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 These deposits can be withdrawn by cheques, drafts or any other acceptable mode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.

UNIT TWO

DEPOSITS

The major function of a bank is to accept deposits and lend/invest the money accepted as loans and
advances. In the course of business, a bank is bound to meet and interact with a large cross-section of
customers. Obviously, their needs will differ; therefore, the bank has to put on the table various types of
deposits to enable customers to have manifold banking transactions. Again, a banker should be very
careful in opening deposit accounts. Some of the deposit accounts are operated very often. Therefore,
he should safeguard his position in such a way that he may not be victimized by unscrupulous persons.
The should observe certain general precautions before opening a deposit account.

GENERAL PRECAUTIONS
Application Forms:

The prospective customer is first of all ask to fill and sign an application form prescribed for that
purpose. This application contains the rules and regulations of the bank along with the terms and
conditions of the deposit. The application forms vary with the classes of customers and for the kinds of
deposit. Different banks also print their application forms different from other banks.

Specimen Signature

Every new customer is required to give three or more specimen signatures. Usually, they are obtained on
cards which are filed alphabetically for easy reference.

Letter of Introduction:

It is always advisable on the part of the banker to allow the prospective customer to open an account
with proper introduction. The banker is to demand a letter of introduction from a responsible person
known to both parties. The person issuing the introduction letter must be aware that if he supplies any
false information about the party, he would be liable for any loss suffered by the banker (Bloodnok &
Sons vs. United Kingdom Bank). If the introduction turns out to be a forged one, the account is treated as
having been introduced at all.

Passport-size Photograph:

In recent times, prospective customers are required to affix their passport-size photograph to the
application forms to prevent impersonation and for easy identification at the of opening the account.

Verification of Documents:

If the new party happens to be a corporate body, it is essential that the banker should verify some of the
important documents such as Memorandum of Association, Article of Associations, bye-laws copy, etc. In
Lumsden & Co. vs. London Trusty Savings Bank, one of the grounds for banker’s negligence was the
failure to verify the passport of the customer who had recently arrived from Australia.

Interview:

At the time of opening a new account, it is always advisable to have an interview with the prospective
customer so as to obviate the chances of perpetration of any fraud in future

Account in Cash:

It is a common practice to allow a new party to open an account only in cash. In the absence of an
express notice, a banker need not worry about the source of money or the customer’s title over the
money.
What is Deposit

Deposit means a claim of other entities on the bank in cash, with or without interest
or premium of any kind that is to be repaid on demand or at a certain period, depending on
the agreed conditions at the time the deposit was placed.

Types of Deposits

Savings Bank (SB) Accounts

To inculcate the habit of savings and to encourage thrift, the savings account facility is available with all
the banks. The main aim of this type of deposit is to bring awareness among the general public that
banks can help individuals develop their savings habit.

Savings Bank (SB) Accounts are opened with proper introduction or identification (to confirm the
genuineness of the person opening the account and conducting its transactions and also to curb
fraudulent transactions). The central bank regularly advises banks, through its circulars to follow certain
basic pattern or know your customer (KYC) rules to ensure that accounts are opened properly so that
fraud and malpractices are avoided.

A rate of interest is paid based on the amount (deposit) kept by the depositor with the bank in the
savings bank account. The interest is calculated based on the minimum balance maintained in the
savings bank account between 10th and the last day of every month. Interest is arrived at on the basis of
minimum balance and simple interest is calculated on product basis and credited to the respective
account, on a half-yearly basis. If the account is opened after the 10th of any month, the account holder
is not entitled to interest for that month. Also, interest is not paid on the SB balance for the month the
account is closed.

An individual may open a savings account with any bank subject to completing the minimum
formalities. The SB may be a single account or a joint account. While opening a SB account, the account
holder (customer) has to fill up an application form furnishing relevant details, duly accompanied by
specimen signatures. Other requirements like proper introduction, address/residence proof,
photographs, identity proof, etc are to be complied with.

Withdrawals from the SB account are allowed with cheques or withdrawal slips or forms. If the account
holder issues cheques without sufficient funds in his/her account, the bank dishonours the cheque and if
it repeats, charges a penalty or even closes the account after issuing a proper notice to the account
holder.

During the opening of the account, the account holder is required to nominate someone by filling the
relative nomination form.

Generally, banks allow joint accounts (savings bank) with not more than three people. Apart from the
usual formalities to be followed, the instruction to operate such an account is very vital. A joint SB
account can be operated by all the account holders together. This means that the bank will honour
payment only after all three holders have given their consent to withdraw money. However, if the
instruction to operate such an account is severally or by any one, then the bank is required to pay based
on any one of the joint holder’s instruction subject to availability of funds in the account and the cheque
in question being otherwise in order. In case the bank fails to carry out the instruction it cannot claim
protection under provisions of Negotiable Instrument Act.

In addition to the above, banks also open SB accounts for NGO’s, clubs, registered societies and
educational institutions provided these are not engaged in any trade or business. Those engaged in
trade cannot have SB accounts.

Banks are also prohibited from opening an SB account in the name of government departments/bodies,
which depend on budgetary allocations for the performance of their functions. Also, banks cannot open
an SB account for any trading or business or professional concerns and political parties.

The other requirements of an SB account are:

a) Completing the formalities such as obtaining proper introduction, proof of residence, photographs,
specimen signature, etc.
b) As per KYC norms, proper identification of the person is a must.
c) The introducer may be an existing account holder or a well-known person from the locality
acceptable to the bank.
d) Borrowers may also introduce a person wishing to open an account.
e) The address furnished by the account holder must be verified and satisfied, based on any one of the
following:
i) Voter ID card
ii) ID issued by employer
iii) Valid driving license
iv) Passport
v) Electricity/telephone bills
f) The SB account holder is given a cheque book / withdrawal slip.
g) An ATM card is made available to an SB customer

Other features of an SB account are:

a) No overdrawing is to be allowed in the SB accounts
b) Nomination facility is available for individuals only. The banker has to explain the importance of
nomination in a proper manner and obtain nomination. Joint account holders are allowed only one
nomination.
c) An SB account holder who wishes to withdraw a huge amount of cash from the account is required
to give an advance notice to enable the branch to make necessary arrangements.
d) The bank reserves the right to change the rules of business at any time with or without notice to the
depositors individually.
e) One cheque book is issued at a time
f) The account holder who wishes to close his/her accounts has to give an application. The bank has to
make enquiries about the reason for such a closure (especially to find out whether the account is closed
on account of non-satisfactory service of the bank) and then proceed to close the account. The bank will
obtain the unused cheque book and ATM card before closing the account.
g) In the case of death of the account holder, the account will be closed after completing the
formalities (setting the claim in favour of the nominee or legal heirs or allowing operation to the survivor,
as the case may be).

Current Deposit (CD) Account

Current Deposit (CD) Accounts are opened to meet the transaction of business and trade. A current
account will generally have more transactions and also involve large amounts. Current account balances
do not earn any interest.

A current account can be opened by individuals who are competent to contract business
entities/traders/partnership firms/corporate/joint stock companies/banks.

Before opening a current account the formalities required for opening bank accounts are to be followed
without fail. A current account can be opened only if introduced by another existing current account
holder.

While opening the account, besides obtaining proper introduction, the other requirements of KYC norms
are to be followed. The bank, at any point in time, has to prove that the account holder is its
customer. Only then can it claim protection under Sec 131 of the NI Act, 1881 when he collects a
cheque.

Unlike an SB account, third party cheques may be collected for current holders. However, the required
endorsements obtained are to be verified and the bank has to be satisfied that its current account
customer is entitled to receive payment if the cheque is originally payable to a third party.

The current account holder is expected to maintain sufficient balance in his/her current account while
issuing cheques. If not, cheques issued may be returned by the bank leading to the attraction of
provisions of Sec 138 and related section of NI Act, 1881.

