Theory and Practices of Banking

8/3/2019 Theory and Practices of Banking

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Theory and Practices of Banking (0000)

Introduction:

1. What do you mean by bank?

Ans: A bank is an establishment which trades with money with the aim to earn profit. It is an

establishment which creates money with money. It is a financial intermediary and dealer in

loans and debts.

2. Definition of banker.

Ans: Any person carrying on the business of banking is a banker. Banker includes a body of

persons whether incorporated or not, who carrying on business of banking.

3. Definition of banking.

Ans: banking is a business of a banker, keeping or management of a bank.

4. Write down the objectives of a bank.

Ans: Objectives of a bank are written below-

From bank owners point of view: earning profits, goodwill, raising efficiency, rendering

services, investment of capital etc.

From governments points of view: issues of notes and currencies, capital information,

capital investment and industrialization, money market control, employment, advice on

financial matters.

From clients point of view: deposits, safety, advisors and consultants, representative or

trustee, raising living standard.

Central banking practices

1. What do you mean by central bank?

Ans: Generally, central bank is a bank for the government and a bank for all the banks. Broadly,

the central bank is the organ of government that undertakes the major financial operations of

the government and by its conduct of these operations and by other means influences the

behavior of financial institutions so as to support the economic policy of the government.


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2. What are the natures of central bank?

Ans: The natures of central bank are written below-

a. Single organization: In every country there exist only one central bank, so it needs not o

compete with others.

b. Legal entity: It is established by the special act by the government so its legal entity is

much stronger than others.

c. Nature of ownership: The nature of central bank can be of fully of government, or joint

venture of govt. and private ownership.

d. Objective: Earning profit is the secondary objective of the central bank. its mainly

concerned with the monetary and credit situation.

e. Note issue: The most appropriate and suitable medium for the issue of note is the

central bank. No other bank has the authority of note issuance.

f. Govt. control: It is controlled by the govt. and works under the direction of department of

finance or treasury.

g. Relation with govt.: Its the banker, financial advisor, an organ of govt. and performingthe banking operations of the govt.

h. Guardian of money market:It has a centralized control over both currency and credit for

effective monetary control.

i. Banker and controller of other banks: It functions as the bankers bank, and controls and

regulates the commercial bank and other financial institutions.

j. Lender of the last resort: It gives loan to the govt. when requires. It provides rediscounts

and advances to commercial banks in times of credit stringency.

k. Controller of foreign exchange: It maintains the foreign exchange reserves of the

country and attempts to stability in the exchange rates.

3. What are the functions of central bank?

Ans: functions of central are written below-

General functions includes:

a. Issuing notes and maintenance of the value of currency.

b. Direction and control the money market.

c. Controlling credit and foreign exchange.

Functions as government bank includes:

a. Maintenance of govt. fund and collection and transfer of money.

b. Handling of govt. monetary transaction and of govt. account.

c. Loan issue and its supervision.

d. Acts as advisor and agent of govt.e. Implementation of govt. monetary policy.

Functions as a banker of other banks include:

a. Scheduling bank.

b. Acts as clearing house.

c. Sanction and supervising loan.

d. Audit, collection and preservation of accounts.


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e. Acts as advisor and agents.

Development functions includes:

a. Development of different production oriented sectors.

b. Developing banking system, foreign trade, natural resources.

c. Improving quality of manpower and economic plan.

Other functions include:a. Economic research.

b. Collection and supply of data.

c. Preparation of reports and publication etc.

4. What are the principles of note issue?

Ans: The principles of note issue are

a. The currency principle.

b. The Banking principle.

5. What do you mean by bank rate policy?

Ans: The bank or discount rate is the rate at which the central bank makes available financial

accommodation to commercial bank by discounting govt. or other first class securities offered by

the commercial bank. It influences short term loan. It cannot generate profit or loss by imposing

this policy. This policy has indirect influence. If commercial bank does not avail loan from central

bank than this has no influence on interest rate, as a result in any influence on the total loan of

commercial banks.

6. What do you mean by open rate policy?

Ans: Open market operation means the purchase or sale by a govt. of bonds in exchange for

money. It influence short-term as well as long-term. When there is lack of currency in the

market, central bank sells securities and indirectly sends money to the market, and vice versa.

There is the chance of profitability or loss by exchanging the securities.

