CHAPTER 1

INTRODUCTION TO BANKING SYSTEM

1.1. NTRODUCTION
Banking system generally consists of commercial banks, savings and loan associations, credit
unions, and other financial institutions. Money goes round and round: individuals receive money
in the form of salaries, wages, which they spend on goods and services. This process of moving
money from person to person and business to business is facilitated by a net work of financial
institutions. The main source of banking services for business, however, remains with
commercial banks. Commercial banking and central banking occupy quite an important place in
the framework for every country’s economy.

1.2. The Evolution, Origin and Growth of Commercial Banking

The word “bank” is used in the sense of a commercial bank. It is of Germanic origin though
some persons trace it to the French word ‘Banqui’ and the Italian word ‘Banca’. It referred to a
bench for keeping, lending, and exchanging of money or coins in the market place by
moneylenders and moneychangers.

As early as 2000BC Babylonians had developed a system of banking. In ancient Greece and
Rome the practice of granting credit was also widely prevalent. During the early periods,
although the banking business was mostly done by private individuals, many countries
established public banks either for the purpose of facilitating commerce or to serve the
government .The bank of Venice established in 1157 to finance the monarch in his wars is
supposed to be the most ancient bank. After wards in 1401 a public bank was established in
Barcelona. During 1407 the bank of Genoa was established. The bank of Amsterdam was
established in 1609. However, modern banking began with the English gold smith only after
1640.

The business of goldsmith was such that he had to take special precautions against theft of gold
and jewelers. As evidence of receiving valuables, he (the gold smith) issued receipt. Since gold
and silver coins had no marks of the owner, the goldsmith started lending them. As the goldsmith
was prepared to give the holder of the receipt an equal amount of money on demand, the
goldsmith receipts became like checks as a medium of exchange and a means of payment.

The next stage in the growth of banking is the money lenders. The goldsmith found that on an
average the withdrawals of coins were much less than the deposits with him. So he started
advancing the coins on loan by charging interest. As a safeguard, he kept some money in the
reserve. Thus, the goldsmith moneylender became a banker who started performing the two
functions of modern banking that of accepting and advancing loans.

The evolution of banking which lasted for centuries until two types of modern banking
developed in the industrially advanced economies in the late 19th century was an integral part of
the expansion of capitalism. The techniques of banking developed in the 17th century facilitated
the industrial and territorial expansion that began about the same time. The two systems of
banking are the market oriented financial system (Anglo Saxon) characterized by a division of
functions and the bank oriented financial system (central European) characterized by universal
banking. In a market oriented financial system, specialized financial institutions including banks,
financial markets and market intermediaries cater to the different financial needs. In a bank
oriented financial system savings are largely transferred directly from those who generate them
to those wishing to use them by the intermediation of banks. Britain with her functional
specialization represents a market oriented financial system while Germany with her tradition of
universal banking has a bank oriented financial system.
1.3. Definition of a Bank
The term ‘Bank’ has been defined in different ways by different economists. A few definitions
are:
 Chamber’s Twentieth Century Dictionary defines a bank as an “institution for the keeping,
lending, and exchanging, etc. of money.”
 According to Kent”a bank is an organization whose principal operations are concerned with
the accumulation of the temporarily idle money of the general public for the purpose of
advancing to other for expenditure.
 According to Sayers” Ordinary business consist of changing cash for bank deposits and bank
deposits for cash from one person or corporation to another, giving bank deposit in exchange
for bills of exchange , government bonds, the secured and unsecured promise of
businessmen to repay, etc.

Thus a bank is a financial institution which accepts deposits of money from the public for the
purpose of lending or investment repayable on demand or otherwise withdrawn by checks, drafts
or order or otherwise.”
We can say that a bank is a financial institution which deals in debts and credits. It accepts
deposits, lends money and also creates money. It bridges the gap between the savers and
borrowers. Banks are not merely traders in money but also in an important sense manufacturer of
money.
1.4. TYPES OF BANKS
Broadly speaking, banks can be classified into commercial banks and central bank.Commercial
banks are those which provide banking services for profit. The central bank hasthe function of
controlling commercial banks and various other economic activities.

1.4.1. Commercial banking

A commercial bank is a profit-seeking business firm, dealing in money and credit. It is a

