wrongly made or included may be advantages either to the customer or the banker. Both the parties can indicate the mistakes or omissions to get th em recti ed.So entries made upto date are prima facie evidence and not conclusive evidence. In KeptigullaRubber Estates Co. Vs National Bank of India, it was held that When a pass book is returnedto the bank by the customer without objection, the account cannot be regarded as settledaccount and it is not binding on both t

he banker and customer. In Mowji Vs Registrar of Co-operative Societies, Madras, it was stated that the entries in the pass book can be regardedas prima facie ev idence and not conclusive evidence. Thus entries in the pass book are not conclus ive evidence of their correctness, in stating the position of customers account. Theyare subject to alternation on the basis of real facts customer, and (b) The loss of credit or reputation in the market. Thus, the bank er is liableto compensate the drawer not only for the actual monetary loss suffe red by him, but also forthe injury top or loss of his reputation, as a result of dishonour of a cheque.In case the customer happens to be a trader, the loss wou ld be substantial damages.In case the customer is a non-trader, the banker would be liable only for normal damages{(Case: Robin Vs Steward (1854) 146 - B 595) ( Case: Gibbs Vs Westminister Bank (1939)2 K.B. 882)}. In the case of Sterling Vs Barclays Bank Ltd., where the banker had made amistake in wrongfully dishonouring the customers cheque, the customer was not entitled tosubstantial damages but re asonable damages as the customer had two cheques dishonouredearlier and further, people in that trade did not think much of cheques being dishonouredas they jus t carried on their living with bare necessaries. (Case: Davidson Vs BardaysBank L td., 1940 AII. E.R. 316). The customer had issued a cheque for 2-15-8 and it was dishonoured and the matter was referred to the court and the court ordered that substantialdamages to the tune of 250 should be paid. 2. Obligation to Maintain Secrecy of Customers Account In every profession, there are certain things to be maintained absolutely in sec ret; for example,a doctor is not expected to disclose the details of his patient s to others. The professiondemands from him that he must maintain those matters in strict con dence. Similarly, a banks profession also demands that he should main tain the particulars of his customersaccounts in secret.The banker has an implied obligation to maintain secrecy of the customers account.He should not disclose matters relating to the customers nancial position since it mayadversely affect th e customers credit and business. This obligation continues even after theaccount of the customer is closed.Only in the following circumstances, disclosure is jus ti ed: (a) To Satisfy Statutory Requirements: According to the Income Tax Act, the bankeris required to give out information r egarding his customers to the Income TaxDepartment. Similarly, whenever the cour t needs any information regarding thecustomers, the banker is required to give t he information. According to the BankingRegulation Act, all banks are required t o give in the prescribed forms detailedinformation regarding the customers to th e Reserve Bank of India. (b) As a Common Courtesy: In this case, it is a common practice followed among bankersto exchange informat ion regarding their customers, accounts etc., as a matter of common courtesy. Wh enever the banker is called upon to give information regarding his customers, he can do so without any dif culty. As far as possible, he shouldfurnish bare facts while expressing his opinion. He should be very careful whileexpressing his opin ion. He should not exaggerate nor underestimate the nancialstanding of his custom ers. Disclosure at the will of Customer: The banker can disclose the state of affairs of thecustomers account when the cus tomer gives his consent to disclose the accounts.The auditor of the organisation can fully examine the customers account whenan express consent is given by him. Similarly when a customer gives the name of aguarantor, the guarantor can examin e the accounts of the customer which the banker should furnish. When banker acts as a reference, he can disclose the accounts of the customer. (d) To Protect his Own Interest: Whenever the banker is required to protect his owninterest, if he discloses the details of a customers account, it must be a reasonableand proper occasion. For e xample, if the banker is to recover his own money from aparticular customer, he may give the details to his lawyers.

(e) To Protect Public Interest: The Banking Commission (1972) opined as follows: When banks are required to give out information regarding their customers in the interestof the public, the inf ormation should relate to nancial aspect of the customers. Thefollowing are insta nces of such cases:(i) Where considerable amounts are received from other countr ies.(ii) In case the bank thinks that the customer is carrying on such activitie s which arenot congenial in the interest of the nation.(iii) In case the banker thinks that the customer is trying to break the provisions of the law on the bas is of his records.(iv) When the Government calls upon the bank to give informati on regarding aparticular customer and when the bank feels that a particular cust omer hascommitted an offence. 3. Obligation to Receive Cheques and Other Instruments for Collection Basically, the business of banking, as it is known today, comprises acceptance o f moneyon deposit account and payment of cheques. It also includes collection of cheques. It mayrightly be contended that anyone who does not perform these esse ntial services is not a banker. Whenever a banker is entrusted with the job of c ollection of cheques, they must becollected as speedily as possible through the accepted channels. Failure to exercise propercare and employ the recognised rout e for collection may make the bank liable for any losswhich the customer may sus tain. 4. Obligation to Give Reasonable Notice before Closing the Account According to law, a debtor and a creditor may terminate the relationship without notice bythe debtor paying off the balance or the creditor recalling the debt. It is not so simple betweena banker and a customer for the obvious reason that t he banker is under an obligation to honour his customers cheques. If this obligat ion could be terminated by the banker withoutnotice, the customer might be faced with an embarrassing situation. Reasonable time must be granted to enable him t o make alternative arrangements. Where any customer becomesa nuisance through ov erdrawing without arrangement or issuing post-dated cheques etc., itis advisable to close his account. But reasonable time has to be given to enable him to make alternative arrangements if he so desires. If a bank abruptly closes the custom ers account, itmight affect his credit, giving cause for an action against the b ank for damages. Obligations of Customers Customers are under the obligations to ful l certain duties while dealing with ban ks. Suchobligations are as under: (a) Not to draw cheques without suf cient balance. (b) To draw cheques in such a manner so as to avoid any change of alternation. (c) To pay reasonable charges for services rendered. (d) To make a demand on the banker for repayment of deposit.So far we have discu ssed the primary and special relationship between the banker andthe customer. Th is relationship starts right from the moment an account is opened and itcomes to an end immediately on closure of the account. The relationship stands establish edas soon as the agreement or contract is entered into. This relationship is sho wn in thefollowing chart. General RelationshipSecondaryDebtor and creditor AgentTrustee BaileeSpecial Rel ationshipRightsObligationsLienSet-off AppropriatepaymentChargeinterestGarnisheeo rder CloseaccountsMaintainsecrecyCollection of chequesIssue noticePrimaryBanker obligationsCustomersobligationsTo honour customerschequesRELATIONSHIP BETWEEN BAN KER AND CUSTOMER Conclusion To conclude, it is rightly said that the relationship between a banker and its c ustomer is thatof a bailee and bailor. As a bailee, the banker is bound to take as much care of the goods bailed to him as a man of ordinary prudence would, und er similar circumstances, take of his.lationship own goods of the same bulk, quality and value as the goods bailed. However, in t he absenceof any special contract, the bailee gets protection and is not held re sponsible for the loss,distruction or deterioration of the thing bailed, if he h

as taken the amount of care of it.

