Indian financial system

Indian Financial System, Institutions &
Markets
Ramesh Subramanian
M.com., C.A.I.I.B.,F.C.S.,LL.M.,ACMA
September 24 , 2012

Presentation Plan
Definition
Features
Framework
Constituents
High Level Committee of Regulators
Financial Sector Reforms
Financial Inclusion
Acts -Overview
National Payments Corporation of India

Financial System
• System (from Latin systēma, in turn from Greek ''''
systēma) is a set of interacting or interdependent entities
forming
an
integrated
whole.
• A system that aims at establishing and providing a regular,
smooth, efficient and cost effective linkage between
depositors and investors is known as Financial System.
• A
set
of
complex
and
closely
connected
instructions/institutions agents, practices, markets,
transactions, claims and liabilities relating to financial
aspects of an economy may be referred to as a financial
system.
• Activities related to finance and organised into a system
may be called financial system.
• A well-developed financial system enables transfer of
resources
from
depositors/savers
to
borrowers/investors/entrepreneurs and plays a crucial role
in the functioning of the economy.

Features
• Provides a linkage between depositors and
users/investors (encourages savings and
investments)
• Expansion of financial markets
• Efficient allocation of financial resources
• Enables deployment of funds for socially
desirable and economically productive
purposes
• Aids rapid economic development

Framework
• The legal framework for Bank supervision is
provided under the Banking Regulation Act, 1949,
RBI Act, 1934, FEMA, 1999.
• Institutional framework RBI has the following
important departments for the same:
– Department
of
Banking
Operations
&
Development
– Department of Banking Supervision
– Department of Non Banking Supervision
– Foreign Exchange Department

Constituents

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Financial
Financial
Financial
Financial

Institutions
Services
Markets
Instruments

Financial Institutions
• Institutions that provide Financial Asset
and Liability products
• Loans & Advances
• Savings products
• Regulated by RBI, SEBI, IRDA
• Banking and Non-Banking (NBFCs)
• Specialised Institutions – NABARD, EXIM
Bank, SIDBI,LIC, GIC etc.

• Difference between Banks and NBFCs:
• Banks can accept Demand deposits but NBFCs
cannot. They can only accept Time deposits.
• An NBFC is not a part of the payment and
settlement system and cannot issue cheques
drawn on itself.
• Deposit insurance facility of DICGC is not
available for NBFC depositors unlike in case of
banks

Financial Services
• Services that help in borrowing/lending,
investing, buying, selling securities, enabling
payment and settlements,
• Comprises services provided by FIs.
• Enable raising of funds and efficient distribution
of financial products
• Examples- underwriting, stock-broking, Hire
purchase, leasing, factoring, credit rating,
depositories, etc.
• Various services provided by banks – collection of
bills/cheques, BGs, LCs, locker facilities etc.

Financial Markets
• FM – facilitate buying and selling of financial
claims, securities etc
• Enables transfer of funds from surplus to deficit
units.
• Consists of merchant bankers, dealers, lenders,
borrowers, investors, agents, etc.
• Organised and Unorganised
• Unorganised – no adequate regulation, nonstandardised in character, no proper settlement
mechanism etc.
• Organised - Act, Rules, Regulations,
• Organised - High degree of institutionalisation &
instrumentalisation

Financial Markets
• FMssignificant
role
in
resource
management
• Act as a bridge between savers and
spenders through various instruments like
equity or debt or a combination
• Facilitates price discovery
• Provides liquidity

Financial Markets
• Money Market & Capital Market
• MM – Short Term claims or financial assets
for a period of ONE DAY to one less than
ONE YEAR
• MM – mostly dominated by Banks, Financial
Institutions.
• MM – MM is a whole sale debt market for low
risk, highly liquid, short-term instruments

Financial Markets
• Capital Market – Designed to finance Long Term
investments above one year.
• CM – a place where people buy and sell financial
instruments in equity or debt.
• CM- a mechanism to facilitate the exchange of
financial assets.
• Primary Market – both corporate and Government
raise funds by issuing securities.
• Secondary Market – through continuous trading
activities provides liquidity in the system and
reflects the changing perception of the investors.
Barometer of economy.

Financial Markets
• Forex
market
–
deals
with
multicurrency requirements which are
met by exchange of currencies. Most
developed and integrated market.
• Credit Market – Banks, FIs, NBFCsprovide short, medium, and long-term
loans to corporate and individuals.