financial institution dealing in money in the sense that it accepts deposits of money from the
public to keep them in its custody for safety. So also, it deals in credit, i.e., it creates credit by
making advances out of the funds received as deposits to needy people. It thus, functions as a
mobiliser of saving in the economy. A bank is, therefore like a reservoir into which flow the
savings, the idle surplus money of households and from which loans are given on interest to
businessmen and others who need them for investment or productive uses.
Thereare many types of commercial banks such as deposit banks, industrial banks, savings
banks,agricultural banks, exchange banks etc.
1. Deposit Banks: The most important type of deposit banks is the commercial banks. They
have connection with the commercial class of people. These banks accept deposits from the
public and lend them to needy parties. Since their deposits are for short period only, these banks
extend loans only for a short period. Ordinarily these banks lend money for a period between 3 to
6 months. They do not like to lend money for long periods or to invest their funds in any way in
long term securities.
2. Industrial Banks: Industries require a huge capital for a long period to buy machinery and
equipment. Industrial banks help such industrialists. They provide long term loans to industries.
Besides, they buy shares and debentures of companies, and enable them to have fixed capital.
Sometimes, they even underwrite the debentures and shares of big industrial concerns. The
important functions of industrial banks are:
1. They accept long term deposits.
2. They meet the credit requirements of industries by extending long term loans.
3. These banks advise the industrial firms regarding the sale and purchase of shares and
debentures.
The industrial banks play a vital role in accelerating industrial development.
3. Savings Banks: These banks were specially established to encourage thrift among small
savers and therefore, they were willing to accept small sums as deposits. They encourage savings
of the poor and middle class people.
4. Agricultural Banks: Agriculture has its own problems and hence there are separate banks to
finance it. These banks are organized on co-operative lines and therefore do not work on the
principle of maximum profit for the shareholders. These banks meet the credit requirements of
the farmers through term loans, viz., short, medium and long term loans. There are two types of
agricultural banks,
(a) Agricultural Co-operative Banks-Co-operative Banks are mainly for short periods, and
(b) Land Mortgage Banks-For long periods there are Land Mortgage Banks.
5. Exchange Banks: These banks finance mostly for the foreign trade of a country.
Their main function is to discount, accept and collect foreign bills of exchange. They buy and
sell foreign currency and thus help businessmen in their transactions. They also carry on the
ordinary banking business.
They purchase bills from exporters and sell their proceeds to importers. They purchase and sell
“forward exchange” too and thus minimize the difference in exchange rates between different
periods, and also protect merchants from losses arising out of exchange fluctuations by bearing
the risk. The industrial and commercial development of a country depends these days, largely
upon the efficiency of these institutions.
 Functions of Commercial Banks
Commercial banks have to perform a variety of functions which are common to both developed
and developing countries. These are known as ‘General Banking’ functions of the commercial
banks. The modern banks perform a variety of functions. These can be broadly divided into two
categories: (a) Primary functions and (b) Secondary functions.

A. Primary Functions
Primary banking functions of the commercial banks include:
1. Acceptance of Deposits: This is the oldest function of a bank and the banker used to charge a
commission for keeping the money in its custody when banking was developing as an institution.
Now a day a bank accepts three kinds of deposits from its customers”
a) Saving Deposits. On which the bank pays small interest to the depositors who are usually
small savers.
b) Current/Demand/Accounts. Depositors in this account can withdraw any amount standing
to their credit by checks without notice. The bank does not pay interest on such accounts.
c) Fixed or Time Deposits. Savers who do not need money for a stipulated period from 6
months to longer period ranging up to 10 years or more are encouraged to keep in fixed
deposit accounts. The bank pays a higher rate of interest on such deposit. The rate of interest
increases with the length of the time period of fixed deposit.
2. Advancing Loans: The second primary function of a commercial bank is to make loans and
advances to all types of persons, particularly to businessmen and entrepreneurs. A bank lends a
certain percentage of the cash lying in deposit on a higher interest rate than it pays on such
deposits. The bank advances loans in the following ways.
(a) Overdraft Facilities: In this case, the depositor in a current account is allowed to draw over
and above his account up to a previously agreed limit. The bank, however, charges interest only
on the amount overdrawn from the account.
(b) Cash Credit: Under this account, the bank gives loans to the borrowers against certain
security. But the entire loan is not given at one particular time, instead the amount is credited
into his account in the bank; but under emergency cash will be given. The borrower is required to
pay interest only on the amount of credit availed to him. He will be allowed to withdraw small
sums of money according to his requirements through cheques, but he cannot exceed the credit
limit allowed to him. Besides, the bank can also give specified loan to a person, for a firm
against some collateral security. The bank can recall such loans at its option.
(c) Discounting Bills of Exchange: This is another type of lending which is very popular with
the modern banks. The holder of a bill can get it discounted by the bank, when he is in need of
money. After deducting its commission, the bank pays the present price of the bill to the holder.
Such bills form good investment for a bank. They provide a very liquid asset which can be
quickly turned into cash. The commercial banks can re-discount the discounted bills with the
centralbanks when they are in need of money. These bills are safe and secured bills.When the bill
matures the bank can secure its payment from the party which had accepted the bill.
(d) Money at Call: Bank also grant loans for a very short period, generally not exceeding 7 days
to the borrowers, usually dealers or brokers in stock exchange markets against collateral
securities like stock or equity shares, debentures, etc., offered by them. Such advances are
repayable immediately at short notice hence; they are described as money at call or call money.
(e) Term Loans: Banks give term loans to traders, industrialists and now to agriculturists also
against some collateral securities. Term loans are so-called because their maturity period varies
between 1 to 10 years. Term loans; as such provide intermediate or working capital funds to the
borrowers. Sometimes, two or more banks may jointly provide large term loans to the borrower
against a common security. Such loans are called participation loans or consortium finance.
(f) Consumer Credit: Banks also grant credit to households in a limited amount to buy some
durable consumer goods such as television sets, refrigerators, etc., or to meet some personal
needs like payment of hospital bills etc. Such consumer credit is made in a lump sum and is
repayable in installments in a short time. Under the 20-point programme, the scope of consumer
credit has been extended to cover expenses on marriage, funeral etc., as well.
(g) Miscellaneous Advances: Among other forms of bank advances there are packing credits
given to exporters for a short duration, export bills purchased/discounted, import finance-
advances against import bills, finance to the self employed, credit to the public sector, credit to
the cooperative sector and above all, credit to the weaker sections of the community at
concessional rates.
3. Creation of Credit: A unique function of the bank is to create credit. Banks supply money to
traders and manufacturers. They also create or manufacture money. Bank deposits are regarded
as money. They are as good as cash. The reason is they can be used for the purchase of goods
and services and also in payment of debts. When a bank grants a loan to its customer, it does not
pay cash. It simply credits the account of the borrower. He can withdraw the amount whenever
he wants by a cheque. In this case, bank has created a deposit without receiving cash. That is,
banks are said to have created credit. Sayers says “banks are not merely purveyors of money, but
also in an important sense, manufacturers of money.”
4. Promote the Use of Cheques: The commercial banks render an important service by
providing to their customers a cheap medium of exchange like cheques. It is found much more
convenient to settle debts through cheques rather than through the use of cash. The cheque is
the most developed type of credit instrument in the money market.
5. Financing Internal and Foreign Trade: The bank finances internal and foreign trade through
discounting of exchange bills. Sometimes, the bank gives short-term loans to traders on the
security of commercial papers. This discounting business greatly facilitates the movement of
internal and external trade.
6. Remittance of Funds: Commercial banks, on account of their network of branches
throughout the country, also provide facilities to remit funds from one place to another for their
customers by issuing bank drafts, mail transfers or telegraphic transfers on nominal commission
charges. As compared to the postal money orders or other instruments, bank drafts have proved
to be a much cheaper mode of transferring money and have helped the business community
considerably.
B. Secondary Functions
Secondary banking functions of the commercial banks include:
1. Agency Services: Banks also perform certain agency functions for and on behalfof their
customers. The agency services are of immense value to the people at large.
The various agency services rendered by banks are as follows:
(a) Collection and Payment of Credit Instruments: Banks collect and pay various credit
instruments like cheques, bills of exchange, promissory notes etc., on behalf of their customers.
(b) Purchase and Sale of Securities: Banks purchase and sell various securities like shares,
stocks, bonds, debentures on behalf of their customers.
(c) Collection of Dividends on Shares: Banks collect dividends and interest on shares and
debentures of their customers and credit them to their accounts.
(d) Income-tax Consultancy: Banks may also employ income tax experts to prepare income tax
returns for their customers and to help them to get refund of income tax.
(e) Execution of Standing Orders: Banks execute the standing instructions of their customers
for making various periodic payments. They pay subscriptions, rents, insurance premium etc., on
behalf of their customers.
(g) Acts as Trustee and Executor: Banks preserve the ‘Wills’ of their customers and execute
them after their death.

