UNIT- 3

RESERVE BANK OF INDIA

INTRODUCTION

The central bank plays an important role in the monetary and banking structure of nation. It
supervises controls and regulates the activities of the banking sector. It has been assigned to
handle and control the currency and credit of a country. In older days, the central banks were
empowered to issue the currency notes and bankers to the Union governments.

RESERVE BANK OF INDIA

The Reserve Bank of India, the central bank of our country, was established in 1935 under
the aegis of Reserve Bank of India Act, 1934. It was a private shareholders institution till
January 1949, after which it became a state-owned institution under the Reserve Bank of
India Act, 1948. It is the oldest central bank among the developing countries. As the apex
bank, it has been guiding, monitoring, regulating and promoting the destiny of the Indian
financial system.

OBJECTIVES OF RBI

It plays a more positive and dynamic role in the development of a country. The financial
muscle of a nation depends upon the soundness of the policies of the central banking. The
objectives of the central banking system are presented below:

i. The central bank should work for the national interest of the country.
ii. The central bank must aim for the stabilization of the mixed economy.
iii. It aims at the stabilization of the price level at average prices.
iv. Stabilization of the exchange rate is also essential.
v. It should aim for the promotion of economic activities.
 STRUCTURE OF RBI

Reserve Bank of India has been constituted as a corporate body having perpetual succession
and a common seal. Its capital is Rs. 5 crores wholly owned by the Government of India. The
general superintendence and direction of the affairs and business of the Bank has been vested
in the Central Board of Directors. The Central Government, however, is empowered to give
such directions to the Bank as it may, after consultation with its Governor, consider necessary
in the public interest.

The Central Board of Directors consists of the following:

a. A Governor and not more than four Deputy Governor to be appointed by the
Central Government.
b. Four directors to be nominated by the Central Government, one from each of the
four local boards.
c. Ten directors to be nominated by the Central Government.
d. One Government official to be nominated by the Central Government.

Besides the Central Board of Directors, four Local Boards have also been constituted for each
of the four areas specified in the first schedule to the Act. A Local Board has five members
appointed by the Central Government to represent as far as possible, territorial and economic
interests and the interests of cooperative and indigenous banks. A Local Board advises the
Central Board on matters referred to it by the Central Board and performs such duties as are
delegated to it by the Central Board.

FUNCTIONS OF RBI

The RBI functions are based on the mixed economy. The RBI should maintain a close and
continuous relationship with the Union Government while implementing the policies. If any
differences arise, the government’s decision will be final. The main functions of the RBI are
presented below:

1. Welfare of the public

2. To maintain the financial stability of the country.
 3. To execute the financial transactions safely and effectively.
4. To develop the financial infrastructure of the country.
5. To allocate the funds effectively without any partiality.
6. To regulate the overall credit volume for price stability.

Other functions of the RBI include:

 Safeguarding financial and economic stability of the country.

 RBI is the reservoir of credit and hence other banking institutions rely on it for aid in
situations of crisis.
 Acts as banker to the State and banker’s bank
 Ensures economic stability and promotes economic development
 Printing of currency notes and managing mints
 Maintain internal as well as external value of currency
 Monetary Policy- One of the primary functions of RBI includes use of monetary
instruments by the RBI in a manner that it aids in achievement of the inflation target.
To achieve this goal the Centre has constituted the Monetary Policy Committee
(MPC) which determines the policy interest rates. The various instruments used by
the RBI to regulate monetary policy includes:
 Repo rate- It is the interest rate at which the RBI provides overnight liquidity to banks.
 Reverse repo rate- The interest rate at which the RBI absorbs liquidity on an
overnight basis from the banks.
 Bank rate- This is the rate at which the RBI buys or rediscounts bills of exchange or
other commercial papers.
 Cash Reserve Ratio (CRR)- This is the average daily balance that a bank is required
to maintain with the RBI as a share of such percent of its Net demand and time
liabilities.
 Statutory Liquidity Ratio- The share of Net Demand and Time Liabilities that a
bank is required to maintain in safe and liquid assets.
 Open Market Operations (OMOs): These include both, outright purchase and sale
of government securities, for injection and absorption of durable liquidity,
respectively.
 AUTHORITIES OF RBI

The RBI has the full authority in the following aspects:

1. Currency issuing authority

2. Monitoring authority
3. Banker to the Union Government
4. Foreign exchange control authority
5. Promoting authority.
1. Currency Issuing Authority- The RBI has the sole authority to issue the currency
notes and coins. It is the fundamental right of the RBI. The coins and one-rupee notes
are issued by the Government of India and they are circulated through the RBI. The
notes issued by the RBI issues by the RBI will have legal identity everywhere in
India. The RBI issues the notes of the denomination of RS. 1000, 500, 100, 50, 20 and
10. The RBI has the authority to circulate and withdraw the currency from circulation.
It has also the authority to exchange notes and coins from one denomination to other
denominations as per the requirement of the public. The currency notes may be
distributed throughout the country through its 15 full pledged offices, 2 branch
offices, and more than 4000 currency chests. The currency chests are maintained by
different banks in various locations. The RBI issues currency notes, based on the
availability of balances of gold, bullion, foreign securities, rupees, coins and
permitted bills.
2. Monitoring Authority- The RBI has the full authority to control all the aspects of the
banking system in India. The RBI is known as the Banker’s Bank. The banking
system in India works according to the guidelines issued by the RBI. The RBI is the
premier banking institute among the commercial banks. All the commercial banks,
foreign banks and cooperative urban banks in India should obey the rules and
regulations which are issued by the RBI from time to time. The RBI controls the
deposits of the commercial banks through the CRR and the SLRs. Every bank should
deposit a certain amount in the RBI. The commercial banks have the power to borrow
the money from the RBI when they are in need of finance. Hence it is known as the
lender of the last resort. The RBI has the authority to control the credit supply in the
economy or monetary systems of the nation.
3. Banker to the Union Government- Generally in any country all over the world the
Central bank dominates the banking sector. It advises the government on monetary
policies. The RBI is the bankers to the Union Government and also to the state
governments in the country. It provides a wide range of banking services to the
government. It also transfers the funds, collects the receipts and makes the payment
on behalf of the Government. It also manages the public debts. The Government will
not pay any remuneration or brokerage to the RBI for rendering the financial services.
Any deficit or surplus in the Central Government account with the RBI will be
adjusted by creation or cancellation of the treasury bills. The treasury bills are known
as the Adhoc Treasury bills.
4. Foreign Exchange Regulation Authority- The RBI’s another major function is to
control the foreign exchange reserves position from time to time. It maintains the
stability of the external value of the rupee through its domestic policies and forex
market. The RBI has the full authority to regulate the market as discussed below:
a. To monitor the foreign exchange control.
b. To prescribe the exchange rate system.
c. To maintain a better relation between rupee and other currencies.
d. To interact with the foreign counterparts.
e. To manage the foreign exchange reserves.

