LLM Group 2 Business Law Banking Laws 2015 Question Paper with Solutions

For full marks, cover: the statutory foundation first, because the examiner has set three heads that are all statutory functions and an answer that opens on economics rather than on the Reserve Bank of India Act, 1934, loses the law marks; then each head in turn with its own sections, because three heads means three separate treatments; under currency, the sole right of issue, the Issue Department, the minimum reserve system and the demonetisation power with the decision that tested it; under banker to the Government, the distinction between the obligation and the right, and the management of public debt; under bankers' bank, the cash reserve ratio, the clearing function and the lender of last resort; under bank rate, the definition the Act itself gives, the reason the rate has become a legal reference point rather than an operative one, and what displaced it.

The preamble states the mandate and is worth quoting in an answer because all three heads set by this question fall out of it. It speaks of regulating the issue of bank notes and keeping of reserves with a view to securing monetary stability in India, and generally operating the currency and credit system of the country to its advantage. The Finance Act, 2016, added a further clause, that the primary objective of monetary policy is to maintain price stability while keeping in mind the objective of growth. Currency is the first limb, the reserves of the banking system are the second, and the bank rate is one of the instruments by which the credit system is operated.

The Bank works through a Central Board constituted under section 8. It consists of the Governor, not more than four Deputy Governors, four Directors nominated one each from the four Local Boards, ten Directors nominated by the Central Government and two Government officials. Section 7 preserves a power in the Central Government to give directions in the public interest after consultation with the Governor, a section that has never formally been invoked but was publicly discussed during the disagreement between the Government and the Bank in 2018. The point for an answer is that the Bank's autonomy is statutory and qualified rather than constitutional.

The backing for the note issue rests on the minimum reserve system introduced by the Reserve Bank of India (Amendment) Act, 1957. Before that the Bank ran a proportional reserve system under which forty per cent of the note issue had to be covered by gold and sterling securities. Section 33 now requires the assets of the Issue Department to include gold coin, gold bullion and foreign securities of an aggregate value of not less than two hundred crore rupees, of which the gold component is not to be less than one hundred and fifteen crore rupees, the balance being made up of rupee securities and eligible bills. The change is significant in principle: the note issue is no longer tied to a metallic proportion, and the real discipline on the quantity of money is monetary policy rather than the cover requirement.

Section 26(1) makes every bank note legal tender for the amount expressed in it and guaranteed by the Central Government. Section 26(2) is the provision under which currency is withdrawn from circulation. It permits the Central Government, on the recommendation of the Central Board, by notification in the Gazette, to declare that any series of bank notes of any denomination shall cease to be legal tender, save at such office or agency and to such extent as may be specified.

Nagarathna J. dissented and the dissent is the more useful half of the case for an examination answer. She held that "any series" cannot be read to include the entire denomination, that a proposal originating with the Central Government cannot be dressed up as a recommendation of the Central Board, and that a measure withdrawing eighty six per cent of the currency in circulation by value could only be taken by legislation, since Parliament is the forum in which such a measure must be debated. She declined to grant relief because the notes had long since been exchanged, so the dissent is declaratory. It matters because it identifies the constitutional limit on an executive currency power and because it treats the Central Board's independent recommendation as a jurisdictional fact rather than a formality.

Currency regulation has since acquired a digital limb. The Finance Act, 2022, amended the definition of "bank note" in the Reserve Bank of India Act to include a bank note issued in digital form, which read with section 22 is what allows the Bank to issue central bank digital currency. The wholesale pilot of the digital rupee began on 1 November 2022 and the retail pilot on 1 December 2022. The legislative technique is worth noticing: rather than create a new instrument, Parliament extended the definition of the old one, so the digital rupee is legal tender on exactly the same footing as a printed note.

Three practical consequences follow and each is worth a sentence. First, the Bank manages the public debt of the Union and of the States, which means it conducts the auctions of dated securities and treasury bills, maintains the ownership records and services the interest. Secondly, it provides Ways and Means Advances, temporary accommodation to bridge the mismatch between receipts and payments, repayable within three months, which are limited in amount by agreement and are not a means of financing the deficit. Thirdly, since the Fiscal Responsibility and Budget Management Act, 2003, the Bank has been prohibited from subscribing to primary issues of Central Government securities, which ended the automatic monetisation of the deficit and is the single most important structural reform in this relationship.

The companion requirement, the statutory liquidity ratio, sits not in the Reserve Bank of India Act but in section 24 of the Banking Regulation Act, 1949, and requires every banking company to maintain in cash, gold or unencumbered approved securities a stated percentage of its demand and time liabilities, subject to a statutory ceiling of forty per cent. The two ratios do different work: the cash reserve ratio drains liquidity to the central bank, while the statutory liquidity ratio compels the banks to hold safe assets and so protects depositors as well as funding the Government. At the policy of August 2026 the cash reserve ratio stands at three per cent and the statutory liquidity ratio at eighteen per cent.

(c) Bank rate

Bank rate is defined by section 49 of the Reserve Bank of India Act as the standard rate at which the Bank is prepared to buy or rediscount bills of exchange or other commercial paper eligible for purchase under the Act. The section requires the Bank to make the rate public. Historically it was the pivot of monetary policy: raising it made refinance from the central bank dearer, which was passed on in lending rates and contracted credit, and lowering it did the reverse.

Its operative role has been displaced, and an answer that presents the bank rate as the working instrument of Indian monetary policy is out of date by many years. Since the liquidity adjustment facility was introduced the working rate has been the repo rate, the rate at which the Bank lends overnight to banks against Government securities. Since the realignment of February 2012 the bank rate has been kept equal to the marginal standing facility rate, which is itself fixed at a margin above the repo rate, so the bank rate now moves automatically with the repo rate and carries no independent signal.

Section 45ZB constitutes the Monetary Policy Committee of six members: the Governor as ex officio chairperson, the Deputy Governor in charge of monetary policy, an officer of the Bank nominated by the Central Board, and three members appointed by the Central Government. Decisions are by majority and the Governor has a casting vote in the event of a tie. The Committee must meet at least four times a year, and section 45ZN makes a failure to maintain the target for three consecutive quarters a failure that obliges the Bank to report to the Central Government with the reasons and the remedial action proposed.

The instruments the Committee actually uses are worth naming. The repo rate is the policy rate; the standing deposit facility, introduced in April 2022, is the floor of the corridor and absorbs liquidity without collateral; the marginal standing facility is the ceiling; and open market operations, the cash reserve ratio and the statutory liquidity ratio are the quantitative instruments. At the meeting of 5 August 2026 the Committee kept the repo rate at 5.25 per cent with a neutral stance. The legal significance of the 2016 framework is that monetary policy ceased to be the personal responsibility of the Governor and became a statutory committee decision against a statutory target, which is a substantial change in the constitutional position of the central bank.

The consequence is the whole of Part III. Because the discrimination is justified, the High Court may be bound rather than left with a discretion, the Reserve Bank rather than a creditor may hold the initiative, and the Bank's own opinion on solvency may be made the operative fact. Every feature of the winding up code that looks harsh beside ordinary company law rests on this decision.

Two later decisions mark the outer edge of the Bank's powers and both should be given. In Reserve Bank of India v. Peerless General Finance and Investment Co. Ltd., (1987) 1 SCC 424, a residuary non banking company ran a savings scheme under which a subscriber who defaulted forfeited most of what he had paid, and the Bank issued directions regulating such schemes. The Supreme Court upheld the directions, holding them within the wide depositor protecting power in Chapter III B, so the Bank's reach extends to institutions that are not banks at all.

Conclusion. The three heads set by this question are not three separate activities but three faces of one statutory mandate. The Reserve Bank regulates currency because section 22 gives it the monopoly of note issue and section 33 tells it what must stand behind the notes; it is banker to the Government because sections 20 and 21 impose a duty and confer a corresponding right, and banker to the banks because section 42 compels every scheduled bank to keep its reserves with it and sections 17 and 18 make it the lender of last resort; and it fixes the bank rate under section 49 because the price of central bank money is how the credit system is operated to the country's advantage, which is what the preamble requires of it.

For full marks, cover: the statutory definition in section 5(b) of the Banking Regulation Act, 1949, and then the three elements that make it up, because the whole of the first limb turns on the words "deposits of money from the public, repayable on demand or otherwise, and withdrawable by cheque, draft, order or otherwise"; the case law that decides what is and is not banking; then deposits and lending as the two sides of one balance sheet, with the legal character of each; then licensing under section 22, the grounds on which a licence may be refused and cancelled, and the appeal; and finally the acquisition power in sections 36AE to 36AJ, which is a different thing from amalgamation and reconstruction and must not be confused with them.

The requirement that deposits be withdrawable by cheque or order is what has historically separated banks from non banking financial companies. A non banking financial company may lend, may invest and may take deposits, and is regulated by the Reserve Bank under Chapter III B of the Reserve Bank of India Act, 1934, but it may not offer accounts operable by cheque and it is not part of the payment and settlement system in the way a bank is. That is why the licensing regime and the acquisition regime in the Banking Regulation Act apply to banks and not to them.