Financial Instruments

• FIs – financial assets and securities
dealt with in a financial market.
• Debt – Government bonds, corporate
bonds
• Capital – Equity, Preference
• Classification
–
Money
Market
Instruments and Capital Market
Instruments

Money Market Instruments
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ST in nature – are near substitutes for money.
Call/Notice Money : Call one day, Notice >1 day <
14 days
No collateral security is required.
Term Money : Inter-bank deposits for maturity
beyond 14 days is referred to as term money.
Treasury Bills – T-Bills are borrowing instruments
of the Central Government – issued for ST. Issued
at a discount to Face Value.
Certificate of Deposits – Is negotiable instrument
issued by Banks and FIs. Governed by RBI
guidelines.
Commercial Paper – CP is an unsecured
Promissory Note privately placed issued by

Elements of Markets
– Investors
– Issuers
– Intermediaries
– Regulators

Financial Regulation
• The formal financial system comes under the
purview of the Ministry of Finance.
• Regulation of Banks and Finance Companies Delegated to Reserve Bank of India. (Banking
Regulation Act, and RBI Act)
• Capital Markets are regulated by Securities and
Exchange Board of India (SEBI)
• Insurance Sector – regulated by Insurance
Regulatory & Development Authority (IRDA)

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Overview of the Acts regulating the
Financial Sector
Banking Regulation Act, 1949
Reserve Bank of India Act, 1934
Negotiable Instruments Act,1881
Securities and Exchange Board of India Act,
1992
Insurance Regulatory and Development Act,
1999
Payment and Settlements System Act,2007
Foreign Exchange Management Act, 1999
Companies Act, 1956

Banking Regulation Act, 1949 - Objective

• The provisions of law relating to banking
formed part of the Indian Companies Act,
1913.
• Objective of the Company Law is to
safeguard the interests of the stock-holder
while that of Banking Regulation would be
to protect the interests of the Depositor.
• Branch Expansion and rapid strides in
banking.
• Need was felt to have a separate
legislation for Banks.

Banking Regulation Act, 1949 - Features
•

•
•

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•
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A comprehensive definition of the word BANKING so as to
bring within the scope of the legislation all institutions
which receive deposits, repayable on demand or
otherwise, for lending or investment.
Prohibiting non-banking companies from accepting
deposits repayable on demand.
Prohibition of trading with a view to eliminating nonbanking risk.

Prescription of minimum capital standards.
Limiting the payment of Dividends.
Introduction of a comprehensive system of
licensing of banks and their branches.

Banking Regulation Act, 1949 – Important
definitions/provisions

• Section 5 (b) banking means the accepting,
for the purpose of lending or investment,
of deposits of money from the public,
repayable on demand or otherwise and
withdrawable by cheque, draft, order or
otherwise.

Banking Regulation Act, 1949 Important
definitions/provisions
• Reserve Bank of India is the Regulator
• Section 6- Forms of business a bank may undertake (a) to
(n)
• Section 7 – use of words Bank, Banker Banking or Banking
Company
• Section 8 – Prohibition of TRADING- No banking company
shall directly or indirectly deal in the buying or selling or
bartering of goods, except in connection with the
realisation of security given.
• Section 9 –No banking company shall hold any immovable
property except such as is required for its own use for any
period exceeding SEVEN years from the acquisition. RBI has
powers to extend the period by a maximum of 5 years in
depositors interest
• Section 11 – minimum paid up capital

Banking Regulation Act, Important Provisions
• Section 10-A (2) not less than 51 percent of the
total number of members of the BoD shall consist
of persons who shall have special knowledge or
practical experience in respect of one or more of
– accountancy, agriculture and rural economy,
banking, co-operation, economics, finance, law,
SSI others sectors which RBI may prescribe.
• Section 10 (2-A) no Director, Other than its
Chairman or whole-time Director shall hold office
continuously for a period exceeding EIGHT years.
• Voting Rights – Section 12 – No person holding
shares in a banking company shall in respect of any
shares held by him, exercise voting rights on poll
in excess of TEN percent of the total voting rights
of all the shareholders of the banking company.

Banking Regulation Act, 1949
• Section 22-licensing of banking companies
• Discussion paper on Bank Licensing
• Section 24 – Statutory Liquidity Ratio. Present SLR
23%
• Section 35 – Inspection of Banks
• 35 A – Power to issue Directions in public interest
to secure proper management of the Bank
• Section 45 – power to apply to CG for suspension
of banking business
• Section 45 (2) – CG to order moratorium on the
recommendations of the RBI

Discussion Paper on New Bank Licences
• As of March 31, 2009, the Indian banking system comprised
– 27 public sector banks,
- 7 new private sector banks,
-15 old private sector banks,
- 31 foreign banks,
-86 Regional Rural Banks (RRBs),
-4 Local Area Banks (LABs),
-1,721 urban cooperative banks,
- 31 state co-operative banks and
- 371 district central co-operative banks.

The average population coverage by a commercial bank
branch in urban areas improved from 12,300 as on June 30,
2005 to 9,400 as on June 30, 2010 and
-in rural and semi urban areas from 17,200 as on June 30,
2005 to 15,900 as on June 30, 2010.
-

– Though the Indian financial system has made impressive
strides in resource mobilization, geographical and
functional reach, financial viability, profitability and
competitiveness, vast segments of the population,
especially the underprivileged sections of the society,
have still no access to formal banking services.
– The Reserve Bank is therefore considering providing
licences to a limited number of new banks. A larger
number of banks would foster greater competition, and
thereby reduce costs, and improve the quality of
service. More importantly, it would promote financial
inclusion, and ultimately support inclusive economic
growth, which is a key focus of public policy.


