BANKING & INSURANCE OPERATIONS

SEMESTER – I
B.COM REGULAR

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Edition: 2023

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EXHAUSTIVE TOWARDS THE COURSE. THE STUDENTS MUST REFER TO THE
REFERENCE BOOKS AND READING LISTS MENTIONED.

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 BANKING, INSURANCE AND OPERATIONS
Credits –03 Total hours– 45Hrs

Module – 1 INTRODUCTION and OVERVIEW OF BANKING 08HRS

 Evolution of banking -Meaning and definition of bank, Evolution of banking in India.
 Functions of commercial Banks - Primary Functions, Secondary Functions
 Banking structure in India- RBI, Commercial, Rural and Cooperative banks their role and
significance, Monetary policies of RBI

Module – 2 BANKING LAW AND PRACTICES 10HRS

Legal Aspects of Banking- Overview of the Legislations affecting Banking—Banking
Regulation Act, RBI Act, Negotiable Instruments Act-Types of Negotiable Instruments-
Characteristics of Negotiable Instruments-Endorsements, Crossing of Cheques; Paying Banker,
Collecting Banker-Payment in due course, Garnishee Order.

Module – 3 PROCEDURES FOR OPENING & OPERATING OF DEPOSIT ACCOUNT

10HRS
Different types of accounts and its importance - Procedure in opening bank accounts - Types of
account holders:
 Individual account holders – Single or joint, Illiterate, Minor, Married women. Pardahnashin
woman, Non-residents accounts
 Institutional account holders- sole Proprietorship firm, joints stock company Hindu Undivided
family, Clubs, Associations & Societies & Trusts.
 Methods of Remittances- Demand drafts, bankers cheques, Mail transfer, Telegraphic transfer,
Electronic Funds Transfer.

CHAPTER 4 - INTRODUCTION TO INSURANCE 08HRS

Meaning & Definition of insurance, Evolution and Importance of Insurance - Types of
Insurance -General Insurance: Meaning - type- need- Scope - Principles- Functions of general
Insurance - Procedure in Claiming insurance - Life Insurance Meaning- Need-& Principles of
life insurance - Type of life insurance policies. IRDA- introduction and functions

CHAPTER 5 - RISK AND INSURANCE 09HRS

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 Understanding Risk: Types of risk – Risk management - Objectives - Risk identification and
measurement - Pooling arrangements and diversification of risk- Risk aversion and demand for
insurance – By individuals- By corporations- Insurability of risk- contractual provisions- Legal
doctrine- - Loss control –Risk retention and reduction decisions.

BOOKS FOR REFERENCE :

1) L M Bhole ‘Financial Institutions & Markets’ Tata McGraw- Hill
2) Sunderaram and Varshney. “Banking Theory, Law and practice” Sultan Chand & Sons, New
Delhi.
3) Koch W, Timothy, & S. Scott. “Bank Management” Thomson, New Delhiy,
4) Gordon & Natrajan, Banking (Theory, Law and Parctice) Himalaya Publishing
5) Agarwal, O.P. Banking and Insurance, Himalaya Publishing

Course Objectives (CO)

CO1 Summarize the basic knowledge on evolution of banking and functions of banking system

CO2 Illustrate the various banking regulations acts and employ the applicability of negotiable
instruments
CO3 Examine the operations of different types of bank accounts and its importance

CO4 Explain the concept of insurance emphasising the policies based on their requirements

CO5 Demonstrate the fundamentals of risk management and sketch the risk management program

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 MODULE 1
INTRODUCTION AND OVERVIEW OF BANKING

1.1 Evolution of banking

2.1 Meaning and definition of bank
1.3.Functions of Bank- Primary Functions, Secondary Functions
1.4.Banking structure in India
1.5. RBI, Commercial, Rural and Cooperative banks their role and significance, functions,
1.6.SLR, CRR: Concepts, Banking Ratios

1.1.Evolution of banking
Genesis Indian Banking System for the last two centuries has seen many developments. An
indigenous banking system was being carried out by the businessmen called Sharoffs, Seths,
Sahukars, Mahajans, Chettis, etc. since ancient time. They performed the usual functions of
lending moneys to traders and craftsmen and sometimes placed funds at the disposal of kings for
financing wars. The indigenous bankers could not, however, develop to any considerable extent
the system of obtaining deposits from the public, which today is an important function of a
bank. Modern banking in India originated in the last decades of the 18th century. The first banks
were The General Bank of India which started in 1786, and the Bank of Hindustan.

Thereafter, three presidency banks namely the Bank of Bengal (this bank was originally started
in the year 1806 as Bank of Calcutta and then in the year 1809 became the Bank of Bengal) , the
Bank of Bombay and the Bank of Madras, were set up. For many years the Presidency banks
acted as quasi-central banks. The three banks merged in 1925 to form the Imperial Bank of
India. Indian merchants in Calcutta established the Union Bank in 1839, but it failed in 1848 as
a consequence of the economic crisis of 1848-49. Bank of Upper India was established in 1863
but failed in 1913. The Allahabad Bank, established in 1865 , is the oldest survived Joint Stock
bank in India . Oudh Commercial Bank, established in 1881 in Faizabad, failed in 1958.

The next was the Punjab National Bank, established in Lahore in 1895, which is now one of the
largest banks in India. The Swadeshi movement inspired local businessmen and political figures
to found banks of and for the Indian community during 1906 to 1911. A number of banks
established then have survived to the present such as Bank of India, Corporation Bank, Indian

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 Bank, Bank of Baroda, Canara Bank and Central Bank of India. A major landmark in Indian
banking history took place in 1934 when a decision was taken to establish ‘Reserve Bank of
India’ which started functioning in 1935. Since then, RBI, as a central bank of the country, has
been regulating banking system

1.2.Meaning and definition of bank,

A bank is a financial institution licensed to receive deposits and make loans. Banks may also
provide financial services such as wealth management, currency exchange, and safe deposit
boxes. There are several different kinds of banks including retail banks, commercial or corporate
banks, and investment banks. In most countries, banks are regulated by the national government
or central bank
Banks are a very important part of the economy because they provide vital services for both
consumers and businesses. As financial services providers, they give you a safe place to store
your cash. Through a variety of account types such as checking and savings accounts,
and certificates of deposit (CDs), you can conduct routine banking transactions like deposits,
withdrawals, check writing, and bill payments.

Role of Commercial Bank

Commercial banks play an important and active role in the economic development of a country.
If the banking system in a country is effective, efficient and disciplined it brings about a rapid
growth in the various sectors of the economy. The following is the significance of commercial
banks in the economic development of a country:

A. Promotion of capital formation: Commercial banks accept deposits from individuals and
businesses, these deposits are then made available to the businesses which make use of them for
productive purposes in the country.
B. Encourage to Invest in new enterprises: Businessmen normally hesitate to invest their money
in risky enterprises. The commercial banks generally provide short and medium term loans to
entrepreneurs to invest in new enterprises and adopt new methods of production. The provision
of timely credit increases the productive capacity of the economy.
C. Promotion of trade and industry: With the growth of commercial banking, there is vast
expansion in trade and industry. The use of bank draft, check, bill of exchange, credit cards and
letters of credit etc has revolutionized both national and international trade.
D. Development of agriculture: The commercial banks particularly in developing countries are
now providing credit for development of agriculture and small scale industries in rural areas.

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 The provision of credit to agriculture sector has greatly helped in raising agriculture productivity
and income of the farmers.
E. Balanced development of different States: The commercial banks play an important role in
achieving balanced development in different states of the country. They help in transferring
surplus capital from developed regions to the less developed regions.
F. Influencing economic activity: The banks can also influence the economic activity of the
country through its influence on a. Availability of credit b. The rate of interest If the commercial
banks are able to increase the amount of money in circulation through credit creation or by
lowering the rate of interest, it directly affects economic development.
G. Implementation of Monetary policy: The central bank of the country controls and regulates
volume of credit through the active cooperation of the banking system in the country. It helps in
bringing price stability and promotes economic growth within the shortest possible period of
time.

H. Encourage for Export promotion: In order to increase the exports of the country, the
commercial banks have established export promotion cells. They provide information about
general trade and economic conditions both inside and outside the country to its customers. The
banks are therefore, making positive contribution in the process of economic development.

1.3.Functions of Bank- Primary Functions, Secondary Functions

Important functions of Commercial Banks are given below:
1. PRIMARY FUNCTIONS
Primary banking functions of the commercial banks include:
i) Acceptance of deposits,
ii) Advancing loans,
iii) Creation of credit
iv) Clearing of cheques,
v) Financing foreign trade,
vi) Remittance of funds
i) ACCEPTANCE OF DEPOSITS
Commercial bank accepts various types of deposits from public especially from its clients.
These deposits are payable after a certain time period. Banks generally accept three types of
deposits viz., (a) Current Deposits (b) Savings Deposits (c) Fixed Deposits and d) Recurring
Deposit.

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Current Deposits: These deposits are also known as demand deposits. These deposits can be
withdrawn at any time. Generally, no interest is allowed on current deposits, and in case, the
customer is required to leave a minimum balance undrawn with the bank.

Savings Deposits: This is meant mainly for professional men and middle class people to help
them deposit their small savings. It can be opened without any introduction. Money can be
deposited at any time but the maximum cannot go beyond a certain limit.

Fixed Deposits: These deposits are also known as time deposits. These deposits cannot be
withdrawn before the expiry of the period for which they are deposited or without giving a prior
notice for withdrawal.

Recurring Deposit: Recurring Deposits are a special kind of Term Deposits offered by banks in
India which help people with regular incomes to deposit a fixed amount every month into their
Recurring Deposit account and earn interest at the rate applicable to Fixed Deposits. It is similar
to making FDs of a certain amount in monthly instalments, for example Rs 1000 every month.
ii) ADVANCING LOANS
Loans are made against personal security, gold and silver, stocks of goods and other assets. The
second primary function of a commercial bank is to make loans and advances to all types of
persons, particularly to businessmen and entrepreneurs. The most common way of advancing
loans are given below:
Overdraft Facilities: In this case, the depositor in a current account is allowed to draw over and
above his account up to a previously agreed limit. Suppose a businessman has only Rs. 6,000/-
in his current account in a bank but requires Rs. 12,000/- to meet his expenses. He may
approach his bank and borrow the additional amount of Rs. 6,000/-.
Cash Credit: Under this account, the bank gives loans to the borrowers against certain security.
But the entire loan is not given at one particular time, instead the amount is credited into his
account in the bank; but under emergency cash will be given. The borrower is required to pay
interest only on the amount of credit availed to him.
Discounting Bills of Exchange: This is another type of lending which is very popular with the
modern banks. The holder of a bill can get it discounted by the bank, when he is in need of
money. After deducting its commission, the bank pays the present price of the bill to the holder.
Such bills form good investment for a bank.
Money at Call: Banks grant loans for a very short period, generally not exceeding 7 days to the
borrowers, usually dealers or brokers in stock exchange markets against collateral securities like

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 stock or equity shares, debentures, etc., offered by them. Such advances are repayable
immediately at short notice hence; they are described as money at call or call money.
Term Loans: Banks give term loans to traders, industrialists and now to agriculturists also
against some collateral securities. Term loans are so-called because their maturity period varies
between 1 to 10 years.
Consumer Credit: Banks also grant credit to households in a limited amount to buy some
durable consumer goods such as television sets, refrigerators, etc., or to meet some personal
needs like payment of hospital bills etc. Such consumer credit is made in a lump sum and is
repayable in instalments in a short time.
Miscellaneous Advances: The other forms of bank advances there are packing credits given to
exporters for a short duration, export bills purchased/discounted, import finance-advances
against import bills, finance to the self-employed, credit to the public sector and credit to the
cooperative sector.
iii) CREATION OF CREDIT
Credit creation is the multiple expansions of banks demand deposits. It is an open secret now
that banks advance a major portion of their deposits to the borrowers and keep smaller parts of
deposits to the customers on demand. Even then the customers of the banks have full confidence
that the depositor’s lying in the banks is quite safe and can be withdrawn on demand.
iv) PROMOTE THE USE OF CHEQUES, DD OR ONLINE TRANSACTIONS
The commercial banks render an important service by providing to their customers a cheap
medium of exchange like cheques. It is found much more convenient to settle debts through
cheques rather than through the use of cash. The cheque is the most developed type of credit
instrument in the money market.
v) FINANCING FOR INTERNAL AND FOREIGN TRADE
The bank finances internal and foreign trade through discounting of exchange bills. Sometimes,
the bank gives short-term loans to traders on the security of commercial papers. This
discounting business greatly facilitates the movement of internal and external trade.
vi) REMITTANCE OF FUNDS
Commercial banks, on account of their network of branches throughout the country, also
provide facilities to remit funds from one place to another for their customers by issuing bank
drafts, mail transfers or telegraphic transfers on nominal commission charges. As compared to
the postal money orders or other instruments, bank drafts have proved to be a much cheaper
mode of transferring money and have helped the business community considerably.
2. SECONDARY FUNCTIONS
Secondary banking functions of the commercial banks include:

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 i) Agency Services
ii) General Utility Services
i) AGENCY SERVICES
Commercial banks act as attorney for their clients. They buy and sell shares and bonds, receive
and pay utility bills, premiums, dividends, rents and interest for their clients. Banks also perform
certain agency functions for and on behalf of their customers. The agency services are of
immense value to the people at large. The various agency services rendered by banks are as
follows:
(a) Collection and Payment of Credit Instruments: Banks collect and pay various credit
instruments like cheques, bills of exchange, promissory notes etc., on behalf of their customers.
(b) Purchase and Sale of Securities: Banks purchase and sell various securities like shares,
stocks, bonds, debentures on behalf of their customers.
(c) Collection of Dividends on Shares: Banks collect dividends and interest on shares and
debentures of their customers and credit them to their accounts.
(d) Acts as Correspondent: Sometimes banks act as representative and correspondents of their
customers. They get passports, traveler’s tickets and even secure air and sea passages for their
customers.
(e) Income-tax Consultancy: Banks may also employ income tax experts to prepare income tax
returns for their customers and to help them to get refund of income tax.
(f) Execution of Standing Orders: Banks execute the standing instructions of their customers
for making various periodic payments. They pay subscriptions, rents, insurance premium etc.,
on behalf of their customers.
(g) Acts as Trustee and Executor: Banks preserve the ‘Wills’ of their customers and execute
them after their death.
ii) GENERAL UTILITY SERVICES
General utility services are those services which are rendered by commercial banks not only to
the customers but also to the general public. In addition to agency services, the modern banks
provide many general utility services for the community as given below:
a) Safety Locker Facility
b) Collection of Cheque amount
c) Issuing Letter of Credit
d) Bank Drafts
e) ATM
f) Debit Card
g) Credit Card

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h) Tele-Banking
a) Safety Locker Facility
A bank undertakes the safe custody of the customer’s valuables and documents by providing a
safe deposit vault. These are kept in specially constructed strong rooms. There are lockers
available to the customer on a nominal charge. There are two keys for each locker, one is given
to the customer and the other remains with the Bank Manager. The locker is opened as well as
closed by both the keys one after another.
b) Collection of Cheques
The customers deposit cheques, bills of exchange and promissory note into their accounts with
the banks. These instruments are collected by the bank on behalf of their customers and credited
to their accounts. These services are provided by the cheques, bills and promissory notes issued
on branches out of the city are collected with some nominal charges for postage etc. this is a
very popular and essential service provided by the banks to their customers.
c) Issuing Letter of Credit
A letter of credit is a commercial instrument of assured payment. It is widely used by the
businessman for various purposes. The bank undertakes to make payment to a seller on
production of documents stipulated in the letter of credit. It specifies as to when payment is to
be made which may be either on presentation of documents by the paying bank or at some future
date depending upon the terms stipulated in the letter.
d) Bank Drafts
A bank draft is an order from one branch to another branch of the same bank to pay a specified
sum of money to a person named therein or to his order. A draft is always payable on demand.
Banks issue drafts at the request of the customers on their branches at the place of destination
for remitting money from one place to another place.
e) Automated Teller Machine (ATM)
ATM is a channel of banking service to its customers. It’s traditional and primary use is to
dispense cash upon insertion of a plastic card and its unique PIN i.e. Personal Identification
Number. The banks issue ATM card to their customers having current or savings account
holding a certain minimum balance in their accounts.
f) Debit Card
A debit card is a plastic card that provides an alternative payment method to cash when making
purchases. Functionally, it can be called an electronic check, as the funds are withdrawn directly
from either the bank account or from the remaining balance on the card. In some cases, the cards
are designed exclusively for use on the Internet, and so there is no physical card.

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 g) Credit Card
A credit card is an instrument of payment. It is a source of revolving credit. The cards are plastic
cards issued by the banks to their customers. The name of the customer, card number and expiry
date are printed on the plastic cards. Some banks also use the photograph of the customers on
the credit card. The cardholder can buy goods or services from various merchant establishments
where such arrangements exist.
h) Tele Banking
Telephone banking is a service provided by a Commercial Banks, which allows its customers to
perform transactions over the telephone. Most telephone banking services use an automated
phone answering system with phone keypad response or voice recognition capability.

1.4.Banking structure in India

Banking System in India or the Indian Banking System can be segregated into three distinct
phases:

(a) Scheduled Banks: Scheduled Banks in India are the banks which are listed in the Second
Schedule of the Reserve Bank of India Act1934. The scheduled banks enjoy several privileges
as compared to non- scheduled banks. Scheduled banks are entitled to receive refinance
facilities from the Reserve Bank of India. They are also entitled for currency chest facilities.
They are entitled to become members of the Clearing House. Besides commercial banks,
cooperative banks may also become scheduled banks if they fulfill the criteria stipulated by RBI

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(b) Non-scheduled banks: These are those banks which are not included in the Second Schedule of
the Reserve Bank of India. Usually those banks which do not conform to the norms of the
Reserve Bank of India within the meaning of the RBI Act or according to specific functions etc.
or according to the judgement of the Reserve Bank, are not capable of serving and protecting the
interest of depositors are classified as non-scheduled banks.

COMMERCIAL BANKS
A. Public Sector Banks The term ‘public sector banks’ by itself connotes a situation where the
major/full stake in the banks are held by the Government. Till July,1969, there were only 8
Public Sector Banks (SBI & its 7 associate banks). When 14 commercial banks (total 20 banks)
were nationalized in 1969, 100% ownership of these banks were held by the Government of
India. Subsequently, six more private banks were nationalized in 1980. However, with the
changing in time and environment, these banks were allowed to raise capital through IPOs and
there by the share holding pattern has changed. By default the minimum 51% shares would be
kept by the Government of India, and the management control of these nationalized banks is
only with Central Government. Since all these banks have ownership of Central Government,
they can be classified as public sector banks. Apart from the nationalized banks, State Bank of
India, and its associate banks, IDBI Bank and Regional Rural Banks are also included in the
category of Public Sector banks

B. Private Sector Banks

The major stakeholders in the private sector banks are individuals and corporate. When banks
were nationalized under two tranches (in 1969 and in 1980), all banks were not included. Those
non nationalized banks which continue operations even today are classified as Old Generation
Private Sector Banks.. like The Jammu & Kashmir Bank Ltd, The Federal Bank, The Laxmi
Vilas Bank etc. In July 1993 on account of banking sector reforms the Reserve Bank of India
allowed many new banks to start banking operations. Some of the leading banks which were
given licenses are: UTI bank (presently called Axis Bank) ICICI Bank, HDFC Bank, Kotak
Mahindra Bank, Yes Bank etc., These banks are recognized as New Generation Private Sector
Banks. Ten banks were licensed on the basis of guidelines issued in January 1993. The
guidelines were revised in January 2001 based on the experience gained from the functioning of
these banks, and fresh applications were invited.

C. Foreign Banks

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 The other important segment of the commercial banking is that of foreign banks. Foreign banks
have their registered offices outside India, and through their branches they operate in India.
Foreign banks are allowed on reciprocal basis. They are allowed to operate through branches or
wholly owned subsidiaries. These foreign banks are very active in Treasury (forex) and Trade
Finance and Corporate Banking activities. These banks assist their clients in raising External
Commercial Borrowings through their branches outside India or foreign correspondents. They
are active in loan syndication as well. Foreign banks have to adhere to all local laws as well as
guidelines and directives of Indian Regulators such as Reserve Bank of India, Insurance and
Regulatory Development Authority, Securities Exchange Board of India. The foreign banks
have to comply with the requirements of the Reserve Bank of India in respect to Priority Sector
lending, and Capital Adequacy ratio and other norms. Total foreign banks as on 31st March
2013 were 43 having 331 branches. Besides these, 46 foreign banks have their representative
offices in India as on 31st March 2013.

CO-OPERATIVE BANKING SYSTEM

Cooperative banks play an important role in the Indian Financial System, especially at the
village level. The growth of Cooperative Movement commenced with the passing of the Act of
1904. A cooperative bank is a cooperative society registered or deemed to have been registered
under any State or Central Act. If a cooperative bank is operating in more than one State, the
Central Cooperative Societies Act is applicable. In other cases the State laws are applicable.
Apart from various other laws like the Banking Laws (Application to Co-operative Societies)
Act, 1965 and Banking Regulation (Amendment) and Miscellaneous Provisions Act, 2004, the
provisions of the RBI Act, 1934 and the BR Act, 1949 would also be applicable for governing
the banking activities.

