Indian Financial Market: A quick introduction

By Payel Jain, Vinod Kothari & Company

(payel@vinodkothari.com)
Today--with the ‘FEEL GOOD' factor about India in the global arena rising, increased
confidence of the investors in the Indian market, Sensex looking more attractive than ever
before, foreign exchange reserves at an all-time high of more than $140 billion --is the
most susceptible period for the regulators of the Indian financial sector, particularly SEBI
and RBI. In spite of the strict vigilance by the regulators, the investors find Indian market
very attractive.
In recent years, the Indian economy has seen a great transformation from a closed,
controlled, slow growing economy to a more open, liberalised and one of the fastest
growing economies of the world. Economic reforms in India since July 1991 have
accelerated growth, enhanced stability and strengthened both external and financial
sectors.
The rate of savings in India is constantly rising. The gross domestic savings in the year
2005-06 is estimated at 1156809. The rise in the savings rate has with an increase in the
rate of growth of GDP over the last three years, suggesting that the economy is transiting
to a sustainable, higher growth trajectory.
0
5
10
15
GROWTH
IN %
YEAR
GROSS DOMESTIC PRODUCT
TREND Source: Central
Statistical Organisation (CSO)
2000-01
2001-02
2002-03
2003-04
2004-05
2005-06
2006-07
Therefore, Indian markets provide good opportunities to investors from all over world.
Investments in Indian market are considered as the safest investment by the investors.
Financial Intermediaries
A structural change was noticed in the Indian financial system with the establishment of a
host of financial intermediaries during the second phase of evolution of the system.
Financial intermediaries comprises of public financial institutions, NBFCs, mutual funds,
commercial banks, housing bank etc.
Foreign Currency Borrowings
In India, External debt exposure to financial intermediaries is regulated. Their foreign
currency borrowings have been subject to the prudential limit of 25 per cent of their Tier-I
capital. These limits amounted to US $ 2.7 billion as of March 31, 2006. With a view to
enabling banks to raise resources overseas, the latest monetary policy announcement on
October 31, 2006 has enhanced this limit to 50 per cent of their Tier I capital, or US $ 10
million, whichever is higher. With a move towards fuller capital account convertibility,
banks are likely to access forex markets more, underscoring the need for further
enhancement of the risk management capabilities of the banking system.
Banking Companies
The banking sector is the soul-life-blood of the financial system in India. Significant
progress has been made with respect to the banking sector in the post liberalization
period. The financial health of the commercial banks has improved manifolds with respect
to capital adequacy, profitability, asset quality and risk management. Further, deregulation
has opened new opportunities for banks to increase revenue by diversifying into
investment banking, insurance, credit cards, depository services, mortgage,
securitization, etc. Liberalization has created a more competitive environment in the
banking sector. The aggregate foreign investment (FDI plus FII) limit for the private sector
banking has been raised to 74 percent in the recent country budget. The competition has
increased within the banking sector (with the emergence of new private banks and foreign
banks) as well as from other segments of the financial sector such as mutual funds, Non
Banking Finance Companies, post offices and capital markets.
Structure
The central bank of the country is the Reserve Bank of India (RBI), established in April
1935. Reserve Bank of India was nationalised in the year 1949. The banks in the Indian
Banking System are broadly classified into Scheduled Banks and Non-Scheduled Banks.
Nationalised Banks, State Bank, State Co-operative Banks and Regional Rural Banks
come
under the purview of Scheduled Banks whereas Private Sector Banks forms the Non-
Scheduled Group.
Asset-wise position of Banks
The total assets of the Public sector banks in aggregate amounts to Rs.2014898.35 crore
as per the last Balance Sheet. The Nationalised banks hold assets worth Rs1234462.40
crores. The Private Sector Banks hold assets worth Rs. 571407.59 crores. Foreign Banks
in India hold total assets worth Rs.201585.69 crores.
(Source: Balance Sheet of respective banks)
Indian Banking structure also includes the unorganised indigenous sector, which is a mix
of diverse institutions. The Reserve Bank of India is constantly making efforts to bring the
unorganised sector under their regulatory framework.
Cash Reserve Ratio (CRR)
CRR is the amount of cash reserve that is required to be maintained by commercial banks
in India with the RBI. The RBI hiked the CRR by 50 basis points to 5.5 per cent in two
stages on 23 December 2006 and 6 January 2007. Currently the CRR is 5.75% of the
net demand and time liability. From the fortnight beginning from March 3, 2007, the CRR
will be 6%. (Source: RBI)
Statutory Liquidity Ratio (SLR)
SLR is an instrument in the hands of RBI to impose supplementary reserve requirements
on the banking system. The maximum limit of SLR in India is 40%. It was 20% in 1963 and
rose to 38.5% in 1990. The current limit is 25%. The Government has issued ordinance
giving more flexibility to the RBI to fix SLR below the current stipulated limit of 25%.
Specialised financial entities – Housing finance companies
A company, which mainly carries on the business of housing finance or has as one of the
main objects in its Memorandum of Association, business of providing finance for the
housing. To start business of housing finance, the Housing Finance Companies has to get
it registered with the National Housing Bank. The principal mandate of the Bank is to
promote housing finance institutions to improve/strengthen the credit delivery network for
housing finance in the country. The Bank has played a facilitator role in this regard
instead
of itself opening such dedicated housing finance institutions
Non- Banking Finance Companies
Non-Banking Financial Companies are under the regulatory framework of Reserve Bank of
India by virtue of powers vested in Chapter III B of the Reserve Bank of India Act, 1934
At the end of June 2006, there were 13014 NBFCs registered with the Reserve Bank of
India, including 428 NBFCs, which are accepting public deposits. During the year 2005-06,
Net-owned funds of NBFCs increased by 562 crores despite a decline in the number of
reporting NBFCs. Total assets/liabilities of NBFCs (excluding reporting NBFCs) at the end
of March 2006 were Rs. 35561 crores, down marginally by 1.2 percent from 36003 crores at
end of March 2005. in the year 2005-06, there was a significant decline in fee-based
income
of the NBFCs while there was a marginal increase in fund-based income.
A slight overview of NBFCs vs. Banks
� NBFCs have a much lighter regulation than that applicable to banks.
� Formation of an NBFC is much easier than forming a bank.
� Foreign direct investments in NBFCs are also much easier than those in case of
banks.
� A NBFC cannot accept demand deposits like banks
� It is not a part of the payment and settlement system and as such cannot issue
cheques to its customers
Investment Intermediaries
Mutual funds
“Put not your trust in money, put your money in trust”- is the perfect way by which we can
understand the concept of mutual funds. The small investors who lacks expertise to
choose the right kind of investment for themselves opt for a kind of collective investment
vehicle like Mutual Funds which pool their marginal resources, invest in a wide range of
securities and distribute the returns.
The pioneer in the field of mutual fund is Unit Trust of India established in 1964. Net
mobilisation of resources by mutual funds increased by more than four-fold to Rs. 104950
crores in 2006 from Rs. 25454 crore in 2005. The share of UTI and other public sector
mutual funds in the total amount mobilised was around 22.5% in 2005 and 17.8% in 2006.
The total assets under the management of mutual funds during at the end of 2006 was
recorded at 323598 crores.
Risk transfer institutions
Our everyday life is subjected to an innumerable risk like risk of premature death, poor
health, unemployment, loss due to natural calamities etc. Many of these risks are out of
our control. Insurance provides us an opportunity to cover the risk at least in monetary
terms.
The business of insurance is broadly classified into life insurance and non- life insurance
or general insurance as discussed below:
In the beginning of the year 2000, the insurance industry mainly comprises of two players-
The Life Insurance Corporation of India for effecting life insurance and The General
Insurance Corporation of India with its four subsidiaries for effecting fire insurance,
marine insurance and other miscellaneous insurance. From then, a number of insurance
companies have emerged both in the public and private sector to cater to the needs of the
society.
As all other markets, the insurance market is also highly regulated. The Insurance Act,
1938 was the first legislation governing not only life insurance but also the non-life
insurance business in India. After the nationalisation of the insurance business in1956,
Insurance Regulatory and Development Authority regulate the insurance business in
India.
Capital Market
“Capital Market is a market for financial investments that are direct or indirect claims to
capital”. It comprises of the institutions and mechanisms through which funds are pooled
and made available to business, government and individuals.
With the expansion of commercial banking and unprecedented development of
multinational corporations, the domestic financial markets has assumed global outlook.
The integration of world financial and capital market with that of the Indian provides
greater benefits to both the demanders and suppliers of funds and opportunity to diversify
risk. This globalisation has added depth to the market with a large number of market
participants.
Capital market: primary
The market wherein resources are mobilised by companies through issue of new
securities is termed as the primary market. In India, the primary market has grown
exponentially during the last decades.
Funds mobilisation from the market reached its peak in the year 1993-94, 1994-95 and
1997-98. During the year 2006, a total of Rs.161769 crores was mobilised through primary
market by a combination of equity issue, debt issue, private placement and Euro issues
(ADR/GDR).
Capital market is firmly regulated by the Securities and Exchange Board of India (SEBI) to
offer better protection to the investors. The introduction of SEBI Guidelines for Disclosure
and Investor Protection during 1992 revolutionised the Indian capital market. Later it was
replaced by the Guidelines issued in 2000 and SEBI is frequently updating these
guidelines to suit the need of the present time. SEBI has also prescribed regulations for
the Intermediaries, such as the brokers, underwriters, Merchant Bankers, Mutual Funds
etc.
Capital market: secondary
Secondary market popularly known as the Stock Exchange is referred to as the
“Barometer of the economy”. The stock exchanges are the exclusive centres for trading in
equities.
The stock market is touching new heights year after year since 2003, with the BSE and
NSE indices crossing 14000 and 4000, respectively in January 2007. The 3rd of January
witnessed the highest closing indices of 14015 at BSE and 4025 at NSE. NSE continued to
occupy the third position after NASDAQ and NYSE in terms of number of transactions
occurring during the calendar year 2006.
Debt
In a developing country like India, debt market plays a very crucial role. Debt Markets are
markets for the issuance, trading and settlement in fixed income securities of various
types and features. Almost all legal entity like Central and State Governments, Public
Bodies, Statutory corporations, Banks and Institutions and Corporate Bodies issue Fixed
income securities to secure money.
Current debt market has become more efficient, transparent and vibrant with significant
retail participation.
Government of India (GOI) securities continued to account for the major part of activity In
the secondary debt market. The gross issuance of GOI dated securities in 2006 amounted
to Rs.14 000 crores as compared to Rs. 129,350 crore in 2005.
Derivatives
In India, derivatives trading take place under the provisions of the Securities Contracts
(Regulation) Act, 1956 and the Securities and Exchange Board of India Act, 1992. The
turnover recorded during the calendar year 2006 in NSE derivative market is 7046665
crores and in BSE derivative market is 4012 crores showing significant growth over the
previous years.
Commodities market
Commodities Futures trading is a class of Derivatives trading, in which futures contracts
derive their value from the ruling price of underlying commodities. This is a mechanism by
which participants can enter into transactions for purchase and sale of commodities at a
price, where the performance of delivery and payment obligation becomes due on a future
date.
As compared to 59 commodities in January 2005, 94 commodities were traded in the
commodities futures market as of December 2006, and these included major agricultural
commodities, spices, metals, bullion, crude oil, natural gas and polymer, among others.
Gold accounted for the largest share (31 per cent) of trade in terms of value, followed by
silver (19 per cent), guar seed (11 per cent) and chana (10 per cent).
The growth in the commodity derivative trading witnessed in 2005-06 continued during
2006-07. Total volume of trade rose sharply from Rs. 1.29 lakh crore in 2003-04 to
Rs. 27.39 lakh crore in 2006-07 (till December 2006).V

