Fundamentals of Banking CBCFB3T03

Syllabus topics (RTMNU)

• Origin, Meaning and Definition of 'Bank'
• Evolution of Banking in India
• Structure of the Indian Banking System
• Primary Functions: Accepting Deposits: Demand Deposits: Current and Savings; Time Deposits: Recurring and Fixed Deposits, Flexi Deposits (Auto Sweep)
• Granting Loans and Advances: Term Loans, Short-term Credit, Overdrafts, Cash Credit, Discounting of Bills, etc.
• Secondary Functions: Agency Functions: Payment and Collection of Cheques, Bills and Promissory Notes, Execution of Standing Instructions, Acting as a Trustee and Executor
• General Utility Functions: Safe Custody, Safe Deposit Vaults, Remittances of Funds, Pension Payments, Dealer in Foreign Exchange

Origin, Meaning and Definition of 'Bank'

Origin: The word "bank" is believed to come from the Italian word banco, the French word banque and the German word banck, all meaning a bench. Early money-lenders in Italy sat on benches in market places and changed or lent money. When a money-lender failed, people broke his bench — this gave the word "bankrupt" (banco rotto = broken bench).

Meaning: A bank is a financial institution that accepts deposits from the public and uses these funds to give loans and make investments. It is a dealer in money and credit.

Definition (Banking Regulation Act, 1949, Section 5(b)): "Banking means the accepting, for the purpose of lending or investment, of deposits of money from the public, repayable on demand or otherwise, and withdrawable by cheque, draft, order or otherwise."

Essential features of a bank:

1. Deals in money – it accepts deposits and lends money.
2. Public deposits – it accepts deposits from the general public, not only from friends.
3. Repayable on demand or otherwise – deposits are returned on demand or after a fixed time.
4. Withdrawal by cheque/draft – money can be withdrawn by cheque, draft or order.
5. Lending and investment – deposits are used for loans and investment, not for the bank's own trade.
6. Profit and service – it earns interest but also serves the public.

Evolution of Banking in India

The evolution can be seen in three phases: Phase I (1770–1947) – early and Swadeshi banks, many failures; Phase II (1947–1991) – nationalisation and social banking, spread of branches to villages; Phase III (1991 onwards) – reforms, private and foreign banks, technology and digital banking.

Structure of the Indian Banking System

The RBI is at the top as the central bank and regulator. Banks are classified as Scheduled banks (included in the Second Schedule of the RBI Act, 1934) and Non-scheduled banks.

• Commercial banks: (a) Public sector banks – SBI, Bank of Baroda, Punjab National Bank, Canara Bank; (b) Private sector banks – HDFC Bank, ICICI Bank, Kotak Mahindra Bank; (c) Foreign banks – Citibank, HSBC, Standard Chartered; (d) Regional Rural Banks – e.g., Maharashtra Gramin Bank, Vidarbha Konkan Gramin Bank.
• Small finance banks – e.g., AU Small Finance Bank; serve small borrowers.
• Payments banks – e.g., India Post Payments Bank, Airtel Payments Bank; accept small deposits but cannot give loans.
• Co-operative banks: Urban co-operative banks; rural ones – State Co-operative Bank, District Central Co-operative Bank (e.g., Nagpur DCC Bank) and Primary Agricultural Credit Societies (PACS).
• Development / specialised institutions: NABARD (agriculture), SIDBI (small industry), EXIM Bank (foreign trade), NHB (housing).

Primary Functions: Accepting Deposits

Accepting deposits is the first basic function. Deposits are of two kinds:

Primary Functions: Granting Loans and Advances

• Term loans – medium/long-term loans (above 1 year) for buying machinery, buildings, home or vehicles; repaid in EMIs.
• Short-term credit – loans up to 1 year for working capital, crop loans, etc.
• Overdraft – current account holder is allowed to withdraw more than his balance up to a limit; interest only on the amount overdrawn.
• Cash credit – borrower can withdraw up to a limit against security of stock or book debts; interest on the amount used.
• Discounting of bills – bank pays the amount of a bill of exchange before its due date after deducting a discount, and collects it from the drawee on maturity.
• Others – loans against gold, FDs, shares, etc.