It administers the FERA, 1973. It is replaced by the FEMA which would be consistent
with full capital account convertibility with policies of the Central Government. The
RBI administers the control through the authorized forex dealers. The RBI is the
custodian of the country’s foreign exchange reserves. The foreign exchange is
precious and it takes the responsibility of the better utilization.

5. Promoting Authority: The RBI’s function is to look after the welfare of the financial
system. It renders the promotion services to strengthen the country’s banking and
financial structure. It helps in mobilizing the savings and diverting them towards the
productive channel. Thus, the economic development can be achieved. After the
nationalization of the commercial banks, the RBI has taken a number of series of
actions in various sectors such as agriculture sector, industrial sector, lead bank
scheme and cooperative sector.
 Control of R B I by government and its agencies

The Reserve Bank of India (RBI) is the central bank of India and plays a crucial role in the country’s
financial system, monetary policy, and economic stability. While it operates as an autonomous
institution, its operations and policies are influenced and controlled by the government and various
regulatory bodies. Here's an overview of how the RBI is controlled and regulated by the government
and its agencies:

1. Appointment and Oversight

 Governorship Appointment: The Governor of the RBI is appointed by the President of

India, based on the recommendation of the Prime Minister and the Finance Minister. The
RBI's top management, including the Deputy Governors, is also appointed by the
government.

2. Legal and Legislative Framework

 RBI Act, 1934: The RBI operates under the Reserve Bank of India Act, 1934, which outlines
its functions, powers, and governance structure. Amendments to this Act can be made by the
Parliament of India.
 Regulatory Framework: Various regulations and directives issued by the government can
impact the RBI’s policies and operations. For instance, the government may influence the
RBI’s approach to inflation, interest rates, and currency management through legislative
measures.

3. Budgetary and Financial Control

 Annual Report and Accounts: The RBI submits its annual report and financial statements to
the Parliament, which provides transparency about its operations and financial health.
 Government’s Shareholding: The Indian government holds the majority of the RBI’s
shares, which allows it to influence the RBI’s strategic direction and policy decisions.
However, the RBI’s operational autonomy is maintained despite this.

4. Policy Coordination

 Monetary Policy Framework: The RBI and the government collaborate on setting monetary
policy objectives. The Monetary Policy Committee (MPC), which includes members
appointed by the government, is responsible for setting key policy rates like the repo rate and
reverse repo rate.
 Economic Policy Integration: The RBI works closely with the Ministry of Finance to ensure
that monetary policy is aligned with the government’s fiscal policies and economic
objectives.
5. Regulatory Oversight

 Parliamentary Committees: The RBI's functioning is monitored by various parliamentary

committees, such as the Public Accounts Committee and the Estimates Committee, which
review its performance and policies.
 Audit and Compliance: The Comptroller and Auditor General of India (CAG) audits the
RBI’s accounts, providing an additional layer of oversight and ensuring compliance with
legal and financial norms.

6. Government Notifications and Directives

 Policy Directions: The government can issue directions to the RBI on matters of public
interest. For instance, during financial crises or economic disturbances, the government may
issue directives to ensure that the RBI’s policies align with broader economic objectives.
 Consultation on Major Decisions: Major decisions involving monetary policy, banking
sector regulations, and financial stability are often discussed between the RBI and
government officials to ensure coherence with national economic goals.

7. Emergency Powers

 Crisis Management: In times of financial instability or economic crises, the government

may exercise emergency powers that affect the RBI’s policies. For example, during
significant economic events or currency crises, the government may collaborate with the RBI
to implement specific measures to stabilize the economy.

8. Public Accountability

 Transparency Requirements: The RBI is required to maintain transparency in its operations

and decisions. It regularly publishes reports, policy updates, and other documents that are
scrutinized by the government, media, and public.

Overall, while the RBI enjoys operational autonomy to execute its functions effectively, its policies
and operations are subject to oversight and influence by the government and its agencies. This
balance is designed to ensure that the central bank can manage monetary policy independently while
aligning with broader economic and fiscal objectives set by the government.

Need for elimination of systematic risk

Systematic risk, also known as market risk, refers to the risk of losses that affects the entire financial
market or economy. Unlike specific risk, which affects individual assets or companies, systematic
risk impacts all investments in the market. While it is impossible to completely eliminate systematic
risk, there are several strategies and reasons for mitigating and managing it effectively. Here’s why
addressing systematic risk is important and how it can be approached:

1. Stability of Financial Markets

  Preventing Systemic Crises: Systematic risk can lead to systemic crises that affect the entire
financial system. By mitigating this risk, authorities can help prevent scenarios like the global
financial crisis of 2008, where the collapse of major financial institutions had widespread
repercussions.
 Market Confidence: Effective management of systematic risk helps maintain investor
confidence in financial markets. When investors feel that markets are stable, they are more
likely to invest, which contributes to overall economic growth.

2. Economic Growth and Stability

 Sustained Economic Performance: High levels of systematic risk can lead to economic
instability, which can hinder long-term economic growth. Managing this risk helps in
maintaining a stable economic environment conducive to growth.
 Investment Planning: Reducing systematic risk allows businesses and investors to plan and
invest with greater certainty, supporting long-term projects and investments.

3. Risk Management for Institutions

 Financial Health of Institutions: Banks, insurance companies, and other financial

institutions are directly impacted by systematic risk. Effective risk management helps ensure
their financial health, preventing bank runs and insolvencies that can affect the wider
economy.
 Regulatory Compliance: Financial institutions are often required to adhere to regulatory
standards that mandate risk management practices, including those addressing systematic
risk. Compliance helps in maintaining overall financial system stability.

4. Investor Protection

 Reducing Volatility: Systematic risk contributes to market volatility, which can lead to
significant losses for investors. Mitigating this risk helps protect investors from extreme
market fluctuations.
 Diversification Limits: While diversification can reduce specific risk, it cannot eliminate
systematic risk. Therefore, managing systematic risk is crucial for investors seeking to protect
their portfolios from broader market movements.

Strategies for Managing Systematic Risk

1. Monetary and Fiscal Policies

 Central Bank Interventions: Central banks use monetary policy tools such as interest rate
adjustments and quantitative easing to stabilize financial markets and manage economic
cycles.
 Government Fiscal Measures: Fiscal policies, including government spending and taxation,
can influence economic activity and help mitigate the effects of systematic risk.

2. Regulatory and Supervisory Measures

  Financial Regulation: Regulations such as capital adequacy requirements, stress testing, and
liquidity requirements help ensure that financial institutions are resilient to systemic shocks.
 Systemic Risk Monitoring: Regulatory bodies monitor financial markets and institutions for
signs of systemic risk and take preemptive measures to address emerging threats.