Opening and Operating Bank Accounts 6. On Insolvency of the Customer: When the bank comes to know of insolvencyof his customer, he must stop payment. The balance standing to the credit of thecustomer, he must stop payment. The bal ance standing to the credit of the customeris transferred to the of cial receiver or assignee.7. On Receipt of Garnishee Order: The banker should reserve amount speci ed inthe Garnishee Order. He may make payme nt of the customers cheques out of theremaining balance, if any.8. On Receiving Notice of Assignment: When the banker has received notice of assignment of the credit balance in the c ustomers account, he must stop payment from the account. The bank is liable to pa y the balance to the assignee. Insurance of Bank Deposit The Bank Deposit Insurance means giving a guarantee to depositors that their dep osits will be returned if the bank fails. The need for such a guarantee has aris en after the failure of several banks on account of inadequate capital, unsound banking practices etc. In India, thenecessity of Deposit Insurance was felt afte r the failure of Palai Central Bank, a ScheduledBank of South India.Deposit Insu rance is regarded as the most powerful competitive edge of banking industry.Howe ver, the application of the scheme in its present form has shielded the industry frommarket discipline. Since the depositors have no incentives to favour one ba nk over another, badly managed banks, even nearing insolvency, have been able to attract deposits as easily as healthy and well-run institutions. It is high tim e that Deposit Insurance prices the insurancecover on the basis of quality of as sets rather than on uniform pricing basis. This would byitself considerably stre ngthen the banking industry. Deposit Insurance and Credit Guarantee Corporation (DICGC) The Deposit Insurance Corporation Act was passed by the Parliament in 1961 which set up the Deposit Insurance Corporation with effect from January 1, 1962. It too k over theundertaking of the Credit Guarantee Corporation of India Ltd., with ef fect from July 15,1978. Later, by the integration of two organisations the Corpo ration was renamed as theDeposit Insurance and Credit Guarantee Corporation (DIC GC). Objectives The DICGC has twin objectives of giving insurance to small depositors in banks a nd ve credit guarantee schemes (four for small borrowers and one for small-scale industries) guaranteeingthe priority sector advances granted by participating ba nks and nancial institutions. Credit Guarantee Function The DICGC is operating following schemes: (1) Credit Guarantee Schemes for small borrowers,e.g., (a) Small Loans Guarantee Scheme, 1971; (b) Small Loans (Financ ial Corporation)Guarantee Scheme, 1971; (c) Service Co-operative Societies Guara ntee Scheme, 1971; (d) Small Loans (Co-operative Banks) Guarantee Scheme, 1984; (e) Small Loans(Co -operative Credit Societies) Guarantee Scheme, 1982; (2) Credit Guarantee Scheme forsmall-scale industries, 1981. Nomination Facility The Banking Laws (Amendment) Act, 1983, inserted a new Part III B in the Banking Regulation Act, 1949 to give effect to some of the recommendations of the Bankin gCommission. Newly inserted Section 45ZA and the rules framed thereunder in 1985 providefor the facility of nomination by depositors in banks as follows:(a) A d epositor may nominate, in the prescribed manner, person to whom, in the event of the death of the depositor, the amount to his credit may be paid by the banking

company.(b) In case of a joint account, all the depositors together may nominate a person towhom, in the event of death of all the joint depositors, the amount of their credit may be paid by the banking company. Thus, the nominees right to r eceive deposit money arises only after the death of all the depositors. There ca nnot be more thanone nominee in respect of a joint account.(c) Nomination facili ty is available to all types of deposit accounts, including the accounts opened for credit of pension.(d) Nomination can be made in favour of individuals only a nd not associations, societies,trusts or any organisation or their of ce-bearers.( e) In the case of a deposit made in the name of a minor, the nomination shall be made by a person lawfully entitled to act on behalf of the minor.(f) The nomine e can be a minor. The depositor may, while making the nomination,appoint another individual not being a minor, to receive the amount of the deposit on behalf of the nominee in the event of death of the depositor, or as the case may be, all the depositors during the minority of the nominee.(g) In case Safe Deposit Locke rs in joint names without survivorship bene t, nominationcan be made in favour of more than one person. A minor is not accepted as a nomineein case of safe deposi t lockers.(h) In case of death of a sole depositor/all the joint depositors, the name of the nomineecan be substituted at his written request in the deposit acc ount/receipts includingoverdue deposits.(i) The nomination may be varied or canc elled by the depositor in the prescribed manner.In case of a joint account, vari ation or cancellation of a subsisting nomination can bemade by all the surviving depositors acting together.On making payment under the provisions of this Secti on, the banking company shall befully discharged from its liability in respect o f the deposit. The right or claim of any otherperson against the nominee, to who m any payment is made under this section, shall not be Opening and Operating Bank Accounts 195 affected by such payment. No other person shall be able to get notice of his cla im to suchdeposits to the banking company. Nor shall the banking company be boun d by such noticeeven through expressly given to it. Non-Resident Account The non-resident account is de ned as the accounts maintained with banks in India b ypersons, companies, rms, banks etc., resident or situated outside India. When the account opens in the name of persons, rms, companies or associations it is refer red to as PrivateNon-Resident Account. While in the case of banks such accounts ar e called as Non-Resident Accounts.It should be noted that a non-resident means a c itizen of India who is living outsideIndia in the following cases:(a) Taking up employment outside India.(b) Carrying on business outside India. Recent Development There are no major policy changes in the regulations governing Foreign Currency Non-Resident Accounts (FCNRA) and Non-Resident (External) Rupee Accounts [NR (E) RA]except for the conversion rate to be applied for such remittances to NRE A/C s which iscovered under the head of Liberalised Exchange Rate Management System (LERMS). The budget for 1992-93 has cited two more facilities to Non-Resident In dians (NRIs) which aregiven below:1. Gold Import Scheme: The NRIs and returning Indians are permitted to import gold up to 5 kg. on the p ayment of duty of Rs. 440 per 10 gms in Foreign Exchange.The duty was reduced to Rs. 220 per 10 gms subsequently. Each NRI coming fromabroad will be able to bri ng into India a maximum of 5 kg. of gold provided theperson concerned had spent at least six months abroad. NRIs can avail themselvesof the facility once in six months.2. New Deposit Scheme: (With Flexible Deposit Rates): This scheme was effectivefrom June 15, 1992. This scheme covers the following:(a) Authorised Dealers (ADs) can open these account s with fresh foreign inwardremittances or transfers from existing NRE/FCNR accou nts.(b) The deposit can be accepted for a minimum period of six months and maxim umperiod of three years.(c) The deposit will not be included in the net demand a nd time liabilities (NTL) of the banks and hence these are free from reserve req