A. Short Term Agricultural Credit institutions: The short term credit structure consists of the
Primary Agricultural Credit Societies at the base level, which are affiliated at the district level
into the District Central Cooperative bank and further into the State Cooperative Bank at the
State level. Being federal structures, the membership of the DCCB comprises all the affiliated
PACS and other functional societies and for the SCB, the members are the affiliated DCCBs.
The DCCB being the middle tier of the Cooperative Credit Structure, is functionally positioned
to deal with the concerns of both the upper and lower tiers. This very often puts the DCCB in a
position of balancing competing concerns. While the SCB may managing District Central
Cooperative wish the DCCB to prioritize its task in a particular manner, the PACs may have

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 their own demands on the DCCB. Balancing these competing concerns could often be a
dilemma for the DCCBs.

B. Long Term Agricultural Credit Institutions: The long term cooperative credit structure
consists of the State Cooperative Agriculture & Rural Development Banks (SCARDBs) and
Primary Cooperative Agriculture & Rural Development Banks (PCARDBs) which are affiliated
to the SCARDBs. The total No. of SCARDB’s are 19; of which 10 have Federal Structure, 7
have Unitary Structure and 2 have Mixed Structure (i.e. operating through PCARDBs as well as
its own branches).Loans are given to members on the mortgages of their land usually up to 50%
of their value in some states or up to 30 times the land revenue payable in other states, duly
taking into account their need and repayment capacity

C. Urban Cooperative Banks: The term Urban Cooperative Banks (UCBs), although not formally
defined, refers to the primary cooperative banks located in urban and semi-urban areas. These
banks, until 1996, were allowed to lend money only to non-agricultural purposes. This
distinction remains today. These banks have traditionally been around communities, localities
working out in essence, loans to small borrowers and businesses. Today their scope of operation
has expanded considerably. The urban co-operative banks can spread operations to other States
and such banks are called as multi state cooperative banks. They are governed by the Banking
Regulations Act 1949 and Banking Laws (Cooperative Societies) Act, 1965. The total number
of UCBs stood at 1,618 as on 31st March 2012. Scheduled UCBs are banks included in the
Second Schedule of the RBI Act, 1934 and include banks that have paid-up capital and reserves
of not less than 5 lacs and carry out their business in the interest of depositors to the satisfaction
of the Reserve Bank.

1.5. Evolution of the Reserve Bank of India

The origins of the Reserve Bank of India (RBI) can be traced to 1926, when the Royal
Commission on Indian Currency and Finance – also known as the Hilton Young Commission –
recommended the creation of a central bank for India to separate the control of currency and
credit from the Government and to augment banking facilities throughout the country. The
Reserve Bank of India Act of 1934 established the Reserve Bank and set in motion a series of
actions culminating in the start of operations in 1935. Since then, the Reserve Bank's role and
functions have evolved, as the nature of the Indian economy and financial sector changed.
Though started as a private shareholders' bank, the Reserve Bank was nationalised in 1949.

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 The Preamble to the Reserve Bank of India Act, 1934, under which it was constituted, specifies
its objective as “to regulate the issue of Bank notes and the keeping of reserves with a view to
securing monetary stability in India and generally to operate the currency and credit system of
the country to its advantage”. The primary role of the RBI, as the Act suggests, is monetary
stability, that is, to sustain confidence in the value of the country's money or preserve the
purchasing power of the currency. Ultimately, this means low and stable expectations of
inflation, whether that inflation stems from domestic sources or from changes in the value of the
currency, from supply constraints or demand pressures. In addition, the RBI has two other
important mandates; inclusive growth and development, as well as financial stability.
In a country where a large section of the society is still poor, inclusive growth assumes great
significance. Access to finance is essential for poverty alleviation and reducing income
inequality. One of the core functions of the RBI, therefore, is to promote financial inclusion that
leads to inclusive growth. As the central bank of a developing country, the responsibilities of the
RBI also include the development of financial markets and institutions. Broadening and
deepening of financial markets and increasing their liquidity and resilience, so that they can help
allocate and absorb the risks entailed in financing India's growth is a key objective of the RBI
Functions of RBI
I. Issue Functions - Legal Background Right to issue bank notes is one of the key central banking
functions the RBI is 9 mandated to do . Section 22 of the RBI Act confers the RBI with the sole
right to issue bank notes in India. The issue of bank notes shall be conducted by a department
called the Issue Department, which shall be separated and kept wholly distinct from the Banking
Department . The RBI Act enables the RBI to recommend to Central Government the
denomination of bank notes, which shall be two rupees, five rupees, ten rupees, twenty rupees,
fifty rupees, one hundred rupees, five hundred rupees, one thousand rupees, five thousand
rupees and ten thousand rupees or other denominations not exceeding ten thousand rupees .
II. Banker’s Bank:
As bankers’ bank, the RBI holds a part of the cash reserves of commercial banks and lends them
funds for short periods. All banks are required to maintain a certain percentage (lying between 3
per cent and 15 per cent) of their total liabilities. The main objective of changing this cash
reserve ratio by the RBI is to control credit.
The RBI provides financial assistance to commercial banks and State cooperative banks through
rediscounting of bills of exchange. As the RBI meets the need of funds of commercial banks, the
RBI functions as the Tender of the last resort

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 III. Banker to the Government:
The RBI acts as the banker to the government of India and State Governments (except Jammu
and Kashmir). As such it transacts all banking business of these Governments
(i) Accepts and pays money on behalf of the Government.
(ii) It carries out exchange remittances and other banking operations.
IV. Controller of Credit:
The RBI controls the total supply of money and bank credit to sub serve the country’s interest.
The RBI controls credit to ensure price and exchange rate stability.
To achieve this, the RBI uses all types of credit control instruments, quantitative, qualitative and
selective. The most extensively used credit instrument of the RBI is the bank rate. The RBI also
relies greatly on the selective methods of credit control. This function is so important that it
requires special treatment.
V. Exchange Management and Control:
One of the essential central banking functions performed by the Bank is that of maintaining the
external value of rupee. The external stability of the currency is closely related to its internal
stability the inherent economic strength of the country and the way it conducts its economic and
monetary affairs.
Domestic, fiscal and monetary policies have, therefore, an important role in maintaining the
external value of the currency. Reserve Bank of India has a very important role to play in this
area.
VI. Custodian of Cash Reserves of Commercial Banks:
The commercial banks hold deposits in the Reserve Bank and the latter has the custody of the
cash reserves of the commercial banks.
VII. Custodian of Country’s Foreign Currency Reserves:
The Reserve Bank has the custody of the country’s reserves of international currency, and this
enables the Reserve Bank to deal with crisis connected with adverse balance of payments
position.
VIII. Central Clearance and Accounts Settlement:
Since commercial banks have their surplus cash reserves deposited in the Reserve Bank, it is
easier to deal with each other and settle the claim of each on the other through book keeping
entries in the books of the Reserve Bank. The clearing of accounts has now become an essential
function of the Reserve Bank.

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 1.6.Monetary Policies
Meaning:
Monetary policy is the macroeconomic policy laid down by the central bank. It involves
management of money supply and interest rate and is the demand side economic policy used by
the government of a country to achieve macroeconomic objectives like inflation, consumption,
growth and liquidity.
In other words Monetary policy, the demand side of economic policy, refers to the actions
undertaken by a nation's central bank to control money supply to achieve macroeconomic goals
that promote sustainable economic growth.

Tools of monetary policies

I. Quantitative Tools
1. Cash Reserve Ratio (CRR)
CRR is a certain minimum amount of deposit that the commercial banks have to hold as
reserves with the central bank. CRR is set according to the guidelines of the central bank of a
country.
Example: When someone deposits Rs 100 with a bank, it increases the deposits of the bank by
Rs 100. If the CRR is 9%, then the bank will have to hold additional Rs 9 with the central bank.
This means that the commercial bank will be able to use only Rs 91 for investments and/or
lending or credit purpose.

2. Statutory Liquidity ratio:

Every bank must have a specified portion of their Net Demand and Time Liabilities (NDTL) in
the form of cash, gold, or other liquid assets by the day’s end. The ratio of these liquid assets to
the demand and time liabilities is called the Statutory Liquidity Ratio (SLR). The Reserve Bank
of India has the authority to increase this ratio by up to 40%. An increase in the ratio constricts
the ability of the bank to inject money into the economy.
3. Repo rate :
Repo rate is the rate at which the central bank of a country (Reserve Bank of India in case of
India) lends money to commercial banks in the event of any shortfall of funds. Repo rate is used
by monetary authorities to control inflation.

4. Reverse repo rate

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 Reverse repo rate is the rate at which the central bank of a country (Reserve Bank of India in
case of India) borrows money from commercial banks within the country. It is a monetary
policy instrument which can be used to control the money supply in the country.

5. Base or Bank Rate:

Base rate is the minimum rate set by the Reserve Bank of India below which banks are not
allowed to lend to its customers.
Description: Base rate is decided in order to enhance transparency in the credit market and
ensure that banks pass on the lower cost of fund to their customers. Loan pricing will be done by
adding base rate and a suitable spread depending on the credit risk premium.

6. Open market operation

It is the sale and purchase of government securities and treasury bills by RBI or the central bank
of the country. The objective of OMO is to regulate the money supply in the economy. It takes
place When the RBI wants to increase the money supply in the economy, it purchases the
government securities from the market and it sells government securities to suck out liquidity
from the system.

II. Qualitative tools

Unlike quantitative tools which have a direct effect on the entire economy’s money supply,
qualitative tools are selective tools that have an effect in the money supply of a specific sector of
the economy.
1. Margin requirements – The RBI prescribes a certain margin against collateral, which in turn
impacts the borrowing habit of customers. When the margin requirements are raised by the RBI,
customers will be able to borrow less.
2. Moral suasion – By way of persuasion, the RBI convinces banks to keep money in government
securities, rather than certain sectors.
3. Selective credit control – Controlling credit by not lending to selective industries or speculative
businesses
Bank-Specific Ratios
Bank-specific ratios, such as net interest margin (NIM), provision for credit losses (PCL), and
efficiency ratio are unique to the banking industry. Similar to companies in other sectors, banks
have specific ratios to measure profitability and efficiency that are designed to suit their unique
business operations. Also, since financial strength is especially important for banks, there are
also several ratios to measure solvency.

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Ratios for Profitability
1. Net Interest Margin
Net interest margin measures the difference between interest income generated and interest
expenses. Unlike most other companies, the bulk of a bank’s income and expenses is created by
interest. Since the bank funds a majority of their operations through customer deposits, they pay
out a large total amount in interest expense. The majority of a bank’s revenue is derived from
collecting interest on loans.
The formula for net interest margin is:
Net Interest Margin = (Interest Income – Interest Expense) / Total Assets
Ratios for Efficiency
1. Efficiency Ratio
The efficiency ratio assesses the efficiency of a bank’s operation by dividing non-interest
expenses by revenue.
The formula for the efficiency ratio is:
Efficiency Ratio = Non-Interest Expense / Revenue
The efficiency ratio does not include interest expenses, as the latter is naturally occurring when
the deposits within a bank grow. However, non-interest expenses, such as marketing or
operational expenses, can be controlled by the bank. A lower efficiency ratio shows that there is
less non-interest expense per dollar of revenue.
2. Operating Leverage
Operating leverage is another measure of efficiency. It compares the growth of revenue with the
growth of non-interest expenses.
The formula for calculating operating leverage is:
Operating Leverage = Growth Rate of Revenue – Growth Rate of Non-Interest Expense
A positive ratio shows that revenue is growing faster than expenses. On the other hand, if the
operating leverage ratio is negative, then the bank is accumulating expenses faster than revenue.
That would suggest inefficiencies in operations.
Ratios for Financial Strength
1. Liquidity Coverage Ratio
As the name suggests, the liquidity coverage ratio measures the liquidity of a bank. Specifically,
it measures the ability of a bank to meet short-term (within 30 days) obligations without having
to access any outside cash.
The formula for the liquidity coverage ratio is:
Liquidity Coverage Ratio = High-Quality Liquid Asset Amount / Total Net Cash Flow
Amount

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The 30-day period was chosen as it is the estimated amount of time it takes for the government
to step in and help a bank during a financial crisis. Thus, if a bank is capable of fund cash
outflows for 30 days, it will not fall.
2. Leverage Ratio
The leverage ratio measures the ability of a bank to cover its exposures with tier 1 capital. As
tier 1 capital is the core capital of a bank, it is also very liquid. Tier 1 capital can be readily
converted to cash to cover exposures easily and ensure the solvency of the bank.
The formula for the leverage ratio is:
Leverage Ratio: Tier 1 Capital / Total Assets (Exposure)
3. CET1 Ratio
The CET1 ratio is similar to the leverage ratio. It measures the ability of a bank to cover its
exposures. However, the CET1 ratio is a more stringent measurement, as it only considers the
common equity tier 1 capital, which is less than the total tier 1 capital. Also, for the ratio’s
calculation, the risk level of the exposure (asset) is considered as well. A higher risk asset is
given a higher weighting of risk, which lowers the CET1 ratio.
The formula for the CET1 ratio is:
CET1 Ratio = Common Equity Tier 1 Capital / Risk-Weighted Assets
Other Bank-specific Ratios
1. Provision for Credit Losses (PCL) Ratio
The provision for credit losses (PCL) is an amount that a bank sets aside to cover loans they
believe will not be collectible. By having such an amount set aside, the bank is more protected
from insolvency. The PCL ratio measures the provision for credit losses as a percentage of net
loans and acceptances. Looking at it enables investors or regulators to assess the riskiness of
loans written by the bank in comparison to their peers. Risky loans lead to a higher PCL and,
thus, a higher PCL ratio.
The formula for the provision for credit losses ratio is:
Provision for Credit Losses Ratio = Provision for Credit Losses / Net Loans and
Acceptances

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 TERMINAL QUESTIONS:
SECTION A: 5X4=20
1. Briefly describe the role of Commercial Banks.
2. Describe the structure of Indian Banking system.
3. Explain the profitability ratios.
4. Write a note on evolution of RBI
SECTION B: 9x2=18
1 Explain the functions of Reserve Bank of India.
2 Mention two types of NPA
SECTION C: 12x1=12
1. Explain the functions of Commercial Banks.
2. Define monetary policy. Elucidate the tools of monetary policy.
MODULE 2
BANKING LAW AND PRACTICE

2.1. Legal Aspects of Banking- Overview of the Legislations affecting Banking—Banking

Regulation Act,
2.2. RBI Act,
2.3. Negotiable Instruments Act-Types of Negotiable Instruments-Characteristics of Negotiable
Instruments-Endorsements, Crossing of Cheques; Paying Banker, Collecting Banker-Payment in
due course, Garnishee Order.

2.1 Legal Aspects of Banking Banking Regulation Act, 1949

The Banking Regulation Act, 1949 is one of the important legal frame works. Initially the Act
was passed as Banking Companies Act,1949 and it was changed to Banking Regulation Act
1949. Along with the Reserve Bank of India Act 1935, Banking Regulation Act 1949 provides a
lot of guidelines to banks covering wide range of areas. Some of the important provisions of the
Banking Regulation Act 1949 are listed below.

The term banking is defined as per Sec 5(i) (b), as acceptance of deposits of money from the
public for the purpose of lending and/or investment. Such deposits can be repayable on demand
or otherwise and withdraw able by means of cheque, drafts, order or otherwise.
Sec 5(i)(c) defines a banking company as any company which handles the business of banking
Sec 5(i)(f) distinguishes between the demand and time liabilities, as the liabilities which are
repayable on demand and time liabilities means which are not demand liabilities

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 Sec 5(i)(h) deals with the meaning of secured loans or advances. Secured loan or advance
granted on the security of an asset, the market value of such an asset in not at any time less than
the amount of such loan or advances. Whereas unsecured loans are recognized as a loan or
advance, which is not secured.

Sec 6(1) deals with the definition of banking business

Sec 7 specifies banking companies doing banking business in India should use at least on work
bank, banking, banking company in its name – Banking Regulation Act through a number of
sections restricts or prohibits certain activities for a bank.
For example: (i) Trading activities of goods are restricted as per Section 8 (ii) Prohibitions:
Banks are prohibited to hold any immovable property subject to certain terms and conditions as
per Section 9 . Further, a banking company cannot create a charge upon any unpaid capital of
the company as per Section 14. Sec 14(A) stipulates that a banking company also cannot create
a floating charge on the undertaking or any property of the company without the prior
permission of Reserve Bank of India

2.2 AN OVERVIEW OF RBI ACT, 1934 AND BANKING REGULATION ACT 1949
Reserve Bank of India Act, 1934 The Reserve Bank of India Act,1934 was enacted to constitute
the Reserve Bank of India with an objective to (a) regulate the issue of bank notes (b) for
keeping reserves to ensure stability in the monetary system (c) to operate effectively the nation’s
currency and credit system The RBI Act covers: (i) the constitution (ii) powers (iii) functions of
the Reserve Bank of India. The act does not directly deal with the regulation of the banking
system except for few sections like Sec 42 which relates to the maintenance of CRR by banks
and Sec 18 which deals with direct discount of bills of exchange and promissory notes as part of
rediscounting facilities to regulate the credit to the banking system.
The RBI Act deals with:
a. incorporation, capital, management and business of the RBI
b. the functions of the RBI such as issue of bank notes, monetary control, banker to the Central and
State Governments and banks, lender of last resort and other functions
c. general provisions in respect of reserve fund, credit funds, audit and accounts
d. issuing directives and imposing penalties for violation of the provisions of the Act

2.3 Definition and Meaning of Negotiable Instruments:

Section 13 of the Indian Negotiable Instruments Act, 1881 defines a Negotiable Instrument as “a
promissory note, bill of exchange or cheque payable either to order or to the bearer”. This

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 definition merely states about the promissory note, bill of exchange or cheque, but does not give
the meaning of negotiable instruments.

A negotiable instrument can be defined as a document or instrument whose property (legal right
to money represented by it) can be transferred from one person to another by mere delivery or
by endorsement and delivery, and which gives a valid title to the bonafide holder for value.
Characteristics of Negotiable Instruments
The chief characteristics of a negotiable instrument are:
1. Free Transferability
The basic characteristic of a negotiable instrument is that it is freely transferable from one
person to another. i.e., the ownership of the property in a negotiable instrument is freely
transferable. If it is a bearer instrument, it can be transferred by mere delivery. If it is an order
instrument, it can be transferred by endorsement and delivery.
2. Negotiability
Negotiability feature means that the bonafide transferee of a negotiable instrument (i.e. the
person who gets a negotiable instrument for value and in good faith and without the knowledge
of the defect in the title of the transferor) becomes a holder in due course, and gets a better title
than that of the transferor or any of the previous holders. The bonafide transferee is not affected
by the defect in the title of the transferor or any of the previous holders.
3. Right of action in his own name
The holder in due course of a negotiable instrument gets the right to sue upon the instrument in
his own name. In other words, the holder in due course of a negotiable instrument is entitled to
sue the transferor or any other person liable on the instrument in his own name without giving
him (i.e., the transferor or any other party liable on the instrument) any notice.
4. Presumptions
Certain presumptions apply to all negotiable instruments. Section 118 of the Negotiable
Instruments Act, 1881 provides that, unless the contrary is proved, the following presumptions
shall be made by the court as to a negotiable instrument:
 Every negotiable instrument was made, drawn, accepted, endorsed, negotiated or transferred for
consideration.
 Every negotiable instrument bearing a date was made or drawn on that date.
 Every accepted bill of exchange was accepted within a reasonable time after its date and before
its maturity.
 Every transfer of a negotiable instrument was made before its maturity.

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 The endorsements appearing on the negotiable instrument were made in the order in which they
appear therein.
 A lost or destroyed negotiable instrument was duly stamped and the stamp was duly cancelled.
 The holder of a negotiable instrument is a holder in due course.
h. In a suit upon a dishonored instrument, the court, on proof of protest, presumes that it was
dishonored unless this fact is disproved.

Types of Negotiable Instruments

Negotiable instruments can be broadly classified into two:
1. Instruments negotiable by law
2. Instruments negotiable by custom or usage of trade.
Instruments negotiable by custom or usage includes Government promissory notes, dividend
warrants, share warrants etc.

In India, law recognizes only three instruments as negotiable and they are:
1. Promissory Note
2. Bill of Exchange, and
3. Cheque

Promissory Note
Section 4 of the Negotiable Instruments Act defines a Promissory Note as “ an instrument in
writing (not being a bank note or a currency note) containing an unconditional undertaking,
signed by the maker, to pay a certain sum of money only to or to the order of a certain person or
to the bearer of the instrument”.
Thus, a promissory note contains a promise by the debtor to the creditor to pay a certain sum of
money after a certain date. Hence, it is always drawn by the debtor and he is called the ‘maker ’
of the instrument.
Features of Promissory Note:
a. It is an instrument in writing.
b. It is a promise to pay.
c. The undertaking to pay is unconditional.
d. It should be signed by the maker.
e. The maker must be certain.
f. The payee must be certain.
g. The promise must be to pay money and money only.