2. General Utility Services: In addition to agency services, the modern banks provide many
general utility services for the community as given.
(a) Locker Facility: Bank provides locker facility to their customers. The customers can keep
their valuables, such as gold and silver ornaments, important documents; shares and debentures
in these lockers for safe custody.
(b) Traveler’s Cheques and Credit Cards: Banks issue traveler’s cheques to help their
customers to travel without the fear of theft or loss of money. With this facility, the customers
need not take the risk of carrying cash with them during their travels.
(c) Letter of Credit: Letters of credit are issued by the banks to their customers certifying their
credit worthiness. Letters of credit are very useful in foreign trade.
(d) Collection of Statistics: Banks collect statistics giving important information relating to
trade, commerce, industries, money and banking. They also publish valuable journals and
bulletins containing articles on economic and financial matters.
(e) Acting Referee: Banks may act as referees with respect to the financial standing, business
reputation and respectability of customers.
(f) Underwriting Securities: Banks underwrite the shares and debentures issued by the
Government, public or private companies.
(g) Accepting Bills of Exchange on Behalf of Customers: Sometimes, banks accept bills of
exchange, internal as well as foreign, on behalf of their customers. It enables customers to import
goods.
C. Fulfillment of Socio-Economic Objectives
In recent years, commercial banks, particularly in developing countries, have been called upon to
help achieve certain socio-economic objectives laid down by the state. Banking is, thus, being
used to serve the national policy objectives of reducing inequalities of income and wealth,
removal of poverty and elimination of unemployment in the country.
It is clear from the above that banks help development of trade and industry in the country.They
encourage habits of thrift and saving. They help capital formation in the country. They lend
money to traders and manufacturers. In the modern world, banks are to be considered not merely
as dealers in money but also the leaders in economic development.

1.4.2. Central Banking

Introduction
Although the origin of central banking may be dated back to 1894, when the ‘ the Governor and
the Company of the Bank of England’ , the present day Bank of England was established, the art
of central banking assumed new dimensions only during the 20 th century. Central banking is
essentially a 20th century phenomenon. The earlier institution was, by and large, banks of issues
with the sole or principal right of note issue. Modern central banking techniques were unknown
to them. They were not much different from other existing institutions doing banking business
except for the especial relations which they had with their respective Governments. It was only
through a process of trial and error did they come to occupy the pivotal and strategic status
which they enjoy in the present day monetary and banking structure.

Even during the beginning of 20th century, many countries were still without central banks. The
first world War and the consequent chaotic monetary conditions brought home to these
countries the imperative necessity of establishing a centralized institution capable of creating
and maintaining equilibrium in the monetary sphere. The international financial conference held
at Brussels in September 1920, pointed out the urgency of establishing a central bank in those
countries, which had not yet established a central bank. The conference resolved that in countries
where there is no central bank of issue, one should be established. The Genoa Conference, in the
spring of 1922, also emphasized the importance of a central bank as an agency to correct the
financial disequilibrium and to promote international cooperation in the monetary world.

There was a welcome reception to these advices throughout the world. The next three decades
saw many countries equipping themselves with central banks. In 1900, there were only 18 central
banks whereas now there are 172. These central banks have drawn their status in such a manner
as to give novel meanings to central banks, of course, drawing inspiration from the experience of
the older central banks. The dynamic changes in the economic organism of each country raised
the status of its central bank from the position of a bank of issue to that of a leader and symbol
of in the process of evolution and subject to periodical adjustment”.

