Chapter-1 Banker, Banking and Customer

Banking has been in existence in one form or the other for centuries. A bank means different things to different people. To a housewife, it is perhaps a place where she can withdraw some cash before going on a shopping spree. To an auto mechanic, it may be a place where he can get a loan to remodel his garage. To a security trader, it is a place where he can maintain a demat account to route  his selling and buying of shares. For others, it is a place where they can deposit money in their various accounts for saving and security purposes. This is precisely why it is not possible to give an exact definition of words such as bank, banker and banking.

According to Johnson’s Dictionary, bank is “a place where money is laid up to be called for occasionally” and banker is the “one that traffics in money, one that keeps or manages the bank”. However, using analogies, such as the ones mentioned above, various textbook writers have given us definitions of bank, banker and banking which are an admixture of fact and law. Let us now try to understand these words more schematically.

1. Banker

Traditionally, a banker is understood as a person who

• accepts or receives money
• keeps a current or recurring account of his customer
• pays cheques drawn on himself, and
• collects cheques for his customers

This definition of banker has evolved more out of usage, i.e., functions of a banker as described by the courts of law both in England and India during the hearing of legal disputes involving banks. Dr. Harbert L. Hert in his Law of Banking defines a banker as “one who in the ordinary course of business, honours cheques drawn upon him by persons from and for whom he receives money on current accounts.” Walter Leaf describes the bank as “a person or corporation which holds itself out to receive from the public deposits payable on demand by cheque.” Horace White aptly describes a bank as “a manufacturer of credit and a machine for facilitating exchanges.” Although these definitions are fairly exhaustive, they do not throw  light on the various other kinds of activities modern banks undertake, such as: 

• collecting bills of exchange, hundis, promissory notes, cheques, and securities  
• transmitting of money, i.e., demand drafts, mail, and telegraphic transfers, EFT
• issuing credit cards/debit cards/ATM cards
• buying and selling of forex
• selling of insurance products, mutual fund units, etc.
• receiving bonds, scrips, or valuables as deposit or for safe custody
• providing safe deposit vaults
• acting as agent for any government or local authority or any other person
• effecting insurance and guarantee 
• underwriting and participating in managing, and carrying out of any issue of loans or  securities made by State, Municipality, Company, Corporation, etc. 

2. Banking

Section 5 (1) (b) of the Banking Regulation Act, 1949 defines banking as:

“Banking means the accepting, for the purpose of lending or investment, of deposits or money from the public repayable on demand or otherwise, and withdrawal by cheque, draft, order or otherwise.”

We can, therefore, safely conclude that borrowing and lending of funds constitute the mainstay of banking.

Section 6 of the same Act also states that a banking company, in addition to the business of banking i.e., as defined under Section 5 (1)(b), may carry on other forms of business, such as collection of cheques, bills, remittance of funds, opening letters of credit, issuing travellers’ cheques, accepting articles for safe custody, etc. In the emerging scenario, parabanking appears to be overtaking the age-old business of mobilization of deposits and lending funds to entrepreneurs.

3. Customer

Strangely, there is no statutory definition of the word ‘customer’. Whatever understanding of the word that we have today is born out of various judicial pronouncements of various courts both in England and India. The word ‘customer’ is obviously derived from the word ‘custom’, which means the habit of resorting to the same place or person to do business. Even Sir John Paget subscribed to the view that to constitute a customer, there must be some recognizable course or habit of dealing in the nature of regular banking business. However, subsequent judicial pronouncements do not uphold this philosophy. In today’s parlance, a customer is understood to be the one, who opens (with the consent of the bank) an account with the bank, either by depositing money or cheque. It is not necessary that his relationship with the banker should be for some length of time. Lord Chorley, in his Gilbert Lectures for 1955, opined:  

“The contract on which the relationship between the banker and his customer is founded comes into existence in just the same way as many other contracts do, by an offer and an acceptance, an offer made by one party to open an account and an acceptance by the other of such an offer.”