7. How does central bank works as the clearing house?

Ans: Clearing house is a process where a specific areas or region scheduled banks settle their

indebtness, bank representatives meet in a specific time in a specific room of central bank. To

mutually settle their claims over each other arising out of deposit transfer from one bank to

another by their respective customers, the arrangement of clearing house is created.


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Commercial banking practices

1. Define commercial banking.

Ana. Commercial bank is an intermediary profit making institution. The bank which deals with

money and moneys worth with a view to earning profit is known as commercial bank.

2. What are the features of commercial bank?

Ans: Features of commercial are written below-

a. Commercial banks are the financial intermediary or dealer in capital and money.

b. They collect deposits on current, savings and fixed accounts from people.

c. They lend money to different people and organization at a higher interest rate.

d. They honor the customers check.

e. Its main purpose is to earn profit.

3. Write down the functions of commercial bank to its customers.

Ans: General functions of commercial bank includes-

a. Receiving deposits from customers.

b. Giving facilities of money withdrawals.

c. Giving loan at a high interest rate.

d. Investment of surplus funds in profitable sectors.

e. Creating medium of exchange (checks, draft, pay order, bill of exchange) and loan

deposits.

f. Discounting bill.

g. Helping central by providing needed information.

h. Assistance in foreign exchange.

Representational functions includes-

a. Collection and payment of money. b. Purchase and sell of shares and

securities.

c. Acts as trustee, advisor etc. d. work as underwriter.

e. Representative of central bank. f. Safe custody of money and wealth

g. Maintaining secrecy about customer accounts.

Service oriented functions include-

a. Money transfer.

b. Reducing risk of cash transaction.

c. Supplying information.

d. Issue of solvency certificates, advising (about income tax, investment etc) etc.

Other functions include-


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a. To perform managerial activities to run its own business.

b. To monitor lower level employees and different branches.

c. To train employees.

d. To continuo research and development activities.

e. To publish different reports and journals.

4. What are the services of commercial bank?

Ans: Beside borrowing and lending, commercial bank has other functions like as follows:

Agency services includes-

a. Payment of insurance premium, rent, salaries and collection of dividends on behalf of

customers, pension, rent etc.

b. Purchase and sales of shares and securities of joint stock company on behalf of its

customers only.

c. A customer may give his power of attorney to commercial bank and the bank bears all the

responsibilities of such power.

d. They perform different functions as representative of central bank.

e. They provide suggestions to tax payers who may not be able to afford a consultant.

General utility services include-

a. Safe custody of valuables.

b. Travelers check, consultancy services, remittance of fund etc.

5. What are the principles of commercial banking?

Ans: All the commercial banks have to maintain some principles to achieve success. These

principles are-

a. Principle of liquidity: It must keep certain percentage of cash of the deposits to honor the

customers checks

b. Principle of solvency: It must maintain its assets more or equal to its liabilities to survive

successfully.

c. Principle of safety:It must exercise greater care and vigilance in case of granting loan.

d. Principle of granting: It must invest excess liquidity to profitable sectors to earn profit.

e. Principle of loan and investment: After scrutinizing different factors it grants loan and

invests funds in diversified sectors.

f. Principle of economy: Through training all employees and using modern technology it

pursue principle of efficiency.

g. Principle of secrecy: It must maintain secrecy about customers accounts.h. Principle of specialization: Opportunity must be provided to achieve special knowledge and

efficiency for each of its branches.

i. Principle of location: If banks are nearer to the customers, it enhances the security of

customers along with communication facility.

j. Principle of publicity: To keep in touch it must publicize its services to customers.


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k. Principle of goodwill: Banks try to achieve goodwill by providing security, efficient service,

and maximum interest on deposits.

Negotiable Instruments

1. Define negotiable instruments.

Ans: Negotiable instrument means a written document which creates a right in favor of some

person and which is freely transferable. The Negotiable Instruments Act states-negotiable

instrument means a promissory note, bill of exchange or check payable either to order or to

bearer which is transferable from hand to hand by way of negotiation or does not contain words

prohibiting transfer.

2. What are the features of negotiable instruments?

Ans: Features of negotiable instruments are-

a. Easy negotiability: In case of order instruments it is transferable by endorsement and

delivery. In case of bearer instrument it is transferable by mere delivery.

b. Title: The holder in due course is not affected by the defective title of the transfer of any

party.

c. Recovery: The holder in due course can recover the amount of the instrument from the

party liable for payment on the instrument.

d. Presumptions: A negotiable instruments is always subject to certain presumptions.