DEFININTION OF A CENTRAL BANK

  According to Samuelson, a central bank is a bank of bankers. Its duty is control the
monetary base (MB) and through control of this high- powered money to control the
community’s supply of money.
 The broadest definition has been given by Dekock in his words, a central bank is a bank
which constitutes the highest (apex) of the economic development. The importance of
central banking institutions has thus gained universal recognition and the now occupy a
unique position in the economic map of every civilized country. It took nearly three
centuries for the ‘ art of central banking’ to attain the present day importance.
Nevertheless, it would not be correct to say that central banking has attended its full
growth. Indications are that the role of central banks is continually expanding. In the
words of Dekock, “central banks have developed their own code of rules and practices,
which can be described as ‘the art of central banking’ which, in a changing world, is still
monetary & banking structure of its country and which performs as best as it can in the
national economic interest. The following functions:

 The regulation of currency in accordance with the requirements of business & the general
public for which purpose it is granted either the sole right of note issue or at least a partial
monopoly thereof.
 The performance of general banking &agency for the state.
 The custody of cash reserves of the commercial bank
 The custody and accommodation in the nation’s reserves of international currency.
 The granting of accommodation in the form of rediscount and collateral advances to
commercial banks, bill brokers and dealers, or other financial institutions and the
general acceptance of the responsibility of the lender of the last resort.
 The settlement of clearance balance between the banks.
 The control of credit in accordance with the needs of business and with a view to carrying
out the board monetary policy adapted by the state.

De kock’s definition is too long; to be called a definition a definition must be brief.

FUNCTIONS OF A CENTERAL BANK

A central bank performs the following functions, as given by De kock and accepted by the
majority of economists.
1. Regulator of currency
The CB is the bank of issues. It has the monopoly of note issue. Notes issued by it circulate as
legal tender money. It has its issue department which issues notes and coins to commercial
banks.

Central bank has been following different methods of note issue in different countries. The CB is
required by law to keep a certain amount of gold and foreign securities against the issue of notes.
In some countries the amount of gold and foreign currencies bears a fixed proportion, between
25 to 40% of the total notes issued. In other countries like India, a minimum fixed amount of
gold& foreign currencies is required to be kept against note issue by the CB.
The monopoly of issuing notes vested in the CB,
 Ensures uniformity in the notes issued which help in facilitating exchange & trade within
the country.
 Brings stability in the monetary system& creates confidence among the public.
 Enables the CB also to restrict or expand the supply of cash according to the
requirements of the economy. Thus, it provides elasticity to the monetary system.
 The CB also controls the banking system by being the ultimate source of cash.
 Enables the government to earn profit from printing notes whose cost is very low as
compared with their face value.
2. Banker, Fiscal agent and Adviser to the Government
 As a banker to the government, the CB:
 Keeps the deposits of the central (federal) and state governments, but it does not pay interest
on it.
 Buys and sells foreign currencies on the behalf of the government.
 Keeps the stock of gold of the government. Thus, it is the custodian of government wealth.
 As a fiscal agent, the CB
 Makes short- term loans to the government for a period not exceeding 90 days.
 It floats loans, pays interest on them, and finally repays the loan on behalf of the
government.
 As an adviser to the government, the CB:
 advises the government on such matters as controlling inflation or deflation, devaluation or
revaluation of the currency, deficit financing, balance of payment, etc
As pointed out by De kock, central banks everywhere operate as bankers to the state not only
because it may be more convenient & economical to the state but also because of the intimate
connection between public finance and monetary affairs.
3. Custodian of cash Reserves of Commercial Banks
Commercial banks are required by law to keep reserves equal to a certain percentage of both
time & demand deposits liabilities with the central bank. It is on the basis of these reserves that
the central bank transfers funds from one bank to another to facilitate the clearing of checks.

According to De kock, there are many advantages of keeping the cash reserves with the central
bank, which includes:
 The centralization of cash reserves in the central bank is a source of great strength to the
banking system of a country.
 Centralized cash reserves can serve as the basis of a large and more elastic credit
structure than if the same amount were scattered among the individual banks.
 Centralized cash reserves can be utilized fully & most effectively during periods of
reasoned strains & strains in financial crises or emergencies.
  By varying these cash reserves the CB can control the credit creation by commercial
banks.
 The CB can provide additional funds on a temporary & short- term basis to commercial
banks to overcome their financial difficulties
4.Custody & Management of Foreign Exchange Reserves
The CB keeps & manages the foreign exchange reserves of the country.
 It is an official reservoir of gold & foreign currencies.
 It sells gold at fixed prices to the monetary authorities of other countries.
 It buys & sells foreign currencies at international prices. \
 It fixed the exchange rates of the domestic currency in terms of foreign currencies
 Further it manages exchange control operations by supplying foreign currencies to
importers & persons visiting foreign countries on business, studies, etc in keeping with
the rules laid down by the government.
5. Lender of last Resort
By granting accommodation in the form of rediscounts and collateral advances to commercial
bank, bill brokers and dealers, or other financial institutions, the CB acts as the lender of the last
resort. The CB lends to such institution in order to help them in times of stress so as to save the
financial structure of the country from collapse.
6 Clearing House for Transfer & Settlement
As bankers of bank, the Central Bank acts as a clearing house for transfer and settlement of
mutual claims of commercial banks. Since the CB holds reserves of commercial banks, it
transfers funds from one bank to facilitate clearing of checks.

When the CB acts as a clearing agency, it is time saving and convenient for the commercial
banks to settle their claims at one place it also economizes the use of money.

7 Controller of Credit
The most important function of the CB is to control the credit creation power of commercial
bank in order to control inflationary and deflationary pressures with in the economy. For this
purpose, it adopts quantitative and qualitative methods.