3. Risk Assessment and Management

 Stress Testing: Financial institutions conduct stress tests to evaluate their resilience under
various economic scenarios, including extreme market conditions.
 Risk Models: Advanced risk modeling techniques, including Value at Risk (VaR) and
scenario analysis, help in understanding and managing potential impacts of systematic risk.

4. International Cooperation

 Global Financial Stability: International cooperation among regulators and central banks is
crucial for addressing systemic risk that transcends national borders. Organizations like the
Financial Stability Board (FSB) and the Basel Committee on Banking Supervision (BCBS)
work towards global financial stability.
 Information Sharing: Sharing information and best practices among countries and
institutions helps in managing global financial risks more effectively.

5. Market Infrastructure and Transparency

 Improving Market Infrastructure: Strengthening financial market infrastructure, such as

trading platforms and clearinghouses, helps reduce systemic risk by enhancing market
efficiency and stability.
 Enhancing Transparency: Increasing transparency in financial markets and institutions aids
in early detection of risk and helps in informed decision-making.

While complete elimination of systematic risk is not feasible due to its inherent nature, effective
management and mitigation strategies can significantly reduce its impact and contribute to a more
stable financial and economic environment.

MONEY LAUNDERING

Money Laundering is a method of legitimizing the illegally earned money so as to avoid

being caught while carrying on illegal activities and avoid taxes. It involves three stages.
They are:

1. Placement- the person places a sum of money in the bank in the form of cash. This is
the riskiest stage as banks are required to report high value transactions. The money is
 usually broken in smaller amounts and then placed in banks.
2. Layering- at this stage the money is transferred into various overseas anonymous
bank accounts in countries where banks have secrecy codes. This money is then
invested in purchase of valuable things like diamonds, ship, etc.
3. Integration- the illegal money appears legal and can be used by the launderer. It’s
very difficult to catch hold of money laundering at this stage. The investment done in
layering stage can now be sold and the money having received appears to have been
acquired by legal means.

In India, the Prevention of Money Laundering Act, 2002 came into force on 1st July 2005.
Section 3 of Prevention of Money Laundering Act, 2002 says “Whosoever directly or
indirectly attempts to indulge or knowingly assists or knowingly is a party or is actually
involved in any process or activity connected with the proceeds of crime and projecting it as
untainted property shall be guilty of offence of money laundering”. It was amended in 2009.
The Act provides for rigorous imprisonment for a term of not less than 3 years and fine. The
banks are required to keep a record of all the transactions for 10 years and furnish the
information to the director appointed by centre within prescribed time. Under Section 56 of
the Act the Centre can enter into an agreement with foreign county for exchange of
information to prevent such act under the provisions of this act or corresponding law in force
in that country.

CONSTITUTIONAL VALIDITY OF PMLA, 2002

In the case of B. Rama Raju v. UOI & Ors. ([2011]164CompCas149(AP)) constitutional

validity of Section 2 (1) (u), 5, 8 and 23 were challenged. The court looked into the object of
the act. The property in possession of any person other than the one who has been charged
with for committing the offence can also be attached and confiscated. With respect to the
retrospective penalization the court held that the Parliament has the power to allow
confiscation of property acquired by illegal means prior to the enactment of this act. With
respect to the presumption enjoined by section 23 of the Prevention of Money
Laundering Act, 2002 (PMLA,2002) the court held that Section 23 enjoins a rule of
evidence and rebuttable presumption considered essential and integral to effectuation of
purposes of Act in legislative wisdom. It’s a rebuttable and an irrebuttable presumption.
Hence validity of the provisions was upheld.

OMBUDSMAN

Banking Ombudsman Scheme is a mechanism created by the RBI to address the complaints
raised by bank customers. It is run by the RBI directly to ensure customer protection in the
banking industry. According to the RBI, “The Scheme enables an expeditious and
inexpensive forum to bank customers for resolution of complaints relating to certain services
rendered by banks.”

The Banking Ombudsman Scheme was introduced under Section 35 A of the Banking
Regulation Act, 1949 by RBI with effect from 1995. The present Ombudsman scheme was
introduced in 2006. The Banking Ombudsman is a senior official appointed by the Reserve
Bank of India. He has the responsibility to redress customer complaints against deficiency in
certain banking services. At present fifteen Ombudsmen were appointed by the RBI to settle
complaints and they are appointed in state capitals. All Scheduled Commercial Banks,
Regional Rural Banks and Scheduled Primary Co-operative Banks are covered under the
Scheme.

The Banking Ombudsman can receive and consider any complaint relating to a number of
deficiencies related to banking operations including internet banking. RBI has mentioned a
large number of service deficiencies by banks to customers where the customers can
approach the Ombudsman through a complaint. Following are some of the instances.

1) non-payment or inordinate delay in the payment or collection of cheques, drafts, bills

etc.;
 2) non-acceptance, without sufficient cause, of small denomination notes tendered for
any purpose, and for charging of commission in respect thereof;
3) non-acceptance, without sufficient cause, of coins tendered and for charging of
commission in respect thereof;
4) non-payment or delay in payment of inward remittances;
5) failure to issue or delay in issue of drafts, pay orders or bankers’ cheques;
6) non-adherence to prescribed working hours;

A customer can file a complaint before the Banking Ombudsman if the bank doesn’t give a
reply to the customer within a period of one month or the bank rejects the complaint, or if the
complainant is not satisfied with the reply by the bank.

MONOPOLY OF NOTE ISSUE

The central bank in India the RBI has the monopoly of issuing currency notes which are legal
tender. In India the RBI is empowered to issue notes of all denominations except one rupee
note. One-rupee note is the standard money in India and is issued directly by the ministry of
finance of the Government of India. The distribution of the one-rupee note is undertaken by
the RBI. The central bank keeps three considerations in view in its issue of notes, viz.
uniformity, elasticity and safety. The advantages of the monopoly of note issue are:

 It ensures uniformity in the currency making it easy for people to identify it.
 It facilitates effective state supervision.
 It facilitates effective state supervision and therefore regulates the issue of paper
currency by the central bank [ RBI].
 The notes enjoy a distinctive prestige when they are issued by a single bank.
 It enables the government to maintain control over undue credit expansion and avoids
danger of over issue.
 It creates confidence among people.
 It helps to maintain price stability as central banks control credit creation.
 CREDIT CONTROL

Credit control is the most important function of reserve bank of India. Credit control in the
economy is required for the smooth functioning of the economy is required for the smooth
functioning of the economy. By using credit control methods RBI tries to maintain monetary
stability. There are two types of methods:

 Quantitative control to regulate the volume of total credit

 Qualitative control to regulate the flow of credit

The primary objective is to control inflationary tendencies present in the economy to ensure
high economic growth with adequate level of liquidity and maximum utilization of resources.
Other objectives of credit control are as follow:

 To achieve internal price stability

 To achieve financial stability
 To achieve stability in foreign exchange rate
 To meet the financial requirement during slump in the economy
 To maximize income, output and employment in the economy
 To eliminate business cycles and meet business needs
 To promote economic growth and development of the country

BANK RATE POLICY

The bank rate policy is the official interest rate at which RBI rediscounts the approved bills
held by commercial banks. For controlling the credit, inflation and money supply, RBI will
increase the bank rate.

