LEGAL

ASPECTS OF BANKER-CUSTOMER RELATIONSHIP:

LOANS AND ADVANCES

SANKALP JAIN*

ABSTRACT

The relationship between a banker and a customer arises from a contract.

Fundamentally speaking, it is the relationship of debtor and creditor, the respective
positions being determined by the state of the account. However, in relation to other
services rendered by banker, he is sometimes an agent of the customer, for example,
collection of cheques, sale of securities, etc., bailee in relation to the safe custody of
valuables; and trustee when he is entrusted with property to be administered for the
benefit of a named beneficiary. This article will deal with the legal aspects of the
banker and customer relationship in respect of loans and advances, in short, debtor-
creditor relationship and vice-versa.

INTRODUCTION

First of all, what is meant by the word Banker? Bankers perform multifarious functions and
provide numerous services in conjunction with banking. Traditionally, bankers have been
termed as persons who performed the following functions:
1) Acceptance of money on current account and the collection of cheques and drafts
for the customer.

2) Payment of cheques or orders drawn by customers which are essentially payable on

demand.
However, in the era of modern banking, bankers are much more than persons who merely
accept deposits and collect credit. There are many other forms of financial business other
than banking which deal in money and credit. Money lenders receive deposits yet do not fall
under the category of bankers. Similarly, building societies also receive deposits and provide
credit but they are not banks.

*

Email: sankalp_jain11@yahoo.com

1
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The definition of banker is a mere tautology as there is no statutory definition. However, the
understanding of the term banker in its traditional sense would be compromised if the
following definitions are not taken note of:
1. Dr. Herbert Hart says:


A banker is one who in the ordinary course of business, honours cheques drawn
upon him by persons from and for whom he receives money on current account.1

2. Halsburys Laws of England defines banker as an individual, partnership or corporation

whose sole predominating business is banking, that is the receipt of money on current
account or deposit account and the payment of cheques drawn by and the collection of
cheques paid in by a customer.2

3. Sir John Paget says:

No person or body, corporate or otherwise could be a banker who do not:
1. take deposit accounts
2. take current accounts
3. issue and pay cheques and
4. collect cheques crossed and uncrossed for its customers3
According to Section 3 of Negotiable Instruments Act, banker includes any person acting as
banker. Similar definitions are found in Bankers Book Evidence Act, 18914 and Indian Stamp
Act, 1899.5 The first systematic attempt to throw light on the banking functions was made
by the Banking Regulation Act, 1949 which defines banking6 and enumerates the forms of

R. Rajesh & T. Sivagnanasithi, Banking Theory- Law and Practice, 113 (Tata Mcgraw Hill Publishing Company
Limited, New Delhi, 2010)
2
Ibid
3
Ibid
4
Banking Regulation Act, 1949 (Act 10 of 1949)
S. 2- (a) Any company or corporation carrying on the business of banking.
(b) Any partnership of individual to whose books the provisions of this Act shall have been extended as
hereinafter provided,
(c) Any post office savings bank or money order office.
5
S. 2(a)- Banker includes a bank and any person acting as a banker.
6
S. 5(b)- Banking" means the accepting, for the purpose of lending or investment, of deposits of money from
the public, repayable on demand or otherwise, and withdrawal by cheque, draft, order or otherwise;

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business in which the banking companies may engage.7 In this context it is also pertinent to