Quantitative methods; aim at controlling the cost & quantity of credit by adopting bank rate
policy, open market operations, and by variation in reserve ratios of commercial banks.
Qualitative methods; control the use & direction of credit. This involves selective credit controls
and direction of credit. Besides, the CB in a number of developing countries has been entrusted
with the responsibility of developing a strong banking system to meet the expanding
requirements of agriculture, industry, trade & commerce.

Accordingly, the CB possesses some additional powers of supervision and control over the
commercial banks.
They are:
  The issuing of licenses,
 The regulation of branch expansion.
 To see that every bank maintains the minimum paid up capital & reserves as provided
by law.
 inspecting or auditing the accounts of banks,
 To approve the appointment of chairmen and directors of such banks in accordance
with the rules & qualifications,
 To control & recommend merger of weak banks in order to avoid their failures &
to protect the interest of depositors.
 To publish periodical reports relating to different aspects of monetary and economic
policies for the benefit of bank and the public and
 To engage in research and train banking personnel, etc

DIFFERENCE BETWEEN CENTRAL BANK AND COMMERCIAL BANK

A central bank is basically different from a commercial bank in the following ways:
1. The central bank is the apex institution of the monetary and banking structure of the country.
The commercial bank is one of the organs of the money market.
2. The central bank is a no-profit institution which implements the economic policies of the
government. But the commercial bank is one of the organs of the money market.
3. The central bank is owned by the government, whereas the commercial bank is owned by
shareholders.
4. The central bank is a banker to the government and does not engage itself in ordinary
banking activities. The commercial bank is a banker to the general public.
5. The central bank has the monopoly of note issue, while the commercial bank can issue only
checks. The notes are legal tender. But the checks are in the nature of near-money.
6. The central bank is the banker's bank. As such, it grants accommodations to commercial
banks in the form of rediscount facilities, keeps their cash reserves, and clears their balances.
On the other hand, the commercial bank advances loans to and accepts deposits from the
public.
7. The central bank controls credit in accordance with the needs of business and economy. The
commercial bank creates credit to meet the requirements of business.
8. The central bank helps in establishing financial institutions so as to strengthen money and
capital markets in a country. On the other hand, the commercial bank helps industry by
underwriting shares and debentures, and agriculture by meeting its financial requirements
through cooperatives or individually.
9. Every country has only one central bank with its offices at important centers of the country.
One the other hand, there are many commercial banks with hundreds of branches within and
outside the country.
10. The central bank is the custodian of the foreign currency reserves of the country while the
commercial bank is the dealer of foreign currencies.
11. The chief executive of the central bank is designated as "Governor" whereas the chief
executive of a commercial bank is called 'Chairman'.

CHAPTER TWO

THE BANKER AND CUSTOMER RELATIONSHIP

2.1. Definition of Banker: -

According to Dr. H.C.Hart, “a banker or bank is a person or company carrying on the business of
receiving moneys, and collecting drafts, for customers subject to the obligation of honoring
checks drawn upon them from time to time by the customers to the extent of the amounts
available on their current accounts”.

A bank/ banker can also be defined as a person/ company who accept deposits of money from
the public for the purpose of lending/investing, repayable on demand or otherwise, and
withdrawn by checks, drafts…etc.

A banking company is defined as any company which transacts the business of banking and
‘banking’ means “accepting for the purpose of lending or investment, of deposits of money from
the public, repayable on demand or otherwise, and withdrawn by check, draft, or otherwise.”

For an institution to be considered as a banking institution,a banking company must perform

both accepting deposits and lending or investing of money. If the purpose of accepting of
deposits is not to lend or invest, the business will not be called as a banking business.The banker
accepts deposits of money and not of anything else.

The definition also specifies the time and mode of withdrawal of the deposits. The deposited
money should be repayable to the depositor on demand made by the depositor or according to the
adjustment reached between the two parties.The act also specifies that the withdrawal should be
effected through an order, check, and drafts or otherwise.

2.2. Definition of a Customer: -

The term ‘Customer’ has not yet been statutorily defined. However, in general, the term
‘Customer’ means a person who has an account with the bank.

According to Sir John Paget, “to constitute a customer there must be some recognizable course
of dealing in the nature of regular banking business”. Thus, according to the above view, a
person does not become a customer simply by opening an account with the bank. He should be in
the habit of dealing with the bank, i.e. there should be some measure of continuity in his dealings
with the bank. This is popularly known as “Duration theory.Thus, in order to constitute as a
customer, a person should satisfy two conditions;

(i) He should have an account with the bank, whether fixed, savings or current.
(ii) The dealings should be of a banking nature. Dealings of banking nature have to be
differentiated from other dealings, which are of a casual nature. For example
occasionally getting a check cashed, depositing valuables for safe custody.

2.3. General and special Banker-Customer Relationships

The relationship between the banker and the customer arises out of the contract entered in
between them. This contract is created by mutual consent. A contract that exists between a bank
and its customer is a loan contract. This is because if the customer’s account is in credit, the bank
owes him that money and vice versa, if the account is overdrawn. The relationship between the
banker and the customer is vital. The relationship starts right from the moment an account is
opened and it comes to an end immediately on closure of the account. This relationship is of two
types: general and special relationships.

General Relationship between Banker and Customer

The general relationship between a banker and customer can be studied under three heads;

1) Debtor - Creditor relationship.

2) Trustee - Beneficiary relationship.
3) Agent - Principal relationship.

1. Debtor - Creditor Relationship

On the opening of an account, the banker assumes the position of a debtor. The money deposited
by the customer with the banker is in legal terms, lent by the customer to the banker, who makes
use of the same according to his discretion. The creditor has the right to demand back his money
from the banker, and the banker is under an obligation to repay the debt as and when he is
required to do so.