NON- BANKING FINANCIAL INSTITUTIONS

A Non-Banking Financial Company (NBFC) is a company engaged in the business of loans

and advances, acquisition of stocks/ bonds/ debentures issued by government or local
authority. A non-banking financial company provides Banking services to people without
holding a bank
license. A non-banking institution which is a company and has principal business of receiving
deposits in one lump sum or in instalments is also a non- banking financial company.
 UNIT- 4

NEGOTIABLE INSTRUMENTS

INTRODUCTION

In the world of business and finance, negotiable instruments are a very important tool. They
provide the parties with an ease of doing business. And they can also be a source of finance
when in need of funds. Negotiable instruments are the most common credit devices utilized in
business society. Negotiable instruments importance lies in the fact that these are more
readily transferred than ordinary claims or contract rights that the transferee of a negotiable
instrument may acquire greater rights than would an ordinary assignee. Though basically,
negotiable instruments are written promises or orders to pay money, such as promissory
notes, bills of exchange and cheques which when in proper form, may be transferred from
person to person as a substituted of money. The law relating to negotiable instruments in
India is incorporated in Negotiable Instrument Act, 1881. The Act is not comprehensive. It
does not affect the local usage or customs. If any local usage or custom is contrary to the
provisions of this act, the local usage overrides the Act. The act includes only three
instruments in its ambit, viz. Bill of exchange, promissory note and cheque. But the act will
also be extended to other instruments possessing the characteristics of a negotiable
instrument, by local customs, for example Hundi. The act also does not prohibit the transfer
of instruments by other methods. e.g. by assignment.

NEGOTIABLE INSTRUMENT

A negotiable instrument is actually a written document. This document specifies payment to a

specific person or the bearer of the instrument at a specific date. So, it can be defined as “a
document signifying an unconditional promise signed by the person giving promise, requiring
the person to whom it is addressed to pay on demand, or at a fixed date or time, a certain sum
to or to the order of a specified person, or to bearer.” Negotiable instrument are money or
cash equivalents. These can be converted into liquid cash subject to certain conditions.
According to section 13 of Negotiable instruments act of 1881. Negotiable instruments mean
promissory note bills of exchange or cheque payable either to order or to bearer.

According to section 13 (a), Negotiable Instrument means a promissory note, bill of exchange
or cheque payable either to order or to bearer, whether the ‘words’ order or ‘bearer’ appear
on the instrument or not.

CONDITIONS OF NEGOTIABILITY

Any other instrument can be added to these three if it satisfies two conditions of negotiability.

 One is that it is by customs of trade transferable by delivery or by endorsement

and delivery;
 second is that it is capable of being sued upon by the person holding out in his
own name.

The nature of negotiable instrument is such that property in it is acquired by every person
who takes it bona fide and for value, notwithstanding any defect of title in the person from
whom he took it. On this basis a negotiable instrument may be defined as a contractual
obligation in writing and signed by the party executing it, containing an unconditional
promise or order to pay a sum certain in-money on demand, or at a fixed or determinable
future time, payable to bearer or to the order of a specified person.

ESSENTIAL ELEMENTS OF NEGOTIABLE INSTRUMENTS

To be negotiable an instrument must have the following elements:

1. A negotiable instrument must be in writing, which includes typing, printing and

engraving.
2. The instrument must be signed by the maker or drawer.
3. There must be a promise if it is a promissory note or order to pay if it is a bill of
exchange.
4. The promise or order must be unconditional. If it is conditional the instrument is not
negotiable.
 5. A negotiable instrument must call for payment in money. If the promise or order is
for anything else, the instrument is not negotiable.
6. The instrument must not only call for payment in money but also for a certain sum.
7. A negotiable instrument must be payable at a time which is certain to arrive which
may be payable either on demand or at a particular time or at a determinable future
time. If it is payable when convenient, the instrument is not negotiable because the
day of payment may not arrive. The requirement that there must be a time certain to
arrive does not mean that the instrument must specify a fixed date for payment.
8. A negotiable instrument must be payable to order or bearer: Without the words order
or bearer, the instrument would not be negotiable because, if they were not there, no
one but the payee could present them for payment. If it is merely payable to Ram, it
is not negotiable. It is not necessary that the instrument actually use the words
‘order’ or ‘bearer’. And other words indicating the same intention are sufficient. ‘Pay
to holder’ could be used in place of ‘order’ or ‘bearer’.
9. In the case of a bill of exchange or cheque, the drawee must be named or described
with reasonable certainty. The purpose of this requirement is to enable the holder of
the instrument to know to whom he must go for payment.

PRESUMPTIONS AS TO NEGOTIABLE INSTRUMENTS

Since the philosophy underlying the law of Negotiable instruments is that business
transactions should be facilitated by making available evidence of right to money that will
pass freely from hand to hand. In order to facilitate the free transfer of negotiable instruments
from one party to another, Section 118 of the Act provides that until the contrary is proved,
the following presumptions shall be made:

1. That every negotiable instrument was made or drawn, accepted, endorsed and
negotiated or transferred for consideration.
2. That it bears the date on which it was made or drawn.
3. That every accepted bill was accepted within a reasonable time after its date and
before its maturity.
4. That every transfer of a negotiable instrument was made before maturity.
 5. That the endorsements appearing on it were made in the order in which they appear
thereon.
6. Where an instrument has been lost or destroyed, that it was duly stamped and the
stamp was duly cancelled.
7. That the holder of the instrument is a holder in due course.

The object of these presumptions is to declare the instrument as valid and in good order it a
suit is filed in respect of a negotiable instrument; the Court will presume that the instrument
was in good order and valid. If any party challenges its validity, he shall have to prove to the
contrary. These presumptions are necessary in the case of negotiable instruments, as they are
credit instruments and intended to be created as money which can pass freely from hand to
hand.