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h. The amount must be certain.

Bill of Exchange
Section 5 of the Negotiable Instruments Act defines a bill of exchange as “ an instrument in
writing containing an unconditional order, signed by the maker, directing a certain person to pay
a certain sum of money only to, or to the order of a certain person or to the bearer of the
instrument”.
Thus, a bill of exchange is a written acknowledgement of the debt, written by the creditor and
accepted by the debtor. There are usually three parties to a bill of exchange- drawer, drawee or
acceptor and payee. drawer himself may be the payee.

The Drawer: The person who draws the bill.

The Drawee: The person on whom the bill is drawn.
The Acceptor: The person one who accepts the bill. Generally, the drawee is the acceptor but a
stranger may accept it on behalf of the drawee.
The payee: one to whom the sum stated in the bill is payable, either the drawer or any other
person may be the payee.
The holder: is either the original payee or any other person to whom, the payee has endorsed
the bill. In case of a bearer bill, the bearer is the holder.
Drawee in case of need: Besides the above parties. Another person called the “drawee in case
of need” may be introduced at the option of the drawer. The name of such a person may be
inserted either by the drawer or by any endorser in order that resort may be had to him in case of
need, i.e., when the bill is dishonored by either non-acceptance or non-payment.
Acceptor for honour:Further, any person may voluntarily become a party to a bill as acceptor.
A person, who on the refusal by the original drawee to accept the bill or to furnish better
security, when demanded by the notary, accept the bill supra protest in order to safeguard the
honour of the drawer or any endorser, is called the acceptor for honour.

Essential features:
a. It must be in writing.
b. It must be signed by the drawer.
c. The drawer, drawee and payee must be certain.
d. The sum payable must also be certain.
e. It should be properly stamped.

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f. It must contain an express order to pay money and money only. g. The order must be
unconditional.

Holder and Holder in Due Course Holder of a Negotiable Instrument

In terms of Section 8 of the Negotiable Instruments Act:
‘The holder of a promissory note, bill of exchange or cheque means any person entitle in his
own name to the possession thereof and the receive or recover the amount due thereon from the
parties thereto’.

Thus, the holder of a negotiable instrument is the person who is legally entitled to recover the
amount from the parties of the instrument and who is in possession of the instruments. Here the
Indian law makes a slight departure from the english law. under the Bills of exchange Act, a
holder means the payee or endorsee of a bill or note, who is in possession of it, or the bearer
thereof. In terms of this definition, the holder need not necessarily be a lawful holder.

For instance, the finder of a cheque duly endorsed so as to make it payable to bearer is a holder.
For instance the finder of a cheque duly endorsed so as to make it payable to bearer is a holder.
But according to the Negotiable Instruments Act, the holder must be entitled to receive or
recover the amount due thereon from the parties thereto. Therefore, a person who has obtained
possession of a negotiable instrument by theft or any other unlawful means is not a holder.

Holder in Due Course of a Negotiable Instrument

Section 9 of the Negotiable Instruments Act defines a ‘holder in due course ’as:
‘Holder in due course means any person who for consideration became the possessor of a
promissory note, bill of exchange or cheque if payable to bearer or the payee or endorsee thereof
if payable to order, before the amount mentioned in it became payable, and without having
sufficient cause to believe that any defect existed in the title of the person from whom he
derived his title. ’
Thus, a ‘holder in due course ’is a person who:
1. is in possession of the instrument as defined in Section 8;
2. obtains possession of the instrument before maturity;
3. obtains possession of the instrument for valuable consideration
(valuable consideration in the case of a negotiable instrument is always presumed until the
contrary is proved) and

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4. is a holder, without having sufficient cause to believe that any defect existed in the title of the
person from whom he received his title.
Here again, the Negotiable Instruments Act differs slightly from the Bills of exchange Act,

According to Section 29 of the Bills of exchange Act:

‘A holder in due course is a holder who has taken a bill complete and regular on the face of it,
under the following conditions; namely:

(a) that he became the holder of it before it was overdue and without notice that it had been
previously dishonored, if such was the fact;
(b) that he took the bill in good faith and for value, and that at the time the bill was negotiated to
him he had no notice of any defect in the title of the person who negotiated it. ’

From the above definition, it can be seen that a person who takes an instrument in good faith is a
holder in due course, irrespective of whether or not he takes it negligently. In other words, the
fact that a person has not exercised great caution or has not been negligent is not sufficient to
dispute the title of the holder of a negotiable instrument, provided he has acted in good faith.
However, according to Indian law, a person is a holder in due course only if he takes the
instrument without having sufficient cause to believe that any defect existed in the title of the
person from whom he received his title. Thus, according to the Negotiable Instruments Act
person is expected to take an instrument with reasonable care and without negligence.

A holder in due course obtains absolute title, even if he takes the instrument from a thief. All the
previous parties to the instrument are liable to him. An exception to this general rule may be
found when the instrument bears a forged signature of the true owner. Thus transferee of such an
instrument does not get a valid title except in the case of estoppels.

Cheques
Section 6 of the Act defines a cheque as “a bill of exchange drawn on a specified banker and not
expressed to be payable otherwise than on demand and it includes the electronic image of a
truncated cheque and a cheque in the electronic form”.
Thus, a cheque is an instrument in writing, containing an unconditional order, drawn on a
specified banker, signed by the drawer, directing the banker, to pay, on demand, a certain sum of
money only, to a certain person or to his order or to the bearer of the instrument.

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 A cheque is a piece of document/paper which orders the bank to transfer money from the bank
account of an individual or an organisation to another bank account.
The person who writes the cheque is called the “drawer” and the person in whose name the
cheque has been issued is called the “payee”. The amount of money that needs to be transferred,
payee’s name, date and signature of the drawer are all mentioned in a cheque.
There are certain points to remember regarding cheques which are mentioned below:
 A cheque can only be issued against a current or savings bank account
 A cheque without date shall be considered invalid
 Only the payee, in whose name the cheque has been issued, can encash it
 A cheque is only valid 3 months from the date it has been issued
 A 9-digit MICR (Magnetic Ink Character Recognition) code is mentioned at the bottom of the
cheque. This makes the clearance of cheques easier for the banks.

Essentials of a cheque:
1. A cheque must be in writing. oral orders do not constitute a cheque. But, the law has not
specified the writing materials with which a cheque has to be written.
2. It must contain an order. This implies that the cheque must contain an order to pay, and not a
request to pay.
3. The order to pay must be unconditional. No condition should be attached to the order. In other
words, the banker should not be ordered to do anything else except to pay the money.
4. It must be drawn on a banker. It cannot be drawn on any other person, except on the banker.
5. It must be drawn on a specified banker. It cannot be drawn on any bank, but only on the
particular bank where the drawer has an account.
6. It must be drawn only by the customer of the bank, i.e. only by the account holder.
7. It must be signed by the drawer (i.e. , the account holder) or his authorized holder. Rubber stamp
signature is not accepted by the bankers, though it is legally permissible.
8. The order must be for the payment of money only. The order must direct the banker to pay only
money and not any other thing.
9. The order must be for the payment of certain sum of money. The amount of money ordered to
be paid must be certain.
10. The amount must not be expressed to be payable otherwise than on demand.
11. The amount of the cheque must be made payable to a certain person or to his order or to the
bearer of the cheque.

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 Kinds of Cheques:
There are various types of cheques that can be issued. Given below is the list of the various
cheque types:
1. Bearer Cheque
2. Order Cheque
3. Crossed Cheque
4. Account Payee Cheque
5. Stale Cheque
6. Post Dated Cheque
7. Ante Dated Cheque
8. Self Cheque
9. Traveler’s Cheque
10. Mutilated Cheque
11. Blank Cheque

1. Bearer Cheque
The bearer cheque is a type of cheque in which the bearer is authorised to get the cheque
encashed. This means the person who carries the cheque to the bank has the authority to ask the
bank for encashment.
This type of cheque can be used for cash withdrawal. This kind of cheque is endorsable. No kind
of identification is required for the bearer of the cheque.
For example: A cheque has been signed by Arjun (drawer) and the payee for the cheque is
Varun. Varun can either go to the bank himself or can send a third person to get encashment for
the cheque. No identification shall be required for the bearer’s name.
2. Order Cheque
This type of cheque cannot be endorsed, i.e., only the payee, whose name has been mentioned in
the cheque is liable to get cash for that amount. The drawer needs to strike the “OR BEARER”
mark as mentioned on the cheque so that the cheque can only be encashed to the payee.
For Example: If a cheque has been signed with the name of Varun, then only the payee can visit
the bank to get an encashment for the same for a order cheque.

3. Crossed Cheque
In this type of cheque, no cash withdrawal can be done. The amount can only be transferred
from the drawer’s account to the payee’s account. Any third party can visit the bank to submit

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 the cheque. In case of a crossed cheque, the drawer must draw two lines at the left top corner of
the cheque.

4. Account Payee Cheque

This is the same as the account payee cheque but no third party involvement is required. The
amount shall be transferred directly to the payee’s account number.
To ensure that it is an account payee cheque, two lines are made on the left top corner of the
cheque, labelling it for “A/C PAYEE”.

5. Stale Cheque
In India, any cheque is valid only until 3 months from the date of issue. So if a payee moves to
the bank to get withdrawal for a cheque which was signed 3 months ago, the cheque shall be
declared a stale cheque.
For example: If a cheque is dated January 1, 2021, and the payee visits the bank for withdrawal
on May 1, 2021, his/her request shall be denied and the cheque is declared stale.

6. Post Dated Cheque

If a drawer wants the payee to apply for withdrawal or transfer of money after the present date,
then he/she can fill a post dated cheque.
For example: If the date on which the drawer is filling the cheque is May 10, 2021, but he wants
the payment to be done later, he/she can fill the cheque dates as May 30, 2021. It shall be called
a post-dated cheque.

7. Ante Dated Cheque

If the drawer mentions a date prior to the current date on the cheque, it is called ante dated
cheque.
For example: If the current date is January 30, 2021, and the drawer dates the cheque as January
1, 2021. It shall be considered as an ante-dated cheque.

8. Self Cheque
If the drawer wishes cash for himself he can issue a cheque where in place of the Payee’s name
he can write “SELF” and get encashment from the branch where he owns an account.
For example: If a person wants Rs.1,00,000/- in cash, he can issue a self cheque and visit his
bank branch where he owns an account and get encashment in place of a cheque.

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9. Traveller’s Cheque
As the name suggests, the Traveler’s cheque can be used when a person is travelling abroad
where the Indian currency is not used.
If a person is travelling abroad, he can carry the traveller’s cheque and get encashment for the
same in abroad countries.

10. Mutilated Cheque

If a cheque reaches the bank in a torn condition, it is called a mutilated cheque. If the cheque is
torn into two or more pieces and the relevant information is torn, the bank shall reject the
cheque and declare it invalid, until the drawer confirms its validation.
If the cheque is torn from the corners and all the important data on the cheque is intact, then the
bank may process the cheque further.

11. Blank Cheque

When a cheque only has a drawer’s signature and all the other fields are left empty, then such a
type of a cheque is called a blank cheque.
The above-mentioned types of cheques are the most commonly known and used in the Indian
banking industry. Let us now know the parties associated with a cheque.

Number of Parties involved with a Cheque

There are three parties involved with a cheque.
Drawer or Maker – Drawer of the cheque is the customer or account holder who issues the
cheque.
Drawee – Drawee is basically the bank on which the cheque is drawn. Remember that a cheque
is always drawn on a particular banker.
Payee – This is the person who is named in the cheque and gets the payment for the amount
mentioned in the cheque. In particular cases (when the drawer writes a self-cheque), the drawer
and the payee can be the same individual.
Apart from these three, there are two more parties involved with a cheque –

Crossing of cheques
Need
Very often, an open or uncrossed cheque payable across the counter of the paying banker lends
to fraud by unscrupulous persons and causes loss either to the customer or to the banker. In

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 order to avoid such a risk and to protect the true owner of the cheque and the banker, the system
of crossing of Cheques has been introduced.

Meaning
Crossing of a cheque means drawing across the face of the cheque two parallel transverse lines
with or without the words “And Company” or “Not Negotiable” or “Account Payee” between
the parallel transverse lines. It can be hand-written or stamped.

Object of Crossing
Crossing affords security and protection to the true owner, since payment of such a cheque has
to be made through a banker. It facilitates the tracing of the person who has received the
payment of the cheque. This traceability ensures the safety of the cheque.

Who can Cross a Cheque?

1. The drawer of a cheque can cross it at the time of issuing it.
2. Any holder can cross an uncrossed cheque.
3. The banker in whose favor a cheque has been crossed can again cross it in favor of another
banker for the purpose of collection.
Why Cross a Cheque?
 Crossing a cheque gives financial institution-specific instructions on how to handle cash.
 Crossed cheques are typically identifiable by drawing two parallel transverse lines vertically
across the cheque or at the top left-hand corner.
 Between the lines, two or more words such as 'and company' or 'not negotiable' may be used.
Simply drawing the lines without writing anything on them would not change the meaning of
the crossed check.
 Cheque writers can use crossed cheques to protect the amount transmitted from being cashed by
an unauthorized person or stolen.
 The nature of this format for crossed cheques may vary between countries in terms of its format
or assertions.
 Since Crossed Cheques can only be paid through a bank account, the transaction record of the
beneficiary can be tracked down afterwards for additional questions and clarifications.

Types of Crossing:
There are two types of crossing viz.,

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1. General Crossing
Section 123 of the Act, defines a general crossing as “where a cheque bears across its face, an
addition of the words “and company” or any abbreviation thereof between two parallel
transverse lines, or of two parallel transverse lines simply, either with or without the words “not
negotiable”, that addition shall be deemed a crossing and the cheque shall be deemed to be
crossed generally”
So, general crossing means drawing across the face of a cheque two parallel transverse lines
with or without the words “And Company” or “Not Negotiable” or “Account Payee” between
the parallel transverse lines.
Essential features:
a. There must be two parallel transverse lines.
b. The two parallel transverse lines must be on the face of the cheque.
c. The lines are generally drawn on the left hand side.
d. The words “and company” or its abbreviation “and co.” or “& Co” do not form a necessary
part of the general crossing.
e. Words, such as “Not Negotiable” or “Account Payee” also do not form an essential partof the
general crossing.

The paying banker is required to pay the amount of a generally

crossed cheque to another banker, but not to the holder at the counter

2. Special Crossing
Section 124 of the Act defines a special crossing as “where a cheque bears across its face an
addition of the name of a banker with or without the words “Not Negotiable”, that addition shall
be deemed a crossing and the cheque shall be deemed to be crossed specially and to be crossed
to that banker”. So, special crossing means writing across the face of a cheque the name of some
banker with or without lines or words such as “Not Negotiable” or “Account Payee”.

Essential features:
a. Two parallel transverse lines are not required.
b. The name of the collecting banker must be necessarily specified across the face of the cheque,
this itself constitutes special crossing.
c. Words such as “Not Negotiable” or “Account Payee” also do not form a necessary part of
special crossing.
d. The paying banker is required to pay the amount of a specially crossed cheque only to the

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banker named in the cheque or his agent for collection.
e. It makes a cheque safer than general crossing. Not Negotiable Crossing

The words “Not Negotiable” may be included in a general or a special crossing. When a cheque
is crossed generally or specially with the words “Not Negotiable”, it loses its special feature of
negotiability. As a result, such a cheque cannot give to the transferee or the holder a better title
than that of the transferor or the person from whom the transferee received it. But it does not
restrict the transferability of a cheque and does not affect either the paying or the collecting
banker.

3.Account Payee Crossing

The words, “Account Payee” may be included in a general or special crossing. These words
have no statutory recognition. They are used because of banking practice. It is a warning to the
collecting banker that he should collect only for the benefit of the payee. If the collecting banker
collects such a cheque for a party other than the payee, he will be liable to the true owner of the
cheque under the doctrine of conversion. This type of crossing does not affect the paying
banker. When a cheque is crossed generally or specially with the words “Not Negotiable” or
“Account Payee”, it will possess the features of both “Not Negotiable” crossing and “Account
Payee” crossing.

4. Double Crossing
double crossing means crossing a cheque especially to more than one banker. A cheque cannot
have double or two crossings, because the very purpose of the first special crossing is defeated
by the second special crossing. The paying banker should refuse to honour such a cheque as it is
prohibited under the Act. However, the collecting banker need not refuse to collect such a
cheque.
Though a cheque cannot have two special crossings, an exception to this rule has been made for
the purpose of collection. By the virtue of this exception, the banker to whom a cheque is
crossed specially may, either because he does not have a branch at the place of the paying
banker, or because of some other reason, cross it especially to another banker who acts as his
agent for the purpose of collection. But, in such a case, the second special crossing must specify
that the banker to whom the cheque has been specially crossed again acts as the agent of the first
banker for the purpose of the collection of the cheque.

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Marking of Cheque
‘Marking ’means giving a certificate by the banker to a cheque that it is good for payment. This
takes place when a payee has any doubt of the cheque being honoured and not knowing the
whereabouts of the drawer. under such circumstances, the paying banker may be approached for
‘marking’. The paying banker may or may not oblige in such a situation. His refusal to mark the
cheque does not amount to wrongful dishonor of the cheque and does not incur any sort of
liability.
The paying banker, when he simply puts his initial on the cheque or writes the words ‘marked
good for payment ’and puts his initial, the cheque becomes a marked cheque.
The effects of marking are:
1. The drawer has drawn the cheque in good faith.
2. Sufficient funds are available to pay the cheque.
3. It adds to the credit of the drawer and the credit of the paying banker.

The legal aspects of a marked cheque depend upon the circumstances under which it is marked.
Whether it is marked for a drawer or for a payee or the collecting banker or the holder has to be
taken note of.
1. Marking for drawer: The drawer may request the banker to mark the cheque to satisfy the
payee. If the banker marks the cheque, it amounts to constructive payment. This means the
banker cannot dishonor the marked cheque inspite of the death, lunacy or insolvency of the
drawer or even when the garnishee order is against that account. The banker has to earmark the
funds for the payment of the marked cheque and the drawer has no right to countermand the
payment of such cheque.
2. Marking for holder or payee: The banker can also mark the cheque at the instance of the
payee or holder. But such marking does not impose on the paying banker any legal obligation.
Marking in this case simply signifies that there is sufficient amount to meet the cheque at the
time of marking. But the banker need not appropriate funds to meet the obligation of that cheque
when it is presented for payment. It only signifies that the cheque is drawn in good faith.

3. Marking for a collecting banker: When a customer’s cheque is presented by the collecting
banker after the clearing hours, the paying banker can mark the cheque at the request of the
collecting banker. This is done to protect the interest of the customers. When such cheques are
marked, the paying banker should honour the cheque at a later stage. In order to meet such
obligation, he appropriates funds from the drawer’s account. The drawer cannot countermand

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 the payment of such marked cheques. Such marking is construed as an undertaking to pay the
value of cheque and will be considered as a ‘constructive payment’.

Paying banker and collecting banker

can be defined as follows:
“The bank on which a cheque is drawn (the bank whose name is printed on the cheque) and
which pays the amount for which the cheque is written and deducts that sum from the
customer’s account.” The paying banker should use due care and diligence in paying a cheque
so as to refrain from any action potential enough to damage his customer’s credit.

“A Collecting banker is the one who attempts to collect different types of instruments
representing money in favour of his customer or his own behalf from the drawers of these
instruments; some are negotiable instruments as provided for in the Negotiable Instruments Act,
1881.”

Rights of Paying and Collecting Banker

The rights of the banker include:

1. Right of General Lien: can be retained till the owner discharges the debt or obligation to the
possessor. A lien is the right of a creditor in possession of goods, securities or any other assets
belonging to the debtor to retain them until the debt is repaid, provided that there is no contract
express or implied, to the contrary. A banker has the right to retain the property belonging to the
customer until the debt due from him has been paid. It is a right to retain possession of specific
goods or securities or other movables of which the ownership vests in some other person and the
possession
2. Right to set off: The right of set off is also known as the right of combination of accounts. Right
to set off is a right of the banker to adjust his outstanding Joan (debit) in the name of the
customer from his credit balance of any of the accounts he s maintaining with the bank. A bank
has a right to set off a debt owing to a customer against a debt due from him. Right to set off is
nothing but combine the two or more accounts of a customer of the customer. If the customer
have two or more account and in case of absence of agreement the banker can exercise has right
of set off:
 (a) The two or more accounts must be in the name of same customer
 (b) There must be same capacity
 (c) There must be same bank ,though different branches

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 (d) One account should show debit balance and other should show a credit balance
 (e) The debt must be manual
 (f) The amount of debit should be certain one.