In the ordinary course of business, there may be instances when the balances in the account may not be
sufficient to meet the cheque(s) received, then the bank may consider the customer’s request and use its
discretion to permit overdrawing in the current account. This facility is extended for a temporary period.

Though there is no interest paid on the current account balance, banks can charge a fee for handling the
account based on maintaining the minimum amount, folio fees, cheque books charges, cheque return
charges, etc.

There are no restrictions with regard to the number of transactions. The latest cash withdrawal Tax –
The Banking Cash Transaction Tax – is applicable to current account cash withdrawals
(individual/business entity).
While opening a current account, in addition to the current account opening form, specimen signature
cards, photos, and address proof, the banks also obtain additional documents to safeguard the interest
of the bank. Account opening forms are duly signed by the account holders to authenticate their
identity.

In addition to the respective application forms, the other important documents required to be obtained
are:

For Proprietorship concerns

1. Proprietorship letter: The proprietor has to sign in his/her individual capacity.
2. Copy of the shop and establishment certificate.

For Partnership firms

1. Partnership letter signed by all the partners in their individual capacity.
2. Copy of partnership deed certified as the latest by the partner(s).
3. Copy of registration certificate issued by the Registrar of Firms.

For Joint Stock Companies

1. Copy of Memorandum of Association.
2. Copy of Articles of Association
3. Copy of Certificate of Incorporation
4. Board Resolution for opening/operating a current account.

The above documents are required for opening an account for a private limited company. In addition to
the above, for a public limited company that wishes to open an account, a copy of the Certificate of
Commencement of Business should also be taken. A list of present Directors as filled with the Registrar
of Companies has also to be kept on record.

The current account holders are entitled to all types of banking transactions like
i) Standing instruction facility
ii) Cheque book facility including personalized cheque book.
iii) Pass book or monthly pass sheets. In case of more or frequent operations in the account, banks do
consider and provide pass sheets on weekly or fortnightly basis at the request of the customer.
iv) Collection of outstation cheques/other instruments.

Fixed Deposit Account (FDA)

Fixed deposits, also known as term deposits are accepted for a certain period and are repayable on the
date of maturity. As compared to the SB account, the rates of interest on term deposits are higher
depending on the tenure of the deposit. The minimum period of a term deposit is 7 days and the
maximum is 120 months.

Fixed deposits carry simple interest payable on monthly, quarterly, half yearly or yearly basis. Fixed
deposit is for a fixed period and simple interest is payable as per the instruction of the customer.
However, under a monthly income scheme, the interest is payable at a discounted rate.
The Fixed Deposit Receipt: A deposit receipt is not a negotiable instrument. The transferee, therefore,
cannot get a better title than that of the transferor himself. That is why the receipt has been specifically
marked “Not transferable”. However, money in deposit account becomes a debt from the bank and like
any other debt this can be assigned. To be effective, prior notice of assignment should have been served
on the banker. The assignee should also give a notice to the banker informing him of his right to the
deposit.

REINVESTMENT PLAN

While fixed deposits carry simple interest, the reinvestment plans give compound interest. Reinvestment
plan is an extension of fixed deposit. The option is with the customer to decide the type of deposit in
which he / she would like to keep his / her funds.

Unlike the fixed deposit where the interest earned is paid back to the depositor on maturity (on the basis
of monthly, quarterly, half yearly or yearly), under the reinvestment scheme, the bank retains the
interest earned and gives to the customer the principal plus interest upon interest is given on
compounded basis.

All other aspects as applicable to the fixed deposits are applicable to the reinvestment plan deposits.
Generally, banks decide their own rates of interest structure for term deposits which are applicable to all
term deposits like fixed, reinvestment plan, recurring deposits, etc.
Reference
UNIT THREE

TYPES OF ACCOUNT HOLDERS

DIFFERENT TYPES OF ACCOUNTS

MINORS:

A minor is an individual under the age of 18 years. Minors have no contractual liabilities but there are
two categories of contract that are valid when entered into by a minor:

a) A minor is liable to pay a reasonable price for necessaries actually delivered to him
under the contract which he has made.

b) An agreement by which a minor obtains training or carries on a vocation, e.g. Student

Loans’ Scheme for tertiary education, is binding on him if the contract is generally
beneficial to him.

However, contract of a continuing nature are voidable, e.g. partnership, membership of a company he
obtains benefits and assumes corresponding liabilities.

Minors as Bank Customers:

Banks do not open current account for minors, since the general principle is that a minor cannot assume
liability by signing a Bill of Exchange in any capacity. If a minor needs a bank account e.g. under the
student loans’ scheme, a savings account may be opened.

It is unsafe for a bank to have direct dealings with a minor, since it may be that he was too young to
understand the effect of the transactions, and so the bank would not obtain a valid discharge for the
money paid to him or on his behalf. A lot would depend on the circumstances. There is no inherent legal
difficulty in the acceptance of a minor’s instructions by cheque. It is expressly provided by the Bill of
Exchange Act 1961 Section 20(2) that the holder of a bill or a cheque drawn by a minor is entitle to
receive payment.

Nonetheless, a bank in its own interest must recognize that a minor is a special type of customer and, in
particular, avoid lending money to him since a loan to a minor is unenforceable. There is the possibility
that, to avoid this restriction, the minor may overstate his age. If he does so and thereby obtains a loan,
he commits the tort of deceit (Leslie vs. Sheil 1914). Any security given by a minor for a loan is also
unenforceable. If a minor uses borrowed money to pay for necessaries, the lender is subrogated in
equity to the rights of the supplier who has been paid with the lender’s money, and the lender may
recover so much of his loan as corresponding with a reasonable price for the necessaries. For a bank, this
remedy is not particularly useful, since it would involve very difficult and expensive litigation.

Other important points concerning minors are as follows:

a) Provided an account holder has full contractual capacity, a minor can act as that person’s agent on
that account.

b) A minor can be a director of a limited company, provided that the article allows this.

c) A minor cannot act as an executor or trustee.

d) A minor cannot make a valid will unless he is on active service with the armed forces (in case of an
emergency).

e) A minor cannot give guarantee, although he could ratify such a guarantee upon attaining the age of
maturity.

Joint Accounts:

When two or more people wish to open a bank account together in their names then it is known as a
joint account.

There are 2 types of transactions which the bankers come across or handle in joint account instructions.
One is the operation instruction and the other is the settlement instruction.
The operation instruction applies to savings and current accounts. The settlement instruction, generally
applies when one of the joint account holders or all the joint account holders are no more. Alternatively,
if they are alive, the decision to whom balance payment has to be made is based on the conditions
agreed upon at the time of opening the account or subsequently during the existence of the deposit.
Death of a Joint Account Holder: The mandate held for joint accounts normally gives the bank a
satisfactory discharge from the survivor on the death of a joint account holder as the bank’s printed form
takes care of this problem:

a) If a joint account is in credit, it can continue to be operated by the survivor. This means that in the
case of an account for a husband and wife, the surviving spouse will be able to continue to use the
balance of the account without having to wait for probate to be obtained.

b) If cheques are presented, drawn on a joint account, signed by the deceased, they should be returned
marked “Drawer deceased” unless the surviving account holder is willing to authorize payment.

c) If a joint account is over drawn when notice of death of a party to a joint account is received, then
that account should be stopped if the bank wishes to retain its claim against the deceased’s estate.
Otherwise, the rule in Clayton’s case (Devaynes vs. Noble 1816) would mean that fresh credits would
repay the earliest debits, thus reducing the bank’s claim.

d) If an overdrawn joint account is stopped to preserve the bank’s claim, arrangements

Married Woman:

A married woman may be permitted to open and have a bank account in her individual capacity. The
general formalities for opening an account have to be followed without any exception. However, a
woman who has an account opened before her marriage desires that the name be changed, then the
name (after marriage) may be recorded based, on documentary proof like marriage invitation / card /
certification / official gazette publication. She has to make a request in writing and the bank has to
obtain her new specimen signature. The change will not impact cheques sent for collection in her maiden
name which may be credited after realization and the cheques issued by her using her maiden name also
can be paid.