KINDS OF NEGOTIABLE INSTRUMENT

Negotiable instruments act includes only three types of instruments:

1. Promissory note
2. Bill of Exchange
3. Cheque
1. PROMISSORY NOTES: Section 4 of the Act defines, “A promissory note is an
instrument in writing (note being a bank-note or a currency note) containing an
unconditional undertaking, signed by the maker, to pay a certain sum of money to or
to the order of a certain person, or to the bearer of the instruments.” The person who
makes the promissory note and promises to pay is called the maker. The person to
whom the payment is to be made is called the payee.
2. BILL OF EXCHANGE: According to Section 5 of the act, A bill of exchange is “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”. It is also called a Draft. A bill of
exchange is a double secured instrument. In case of immediate requirement, a Bill
may be discounted with a bank.
 3. CHEQUE: According to Section 6 of the act, A cheque is “a bill of exchange drawn
on a specified banker and not expressed to be payable otherwise than on demand”. A
cheque is also, therefore, a bill of exchange with two additional qualification. It is
always drawn on a specified banker. It is always payable on demand.

FEATURES OF NEGOTIABLE INSTRUMENTS

There are certain features of Negotiable Instruments which are as follows:

1. Easily Transferable: A negotiable instrument is easily and freely transferable. There

are no formalities or much paperwork involved in such a transfer. The ownership of
an instrument can transfer simply by delivery or by a valid endorsement.
2. Must be Written: All negotiable instruments must be in writing. This includes
handwritten notes, printed, engraved, typed, etc.
3. Time of Payment must be Certain: If the order is to pay when convenient then such
an order is not a negotiable instrument. Here the time period has to be certain even if
it is not a specific date. For example, it is acceptable if the time of payment is linked
with the death of a specific individual. As death is a certain event.
4. Payee also must be certain: The person to whom the payment is to be made must be
a specific person or persons. Also, there can be more than one payee for a negotiable
instrument. And “person” includes artificial persons as well, like body corporates,
trade unions, chairman, secretary etc.

HOLDER AND HOLDER IN DUE COURSE

As per Negotiable Instrument Act, 1881, a holder is a party who is entitled in his own name
and has legally obtained the possession of the negotiable instrument, i.e. bill, note or cheque,
from a party who transferred it, by delivery or endorsement, to recover the amount from the
parties liable to meet it. The party transferring the negotiable instrument should be legally
capable. It does not include the someone who finds the lost instrument payable to bearer and
the one who is in wrongful possession of the negotiable instrument. Holder in Due Course is
defined as a holder who acquires the negotiable instrument in good faith for consideration
before it becomes due for payment and without any idea of a defective title of the party who
transfers the instrument to him. Therefore, a holder in due course. When the instrument is
payable to bearer, HDC refers to any person who becomes its possessor for value, before the
amount becomes overdue. On the other hand, when the instrument is payable to order, HDC
may mean any person who became endorsee or payee of the negotiable instrument, before it
matures. Further, in both the cases, the holder in both the cases he must acquire the
instrument, without any notice to believe that there is a defect in the title of the person who
negotiated it.

PARTIES

The parties to a negotiable instrument are explained below:

i. Drawer: the person who makes or executes the note promising to pay the amount
ststed therein.
ii. Drawee: the person directed to pay the money by the drawer. The drawee is the
paying bank in case of cheque.
iii. Payee: payee is the person whose name is written on the promissory note or bill of
exchange or cheque. The payee is entitled to receive amount mentioned in the note or
bill or cheque.
iv. Endorser: a signature of the owner would serve the legal rights to transfer an
instrument to another party. The holder of the instrument who transfers his right to
another party by endorsement is called endorser.
v. Endorsee: if the endorser adds a direction to pay the amount mentioned in the
instrument to, or to the order of, a specified person, the person so specified is called
the endorsee of the instrument.

PAYMENT IN DUE COURSE

Section 10 of Negotiable Instrument Acts defines ‘Payment in due course’ as payment in

accordance with the apparent tenor of the instrument in good faith and without negligence to
any person in possession thereof under circumstances which do not afford a reasonable
ground for believing that he is not entitled to receive payment of the amount therein
mentioned.
 NEGOTIATION

According to Section 14 of Negotiable Instrument Act 188 "When a promissory note, bill of
exchange or cheque is transferred to any person, so as to constitute the person the holder
thereof, the instrument is said to be negotiated. Negotiation may take place:

 by delivery
 by endorsement and
 delivery

According to Section 47 Subject to the provisions of Section 58 of the Negotiable Instrument

Act, 1881 a promissory note, bill of exchange or cheque payable to bearer is negotiable by
delivery thereof.

Exception: A promissory note, bill of exchange or cheque delivered on condition that it is not
to take effect except in a certain event is not negotiable (except in the hands of a holder for
value without notice of the condition) unless such event happens.

According to Section 48 of the said Act Negotiation by endorsement, Subject to the

provisions of Section 58, a Promissory Note, bill of exchange or cheque payable to order, is
negotiable by the holder by endorsement and delivery thereof.

PRESENTMENT

A bill of exchange is a negotiable instrument in writing containing an unconditional order,

directing a certain person to pay a certain amount only to or to the order of a certain person or
to the bearer. The drawer is the person who draws the bill and presents it to the drawee for
acceptance. Out of all the negotiable instruments, only bills of exchange require presentment
for acceptance.
 DISCHARGE FROM LIABILITY

The maker, acceptor or endorser respectively of a negotiable instrument is discharged from

liability thereon-

 By cancellation-to a holder thereof who cancels such acceptor's or endorser's name

with intent to discharge him, and to all parties claiming under such holder,
 By release- to a holder thereof who otherwise discharges such maker, acceptor or
endorser, and to all parties deriving title under such holder after notice of such
discharge;
 By payment-to all parties thereto, if the instrument is payable to bearer, or has been
endorsed in blank, and such maker, acceptor or endorser makes payment in due
course of the amount due thereon.

DISHONOUR

Dishonour of a negotiable instrument means the loss of honour for the instrument on the part
of the maker, drawee or acceptor, which renders the instrument unsuitable for the realization
of the payment. Modes of dishonour are as follows:

i. Dishonour by Non-Acceptance: Dishonour by non-acceptance is a situation of

refusal to accept a negotiable instrument. Further, we generally observe dishonour by
non- acceptance in the case of a bill of exchange.
ii. This is because it is the only kind of negotiable instrument that requires presentment
for acceptance or non-acceptance.
iii. Also, in case of dishonour by non-acceptance, only the makers and endorsers are
liable to the holder of the bill, provided the holder issues a notice of dishonour. Some
circumstances that lead to the dishonour of a bill by non-acceptance are:
a. When the drawee refuses to accept it within 48 of presentment for acceptance.
b. In the case of an excuse of presentment, leading to a non-acceptance of the bill.
c. When the drawee is incompetent to contract.
d. When we cannot find the drawee after a reasonable search.
e. If the drawee is a fictitious person.
 f. When acceptance is a qualified one.
iv. Dishonour by Non-payment: A promissory note, bill or cheque is dishonoured if the
maker, drawee or acceptor of the cheque commits default in payment upon being
required to do the same. Furthermore, a holder of a promissory note or bill may call it
dishonoured if the maker or the acceptor expressly excuses the presentment of
payment when payment remains overdue. It is important to realise that all the
endorsers and maker of a bill are liable to the holder in case of dishonour of the bill,
provided the holder issues notice of dishonour. Further note that a drawee is liable to
the holder only in the case of dishonour by non-payment.