Guidelines - JAIIB
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INDIAN
FINANCIAL
SYSTEM &
COMMERCIAL
BANKING
Guidelines - JAIIB
2
THE INDIAN INSTITUTE OF BANKERS
THE ARCADE, WORLD TRADE CENTRE, CUFFE PARADE
MUMBAI 400 005
Established on 30th April 1928
Entered Platinum Jubilee in April 2002
Mission
• To develop professionally qualified and competent bankers and financial
professionals primarily through a process of education, training,
examination, consultancy/counselling and continuing professional
development programs.
Vision
• To be the premier Institute for developing and nurturing competent
professionals in banking and finance field.
Objectives
• To facilitate study of theory and practice of banking and finance.
• To test and certify attainment of competence in the profession of banking
and finance.
• To collect, analyse and provide information needed by professionals in
banking and finance.
• To promote continuous professional development.
• To promote and undertake research relating to Operations, Products,
Instruments, Processes, etc., in banking and finance and to encourage
innovation and creativity among finance professionals so that they could
face competition and succeed.
COMMITTED TO PROFESSIONAL EXCELLENCE
Visit Website : www.iib-online.org
Guidelines - JAIIB
3
INTRODUCTION
As part of the continuing efforts to provide educational support services to the students
appearing
for JAIIB/CAIIB examinations, the Institute has decided to bring out the guidelines under
the
revised syllabus for the benefit of the candidates appearing for the JAIIB/CAIIB
examinations.
In that series, the Institute so far brought out booklets for answering the questions asked
upto
Nov 1999 Associate Examination.
The present publication includes hints for answering the questions asked in June 2000,
Dec.
2000, June 2001, Dec 2001, June 2002 and Dec 2002 Associate Examination of JAIIB.
It is
hoped that students would find them quite useful.
These guidelines are also hosted on the website www.iib-online.org for viewing freely by
students.
These model answers are in no way considered to be complete answers and a
substitute for
studying of textbooks. The candidates may have to suitably elaborate and condense the
answers
depending upon the tone and tenor of questions.
It goes without saying the individual imprint in the answers by way of presentation,
logical
organization of thought and development of the answer will carry a lot of weight in
securing
better marks.
Guidelines - JAIIB
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Guidelines - JAIIB
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1. Define the following terms
(a) Net Assets Value
The NAV of an investment scheme is a number which represents the value in rupees per
fund unit as on a particular date of the assets of the fund less liability and outstanding
expenses. Thus, if the NAV in more than the face value, it means your money has
appreciated
and vice-versa. NAV is only the value that a fund’s assets would realise, less liabilities,
in
case the fund was liquidated as on the particular date to which NAV relates. But there is
no
uniformity in accounting policies of the various funds and hence one cannot compare
one
fund with another.
(b) Debit Cards
A credit card holder buys now and pays later. In effect, the credit card issuer hands him
a
loan. Not so with a debit card. The debit card holder must have an account with the
issuing
bank. When he buys something, the value of his purchase is instantly debited from his
account. The merchant establishment from which the debit card holder makes his
purchase
is linked electronically to the bank’s main computer which contains the account details of
the card holder. The account can be accessed with a personal identification number
(PIN)
known only to the account holder. But through it, the merchant can check the card
holder’s
account and debit the value of his purchase.
(c) Notice of assignment
An assignment can be validity made without a notice of assignment to the debtor.
However,
in the absence of a notice, the dealings of the debtor with the original creditor stands
fully
protected and the assignee may lose his right to recover the debt in case of direct
payment
/ settlement to the original creditor. It is for this reason, a notice of assignment should be
sent to the creditor.
The notice of assignment, under section 131 of T.P. Act. must be in writing and it should
be
signed by the assignor or his authorised agent. It takes effect from the date of execution
of
written instrument so far as the assignor or assignee are concerned. Where the assignor
INDIAN FINANCIAL SYSTEMS AND COMMERCIAL BANKING
JUNE, 2000
CODE NOJ 1148
Guidelines - JAIIB
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refuses to sign, the assignee may sign the notice indicating the refusal of the Assignor to
sign the same.
(d) Usufructuary Mortgage
The mortgagor, under this mortgage, hands over possession of the property to the
mortgage
to be retained by the latter till the debt is repaid. The mortgagee is authorised to receive
income / gains from the mortgaged property in full or in part and appropriate it towards
the
principal and interest on the debt due.
The special features of this mortgage are :-
The mortgagee shall continue to have possession of the property and enjoyment of
income
/ gains from the property till the debt is repaid.
If the debt is not repaid or the mortgagor fails to file a suit for redemption within 60 years
from the date of mortgage, the mortgagee becomes the absolute owner.
The mortgagee cannot sue for foreclosure, or sale or for personal liability.
2. State whether the following sentences are true or false
(a) ATMs are part of Virtual Banking.
(True)
(b) Educational Loan Scheme evolved by Reserve Bank of India if only for students in
Private
Professional Colleges.
(True)
(c) Over The Counter Exchange of India (OTCEI) is non-corporate body.
(False)
(d) The Securities Trading Corporation of India (STCI) was promoted by SEBI jointly with
the
Public Sector Banks.
(False)
3. Fill in the blanks
(a) Section 128 of Negotiable Instruments Act relates to Protection available to Banks in
payment of crossed cheques.
(b) Village adoption Approach was replaced by Service Area Approach in April, 1989.
(c) No collateral security up to an advance for Rs. 5 lakh will be insisted on by banks for
advances to tiny sector.
Guidelines - JAIIB
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(d) Govt. of India has advised banks to achieve 10% benchmark in respect of advances
granted
to Weaker Sections.
(e) Financial Restructuring Authority (FRA) has been proposed in the Union Budget
2000-
2001 for Weak banks .
4. Please choose the correct answer from the alternatives given :
(a) Section 14 of Banking Regulation Act, 1949------
(i) Prohibits a banking company from creating a charge upon any unpaid capital
of the company.
(ii) Contains a system of licensing of banks by the R.B.I.
(iii) Provides that the subscribed capital of a banking company should not be less
than one-half of its authorised capital.
(iv) Non of these Ans (i)
(b) A Bank is under a statutory obligations to honour its customer’s cheques vide -------
---
(i) Section 10 of the Banking Regulation Act, 1949.
(ii) Section 3 of the R.B.I. Act, 1934.
(iii) Section 31 of the Negotiable Instruments Act, 1881.
(iv) None of these Ans (iii)
(c) The Reserve Bank of India was originally constituted as a share holder’s Bank with a
share capital of -------
(i) Rs. 50 lakh
(ii) Rs. 100 lakh
(iii) Rs. 10 crores
(iv) Rs. 5 crores Ans (iv)
(d) Total scheduled banks in our country as on 31-12-1999 are ---------
(i) between 100-200
(ii) between 200-300
(iii) between 300-400
(iv) more than 400 Ans (iii)
Guidelines - JAIIB
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(e) Infrastructure Development Finance Company was established in ---------
(i) 1961
(ii) 1997
(iii) 1994
(iv) 1991 Ans (ii)
(f) Nationalised Banks have been permitted to offer their equity shares to the public to
the extent of 49% of their capital as per amendments made in 1994 in -------------
(i) Banking Regulation Act, 1949
(ii) Banking Companies (Acquisition & Transfer of Undertakings) Acts 1970/1980
(iii) both in (i) and (ii)
(iv) none of the above Ans (ii)
(g) EXIM Bank is owned by ---------
(i) Govt. of India and RBI jointly
(ii) RBI and select Commercial Banks jointly
(iii) Fully owned by Govt. of India
(iv) partly by financial institutions Ans (iii)
(h) Contribution towards Rural Infrastructure Development Fund is made by --------
(i) NABARD and Commercial Banks jointly
(ii) State Govts. And Govt. of India
(iii) Only those commercial banks who fail to achieve the stipulated benchmark of
agricultural advances and / or priority sector advances
(iv) Infrastructure Development Finance Company Ans (iii)
(i) Small Business or Business Enterprises consists of the firms or individual whose
cost price of the equipments used for the purpose of business does not exceed -----
-------
(i) Rs. 10 lakhs with working capital of Rs. 5 lakhs or less
(ii) Rs. 5 lakhs with working capital of Rs. 2 lakhs or less
(iii) No ceiling of equipment price, but working capital should not exceed Rs. 10
lakhs
(iv) None of these Ans (i)
Guidelines - JAIIB
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(j) Married Women Property Act 1874 stipulates that ------------
(i) A husband is liable for the debts contracted by his wife even before her marriage
(ii) The property in the name of women only can be attached for the debts taken in
individual capacity.
(iii) A married woman cannot pledge her husband’s credit and bind his estate even
for necessaries
(iv) (ii) and (iii) of the above. Ans (ii)
(k) Ceiling on investment on Plant and Machinery in the case of Tiny Sector has been
redefined as --------
(i) Upto Rs. 5 lakhs
(ii) Upto Rs. 10 lakhs
(iii) Upto Rs. 25 lakhs
(iv) Upto Rs. 100 lakhs Ans (iii)
5. Explain the underlying rationale/rule for the following practice/procedures being
followed
by banks in India :-
(a) The legal representative of a deceased person cannot negotiate by delivery only, a
bill of exchange promissory note or cheque payable to order and endorsed by the
deceased but not delivered.
Ans. As per section 57 of N.I. Act, if the endorser dies after endorsing the instrument
payable to order but without delivering the same to the endorsee, such endorsement
shall not be valid and his legal representative cannot complete the negotiation by
mere delivery thereof.
(b) Bank can recover the amount of cheques paid by mistake subject to the doctrine of
equity.
Ans. According to section 72 of the Indian Contract Act, a person to whom money has
been paid or anything delivered by mistake or under coercion, must repay it subject
to the doctrine of equity. This doctrine disfavours unjust enrichment. If the payee has
not been enriched unjustly, he cannot be required to payee. In other words, if the
position of the payee has not been altered to his detriment he must repay the money
to the payer. But if position of the payee has been changed to his prejudice and
thereafter the mistake has been detected, he cannot be held liable.
Guidelines - JAIIB
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(c) Bank cannot issue “bearer” drafts.
Ans. Section 31 of RBI Act, 1934 lays down that “No person in India other than the
Reserve
Bank or, as expressly authorised by this Act, the Central Government, shall draw
accept, make or issue any bill of exchange, hundi, promissory note or engagement
for the payment of money payable to bearer on demand, or borrow, owe or take up
any sum or sums of money on the bills, hundies, or notes payable to bearer on
demand of any such person.
(d) Granting “grace period” of three days on all bills or notes payable after a specified
period of time or on a specified date even if the bill contains the words “without
grace”.
Ans. Section 22 of the N I Act provides that every promissory note or bill of exchange
not
payable on demand is at maturity on the third day after the day on which it is expressed
to be payable. As this is statutory provision, the words “Without grace” on the bill has
no meaning.
(e) A minor may draw, endorse, deliver and negotiate such instrument so as to bind all
parties except himself.
Ans. Though a minor is not competent to enter into a valid contract, Section 26 of the
contract act permits him to draw, endorse or negotiate a cheque or a bill. In case a
minor is one of the executants of a promissory note, he/she bears no liability thereon
but it does not absolve the other joint promisor from liability.
(f) RBI has introduced Asset Liability Management System in all Commercial Bank.
Ans. Banks should disclose the maturity pattern of loans and advances, investment in
securities, foreign currency assets and liabilities. Various risks like interest risk, price
risk, liquidity risk relating to adverse movements can be controlled through Asset-
Liability Management. Narsimham Committee – II has also recommended ALM
process in banks.
(g) Revival letters for the loan documents are obtained from borrowers and guarantors
both.
Ans. Limitations Act has stipulated that acknowledgement of debt should be obtained
after a stipulated period. As guarantor is also a co-obligant, acknowledgement of
debt in the format of revival letter should be obtained from borrowers and guarantors
both.
Guidelines - JAIIB
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6. State what decision you will take in the following situations and explain the rationale
for the
decision.
(a) M. Ltd. had an arrangement with your branch to draw against uncleared cheque
lodged in clearing. One day the company deposited 5 cheques drawn on a branch of
another bank and asked you to pay cheques drawn by them presented on the same
day against the amount of the cheques deposited. Subsequently on presentation in
clearing, the drawee bank informed that payment had been stopped on the five
cheques by the drawers. It transpired that M. Ltd had obtained those cheques from
the amount of the five cheques from the drawers as holders in due course. The
drawers resisted the claim on the ground that bank was only the agent of M. Ltd. for
collection.
Ans. Bank can succeed in claiming the amount of cheque on the following grounds :
i) A banker can at one and the same time be an agent for collection of a cheque
and a holder of that cheque for value.
ii) Bank had given value for the cheques as the cheques drawn by M. Ltd. were
paid against the amount of cheques sent for clearing.
iii) Since bank is holder for value and took the five cheques in good faith and
without notice of the defect in M. Ltd.’s title, Bank was holder of the cheques in
due course and entitled to recover in respect of them from the drawers of the
cheques.
(b) Your branch has given a loan of Rs. 50000/- to ‘A’ secured by way of mortgage of
shares of a company and guarantee of ‘B’. ‘A’ defaulted in payment of the loan at a
time when the mortgaged shares were worth at least the amount of the loan. The
shares subsequently became worthless. The branch demanded payment from ‘B’
when ‘A’ failed to pay. A suit was filed against ‘B’ for the guarantee amount. ‘B’
contended that he was not liable on the ground that the shares which were security
for the loan were worth not less than the amount of guarantee when the debt became
due and the Bank knew or ought to have known the declining value of the shares and
should have sold them before they became worthless. Thus failure to sell the shares
when the amount became due was an act of omission inconsistent with the rights of
the surety.
Guidelines - JAIIB
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Ans. Bank had three sources of recovering the loan – it could sue “A”, sell the
mortgaged
securities or sue “B” (Surety). All these remedies could be exercised at any time or
times simultaneously or contemporaneously or successively or not at all. In this case,
Bank did not act injurious to the surety, did not act inconsistant with the rights of the
surety and did not omit any act which his duty enjoined him to do. Bank cannot
become liable to a mortgagee or to a surety for a decline in the value of mortagaged
property, unless it was responsible for the decline.
(c) Ramnath and Co. have issued an order cheque for Rs. 10000/- in favour of Girdhari
Lal Sharma. The cheque bears following endorsements, when presented for payment.
(i) Pay to Murari Lal Shethi
Girdhari Lal Sharma
(ii) Murali Lal Shethi
(iii) Ratan Lal Gupta
Mr. Ratan Lal Gupta does not maintain an account but is reasonably known to you as
the owner of a cycle shop nearby and so you pay the cheque to Ratan Lal Gupta.
After a few days you receive a notice from Murari Lal Shethi that the cheque was
stolen from him and that his endorsement on the cheque was a forgery. Shri Murari
Lal Shethi claims the amount from the bank.
Ans. Section 85 (1) of the Negotiable Instrument Act grants statutory protection to the
paying banker in case of order cheques, if (i) the endorsement on the cheque is
regular (ii) the payment has been made in due course. In the present case, both of
these conditions are fulfilled, viz., the endorsement of Murali Lal Shethi is regular
(though it may not be valid) and the payment has been made to a known person in
good faith and without negligence on the part of the banker. Hence the paying banker
can avail of the protection under section 85(1) and is not liable to meet the claim of
Murari Lal Shethi.
(d) (i) A cheque is drawn “Pay Shriniwas Deshpande” without the words “or order” or
“or bearer”. Is the cheque payable only to Shriniwas Deshpande in person or is
it transferable or negotiable by him ?
Ans. A cheque is transferable or negotiable by the payee. Explanation (1) to Section
Guidelines - JAIIB
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13 of the N.I. Act states that ‘a promissory note, bill of exchange or cheque is
payable to order which is expressed to be so payable or which is expressed to
be payable to a particular person and does not contain words prohibiting transfer
or indicating an intention that it shall not be transferable. In this case no word
prohibiting the transfer of the cheque is used. Hence it is negotiable even without
the words ‘or order’ or ‘or bearer’.
(ii) If on the above cheque words “Not negotiable” written without either parallel
transverse lines or the name of a banker, render the cheque a crossed cheque.
Would the drawee bank be justified in paying such a cheque across the counter ?
Ans. The inclusion of the words ‘not negotiable’ across a cheque without (I) parallel
transverse lines, or (II) the name of a banker does not constitute a crossing.
According to Sections 123 and 124 of N. I. Act, two transverse parallel lines
constitute the general crossing and writing of the name of a bank constitute
special crossing. The words “Not negotiable” may be included in the general or
special crossing. But mere inclusion of these words without either two transverse
line or the name of a bank, will not constitute crossing. The drawee bank will,
therefore, be justified in paying the cheque across the counter.
(e) A, B and C are three partners in Auto Traders dealers in automobile spares. A’s
personal friend, ‘D’ has an outstanding loan of Rs. 25000/- from you bank which the
bank has recalled for inadequate security. At the request of ‘D’, ‘A’ has offered his
firm guarantee to the bank, which your bank accepts. The guarantee is signed by ‘A’
as partner of Auto Traders. Consider the position of Firm’s liability.
Ans. Legally, a partner acts as a agent of the firm for the purposes of carrying on the
business of the firm. According to section 19(1) of the Indian Partnership Act, the act
of a partner which is done to carry on, in the usual way, business of the kind carried
on by the firm binds the firm. This is called the implied authority of a partner.
In the present case, giving guarantees by “A” on behalf of the firm, cannot be deemed
as the business of the firm. Other partners “B” and “C” have also not authorised “A” to
give guarantee on behalf of the firm. The bank should, therefore, not accept such a
guarantee until all the partners sign or authorise “A” to give guarantee on their behalf.
Guidelines - JAIIB
14
(f) A well introduced account was opened in a Bank branch by Mr. X with a cheque of
Rs. 50000/- drawn on another branch of the same bank in the city. No cash deposit
was made initially. Later on it was transpired that the cheque deposited by X was a
stolen one. Bank pleaded protection under Section 131 of N.I. Act. The question
arose whether the thief (Mr. X) was a customer of the Bank so as to get the protection
as claimed.
Ans. A person becomes a customer of a bank when he goes to the Bank with money or
a
cheque and asks to have an account opened in his name, and the Bank accepts the
money or cheque and is prepared to open an account in the name of that person. In
this particular case it was decided that Mr. X was a customer of the Bank and therefore
Bank was entitled protection under Section 131 of N.I. Act.
7 Answer the following :
(a) Discuss the recommendations of Narsimham Committee-II on financial sector
reforms.
Ans. Second Narasimham Committee Recommendations :
1. Capital Adequacy Ratio :
A minimum target of 9 percent CRAR to be achieved by the year 2000 ; the target
should be raised to 10 percent for the year 2002.
2. Risk weights on Investments in Government Securities, approved securities and other
than approved securities :
A risk-weight of 5 percent for market risk for Government / approved securities.
3. Risk weights on Government guaranteed advances:
Risk-weight on Government guaranteed advances to be the same as other advances:
4. Foreign Exchange open position limit:
To carry 100 per cent risk weight.
Provisioning Norms :
(i) A general provision of 1 percent on standard assets.
(ii) An assets to be classified as doubtful if it is in the sub-standard category for 18
months in the first instance and eventually for 12 months and loss if it has
been so identified but not written off.
(iii) The Government guaranteed advances which have turned sticky to be classified
as NPAs.
(iv) Income recognition, asset classification and provisioning norms should apply
to Government guaranteed advances.
Guidelines - JAIIB
15
5. Other Recommendations:
(i) Banks and financial institutions should avoid the practice of evergreening.
(ii) Any effort at financial restructuring must go hand in hand with operational
restructuring. With the cleaning up of the balance sheet, simultaneously steps
to be taken to prevent / limit re-emergence of new NPAs.
(iii) To enable banks in difficulties to issue bonds for Tier II capital, Government
will need to guarantee these instruments which would then make them eligible
for SLR investment.
(iv) There is a need for disclosure in a phased manner of the maturity pattern of
assets and liabilities, foreign currency assets and liabilities, movements in
provision account and NPAs.
(v) Concentration ratios need to be indicated in respect of bank’s exposure to any
particular industrial sector as also to sectors sensitive to asset price fluctuations
such as stock market and real estate. These exposure norms need to be
carefully monitored.
(vi) Banks should bring out revised operational manuals and update them regularly.
(vii) There is need to institute an independent loan review mechanism especially
for large borrowal accounts and to identify potential NPAs.
7(b) What do you understand by the term “Statutory Reserve” ? Discuss the provision of
Section
42 of the RBI Act with special reference to the changes made in the ‘Busy Season’ credit
policy for 1999-2000.
Ans. A scheduled bank is under obligation to keep a cash reserve called the Statutory
Reserve
with the Reserve Bank of India under Section 42. Every scheduled bank is required to
maintain with the Reserve Bank of India an average daily balance equal to three percent
of
its demand and time liabilities. “Average Daily Balance” means the average of balances
held at the close of business on each day of a fortnight.
“Fortnight” shall mean the period form Saturday to the second following Friday, both
days
inclusive.
“Liabilities” shall not include the paid up capital and reserves as well as loans taken from
the Reserve Bank of India, Exim Bank, National Housing Bank, State Bank of India or
any
other notified Bank.
The Reserve Bank of India can increase the rate of such balance from 3% to a rate not
exceeding 20% of the total of the demand and time liabilities.
Guidelines - JAIIB
16
Additional Cash Reserve : The Reserve Bank of India is authorised to direct every
scheduled
Bank to maintain with the Reserve Bank of India in addition to the above an additional
average daily balance at a rate specified by it. This additional cash reserve is not to be
maintained on the entire amount of demand and time liabilities but on the excess of such
liabilities over the level of the total liabilities at the close of the business on the date
specified
in the notification.
For instance the Reserve Bank of India may stipulate that the Banks shall keep an
additional
reserve equal to 15% of the net increase in the total liabilities after a specified date, say,
Ist
October, 1997. Here, a bank whose deposit liabilities registered an increase of Rs. 100
lakhs between 1st October and 1st November will be required to maintain an additional
cash
reserve of Rs. 15 lakhs (15% of Rs. 100 lakhs). This position is subject to the following
conditions :
(1) The additional balance shall not in any case be more than the excess of the total
deposit liabilities over the level of the specified date. In the example citied, the Reserve
Bank of India may require the concerned Bank to maintain additional cash reserve
up to a maximum of Rs. 100 lakhs in the given period and not in excess of that
amount.
(2) And again, both the cash reserve and the additional cash reserve shall not together
exceed the limit of 20% of the total demand and time liabilities.
The Reserve Bank of India may pay interest to the scheduled Banks on –
(a) The cash reserves maintained by the scheduled Banks in excess of the statutory
minimum of 3% of the total liabilities and
(b) The additional cash reserves.
They will be eligible for such, interest in case they maintain the cash reserves to the full
extent indicated by the Reserve Bank of India. At the same time, if a bank maintains a
balance in excess of he enchanced reserve requirement of additional reserve
requirements,
no interest shall become payable on the excess amount.
Non-compliance with this stipulation entails penalties as per the provisions of Section
42(3)
In case the balance maintained by the scheduled Bank during any fortnight is below the
minimum prescribed under the reserve requirements, such banks shall be liable to pay
to
the Reserve Bank of India penal interest at a rate of 3% above the bank rate in the
Guidelines - JAIIB
17
succeeding fortnight if the shortfall continues :
1) Every director, manager or secretary of the Scheduled Bank who is knowingly and
willfully a party to the default, shall be punishable with a fine of Rs. 500/- and with a
further fine which may extend to Rs. 500/- for each subsequent fortnight during which,
the default persists and
2) The Bank may prohibit the scheduled Bank from receiving any fresh deposit after the
said fortnight.
Under Section 42(2) every scheduled Bank is required to send to the Reserve Bank of
India a Return showing the following particulars :
1. The amount of its demand and time liabilities and the amount of its borrowings from
banks in India classifying them into demand and time liabilities.
2. The total amount of legal tender notes and coins held by it in India.
3. The balance held by it at the Bank in India.
4. The balances held by it at other banks in current account and the money at call and
short notice in India.
5. The investments (at book value) in Central and State Government Securities including
Treasury bills and Treasury Deposit Receipts.
6. The amount of advances in India and
7. The inland bills purchased and discounted in India and foreign bills purchased and
discounted.
The above particulars are to be sent on the close of business on each alternate Friday
and
every such return shall be sent not later than seven days after the date to which it
relates.
Latest changes as per busy season credit policy (1999-2000) :
(a) The CRR has been reduced to 9%
(b) In order to improve the cash management by banks as a measure of simplification, a
lag of two weeks in maintenance of stipulated CRR by banks has been introduced
with efforts from November 6, 1999.
(c) The requirements by banks to maintain an incremental CRR of 10 per cent on
increases in liabilities under FCNR (B) Scheme (over the level prevailing as on April
11, 1997) has been withdrawn w.e.f. November 6, 1999.
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18
7(c) “A banker is bound to honour his customer’s cheques”. To what extent is this true ?
Discuss
fully the liability of the banker in case of wrongful dishonour of cheques.
Ans. Obligation to honour the cheques :
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 Instrument Act, 1881, lays down that “the
drawee of a cheque having sufficient funds of the drawer in his hands, properly
applicable
to the payment of such cheque, must pay the cheque when duly required to do so and in
default of such payment must compensate the drawer for any loss or damage, caused
by
such default.” Thus the banker is bound to honour his customer’s cheques provided the
following conditions are fulfilled :
(i) There must be sufficient funds of the drawer in the hands of the drawee. By sufficient
funds is meant” funds at least equal to the amount of the cheues presented”. The
funds must be sufficient in the hands of the banker. Generally the cheques sent for
collection by the customer are not treated as cash in the hands of the banker until
the same are realised. The banker credits the amount of such cheques to the account
of the customer on their realisation. A banker should, therefore, be given sufficient
time to realise the amount of the cheques sent for collection before the said amount
is drawn upon by the customer. If the customer draws a cheque on such unrealised
amount, the banker will be justified in dishonouring the cheques with the remark
“Effects not cleared”.
Further, the credit balances in other accounts of the customer at other branches or
head office of the bank need not be taken into account in computing the sufficiency
of funds for this purpose. Cheques are generally payable at the branch where the
account of the customer is kept and each branch of a bank is treated as a distinct
entity for this purpose. In Mohamed Hussain vs. Chartered Bank (1965) 2 Comp. L.J.
37, it was held that though the bank had the right to combine the several accounts of
its customer, the customer had no right to require the bank to combine the different
accounts in determining whether a cheque on an account may be dishonoured.
Halsbury’s Laws of England says : “A balance at one branch of a bank does not
entitle a customer to draw on another branch where he has no account or had
overdrawn, for different branches of a bank are for this purpose separate entities,
though the bank may apply funds which it holds at one branch to meet an overdraft
of the customer at another.”
Guidelines - JAIIB
19
It is to be noted that the funds in the hands of the drawee banker must be equal to or
more than the amount of the cheques presented for payment. The banker is directed
by the drawer to pay a specified sum of money to the payee and if such sum is not in
the hands of the banker at the time of presentation of the cheque. He would, therefore,
be justified in refusing payment of the cheque. If the payee of the cheque makes a
deposit in the account of the drawer to make up such deficiency and then presents
the cheque for payment, the banker will be justified in making such payment. But the
banker should not disclose to the payee the amount by which the credit balance in
the drawer’s account falls short of the amount of the cheque, otherwise he will be
liable for damages for disclosing information about his customer’s account to a third
party.
(ii) The funds must be properly applicable to the payment of the cheque.
A customer might be having several bank accounts in his various capacities. But it is
essential that the account on which a cheque is drawn must have sufficient funds. If
some funds are earmarked by the customer for some specific purpose, the said
funds are not available for honouring his cheque. Similarly, a depositor having a
debit balance in his current account cannot draw a cheque on the basis of his fixed
deposit with the banker as the latter is a deposit under a separate agreement for a
specific period and can be withdrawn in the prescribed manner and not through a
cheque.
The banker’s obligation to honour the cheques is further extended if an agreement is
reached between the banker and the customer, either expressly or impliedly, whereby
the banker agree to sanction an overdraft to the customer. In such cases the banker’s
obligation to honour the customer’s cheques is extended up to the amount of overdraft
sanctioned by him. If the banker subsequently reduce the limit of overdraft or withdraws
it altogether, he must honour the cheques issued by the customer before the notice
of such reduction or withdrawal is served upon him. Sometimes an obligation also
emerges out of the past practice followed by the banker. For example, if the banker
has honoured the cheques of a customer on several occasions in the past without
sufficient funds and later on requested the customer to make good the deficiency in
his account, an implied arrangement to overdraw the account is presumed to exist.
The banker should not discontinue such practice without giving prior notice to the
customer.
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20
(iii) The banker must be duly required to pay. The banker is bound to honour the
cheques
only when he is duly required to pay. This means that the cheque, complete and in
order, must be presented before the banker at the proper time. Ordinarily a period of
six months is considered sufficient within which a cheque must be presented for
payment. On the expiry of this period the cheque is treated as stale and the banker
dishonours the cheque. Similarly, a post-dated cheque is also dishnoured by the
banker because the order of the drawer becomes effective only on the date given in
the cheque.
Liability of the Banker in Case of Wrongful Dishnour of Cheques:
A Banker has the statutory obligation to honour his customer’s cheques unless there are
valid reasons for refusing payment of the same. In case he dishonours the cheque,
intentionally or by mistake, he is liable to compensate the customer for the loss suffered
by
him. According to section 31 of the Negotiable Instrument Act, 1981, the banker is liable
to
compensate the drawer for any loss or damage caused by the default on his part in
dishonouring the cheques without sufficient reason. The banker thus incurs heavy
liability
for any mistake or default committed in dishnouring his customers cheques.
Causes of Wrongful Dishonour :
Wrongful dishonour of a cheque means “ a dishonour committed by mistake or by
negligence
on the part of the banker or any of his employees”. A banker must honour the cheques
of
the customer so long as the latter’s account has sufficient funds. If the banker commits a
mistake in his account books which reduces correct balance in the account of the
customer
and thus a cheque is dishonoured, the banker will be liable for such wrongful dishnoour.
For example, if a credit made by a customer is posted to some other account or a debit
entry, of some body else is posted to the customer’s account, the latter will not show the
correct balance. Similarly, if a post dated cheque is honoured by the banker before the
date of the cheque and thus the balance in the customers account is reduced, the
banker
will be liable for wrongful dishonour of a cheque subsequently prescribed for payment.
The banker will, however, not be responsible for wrongful dishonour if the customer
makes
a deposit or a credit is received by mail in order to made the funds sufficient after the
cheque has been dishonoured by bank. Similarly, if the banker has not been furnished
with
the names and specimen signatures of the persons who have been authorised to sign
cheques on behalf of a person, firm, company or institution, he can justifiable dishonour
the cheques signed by them.
Guidelines - JAIIB
21
7(d) What are the essential features of Negotiable Instruments ? Explain the difference
between
transferability and negotiability.
Ans. Essential Features of Negotiable Instruments
The following are the special features of the negotiable instruments :
1. The negotiable instruments are easily transferable from person to person and the
ownership of the property in the instrument may be passed on by mere delivery, in
case of a bearer instrument, or by endorsement and delivery, in case of an order
instrument. Transferability is an essential features of a negotiable instrument but all
transferable instruments are not negotiable instruments. Herein lies the difference
between transferability and negotiability, which is explained below.
2. A negotiable instrument confers absolute and good title on the transferee, who takes
it in good faith, for value and without notice of the fact that the transferor had defective
title thereto. This is the most important characteristic of a negotiable instrument. A
person who takes a negotiable instrument from another person, who had stolen it
from somebody else, will have absolute and undisputable title to the instrument,
provided he receives the same for values (i.e. after paying its full value) and in good
faith without knowing that the transferor was not the true owner of the instrument.
Such a person is called the holder in due course and his interest in the instrument is
well protected by the law.
Difference between transferability and negotiability:
In case of any goods or commodity, which is transferable from person to person, the
general
rule of law is that the transferor cannot transfer to the transferee title better than what he
himself possesses. For example, X purchases an article or a commodity, say, a book,
from
Y against payment of its full value. But Y had stolen the book from the house of Z. If the
thief, i.e. Y, is caught for this theft or if the stolen article is found in the possession of X,
the
latter shall have to return the same to the true owner of the article, because the title of X
to
the property is not deemed to be better than the title possessed by Y. In fact, Y had no
title
thereto and hence Y will also stand on the same footing.
A negotiable instrument is an exception to this general rule of law. Suppose in the above
illustration X takes a cheque from Y, instead of a book, for value and without knowledge
of
Guidelines - JAIIB
22
the latter’s defective title, he will have good title thereto and will not be responsible to the
true owner. The latter will have a right against Y, the thief of the instrument. This
privilege of
the holder of a negotiable instrument in due course constitutes the main difference
between
a transferable instrument or article and a negotiable instrument.
Guidelines - JAIIB
23
1. Define the following terms briefly(Answer any three) (3x3=6)
(a) Global Depository Receipts (GDRs)
GDRs are essentially equity instruments created by overseas depository banks (ODB)
which are authorized by the issuing companies in India to issue GDRs to non-resident
investors, outside India to facilitate investment in the shares of issuing companies held
with the nominated custodian banks in India. The shares, correspond to the GDRs in the
fixed ratio e.g. 1 GDR = 10 Shares. The GDRs could be issued in the negotiable forms.
(b) Acceptance for honour
Section 108 of N.I. Act says that when a Bills of Exchange has been noted or protested
for
non acceptance or for better security, any person not being a party already liable
thereupon
may with the consent of the holder by writing on the bill may accept the same for honour
for
any party thereto. The person so accepting is called “acceptor for honour” and the
process
is called “Acceptance for Honour”.
(c) Differential Interest Rate Advances
Weaker section of the society who cannot offer any security/margin money are eligible
under the scheme Rate of Interest is 4% - annual income of the beneficiary should not
be
more than Rs. 7200/- in Urban and Semi Urban areas and Rs. 6400/- in Rural areas.
Quantum of loan should not be more than Rs. 6500/- repayable within a maximum
period
of 5 years. Banks have been provided a target to be achieved of one percent of the
aggregate
advances of pervious year to be given under this scheme.
(d) Conversion (under N.I. Act)
Conversion is the unlawful taking, depositing or destroying of goods which is
inconsistent
with the owner right of possession. Conversion is independent of intention or knowledge
and an innocent party even an agent may be held liable for conversion. When there is no
forgery and the instrument comes into the hands of a holder in due course or where
there
is a forgery and the instrument is a cheque payment whereon has been made in due
INDIAN FINANCIAL SYSTEMS AND COMMERCIAL BANKING
DECEMBER, 2000
CODE NO L-1259
Guidelines - JAIIB
24
course by a banker the true owner of the cheque may be deprived of his rights. In all
other
cases the true owner can maintain a suit for the conversion of the instrument. In other
words conversion means wrongful transfer of benefits of negotiable instrument to a
person
who is not the true owner.
(e) Inchoate Instrument
Section 20 of N.I. Act “when one person signs and delivers to another person a paper
stamped in accordance with the law relating to the Negotiable Instrument either wholly or
blank or having written thereon in a incomplete manner is called Inchoate Instrument.
The
holder thereof can make or complete it.
2. State whether True or False (4x1=4)
(a) A joint Saving Bank Account styled “Either or Survivor” can be transferred from one
branch
to another branch under the instructions of any one of the joint account holders.
ANS- FALSE
(b) ICRA is a credit rating agency promoted by the Industrial Finance Corporation of
India.
ANS- TRUE
(c) Under the Banking Regulation Act, 10% of the profit of a banking company must first
be
transferred to the General Reserve before any dividend can be distributed.
ANS- FALSE
(d) In terms of the Negotiable Instruments Act, finder of a lost cheque is a holder in due
course, if payable to bearer.
ANS- FALSE
3. Fill in the blanks and write full sentence in the answer book given to you (5x1=5)
(a) ICICI Bank was the first Bank to offer Internet banking in India.
(b) RBI has allowed Non Banking Finance companies to maintain 50% of their liquid
assets in
the form of term deposits with scheduled commercial banks.
(c) Net worth of a new insurance company should be Rs.500 Crores.
(d) Urban cooperative Banks are required to achieve the capital adequacy ratio of 9% by
March 2001 (year).
Guidelines - JAIIB
25
(e) Component of Gold and Gold Bullion in the assets of Issue Department of RBI are to
be
not less than Rs. 115 Crores.
4. Choose the correct answer from the alternatives given under each sub-
question.
(9x2=18)
(a) The development programme began in our country with the launch of _____.
i. Community Development Programme
ii. Integrated Rural Development Programme
iii. Small Farmers Development Agency
iv. Intensive Agriculture Area Programme
ANS ( i )
(b) The maximum loan amount under DRI scheme is _______.
i. Rs. 10,000/-
ii. Rs. 25,000/-
iii. Rs. 6,500/-
iv. Rs. 5,000/-
ANS ( iii )
(c) “Sans recourse” means ________.
i. I am not afraid
ii. Do not touch me
iii. Ask the drawer
iv. Without liability to me
ANS- ( iv )
(d) When a drawer draws a cheque without keeping sufficient balalnce and if the cheque
is
bounced for insufficient funds. The drawer is punishable with imprisonment which may
extend to _____ and or a fine.
i. Two Months
ii. One Year
iii. Four Months
iv. Six Months
ANS- ( ii )
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26
(e) The highest credit risk rating that can be awarded to any company by CRISIL is ___.
i. ++A
ii. AAA
iii. +AA
iv. None of the above
ANS- ( ii )
(f) Bankers, in general, are hesitant to finance HUF because ________.
i. The firms ceases to exist when the Karta is dead.
ii. The firm ceases to exist with the death of any of the male coparcener.
iii. The liability of the firm to the banker is susceptible to change with the birth of male
child or with the death of a male coparcener in the HUF.
iv. None of the above.
ANS- ( iii )
(g) Factoring means ______________.
i. Financing against bills receivables.
ii. Financing invoices without recourse only.
iii. Purchasing and/or administering the receivables of a concern.
iv. Collecting the receivables and remitting to the seller.
ANS- ( iii )
(h) Under law of limitation , the liability of a guarantor is _______.
i. 3 years form the date of document.
ii. 3 years from the date of default of the advance.
iii. 3 years from the date when the demand is made on guarantor.
iv. There is not limit of time.
ANS- ( iii )
(i) The first bank to be established in India was _______________,
i. Bank of Bengal
ii. Bank of Hindustan
iii. Allahabad Bank
iv. Punjab National Bank
ANS- ( ii )
Guidelines - JAIIB
27
5. Explain the underlying rationale for the following practices/procedures being followed
by
the banks
(a) Payee of a cheque cannot stop payment of the cheque.
Ans. There is no privity of contract between the payee and the banker on whom the
cheque
is drawn. It is only the drawer who can stop payment of the cheque. However, if the
payee reports loss of cheque and request for stop payment, the banker should tell
him to contact the drawer and ask him to give written instructions to the Bank.
Meanwhile if the cheque is presented banker will be justified in returning the same
with the reasons “payment stopped, awaiting drawer’s confirmation”.
(b) While advancing against security of Term Deposit Receipt, blank undated discharge
is obtained.
Ans. Borrower giver the TDR to the Bank who note their lien on the deposit. This is also
on
implied pledge i.e. the banker has the right to appropriate/sell the security to realize
his dues. But the security should be legally available for sale/appropriation. By
obtaining blank undated discharge bank can obtain the payment even before maturity
if need be.
(c) Mortgagor’s signature is not obtained on the Memorandum prepared in a register for
recording deposit of title deeds for creating equitable mortgage favouring the bank.
Ans. Under Section 58(f) of Transfer of property Act, delivery of documents of title to
immovable property by debtor to his creditor with intention to create security thereon,
creates equitable mortgage and no further act like execution of transfer document by
the debtor or registration. Registrar of assurance is necessary. The memorandum
prepared by the Bank is for its record and if need be to prove the intention of the
borrower to create the equitable mortgage of the property. Hence it is not signed by
the mortgagor. The mortgagor should, however, send a letter by post confirming the
deposit of title with a view to creating mortgage.
(d) Banks do not generally accept for collection cheques with “Not negotiable” crossing.
Ans. Section 130 of N.I. Act state “A person taking a cheque crossed generally or
specially
bearing in either case the words ‘Not Negotiable’ shall not have and shall not be
capable of giving a better title to the cheque than which the person from whom he
took it had. So if the banker collects one such stolen cheque marked ‘Not Negotiable’
Guidelines - JAIIB
28
the banker commits conversion and loses protection under section 131 of the N.I.
Act.
(e) Nominee’s signature is not obtained on the nomination form.
Ans. To maintain secrecy. It also facilitates change of nomination without hindrance
from
the existing nominee.
(f) More than ordinary care is taken in allowing withdrawal in a dormant/inoperative
current/savings bank account.
Ans. To prevent fraudulent withdrawals. Many frauds are perpetuated through these
accounts.
(g) Noting and protesting is necessary in case of dishonour of usance bills and not for
cheques and drafts.
Ans. In case of usance bills, dishonour is not supported by any document. To establish
evidence of dishonour, noting and protesting is necessary. In case of cheques and
drafts reasons for dishonour are invariably given by the bank in writing.
(h) Production of legal representation is not required for disposal of money left with a
Bank in case of deceased Army or Air Force personnel.
Ans. Because the assets of Army and Air Force personnel are governed by the
provisions
of the Army and Air Force (Disposal of Private Property) Act 1950.
6. How would you deal with the following cases as Branch Manager ? Give reasons for
your
answer quoting relevant sections of law, if any, applicable. (6x3=18)
(a) Vishal, a constituent of your branch, wrote to the Bank countermanding payment of a
postdated cheque issued by him on his account. The bank acknowledged receipt of the
instruction, but inadvertently paid the cheque when presented. When the account holder
claimed recovery of the amount, your branch relied on one of the Current Account rules,
which reads as under :-
“The Bank will register instructions from the drawer regarding cheques lost, stolen, etc.,
but cannot guarantee constituents against loss in such cases in the event of a cheque
being paid”.
The customer is not happy and threatens to file a suit.
Guidelines - JAIIB
29
Ans. The bank cannot rely upon the current account rules as the cheque was neither
lost nor
stolen. The payment of the cheque in the instant case solely due to the negligence of the
concerned staff. As such no protection under N.I. Act is available to the Bank.
(b) ‘A and B’ are having a joint account at your branch. They have given a Power of
Attorney in
favour of ‘C’ for operating the account. ‘C’ has been operating the account for sometime.
On
18-12-99, you have been informed that ‘B’ has died. On 19-12-99, a cheque for Rs.
10,000/
- signed by ‘C’ is presented for payment. Sufficient balance is available in the account.
Ans. As both the account holders have jointly given power of attorney to ‘C’, ‘C’ ceases
to be the
agent on the death of one of the principals. In terms of Section 201 of the Indian
Contract
Act, death terminates agency. Hence the banker will be within its right to return the
cheque
unpaid.
(c) A TDR was issued in the name of Mrs. Sunita for Rs. 10,000/- for one year. She died
three
months after the deposit was made in the Bank. Nomination was registered in the books
of
the Bank in favour of her husband Mr. Kamal. Mr. Kamal approaches the Bank for
premature
encashment of the TDR.
Ans. The nomination made under Banking (Amendment) Act 1983 provides for all rights
of the
depositor in respect of the deposit to be vested in the hands of the nominee. It would
therefore be in order for the bank to make premature payment of the TDR to the
nominee
of the deceased provided no legal notice is served on it by any other claimant in the
meantime.
(d) Mr. A had kept a sealed box in safe custody with your branch. He expired sometime
ago,
and his son, Mr. X now brings in the death certificate and wants to take delivery of the
box
deposited by his father. He maintains that he is unable to obtain legal representation
unless
it is known as to what the box contains. Moreover, he feels that the last will of the
deceased
is also kept in the box in question. He, therefore, requests you to deliver the box to him
and
assures you that he will present the necessary legal presentation from a competent
court.
Ans. Bank will arrange to open the sealed box in the presence of all the interested
parties and
two respectable independent witnesses (one of them preferably a magistrate) and
prepare
an inventory of all the contents to be signed by all the persons present and will deliver a
copy of this inventory to Mr. X. If the box contains a will in favour of Mr. X, it will be
delivered
Guidelines - JAIIB
30
to him against proper acknowledgement.
(e) A gentleman walks into your office and introduces himself as Shri Prem Nath, Sales
Manager
of “Excellent Sports Goods Co.” of Ludhiana. He gives you two crossed cheqeus for Rs.
5,000/- and Rs. 10,000/- issued by your clients in favour of “Excellent Sports Goods
Co.”,
and requests you to issue demand drafts crossed and for the same amount, in the name
of
same company i.e. Excellent Sports Goods Co.
Ans. A banker should not endeavor to collect a cheque for a person other than its
customer.
Once the bank drafts are issued the bank shall have to honour these drafts to any
bonafide
holder not withstanding the position of the Bank in relation to the collection of cheques in
collection. Bank will not get protection under Section 131 in the event of collection being
challenged.
(f) Mr. X is maintaining a current account with your branch in his name. His wife comes
and
informs you that he is down with paralysis and cannot sign and that she wants to
withdraw
Rs. 10,000/- immediately for his treatment.
Ans. A married woman can borrow on the credit of her husband, moneys for the
purpose of
maintenance of the family and the money required for the treatment of a paralyzed
husband
would fall within the scope of this purpose. She may, therefore be granted an overdraft in
her personal name and a lien marked on the credit balance of her husband’s account.
Q.7 Answer the following : (10x3=30)
(a) What precaution would you take while opening accounts in the name of the
following :
(i) Illiterate person : (i) Photo of the account holder must be obtained.
(ii) Thumb impression of the account holder be obtained.
(iii) Account must be properly introduced.
(ii) Trusts :
Opening of accounts in the name of trusts :
1. Copy of the trust deed should be obtained and kept on record after verification with
the original.
2. The title of the trust account should tally with the provisions of the trust deed.
3. If the trust deed indicates the name of a specific bank, the trust account should be
opened only with that bank.
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31
4. In the case of a charitable trust, in most States they have to be registered with the
commissioner of Charities and a copy of this certificate should be obtained.
5. The resolution passed by the trustees for opening the account should be obtained.
(iii) Clubs /Associations/Societies :
Opening of accounts in the name of clubs & associations :
1. If the Association/Society or club is registered under the Societies Registration Act
1960 or Companies Act, a copy of the Registration Certificate or the Certificate or
Incorporation should be obtained.
2. The bank should obtain a certified copy of the by-laws, rules and regulations.
3. A list of the members of the Managing Committee to be obtained.
4. A certified copy of the resolution passed by the committee, to open a bank account
together with the details of authorised signatories and instruction regarding the
operation of the account should be obtained.
5. The account must be properly introduced.
(v) Joint Accounts :
A joint account is an account opened by two or more persons :
Opening the Account : The Account Opening Form should be signed by all the joint
account holders. The names, addresses and other details of all of them should also
be obtained on the Account Opening Form. The account-holders should also indicate
how the account is to be operated – the banker should obtain specific directions as
to one or more of them will operate on the account. When a joint account is in the
name of two persons, the operations may be done by:
a. both or survivor ;
b. both jointly ;
c. either or survivor ;
d. former or survivor ;
e. latter or survivor ;
A joint account in the name of more than two persons may be payable to,
a. all of them or survivors ;
b. any one or more of them or survivor or survivors.
In the absence of such instructions, the operations will be by all the persons jointly.
Since
all the instructions are to be given by the account-holders jointly at the time of opening
the
Guidelines - JAIIB
32
account, they can not be revoked by any one of them singly. All fresh instructions and
changes in the existing instructions must be given in writing signed by all the account
holders. However, any one of them can stop payment of a cheque issued by any other
joint
account holder. Any request for granting of an advance should be made by all the
parties
jointly.
(b) What is meant by charging of securities ? State and explain various modes of
charging the
securities.
Ans. When a banker obtains a security for an advance given, it does not necessarily
always
mean transfer of ownership or possession of the security-property. It is possible to obtain
security by having a charge on it. A charge is nothing but creation of a right to payment
out
of a property. It may therefore, be understood that obtention of security as cover for
lending
involves essentially a charge on the security. The type of charge that a banker would
prefer
depends on the nature of the property to be charged. There are various types of charges
and methods of creating charge on securities.
Hypothecation :
Hypothecation is a charge which is preferred when the property to be taken as security
is
movable. In any property, be it movable or immovable, there are three primary rights
associated with it. These are right of ownership, right of possession and right of
enjoyment.
When a charge is created on a property, it normally affects the owner with respect to any
or all of these rights. But this charge of hypothecation does not, however, involve
transfer
of ownership or possession of or even ‘interest’ in a property. It creates merely an
equitable
or notional charge on the property with a right to a banker to take possession of the
property
and sell the goods on default or a right to sue the owner to bring the property to sale and
for realisation of the amount due.
The person who creates the charge of hypothecation is called hypothecator and the
person
in whose favour it is created is known as hypothecate and the property which is
hypothecated
is denoted as hypothecated property. In an advance against hypothecation of goods,
banker
is the hypothecate and the borrower is the hypothecator.
Hypothecation per se has no backing in law, in that there is no enactment covering the
creation, operation and implication of Hypothecation. Hypothecation has been differently
Guidelines - JAIIB
33
defending several judicial cases. It is suffice if we could understand it as a charge which
extends to movable properties and it creates an equitable charge on goods. There is no
transfer of ownership or possession of goods in a charge of hypothecation and both
remain
with the hypothecator i.e. the owner of the goods. The hypothecate, by virtue of the
equitable
charge on the goods, has a right to seize the goods on default from the hypothecator
and
sell the goods by auction. Else, he has a right to sue the hypothecator for sale of
hypothecated goods and adjustment of the amount due, from out the sale proceeds of
hypothecated goods.
As the hypothecator holds the ownership and possession of the hypothecated goods,
hypothecation can be considered as an extended pledge, with the hypothecator holding
possession of the goods in trust for the hypothecate.
Pledge:
Pledge is defined in Section 172 of the Indian Contract Act 1872 as a bailment of goods
as
security for repayment of a debt or performance of a promise.
Section 148 of the Indian Contract Act 1872, defines bailment as delivery of goods by
one
person to another, as security for any some purpose, upon a contract that the goods,
shall,
when the purpose is accomplished, be returned or disposed off according to the
instructions
of the person delivering the goods.
A pledge primarily involves delivery of goods by one person to another, i.e. it involves
transfer of possession of goods by one person to another. Some-times, it could be even
transfer of possession of document of title of goods (constructive delivery) and not
necessarily always the transfer of possession of goods. The person who pledges the
goods
is called the pledgor and the person receiving the pledge of goods is called the pledgee.
Mortgage :
Mortgage is creation of a charge on an immovable property. Mortgage is not sale of
property.
In a sale, there is always a transfer of absolute ownership without conditions
accompanied
by transfer of possession and enjoyment of the property. But in a mortgage there is no
transfer of absolute ownership. Nor is there transfer of possession in every case of
mortgage.
Mortgage is defined under Section 58 of Transfer of Property Act as ‘transfer of an
interest
Guidelines - JAIIB
34
in a specific immovable property for the purpose of securing the money advanced or to
be
advanced or an existing or a future debt or for performance of an engagement which
may
give rise to a pecuniary liability’.
The person who is creating the charge of mortgage is called the ‘mortgage’ and the
person
in whose favour it is created is known as the mortgagee’. The immovable property which
is
the subject of mortgage is referred to as ‘mortgaged property’.
Lien :
Lien is a right possessed by a person to detain or retain the goods or property belonging
to
another until he has received the due remuneration for the services he has rendered in
respect of them. This is defined under section 170 of the Indian Contract Act, 1872.
(c) What is Commercial Paper (CP) ? Explain the present regulations governing
commercial
paper. What are the problems facing CP market in India.
Ans. Commercial Paper (CP) is an unsecured money market instrument issued in the
form of a