Lunatics:

Since a lunatic is not in a proper frame of mind and cannot understand what he is doing, the account of a
lunatic person should not be opened. When the bank receives the notice of lunacy of its customer from
the court or from other genuine sources, it will have to stop operations in the existing account. The same
may be restored when the bank receives an order from the competent court or a certificate from the
registered medical practitioner certifying that the said person is no more a lunatic and has a sound mind
to understand and react.

Illiterate Persons:

A person who is not able to read or write or subscribe his signature is called an illiterate person. There is
no bar in opening a savings or a term deposit account for an illiterate person. Since she / he cannot read
/ write / sign, the thumb impression is obtained on the relevant documents. Accounts are opened
following other general formalities required to do so. Since the illiterate person cannot understand the
contents of the application form and other rules the same are to be explained to him in his language and
to that effect a proper letter has to be taken from the person who has explain to him or her.

Since the illiterate person cannot understand the contents of the application form and other rules, the
same are to be explained to him in his language and to that effect a proper letter has to be taken from
the person who has explained it to him / her.

Usually, the LEFT hand thumb (LTH) impression of an illiterate person is taken. However, there is no hard
and fast rule. Even the right hand thumb (RTH) impression will serve the purpose.

What is important is that the bank has to maintain a record of whether it is the right hand or the left
hand thumb impression that was taken. Whichever thumb impression was used, it has to be properly
recorded in this manner. “Left hand / right hand thumb impression of Mr. / Mrs. / Ms……” has to be
attested by the person known to the bank or the manager of the branch. The thumb impression has to
be affixed in the presence of a responsible official of the bank. The bank must not open a current account
in the name of an illiterate person.

INSOLVENT

An insolvent is one who is not able to pay (discharge) his liabilities either in full or in part. A creditor or
the person himself can move the court to declare him as an insolvent. Once the person is declared as
insolvent, the financial transactions that he subsequently enters into become invalid. Also, the
transactions already entered into during the previous six months become invalid. The entire estate of the
said insolvent is vested in the official assignee (Presidency towns) and official receiver (for Provisional
Insolvency Act). Such persons are duly appointed by a competent court.

If a person is declared an insolvent, then the operations in the account are to be stopped immediately.
The official assignee or receiver as per the respective court orders is to be allowed to operate such
accounts. Credit balance, if any, is to be disposed of as per the instructions of such officials.
Minors and lunatics cannot be declared as insolvents.

LIQUIDATORS

In the event of the liquidation of a company, a person is appointed to look after the winding up of the
company. Such a person is known as the liquidator. He may be appointed by the creditors in the case of
voluntary liquidation or by the court. The liquidator cannot borrow unless otherwise specifically
permitted by the court.
It is the duty of the liquidator to account for all the moneys realized from the disposal of the company’s
assets. He has to distribute the same among the creditors. Surplus, if any, will go to the owners
(shareholders of the company).

Once the company is under liquidation, the banker has to stop operations in the said company’s account.
Even cheques issued prior to the notice of liquidation should not be paid. The usual credits, however,
may be permitted. In case the company is a borrower and owes money to the bank, the bank need not
part with the balance money.
Before opening an account for a company under liquidation, the court order should be carefully studied
and as per the contents of the order, the account has to be opened. The bank has to be satisfied that the
liquidator is authorized to open an account.

The bank has to ensure that the instruments standing in the name of the liquidator representing the
liquidated company should not be credited to the personal account of the liquidator.

However, a liquidator may be permitted to have an account with the bank in his individual capacity
subject to the completion of the usual formalities for opening an account and as per KYC norms. In such
cases, the said bank has to handle the account of the liquidated company and its transactions with great
care.

Blind Persons

Blind persons are entitled to have bank accounts. While handling accounts of such people, the banker
has to carefully explain about the transaction that has taken place. Since the signature may not be the
same as the one lodged with the bank, to avoid complications, bankers pay by obtaining the signature of
an individual person as witness.

Agents

An agent is a person who has been appointed by another person (who is competent to contract). An
agent can be minor whereas a principal has to be a major. The banker opening an account of an agent
has to be careful. He has to understand the rights given by the principal.

The banker has to ensure that he (the agent) is a major because a minor cannot be an agent of another
person. An agent acting within the scope of authority given to him can bind his principal. If he acts
beyond the authority, the principal is not bound, unless he ratifies (confirms) such acts later.
On receipt of information about the death, insanity or insolvency of the principal, the banker has to stop
or suspend operations by the agent in the account of the principal.

RECEIVERS

A receiver is a person who is appointed by the court to look after the properties or estates pertaining to
the civil suits. He may also be appointed to look after the properties or assets of minors or persons of
unsound mind.

While opening an account in the name of the receiver, the bank has to ensure that the said person has
been appointed by a competent court. The branch of the bank has to insist on the certified copy of the
court order and a copy of the same has to be kept by the bank. The account so opened has to clearly
indicate that it is for a receiver.

Eg. “Mr. Debrah, receiver to the estate of Mr. Williams”.

The banker has to see that the proceeds of the instruments pertaining to the receiver should not be
placed to the credit of the personal account of the receiver. The operations in the account should be
according to the contents of the order, appointing him as a receiver.

EXECUTORS AND ADMINISTRATORS

An individual may write a will during his life time mentioning there about his intention regarding the
bequeathing of his property or assets after his death. The will has to be in writing and the testator has to
sign or affix his mark to the will. However, the will has to be witnessed by at least two witnesses.

The person who writes the will may specify a person who has to look after his assets and give him certain
rights. This person is called the Executor. On the death of the person who wrote the will, the executor
can approach the court and get the will probated.

When a person dies intestate, i.e. without leaving a will, the court may appoint a third person to look
after the estates of the deceased by issuing a letter of administration. Such a person is known as an
Administrator. Since the executor or an administrator is regarded as a trustee to manage the estate of
the deceased, the bank has to follow all precautions pertaining to a trust account. The bank has to obtain
the copy of the probate and act as per the contents and allow operations. It should be noted that in
either cases the bank has to stop operations in the account of the deceased person and open fresh
account in the name and style of the Executor of Administrator.

PROPRIETORSHIP CONCERN

An individual doing business is known as a proprietor and such business enterprises are called a
proprietorship concern. A bank can open an account in the name of a proprietorship concern. While
opening the account, the banker has to obtain, besides the application for current account, a
proprietorship letter. Such a letter has to state that the signatory is the sole proprietor and the person
concerned is the sole owner of the concern and no one else has any stake / interest in the business as an
owner.

The Cheques in favour of the proprietor may be routed through the proprietorship concern’s account.
Nomination facility is not available for proprietorship concerns. Hence, on the death of the proprietor,
the claim has to be settled in favour of his / her legal heirs.

PARTNERSHIP FIRMS

The Indian Partnership Act, 1932, defines partnership as the “relationship between persons who have
agreed to share the profits of a business carried on by all or any of them acting for all”.

The partners’ liability is unlimited. The banker opening the account of a partnership firm has to obtain a
copy of the partnership deed and retain the same after duly comparing it with the original.

He should go through the contents of the deed with special attention to the bank account(s) and
operation conditions. The banker has to obtain separate and specific operational instructions.

Example:
While opening / handling a partnership firm’s account, the following are to be considered:
1. A banker has to open a bank account in the partnership firm’s name only.

2. The usual formalities for the opening of current account, including proper introduction, has to be
obtained without fail. All requirements of KYC norms have to be complied with.

3. All the partners have to sign the partnership application representing the firm, besides signing the
partnership letters in their individual capacity.

4. Proper and clear instructions (signed by all partners) have to be obtained with regard to operation
conditions of the firm’s account.

5. If there is any dispute among the partners regarding operations of the account, the operations are
to be stopped and fresh instructions have to be sought.