A depositor remains a creditor of his banker so long as his account carries a credit balance. The
relationship will be reversed as soon as the customer’s account is over drawn. Though the
relationship between a banker and his customer is mainly like a debtor and creditor, this
relationship differs from similar relationship arising out of ordinary commercial debts in the
following ways:

(i) The Creditor must demand payment:

In case of ordinary commercial debt, the debtor pays the amount on the specified date or earlier
or whenever demanded by the creditor. But in case of a bank deposit, the debtor (banker) is not
required to repay the amount on his own. It is essential that the creditor (depositor) must make a
demand for the payment of the deposit in the proper manner. This difference is because a banker
is not an ordinary debtor; he is termed as a privileged debtor.

(ii) Proper Place and Time of Demand

The demand by the creditor must be made at the proper place and in proper time. His demand for
the repayment of the deposit must be made at the same branch of the bank, where the customer’s
account is maintained, otherwise, the banker is not bound to honor the checks.

It is also essential that the demand must be made during a working day of a bank i.e. not on a
holiday or a day which is closed for public. And in addition, it must be presented during business
hours i.e., it should not be presented either before or after the business hours.

(iii) Demand must be made in Proper Form

Demand for the refund of money deposited must be made through a check or an order. In other
words, the demand should not be made verbally or through a telephonic message.

2. Trustee – Beneficiary Relationship

In certain circumstances, the banker may acts as a trustee also. A trustee holds money or assets
and performs certain functions for the benefit of some other person called the beneficiary. For
e.g. if the customer deposits securities or other valuables with the banker for safe custody, the
banker acts as a trustee of his customer.

The legal position of the banker, as a trustee, therefore differs from that of a debtor of his
customer. The position of a banker as a trustee or as a debtor is determined according to the
circumstances of each case. For e.g. in case of a check sent for collection, the banker acts as a
trustee till the check is realized and credited to the customer’s account and thereafter he will be
the debtor for the same amount.

3. Agent –Principal Relationship

A banker acts as an agent of his customer and performs a number of agency services. For e.g. the
banker buys and sells securities on behalf of his customer, collects checks on behalf of his
customer and makes payment of various dues of his customer. Thus, the range of such agency
functions has become much wider and the banks are now rendering large number of agency
services.

Special Relationship between Banker and Customer

The special relationship between banker and customer takes the form of rights which the banker
can exercise and the obligations/ duties which he owes to his customers.

2.4. Duties andRights of a Banker

Following are the rights enjoyed by the banker with regard to the customer’s account:

1. Right of General Lien

One of the important rights enjoyed by a banker is that of general lien. A lien may be defined as
the right to retain property belonging to a debtor until he has discharged a debt due to the retainer
of the property. In case lien is exercised by a trader on his customer’s goods, he has neither right
to use the goods nor any right to sell them. All that he can do is to retain the goods until the
obligations are cleared. Once the obligations are cleared by the customer, it is an obligation on
the part of the trader to return back his goods immediately. There are two kinds of lien: general
lien and particular lien

(a) Particular Lien: A particular lien confers a right to retain the goods in respect of a particular
debt involved in connection with a particular transaction. This lien is enjoyed by the persons who
have spent their labor on such properties and have not yet recovered their labor charges or
service charges from the debtors. For example, a tailor has the right to retain the cloths made by
him for his customer until his tailoring charges are paid by the customer. So is the case with
public carriers and the repair shops.

(b) General Lien: A general lien confers a right to retain goods not only in respect of debts
incurred in connection with a particular transaction but also in respect of any general balance
arising out of the general dealing between the two parties. This right can be exercised only by
persons such as bankers, factors, policy brokers, wharfingers, attorneys of High Court, etc. The
basic object of general lien is to have protection for the bank funds. The loans or advances
granted to customers can be recovered easily if the general lien is exercised by the bankers

Banker’s lien is a general lien in that bankers have general lien on all securities deposited with
them as bankers by a customer, unless there be an express contract or circumstances that show an
implied contract, inconsistent with the lien.

Further, in the same judgment, a banker’s lien has been defined as an implied pledge. Pledge is
superior and strengthens the hands of the person who exercises the pledge. In case of pledge, not
only the goods will come into the possession of the pledge but in addition, if default is made in
complying with the terms of the pledge, the pledgee after giving reasonable notice, can definitely
auction the property pledged, recover the proceeds and appropriate the same towards his
outstanding arrears. It is because of this reason pledge is said to be much superior and more
powerful than lien. But in case of bankers, whenever they exercise their power of lien, it has the
effect of pledge. Therefore, it is rightly said that the banker’s lien is an implied pledge.

The right of general lien is available to the banker only with following conditions;

The banker possesses the right of general lien on all the goods and services entrusted to him in
his capacity of a banker. Thus he cannot exercise his right of general lien if;

The goods and securities have been received by the banker as a trustee or an agent.

The goods of securities are required by the banker for some specific purpose.

The right of lien can be exercised on goods and securities standing in the name of the borrower
only and not jointly with other.

The banker can exercise his right of lien on the securities remaining in his possession after the
customer repays the loan. In such cases, it is an implied presumption that the customer has re-
offered the same securities as a cover for any other-advance outstanding on that date.

Exception to the right of general lien: -

The right of general lien cannot be exercised by the banker in the following circumstances.

(a) Safe custody of valuables:A customer deposits his valuables such as securities, documents,
ornaments etc. with the bank. He entrusts them to the banker as a bailee or transfee in order to
ensure the safety from theft fire etc., thus the banker cannot exercise his right of general lien over
such valuables.