Section 6 of the Banking Regulation Act then lists the other forms of business a banking company may engage in, and it is a long list: discounting bills, granting and issuing letters of credit, buying and selling foreign exchange, providing safe deposit vaults, acting as an agent, underwriting, and so on. Section 6(1)(o) permits any other form of business which the Central Government may by notification specify as lawful, and section 6(2) prohibits a banking company from engaging in any form of business other than those referred to. Section 8 separately prohibits trading, that is buying, selling or bartering goods, except in connection with the realisation of security. The scheme is one of enumerated powers: a bank may do what the Act allows and nothing else.

Deposits are of several kinds and the classification carries legal consequences. A demand deposit, whether a current account or a savings account, is repayable on demand. A time or fixed deposit is repayable at the end of an agreed period, and the relationship until then is still debtor and creditor but the debt is not presently payable, which is why a bank may lawfully refuse premature withdrawal except on its own terms. Recurring deposits are time deposits paid in instalments. The distinction feeds directly into the calculation of net demand and time liabilities on which the cash reserve ratio and the statutory liquidity ratio are computed.

The Banking Laws (Amendment) Act, 2025, has altered the law of deposits in one practical respect that should be mentioned in any current answer. With effect from 1 November 2025 a depositor may nominate up to four persons in respect of a deposit account or a locker, either simultaneously, specifying the percentage share of each so that the shares total one hundred, or successively, so that a nominee lower in the order takes only on the death of the one above. Before this the law permitted a single nominee. The change is procedural rather than proprietary: a nominee still receives as a trustee for those entitled under succession law and does not take beneficially, but it removes a common cause of delay in settling claims.

Lending: the legal character

Lending is the other side of the same balance sheet, and its legal character is the mirror of the deposit. When a bank lends, the relationship reverses: the bank is creditor and the customer is debtor. Every advance is a contract governed by the Indian Contract Act, 1872, and where security is taken, by the Transfer of Property Act, 1882, in the case of mortgages, by the Indian Contract Act in the case of pledge, indemnity and guarantee, and by the Sale of Goods Act, 1930, in the case of hypothecation of movables.

The regulatory constraints on lending are as much a part of the function as the contract. Section 20 of the Banking Regulation Act prohibits a banking company from granting loans on the security of its own shares, and from granting loans to its directors or to firms and companies in which a director is interested, a prohibition aimed squarely at connected lending. Section 21 empowers the Reserve Bank to give directions on advances, which is the basis of the whole apparatus of directed and priority sector lending. Section 21A, inserted in 1984, provides that a transaction between a banking company and its debtor shall not be reopened by any court on the ground that the rate of interest is excessive, which excludes the usury legislation of the States from bank lending.

The Banking Laws (Amendment) Act, 2025, also raised the threshold of "substantial interest" in section 5 of the Banking Regulation Act from five lakh rupees to two crore rupees, the first revision since 1968. The definition matters because it is the trigger for the connected lending prohibitions in section 20 and for various disclosure obligations, and a threshold fixed in 1968 had come to catch shareholdings of no economic significance. The amendment is a good illustration of a point worth making in a general answer: much of the Banking Regulation Act's machinery is quantitative, and quantitative machinery decays unless it is revised.

Section 22(3A) adds further conditions for a company incorporated outside India, including that the carrying on of banking business by it in India will be in the public interest and that the law of its own country does not discriminate against Indian banks.

Two features of that list are worth commenting on. First, every condition is directed to the protection of depositors, which confirms that the licence is a depositor protection device and not a commercial franchise. Secondly, the last condition, that the grant should not be prejudicial to the consolidation of the banking system, gives the Bank an explicitly structural discretion, which is what allows it to run on tap licensing, to license differentiated banks such as small finance banks and payments banks, and to refuse a licence for reasons that have nothing to do with the applicant's own soundness.

The Supreme Court held that the rule of audi alteram partem must be read into the Directions, because classification entails serious civil consequences, and that the borrower must be given notice, the material relied on, and an opportunity to represent, followed by a reasoned order. The case is the best modern illustration of the proposition that regulatory action in banking which affects a person's rights must be procedurally fair even where the rule making authority has not said so.

The power to acquire undertakings: sections 36AE to 36AJ

Sections 36AE to 36AJ confer on the Central Government a power to acquire the undertaking of a banking company, and it must be kept separate from the very different powers of amalgamation and reconstruction. The distinction is that acquisition transfers the undertaking to the Government or to a company owned by it and pays compensation, whereas an amalgamation under section 45 transfers it to another bank under a scheme sanctioned by the Reserve Bank.

The constitutional background is the bank nationalisation litigation, and an answer is much stronger for using it. In Rustom Cavasjee Cooper v. Union of India, (1970) 1 SCC 248, the Supreme Court struck down the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1969, by which fourteen major banks had been nationalised.

The Court held that the Act was discriminatory in that it prohibited the named banks from carrying on banking business while permitting other banks and even foreign banks to do so, and that the compensation provisions were illusory because they specified the components to be valued in a manner that excluded significant assets and adopted principles that were irrelevant to the determination of true value. The decision is also the source of the "effect test", the holding that the impact of State action on fundamental rights is to be judged by its direct operation and not by the object the legislature declared, which overruled the compartmentalisation of the freedoms accepted in A.K. Gopalan v. State of Madras, AIR 1950 SC 27.

The case law behind licensing and acquisition

Why a licence may be refused on grounds that would be intolerable in any other trade is answered by Joseph Kuruvilla Vellukunnel v. Reserve Bank of India, AIR 1962 SC 1371, decided on 7 March 1962. The Palai Central Bank Ltd., the largest bank in Kerala with twenty five branches, was wound up on the Reserve Bank's opinion that it could not pay its depositors in full. A director challenged sections 38 and 39 of the Banking Companies Act, 1949, under Article 14 as denying banks the protections other companies enjoy.

The Supreme Court upheld the sections, holding that banks are a class apart because they trade on money taken from the public, so a separate and stricter procedure is a permissible classification. The consequence runs straight through section 22: if a bank may be wound up on the regulator's opinion, it follows that it may be refused entry on the regulator's satisfaction, and the conditions in section 22(3) are drafted in exactly those terms.

Conclusion. The first limb of this question is answered by section 5(b) and the second by sections 22 and 36AE, but the two limbs are connected and the connection is the depositor. Banking is defined by reference to deposits taken from the public for lending or investment and withdrawable by cheque, and because those deposits are, on the authority of Foley v. Hill, a debt and not a trust, the depositor is an unsecured creditor of an institution that lends his money to strangers. Everything else in the Banking Regulation Act follows from that vulnerability.

Licensing under section 22 is the first line of protection, and every one of its conditions is expressed in terms of the ability to pay depositors in full and the conduct of the company's affairs. The acquisition power in sections 36AE to 36AJ is the last, a compulsory transfer of the undertaking when directions have failed and a moratorium would not be enough, hedged with a report from the Reserve Bank, a hearing, a scheme, compensation on statutory principles and a Tribunal to fix the amount, all of which the bank nationalisation case in Rustom Cavasjee Cooper shows to be constitutionally necessary rather than merely prudent.

For full marks, cover: who is a customer, because the whole of the second limb depends on it; the general relationship as debtor and creditor and the two cases that establish it; the special relationships that overlay it, each with the different legal consequence it carries; the duties on each side, with the duty of secrecy set out through its four exceptions; then section 131 of the Negotiable Instruments Act, 1881, taken condition by condition, since the examiner wants the elements and not a paraphrase; and finally termination, arranged as voluntary, operation of law and act of a third party, which is the arrangement that shows the difference between an account that is closed and a mandate that is merely suspended.

The modern gloss is that there must also be a banking relationship, not merely any relationship. Buying a bank draft over the counter for cash does not make the purchaser a customer, and this remains important because the statutory protection to a collecting banker is expressly confined to collection "for a customer".

The general relationship: debtor and creditor

The foundation is Foley v. Hill, (1848) 2 HLC 28, and no answer on this topic is complete without it. A customer sued his bankers for an account, on the footing that they were his trustees. The House of Lords held that money paid into a bank ceases altogether to be the money of the customer; it is the money of the banker, who is bound to return an equivalent by paying a similar sum to that deposited when called for. The banker is not an agent or a factor or a trustee, but a debtor. Lord Cottenham LC said in terms that the money is not held in a fiduciary character.

The special relationships

Over the general debtor and creditor relation there sit particular relationships, each attaching a different body of law, and the examiner is looking for the legal consequence and not the label.

Agency. When a bank collects a cheque, pays a standing instruction, buys or sells securities or remits funds, it acts as the customer's agent, and Chapter X of the Indian Contract Act, 1872, applies. The consequence is that the bank owes the duties of an agent, must account, and must exercise reasonable skill and care. It is also the reason the collecting banker needs a statutory protection at all: an agent who receives money for a principal with no title converts the true owner's property.

Bailment. Where articles are deposited for safe custody the bank is a bailee under sections 148 and 151 of the Contract Act and must take the care of a prudent man of his own goods of the same description. The consequence is that liability turns on negligence and the burden is effectively on the bailee to explain the loss.

Pledgee, mortgagee and hypothecatee, where security has been taken, in which case the bank is a secured creditor and the Transfer of Property Act, 1882, or the Contract Act, as the case may be, governs.

Duties of the banker

The primary duty is to honour the customer's cheques, and section 31 of the Negotiable Instruments Act puts it in statutory form. The drawee of a cheque having sufficient funds of the drawer in his hands, properly applicable to the payment of the cheque, must pay it when duly required, and in default must compensate the drawer for any loss or damage caused by the default. Wrongful dishonour therefore sounds in damages without proof of special damage where the customer is a trader, on the principle in Marzetti v. Williams, (1830) 1 B & Ad 415, and Rolin v. Steward, (1854) 14 CB 595, where the smaller the amount of the cheque the greater the injury to credit is treated as a fair inference.