If the partnership comes to an end (dissolved) on account of any reason, the credit balance in the
account can be paid to the remaining partners. Such a payment will serve as vital payment. It is advisable
to close the existing account and open a new one even though the deed may provide for continuation. If
the bank receives any cheque signed by the deceased partner, then the same should not be paid without
the consent of the other partners.

If, at the time of any of the above events, the balance is in debit, then the operation in the firm’s account
has to be stopped immediately, so as to protect the bank’s right to proceed against the estate. If not
stopped, the rule in Clayton’s case will apply.

A minor cannot be a partner. However, he may be admitted to receive the benefits of partnership with
the consent of all the existing partners. The banker has to go through the contents of the partnership
deed to understand the provisions of the same.

Generally, it is a current account that is opened for partnership firms. They can also place their deposits
in term deposits. While closing the account, all the partners have to sign the request letter by
surrendering unused cheque leaves.

JOINT STOCK COMPANIES

A company is considered as an artificial person backed by a legal status with a common seal and having
perpetual succession.A company may be private limited or public limited one. The members of the
company are called shareholders (owners). For both companies (private or public limited), there are
common documents like the

Memorandum of Association
Articles of Association

Certificate of Incorporation
.
For a public limited company, in addition to these three, another document called Certificate of
Commencement of Business is a must. For a private company, this certificate (Certificate of
Commencement) is not required. In fact, a private company can start operation on obtaining the
Certificate of Incorporation. In addition to these, one more important document is the RESOLUTION.

A banker who wishes to open a company’s account has to obtain certified copies of the Memorandum of
Association, Articles of Association, Certificate of Incorporation and Board Resolution for a private
company. For a public one, in addition to these, the certificate of commencement of business should also
be obtained.

Further, the list of the present directors as filed with the Registrar of companies has to be obtained and
kept on record with the bank.

The copy of the Resolution should be certified by the chairman of the meeting at which the resolution
was passed and counter-signed by the company secretary.

If there is any change in authorized signatories, a fresh resolution has to be passed and a certified copy
has to be given to the banker to allow operations.

The Memorandum of Association

The Memorandum of Association is one of the basic documents of the company. It describes the various
aspects of the particular company through its many clauses. These clauses are Name, Place, Object,
Liability, Capital and Association. The banker must clearly know the main objective of the company. He
should also be familiar with the contents of the Memorandum of Association.

The Article of Association

The Article of Association deals with the rules and regulations for internal management of the company.
It discusses in detail the functioning of the company. The articles discuss issues like the powers of the
directors, rules for conducting meetings, etc. Both documents are called public document.

A board resolution authorizing the opening of the account is equally important. Without a proper board
resolution, a bank should not open a company’s account. Anything done within the scope of the
Memorandum, supported by a proper resolution, either passed by the board of directors or by the
members at the general body meeting, binds the company. The resolution for opening an account should
be specific and not issued by way of circular. When resolution is given, the banker has to verify details
regarding: (a) the proper quorum at the meeting,( b) the date and venue of the meeting mentioned,( c)
the genuineness of the extract of the minutes of the meeting. For the purpose of bank dealings (such as
opening of a/c, its operations, and seeking finance) generally the board resolution contains three parts:

1. Name of the bank where the account is to be opened.

 2. Name of the persons who will operate the a/c on behalf of the company
3. Borrowing powers, if any, of authorized persons.

Regarding the borrowing powers, the resolution must state the type and quantum of credit facility
required. It should also state the type of securities to be offered, who will sign the loan documents and
other related issues relating to the credit facility sought. The resolution could be:

OTHER SERVICES RENDERED BY BANKS

BANCASSURANCE

With growing competition on account of many players in the field of banking, there is a need to increase
the income. Income out of banking business alone may not be sufficient. With the Government decision
to open up the scope in the field of insurance – both Life and Non-life (General) – bankers have got an
opportunity to enter into insurance business. They can participate with insurance companies on a
“Referral” basis or on a “Corporate Agency” basis.

Since these banks are already established and have their regular customers, the same is considered as an
opportunity (better platform) to offer other services as well. Based on the Universal Banking principles,
customers now get additional services under a single roof.

Under the “Referral” basis, banks collect information and pass on the same to the insurance company
with whom they have entered into an agreement. Then, the insurance company representatives
approach such customers and try to sell their insurance products. Since the insurance company has got
the contact through the bank and this has resulted in business, such insurance companies pay a sort of
commission to the bank. This is additional income the bank earns for the services rendered.

The “Corporate Agency” basis means that the bank staff will sell the products of insurance companies at
their premises. Since the space, infrastructure, staff members’ services are utilized, the return, by way of
income, is more for the bank.

The customers are able to get additional service in a single place under both bases. Since bank
employees interact with a cross-section of customers, they are better exposed to handle customers

PLASTIC MONEY

Innovative products attract people and the banking field is not an exception. A number of innovative
steps are being taken on an ongoing basis. The introduction of plastic money has helped the clients as
this provides a value added service.

Credit cards are issued by the banks after assessing the need of the person, his capacity to utilize the
credit limit fixed and returning the money utilized. The advantage for the customer is that the plastic
cards are easy to carry. Both credit and debit cards are popular. With the help of these cards, the
carrying of hard cash is avoided. The usage of travelling, etc, has increased its popularity. A card holder is
able to get credit at short notice and can also avail of the add-on facility. A debit card enables the
customer to use only the available balance in the account. This can bring a sort of discipline in one’s
savings and spending.

ATM

In order to provide a round-the-clock service beyond the usual banking place and hours, ATMs have been
installed by almost all the banks. This system provides customers easy accessibility and convenient
withdrawals as well as deposit cash and charges. The ATMs serve as banks and also extend the anytime
banking facility. It has become so popular that banks have started offering the ATM service even away
from the banking premises. ATMs are installed at strategic locations, to enable the customers to avail of
the services. From the angle of cost saving, banks have adopted shared ATM machines, which help the
customers of different banks to use the same machines.

TELE BANKING

In this system, the computer at the bank-end is linked to a telephone connected to a modem. Based on
the voice processing facility and the available software, the bank customer is served. This saves time as
the customer need not visit the bank premises.

INTERNET BANKING

This is one more service available to bank customers. Using the internet facility, bank customers can
interact with their bankers and the information / clarifications are provided online with regard to their
account or banking schemes, etc. This service is very quick and works out cheaper and serves the
customer better. Banking through mobile phone is also available.

BANK MARKETING SERVICES

Organizations have to be in tune with changing times. At present, banks are showing a keen interest in
setting up exclusive departments to market their various products along with other products. With the
shift towards Care Banking Solutions the excess staff members at the branch locations are trained to
market the products effectively. By moving out of their premises and visiting the places of the customers,
the bankers are able to save the customers’ time and explain to them about various products along with
the value added services extended by banks. A bank, with a well-experienced / trained marketing set up
can have an edge over other competitors and corner the business for the bank. Since varied services like
banking coupled with insurance, mutual fund and other products will be available at their doorstep,
customers will be willing to welcome the move by the bankers,
UNIT FOUR

NEGOTIABLE INSTRUMENTS

NEGOTIABLE INSTRUMENTS
There are basically three negotiable instruments

· Promissory Note

· Bill of Exchange

· Cheque.

Negotiation refers to transfer of title (right to receive payment) from one person to another. The
instruments that help the person to achieve this transfer are called negotiable instruments. This title
transfer can be effected based on the characteristics of respective instruments and the nature of such
instruments. Thus negotiation plays a crucial role.

The following are the basic aspects of negotiable instruments:

1. It is an unconditional instrument in writing, signed by the maker directing a certain person
(including himself in the case of a promissory note) to pay a certain sum of the money.
2. The money has to be paid to a certain person or as per direction (may be a bearer or an order).
3. It has to be dated.
4. It is valid only when it is supported by consideration (value received)

Sec 4 of the NI Act 1881 deals with the promissory note. It is an undertaking in writing, signed by the
maker (promisor) undertaking (promises) to pay to a certain person (promisee) or his bearer or his order
(as the case may be). Accordingly issuing of bearer promissory note is prohibited as it amounts to
currency note.