• The initial minimum paid up capital was
prescribed at Rs. 200 crore to be raised to
Rs.300 crore within three years of
commencement of business.
• Reserve Bank’s experience
• 10 new banks were set up in the private sector after the
1993 guidelines and 2 new banks after the 2001 revised
guidelines. Out of these, four were promoted by financial
institutions, one each by conversion of co-operative bank
and NBFC into commercial banks, and the remaining six by
individual banking professionals and an established media
house.

Reserve Bank Experience
– Out of the four banks promoted by individuals in 1993, only one
has survived with muted growth. One bank has been compulsorily
merged with a nationalized bank due to erosion of networth on
account of large capital market exposure. The other two banks
have voluntarily amalgamated with other private sector banks
over a period of 10 to 13 years due to the decisions of the
majority shareholders arising out of poor governance and lack of
financial strength.
– Out of the remaining six banks that were licensed in 1993, one bank
promoted by a media group has voluntarily amalgamated itself with
another private sector bank within five years of operations and four
banks promoted by financial institutions have either merged with the
parent or rebranded and achieved growth over a period of time. The
bank that was converted from a Cooperative bank has taken some time in
aligning itself to the commercial banking and is endeavoring to stabilize
itself.

Reserve Bank Experience
• The experience of the Reserve Bank over these 17 years
has been that banks promoted by individuals, though
banking professionals, either failed or merged with other
banks or had muted growth.
• Only those banks that had adequate experience in broad
financial sector, financial resources, trustworthy people,
strong and competent managerial support could
withstand the rigorous demands of promoting and
managing a bank.


• Preamble –
Whereas it is expedient to constitute a
Reserve Bank for India to regulate the issue
of Bank Notes and the keeping of reserves
with a view to securing the monetary
stability in India and generally to operate
the currency and credit system of the
country to its advantage.

RBI Act- Important Provisions

– Business which the Bank may transact
section 17• Accepting money on deposit from CG, SG.
• Export credit refinance
• Loans and advances to SCBs, State Coop
Bannks
• Loans and advances to Fis like IDBI, IFCI,
NABARD etc
• Advances to CG, SG
• Management of public debt
• Issue of bank notes

RBI Act- Provisions

Section 19 - Business which the Bank may
not Transact• Engage in trade or have direct interest in any
commercial, industrial undertaking.
• Purchase the shares of any banking company
• Become owner of immovable property except as
required for its own use and officers and staff
• Make loans or advances
• Draw or accept bills otherwise than on demand
• Allow interest on deposits or current amounts

RBI Act, Important Provisions
• Section 20 – obligation of the Bank to transact
CG business. (shall)
• Section 21 – CG shall entrust to the Bank its
business (shall)
• Section 21 A – Bank MAY by agreement with SG
undertake its business.
• Section 22 – Right to Issue Bank Notes – Sole
Right-Monopoly.
• Section 24 – Denomination of bank notes – 2, 5,
10, 20, 50, 100, 500, 1000, 5000, 10000, and
such other denomination not exceeding 10000
as the CG may on the recommendation of the
Central Board specify in this behalf.

RBI Act, Provisions
– Section 42 Cash Reserve Ratio. Present CRR 4.75%
– Section 45 – appointment of agents – SBI, PSBs,
NABARD
– Chapter III B 1997.- NBFCs brought under RBI
purview.
– Section 45 IA Registration of NBFCs
– Section 49 – Publication of Bank Rate- the Bank shall
make public from time to time the standard rate at
which it is prepared to buy or re-discount bills of
exchange or other commercial paper eligible for
purchase under the Act. Present BR 6.00%
– Returns – within two months of closing of annual
accounts the Bank shall transmit to the CG a copy of
the annual accounts.

RBI Act, Provisions
• Section 47 – allocation of surplus profits – after
making necessary provisions, depreciation of
assets etc. the balance of profits shall be paid
to the CG.
• Scheduled Banks in India constitute those banks
which have been included in the Second
Schedule of Reserve Bank of India(RBI) Act,
1934. RBI in turn includes only those banks in
this schedule which satisfy the criteria laid
down vide section 42 (6) (a) of the Act.

RBI Act - Provisions
The banks included in this schedule list should fulfil two
conditions 1. The paid capital and collected funds of bank should not be
less
than
Rs.
5
lac.
2.Any activity of the bank will not adversely affect the
interests
of
depositors.
Every Scheduled bank enjoys the following facilities.
1. Such bank becomes eligible for debts/loans on bank rate
from
the
RBI.
2. Such bank automatically acquire the membership of
clearing house.

Repo & Reverse Repo
• Repo is the mechanism by which RBI adds
liquidity to the banking system. Any bank can
park its Government securities with the RBI and
meet its liquidity requirement with an
agreement to buy the security back from RBI
after a specified number of days. (Present Rate
-8%)
• Under the reverse repo the banking system parks its
excess liquidity with the RBI and in turn purchases the
Government security of equivalent amount with an
underlying agreement to reverse the transaction at a
later date. The mechanism helps in absorption of
excess liquidity from the system. (Present Rate –7 %)

Repo & Reverse Repo

• Repo rate is the rate at which RBI lends its
short term funds or the process of injecting
funds into the system. Reverse repo is the rate
at which the RBI borrows short term funds from
commercial banks or the process of sucking off
of funds from the system.
• The impact of increase in the repo rate will
make loans costlier as the reverse repo rate
represents the benchmark interest rate. Repo
rate also serves as the bench mark rate for the
short/medium term, while the Bank Rate is an
indicator of the long rate rates.