uirements.(d) Principal and interest are not repatriable.(e) Once these deposits are withdrawn, these bene ts cannot be extended even if thedeposit is redeposited in other banks. 3. Home Loan Account Scheme: The Home Loan Account Scheme which has beenin operation since July 1, 1989, has now been extended to select housing nancecompanies and Apex Co-operative Housing Finance Societies. Under this schememore than 12 lakh accounts have been opened by the end of November 1997. Theamount of deposits collected was about Rs. 100 c rores. Conclusion To conclude, it is rightly said that the relationship between a bank and a custo mer beginswhen the customer opens an account with the bank. For the attraction o f customers the banks offer different types of facilities. In order to avoid mea ningless competition amongseveral banks the Reserve Bank of India has been given the power to x deposit interest rates. For this purpose, the RBI issues directiv es from time to time.Here, it is made clear that all the accounts are opened wit h the bank with the cash money by the customer and that is why, in other words, these are known as Deposit Accounts.Under Section 6 of the Banking Regulation Act 1949, the most important function of amodern bank is to accept deposit of money from the public. The banks have, therefore,introduced different types of account s with various facilities and privileges. Double Crossing: According to Section 127 of the Negotiable Instruments Act, 1881:Whereas a cheque is crossed specially to more than one banker, except when crossedto an agent fo r the purpose of collection, the banker on whom it is drawn shall refusepayment thereon. This type of crossing may be used only when the banker in whosefavour th e cheque is specially crossed does not have any branch at the place where theche que is to be paid. A specimen of such a crossing is given below: Significance of Crossing: In the case of general crossing, the addition of the words & Co. does not have any legalsigni cance; but the words not negotiable have legal signi cance. By crossing a chequegenerally the person who is not entitled to get its payment, is prevented from getting thecheque cashed at the counter of the paying banker. While in the case of special crossing,the name of the banker must be written on the face of t he cheque, to whom or to whosecollecting agent, payment of cheque is to be made. It is to be noted that the lines are not essential for a special crossing. By c rossing a Cheque specially, it is quite safer than the generally crossed cheque. In such a case the banker to whom a cheque is crossed specially,may appoint another banker as his agent for the collection of such che ques. Such chequesmay be sent through ordinary post.In short, a cheque can be cr ossed by the drawer, holder or banker. Section 125 of the NegotiableInstruments Act states, Whereas a cheque is crossed generally or specially, the holder may ad dthe words not negotiable. In the case of a banker, the above Section further state s: whereasa cheque is crossed specially, the banker to whom it is crossed may aga in cross it specially toanother banker as his agent for collection. While in the case of a drawer, he has the right tocancel the crossing by putting his full sig nature and writing the words Pay Cash. ENDORSEMENT Endorsement literally means writing on the back of the instrument. But under Negot iableInstruments Act, it means writing of a persons name on the back of the instru ment oron any paper attached to it for the purpose of negotiation. The person who signs theinstrument for the purpose of negotiation is called the endorser. The pe rson to whomthe instrument is endorsed or transferred is called the endorsee. Mere endorsement is not suf cient unless the instrument is delivered to the endorsee. The endorsement is completed by delivering the signed instrument to the endorsee . The purpose or object of endorsement is negotiation or transfer of the instrum

ent. Definition of Endorsement According to Section 15 of the Negotiable Instruments Act when the maker or holde r of a negotiable instrument signs his name, otherwise than as such maker, for t he purpose of negotiation, on the back or face thereof or on a slip of paper att ached thereto, he is saidto have endorsed the instrument. Thus a person entitled to get money on a negotiableinstrument can transfer his right to another. He may be a maker or holder of the instrument.If he wants to transfer his right to ano ther, he must sign the instrument. The signature isusually made on the bank of t he instrument. Essentials of a Valid Endorsement The following are the essentials of a valid endorsement:(a) Endorsement must be on the back or face of the instrument. If no space is left on theinstrument, it must be made on a separate paper attached to it.(b) It should be made in ink. An endorsement in pencil or rubber stamp is invalid.(c) It must be made by the mar ker or holder of the instrument. A stranger cannot endorse it.(d) It must be sig ned by the endorser.(e) It must be completed by delivery of the instrument.(f) I t must be an endorsement of the entire bill. A partial endorsement does not oper ateas a valid endorsement. Kinds of Endorsement Endorsement may be of any of the following kinds:1. Blank endorsement,2. Special endorsement,3. Partial endorsement,4. Restrictive endorsement,5. Conditional en dorsement.1. Blank Endorsement: It is also called general endorsement. An endorsement is said to be blank if the e ndorser signs his name only on the face or back of theinstrument. Endorsement in blank speci es no endorsee. It simply consists of thesignature of the endorser on the endorsement. A negotiable instrument even thoughpayable to order becomes a bearer instrument if endorsed in blank. Thus, a blankendorsement converts an ord er instrument into a bearer one. It is negotiable bydelivery of the instrument. Example: A bill is payable to the order of Swaroop. Swaroop signs on the back of the bill . This is an endorsement in blank by Swaroop. The bill becomes payable to bearer and is negotiable without any further endorsement. 2. Special Endorsement: It is also called full endorsement. In this type of endorsement, the name of the e ndorsee is speci cally stated. If the endorser addsdirection to pay the amount men tioned in the instrument to, or to the order of aspeci ed person, the endorsement is said to be special. In other words, it speci es theperson to whom or to whose o rder the cheque is to be payable. A blank endorsement can be easily converted in to a special endorsement by any holder of negotiableinstrument. Example: (a) Pay to x or order, (b) Pay to the order of x3. Partial Endorsement: If an instrument is endorsed for a part of its amount, suchan endorsement is sai d to be partial. Similarly, if an instrument is endorsed to two ormore endorsees separately and not jointly, the endorsement becomes partial. Suchan endorsement does not operate as a negotiation of the instrument. No right of action arises under a partial endorsement. It is invalid. Example: The holder of a promissory for Rs. 1,000 writes on it pay B Rs. 500 andendorses the note. The endorsement is invalid for the purpose of negotiation.4. Restrictive Endorsement: An endorsement is said to be restrictive when it prohibits or restricts the furt her negotiability of the instrument. It merely gives the holder of the instrumen t the right to receive the amount on the instrument for aspeci c purpose. It does not give power to him to transfer his rights in endorsement to any one else. Pay X only or pay X for my use are examples of restrictive typesof endorsement.5. Conditional Endorsement: It is also called quali ed endorsement. Anendorsement where the endorser limits or n