3. What is promissory note? State its features.

Ans: A promissory note is an instrument in writing containing an unconditional undertaking,

signed by the maker, to pay a certain sum of money to the order of a certain person, or to the

bearer of the instrument. Features of promissory note are written below-

a. It must be in writing and signed, stamped by the maker.

b. It must contain a promise to pay and the promise must be unconditional.

c. The payee, maker and the sum must be certain.

4. What is bill of exchange? State its features.

Ans: A bill of exchange is an instrument in writing containing an unconditional order, signed by

the maker, directing a certain person to pay a certain sum of money only to or o the order of a

certain person or to the bearer of the instrument. Features are written below-

a. It must be in writing and signed by drawer.

b. It must contain an order to pay money and it must be unconditional.

c. The drawer, drawee, payee, and sum must be certain.

d. It must comply with the formalities as regards date, stamps, consideration etc.

5. What is check? State its features.

Ans: A check is a bill of exchange drawn on a specified banker and not expressed to be

payable otherwise than on demand. Features of check are written below-


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a. It is a printed paper, containing the bank and branch address.

b. Its always drawn on a specified banker.

c. It contains an order to pay money, the order must be unconditional.

d. It must have a date and check number.

e. The sum payable must be certain.

6. Some related issues.

Ans: Holder in due course:A person becomes holder in due course if following conditions hold-

a. The negotiable instrument must be in the possession of the holder in due course.

b. The instrument must be regular and complete, and have been obtained for valuable

consideration before it is matured,

c. The holder in due course must obtain the instrument without having sufficient cause to

believe that any defect existed in the title of the transferor.

Bearer: It means the person who by negotiation comes into possession of a negotiable

instrument, which is payable to bearer.

Defective title: A person who receives an instrument which has been lost or by means of fraud

or any other unlawful means is not entitled to receive the amount due there on unless he

claims as holder in due course.

Crossing and payment of checks

1. Define crossing.

Ans: A check is said to be crossed when two transverse parallel lines with or without any words

are drawn across its face. Its an instruction to the paying banker to pay the amount of the

check through a banker only and not directly to the person presenting it at the counter.

2. Objectives/ advantages of crossing.

Ans: a. to prevent the payment of the check to a wrongful holder.

c. To assure safety in circulation of checks.

d. To ensure the safe transmission of money from the sender (drawer)to the receiver (payee).

3. What are the types of crossing?

Ans: Crossing of a check is of 2 types-

a. General crossing: If any check bears only two transverse parallel lines or the lines with thewords And company or any abbreviation thereof simply, with or without the words Not

Negotiable the check shall be deemed to be crossed generally.

b. Special crossing: If a check bears across its face an addition of the name of a banker either

with or without the words Not Negotiable the check is said to be crossed specially.

4. Precautions to be taken by the paying banker.

Ans: Before honoring a check paying banker must take the following precautions-


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a. The check must be drawn in the printed form supplied by the banker.

b. An undated check will not be honored.

c. Sufficient amount specified in the check must exist in the customers account.

d. The check must be signed by the drawer and presented within banking hours.

e. If a check is torn into two or more pieces, its multilateral check, if banker is satisfied that

mutilations was unintentional and obtains the confirmation of the drawer, then the check ishonored. Other material alteration must be confirmed by the drawers full signature.

5. Some related issues.

Ans: Stale check: If a check is not presented within a reasonable period after the date of its

issue, its called stale check.

Post dated check: if the drawer mentions a date on the check, which is subsequent to the date

on which it is drawn, its called a post dated check.

6. What is Garnishee Order?

Ans: When a debtor fails to pay the money due to his creditor, the creditor may apply to thecourt to issue a Garnishee Order on the debtors bank, as a result the debtors account with the

bank is to be frozen and the bank cannot make any payment out of the account defraying the

order of the court. The obligation of a banker to honor his customers check is extinguished on

receipt of an order of the court, called Garnishee Order. This order is issued by the court in

two parts-

a. Order Nisi: Ask the banker to freeze the debtors account and explain why this freezed fund

should not be used for payment of judgment-creditor.

b. Order Absolute: By this order the court directs the banker to pay either the whole or a part

of the funds in the account against which Order Nisi has been issued to judgment-creditor.

Loans and Advances

1. What is cash credit?

Ans: A cash credit is an arrangement by which the customer is allowed to borrow money up to

a certain limit known as the cash credit limit. Usually the borrower is required to provide

security in the form of pledge or hypothecation of tangible securities. Sometimes this facility is

also provided against personal security to those having unquestionable financial soundness.