Inspection of Banks & NBFCs
• Section 35 of Banking Regulation Act
• Department
of
Banking
Operations
&
Development (DBOD) is the Regulatory Deptt.
• Department of Banking Supervision carries out
the inspection
• Chapter III B of RBI Act, 1934 deals with NBFC
regulation
• Inspection of NBFCs u/s 45N of RBI Act
• Section 45 IA of RBI Act requires CoR for NBFCs

Inspection of Banks
• Onsite Inspection –
– CAMELS pattern of Inspection
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Capital
Asset Quality
Management
Earnings
Liquidity
Systems & Controls

-Risk Based Supervision
Off site Monitoring and Surveillance System (OSMOS)

Inspection of Banks - INROADS
• The Reserve Bank of India (RBI) has
decided to change the way it monitors
and supervises banks in order to make the
process more forward-looking.
• The move comes against the backdrop of
the risks that have emerged after the
global financial crisis of 2008, with
lenders shifting from offering traditional
products to more complex ones.

• The country’s financial sector would now be
evaluated under a dynamic risk-based
mechanism, an aspect the present CAMELS
rating system lacked, central banking sources
said. RBI proposes to replace CAMELS with
INROADS (Indian Risk-Oriented and Dynamic
Rating System) from the next round of annual
financial inspection, in 2013.
• At present, the central bank uses the CAMELS (Capital
adequacy, Asset quality, Management, earnings,
Liquidity, and Systems and control) method, to assign
ratings to Indian banks. CAMELS, which goes from A+ to
D is assigned to a bank while finalising the annual
financial inspection (AFI) report.

• RBI has argued that the present form of rating
captures only a few risk elements and
represents a bank’s past-year performance.
Besides, RBI is of the view, the present rating
does not capture the risks that could cause a
bank to fail.
• Some of the broader risks, such as credit risk,
operational risk, and strategic and business group risk,
increase the probability of a bank’s failure.
• The process of annual financial inspection has been
expedited and it is now proposed that banks should
address the areas of concern mentioned in AFI during a
particular year. In a given year, AFI is undertaken for
the previous year, and significant delays were noticed
last year.

• The banking regulator is also entering into
mutual regulatory cooperation agreements with
regulators of other countries to extract
information about Indian banks operating
overseas and vice versa.
• RBI has already signed an agreement with 14-15
countries and is in talks with the US – a country
where a majority of Indian banks have
presence.
• Since the US had three federal banking
supervisors, the process might take some time.

• The central bank is also planning to
create a single-point contact for each
bank in order to plug the regulatory
lacuna.
• It is quite often the case that information
about a bank with one department of RBI
is not known to other departments.
• So, a single-point contact will be created
for each banks.

Board for Financial Supervision
• Constituted on November 16, 1994
• Chaired by the Governor, RBI
• Consist of Four Directors of the Central Board
and DGs of RBI
• Department of Banking Supervision is the
Secretariat
• Supervises the commercial banks, FIs and NBFCs
• Provides recommendations for effective
supervision and monitoring

High Level Committee on Financial Markets
• HLCC consists of top officials of Indian banking,
capital markets, insurance and pension
regulators besides representatives from the
ministry of finance.
• The government is in favour of creating a formal
structure, even enacting a law to enable and
strengthen
coordination
between
various
financial sector regulators and plug the gaps in
the current regulatory framework.
• The Indian banking regulator seems to be not
comfortable with the idea. Reserve Bank of India
governor D. Subbarao had said the issue had to
be debated.

Financial Stability and Development Council

• The then Finance Minister Pranab
Mukherjee said that the proposed highlevel Financial Stability and Development
Council (FSDC) would be established soon
but would not dilute the autonomy of
individual regulators.
• To strengthen and institutionalize the
mechanism for maintaining financial
stability.
• All regulatory heads would be members.
• Governor RBI would be the VC
• Would be Chaired by the Finance Minister.

Financial Stability and Development Council

• First meeting held on January 1, 2011.
• Mukherjee in his Budget speech had proposed
to set up the FSDC to deal with financial
stability, financial sector development, interregulatory coordination, financial literacy,
financial inclusion and macro-prudential
supervision of the economy, including the
functioning of large financial conglomerates.
• Council would be in the Department of Economic Affairs,
Ministry of Finance.
• It is also expected to coordinate the country's
international interface with financial sector bodies such
as the Financial Action Task Force (FATF) and Financial
Stability Board (FSB).

Financial Inclusion
• Financial inclusion is not merely providing
reliable access to an efficient payments system.
• Financial inclusion is also not just micro finance
• Financial inclusion represents reliable access to
affordable savings, loans, remittances and
insurance services.
• Financial inclusion primarily implies access to a
bank account backed by deposit insurance,
access to affordable credit and the payments
system.