Secondary Functions: Agency Functions

• Payment and collection of cheques, bills and promissory notes for customers.
• Execution of standing instructions – paying insurance premium, rent, EMI, SIP or utility bills regularly as instructed.
• Acting as trustee and executor – managing property as a trustee or carrying out a person's will after death.
• Collecting dividend, interest, pension; buying and selling shares as agent.

Secondary Functions: General Utility Functions

• Safe custody – keeping documents, shares, wills in the bank's safe care.
• Safe deposit vaults (lockers) – customers keep jewellery and documents on annual rent.
• Remittance of funds – sending money through drafts, NEFT, RTGS, IMPS.
• Pension payments – paying pension to government and other pensioners.
• Dealer in foreign exchange – authorised banks buy and sell foreign currency for import, export, travel and education.
• Others: issuing letters of credit, bank guarantees, credit information.

Likely exam questions

1. (Long, 8/16 marks) Define a bank. Trace the evolution of banking in India and explain the structure of the Indian banking system.
2. (Long, 8/16 marks) Explain the primary and secondary functions of a commercial bank.
3. (Short, 4 marks) What is a Flexi Deposit (Auto Sweep) account?
4. (Short, 4 marks) Distinguish between Overdraft and Cash Credit.
5. (Short, 4 marks) State any four general utility functions of a bank.

Syllabus topics (RTMNU)

• Types of Account Holders: Individual Account Holders: Single, Joint, Illiterate, Minor, Non-resident Accounts
• Institutional Account Holders: Sole Proprietorship, Partnership Firm, Joint Stock Company, Hindu Undivided Family, Clubs, Associations and Societies and Trusts
• Procedure for Opening of Deposit Account: Know Your Customer- Needs and Norms (KYC Norms), Application form, Introduction, Proof of residence, Specimen signature and Nomination: Their Importance
• Procedure for Operating Deposit Account: Pay-in-slips, Withdrawal slips, Issue of pass book, (Current Savings or Recurring deposits), Issue of Cheque book, Issue of fixed deposit receipt
• Premature encashment of fixed deposits and loan against fixed deposit
• Recurring deposits: Premature encashment and loan against recurring deposits
• Closure of Accounts
• Transfer of Accounts to Other Branches/Banks

Types of Account Holders: Individual Account Holders

An account holder is a person or body in whose name a bank account is opened. Banks must take special care with each type.

• Single account – opened in the name of one person; only he can operate it.
• Joint account – opened by two or more persons (e.g., husband and wife). The mandate decides who operates: "Jointly", "Either or Survivor", "Former or Survivor", "Anyone or Survivor". On death of one, balance goes as per the mandate.
• Illiterate person – account opened with thumb impression in the presence of a bank officer; withdrawal only in person, with a photograph on record; cheque book is generally not issued.
• Minor (below 18 years) – account can be opened through the natural or legal guardian; a minor above 10 years may be allowed to open and operate a savings account independently as per the bank's policy and RBI rules. No overdraft or loan is given to a minor, because a contract with a minor is void.
• Non-resident accounts – for NRIs: NRE (Non-Resident External, in rupees, money freely repatriable), NRO (Non-Resident Ordinary, for income earned in India) and FCNR(B) (fixed deposit in foreign currency).

Institutional Account Holders

Procedure for Opening of Deposit Account

Know Your Customer (KYC): Needs and Norms. KYC means the bank verifies the identity and address of the customer before opening an account. It is required by RBI's KYC Master Direction under the Prevention of Money Laundering Act, 2002.

• Need: stops money laundering and terror financing; prevents fake/benami accounts; helps the bank know the customer's risk; protects the bank from fraud.
• Norms: recent photograph; PAN (or Form 60); one Officially Valid Document (OVD) – passport, driving licence, voter ID card, proof of possession of Aadhaar, NREGA job card, or NPR letter; customers classified as low/medium/high risk; periodic updation (re-KYC); Video-KYC and e-KYC through Aadhaar allowed.

Steps in opening an account:

1. Application form – filled with name, address, occupation, type of account, signed by the applicant.
2. Introduction – earlier, an existing account holder introduced the new customer. After full KYC, introduction is no longer compulsory, but it still gives the bank extra comfort.
3. Proof of residence – an OVD showing current address; utility bills may be accepted as deemed proof for a limited time.
4. Specimen signature – the customer signs on the specimen signature card; the bank compares it with signatures on cheques. It protects against forgery.
5. Nomination – the customer names a person to receive the money after his death (Section 45ZA, Banking Regulation Act, 1949). It avoids legal delay for the family. Recent amendments allow more than one nominee (up to four).
6. Initial deposit is made and the account number, passbook, cheque book and debit card are issued.