3. Right to close an account: There should be no confusion between closing the account and
stopping operation of the account. The contractual relationship between banker and customer is
terminated by closing the account. There is no opportunity for the customer to operate the
account once again. On the other hand, stopping operation of an account refers to the suspension
of the operation of an account for the time being, at the advent of certain events. It is purely
suspension of the relationship between a banker and a customer and the customer can operate
the account, after such events come to a close
4. Right to appropriate payments: The banker has the right to appropriate the money deposited
by a customer to any one of the loan account due by him. The appropriation arises when the
customer has more than one account one showing the debit balance and the other with a credit
balance. The customer is given the first option to decide the account to which the amount should
be credited. If the customer fails to indicate his choice then the banker has every legal right to
credit the amount in any one account of that customer

Liabilities of Paying Bankers

Following are the liabilities of paying bankers:
o Checking the signature of the drawer.
o Verification of the genuineness of the instrument.
o Payment not stopped by the A/c holder
o Holder’s title on the cheque is valid.
o A/c is not dormant one.
o A/c holder is not bankrupt or deceased.
o A/c is not under subject of liquidation process.
o No ‘Garnishee Order’ is issued by court.
o Properly endorsed.
o Cheque is not drawn beyond limit fixed by the drawer is respect of amount.
o Instrument being presented is crossed.
o Instrument is not state or postdated.
o No material adjustment is made.
o Sufficient balance in the A/c

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 Liabilities of Collecting Bankers
Following are the liabilities of collecting bankers:
a) Acting as agent: While collecting an instrument, the Bankers works as agent of his customer. As
an agent he has to take some steps & precautions to protect the interest or his customer as a man
of ordinary discretion would take to safeguard his own interest.
b) Scrutinizing the instruments: Name of the holder, Branch name, amount in world and figure,
date, material alteration of any to be checked carefully.
c) Checking the endorsement: Bankers have to check the instrument whether it has been endorsed
properly.
d) Presenting the instrument in due time: It is the responsibility of the collecting bank to present
the instrument in due time to the paying bank.
e) Collecting the proceeds in the payee’s account: It is the duty of collecting banks to collect and
credit the proceeds of the instruments to the proper/correct account.
f) Notice of dishonour and returning the instruments: If any instrument is dishonoured by the
paying bank it should be informed to the customer on the day following the receipt of the unpaid
instruments.

Material Alterations:
A material alteration is an alteration which alters (i.e., changes) materially or substantially the
operation of a cheque, and thereby, the rights and liabilities of the parties thereto. Such
alterations will be material alteration, whether it is beneficial or detrimental to any party to the
instrument.
examples:
1. Alteration of the date or sum payable or place of payment or the name of the payee.
2. Changing an order cheque into a bearer cheque.
3. Cancelling the crossing on a cheque.
4. Changing a specially crossed cheque into a generally crossed cheque.
5. Striking off the words “Not Negotiable” or “Account Payee” from a general or special
crossing.

There are certain alterations which cannot be regarded as material alterations. For example:
1. Changing a bearer cheque into an order cheque.
2. Changing an open or uncrossed cheque into a crossed cheque.
3. Changing a generally crossed cheque into a specially crossed cheque.

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4. Adding the words “Not Negotiable” or “Account Payee” to a general or to a special crossing.
5. Completing an inchoate (i.e., an incomplete) cheque by filling up the blanks.

Effects of Material Alteration:

A cheque which contains a material alteration cannot be regarded as a cheque. However, such a
cheque becomes valid, if the material alteration is confirmed by the drawer under his full
signature. When the material alteration is apparent and is presented for payment to the paying
banker, he should see whether it is confirmed by the drawer or not. If it is confirmed then he can
pay such a cheque without any risk. If such alteration is not confirmed then he should return the
cheque unpaid with remark for the same.

If the material alteration is not apparent or is very difficult to detect even on a careful
examination and consequently, the payment is made without the drawer’s confirmation, the
paying banker is protected, provided the payment is made in due course.

A garnishee order
A garnishee order is an order passed by an executing court directing or ordering a garnishee
not to pay money to judgment debtor since the latter is indebted to the Garnisher (decree-
holder). It is an order of court to attach money or goods belonging to the judgment debtor in the
hands of a third person.

A court order instructing a garnishee (a bank) that funds held on behalf of a debtor (the
judgement debtor) should not be released until directed by the court. The order may also instruct
the bank to pay a given sum to the judgement creditor (the person to whom a debt is owed by
the judgement debtor) from these funds. It is an order of court to attach money or goods
belonging to the judgment debtor in the hands of a third person. It is a remedy available to any
judgment creditor; this order may be made by the court to holders of funds (3rd party) that no
payments are to make until the court authorizes them. The word ‘Garnish’ is derived from an old
French word ‘garnir’ which means to warn or to prepare. It is to serve an heir with notice i.e. to
warn of certain debts that must be paid before the person is entitled to receive property as an
heir.

Garnishee means a judgment-debtor’s debtor. He is a person or institution that is indebted to

another whose property has been subject to garnishment. He is a person who is liable to pay a
debt to a judgment debtor or to deliver any movable property to him. A third person or party in

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 whose hands money is attached by process of court; so called, because he had garnishment or
warning, not to pay the money to the defendant, but to appear and answer to the plaintiff
creditor’s suit.

Garnisher is a judgment-creditor (decree-holder) who initiates a garnishment action to reach the

debtor’s property that is thought to be held or owed by a third party.

For Example
- Suppose A owes Rs. 1000 to B and B owes Rs. 1000 to C. by a garnishee order the court may
require A not pay money owed to him to B, but instead to Pay C, since B owes the said amount
to C, who has obtained the order.
- Suppose A owes B Rs 2,000/. A refuses to repay the amount to B and B sues A. He obtains a
decree in his favour. Here B is a judgment-creditor and A is the judgment-debtor.

How a garnishee order works?

A default judgement is usually obtained by a creditor either when a debt has gone unpaid, you
haven’t been able to come to any agreement with the creditor about repaying the debt, or other
alternative debt collection avenues have been exhausted. If a garnishee order is made against
you, then your bank, financial institution, or employer will likely be notified rather than you.
The payment made by the garnishee into the court pursuant to the notice shall be treated as a
valid discharge to him as against the judgment debtor. The court may direct that such amount
may be paid to the decree holder towards the satisfaction of the decree and costs of the
execution.

Features of the Garnishee Order

The bank upon whom the order is served is called Garnishee. The depositor who owes money to
another person is called judgement debtor.
 Garnishee Order applies to existing debts as also debts accruing due i.e. SB/CD, RD/FD
Accounts.
 Garnishee Order applies only to those accounts of Judgement Debtor which have credit balance.
 The relationship between bank and judgement debtor is of debtor and creditor. Bank is the
debtor of Judgement Debtor who is a creditor of the bank.
 Garnishee Order does not apply to money deposited subsequent to receipt of Garnishee Order. It
also does not apply to cheques sent for collection but yet to be realized. But if credit was

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 allowed in the account before realization with power to withdraw to customer, Garnishee order
will be applicable on this amount.
 Garnishee Order does not apply to unutilized portion of overdraft or cash credit account of the
borrower as no debt is due to judgement debtor. For example, if limit is Rs 4 crore and
outstanding is debit Rs 3 crore, Garnishee order is not applicable on the balance Rs 1 crore.
 Bank can exercise right of set off before applying Garnishee Order.
 Garnishee Order is applicable only if both debts are in same right and same capacity.
 Garnishee Order issued in a single name does not apply to accounts in the joint names of
judgement debtor with another person(s). But if Garnishee Order is issued in joint names, it will
apply to individual accounts also of the same debtors. When Garnishee Order is in the name of a
partner it will not apply to partnership account but when Garnishee Order is in the name of firm,
accounts of individual partners are covered.

TERMINAL QUESTIONS:

SECTION A: 5x4=20
1. Explain types of Negotiable instruments.
2. Define Crossing of cheques. Explain types of crossing of cheques.
3. Define Promissory note. State the features of promissory notes.
4. Define bill of exchange. State the features of Bill of Exchange.
5. Define garnishee order
6. Define paying and collecting banker.

SECTION B: 9x2=18
1) Explain the features of cheque.
2) Define Holder in due course.
3) State the perquisite necessary for DEMAT

SECTION C: 12X1=12
1. Define Negotiable Instruments. Describe the features of Negotiable Instruments.
2. Define cheques and explain the types
3. Explain roles and responsibilities of paying and collecting banker.

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 MODULE 3
PROCEDURE FOR OPENING & OPERATING OF DEPOSIT ACCOUNT

3.1. Procedure for opening of Deposit account: Know your Customer Norms (KYC norms),
Application form, Introduction, Proof of residence, Specimen signature & Nomination: Their
importance

3.1 Procedure for operating Deposit account: Pay - in- slips, Issue of pass book, Issue
of Cheque book, Issue of fixed deposit receipt, premature encashment of fixed deposits & loan
against fixed deposit. Recurring deposits: Premature encashment & loan against fixed deposit,
closure of accounts.
3.2 Types of account holders a) Individual account holders – Single or joint, Illiterate,
Minor, Married women. Pardahnashin woman, Non-residents accounts b) Institutional account
holders- sole Proprietorship firm, joints stock company Hindu Undivided family, Clubs,
Associations & Societies & Trusts.
3.3 Methods of Remittances- Demand drafts, banker’s cheques, Mail transfer,
Telegraphic transfer, Electronic Funds Transfer.

Introduction:
The basic function of a banker is accepting money from the public by way of deposits and
deploying the same by means of loans and investments. The relationship between a banker and
his customer begins with the opening of an account by the customer in the bank. Initially all
the accounts are opened with a deposit of money and hence these accounts are called deposits
accounts. To accept deposit from public is an important function of banks. The banks provide
various facilities and privileges to customers through two types of deposits. They are i)
Demand Deposits, and ii) Time Deposits. These deposits are further classified into savings
deposits, current deposits, fixed deposits etc. All these deposits have special features. The
present chapter deals with the opening and operating of such deposits

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 3.1 PROCEDURE IN OPENING BANK ACCOUNTS

With the opening of an account in a bank, a customer enters into relationship with a bank. This
relationship imposes several obligations on the bank. So, a banker should be very careful in
opening an account in the name of a customer. Though any person may apply for opening an
account in his name but whether to accept a deposit is at the discretion of the bank. Due care is
to be taken while opening an account.

3.1.1 Know Your Customer (KYC) :

With the opening of an account in a bank, a customer enters into relationship with a bank. This
relationship imposes several obligations on the bank. So, a banker should be very careful in
opening an account in the name of a customer. Though any person may apply for opening an
account in his name but whether to accept a deposit is at the discretion of the bank.

Due care is to be taken while opening an account.

1) Procedures to verify the bonafide identification of individuals / corporate opening an account.

2) Processes and procedures to monitor high value transactions and transactions of

suspicious nature in accounts.

3) Systems for conducting due diligence and reporting of such transactions.

i) Need of KYC Norms : The main objective of the KYC policy is to prevent banks from
being used, intentionally or unintentionally, by criminal elements for money laundering
activities. In order to arrest money laundering, where Banks are mostly used in the process, it
is imperative that they know their customers well. RBI has issued the KYC guidelines under
Section 35 (A) of the Banking Regulation Act, 1949 and any contravention of the same will
attract penalties under the relevant provisions of the Act. Thus, the Bank has to be fully
compliant with the provisions of the KYC procedures also enable Banks to know and
understand their customers and their financial dealings better which in turn help them manage
their risks prudently. Know Your Customer is the principle on which the banking system
operates to avoid the pitfalls of operational, legal and reputation risks and consequential losses
by scrupulously adhering to the various procedures laid down for opening and conduct of

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 accounts.

ii) KYC Norms :

A) Customer Identification: KYC norms indicate that the customer identification will be through
an introductory reference from an existing account holder or a person known to the bank or on
the basis of documents provided by the customer. A deposit account must be opened on the
bases of any one of the following :

a) An introduction from a third person having satisfactory conduct of the account

for the period stipulated by the bank from time to time or be well known local authorities or
through staff members knowing the potential customer.

b) Passport alone when the address on the passport is the same as the address on
the account opening form.

B) Customer Profile: For the purpose of exercising due diligence on individual transactions in
accounts, it is felt desirable to include customer profile of individual account holders in the
account opening forms. It should cover the following information:
1) Occupation, 2) Source of funds, 3) Monthly income, 4) Annual turnover, 5) Date of birth, 6)
Educational qualification, 7) Spouse's qualification (optional), 8) Family members(optional),
9) Any relative settled abroad, 10) Dealings with other banks, 11) Existing credit facilities, 12)
Assets (appropriate value). For opening accounts by transfer from other branches, a new set of
account opening forms along with the customer profile should be obtained, while transferring
accounts from inoperative account to live ledger, a new set of account opening form along with
customer profile should obtained. Customer profiles have to be reviewed once in three years. It
is to be noted that implementation of KYC guidelines should not result in denial of opening of
new account at branches.

C) High Value Transactions: A bank should have a close watch of individual cash withdrawal
and cash deposit of Rs.10 lac and above in deposit account, cash credit account or overdraft
account. Branches of the banks are required to record and report all individual cash deposits /
withdrawals of Rs.10 lac on above at fortnightly basis. Demand drafts, Telegraphic transfers,
Traveller's cheques, Banker's cheques for Rs.50,000 and above should be issued only by debit
to customer's accounts or against cheques and not in cash. Application for exceeding Rs.50,000

45 *For private circulation only

 would require PAN to be affixed thereon by the applicant.

D) Transactions of Suspicious Nature: For identification of suspicious transactions one has to be

very cautious and use this judgment as a man of ordinary prudence.

3.1.1 Application Form:

To open an account the request is made in the prescribed form of the bank. There are different
kinds of forms kept by the bank for different kinds of accounts. The applicant has to mention
his name, occupation, full address, specimen signature and the name and signature of referee.
He has to give undertaking to comply with the bank rules in force from time to time for the
conduct of the account. Such rules may be changed or modified by the bankers and such
modified rules shall be acceptable to the customer.

Importance:

i. It contains detailed information in respect of a person opening an account in the bank.

ii. Signing of such application form is a contract between the account holder and bank.
iii. It is assurance given by the account holder to follow all rules and regulation of the
bank.
iv. This is a first step in the process of account opening

3.1.3. Identification :
The question of obtaining introduction and references for a customer to establish identity is
important as various benefits accrue to the banker. The banker can confirm the integrity and
respectability of the customer. This would minimise the probable risk of the applicant desiring
for bad purpose to obtain possession of a cheque book and misusing of cheques to cause
damage and loss to the payee and endorsee who part with goods and services of value in
exchange of worthless cheques. Personnel of bad moral characters apt to commit frauds upon a
bank which would lead to unsound banking practices to handle their accounts. If the
prospective customer is reputable, the possibilities of frauds are reduced. Failure to obtain
introduction / reference on the part of a banker shows negligence. So for statutory protection
under section 131 of the Negotiable Instrument Act, the banker should act in good faith and
without negligence in this case. At the identification point great care must be exercised when
relying on any cards / letters or documents offered for identification.

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 Importance:

I. The banker is in a position to confirm the integrity and respectability of the customer.
II. It minimises the risk of the applicant opening a bank account with intend to commit offences
such as money laundering, fraud etc.
III. It is a written assurance given by the introducer.
IV. If the prospective customer is reputable the possibilities of frauds are reduced.

3.1.4. Introduction: It is absolutely necessary for a bank to verify the identity of the
customer and satisfy itself that he is credit worthy. Many times accounts in bogus names are
opened and financial crimes are committed through the accounts. Recommendation from the
account holder of the same branch should be insisted. His full name, account number and
signature should be verified.

A) Ways of Introduction : The applicant may be introduced to the bank in any of the
three ways :

i) A respectable person, either a customer of the same branch of the bank or who is known
to the staff of the branch introduces him by signing on the application form itself along with
his full address.

ii) The applicant may give the name of any respectable person or that of another bank as
referee. The bank enquires from the said referee about the integrity, honesty, respectability and
financial standing of the applicant and his past experience in dealing with the applicant. If
reply is not received from the referee, the bank should not open the account unless satisfactory
introduction is given otherwise.

iii) As per the guidelines given by the RBI, banks can accept pass books or postal
identification cards or identity cards of armed forces, police, government department or
passports for identity of persons.

B) Importance :

i) The bank can have protection of law when an account holder issues fraudulent or stolen
cheques or bills of exchange.

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 ii) In case of issue of overdraft or payment by mistake, such introduction protects the bank
from loss.
iii) If a cheque book is issued to fraudulent person / customer there is possibility of
commission of offences such as issue of cheques with fraudulent intention etc.

3.1.5. Proof of Residence :

While opening an account in the bank, applicant has to give proof of his residence. The bank
should not open an account of a person without the proof of residence. For this purpose, the
bank can accept ration card, identity card from any government department, electricity bill,
telephone bill, etc. Such documents are proof of address. They indicate that the person desirous
to open an account stays on that address. Thus, the bank should insist upon proof of residence.
Such proof is helpful for the bank to prevent financial crimes committed through the accounts.
Importance: i) It is a proof that a person / customer stays on that address. ii) It prohibits the
offences by giving false address

3.1.6. Specimen Signature :

A new customer is required to sign an account opening form and a specimen signature
slip/card in the presence of an authorised officer who attests his specimen signature at the time
of opening an account. The specimen signature cards are preserved by the bank. The bank
compares the signature on the withdrawal slip with the specimen signature.

Importance:

I. The signature on the card can be verified at the time of withdrawal.

II. It provides payment of money to right person.
III. One cannot say that he has not withdrawn money from the bank.

3.1.7. Nomination: In case of death of an account holder, the problem of whom to pay the
balance arises. Now-a-days banks take nomination in writing in case of all accounts. In case of
the death of an account holder the bank pays the money to the nominee and closes the account.
A nomination made by a depositor in the prescribed manner will confer the nominee right to
receive the amount of deposit from the bank. The nominee shall be entitled to all the rights of
the depositor. The depositor may amend or cancel nomination in a prescribed manner.
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 Importance:

I. In case of death of account holder the problem of whom to pay the balance does not arise.
II. Bank can pay the money to the right person whose name is given as nominee in the bank
opening form.
III. It confers the nominee's right to receive the amount of deposit from the bank.

PROCEDURE FOR OPERATING DEPOSIT ACCOUNT The word operate in relation to

a bank account means that the customer deposits further sums of money and cheques etc., into
the bank and withdrawals money according to his need or convenience. A special feature of
banking business is that each and every transaction of money with the customer is supported
by a separate slip or document. A customer is, therefore, required to make use of pay in slips
for depositing money and withdrawal slip of cheques for withdrawing money from the bank.
The operation of deposit accounts involves the following procedure.

3.2.1. Pay in Slips:

The pay-in-slip book contains slips with perforated counterfoils to be filled in by the account
holder himself or by his agent at the time of depositing cash, cheques, drafts, bills, etc. to the
credit of his account. Every bank provides separate pay-in-slips free of cost to the customers
for depositing an amount of money in his account. The design and size of such slips vary from
bank to bank but the contents include information relating to the date of deposit, name and
account number of the customer, amount to be deposited, the denomination of currency notes,
etc. In case of cheques the cheque number and the name of the drawee is to be filled in.After
filling in all such details on the foil and the counterfoil, the customer has to handover it with
the cash or cheque to the cashier or to any other responsible officer. He acknowledges the
receipt of the same and issues the counterfoil along with the stamp of the bank to the customer.
The slip retained by the bank is passed on to the clerk concerned for making necessary credit
entries in the account of the customer.

3.2.2. Withdrawal Slip: Like the pay-in-slips, the bank provides the withdrawal slips free
of cost to its customers for withdrawing money from their accounts. These slips include the
information regarding the name, account number, amount to be withdrawn in figures and in
words. The slip must be signed by the account holder. The signature must be as per the
specimen signature given to the bank. This slip must be signed on the reverse of the
49 *For private circulation only
withdrawal slip. The withdrawal slip must be accompanied by the pass book.

3.2.3. Issue of Passbook: A pass book is a small handy book issued by a bank to its
customer. All the dealings between the bank and the customers are recorded in this book. It is
an authenticated copy of the customer's account in the account books of the bank. The object
of a pass book is to inform the customer from time to time the condition of his account as it
appears in the books of the bank. The pass book also contains rules and regulations governing
the savings account. The customer deposits the pass book periodically with the bank for the
purpose of recording entries therein. As it passes from the hands of the customer to the banker
and vice versa, it is called a pass book. A pass book is very important for the customer. It gives
him an account of the entries made by the banker in his ledger account. It is helpful to prepare
bank reconciliation statements. Entries in the pass book are to be recorded by the bank clerk. It
must bear the initials of the accountant.

3.2.4. Issue of Cheque Book: For making withdrawals of money from the account a bank
provides a cheque book to the customer. The request for the supply of the first cheque book
can be made on the basis of the request embodied in the account opening form itself or by
means of a separate letter. The customer's signature on the letter should be verified with the
specimen signature on the bank record. Every cheque book contains a requisition slip which is
required to be filled up and signed by the customer for obtaining a cheque book. Utmost care
must be taken by a banker to verify the customer's signature on the requisition slip for
preventing the cheque book being obtained by someone who is not entitled to it. When the
customer does not come personally to get the cheque book and the requisition is presented by a
person other than the customer himself, the cheque book should be sent to him through a bank
messenger if the customer is local or under registered post. In no case a cheque book should be
issued to a messenger who is unknown to the banker. If a request for supply of a cheque book
is made on the separate ordinary letter instead of the usual printed slip, the banker should
scrutinize closely the genuineness of the customer's signature on the slip of the paper asking
for a cheque book.