A summation of important judicial pronouncements attributes the following characters to a customer:

• a customer is one who maintains a deposit account with the bank
• duration of the account is immaterial
• state of the account, i.e., whether it is in debit or credit, is immaterial
• banker-customer relationship would exist between two banks if one has the account with the other, and cheques etc., are collected through that account
• merely visiting a bank frequently for purchasing a draft or for encashing a cheque etc., does not confer on the visitor the status of a customer i.e., maintenance of a deposit account is a sine qua non of the eligibility criterion for a customer • a customer of one branch does not automatically become a customer of another branch of the same bank where he does not maintain an account
• even an agreement to open an account would make a prospective depositor a customer of the bank.

  

4. Banker-Customer Relationship

Basically, a banker-customer relationship is that between the mandatee (the bank) and the mandator (the customer). It nevertheless embraces mutual duties and obligations, and also offers privileges to both. Sir John Paget describes the relationship between a banker and a customer primarily as one between a debtor and a creditor, the respective positions being determined by the existing state of the account.

This banker-customer relationship is a contractual one, even though the terms of the contract are not usually embodied in any written agreement executed by the parties. This contractual relationship basically rests on the customs and usages of bankers. Many of these customs and usages have been recognised by the courts, and to the extent that they have been so recognised, they have been treated as implied terms of the contract between the banker and the customer.

Basically, the banker-customer relationship is guided by the following principles:

• The banker receives cash to credit it to the customer’s account and collects the proceeds of such items as cheques, interest, dividend warrants, pay orders, drafts, and bills of exchange for his customer’s account.
• The money so received becomes the property of the banker. The banker does not hold the money as his customer’s agent, trustee, or bailee. The banker becomes the debtor of the customer for an equivalent sum. In this sense, the banker-customer relationship is a debtor-creditor relationship. It is a contract of debt with some special terms. There are, of course, certain exceptions like when the customer deposits money with explicit or implied trust, the banker holds it as a trustee and not as a debtor of the depositor.
• The banker undertakes to repay to the customer or to his order the equivalent of the money received on a demand by the customer during the banking hours at the branch of the banker where the account is maintained.
• It is the legal duty of the banker to maintain secrecy about his customer’s affairs. This duty arises the moment the banker-customer relationship is established. It would not cease even after the closure of the account or the termination of the banker-customer relationship. However, there are certain exceptions to this rule of secrecy, and a banker may choose to reveal the nature and details of his customer’s transactions under the following circumstances. (a) Disclosure under compulsion of law: the banker may reveal the details about his customer’s affairs on receipt of court directions under civil/criminal proceedings governed by the provisions of Civil Procedure Code, Criminal Procedure Code, Income Tax Act, etc.; (b) Disclosure as part of public duty: it is difficult to cite an instance of this nature since the law has not defined as to what constitutes ‘duty’ to the public; (c) Disclosure in the interests of a bank: as in civil litigations for recovering a bank’s dues, etc.; (d) Disclosure with the customer’s consent: if the customer gives his consent, explicitly or  implicitly, for such a disclosure by the Bank.

The customer undertakes to exercise reasonable care while drawing his cheques so as not to mislead the banker, or facilitate forgery or fraud. Failure to do so will constitute negligence. If the customer draws the cheque in a manner which facilitates fraud, he is guilty of breach of duty as between himself and the banker, and he will be responsible to the banker for any loss sustained by the banker as a natural and direct consequence of this breach of duty (London Joint Stock Bank Ltd. V. Macmillon & Arthur 1918).

• The customer also undertakes to inform his banker immediately if he discovers that cheques, purported to have been signed by him, have been forged.
• The customer also agrees to pay a reasonable charge for the banker’s services.

Primarily, these rights and obligations have arisen out of the implied conditions of the contract. Besides these obligations, the banker must also take cognizance of any special mandate or authority given by the customer.

5. Types of Customers

Bank accounts could be maintained by an individual, individuals jointly, proprietors, partnership firms, companies, trustees, clubs, associations, etc. However, owing to their special nature, establishment of contractual relationship with such diverse groups demands additional precautions and compliance with various legal provisions.

Know Thy Customer

Like many other socio-economic evils, money laundering is perhaps as old as money itself. In the recent past, it has, however, acquired menacing proportions. The International Bank of Settlement, Basel, Switzerland, has defined money laundering as:

“Bank and other Financial Institutions may be unknowingly used to transfer or deposit of funds arising out of criminal activities. Criminals and their accomplices use the financial system to make payments and transfer funds from one account to the other to hide the source, ownership and beneficiary of funds and to store currency in safe deposit boxes.”