egatives his liability by putting some condition in the instrument is called a conditional endorsement. If for instance , theendorser endorses an instrument with the words pay A or order on his marryin gB, the endorsement becomes conditional. A conditional endorsement, unlike theres trictive endorsement, does not affect the negotiability of the instrument. It do esnot invalidate the instrument. An endorsement may be made conditional in any o f the following forms:(a) Sans recourse Endorsement: An endorser may, by express words, exclude his own liability thereon to the endo rsee or any subsequent holder in case of dishonour of the instrument. Such an en dorsement is called an endorsement sans recourse(without recourse). Pay to A or ord er without recourse to me is an example of this type of endorsement. The endorser sans recourse is however, liable to theprevious endorsers. (b) Facultative Endorsement: An endorsement where the endorser extends his liabilityor gives up some rights u nder a negotiable instrument, is called a facultativeendorsement. Pay A or order, n otice of dishonour is waived is an exampleof facultative endorsement. Thus, endor ser makes himself liable to subsequent endorsees of the cheque even though no no tice of dishonour is received by himfrom the holder. In this type of endorsement , the holders duties towards theendorser are waived.(c) Sans Frais Endorsement: Where the endorser, does not want the endorsee orany subsequent holder to incur any expenses on his account, on the instrument,the endorsement is called sans fra is endorsement. Legal Effects of an Endorsement The endorsement of a cheque of bill or exchange has a varied signi cance. It has f ollowing legal effects:(a) It transfers the property in the negotiable instrumen t.(b) It gives the right to sue the acceptor of the bill for recovery of the amo unt duethereon.(c) It gives the right to recover from the endorsee and those abo ve him on dishonour.(d) It gives the holder the right of further negotiation to any one he pleases. Differences between a Bill of Exchange and Cheque All cheques are bills of exchange, but all bills of exchange are not cheques. Th e following arethe main differences between a bill and a cheque:1. Drawee: A cheque is always drawn on a banker. But a bill can be drawn on anyperson inclu ding a banker.2. Payable on Demand: A cheque is always payable on demand. As a matter of fact,a cheque is meant for immediate payment. But a bill of exchange may be payable ondemand or on the expi ry of a xed period. Cheque Promissory note 3. Drawee 3. A promissory note may be The drawee of a cheque is always executed either by a banker or by a non-banker. \ Payable on demand 4. A promissory note may beA cheque is always payable payable either on demand o ron demand. after a certain period.5. Bearer or order 5. A promissory note cannot beA cheque may be payable to order or made payable t o the bearer onto bearer. demand. Crossing 6. There is no practice of crossingA cheque can be crossed. a promissory note. Stamping 7. A promissory note must beA cheque does not require any stamp. properly stampe d.8. Days of grace 8. A grace period of three days isGrace days are not allowed because the allowed .cheque is always payable ondemand.

9. Discounting 9. A promissory note can beA cheque is not discounted. discounted and rediscount ed withbanks. HOLDER AND HOLDER IN DUE COURSEHolder According to Section 8 of the Negotiable Instruments Act, a holder means any pers onentitled in his own name to the possession of the negotiable instrument and to recover orreceive the amount due thereon from the parties liable thereto. A hold er must, therefore, have the possession of the instrument and also the right to recover money in his own name.In other words, a holder must be in possession of it under a legal title. Holder implies de jure holder and not de facto holder.Th us, a person who is in possession of the instrument may or may not be a holder. Forexample, a nder of lost instrument or a thief cannot be a holder. Similarly, a bene ciary or anagent in possession of an instrument will not be a holder. But le gal representatives of deceased holder or of cial assignee or of cial receiver would be treated as holders of the instruments. It isonly the holder and no other per son, who can give a valid discharge for the instrument. Holder in Due Course In English Law, a holder in due course is known as bona de holder for value without notice.A holder in due course is a person who acquires a promissory note, bill o r cheque bona de forvalue and maturity. Section 9 of the Negotiable Instruments Ac t de nes a holder in due courseas any person who for consideration became the posse ssor of a negotiable instrument if payable to bearer; or the payee or endorsee thereof, if payable to order, before the amo unt mentioned init becomes payable, and without having suf cient cause to believe that any defect existed in thetitle of the person from whom he derived his title . In other words, a holder in due course is aperson who takes the instrument in g ood faith and for value.Thus, a holder in due course must satisfy the following conditions:(a) He must have obtained the instrument for valuable consideration o r value.Consideration must not be void or illegal. The consideration must be val uable and lawful. So, the donee of a negotiable instrument is not a holder in du e course.(b) He must have become a holder of the instrument before the date of i ts maturity.(c) He must have become a holder of the instrument in good faith.(d) He must have taken the instrument complete and regular on the face of it.It is thus obvious that every holder is not a holder in due course. A holder of a nego tiableinstrument will not be a holder in due course, if:(a) he has obtained the instrument by gift, or(b) he has obtained the instrument for unlawful considerat ion, or(c) he has obtained the instrument after its maturity, or(d) he has obtai ned the instrument by some illegal method, or(e) he has not obtained the instrum ent in good faith. Privileges of a Holder in Due Course A holder in due course occupies a privileged position in the law of negotiable i nstruments.He has a title free from equities. He enjoys certain rights and privi leges which an ordinary holder can never possess. These rights and privileges ar e as follows:1. Instrument Purged or Cured of all Defects: The holder in due course gets theinstrument free from all the defects in the tit le. Once a negotiable instrument passesthrough the hands of a holder in due cour se, it is purged or cured of defects. It is likea current coin. Anybody who take s a negotiable instrument from a holder in duecourse can recover the amount from all parties prior to such holder. An instrument once free from defects is alway s free. 2. Liability of Prior Parties: All prior parties to the instrument (the drawer,acceptor or endorser) continue t o remain liable to the holder in due course until theinstrument is duly satis ed. The holder in due course can le a suit against the priorparties liable to pay in his own name. Section 36 of the Act states that every priorparty to a negotiable instrument is liable thereon to a holder in due course until theinstrument is du ly satis ed.3. Rights in Case of Inchoate Instrument: An inchoate instrument is one which isincomplete in some respects. A person who