Procedure for Operating Deposit Account

• Pay-in-slip – form used to deposit cash or cheques; the counterfoil is the customer's receipt.
• Withdrawal slip – used by savings account holders to withdraw cash at the branch, only by the account holder.
• Pass book – a record of all deposits, withdrawals and balance, issued for savings, current (now statements) and recurring deposit accounts; it is a copy of the customer's account in the bank's books.
• Cheque book – issued on request to savings and current accounts; CTS-2010 standard cheques are used now.
• Fixed Deposit Receipt (FDR) – issued for a fixed deposit showing amount, rate, period and maturity date; it is not a negotiable instrument.

Fixed and Recurring Deposits: Premature Encashment and Loans

• Premature encashment of FD – depositor can withdraw an FD before maturity; the bank pays interest at the rate applicable for the period actually run, minus a penalty (e.g., 0.5% to 1%).
• Loan against FD – instead of breaking the FD, the depositor can take a loan or overdraft up to about 75–90% of the deposit, at a rate 1–2% above the FD rate. The FD earns interest and the saving stays.
• RD premature encashment – allowed with a lower interest rate/penalty, like FD.
• Loan against RD – up to a percentage (e.g., 75–90%) of the balance in the RD account.

Closure of Accounts

An account may be closed by:

• Customer – by written request, returning unused cheques and debit card; balance paid.
• Bank – after notice, if the account is misused, frequent cheque bouncing, KYC not updated, or customer's conduct is unsatisfactory.
• Law / events – death (paid to nominee or legal heirs), insolvency, insanity of customer, garnishee order of court, or winding up of a company.

Transfer of Accounts to Other Branches/Banks

• To another branch of the same bank – simple request letter or online request (net/mobile banking); same account number continues under core banking; KYC need not be repeated.
• To another bank – open a new account in the other bank, then close the old account and transfer the balance by NEFT/cheque; standing instructions, ECS/NACH mandates must be changed to the new account.

Likely exam questions

1. (Long, 8/16 marks) Explain the precautions a banker should take while opening accounts of a minor, a joint stock company, an HUF and a trust.
2. (Long, 8/16 marks) What is KYC? Explain the procedure for opening a deposit account and the importance of specimen signature and nomination.
3. (Short, 4 marks) Write a note on Non-resident accounts (NRE, NRO, FCNR).
4. (Short, 4 marks) What is premature encashment of a fixed deposit? Is a loan against FD better?
5. (Short, 4 marks) State the circumstances in which a bank account is closed.

Syllabus topics (RTMNU)

• Need and Importance of Technology in Banking
• Meaning, Features, Need and Importance of the following: ATM, Credit Card, Debit Card, Smart Card, Tele Banking, Mobile Banking, Net Banking
• Meaning, Features, Need and Importance of the following: EFT, ECS, E-Wallets, RTGS, NEFT, IMPS and SWIFT
• Advantages and Disadvantages of Technology in Banking
• Cyber Frauds in Banking

Need and Importance of Technology in Banking

Banking technology means the use of computers, internet, mobile phones and networks to give banking services quickly and safely. With Core Banking Solution (CBS), a customer of one branch can bank at any branch of the same bank.

1. Speed – transfers in seconds instead of days.
2. 24×7 service – banking anytime, anywhere ("anywhere, anytime banking").
3. Lower cost – digital transactions cost less than branch transactions.
4. Financial inclusion – villagers can use mobile banking, UPI and Business Correspondents (e.g., Jan Dhan accounts, DBT of subsidies).
5. Accuracy and records – fewer manual errors; instant statements.
6. Competition – banks must offer digital services to keep customers.

ATM, Credit Card, Debit Card and Smart Card

• ATM (Automated Teller Machine) – a machine that lets a customer withdraw cash, check balance, get mini statement and change PIN using a card and PIN. Features: 24×7, cash withdrawal at any bank's ATM (with a free-transaction limit), card-less cash in some banks. Importance: reduces branch rush.
• Debit Card – a card linked to the customer's savings/current account; amount is deducted immediately from the balance. Used at ATMs, POS machines and online.
• Credit Card – a card that allows purchases on credit up to a credit limit; the holder pays the bill later within an interest-free period (about 20–50 days); interest is charged on unpaid dues.
• Smart Card – a plastic card with a microchip that stores data securely (EMV chip cards, metro cards, RSBY cards). More secure than magnetic-stripe cards.