In general parlance, money laundering is said to be an attempt to give apparent legitimacy to illegally obtained funds. Usually, this is accomplished by following a mechanism:

Placement – Depositing ill-gotten funds into banking system; introducing ill-gotten funds into the stream of trade and commerce; methods adopted are situation-specific. This is the riskiest stage in money laundering, since large amounts of cash are pretty conspicuous, which attracts the attention of the bankers.

Layering/Concealment – De-linking the means of ill-gotten funds from its apparently legitimate future income through complex financial transactions via banking channel; mainly to disguise the audit trail and provide anonymity; typical layering transactions use the services of shell companies, front companies and sham transfers from the so-called tax heavens.

Integration – Providing legitimacy to the profits generated from ill-gotten funds; enables the re-entry of ill-gotten funds into financial system appearing to be legitimate business funds – typically being used to purchase luxury goods etc.; these funds are returned to the very criminals in the form of off-shore loans, cashing out the earlier sham transfers, sale of assets of front companies, earnings from alleged overseas investments.

Money laundering is a complex criminal process and no single measure perhaps could mitigate it. It is, therefore, essential for the operating bankers to safeguard their system from being misused by the money launderers by practicing certain basic precautionary measures such as:

• Knowing the customer;
• Being Satisfied of the source of funds;
• Being Satisfied of the legitimacy of transaction; and
• Displaying due diligence.

Particular attention must be paid to the following:

• Insufficient, false or suspicious information provided by the customer; Cash deposits not consistent with the business activity of the customer;
• Purchase of DDs/Pay Orders in cash/through transfers not consistent with the levels of business activity of the customer;
• Customer, who receives wire transfers and immediately converts into DDs. etc., in favour of third parties;
• Opening of FDR and immediately asking for loan there against;
• Customer making constant deposit of funds into the account and immediately requesting for wire transfers to another city, inconsistent with his activity; and;
• Transactions which do not make economic sense. According to Section 3 of the Prevention of Money Laundering Act 2002, “Whosoever, directly or indirectly, attempts to indulge or knowingly assists or knowingly is a party or is actually involved in any process or activity connected with the proceeds of crime and projects it as untainted property shall be guilty of offence of money laundering.” It has thus become mandatory for banks to know their customers well and allow them to avail bank’s services for legitimate transactions only. Any association of a bank with transactions of money launderers can entail even termination of operating license by the regulators.

6. Nomination in Bank Accounts

Section 45ZA (1) & (2) of the Banking Laws (Amendment) Act, 1983 has made a provision enabling banks to offer nomination facility in deposit accounts. A sole depositor or all depositors together can nominate one person in the prescribed form, authorizing the banks to pay the amount of deposit to the said nominee in the event of the death of the sole depositor or all the depositors.

Such payments to the nominee shall give valid discharge to the bank since the nominee is clothed with the right to receive the amount from the bank. Similarly, in respect of safe custody of articles and safety lockers, Sections 45ZC (1) & (4) and 45ZE (1) & (2) empower the depositor/s of article or the hirer/s of a locker to nominate any one person to receive the article/contents of the locker in the event of the death of the sole depositor/hirer or all the depositors/hirers. Provision has also been made for cancellation/variation of nomination.

7. Banker’s Lien

A lien is a right to retain possession of specific goods/securities/other movables of which another person is the owner until the owner discharges his debt or obligation to the possessor. Lien is of two types:

• Particular Lien: The right of retention limits to the very goods in possession against which debt obligation arose. For example, unpaid seller of goods has a lien on them until the owner pays the price. A jeweller entrusted with the making of ear studs has got a right to retain them until the owner pays him for his labour.

• General Lien: Empowers the possessor to retain the possession of any goods until the whole debt is paid. Banker’s lien is recognized as a general lien by law, i.e., banks have a lien on all the securities/movables of a customer that came into their hands and thus can retain them until the debt due from the customer is fulfilled.

Banker’s lien is recognized as an implied pledge, i.e., the banker can not only retain possession but also sell/encash movables and realize the debt. However, adequate notice has to be given to the debtor before the securities are sold by the banker.