The constitutional limit on the first exception was drawn in District Registrar and Collector, Hyderabad v. Canara Bank, (2005) 1 SCC 496. A State amendment to the Indian Stamp Act, 1899, empowered any officer authorised by the Collector to enter a bank's premises, inspect and seize documents to detect stamp duty evasion. The Supreme Court struck the provision down.

It held that a customer's documents do not cease to be private merely because they are in the custody of the bank, that the customer retains an interest in them, and that a power of search and seizure without any safeguard, exercisable by an unspecified officer without reasons recorded, was an unreasonable invasion of privacy. The case anticipates Justice K.S. Puttaswamy (Retd.) v. Union of India, (2017) 10 SCC 1, and it is now reinforced by the Digital Personal Data Protection Act, 2023, which puts bank held personal data on a statutory footing.

Other duties include the duty to honour standing instructions, the duty to render an account, the duty of reasonable care in collecting and paying, and the duty not to close an account without reasonable notice, which comes from Joachimson and from Prosperity Ltd. v. Lloyds Bank Ltd., (1923) 39 TLR 372, where one month's notice was held insufficient to a company that had already advertised the account for a national subscription campaign.

Set off is a distinct right and must not be confused with the lien. It is the right to combine two accounts of the same customer in the same right and to strike a single balance, and it arises where the debts are mutual, due and certain. It does not apply between an account held by a person in his own right and one held as trustee, nor to a fixed deposit before maturity without agreement. The right of appropriation is a third and separate right, governed by sections 59 to 61 of the Contract Act and, in a running account, by the rule in Devaynes v. Noble, (1816) 35 ER 781, generally called Clayton's case, under which the first item on the debit side is discharged by the first item on the credit side.

The protection of the collecting banker: section 131

Section 131 provides that a banker who has in good faith and without negligence received payment for a customer of a cheque crossed generally or specially to himself shall not, in case the title to the cheque proves defective, incur any liability to the true owner of the cheque by reason only of having received such payment. Section 131A applies the same protection to drafts. The protection exists because a collecting banker acting as agent would otherwise be liable in conversion to the true owner even though it took no benefit and had no notice, which would make collection commercially impossible.

Thirdly, the cheque must be crossed, generally or specially to the collecting banker itself, before it reaches the banker. An uncrossed cheque attracts no protection under this section, and a banker cannot manufacture the protection by crossing the cheque itself after receipt.

Fourthly, the banker must have acted as an agent for collection and not as a holder in due course in its own right. Where the bank has given value, by allowing the customer to draw against the cheque before clearance, it may become a holder for value, and its position is then governed by the law of holders and not by section 131. The two capacities are alternatives and a bank often pleads them in the alternative.

Explanation II, inserted by the Negotiable Instruments (Amendment and Miscellaneous Provisions) Act, 2002, with effect from 6 February 2003, adapts the section to cheque truncation. It imposes on a banker who receives payment on an electronic image of a truncated cheque a duty to verify the prima facie genuineness of the cheque and any fraud, forgery or tampering apparent on the face of the instrument that can be verified visually. This is the provision that reconciles a nineteenth century protection with an electronic clearing system, and it is worth noting that the duty is confined to what is apparent on the face, because the physical instrument no longer reaches the collecting bank.

By act of the parties. The customer may close the account at any time, and the bank must comply. The bank may close an account in credit only after reasonable notice, on the authority of Joachimson and Prosperity Ltd., and what is reasonable depends on the use to which the account is being put. Where the account is overdrawn the bank may demand repayment and combine accounts, but even then the courts require the customer to be given a reasonable opportunity to make alternative arrangements before cheques are returned.

By operation of law. The death of the customer determines the bank's authority to pay, because the authority is a mandate and a mandate ends with the death of the principal under section 201 of the Contract Act; the balance then goes to the legal representatives, subject to the nomination made under section 45ZA of the Banking Regulation Act. Insanity, on notice, has the same effect. Insolvency vests the estate in the assignee or, for a company, in the liquidator. The winding up of a corporate customer determines the mandate on the appointment of a liquidator. A change in the constitution of a firm or company terminates the account as originally constituted, and the rule in Clayton's case operates on the running account from that date, which is the practical reason a bank rules off and opens a new account when a partner dies or retires.

Conclusion. The relationship is one contract with several legal characters, and the examiner is testing whether a candidate can tell which character governs which dispute. At its base it is debtor and creditor, on the authority of Foley v. Hill, qualified by Joachimson so that the debt is payable only on demand at the branch, and that base explains why a depositor ranks as an unsecured creditor and why deposit insurance and the licensing regime exist at all. Layered on it are agency, bailment, the locker relationship that Amitabha Dasgupta refused to treat as a bare licence, and, where money is paid for a purpose, trust.

Section 131 exists because the agency character would otherwise ruin the collecting bank, and its four conditions, good faith and absence of negligence, collection for a customer, a crossing already on the instrument, and collection as agent rather than as holder for value, are what a candidate must be able to state and apply. Explanation II shows the section being kept alive in an age of truncated cheques by confining the duty to what is visually verifiable. Termination, finally, repays being arranged as voluntary closure, operation of law and third party intervention, because only the first actually ends the relationship: death, insolvency, garnishee and attachment suspend or redirect the mandate while leaving the debt precisely where Foley v. Hill put it, on the bank.

Why a special code

A banking company is a company, but it is not wound up as an ordinary company is. Part III of the Banking Regulation Act, 1949, headed "Suspension of business and winding up of banking companies", displaces the general law in the respects it covers, and section 38(1) says so expressly by opening with a non obstante clause directed at the compromise, arrangement and winding up provisions of the Companies Act. The reason is that a bank's creditors are its depositors, they are numerous, individually small and unable to protect themselves, and the failure of one bank is capable of causing the failure of others.

The point most often missed is that the Insolvency and Bankruptcy Code, 2016, does not apply to banks. The Code applies to corporate persons, but a "financial service provider" is excluded from Part II by the definition in section 3(7) read with section 3(17). Section 227 permits the Central Government, in consultation with the financial sector regulators, to notify categories of financial service providers for insolvency and liquidation proceedings, and that power has been used for non banking financial companies and housing finance companies, under rules of 2019 first applied to Dewan Housing Finance Corporation.

Section 37(2) is the real control. No such application is maintainable unless it is accompanied by a report of the Reserve Bank indicating that in the Bank's opinion the company will be able to pay its debts if the application is granted. The proviso permits the Court to grant relief for sufficient reasons without the report, but it must then call for one and may rescind its order on receiving it. The section therefore distinguishes illiquidity from insolvency: a moratorium is for a bank that is temporarily unable to pay, and the Reserve Bank's opinion on which of the two it is, is effectively decisive.

Winding up by the High Court: section 38

Section 38(1) is mandatory in form. The High Court "shall" order the winding up of a banking company (a) if the banking company is unable to pay its debts, or (b) if an application for its winding up has been made by the Reserve Bank under section 37 or section 38. There is no discretion to refuse once either ground is established, which is a marked departure from the just and equitable jurisdiction of ordinary company law.

Section 38(2) obliges the Reserve Bank to apply where it is directed to do so by an order under section 35(4)(b), that is following an inspection.

The section also defines inability to pay debts for banking purposes. A banking company is deemed unable to pay its debts if it has refused to meet any lawful demand made at any of its offices or branches within two working days, where the demand is made at a place where there is an office of the Reserve Bank, and within five working days in any other case, and the Reserve Bank certifies in writing that the company is unable to pay its debts; or if the Reserve Bank so certifies of its own motion. The certificate is therefore the operative document, and the ordinary company law route of a statutory demand followed by a presumption does not apply.

The liquidation: sections 39 to 43A

Section 39 provides that where a winding up order is made, the Reserve Bank, the State Bank of India or any other bank notified by the Central Government, or an individual, shall be appointed the official liquidator. Putting the regulator in charge of the liquidation is unusual and deliberate: the body with the information and the expertise conducts the realisation.

Two hundred and fifty rupees was fixed by the Banking Companies (Second Amendment) Act, 1960, and has never been revised. In 1960 it was a meaningful sum; today it is a nullity. The observation to make is not merely that the figure is absurd but that its obsolescence explains the architecture of modern depositor protection: because the statutory preference is worthless, the protection of the small depositor has had to be moved outside the Act altogether, into deposit insurance.

The cover under the Deposit Insurance and Credit Guarantee Corporation Act, 1961, was raised from one lakh to five lakh rupees per depositor per bank with effect from 4 February 2020, and the amending Act of 2021, in force from 1 September 2021, inserted section 18A requiring interim payment of the insured amount within ninety days of a bank being placed under all inclusive directions. That reform was a direct answer to the Punjab and Maharashtra Co-operative Bank failure of September 2019.

Sub-section (4) is the operative power. If the Reserve Bank is satisfied that it is necessary in the public interest, or in the interests of the depositors, or to secure the proper management of the banking company, or in the interests of the banking system as a whole, it may prepare a scheme for the reconstruction of the company or for its amalgamation with another banking institution. Sub-section (5) lists what the scheme may provide for, including the constitution of the transferee, the transfer of assets and liabilities, the rights of members and creditors, the continuance of employees and the reduction of the interest or rights of members and depositors to the extent necessary. Sub-section (7) requires the scheme to be sanctioned by the Central Government, and the sanctioned scheme is binding on everyone.