Tele Banking, Mobile Banking and Net Banking

• Tele Banking – banking through a telephone call to the bank's phone banking/IVR number: balance enquiry, cheque book request, stop payment, card blocking. Useful for people without internet.
• Mobile Banking – banking through the bank's mobile app or SMS/USSD (*99#): fund transfer, bill payment, UPI, FD opening. Very popular because of smartphones (e.g., SBI YONO).
• Net Banking (Internet Banking) – banking through the bank's website with user ID, password and OTP: fund transfer, statements, tax payment, opening deposits.

EFT, ECS, E-Wallets

• EFT (Electronic Funds Transfer) – any transfer of money electronically from one account to another without cheque or cash. NEFT, RTGS and IMPS are forms of EFT.
• ECS (Electronic Clearing Service) – used for bulk, repeated payments. ECS Credit: one company pays many people (salary, dividend, pension). ECS Debit: many payments are collected by one company (EMIs, insurance premium, electricity bills). ECS is now largely replaced by NACH (National Automated Clearing House) run by NPCI.
• E-Wallets – prepaid digital wallets in the mobile phone in which money is loaded and used for payments (e.g., Paytm Wallet, Amazon Pay, PhonePe Wallet). Regulated by RBI as Prepaid Payment Instruments.

RTGS, NEFT, IMPS and SWIFT

NEFT has been available 24×7 since December 2019 and RTGS 24×7 since December 2020. Details needed: beneficiary name, account number and IFSC code.

SWIFT (Society for Worldwide Interbank Financial Telecommunication) – a worldwide secure messaging network of banks, started in 1973 and based in Belgium. Each bank has a SWIFT/BIC code. It is used to send instructions for international money transfers, letters of credit and foreign exchange deals. Importance: fast, standard and secure foreign trade payments.

Advantages and Disadvantages of Technology in Banking

Cyber Frauds in Banking

Cyber fraud means cheating customers or banks by using computers, phones or the internet to steal money or data.

• Phishing – fake emails/websites that look like the bank to steal passwords.
• Vishing – fake phone calls ("KYC expired, tell OTP").
• Smishing – fake SMS with links.
• Card skimming – a device on the ATM copies card data; a hidden camera records the PIN.
• SIM swap – fraudster gets a duplicate SIM and receives OTPs.
• UPI frauds – "scan QR to receive money" tricks, fake collect requests.
• Malware / remote-access apps – apps like screen-sharing tools used to control the victim's phone.
• Identity theft – using stolen KYC documents to open accounts or take loans.

Prevention: never share OTP, PIN or CVV; bank never asks for them; use official apps only; enable transaction alerts; set card limits; report fraud at once to the bank and to the national cyber crime helpline 1930 or cybercrime.gov.in.

Likely exam questions

1. (Long, 8/16 marks) Explain the need and importance of technology in banking. Discuss its advantages and disadvantages.
2. (Long, 8/16 marks) Explain the meaning and features of RTGS, NEFT, IMPS and SWIFT. Distinguish between RTGS and NEFT.
3. (Short, 4 marks) Distinguish between Debit Card and Credit Card.
4. (Short, 4 marks) What is ECS? Explain ECS Credit and ECS Debit.
5. (Short, 4 marks) What are cyber frauds in banking? How can customers prevent them?

Syllabus topics (RTMNU)

• Definition, Meaning and Characteristics of the following: Promissory Notes, Bill of Exchange, Demand Drafts (Banker’s Cheques), Pay Orders and Cheques
• Types of Cheques: Bearer, Order and Crossed
• Types of Crossing- General and Special
• Definition and Meaning of Endorsement
• Essentials of a Valid Endorsement
• Types of Endorsement: Blank, Full or Special, Restrictive, Partial, Conditional, Sans Recourse, Facultative

A negotiable instrument is a written document that promises or orders payment of money and can be transferred freely from one person to another by delivery or by endorsement and delivery. In India they are governed by the Negotiable Instruments Act, 1881. Section 13 names three: promissory note, bill of exchange and cheque.

Promissory Note

Definition (Section 4): A promissory note is an instrument in writing (not being a bank note or 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.