has signed and delivered a stamped but inchoate (incomplete) instrument cannot a rgue as against a holder in due course that the instrument has not been complete d according to the authority given by him. 4. No Effect of Conditional Delivery: Where a negotiable instrument deliveredconditionally is negotiated to a holder i n due course, the other parties to theinstrument cannot escape liability on the ground that the delivery of the instrument was conditional or for a special purp ose only.5. Right in Case of Fictitious Bills: If a bill is drawn on behalf of a ctitious personand is payable to his order, the acceptor is not relieved from his liability to holder indue course because of s uch ctitious name.6. No Effect of Absence of Consideration: The plea of absence of consideration orunlawful consideration is not available a gainst the holder in due course. The partyresponsible is liable to make the paym ent. 7. Estoppel Against Denying Original Validity of the Instrument: The plea of original invalidity of the instrument cannot be putforth against the holder in duecourse by the drawer of a bill of exchange or cheques, or by an ac ceptor for the honour of the drawer. 8. Estoppel Against Denying the Capacity of the Payee to Endorse: The makerof a promissory note or the acceptor of a bill is precluded from denyin g against a holder in due course the existence of the payee and his capacity to endorse. 9. . Estoppel Against Endorser to Deny Capacity of Prior Parties: An endorser of the bill by his endorsement guarantees that all previous endorsem ents are genuine and that all parties had capacity to enter into valid contracts . Therefore, he cannot subsequentlydeny signature or capacity to contract of any prior party to the instrument.10. Every Holder is a Holder in Due Course: The law presumes that every holder isa holder in due course although the presump tion is rebuttable. Distinction between Holder and Holder in Due Course The following are the differences between holder and holder in due course:1. Entitlement: A holder is entitled in his own name to the possession of theinstrument. But a h older in due course acquires the possession of the instrument forconsideration.2 . Consideration: In case of holder, consideration is not necessary. The instrument may be given a s a gift or donation. But consideration is necessary for becoming a holder in du e course. A person cannot be a holder in due course if he had obtainedthe instru ment without consideration.3. Before and after Maturity: A holder may get the instrument even after it has become payable. But a holder i n due course must get the possession of the instrument before its maturity.4. Title: A holder does not acquire good title, if the title of any of the prior parties w asdefective. But a holder in due course acquires good title even though there wa s defect in the title of any prior parties, provided he had no notice of the def ect. His title isfree from defects. 5. Presumption: Every holder in due course is a holder, but every holder may not bea holder in d ue course. 6. Right to Recover the Amount: All prior parties to a negotiable instrument continueto remain liable to the hol der in due course until the instrument is duly satis ed. But a holder of an instru ment can recover the amount from maker and the transferor but not all the prior

parties. 7. Privileges: A holder does not enjoy any special privileges, but a holder in due courseenjoys certain special privileges. Conclusion The above discussion clearly shows that, a cheque is a negotiable instrument spe ci ed inNegotiable Instruments Act, 1881. It is an unconditional order, drawn on a speci ed bankersigned by the drawer, directing the drawee to pay on demand a cert ain sum of money toor to the order of a speci ed person or to the bearer of the in strument. The payment of acrossed cheque can be obtained through the bank of the holder. If a cheque is crossed it iseasy to trace the person for whose bene t the payment was collected. The crossed chequeis negotiable by mere delivery; it is payable to bearer by endorsement and delivery in case ispayable to order 5. Presumption: Every holder in due course is a holder, but every holder may not bea holder in d ue course. 6. Right to Recover the Amount: All prior parties to a negotiable instrument continueto remain liable to the hol der in due course until the instrument is duly satis ed. But a holder of an instru ment can recover the amount from maker and the transferor but not all the prior parties. 7. Privileges: A holder does not enjoy any special privileges, but a holder in due courseenjoys certain special privileges. Conclusion The above discussion clearly shows that, a cheque is a negotiable instrument spe ci ed inNegotiable Instruments Act, 1881. It is an unconditional order, drawn on a speci ed bankersigned by the drawer, directing the drawee to pay on demand a cert ain sum of money toor to the order of a speci ed person or to the bearer of the in strument. The payment of acrossed cheque can be obtained through the bank of the holder. If a cheque is crossed it iseasy to trace the person for whose bene t the payment was collected. The crossed chequeis negotiable by mere delivery; it is payable to bearer by endorsement and delivery in case ispayable to order In case, payment is made to a wrong person whose signature is not according tosp ecimen signature, the protection is given to a banker under Section 16 (2) of th eNegotiable Instruments Act : It is not possible for a banker to know each of the endorsersand their signatures. For getting the protection, the banker should not e the following:(a) Regular Endorsement: According to Section 85 (1) of the Act the endorsement should be regular. For ex ample, if a cheque is payable to a right person andsignature is bearing same nam e and the same spellings this is known as regularendorsement. Though this is not a valid endorsement. (b) Payment in Due Course: According to Section 10 of the Act the cheque should be paid in due course. In c ase the payment is made on forged signature of theendorser and not that of the d rawer, the banker gets statutory protection underSection 10 of the Act.3. Protection in Case of Crossed Cheque: Regarding payment of crossed cheque, thepaying banker gets the protection under Section 128 of the Negotiable InstrumentsAct, 1881 : Whereas the banker on whom a crossed cheque is drawn has paid thesame in due course, the banker paying the c heque and the drawer thereof (in casesuch cheque has come to the hands of the pa yee) shall be entitled respectively to thesame rights and placed in the same pos ition if the amount of the cheque had beenpaid to and received by the true owner thereof.In case the payment is made on the instructions of the drawer in good fa ith without any negligence, the paying banker gets the statutory protection unde r the NegotiableInstruments Act, 1881: The payment of crossed cheque in due cours e makes thedrawee banker liable to the true owner of the cheque besides disentit ling himself todebit the customers account.4.