Section 5 of the NI Act deals with the bill of exchange. A bill of exchange is an instrument in writing
signed by the maker (drawee) to make the payment on the bill, a certain sum of money to a certain
person (payee) or to his bearer or order. It is an unconditional instrument. Consideration for the
transaction is essential. The Bill has to be dated.

Section 6 of the NI Act deals with cheques. A cheque is a bill of exchange drawn on a specified banker
and payable on demand (Section 72 of the Bill of Exchange Act 1961 – Act 55). All the characteristics of a
bill of exchange are applicable to a cheque. The additional requirement is that it has to be drawn on a
particular bank (specified bank) and is always payable on demand. It is transferred based on whether it is
payable to bearer or order. If payable to bearer then transfer of title is effected by mere delivery. If it is
payable to order, then transfer is possible by way of endorsement, which is to be followed by delivery.
Crossing (both general as well as special) is applicable only to cheques (Sec.123 & 124 of NI Act 1881).

FEATURES OF A NEGOTIABLE INSTRUMENT

1. Free Transfer: There is no formality to be complied with the transfer of a negotiable instrument. It
can be very easily transferred from one person to another, either by mere delivery, or by endorsement
and delivery.

2. Transfer free from defect: It confers an absolute and good title on the transferee. Even if the
transferor has a bad title to the instrument, he can still pass on a good title to any holder who takes it in
good faith and without negligence and for valuable consideration. Thus it cuts off prior defects in the
instruments.

3. Right to sue: It confers a right on the holder to sue in his own name, in case of need.

4. No notice of transfer: The transferor of a negotiable instrument can simply transfer the document,
without serving any notice of transfer to the party who liable on the instrument to pay.

5. Presumptions regarding negotiable instrument: It is presumed that the instrument has been
obtained for consideration. Also, there are other presumptions regarding date, time of acceptance, time
of transfer, order of endorsement, stamp, holder to be holder in due course. (Section 118-119 of the NI
Act).

IMPORTANT ASPECTS OF NEGOTIABLE INSTRUMENT ACT

Similarities and differences between a cheque and a bill of exchange

1. Both are considered as Negotiable Instruments.

2. Both are signed by the maker (drawer) directing the other person (drawee) to make the
payment to a certain person or to bearer or the order.
3. Both should specify the amount.
4. Both should be dated.
5. A bill needs to be stamped whereas a cheque need not be stamped.
6. A bill may be drawn on any person, whereas a cheque has to be drawn on a specified bank only.
7. A bill may be a demand bill or acceptance bill, whereas a cheque should always be a demand
instrument.

CHEQUES

A cheque is a bill of exchange drawn on a specified banker and payable on demand:

An open (uncrossed) cheque is different from a crossed cheque. In an open cheque, the intention of the
drawer is that his/her bank has to make a cash payment to the payee. It is also known as payment over
the counter. Before making payment of an uncrossed cheque a drawee banker (paying bank) has to
examine certain aspects such as whether:

1. It is a cheque payable to bearer

2. It is a cheque payable to order, then the bank may pay only after satisfying about the payee’s
identity.
3. It is stale cheque (date of the cheque has crossed six months period) / not post dated.
4. The words and figures match
5. The signature of the drawer / authorized person matches with that of the specimen signature
(mandate) lodged with the bank.
 6. The account has sufficient balance to meet the cheque amount or proper arrangement is made
in this regard.
7. Any stop payment instrument that has been received is noted or not.

After satisfying itself with all the above aspects, the paying bank may make the payment to get necessary
protection under the NI Act 1881.

CROSSING OF CHEQUES.

A crossed cheque bears two parallel lines on the face of the cheque. Generally, it is drawn on the left-
hand top corner of a cheque. Once a cheque is crossed, then the paying banker is prevented from
making the payment over the counter (cash payment). A crossed cheque has to be paid through a bank.
It should be routed through a bank account.

TYPES OF CROSSING
There are basically two types of crossings: general crossing and special crossing.

GENERAL CROSSING: The important requirements of a general crossing are:

1. It must have two parallel lines
2. In addition, it may contain the words “and company” or “Not negotiable” or any other
abbreviations like Account payee only (Sec.75(1) of the Bill of Exchange Act 1961)
i.e.

And
Co Not Negotiable A/c Payee

If the cheque is crossed generally, the same could be collected by any bank who acts as a collecting
banker.

SIGNIFICANCE OF GENERAL CROSSING

a) The effect of general crossing is that it gives a direction to the paying banker.
b) The direction is that, the paying banker should not the cheque at the counter. It should only to a
fellow banker

SPECIAL CROSSING:

The extension of general crossing leads to special crossing. In addition to the features of the general
crossing, when the name of the bank appears on the face of the cheque, then the cheque has been
crossed specially. Even a mere name of the bank appearing on the cheque, without crossing also
amounts to special crossing. The addition of the name of a bank is essential for a special crossing. This
will prevent any other bank from acting as a collecting bank. If a cheque bears a special crossing, then the
bank whose name appears has to be the collecting bank.
Example:

UBA Bank Account Payee – GCB

In the above cases, the cheques are to be collected (or routed) through the bank accounts of respective
banks. As compared to a general crossing, the special crossing gives a better protection.
The paying bank has to be satisfied that the bank whose name has been mentioned on the cheque
(specially crossed) has collected the cheque. If it overlooks this and pays, then the same may not be
treated as payment in due course.

SIGNIFICANCE OF SPECIAL CROSSING

a) It is also a direction to the paying banker. The direction is that the paying banker should pay the
cheque only to the banker whose name appears in the crossing or to his agent.
b) If a cheque specially crossed to a bank is presented by another bank, not in the capacity of its agent,
the paying banker is justified in returning the cheque.

ACCOUNT PAYEE CROSSING:

The popular crossing known as “Accounts Payee” crossing is neither defined nor discussed in any Act.
However, in practice, the courts have recognized the importance of such a type of crossing. Account
payee crossing is an indication that the payment has to go to the payee’s account mentioned. Account
payee crossing serves as a better protection. Both the collecting bank and the paying bank have their
responsibilities with regard to this type of crossing. The collecting bank has to ensure that it is collecting
only for the payee mentioned. The paying bank has to see that the collecting banker has NOT collected
for any other than the payee mentioned. (House Property Co. of London vs. London Country and
Westminster Bank Ltd 1915)

SIGNIFICANCE OF A/C PAYEE CROSSING

A/c payee crossing does not restrict the transferability of cheques. In British Bank of Middle East vs.
Abmal Brothers, the drawer of a cheque (Abmal Brothers) pleaded, that since the cheque had been
marked a/c payee only, the negotiation on it was null and void, but it was held that A/c payee crossed
cheque can be negotiated. However, if the words “or order” which appear immediately after the payee’s
name are struck through and if the cheque is crossed A/c payee, that cheque will be considered to be not
transferable.

This type of crossing gives a further protection to a cheque. This crossing gives a direction to the
collecting banker. The direction is that the collecting banker should not collect it for any person other
than the payee. In other words, the collecting should ensure that, the cheque is credited only to the
account of the payee. Hence, practically, such cheques cannot be negotiated further.

If a collecting banker collects such a crossed cheque for any person other than the payee, it will
constitute negligence on the part of the collecting banker and he will lose protection under the law.
NOT NEGOTIABLE CROSSING

“Not Negotiable” crossing serves as a caution to the persons who are dealing with the cheque. A cheque
with a not negotiable crossing can be passed on by the payee (transferor) to another person (transferee).
However, the transferee has to be careful. Otherwise, he/she would carry the same title the transferor
had at the time of transferring to him or her. If the transferor had a bad title (i.e. if he were not entitled
to receive payment / no title) then the same would be passed on to the transferee.