The Banking Regulation (Amendment) Act, 2020, made two changes to this section that a current answer must state. It inserted in sub-section (4) the words "or at any other time", so that the Reserve Bank may now prepare a scheme of reconstruction or amalgamation without first obtaining an order of moratorium. And it applied the Act to co-operative banks. The reason for the first change is that a moratorium freezes depositors out, so the earlier sequence forced the regulator to injure the depositors it was trying to protect before it could rescue them.

Capital and liquidity, the first ring. Section 11 fixes the minimum paid up capital and reserves, and section 12 regulates the capital structure. Section 17 requires a banking company to transfer to a reserve fund not less than a stated proportion of the profit disclosed in its profit and loss account before any dividend is declared, and section 15 restricts payment of dividend until capitalised expenses are written off. On top of the statute sits the Basel III framework, which the Reserve Bank has implemented as minimum common equity, tier 1 and total capital ratios, a capital conservation buffer, a leverage ratio and the liquidity coverage and net stable funding ratios. The statutory liquidity ratio under section 24 and the cash reserve ratio under section 42 of the Reserve Bank of India Act do the same work from the liability side.

Section 35A is the general power to give directions to banking companies in the public interest, in the interests of banking policy or to prevent the affairs of a company being conducted in a manner detrimental to depositors, and it is the source of the all inclusive directions used at Punjab and Maharashtra Co-operative Bank. The apparatus of income recognition, asset classification and provisioning norms rests on section 35A, as does the Master Direction on frauds considered in State Bank of India v. Rajesh Agarwal, decided on 27 March 2023, where the Supreme Court read the rule of audi alteram partem into it and required notice, disclosure of the material and a reasoned order before an account is classified as fraudulent.

Two further measures belong to the answer because they attack the cause rather than the symptom. The first is recovery: the Recovery of Debts and Bankruptcy Act, 1993, the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, and the Insolvency and Bankruptcy Code, 2016, exist so that banks can realise bad assets before those assets destroy them, and the asset reconstruction company created under the 2002 Act allows a bank to move a distressed portfolio off its balance sheet. The second is consolidation: the merger of weak public sector banks into stronger ones, most extensively in the amalgamations effective 1 April 2020, is a preventive measure carried out under the Banking Companies (Acquisition and Transfer of Undertakings) Acts rather than under section 45, and it treats scale and capital as substitutes for supervision.

The consequence is the whole of Part III. Because the discrimination is justified, the High Court may be bound rather than left with a discretion, the Reserve Bank rather than a creditor may hold the initiative, and the Bank's own opinion on solvency may be made the operative fact. Every feature of the winding up code that looks harsh beside ordinary company law rests on this decision.

The only reported Supreme Court decision testing a scheme under section 45 is Ganesh Bank of Kurundwad Ltd. v. Union of India, (2006) 10 SCC 645, decided on 28 August 2006, and it should be worked out because it shows the section operating at speed. Ganesh Bank of Kurundwad was placed under a moratorium, which was advertised on 7 January 2006. The Federal Bank submitted its proposal the very next day, 8 January 2006, and the Reserve Bank prepared a scheme amalgamating the two.

The bank and its shareholders challenged the scheme, complaining of the haste, of inadequate consultation and of the terms on which their interest was extinguished. The Supreme Court dismissed the challenge and upheld the amalgamation, holding that once a moratorium is imposed the Reserve Bank is under a duty to prepare a scheme of reconstruction or amalgamation under section 45(4), and that such a scheme may properly merge a weak bank into a strong one in the interests of the depositors of the weak one.

The reason is the second limb of the question. Winding up a bank is a failure of everything that precedes it, because liquidation converts a going concern into a pile of discounted assets and the depositors bear the difference. The systematic measures that prevent it are therefore not measures about winding up at all: they are capital and liquidity floors, a governance code that keeps insiders away from the lending decision, inspection and directions under sections 35 and 35A, early intervention under sections 36AA and 36AB and the Prompt Corrective Action framework, and a recovery apparatus that lets a bank clear bad assets before they clear the bank.

Behind all of them stands deposit insurance, which exists precisely because the statutory priority in section 43A is still expressed in two hundred and fifty rupees fixed in 1960, and which the amendments of 2020 and 2021 raised to five lakh rupees and made payable within ninety days.

(a) Privileges of a holder in due course

Section 9 defines a holder in due course as a person who, for consideration, became the possessor of a promissory note, bill of exchange or cheque if payable to bearer, or the payee or indorsee thereof if payable to order, before the amount mentioned in it became payable, and without having sufficient cause to believe that any defect existed in the title of the person from whom he derived his title. Four elements follow: consideration, possession or the character of payee or indorsee, acquisition before maturity, and absence of sufficient cause to believe in a defect of title. The last is not merely honesty; a person who shuts his eyes to an obvious defect has sufficient cause.

Sections 120 to 122 impose estoppels for his benefit. The maker or drawer may not deny the original validity of the instrument; the maker of a note or the acceptor of a bill payable to order may not deny the payee's capacity to endorse; and an endorser may not deny the signature or capacity of any prior party. Section 118(g) completes the picture by presuming that the holder of a negotiable instrument is a holder in due course, throwing the burden on the party alleging otherwise, subject to the proviso that where the instrument was obtained by an offence, fraud or unlawful consideration the burden shifts back to the holder.

The rationale is worth a closing sentence. Negotiability exists so that a commercial instrument can circulate as money does, and it can do that only if a purchaser need not investigate the title of his transferor. The holder in due course is therefore given a better title than his transferor had, which is a deliberate exception to the rule nemo dat quod non habet, and the price of the exception is the strictness of the four conditions in section 9.

Presentment for payment is governed by sections 64 onwards. Section 64 requires promissory notes, bills of exchange and cheques to be presented for payment to the maker, acceptor or drawee by or on behalf of the holder, in default of which the other parties are not liable. Section 65 requires presentment during the usual hours of business, and in the case of a banker, within banking hours. Section 66 fixes maturity as the date of presentment for an instrument payable after date or after sight. Section 68 requires presentment at the proper place where one is specified. Section 74 requires an instrument payable on demand to be presented within a reasonable time after it is received by the holder.

Sections 72 and 73 deal with cheques and the distinction between them is regularly examined. Section 72 requires a cheque to be presented at the bank on which it is drawn before the relation between the drawer and his banker has been altered to the drawer's prejudice, if the drawer is to be charged. Section 73 requires presentment within a reasonable time of delivery if any other person, that is an endorser, is to be charged. The difference reflects the different positions of the two: the drawer is prejudiced only if the delay costs him his funds, whereas an endorser is entitled to prompt presentment as such.

The first was answered by the Information Technology Act, 2000. Section 4 provides that where any law requires information to be in writing, that requirement is satisfied if the information is rendered or made available in an electronic form and accessible so as to be usable for subsequent reference. Section 5 gives legal recognition to electronic signatures where a law requires a signature. Sections 43 and 66 create liability for unauthorised access and computer related offences, and section 43A imposes on a body corporate handling sensitive personal data a liability to pay compensation where negligence in maintaining reasonable security practices causes wrongful loss. That last provision is the direct route by which a customer sues a bank for a data breach.

The second was answered inside the Negotiable Instruments Act itself. The amending Act of 2002, in force from 6 February 2003, rewrote section 6 so that a cheque now includes the electronic image of a truncated cheque and a cheque in the electronic form, and defined both expressions. A truncated cheque is one truncated during the clearing cycle by the clearing house or by a bank, the physical instrument being retained and the image transmitted.

On top of it the Reserve Bank's directions of 6 July 2017 on customer liability in unauthorised electronic banking transactions provide for zero liability where the loss is due to the bank's contributory fraud, negligence or deficiency, or to a third party breach where neither bank nor customer is at fault and the customer notifies within three working days; and limited liability on a sliding scale where notification is delayed. The burden of proving customer liability lies on the bank. The Banker's Books Evidence Act, 1891, was amended to bring printouts and electronic records within "bankers' books", subject to the certificates required by section 2A, without which a computer record is inadmissible.

The evaluation to close on is that automation has shifted the legal question from formality to security. The old law asked whether an instrument was in the right form; the new law asks whether the system was reasonably secure and who should bear the loss when it was not. The Digital Personal Data Protection Act, 2023, continues that shift by putting a bank's handling of customer data on a statutory footing with its own penalties.

The second is failed transactions, where the account is debited and cash is not dispensed; the Reserve Bank's harmonisation directions of September 2019 fix a turnaround time for automatic reversal and require the bank to pay compensation for each day of delay beyond it, without the customer having to complain. The third is deficiency of service, for which the customer may go to the consumer forum under the Consumer Protection Act, 2019, or complain under the Reserve Bank Integrated Ombudsman Scheme, 2021.

Internet and mobile banking raise the same questions with two additions. Authentication is regulated: the Reserve Bank has required additional factor authentication for card not present transactions, which is the reason an Indian online card payment carries a second step that many foreign systems do not. And jurisdiction becomes live, because the customer, the server and the beneficiary may be in different places; section 75 of the Information Technology Act asserts extraterritorial application where the contravention involves a computer resource located in India.