However, the banker gets the right of general lien over those goods or securities that came into his possession in the normal course of banking business. If there are any express contracts or circumstances that show an implied contract inconsistent with the lien, the banker does not acquire the right of lien.

To summarise, the availability of banker’s lien is subject to:

• The property coming into the hands of the banker in his capacity as a banker and not otherwise;
• Property not entrusted to the banker for any other specific purpose, which is inconsistent with the lien;
• The possession should have been obtained lawfully; and
• The banker should not have made any agreement with the customer inconsistent with the lien.

Lien cannot be exercised on securities deposited for safe custody. Suppose a customer, after having undertaken a transaction with the bank and before leaving the bank premises, inadvertently leaves a bunch of share certificates standing in his name on the table of the bank manager, the bank cannot claim a lien on such share certificates.

Lien extends to bills and cheques lodged for collection and credit to the customer’s account. However, if such bills are accompanied by special instructions; for example, “collect the proceeds and purchase shares of Reliance, exclude banker’s lien”. Such norms also extend to the collection of dividend/interest warrants lodged by the customer. However, securities pledged in On Demand (OD) Account can be retained for the customer’s liability in other Loan Account. Similarly, surplus from the sale proceeds of a particular security lodged in OD Account can be used for appropriation in his other Loan Account. [Re London and Globe Finance Corporation (1902) 2 Ch. 416] Banks cannot exercise lien where it can exercise the right of set-off. Similarly, the right of lien cannot be exercised when the debt has not yet matured. Suppose, the bank has discounted a 90-day bill falling due on February 20, 2000, and if on January 10 securities worth Rs.10,000 come into possession of the bank in its ordinary course of business, it cannot exercise the right of lien as the debt is still not due for payment. Since the banker’s lien is an implied pledge, it is mandatory to serve a notice before exercising the lien.

8. Right of Set-Off

We have learnt at the beginning of this unit that, when money is deposited by a customer in a bank account, it becomes the money of the bank. But the only obligation of the banker is to pay an equivalent amount on demand by the customer. In view of this, the question of exercising lien on such deposits does not arise. However, a banker has got the right to set-off debit in one account of a customer against the credit in another account. This right to combine accounts is incidental to lien. The nature and extent of this right has been defined by Lord Denning in the following words:

“Using this phraseology, the question in this case is suppose a customer has one account in the credit and another in debit. Has the banker a right to combine the two accounts so that he can set-off the debit against the credit and be liable only for the balance? The answer to this question is yes. The banker has a right to combine these two accounts whenever he pleases and to set-off one against the other, unless he has made some agreement express or implied to keep them separate.”

The right of set-off can be exercised when the same customer is in debit and credit in two accounts. It means that there is no right of set-off against the joint credit account of Rama and Krishna for the debit in Rama’s single account.

Similarly, the right of set-off can only be exercised when the funds under credit and debit accounts have become due for payment.

8.1. Rule in Clayton’s Case

The rule derived from Clayton’s case has assumed a significant role in defining the right of set-off in banking transactions. Sir William Grand defines the rule of appropriation as under:

“The first item on the debit side of the account is discharged or reduced by the first item on the credit side. The credit entries in the account adjust or set off the debit entries in the chronological order.”

All running accounts maintained with banks are subject to Clayton’s Rule. In the case of death or insolvency of a partner of a firm, the then existing debt due from the firm is adjusted or set off by subsequent credits made in the account.

As per Clayton’s Rule, the credit entry on the 15th November reduces the liability of the  deceased/retired/insolvent partner by Rs.8,000 and the credit entry on the 20th November discharges him/ his estate fully from the liabilities of a firm to the bank. In other words, the debit outstanding as on 15.12.1999, i.e., Rs.20,000 and any amount that may subsequently become due from the firm, cannot be claimed from the retired/insolvent/deceased partner of the firm. In such situations, to make Clayton’s Rule inapplicable, banks should break the account of the firm by drawing a line on the date they come to know about the death/retirement/insolvency of a partner and route fresh transactions through a new ledger folio. This way, banks can keep the deceased borrower’s estate liable towards the debt incurred prior to his death. Clayton’s Rule is applicable to running current/cash credit accounts, and the banks usually encounter Clayton’s Rule in these accounts. 