promissory note. CP as a privately placed instrument, was introduced in India in 1990

with
a view to enabling high rated corporate borrowers to diversify their sources of short term
borrowings and provide an additional instrument to investors. Corporates, primary
dealers
and satellite dealers, and the all-India financial institutions that have been permitted to
raise short term resources under the umbrella limit fixed by Reserve Bank of India are
eligible to issue CP. A corporate would be eligible to issue CP provided- (a) the tangible
net
worth of the company, as per the latest audited balance sheet, is not less than Rs.4
crore;
(b) company has been sanctioned working capital limit by banks or all-India financial
institutions; and (c) the borrowal account of the company is classified as a Standard
Asset
by the financing bank/institution. CP can be issued for maturities between a minimum of
15
days and a maximum up to one year from the date of issue and in denomination of Rs.5
lakh or multiple thereof. Amount invested by single investor should not be less than Rs.5
lakh (face value).
Previously, an option was available to both issuer and subscriber to issue/hold CP in
dematerialized or physical form. But, now w.e.f. November 1, 2001, these entities will
hold
CP only in dematerialized form. With the reducing rate of interest on advances as well as
deposited, the big corporates are encouraged in making use of Commercial Paper in a
big
Guidelines - JAIIB
35
form so as to cut their cost of borrowing.
(d) What are the requisites of a “Payment in due course” ? What is the protection
available to
a paying banker in case of crossed cheques ?
Ans. Payment in due course : (Section 10)
“Payment in due course means 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”.
If the payment is made in due course the drawee of the cheque (the banker) is
discharged
from all liabilities that may arise from making the payment.
Protection Available to the Paying Banker in the case of crossed cheques :
Section 126 : Where a cheque is crossed generally, the banker on whom it is drawn
shall
not pay it otherwise than to a banker. Where a cheque is crossed specially, the banker
on
whom it is drawn shall not pay it otherwise than to the banker to whom it is crossed, or
his
agent for collection.
Section 127 : Where a cheque is crossed specially to more than one banker, except
when
crossed to an agent for the purpose of collection, the banker on whom it is drawn shall
refuse payment thereof.
Section 129 : Any banker paying a cheque crossed generally otherwise than to a banker
or
a cheque crossed specially otherwise than to the banker to whom the same is crossed
or
his agent for collection being a banker shall be liable to the true owner of the cheque for
any loss he may sustain owning to the cheque having been so paid.
Guidelines - JAIIB
36
1. Write short notes on the following :(Answer any three)
‘MAST’ Principle of Securities
(a) : While advancing against securities, a banker has to bear in mind that the securities
should be such that they conform to the ‘MAST’ Principle.
MARKETABLE i.e. they are easily marketable
ASCERTAINABLE i.e. their value is ascertainable
STABLE i.e. they are stable in terms of its value and not widely
fluctuating
TRANSFERABLE i.e. and they are easily transferable
A banker, being one who, when confronted with default of repayment by a borrower,
has to proceed against the securities obtained and realize quickly the value of the
securities by sale to get paid, should always evaluate the securities offered against
the above touchstones before accepting them.
(b) Gold Deposit Scheme
The Union Finance Minister had announced the introduction of a Gold Deposit Scheme
in the budget for 1999-2000. The scheme seeks to provide depositors the opportunity
to earn interest on their idle gold holdings along with the benefits of safety and security
of holding gold without any cost. Banks are free to fix their own interest rates on the
gold deposit scheme. The scheme will have maturity range from 3 to 7 years. Gold
under the scheme will be accepted in scrap form only. After assessing the purity of
gold bank will issue a certificate which will be transferable by endorsement and
delivery. The deposit will be repaid in the form of standard gold bar of 0.995 fineness
or in rupees equivalent to the price of gold as on the date of maturity at the option of
the depositor. The depositor will have to exercise the option at the time of application
INDIAN FINANCIAL SYSTEMS AND COMMERCIAL BANKING
JUNE, 2001
CODE NO R-1326
Guidelines - JAIIB
37
or once during the tenure of the bond. Nomination facility will be available on these
deposits. Rupee loans will be available against collateral of the gold deposits.
(c) Order Nisi
The obligation of a banker to honour his customer’s cheques is extinguished on
receipt of an order of the court known as the Garnishee order, issued under Order
21 Rule 46 of the Code of the Civil Procedure; 1908. If a debtor fails to pay the debt
owed by him to his creditor, the latter may apply to the court for the issue of a
Garnishee Order on the banker on his debtor. It is issued in two parts. First, the
Court directs the bankers to stop payments out of the account of the judgement
debtor. Such order called “Order Nisi”, also seeks explanation from the Banker as to
why the funds in the said account should not be utilised for meeting the judgement
debtor’s claim. The Banker is prohibited from paying the amount due to his customer
on the date of receipt of the “Order Nisi”. He should, therefore, immediately inform
the customer so that the dishonour of any cheques issued by him may be avoided.
After the bankers files his explanation, if any, the court may issue the final order
called “Order Absolute”, whereby the entire balance in the account or a specified
amount to attached to be handed over to the judgement creditor.
(d) Obliterating a Crossing
Some times the crossing on a cheque is obliterated or erased by dishonest persons
so cleverly and skillfully that the paying banker is unable, despite utmost efforts on
his part, to detect such obliteration’s and pays the cheque as an open cheque. Section
89 of N.I. Act provides protection to the paying banker provided the following condition
are fulfilled:-
i) The cheque does not appear to be a crossed one at the time of its presentation
or obliteration of the crossing is not apparent ; and
ii) The payment is made according to the apparent tenor of the cheque and in
due course.
(e) Local Area Banks
The objective of setting up of local area banks (LABO) in the private sector is to
provide institutional mechanism for promoting rural savings and provision of credit
for viable economic activities in local areas. The minimum capital of a LAB shall be
Rs. 5 Crore. The promoters contributions for such a bank shall atleast be Rs. 2 Crores.
Guidelines - JAIIB
38
The promoters of the bank may comprise in the individuals, corporaters, trusts and
societies. The area of operations for LAB shall be a maximum of three geographically
contiguous districts and the Head Office of the banks shall be located at a centre
within the area of operation. These banks have to achieve benchmarks under lending
to priority sector, weaker sections and agricultural as applicable to domestic banks.
The banks shall be registered as a public limited company and will be licensed under
the banking regulations Act 1949.
2. State whether true or false :
(a) the denomination of a commercial paper should be minimum of Rs. 5 lakh and
multiples thereof
ANS - (True)
(b) The concept of Weaker Sections was introduced by the Gadgil Working Group on
rural credit.
ANS- (False)
(c) Minimum paid up capital for entry of new private sector banks is Rs. 200 crore.
ANS- (False)
(d) Provisions of Banking regulation Act are not applicable to Co-operative banks.
ANS- (False)
3. Fill in the blanks and write full sentence in the answer book given to you.
(a) The minimum maturity period for Certificate of Deposit is fixed at 15 days.
(b) Section 130 of the Negotiable Instruments Act relates to “Not negotiable” crossing.
(c) Maximum loan amount under Education Loan Scheme of Reserve Bank of India or
payment seat students is Rs. 50000.
(d) Banks having minimum net worth of Rs. 500 crore and satisfying the prescribed
criteria of capital adequacy and profitability can enter into insurance business.
(e) Ganga Kalyan Yojana has been merged with Swarn Jayanti Gram Swarojgar Yojana
4. Choose the correct answer from the alternatives given under each sub-
questions
(a) What was the main base for nationalisation of banks in 1969 ?
(i) Minimum deposits of Rs. 150 crore and above
(ii) Minimum deposits of Rs. 50 crore and above
(iii) Total business of Rs. 150 crore and above
(iv) None of these Ans ( ii )
Guidelines - JAIIB
39
(b) Which type of securities are held by Reserve Bank of India before issuance of
currency
notes ?
(i) Gold coins and bullion
(ii) Foreign Securities
(iii) Government of India’s securities
(iv) All of these Ans (iv)
(c) Quasi Negotiable Instrument is accepted like Negotiable Instrument because of
_________
(i) the force of law
(ii) the customs and practice
(iii) their character of negotiability
(iv) none of these Ans (ii)
(d) Loan documents executed out of India must be presented for registration within
________ of its arrival in India.
(i) three months
(ii) four months
(iii) six months
(iv) twelve months Ans (ii)
(e) Usance bills or promissory notes drawn out of India are required to be stamped by
________
(i) first holder in India
(ii) any holder
(iii) any party Ans (i)
(f) Command Area Development Programme relates to _____________
(i) Desert development
(ii) Hill area development
(iii) Livestock development
(iv) Irrigation development Ans (iv)
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40
(g) The minimum percentage of Priority Sector advances to be maintained by foreign
banks in India is __________.
(i) 40%
(ii) 22%
(iii) 32%
(iv) 18% Ans (iii)
(h) The Committee to study the problems of Multy-Agency approach was headed by
_________
(i) M.L. Dantwala
(ii) C.E. Kamath
(iii) A. Ghosh
(iv) C.M. Vasudev
(v) none of these Ans (ii)
(i) Margin money scheme of KVIC is applicable to the project of individuals and
entrepreneurs ____________.
(i) Where the total project cost does not exceed Rs. 10 lakh
(ii) Where the total project cost does not exceed Rs. 25 lakh
(iii) Where the total project cost does not exceed Rs. 5 lakh
(iv) None of these Ans (i)
5. Explain the underlying rationale for the following practices / procedures being
followed by banks. (8X2=16)
(a) Advances granted to limited companies against the pledge of goods, need not be
registered
with the Registrar of Companies under Section 125 of the Companies Act.
Ans. As the bank is in possession of the goods, there is no need for notice to third
parties and
hence the registration of a pledge charge is not provided for under section 125 of the
companies Act.
(b) Assignment of LIC policy is done on the policy itself.
Ans. It is done on a separate paper, it will attract stamp duty. Moreover, it is convenient.
(c) Banker’s lien is called an implied pledge.
Ans. Bankers has right to sale of available security under banker’s right of lien.
Therefore it is
Guidelines - JAIIB
41
said that banker’s lieu tent amounts to an implied pledge.
(d) In case of partnership account, if account shows debit balance at the time of death of
a
partner, bank closes the account and opens a fresh account for further transactions.
Ans. If banker wishes to hold the claim against the estate of deceased partner account
of the
firm should be closed immediately to determine the liabilities of each partner.
Subsequently
credits should be accepted in the fresh account, otherwise clayton’s rule will become
operative and deceased partners assets would stand discharged by the amount of
subsequent credits.
(e) Banks do not obtain promissory notes attested by some one.
Ans. It attracts stamp duty as a bond under section 2(5) (b) of the Indian Stamp Act.
(f) Endorsement by an illiterate person affixing thump impression is invalid.
Ans. In terms of section 15 of the Negostiable Instrument Act 1881, signature is must to
constitute
or valid endorsement.
(g) Bank cannot countermand payment of its own draft.
Ans. Once the draft is issued to the purchaser and he sends it to payee, bank became
trustee of
the payee. Draft is equivalent to banks promissory note and, therefore, bank cannot
make
stop payment of the draft.
(h) Bank’s seal is not affixed on the boxes / envelopes deposited for safe custody in the
Bank.
Ans. Bank is not aware of the contents of the box/envelope deposited for safe custody
and it is
the duty of the Bank to return the box intact in the same position in which it was
received.
Therefore, bank does own any responsibility about the contents of the box and due to
this
Bank’s seal is not affixed.
Q.6 How would you deal with the following cases as Branch Manager ? Give
reasons for
your answer quoting relevant sections of law, if any, applicable.
(a) The closing hour of your branch was 3 p.m. Your customer ‘B’ gave a cheque of Rs.
10000
to ‘C’ at about 3 p.m. ‘C’ brought it to your branch at 3.05 p.m. and the branch paid it
over
the counter. Next day, ‘B’ sent his son to the branch at 9 a.m., the opening hour of the
branch, to give instructions to stop payment of the cheque. On knowing that the cheque
was paid at 3.05 p.m. on the previous day, he brought an action against the Bank to
recover
Guidelines - JAIIB
42
the sum as having been paid beyond banking hours.
Ans. Demand must be made within the prescribed banking hours. Cheque presented
and paid
after business hours is not a “payment in due course”. However, in the case of “Bains
Vs.
National Provincial bank limited (1927) 32 Comp. Cas. 216” it was held that the cheque
may be paid within a reasonable margin after the closing time.
(b) You have given a demand loan to ‘S’ for purchasing a T.V. He is employed in Private
company
on contract for three years which is going to expire soon. He defaulted three installments
and due to this you telephoned to employer company of ‘S’ for pressurising him to pay
the
loan installments. In the course of conversation with two directors of the company, you
also
disclosed that ‘S’ is heavily indebted due to his involvement in share broking. As a result
of
this conversation, the company did not renew its contract with ‘S’. He sued the Bank for
damages for slander and breach of duty of secrecy.
Ans. The Bank is legally bound to maintain secrecy arising out of contract implied in the
relation
of banker and customer, a breach of which could give rise to an action for damages.
(c) A partner of ‘W and M’, a firm, signed a blank crossed cheque with the words ‘not
negotiable’
printed on it. He handed over the cheque to an employee of the firm and instructed her
to
fill it in for Rs. 2000 in favour of Commissioner of Sales Tax. The employee filled in the
cheque for Rs. 20000 in favour of ‘P’, who was the employee’s creditor. ‘P’ got the
cheque
collected in an account with your branch. The firm has filed a suit against ‘P’ and the
Bank
for conversion of the cheque.
Ans. A person who puts an inchoate instrument into circulation must be taken to have
authorised
whatever is subsequently inserted in it in order to make it a complete instrument. In this
case firm cannot allege that ‘P’ had not title.
(d) A cheque drawn in favour of ‘Cycle Co.’ was stolen by its employee. He endorsed it
in
favour of Nilgiri Potato Co. The Potato Co. got discounted the cheque with Kanhaiyalal
Thakurdas a money lender. The money lender got the cheque collected in his account
maintained with your branch. After discovery of the fraud, the Cycle Co. sued (i) its
employee
(ii) Potato Co. (iii) the money lender and (iv) your bank.
Guidelines - JAIIB
43
Ans. If the payee is in cycle business and he endorses a cheque to somebody doing
potato
business, the collecting banker should make enquiries how the apparent connection
between
such divergent things like cycle and potato came about, Further, contributory negligence
cannot be pleaded by a collecting banker against the true owner.
(e) You have given a gold loan to a farmer against the pledge of gold ornaments. After
six
months, the farmer repaid the loan with interest and demanded back the ornaments
pledged
with your branch. You refused to give him the ornaments for the reason that the farmer
was
a surety of a defaulted and recalled loan. Farmer has sued you for the offences
punishable
under Section 409 and 420 of Indian Penal Code.
Ans. The bank is entitled to exercise the right of the general lien under section (7) of the
contract
act even in respect of the borrower’s obligations as a surety and for that purpose it is in
order to retain the security offered by him for the loan obtained for personal use.
(f) Your customer ‘A’ has deposited an outstation cheque for Rs. 3000/- which was sent
for
collection to Bangalore on Feb. 20, 2001. Bangalore branch realised the cheque on Feb.
24, 2001 and sent the requisite advice which was received by your branch only on 29th
Feb.
2001. In the meanwhile, on Feb. 28, 2001, a third party garnishee order issued by a
court
requiring the Bank to freeze the said account to the extent of Rs. 2250/- was served. As
the
account had credit balance of Rs. 800/- only, your branch applied the garnishee order to
that extent. The proceeds of cheque for Rs. 3000/- sent under collection was later
disputed
in the court at the request of the judgement debtor.
The moment a cheque sent for collection by other Bank had been realized, the
realization
must be treated as having accrued to the principle bank and in this case the cheque was
realized on the 24th Feb. on the basis of this principle on the material date when the
garnishee
order was served on the Bank on Feb. 28, 2001, the Bank had more than Rs. 2250/- to
the
credit of “A”.
7 Answer the following : (3X10=30)
(a) Describe ten major recommendations of Narsimham Committee- II.
Ans. Second Narasimham Committee Recommendations :
1. Capital Adequacy Ratio :
A minimum target of 9 percent CRAR to be achieved by the year 2000 ; the target
Guidelines - JAIIB
44
should be raised to 10 percent for the year 2002.
2. Risk weights on Investments in Government Securities, approved securities and other
than approved securities :
A risk-weight of 5 percent for market risk for Government / approved securities.
3. Risk weights on Government guaranteed advances:
Risk-weight on Government guaranteed advances to be the same as other advances:
4. Foreign Exchange open position limit:
To carry 100 per cent risk weight.
Provisioning Norms :
(i) A general provision of 1 percent on standard assets.
(ii) An assets to be classified as doubtful if it is in the sub-standard category for 18
months in the first instance and eventually for 12 months and loss if it has
been so identified but not written off.
(iii) The Government guaranteed advances which have turned sticky to be classified
as NPAs.
(iv) Income recognition, asset classification and provisioning norms should apply
to Government guaranteed advances.
5. Other Recommendations:
(i) Banks and financial institutions should avoid the practice of evergreening.
(ii) Any effort at financial restructuring must go hand in hand with operational
restructuring. With the cleaning up of the balance sheet, simultaneously steps
to be taken to prevent / limit re-emergence of new NPAs.
(iii) To enable banks in difficulties to issue bonds for Tier II capital, Government
will need to guarantee these instruments which would then make them eligible
for SLR investment.
(iv) There is a need for disclosure in a phased manner of the maturity pattern of
assets and liabilities, foreign currency assets and liabilities, movements in
provision account and NPAs.
(v) Concentration ratios need to be indicated in respect of bank’s exposure to any
particular industrial sector as also to sectors sensitive to asset price fluctuations
such as stock market and real estate. These exposure norms need to be
carefully monitored.
(vi) Banks should bring out revised operational manuals and update them regularly.
(vii) There is need to institute an independent loan review mechanism especially
for large borrowal accounts and to identify potential NPAs.
Guidelines - JAIIB
45
(b) Supervisory and Regulatory Functions :
(a) Monopoly of Note Issue
Under Section 22 of the Reserve Bank of India Act, the Reserve Bank has the sole right
for
the issue of currency other than one rupee coins and notes and subsidiary coins; and as
in
the case of Bank of England, the Reserve Bank maintains two departments viz., The
Issue
Department and The Banking Department. The notes are a liability of the issue
department
alone. The assets of the issue department which form the backing for the note issue are
kept distinct from those of the Banking Department. According to Sec.33 of The Reserve
Bank of India Act, the assets of the Issue Department against which Bank loans are
issued
should consist of gold coin and bullion, foreign securities, rupee coin, Government of
India
securities and such Bills of Exchange and Promissory Notes payable in India and as are
eligible for purchase by the Bank.
Under the original Act of 1934, not less than 2/5th of the assets of the Issue Department
were to be required to be held in gold coin, gold bullion or foreign securities, the value of
the gold coin and gold bullion not being below Rs. 40 crores. This was amended by The
Reserve Bank of India Amendment Act of 1959 which bought in the following changes :
a. Revaluation of the gold reserves held by the Reserve Bank from the original very low
price of Rs. 21.24 per tola to Rs. 62.50 per tola, which was Rupee equivalent of the
price agreed to by the International Monetary Fund.
b. A shift from the proportionate to the minimum reserve system with regard to the
issue of currency.
Simultaneously, with the revaluation of gold, the minimum reserve to be held in gold was
fixed at Rs. 115 crores instead of Rs. 40 crores. According to the second change there
would be no limit to the volume of currency that could be issued by the Reserve Bank,
provided it maintained a minimum of Rs. 115 crores of gold and Rs. 400 crores of
foreign
exchange. There were some amendments to these provision and as per the present
provision
the aggregate value of gold bullion and foreign securities held in the Issue Department of
the Bank should not at any time be less than Rs. 200 crores of which the value of the
gold
coin and gold bullion should at no time be less than Rs. 115 crores.
Guidelines - JAIIB
46
(B) Control of Credit through Monetary Policy :
The objective of monetary policy in our country has been two-fold. It has to facilitate the
flow of an adequate volume of bank credit to industry, agriculture and trade to meet their
genuine needs. It is also with a view of provide selective encouragement to sectors
which
stand in need of special assistance such as the weaker sections of the community and
the
neglected sectors and areas in the country. At the same time, to keep inflationary
pressures
under check it has to restrain undue credit expansion and also ensure that credit is not
diverted for undesirable purposes. As the central monetary authority, the Reserve
Bank’s
chief function is to ensure the availability of credit to the extent that it appropriate to
sustain
the tempo of development and promote the maintenance of internal price stability.
The instruments of credit control are of two types as under –
a. General or Quantitative
b. Selective or Qualitative
Under the General Credit Control, the instruments often employed by The Reserve Bank
of India
are –
i. Bank Rate Policy
ii. Reserve Requirements
iii. Moral Suasion
iv. Direct action
7 (c) Changes in Role and Functions of Commercial Banks :
Ans. There has been a tremendous change over the years in the very meaning of
Banking.
Banking earlier was purely restricted to borrowing money as deposits, with a view to
lending
them as advances. Thus the main facets were confined to the acceptance of deposits
and
lending of loans.
With the growth of Indian Economy and also as an off-shoot of reform measures, banks
have come to take upon themselves, various other activities which may not measure
upto
this old definition of banking.
These activities include –
1. Investment Counselling
2. Investment Banking
3. Mutual Fund
Guidelines - JAIIB
47
4. Project Appraisal
5. Merchant Banking Services
6. Taxation Advisory Services
7. Executor Trustee Services
8. Housing Finance Activities
9. Segment – wise specilised branches
10. Credit Card Services
11. Computer Software Development
12. Forex Consultancy Services
13. 24 hours banking
14. ATM Services (Automated Teller Machines)
15. Transaction of Government business.
16. Securities Trading
17. Money Market Mutual Funds
18. Factoring
19. Leasing and hire-purchase
20. Gold / Silver / Platinum trading
21. Venture Capital Financing.
22. Insurance-life / general
These activities are either being pursued by separate departments of the banks or by
separately floated independent subsidiaries formed for undertaking such activities
exclusively.
Recently, banks have given more focus to increase and improve their profits from non-
fund
based activities like guarantees and Letter of Credits, as the revenues from increased
lending activities are on the decline. And again, the recently introduced prudential norms
act as a sort of deterrence to banks to avoid lending activity and embrace investment
avenues in its place.
Further, with the massive computerisation taking place in the entire industry, banks have
been able to reduce the transaction time / cost, thus benefiting the customers.
Also, banks which were hitherto confining themselves with working capital finance have
embarked upon project financing activities too and in the process face stiffer competition
Guidelines - JAIIB
48
from financial institutions.
In the days to come, banking sector will witness a dramatic change. The internet banking
will bring a great revolution possibly ushering in “Branchless Banking”.
7 (d) Approach to Social and Development Banking :
Ans. Approach to Social and Development banking is a multi-level approach. It was not
an easy
task to turn a traditional banker into a social and development banker, as the concept of
both banking systems were quite apart. It took sometime for the bankers to accept the
concept of social and development banking in its true meaning and use the resources
available with banks for the development of the society. The following steps may be
regarded
as the approach to Social and Development Banking in India :
1. Social Control over Banks :
The first attempt to give a radical orientation to commercial banking in India was
made in the year 1968. Traditionally developed commercial banking in India was not
paying any attention to the undeveloped sectors of the economy viz. agriculture,
small scale industries, transport and small businesses etc. This was the background
that the “Social Control” over banks was introduced in 1968.
2. Setting Up of National Credit Council :
As per the decision taken under the Policy of Social Control, National Credit Council,
was set up in February 1968 with the following objectives.
i. To determine the demand for credit from various sectors of the economy.
ii. To determine priorities for the grant of loans and advances or for investment,
having regard to availability of financial resources with commercial banks as
also financial requirements of various priority sectors of the economy,
particularly agriculture, small scale industries, self employed persons, rural as
well as urban artisans.
iii. To coordinate lending and investment policies between commercial banks and
cooperative banks and specialised financial institutions in the country with the
objectives of making maximum use of financial resources available with all the
financial institutions in the country.
3. Nationalisation of 14 Banks :
As the objectives of social control of banks was not achieved as expected, 14 major
commercial banks were nationalised on 19th July, 1969 bringing about 85% of the
Guidelines - JAIIB
49
total commercial banking business in the country in the hands of the Government.
Major objectives of the nationalisation of commercial banks in India as set forth by
the then Prime Minister are as follows :
a. Removal of the control of a few large industrial houses over commercial banking
in the country.
b. Provision of adequate credit to the priority but so far neglected sector of the
economy like agriculture, small scale industries, exports etc.
c. Introduction of professional management in commercial banking business in
the country.
d. Providing proper stimulus so that a new class of entrepreneurs emerges in the
country. and
e. Provision of adequate training and reasonable terms and conditions of service
for bank employees.
4. Lead Bank Scheme :
Lead Bank Scheme launched in December, 1969 brought involvement of banks in
the planning process of the rural development to promote socio-economic activities
in the rural areas.
Thereafter the Village Adoption Scheme brought the bankers nearer to the villages.
5. Branch Expansion :
At the time of nationalisation only 22% of the total bank branches were in rural areas.
To fulfil the objectives of the social control vast branch expansion programme took
place increasing the percentage of rural branches to 47% of total bank branches.
6. Credit Guarantee Corporation of India :
Credit Guarantee Corporation of India was set up in 1971 to ensure comprehensive
guarantee cover to loans extended by banks directly to borrowers under priority sector.
7. 20 Point Economic Programme :
This progamme originally announced on 1st July, 1975 was modified in January, 1980.
It was further restructured and announced on 20th August 1986 and was implemented
since 1st April 1987. The objective of the programme was to remove poverty and
create employment.
Guidelines - JAIIB
50
8. Regional Rural Banks :
Beginning of the Regional Rural Banks in 1975 was another step to give fillip to the
rural banking.
9. Weaker Sections :
The concept of weaker section came into effect in the year 1980 and a sub target of
10% of the total advances outstanding was fixed for weaker sections.
10. Service Area Approach :
A new approach for social and development banking was introduced on 1st April,
1989, called as Service Area Approach.
Setting up of various financial institutions :
1. Industrial Finance Corporation of India (IFCI) - 1948
2. Industrial Credit and Investment Corporation of India (ICICI) - 1955
3. National Small Industries Corporation of India (NSICI) - 1955
4. Industrial Development Bank of India (IDBI) - 1964
5. Housing Development Financing Corporation (HDFC) - 1977
6. Export Import Bank of India (EXIM BANK) - 1.1.1982
7. National Bank for Agriculture & Rural Development (NABARD) - 12.7.1982
8. Industrial Reconstruction Bank of India (By converting
Industrial Reconstruction Corporation of India - 1985
9. National Housing Bank (NHB) - 9.7.1988
10. Small Industries Development Bank of India (SIDBI) - 2.4.1990
These are the major approaches to social and development banking, which has made
the
banking system in India available to rural areas and the economically weaker sections
also.
Guidelines - JAIIB
51
1. Write short notes on the following :
(a) Kite Flying
Kite flying in Bills is done in the form of accommodation bills. Where there is no
monetary
dealing between the drawer and the drawee of the bill and the bill has been drawn
simply
to accommodate the drawer so that he can get it discounted with the Bank In such
cases,
on maturity the drawer pays to the drawee the amount of the bill so that he may honour
the
bill. – See Sec 43 of Negotiable Instruments Act.
(b) Nomination in joint accounts
In the case of joint accounts nominations should be given by all the joint account
holders,
instructions in this regard should be very clear. In a joint account of A and B with
instructions
either or survivor the nominee has a right to money only on the death of both A and B.
(c) Conversion
Conversion is the unlawful taking, depositing or destroying of goods which is
inconsistent
with the owners right of possession (wrong collection of cheque by the bank is a form of
conversion).
(d) Bank Rate
The standard rate of interest at which RBI is prepared to buy / rediscount bills of
exchange
or other commercial paper from banks (See 49 of RBI Act).
(e) General Lien
Right to retain securities in respect of general balance due by their owner to the banker.
Lien does not extend to safe custody deposit/bills of exchange/money deposited for a
specific
purpose
2. State whether True or False(4X1=4)
(a) Reserve Bank of India can prescribe Cash Reserve Ratio (CRR) not less than 3%
and not
INDIAN FINANCIAL SYSTEMS AND COMMERCIAL BANKING
NOVEMBER / DECEMBER 2001
SECTION I
Guidelines - JAIIB
52
more than 15%.
ANS- FALSE
(b) Equipment leasing Company is a Non-banking Finance Company (NBFC).
ANS- TRUE
(c) Unit Trust of India is a Mutual Fund in private sector.
ANS - FALSE
(d) If a drawer of cheque puts a line across the word “bearer”, it is a material alteration.
ANS- FALSE
3. Fill in the blanks (write full sentence in the answerbook given to you)
(a) The Reserve Bank of India was originally constituted as a shareholder’s Bank with a
share
capital of Rs. 5 Crore divided into 5 Lakhs fully paid up shares of Rs. 100 each.
(b) The first Development Bank opened in India was Industrial Finance Corporation of
India.
(c) Opening of Private Sector Money Market Mutual Funds (MMMFs) are subject to
clearance
from SEBI.
(d) Rural Infrastructure Development Fund (RIDF) is maintained by NABARD.
(e) It is presumed that every negotiable instrument was made or drawn, accepted,
endorsed,
negotiated or transferred for Consideration.
SECTION II
4. Choose the correct answer from the alternatives given under each sub-
questions
and write the same in the answerbook given to you :
(a) EXIM Bank is owned by –
i. Government of India and RBI jointly
ii. RBI and select commercial banks jointly
iii. Fully owned by Government of India
iv. Partly by financial institutions
ANS - ( iii )
(b) Ceiling on investment on plant and machinery in the case of Tiny Sector has been
redefined
as :
Guidelines - JAIIB
53
i. upto Rs. 5 Lakh
ii. upto Rs. 10 Lakh
iii. upto Rs. 25 Lakh
iv. upto Rs. 50 Lakh
ANS - ( ii )
(c) “Customer” is defined in –
i. Banking Regulation Act
ii. N.I. Act
iii. R.B.I. Act
iv. Nowhere it is defined
ANS- ( iv )
(d) Prospectus is issued by a Private Limited Company when it issues
i. Debentures
ii. Shares
iii. Both debentures and shares
iv. None of these
ANS - ( iv )
(e) A Public Limited Company should have minimum membership of –
i. 50
ii. 15
iii. 7
iv. No limit
ANS- ( iii )
(f) Introduction of rating methodology for banks was introduced by RBI on the lines of –
i. CAMEL
ii. IRAC
iii. CMA
iv. None of these
ANS- ( i )
Guidelines - JAIIB
54
(g) In terms of the N.I. Act, finder of a lost cheque is :
i. A holder but not holder in due course, if payable to order
ii. A holder in due course, if payable to bearer
iii. Both holder and holder in due course, in either case
iv. None of these
ANS- ( iv )
(h) The charge created on a security of National Savings Certificate is –
i. Pledge
ii. Hypothecation
iii. Assignment
iv. Mortgage
ANS- ( i )
(i) The minimum percentage of Priority Sector Advances to be maintained by foreign
banks in
India is –
i. 40%
ii. 22%
iii. 30%
iv. 32%
ANS- ( iv )
5. Explain the underlying rationale for the following practice/procedure being
followed
by the bank :
(a) Rupee Traveller cheques are paid even after banking house
Ans. As travellers cheque is not a negotiable instrument payment within banking hours
and
consequential protection to a paying bank in terms of Sec 10 of Negotiable Instruments
Act is not relevant for payment to travellers cheques.
(b) The transferee of a cheque bearing “Not negotiable” crossing does not become a
holderin-
due course.
Ans. “Not Negotiable” crossing does not make the cheque non-transferable but the
endorsor of
such cheque shall not be capable of giving a better title to the endorsee of the cheque
than
which he holds. Refer to Sec 130 of Negotiable Instruments Act.
Guidelines - JAIIB
55
(c) Payee of a cheque cannot stop payment of the cheque.
Ans. The contractual banker customer relationship is only between the drawer of the
cheque
and his banker. Further, there is no priority of contract between the payee and the
banker
on whom the cheque is drawn.
(d) While advancing against security of Term Deposit Receipt, blank undated discharge
is
obtained.
Ans. The banker obtains blank discharge of the TDR from the depositor so that payment
may be
obtained even before maturity, if need be.
(e) A time – barred document can be revived.
Ans. Promise to pay a time – barred debt does not require fresh consideration in terms
of Sec
25(iii) of the Indian Contract Act 1872 and as such revival would not only be valid but
also
will have the effect of reviving original agreement.
(f) Overdraft is granted against shares, LIC policy etc. and not a demand loan.
Ans. LIC policy, shares are not authorized securities and can only be assigned in favour
of the
bank. Frequent changes in drawing powers may take place depending on the changes in
surrender vlaue/market price of shares.
(g) Noting and protesting is necessary in case of usance bills and not for cheque and
drafts.
Ans. In case of user bills, dishonour is not supported by any document. To establish
evidence of
dishonour, noting and protesting is necessary. In the case of cheques and drafts, the
reasons
for dishonour are invariably given by the bank in writing.
(h) Mortgagor’s signature is not obtained on the memorandum prepared for recording
deposit
of title deeds for creating equitable mortgage in favour of bank.
Ans. The memorandum prepared by the bank is for its record and if need be, to prove
the
intention of the borrower to create the equitable mortgage of the property. Hence it is not
signed by the mortgager. The mortgager should, however, send a letter by post
confirming
the deposit of title with a view to creating mortgage.
Guidelines - JAIIB
56
SECTION III
6. Attempt the following problems by giving reasons for your answer and also
quoting
relevant sections of law, it any, applicable.
(a) A and B have a term deposit with you which is payable to “Former or Survivor”. B has
given
a guarantee for a loan granted to C, which has become overdue. You want to set – off
the
term deposit to liquidate the loan, which has been resisted by B.
Ans. Bank cannot set off the amount of TDR to liquidate the loan given to ‘C’ on the
guarantee of
‘B’.
(b) A had presented a cheque for Rs. 10,000/- for cash payment. After obtaining his
discharge
a token was issued to him. The cheque was, thereafter passed for payment and sent to
the
cash department. A did not turn up till the close of banking house to receive the
payment.
The next day you receive an attachment order from the Commercial Tax Officer and he
insists to attach Rs. 10,000/- also which has been debited in the a/c on the previous
date.
Ans. The amount debited to the account will also be included for the purpose of
attachment
order, as it has not been paid till the receipt of attachment order.
(c) A cheque bears date in vernacular language with red ink. Name of the payee with
another
handwriting in English in blue ink. Amount in figures in the roman script with some other
handwriting in green ink. The signature of the drawer in silver ink tallies with the
specimen
on your records. Bank has refused to pay this cheque. The dishonour has been
challenged
by the drawer in the court.
Ans. Legally, the cheque can be paid. In practice, cheque bearing amount in figures in
Roman
scripts are not accepted, but Sec 18 of Negotiable Instruments Act provides that the
amount
in the words shall be the amount undertaken or ordered to be paid.
(d) On 1st February, a 30 days Bill drawn by Shri Mehta, which has been discounted by
you
was accepted by Shri Bhatia. On 18th February, the Branch receives a notice of Shri
Bhatia’s
insolvency. Bank has filed a suit against Shri Mehta and Shri Bhatia to recover the
amount
of the bill. Shri Bhatia has resisted the suit on account of insolveny.
Ans. On receiving the notice of insolvency of Mr. Bhatia, the bill becomes due for
payment
immediately and will be automatically treated as dishonoured. Legal action may be taken
Guidelines - JAIIB
57
against Mr. Bhatia and Mr. Mehta for recovery.
(e) A young boy of 14 years of age approaches you with a request to open a Savings
Banks A/
c in his personal name and he gives you a cheque issued in his favour by his father as
an
initial deposit for opening the account. The cheque is issued by the father on his account
with your branch.
Ans. Legally, there should be not objection in opening a savings bank account with a
cheque as
an initial deposit. However, in practice, banks open account with cash only.
(f) “M” Bank has called for your opinion on financial status of your customer Mr. R. Your
dealings
with the customer indicate sound financial position of the customer. You have heard
from
some one that recently the customer has suffered a huge loss due to speculative
activities
which has adversely affected his financial position. What will be your opinion about the
customer’s financial position ?
Ans. Bank should comment on the financial position as per the conduct of the account
and bank
record and not on hearsay information. Personal opinion of the bank official should not
be
incorporated.
Q. 7 :Answer the following :
(a) Distinguish “Safe Custody” and “ Safe Deposit Lockers” services. What are the
provisions
of operating a locker in joint names, if one of the hirers dies ?
Ans. Safe Custody of Articles :
One of the miscellaneous services that a banker does / renders is to keep articles
delivered
for safe custody, by customers. While rendering this service, the relationship between a
customer and a banker is that of a bailor and bailee. The customer delivering the article
is
a bailor and the banker taking the article for safe custody is a bailee.
Safe Deposit Lockers :
The relationship between a banker and a customer in the context of availment of this
service
by the latter is that of a lessor and a lessee. The banker who is letting the locker for use
is
the lessor and the customer who is availing of the use of the locker is the lessee.
In case of death of lessee/s :
The death of a lessee of a safe deposit locker cancels any authority given by him to any
person to operate the locker. The locker can be allowed to be operated only if it stands
in
Guidelines - JAIIB
58
joint names with instructions permitting the survivor/s to operate the locker. On receipt of
notice of death of the lessee, a note should be made in all the records pertaining to the
locker about his death. A slip stating ‘Hire Deceased’ may be pasted on the locker. A
banker
when approached by his legal heirs, should ask them to furnish the following documents.
a. Claim form in the standard format signed by all legal heirs of the deceased.
b. A copy of the Death certificate.
c. Any one of the following viz. Legal heir ship certificate or a letter of probate or a letter
of administration.
d. If there is more than one legal heir, a latter of authority signed by all the legal heirs
authorizing one amongst them to open the locker and receive the articles found in
the locker.
When the claim is found genuine and admitted, the authorized person should be asked
to
sign the Locker register mentioning his capacity and then, be asked to open the locker in
the presence of bank officials using the locker key left behind by the lessee with, of
course,
the joint operation of the custodian’s key. The legal heir / representative should be asked
to
prepare an inventory of the articles taken out of the locker and the same should be
signed
both by of huge value of prized possession, an indemnity bond on a stamp paper of
required
value should be obtained from the claimants along with two sureties of good standing
and
means. The locker should be got vacated thereafter. If it is decided to allot a locker to
the
legal heir/s, it should be treated as a fresh contract of lease and necessary documents
thereof, should be obtained.
7(b) Which are the ineligible deposits against which no advance will be granted by
a
banker? Explain the implications of SLR and CRR on the loan granted against
Bank’s
own term deposits.
Ans. Deposits accepted under the following schemes are not eligible for grant of loan.
1. Deposits under Capital Gains Scheme (under section 54E of Income Tax Act.)
2. Deposits representing earnest money for a contract.
3. Deposits already under lien to the bank for some purpose.
4. Deposits maintained by minor in his single name and operated by him.
5. Third party loan against guardian operated minor deposit account.
Wherever deposits stand in the name of more than one name, all the depositors should
join as parties to the loan or they should authorize one amongst them to raise the loan
not
Guidelines - JAIIB
59
only on his behalf but also on their behalf.
A guardian of a minor can raise a loan against deposits standing in the name of the
minor
nad himself as guardian, provided the loan is raised for the benefit of minor. A
declaration
needs to be obtained to this effect from the guardian.
Implications of SLR/CRR on advance against Bank’s own FDRs. :
Suppose Bank has received a deposit of Rs.100 at the interest rate of 7% p.a. Bank will
earmark 25% of this deposit for SLR and 5% for CRR . Bank may get an average return
of
5% on the investment made under SLR securities and 3% on CRR balances. When we
make an advance to the tune of 75% of the deposits plus interest, we get 9% income on
Rs.75. The profitability of this transaction may be analysed below :
Income received :
(a) Interest on Rs.75 @ 9% - Rs.6.75
(b) Interest on SLR @ 5% - Rs.1.25
Expenses:
(a) Interest paid on TDR @7% - Rs.7.00
(b) Transaction cost @2% - Rs. 2.00
(c) Loosing @4% on CRR balances as compared to the interest paid by us on TDR.
Therefore, the decision on advances against TDR of heavy amount should be based on
the ALM and average cost of deposits as compared to the interest earned on such
advances.
7(c) What are non fund based limits ? Explain legal aspects of invocation of a bank
guarantee
by the beneficiary .
Ans. Bank Guarantees : A guarantee, as distinguished from an indemnity, involves
three parties.
The provider of the guarantee viz. the surety, the person to whom it is provided viz the
beneficiary of the guarantee or the Creditor and the person on whose behalf the
guarantee
is provided viz. the principal debtor. In the business of banking, a banker’s position could
be that of a beneficiary (Creditor) of a guarantee when he accepts a personal guarantee
given by the borrowers in his favour or a surety when he (Banker) issue a bank
guarantee
on behalf of a customer to another.
Guidelines - JAIIB
60
Deferred Payment Gurantees : These are basically financial guarantees. These are
given
mostly when transactions of sale-purchase of capital goods are involved. For example, a
machinery manufacturer may agree to sell a machinery on deferred payment terms to a
buyer provided a banker issues a bank guarantee guaranteeing such payment. Usually
in
such transactions, a down payment of around 15% of the cost of machinery is made and
the balance of 85% including interest thereon is agreed to be made payable in
installments
spread over a period of time.
A letter of Credit is a mechanism which helps a trade transaction to be put through
between
a seller and a buyer. A Letter of Credit is an arrangement whereby a banker acting at the
request of a customer, undertakes to pay a third party, by a given date according to
agreed
stipulations and against presentation of documents, the counter-value of the goods or
services rendered or otherwise.
Invocation of Guarantee and Payment of Claim :
In the event of default by the customer on whose behalf of the guarantee is given, the
beneficiary will invoke the guarantee which in, other words, means that the beneficiary
will
demand payment of the sum undertaken by the guaranteeing banker. If a guarantee, be
it
financial or performance, is invoked, a banker has to make payment of it without any
hesitation or demur subject, of course, to ensuring the following :-
a. That there is a letter from the beneficiary advising the banker of the default of the