Protection in Case of Obliterated Cheques: According to Section 89 of theNegotiable Instruments Act, 1881, Whereas a cheque is presented for payment which does not at the time of presentation appear to be crossed or to have had acrossing which has been obliterated, payment thereof by a banker is liable to be paidand paying the same according to the apparent teno r thereof at the time of payment and otherwise in due course, shall discharge su ch banker from all liability thereonand such payment shall not be questioned by reason of the cheque having beencrossed. Thus the above Section is very meaningfu l where crossing of a chequeis obliterated by dishonest person. Under the above Section the banker gets theprotection in the way that the payment is made accord ing to the apparent tenor of the cheque and due course.5. Protection in Case of Drafts: In case of demand drafts drawn by one branch of a bankupon another branch of the same bank, the banker gets protection under Section 85 of the Negotiable Instru ments Act. The Section states: Whereas any draft, that is, an orderto pay money d rawn by one of ce of a bank upon another of ce of the same bank for asum of money pa yable to order on demand, purports to be endorsed by or on behalf of the payee, the bank is discharged by payment in due course. In short, a banker may get statutory protection under the various Sections of th eNegotiable Instruments Act, if he ful ls the terms and conditions of the said Sec tionof the said Act. No protection, however is available, in case the drawers sig nature isforged. Dishonour of Cheques A paying banker must refuse payment on cheques, issued by his customers, in the followingcircumstances:1. When the Customer Countermands the Payment: A banker must refuse to honour cheque when the customer countermands the cheque. Countermandsmeans the instruction conveyed by the drawer of a cheque to drawee b ank not to pay the cheque, when it is presented. The instructions of the customer to stoppayment should be in writing. It should be signed by the drawer. The ins tructionsshould include the number, the date, the name of the payee and the amou nt of thecheque. Any one of the partners in partnership accounts or any one of t he joint account holders may countermand the cheques. Then the banker has to fol low theinstructions. Suppose, if there is a request to remove stop order, the ba nker shouldget such request signed by all the required signatories. It is better for a banker tosuggest the issue of a new cheque. A banker must follow the cust omers instructionsto stop payment very carefully (Hilton Vs Westminister Bank Ltd .). If instructionsare given to stop payment by telegram or telephone, the banke r should postpone andrequest the drawer to send a written con rmation. At best he may return the chequemarking Payment Countermanded by Telegram, or payment postpon ed pendingcon rmation, present again.The banker owes no duty to a holder of cheque. Hence, he should not rely onthe instructions from a holder on the plea that he had lost the cheque. He shouldsuggest to the holder to obtain written instructio ns from the drawer. If the cheque ispresented in the meanwhile, he may return th e cheque in the case of stop telegram.However, he should see that the customers cre dit is not affected or damaged. If the holder of an order cheque has lost it and informs the banker that he has not endorsed it, the banker should stop payment because the presenter must be claimingthe amount through a forged endorsement. O therwise, the banker will be held liablefor not acting in good faith and without negligence.If the banker pays a countermanded cheque, he will not only be requi red toreverse the entry but also be held liable to pay damages for dishonouring the chequespresented subsequently which would have been honoured otherwise.2. Notice of the Customers Death: The banker should not make payments oncheques presented after the death of the c ustomer. He should return the cheque withthe remark Drawer Deceased. However, if t he payment is made without knowingthe fact of the customers death, the banker can not be held liable. Notice of Customers Insanity: The banker should stop the payment on chequesdrawn and received after the receip

t of notice of the customers insanity. However,the banker should be very careful in this regard. He can believe that the customeris insane only when the latter i s sent to the lunatic asylum. Otherwise, he had toobtain the certi cate from the c ompetent doctor. Cheques drawn at a time when thecustomer was rational may be ho noured.4. Notice of the Customers Insolvency: A banker should refuse payment on thecheques soon after the customer is adjudica ted as insolvent.5. Receipt of the Garnishee Order: Where Garnishee order is received attaching thewhole amount, the banker should s top payment on cheques received after the receipt of such an order. But if the o rder is for a speci c amount, leaving the speci ed amount,cheques should be honoured if the remaining amount is suf cient to meet them.6. Notice of Assignment: The banker should stop the payment, on receipt of thenotice of assignment signed by the customer of the credit balance in his account.7. Trust Accounts: If the banker feels suspicious that the trustee wants to use theamount of the ch eque for his personal use, he must stop payment.8. Suspicion about the Title over the Cheque: When the banker believes that theperson presenting the cheque is not entitled to receive the payment, he should refuseto make payment. For example, stolen chequ e. When a Banker can Dishonour Cheques A banker may dishonour a cheque without incurring any liability in the following cases: 1. Post-dated Cheques: Refusal to pay post-dated cheque before the date mentionedon the cheque does not amount to dishonour. So, post-dated cheques can bedishonoured. 2. Insuf ciency of Funds: The banker can refuse to pay the amount if the fundsare not suf cient. However, th e banker may honour the cheque if he feels that thecustomer is a trustworthy and long-standing customer. 3. Presentation of Cheque: The banker may refuse the cheque of his customer if it isnot duly presented. Pre sentation of cheque out of business hours, for example, can be dishonoured. 4. Joint Accounts: In the case of joint account, the banker can refuse to make payment on the chequ e if it is not signed by all the joint account holders. 5. Material Alterations: When there is material alteration in the cheque, the bankermay refuse payment. 6. Stale Cheques: When the cheque is presented after the period of six months fromthe date it bear s, the banker may refuse to make payment. 7. Drawers Signature: If the signature of the drawer on the cheque does not tallywith the specimen sig nature, the banker may refuse to make payment. 8. Difference between Words and Figures: If there is difference between the amount written in words and gures, the banker may refuse to make payment. 9. Endorsement: If the endorsement is irregular, the banker may refuse payment onthe cheque. 10. Proper Form of the Cheque: If the cheque is not in the proper form i.e., in accordancewith the provisions o f the Negotiable Instruments Act, and with conditions, the banker should refuse the payment. 11.Drawn on Another Branch: If the cheque is presented at another branch of thesame bank, it should not be h onoured unless special arrangements are made by thecustomer in advance. Banks Remarks on Dishonoured Cheques