CIVIL LIABILITY

Generally, in case of dishonour of cheque, the payee or holder in due course, as the case may
be, has two remedies:

 To file a civil suit

 To bring a criminal prosecution under Section 138

A civil suit for recovery of money as well as a complaint under Section 138 is maintainable.
Civil liability of dishonour of cheque is not taken away or curtailed because of incorporation
of Chapter XVII in the Act. Mere launching of a prosecution under Section 138 or even
obtaining conviction under Section 138 against the drawer would not prevent the complainant
from taking a civil action for recovery of the cheque amount or any part of it. It would not
offend the rule against double jeopardy. The Supreme Court has held that pendency of the
criminal matters would not be an impediment to the proceedings with the civil suits. Both
remedies may be simultaneously possible.

PAYING BANKER: The banker on whom a cheque is drawn or the banker who is required
to pay the cheque drawn on him by a customer is called the paying banker.

Procedure for prosecution under the Negotiable Instruments Act, 1881

The procedure for prosecution under the Negotiable Instruments Act, 1881, primarily deals with offenses
related to dishonor of cheques, including dishonor due to insufficient funds or exceeding the amount covered
by the drawer's account. Here is a detailed outline of the prosecution procedure under the Act:*1. Filing of
Complaint
 Dishonor of Cheque: When a cheque is dishonored due to reasons like insufficient funds or
exceeding the amount covered, the payee or holder of the cheque must first ensure that the dishonor is
due to valid reasons as stipulated by the Act.
 Notice of Dishonor: The payee or holder must issue a formal written notice to the drawer of the
cheque within 30 days of the dishonor. This notice must demand payment of the cheque amount and
inform the drawer of the intention to initiate legal proceedings if the amount is not paid within 15 days
of receiving the notice.
 Proof of Service: The notice should be sent via registered post or any other method that provides
proof of delivery to ensure that the drawer receives it.
2. Lodging of Complaint
 Jurisdiction: The complaint must be filed in the court of a Metropolitan Magistrate or a Judicial
Magistrate of the First Class having jurisdiction over the area where the cheque was dishonored or
where the drawer resides.
 Complaint Filing: The complainant (payee or holder) files a criminal complaint under Section 138 of
the Negotiable Instruments Act, detailing the dishonor of the cheque and the steps taken as per the
Act. The complaint must include:
o A copy of the dishonored cheque.
o The bank memo or return memo showing the reason for dishonor.
o Proof of the notice sent to the drawer.
o Proof of the drawer’s non-payment within the specified period.
3. Issuance of Process
 Summons or Warrant: Upon receipt of the complaint, the Magistrate will issue a summons to the
accused (drawer) to appear in court. In case of non-compliance or if the drawer is not found, the
Magistrate may issue a warrant for the accused's arrest.
 Preliminary Hearing: The court conducts a preliminary hearing to assess the evidence and the
validity of the complaint.
4. Trial Procedure
 Presentation of Evidence: During the trial, the complainant must present evidence proving the
dishonor of the cheque, the notice sent, and the drawer's non-payment.
 Defense: The accused (drawer) has the opportunity to present their defense. Common defenses
include claiming that the cheque was not issued, that there was a mistake, or that the notice was not
received.
5. Judgment and Sentencing
 Conviction or Acquittal: After examining the evidence and hearing both sides, the court will render a
 judgment. If the accused is found guilty, the court may impose a penalty, which can include
imprisonment of up to two years or a fine that can be twice the amount of the dishonored cheque or
both.
 Appeal: Both the complainant and the accused have the right to appeal the decision to a higher court
if dissatisfied with the judgment.*6. Execution of Sentence
 *6. Execution of Sentence
 Enforcement: If the court imposes a fine, the amount may be recovered from the accused. If
imprisonment is ordered, it will be carried out as per the court’s directions.
Additional Considerations
 Civil Suit: In addition to criminal proceedings, the payee may also file a civil suit for recovery of the
cheque amount. This is separate from the criminal prosecution under the Negotiable Instruments Act.
 Limitation Period: The complaint must be filed within one month from the date of expiration of the
15-day notice period. Any delay beyond this period may result in the dismissal of the complaint due to
the limitation period.
By following these steps, the aggrieved party can pursue legal action under the Negotiable Instruments Act to
seek redressal for the dishonor of a cheque.

Extent of Penalty

Under the Negotiable Instruments Act, 1881, the penalties for offenses related to the dishonor of
cheques are specified in Sections 138 to 142. The extent of the penalty varies depending on the
nature of the offense and the specific section under which the prosecution is brought. Here is a
detailed overview of the penalties:

1. Section 138: Dishonor of Cheque for Insufficient Funds

 Imprisonment: The maximum term of imprisonment can be up to two years.

 Fine: The fine can be up to twice the amount of the dishonored cheque. Alternatively, the
fine can be the amount of the cheque itself, whichever is higher.

2. Section 139: Presumption in Favor of Holder

 This section provides for a presumption in favor of the holder of the cheque, which assumes
that the cheque was issued for the discharge of a debt or liability. This section itself does not
specify penalties but supports the enforcement of penalties under Section 138.

3. Section 140: Offenses by Companies

  Imprisonment: If a company is found guilty, the directors or other officers who were
responsible for the company’s affairs can be held liable. The imprisonment term can be up to
two years.
 Fine: The fine can be up to twice the amount of the dishonored cheque or the cheque
amount itself, whichever is higher.

4. Section 141: Liability of Company Officers

 Imprisonment: The maximum term of imprisonment for individuals (directors, managers, or

other officers) responsible for the company's affairs can be up to two years.
 Fine: The fine for individuals can be up to twice the amount of the dishonored cheque or
the cheque amount itself, whichever is higher.

5. Section 142: Cognizance of Offenses

 Limitation Period: Complaints under Section 138 must be filed within one month from the
date of the expiration of the 15-day notice period. This section does not specify penalties but
outlines the procedure for filing complaints.*6. Section 143: Summary Trials

 Summary Trial Procedure: In certain cases, the trial of offenses under Section 138 can be
conducted summarily. This procedure aims for a quicker resolution but the penalties remain
the same.