SIGNIFICANCE OF NOT NEGOTIABLE CROSSING

“Not Negotiable” does not mean not transferable. Not negotiable crossing does not affect the
transferability, but it kills only the negotiability. Negotiability is something different from transferability.
Negotiability is a broader term which includes transferability. As per law, negotiability means
transferability by mere delivery or endorsement and delivery plus transferability free from defect.
Transferability does not posses the second quality, namely, transfer free from defect, so one part of
negotiability is transferability. In other words, if a document is a negotiable one, a bonafide transferee
who receives it in good faith and for value paid, can obtain a good title, despite the fact that the
document has prior defect. In case a document is a not negotiable instrument, the transferee cannot
obtain a good title, when there is a prior bad title.

Hence, no one can be a holder in due course in the case of a not negotiable instrument. In Hibernian
Bank Ltd. vs. Gysin and Hansan, it was held that the words “not negotiable” when they appear on a bill
must be assigned their ordinary meaning in law, i.e. the instrument is deprived of one of the most
important characters of negotiable instruments, namely, transferability free from defects. Thus, a
cheque crossed not negotiable can be transferred like any other cheque, but the transferee cannot
obtain a better title than that of the transferor. “A person taking a cheque crossed generally or specially,
in either case bearing the words “not negotiable”, shall not have and shall not be capable of giving a
better title to the cheque than that, which the person form whom he took it had.” (Sec. 130 of the
Negotiable Instrument Act)

SOME IMPORTANT ASPECTS OF ENDORSEMENT

a) It has to be in writing. Generally, it is done on the reverse (back) of the cheque.

b) In case there is sufficient space for further endorsements, the same can be effected by attaching a
piece of paper to the instrument. This paper which is attached is known as allonge. In that case, while
effecting further endorsements a portion of the same should appear on the cheque and the other
portion on the allonge.
c) For bearer instruments, transfer of title can be effected by way of mere delivery. Hence,
endorsements do not carry any importance for bearer instruments.
d) For order instruments, the title can be trandferred only by endorsement and it is only then followed
by delivery. In other words, without proper endorsements, title on an order instrument cannot be
transferred (shifted).
e) Endorsement of a negotiable instrument, supported by delivery, transfers the right of the property
to an endorsee. He/she has the right to negotiate further.
STOPPED CHEQUES PROCEDURE

Customers have the right to stop any cheque they have issued. When stopping a cheque, a customer
must provide his bank with clear and unambiguous details which identifies the cheque. The “stop”
should be in writing and signed by the account holder or the person mandated to operate the account.

When a bank returns a stopped cheque, the usual reason to be stated in red on the cheque is “Payment
countermanded by the drawer” or “Orders not to pay”.

Occasionally, a bank may accept stop instructions from a payee, and when this arises the reason stated
on the cheque for returning it should be “Payment countermanded at the request of payee – drawer’s
confirmation awaited”.

The bank should be expressly advised of the stop in writing. When notice has been communicated to the
bank and the bank has not actually seen or read it, the stop is ineffective. When the letter is in the post,
the stop is ineffective. It only becomes effective when the bank opens the letter and becomes aware of
the contents: Curtice vs. London City and Midland Bank Ltd. (1908).

In stopping the payment of any cheque the notification of the correct number is essential. If a customer,
when giving his bank details of a stop provides them with the wrong cheque number, the bank will not
be liable for paying the cheque that the notice was intended to stop. Westminster Bank Ltd. vs. Hilton
(1926). In this case, the bank paid a cheque, thinking it was a duplicate bearing a later number. The
customer advised the bank for the incorrect number when giving the stop instructions. The House of
Lords held that the bank was absolved from liability, as the one sure means of identification is the
cheque number.

Payment of Drafts
In the course of the banking business, bankers issue demand drafts. Demand drafts are order
instruments. While effecting payment of an open draft uncrossed, the banker has to get the payee’s
signature identified (usually from the existing customer) and make the payment. The protection available
for an order cheque under Sec. 85, by virtue of Sec 85 A is available to the bank for payment of a demand
draft.

Material Alteration

According to Sec. 87 of the NI Act 1881, “Any material alteration of a negotiable instrument renders the
same void as against anyone who is party thereto at the time of making such alteration and does not
consent thereto, unless it was made in order to carry out the common intention of the original parties;
and any such alteration, if made by any endorsee, discharges his endorser from liability to him in respect
of consideration thereof”.

The instrument becomes invalid if it has material alterations. A paying banker will not get protection if he
makes a payment of a cheque which is materially altered. This may be with regard to the altering of the
name of the payee, or the date, or the mismatch between words and figures or by making the order
instruction into bearer. These alterations may defeat the intention of the drawer, if paid. If the paying
banker makes a payment on a materially altered cheque, then that amounts to acting with negligence. A
materially altered cheque, if paid will not give a proper discharge. The person making the alteration is
responsible for the cheque. An alteration does not in any way affect the liability of the persons becoming
parties subsequent to the alteration. A holder is not entitled to recover or get money on the basis of an
altered instrument with which he has parted.

UNIT FIVE

OTHER ASPECTS OF BANKING SERVICE

LIEN

The banker has certain rights. One of such rights is the right of lien. Lien is the right to keep in one’s
possession the property belonging to another person till he repays his dues. The right of lien means the
right to retain. The right of lien itself does not permit the right to sell. The right of lien exists as long as
one has in his possession. Once the possession is not with the person, then the right of lien cannot be
exercised. Lien is available without any specific agreement and in effect is a statutory right.

Lien is generally classified into two types: General and Particular. The banker has a general lien on all the
deposits of customers. While the banker has a general lien on all deposits, if the deposit is given as a
security for raising a loan or discharging an obligation, then the lien on the said deposit, the particular
lien, exists till the debt is cleared or the obligation is fulfilled.

E.g. A depositor approaches his bank for a loan against his fixed deposit for GH¢ 10,000. When the said
deposit is taken as security and a loan is granted under pledge, the bank registers his lien on the deposit
receipt and makes a note of this on the ledger or computer system for that particular deposit. This is
known as particular lien. Here, it is noted for a specific performance, i.e. repaying the loan on the
security of the said deposit. If the depositor repays the loan, then the particular lien will be lifted /
cancelled. Lekshmy & KC Shekhar (2007)

General lien covers the entire amount due from the debtor. As per Sec. 171 of the Contract Act, “The
bankers, factors, attorneys of High Court and policy brokers may, in the absence of any contract to the
contrary, retain as security for general balance of account, any goods bailed to them, but no other
persons have a right to retain as a security for such balance of goods bailed to them, unless there is an
express contract to that effect.”

Hence, the banker has a general lien under the following circumstances:
a) When the banker receives goods and securities
b) He has received them for a purpose
c) There is no contract to the contrary
d) Lien covers items which belong to the person who gives it to the banker
e) When the debt is not barred by limitation.

The banker’s lien is an implied pledge. That means that the banker has the right to retain and if need be,
also sell the goods / securities charged to him as the creditor. In the event of the debt not being cleared
he gets the right to sell those goods which came into his possession as a banker in the ordinary course of
banking business.
The banker can exercise his right of lien in the following cases:
a) On goods / securities pledged to him on which he has a lien. He can sell them to adjust the liability of
the debtor.
b) Under Sec. 171, in addition to factors, wharfingers, attorneys of High Court and policy brokers,
bankers can also exercise lien.
c) On the goods of the customer only.
d) For a joint account of the debtor, right of lien is not applicable unless otherwise agreed upon by the
joint account holders.

SET-OFF OR ADJUSTMENT

During the course of business, the banker plays the role of debtor (deposits) and creditor (advances).
While he has the right of general lien on all deposits, the banker is also entitled to use the right of set-
off. Set-off means adjustment.

When the same person (customer) is the debtor and creditor, then the right to set-off is possible.
When a customer has credit balance in one account and the other account is showing a debit balance,
then the banker can adjust the credit balance for the amount due to the bank and arrive at the net
amount due to the customer. Combining the two accounts and arriving at the set-off position is a right
available to the banker.