When a cheque is returned unpaid, the banker should attach a slip containing bri ef remarks,to convey the reason for dishonouring the cheque. The following remar ks are generallymade:(a) R.D. (Refer to Drawer): This remark is used only when t here is reasonable groundto suspect the veracity of the cheque.(b) N.S. (Not suf c ient), N.E. (No. Effects): These are used where the drawers balanceis inadequate to meet the cheque.(c) E.I. (Endorsement Irregular)(d) E.N.C. (Effect is not cle ared): This is used when cheques deposited are not yet collected and not availab le for withdrawal. Conclusion In conclusion, it may be observed that the banker must be guided by the recognis ed practiceof bankers. In all cases, the banker must use his own judgement and h is knowledge of thegeneral practice of banker. The phrase in good faith means honestly and without notice or interest of deceit o rfraud and does necessarily require carefulness. Negligence means failure to exe rcisereasonable care. It is not for the customer or the true owner to prove negl igence onthe part of the banker. The burden of proving that he collected in good faith andwithout negligence is on the banker. The banker should have exercised reasonablecare and deligence. What constitutes negligence depends upon facts of each case.Following are a few examples which constitute negligence:(a) Failure t o obtain reference for a new customer at the time of opening theaccount.(b) Coll ection of cheques payable to trust accounts for crediting to personal accountsof a trustee.(c) Collecting for the private accounts of partners, cheques payable to the partnership rms.(d) Omission to verify the correctness of endorsements on che ques payable toorder.(e) Failure to pay attention to the crossing particularly t he not negotiablecrossing.2. Collection for a Customer: Statutory protection is available to a collecting bankerif he collects on behalf of his customer only. If he collects for a stranger or non-customer, he does no t get such protection. As Jones aptly puts if duly crossedcheques are only protec ted in their collection, if handled for the customer. A bankcannot get protection when he collects a cheque as holder for value. In Great WesternRailway Vs Londo n and Country Bank it was held that the bank is entitled forprotection as it rece ived collection for an employee of the customer and not for thecustomer.3. Acts as an Agent: A collecting banker must act as an agent of the customer inorder to get protecti on. He must receive the payment as an agent of the customerand not as a holder u nder independent title. The banker as a holder for value is not competent to cla im protection from liability in conversion. In case of forgery, the holder for v alue is liable to the true owner of the cheque. 4. Crossed Cheques: Statutory protection is available only in case of crossed cheques.It is not avai lable in case uncrossed or open cheques because there is no need tocollect them through a banker. Cheques, therefore, must be crossed prior to theirpresentment to the collecting banker for clearance. In other words, the crossingmust have be en made before it reached the hands of the banker for collection. If thecheque i s crossed after it is received by the banker, protection is not available. Evend rafts are covered by this protection.To conclude, it is necessary that the colle cting banker should have acted without negligence if he wants to claim statutory protection under Section 131 of the said Act. Thestatutory protection is availa ble to the banker if he collects a cheque marked Not Negotiable for a customer, whose name is not used as the payee there-in provided the requir ements of the said sections are duly complied with. Duties and Responsibilities of a Collecting Banker The duties and responsibilities of a collecting banker are discussed below:1. Du e care and diligence in the collection of cheque.2. Serving notice of dishonour. 3. Agent for collection.4. Remittance of proceeds to the customer.5. Collection of bill of exchange. 1. Due Care and Diligence in the Collection of Cheques: The collecting banker is bound to show due care and diligence in the collection of cheques presented to him.In case a cheque is entrusted with the banker for co llection, he is expected to showit to the drawee banker within a reasonable time

. According to Section 84 of theNegotiable Instruments Act, 1881, Whereas a chequ e is not presented for payment within a reasonable time of its issue, and the dr awer or person in whose account it is drawn had the right, at the time when pres entment ought to have been made, as between himself and the banker, to have the cheque paid and suffers actual damage,through the delay, he is discharged to the extent of such damage, that is to say, to theextent to which such drawer or per son is a creditor of the banker to a large amount than he would have been if suc h cheque had been paid.In case a collecting banker does not present the cheque fo r collection throughproper channel within a reasonable time, the customer may su ffer loss. In case thecollecting banker and the paying banker are in the same ba nk or where the collecting branch is also the drawee branch, in such a case the collecting banker should present the cheque by the next day. In case the cheque is drawn on a bank in another place,it should be presented on the day after rece ipt. 2. Serving Notice of Dishonour: When the cheque is dishonoured, the collecting banker is bound to give notice of the same to his customer within a reasonable time.It may be noted here, when a cheque is returned for con rmation of endorsement,notice must be sent to his custo mer. If he fails to give such a notice, the collecting banker will be liable to the customer for any loss that the customer may have sufferedon account of such failure.Whereas a cheque is returned by the drawee banker for con rmation of endor sement, it is not called dishonour. But in such a case, notice must be givento t he customer. In the absence of such a notice, if the cheque is returned for thes econd time and the customer suffers a loss, the collecting banker will be liable forthe loss. 3. Agent for Collection: In case a cheque is drawn on a place where the banker is not a member of the clea ring-house, he may employ another banker who is a member of the clearing-house fo r the purpose of collecting the cheque. In such a case the banker becomes a substituted agent. According to Section 194 of the Indian Contract Ac t,1872, Whereas an agent, holding an express or implied authority to name another person to act in the business of the agency has accordingly named another person ,such a person is a substituted agent. Such an agent shall be taken as the agent of aprincipal for such part of the work as is entrusted to him.4. Remittance of Proceeds to the Customer: In case a collecting banker has realisedthe cheque, he should pay the proceeds t o the customer as per his (customers)direction. Generally, the amount is credited to the account of the customer on thecustomers request in writing, the proceeds may be remitted to him by a demanddraft. In such circumstances, if the customer gives instructions to his banker, thedraft may be forwarded. By doing so, the re lationship between principal and agent comes to an end and the new relationship between debtor and creditor will begin.5. Collection of Bills of Exchange: There is no legal obligation for a banker to collect the bills of exchange for i ts customer. But, generally, bank gives such facility to itscustomers. In collec tion of bills, a banker should examine the title of the depositor asthe statutor y protection under Section 131 of the Negotiable Instruments Act, 1881.Thus, the collecting banker must examine very carefully the title of his customertowards the bill. In case a new customer comes, the banker should extend this facilityto him with a trusted reference.From the above discussion, there is no doubt to sa y that the banker is acting as amere agent for collection and not in the capacit y of a banker. If the customer allows his banker to use the collecting money for its own purpose at present and to repayan equivalent amount on a xed date in fut ure the contract between the banker andthe customer will come to an end. Marking of Cheque The marking of cheque means a cheque which is marked or certi ed by the drawee bank er,to the effect, that it is good for payment. The drawee bank certi es that the dr awer of thecheque has suf cient balance in his account and the cheque will not be dishonoured due to lack of funds. Such a certi cate is known as Marking of Cheques.G enerally, the marking of a cheque is done by drawee in writing the words good for