(e) The banker's right to claim over securities and set off

Three distinct rights are commonly run together and the whole value of this note lies in separating them.

The general lien. Section 171 of the Indian Contract Act, 1872, names bankers among those who may, in the absence of a contract to the contrary, retain as security for a general balance of account any goods bailed to them. It is a general lien, so it secures the whole balance and not only the advance on which the goods came in, and it needs no express agreement. It does not extend to goods deposited for a specific purpose inconsistent with retention, nor to articles left in safe custody, nor to securities lodged for a particular transaction, and it is displaced by a contract to the contrary.

Set off. This is the right to combine two or more accounts of the same customer and strike a single balance, and it rests on the mutuality of the debts. The conditions are that the accounts are in the same name and in the same right, that the debts are due and certain, and that no contract or course of dealing excludes it. It does not apply between a personal account and one held as trustee or executor, nor to a future or contingent liability, nor ordinarily to a fixed deposit before maturity unless the deposit was taken as security. Notice is generally required before a bank combines accounts and dishonours cheques on the strength of the combination.

Appropriation. Where a customer owes several debts and pays a sum insufficient to discharge all of them, sections 59 to 61 of the Contract Act decide which debt is discharged: the debtor may appropriate at the time of payment, failing which the creditor may, and failing both the payment is applied in order of time. In a running account the rule in Devaynes v. Noble, (1816) 35 ER 781, always cited as Clayton's case, applies: the first item on the debit side is discharged by the first item on the credit side. The practical importance is in guarantee cases, where a bank that fails to rule off an account on the death or retirement of a surety may find the guaranteed debt extinguished by subsequent credits.

On presentment and payment, the paying banker's protection is only as good as the mandate, and Canara Bank v. Canara Sales Corporation, (1987) 2 SCC 666, shows where it stops. An accountant forged the managing director's signature on many cheques over several years. The Supreme Court held the bank bound to recredit the account: a forged signature is wholly inoperative, so the payment was made without any mandate, and the customer's failure to detect it from the pass book was no defence because he owes the bank no duty to examine his statements.

On automation and the automated teller machine the same principle governs an electronic debit, which is why the Reserve Bank's directions of 6 July 2017 put the burden of proving that a disputed transaction was authorised on the bank and not on the customer.

On the banker's side, automation and the automated teller machine show a body of law that has been adapted by amendment rather than rewritten, section 6 and Explanation II to section 131 of the Negotiable Instruments Act being the clearest instances, with the real rules of loss allocation now made by the Reserve Bank under section 35A of the Banking Regulation Act rather than by Parliament. The banker's lien, set off and appropriation complete the picture from the other end: they are the oldest of the bank's self help remedies, and the modern statutes of 2002 and 2016 continue the same policy of letting a secured creditor realise without first going to court.

For full marks, cover: the indigenous system first and, crucially, the fact that it is not merely history because section 1 of the Negotiable Instruments Act, 1881, expressly saves it; then the arrival of joint stock banking and the presidency banks; the crises that produced regulation, because in this subject every statute is the answer to a failure; the modern classification of banks with the statute that creates each class; and then the legal issues, which should be argued and not listed, the strongest being the boundary of the definition of banking, the dual control of co-operative banks and the regulation of institutions that lend without taking deposits.

The crucial legal point is that the Negotiable Instruments Act, 1881, did not abolish this system. It preserved it. Section 1 provides that nothing in the Act affects any local usage relating to any instrument in an oriental language, with a proviso that such usages may be excluded by words in the body of the instrument indicating an intention that the legal relations of the parties shall be governed by the Act. A hundi is therefore governed by custom unless the parties contract into the statute, which reverses the usual relation between code and usage. The saving is not a dead letter: hundis remain in commercial use, and disputes on them continue to be decided by proof of the relevant mercantile usage.

Elsewhere the story is similar in shape. Deposit banking in Europe grew from the goldsmiths of London, whose receipts for deposited bullion began to circulate and became the ancestor of the bank note, and from the Italian merchant bankers whose bills of exchange solved the problem of transferring value across jurisdictions without moving coin. The Bank of England was founded in 1694 as a lender to the Crown and acquired the note monopoly and the central banking functions only gradually. The lesson common to both traditions is that banking begins as a private mercantile activity and that central banking, note monopoly and regulation are all later impositions.

Crisis and regulation

Every stage of Indian banking regulation is a response to a failure, and saying so gives the answer a spine. The bank failures between 1913 and 1917, in which a large number of banks collapsed for want of capital, reserves and any supervision, produced the first tentative provisions for banking companies in the Indian Companies Act, 1913. The Indian Central Banking Enquiry Committee of 1929 to 1931 recommended a central bank and a special banking law. The first produced the Reserve Bank of India Act, 1934. The second waited until the Banking Companies Act, 1949, which was renamed the Banking Regulation Act, 1949, by the amending Act of 1966.

Liberalisation reversed the direction. The Narasimham Committee reports of 1991 and 1998 recommended prudential norms, the reduction of the statutory pre-emption of bank funds through the cash reserve and statutory liquidity ratios, capital adequacy on Basel lines, autonomy for public sector bank boards and entry for new private banks. The licensing rounds of 1993 and 2001 produced the modern private banks, on tap licensing followed in 2016, and differentiated licences for payments banks and small finance banks were issued from 2015. In the other direction, the amalgamation of public sector banks with effect from 1 April 2020 reduced their number substantially, and the strategic disinvestment of IDBI Bank, approved in 2021, remains incomplete.

The kinds of banks and the statute that creates each

A classification is only worth marks if each class is tied to its enabling law. Commercial banks are banking companies licensed under section 22 of the Banking Regulation Act, and are subdivided into public sector banks constituted under the State Bank of India Act, 1955, and the Banking Companies (Acquisition and Transfer of Undertakings) Acts of 1970 and 1980; private sector banks incorporated under the Companies Act and licensed by the Reserve Bank; and foreign banks operating through branches or wholly owned subsidiaries.

Non banking financial companies stand deliberately outside this scheme. They are regulated by the Reserve Bank under Chapter III B of the Reserve Bank of India Act, 1934, and although they lend, invest and in some cases accept deposits, they may not offer accounts withdrawable by cheque, and section 49A of the Banking Regulation Act prohibits anyone other than a banking company from accepting deposits withdrawable by cheque. That prohibition is the legal boundary between the two, and it is the boundary that the growth of digital finance has put under pressure.

The legal issues

The first is the definition itself. Section 5(b) defines banking by reference to deposits withdrawable by cheque, an instrument of declining importance. Payment now happens through the unified payments interface, cards and mobile wallets, and none of them is a cheque. A prepaid instrument issuer under the Payment and Settlement Systems Act, 2007, performs the payment function of a bank without being one. The result is that a definition written in 1949 is doing regulatory work in a system whose payments no longer pass through the instrument the definition names.

The third is the regulation of lending without deposits. Non banking financial companies, and now digital lending platforms, extend credit funded by borrowing rather than by deposits, which puts them outside the depositor protection rationale but squarely inside the systemic risk one, as the collapse of Infrastructure Leasing and Financial Services in 2018 demonstrated. The Reserve Bank's response has been a scale based regulatory framework for non banking financial companies and, since 2022, directions on digital lending requiring the flow of funds to be direct between the lender and the borrower without pooling by an intermediary. The insolvency of these entities is dealt with under section 227 of the Insolvency and Bankruptcy Code, 2016, and the rules of 2019 made under it, first used for Dewan Housing Finance Corporation.

The Reserve Bank formed the opinion that the bank could not pay its depositors in full and applied for its winding up. A director challenged sections 38 and 39 of the Banking Companies Act, 1949, under Article 14, arguing that banks were denied the protections other companies enjoy. The Supreme Court upheld the sections, holding that banks are a class apart because they trade on public deposits, so a stricter and separate procedure is a permissible classification. The Act of 1949 thereby survived its first constitutional test.

The second is Rustom Cavasjee Cooper v. Union of India, (1970) 1 SCC 248, which is the turning point of the nationalisation stage. The Banking Companies (Acquisition and Transfer of Undertakings) Act, 1969, was struck down because it prohibited the fourteen named banks from carrying on banking business while leaving every other bank, including foreign banks, free to do so, and because the compensation excluded classes of asset such as goodwill and unexpired leases.

Each of those was added in response to a failure, and the pattern is unbroken. The bank failures of 1913 to 1917 produced the first statutory provisions; the Central Banking Enquiry Committee produced the Reserve Bank of India Act, 1934; the post independence failures produced the Banking Companies Act, 1949; the fiscal crisis of 1991 produced the Narasimham reforms; and the collapse of the Punjab and Maharashtra Co-operative Bank produced the Banking Regulation (Amendment) Act, 2020. The legal issues now open are of the same kind. A definition of banking anchored on the cheque, a boundary between banks and non banking financial companies drawn by section 49A, and a resolution regime that still rests on Part III of the Act of 1949 because the Financial Resolution and Deposit Insurance Bill, 2017, was withdrawn, are each a rule written for a system that has since changed shape.

Recovery: the ordinary suit and limitation

The base remedy is a civil suit for the debt, and where the claim rests on a written contract or a negotiable instrument the bank may sue summarily under Order XXXVII of the Code of Civil Procedure, 1908, in which the defendant must obtain leave to defend. Where the debt is secured by a mortgage the bank sues for a preliminary and then a final decree for sale under Order XXXIV.