(b) Documents deposited for special purpose: If a customer sends any document with the
specific instruction for utilizing its proceeds for any specific purpose, the right of general lien
does not exist. Similarly, if a customer hands over some shares to the banker with some
instruction to sell them at certain price, and the same are lying unsold with the banker, here also
the banker cannot exercise the right of lien. However, if the security comes into the possession of
the banker in the ordinary course of business, he can exercise his right of general lien.
(c) Securities left with the bank negligently: The banker does not possess the right of lien on the
documents or valuables left in his possession by the customer by mistake or by negligence.

(d) Securities held in trust: The banker cannot exercise his right of general lien over the
securities deposited by the customer as a trustee in respect of his personal loan.

(e) The bankers’ right of lien extends over goods and securities handed over to the banker.
Money deposited in the bank and the credit balances in the accounts do not fall in the category of
goods & securities. Therefore, the banker may exercise his right of set-off rather than the right of
general lien.

(f) The banker cannot exercise his right of general lien over the securities given to him for
securing a loan, before such loan is actually granted to him.

(2) Right of Set-Off:

A banker possesses the right of set-off, which enables him to combine two accounts in the name
of the same customer and to adjust the debit balance in one with the credit balance in the other.
For example, Mr. A has taken an overdraft from his banker to the extent of Br.10000 and he has
a balance of Br.5000 in his SB account. Hence, the banker can combine both of these accounts
and claim the remaining amount of Br.5000 only. This right of set-off can be exercised by the
banker after a notice is served on the customer intimating the decision of the banker of set-off.

The right of set-off can be exercised subject to the fulfillment of the following conditions;

(1) The accounts must be in the same name and in the same right:Here the account with the
banker must not only be in the same name but also in the same right. “The same right” means
that the capacity of the account holder in both the accounts must be the same. Thus the funds
belonging to someone else, but standing in the same name of the account holder, should not be
made available for satisfy his personal debts. Example the personal account of the trustee cannot
be set-off with the trust account money.

(2) The right can be exercised in respect of debts due and not in respect of future debts. For
example, a banker can set-off a credit balance in the account of a customer towards the payment
of a bill which is already due, but not in respect of a bill which will mature in future.

(3) The amount of debts must be certain:It is essential that the amount of debts due from both
the parties to each other must be certain. If liability of anyone of them is not determined exactly,
the right of set-off cannot be exercised. For example, if Mr. A is a guarantor for a loan of Br.100,
000 given by a bank to Mr. B his liability as guarantor will arise only after Mr. B delays in
making payment. The banker cannot set-off the credit balance of the guarantor till his liability as
a guarantor is determined. For this purpose, the banker must first demand payment from his
debtor. If the debtor defaults in making payment of his debt, only then the liability of the
guarantor arises and the banker can exercise his right of set-off against the credit balance in the
account of the guarantor.
(4) The right may be exercised in the absence of an agreement to the contrary. If there is an
agreement express or implied, the banker cannot exercise the right.

(5) For the purpose of exercising this right, all the branches of a bank constituteone entity and
the bank can combine two or more accounts in the name of the same customer at more than one
branch.

(6) The banker has the right to exercise this right before his garnishee order is made
effective. In case a banker receiving a garnishee order in respect of the funds belonging for his
customer, he has the right first to exercise his right of set-off & thereafter to surrender only the
remainder amount to the judgment creditor.

(3). Right of Appropriation

When money is paid by the customer, or when the banker receives money from third parties for
credit to the customer, the customer has the right to say that it should be placed to a particular
account or should be applied in payment of a particular debt or in meeting certain cheques or
bills. The banker is bound to appropriate it accordingly, irrespective of the state of accounts
between them. However, if the customer does not make any specific appropriation, the banker
can appropriate it.

(4). Right to Charge Interest & Commission

A banker is entitled to charge interest on loans, by express agreement either by right of custom or
usage of trade. The banker is also entitled to charge commission for services rendered to his
customer.

(5). Right to Close an Account

A customer can close the account at any time he feels like without assigning any reasons, though
the usual reasons could be that he: A). does not agree with the terms and conditions of the bank
B). feels unhappy with services. C). Otherwise loses confidence on the bank.He may close the
account merely by presenting a cheque for the balance in his favor though it is common to
inform the banker of his intention and return unused cheques with him.

The banker can also decide to close an account, which has been unsatisfactorily conducted by
sending a written intimation to the customer. He may state there in that he will not receive any
further credits and may additionally request the customer to withdraw his balance. Else, he may
inform that he will honor the cheques only until the balance is exhausted. The overriding
condition, however is that the banker must give sufficient time before the account is closed.

Duties of a Banker

The obligations of a banker can be studied under three categories:

 Obligation to honor the checks.

 Obligation to maintain secrecy of accounts.
 Obligation to carry directions given by the customer
I. Obligation to Honor the Checks:

The deposits accepted by a banker are his liabilities repayable on demand. Therefore the banker
is under a statutory obligation to honor his customer’s checks in the usual course.

“The drawee of a check having sufficient funds of the drawer in his hands properly applicable to
the payment of such check, must pay the check. When duly required to do so and in default of
such payment must compensate the drawer for any loss or damage caused by such default.”

Thus according to the above, the banker is bound to honor his customer’s checks provided the
following conditions are fulfilled;

There must be sufficient funds of the drawer in the hands of the drawee

Sufficient funds means, the funds at least equal to the amount of the check presented. Generally
checks sent for collection by the customer are not treated as cash in hands of the banker until the
same are realized. Further, the credit balances in other accounts of the customer at other branches
need not be taken into account in computing sufficiency of funds for his purpose. The funds in
the hands of the drawee banker must be equal to or more than the amount of the check presented
for payment. The banker is directed by the drawer to pay a specified sum of money to the payee,
and if such sum is not in the hands of the banker at the time of presentation of the check, the
banker is under no obligation to make part payment of the check. If the payee of the check makes
a deposit in the account of the drawer to make in such deficiency and then presents the check for
payment, the banker will be insisted in making such payment.