Financial Inclusion
• First, the lead bank in each district has been asked to
draw a roadmap by the end of March 2010, for ensuring
that all villages with a population of over 2,000 will
have access to financial services through a banking
outlet, not necessarily a bank branch, by March 2012.
• Banks will have to harness technology and innovate low
cost business models to accomplish this.
• Second, all domestic public and private sector
commercial banks have agreed to come up with their
specific, Board approved Financial Inclusion Plans (FIPs)
by March 2010 to be rolled out over the next three
years. These Plans will have both qualitative indicators
and quantitative milestones.
• Third, we have urged all banks to include criteria
regarding financial literacy and financial inclusion in the
performance evaluation of their field staff.

Financial Inclusion –Regulatory initiatives
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Banking Correspondents
Branch Licensing
No Frills account (since replaced by Basic SB Deposit A/c (vide
DBOD.No. Leg. BC.35/09.07.005/2012-13 dated August 10, 2012)
Priority Sector Lending
KYC - In rural areas, this is addressed by asking for identification by
local officials and requiring a photograph of the account holder.
Drives for financial inclusion locally have been achieved through
active involvement of government in the identification process.
In big towns and cities where there are a large number of migrants
who do not have any documents, fulfilling KYC norms and opening a
bank account continue to be a challenge. As a proportional
regulatory dispensation having regard to the degree of risk, RBI has
simpler KYC norms for small value accounts where the balances in
the account do not exceed about $1000 and where the annual
credits in the account do not exceed about $4000.
There are similar dispensations for walk-in clients for small
remittances and payments not exceeding US$1,000.

Financial Inclusion
• Interest rates for loans up to Rs.200000
(about $4200) in the priority sector are
capped at the prime lending rates of
banks. RBI has taken a decision to free
the interest rates, which has come into
effect from July 1, 2010
• Non-banking non-financial players are
encouraged to be partners and agents of
banks rather than principal providers of
financial services. (BC Model)

The Negotiable Instruments Act,
1881

The Negotiable Instruments Act, 1881
• The Act does not define a negotiable instrument
• Section 13 merely states that a negotiable
instrument means a promissory note, bill of
exchange or cheque payable either to order or
bearer.
• This does not indicate the characteristics of a
negotiable instrument but only states that Three
instruments are Negotiable.
• These three instruments are, therefore, by
statute.
• This section does not prohibit any other
instrument which satisfies the essential features
of negotiability to be treated as negotiable
instrument.

Essential Features of Negotiable Instrument
• Justice K.C.Wells ‘one the property in which is acquired
by any one who takes it bona fide and for value
notwithstanding any defect of title in the person from
whom he took it.’
• Thomas - an instrument is negotiable when it is, by
a legally recognised custom of trade or by law,
transferable by delivery or by endorsement and
delivery, without notice to the party liable, in such a
way that a) the holder of it for the time being may
sue upon ii in his own name, and b) the property in it
passes to a bona fide transferee for value free from
any defect in the title of the person from whom he
obtained it’.

Essential features
• A negotiable Instrument –

– A transferable document either by
application of law or by the custom of the
trade concerned
– It confers a privilege on the person who
receives it bona fide and for value
– To possess good title thereto,
– Even if the transferor had no title or Had
defective title to the instrument

Essential features
Special Features of a Negotiable Instrument
•

Transferable from person to person and the ownership of the
property in the instrument passes by mere delivery in case of a
bearer instrument
• By endorsement and delivery in case of an order instrument
• Transferability is an essential feature of a negotiable instrument
BUT all transferable instruments are not Negotiable instruments.
• 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 NI. Such a person is
called the HOLDER IN DUE COURSE and his interest in the
instrument is well protected by the law.
e.g a person who taken a NI from another person, who had stolen it
from somebody will have absolute and undisputable title to the
instrument provided he receives the same for VALUE and in GOOD
FAITH without knowing that the transferor was not the true owner
of the instrument.

Transferability and Negotiability
• In the case of any goods or commodity, which is
transferable from one person to another the general
rule of law is that the Transferor cannot transfer a title
better than what he himself possesses.
E.g X purchases an article or a commodity (BOOK) from Y
against payment of its full value. But Y had stolen the
book from the house of Z. If Y is caught for his theft or
if the stolen book is found in the possession of X the
latter will 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 X will also stand
on the same footing.

Contd
• A NI is an exception to this general rule of law.
Suppose in the above eg X takes a cheque he will
have good title thereto and will not be
responsible to the true owner Z. The latter will
have a right against Y the thief of the
instrument. This privilege of the HOLDER of a NI
in due course constitutes the main difference
between a transferable instrument or article and
a NI.
• A HOLDER IN DUE COUSE can sue upon the NI in
his own name. Thus he can recover the amount
of the NI from the party liable to pay thereon.

CONTD
• A drawer or holder of a NI may take away the
essential characteristic of negotiability and thus
instrument ceases to be a NI. E.g if a cheque is
payable to a specified person only and NO TO
HIS ORDER OR BEARER, it cannot be transferred
to any other person and hence it loses its
negotiability.
• Another eg.if a cheque is crossed NOT
NEGOTIABLE it can be transferred BUT without
conferring on the transferee absolute and good
title in all cases. The transferee of such a
cheque will stand at par with the transferee of
any other commodity and shall not possess title
better than that that of his transferor.