principal debtor (customer on whose behalf the guarantee has been issued) to perform
the obligations undertaken by him in the contact which formed the basis for issuing
bank guarantee.
b. That the letter demands the payment of the sum undertaken in the guarantee.
c. That the authority invoking the guarantee is the beneficiary, in his own right and
capacity.
d. That the guarantee has not expired or the invocation period given in the guarantee
bond is not over yet.
On invocation, a banker shall have to make payment of guarantee immediately. When
called
upon to pay, a banker
• Is not entitled to raise questions about default or cannot sit in judgement to decide
whether default has taken place or not.
• Cannot refuse payment on the ground that the principal debtor has stalled payment
Guidelines - JAIIB
61
of the guaranteed amount or has not authorise him to pay.
• Cannot delay payment on the ground that the principal debtor has promised settlement
direct with the beneficiary or the principal debtor proposes to get a stay from the
court of law etc.
7(d) Specify any five provisions of the Banking Regulation Act, 1949, applicable to
nationalized
banks. Also, explain five provisions of the Banking Regulation Act, 1949, which are not
applicable to nationalized banks.
Ans. As per Section 51 of the Banking Regulation Act, 1949 and Sections 3[5] and 20 of
the
Banking Companies [Acquisition and Transfer of Undertakings] Acts, the Sections which
apply to the nationalized banks are :
Sections 5, 6(1), 10, 13, 14, 14A, 15,17,19,20,21,21A, 23,24,25,26, 27, 28, 29
(Excluding
Sub-Section(3)], Subsections 1B, 1C and 2 of Section 30, 31, 34, 34A, 35, 35A, 36
[Excluding
Clause (d) of Sub-Section (1)], 36AD, 45Y to 45ZF, 46, 47, 48, 50, 51, 52, 53.
Those Sections of the Act which don’t have application to the Nationalised Banks are : 1,
2, 3, 4, 6(2), 7, 8, 9, 10A, 10B, 10BB, 10C, 10D, 11, 12, 16, 18, 20A, 22, 29(3),
30(excluding
subsection 1B, 1C and 2), 32, 33, 35B, 36 (1) (d) 36A, 36AA, 36AB, 36AC, 36AE, 36AF,
36AG, 36AH, 36AH, 36AI, 36AJ, 36B, 37, 38, 38A, 39, 39A, 40, 41, 41A, 42, 43, 43A,
44,
44A, 44B, 45, 45A to 45X, 46A, 49, 49A, 49B, 49C, 54, 55, 55A, 56.
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1. Define the following terms briefly (Answer any three)
(a) Clayton’s Rule
The rule derived from the Clayton’s case is of great practical significance to the bankers.
In
the cases of death, insolvency of a partner of a firm, the then existing debt due from the
firm is adjusted or set off by subsequent credit made in the account. Thus, the banker
loses his right to claim such debt from the assets of the deceased, retired or insolvent
partner an dmay ultimately suffer the loss if the debt, cannot be recovered from the
remaining
partners. Therefore, to avoid the operation of the rule given in the Clayton’s case, the
banker closes the old account of the firm and opens a new one in the name of the
reconstituted firm. Thus the liability of the deceased, retire or insolvent partner, as the
case may be at the time of death, retirement or insolvency is determined and he may be
held liable for the same. Subsequent deposits made by the surviving partner will not be
held applicable to discharge the same. In the case of a debit balance of a Partnership
Account, on the death, insolvency, retirement, or mental incapacity of a partner, the rule
in
Clayton’s case would prevail.
(b) Collateral Security
Collateral security is obtained in addition to the primary security (which has been created
out of the funds provided by the Bank). It may be in the form of third party guarantee or
mortgage of immovable property or pledge/assignment of movable assets.
(c) Revolving Letter of Credit
Revolving letter of credit is a credit where under the terms and conditions of the credit,
the
amount if revived or reinstated with out requiring the specific amendment to the credit.
The
amount under the credit may revolve in relation to time or value. The basic principal of a
revolving credit is that after a drawing is made, the credit reverts to its original amount
for
re-use by the beneficiary.
(d) Once a Bearer Always a Bearer
Sub-section 2 to Section 85 of the N.I. Act reads “ Where a cheque is originally
expressed
INDIAN FINANCIAL SYSTEMS AND COMMERCIAL BANKING
JUNE, 2002
CODE NO N-9872
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63
to be payable to bearer, the drawee is discharged by payment in due course to the
bearer
thereof, notwithstanding any endorsement whether in full or blank appearing thereon and
notwithstanding any such endorsement purports to restrict or exclude further
negotiation.”
2. State whether true or false
(a) A bank can claim protection on payment of a cheque with forged signatures if it has
been stolen.
ANS- (False)
(b) The definition of Bankers does not include Indian money – lenders or Mahajans or
Sahukars or Shettys.
ANS- (True)
(c) A Bank can also exercise the right of set off in respect of the future or contingent
debts.
ANS - (False)
(d) Loans cannot be sanctioned under Professional and Self Employed Scheme
exceeding Rs. 10 lakh
ANS- (True)
3. Fill in the blanks and write full sentence in the answer book given to you.
(a) Maximum loan amount that can be granted under village and cottage industries is
Rs. 50000/-
(b) Banks are required to make provision for accounts having overdue interest for 90
days w.e.f. 31st March 2002.
(c) The Chief promoter of “Clearing Corporation” is State Bank of India.
(d) The charge created on security of National Savings Certificate is called a Pledge.
(e) A contract of insurance is a contract of Indemnity.
SECTION II
4. Choose the correct answer from the alternatives given under each sub-questions.
(9X1=9)
(a) Under law of limitation, the liability of a guarantor is
(i) 3 years from the date of document
(ii) 3 years from the date of advance
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64
(iii) 3 years from the date of invocation
(iv) None of the above as there is no limit of time ANS-(iii)
(b) Drawing power in an account means
(i) Limit sanctioned
(ii) Value of security
(iii) Value of security minus unpaid stock
(iv) Value of stock minus unpaid stock minus margin ANS- (iv)
(c) Lien becomes time-barred three years after
(i) the date of loan
(ii) date of delivery o the relative goods
(iii) due date of loan
(iv) lien has no limitation period ANS-(iv)
(d) Negative lien means –
(i) a declaration by a company not to encumber assets of the company without
previous consent of banker
(ii) Deposit of title deeds with the Bank with an oral declaration to mark bank’s lien
(iii) A lien letter executed by the company authorising the Bank to mark lien on its
fixed deposit receipt
(iv) A trust letter executed by the company when goods are taken from the pledged
stock.
ANS-(i)
(e) Letter of Probate means-
(i) A letter attached with a Will containing signatures of the witnesses
(ii) Confirmation of Succession Certificate
(iii) A certificate issued by the court containing the name of the person who has to
administer the property of a deceased person
(iv) A certificate issued by the court containing also the name of the Executor of a
will
ANS-(iv)
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(f) Non-registration of a firm will affect in the following manner-
(i) On dissolution of the firm, remaining partners will have to approach to the
court for settlement of their dues.
(ii) Bank will not allow an unregistered firm to open an account.
(iii) No partner shall be in a position to institute a suit against any other partner of
the firm
(iv) None of these ANS-(iii)
(g) Working Capital Gap means-
(i) Total current assets minus Total current liabilities
(ii) total assets minus intangible assets
(iii) total liabilities minus terms liabilities.
(iv) Total current assets minus current liabilities (other than bank borrowing)
ANS-(iv)
(h) __________ of the Companies Act details the borrowing limits of the company.
(i) Section 261 (1)
(ii) Section 116 (1)
(iii) Section 125 (1)
(iv) Section 293 (1) ANS-(iv)
(i) Banker’s lien is a type of __________ security.
(i) Hypothecated
(ii) Mortgaged
(iii) Implied pledge
(iv) pledged ANS- (iii)
5. Explain the underlying rationale for the following practice / procedure being
followed
by the banks
(a) Banks generally ask for the identification of the payee or the endorsee of an order
cheque.
Ans. Payment of an order cheque to another person (who is not either payee or
endorsee) will
tentamounts to negligence on the part of the bank.
(b) A time-barred debt cannot be revived except by another agreement.
Ans. Acknowledgement of a debt (as permitted in law) of a time barred debt will not
revive the
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66
debt. There is no need of consideration in the case of an agreement of time barred debt
as
per section 25 (iii) of the Contract Act.
(c) The documents of title to goods, if it is a documentary bill, should be drawn with the
name
of the banker as consignees.
Ans. This provides an ownership of the goods consigned and consequential rights.
(d) Gold ornaments pledged under demand loan, can be detained for liquidating another
loan
of the same borrower, after repayment of demand loan.
Ans. Bank has a general lien on the securities pledged for any loan.
(e) A mandate letter should not be accepted from the limited companies and co-
operative
societies.
Ans. Mandate is given by individual person to a bank, whereas in the case of a company
or
society, the operating instructions are vested in more than one person.
(f) If both the original and duplicate drafts are presented at the same time for payment
through
clearing, only duplicate draft should be paid.
Ans. Once the duplicate draft is issued at the request of the purchaser (where payee
has
confirmed about the non-receipt of the draft), the original draft has no legal validity as
per
the Negotiable Instrument Act.
(g) While renewing working capital limits the credit summations in the account are taken
into
consideration.
Ans. The credit summations should tally with the sales turnover as it is obligatory on the
part of
the borrower to deposit all sales in the account. If there is a discrepancy it may indicate
diversion of funds and /or non-achievement of projected turnover which can put the bank
on alert.
(h) The banker is called a privileged debtor.
Ans. Because there is a precondition for repayment of deposits. Demand must be made
in writing
during stipulated public hours for business at the branch where the account is kept or
following prescribed procedure in electronic banking. Further, the banker does not
provide
any security against deposit kept.
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SECTION III
6. How would you deal with the following cases as Branch Manager ? Give reasons for
your
answer quoting relevant sections of law, if any, applicable.
(a) ABC & Company had deposited Rs. 20000/- in their current account on 24.01.2001
and
issued a cheque for Rs. 15000/- in favour of Mr. X. The bank credited this sum by
mistake
into the current account of ABO & Company. So, when the cheque favouring Mr. X was
presented through clearing, it was returned with the remark “Insufficient Funds”.
Meanwhile
ABO & Co. had withdrawn the amount & Meanwhile ABO & Co. has threatened the bank
with legal action for loses if the amount is not credited to their account immediately.
Ans. The mistake is on the part of the bank. It should provide credit for Rs. 20000/- in
the current
account of ABC and company. However, the bank has the right to recovers Rs. 20000/-
alongwith interest from ABO and company as the credit in the said account was made by
mistake inadvertently.
(b) Your customer has drawn a cheque for Rs. 30/- inadvertently leaving blank space
after the
amount, both in words and figures. The amount was fraudulently raised by the payee to
Rs.
30000/- and obtained payment from the Bank. Your customer has alleged negligence on
the part of the bank which the Bank has refuted on the ground that the alterations were
not
visible.
Ans. Section 89 of Negotiable Instrument Act protects the banker completely for
payment in due
course of materially altered cheques which do not appear to have been so altered
according
to apparent tenor. Banker will get the protection in the cited case.
(c) Your customer has complained that the bank has wrongly debited his account by Rs.
10000
on 25.06.2001. Upon enquiry, it was found that ______.
(i) Rs. 10000/- were debited on 25.06.2001 on the strength of a cheque presented in
clearing by another bank B.
(ii) The cheque leaf belongs to the cheque book which was issued by your branch to a
third person on production of a letter.
(iii) The letter produced to the bank for obtaining cheque book bears forged signature of
the account holder.
(iv) Signatures on the cheque resemble with the specimen on Bank’s record, but your
customer refuses to having issued the cheque.
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68
(v) The beneficiary of the cheque with bank B, has withdrawn full money and has closed
the account. The beneficiary and its introducer both are not traceable at the given
address.
Ans. Paying banker was negligent in not ensuring issuance of cheque to the account
holder or
his authorised person as the signatures on the authority letter were forged. Customer
has
also refused having issued the cheque and the circumstances indicate that the
signatures
on the cheque where forged. Hence, the paying banker will have to refund the money to
the
customer. On the other hand, collecting banker was also negligent in not adhering to the
prescribed procedure in regard to the opening of account. It cannot get protection under
section 131 and the paying banker can lodge a claim on the collecting banker for
recovery
of the amount of cheque paid.
(d) Your customer Mr. Ramesh Kumar Jain draws a cheque for Rs. 50000 in favour of Y
and
writes to the bank not to pay the cheque because he has intentionally signed as Ramesh
Kumar Jain, whereas his specimen signatures are “R.K. Jain”. This letter was received
by
the bank after it has already paid the cheque. Shri Jain claims the amount from the bank
on
the plea that hi signature on the cheque does not tally with the Bank’s record. Hence, the
payment is wrong.
Ans. As the customer is accepting in writing having signed the cheque, however, in
different
form, it would be treated a mandate by him to make payment and he cannot claim the
amount of the cheque from the bank.
(e) Your Bank has sanctioned a cash credit limit of Rs. 25000/- to Mr. A against the
guarantee
of Mr. B. After about an year B write to the Bank saying that he wishes to terminate his
guarantee on a date mentioned in the letter. A debit balance of Rs. 24000/- was
outstanding
in the cash credit account. The letter is received at your bank and acknowledged, but is
misplaced and hence no action is taken. After three months of the date of guarantee
termination letter, you observe that the cash credit is running irregular and overdrawn by
Rs. 2000/-. You send a notice to the guarantor Mr. B for repaying the advance. Mr. B
Calls
your attention to the letter and repudiates the liability.
Ans. The guarantor has a right to terminate the guarantee at any time during the
continuance of
the limit. The guarantor is liable for the debit balance outstanding in the account at the
time
of revocation of the guarantee along with interest thereon till it is repaid. In this case the
guarantor is liable only for Rs. 24000/- and interest thereon.
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69
(f) A term deposit has matured on 23rd June 2001. Bank’s rate for one year was 7.50%
on that
date. It was changed to 8.50% from 24th June 2001. On 15th October 2001 (When the
rate
was 8% p.a. for one year), the depositor requested the Bank to renew the overdue
deposit
for one year. To get the higher rate of interest, the depositor requested the bank to
renew
the deposit from 24th June 2001.
Ans. The term deposit can be renewed only from 23rd June 2001 and not from 24th June
2001.
SECTION IV
Q.7 Answer the followings :
(a) (i) “ Banks are diversifying their activities and entering into insurance business”. Why
it
is needed.
(ii) Give a brief account of the new technologies adopted by banks for improving
customer
service.
Ans. Changes in Role and Functions of Commercial Banks :
There has been a tremendous change over the years in the very meaning of Banking.
Banking earlier was purely restricted to borrowing money as deposits, with a view to
lending
them as advances. Thus the main facets were confined to the acceptance of deposits
and
lending of loans.
With the growth of Indian Economy and also as an off-shoot of reform measures, banks
have come to take upon themselves, various other activities which may not measure
upto
this old definition of banking.
These activities include –
23. Investment Counselling
24. Investment Banking
25. Mutual Fund
26. Project Appraisal
27. Merchant Banking Services
28. Taxation Advisory Services
29. Executor Trustee Services
30. Housing Finance Activities
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70
31. Segment – wise specilised branches
32. Credit Card Services
33. Computer Software Development
34. Forex Consultancy Services
35. 24 hours banking
36. ATM Services (Automated Teller Machines)
37. Transaction of Government business.
38. Securities Trading
39. Money Market Mutual Funds
40. Factoring
41. Leasing and hire-purchase
42. Gold / Silver / Platinum trading
43. Venture Capital Financing.
44. Insurance-life / general
These activities are either being pursued by separate departments of the banks or by
separately floated independent subsidiaries formed for undertaking such activities
exclusively.
Recently, banks have given more focus to increase and improve their profits from non-
fund
based activities like guarantees and Letter of Credits, as the revenues from increased
lending activities are on the decline. And again, the recently introduced prudential norms
act as a sort of deterrence to banks to avoid lending activity and embrace investment
avenues in its place.
Further, with the massive computerisation taking place in the entire industry, banks have
been able to reduce the transaction time / cost, thus benefiting the customers.
Also, banks which were hitherto confining themselves with working capital finance have
embarked upon project financing activities too and in the process face stiffer competition
from financial institutions.
In the days to come, banking sector will witness a dramatic change. The internet banking
will bring a great revolution possibly ushering in “Branchless Banking”. Introduction of
ATMs
and Phonebanking is another step for improving customer service in the Banking sector.
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71
7(b) (i) Discuss briefly the supervisory role of the Reserve Bank of India.
(ii) Write in brief the role of the Reserve Bank of India as a lender of the last resort.
(i) Supervisory Functions :
(a) Monopoly of Note Issue
Under Section 22 of the Reserve Bank of India Act, the Reserve Bank has the sole right
for
the issue of currency other than one rupee coins and notes and subsidiary coins; and as
in
the case of Bank of England, the Reserve Bank maintains two departments viz., The
Issue
Department and The Banking Department. The notes are a liability of the issue
department
alone. The assets of the issue department which form the backing for the note issue are
kept distinct from those of the Banking Department. According to Sec.33 of The Reserve
Bank of India Act, the assets of the Issue Department against which Bank loans are
issued
should consist of gold coin and bullion, foreign securities, rupee coin, Government of
India
securities and such Bills of Exchange and Promissory Notes payable in India and as are
eligible for purchase by the Bank.
Under the original Act of 1934, not less than 2/5th of the assets of the Issue Department
were to be required to be held in gold coin, gold bullion or foreign securities, the value of
the gold coin and gold bullion not being below Rs. 40 crores. This was amended by The
Reserve Bank of India Amendment Act of 1959 which bought in the following changes :
a. Revaluation of the gold reserves held by the Reserve Bank from the original very low
price of Rs. 21.24 per tola to Rs. 62.50 per tola, which was Rupee equivalent of the
price agreed to by the International Monetary Fund.
b. A shift from the proportionate to the minimum reserve system with regard to the
issue of currency.
Simultaneously, with the revaluation of gold, the minimum reserve to be held in gold was
fixed at Rs. 115 crores instead of Rs. 40 crores. According to the second change there
would be no limit to the volume of currency that could be issued by the Reserve Bank,
provided it maintained a minimum of Rs. 115 crores of gold and Rs. 400 crores of
foreign
exchange. There were some amendments to these provision and as per the present
provision
the aggregate value of gold bullion and foreign securities held in the Issue Department of
the Bank should not at any time be less than Rs. 200 crores of which the value of the
gold
coin and gold bullion should at no time be less than Rs. 115 crores.
(b) Bank Rate Policy
(c) Reserve Requirements
(d) Open market operations
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(e) Moral suasion
(f) Direct Action
(ii) Lender of the last resort:
The Scheduled Banks are eligible for financial facilities from the Reserve Bank of India.
In
return they owe certain obligations to the Reserve Bank of India. They are required to
submit to the bank a weekly statement showing their position in the form prescribed by
the
Reserve bank of India Act. Failure in this regard will entail levy of penalty apart from
prohibition of accepting fresh deposit during the period of default. The facilities which are
provided by the Reserve Bank of India for the financial needs of the banks are laid in
Section 17 of the Reserve Bank of India Act. The facility is generally provided in the form
of
rediscount of eligible bills and loans and advances against eligible securities. The
Reserve
Bank of India takes into the account the general profile of any bank applying for such
facilities and considered the nature of banking transactions besides having a look into
the
kind of banking practices adopted by the bank. The Reserve Bank of India has been
empowered to call for any information as well as to impose any restriction on the banks
while considering such requests.
7 (C) What is factoring ? Explain the various types of factoring.
Ans. Factoring :
Factoring is an arrangement by which a person purchases and or administers the
receivables
of a concern.
It is a continuing arrangement pursuant to which a factor performs the following services
with respect to accounts Receivables existing from sale of such goods or services.
a. Purchases all account receivables for immediate cash.
b. Maintains the ledgers and performs the other book keeping duties relating to such
account receivables.
c. Collect the account receivables.
d. Assumes the losses in which may arise from any customers financial inability to pay.
(credit losses).
e. In addition to the cash furnished through the purchase of accounts receivables, further
funds are available on a seasonal or term basis, unsecured or secure.
f. Advisory services-market surveys, management and production counseling and data
processing services.
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73
Mechanics of Factoring :
1. The client (seller) sells the goods to the buyer and prepares an invoice with a notation
that debts due on account of this invoice is assigned to and must be paid to Factor.
2. He submits the invoice copy and delivery challan evidencing delivery of goods to the
factor.
3. The factor, after scrutiny of these papers, allow payment of 80% of invoice value. The
drawing limit is adjusted on a continuous basis after taking into account the collection
of factored debts.
4. Once the buyer of the goods/services pays the invoice value in full to the factor, the
balance of 20% of the invoice value is credited to the client’s account.
5. It is the responsibility of the factor to follow-up and obtain payment from the buyer.
Types of Factors :
The factor, besides providing finance, undertakes sales ledger administration, collection
of
debts as well as insuring against bad debts.
In this kind of factoring, the factor purchases the accounts receivable without recourse
from the seller of goods/services. It means, on default of payment by the buyer, the loss
is
to be borne by the factor, i.e. the credit risk in the credit sale transaction is borne by the
factor and not by the seller of goods/services.
Hence, a factor before purchasing accounts receivables, will assess the debtor (buyer)
in
regard to his credit worthiness and standing and fix debtor wise limits which along will
rank
as approved debts for factoring.
However, it cannot be said that recourse is totally absent in this kind of factoring
because
where the debt is disputed on account of quality of goods or services provided or there is
a dispute on account of difference in trade discounts agreed upon, the debt, though
originally
purchased by the factor, will be assigned back to the seller.
Recourse Factoring :
This is identical to Free Service Factoring except for one important difference. Unlike in
Free Service Factoring where there can be no recourse for the factor back to the seller
and
the credit risk is borne by the factor, the recourse is available to the factor in Recourse
Factoring. Hence the credit risk continues to remain with the seller despite the fact the
debt
Guidelines - JAIIB
74
is factored. The loss, on account of default of payment if any, by the debtor shall have to
be
done only by the seller and not by the factor.
In Recourse Factoring, a factor does all other services such as sales administration and
collection of debts etc.
Invoice Factoring :
This is analogous to invoice discounting. This factoring is normally, with recourse. That
means, the credit risk and the attendant loss if any, is borne by the seller and not by the
factor. However, in some special cases where the debtor is exceptionally good, factor
may
provide credit risk protection too.
Under this factoring, financing against invoices is the only service undertaken and the
financing is provided not fully but only to an extent of 70% to 85% of the invoice value.
7(D) Distinguish a letter of probate from a letter of administration. A receiver may
not
necessarily be a liquidator”. Elucidate.
Ans. Executors and Administrators
An Executor is a person appointed in a Will by the maker or the testator of the Will to
execute his desire in relation to his estate. A person named in the Will, on his
approaching
the court, is issued a certificate which is called the ‘Letter of Probate’. A Letter of Probate
is an official copy of a Will with the certificate of it having been proved.
Where the deceased dies intestate, i.e. without a Will or where the nominated person’s
in
a Will is/are dead, the Court appoints a person to look after the estate of the deceased.
The order appointing such a person is called the ‘Letter of Administration’. An
Administrator
so appointed shall have full power to deal with the estate of the deceased as per the
terms
of the Letter of Administration until the same is revoked by the court.
Receivers
A Receiver is not necessarily a Liquidator, though, sometimes she may be both. A
Receiver
is appointed by or at the request of the debenture holders or mortgagees under powers
vested in them by the document creating the security.
Where a banker is approached by a Receiver for credit facility to defray certain
expenses
Guidelines - JAIIB
75
incidental to putting the property under his charge to sale and realizing it, the following
points should be carefully noted.
a. A copy of the order issued by the court appointing him as a Receiver should be
collected and kept on record after verifying it with the original.
b. If the Receiver is appointed by the debenture-holders, a copy of the debenture or
trust deed should be obtained and verified to find out whether he has power to raise
a loan by charging the properties under his receivership.
c. It should also be looked into, before grant of credit facility to a Receiver, as to whether
there is specific sanction by the Court or by the debenture holders, as the case may,
agreeing to the Receiver charging the property (under his receivership) in favour of
the banker for the credit sought, which will rank in priority over the creditors’ or the
debenture holder’s charge.
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76
1. Write short notes on the following:
(a) Risk-based Supervision
Ans- Considering the graving diversities and complexities of banking business, the
spate of
product innovation and complex risk phenomenon, R.B.I. has directed banks to
implement
Risk-based supervision w.e.f. 1st Jan. 2003. Under RBS approach , supervisory
resources
would be focused on the areas of higher risk to a bank. The risk profile would
highlightboth
the strengths and vulnerabilities of a bank and would provide a foundation from which
to determine the procedures to be conducted, during an in-site examination. Risk profile
of
each bank will determine the supervisory programme comprising:
(a) Off-site surveillance
(b) Targeted on-site inspection
CAMEL approach of supervision based on financial parameter such as capital
adequacy,
asset quality, managerial aspects, earning and liquidity , would be the core of risk profile
compilation, but the successive ratings would be used to reflect trends in contrast to
being
used as a static annual indicator of risk.
(b) Multiple Banking
Ans- The purpose of Multiple Banking is to provide freedom to banks in regard to the
fixing of
interest as per their PLR and risk assessment in the light of deregulation process .
Multiple
Banking is different from consortium banking. Its main features are as follows:-
(a) The bank with the largest loan exposure will assess the credit worthiness of the
borrower.
(b) Banks will be free to devise margin, limits and interest rates.
(c) Lenders must keep other informed about the developments.
(d) Documentation to be done by the banks individually.
(e) Borrowers to furnish financial details at regular intervals. For furnishing such
information, the Managing Director or the Company Secretary shall be responsible.
(c) Corporate Debt Restructuring
Ans With a view to preserve viable corporates that are affected by certain internal and
external
INDIAN FINANCIAL SYSTEMS AND COMMERCIAL BANKING
DECEMBER, 2002
SECTION I
Guidelines - JAIIB
77
factors and minimize the losses to the creditors and other stakeholders through an
orderly
and co-ordinated restructuring programme, R.B.I. / Govt. based on experience of other
countries have issued guidelines on Corporate Debt Restructuring (CDR)
Corporate debts above Rs.20 Crore (Standard and Sub-standard) are eligible for fresh
financing by lenders through CDR process. CDR Mechanism is a voluntary system
based
on debtor-creditor agreement and inter-creditor agreement. The scheme is applicable to
multiple banking accounts / syndication / consortium accounts only. There would be no
requirement of the account / company being sick, NPA or being in default for a specific
period.
(d) Universal Banking
Ans- Universal Banking means removal of distinction between the activities which the
Financial
Institutions such as I.D.B.I. and commercial banks undertake and allowing FIs and banks
to undertake any activity of banking or development financing or activity associated with
that, subject to compliance of statutory and other requirements prescribed by R.B.I.,
Govt.
and related legal acts. This will help bring harmony in the role of FIs and banks, offer
world
class efficient services under one roof, compete with international banks due to their size
and reap the cost benefits arising from economies of scale. Merger of ICICI with ICICI
Bank is a recent example of Universal Banking. This concept is being adopted as per
recommendations of S. H. Khan Committee report. Such banks will accept deposits & do
investment banking, securities trading and also Insurance.
(e) Education Loan Scheme
Ans- Different banks have introduced Education Loan Schemes to enable meritorious
students
for pursuing higher education. Indian Banks Association has also framed a model
scheme
and forwarded to all banks. The salient features of the scheme are as under:
Maximum loan limit: For pursuing higher education in India -Rs 7.50 Lac
For studying abroad - Rs. 15.00 Lac
Interest rate: up to Rs 4 Lac - PTLR,
above Rs. 4 Lac - PTLR +1%
Margin: up to Rs. 4 Lac- Nil
above Rs 4 Lac-5% to 15%.
Repayment: 5-7 years after completion of education.
Security: no collateral required upto Rs 4 Lac.
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78
2. State whether true or false.
(a) “nemo dat quod non-habet” “A bearer is always a bearer”.
Ans- False
(b) Clayton’s rule deals with the appropriation of funds.
Ans- True
(c) Every prior party to a negotiable instrument is liable thereon to a holder in due course
until
the instrument is duly satisfied.
Ans- True
(d) ICICI was promoted as a private sector development bank at the initiative of the
World
Bank in 1955.
Ans- True
3. Fill in the blanks. (Write full sentence in the answerbook given to you)
(a) The Reserve Bank of India was nationalised in the year ___________.
Ans- 1949
(b) Bhandari Committee’s recommendations relate to _______________.
Ans- Regional Rural Banks
(c) Initial guidelines in regard to Local Area Banks were issued in _____.
Ans- August 1996
(d) Loan for fish rearing is __________ advance.
Ans- Agricultural
(e) The right of set off is ____________ discretion.
Ans- Bank's
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79
SECTION II
4. Choose the correct answer from the alternatives given under each sub-
questions
and write the same in answer book given to you:
(a) Section 85(1) of the Negotiable Instrument Act 1881 provides protection to the paying
banker in respect of _____________
(i) forged endorsement
(ii) material alterations on the face of the cheque
(iii) forgery of drawer’s signature
(iv) all of these
Ans- (i) forged endorsement
(b) By virtue of Section 140 of the Negotiable Instrument Act 1881, it shall not be a
defence in
a prosecution for an offence under Section 138 of the Act that ___
(i) the cheque was issued for an illegal consideration
(ii) the cheque was not issued in discharge of a debt but merely as a donation.
(iii) the drawer had no reason to believe when he issued the cheque that the cheque
may be dishonoured on presentment for the reasons stated in that section
(iv) none of these
Ans- (iii) the drawer had no reason to believe when he issued the cheque that the
cheque
may be dishonoured on presentment for the reasons stated in that section
(c) Under the powers derived from Section 20, 21 and 21A of the Reserve Bank of India
Act,
1934 _________
(i) The Reserve Bank manages the public debt and issues new loans on behalf of the
Central and State Governments
(ii) The Reserve Bank provides refinance to NABARD in respect of agricultural
advances.
(iii) The Reserve Bank regulates flow of credit to the economy by variations in the
Statutory
Liquidity Requirement and Cash Reserve Ratio
(iv) None of these
Ans- (i) The Reserve Bank manages the public debt and issues new loans on behalf of
the
Central and State Governments
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80
(d) In periods of boom, which leads to economic instability, Reserve Bank resorts to
_______
(i) sale in the market of first class securities in its possession to reduce the supply of
money as a measure of open market operations
(ii) buying of approved securities in the market as a measure of pen market operations
(iii) hike in the bank rate as a measure of open market operations
(iv) none of these
Ans- (i) sale in the market of first class securities in its possession to reduce the supply
of
money as a measure of open market operations
(e) Under Section 17 of the Banking Regulation Act 1949, every banking company
incorporated
in India is required to transfer each year to a reserve fund a sum equivalent to not less
than
__________
(i) 10 per cent of profit before dividends;
(ii) 20 per cent of profit after interest tax and dividend;
(iii) 20 per cent of profit before dividends;
(iv) 5 per cent of gross profit
(v) none of the above
Ans- (iii) 20 per cent of profit before dividends
(f) After a customer has closed the account ___________
(i) the banker is no more liable to observe secrecy of his account because the
contractual
relationship comes to an end
(ii) the banker is still bound by his duty of secrecy
(iii) the banker’s duty of secrecy comes to an end in terms of the provisions of the
Negotiable Instrument Act, 1881
(iv) none of these
Ans- (ii) the banker is still bound by his duty of secrecy
(g) In case a Banker fails to comply with the attachment order Section 226(3) of the
Income
Tax Act, 1961 ___________
(i) The Branch Manager will be held personally liable upto the amount of the attachment
order
(ii) The Branch Manager will be liable to be prosecuted entailing a fine up to Rs. 5,000
or imprisonment which may extend up to one year or both
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81
(iii) The bank shall be deemed to be an assessee in default and amount can be
recovered
from it as arrears of income tax due from the Bank
(iv) None of these
Ans- (iii) The bank shall be deemed to be an assessee in default and amount can be
recovered
from it as arrears of income tax due from the Bank
(h) A mandate may continue to be operative even in the case of —
(i) death of the agent
(ii) lunacy of the agent
(iii) insolvency of the agent
(iv) none of these
Ans- (iii) insolvency of the agent
(i) A Hindu undivided family consists of ___________
(i) all the members of the family i.e. male, female, minors and major;
(ii) only major male members of the family;
(iii) all persons lineally descended from a common ancestor and included their wives
(iv) none of these
Ans- (iii) all persons lineally descended from a common ancestor and included their
wives
5. Explain the underlying rationale for the following practice/procedure being
followed
by banks in India:
(a) A bank draft is not issued payable to a bearer.
Ans- A bank draft payable to bearer is equivalent to a currency note which can be issued
by RBI
only. Moreover, it is prohibited as per Section 31 of RBI Act and is a punishable crime.
(b) Bank does not advance against its own shares.
Ans- Advancing against one's own shares means depleting one’s own capital. Moreover,
this is
prohibited as per Section 20 of the Banking Regulation Act. For depletion, permission is
to
be sought from Company law board (Section 100 of Companies Act)
(c) Insurance of pledged goods for the full value is insisted upon.
Ans- In the absence of full value Insurance, in case of loss or mishap the average clause
would
operate in detriment to the bank’s interest. Hence, always full value insurance is insisted
upon.
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82
(d) A bank tries to keep the cash balance to the minimum required level.
Ans- Cash balance with the branch is an idle asset which will not earn any yield to the
bank. If
this amount had been deposited in the currency chest of RBI, it would have been
counted
for computation of CRR.
(e) Bank does not provide loans against 24 carat gold.
Ans- 24 carat gold is a trading commodity. Hence advances against such gold obviate
the
possibilities of advancing for a hoarding purpose which is not permitted under law.
(f) Cash a/c always shows debit balance.
Ans- The accounting system in bank is based on double entry system wherein all real
account
shows debit balance and cash account is also a real account.
(g) Though contract with a minor is void, banks open the accounts in the name of minor.
Ans- Such accounts are opened to inculcate the saving habits among the children right
from the
beginning. Bank runs no risk as no overdrafts are permitted in such accounts.
(h) If a bank receives an intimation regarding death or insolvency of one of the joint
account
holder or partners of a firm, the operations on such a joint account or firm’s account are
stopped if it shows a debit balance.
Ans- To avoid the application of Clayton’s rules so as to determine the liabilities of the
deceased
or insolvent partner.
SECTION III
6. Attempt the following problems by giving reasons for your answer and also quoting
sections
of law, if any, applicable.
(a) A bill is drawn payable to ‘A’ or order. ‘A’ loses the bill and X who finds it, forges ‘A’s
signature and endorses it to ‘B’ who takes it for value and in good faith. Examine the
right
of ‘B’.
Ans- Forged endorsement by ‘X’ is no endorsement and it does not confer any title to ‘B’
despite
the fact that he takes it for value and in good faith because with a view to passing on a
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83
good title to the endorsee, there must be a genuine endorsement by the endorser.
Therefore,
‘B’ will not get the better title.
(b) A cheque of Rs. 10,000/- is presented by you in clearing for collection in the account
of ‘X’.
It was returned by the drawee bank for irregularity of endorsement. You, then confirm
the
endorsement and re-lodge the cheque without any information to ‘X’. The cheque is
returned
for the second time for want of funds. Mr. ‘X’ refuses to get his account debited with the
amount of the returned cheque. Discuss the position.
Ans- On dishonour of a negotiable instrument, it is mandatory to give a notice of
dishonour
within a reasonable time to all parties. The bank has been negligent in not informing Mr.
‘X’
the returning of cheque for the first time. On the assumption that the cheque might have
been cleared, the account holder may issue cheque. This may put the customer to an
awkward position. However, the bank can recover the amount from X’s account if he has
not changed the position or suffered any loss.
(c) Mr. ‘R’ and Mr. ‘P’ have a joint account with your bank with instructions of payment to
“either
or survivor”. On the death of Mr. ‘P’, Mr. ‘R’ claims the balance and Mr. P’s legal heirs
also
prefer a claim on the bank. How should you deal with the matter?
Ans- The very object of taking instructions “payable to either or survivor” is to facilitate
making
payment of the amount standing to the credit of a joint account to the survivor, on the
death
of the other account holder. Bank can make payment to ‘R’ ignoring the claim of the
legal
heirs of ‘P’. However ‘P’s legal heirs can file a suit against ‘R’ claiming their share, but
not
against the bank.
(d) M/s P. Nand Lal & Co. draws a cheque for Rs. 7,000/- on your bank favouring
“Yourselves”.
A clerk of the firm presents this cheque to you and requests you to give a draft for Rs.
7,000/- on your Ahmedabad office, in favour of Mr. Ramlal A. Shah. What will you do ?
Ans- The bank should not accede to the request of the clerk of M/s P Nandlal and Co.
The
company might have issued the cheque favouring the drawee bank itself for some other
purpose than the issuance of the draft. The clerk has no locus standi in the cheque and
he
might be trying to defraud the company and appropriate it to himself through Mr Raman
Lal A.Shah for whom he wants a draft to be issued. The cheque should bear the
endorsement
by the firm stating the mode of disposal of the cheque.
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84
(e) A loan of Rs.25,000/- has been granted to Sundarmal against the equitable mortgage
of
his house property valued at about Rs.60,000/-. The loan is also guaranteed by a
reputed
third party. After a few months, Sundarmal came to you with a request to have title
deeds
back to him temporarily for the purpose of showing it to his lawyer. He assures you that
the
title deeds will be returned to you within an hour. Can his request be acceded to ?
Ans- Custody of title deeds with the bank is the only evidence of having created
equitable
mortgage. The banker should be very careful in such cases and should not part with the
document of title in any case. If Sundermal desires to show such documents to his
lawyer,
he should be permitted to do so in the bank premises in the presence of bank official.
(f) A current account in the name of ‘Sports Club’ is opened with your bank. Two
cheques for
Rs.1,000 and Rs.500 respectively signed by Mr. ‘A’, president of the club is presented
for
payment. At the same time, you receive a notice of death of Mr. ‘A’ from the Secretary of
club. How will you act ?
Ans- In case of accounts of club, societies, companies, merely death of an authorised
signatory
will not suspend the obligation of the institution. As such ‘A’ has signed the cheque, as
“President” of the club and subsequent information regarding his death will not invalidate
the instrument.
7. Answer any three of the following.
(a) Discuss the promotional and developmental role of the Reserve Bank of India.
Ans- (A) BANKER TO GOVERNMENT
Sections 20, 21 and 21A of the Reserve Bank of India Act form the statutory basis for
these functions. In terms of the first two sections, the bank has the obligation to transact
the banking business of the Central Government, which in turn is required to entrust the
conduct of such business to the bank. Accordingly, the bank is required to accept money
for account of the Government, to make payments on its behalf up to the amount
outstanding
to the credit of its account and also to carry out the Government’s exchange, remittance
and other banking operations including the management of the public debt. Central
Government is obliged to deposit free of interest, all its cash balances with the Bank and
to
entrust it with all its banking, remittance and other transactions in India, the management
of its public debt and issue of new loans.
The Bank performs similar functions on behalf of the State Governments by virtue of
agreements entered into with them under Section 21A.
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85
Apart from the above, the bank also grants ways and means advances to the
government
to bridge the interval between the expenditure and the flow of receipts of revenue. These
advances are meant to provide for marginal and unanticipated but purely temporary
difficulties on account of shortfall in revenue or other receipts for meeting the liabilities of
the government. In terms of Section 17 (5) of the Reserve Bank of India Act, the bank is
authorised to make to the Central and State Governments, ways and means advances
which are repayable not later than three months from date of making the advance.
A ceiling for such borrowings has been prescribed besides stipulating that the
borrowings
will be at market determined rates of interest as against the concessional rates of
interest
prevalent so far.
Public Debt: Public Debt management is concerned with the raising of finance by the
government. The borrowing needs of the government in any year are determined by
budgetary considerations but the interest rate, timing and manner of raising new loans
are
conditioned by the state of liquidity and the expectations of the market. The Reserve
Bank
operates on securities market to bring about the changes in the size, composition and
ownership distribution of marketable debt held by investors and also to influence the
prices
and yields of securities in furtherance of the credit and interest rate policies of the Bank
and Government. However, the long term considerations in debt management is to
ensure
that adequate finance for the government is available in the future, so that recourse to
short-term borrowings from the bank on Treasury Bills is kept to the minimum.
Treasury Bills: Treasury Bills are the main instrument of short-term borrowings by the
government and serve as a convenient gilt-edged security for the money market. The
qualities of high liquidity, absence of risk of default and negligible capital depreciation in
case of sale before maturity make them an ideal form of short-term investment for banks
and other financial institutions. The Reserve Bank as the agent of the government issues
Treasury Bills at a discount. These are negotiable securities and can be rediscounted
with
the bank at any time before upon terms and conditions determined by it from time to
time.