There is probability of frauds in this case. So, the utmost care should be taken by the bank
while issuing a cheque book in this way. A bearer of the requisition slip should not be issued a
cheque book unless he is known to the bank.

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3.2.5. Issue of Fixed Deposit Receipt :

Banks accept term deposits. These deposits may be from 15 days up to 5 years. The rate of
interest increases as the term deposits may be short term or long term deposits. A depositor is
given the receipt of his deposit credited in his account. A depositor can receive the amount of
his deposit with interest after the maturity of his deposit or he may have an option of monthly,
quarterly interest on his deposit upto its maturity. These deposits may be of individual or joint
account. In case of the death of the receipt holder, his nominee gets the amount of this deposit
after its maturity.

3.2.6. Recurring Deposit :

The Recurring Deposit account is an account in the bank (or a Post office in some countries)
where an investor deposits a fixed amount of money every month for a fixed tenure (mostly
ranging from one year to five years). This scheme is meant for investors who want to deposit a
fixed amount every month, in order to get a lump sum after some years. The small monthly
savings in the Recurring Deposit scheme enable the depositor to accumulate a handsome
amount on maturity. Interest at term deposit rates is computable on quarterly compounded
basis. Recurring Deposits are a special kind of Term Deposits offered by banks in India which
help people with regular incomes to deposit a fixed amount every month into their Recurring
Deposit account and earn interest at the rate applicable to Fixed Deposits. It is similar to
making FDs of a certain amount in monthly instalments, for example Rs 1000 every month.
This deposit matures on a specific date in the future along with all the deposits made every
month. Thus, Recurring Deposit schemes allow customers with an opportunity to build up their
savings through regular monthly deposits of fixed sum over a fixed period of time.

1) Premature Encashment of Recurring Deposit :

When the RD account is opened, the maturity value is indicated to the customer assuming that
the monthly instalments will be paid regularly on due dates. But premature withdrawal is
allowed. Each institution follows its own premature closure or withdrawal policy. For example,
In case of Post Office RD Premature closure is allowed after three years. In fact Post Office
RD offers part withdrawal facility. In case of State Bank of India Loan / Overdraft facilit y
available against the balance in RD account and premature withdrawal is allowed at 1% below
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 the rate applicable for the period the deposit has remained with the Bank. No partial
withdrawal is allowed. While Banks like HDFC and ICICI do not allow partial withdrawal.
Premature closure is allowed but with some penalty.

2) Loan Against Recurring Deposit :

A fixed deposit receipt is issued by a bank for a deposit made for a specific period. If, before
the expiry of that period, the customer urgently needs money, he may take a loan from the
bank on the security of the fixed deposit receipt or against the deposit in the recurring account
of the account holder. The amount of loan can be up to 75% of the actual deposit plus interest
accrued thereupon up to the time the loan is given. On such advances the bank charges a rate of
interest which is 2% higher than the interest payable on the deposit.

3.2 CLOSURE OF ACCOUNTS :

An account can be closed either by the bank or by the customer by giving due notice. The
account holder has to apply in writing for closure of his account with or without giving any
reason for the closure. However, the bank can suspend payment out of customer's account
under the provisions of law.

The Rights and Obligations of a Bank in this Regard are as follows:

i) Customer's Application: A customer has to give an application for closure of his account. A
bank is bound to comply with such direction. Bank cannot ask reasons for such closure. In
such case, all the unused cheques should be returned to the bank and after paying the balance
the account is closed.

ii) Request by the Bank: Sometimes, the bank may request the customer to close its account, if it
is not operated for a very long period. If the customer could not be traced after reasonable
effort the bank usually transfers the balance to an 'Unclaimed Deposit Account' and the
account is closed.

iii) Violation of Rules of Banks by a Customer: If the bank finds that the customer is no more a
desirable customer, the bank can terminate its relationship with him. The bank takes this step
in circumstances when the customer is guilty of conducting his account in an unsatisfactory
manner such as convicted for forging cheques, issuing cheques without sufficient funds,

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 bouncing of cheques deposited, etc.

iv) Death of a Customer: On receipt of the notice of death of a customer the bank must stop the
operation of his account because the authority of the customer terminates with his death.

v) Insanity of a Customer: If a bank receives a notice regarding the insanity of its customers, it
is bound to stop payment from his account.

vi) Insolvency of a Customer: The relationship between the bank and customer is also affected if
the customer becomes insolvent. The credit balance of the customer is transferred to the
official receiver of the insolvent customer.

vii) Notice of Assignment: When the bank has received a notice of assignment of the credit
balance in the account of a customer to a third party, the bank is bound to pay the same amount
to the said third party.

viii) Issue of notice to the Customer: In the case of the closure of the account by the bank, the
bank has to give to the customer due notice of its intention to close the account. The bank
should request the customer to close his account. Sufficient time should be given to the
customer, to make alternative arrangements. The bank should not on its own, close the account
without such notice or transfer the same to any other branch. If the account holder does not
respond to notice of closure of account, his balance should be sent by draft on his address and
the account is treated as closed.

3.3 Types of Account Holders:

Banks solicit deposits of money from public. For this purpose accounts are to be opened in the
bank. Any person legally capable to contract can open an account with a banker if the later is
satisfied as to the bonafide of the former and if he is willing to enter into the necessary
business relations with the former. The capacity of certain classes of persons however, to make
valid agreements is subject to well recognized restrictions, as is the case with minors, lunatics,
drunkards, married women, undischarged bankrupts, agent, trustees, executors, administrators
etc. These are different types of account holders.

3.3.1 . INDIVIDUAL ACCOUNT HOLDER (SINGLE OR JOINT):

An account can be opened in the bank singly or jointly. A singly operated account means an
account opened in the name of one person. It is operated by only one person, in whose name an
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 account is opened in the bank. For this purpose, he has to apply in the prescribed form and
manner to the bank. Joint account means an account which is opened in the names of two or
more persons. When a joint account is opened with a bank, precise instructions in writing as to
which members are entitled to draw cheques and whether the balance in the account has to be
paid to the survivor in the event of the death of any of the parties to the joint account, or
whether it is to be dealt with in any other manner, should be given to the bank. This written
document should be signed by all parties in whose names the joint account is opened.

A. Illiterate Person: A person who, for want of education, cannot read or/and write is known as
illiterate. As per section 11 of Indian Contract Act- "Every person is competent to contract who
is of the age of majority according to the law to which he is subject, and who is of sound mind
and is not disqualified from contracting by any law to which he is subject." Thus, an illiterate is
competent to contract and bank may open the accounts of illiterate persons. The account of
such person may be opened provided he/she calls on the bank personally along with a witness
who is known to both the depositor and the bank. A passport size photograph of the illiterate
person is identified before the banker in presence of the account holder. The left hand thumb
impression in case of a male illiterate and the right hand thumb impression in case of a female
illiterate are duly attested by some responsible person on the account opening form. The
illiterate person should be provided with a pass book which should also contain the photograph
of the illiterate person and the same photograph should be affixed on the account opening form
with a view to avoid any problem in dealing with such persons.

B. Minor Person : The minor is a person who is below the age of 18 years generally or below the
age of 21 years in case his guardian is appointed by the court. Special provisions have been
made in laws for the protection of the general welfare of the minors. The law protects them,
preserves their rights and estates, excused their laches and assists them in their pleadings; the
judges are their counsellors, the jury is their servants and law is their guardian.

C. Married Woman:

A married woman may open an account. The money standing to such an account in the married
woman's own name is deemed to be her own estate so as to entitle her to deal with her. The
Hindu married women are governed by the Hindu Succession Act, 1956. In case of married
women belonging to other than Hindu religion, the status is governed by the Indian Succession
Act, 1925 and the 'Married Women's Property Act, 1874'. Married women can enter into
contracts and bind her estate (Stridhan). It would be a binding contract as she has the power to
54 *For private circulation only
 draw cheques and give a sufficient discharge. If she is competent to contract, i.e., if she is not a
minor, or insane or a person of unsound mind, than then the bank can safely enter into a banking
relationship with her. While opening an account of a married woman, the bank should inquire
about her means and circumstances, and if she is living with her husband, something about him
and his occupation or position in life, and if he is an employee, the name of his employer. A
question arises whether a married woman can make her husband liable for the debts which are
incurred by her. The only answer can be that legally there is no obligation on a husband to make
payment to any other person who may have spent money for providing the maintenance to his
wife and thus though in equity, the bank may have the right to claim from the husband. A
married woman cannot be committed to prison in execution of a decree and even if the bank
obtains a decree against the married woman, it would be useless as it cannot be executed like the
other decrees. In case, the bank grants an overdraft to a married woman to enable her to
purchase medicines, clothing and other necessities of life, the bank may have the right in equity
to claim this amount from her husband. Thus, while granting loan and overdraft facilities to a
married woman, precaution should be kept in mind regarding her status and capacity to pay and
the purpose for which the borrowings are being made.
D. Pardahnashin Women:

A pardahnashin woman is one who is totally secluded from ordinary social intercourse and
does not deal with people otherwise than her own family members. A contract with a
pardahnashin woman is presumed to have been induced by undue influence. The burden lies on
the other party to show that no undue influence was used. It means that the contract was fully
explained to her and she freely consented. Thus, a pardahnashin woman can enter into
contracts if it is fully explained to her and she is competent to contract. In such a case the bank
can safely enter into a banking relationship with her. While opening an account of a
pardahnashin woman the bank should enquire about her means and circumstances and about
her family members.
E. Non Resident Accounts:

In the last few decades, a large number of Indians have gone abroad either temporarily on a job
or have permanently settled there. Most of them earn and save and even repatriate large sums
of money to their dependents or relatives in India. To mobilise such savings and attract the
savings as deposits in Indian banks, the government has offered many concessions and
incentives to Non-Resident Indians (NRI).
There are two types of deposit accounts for Indians living in foreign countries. They are as
follows:

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i) Non-Resident (External) Account: Non-Resident Indians can open current or savings bank
account in rupee units in India. The capital and interest earned on these accounts are freely
irreparable at the prevailing rate of exchange. The amount deposited in such accounts can be
invested in Government Securities, National Savings Certificates, units of Unit Trust of India,
etc. Interest earned on these accounts is tax free.
ii) ii) Foreign Currency (Non-Resident) Account Scheme: Under this scheme, NRI's are permitted
to open accounts in foreign currencies in India. The amount to be deposited may be remitted by
the depositor by bank draft, cheque, mail transfer or telegraphic transfer. Interest on deposit is
free of income tax

3.3.2 INSTITUTIONAL ACCOUNT HOLDER

Like an individual various institutions can open different types of accounts in banks.
Institutions are legal entities in the eyes of law. So they can open accounts in banks. These
institutional account holders are as follows:

A) Sole Proprietorship: A sole proprietor of a firm is in business by himself for himself.

The account of a sole proprietorship of business is not very different from the ordinary personal
banking account. While opening the account the sole proprietor declares that no other person is
sharing in his business as partner or otherwise and that all transactions are being entered into
by him as a sole proprietor of the concern and that he will be personally liable for all dealings
and obligations in the name of his business. Proprietors of any business require finance from
the bank. There is no legal provision for a sole trader to produce a set of accounts at the end of
his financial year. However, it is usual for these to be prepared in order that profit (or loss)
shown by the accounts may be used by the tax authorities to assess the liability to tax. If the
bank is lending, the manager will be likely to see these year-end accounts and balance sheet so
that he can see how profitable the business has been and can access any risk to the bank
advance.

B) Partnership Firm: Partnership is governed by the Indian Partnership Act of 1932. The
account of partnership is difficult for a bank because each of the partners can act on behalf of
other and all have unlimited liability. The firm does not have separate existence from the
partners.

C) Joint Stock Company: Every company is required to have two documents, one called
the Memorandum of Association which defines its constitution, and the other, the Articles of
Association, which specifies its rules of conduct. In his dealings with company, trading or
nontrading, a banker has to be very careful because the law relating to such companies is
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permissive, that is what the company may do and no prohibitory or laying down what it may
not do, which is the case with the human being. A company is brought into existence by means
of a statute and enjoys a good many of the attributes of a person.

D) Hindu Undivided Family: HUF is a larger body consisting of a group of persons who
are united by the marriage or adoption. The head of family is known as 'Karta' of the family
and his powers are limited and a charge created by him in binding on the family property only
when the loan taken by him is for the purpose of necessity of the family or for the benefit of the
family or is in discharge of a lawful antecedent debt due from the family. The Karta of HUF is
usually the oldest living member of the family. A Hindu Undivided Family consists of all
persons lineally descended from a common ancestor and includes their wives. After marriage a
daughter ceases to be member of her father's family. The male members of a Hindu Undivided
Family are called co-partners. The eldest male member of the Hindu Undivided Family is
known as the 'Karta' of the family. He manages the affairs of Hindu Undivided Family. A
minor male child can act as 'Karta' of the family through his natural guardian mother, where the
father's whereabouts are not known at the time. The membership to a Hindu Undivided Family
is acquired by birth. The 'Karta' has implied authority to act for the benefit of the family
business and bind the HUF property of all other coparceners also. When the Karta of HUF
conducts the family business and opens a bank account, it is implied that he has an implied
authority to make, draw, accept, and endorse a negotiable instrument in the interest of the
family business. He can borrow loan, mortgage the family property, sell the family estate and
his acts shall bind the other coparceners including minors provided these acts are for the
benefit and needs of the family. Not only the other members but by his action the Karta also
binds himself. So far as the liability of the coparceners is concerned it is presumed that the
Karta of the family is working with their consent and acquiescence and thus they are bound by
his action and are responsible for all the best.

E) Clubs, Associations, Societies and Trusts: There are some non-trading associations
whose object is not to earn profit but to serve some social purpose such as educational
institutions, hospitals, sports clubs, charitable institutions, etc. It is necessary that such
associations are registered under any of the following Acts, viz., Charitable Trust Acts,
Society's Registration Act, Companies Act or Co - Operative Societies Act. It is not bank's
responsibility to go into the correctness of the Registration. It has to insist on Registration.

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 3.4. METHODS OF REMITTANCES

Introduction:
Different kinds of agency services are provided by the banks. Banks act as agents for their
customers. Remittance of funds is one of these services. Remittance means the sending of
money to someone at a distance. It may be a transfer of money by a foreign worker to his or her
home country. Remittances contribute to economic growth and to the livelihood of people
worldwide. Moreover, remittance transfers can also promote access to financial services for the
sender and recipient, thereby increasing financial and social inclusion. There are several
occasions on which remittance of funds become necessary. All the big commercial banks have
a network of branches throughout the country. With this facility, banks can conveniently
provide the service of transfer of funds from one place to another. Remittances of funds by
banks are simple, convenient, safe and inexpensive.

3.4.1 Demand Drafts: A demand draft is an order from one bank to another branch of the
same bank to pay a specified sum of money to a person named there in or to his order. A draft
is always payable on demand. Banks issue demand drafts on their branch at the place of
destination for remitting money from one place to another. According to Section 85-A of the
Negotiable Instrument Act, "A demand draft is an order to pay money, drawn by one office of
the bank upon another office of the same bank for a sum of money payable to order on
demand. “A person may buy a draft by paying the amount in advance to the bank. The bank
then issues the draft. The purchaser of the draft then sends the draft to the payee's place by
simple or registered post. The bank issuing such draft charges a commission for rendering this
service

Meaning: The Demand Draft is an instrument used to transfer payments from one bank
account to another. Demand Draft also is like cash, but much more secured than cash. Some
secured features are:

i. No chance of fake notes circulating in India

ii. Can be encashed only by the person on whom it is issued
iii. Can be easily carried, no threat to life due to robbers when carried
iv. Extremely unlikely to be stolen and used
v. Can be safely sent by courier or post
vi. Can be easily cancelled

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vii. Sender can be easily identified It is quite popular instrument. Also it's the preferred method of
payment for applying any admission in institutes, paying fees, applying for subscriptions etc.

Parties:
There are three parties to a demand draft:

1) The drawer branch.

2) The drawee branch.

3) The Payee. The person who receives the draft can get the money from the local branch
at his residence. The purchaser of a draft may not be a customer or account holder of the bank.
The service is provided by the bank to the public in general.

Legal Status of a Bank Draft: A bank draft is a bill of exchange because it fulfils all the
essential requisites of a bill. e.g. i) It is an instrument in writing. ii) It contains an unconditional
order. iii) It is signed by its maker. Actually a bank draft is not specially mentioned as a
negotiable instrument in Section 13 of the Negotiable Instrument Act. But because of the
resemblance of a bill of exchange as mentioned above, it is considered as a negotiable
instrument.

3.4.2 Banker’s Cheques

Meaning : A cheque which is payable by a bank itself, as opposed to an ordinary cheque

payable only out of the funds of a particular customer's account. A bank cheque is normally
obtained by a bank customer (by paying its face value), the point is that the person receiving
the cheque has the security of knowing it's payable by the bank and thus cannot bounce.
Banker's cheque or bankers Draft is a cheque (or check) where the funds are withdrawn
directly from a bank's funds, not from an individual's account. Banker's Cheques are negotiable
instruments payable to order and attract all provisions applicable to an order cheque and are
valid for six months from the date of issue and in genuine cases may be revalidated.

Normal Banking Cheques: If an individual or company operates a current account (or

checking account), they may draw cheques to transfer funds from their account to an account
belonging to a creditor. The creditor passes that cheque to their own bank, which will use a

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 clearing house or similar system to arrange for the funds to be moved from the debtor to the
creditor during a clearance period of a few days. Any debt is thus settled.

Banker’s Cheque as a Reduction of Risk: The problem with normal cheques is that they are
not as secure as cash. A cheque received in the post could be potentially worthless if there are
insufficient funds for the cheque to be honoured. In this instance, the clearance house or bank
will return the cheque to the creditor, who will receive no money. Therefore, any cheque
carries the risk that it might be returned unpaid (or "bounced", in the vernacular). To reduce
this risk, a person can request for a type of cheque where the funds are, in effect, drawn
directly against the bank's own funds, rather than that of one of their accounts. This is less risky
for a creditor, because the cheque will be honoured unless the cheque has been forget or the
issuing bank goes out of business before the draft is cashed. In order that the issuing bank can
be sure that its customer has sufficient funds to honour the draft, the bank will withdraw the
value of the draft (plus any charges) from the customer account immediately.

3.2.3 Mail Transfer

Nature: Money can be sent through mail transfers to anybody who has an account in any
other branch of the same bank. For this purpose the sender shall have to furnish details like the
name of the beneficiary, his / her account number, the amount to be transferred and the name
of the branch where the account is maintained.

Advantages of Mail Transfer:

1) Many transfers can be sent in one letter. The banker has to spend very little for such transfer.

2) It is a very cheap process of transferring money.

3) The instruments such as cheques, drafts are not required to send to the other branch
which reduces misappropriation, fraud etc.

4) In this process money is transferred from one branch to another branch in the account of
the same person and it is debited to the account of another person. So, this process is useful for
both the parties.

4.5 Telegraphic Transfer: The telegraphic transfer is a means of wiring funds from one
location to another. Originally, telegraphic transfers made use of the telegraph as a means

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 of transferring money between a point of origin and a point of termination. Today, the process
of transferring money between two parties no longer involves the telegraph, but the use of the
term remains common in several countries. Sometimes referred as a Telex Transfer or simply
TT, the telegraphic transfer has long been a means of communication between banking
institutions. In days gone by, the telegraphic transfer could be used to send money from an
account in one bank to an account at a bank located anywhere else in the world. Generally,
there were charges associated with the performance of a telegraphic transfer, with both the
sender and the recipient paying a small fee for the transaction.

4.6 Electronic Fund Transfer:

Meaning: Electronic funds transfer or EFT refers to the computer-based systems used to
perform financial transactions electronically. This term is used for a number of different
concepts :

1) Cardholder initiated transactions, where a cardholder makes use of a payment card.

2) Electronic payments by business, including salary payments.
3) Electronic check (for cheque) clearing. Electronic fund transfer provides for electronic
payments and collections. EFT is safe, secure, efficient and less expensive than paper cheque
payments and collection.

Transaction Types: A number of transactions may be performed by EFT. It includes

following transactions

1) Sale: Where the cardholder pays for goods or service.

2) Refund: Where a merchant refunds an earlier payment made by a cardholder.
3) Withdrawal: The cardholder withdraws funds from their account, e.g. from an ATM.
The term Cash Advance may also be used, typically where the funds are advanced by a
merchant rather than at an ATM.

4) Deposit : Where a cardholder deposits funds to their own account (typically at an ATM)
5) Cash back: Where a cardholder withdraws funds from their own account at the same
time as making a purchase.

6) Inter-account Transfer: Transferring funds between linked accounts belonging to the same
cardholder.
7) Payment: Transferring funds to a third party account.
8) Enquiry: A transaction without financial impact, for instance balance enquiry, available

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funds enquiry, linked accounts enquiry or request for a statement of recent transactions on the
account.

9) E top-up: Where a cardholder can use a device (typically POS or ATM) to add funds
(top-up) their pre-pay mobile phone.

10) Administrative: This covers a variety of non-financial transactions including PIN

change.