Section 138
• Till 1989 the Drawer of cheque was subject to
civil liability only in respect of money due on a
cheque, if it was dishonoured for reasons
whatsoever.
• April 1, 1989 NI Act was amended.
• Section 138 - Dishonour of cheques because of
insufficiency of funds was deemed as an offence
for which the drawer may be punished with
imprisonment for a term upto TWO years or
fine up to twice the amount of the cheque or
with both. Such a punishment will be in addition
to a civil suit.

Conditions for punishment
– The cheque has been issued in discharge of a debt or other
liability in whole or in part
– Cheque given in gift will not attract punishment.
– The cheque should be presented to the paying banker within
6 months or its specific validity period, which ever is earlier.
– The dishonour of the cheque must be on account of
insufficiency of funds only.
– The payee or holder in due course should give notice in
writing to the drawer demanding payment, within 15 days of
his receiving information of dishonour.
– The drawer can make payment within 15 days of the receipt
of the notice.
– The complaint is to be made within one month of the cause
of action (i.e expiry of 15 days time given to the drawer to
make payment)
– No Court lower to that of Metropolitan Magistrate or Judicial
Magistrate of 1st Class will try the offence.

Company’s responsibility
• If the dishonoured cheque was drawn on behalf of a
company, a firm or association of individuals every
person who was incharge of and was responsible to the
company or the firm for the conduct of the business, at
the time the offence was committed shall be deemed
to be guilty of the offence. Section 141
• An offence in terms of section 138 is committed even if
the cheque is returned on the ground of closure of
account
(G.Venkataramanaiah
Vs
Sillakollu
Ventakeswarlu (1997 97 Comp Cas 13.)
• Even if a cheque is dishonoured because of ‘stop
payment’ instruction to the bank, section 138 would get
attracted (ET & TDC Vs Indian Technologists and
Engineers 1996 (2) SCC 739

Payment and Settlement Act,
2007

Payment and Settlement Act, 2007
•

The PSS Act, 2007 received the assent of the President on 20th December
2007 and it came into force with effect from 12th August 2008.

•

The PSS Act, 2007 provides for the regulation and supervision of payment
systems in India and designates the Reserve Bank of India (Reserve Bank)
as the authority for that purpose and all related matters. The Reserve
Bank is authorized under the Act to constitute a Committee of its Central
Board known as the Board for Regulation and Supervision of Payment and
Settlement Systems (BPSS), to exercise its powers and perform its
functions and discharge its duties under this statute. The Act also
provides the legal basis for “netting” and “settlement finality”. This is of
great importance, as in India, other than the Real Time Gross Settlement
(RTGS) system all other payment systems function on a net settlement
basis.

•

Under the PSS Act, 2007, two Regulations have been made by the Reserve
Bank of India, namely, the Board for Regulation and Supervision of
Payment and Settlement Systems Regulation, 2008 and the Payment and
Settlement Systems Regulations, 2008. Both these Regulations came into
force along with the PSS Act, 2007 on 12th August 2008.

•

All systems (except stock exchanges and clearing corporations set
up under stock exchanges) carrying out either clearing or settlement
or payment operations or all of them are regarded as payment
systems. All entities operating such systems will be known as system
providers. Also all entities operating money transfer systems or card
payment systems or similar systems fall within the definition of a
system provider. To decide whether a particular entity operates the
payment system, it must perform either the clearing or settlement
or payment function or all of them.

•

In terms of Section 4 of the PSS Act, 2007 no person other than the
Reserve Bank can operate or commence a payment system unless
authorized by the Reserve Bank. Any person desirous of commencing
or operating a payment system needs to apply for authorization
under the PSS Act, 2007(Section 5). Any unauthorized operation of a
payment system would be an offence under the PSS Act, 2007 and
accordingly liable for penal action under that Act.

• Under the PSS Act, 2007, dishonor of an
electronic fund transfer instruction due to
insufficiency of funds in the account etc.,
is
an
offence
punishable
with
imprisonment or with fine or both, similar
to the dishonor of a cheque under the
Negotiable Instruments Act 1881. Subject
to complying with the procedures laid
down under the PSS Act, 2007, criminal
prosecution of defaulter can be initiated
in such cases. This provision was
introduced to discourage dishonour of
electronic payment instructions. (Section
25 of the Act)

Electronic Clearing Service
• ECS is an electronic mode of payment / receipt
for transactions that are repetitive and periodic
in nature.
• ECS is used by institutions for making bulk
payment of amounts towards distribution of
dividend, interest, salary, pension, etc., or for
bulk collection of amounts towards telephone /
electricity / water dues, cess / tax collections,
loan
installment
repayments,
periodic
investments in mutual funds, insurance
premium etc.
• Essentially, ECS facilitates bulk transfer of
monies from one bank account to many bank
accounts or vice versa.

• There are two variants of ECS - ECS Credit and
ECS Debit.
• ECS Credit is used by an institution for
affording credit to a large number of
beneficiaries
(for
instance,
employees,
investors etc.) having accounts with bank
branches at various locations within the
jurisdiction of a ECS Centre by raising a single
debit to the bank account of the user
institution.
• ECS Credit enables payment of amounts
towards distribution of dividend, interest,
salary, pension, etc., of the user institution.