The following are the features related to the set-off:

a) The right to set-off is a statutory right. It is not applicable to contingent liabilities. The liability has to
be certain.
b) The liabilities are due and the payment is arrived at.
c) The customer has to have the credit and debit balance in the same capacity.
d) The banker has to give prior information about his intention to exercise the right of set-off.
e) The set-off is applicable to those debts which have become due and the creditor has the right to
recover the same at the time of using the right of set-off.
f) For time-barred debt also, the right of set-off is applicable.
- .
.

APPROPRIATION

The banker comes across situations where he has to follow set principles or practices to safeguard the
interest of all concerned. One such principle is known as the “Clayton’s case”. This deals with the
“appropriation of payments”.

When an individual account holder dies, then the balance in his deposit account is settled in favour of
the nominee (if the account holder has named a nominee). In the absence of a nominee, the money will
be remitted in favour of the legal heirs. In case there is no nomination and if there is a will, it will be dealt
with according to the contents of the will.
However, for partnership firm, the same comes to an end (dissolved) on the death, insolvency, insanity,
retirement of a partner(s) or if the provisions of the partnership permit the account to continue even
after the above mentioned events.

In case the account has to be closed in view of one of the above events, then the credit balance lying in
the partnership firm has to be paid to the remaining or existing partners. The amount so paid will serve
the purpose of valid payment. It is advisable to close the old account and open a fresh account, even if
the partnership deed allows for continuance.

If the partnership account shows a debit balance at the time of death, insanity, insolvency or retirement
of a partner, then further operations in the partnership firm’s account are to be stopped forthwith. This
is required to preserve the bank’s right to proceed against the estate of the deceased partner or if the
bank fails to stop operations, then the rule in Clayton’s case will take over.

Application of Clayton’s case of appropriation of payments is as follows:

1. A debtor who has a number of debt accounts has the first right to choose to which account the
payment has to be appropriated (credited). He has to clearly mention his intention at the time of
payment; otherwise the right of appropriation will pass on to the creditor. In fact, the debtor has got the
right to indicate his intention that the amount may be credited even to his deposit accounts. As
required by the debtor, the banker has to carry out the instructions of the debtor.

Example:

Mr. Appiah, a borrower, wished to remit a sum of GH¢ 10,000 towards his personal loan liability
(whereas he has an overdue liability in his home loan, vehicle loan, besides temporary overdraft in the
current account). The banker has to appropriate the amount ¢10,000 to the personal loan account only
and not otherwise, since Appiah has indicated his intention clearly at the time of the payment itself.

2. If the debtor has not indicated his intention at the time of payment, then the creditor has the right to
adjust or appropriate the funds so received. According to his convenience and the manner in which he
feels is appropriate, he may adjust the payment so received. Once the creditor has informed the debtor
about the appropriation, it is binding on both the parties. The same may be altered on the option of the
creditor only.

3. In case of running accounts like the current account, the account first paid in is appropriated (adjusted
) towards the amount first paid out, i.e. first item of the debit side of the account that is discharged.

4. In case of debit balance, the credits in the said account will be appropriated towards the debit in the
chronological order in which they appear in the account. In order to retain or preserve the right of the
bank against the estate of a deceased person/partner, it is required that the banker, on receipt of such
information or announcement should stop the operations and rule off the account (when the same
shows a debit balance).Such an action on the part of the banker will save the banker’s interest.

GARNISHEE ORDER

By approaching a competent court, a creditor may seek prevention of payment to his debtor. This is the
essence of the garnishee order. The banker, in the ordinary course of business, opens accounts for his
depositors. He also lends money to his borrowers. The banker has to repay the same either on demand
(savings/current, or overdue matured) or on the due date or before the due dates in respect of
term/time deposits. In such cases, the banker is the debtor and the customer is the creditor. There is a
possibility that the said depositor may be a borrower of some other banker. This depositor may owe
money to that banker. Since the right of set-off between two banks is not possible, the only way to get
the money from the other bank is to seek the intervention of a competent court. By applying to the
court, the creditor banker requests the court to direct the debtor banker Not to make the payment of
the money deposited with him to his depositor but, instead, to make the payment to him (as the
borrower’s banker). Lekshmy & KC Shekhar (2007)

This process is done through a garnishee order. The garnishee order is applicable for the attachment of
debts which are actually due from the garnishee. The order’s receipt date is important to arrive at the
position of the debt as well as other details. The debt may be payable on the date of the order or may be
due for payment at a future date. However, the date of receipt of order will determine the amount(s)
attachable. The demand deposit balances such as savings bank account balance or current account
balance or the matured term deposits (overdue) are attachable. Term deposits which mature at a future
date are also attachable.

E.g. Mr. Opoku, a customer of GCB, has a savings bank A/c no.377 with a balance of GH¢ 22.345 and a
fixed deposit (FDR no. 22/2005) opened on 30/5/05 for GH¢ 45,000 due on 30/5/2007. Opoku has taken
a loan for GH¢ 50,000 from SG-SSB and the liability is GH¢ 64,895 with interest. Since the banks are
different, the right of set-off is not applicable.

If SG-SSB (creditor bank) requests the court to issue a garnishee order on the GCB directing them not to
pay the amount due to Mr. Opoku (judgment debtor) but to remit the same to them (SG-SSB), the
savings bank account balance as well as the balance of fixed deposit are attached by the garnishee order.
Although the fixed deposit amount is due on 30/5/2007 (since the deposit has been existing on the date
of receipt of the order by the garnishee bank) it is also attachable.

A garnishee order has two parts. Once the court is satisfied about the claim of the creditor bank, it will
issue a direction to the judgment debtor’s bank calling for the details about the accounts due from him
to the judgment debtor. The first part of the garnishee order is called order NISI.

The second and final part is called order Absolute. Through order nisi, the court directs the judgment
debtor’s bank.
1) To freeze or stop all the transactions of the debtor.
2) To explain why funds in the debtor’s account should not be paid to the judgment creditor towards
the money owed by the judgment debtor to the judgment creditor.

Once the order nisi is received, the bank has to stop payment of cheque(s) and send its explanation to
the court. On receipt of the order, the bank has to record the time and date of receipt of the order, the
bank has to record the time and date of receipt. A copy of the order has to be served on the time of
judgment debtor or the garnishee (bank). If at the time of receipt of such an order (order NISI), any
amount is due to them, the same may be recovered and the balance amount may be intimated to the
court. In case the customer owes some amount and does not have any deposit, then the garnishee order
is not applicable. This is because the said bank itself is the creditor and not the debtor.
If the bank does not furnish sufficient cause or the bank replies to the order nisi, the court will issue a
final order known as order absolute. Through the absolute order, the court may direct the bank to pay
the entire or portion of the amount in the account. Once the payment is made as per the directions of
the court, the bank may allow further withdrawals. However, the bank which received the garnishee
order nisi should not part with the funds of the customer until the order is made absolute. Since the
garnishee order attaches the money due and accruing due, it is advisable to open a separate account or
new accounts for further operations. In the event of any cheque received for payment, the same has to
be paid only if there is sufficient balance in the account after satisfying the court order or remitting the
garnishee amount. The payment so made at the direction of the competent court will serve as a
discharge of his liability to the customer.

This means that had there not been a garnishee order, in the ordinary course of business, a banker
would be paying to his customer or as per his direction, his deposit money and thereby it gets the
discharge of his liability. In view of the garnishee order, the banker makes the payment of the customer’s
deposit money to the court, and automatically gets discharged of its liability to his depositor. Lekshmy &
KC Shekhar (2007)

ATTACHMENT ORDERS

Bankers receive not only garnishee order, but also attachment orders issued by Government
departments for their dues to be received from the bank’s customers. The bank has to understand the
contents of such attachment order, when received, and act accordingly. The income tax department
based on the rights conferred on them may send attachment order advising the bank to pay the amount.
They can attach any debt or amount.
a) due and payable
b) due and not payable
c) received subsequently.