4.7 RTGS (Real Time Gross Settlement): The real time gross settlement solution is a
milestone in the history of Indian payment system. It is the key critical element. It provides the
missing link in the process of the setting up of the Integrated payment and settlement system in
the country. Now-a-days, it is the preferred mode of the settlement of large value interbank
payments in the world over.

As a settlement process, RTGS minimizes settlement risks by settling individual payments in

real time in the books of account held at the central bank. Under RTGS, the practically instant
settlement ensures fast, secure, final and irrevocable settlement of payment transactions. The
real time gross settlement system is designed to provide large value funds transfer and
settlement in an on-line real time environment to the banking industry, with settlement on a
gross basis. It will enhance competitiveness within the system. It gears up the banks to meet
future challenges posed by the external environment. If this system is

implemented with due precautions and proper action plan, it will certainly help the Indian
Banking Industry to attain global standards.

RTGS is an ultimate in the payment and settlement architecture in any country primarily for
online, real time interbank payment and settlement of large value funds. RTGS payment
system can also be called as one in which payment instructions between banks are processed
and settled individually and continuously throughout the day.

Facilities Provided by RTGS: It facilitates participants:

1) View of Transaction: To view their respective transactions held in payment queues, to

cancel such transactions and even change their priorities.

2) Movement of Funds: Initiates movement of funds between various accounts held by it to

optimise funds deployment and economies intra-day liquidity requirements.

3) Various Types of Transactions: By providing a wide array of transaction types which

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 can be flexibly deployed to meet varying requirements.

4) Types of Interbank Transactions: By providing interbank transactions types which can be used

TERMINAL QUESTIONS:

SECTION A: 5X4=20

1 Briefly describe the procedure for opening bank account.

2 Explain the various types of Individual account.
3 Define bill of exchange
4 How is crossing of cheque done?
5 State the features of Negotiable instrument

SECTION B: 9x2=18

1Elucidate the various forms of remittances.

2Write a note on Institutional account holders.
3 Explain different types of endorsement

SECTION C: 12x1=12

1. Briefly describe the procedure for operating bank account.

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 MODULE 4

INTRODUCTION TO INSURANCE

Structure

4.1. Meaning & Definition of insurance, Evolution and Importance of Insurance.

4.2. Types of Insurance

4.3. General Insurance: Meaning - type- need- Scope.

4.4. Principles- Functions of general Insurance.

4.5. Procedure in Claiming insurance.

4.6. Life Insurance Meaning- Need-& Principles of life insurance, Type of life insurance
policies.

4.7. Factors affecting Attitudes Towards Insurance Covers

4.8. IRDA- introduction and functions

4.1 Meaning:

Insurance is a contract, represented by a policy, in which an individual or entity receives

financial protection or reimbursement against losses from an insurance company. The company
pools clients' risks to make payments more affordable for the insured. Insurance policies are
used to hedge against the risk of financial losses, both big and small, that may result from
damage to the insured or her property, or from liability for damage or injury caused to a third
party.

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NEED AND IMPORTANCE OF INSURANCE

(a) To provide Security and Safety:

The Life Insurance provides security against premature death and payment in old age to lead
the comfortable life. Similarly in general Insurance, the property can be insured against any
contingency i.e. fire, earthquake etc.

(b) To provide Peace of Mind:

The uncertainty due to fire, accident, death, illness, disability
in the human life, it is beyond the control of the human beings. By way of Insurance, he may
be compensated financially but not emotionally. The financial compensation provides not
only peace of mind but also motivates to work more and more.

(c) To Eliminate Dependency:

On the death of the breadwinner, the consequences need not be explained. Similar to the
destruction of property and goods the family would suffer a lot. It could lead to reduction in
the standard of living or begging from relatives, friends or neighbors. The economic
independence of the family is reduced. The Insurance is the only way to assist and provider
them adequate at the time of sufferings.
(d) To Encourage Savings:

Life Insurance provides protection and investment while general Insurance provides only
protection to the human life and property respectively. Life Insurance provides systematic
saving because once the policy is taken then the premium is to be regularly paid otherwise
the amount will be forfeited.

(e) To fulfil the needs of a person:

i) Family needs ii) Old age needs iii) Re-adjustment needs iv) Special needs: Education,
Marriage, health v) The clean-up needs: After death, ritual ceremonies, payment of wealth tax
and income taxes are certain requirements, which decreases the amount of funds of the
family members.

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(f) To Reduce the Business Losses:

In business the huge amount is invested in the properties i.e. Building and Plant and
Machinery. These properties may be destroyed due to any negligence, if it is not insured
nobody would like to invest a huge amount in the business and industry. The Insurance
reduced the uncertainty of business losses due to fire or accidents etc.

(g) To Identify the Key man:

Key man is a particular man whose capital, expertise, energy and dutifulness make him the most
valuable asset in the business and whose absence well reduce the income of the employer
tremendously and upto that time when such employee is not substituted. The death or disability
of such valuable lives will prove a more serious loss than that fire or any hazard. The potential
loss to be suffered and the compensation to the dependents of such employee require an
adequate provision, which is met by purchasing an adequate life policies.

(h) To Enhance the Limit:

The business can obtain loan but pledging the policy as collateral for the loan. The insured
persons are getting more loan due to certainty of payment at their death. (i) Welfare of
Employees: The welfare of the employees is the responsibility of
the employer. The employer is supposed to look after the welfare of the employees. The
provisions are being made for death, disability and old age. Though these can be insured
through individual life Insurance but an individual may not be insurable due to illness and
age. But the group policy will cover his Insurance and the premium is very low in group
Insurance. The expenditure paid on account of premium will be allowable expenditure.

Insurance Policy Components.

When choosing a policy, it is important to understand how insurance works.

A firm understanding of these concepts goes a long way in helping you choose the policy that
best suits your needs. For instance, whole life insurance may or may not be the right type of
life insurance for you. There are three components of any type of insurance (premium, policy
limit, and deductible) that are crucial.

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Premium
A policy's premium is its price, typically expressed as a monthly cost. The premium is
determined by the insurer based on your or your business's risk profile, which may include
creditworthiness.
For example, if you own several expensive automobiles and have a history of reckless
driving, you will likely pay more for an auto policy than someone with a single mid-range
sedan and a perfect driving record. However, different insurers may charge different
premiums for similar policies. So finding the price that is right for you requires some
legwork.

Policy Limit
The policy limit is the maximum amount an insurer will pay under a policy for a covered
loss. Maximums may be set per period (e.g., annual or policy term), per loss or injury, or
over the life of the policy, also known as the lifetime maximum.

Typically, higher limits carry higher premiums. For a general life insurance policy, the
maximum amount the insurer will pay is referred to as the face value, which is the amount
paid to a beneficiary upon the death of the insured.

Deductible

The deductible is a specific amount the policy-holder must pay out-of-pocket before the insurer
pays a claim. Deductibles serve as deterrents to large volumes of small and insignificant claims.

Deductibles can apply per-policy or per-claim depending on the insurer and the type of
policy. Policies with very high deductibles are typically less expensive because the high out-
of-pocket expense generally results in fewer small claims.

SCOPE OF INSURANCE

The insurance sector has a huge potential not only because incomes are increasing and assets
are expanding but also because the increasing instability in the system. In a sense, we are
living in a extra risky world. Trade is becoming more and more global. Technologies are
changing and getting replaced at a faster rate. In this more uncertain world, for which enough

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evidence is available in the recent period, insurance have an imperative role to play in
reducing the risk burden that the individuals and businesses have to bear. The approach to
insurance should be in tune with the changing times. The aim of the insurance sector in India
is to extend the insurance coverage over a larger section of the population and a wider
segment of activities.

The three guiding principles of the industry must be to charge premium not higher than what
is acceptable by strict actuarial considerations, to invest the funds for obtaining maximum
yield for the policy holders consistent with the safety of capital and to render efficient and
prompt service to policy holders. With a creative corporate planning and an abiding
commitment to improved service, the mission of widening the network of insurance can be
achieved There is a probability of a shoot in employment opportunities. A number of web-sites
are coming up on insurance, a few financial magazines exclusively devoted to insurance
and also a few training institutes are being set up. Many of the universities and management
institutes have already started or are contemplating new courses in insurance89. Life
insurance has today become a mainstream of any market economy since it offers plenty of
scope for collecting large sums of money for long periods of time. A well-regulated life
insurance industry which moves with the times by offering its customers specially made
products to satisfy their financial needs is, therefore, essential to progress towards a
unstressed future Thus, one can understand the term ‘insurance’ better from its legal nature,
principles and functions as discussed above and is the base for all the types of insurances

4.2 Types of Insurance:

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1. Life Insurance or Personal Insurance.
2. Property Insurance.
3. Marine Insurance.
4. Fire Insurance.
5. Liability Insurance.
6. Guarantee Insurance.
7. Social Insurance.

1. Life Insurance

Life Insurance is different from other insurance in the sense that, here, the subject matter of
insurance is the life of a human being. The insurer will pay the fixed amount of insurance at
the time of death or at the expiry of a certain period. At present, life insurance enjoys
maximum scope because life is the most important property of an individual.

Each and every person requires insurance. This insurance provides protection to the family at
the premature death or gives an adequate amount at the old age when earning capacities are
reduced. Under personal insurance, a payment is made at the accident. The insurance is not only
a protection but is a sort of investment because a certain sum is returnable to the insured
at the death or the expiry of a period.

Important Features of Life Insurance Bonus

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a. The contract is not terminated because of converting the policy into a paid-up one and
in fact, the policy stands for a reduced cover.

b. Paid-up value proportionately increases if it takes place during the latter part of the
policy period.

c. Paid-up value is not paid, immediately, but is paid as per the original terms of the
contract (i.e., death or maturity).

d. No further premium is required to be paid from the time of Conversion of the policy.

The life cover still remains operative for this reduced sum-insured and this sum-insured is
paid as per original terms of the policy, (i.e., death or maturity) The students should realize
that no further premium is required to be paid from the time the policy is converted into paid-
up.

2. General Insurance:

General insurance includes Property Insurance, Liability Insurance, and Other Forms of
Insurance. Fire and Marine Insurances are strictly called Property Insurance. Motor, Theft,
Fidelity and Machine Insurances include the extent of liability insurance to a certain extent.

3. Property Insurance:

Under the property insurance property of person/persons are insured against a certain
specified risk. The risk may be fire or marine perils, theft of property or goods damage to
property at the accident.

4. Marine Insurance:

The marine perils are; collision with a rock or ship, attacks by enemies, fire, and captured by
pirates, etc. these perils cause damage, destruction or disappearance of the ship and cargo and
non-payment of freight. So, marine insurance insures ship (Hull), cargo and freight.
Previously only certain nominal risks were insured but now the scope of marine insurance

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had been divided into two parts; Ocean Marine Insurance and Inland Marine Insurance. The
former insures only the marine perils while the latter covers inland perils which may arise
with the delivery of cargo (gods) from the go-down of the insured and may extend up to the
receipt of the cargo by the buyer (importer) at his go down.

5. Fire Insurance:

In the absence of fire insurance, the fire waste will increase not only to the individual but to
the society as well. With the help of fire insurance, the losses arising due to fire are compensated
and the society is not losing much. The individual is preferred from such losses
and his property or business or industry will remain approximately in the same position in
which it was before the loss. The fire insurance does not protect only losses but it provides
certain consequential losses also war risk, turmoil, riots, etc. can be insured under this
insurance, too.

6. Liability Insurance:

The general Insurance also includes liability insurance whereby the insured is liable to pay
the damage of property or to compensate for the loss of persona; injury or death. This
insurance is seen in the form of fidelity insurance, automobile insurance, and machine
insurance, etc.

7. Social Insurance:

The social insurance is to provide protection to the weaker sections of the society who are
unable to pay the premium for adequate insurance. Pension plans, disability benefits,
unemployment benefits, sickness insurance, and industrial insurance are the various forms of
social insurance.

4.3 General Insurance: Meaning - type- need- Scope.

Definition: Insurance contracts that do not come under the ambit of life insurance are called
general insurance. The different forms of general insurance are fire, marine, motor, accident
and other miscellaneous non-life insurance.

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Description: The tangible assets are susceptible to damages and a need to protect the
economic value of the assets is needed. For this purpose, general insurance products are
bought as they provide protection against unforeseeable contingencies like damage and loss
of the asset. Like life insurance, general insurance products come at a price in the form of
premium.

Functions of General Insurance:

The functions of insurance may be categorised as below:

1.Primary Functions
2. Secondary Functions
3. Other Functions

1. Primary Functions

The primary functions of insurance include the following.

1. Provide protection:

The primary purpose of insurance is to provide protection against future risk, accidents and
uncertainty. Insurance cannot check the happening of the risk, but can certainly provide for the
losses of risk. Professor Hopkins observes, "Insurance is a protection against economic loss by
sharing the risk with others." He further adds "Insurance is the protection against economic
loss".

2. Collective bearing of risk :

Insurance is a device to share the financial loss of few among many others Dinsdale opines,
insurance is a mean by which few losses are shared among longer people. Similarly, William
Bevrigdge observes. "The collective bearing of risks is insurance." All the insureds contribute
the premiums towards a fund and out of which the persons exposed to a particular risk is paid.
Similarly, Rigel and Miller observe. "Insurance is a device whereby the uncertain
risks may be made more certain."

3. Evaluation of risk :
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Insurance determines the probable volume of risk by evaluating various factors that give rise to
risk. Risk is the basis for determining the premium rate also. 4. Provide certainty against risk :
Insurance is a device which helps to change from uncertainty to certainty. This may the reason
that John Magee writes that the function of insurance is to provide certainty.Similarly, Riegel
and Miller observe, "The function of insurance is primarily to decrease the uncertainty of
events."

4. Provide certainty against risk:

Insurance is a device which helps to change from uncertainty to certainty. This may the reason
that John Magee writes that the function of insurance is to provide certainty

5. Spreading risks:

The concept of insurance is based on the law of cooperation to share the loss. When riss takes
place, the loss is shared by all the persons who are exposed to the risk. The share is obtained
from each and every insured in the shape of premium without which the insurer does not
guarantee the protection. Professor Thomas has correctly written that "Insurance is the device
for spreading or distributing risks."

II Secondary Functions

1. Prevention of losses:

Insurance cautions individuals and businessmen to adopt suitable device to prevent unfortunate
consequences of risk by observing safety instructions; installation of automatic sparkler or alarm
systems, etc. Prevention of losses cause lesser payment to the assured by the insurer and this
will encourage for more saving by way of premium. Reduced rate of premiums stimulate for
more business and better protection to the insureds. The loss Prevention Association of India
formed by the Insurers, alerts the people about future risks and uncertainties through publicity
measures.

2. Small capital to cover larger risks :

Dinsdale observes, insurance relieves the businessmen and others from security investments, by
paying small amount of premium against larger risk and uncertainty. There is no need for them
to invest separately for security purpose and this money can be invested in other activities.

3. Contributes towards the development of larger enterprises:

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Insurance provides development opportunity to those larger enterprises having more risks in
their setting up. Even the financial institutions may be prepared to give credit to sick industrial
units which have insured their assets including plant and machinery.

III. Other Functions

There are indirect functions of insurance which benefit the economy indirectly. Some of such
functions are:

1. Means of savings and investments:

Insurance serves as savings and investment. Insuranmce is a compulsory way of saving and it
restricts the unnecessary expenses by the insureds. For the purpose of availing income-tax
exemptions also, people invest in insurance. In the words of Magee "Although investment is not
the primary function of insurance investment service is proved to be an important benefit of
insurance."

2. Source of earning foreign exchange :

Insurance is an international business. The country can earn foreign exchange by way of
issue of marine insurance policies. 3. Promotes exports : Insurance makes the foreign trade risk
free through different types of policies issued under marine insurance cover. In case of loss of
cargo and others due to narine perils the insurance makes good the loss.

4. Provides social security :

Through various social protection plans, the insurance provides social security to people. It not
only provide security at the time of death but also provides assistance to the insureds at the time
of sickness, old age, maternity etc.

Differences between life insurance and general insurance:

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75 *For private circulation only
4.4 Principles of General Insurance:

Principle #1 – Principle of Utmost Good Faith

The principle of utmost good faith is the most basic and primary level principle of insurance
and it applies to all kind insurance policies. It simply means that the person who is getting
insured must willingly disclose to the insurer, all his complete & true information regarding
the subject matter of insurance. The insurer’s liability exists only on the assumption that no
material fact is hidden or falsely presented by the person getting insured.

There is a process called as “Underwriting” in insurance industry which is the activity of

studying the risk and assigning the premium value for the case and it’s very important that
the person buying any kind of insurance tells all the facts correctly and does not hide it.

If you think about term plan or health insurance, you need to correctly mention things like:

 If you are a smoker or drinker

 Your family illness history
 The Industry you work for
 Your Income
 Your Age
 Your current illnesses (which you are already aware of)

If you do not tell these things correctly, you are violating the “Principle of utmost good faith”
here and it can impact your insurance claim process in future.

Principle #2 – Principle of Insurable Interest

This principle says that the person who is taking insurance should have some insurable
interest in that thing which is getting insured. So if there will be financial loss to the person if
the insured object gets destroyed. If this is not the case, insurance cannot be taken So when a
breadwinner takes life insurance for his life, it makes sense because in case the person dies,
there will be financial loss to family . In the same way, you can get your car, bike, home,

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gold insured because you have insurable interest in that object. You can’t get your neighbour
car insured and benefit because you do not have insurable interest in that.

Principle #3 – Principle of Indemnity

Principle of Indemnity says that Insurance is not to make profit, but only to compensate you
against the losses incurred. It’s an assurance to restore the same position which was there
before the loss. So the compensation paid cannot be more than the losses incurred. In term
plan, people ask why companies ask for income details. It’s to make sure that a person takes
limited insurance which goes with his financial status and is good enough to restore back his
family life style which was there in existence. If a person earns Rs 1 lacs per month, then Rs
2-3 crores is a good enough life insurance for the person and they cannot take Rs 500 crore
insurance even if they can pay the premiums, because then the intention is not to cover your
financial loss but to benefit/profit from the insurance policy.

Principle #4 – Principle of Contribution

This principle is just a corollary of the principle of indemnity. As per this principle, the
insured company are liable to pay only their own contribution and they have right to recover
back the excess money paid from other insurer.

E.G. Imagine you have two health insurance policies A and B, both for Rs 5 lacs sum
assured. If there is a claim for Rs 4 lacs, then each insurer is liable to contribute Rs 2 lacs
each for this claim. However in real life, you as insurer can go to any insurer and claim it
from them or divide it between insurers. So you can claim full Rs 4 lacs either from policy A
or policy B or Rs 2 lacs from A and B each. However if you claim Rs 4 lacs from company
A, in that case company A can recover back Rs 2 lacs from company B as per the principle of
contribution.

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Principle #5 – Principle of Subrogation

As per this principle, once the insured is paid for the losses due to damage to his insured
property, then the ownership right of such property shifts to the insurer. So if your car / bike /
house / valuables which you have insured is fully damaged and once you get compensation
from insurance company, then they get the ownership of the item and now they can sell off
the remains to recover their dues by that process.

Principle #6 – Principle of Loss minimization

As per this principle, it’s the insured duty & responsibility to take all actions to minimize the
losses if it’s in their control. The insured person should take all necessary steps to control and
reduce the losses if possible. Imagine there is a small fire in the car for example. If the car is
insured, the insured person can’t just sit and relax thinking that the car is insured, he will get
the claim for sure. If it’s in his control, he can try to control the fire, call the fire department
or take first level steps like throwing water etc. If they don’t do it, it’s the violation of this
principle.

Principle #7 – Principle of Causa Proxima (Nearest Cause)

This is a very important principle of insurance which an insured person should be aware
about. As per this principle of causa proxima, when a loss if caused by more than one causes,
then the nearest or the closest cause should be taken into consideration to decide the liability
of the insurer. The nearest cause should be insured by the insurer, only then the insurer

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liability comes into picture and policy holder will be paid. Insurer will not be liable for the
farthest cause.

One of the common examples given for this is this:

A cargo ship base was punctured by rats and because of that puncture, sea water entered the
ship. If you look at the events, there are two reasons for damage of ship:

 Rats punctured the base of ship (farthest)

 Sea Water entered the ship (closest)

Here as the insurance company will have to pay because the ship was insured against sea
water entering the ship and that reason was closest.

Different Types of General Insurance:

1. Home Insurance

As the home is a valuable possession, it is important to secure your home with a proper home
insurance policy. Home and household insurance safeguard your house and the items in it. A
home insurance policy essentially covers man-made and natural circumstances that may
result in damage or loss.

2. Motor Insurance

Motor insurance provides coverage for your vehicle against damage, accidents, vandalism,
theft, etc. It comes in two forms, third-party and comprehensive.

When your vehicle is responsible for an accident, third-party insurance takes care of the harm
caused to a third-party. However, you must take into account one fact that it does not cover
any of your vehicle’s damages. It is also important to note that third-party motor insurance is
mandatory as per the Motor Vehicles Act, 1988.

A comprehensive insurance policy safeguards your vehicle against fire, earthquake, theft,

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impact damage, etc. Additionally, it provides coverage against any third-party liability in the
case of third-party property damage, bodily injury, or death.