• ECS Debit is used by an institution for raising
debits to a large number of accounts (for
instance, consumers of utility services,
borrowers, investors in mutual funds etc.)
maintained with bank branches at various
locations within the jurisdiction of a ECS
Centre for single credit to the bank account of
the user institution.
• ECS Debit is useful for payment of telephone /
electricity / water bills, cess / tax collections, loan
installment repayments, periodic investments in
mutual funds, insurance premium etc., that are
periodic or repetitive in nature and payable to the user
institution by large number of customers etc.

National Electronic Funds Transfer (NEFT)
• National Electronic Funds Transfer (NEFT) is a
nation-wide payment system facilitating one-toone funds transfer.
• Under this Scheme, individuals, firms and
corporates can electronically transfer funds from
any bank branch to any individual, firm or
corporate having an account with any other bank
branch in the country participating in the
Scheme.
•
•

Individuals, firms or corporates maintaining accounts with a bank
branch can receive funds through the NEFT system.
It is, therefore, necessary for the beneficiary to have an account
with the NEFT enabled destination bank branch in the country.

• The NEFT system takes advantage of the core
banking system in banks. Accordingly, the
settlement of funds between originating and
receiving banks takes places centrally at
Mumbai, whereas the branches participating in
NEFT can be located anywhere across the length
and breadth of the country.
• Presently, NEFT operates in hourly batches there are eleven settlements from 9 am to 7 pm
on week days (Monday through Friday) and five
settlements from 9 am to 1 pm on Saturdays.

• IFSC or Indian Financial System Code is an alphanumeric code that uniquely identifies a bankbranch participating in the NEFT system. This is
an 11 digit code with the first 4 alpha characters
representing the bank, and the last 6 characters
representing the branch. The 5th character is 0
(zero).
• IFSC is used by the NEFT system to identify the
originating / destination banks / branches and
also to route the messages appropriately to the
concerned banks / branches.
• NEFT is a credit-push system i.e., transactions
can be originated only to transfer / remit funds

Real Time Gross Settlement (RTGS)
• Real Time Gross Settlement, which can be
defined as the continuous (real-time) settlement
of funds transfers individually on an order by
order basis (without netting).
• 'Real Time' means the processing of instructions
at the time they are received rather than at
some later time.
• 'Gross Settlement' means the settlement of funds
transfer instructions occurs individually (on an
instruction by instruction basis).
• The RTGS system is primarily meant for large value
transactions. The minimum amount to be remitted
through RTGS is Rs. 2 lakh. There is no upper ceiling
for RTGS transactions.

Real Time Gross Settlement (RTGS)
• NEFT is an electronic fund transfer system that
operates on a Deferred Net Settlement (DNS)
basis which settles transactions in batches.
• In DNS, the settlement takes place with all
transactions received till the particular cut-off
time.
• These transactions are netted (payable and
receivables) in NEFT whereas in RTGS the
transactions are settled individually.
• Any transaction initiated after a designated settlement
time would have to wait till the next designated
settlement time Contrary to this, in the RTGS
transactions are processed continuously throughout the
RTGS business hours.

Speed Clearing
• Speed Clearing refers to collection of outstation
cheques (a cheque drawn on non-local bank
branch) through the local clearing.
• It facilitates collection of cheques drawn on
outstation core-banking-enabled branches of
banks, if they have a net-worked branch locally.
• The collection of outstation cheques, till now, required
movement of cheques from the Presentation centre (city
where the cheque is presented) to Drawee centre (city
where the cheque is payable) which increases the
realisation time for cheques. Speed Clearing aims to
reduce the time taken for realisation of outstation
cheques.

Speed Clearing
• A person who has an outstation cheque with him
deposits it with his bank branch.
• This bank branch is called the Presenting
branch.
• The cheque is sent for collection to the city
where it is payable / drawn called Destination
centre or Drawee centre.
• The branch providing the collection service at
the Destination centre is called the Collecting
branch.
• On receipt of the cheque, the Collecting branch
presents it in local clearing to the Drawee
branch or the Destination branch.

Speed Clearing
• Once the cheque is paid the Collecting branch remits the
proceeds to the Presenting branch.
• On receipt of realisation advice of the cheque from the
Collecting branch, the customer’s account is
credited. This, in short, is the process of Collection.
• Banks have networked their branches by implementing
Core Banking Solutions (CBS). In CBS environment,
cheques can be paid at any location obviating the need
for their physical movement to the Drawee branch. The
concept of Speed Clearing combines the advantages of
MICR clearing with that of CBS.
• Cheques drawn on outstation CBS branches of a Drawee
bank can be processed in the Local Clearing under the
Speed Clearing arrangement if the Drawee bank has a
branch presence at the local centre.

Cheque Truncation System
• Truncation is the process of stopping the flow of the
physical cheque issued by a drawer at some point with
the presenting bank en-route to the drawee bank
branch.
• In its place an electronic image of the cheque is
transmitted to the drawee branch by the clearing house,
along with relevant information like data on the MICR
band, date of presentation, presenting bank, etc.
• Cheque truncation thus obviates the need to move the
physical instruments across branches, other than in
exceptional circumstances for clearing purposes.
• This effectively eliminates the associated cost of
movement of the physical cheques, reduces the time
required for their collection and brings elegance to the
entire activity of cheque processing.