payment across one corner of the cheque, with the signature of the banks authorise dof cial and the banks stamp. The marked cheques are very useful for businessmen as theycan purchase the goods required by them, and the sellers will accept the ma rked cheques likecurrency-notes. It is to be noted here that marking post-dated cheques is not valid. Who Can Get the Cheque Marked? The marking of cheques may be done at the request of:(a) the drawer(b) the holde r, and(c) another banker. These have been discussed below.(a) Marking at the Request of the Drawer: Whereas a cheque is marked by thedrawee bank at the request of the drawer, the l atter cannot stop payment. In suchcase, the banker is bound to honour the cheque so marked by it. In case the drawerdies or becomes insane, the banker will have to make the payment because of thecheque having been marked at the request of t he drawer. In such case, the banker has statutory protection in refusing other c heques of the customer if there are not suf cient funds in his account. ( b) Marking at the Request of the Holder: The marking of a cheque at the request of the holder or payee does not virtually place any liability on the paying banker. It simply means that at the time of m arking, the drawee banker has suf cient fundsto the credit of the drawer to meet t he cheque. In such circumstances, there is noguarantee to the holder that the am ount of the cheque will be paid to him when hepresents it for payment. If a cust omer has suf cient funds in his account and hepresents a cheque for payment, the b anker will honour the cheque immediately. c. Marking at the Request of Another Banker: When a banker marks a chequeat the request of another banker for clearance purpo ses, the paying banker isundertaking an obligation to honour it. In actual pract ice, marking a cheque forclearance purposes entitles the paying banker to earmar k the necessary funds tomeet the cheque. Sir John Paget expressed his views, Such marking constitutesa constructive payment or appropriation to a speci c person th ough not directlyindicated by the customer.For the signi cance of marking of cheque , it is necessary that the suf cient balanceof money must be on credit with the dr awer on that particular date. It is, however,made clear by the following illustr ation:A cheque drawn on Canara Bank on 21st February, 1987 post-dated to 26th Fe bruary,1987, was certi ed by the Manager of the Bank Good for Payment on 26th Febru ary,1987. State Bank of India became holder of the cheque in due course, which wh enpresented for payment on 26th February, 1987, was dishonoured on account of la ck of funds. In such a case, Canara Bank would not be liable for the cheque.In s hort, the practice of marking of cheques at present, has been stopped in Indiaon account of inter-bank agreement. Conclusion From the above discussion, there is no doubt to say that, a banker who acts as a collecting banker has certain duties and liabilities, and he is bound to use re asonable care and skill whilecollecting cheques and other negotiable instruments . Dr. D.L. Hart has observed in connectionwith the duties of a collecting banker , that, as his customers agent in the matter, the bankeris bound to use reasonabl e skill, care and diligence in presenting and securing payment of thedrafts entr usted to him for collection and placing the proceeds to his customers account, or in taking such other steps as may be proper to secure the customers interests. Loan & Addvance INTRODUCTION One of the primary functions of a bank is to grant loans. Whatever money the ban k receives by way of deposits, it lends a major part of it to its customers by w ay of loans, advances, cashcredit and overdraft. Interest received on such loans and advances is the major source of itsincome. The banks make a major contribut ion to the economic development of the country by granting loans to the industri al and agricultural sectors.The banks make loans and advances out of deposits, r eceived from their customers. Most of these deposits are payable on demand. As s uch the bank owes a greater responsibility tothe depositors. Hence he should be extremely careful while granting loans.

General Rules of Sound Lending A banker should use his third eye and third ear (although the God has given him only twoeyes and two ears) while granting loans. In other words, he must be extr a careful whilegranting loans. A banker should take the following precautions: Principles of Sound Lending1. Safety2. Liquidity3. Profitability4. Diversificati on5. Object of loan6. Security7. Margin Money8. National Interest9. Character of theborrower Margin moneyNational interest These are discussed below.. 1. Safety: The most important golden rule for granting loans is the safety of funds.The mai n reason for this is that the very existence of the bank is dependent uponthe lo ans granted by him. In case the bank does not get back the loans granted byit, i t might fail. A bank cannot and must not sacri ce the safety of its funds to get higher rate of interest. For example, if a reputed credit-worthy businessman off ersto pay 10% interest per annum and on the other hand a pauper offers 15% rate of interest per annum. Obviously as per safety rule, the banker should not grant loanto the pauper although paying 5% higher rate of interest. 2. Liquidity: The second important golden rule of granting loan is liquidity. Liquiditymeans p ossibility of converting loans into cash without loss of time and money.Needless to say, that the funds with the bank out of which he lends money arepayable on demand or short notice. As such a bank cannot afford to block its fundsfor a lon g time. Hence the bank should lend only for short-term requirements likeworking capital. The bank cannot and should not lend for long-term requirements, like xed capital. 3. Return or Pro tability: Return or por tability is another important principle.The funds of the bank should be invested to earn highest return, so that it may pay areasonable rate of inte rest to its customers on their deposits, reasonably good salariesto its employee s and a good return to its shareholders. However, a bank should not sacri ce eithe r safety or liquidity to earn a high rate of interest. Of course, if safetyand l iquidity in a particular case are equal, the banker should lend its funds to ape rson who offers higher rate of interest. 4. Diversi cation: One should not put all his eggs in one basket is an old proverbwhich very clearly explains this principle. A bank should not invest all its funds inone industry. In case that industry fails, the banker will not be able to recover his loans. H ence, the bank may also fail. According to the principle of diversi cation,the ban k should diversify its investments in different industries and should give loans to different borrowers in one industry. It is less probable that all the borrow ersand industries will fail at one and the same time. 5. Object of Loan: A banker should thoroughly examine the object for which hisclient is taking loan s. This will enable the bank to assess the safety and liquidityof its investment . A banker should not grant loan for unproductive purposes or to buy xed asset. T he bank may grant loan to meet working capital requirements.However, after natio nalisation of banks, the banks have started granting loans tomeet loan-term requ irements. As per prudent banking policy, it is not desirable because of term len ding by banks a large number of banks had failed in Germany. 6. Security: A banker should grant secured loans only. In case the borrower fails toreturn th e loan, the banker may recover his loan after realising the security. In caseof unsecured loans, the chances of bad debts will be very high. However, the bankma y have to relax the condition of security in order to comply with the economic