Adviser to Government: The Bank has ordinary Banking relationship with the
Government
performing deposit and lending functions. It manages the public debt on behalf of the
Government. Besides, the Bank is entrusted with a wide range of statutory functions
such
as buying and selling of foreign exchange, administration of exchange control and
provision
Guidelines - JAIIB
86
of rural credit the performance of which is attuned to the policies of the government. It
maintains close co-ordination at all levels, especially with the Ministry of Finance, both in
the day to day affairs and through participation in the various official committees.
The Bank is the main channel of communication between the Government on the one
hand and the banks and financial institutions on the other. The Bank also keeps the
Government informed of the developments in the financial markets from time to time.
Through periodical statements released to the public such as the Annual Reports,
Report
on Currency and Finance, Speeches of the Governors and other top officials of the
Reserve
Bank, and Confidential Communications addressed to the Governments of the Day the
Reserve Bank has constantly offered advice on vital issues of economic importance
confronting the nation from time to time. The Reserve Bank of India Bulletin provides an
opportunity for the Bank to publish each month a review of the financial and economic
scene.
(B) BANKER TO BANKS
Under the Reserve Bank of India Act the Scheduled Banks are eligible for certain
financial
facilities from the Reserve Bank of India. In return, they bear certain obligations to the
Reserve Bank. They are required to submit to the bank a weekly statement showing
their
position in the form prescribed by the Reserve Bank of India Act. Failure to submit the
return involves penal measures under the Act. Similarly, Banks have to maintain the
required
amount of reserves as prescribed in the Act, failing which apart from paying penal
interest,
Banks are prohibited from accepting fresh deposit during the period of default.
(C) AGRICULTURAL FINANCE
An important feature of the Reserve Bank of India Act was that it made agricultural
finance,
the Bank’s special responsibility. This is indicative of the significance attached to the
agricultural sector which accounted for more than 50% of the national income. The
Reserve
Bank of India has been providing tremendous supportive guidance in institutionalising
the
flow of credit to agriculture. To start with the attention was to provide a co-operative
credit
structure for agriculture besides prescribing credit norms. Two special funds under the
captions “National Agricultural Credit Fund” {Long term Operations} and “National
Agricultural Credit (Stabilisation) Fund” were created with a view to strengthen the
cooperative
credit structure.
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87
To answer the felt need of providing term finance for agricultural operations Agricultural
Refinance Corporation was established by the Reserve Bank of India in the year 1963.
Commercial Banks and Co-operative Banks were provided medium and long term loans
by Agricultural Refinance Corporation. In order to highlight the promotional role being
played
by Agricultural Refinance Corporation the name was modified as Agricultural Refinance
and Development Corporation in 1975. This body subsequently in the year 1982 took the
shape of National Bank for Agriculture and Rural Development (NABARD). NABARD
has
taken upon itself the responsibility of providing refinance to all agricultural lending
extended
through Commercial Banks, Regional Rural Banks and Co-operative Credit Institutions.
Regional Rural Banks: The Reserve Bank of India came out with a new experiment to
spread the flow of credit in rural areas by establishment of Regional Rural Banks in 1975
as an organisation jointly owned by Central Government, the sponsoring Commercial
Banks
and the State Government. The Reserve Bank of India extended several facilities such
as
providing direct refinance, inclusion in Schedule II of the Reserve Bank of India Act and
a
lower percentage of cash reserves under the Act.
(D) INDUSTRIAL FINANCE
The Reserve Bank of India has played an active role in the field of Industrial Finance
also.
Its most notable contribution has been in establishing a broad institutional framework to
cater to the medium and long term needs of finance for the industrial sector. Some of the
institutions in this category for the establishment of which the Reserve Bank of India took
the initiative were
a] Industrial Finance Corporation of India
b] State Financial Corporations
c] Industrial Development Bank of India
d] Deposit Insurance and Credit Guarantee Corporation
e] Unit Trust of India
For more than a decade Industrial Development Bank of India and the Unit Trust of India
functioned as subsidiaries of the Reserve Bank of India. They were delinked from the
Reserve Bank of India in 1976 pursuant to enactment of Public Financial Institutions
Laws
(Amendment) Act, 1975. The Bank however continues to provide funds to the Industrial
Development Bank of India and other term financing institutions through loans and
advances
in accordance with the provisions of the Reserve Bank of India Act. The Bank has also
set
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88
up the National Industrial Credit (Long term Operations) Fund. Annual allocations from
its
profits are made to this fund. The fund is being exclusively used to finance the IDBI and
more recently Export-Import Bank of India.
The enlargement of credit to the small scale industries sector has also been a matter of
great concern in view of the importance of the sector to the country’s economy. With this
end in view the Bank was administering a credit guarantee scheme for two decades as
agent of the Central Government for affording a measure of protection to the banks and
other institutions lending to small scale industries etc. Further more, the Deposit
Insurance
Credit Guarantee Corporation, a wholly owned subsidiary of the Reserve Bank operates
Credit Guarantee schemes with the objective of providing cover against defaults in
repayment of loans granted to small borrowers including small scale industrial borrowers
so that credit flow to them in enlarged. Under the impetus provided by the schemes of
the
Corporation, there has been a tremendous growth in advances to small scale industries
by
banks and financial institutions.
The Reserve Bank has also a major co-ordinating role in regard to the measures taken
by
the banks and term lending institutions to rehabilitate borrowers who have subsequently
turned sick.
The Reserve Bank of India has stipulated that the flow of credit to the agricultural sector
should not be less than 18% of the bank credit.
(E) EXPORT FINANCE
THE Reserve Bank with the objective of increasing Bank lending to the export sector
and
assisting the export trade in general has taken a number of measures. The most
important
of these has been the facility of refinance to Scheduled Commercial Banks against their
advance for exports. In fact the credit for exports is one of the only two refinance areas,
the
other being food procurement, for which the Reserve Bank refinance has always been
available to the Commercial Banks although to a varying extent depending upon the
prevailing degree of credit restraint.
The Bank also had a scheme of grant of subsidy in interest rates on advances made to
exports. This particular scheme has since been withdrawn.
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89
The Bank is extending concessional rates of interest on advances extended to exports.
However, the rates of interest are subject to variation by the Reserve Bank of India
depending
upon the monetary and credit policy being pursued by the Bank.
In order to give a fillip to enlarging the export finance, the Reserve Bank has stipulated
that
export credit should constitute not less than 12% of the net credit of the commercial
banks.
The Bank has been instrumental in the establishment of Export Import Bank of India on
January 1, 1982 as a wholly owned Corporation of the Central Government under the
Export-Import Bank of India Act, 1981. The functions of Export-Import Bank of India are
to
provide financial assistance to exporters and importers, act as the principal institution for
co-ordinating the working of other institutions engaged in the field of financing
international
trade. The Bank also extends refinance to export finance. Further, the Export Import
Bank
has introduced a number of services with a view to improve the export of the country.
The Board of Directors of EXIM Bank includes a nominee of the Reserve Bank.
The EXIM Bank of India can avail loans and advances from out of the National Industrial
Credit (Long Term Operations) Fund in terms of Section 17 (4G) read with Section 46
C(2)(c) of the Reserve Bank of India Act.
(F) STRENGTHENING THE COOPERATIVE STRUCTURE
THE Bank has taken a number of steps to strengthen the co-operative structure in the
country. Many societies were operating at a loss with poor management practices. The
Bank took the initiative to strengthen these societies by merging the weak societies,
providing necessary training in management practices and injecting the required share
capital in many cases. Personal contacts were also established by the Regional Offices
of
the Bank so as to sustain and strengthen these societies. The Bank could get
tremendous
support from the State Governments and Central Government in this regard.
(G) COLLECTION OF DATA AND PUBLICATION
THE Bank has been empowered to collect on a periodical basis various information from
the banks and the financial institutions as per various provisions of the Reserve Bank of
India Act. All these information and data are compiled and made available through
publication
of the following:
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90
i. The Reserve Bank of India Bulletin
ii. Credit information Review
iii. Annual Report of the Reserve Bank of India
iv. Report on Currency and Finance
v. Report on Trends in Banking
(H) PROMOTION AND DEVELOPMENT OF INSTITUTIONS
As seen earlier the Reserve Bank of India played a vital role in the formation of the
Industrial
Development Bank of India, National Bank for Agriculture and Rural Development,
Deposit
Insurance and Credit Guarantee Corporation, State Financial Corporations, Export
Import
Bank of India.
These apart Reserve Bank of India took initiative in the formation of several other
institutions
as can be seen from the following paragraph.
(b) What is factoring ? Explain the various types of factoring.
Ans- Factoring is an arrangement by which a person purchases and or administers the
receivables
of a concern.
It is a continuing arrangement pursuant to which a factor performs the following services
with respect to accounts Receivables existing from sale of such goods or services.
a. Purchases all account receivables for immediate cash.
b. Maintains the ledgers and performs the other book keeping duties relating to such
accounts receivables.
c. Collect the account receivables.
d. Assumes the losses in which may arise from any customer’s financial inability to pay.
(Credit losses).
e. In addition to the cash furnished through the purchase of accounts receivables, further
funds are available on a seasonal or term basis, unsecured or secured.
f. Advisory services- market surveys, management and production counselling and
data processing services.
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91
MECHANICS OF FACTORING
1. The client (seller) sells the goods to the buyer and prepares an invoice with a notation
that debts due on account of this invoice is assigned to and must be paid to Factor.
2. He submits the invoice copy and delivery challan evidencing delivery of goods to the
factor.
3. The factor, after scrutiny of these papers, allows payment of 80% of invoice value.
The drawing limit is adjusted on a continuous basis after taking into account the
collection of factored debts.
4. Once the buyer of the goods/services pays the invoice value in full to the factor, the
balance of 20% of the invoice value is credited to the client’s account.
5. It is the responsibility of the factor to follow-up and obtain payment from the buyer.
TYPES OF FACTORS
Full Service Factoring
The factor, besides providing finance, undertakes sales ledger administration, collection
of
debts as well as insuring against bad debts.
In this kind of factoring, the factor purchases the accounts receivable without recourse
from the seller of goods/services. It means, on default of payment by the buyer, the loss
is
to be borne by the factor, i.e. the credit risk in the credit sale transaction is borne by the
factor and not by the seller of goods/ services.
Hence, a factor before purchasing accounts receivables, will assess the debtor (buyer)
in
regard to his credit worthiness and standing and fix debtor-wise limits which along will
rank as approved debts for factoring.
However, it cannot be said that recourse is totally absent in this kind of factoring
because
where the debt is disputed on account of quality of goods or services provided or there is
a dispute on account of difference in trade discounts agreed upon, the debts, though
originally purchased by the factor, will be assigned back to the seller.
Recourse Factoring
This is identical to free Service Factoring except for one important difference. Unlike in
Free Service Factoring where there can be no recourse for the factor back to the seller
and
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92
the credit risk is borne by the factor, the recourse is available to the factor in Recourse
Factoring. Hence the credit risk continues to remain with the seller despite the fact the
debt
is factored. The loss, on account of default of payment if any, by the debtor shall have to
be
borne only by the seller and not by the factor.
In Recourse Factoring, a factor does all other services such as sales administration and
collection of debts etc.
Invoice Factoring
This is analogous to invoice discounting. This factoring is normally, with recourse. That
means, the credit risk and the attendant loss if any, is borne by the seller and not by the
factor. However, in some special cases where the debtor is exceptionally good, factor
may
provide credit risk protection too.
Under this factoring, financing against invoices is the only service undertaken and the
financing is provided not fully but only to an extent of 70% to 85% of the invoice value.
(c) What is registration of charge ? What should be done when limits granted to a banker
are
revised upward ? What will happen if the charge on assets for a credit granted to a
company
is not registered with ROC ?
Ans- Whenever an advance is granted charging the assets of the company, the charge
has to be
registered with the ROC (who has jurisdiction over its Registered Office) within 30 days
from the date of creation, under Section 125 of the Companies Act 1956. This is created
by
filing Form No. 8 and Form No. 13 with the ROC. Normally it is the duty of the company
to
file the charge. In case of failure or delay by the company, the creditor can also file the
forms. If for any reason, the same could not be filed within the first 30 days from the date
of
document creating the charge, an extended time of 30 days is available during which the
charge could be created, of course, on payment of a fine and filing reason for delay, to
the
ROC.
A banker shall charge the assets of the company in respect of all credit facilities
extended,
except pledge.
Non Registration of charge on the assets of the company shall not render the debt
invalid.
The right of the creditor (banker) shall not be affected until the company is a going one.
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93
Once the company goes into liquidation, the liquidator who may be appointed, shall take
notice of only those debs in respect of which charge has been registered with the ROC.
As
such, if the charge is not registered with the ROC, the banker will be pushed down to the
position of an unsecured creditor though, in actuality he had a charge on the assets of
the
company.
MODIFICATION OF CHARGE
The charge registered with the ROC should be modified as and when there are changes
in
the terms of sanction which include change in the credit limits, margin, scope and
coverage
of security and addition or deletion of security. The modification has to be done by filing
Form No.8 and For No.13 again with columns appropriately filed up bringing out the
change
in the charge already registered.
Again, the time available for filing modification of charge is 30 days from the date of
document/modification of charge and if for any reason the modification is delayed, the
forms could be filed within the next 30 days which will be entertained by the ROC on the
fine being paid and the reason for delay being explained.
SATISFACTION OF CHARGE
Once the debt is repaid and the creditor (banker) wishes to release the charge on the
assets of the company, Form No.17 shall have to be filed with the ROC.
SEARCH OF RECORDS OF ROC AND REGISTER OF CHARGES AT REGISTERED
OFFICE OF THE COMPANY
Before release of credit, a banker should take a search of the register of the Company’s
records at the ROC and ensure for himself whether the assets proposed to be charged
for
the credit facilities are free of encumbrances or encumbered only to the extent as was
made known to him by the company earlier. This search would keep the banker posted
with
regard to the extent of availability of the assets for the proposed credit facility. This is
very
essential and should be taken whenever a credit facility is either sanctioned first or
enhanced.
Likewise, a search of ‘Register of Charges’ maintained by the Company at its Registered
Office should also be conducted to verify whether there are any charges against the
assets
of the Company other than those revealed from the search of ROC’s record of the
Company.
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94
(d) Explain in detail the activities undertaken by a Merchant Banker.
Ans- Merchant banking is an agency retained by a company to advise an assist in
capital
structuring/restructuring and its mobilization, with the prescribed regulatory framework.
Thus merchant banker’s role can be institutional loan syndication, institutional
placements,
advisory services, including mergers, alliance and primary markets.
In primary markets, a merchant banker is one of the many important agencies retained
by
the company to assist it in mobilization of funds. However, there is a critical difference in
that a merchant banker helps, select and coordinate the work of other agencies. In the
process, the merchant banker has to shoulder the high responsibility of an elder brother
and be indirectly responsible for the acts of other agencies.
MERCHANT BANKERS AND REGULATORY FRAMEWORK
Merchant Banking has been statutorily brought under the regulatory frame work of the
Securities and Exchange Control Board of India (SEBI) to ensure greater transparency
in
the operations of Merchant Bankers and make them accountable.
No person can act as Merchant Banker without obtaining a certificate of registration from
SEBI. The Merchant Bankers have been categrised into four groups for registration
according
to the nature of functions and their capital adequacy norms have also been prescribed.
SERVICES OFFERED BY MERCHANT BANKERS
The main Merchant Banking activities are
• Appraisal (Project Analysis and Counselling) Syndication of loan and project financing.
• Merchant Banker helps/undertakes to liaise with banks/financial institutions and
arranges for the required amount of credit for implementation of the project. It may
also involve lying up of foreign currency loans/line of credit etc.
• Lead Manager/Co Lead Manager/Co Manager to the issues brought up by Companies
• Bankers to the issue.
• Underwriters to the issue.
• Direct, Standby, & contingent.
• Advisers to the issue.
• Liaisory services - Permission from Government bodies like SEBI/ROC and other
institutions such as Stock Exchanges.
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95
• Arrangement of working capital requirement Foreign Currency loans.
• Private placement of bonds issued by public sector undertakings.
(e) Evaluate the co-operative banking system in India.
Ans- THE CO-OPERATIVE Banks play an important role in the Indian Financial System,
especially at the village level. The growth of Co-operative Movement commenced with
the
passing of the Act of 1904, which officially launched the Movement in India. The Act
provided
an easy legal framework for their formation as well as governance by making the co-
operative
banks free from the complicated provisions of the Indian Companies Act. The Act as it
was
originally conceived did not have provisions with respect to the registration of the
Cooperative
Banks as well as any controlling aspects over these banks. These lacunae were
removed by the Act of 1912. Again, the Movement gained momentum with the
enactment
of Government of India Act of 1919 under which “Co-operation” became a provincial/
state
subject. The Act of 1912 has been replaced by Provincial Acts in Mumbai and Chennai
in
1925 and 1931 respectively. There have been attempts in recent times to strengthen
and
consolidate the gains of the Co-operative Movement.
Generally speaking, in many countries other than India, Co-operative Movement arose
spontaneously from the participation of the people directly. In our country, the
Government
gave the lead and participated and propagated the co-operative Movement. The
Reserve
Bank of India has been playing a very active role in the formation, promotion of Co-
operative
Banks as well as support activities extended to them. The co-operative principle of
managing
finance in India serves as a via media between sophisticated institutions like modern
commercial banks on the one hand and usurious and unscrupulous money lenders on
the
other. Despite the tremendous and vast network of the commercial banks, more so of
the
nationalised sector, co-operative banking remains an effective instrument of credit
delivery
in the case of rural borrowers even to this day.
The Co-operative Credit system consists of -
a. Short-term agricultural credit institutions
b. Long-term agricultural credit institutions
c. Non-agricultural credit institutions
The short-term agricultural credit institutions are in three categories:
i. Primary Agricultural Credit Societies at the Village level
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96
ii. Central Co-operative Banks at the District level
iii. State Co-operative Banks at the State level.
The Long-term agricultural credit institutions are as under—
1. Primary Land Development Banks [at the base]
2. Central Land Development Banks [at the apex]
Thus, the apex of the co-operative organisation in a state is the State Bank to which
Central
Banks are affiliated. The Primary societies are mostly affiliated to the Central Banks.
Some
of them are grouped into local unions for the purposes of supervision. All of them are
forbidden to lend to non-members except with the sanction of the Registrar of Co-
operative
societies. Let us have a quick account of these individual entities in detail.
EVALUATION OF PERFORMANCE OF CO-OPERATIVE BANKS - STRENGTHS AND
WEAKNESSES
There has been really a marked improvement in the progress of CO-OPERATIVE credit
movement in our country aided frequently by the governmental support and the
intervention
of the Reserve Bank of India. Co-operative Credit has been expanding over the years
although it is a question of doubt if the entire credit needs of the rural borrowers in the
respective areas have been catered to by the Co-operative credit. Further, the problem
of
over dues has been posing a very serious threat to the Co-operative Credit. Further, the
problem of overdues has been posing a very serious threat to the Co-operative Credit
Movement and in some cases even creating problems of even sheer survival.
The Co-operative Credit Movement despite its making inroads into rural setting, has
been
beset by the following deficiencies:
a] Delay in sanction of loans;
b] Provision of inadequate credit;
c] Reducing spread between income and expenditure;
d] Excessive control by bureaucracy;
e] Inadequate training to the workforce;
f] Lack of co-ordination between commercial banks, RRBs and Co-operative Banks;
g] Lack of co-ordination between agricultural and co-operative departments;
h] Ineffective audit over the operations;
i] Improper organisational structure;
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97
The Reserve Bank of India has been pursuing vigorously various measures based upon
the findings of different committees on rural credit with a view to strengthen the co-
operative
movement besides consolidating the gains achieved so far. Even to this day, co-
operative
movement is playing a very significant role in the domain of rural credit. We shall have
an
overview of recent charges introduced in this regard.
RECENT CHANGES
We shall now enumerate the recent changes that have occured in the Co-operative
Banking
Scene, subsequent to the reform measures initiated by the Government.
• During 1992-93 the Reserve Bank of India liberalised the licensing policy for new
Primary Urban Co-operative Banks greatly; prescribed the entry point viability norms
and advised to follow the guidelines relating to their operations and advised to adopt
norms in respect of income recognition, classification of assets and provisioning on
the lines stipulated for commercial banks.
• During 1993-94 the National Co-operative Bank of India [NCBI] was registered on
5th August 1993 as a Multi-State Co-operative Society.
• A Co-operative Development Fund was set up by NABARD to help the Co-operative
Banks to improve managerial systems and skills.
• For the first time Scheduled Urban Co-operative Banks were permitted to invest their
surplus funds in Certificate of Deposits and Commercial Papers of those institutions
/ Corporates with credit rating P1 / A1 from CRISIL / ICRA.
• During 1994-95 with a view to improving the viability as also to strengthening the
credit delivery systems, the Co-operative Credit institutions were advised to prepare
Development Action Plans [DAPs] and enter into Memorandum of Understandings
[MOUs] with NABARD and concerned State Governments for their effective
implementation.
• With a view to maintaining the rural credit flow uninterrupted from SCBs and RRBs
the relaxation in the stipulation that they must recover loans at least 40% of the
demand for the previous year to be eligible for refinance from NABARD was extended
upto June 30, 1996.
• Lending and deposit rates of all Co-operative Banks were deregulated in various
phases.
• Effective from April 24, 1995, PCBs were allowed to invest their surplus funds in
equity bonds of all India financial institutions in addition to their investment in PSU
Guidelines - JAIIB
98
Bonds within the ceiling of 10% of their deposits.
• Effective from August 24, 1995 State Co-operative Banks and Central Co-operative
Banks were permitted to invest 5% of their non-SLR surplus fund, according to the
discretion of the local management.
• In February 1996, PCBs were allowed to invest their surplus funds in Certificate of
Deposits issued by banks and other financial institutions, approved by the Reserve
Bank subject to fulfilling certain conditions.
• During 1995-96, all Scheduled PBCs were brought under the purview of the provisions
of the Banking Ombudsman Scheme, 1995.
• In April 1996, Scheduled PCBs were allowed to undertake equipment leasing and
hire purchase financing activities after complying with certain prudential requirements.
Non-scheduled PCBs desiring to undertake the above activities were required to
approach the Reserve Bank through the Regional Offices concerned.
• Consequent to allowing PCBs to extend their area of operation, to the entire district
of registration, including rural areas, in the context of the credit gap in agricultural
sector effective December 1996, PCBs were permitted to extend direct finance for
agricultural activities which would be counted as priority sector advances.
• All scheduled and non-scheduled PCBs with deposits of over Rs.50 crore were
required to introduce the system of concurrent audit.
• The prudential accounting norms viz., income recognition, asset classification,
provisioning for bad and doubtful debts and capital adequacy were applied to State
Co-operative Banks and Central Co-operative Banks from the year 1996-97 in two
phases viz., 1996-97 and 1997-98.
6
INDIAN STOCK MARKET : AN OVERVIEW
Question 1
Write short note on Random Walk Theory. (5 marks) (November, 1996)
Answer
Random Walk Theory: It is generally believed that stock market prices can
never be
predicted because they are not a result of any underlying factors but are
mere statistical ups
and downs. This hypothesis is known as Random Walk Hypothesis. According
to this theory
there is no relationship between present prices of shares and their future
prices. It is argued
that stock market prices are independent. M.G. Kendell found that changes in
security prices
behave nearly as if they are generated by a suitably designed roulette wheel
for each outcome
is statistically independent of past history. Successive peaks and troughs in
prices are
unconnected. In layman’s language it may be said that prices on the stock
exchange behave
exactly the way a drunk would behave while going in a blind lane – up and
down with an
unsteady gait going in any direction he likes, bending backward and forward,
going on sides
now and then.
Question 2
Write short note on Advantages of a depository system. (5 marks)
(November, 2001)
Answer
Advantages of a depository system:
The different stake-holders have advantages flowing out of the depository
system. They are:-
(I) For the capital market:
(i) It eliminates bad delivery;
(ii) It helps to eliminate voluminous paper work;
(iii) It helps in the quick settlement of dues and also reduces the settlement
time;
(iv) It helps to eliminate the problems concerning odd lots;
(v) It facilitates stock-lending and thus deepens the market.
(II) For the investor:
(i) It reduces the risks associated with the loss or theft of documents and
securities
and eliminates forgery;
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188
(ii) It ensures liquidity by speedy settlement of transactions;
(iii) It makes investors free from the physical holding of shares;
(iv) It reduces transaction costs; and
(v) It assists investors in securing loans against the securities.
(III) For the corporate sector or issuers of securities:
(i) It provides upto date information on shareholders’ names and addresses;
(ii) It enhances the image of the company;
(iii) It reduces the costs of the secretarial department;
(iv) It increases the efficiency of registrars and transfer agents; and
(v) It provides better facilities of communication with members.
Question 3
Write short note on Asset Securitisation. (4 marks) (May 2002)
Answer
Asset Securitisation: Securitisation is a process of transformation of illiquid
asset into
security which may be traded later in the open market. It is the process of
transformation of
the assets of a lending institution into negotiable instruments. The term
‘securitisation’ refers
to both switching away from bank intermediation to direct financing via
capital market and/or
money market, and the transformation of a previously illiquid asset like
automobile loans,
mortgage loans, trade receivables, etc. into marketable instruments.
This is a method of recycling of funds. It is beneficial to financial
intermediaries, as it helps in
enhancing lending funds. Future receivables, EMIs and annuities are pooled
together and
transferred to an special purpose vehicle (SPV). These receivables of the
future are shifted to
mutual funds and bigger financial institutions. This process is similar to that
of commercial
banks seeking refinance with NABARD, IDBI, etc.
Question 4
Write a note on buy-back of shares by companies. (10 marks)(May 2003)
Answer
Buyback of shares:
Till 1998, buyback of equity shares was not permitted in India. But now they
are permitted
after suitably amending the Companies Act, 1956. However, the buyback of
shares in India
are permitted under certain guidelines issued by the Government as well as
by the SEBI.
Several companies have opted for such buyback including Reliance, Bajaj,
Ashok Leyland etc.
to name a few. In India, the corporate sector generally chooses to buyback by
the tender
method or the open market purchase method. The company, under the
tender method, offers
to buyback shares at a specific price during a specified period which is
usually one month.
Under the open market purchase method, a company buys shares from the
secondary market
Indian Stock Market : An Overview
189
over a period of one year subject to a maximum price fixed by the
management. Companies
seem to now have a distinct preference for the open market purchase
method as it gives them
greater flexibility regarding time and price.
As impact of buyback, the P/E ratio may change as a consequence of buyback
operation. The
P/E ratio may rise if investors view buyback positively or it may fall if the
investors regard
buyback negatively.
Rationale of buyback: Range from various considerations. Some of them
may be:
(i) For efficient allocation of resources.
(ii) For ensuring price stability in share prices.
(iii) For taking tax advantages.
(iv) For exercising control over the company.
(v) For saving from hostile takeover.
(vi) To provide capital appreciation to investors which may otherwise be not
available.
This, however, has some disadvantages also like, manipulation of share
prices by its
promoters, speculation, collusive trading etc.
Question 5
Write a short note on ‘Book building’.
(5 marks) (May 2001), (1 mark) (November, 2002)and (4 marks)(November,
2003)
Answer
Book Building: Book building is a technique used for marketing a public
offer of equity
shares of a company. It is a way of raising more funds from the market. After
accepting the
free pricing mechanism by the SEBI, the book building process has acquired
too much
significance and has opened a new lead in development of capital market.
A company can use the process of book building to fine tune its price of issue.
When a
company employs book building mechanism, it does not pre-determine the
issue price (in case
of equity shares) or interest rate (in case of debentures) and invite
subscription to the issue.
Instead it starts with an indicative price band (or interest band) which is
determined through
consultative process with its merchant banker and asks its merchant banker
to invite bids from
prospective investors at different prices (or different rates). Those who bid
are required to pay
the full amount. Based on the response received from investors the final price
is selected.
The merchant banker (called in this case Book Runner) has to manage the
entire book
building process. Investors who have bid a price equal to or more than the
final price selected
are given allotment at the final price selected. Those who have bid for a lower
price will get
their money refunded.
In India, there are two options for book building process. One, 25 per cent of
the issue has to
be sold at fixed price and 75 per cent is through book building. The other
option is to split 25
Management Accounting & Financial Management
190
per cent of offer to the public (small investors) into a fixed price portion of 10
per cent and a
reservation in the book built portion amounting to 15 per cent of the issue
size. The rest of the
book-built portion is open to any investor.
The greatest advantage of the book building process is that this allows for
price and demand
discovery. Secondly, the cost of issue is much less than the other traditional
methods of
raising capital. In book building, the demand for shares is known before the
issue closes. In
fact, if there is not much demand the issue may be deferred and can be
rescheduled after
having realised the temper of the market.
Question 6
Write short note on Stock Lending Scheme. (6 marks)(May 2004)
Answer
Stock Lending: In ‘stock lending’, the legal title of a security is temporarily
transferred from a
lender to a borrower. The lender retains all the benefits of ownership, other
than the voting
rights. The borrower is entitled to utilize the securities as required but is
liable to the lender
for all benefits.
A securities lending programme is used by the lenders to maximize yields on
their portfolio.
Borrowers use the securities lending programme to avoid settlement failures.
Securities lending provide income opportunities for security-holders and
creates liquidity to
facilitate trading strategies for borrowers. It is particularly attractive for large
institutional
shareholders as it is an easy way of generating income to off set custody fees
and requires little
involvement of time. It facilitates timely settlement, increases the
settlements, reduces market
volatility and improves liquidity.
The borrower deposits collateral securities with the approved, intermediary.
In case the borrower
fails to return the securities, he will be declared a defaulter and the approved
intermediary will
liquidate the collateral deposited with it. In the event of default, the approved
intermediary is liable
for making good the loss caused to the lender. The borrower cannot
discharge his liabilities of
returning the equivalent securities through payment in cash or kind.
Current Status in India:
National Securities Clearing Corporation Ltd. launched its stock lending
operations (christened
Automated Lending & Borrowing Mechanism – ALBM) on February 10, 1999.
This was the
beginning of the first real stock lending operation in the country. Stock
Holding Corporation of India,
Deutsche Bank and Reliance are the other three stock lending intermediaries
registered with SEBI.
Under NSCCL system only dematerialized stocks are eligible. The NSCCL’S
stock lending system
is screen based, thus instantly opening up participation from across the
country wherever there is
an NSE trading terminal. The transactions are guaranteed by NSCCL and the
participating
members are the clearing members of NSCCL. The main features of NSCCL
system are:
Indian Stock Market : An Overview
191
(i) The session will be conducted every Wednesday on NSE screen where
borrowers and
lenders enter their requirements either as a purchase order indicating an
intention to
borrow or as sale, indicating intention to lend.
(ii) Previous day’s closing price of a security will be taken as the lending price
of the
security.
(iii) The fee or interest that a lender gets will be market determined and will
be the difference
between the lending price and the price arrived at the ALBM session.
(iv) Corresponding to a normal market segment, there will be an ALBM
session.
(v) Funds towards each borrowing will have to be paid in on the securities
lending day.
(vi) A participant will be required to pay-in-funds equal to the total value of
the securities
borrowed.
(vii) The same amount of securities has to be returned at the end of the ALBM
settlement on
the day of the pay-out of the ALBM settlement.
(viii) The previous day’s closing price is called the lending price and the rate
at which the
lending takes place is called the lending fee. This lending fee alone is
determined in the
course of ALBM session.
(ix) Fee adjustment shall be made for any lender not making full delivery of a
security. The
lender’s account shall be debited for the quantity not delivered.
(x) The borrower account shall be debited to the extent of the securities not
lend on account
of funds shortage.
Question 7
(a) Briefly explain ‘Buy Back of Securities’ and give the management
objectives of buying
Back Securities.
(b) Explain the term ‘Insider Trading’ and why Insider Trading is punishable.
(5 + 5 = 10 marks)(November, 2004)
Answer
(a) Buy Back of securities:
Companies are allowed to buy back equity shares or any other security
specified by the
Union Government. In India Companies are required to extinguish shares
bought back
within seven days. In USA Companies are allowed to hold bought back shares
as
treasury stock, which may be reissued. A company buying back shares makes
an offer
to purchase shares at a specified price. Shareholders accept the offer and
surrender
their shares.
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192
The following are the management objectives of buying back securities:
(i) To return excess cash to shareholders, in absence of appropriate
investment
opportunities.
(ii) To give a signal to the market that shares are undervalued.
(iii) To increase promoters holding, as a percentage of total outstanding
shares, without
additional investment. Thus, buy back is often used as a defence mechanism
against potential takeover.
(iv) To change the capital structure.
(b) Insider Trading:
Insider Trading is a buying or selling or dealing in securities of a listed
company, by a
director, member of management, an employee or any other person such as
internal or
statutory auditor, agent, advisor, analyst consultant etc. who have knowledge
of material,
‘inside’ information not available to general public. The dealing in securities
by an insider
is illegal when it is predicated upon utilization of inside information to profit
at the
expense of other investors who do not have access to such investment
information. The
word insider has wide connotation. An outsider may be held to be an insider
by virtue of
his engaging himself in this practice on the strength of inside information.
Insider trading which is an unethical practice resorted by those in power in
corporates
has manifested not only in India but elsewhere in the world causing huge
losses to
common investors thus driving them away from capital market. Therefore, it
is
punishable.
Question 8
Explain the term “Offer for Sale”. (4 marks (May, 2005)
Answer
Offer for sale is also known as bought out deal (BOD). It is a new method of
offering equity
shares, debentures etc., to the public. In this method, instead of dealing
directly with the
public, a company offers the shares/debentures through a sponsor. The
sponsor may be a
commercial bank, merchant banker, an institution or an individual. It is a type
of wholesale of
equities by a company. A company allots shares to a sponsor at an agreed
price between the
company and sponsor. The sponsor then passes the consideration money to
the company and
in turn gets the shares duly transferred to him. After a specified period as
agreed between the
company and sponsor, the shares are issued to the public by the sponsor
with a premium.
After the public offering, the sponsor gets the shares listed in one or more
stock exchanges.
The holding cost of such shares by the sponsor may be reimbursed by the
company or the
sponsor may get the profit by issue of shares to the public at premium.
Thus, it enables the company to raise the funds easily and immediately. As
per SEBI
guidelines, no listed company can go for BOD. A privately held company or an
unlisted
Indian Stock Market : An Overview
193
company can only go for BOD. A small or medium size company which needs
money urgently
chooses to BOD. It is a low cost method of raising funds. The cost of public
issue is around
8% in India. But this method lacks transparency. There will be scope for
misuse also.
Besides this, it is expensive like the public issue method. One of the most
serious short
coming of this method is that the securities are sold to the investing public
usually at a
premium. The margin thus between the amount received by the company
and the price paid
by the public does not become additional funds of the company, but it is
pocketed by the
issuing houses or the existing shareholders.
Question 9
Write short notes on the following:
1. Debt Securitisation.
2. Stock Lending Scheme – its meaning, advantages and risk involved.
(4 Marks)(May, 2005)
Answer
(1) Debt Securitisation:
Debt securitisation is a method of recycling of funds. It is especially beneficial
to
financial intermediaries to support the lending volumes. Assets generating
steady cash
flows are packaged together and against this assets pool market securities
can be
issued. The process can be classified in the following three functions.
1. The origination function: A borrower seeks a loan from finance company,
bank or
housing company. On the basis of credit worthiness repayment schedule is
structured over the life of the loan.
2. The pooling function: Similar loans or receivables are clubbed together to
create an
underlying pool of assets. This pool is transferred in favour of a SPV (Special
Purpose Vehicle), which acts as a trustee for the investor. Once, the assets
are
transferred they are held in the organizers portfolios.
3. The securitisation function: It is the SPV’s job to structure and issue the
securities
on the basis of asset pool. The securities carry coupon and an expected
maturity,
which can be asset based or mortgage based. These are generally sold to
investors through merchant bankers. The investors interested in this type of
securities are generally institutional investors like mutual fund, insurance
companies
etc. The originator usually keeps the spread.
Generally, the process of securitisation is without recourse i.e. the investor
bears the
credit risk of default and the issuer is under an obligation to pay to investors
only if the
cash flows are received by issuer from the collateral.
(2) Stock Lending Scheme:
Stock lending means transfer of security. The legal title is temporarily
transferred from a
lender to a borrower. The lender retains all the benefits of ownership, except
voting
Management Accounting & Financial Management
194
power/rights. The borrower is entitled to utilize the securities as required but
is liable to
the lender for all benefits such as dividends, rights etc. The basic purpose of
stock
borrower is to cover the short sales i.e. selling the shares without possessing
them.
SEBI has introduced scheme for securities lending and borrowing in 1997.
Advantages:
(1) Lenders to get return (as lending charges) from it, instead of keeping it
idle.
(2) Borrower uses it to avoid settlement failure and loss due to auction.
(3) From the view-point of market this facilitates timely settlement, increase
in
settlement, reduce market volatility and improves liquidity.
(4) This prohibits fictitious bull run.
The borrower has to deposit the collateral securities, which could be cash,
bank
guarantees, government securities or certificates of deposits or other
securities, with the
approved intermediary. In case, the borrower fails to return the securities, he
will be
declared a defaulter and the approved intermediary will liquidate the
collateral deposited
with it.
In the event of default, the approved intermediary is liable for making good
the loss
caused to the lender.
The borrower cannot discharge his liabilities of returning the equivalent
securities
through payment in cash or kind.
National Securities Clearing Corporation Ltd. (NSCCL), Stock Holding
Corporation of
India (SHCIL), Deutsche Bank, Reliance Capital etc. are the registered and
approved
intermediaries for the purpose of stock lending scheme. NSCCL proposes to
offer a
number of schemes, including the Automated Lending and Borrowing
Mechanism
(ALBM), automatic borrowing for settlement failures and case by case
borrowing.
Question 10
Following information is available in respect of dividend, market price and
market condition after
one year.
Market condition Probability Market Price Dividend per share
Rs. Rs.
Good 0.25 115 9
Normal 0.50 107 5
Bad 0.25 97 3
The existing market price of an equity share is Rs. 106 (F.V. Re. 1), which is
cum 10% bonus
debenture of Rs. 6 each, per share. M/s. X Finance Company Ltd. had offered
the buy-back of
debentures at face value.
Find out the expected return and variability of returns of the equity shares.
And also advise-Whether to accept buy back after? (8 Marks) (November,
2005)
Indian Stock Market : An Overview
195
Answer
The Expected Return of the equity share may be found as follows:
Market
Condition
Probability Total Return Cost (*) Net Return
Good 0.25 Rs. 124 Rs. 100 Rs. 24
Normal 0.50 Rs. 112 Rs. 100 Rs. 12
Bad 0.25 Rs. 100 Rs. 100 Rs. 0
Expected Return = (24 × 0.25) + (12 × .050) + (0 × 0.25)
= 100 12%
100
12 = × 