Cheque Truncation System
• The Reserve Bank has implemented CTS in the National
Capital Region (NCR), New Delhi and Chennai with effect
from February 1, 2008 and September 24, 2011.
• After migration of the entire cheque volume from MICR
system to CTS, , the traditional MICR-based cheque
processing has been discontinued in these two locations.
• Grid based CTS clearing has since been started in
Chennai by including a few banks from Coimbatore and
Bengaluru with effect from March 2012.
• It has also been envisaged to bring all the bank branches
in the states of Tamilnadu, Kerala, Karnataka, Andhra
Pradesh and the Union Territory of Puducherry under
Chennai Grid in a phased manner.

• National Payments Corporation of India (NPCI) was
incorporated in December 2008 and the Certificate of
Commencement of Business was issued in April 2009.
• It has been incorporated as a Section 25 company under
Companies Act and is aimed to operate for the benefit of
all the member banks and their customers.
• The authorized capital has been pegged at Rs. 300 crore
and paid up capital is Rs. 60 crore.
• Presently, there are ten core promoter banks ( State
Bank of India, Punjab National Bank, Canara Bank, Bank
of Baroda, Union bank of India, Bank of India, ICICI Bank,
HDFC Bank, Citibank and HSBC).
• The Board constitutes of Shri N. R. Narayana Murthy
among others.

• The Board for Regulation and Supervision of Payment and
Settlement Systems (BPSS) at its meeting held on
September 24,2009 has approved in-principle to issue
authorisation to NPCI for operating various retail
payment systems in the country and granted
Certificate of Authorisation for operation of National
Financial Switch (NFS) ATM Network with effect from
October 15, 2009.
• NPCI has deputed its officials to IDRBT Hyderabad and
NPCI has taken over NFS operations from December
14, 2009.
• NPCI would function as a hub in all electronic retail
payment systems which is ever growing in terms of
varieties of products, delivery channels, number of
service providers and diverse Technology solutions.

• NPCI has a mandate to create a domestic card scheme.
The Brand name finalised for the same is RuPay.
• This scheme would be similar to domestic card schemes
one of which is China UnionPay in China. China UnionPay
(CUP) was a national agenda for a few years by
mandating all domestic transactions to be routed
through the national card system.
• Now China UnionPay cards are accepted in 26 countries.
The card base is 1.8 billion. Bulk of the payments are
made in China by CUP cards.
• Although it may not be possible to mandate such
transaction flow in India, a domestic card is not a distant
dream if all banks work in a co-operative framework.
•

NPCI can reach the scale of China UnionPay by excelling in
service quality and by placing the next generation products and
services.

• Vocalink in UK provides another benchmark for NPCI.
Vocalink facilitates money transfer from any bank
account to any other bank account in UK on a real time
24 x 7 basis. This implies that the experience of RTGS
has been extended to retail payment segment.
• Now that more than 60,000 bank branches in the country
are covered under Core Banking Solution, this is very
much a feasible proposition in India and would be known
as India MoneyLine.
• NPCI would also benchmark against Bankserv in South
Africa and KFTC in South Korea in terms of operational
efficiency, reach across the country and range of
products and service.

Financial Sector Legislative Reforms Commission -

FSLRC
• Chairman – Justice (Retd.) B.N.Srikrishna
• To rewrite and clean up the financial sector laws to bring
them in tune with current requirements.
• Set up in March 2011
• To submit recommendations within 24 months
• The terms of reference of the commission include to
examine the architecture of the legislative and
regulatory system governing the financial sector in
India and to look at the most appropriate means of
oversight over regulators and their autonomy from the
government.

Financial Sector Legislative Reforms Commission -

FSLRC
• There are over 60 Acts and numerous rules and
regulations dealing with the financial sector and many of
them are considered to be archaic.
• Large number of amendments made in in these Acts over
time has increased the ambiguity and complexity of the
system.
• The 11-member commission is to be headed by Retired
Supreme Court Justice BN Srikrishna.
• The then Finance Minister Pranab Mukherjee had in his
Budget for 2010-11 announced plans to set up such a
committee to rewrite and harmonise financial sector
legislations, rules and regulations.

Indian Financial System
Indian Financial System

Formal (organised )
Financial System

Regulators :
MOF, SEBI, RBI, IRDA

(Intermediaries)

Informal (unorganised)
Financial System

Financial Markets

(Intermediaries)

Banking Institutions
(Scheduled Commercial
Banks
And
Scheduled Cooperative
Banks)

Non-Banking Institutions
(Non Banking Finance
Companies
And
Development Finance
Institutions)

Mutual Funds
(Public Sector
And
Private Sector)

Insurance and Housing
Finance Companies

Financial Markets
Financial Markets

Capital Market

Equity Market

Money Market

Debt Market

Primary market

Secondary Market

Derivatives Market

Thank you

IIT Research Park , Chennai
www.trust.ifmr.co.in

Indian financial system

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