Lecture Notes- Banking Law and Operations -Unit 1

UNIT ONE

INTRODUCTION TO BANKING LAW AND OPERATIONS

INTRODUCTION

Banking is a service-oriented activity.  The main functions of a bank are to accept deposits and lend money, in addition to taking care of investments. As per the Banking Regulation Act, 1949, Sec 5(b), banking means: “Accepting deposits for the purpose of lending or investment, deposits of money from the public, repayable on demand or otherwise and withdrawable by cheque, drafts, and orders or any other acceptable mode”.

WHAT IS A BANK?

A bank is a firm or a joint stock company formed for the purpose of dealing in money or credits.

Again, under the United Dominions Trust vs. Kirkwood (1966) which case occurred in the United Kingdom, a bank was defined as an organization that operated with the following objectives:

a)    Accepting deposits from customers

b)   Honouring cheques and other withdrawals from customers.

c)    Maintaining all sorts of accounts and being recognized as a bank in the financial community

THE MAIN FUNCTIONS OF A BANK

Accepting Deposits

During the course of the banking business, a banker has to receive deposits from the public.  Deposits accepted are to be repaid on demand (demand deposits) or as per terms and conditions (term deposits) of business. These deposits can be withdrawn by cheques, drafts or any other acceptable mode (including crediting to the operative accounts).  Customers are entitled to get back their deposits from the bank on demand.  The bank is obliged to pay according to the scheme and terms and conditions agreed upon.

Lending Money

Deposits have to be used for lending or investment.  A bank cannot lend all the money accepted by it as loans and advances.  After keeping a certain portion of the deposits as Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (STL), the bank is allowed to lend as per the directives of the central bank.  This is mainly to retain public confidence and to comply with the directives of the regulator.

Investing Money

Besides lending money, the other main function of a bank is to invest.  While lending or investing, the bank is expected to take precautions and assess the quantum, the security applicable, the repayment capacity and other relevant factors, as well as the need of the person borrowing from the bank.

      Other functions of a bank

These functions, as per Sec 6 of the Banking Regulation Act, 1949, include:

a)    Collection of cheques and bills

b)   Purchase and discounting of bills;

c)    Safe custody facilities (Safe deposit lockers)

d)   Handling foreign exchange transactions

e)    Handling central and state government transactions

f)     Payment of insurance premium, electricity and telephone bills

g)    Acting as trustees, executors, administrators, attorneys on behalf of the customers

h)   Purchase and sale of securities including shares for customers;

i)     Issuing of credit/debt cards, providing ATM facility

WHO IS A BANK CUSTOMER?

“To constitute a customer, there has to be some recognizable course or habit of dealing in the nature of regular banking business.”  Dr. Hart’s definition is that “a customer is one who has an account with a banker or for whom the banker habitually undertakes to act as such.” A bank customer is one who maintains some sort of account with a bank, Great Western Railway Co. vs. London County Bank (1901).

A bank customer is one who has been properly identified and generally introduced to the banker by an existing bank customer (account holder).  Besides a proper introduction, the banker has to be sufficiently convinced that the person who wishes to be a customer is competent to contract and is a genuine person. For this, he has to rely on certain basic documents. Moreover, it is the responsibility of the banker to interact with the proposed customer to satisfy himself and then open the account of such a customer.

The role of the banker is very crucial, since she / he has to handle the banking transactions of the customer. A bank customer may be an individual, business entity, semi-government or a government organization.

The introduction of customer is very important. Following are some of the features of introduction for becoming a bank customer:

1.  An existing customer (account holder who has had dealings with the bank for at least 6 months and these dealings have been satisfactory) may introduce a new customer

2.  This account holder has to recommend and declare “I know Mr. / Mrs. / Ms………….. for so many months / years and I recommend that his / her account may be opened at your bank.” The introducer has to sign this statement and give his account number.

3.  The introducer owes a moral responsibility to the bank and so has to be careful while introducing   a new customer.

4.  The introduction serves as a platform for the bank to come into contact with new customers.

5.  Without a proper introduction, a customer should not be allowed to become a bank customer.

6.  Bankers have to be careful while opening a new account and should not be casual in their approach.

BANK-CUSTOMER RELATIONSHIPS

A relationship between a bank and customer is built depending upon the nature of transactions and on the basis of the services rendered. This relationship varies as it is dependent on the terms and conditions agreed upon and the mutual understanding between the two. This relationship falls under two broad categories, namely: general relationship and special relationship.