10. Termination of Banker-Customer Relationship

Termination of the relationship between the banker and a customer could be by agreement between the parties, i.e., closure of the account by the customer or by the bank. A customer can close the account without any prior notice, but the banker cannot close an account without giving a prior notice to the customer about his intentions to close the account. The account may also be closed by the operation of law.

10.1. Termination Owing to Operation of Law

Operations in an account may come to an end by the operation of law, i.e., contrary to the intentions of the banker and the customer, the law may direct the banker not to oblige the demands of the customer. Such a situation may arise in any one of the following situations:

10.1.1. Prohibitory (Garnishee) Orders under Civil Procedure Code

Rule 46 of the Civil Procedure Code (CPC) provides that a debt shall be attached by a written order prohibiting the creditor (customer) from receiving the debt and the debtor (banker) from paying it until further order from the court. The debtor on whom such order is served is called Garnishee and the customer is called Judgement Debtor. Compliance with such orders, i.e., payment of credit balance in an account, does give a valid discharge to the banker against the customer. If the banker believes that the said credit balance cannot be appropriated under the prohibitory order, he has to show cause as to why such compliance cannot be arranged.

There are certain exceptions to this rule:

• When the debt is not actually due to the customer;
• When the money in the account is payable not only on the customer’s demand, but also when he has to comply with certain conditions;
• When the account is in the joint names of judgement debtor and other persons;
• When the bank is aware that the money in the account is held by the customer as a trustee or is impressed with the trust; and
• When the bank is entitled to set-off the balance against debt owed by the judgement debtor to the bank.

10.1.2. Order for Payment under Section 226 (3) of the Income Tax Act, 1961

Section 226 (3) of the Income Tax Act, 1961 confers special powers on the Income Tax authorities for recovering the tax due from a customer out of the credit balance in his bank account. It is like a Garnishee Order but with more powers.

The Income Tax Officer can issue a notice to any person from whom money is due or may become due to the assessee, or who holds or may subsequently hold money for or on account of the assessee. The important differences between a notice under this Section (Income Tax Act) and the Garnishee Order of a Civil Court are:

• In the case of a notice from the Income Tax Authorities under Section 226 (3), the banks cannot refuse payment and refuse compliance on the plea that as per the contract the customer has to comply with certain conditions before getting his money like production of discharged FDR, etc. The conditions simply become inoperative. Payment of money to the tax authority without such compliance as well gives a valid discharge to the bank. However, in the case of Garnishee Orders, such requirements continue to be operative. 
• If the assessee is a customer holding a joint account with others, the share of all the joint holders shall be presumed to be equal until the contrary is proved. Accordingly, his share must be remitted to the tax authorities. Whereas, under a Garnishee Order, such assumption cannot be made. The bank can object to the notice on two grounds: that the sum demanded is not due to the assessee; and that he does not hold any money for the assessee. This has to be intimated to the Income Tax Officer by a statement on oath.

Any claim over the money in the account, which arises after the receipt of notice by the bank, shall be void as against the demand contained in the notice. If the bank does not comply with such notice, it shall be deemed to be an assessee in default.

10.1.3. Restraining Order or Injunction from a Court

The banker can be restrained by an order of a court from honouring his customer’s demands. Sometimes, the customer himself can be restrained from withdrawing money from his account. If the banker comes to know of such orders, he should stop payment on the customer’s behalf.

10.1.4. Notice of Death of Customer

On the death of a customer, the title to the money in the account rests with the legal representatives and the demand of the deceased becomes ineffective. Therefore, any cheque received after the notice of the death of the customer is to be returned even if it bears a date prior to his death.

10.1.5. Lunacy of the Customer

On lunacy, a customer becomes legally incompetent to contract, and therefore, to make an effective demand. On receiving notice of such lunacy, the bank has to stop all the operations in the account of the customer.

10.1.6. Insolvency of Customer

Once a customer is declared insolvent, the relationship between the bank and the customer automatically gets terminated.