The funds must be properly applicable to the payment of the check:

A customer might be having several bank accounts, but it is essential that the account on which a
check is drawn must have sufficient finds. Similarly, a depositor having a debit balance in his
current account cannot draw a check on the basis of his fixed deposit with the banker. If there is
an agreement between the banker and the customer, where by the banker agrees to sanction an
overdraft, the banker’s obligation to honor the customer’s checks is extended up to the amount of
overdraft sanctioned by him.

The banker must be duly required to pay:

The banker is bound to honor the checks only when he is duly required to pay. This means that
the check, complete in order must be presented before the banker at the proper time, ordinarily, a
check will have validity for a period of six months. On the expiry of this period, the check is
treated as stale and the banker can dishonor the check. Similarly a post-dated check is also
dishonored by the banker because the order of the drawer becomes effective only on the date
given in the check.

II. Obligation to Maintain Secrecy of Accounts

The banker is under an obligation to take utmost care in keeping secrecy about the accounts of
his customer. If the facts about customer’s account are made known to others the customer’s
reputation may suffer and he may incur losses also.
Thus, the banker is under an obligation not to disclose deliberately or intentionally any
information regarding his customer’s accounts to third party and also takes all necessary
precautions and care to ensure that no such information lends out of the account books.

 When the law requires such disclosure to be made.

 When the practices and usages among the banker permit such disclosure.

Thus, a banker will be justified in disclosing information about his customer account on
reasonable and proper occasions only as stated below:

Disclosure permitted as per law: If the government departments such as Federal Inland
Revenue Authority, police department, Customs, etc. are in need of information about bank
balances maintained by a person who has a bank account, the banker is under obligation to
provide information to them.

Disclosure Permitted by the Banker’s Practices and Usages:

With express or implied consent of the customer: The banker will be justified in disclosing any
information relating to his customer’s account with the consent of the customer, which may be
express or implied. Express consent exists in case the customer directs the banker in writing to
institute the balance in his account to his agent. In certain circumstances, the implied consent of
the customer permits the banker to disclose necessary information. For example if the banker
sanctions a loan to a customer on the guarantee of a third person and the guarantor asks the
banker certain questions relating to the customer’s account. Here the bank is justified in
disclosing the facts to the guarantor, as there is an implied consent of the customer.

Disclosure in Public Interest: If a customer holds an illegal account, which is against the interest
of the nation, the banker should disclose the account to proper authorities.

Disclosure in the Interest of the Banks: The banker in his own interest can disclose the account
of the customer. If the customer fails to clear the debt, the banker will approach the guarantor
and the guarantor can ask for the disclosure of the borrower’s account, which the banker does
and he is insisted in doing so. Thus the banker is justified in providing the details about the
customer’s account.

2.5. Duties and rights of a customer

Duties a customer

Customer’s duties to his/her bank include the following:

a) Duty of reasonable care in drawing checks

b) Duty to disclose forgeries- if the customer discovers that the check purporting to have
been signed by him/her have been forged, he/she must inform to his/her banker.
c) Duty to pay interest for loans and commission for current accounts and other banking
services.

Rights of a customer
 a) Right to repayment: the customer has a right to be repaid by a banker a sum equivalent to
that paid into his/her bank.
b) Right to draw checks: a customer has a right to draw checks upto an amount standing in
his/her current account.
c) Right to interest: except a current account, a customer has a right to earn interest for
his/her deposits.

2.6. Termination of the banker-customer relationships

In theory, the relationship between banker and customer may like any other contractual relations
be terminated by mutual agreement.

In practice, however, it is nearly always the one party or the other who wishes to put an end to
the relationship and to the contract is usually unilaterally. Accordingly, either a customer or a
banker may take initiatives in question of closure of accounts.

A customer may want to close his/her account with a bank for some reasons or others. For
example; he/she may be dissatisfied with the facilities provided by the banker. When the
customer wishes to close the account, he/she may do so by demanding the repayments or
withdrawals of the full amount due less accrued bank service charges, if any and returning the
unused checks. It is prudent for the bank to ensure that the customer states in writing that he/she
is in fact closing the account and not nearly withdrawing the available balance.

Similarly, a banker may like to closethe account of the customer. The banker may consider the
customer undesirable for one reason or the other. A banker who wishes to cease transacting
business for a customer must give the customer a reasonable notice and the period of notice must
be long enough that enable the customer having repaidto all the surrounding circumstances to
make alternatives.

There are other cases under which the relationship between the banker and the customer may be
terminated. Some of which are:

i) Death of a customer: upon the customer’s death the right to receive any sum owing
to him/her including bank balances passes as a general rule to his/her personal
representatives.
ii) Mental incapacity of the customer: persons of unsounded mind are used to be
known as lunatics. A banker is bound to stop an account in the event of insanity of a
customer. As soon as the bankers come to know the lunacy of his customer, he must
suspend all operation on the account.
iii) Bankruptcy of a customer: a banker should cease to honor his customer’s checks as
he learns that a bankruptcy petition has been presented.
iv) Winding up of company customer: when a company is winding up, it ceases to
have any legal existence and all its contractual relationship come to an end.
v) Winding up of the bank: the winding up of a bank will likewise put an end to the
contract between banker and customer.
vi) Garnishee order: when a banker is served with a garnishee order, he should stop
operations other accounts of the customer. It must remain dormant until the order is
discharged.