General Relationship:

a)    Depository relationship:

Depository is one who receives some valuables and returns the same on demand. Presently, a banker is not bound to return the same coins and currency notes deposited by a customer. Instead, he is required to give the same amount. If the customer insists on the return of the same currency notes, then a banker cannot run his main business of lending. Moreover, if a banker is acting as a depository, he cannot make use of the money to his best advantage. A banker has to make use of the money in deposit with him for earning the maximum profit and the whole income is not returned to the customer.

        

The banker, here, is a privileged debtor. The banker’s indebtedness is not the same as an ordinary commercial debtor who has to seek out the creditor and pay the money. The privileges enjoyed by the banker are:

b)   Trustee Relationship?

Prof. Keeton defines a trust as a relationship which arises whenever a person called trustee is compelled in equity to hold property, whether real or personal by legal or equitable title for the benefit of some person. If a banker is regarded as a trustee, he cannot make use of the money deposited by the customer to his best advantage. He will be bound by the trust deed and he will have to render account for everything he does with the money. For this reason he is not a trustee when he opens an account for a customer. A banker becomes a trustee only under certain circumstances. For instance, when money is deposited for specific purpose, till that purpose is fulfilled, the banker is regarded as a trustee for that money.

c)    Safe Custody (bank as bailee and customer as bailor). Under the safe custody facility, the customer entrusts the bank with his/her valuables, bonds, documents, etc. The bank’s role here is that of trustee and the relationship between the banker and the customer is that of a bailee and bailor.  It is the duty of the banker to return the articles so received intact to the customer. The bank is entitled to charges for rendering this service.

d)   Collection of cheques/instruments (bank as agent and customer as principal). The bank collected the local/outstation cheques/other instruments and clearing cheques on behalf of its customer.  In such cases, the bank plays the role of an agent.  As agent, the bank has to protect the interest of the principal while discharging its duty.  The relationship here is that of an agent and principal.

e)    Safe Deposit Lockers (bank as lessor and customer as lessee). The bank provides locker facility to the customer.  By letting the customer use the bank locker, or in other words, by leasing out the use of the locker, the bank acts as a lessor.  For this facility, the bank can collect the rent in advance.

DUTIES OF A BANKER

Under Joachinson vs. Swiss Bank Corporation (1921) it was established that the duties of a banker were:

a)    To receive customers cash for deposit and cheques for collection.

b)   To repay money on demand in accordance with the customers’ written instructions. However, the bank is justified in refusing to pay a customer’s cheque when presented in the following cases:

When the customer has insufficient funds in the account, or wants to draw against uncleared effects.

When the cheque is defective, i.e. when the amount in words differs from that in figures or when the cheque is incompletely drawn, or has a defect in endorsement, or has an alteration on the face without the customer’s attestation.

When there is a legal bar to pay the cheque such as insufficient mandate, notice of

      death, countermand of payment, garnishee order from court.

c)    Under Prosperity Ltd. Vs Lloyds Bank Ltd. (1923) it was established that the banker must

give a reasonable notice (between 1 to 3 months) to his customer if he wants to close the

customer’s account.

d)   To maintain secrecy regarding a customer’s account and affairs.

         Closure of a Customer’s Account

     The following procedure is to be applied when closing the account of a troublesome customer who has not been operating his account satisfactorily.

a)    The customer must be given a written notice in which it should be stated the last date on which credit/debit will be accepted by the bank and the intended date of closure (usually 1 month if a private individual and 3 months if accompany) depending on the financial affairs. Request the return of unused cheque books and ask him/her to make the necessary arrangement to collect the balance on the account.

b)   After the closure date any cheque received for payment should be returned marked  “Account Closed”

c)    Credits received after the closure should be placed on a suspense account and the

customer invited to collect it.

       DUTIES OF A CUSTOMER TO A BANKER

       The customer owes the bank a duty to take a reasonable care in drawing his cheques, so as to reduce the risk of the banker in making a payment which he has not authorized. If he fails  in that duty the bank is entitled to debit the payment to his account although he did not authorize it.

      In the case of Joachinson vs. Swiss Bank Corporation (1921), it was established that:

i)             A customer must seek out the banker if payment is required.

ii)           Issue cheques if there is sufficient credit balance or unutilized overdraft facility

iii)          Pay charges as agreed

iv)          A customer must exercise reasonable care in drawing cheques so that the bank will neither be misled nor fraud be easily facilitated.