3. Travel Insurance

When you are travel internationally and suffer losses because of loss of baggage, trip
cancellation, or delay in flight, a travel insurance policy safeguards you. You may also be
offered cashless hospitalization if you are hospitalized while travelling.

4. Health Insurance

Health insurance is a vital tool for risk mitigation and helps you deal with medical
emergencies. A health insurance plan covers hospitalization expenses up to the sum insured.
When it comes to health insurance, one can opt for a standalone health policy or a family
floater plan that offers coverage for all family member.

4.5 Claim Settlement under Non-Life Insurance

The non-life insurance industry is witnessing shifting trends across policy administration,
and claims—the two core functions in insurance.

The claims process is the defining moment in a non-life insurance customer

relationship. To retain and grow market share and improve customer acquisition and
retention rates, insurers are focused on enhancing customers’ claims experience.

In a highly competitive insurance market, differentiation through new and more

effective claims management practices is one of the most important and effective
ways to maintain market share and profitability.

In particular, insurers can transform the claims processing by leveraging modern

claims systems that are integrated with robust business intelligence, document and
content management systems. This will enhance claims processing efficiency and
effectiveness. It can benefit the insurers both operationally and strategically by
enabling them to reduce claims costs to improve their combined ratio, improve
claims processing efficiency, and drive customer retention and acquisition.

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Today in any insurance office the claim process is built on:

• Claim document & content management tool

• Mobile based & smart phone based technology solutions the key
• STP processing to minimize delay
• Modern claim processing platform which is seamless & robust

Normal claim process followed by General Insurers:

1. An insured or the claimant shall give notice to the insurer of any loss arising
under contract of insurance at the earliest or within such extended time as may be
allowed by the insurer.

2. On receipt of such a communication, a general insurer shall respond

immediately and give clear indication to the insured on the procedures that he should
follow. In cases where a surveyor has to be appointed for assessing a loss/ claim, it
shall be so done within 72 hours of the receipt of intimation.

3. Where the insured is unable to furnish all the particulars required by the
surveyor or where the surveyor does not receive the full cooperation of the insured,
the insurer or the surveyor as the case may be, shall inform in writing the insured
about the delay that may result in the assessment of the claim.

4. The surveyor shall be subjected to the code of conduct laid down by the
Authority while assessing the loss, and shall communicate his findings to the insurer
within 30 days of his appointment with a copy of the report being furnished to the
insured, if he so desires. Where, in special circumstances of the case, either due to its
special and complicated nature, the surveyor shall under intimation to the insured,
seek an extension from the insurer for submission of his report.

5. In no case shall a surveyor take more than six months from the date of his
appointment to furnish On receipt of the survey report or the additional survey
report, as the case may be, an insurer shall within a period of 30 days offer a
settlement of the claim to the insured. If the insurer, for any reasons to be recorded

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in writing and communicated to the insured, decides to reject a claim under the
policy, it shall do so within a period of 30 days from the receipt of the survey report.

6. Upon acceptance of an offer of settlement by the insured, the payment of the

amount due shall be made within 7 days from the date of acceptance of the offer by
the insured. In the cases of delay in the payment, the insurer shall be liable to pay
interest at a rate which is 2% above the bank rate prevalent at the beginning of the
financial year in which the claim is reviewed by it.

4.6 LIFE INSURANCE

Life Insurance is an arrangement through which a person can plan for the continuation of
income when uncertainties and certainties (i.e.) illness or Accident and death or old age
disrupt or destroy his ability to earn his livelihood.

Therefore the Insurance is:

1. The business of insurance is related to protection of human life, human created assets,
human disability and business liabilities possessed by human beings which have a definite
value, and

2. Assets and human life generate benefit and income for the owner and his/her family
members, and

3. Loss of assets / human life for any reason stops the benefits and income to the owner and
family members respectively, and

4. Results in falling of living standards in the family, quality of life and future growth of the
associated family members,

5. Insurance is a mechanism that helps to reduce such adverse consequences through pooling,
spreading and sharing of risk.

Benefits to Economy:

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i. Rapid investment z Improve Quality to Life (New risk covers)
ii. Competition will bring Consumer Friendly Products
iii. Large Scale Mobilisation of Funds
iv. Insurance & Reinsurance Facilities to Major Projects
v. Export Projects covered at Home

Benefits to Government:

i. Long Term Funds for Infrastructure

ii. Long Term Debt Market Instruments Available
iii. Increased Employment Opportunities & Compensation
iv. Reduced Financial Burden of Rural, Social & Backward Classes
v. Contributions in Calamities (Sharing of Social Responsibilities)

Benefits to Consumer:

i. Superior Quality at Lower Prices

ii. Wider Choice of Products
iii. World Class Service to the Consumer
iv. Increased Penetration of Insurance

Benefits to Employee:

i. Human Resource Development

ii. Exposure to ‘State of the Art Practices”
iii. Greater Job Opportunities
iv. Higher Remuneration
v. Professional Management Practices

Benefits to Society:

Insurance Companies Act as Guardians in number of Ways: -

i. Risk cover for Large Industry, Trade & Property are offered in Compliance to Law

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ii. Environmental Risks get Reduced
iii. Hit – and – Run Compensations
iv. Crop Insurance for Covering Risk of Nature – Poor Rainfall etc.

Type of life insurance:

Life Insurance products

1. Term insurance plans

Term insurance is valid only during a certain time period that has been specified in
the contract. The term can range from as short as it takes to complete an airplane trip
to as long as forty years. Protection may extend up to age 65 or 70. One-year term
policies are quite similar to property and casualty insurance contracts.
All premiums received under such a policy may be treated as earned towards the cost
of mortality risk by the company. There is no savings or cash value element accruing
to the insured.

a) Purpose:
A term life insurance fulfils the main and basic idea behind life insurance, that is, if
the life insured dies prematurely there will be a sum of money available to take care
of his/her family. This lump sum money represents the insured’s human life value for
his loved ones: either chosen arbitrarily by self or calculated scientifically. A term
insurance policy also comes handy as an income replacement plan. Here in place of
payment of a lump-sum amount to the dependents, on the happening of an
unfortunate death during the term of the policy, a series of monthly, quarterly or
similar periodical pay outs for a pre-defined duration may be provided to the
dependent beneficiaries.

b) Disability:

Normally a term insurance policy covers only death. However, when it is purchased
with a disability protection rider on the main policy and if someone were to suffer
such a catastrophe during the period of term insurance, the insurance company will
provide a pay-out to the beneficiaries/insured person. If the insured dies after the

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term ends, there are no benefits available as the deal is over as soon as the term
expires.

2. Whole life insurance

While term assurance policies are examples of temporary assurance, where protection
is available for a temporary period of time, whole life insurance is an example of a
permanent life insurance policy.

In other words there is no fixed term of cover but the insurer offers to pay the agreed
upon death benefit when the insured dies, no matter whenever the death might occur.
The premiums can be paid throughout one’s life or for a specified period of time
which is limited and is less than one’s lifetime.

Whole life premiums are much higher than term premiums since a whole life policy
is designed to remain in force until the death of the insured, and therefore it is
designed to always pay the death benefit. After the insurance company takes the
amount of money it needs from the premium, to meet the cost of term insurance, the
balance money is invested on behalf of the policyholder. This is called cash-value.

A whole life policy is a good plan for one who is the main income earner of the family
and wishes to protect the loved ones from any financial insecurity in case of premature
death. Whole life insurance plays an important role in household saving and creating wealth
to be passed on to the next generation.

3. Endowment assurance

An endowment assurance contract is actually a combination of two plans:

A term assurance plan which pays the full sum assured in case of death of the
insured during the term. b. A pure endowment plan which pays this amount if the
insured survives at the end of the term.

The product thus has both a death and a survival benefit component. From an
economic point of view, the contract is a combination of decreasing term insurance
and an increasing investment element.

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Shorter the policy term, larger the investment element. The combination of term and
investment elements is also present in whole life and other cash value contracts. It is
however much more pronounced in the case of endowment assurance contracts. This
makes it an effective vehicle to accumulate a specific sum of money over a period of
time.

4. Money back plan

A popular variant of endowment plans in India has been the Money Back policy. It is
typically an endowment plan with the provision for return of a part of the sum
assured in periodic instalments during the term and balance of sum assured at the end
of the term.

Example:
A Money Back policy for 20 years may provide for 20% of the sum assured to be
paid as a survival benefit at the end of 5, 10 and 15 years and the balance 40% to be
paid at the end of the full term of 20 years.

If the life assured dies at the end of say 18 years, the full sum assured and bonuses
accrued are paid, regardless of the fact that the insurer has already paid a benefit of
60% of the face value. These plans have been very popular because of their liquidity
(cash back) element, which renders them good vehicles for meeting short and
medium term needs.

Full death protection is meanwhile available when the individual dies at any point
during the term of the policy.

5. Unit linked insurance

Unit Linked Insurance Plan (ULIP) is a mix of insurance along with investment.
From a ULIP, the goal is to provide wealth creation along with life cover where the
insurance company puts a portion of your investment towards life insurance and rest
into a fund that is based on equity or debt or both and matches with your long-term

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goals. These goals could be retirement planning, children’s education or another
important event you may wish to save for.

When you make an investment in ULIP, the insurance company invests part of the
premium in shares/bonds etc., and the balance amount is utilized in providing an
insurance cover. There are fund managers in the insurance companies who manage
the investments and therefore the investor is spared the hassle of tracking the
investments.

ULIPS allow you to switch your portfolio between debt and equity based on your risk
appetite as well as your knowledge of the market’s performance. Benefits like these
which offer investors the flexibility of switching is a huge factor contributing to the
popularity of these investment instruments.

One of the changes brought about by the Insurance Regulatory and Development
Authority of India (IRDAI) in the year 2010 as regards ULIPs, was to increase the
lock in a period from 3 years to 5 years. However, insurance being a long-term
product, as an investor you may not really reap the benefits of the policy unless you
hold it for the entire term of the policy which can range from 10 to 15 years.

6. Index linked insurance policy

The index linked policies are life insurance policies with which insurance premiums
are invested in instruments whose returns are linked to the performance of one or
more indices.

As the trend of the performance indices is uncertain by definition, if it is not suitable

to the risk profile of the subscriber, the policy is often accompanied by a guarantee
on the capital that has been invested. In this case the greater part of the money is
invested in zero coupon bonds and the remainder is invested in structured products
linked to the indices and are therefore more risky.

In addition, for index linked policies are estimated implicit and explicit costs. The
former are very clear in the statements that concern the classic illustrative and
expenses related to an insurance policy. The implicit costs are those relating to

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instruments on which invests the policy. Zero coupon bonds for this feature usually
have a higher price than the market and then structured products which have a not
predictable cost because usually incorporate tools financial derivatives.

7. Life Annuity:

A life annuity is an insurance product that features a predetermined

periodic pay-out amount until the death of the annuitant. They are commonly used to
provide for a guaranteed income in retirement that cannot be outlived. Typically, the
annuitant pays into the annuity on a periodic basis when he or she is still working.

However, annuitants may also buy the annuity product in one large, lump-sum
purchase, usually at retirement.

Defined benefit pension plans are a form of a life annuity, in that they pay a lifetime
benefit based on an employee's salary, age, and length of service.

Once funded and enacted, the annuity makes periodic pay-outs to the annuitant,
usually monthly, providing a reliable source of income. When a triggering event
occurs, such as death, the periodic payments from the annuity usually cease, though
they may continue to pay out depending on the option the annuity buyer chooses.

While annuities generally pay a benefit every month, but can also pay quarterly,
annually or semi-annually, depending on the needs or tax circumstances of the
annuitant. Many retirees fund a life annuity to match their recurring housing
(mortgage or rent), assisted living, health care, insurance premium or medical
expenses. While a life annuity pays a guaranteed income, it is not indexed to
inflation, so purchasing power can erode over time. A life annuity, once enacted, is
not revocable.

There are two phases to an annuity: accumulation (or deferral), when the buyer funds
an annuity with premiums, and distribution during which the annuitant receives
payments until death.

Principles of life insurance

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Life Insurance is a give- and- take process. It is based on a basic principle of trust and security
between the insured and the insurer. The parties involved are interdependent, and the contract
between them functions on some core principles. Its main motive is cooperation. Also, the
principles of life insurance are based on such that it meets the market conditions. It also makes
sure that the company can make a profit, and the insured individuals get secured policies.

Following are the principles of life insurance on which the policies are stipulated:

1. Principle of Good Faith

2. Principle of Insurable Interest
3. Principle of Indemnity
4. Principle of Subrogation
5. Principle of Proximate Cause
6. Principle of Contribution
7. Principle of Loss Minimization
8. Nature of the Contract

Principle of Good Faith

As we discussed above, a life insurance policy is a two-way contract. Hence, there must be good
faith established between the insurer and the insured person. It is of utmost importance that the
policyholder provides the relevant details with honesty to the insurance company. The client is
bound to disclose all the facts properly. Concealing the information may result in serious
consequences. In the same way, the company must also be faithful to clients and clearly state all
the clauses and aspects of the policy to its clients.

Principle of Insurable Interest

This principle specifies that the policyholder must have an interest in the subject matter. For
example: If you want to purchase a housing policy, you must have an interest in that; you must
be living in it. In the case of life insurance, it could be a relationship, family bond etc. The
absence of insurable interest will make the contract invalid. Also, the insurable interest must
prevail at the time of buying the insurance policy and at the time of the accident.

Principle of Indemnity

Although this principle does not apply to the life insurance policy, it ensures that the insured
gets the compensation that is equivalent to the actual loss. The amount will not exceed the loss
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so that the insured does not make additional profits from the company. In simple words, the
policyholder will be provided with an amount equal to the loss and not more.

Principle of Subrogation

This principle is one of the most important, keeping in mind the unpredictability of life.
Subrogation means that the insured is enabled to claim compensation from any third party that is
responsible for the loss. The insured is thus allowed to go for legal methods to recover the loss.
It also gives the insurance company the right to ownership from the insured to claim an amount
from the third party.

Principle of Proximate Cause

This principle is concerned with the discovery of the dominant effective cause or the nearest
cause that produced the loss being claimed for under the insurance. It means that in case of
damage, the direct cause is considered. Hence, this principle is only applicable when the loss has
occurred as a result of two or more causes. The principle does apply to every other materialistic
policy, but comparatively, it has rather less significance with life insurance.

Principle of contribution

This principle can be implied if there more than one insurer involved. So, the insured cannot
make any profits from different policies.

Principle of Loss Minimization

Purchasing life insurance means entering into a legal contract between the company and the
insured person. Therefore, it is important to keep in mind that there should be minimal loss and
risk involved. In such clauses, the owner of the policy is expected to take the necessary steps to
limit him/her from any damage. This may include steps to follow a healthy lifestyle, not
indulging in life-threatening habits like smoking etc.

Nature of the contract

Lastly, the nature of the contract is a fundamental determiner of cooperation between the client
and the company. Thus, the contract should be simple and free of invalid information. The
contract must also be signed with the full consent of the client.

4.7. Factors Affecting Attitudes Towards Insurance Covers:

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 A. Insurance to an Individual

 Security and safety- The life insuranc provides securty agaist death and payment in old age to
lead a tension free and comfortable life. Similarly, in general insurance, the property can be
insured against any contingency i.e. fire accident or earthquake etc. The insurance provides
safety and security against the loss against a particular event.
 Peace of Mind- The uncertainties due to fire, accident, death, illness, disability in the human
life, are beyond the control of the human beings. Insurance provides financial compensation
against the loss caused by certain contingencies. The financial compensation provides not only
peace of mind but also motivates to work more and more.
 Insurance provides protection to Mortgaged Property- An individual who has taken loan for
the construction of a house may die prematuredly. The property ill be taken over by the lender
untill te loan is repaid. The dependents will be deprived of the use of the property. The insurance
will provide adequate amount to the dependents at the premature death of the owner to pay off
the outstanding balance.

B. Insurance to Business:

The insurance is useful to business society as under:

 Uncertainty of Business losses are reduced- In business the huge amount is invested in the
properties i.e Building, Plant and Machinery. These properties may be destroyed due to
negligence, if it is not insured. The insurance reduces the uncertainties of business losses due to
fire, accidents and other contingencies.
 Key-man Indemnification- Key-man is a prticular man whose capital, expertise, energy and
dutifulness makes him the most valuable asset in the business and whose absence will reduce the
income of the employer tremendously and upto that time until such employee is not substituted.
The death or disability of such valuable lives will prove a serious loss than that of fre or any
hazard. The potential loss to be suffered and the compensation to the dependents of such
employee require an adequate provision which is met by purchasing an appropriate life policy.
 Enhancement of Credit- The business can obtain loan by pledging te policy as collateral
security for the loan. The insured persons are getting more loans due to certainty of payment at
their death. In case of death, this cash value of policy can be used for setting of the loan
alongwith interest.
 Welfare of employees: The welfare of the employees is the responsibility of the employer. The
employer is supposed to look after the welfare of the employees. The provisions are being made

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 for death, disability and old age. Though these can be insured through individual life insurance
but an individual may not be insurable due to illness and age.

C: Insurance to Society:

 Wealth of the society is protected- The loss of a particular weath can be protected with the
insurance. Life Insurance provides protection against loss of human life. Similrly, the loss of
damage of property by fir, accident etc can well be compensated by the property insurance.
Cattle, crop, profit and machines are also protected against their accidental and economic loss.
With the advancement of the society, the weath or the property of the society attracts more
hazardous and new types of insurance are also invented to protect them against the possible
losses.
 Economic Growth of the Country- Insurance provides strong hand and mind, protection
against loss of property and adequate capital to produce more wealth for the economic
development of the country. The insurance meets all the requirements for the economic growth
of a country.
 Reduction in Inflation- The insurance reduces the inflationary pressure in two ways- by
extracting money in circulation by the amount of premium collected and by providing sufficient
funds for production, thus reducing the inflationary pressure in an economy.

4.8 Insurance Regulatory and Development Authority (IRDA):

The Committee on reforms of the insurance sector under the chairmanship of Shri R
N Malhotra, ex-governor of Reserve Bank of India, recommended for the creation of
a more efficient and competitive financial system in tune with global trends. It
recommended amendments to regulate the insurance sector to adjust with the
economic policies of privatization.

The decision to establish the Insurance Regulatory and Development Authority was
implemented by the passing of the Insurance Regulatory and Development Authority Act,
1999. In India, presently after the opening up of the insurance sector, the regulator for the
monitoring of the operations of the insurance companies is the IRDA, having its head
office in Hyderabad.

The regulatory framework mainly aims to focus on three areas, viz.,

i. The protection of the interest of the consumers;

ii. To ensure the financial soundness of the insurance industry;
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iii. To pave the way to help a healthy growth of the insurance market
where both the government and the private players play simultaneously.

Some of the important duties, powers and functions of Authority include:

A. To Issue certificate of registration, to applicants interested in insurance
business, and also to renew, modify, withdraw, suspend or cancel such
registration.
B. Specify requisite qualifications and practical training for insurance
intermediaries and agents.
C. Specify the code of conduct for surveyors and loss assessors.
D. Levy fees and other charges for carrying out the purposes of this Act
E. Control and regulate the rates, terms and conditions that may be offered by insurers
in respect of general insurance business.
F. Regulate investment of funds by insurance companies.
G. Regulate maintenance of margin of solvency
H. Adjudication of disputes between insurers and insurance intermediaries
I. Supervise the functioning of the Tariff Advisory Committee.
J. Specify percentage of life and general insurance business to be undertaken
by the insurer in the rural or social sector.

TERMINAL QUESTIONS:

SECTION A 5x4=20
1. Define Insurance. State the importance of Insurance.
2. Differentiate between Life Insurance and General Insurance.
3 . Explain IRDA

4 Briefly describe the principles of Insurance.

5 Write short note on ULIP

SECTION B: 9X2=18
1. Briefly describe the various forms of Life Insurance.
2. Write a note on duties and functions of IRDA.

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3. Explain the functions of Life Insurance.
4. Explain the various forms of General Insurance.

SECTION C: 12X1=12
1. Explain the procedure of settlement of Insurance

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 MODULE 5

RISK AND INSURANCE

5.1 Understanding Risk

5.2 Types of risk and importance of insurance

5.3 Risk management - Objectives

5.4 Risk identification and measurement - Pooling arrangements and diversification of risk

5.5. Risk aversion and demand for insurance – By individuals- By corporations-

5.6 Insurability of risk- contractual provisions- Legal doctrine- - Loss control –Risk retention
and reduction decisions

5.1 Introduction

Risk is defined in financial terms as the chance that an outcome or investment's actual gains
will differ from an expected outcome or return. Risk includes the possibility of losing some or
all of an original investment. Quantifiably, risk is usually assessed by considering historical
behaviours and outcomes. In finance, standard deviation is a common metric associated with
risk. Standard deviation provides a measure of the volatility of asset prices in comparison to
their historical averages in a given time frame.

5.2 Types of risk

The 2 broad types of risk are systematic and unsystematic.