Limitation defeats more claims than any defence and must be stated with its articles. Under the Limitation Act, 1963, a suit for money lent is governed by Article 19, three years from when the loan is made; money payable for money deposited under an agreement that it shall be payable on demand by Article 22, three years from the demand; a suit to enforce payment of money secured by a mortgage or otherwise charged upon immovable property by Article 62, twelve years from when the money becomes due; a suit for foreclosure by Article 63; and the execution of a decree by Article 136, twelve years.

On adjudication it issues a recovery certificate, which is executed by a Recovery Officer with powers modelled on the Income Tax Act, including attachment and sale, arrest and detention, and the appointment of a receiver. An appeal lies to the Debts Recovery Appellate Tribunal, and the appeal by a borrower is conditional on a deposit of fifty per cent of the amount, which the Appellate Tribunal may for reasons recorded reduce to not less than twenty five per cent. The jurisdiction of civil courts over matters the Tribunal may decide is barred.

The constitutionality of the Act was upheld in Union of India v. Delhi High Court Bar Association, (2002) 4 SCC 275. The Delhi High Court had struck the Act down on the ground that Parliament lacked competence and that the exclusion of the civil court's jurisdiction and the absence of a judicial member of appropriate standing were bad. The Supreme Court reversed, holding that Parliament was competent under Entries 45 and 95 of the Union List, that the creation of a special forum for a class of claims is not discriminatory where the classification has a rational nexus, and that the Tribunal could try the borrower's counter claim, which removed the objection that the borrower was left without a forum. The Court did, however, direct that the qualifications and conditions of service of the presiding officers be brought into line with judicial standards.

The Act was upheld, with one provision struck down, in Mardia Chemicals Ltd. v. Union of India, (2004) 4 SCC 311. The challenge was that the Act permitted a creditor to be judge in its own cause and left the borrower with no meaningful remedy. The Supreme Court upheld the Act as a whole, accepting that the burden of non performing assets justified a special enforcement mechanism, but struck down section 17(2) as it then stood, which required a borrower to deposit seventy five per cent of the claimed amount before his appeal could be entertained, holding the condition onerous, oppressive and illusory as a remedy.

The Court also held that although the section then made no provision for it, the borrower must be permitted to make a representation against the section 13(2) notice and the creditor must give reasons for rejecting it. That direction was enacted by Parliament as section 13(3A), which is a notable instance of a judicial gloss being converted into statute.

The current position on the borrower's right to redeem is Celir LLP v. Bafna Motors (Mumbai) Private Limited, decided on 21 September 2023. Before the amendment of 2016, section 13(8) preserved the right of redemption until the sale or transfer of the secured asset. The amended section confines it to the period before publication of the notice for public auction. The Supreme Court held that the right of redemption is now extinguished on the date of publication of the auction notice, and that a borrower cannot after the auction come forward and tender the amount, because an unrestricted right of redemption would destroy confidence in the auction process. The decision is important for the second limb of this question too, because it means that the borrower's last opportunity now falls very early, which changes the whole timetable of a distressed account.

In Committee of Creditors of Essar Steel India Ltd. v. Satish Kumar Gupta, (2020) 8 SCC 531, the Court held that the commercial wisdom of the committee of creditors in approving a resolution plan is not justiciable on merits, and that there is no principle requiring equal treatment of secured and unsecured or of financial and operational creditors, the plan being required only to meet the statutory minimum. For a bank, the significance is that its recovery in insolvency is determined by its position in the committee and not by a court.

The Code also reaches personal guarantors, who are almost always the promoters. In Lalit Kumar Jain v. Union of India, decided on 21 May 2021, the notification bringing the personal guarantor provisions into force was upheld and it was held that the approval of a resolution plan does not discharge the guarantor, and in Dilip B. Jiwrajka v. Union of India, decided on 9 November 2023, sections 95 to 100 were upheld against a challenge based on the absence of adjudication at the admission stage.

Precautionary measures before sanction

The precautions should be presented as the mirror image of the recovery routes just described, because that is what turns a list into an argument.

Credit information. The Credit Information Companies (Regulation) Act, 2005, obliges banks to furnish and permits them to obtain credit information, and a credit information report is now the first step in appraisal. To it must be added the Reserve Bank's central repository of information on large credits and the wilful defaulter framework issued under section 35A.

Title, valuation and search. For immovable security a bank must obtain a search report and a legal opinion on title, a valuation by an approved valuer, and confirmation that the property is not agricultural land, which section 31 of the Act of 2002 excludes from enforcement. It must search the register of charges maintained under section 77 of the Companies Act, 2013, where the borrower is a company, and must search the Central Registry established under section 20 of the Act of 2002.

Compliance limits. Section 20 of the Banking Regulation Act prohibits advances to directors and to concerns in which they are interested, and prohibits lending against the bank's own shares. The Reserve Bank's large exposures framework caps exposure to a single counterparty and to a group. A sanction in breach of these is not merely irregular; it exposes the officers to action under sections 36AA and 46 and the bank to penalty under section 47A.

Post sanction monitoring, which is a precaution although it comes after sanction. End use verification, periodic inspection of stocks, review of the account, and prompt classification under the income recognition and asset classification norms all determine whether the bank can invoke section 13(2), since the power arises only on classification as a non performing asset. And where fraud is suspected, the Reserve Bank's Master Direction on frauds applies, subject to State Bank of India v. Rajesh Agarwal, decided on 27 March 2023, in which the Supreme Court held that a borrower must be given notice, the material relied on and an opportunity to represent, followed by a reasoned order, before his account is classified as fraudulent.

The second limb follows from the first. Because enforcement is now largely self help, the quality of what the bank did before it lent has become decisive. Registration under section 77 of the Companies Act and in the Central Registry determines priority under sections 26D and 26E; correct stamping determines admissibility; acknowledgements determine limitation; the exclusion of agricultural land under section 31 determines whether the Act of 2002 is available at all; and classification as a non performing asset in accordance with the norms determines when section 13(2) can be invoked. Recovery is therefore not a separate stage that begins on default. It is the cashing in of decisions taken at the moment of sanction, and a bank that treats appraisal, documentation and registration as paperwork discovers on default that it has an unsecured claim and a time barred one.

(a) Functions of the Reserve Bank of India

The functions are best classified into four groups, each with its statutory source.

Traditional central banking functions. The monopoly of note issue under section 22, conducted through a separate Issue Department under section 23 and backed under section 33. Banker to the Government under sections 20, 21 and 21A, which impose a duty on the Bank and confer a corresponding right, and include the management of the public debt. Bankers' bank and custodian of the cash reserves of the banking system under section 42, which requires every scheduled bank to maintain a cash reserve with the Bank. Lender of last resort under section 17(4) and, in emergency and against security it would not ordinarily take, under section 18. Custodian of foreign exchange reserves, exercised together with the Bank's powers under the Foreign Exchange Management Act, 1999.

Promotional and developmental functions. The direction of credit to the priority sector under section 21 of the Banking Regulation Act, the promotion of financial inclusion, the establishment of specialised institutions such as the National Bank for Agriculture and Rural Development in 1982, and the operation of the payment and settlement infrastructure. These have no single statutory source and rest on the general words of the preamble about operating the currency and credit system of the country to its advantage.

(b) Presumptions as to negotiable instruments

Section 118 provides that until the contrary is proved the following presumptions shall be made, and the list should be given clause by clause because that is the answer. Clause (a), of consideration: that every negotiable instrument was made or drawn for consideration, and that every such instrument, when accepted, indorsed, negotiated or transferred, was so for consideration. Clause (b), as to date: that every instrument bearing a date was made or drawn on that date.

The presumptions matter most in prosecutions under section 138. The presumption of consideration in section 118(a), read with the presumption in section 139 that the holder of a cheque received it in discharge of a debt or liability, means that once issuance of the cheque and the signature are admitted or proved, the burden shifts to the accused to raise a probable defence. The standard of that rebuttal is preponderance of probabilities and not proof beyond reasonable doubt, and the accused may discharge it from the complainant's own evidence without entering the box. The combined effect is that section 138 is in form a criminal provision but is worked through a reverse burden that is characteristic of civil recovery.

(c) Smart card and debit card

Neither instrument is a negotiable instrument and the note should begin by saying so. A negotiable instrument under section 13 of the Negotiable Instruments Act, 1881, is a promissory note, bill of exchange or cheque payable to order or bearer. A card is none of these: it contains no unconditional order to pay a sum certain, it is not transferable, and title to it cannot pass by delivery or indorsement. It is a token that authenticates an instruction, and the instruction operates on the underlying banker and customer contract.

The legal issues that arise on cards are three. Liability for unauthorised use, governed by the Reserve Bank's directions of 6 July 2017, which provide for zero liability where the loss arises from the bank's own fraud, negligence or deficiency, or from a third party breach reported within three working days, with limited liability on a sliding scale thereafter, and which place the burden of proving customer liability on the bank. Recovery practices on credit cards, which the Bank has regulated through the Fair Practices Code. And data security, now governed by section 43A of the Information Technology Act, 2000, and by the Digital Personal Data Protection Act, 2023.

(d) Control of the Reserve Bank over non banking companies

The regulation of non banking financial companies is contained in Chapter III B of the Reserve Bank of India Act, 1934, and it is separate from the Banking Regulation Act because such companies are not banks. Section 45-I contains the definitions, including "financial institution", "non banking institution" and "non banking financial company". The dividing line remains section 49A of the Banking Regulation Act, which forbids anyone other than a banking company to accept deposits withdrawable by cheque.