Parties: Maker (who promises to pay) and Payee (who receives).

1. In writing.
2. Contains a promise to pay, not an order.
3. Promise is unconditional.
4. Signed by the maker.
5. Certain sum of money only (not goods).
6. Payee is certain.
7. Properly stamped as per the Stamp Act.

Bill of Exchange

Definition (Section 5): 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.

Parties: Drawer (creditor who writes the bill), Drawee (debtor who accepts and pays) and Payee. Example: Ram sells goods to Shyam for ₹50,000 and draws a 3-month bill on Shyam; Shyam accepts it.

1. In writing and contains an order to pay.
2. Order is unconditional.
3. Signed by the drawer.
4. Must be accepted by the drawee.
5. Certain sum of money to a certain person.
6. Three parties; stamped.

Demand Drafts (Banker's Cheques) and Pay Orders

Demand Draft (DD): An order issued by one branch of a bank to another branch (or by a bank to its correspondent) to pay a specified sum to a named person on demand. The buyer pays the amount in advance, so it cannot bounce. Used to pay fees, application money, etc., in another city. (Section 85A of the NI Act deals with drafts.)

Pay Order (Banker's Cheque): An instrument issued by a bank directing its own branch to pay a fixed sum to a named payee in the same city. Example: a pay order for ₹2,00,000 for a property deposit.

1. Prepaid – the bank receives money first, so payment is sure.
2. Always payable to order (named payee), not bearer.
3. Valid for 3 months from the date of issue.
4. Generally crossed "A/c Payee" when above the amount fixed by RBI.

Cheques

Definition (Section 6): A cheque is a bill of exchange drawn on a specified banker and not expressed to be payable otherwise than on demand; it includes the electronic image of a truncated cheque and a cheque in electronic form.

1. Always drawn on a specified bank.
2. Always payable on demand.
3. Unconditional order, signed by the drawer (account holder).
4. Certain sum of money to a certain person or bearer.
5. No acceptance needed and no stamp needed.
6. Valid for 3 months from its date.

Types of Cheques: Bearer, Order and Crossed

• Bearer cheque – payable to the person who presents it ("Pay Rahul or bearer"). Transferred by mere delivery; risky if lost.
• Order cheque – the word "bearer" is cancelled or "or order" written; paid only to the named payee or to the person to whom he endorses it, after identification.
• Crossed cheque – two parallel transverse lines drawn across the face; the amount is not paid in cash at the counter but only credited to a bank account. It is safer.

Types of Crossing: General and Special

• General crossing (Section 123) – two parallel lines, with or without words like "& Co." or "Not Negotiable". Payment is made only through any bank.
• Special crossing (Section 124) – the name of a particular bank is written across the face (e.g., "State Bank of India"), with or without lines. Payment only through that named bank.
• Other forms used in practice: Account Payee crossing ("A/c Payee") – amount credited only to the payee's account; Not Negotiable crossing (Section 130) – the transferee gets no better title than the transferor.

Definition and Meaning of Endorsement

Endorsement (Section 15): When the maker or holder of a negotiable instrument signs it, usually on the back, for the purpose of negotiation (transfer), he is said to endorse it. The person who signs is the endorser; the person to whom it is transferred is the endorsee.

Essentials of a Valid Endorsement

1. Made on the instrument itself (usually the back) or on an attached slip called an "allonge".
2. Signed by the endorser; mere name without signature is not enough.
3. Signature in the same spelling as the name of the payee on the cheque.
4. For the whole amount – an endorsement for part of the amount is not valid for negotiation.
5. Followed by delivery of the instrument to the endorsee.
6. Made by the holder or his authorised agent; a person signing for a company must state his capacity (e.g., "For ABC Ltd., Director").
7. Endorsements must be in order, starting with the payee.

Types of Endorsement

Likely exam questions

1. (Long, 8/16 marks) Define promissory note, bill of exchange and cheque. Explain their characteristics and distinguish between a bill of exchange and a cheque.
2. (Long, 8/16 marks) What is endorsement? State the essentials of a valid endorsement and explain its different types with examples.
3. (Short, 4 marks) Distinguish between General crossing and Special crossing.
4. (Short, 4 marks) What is a Demand Draft? How is it different from a Pay Order?
5. (Short, 4 marks) Explain Sans Recourse and Facultative endorsement.