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Chapter 9

The Law of Banking

What is a bank?

A bank is a financial institutions and a financial intermediary that accepts deposits and
channels those deposits into lending activities, either directly by loaning or indirectly
through Capital Market. A bank links together customers that have capital deficits and
customers with capital surpluses.


Deposit account is a savings account, current accounts or other type of bank account, at a
banking institution that allows money to be deposited and withdrawn by the account
holder. These transactions are recorded on the bank's books, and the resulting balance is
recorded as a liability for the bank and represents the amount owed by the bank to the
customer. Some banks may charge a fee for this service, while others may pay the customer
interest on the funds deposited.

Capital Market

Markets for buying and selling equity and debt instruments. Capital markets channel savings
and investment between suppliers of capital such as retail investors and institutional
investors, and users of capital like businesses, government and individuals. Capital markets
are vital to the functioning of an economy, since capital is a critical component for
generating economic output. Capital markets include primary markets, where new stock and
bond issues are sold to investors, and secondary markets, which trade existing securities.


Types of banks

There is lot of types of Banks. However, for the purpose of this lecture, we will discuss the
definition of conventional banks and investment banks only.

1. Conventional banks

A financial institution that provides services, such as accepting deposits, giving business
loans and auto loans, mortgage lending, and basic investment products like savings accounts
and certificates of deposit. The traditional commercial bank is a brick and mortar institution
with tellers, safe deposit boxes, vaults and ATMs. However, some commercial banks do not
have any physical branches and require consumers to complete all transactions by phone or
Internet. In exchange, they generally pay higher interest rates on investments and deposits,
and charge lower fees.

Please differentiate with Islamic banking for holistic understanding of the banking business.

2. Investment bank

A specific division of banking related to the creation of capital for other companies.
Investment banks underwrite new debt and equity securities for all types of corporations.
Investment banks also provide guidance to issuers regarding the issue and placement of

Negotiable Instruments

A negotiable instrument is a document guaranteeing the payment of a specific amount of
money, either on demand, or at a set time with the payer named on the negotiable
instrument. More specifically, it is a document contemplated by a contract, which warrants
the payment of money without condition, which may be paid on demand or at a future date.


We may say that it is a form of transfer of ownership from one person to another. The
document is an evidence of a contractual obligation to pay money. Examples of negotiable
instruments are bills of exchange, cheques, bank draft, bank notes etc.

A cheque is defined in section 73 of the Bills of Exchange Act 1949 as a bill of exchange
drawn on a banker payable on demand.

The bank will pay the amount stated on the cheque. Now, cheques will be printed with the
notice that the cheque must be cash in before the end of six months period. Failure to cash
in the cheque after six months will render the cheque as stale cheque. The Bank is not
under the duty to honor undated cheques or forged cheques. In a case of a forged cheque,
there is no authority from the customer to debit the customers account.

In practice, the Bank will call the customer if there is a cheque issued and the amount is
quite substantial. The Bank also will send out bank statement to their customers. The Bank
statement will require the customer to revert to the Bank within certain number of days
after receiving the statement. If the customer does not revert to the Bank, the transactions
itemized in the bank statement will deemed to be accurate and authorized by the customer.

To minimize the risk of forged cheque, the Bank also in practice will not honor any cheque,
which has been altered, erased, or amended.

Protection of paying banker

When a customer draws a cheque, his banker will be known as the paying bank. The bank
must perform its duty in accordance with the instruction by the customer. The common
mistake is payment to the wrong party. However, the bank may rely on the provision of
section 59 of the Bill of Exchange Act 1949:-

(1) A bill is discharged by payment in due course by, or on behalf of the drawee or
acceptor. Payment in due course means payment made at or after the maturity of
the bill to the holder thereof in good faith and without notice that his title to the bill
is defective.
(2) Subject to the provisions hereinafter contained, when a bill is paid by the drawer or
an indorser it is not discharged; but:
(a) where a bill payable to, or to the order of, a third party is paid by the drawer,
the drawer may enforce payment thereof against the acceptor, but may not
reissue the bill;
(b) where a bill is paid by an indorser, or where a bill payable to drawers order is
paid by the drawer, the party paying it is remitted to his former rights as regards
the acceptor or antecedent parties, and he may, if he thinks fit, strike out his
own and subsequent indorsements, and began negotiate the bill.
(3) Where an accommodation bill is paid in due course by the party accommodated, the
bill is discharged.

payment in due course means the bank make the payment to the holder of the cheque
without any notice that the holders title is defective.