The variability of return can be calculated in terms of standard deviation.
V SD = 0.25 (24 – 12)2 + 0.50 (12 – 12)2 + 0.25 (0 – 12)2
= 0.25 (12)2 + 0.50 (0)2 + 0.25 (–12)2
= 36 + 0 + 36
SD = 72
SD = 8.485 or say 8.49
(*) The present market price of the share is Rs. 106 cum bonus 10%
debenture of Rs. 6 each;
hence the net cost is Rs. 100 (There is no cash loss or any waiting for refund
of debenture
amount).
M/s X Finance company has offered the buy back of debenture at face value.
There is reasonable
10% rate of interest compared to expected return 12% from the market.
Considering the dividend
rate and market price the creditworthiness of the company seems to be very
good. The decision
regarding buy-back should be taken considering the maturity period and
opportunity in the market.
Normally, if the maturity period is low say up to 1 year better to wait
otherwise to opt buy back
option.
Question 11
Explain the terms ESOS and ESPS with reference to the SEBI guidelines for
The Employees Stock
Option Plans (ESOPs). (4 Marks) (November, 2005)
Management Accounting & Financial Management
196
Answer
ESOS and ESPS
ESOS ESPS
1. Meaning
Employee Stock Option Scheme means a
scheme under which the company grants
option to employees.
Employee Stock Purchase Scheme
means a scheme under which the
company offers shares to employees as a
part of public issue.
2. Auditors’ Certificate
Auditors’ Certificate to be placed at each
AGM stating that the scheme has been
implemented as per the guidelines and in
accordance with the special resolution
passed.
No such Certificate is required.
3. Transferability
It is not transferable. It is transferable after lock in period.
4. Consequences of failure
The amount payable may be forfeited. If
the option are not vested due to nonfulfillment
of condition relating to vesting of
option then the amount may be refunded to
the employees.
Not applicable.
5. Lock in period
Minimum period of 1 year shall be there
between the grant and vesting of options.
Company is free to specify the lock in
period for the shares issued pursuant to
exercise of option.
One year from the date of allotment. If
the ESPS is part of public issue and the
shares are issued to employees at the
same price as in the public issue, the
shares issued to employees pursuant to
ESPS shall not be subject to any lock in.
Question 12
Distinguish between:
(i) Forward and Futures contracts.
(ii) Interinsic value and Time value of an option. (8 Marks) (May, 2006)
Answer
(i) Forward and Future Contracts:
Forward contracts are private bilateral contracts which have well established
commercial
usage. On the other hand future contracts are standardized tradeable
contract fixed in
Indian Stock Market : An Overview
197
terms of size, contract and other features and traded on an exchange.
In forward contracts, price is not publicly disclosed, whereas in future
contracts, price is
transparent.
Forward contract is exposed to the problem of liquidity whereas to futures
there is no
liquidity problem.
Forward contracts are usually settled on one specified delivery date. In the
case of
futures, there is a range of delivery dates.
Forward contracts are settled at the end of contract, but futures are settled
daily.
In forwards, delivery or final cash settlement usually takes place whereas in
futures,
contract is closed out prior to maturity.
(ii) Intrinsic value and the time value of An Option: Intrinsic value of an
option and the
time value of an option are primary determinants of an option’s price. By
being familiar
with these terms and knowing how to use them, one will find himself in a
much better
position to choose the option contract that best suits the particular
investment
requirements.
Intrinsic value is the value that any given option would have if it were
exercised today.
This is defined as the difference between the option’s strike price (x) and the
stock actual
current price (c.p). In the case of a call option, one can calculate the intrinsic
value by
taking CP-X. If the result is greater than Zero (In other words, if the stock’s
current price
is greater than the option’s strike price), then the amount left over after
subtracting CP-X
is the option’s intrinsic value. If the strike price is greater than the current
stock price.
Then the intrinsic value of the option is zero – it would not be worth anything
if it were to
be exercised today. An option’s intrinsic value can never be below zero. To
determine
the intrinsic value of a put option, simply reverse the calculation to X - CP
Example: Let us assume Wipro Stock is priced at Rs.105/-. In this case, a
Wipro 100
call option would have an intrinsic value of (Rs.105 – Rs.100 = Rs.5).
However, a Wipro
100 put option would have an intrinsic value of zero (Rs.100 – Rs.105 =
-Rs.5). Since
this figure is less than zero, the intrinsic value is zero. Also, intrinsic value can
never be
negative. On the other hand, if we are to look at a Wipro put option with a
strike price of
Rs.120. Then this particular option would have an intrinsic value of Rs.15
(Rs.120 –
Rs.105 = Rs.15).
Time Value: This is the second component of an option’s price. It is defined as
any
value of an option other than the intrinsic value. From the above example, if
Wipro is
trading at Rs.105 and the Wipro 100 call option is trading at Rs.7, then we
would
conclude that this option has Rs.2 of time value (Rs.7 option price – Rs.5
intrinsic value =
Rs.2 time value). Options that have zero intrinsic value are comprised
entirely of time
value.
Time value is basically the risk premium that the seller requires to provide
the option buyer
with the right to buy/sell the stock upto the expiration date. This component
may be regarded
as the Insurance premium of the option. This is also known as “Extrinsic
value.” Time value
Management Accounting & Financial Management
198
decays over time. In other words, the time value of an option is directly
related to how much
time an option has until expiration. The more time an option has until
expiration. The greater
the chances of option ending up in the money.
Question 13
What is the procedure for the book building process? Explain the recent
changes made in the
allotment process. (6 Marks) (May, 2006)
Answer
The modern and more popular method of share pricing these days is the
BOOK BUILDING route.
After appointing a merchant banker as a book runner, the company planning
the IPO, specifies the
number of shares it wishes to sell and also mentions a price band. Investors
place their orders in
Book Building process that is similar to bidding at an auction. The willing
investors submit their
bids above the floor price indicated by the company in the price band to the
book runner. Once the
book building period ends, the book runner evaluates the bids on the basis of
the prices received,
investor quality and timing of bids. Then the book runner and the company
conclude the final price
at which the issuing company is willing to issue the stock and allocate
securities. Traditionally, the
number of shares are fixed and the issue size gets determined on the basis of
price per share
discovered through the book building process.
Public issues these days are targeted at various segments of the investing
fraternity. Companies
now allot certain portions of the offering to different segments so that
everyone gets a chance to
participate. The segments are traditionally three -qualified institutional
bidders (Q1Bs), high net
worth individuals (HNIs) and retail investors ( general public). Indian
companies now have to offer
about 50% of the offer to Q1Bs, about 15% to high net worth individuals and
the remaining 35% to
retail investors. Earlier retail and high net worth individuals had 25% each.
Also the Q1Bs are
allotted shares on a pro-rata basis as compared to the earlier norm when it
was at the discretion of
the company management and the investment bankers. These investors
(Q1B) also have to pay
10% margin on application. This is also a new requirement. Once the offer is
completed, the
company gets listed and investors and shareholders can trade the shares of
the company in the
stock exchange.
Question 14
The market received rumour about ABC corporation’s tie-up with a
multinational company.
This has induced the market price to move up. If the rumour is false, the ABC
corporation
stock price will probably fall dramatically. To protect from this an investor has
bought the call
and put options.
He purchased one 3 months call with a striking price of Rs.42 for Rs.2
premium, and paid Re.1 per
share premium for a 3 months put with a striking price of Rs.40.
(i) Determine the Investor’s position if the tie up offer bids the price of ABC
Corporation’s
stock up to Rs.43 in 3 months.
(ii) Determine the Investor’s ending position, if the tie up programme fails
and the price of
the stocks falls to Rs.36 in 3 months. (7 Marks) (May, 2006)
Indian Stock Market : An Overview
199
Answer
Cost of call and put options
= (Rs.2 per share) x (100 share call) + (Re.1 per share) x (100 share put)
= Rs.2 x 100 + 1 x 100
= Rs.300
(i) Price increases to Rs.43. Since the market price is higher than the strike
price of the put,
the investor will exercise it.
Ending position=(─Rs.300 cost of option)+(Re.1 per share gain on call) x 100
= ─ Rs.300 + 100
Net Loss = Rs.200
(ii) The price of the stock falls to Rs.36. Since the market price is lower than
the strike price,
the investor may not exercise the call option.
Ending Position: = (─ Rs.300 cost of 2 option)+(Rs.4 per stock gain on
put)x100
= ─ Rs.300 + 400
Gain = Rs.100
Question 15
Abhishek Ltd. has a surplus cash of Rs.90 lakhs and wants to distribute 30%
of it to the
shareholders. The Company decides to buyback shares. The Finance Manager
of the Company
estimates that its share price after re-purchase is likely to be 10% above the
buyback price; if the
buyback route is taken. The number of shares outstanding at present is 10
lakhs and the current
EPS is Rs.3.
You are required to determine:
(a) The price at which the shares can be repurchased, if the market
capitalization of the
company should be Rs.200 lakhs after buyback.
(b) The number of shares that can be re-purchased.
(c) The impact of share re-purchase on the EPS, assuming the net income is
same.
(6 Marks) (May, 2006)
Answer
(a) Let P be the buyback price decided by Abhishek Ltd.
Market Capitalisation After Buyback:
1.1 P (Original Shares – Shares Bought back)
=