Sections 45J to 45MC give the Bank its operative powers. Section 45J allows it to regulate or prohibit the issue of prospectuses or advertisements soliciting deposits. Section 45JA empowers it to determine policy and give directions on income recognition, accounting standards, provisioning, capital adequacy and deployment of funds. Sections 45K, 45L and 45M require the furnishing of information and returns and give powers of inspection.

Section 45MB empowers the Bank to prohibit a company from accepting deposits and to prohibit the alienation of its assets, and section 45MC empowers it to apply for the winding up of a non banking financial company on stated grounds, including that it is unable to pay its debt or has been prohibited from accepting deposits. Section 45QA empowers the Tribunal, on the application of a depositor, to order repayment of a deposit. Contravention is penalised by sections 58B and 58C.

The Information Technology Act, 2000, supplies form. Section 4 provides that a requirement of writing is satisfied by an electronic record accessible for subsequent reference; section 5 gives legal recognition to electronic signatures. Without these two sections no electronic banking instruction would satisfy a statutory requirement of writing. Sections 43, 43A, 66 and 72A supply the liability and offence provisions, section 43A imposing compensation on a body corporate that is negligent in maintaining reasonable security practices in relation to sensitive personal data.

The Negotiable Instruments Act, 1881, as amended in 2002, supplies the instrument. Section 6 now defines a cheque to include the electronic image of a truncated cheque and a cheque in the electronic form, and Explanation II to section 131 imposes on the collecting banker a duty to verify the prima facie genuineness of a truncated cheque and any fraud, forgery or tampering apparent on its face that can be verified visually. Cheque truncation is what made same day national clearing possible.

Above these sits regulation. The customer liability directions of 6 July 2017 allocate the loss on unauthorised electronic transactions, the harmonisation directions of September 2019 require automatic reversal of failed transactions with compensation for delay, and the Reserve Bank Integrated Ombudsman Scheme, 2021, in force from 12 November 2021, provides a single jurisdiction neutral forum. The Digital Personal Data Protection Act, 2023, adds a general data protection regime on top. The direction of the law is clear and worth stating: as banking has automated, the operative rules have shifted from statute to regulation, and from questions of form to questions of security and loss allocation.

The authorities behind these five notes

The Reserve Bank's regulatory reach was settled in Reserve Bank of India v. Peerless General Finance and Investment Co. Ltd., (1987) 1 SCC 424, and it is the case the fourth note needs. Peerless, a residuary non banking company, ran a savings scheme under which a subscriber who stopped paying forfeited a large part of what he had already paid. The Bank issued directions under Chapter III B regulating such schemes and the company challenged them as beyond power.

On the presumptions, Rangappa v. Sri Mohan, (2010) 11 SCC 441, decided on 7 May 2010, completes the second note. Three judges held that the presumption under section 139 extends to the existence of a legally enforceable debt and not merely to the issue of the cheque, that it is a reverse onus clause enacted to make negotiable instruments credible, and that it is rebutted on the preponderance of probabilities, the accused being entitled to rely on the complainant's own evidence.

And on cards and automation, Canara Bank v. Canara Sales Corporation, (1987) 2 SCC 666, supplies the principle. A forged signature is no mandate, so a bank that pays on one pays with its own money and must recredit, and the customer is under no duty to police his pass book. The Reserve Bank's directions of 6 July 2017 carry that principle into the electronic world by placing the burden of proving authority on the bank.

Conclusion. The five notes divide into two groups and the division is worth naming. The first, third and fifth are about the machinery of modern banking, the central bank's functions, the cards through which retail payment now happens, and the statutes that made automation lawful; and in all three the operative rules are increasingly made by the Reserve Bank under section 35A of the Banking Regulation Act and under the Payment and Settlement Systems Act, 2007, rather than by Parliament.

For full marks, cover: begin with the reason a bank is not allowed to fail in the ordinary way, because that reason governs everything that follows; then compare the three tools the Act provides, winding up, voluntary amalgamation and compulsory reconstruction, and show which one is actually used; then the provisions in outline with the two that carry the most weight, section 38 and section 45; then the record of the last twenty years as evidence of what the law does in practice; and for the second limb, treat prevention as a supervisory cycle running from entry to exit rather than as a list of measures.

(This question is set in identical terms on the other paper in this scan, where it is answered through the statutory machinery in sequence. It is taken here from the other end, through the choice between the three resolution tools and the record of the failures that tested them, so that a candidate sitting either paper has a complete answer.)

Indian law responds to this in three ways. It puts the failing bank outside the general insolvency law altogether: the Insolvency and Bankruptcy Code, 2016, excludes financial service providers from Part II, and although section 227 permits the Central Government to notify categories of financial service providers, it has been used for non banking financial companies and housing finance companies and never for banks. It gives the Reserve Bank, and not the creditors, the initiative. And it prefers rescue to liquidation in every case where rescue is possible.

The three tools, compared

The provisions in outline

Section 37 provides for a moratorium of not more than six months granted by the High Court on the application of a bank temporarily unable to meet its obligations, and section 37(2) makes the application unmaintainable without a report of the Reserve Bank that the bank will be able to pay its debts if relief is granted. The section therefore draws the line between illiquidity, which a moratorium can cure, and insolvency, which it cannot, and it puts the drawing of that line in the hands of the regulator.

Section 43A gives depositors a preference, and the figure exposes the whole scheme. After the general preferential payments, the liquidator must pay each savings bank depositor, and then each other depositor, two hundred and fifty rupees or the balance at his credit, whichever is less, in priority to all other debts, and only then distribute pro rata among general creditors and depositors for the balance. The sum was fixed by the Banking Companies (Second Amendment) Act, 1960, and has never been revised.

The lesson is not that Parliament forgot, but that the protection of the small depositor was deliberately moved out of the Act and into deposit insurance, where it now stands at five lakh rupees per depositor per bank since 4 February 2020, with an obligation of interim payment within ninety days under section 18A of the Deposit Insurance and Credit Guarantee Corporation Act, 1961, inserted by the amending Act of 2021 in force from 1 September 2021.

Section 44 permits voluntary winding up only if the Reserve Bank certifies that the bank can pay its debts in full, and section 44A prescribes the procedure for a voluntary amalgamation: a scheme approved by a majority in number representing two thirds in value of the shareholders of each bank, dissentients entitled to the value of their shares, and sanction by the Reserve Bank.

Yes Bank, March 2020. The moratorium was imposed on 5 March 2020 and the Yes Bank Limited Reconstruction Scheme was notified on 13 March 2020, under which State Bank of India took a controlling stake and other banks subscribed capital. The moratorium was lifted in thirteen days. The episode showed both the strength of section 45, which allowed a systemically significant bank to be recapitalised in under a fortnight, and its weakness, since the moratorium had frozen depositors and the write down of additional tier 1 bonds under the scheme produced litigation of its own.

Lakshmi Vilas Bank, November 2020. Amalgamated with DBS Bank India Limited under a scheme. This was the first significant use of the amendment of 2020, and the transferee was the wholly owned Indian subsidiary of a foreign bank, which is worth noticing because it shows the range of institutions available as a transferee under section 45.

Entry. The licence under section 22 is the first filter, and its conditions are all about the ability to pay depositors in full and the character of the proposed management. Section 11 fixes minimum paid up capital and reserves and section 12 regulates the capital structure. A regulator that licenses badly cannot supervise its way out of the consequence, which is the argument for the Reserve Bank's cautious approach to new bank licences.

Continuing prudential requirements. Capital adequacy under the Basel III framework, the statutory liquidity ratio under section 24 of the Banking Regulation Act and the cash reserve ratio under section 42 of the Reserve Bank of India Act, the reserve fund obligation in section 17, the restriction on dividends in section 15, and the exposure limits set by directions under section 21. These are the standing constraints and they operate without any judgment about a particular bank.

Early intervention. The Prompt Corrective Action framework, revised with effect from 1 January 2022, sets thresholds on capital adequacy, net non performing assets and the leverage ratio, and imposes escalating restrictions as each is breached. Sections 36AA and 36AB allow the removal of managerial persons and the appointment of additional directors, and section 36ACA the supersession of the board. Section 35A supports directions up to and including the all inclusive directions used at Punjab and Maharashtra Co-operative Bank. The point of this group is that it operates while the bank is still solvent, and its absence is what turned earlier failures into liquidations.

Cleaning the balance sheet. The Recovery of Debts and Bankruptcy Act, 1993, the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, and the Insolvency and Bankruptcy Code, 2016, exist so that a bank can convert a bad asset into cash or into somebody else's problem before it consumes the bank's capital, and the asset reconstruction company created by the Act of 2002 exists for the same purpose. Prevention of bank failure is, to a large extent, the law of debt recovery seen from the creditor's side.

The bank and its shareholders challenged the scheme, complaining of the haste, of inadequate consultation and of the terms on which their interest was extinguished. The Supreme Court dismissed the challenge and upheld the amalgamation, holding that once a moratorium is imposed the Reserve Bank is under a duty to prepare a scheme of reconstruction or amalgamation under section 45(4), and that such a scheme may properly merge a weak bank into a strong one in the interests of the depositors of the weak one.