7. Additional Penalties

 Compensation: In addition to the fine, the court may also direct the accused to pay
compensation to the complainant for any loss or injury caused by the dishonor of the cheque.
 Recovery of Amount: If the fine is not paid, the court may order recovery of the cheque
amount as part of the fine.

8. Appeals and Further Actions

 Appeal: The accused or the complainant can appeal the court's decision if they are
dissatisfied with the judgment. The appeal may seek to alter the penalty imposed or challenge
the decision.
 Execution: If a fine is imposed, the court may order its execution. In cases of imprisonment,
the sentence is carried out according to legal procedures.

The penalties for offenses under the Negotiable Instruments Act are designed to act as a deterrent
against the dishonor of cheques and ensure that parties involved in such transactions fulfill their
financial obligations.

The paying Bankers

In the context of banking and the Negotiable Instruments Act, 1881, the term "paying banker"
refers to a bank that is responsible for paying out the amount of a negotiable instrument, such as a
cheque, when it is presented for payment. Here’s an overview of the role and responsibilities of
paying bankers:

Role of the Paying Banker

1. Payment Processing:
o The primary role of the paying banker is to honor and pay the amount specified on a
cheque or other negotiable instruments when presented for payment, provided that the
cheque is valid and there are sufficient funds in the drawer’s account.
2. Cheque Clearing:
o The paying banker processes cheques through the clearing system, which involves
presenting the cheque to the central clearing house and ensuring that the payment is
made from the drawer’s account to the payee’s account.

Responsibilities of the Paying Banker

1. Verification of Cheque:
o Signature: Ensure that the signature on the cheque matches the signature on record.
o Date: Check that the cheque is dated correctly and is within its validity period
(typically six months from the date of issuance).
o Amount: Verify that the amount in words matches the amount in figures.
2. Sufficiency of Funds:
3.
o The paying banker must ensure that there are sufficient funds in the drawer’s account
to cover the amount of the cheque. If the account has insufficient funds, the banker
may refuse to honor the cheque, resulting in dishonor.
4. Compliance with Legal and Regulatory Requirements:
5.
o Endorsement: Verify that the cheque has been properly endorsed, if required.
o Stop Payment Instructions: If the drawer has issued a stop payment instruction or if
the cheque is marked "stale" (i.e., presented after its validity period), the paying
banker must refuse payment.
o Account Status: Check that the account is active and not frozen or closed.
6. Handling Dishonored Cheques:
7.
o Return Memo: If a cheque is dishonored, the paying banker must issue a return
memo indicating the reason for dishonor (e.g., insufficient funds, account closed).
o Notice to Drawer: The paying banker may need to assist in sending a notice to the
drawer if required for the complainant to initiate legal action under the Negotiable
Instruments Act.
8. Dispute Resolution:
9.
o Communication with Customers: Address any disputes or queries from the drawer
or payee regarding the payment or dishonor of cheques.
o Record Keeping: Maintain proper records of all transactions and communications
related to cheque payments and dishonors.
Legal Protections and Duties

1. Protection Under Negotiable Instruments Act:

o Good Faith: The paying banker is protected under the Act if they act in good faith
and follow due diligence. If the banker follows all prescribed procedures and the
cheque is dishonored for valid reasons, they are not liable for penalties.
o Due Diligence: The paying banker must exercise reasonable care and diligence in
verifying the cheque and the account details to avoid wrongful dishonor.

2. Liability for Wrongful Dishonor:

o Compensation Claims: If a paying banker dishonors a cheque without valid reasons
or fails to act according to legal requirements, they may be liable for damages and
compensation claims from the payee or drawer.
3.

Legal Framework and Procedures

1. Negotiable Instruments Act, 1881:

o The Act outlines the roles and responsibilities of paying bankers, including the
procedures for honoring or dishonoring cheques and the legal implications of such
actions.
2. Banking Regulations and Guidelines:
o Banks must comply with regulations set by the Reserve Bank of India (RBI) and other
regulatory bodies regarding the handling and processing of negotiable instruments.

By fulfilling these roles and responsibilities, the paying banker ensures the smooth operation of the
financial system, maintains trust between parties, and supports the integrity of financial transactions
involving negotiable instruments.
 DUTY TO HONOUR CUSTOMER’S CHEQUE

The deposits accepted by a banker are his liabilities repayable on demand or

otherwise. The banker is, therefore, under a statutory obligation to honour his
customer’s cheques in the usual course. Section 31 of the Negotiable Instruments Act,
1881, lays down that, “The drawee of a cheque having sufficient funds of the drawer
in his hands, properly applicable to the payment must compensate the drawer for any
loss or damage caused by such default.”

Exception to the duty to Honour Cheque

Under the Negotiable Instruments Act, 1881, the paying banker generally has a duty to honor
a cheque when it is presented for payment, provided that all conditions for payment are met.
However, there are several exceptions to this duty where the paying banker is justified in
refusing to honor a cheque. These exceptions are outlined in various provisions of the Act
and in general banking practice. Here’s an overview of these exceptions:

1. Insufficient Funds

 Explanation: If the drawer’s account does not have sufficient funds to cover the
amount of the cheque, the paying banker can refuse to honor the cheque.
 Example: A cheque presented for payment exceeds the available balance in the
drawer's account.

2. Account Closed

 Explanation: If the drawer’s account has been closed before the cheque is presented,
the paying banker is not obligated to honor the cheque.
 Example: A cheque is presented for payment after the drawer has closed their bank
account.

3. Stale Cheque

 Explanation: A cheque that is presented after the validity period, typically six
months from the date of issuance, is considered "stale" and can be refused by the
paying banker.
 Example: A cheque dated January 1 is presented for payment on July 2, after six
months have elapsed.

4. Post-Dated Cheque
  Explanation: If a cheque is presented for payment before its stated date, the paying
banker may refuse to honor it, as it is not yet due for payment.
 Example: A cheque dated October 15 is presented for payment on October 10.

5. Signature Mismatch

 Explanation: If the signature on the cheque does not match the signature on record
with the bank, the paying banker can refuse payment.
 Example: The signature on the cheque differs significantly from the signature in the
bank's records.

6. Altered or Forged Cheque

 Explanation: If a cheque appears to be altered or forged, the paying banker is not

obligated to honor it. Alterations must be properly authenticated, and forgeries are not
valid for payment.
 Example: The amount or payee details on the cheque are altered without proper
authentication.

7. Cheque Stopped Payment

 Explanation: If the drawer has issued a stop payment instruction on the cheque, the
paying banker must refuse to honor it.
 Example: The drawer informs the bank to stop payment on a cheque before it is
presented for payment.

8. Cheques Issued with Conditions

 Explanation: If the cheque is issued subject to specific conditions that have not been
met, the paying banker can refuse payment. This includes cheques issued as "payable
only on fulfillment of conditions" that have not been met.
 Example: A cheque issued as a part of a settlement agreement that has specific
conditions, which have not been fulfilled.