 −
P
1.1P(10Lakhs 30%of 90lakhs
Management Accounting & Financial Management
200
= 11 Lakhs x P – 27 lakhs x 1.1
= 11 lakhs x P – 29.7 lakhs
Market capitalization rate after buyback is 200 lakhs.
Thus, we have:
11 Lakhs x P – 29.7 lakhs = Rs.200 lakhs
OR 11P = 200 + 29.7
OR P = Rs.20.88
11
229.7 =
(b) Number of shares to be bought back:
1.29 lakhs (Approximaely)
20.88
27Lakhs = =
(c) New Equity Shares
= (10 – 1.29) lakhs = 8.71 lakhs
EPS = Rs.3.44
8.71L
30L
8.71lakhs
3 10lakhs = =
×
Thus EPS of Abhishek Ltd., increases to Rs.3.44
Question 16
Explain briefly the advantages of holding securities in ‘demat’ form rather
than in physical form.
(4 Marks) (November, 2006)
Answer
ADVANTAGES OF HOLDING SECURITIES IN ‘DEMAT’ FORM
The Depositories Act, 1996 provides the framework for the establishment and
working of
depositories enabling transactions in securities in scripless (or demat) form.
With the arrival of
depositories on the scene, many of the problems previously encountered in
the market due to
physical handling of securities have been to a great extent minimized. In a
broad sense, therefore,
it can be said that ‘dematting’ has helped to broaden the market and make it
smoother and more
efficient.
From an individual investor point of view, the following are important
advantages of holding
securities in demat form:
• It is speedier and avoids delay in transfers.
• It avoids lot of paper work.
• It saves on stamp duty.
Indian Stock Market : An Overview
201
From the issuer-company point of view also, there are significant advantages
due to dematting,
some of which are:
• Savings in printing certificates, postage expenses.
• Stamp duty waiver.
• Easy monitoring of buying/selling patterns in securities, increasing ability to
spot takeover
attempts and attempts at price rigging.
Question 17
From the following data for certain stock, find the value of a call option:
Price of stock now = Rs.80
Exercise price = Rs.75
Standard deviation of continuously compounded annual
return
= 0.40
Maturity period = 6 months
Annual interest rate = 12%
Given
Number of S.D. from Mean, (z) Area of the left or right (one tail)
0.25 0.4013
0.30 0.3821
0.55 0.2912
0.60 0.2578
e 0.12x0.05 = 1.0060
In 1.0667 = 0.0645
(8 Marks) (November, 2006)
Answer
Applying the Black Scholes Formula,
Value of the Call option now:
The Formula C = SN(d ) K N(d2 )
( rt)
1e
−−
d1 = In (S/K) + ( r + σ 2 / 2) t
d2 = d1 −σ t
Where,
C = Theoretical call premium
S = Current stock price
Management Accounting & Financial Management
202
t = time until option expiration
K = option striking price
r = risk-free interest rate
N = Cumulative standard normal distribution
e = exponential term
σ = Standard deviation of continuously compounded annual return.
In = natural logarithim
.40 0.5
d In(1.0667) (12% (0.08)
0.5
1