The bank also may rely on section 60 of the Bills of exchange Act 1949

When a bill payable to order on demand is drawn on a banker, and the banker on
whom it is drawn pays the bills in good faith and in the ordinary course of business, it
is not incumbent on the banker to show that the indorsement of the payee or any
subsequent indorsement was made by or under the authority of the person whose
indorsement it purports to be, and the banker is deemed to have paid the bill in due
course, although such indorsement has been forged or made without authority.

Section 82 of the Bills of Exchange Act 1949 also accords a protection the paying bank.

(1) where a banker in good faith and in the ordinary course of business pays a cheque
drawn on him which is not indorsed or is regularly indorsed, he does not, in doing
so, incur any liability by reason only of the absence of, or irregularity in,
indorsement, and he is deemed to have paid it due course.
(2) Where a banker in good faith and in the ordinary course of business pays any such
instrument as the following, namely:
(a) a document issued by a customer of his which, though not a bill of exchange, is
intended to enable a person to obtain payment from him of the sum mentioned
in the document;
(b) a draft payable on demand drawn by him upon himself, whether payable at the
head office or some other office of his bank;

he does not, in doing so, incur any liability by reason only of the absence of, or
irregularity in, indorsement, and the payment discharges the instrument.

The key words in section 82 are good faith and in the ordinary course of business.

Lastly, the paying bank can rely on section 80 of the Bills of Exchange Act 1949, which is
exclusive to crossed cheque.

Where the banker, on whom a crossed cheque is drawn, in good faith and without
negligence pays it, if crossed generally, to a banker, and if crossed specially, to the
banker to whom it is crossed, or his agent for collection, being a banker, the banker
paying the cheque, and, if the cheque has come into the hand of the payee, the
drawer, shall respectively be entitled to the same rights and be placed in the same
position as if payment of the cheque has been made to the true owner thereof.

Protection of the collecting bank

A collecting banker is the bank that the holder of a cheque presents the cheque to be
credited in the account of the cheque holder. A collecting banker may be liable to its
customer for breach of contract.

Protection to the collecting banker was provided under section 85 of the Bill of Exchange Act

(1) Where a banker, in good faith and without negligence:
(a) receives payment for a customer of an instrument to which this section applies;
(b) having credited a customers account with the amount of such instrument,
receives payment thereof for himself; and the customer has no title, or a
defective title, to the instrument, the banker does not incur any liability to the
true owner of the instrument by reason only of having received payment
(2) This section applies to the following instruments, namely:
(a) cheques;
(b) any document issued by a customer of a banker which, though not a bill of
exchange, is intended to enable a person to obtain payment from that banker
upon himself, whether payable at the head office or some other office of his

(3) A banker is not to be treated for the purposes of this section as having been
negligent by reason only of his failure to concern himself with absence of, or
irregularity in, indorsement of an instrument.

A collecting banker acting in good faith and in the absence of negligence, receives payment
of a cheque for a customer without no title, the collecting banker is not liable to the true
owner. The collecting Banker must prove the presence of the following elements:-

1. the Collecting Bank is acting on behalf of its customer who maintains an account
with the Bank.
2. The Collecting Bank is acted in good faith and without negligent as defined in section
95 Bills of Exchange Act 1949.

A thing is deemed to be done in good faith, within the meaning of this Act, where it
is in fact done honestly whether it is done negligently or not.

Whether the collecting bank is negligent, it is a question of facts. However, the test of
negligence; is whether the transaction of paying in any given cheque was so out of ordinary
course that it ought to have aroused doubts in the bankers mind, and caused the collecting
bankers to make inquiry. Hence, we may conclude that if the cheque conforms with the
banking industry standard, the collecting bank may be said acting in good faith without

Termination of a bankers authority to pay

The duty of the bank to honour the customers cheque is up to the customers credit balance
or any agreed overdraft.

The bankers authority to pay a cheque may be terminated in the following ways:-

1. Countermand of payment.
- instruction from customer to cancel the payment.
- Can be oral or writing.

2. Notice of the customers death.
- the authority to pay stop when the bank receive a notice of the customers

3. Notice of the customer becomes insane.

4. Garnishee order attaching the customers monies.

5. Knowledge that the customer committed an act of bankruptcy.

6. Defect in presenters title.

7. Customer commits a breach of trust for a trust fund.

8. Customer had assigned his money to third party.

9. Notice that the customer had closed his account.

10. Insufficient fund in the account.