9. Presentation Outside Banking Hours

 Explanation: If the cheque is presented outside the normal banking hours or beyond
the time set by the bank for presenting cheques, the paying banker might refuse
payment until the next business day.
 Example: A cheque is presented at a time when the bank’s clearing house is closed.

10. Dishonor Due to Legal Restrictions

 Explanation: If there are legal restrictions or court orders against the drawer's
account or specific cheques, the banker must comply with these legal instructions.
 Example: A court order or attachment order prohibits the payment of a cheque.

11. Irregularity in Endorsement

  Explanation: If the cheque has not been properly endorsed or has an irregular or
missing endorsement where required, the paying banker can refuse to honor it.
 Example: A cheque is presented for payment but lacks the required endorsements for
negotiation.

12. Cheque Not Presented to the Paying Bank

 Explanation: If the cheque is not presented to the paying banker within the stipulated
time or at the correct branch, the banker may refuse to honor it.
 Example: A cheque is presented for payment at a branch where it is not payable.

These exceptions provide a framework for when a paying banker can rightfully refuse to
honor a cheque. It is important for both the drawer and the payee to be aware of these
conditions to ensure smooth transactions and to avoid potential disputes.

Money paid by mistake, good faith,

Under the Negotiable Instruments Act, 1881, which governs the use and regulation of
negotiable instruments like promissory notes, bills of exchange, and checks in India, the
concepts of "money paid by mistake" and "good faith" have specific implications. Here's a
detailed explanation:

Money Paid by Mistake

1. General Principle:
o If money is paid under a mistake of fact, the payer has the right to claim it
back, as it was not intended to be transferred under the conditions of the
payment. This principle applies broadly in contract law and can also be
relevant in the context of negotiable instruments.
2. Section 72 of the Indian Contract Act, 1872:
o While not part of the Negotiable Instruments Act, Section 72 of the Indian
Contract Act, 1872 deals with money paid by mistake or under coercion. It
states that a person who has received money by mistake or under coercion
must repay or return it.
o Example: If a bank mistakenly pays out money to someone due to an error,
the recipient is generally obligated to return the money once the mistake is
discovered.

Good Faith in Negotiable Instruments

1. Definition of Good Faith:

o Good faith refers to the honesty and integrity in the transactions involving
negotiable instruments. The holder of a negotiable instrument is often
expected to act in good faith and without knowledge of any defects in the
instrument.
2. Section 9 of the Negotiable Instruments Act:
 oThis section highlights that "a holder in due course" is one who takes an
instrument (e.g., a check or promissory note) for value, in good faith, and
without any notice of defects or claims to it.
o Holder in Due Course: The holder in due course has better rights than the
transferor and is protected against claims and defenses that could be raised
against the previous holder.
3. Protection for Good Faith:
o A holder who acquires an instrument in good faith and for value, without
knowledge of any issues with the instrument, is protected under the law. This
means they are not liable for claims or disputes that arise from defects or fraud
associated with the instrument.

Application in Practice

 Mistaken Payment:
o If a check is mistakenly issued or paid, the payee who received the money
without realizing it was a mistake may be required to return it. The bank or
issuer must prove the mistake and often follow legal processes to recover the
funds.
 Good Faith Transactions:
o If a person receives a check from someone who had no right to issue it, but the
person receiving it was unaware of this and acted in good faith, they are
generally protected as a holder in due course. This protection allows them to
retain the check even if disputes arise about its legitimacy.

In summary, under the Negotiable Instruments Act, the concepts of money paid by mistake
and good faith are intertwined with broader legal principles. Mistaken payments must be
returned, while good faith ensures that holders of negotiable instruments who act without
knowledge of defects are protected in transactions.

STATUTORY PROTECTION TO THE COLLECTING BANKER

Section 131 of the Negotiable Instruments Act provides protection to a collecting

banker who receives payment of a crossed cheque or draft on behalf of his customers.
According to Section 131 of the Act “a banker who has, in good faith and without
negligence, received payment for a customer of a cheque crossed generally or
specially to himself shall not, in case the title to the cheque proves defective, incur
any liability to the true owner of the cheque by reason only of having received such
payment.” The protection provided by Section 131 is not absolute but qualified. A
collecting banker can claim protection against conversion if the following conditions
are fulfilled.

1. Good Faith and Without Negligence: Statutory protection is available to a

 collecting banker when he receives payment in good faith and without
negligence. The phrase in “good faith” means honestly and without notice or
interest of deceit or fraud and does necessarily require carefulness.
Negligence means failure to exercise reasonable care. It is not for the
customer or the true owner to prove negligence on the part of the banker. The
burden of proving that he collected in good faith and without negligence is on
the banker. The banker should have exercised reasonable care and diligence.
Following are a few examples which constitute negligence:
a) Failure to obtain reference for a new customer at the time of
opening the account.
b) Collection of cheques payable to ‘trust accounts’ for crediting to
personal accounts of a trustee.
c) Collecting for the private accounts of partners, cheques payable to
the partnership firms.

d) Omission to verify the correctness of endorsements on cheques

payable to order.
e) Failure to pay attention to the crossing particularly the “not negotiable
crossing.”
2. Collection for a Customer: Statutory protection is available to a collecting
banker if he collects on behalf of his customer only. If he collects for a
stranger or noncustomer, he does not get such protection. As Jones aptly puts
if “duly crossed cheques are only protected in their collection, if handled for
the customer”. A bank cannot get protection when he collects a cheque as
holder for value. In Great Western Railway Vs London and Country Bank it
was held that “the bank is entitled for protection as it received collection for
an employee of the customer and not for the customer.”
3. Acts as an Agent: A collecting banker must act as an agent of the customer
in order to get protection. He must receive the payment as an agent of the
customer and not as a holder under independent title. The banker as a holder
for value is not competent to claim protection from liability in conversion. In
case of forgery, the holder for value is liable to the true owner of the cheque.
4. Crossed Cheques: Statutory protection is available only in case of crossed
 cheques. It is not available in case uncrossed or open cheques because there is
no need to collect them through a banker. Cheques, therefore, must be
crossed prior to their presentment to the collecting banker for clearance. In
other words, the crossing must have been made before it reached the hands of
the banker for collection. If the cheque is crossed after it is received by the
banker, protection is not available. Even drafts are covered by this protection.

To conclude, it is necessary that the collecting banker should have acted without
negligence if he wants to claim statutory protection under Section 131 of the said Act.
The statutory protection is available to the banker if he collects a cheque marked “Not
Negotiable” for a customer, whose name is not used as the payee there-in, provided
the requirements of the said sections are duly complied with.