Hypothecation: Here the possession of goods is not given to the bank, and remains at

the disposal and go-down of the borrower. The bank can have access whenever it so

desires. Bank grants this only to those persons in whose integrity it has full confidence.

Pledge: Here the goods are pledged in the custody of the bank with its name on the go-

down where they are stored. The borrower has no right to deal with them.

2. What is overdraft?

Ans: A loan made to customer with a check account at a bank or building society, in which the

account is allowed to go into debit, usually up to a specified limit, is called bank overdraft.


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Overdraft is an arrangement between a banker and his customer by which the later is allowed

to withdraw over and above his credit balance in the current account up to an agreed limit.

3. What is loan?

Ans: Money lent on condition by a bank that is repaid either in installments or all at once, on

agreed dates and usually that the borrower pays the lender an agreed rate of interest, unless it

is an interest free loan. The amount is provided by the bank after opening a current by the

client.

4. What do you mean by purchase and discounting bills?

Ans: The net amount, after deducting the amount of interest /discount from the instrument, is

credited in the account of the customer. The interest is received in advance by the bank.

Bills which are accompanied by documents or title to goods (bill of lading, railway receipt etc)

are purchased by the bankers. The bankers grant loans (overdraft, cash credit) against the

security of the bills.

5. What is lien?

Ans: Lien is the right of the creditor to retain the properties belonging to the debtor until debt

due to him is repaid. It does not give the power to sell the goods retained unless such a right is

expressed by statute or by custom or by usage. After serving reasonable notice to the

borrower, banker has the right to sell the securities if the due debtor is unable to repay the

loan.

6. What is mortgage?

Ans: A mortgage is a method of creating charge on immoveable properties like land or building.

Broadly, a mortgage is the transfer of an interest in specific immoveable property for the

purpose of securing the payment of money advanced

Some related issues

1. What is electronic banking?

Ans: Electronic banking is a modern computerized system of providing banking services by the

banks to their customers. By using the modern technology, banks have become able to provide

their existing services more quickly, accurately and conveniently.

2. What is home banking?

Ans: Through developed electronic fund transfer system, banks can offer its financial services to

the doors of customers. They offer telephone bill payment system (TBP) process so that clients

can enjoy banking while staying at home.

3. What is internet banking?


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Ans: Financial institutions can solve banking transactions through internet to get quick solution.

Normal banking transactions and fund transfer related activities like, auditing, payment of bills,

investments, stock exchange related activities can be done using internet banking system.

4 .What do you mean by Artha Rin Adalat Ain 2003?

Ans: The Artha Rin Adalat or Court means a court established under section for carrying our

purpose of this act of court of joint district judge to be recognized as an Artha Rin Adalat Ain or

court. In realizing the loans from defaulters the law has been playing a vital role. Its purposes

are as follows-

a. To remove the difficulties of dues.

b. To change the law by way of amendments since its inception.

c. To bring changes in the administration of justice delivery system for regulating suits.

d. To fulfill the expectation of bankers.

e. To minimize the bank loan default problem.

f. To inspire and encourage efficient entrepreneurship.

g. To protect interest and security of financial sectors.

6. What do you mean by Money Laundering Prevention Act-2002?

Ans: Concerted efforts are now being made through the world to nab the persons involved in

criminal activities. This has led to an obligation on banks and other financial institutions to

assist in nabbing the criminals. The criminals aim is to make it appear that money obtained

illegally has originated from legitimate sources. The ways in which this transformation is

attempted are known money laundering. Banks must do all they can to identify money

laundering transactions so that the criminals involved therein can be arrested, brought to trial

and convicted. Money laundering is the process of integrating the proceeds of crime into the

legitimate stream of financial system by masking its origin.

Why we must combat money laundering?

Money laundering has serious economic, security and social consequences.

Tax evasion is encouraged leading to reduction of govt. revenue.

Distorts assets and commodity price and misallocation of resources.

Mixes ill gotten money with legitimate money through use of front offices of private

sector companies engaged in financial transaction.

IMF estimates 2%-5% of world domestic products are carried out through money

laundering. In some countries this dwarfs the govt. budgets even.

Socio-economic effect is severe. It transfers economic power from stale to criminals. Social and political costs are severe. Bribing is made institutional.


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Theory and Practices of Banking

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