11. Reserve Bank of India Act, 1934

Banking is the most regulated business all over the globe. The reason is simple: it has a sway on the macro economy of nations. Essentially, Central Banks monitor financial intermediaries to ensure their solvency and thereby elimination of systemic risks. Any instability amongst the intermediaries is potential enough to rock the very financial architecture of a nation. It is to minimize this risk of contagion, Central Banks initiate several steps for compliance with certain prudential norms and ensure transparency in the financial

reporting by banks. One obvious mechanism to track the functioning of banks as per the laid down prudential norms is on-site inspection of their books. The Reserve Bank of India Act 1934 was enacted to constitute the Reserve Bank of India with the objectives of:

• Regulating the issue of bank notes;
• Securing monitory stability through reserves; and
• Operating the currency and credit system of the country to the best advantage of the country.

The Act deals with the constitution, powers and functions of the Reserve Bank. It has been amended from time to time to meet the demands of the changing times. It, however, does not deal directly with the regulation of the banking system except for Section 42. The Reserve Bank is a body corporate, having perpetual succession and common seal. It functions under the General Superintendents and directions of the Central Board of Directors. However, it has to abide by the directions given by the Central Government. As per Section 20, it undertakes banking business for the central government. It provides ways and means of advances to the central and state governments. It, by virtue of the provisions under Banking Regulation Act 1949, functions as the regulator of banking sector. It has power to:

• Grant licence for opening new banks and new branches;
• Appoint and remove banking boards;
• Regulate the business of banks;
• Give directions;
• Inspect and supervise banks;
• Get banks audited;
• Collect and furnish credit information;
• Handle moratorium, amalgamation and winding up of banks;
• Impose penalties; and
• Frame regulations for regulating payment systems of banks and financial institutions.

12. Banking Regulation Act, 1949 – Important Provisions

Banking Regulation Act, 1949 provides a control mechanism for the Indian Banking System. Its important provisions include:

• Section 11 – Paid up capital and reserves: Prescribes the minimum requirements as to the paid up capital and reserves.
• Section 18 – Cash Reserves: Every banking company, not being a scheduled bank, has to maintain in India, by way of cash reserves with itself or in current account with the Reserve Bank of India (RBI) or by way of net balances in current accounts or in one or more of the aforesaid ways, a sum equivalent to at least 3% of its total demand and time liabilities as on the last Friday of the 2nd preceding fortnight and submit to the RBI, before the 20th day of every month, a return showing the amount so held on alternate Fridays during a month with particulars of its demand and time liabilities on such Fridays. As per Section 42 (i) of the RBI Act, every scheduled bank is required to maintain this Cash Reserve only with the RBI.

The RBI may also increase this rate by notification up to 20% of the total of demand and time liabilities.

•  Section 21 – Advances portfolio: Empowers the RBI to give policy directions to the banks with regard to their advances portfolio.
• Section 21A – Rates of Interest: Rates of Interest charged by the banking companies are not subject to scrutiny by courts.
• Section 22 – banking license: Every banking company should hold a licence issued by the RBI.
• Section 24 – Maintenance of Percentage of Assets: Every banking company in India, whether scheduled or non-scheduled, is required to maintain in India in cash, gold or unencumbered approved securities an amount which is not less than 25% of the total of its demand and time liabilities in India. This is otherwise known as Statutory Liquidity Ratio, which can be increased by the RBI as and when it deems fit.
• Section 29 – Accounts and Balance Sheet: Every banking company shall prepare the Balance Sheet and Profit & Loss Account on the last working day of the year in the forms set out in the 3rd schedule.
• Section 35 – Inspection: The RBI, either by itself or on being directed by the Central Government, can ask one or more of its officers to inspect the books and accounts of any banking company. Under Section 35 A (1), the RBI may direct any bank in writing to preserve any books, accounts or registers for a longer period than the period specified under the rules framed by the Central Government.
• Section 38 – The High Court shall order the winding up of a banking company in the circumstances as spelt under Section 38 of the Banking Regulation Act.

 

Summary

The banking system in the country is supervised by the RBI as per the provisions of the Banking Regulation Act, 1949. The important provisions include: Section 18—maintenance of cash reserve ratio @3% of total demand and time liabilities; Section 24—maintenance of not less than 25% of total demand and time liabilities in the form of cash, gold and approved government securities under the name of SLR; and Section 39 under which the RBI can inspect the books and accounts of any banking company.