++
=
=
0.40 0.7071
0.0645 (0.2)0.5
×
+
=
0.2828
0.1645
= 0.5817
d2 = 0.5817 – 0.2828
= 0.2989
Nd1 = N (0.5817)
Nd2 = N (0.2989)
e N(d )
Pr ice S N(d ) E
2

×
o 1 rt

= −
= (80 x Nd1) – 75/[1.0060 x N[d2]
Value of option
= 80 Nd1-
2 1.0060 Nd

75
×
Nd1 = N (0.5817)
= 0.7190 + 0.000578
= 0.7195
Nd2 = N(0.2989)
= 0.6141 + 0.003382
= 0.6175
Indian Stock Market : An Overview
203
Price = 80 x 0.7195
1.0060 0.6175
75
×
−
= 57.56 – 74.55 x 0.6175
= 57.56 – 46.04
= Rs.11.52
Question 18
The 6-months forward price of a security is Rs.208.18. The borrowing rate is
8% per annum
payable with monthly rests. What should be the spot price? (4 Marks)
(November, 2006)
Answer
Calculation of spot price
The formula for calculating forward price is:
A = P (1+r/n) raised to nt Where A = Forward price
P = Spot Price
r = rate of interest
n = no. of compoundings
t = time
Using the above formula,
208.18 = P (1 + 0.08/12) raised to 6
Or 208.18 = P x 1.0409
P = 208.18/1.0409 = 200
Hence, the spot price should be Rs.200.
Question 19
(a) XYZ Ltd. a US firm will need £ 3,00,000 in 180 days. In this connection,
the following
information is available:
Spot rate 1 £ = $ 2.00
180 days forward rate of £ as of today = $1.96
Interest rates are as follows:
U.K. US
180 days deposit rate 4.5% 5%
180 days borrowing rate 5% 5.5%
A call option on £ that expires in 180 days has an exercise price of $ 1.97 and
a premium
of $ 0.04.
Management Accounting & Financial Management
204
XYZ Ltd. has forecasted the spot rates 180 days hence as below:
Future rate Probability
$ 1.91 25%
$ 1.95 60%
$ 2.05 15%
Which of the following strategies would be most preferable to XYZ Ltd.?
(a) a forward contract
(b) a money market hedge
(c) an option contract
(d) no hedging
Show calculations in each case (16 marks) (May, 2007).
Answer
(a) Forward contract: Dollar needed in 180 days = £3,00,000 x $ 1.96 =
$5,88,000/-
(b) Money market hedge: - Borrow $, convert to £, invest £, repay $ loan in
180 days
Amount in £ to be invested = 3,00,000/1.045 = £ 287081
Amount of $ needed to convert into £ = 2,87,081 x 2 = $ 5,74,162
Interest and principal on $ loan after 180 days = $5,74,162 x 1.055 = $
6,05,741
(c) Call option:
Expected
Spot rate in
180 days
Prem./
unit
Exercise
Option
Total price
per unit
Total price
for
£3,00,000
xi
Prob.
Pi
pixi
1.91 0.04 No 1.95 5,85,000 0.25 1,46,250
1.95 0.04 No 1.99 5,97,000 0.60 3,58,200
2.05 0.04 Yes 2.01 6,03,000 0.15 90,450
5,94,900
(d) No hedge option:
Expected Future spot
rate
Dollar needed
Xi
Prob. Pi Pi xi
1.91 5,73,000 0.25 1,43,250
1.95 5,85,000 0.60 3,51,000
2.05 6,15,000 0.15 92,250
5,86,500
Indian Stock Market : An Overview
205
The probability distribution of outcomes for no hedge strategy appears to be
most
preferable because least number of $ are needed under this option to
arrange
£3,00,000.
Question 20
(i) What are Stock futures?
(ii) What are the opportunities offered by Stock futures?
(iii) How are Stock futures settled? (4 marks)(May, 2007)
Answer
(i) Stock future is a financial derivative product where the underlying asset is
an individual
stock. It is also called equity future. This derivative product enables one to
buy or sell
the underlying Stock on a future date at a price decided by the market forces
today.
(ii) Stock futures offer a variety of usage to the investors. Some of the key
usages are
mentioned below:
Investors can take long-term view on the underlying stock using stock
futures.
(a) Stock futures offer high leverage. This means that one can take large
position with
less capital. For example, paying 20% initial margin one can take position for
100%, i.e., 5 times the cash outflow.
(b) Futures may look over-priced or under-priced compared to the spot price
and can
offer opportunities to arbitrage and earn riskless profit.
(c) When used efficiently, single-stock futures can be effective risk
management tool.
For instance, an investor with position in cash segment can minimize either
market
risk or price risk of the underlying stock by taking reverse position in an
appropriate
futures contract.
(iii) Up to March 31, 2002, stock futures were settled in cash. The final
settlement price is
the closing price of the underlying stock. From April 2002, stock futures are
settled by
delivery, i.e., by merging derivatives position into cash segment.
Question 21
BSE 500
Value of portfolio Rs.10,10,000
Risk free interest rate 9% p.a.
Dividend yield on Index 6% p.a.
Beta of portfolio 1.5
We assume that a future contract on the BSE index with four months
maturity is used to hedge the
value of portfolio over next three months. One future contract is for delivery
of 50 times the index.
Based on the above information calculate:
(i) Price of future contract.
Management Accounting & Financial Management
206
(ii) The gain on short futures position if index turns out to be 4,500 in three
months.
(8 Marks)( Nov 2007)
Answer
(i) Current future price of the index = 5000 + 5000 (0.09-0.06)
12
4
= 5000+ 50= 5,050
∴ Price of the future contract = Rs.50 х 5,050 = Rs.2,52,500
(ii) Hedge ratio = 1.5
252500
1010000 × = 6 contracts
Index after there months turns out to be 4500
Future price will be = 4500 + 4500 (0.09-0.06)
3
1 × =4,545
Therefore, Gain from the short futures position is = 6 х (5050 – 4545) х 50
= Rs.1,51,500
Alternative solution when BSE index is considered to be as 500
(i) Current future price of index = 500 + 500 (0.09 – 0.6)
12
4 = 500 + 5 = 505
∴ Price of the future contract = Rs.50 x 505 = Rs.25,250.
(ii) Hedge Ratio = 1.5 60contracts
25,250
10,10,000, × =
Index after three months turn out to be 4,500.
Future Price will be
= 4,500 + 4,500 (0.09 – 0.06) 3
1 = 4,545
Therefore, gain from the short future position is
= 60 x (505 – 4545) х 50
= -12,12,00,00.
Question 22
From the following data for Government securities, calculate the forward
rates:
Face value (Rs.) Interest rate Maturity
(Year)
Current price
(Rs.)
1,00,000 0% 1 91,500
Indian Stock Market : An Overview
207
1,00,000 10% 2 98,500
1,00,000 10.5% 3 99,000
(6 Marks) (Nov, 2007)
Answer
Consider one year treasury bill.
I rI
91,500 1,00,000
+
=
1+r1 =
91500
100,000 = 1.092896
r1 = 0.0929 or 0.093
Consider two year Government Security
98,500 =
(1.093(1 r2)
1,10,000
1.093
10,000
+
+
98500 = 9149.131 +
1.093(1 r2)
1,10,000
+
⇒ 89350.87 =
1 r2
100640.4
+
⇒ 1 + r2 = 1.126351
r2 = 0.12635
= > r2 = 0.1263
Consider three year Government Securities:
99,000=
1.093 1.1263(1 r3)
1,10,500
1.093 1.1263
10,500
1.093
10,500
× +
+
×
+
⇒ 99000 = 9606.587 + 8529.65+
1 r3
89764.42
+
⇒ 80863.763 =
1 r3
89764.42
+
⇒ 1+r3 = 1.1100697
⇒ r3 = .1100697
Question 23
(i) What are derivatives?
(ii) Who are the users and what are the purposes of use?
Management Accounting & Financial Management
208
(iii) Enumerate the basic differences between cash and derivatives market.
(8 Marks) ( Nov, 2007)
Answer
(i) Derivative is a product whose value is to be derived from the value of one
or more basic
variables called bases (underlying assets, index or reference rate). The
underlying
assets can be Equity, Forex, Commodity.
Users Purpose
(i) Corporation To hedge currency risk and inventory risk
(ii) Individual Investors For speculation, hedging and yield enhancement.
(iii) Institutional
Investor
For hedging asset allocation, yield enhancement and
to avail arbitrage opportunities.
(iv) Dealers For hedging position taking, exploiting inefficiencies
and earning dealer spreads.
The basic differences between Cash and the Derivative market are
enumerated below:-
In cash market tangible assets are traded whereas in derivate markets
contracts based
on tangible or intangibles assets likes index or rates are traded.
(a) In cash market tangible assets are traded whereas in derivative market
contracts
based on tangible or intangibles assets like index or rates are traded.
(b) In cash market, we can purchase even one share whereas in Futures and
Options
minimum lots are fixed.
(c) Cash market is more risky than Futures and Options segment because in
“Futures
and Options” risk is limited upto 20%.
(d) Cash assets may be meant for consumption or investment. Derivate
contracts are
for hedging, arbitrage or speculation.
(e) The value of derivative contract is always based on and linked to the
underlying
security. Though this linkage may not be on point-to-point basis.
(f) In the cash market, a customer must open securities trading account with
a
securities depository whereas to trade futures a customer must open a future
trading account with a derivative broker.
(g) Buying securities in cash market involves putting up all the money upfront
whereas
buying futures simply involves putting up the margin money.
(h) With the purchase of shares of the company in cash market, the holder
becomes
part owner of the company. While in future it does not happen.
Indian Stock Market : An Overview
209
Question 24
Given below is the Balance Sheet of S Ltd. as on 31.3.2008 :
Liabilities Rs.
(in lakh)
Assets Rs.
(in lakh)
Share capital
(share of Rs. 10)
Reserves and
surplus
Creditors
100
40
30
170
Land and building
Plant and machinery
Investments
Stock
Debtors
Cash at bank
40
80
10
20
15
5
170
You are required to work out the value of the Company's, shares on the basis
of Net Assets
method and Profit-earning capacity (capitalization) method and arrive at the
fair price of the shares,
by considering the following information:
(i) Profit for the current year Rs. 64 lakhs includes Rs. 4 lakhs extraordinary
income and Rs.
1 lakh income from investments of surplus funds; such surplus funds are
unlikely to
recur.
(ii) In subsequent years, additional advertisement expenses of Rs. 5 lakhs are
expected to
be incurred each year.
(iii) Market value of Land and Building and Plant and Machinery have been
ascertained at
Rs. 96 lakhs and Rs. 100 lakhs respectively. This will entail additional
depreciation of Rs.
6 lakhs each year.
(iv) Effective Income-tax rate is 30%.
(v) The capitalization rate applicable to similar businesses is 15%. (16 Marks)(
May, 2008)
Answer
Rs. lakhs
Net Assets Method
Assets: Land & Buildings 96
Plant & Machinery 100
Investments 10
Stocks 20
Debtors 15
Cash & Bank __5
Total Assets 246
Less: Creditors __30
Net Assets 216
Management Accounting & Financial Management
210
Value per share
(a) Number of shares 10,00,000
10
1,00,00,000 =
(b) Net Assets Rs.2,16,00,000
Rs.21.6
10,00,000
Rs.2,16,00,000 =
Profit-earning Capacity Method
Profit before tax 64.00
Less: Extraordinary income 4.00
Investment income (not likely to recur) 1.00 5.00
59.00
Less: Additional expenses in forthcoming years
Advertisement 5.00
Depreciation 6.00 11.00
Expected earnings before taxes 48.00
Less: Income-tax @ 30% 14.40
Future maintainable profits (after taxes) 33.60
Value of business 224
Capitalisation factor
=
0.15
33.60
Less:External Liabilities (creditors) 30
194
Value per share
= Rs.19.4
10,00,000
1,94,00,000 =
Fair Price of share Rs.
Value as per Net Assets Method 21.6
Value as per Profit earning capacity (Capitalisation) method 19.4
Fair Price= Rs.20.5
2
41
2
21.6 19.4 = =
+
Indian Stock Market : An Overview
211
Question 25
Distinguish between Forward and Futures contract. ( 5 marks) ( Nov 2008)
Answer
FORWARD AND FUTURE CONTRACTS:
S.No. Features Forward Futures
1. Trading Forward contracts are traded on
personal basis or on telephone or
otherwise.
Futures Contracts are traded in a
competitive arena.
2. Size of Contract Forward contracts are individually
tailored and have no standardized
size
Futures contracts are
standardized in terms of quantity
or amount as the case may be
3. Organized
exchanges
Forward contracts are traded in
an over the counter market.
Futures contracts are traded on
organized exchanges with a
designated physical location.
4. Settlement Forward contracts settlement
takes place on the date agreed
upon between the parties.
Futures contracts settlements are
made daily via. Exchange’s
clearing house.
5. Delivery date Forward contracts may be
delivered on the dates agreed
upon and in terms of actual
delivery.
Futures contracts delivery dates
are fixed on cyclical basis and
hardly takes place. However, it
does not mean that there is no
actual delivery.
6. Transaction
costs
Cost of forward contracts is based
on bid – ask spread.
Futures contracts entail brokerage
fees for buy and sell orders.
7. Marking to
market
Forward contracts are not subject
to marking to market
Futures contracts are subject to
marking to market in which the
loss on profit is debited or credited
in the margin account on daily
basis due to change in price.
8. Margins Margins are not required in
forward contract.
In futures contracts every
participants is subject to maintain
margin as decided by the
exchange authorities
9. Credit risk In forward contract, credit risk is
born by each party and, therefore,
every party has to bother for the
creditworthiness.
In futures contracts the
transaction is a two way
transaction, hence the parties
need not to bother for the risk.
Management Accounting & Financial Management
212
Question 26
Calculate the price of 3 months PQR futures, if PQR (FV Rs.10) quotes Rs.220
on NSE and the
three months future price quotes at Rs.230 and the one month borrowing
rate is given as 15
percent and the expected annual dividend yield is 25 percent per annum
payable before expiry.
Also examine arbitrage opportunities.
Answer
Future’s Price = Spot + cost of carry – Dividend
F = 220 + 220 × 0.15 × 0.25 – 0.025** × 10
= 225.75
** Entire 25% dividend is payable before expiry, which is Rs.2.50.
Thus we see that futures price by calculation is Rs.225.75 which is quoted at
Rs.230 in the
exchange.
Analysis:
Fair value of Futures less than Actual futures Price:
Futures Overvalued Hence it is advised to sell. Also do Arbitraging by buying
stock in the cash
market.
Step I
He will buy PQR Stock at Rs.220 by borrowing at 15% for 3 months. Therefore
his outflows are :
Cost of Stock 220
Add: Interest @ 15 % for 3 months i.e. 0.25 years 8.25
(220 × 0.15 × 0.025)
Total Outflows (A) 228.25
Step II
He will sell March 2000 futures at Rs.230. Meanwhile he would receive
dividend for his stock.
Hence his inflows are 230
Sale proceeds of March 2000 futures 2.50
Total inflows (B) 232.5
Inflow – Outflow = Profit earned by Arbitrageur
= 232.5 – 228.25
= 4.25

Background Paper on Indian Financial Sector

_____________________________________________________________________________
Background
Major constituents of the Indian financial sector are banks, financial institutions, and
markets, which mobilize the resources from the surplus sector and channelize the
same to the different needy sectors in the economy. In fact, the Indian financial
system is characterised by its two major segments - an organized sector and a
traditional sector that is also known as informal credit market. Financial
intermediation in the organized sector is conducted by a large number of banks and
financial institutions. Financial institutions are further classified based on their
mandate and activities, which may be term lending, specialized, and investment
institutions. Banks are further classified into public and private sector banks,
cooperative banks, and regional rural banks. Non-bank financial institutions include
hire purchase and leasing companies, and investment institutions include LIC, GIC,
and UTI. The banking system is, by far, the most dominant segment of the financial
sector, accounting for over 60% of the funds flowing through the financial sector. The
Government has also set up two separate regulatory bodies, viz., Insurance
Regulatory Development Authority (IRDA) of India for the insurance sector, and the
Securities and Exchange Board of India (SEBI) for the capital market.
The Indian financial sector today is significantly different from what it used to be in
the 1970s and 1980s. The financial sector prior to the 1990s was characterized by
segmented and underdeveloped financial markets coupled with paucity of
instruments. For maintaining spreads of banking sector, regulation of both deposit
and lending rates resulted not only in distorting the interest rate mechanism, but also
adversely affected the viability and profitability of banks. The low level of recognition
of the importance of transparency, accountability and prudential norms in the
operations of the banking system also led to a rising burden of non-performing
assets.

Background Paper on Indian Financial Sector

_____________________________________________________________________________
Background Paper on Indian Financial Sector
_____________________________________________________________________________

Indian Financial System

Securities and Exchange Board of India

Reserve Bank of India

Financial Institutions

Public Sector Banks

Private Sector Banks
Cooperative Banks
Regional Rural Banks
Foreign Banks

Primary Dealers

Banks

NBFCs

Mutual Funds

Venture Capital Funds

Capital Markets

Term Lending Institutions IFCI

SIDBI

Hire Purchase Cos

Leasing Companies
 Stock Exchanges
Stock Brokers
Foreign Inst. Investors
Depositories
Underwriters
Custodians
Investors
Merchant Banks

Investment Corporations
Life Insurance Corporation
General Insurance Corporation
Unit Trust of India

State Level Institutions

SIDCs
SFCs

Specialised Lending Institutions

Exim Bank of India
NABARD
Tourism Finance Corporation
Power Finance Corporation

1 Background Paper on Indian Financial Sector

_____________________________________________________________________________
Background
Major constituents of the Indian financial sector are banks, financial institutions, and
markets, which mobilize the resources from the surplus sector and channelize the
same to the different needy sectors in the economy. In fact, the Indian financial
system is characterised by its two major segments - an organized sector and a
traditional sector that is also known as informal credit market. Financial
intermediation in the organized sector is conducted by a large number of banks and
financial institutions. Financial institutions are further classified based on their
mandate and activities, which may be term lending, specialized, and investment
institutions. Banks are further classified into public and private sector banks,
cooperative banks, and regional rural banks. Non-bank financial institutions include
hire purchase and leasing companies, and investment institutions include LIC, GIC,
and UTI. The banking system is, by far, the most dominant segment of the financial
sector, accounting for over 60% of the funds flowing through the financial sector. The
Government has also set up two separate regulatory bodies, viz., Insurance
Regulatory Development Authority (IRDA) of India for the insurance sector, and the
Securities and Exchange Board of India (SEBI) for the capital market.
The Indian financial sector today is significantly different from what it used to be in
the 1970s and 1980s. The financial sector prior to the 1990s was characterized by
segmented and underdeveloped financial markets coupled with paucity of
instruments. For maintaining spreads of banking sector, regulation of both deposit
and lending rates resulted not only in distorting the interest rate mechanism, but also
adversely affected the viability and profitability of banks. The low level of recognition
of the importance of transparency, accountability and prudential norms in the
operations of the banking system also led to a rising burden of non-performing
assets.
______________________________________________________________________ 2
Background Paper on Indian Financial Sector
_____________________________________________________________________________
 Indian Financial System

Securities and Exchange Board of India

Reserve Bank of India

Financial Institutions

Public Sector Banks

Private Sector Banks
Cooperative Banks
Regional Rural Banks
Foreign Banks

Primary Dealers

Banks

NBFCs

Mutual Funds

Venture Capital Funds

Capital Markets

Term Lending Institutions IFCI

SIDBI

Hire Purchase Cos

Leasing Companies

Stock Exchanges
Stock Brokers
Foreign Inst. Investors
Depositories
Underwriters
Custodians
Investors
Merchant Banks

Investment Corporations
Life Insurance Corporation
General Insurance Corporation
Unit Trust of India

State Level Institutions

SIDCs
 SFCs

Specialised Lending Institutions

Exim Bank of India
NABARD
Tourism Finance Corporation
Power Finance Corporation
______________________________________________________________________ 3
Background Paper on Indian Financial Sector
_____________________________________________________________________________
Post 1991, the financial sector liberalization was calibrated on cautious and
appropriate sequencing of reform measures and was marked by a gradual opening
up of the economy. This gradualist strategy seemed to have served the country well,
in terms of aiding growth, avoiding crises, enhancing efficiency and imparting
resilience to the system. From the vantage point of 2010, one of the successes of
the Indian financial sector reform has been the maintenance of financial stability and
avoidance of any major financial crisis (caused due to domestic reasons) since early
1990s - a period that has been turbulent for the financial sector in most emerging
market countries.
The process of financial liberalization has resulted in innovations in instruments and
processes, technological sophistication and growing capital flows. In order to fulfill
the broad objectives of the financial liberalization in India, a multi-pronged approach
is being adopted. This includes: removing the constraints faced by the financial
system through the creation of an enabling policy environment; improving the
functioning of the financial institutions, and through the pursuit of financial stability as
an essential ingredient of macroeconomic stability.
Major Market Players
Players in Banking Industry
As per the Reserve Bank of India Act, 1934, banks in India are classified into
scheduled and non-scheduled banks. Scheduled banks are those which are entered
into the second schedule of the RBI Act, 1934. It includes those banks which have a
paid-up capital and reserves of an aggregate value of not less than Rs.5 lakhs and
which satisfy RBI that their affairs are being carried out in the interests of the
depositors. While, non-scheduled banks are those which have not been included in
the second schedule of the Act. The scheduled banks comprise scheduled
commercial banks and scheduled cooperative banks. Further, the scheduled
commercial banks in India are categorised into five different groups
______________________________________________________________________ 4
Background Paper on Indian Financial Sector
_____________________________________________________________________________
according to their ownership and/or nature of operation:- (i) Nationalised Banks; (ii)
State Bank of India and its associates; (iii) Regional Rural Banks (RRBs); (iv)
Foreign banks; and (v) Other Indian private sector banks. Scheduled Co-operative
Banks consist of Scheduled State Co-operative Banks and Schedule Commercial
Banks.
At present, there are 170 scheduled commercial banks in the country, which includes
91 regional rural banks (RRBs), 19 nationalised banks, 8 banks in State Bank of
India group and the Industrial Development Bank of India (IDBI Ltd). Besides, there
are only four non-scheduled commercial banks in the country.
Public Sector Banks in India Allahabad Bank Indian Bank
Andhra Bank Indian Overseas Bank
Bank of Baroda Oriental Bank of Commerce
Bank of India Punjab & Sind Bank
Bank of Maharshtra Punjab National Bank
Canara Bank Syndicate Bank
Central Bank of India UCO Bank
Corporation Bank Union Bank of India
Dena Bank United Bank of India
Vijaya Bank