The consequence for a candidate is that the speed which looks like unfairness is the point of the section. A bank under moratorium is a bank whose depositors cannot get their money, so a scheme settled in weeks is protection and not haste, and the shareholders' loss is the price of the depositors' rescue.

Why the winding up alternative is drawn so harshly is answered by Joseph Kuruvilla Vellukunnel v. Reserve Bank of India, AIR 1962 SC 1371, decided on 7 March 1962. The Palai Central Bank Ltd., the largest bank in Kerala with twenty five branches, was wound up on the Reserve Bank's opinion that it could not pay its depositors in full and that its continuance was prejudicial to them. A director attacked sections 38 and 39 of the Banking Companies Act, 1949, under Article 14 for denying banks the safeguards other companies enjoy.

The systematic measures for preventing winding up therefore form a cycle rather than a list, and the cycle is entry control through licensing, standing prudential constraints on capital and liquidity, governance rules aimed at the insider who is the usual cause, information through audit, inspection and asset classification, early intervention through the Prompt Corrective Action framework and sections 36AA to 36ACA, and a recovery apparatus that lets the bank clear bad assets while it still has capital.

Behind all of it stands deposit insurance, which exists because the statutory preference in section 43A is still expressed in the two hundred and fifty rupees of 1960, and which the reforms of 2020 and 2021 raised to five lakh rupees payable within ninety days. That figure, frozen for sixty five years in a section that was once the depositor's main protection, is the best single illustration of how this branch of the law actually develops: the old provision is left standing and the real protection is built somewhere else.

(a) Features of a promissory note and a bill of exchange

Section 4 defines a promissory note as an instrument in writing, not being a bank note or a currency note, containing an unconditional undertaking signed by the maker, to pay a certain sum of money only to, or to the order of, a certain person, or to the bearer of the instrument. Its features follow from the words: it must be in writing; it must contain an undertaking to pay and not a mere acknowledgement of debt; the undertaking must be unconditional; it must be signed by the maker; the sum must be certain and must be money only; and the payee must be certain. There are two parties, the maker and the payee.

Section 5 defines a bill of exchange as an instrument in writing containing an unconditional order, signed by the maker, directing a certain person to pay a certain sum of money only to, or to the order of, a certain person or to the bearer of the instrument. The features are the same with one structural difference: it contains an order rather than a promise, and there are three parties, the drawer who gives the order, the drawee on whom it is drawn, and the payee.

A cheque is a species of bill of exchange, defined by section 6 as a bill drawn on a specified banker and not expressed to be payable otherwise than on demand, and since the amendment of 2002 it includes the electronic image of a truncated cheque and a cheque in the electronic form. The relation between the three should be stated because it is often examined: every cheque is a bill of exchange, but no bill is a cheque unless it is drawn on a banker and payable on demand, and a promissory note is neither.

One practical rule closes the note. Whether a document is a promissory note is a question of construction of the whole instrument and not of the label it bears, and a document that merely acknowledges a debt, or that makes payment conditional on an event, is not a promissory note however it is described. The consequence is not merely academic: an instrument that is a promissory note attracts stamp duty as such, and section 35 of the Indian Stamp Act, 1899, makes an unstamped or insufficiently stamped instrument inadmissible in evidence, so misclassification can destroy the claim.

(b) The banker's right to claim over securities and set off

These are the bank's self help rights, and they are best understood as the lowest rungs of a ladder of remedies that now runs from the counter to the tribunal.

The second rung is set off, the right to combine two accounts of the same customer held in the same right and strike a single balance. It requires mutuality, and the debts must be due and certain, so it does not operate between a personal account and a trust or executorship account, nor against a contingent liability, nor ordinarily against a fixed deposit before maturity unless it was taken as security. Notice is generally required before the bank combines accounts and returns cheques.

The third rung is appropriation, governed by sections 59 to 61 of the Contract Act and, in a running account, by the rule in Devaynes v. Noble, (1816) 35 ER 781, Clayton's case, under which the first item on the debit side is discharged by the first on the credit side. Its practical importance is in guarantees, where a bank that does not rule off the account on the death or retirement of a surety may find the guaranteed debt paid off by subsequent credits.

By source, the Bank's powers come from four statutes. Under the Reserve Bank of India Act, 1934, it has the note issue monopoly in section 22, the relationship with the Government in sections 20 to 21A, the reserve requirement in section 42, lender of last resort powers in sections 17 and 18, the monetary policy framework in Chapter III F, and the regulation of non banking financial companies in Chapter III B. Under the Banking Regulation Act, 1949, it licenses under section 22, controls advances under section 21, inspects under section 35, gives directions under section 35A, removes managerial persons under section 36AA, and prepares schemes of reconstruction or amalgamation under section 45.

Under the Foreign Exchange Management Act, 1999, it regulates capital account transactions and authorises dealers. Under the Payment and Settlement Systems Act, 2007, it authorises and regulates payment systems.

(d) Powers and functions of the Debts Recovery Tribunal

The Tribunal was created by the Recovery of Debts Due to Banks and Financial Institutions Act, 1993, renamed the Recovery of Debts and Bankruptcy Act, 1993, by the Insolvency and Bankruptcy Code, 2016. It followed the Tiwari Committee of 1981 and the first Narasimham Committee, both of which found that ordinary civil litigation was locking up bank funds for a decade or more.

Its jurisdiction is over applications by a bank or financial institution for the recovery of a debt above the prescribed amount, originally ten lakh rupees and raised to twenty lakh rupees by notification in September 2018. The jurisdiction of civil courts over such matters is barred. It also hears applications by a borrower under section 17 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, against measures taken under section 13(4), so it sits both as the bank's forum and as the borrower's.

Its constitutionality was upheld in Union of India v. Delhi High Court Bar Association, (2002) 4 SCC 275, the Supreme Court reversing the High Court and holding that Parliament was competent, that a special forum for a class of claims is a permissible classification, and that the availability of a counter claim answered the objection that the borrower had no forum. The Court nevertheless directed that the qualifications and conditions of service of presiding officers be brought into line with judicial standards, a theme that has run through tribunal jurisprudence ever since.

The candid assessment, which earns marks, is that the Tribunal has not delivered what was expected of it. Case loads have far exceeded capacity, vacancies have been chronic, and the median time to a recovery certificate has been measured in years rather than the six months contemplated. That failure is the direct reason for the Act of 2002, which took enforcement out of the adjudicatory process altogether, and for the Code of 2016, which moved resolution to a creditors' committee. A specialist tribunal was the first answer to delay; when it did not work, the legislature stopped trying to speed up adjudication and removed the adjudication instead.

Section 45 provides for compulsory reconstruction or amalgamation and is the operative provision. The Reserve Bank may apply to the Central Government for a moratorium of up to six months; and during the moratorium, or, since the Banking Regulation (Amendment) Act, 2020, at any other time, it may prepare a scheme if satisfied that it is necessary in the public interest, in the interests of depositors, to secure proper management of the bank, or in the interests of the banking system as a whole. The scheme may deal with the constitution and capital of the transferee, the transfer of assets and liabilities, the rights of members and creditors, the continuance of employees, and the reduction of the interest or rights of members and depositors to the extent necessary. It takes effect on sanction by the Central Government and is binding on all concerned.

The difference between reconstruction and amalgamation is worth stating precisely. In a reconstruction the bank survives as a legal entity and its capital structure is rebuilt, typically by writing down existing capital and inducting new investors, which is what happened to Yes Bank in March 2020. In an amalgamation the bank ceases to exist and its business is transferred to a transferee bank, which is what happened to Global Trust Bank in 2004, to Lakshmi Vilas Bank in November 2020 and to Punjab and Maharashtra Co-operative Bank in January 2022.

The Court held that a contract for interest with rests capitalises the interest, so that principal and accrued interest together form the principal sum adjudged at the date of the suit, but that interest on interest cannot be capitalised as being contrary to public policy, and that penal interest may be charged only once for one period of default and cannot be capitalised at all. It also noted that section 21A of the Banking Regulation Act, 1949, removes the court's power to reopen a bank transaction for excessive interest. The case is the reason bank interest is not simply a matter of contract.

On the Debts Recovery Tribunal, Union of India v. Delhi High Court Bar Association, (2002) 4 SCC 275, should be worked and not merely cited. The High Court had struck down the Recovery of Debts Due to Banks and Financial Institutions Act, 1993, holding Parliament incompetent and the exclusion of the civil courts bad because it left the borrower without a forum. The Supreme Court reversed, holding Parliament competent under the Union List, the classification of bank claims rational, and the borrower's right to file a counter claim before the Tribunal a sufficient answer, while directing that the qualifications and service conditions of presiding officers be brought into line with judicial standards.

The second is the law of the institution, and read together the three notes show one movement. The banker's lien, set off and appropriation are self help remedies of the nineteenth century, strengthened by the characterisation of the lien as an implied pledge and then overtaken by enforcement without a court under the Act of 2002 and by the priority of a registered secured creditor. The Debts Recovery Tribunal was the first attempt to solve delay by specialisation, and its failure to solve it is the reason the later statutes bypassed adjudication altogether.

And sections 44A and 45 show the same preference at the level of the institution itself: a failing bank is reconstructed or amalgamated, not liquidated, because liquidation converts a going concern into a discounted pile of assets and the depositors pay the difference. In each of the three the direction is identical, which is towards keeping the resolution of bank claims out of the ordinary courts.