Systematic risk is risk within the entire system. This is the kind of risk that applies to an entire
market, or market segment. All investments are affected by this risk, for example risk of a
government collapse, risk of war or inflation, or risk such as that of the 2008 credit crisis. It is
virtually impossible to protect your portfolio against this risk. It cannot be completely
diversified away. It is also known as un-diversifiable risk or market risk.

Unsystematic risk is also known as residual risk, specific risk or diversifiable risk. It is unique
to a company or a particular industry. For example strikes, lawsuits and such events that are
specific to a company, and can to an extent be diversified away by other investments in your
portfolio are unsystematic risk.
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Within these two types, there are certain specific types of risk, which every investor must know.

1. Credit Risk (also known as Default Risk)

Credit risk is just the risk that the person you have given credit to, i.e. the company or
individual, will be unable to pay you interest, or pay back your principal, on its debt obligations.

If you are investing in Infrastructure Bonds or Company Fixed Deposits right now, you should
be aware of the credit / default risk involved. Government bonds have the lowest credit risk (but
it is not zero - think of Portugal, Ireland or Spain right now), while low rated corporate deposits
(junk bonds) have high credit risk. Before investing in a bond or a corporate deposit, be sure to
check how highly it is rated by a well known rating agency such as CRISIL, ICRA or CARE.
Remember, even a bank FD has some credit risk, as only a maximum of Rs. 1 lakh is guaranteed
by the Government.

2. Country Risk
When a country cannot keep to its debt obligations and it defaults, all of its stocks, mutual
funds, bonds and other financial investment instruments are affected, as are the countries it has
financial relations with. If a country has a severe fiscal deficit, it is considered more likely to be
risky than a country with a low fiscal deficit, ceteris paribus.
Emerging economies are considered to be riskier than developed nations.

3. Political Risk
This is also higher in emerging economies. It is the risk that a country's government will
suddenly change its policies. For example, today with the continuing raging debate on FDI in
retail, India's policies will not be looking very attractive to foreign investors, and stock prices
are negatively affected.

4. Reinvestment Risk
This is the risk that you lock into a high yielding fixed deposit or corporate deposit at the highest
available rate (currently above 9.50%), and when your interest payments come in, there is no
equivalent high interest rate investment avenue available for you to reinvest these interest
proceeds (for example if your interest is paid out after 1 year and the prevailing interest rate is
8% at that time).

Currently as we are at an interest rate peak, it would be advisable to lock in for a longer tenor
(provided your financial goal time horizon permits) to avoid facing reinvestment risk.

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5. Interest Rate Risk
A golden rule in debt investing is this: Interest Rates go up, prices of bonds go down. And vice
versa. So for example in our situation today, we appear to be at an interest rate peak. This means
that since interest rates are going to go down from here, prices of bonds are going to go up. So if
you were to invest in debt funds now, you would be buying at a low, and can sit back and watch
as your investments start to give gains as interest rates fall.

6. Foreign Exchange Risk

Forex risk applies to any financial instruments that are denoted in a currency other than your
own. For example, if a UK firm has invested in India, and the Indian investment does well in
rupee terms, the UK firm might still lose money because the Rupee has depreciated against the
Pound, so when the firm decides to pull out its investment on maturity, it gets fewer pounds on
redemption. With the recent very sharp fall in the rupee, the forex risk of our country as an
investment destination has greatly increased.

7. Inflationary Risk
Inflationary risk, or simply, inflation risk, is when the real return on your investment is reduced
due to inflation eroding the purchasing power of your funds by the time they mature.
For example, if you were to invest in a fixed deposit today and you were to earn a 10% interest
on it in 1 year's time, then if inflation has been 8% in that year, your real rate of return comes
down to 2%, keeping purchasing power in mind.

8. Market Risk
This is the risk that the value of your investment will fall due to market risk factors, which
include equity risk (risk of stock market prices or volatility changing), interest rate risk (risk of
interest rate fluctuations), currency risk (risk of currency fluctuations) and commodity risk (risk
of fluctuations in commodity prices).There are other types of risk too, such as legislative risk,
global risk, timing risk and more, but for the scope of this article, the ones explained above are
the main ones you need to keep in mind, both on a macro (country) and a micro (individual
investments) level.

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Importance of Insurance

I.INDIVIDUAL II ECONOMIC III SOCIAL ASPECTS IV NATIONAL

ASPECTS ASPECTS ASPECTS
1. Security for 1. Safety 1. Stability in 1. Increase the
health and property against risk family life. national savings
2. Encourage 2. Protection to 2. Development 2. Helps in
savings employees of employment development
3. Encourage the 3. . Basis of opportunity opportunities
habit of forced thrift Credit. 3. Encourage 3. Develops the
4. Provide 4. Protection alertness money market
mental peace from the loss of 4. Contributes to 4. Earns
5. Increase key man the development of foreign exchange
efficiency 5. Encourage basic facilities 5. Capitalizes
Provision for the loss prevention the savings
future methods
6. Awareness for 6. Reduction of
the future cost
7. Credit Facility 7. Promote
8. Tax foreign trade 8.
exemption Development of
9. Contribution big industries
to the conservation 8. Increase in
of health efficiency
10. Cover for
legal liability
11. Security to the
mortgaged property
12. Poster
economic
independence

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 Need for Insurance

1. Removal of uncertainties:
Insurance company takes the risks of large but uncertain losses in exchange for small premium.
So it gives a sense of security, which is real gift to the business man. If all uncertainty could be
removed from business, income would be sure. Insurance removed many uncertainties and to
that extent is profitable.

2. Stimulant of business enterprise:

Insurance facilitates to maintain the large size commercial and industrial organizations. No large
scale industrial undertaking could function in the modern world without the transfer of many of
its risks to insurer. It safeguards capital and at the same time it avoids the necessity on the part
of industrialists. They are therefore free to use their capital as may seem best.

3. Promotion of saving:
Saving is a device of preparing for the bad consequences of the future. Insurance policy is often
very suitable way of providing for the future. This type of policy is found particularly in life
assurance. It promotes savings by making it compulsory which has a beneficial effect both for
the individual and nation.

4. Correct distribution of cost:

Insurance helps to maintain correct distribution of cost. Every business man tries to pass on to
the consumer all types of costs including accidental and losses also. In the various fields of
Insurance such losses are correctly estimated keeping in view a vast number of factors bearing
on them. In the absence of insurance these losses and costs would be assessed and distributed
only by guess work.

5. Source of credit:
Modem business depends largely on credit; insurance has contributed ‘a lot in this regard. A life
insurance policy increases the credit worthiness of the assured person because it can provide
funds for repayment if he dies. Credit extension is also obtained by means of various kinds of
property insurance. A businessman who stock of goods has been properly insured can get credit
easily. Similarly, marine insurance is an essential requirement for every transaction of import
and export.

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6. Reduction of the chances of loss:
Insurance companies spend large sums of money with a view to finding out the reasons of fire
accidents, theft and robbery and suggest some measures to prevent them. They also support
several medical programs in order to make the public safety minded. Without such losses
preventive activities of insurance companies, the chances of loss would have been greater than
they are at present days.

7. Solution of social problems:

Insurance serves as a useful device for solving complex social problems e.g. compensation is
available to victims of Industrial injuries and road accident while the financial difficulties
arising from old age, disability or death are minimized. It thus enables many families and
business units to continue intact even after a loss.

8. Productive utilization of fund:

Insurer accumulates large resources from the various insurance funds. Such resources are
generally invested in the country, either in the public or private sector. This facilitates
considerably in overall development of the economy.

9. Insurance as an investment:
A life policy is a combination of protection and investment which serves a useful purpose. The
premium that is paid by insured goes on accumulating in a fund every year. The sum so
accumulated by the insurance company earns interest. Under life assurance a person may also
invest his capital in an annuity which will pay him an income every year till death. Therefore,
insurance may be regarded as an investment.

10. Promotion of international trade:

The growth of the international trade of the country has been greatly helped by shifting of risk to
insurance company. A ship sailing in the sea faces some misfortune. A fire breaks out and burns
to ashes all the merchandise of a business man. But insurance is one of the devices by which
these risks may be reduced or eliminated. So industrialists and exporter may devote their full
attention toward the promotion of business which may increase the export activities.

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11. Removing fear:
Insurance helps to remove various types of fear from the mind of the people. The insured is
secured in the knowledge that the protection of the insurance fund is behind him if some sad
event happens. It thus creates confidence and eliminates worries which are difficult to evaluate,
but the benefit is very real.

12. Favourable allocation of factors of production:

Insurance also helps in achieving favourable allocation of the factors of production. Capital is
usually shy in the risky business. People hesitate to invest their capital where financial losses are
great. If protection is provided against these risks by means of insurance, several investors will
become ready to invest their funds in those fields.

13. Growth of Business competition:

Insurance enables the small business units to compete upon more equal terms with the bigger
organization. Without insurance it would have been impossible to undertake the risks
themselves. On the other side bigger organization could absorb, their losses due to great
financial strength. Moreover insurance removes uncertainty of financial losses arising out of the
certain causes. It thus increases knowledge which is one of the most important preconditions of
perfect competition.

14. Employment opportunity:

Insurance provides employment opportunity to jobless persons which is helpful for the
improvement and progress of social condition

15. Miscellaneous benefits: Following are some other miscellaneous benefits offered by
insurance:
(a) It establishes the relation between the employed and employer by providing various facilities
i.e. group life insurance, social security scheme, retirement income plan, and workman’s
compensation insurance.
(b) Insurance creates the confidence and sense of security among the policy holder.
(c) Insurance company provides valuable services of skilled and expert persons to industries and
business in order to eliminate various risks.

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 (d) It promotes economic growth and development. This would be impossible in the Notes
absence of insurance.
(e) It contributes to the efficiency of business and also industrial and commercial executives.
(f) Security of dependents is made possible through life assurance. It gives relief to helpless
families after the death of the earning member of the family.

5.3 Risk management - Objectives

In the financial world, risk management is the process of identification, analysis, and acceptance
or mitigation of uncertainty in investment decisions. Essentially, risk management occurs when
an investor or fund manager analyzes and attempts to quantify the potential for losses in an
investment, such as a moral hazard, and then takes the appropriate action (or inaction) given the
fund's investment objectives and risk tolerance.

Objectives of Risk Management

a) Ensure the management of risk is consistent with and supports the achievement of the strategic
and corporate objectives.
b) Provide a high-quality service to customers.
c) Initiate action to prevent or reduce the adverse effects of risk.
d) Minimize the human costs of risks where reasonably practicable.
e) Meet statutory and legal obligations.
f) Minimize the financial and other negative consequences of losses and claims.
g) Minimize the risks associated with new developments and activities.
h) Be able to inform decisions and make choices on possible outcomes.

Risk Management Process

The risk management process is a framework for the actions that need to be taken. There are
five basic steps that are taken to manage risk; these steps are referred to as the risk management
process. It begins with identifying risks, goes on to analyze risks, then the risk is prioritized, a
solution is implemented, and finally, the risk is monitored. In manual systems, each step
involves a lot of documentation and administration.

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The Risk Management Process

The risk management process is the set of steps you should be taking routinely, habitually, to
assess and mitigate the hazards present in your organization and lines of business. This should
become part of your organization’s culture. It should become as habitual for your company as it
is for a person to look both ways before they cross the street. It needs to be a cycle because it
can take several iterations to get where you need to be and also because things change over time.
Risk management and mitigation is not a project, but an ongoing aspect of resiliency.

Risk Management Process

The 5 Step Risk Management Process

Implementing a risk management process is vital for any organization. Good risk management
doesn’t have to be resource intensive or difficult for organizations to undertake or insurance
brokers to provide to their clients. With a little formalization, structure, and a strong
understanding of the organization, the risk management process can be rewarding.

Risk management does require some investment of time and money but it does not need to be
substantial to be effective. In fact, it will be more likely to be employed and maintained if it is
implemented gradually over time. The key is to have a basic understanding of the process and to
move towards its implementation.

The 5 Step Risk Management Process

1. Identify potential risks

What can possibly go wrong?

The four main risk categories of risk are hazard risks, such as fires or injuries; operational risks,
including turnover and supplier failure; financial risks, such as economic recession; and strategic
risks, which include new competitors and brand reputation. Being able to identify what types of
risk you have is vital to the risk management process.

An organization can identify their risks through experience and internal history, consulting with
industry professionals, and external research. They may also try interviews or group
brainstorming, as discussed in this Project Manager article 8 New Ways to Identify Risks.

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It’s important to remember that the risk environment is always changing, so this step should be
revisited regularly.

2. Measure frequency and severity

What is the likelihood of a risk occurring and if it did, what would be the impact?

Many organizations use a heat map to measure their risks on this scale. A risk map is a visual
tool that details which risks are frequent and which are severe (and thus require the most
resources). This will help you identify which are very unlikely or would have low impact, and
which are very likely and would have a significant impact.

Knowing the frequency and severity of your risks will show you where to spend your time and
money, and allow your team to prioritize their resources.

More details on risk maps can be found in our blog posts on the topic: The Importance of Risk
Mapping and How to Build a Risk Map.

3. Examine alternative solutions

What are the potential ways to treat the risk and of these, which strikes the best balance between
being affordable and effective? Organizations usually have the options to accept, avoid, control,
or transfer a risk. Accepting the risk means deciding that some risks are inherent in doing
business and that the benefits of an activity outweigh the potential risks. To avoid a risk, the
organization simply has to not participate in that activity.

Risk control involves prevention (reducing the likelihood that the risk will occur) or mitigation,
which is reducing the impact it will have if it does occur. Risk transfer involves giving
responsibility for any negative outcomes to another party, as is the case when an organization
purchases insurance.

4. Decide which solution to use and implement it

Once all reasonable potential solutions are listed, pick the one that is most likely to achieve
desired outcomes. Find the needed resources, such as personnel and funding, and get the
necessary buy-in. Senior management will likely have to approve the plan, and team members
will have to be informed and trained if necessary.

Set up a formal process to implement the solution logically and consistently across the
organization, and encourage employees every step of the way.

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5. Monitor results

Risk management is a process, not a project that can be “finished” and then forgotten about. The
organization, its environment, and its risks are constantly changing, so the process should be
consistently revisited. Determine whether the initiatives are effective and whether changes or
updates are required. Sometimes, the team may have to start over with a new process if the
implemented strategy is not effective.

Potential Risk Treatments

Once risks have been identified and assessed, all techniques to manage the risk fall into one or
more of these four major categories;

A. Risk Transfer

Risk Transfer means that the expected party transfers whole or part of the losses consequential o
risk exposure to another party for a cost. Insurance contracts fundamentally involve risk
transfers. Apart from the insurance device, there are certain other techniques by which the risk
may be transferred.

B. Risk Avoidance

Avoid the risk or the circumstances which may lead to losses in another way, Includes not
performing an activity that could carry risk. Avoidance may seem the answer to all risks, but
avoiding risks also means losing out on the potential gain that accepting (retaining) the risk may
have allowed. Not entering a business to avoid the risk of loss also avoids the possibility of
earning the profits.

C. Risk Retention

Risk-retention implies that the losses arising due to a risk exposure shall be retained or assumed
by the party or the organization. Risk-retention is generally a deliberate decision for business
organizations inherited with the following characteristics. Self-insurance and Captive insurance
are the two methods of retention.

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 D. Risk Control

Risk can be controlled either by avoidance or by controlling losses. Avoidance implies that
either a certain loss exposure is not acquired or an existing one is abandoned. Loss control can
be exercised in two ways.

Definition of 'Risk Averse'

Definition: A risk averse investor is an investor who prefers lower returns with known risks
rather than higher returns with unknown risks. In other words, among various investments
giving the same return with different level of risks, this investor always prefers the alternative
with least interest.

Description: A risk averse investor avoids risks. S/he stays away from high-risk investments and
prefers investments which provide a sure shot return. Such investors like to invest in
government bonds, debentures and index funds.

5.6 Insurability of risk- contractual provisions- Legal doctrine- - Loss control –Risk
retention and reduction decisions

Insurable risks are risks that insurance companies will cover. These include a wide range of
losses, including those from fire, theft, or lawsuits.

When you buy commercial insurance, you pay premiums to your insurance company. In return,
the company agrees to pay you in the event you suffer a covered loss. By pooling premiums
from many policyholders at once, insurers are able to pay the claims of the few who do suffer
losses, while providing protection to everyone else in the pool in case they need it.

Contractual provisions
1. A legal doctrine :
It is a framework, set of rules, procedural steps, or test, often established through precedent in
the common law, through which judgments can be determined in a given legal case. A doctrine
comes about when a judge makes a ruling where a process is outlined and applied, and allows
for it to be equally applied to like cases. When enough judges make use of the process, it may
become established as the de facto method of deciding like situations.
In other words A doctrine is defined as a core principle within a system of knowledge. As the
term applies to the law, it refers to one of these principles that is formed by continued
legal precedents (judicial decisions that have been made in cases over a period of time). Legal
doctrines are considered crucial within the legal sub-fields where they apply because they
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 provide a blueprint for how to resolve a given type of case or legal dispute. Within the common
law philosophy, which provides the foundation for the United States judicial system, legal
doctrines (and judicial precedent as a whole) are crucial to the daily operation of the justice
system at every level—from the lowest to highest courts in the land and across both criminal
and civil law.

2. Loss control
Loss control is a risk management technique that seeks to reduce the possibility that a loss will
occur and reduce the severity of those that do occur. A loss control program should help reduce
claims, and insurance companies reduce losses through safety and risk management information
and services.
The term insurance loss control is a set of risk management practices designed to reduce the
likelihood of a claim being made against an insurance policy. Loss control involves identifying
the sources of risk and is accompanied by either voluntary or required actions that a client or
policyholder should undertake to reduce risk.
Insurance loss control is a form of risk management that reduces the potential for losses in an
insurance policy. This requires an assessment or a set of recommendations made by insurers to
policyholders. The insurer may conduct a risk assessment before providing coverage.
Insurers may provide policyholders with incentives to be more risk averse. For example, an auto
insurance company may reduce the premium for a policy if the driver takes a driver’s education
course. This means that the company will collect a smaller premium, but it also reduces the risk
of a claim being filed by the insured because a trained driver is more likely to operate the
vehicle in a way that is safer, making them less likely to get into an accident.
Insurance companies may also require policyholders to take specific actions in order to
reduce risk. For example, they may require a commercial building to install sprinkler systems to
reduce the likelihood of fire damage, or they might require the installation of a security system
in order to reduce the threat of theft.

3. Risk retention and reduction

It is the practice of setting up a self-insurance reserve fund to pay for losses as they occur, rather
than shifting the risk to an insurer or using hedging instruments. A business is more likely to
engage in risk retention when it determines that the cost of self-insurance is lower than the
insurance payments or hedging costs required to transfer the risk to a third party. A large
deductible on an insurance policy is also a form of risk retention.

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Risk avoidance is not performing any activity that may carry risk. A risk avoidance
methodology attempts to minimize vulnerabilities that can pose a threat. Risk avoidance and
mitigation can be achieved through policy and procedure, training and education, and
technology implementations.
For example, suppose an investor wants to buy stock in an oil company, but oil prices have been
falling significantly over the past few months. There is political risk associated with the
production of oil and credit risk associated with the oil company. If an investor assesses the risks
associated with the oil industry and decides to avoid taking a stake in the company, this is
known as risk avoidance.
On the other hand, risk reduction deals with mitigating potential losses through more of a
staggered approach. For example, suppose an investor already owns oil stocks. The two factors
discussed earlier are still relevant: there is political risk associated with the production of oil,
and oil stocks often have a high level of unsystematic risk. As opposed to a risk avoidance
strategy, this investor can reduce risk by diversifying their portfolio by keeping their oil stocks
while at the same time buying stocks in other industries, especially those that tend to move in
the opposite direction to oil equities.
In order to engage in risk management, a person or organization must quantify and understand
their liabilities. This evaluation of financial risks is one of the most important and most difficult
aspects of a risk management plan. However, it is crucial for the well-being of your assets to
ensure you understand the full scope of your risks. If you have several streams of income, for
instance, losing one stream won't hurt as much if only 25% of a person's income comes from
that stream.

TERMINAL QUESTION:
SECTION A 5X4=20
1.Describe the risk treatment techniques.
2.Explain the risk management process.
3 Define risk retention
4 Define risk transfer

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SECTION B: 9X2=18

1.State the objectives of Risk management

2. Explain importance of insurance

SECTION C: 12X1=12
1.Define Risk. Explain various types of Risk.
2. Explain various constitutions provisions under insurance

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 MODEL QUESTION PAPER Max Marks 50
Section A
Answer any four each questions .Each sub question carries 5marks 5X4=20
Q1 Write a note on banker’s lien.
Q2 Define collecting banker
Q3 How is crossing of cheque done?
Q4 Define bills of exchange
Q5 Explain MICR & RTG
Q6 Define E-Services.

Section B
Answer any two each questions .Each sub question carries 9marks 9X2= 18
Q1 Discuss the secondary functions of a banker.
Q2 State the features of negotiable instruments
Q3 State the prerequisites required for DEMAT
Q4 Explain briefly holder in due course.

Section C

Answer any ONE each questions .Each sub question carries 12marks 12X1= 12

1 Explain various constitutions provision under insurance.

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