If the attachment order is for the amount lying in a joint account, but on account of one of the joint
account holders then also the attachment order is applicable. Accordingly, 50% is considered as the
money due to one of them (in the case of 2 persons holing the joint account and the order is received for
one of them). Accordingly, the bank has to effect the order. The request of the customer(s) not to effect
the payment should not be considered nor recognized.

LOANS AND ADVANCES

LOANS AND ADVANCES: DEFINITION AND CONCEPTS

Lending is the basic function of banks which involves the process of granting loans and advances. While
loans and advances essentially mean lending of money, and are used interchangeably, there is an
inherent difference between the two. The term “advance is commonly used as a process of lending
against certain underlying security such as shares, banks own fixed deposit; whereas the term “loan”
signifies the process of granting a loan which, as per its tenor, is classified as short-term loan, medium to
long-term loan.

PRINCIPLE OF LENDING

A banker is always concerned with the money which he has lent, and to ensure that what he has lent is
repaid he has to follow certain cardinal principles of lending which have evolved over a period of time.
These lending principles are:

Principle of Safety of Funds:

Safety of funds is ensured when money lent comes back through repayment as per sanction terms. This
depends upon the willingness of the borrower to repay, his honesty and integrity and his financial
standing.

Principle of Profitability:

The objective of giving a loan is to earn sufficient income that will not only take care of the cost of money
raised but also the cost of operation and premium of loan default. The pricing of loan is done keeping
these aspects in mind.

Principle of Liquidity:

If the money lent is not received back as per terms, a bank may face liquidity problem in meeting its
commitments to depositors. The other reason affecting liquidity is the account turning into NPA and
asset-liability mismatch due to leveraging of short-term sources for financing of long-term assets.

Principle of Purpose:

Traditionally, banks lend only for productive purposes so that enough surplus is generated by the activity
to repay the loan. Of late, banks have started granting loan for consumption purposes like loan for the
purchase of consumer goods, education, housing, etc where quantum of loan is decided upon by the
capacity of the borrower to repay.

Principle of Risk Spread:

This risk is managed by financing borrowers of different strata of society, residing in a wide geographical
area and engaged in different types of industries and trades.

Principle of Security:

Here, it is attempted to make an in-built arrangement in the loan process to fall back on, in case a
borrower turns willful defaulter or fails to repay due to failure of his business. For loans granted to
weaker sections of society or to tiny and village industry for social consideration, banks are prohibited
from insisting on security. All loans are usually backed by third-party guarantee and collateral security,
which banks insist upon before sanctioning loans.

While accepting security, the bank is required to satisfy itself that the security is marketable (can be sold
with least delay and / or inconvenience), stable (non-perishable), ascertainable (can be identified) and is
transferable (can be transferred to intended buyer both physically and legally). To further safeguard its
interest, the bank generally stipulates insurance against various risks, so that in case of any unforeseen
eventuality or loss of security, the money can be realized from the insurance company.

PRE-CREDIT APPRAISAL STANDARDS

The process of giving a loan is divided into four parts; pre-sanction credit appraisal, sanction,
documentation and monitoring, and follow-up. Pre-credit appraisal is the most critical part of the lending
process since it is through this process that the bank takes a decision to accept or reject a loan proposal.
The terms and conditions, on which the loan is sanctioned, are decided through the appraisal process.
The quality of appraisal ultimately determines the quality of loan assets.

(a) Managerial competence, which determines the capacity and competence of the proponent to do
business. A credit officer should ascertain the background of the proponent, his work experience, his
qualification, his market report and his past dealings with other banks, if any, so as to satisfy himself
about the honesty, integrity and business ability of the applicant borrower. In the case of a legal person,
like a limited company, the officer should examine its charter so as to satisfy himself that the company
can engage itself in a particular line of business and has the requisite powers to borrow and execute
documents. The credit officer should examine the adequacy and suitability of the management structure,
quality of management and management capability under stress, personnel policies including succession
planning, bargaining power with suppliers and financial strength.

b) Technical feasibility, which involves assessment of availability of technology, latest or proven, to

produce the required quantity and quality of goods. It also involves assessing the availability of skilled
manpower, availability of raw material, availability of machinery, pollution or environmental clearance
required, if any, so that the project can be completed without time or cost overrun.

c) Market appraisal, which is done through demand forecasting and simulating demand through product
promotion and selling strategies. Market appraisal also involves assessment of competitive advantage
which the unit enjoys, economic and social trends which may have a bearing on the demand for the
product, who are the major buyers; whether the market demand is stable, seasonal or permanent; what
substitutes are already available in the market; what is the extent of competition from abroad; what are
the import restrictions; what is the product range; what product mix is available; what distribution set up
is required for marketing the product; how government policies are likely to impact the future of the
industry; and whether raw material, skilled labour, power, etc, are available for uninterrupted
production.

d) Financial viability, which is determined by the assessment of cost of the project and promoter’s ability
to raise requisite resources to meet the same. This also involves analyzing the financial health of the
borrower by examining current ratio, debt equity ratio, interest coverage ratio, etc. Cash flow statement
is also analysed to ensure that a large borrower will be able to serve his commitment for letter of credit,
payment of installment and service monthly interest.
e) Financial requirement of the borrower for acquiring fixed assets and meeting working capital
requirement, which is the final part of the appraisal process. Terms and conditions of loan, interest rate,
margin, security – both primary and collateral – repayment terms, period of limit and documents to be
executed, are all determined through this process.

APPRAISAL OF TERM LOAN

A unit requires funds for purchasing various items of fixed assets such as land and building, plant and
machinery, electrical installation and other preliminary and pre-operative expenses. These fixed assets
are used over a period of time to produce goods or services which enable the unit to earn profit, thereby
helping it to repay the loan. The term loan is sanctioned by a loan agreement, which specifies terms and
conditions and covenants on which the loan has been sanctioned, including repayment terms. These
assets created out of the bank loan are charged/hypothecated go the bank as security. While
determining the quantum of finance, a banker has to make assessment of actual cost of assets to be
acquired, margin to be contributed, sources of repayment, etc. The appraisal of term loan broadly
addresses the following:

1. Financial viability

To conduct financial viability, a credit officer is required to assess:

(a) Cost of project: The cost of project generally consists of :

i) Cost of land and its development,

ii) Cost of construction of sheds, building, boundary walls, go-down, etc,

iii) Cost of plant and machinery including electrical installation,

iv) Miscellaneous fixed costs for effluent collection treatment, vehicles, office tools, office furniture
and fixtures,

v) Preliminary and pre-operative expenses which are capitalized

vi) Margin for working capital.

(b) Means of Financing: Means of financing companies:

( i) owners’ capital,

ii) reserves and surplus,

( iii) retained profit,

(iv) long-term loan from bank, and

(v) subsidy

(c) Cost of Production and Profitability: All elements of cost of production are realistically assessed on
the basis of past trend (for existing units) or industry benchmarks. Estimated profitability is thereafter
determined after deducting cost from estimated income.

(d) Cash Generation and Debt Service Coverage Ratio: The relationship between the repayment
capacity (cash generation) and commitments is expressed in terms of debt service coverage ratio
(DSCR). DSCR is calculated using the following formula:

DSCR = Profit after tax + Depreciation + interest on term loan and deferred credit / repayment of
installments on term loan and deferred credit + interest on term loan and deferred credit.

The ratio indicates the coverage of liability of the borrower to pay interest and principal out of expected
cash generation. DSCR is used to determine

(i) when the repayment of the should start,

(ii) how many installments can be fixed,

(iii) what the repayment period should be.

(e) Break-Even Analysis: Break-even analysis is also known as cost-volume-profit analysis. Knowledge of
break even point (BEP) provides an insight into the possible risk of a borrower by conducting sensitivity
analysis of change in cost or sale price per unit to determine the level at which the unit may incur loss.
BEP is calculated as:

BEP in sales = Fixed cost x sales value / contribution where contribution = sales price per unit – variable
cost per unit