7

S. 6(1)- Forms of business in which banking companies may engage

In addition to the business of banking, a banking company may engage in any one or more of the following
forms of business, namely:
(a) the borrowing, raising, or taking up of money; the lending or advancing of money either upon or
without security; the drawing, making, accepting, discounting, buying, selling, collecting and dealing
in bills of exchange, hoondees, promissory notes, coupons, drafts, bills of lading, railway receipts,
warrants, debentures, certificates, scrips and other instruments and securities whether transferable
or negotiable or not; the granting and issuing of letters of credit, traveller's cheques and circular
notes; the buying, selling and dealing in bullion and specie; the buying and selling of foreign exchange
including foreign bank notes; the acquiring, holding, issuing on commission, underwriting and dealing
in stock, funds, shares, debentures, debenture stock, bonds, obligations, securities and investments
of all kinds; the purchasing and selling of bonds, scrips or other forms of securities on behalf of
constituents or others, the negotiating of loans and advances; the receiving of all kinds of bonds,
scrips or valuables on deposit or for safe custody or otherwise; the providing of safe deposit vaults;
the collecting and transmitting of money and securities;
(b) acting as agents for any Government or local authority or any other person or persons; the
carrying on of agency business of any description including the clearing and forwarding of goods,
giving of receipts and discharges and otherwise acting as an attorney on behalf of customers, but
excluding the business of a managing agent or secretary and treasurer of a company;
(c) contracting for public and private loans and negotiating and issuing the same;
(d) the effecting, insuring, guaranteeing, underwriting, participating in managing and carrying out of
any issue, public or private, of State, municipal or other loans or of shares, stock, debentures, or
debenture stock of any company, corporation or association and the lending of money for the
purpose of any such issue;
(e) carrying on and transacting every kind of guarantee and indemnity business;
(f) managing, selling and realising any property which may come into the possession of the company
in satisfaction or part satisfaction of any of its claims;
(g) acquiring and holding and generally dealing with any property or any right, title or interest in any
such property which may form the security or part of the security for any loans or advances or which
may be connected with any such security;
(h) undertaking and executing trusts;
(i) undertaking the administration of estates as executor, trustee or otherwise;
(j) establishing and supporting or aiding in the establishment and support of associations, institutions,
funds, trusts and conveniences calculated to benefit employees or ex-employees of the company or
the dependents or connections of such persons; granting pensions and allowances and making
payments towards insurance; subscribing to or guaranteeing moneys for charitable or benevolent
objects or for any exhibition or for any public, general or useful object;
(k) the acquisition, construction, maintenance and alteration of any building or works necessary or
convenient for the purposes of the company;
(l) selling, improving, managing, developing, exchanging, leasing, mortgaging, disposing of or turning
into account or otherwise dealing with all or any part of the property and rights of the company;
(m) acquiring and undertaking the whole or any part of the business of any person or company, when
such business is of a nature enumerated or described in this sub- section;
(n) doing all such other things as are incidental or conducive to the promotion or advancement of the
business of the company;
(o) any other form of business which the Central Government may, by notification in the Official
Gazette, specify as a form of business in which it is lawful for a banking company to engage.

note that banking business must be the main business of a banker which as a view was held
in Stafford v. Henry.8 It, therefore, would be correct to interpret that a person who is
engaged in the forms of business laid under Section 6 of Banking Regulation Act is a banker.
Like banker, the term Customer is also not defined by law. Ordinarily, a person who has an
account in a bank is considered its customer. Banking experts in the past, however, used to
lay emphasis on the period for which such account was actually maintained with the bank.
According to Sir John Paget,
[T]o constitute a customer there must be some recognizable course or habit of
dealing in the nature of regular banking business.
This view point lays emphasis on the duration of the dealings between the banker and the
customers and is, therefore, known as the duration theory. According to duration theory, a
person does not become a customer of the bank just by virtue of opening an account. He
must have been accustomed to deal with the banker before he is designated as a customer.
Therefore, in traditional sense, to constitute customer:
1) There must be some recognizable course or habit of dealing between him and the
bank;
2) The transaction were in the nature of regular banking business.
The duration theory was questioned in Ladbroke v. Todd,9 in which Justice Bailhache said
that the relation of banker and customer begins as soon as the first cheque is paid in and
accepted for collection. This view was further supported in Commissioners of Taxation v.
English, Scottish and Australian Bank Ltd.10 where the Privy Council held:
[T]he word customer signifies a relationship of which duration is not of the essence.
The contract is not between habitu and newcorner, but between a person for whom the
bank performs a causal service and a person who has an account of his own at the bank.
According to Dr. Hart, a customer is one who has an account with a banker or for whom a
banker habitually undertakes to act as such. Supporting this viewpoint, the Kerela High

8

(1850) 12 I. Eq. R. 400 (6)

(1914) 30 TLR 433
10
(1920) AC 683
9

Court in Central Bank v. Gopinathan Nair11 observed:

Broadly speaking, a customer is a person who has the habit of resorting to the same
place or person to do business. So for as banking transactions are concerned he is a person
whose money has been accepted on the footing that the banker will honour up to the
amount standing to his credit irrespective of his connection being of short or long standing.
In the contemporary era, duration of the account is not a pre-condition. Even a single
transaction in the account is sufficient to designate a person as customer of the bank. The
dealings of the customer with the bank must be relating to the business of banking. Thus, to
constitute a customer, the following essential requisites must be fulfilled:
1) a bank account must be opened in his name by making necessary deposit of money,
and

2) the dealing between the banker and the customer must be of the nature of banking
business.
As the title of this article suggests, now we shall move on to the banker-customer
relationship pertaining to loans and advances, in other words, the debtor-creditor
relationship and vice-versa.

CREDITOR & DEBTOR RELATIONSHIP

Banker-Customer contract is an exception to the rule that a debtor should find his creditor.
Creditor (customer) has to make demand on the debtor (Banker). The debtor-creditor
relationship departs from the original view that the banker is a mare depository of the funds
of the customer. It was observed in Foley v. Hill:12
The money, when paid into bank ceases altogether to be the money of the principal;
it is then the money of the banker who is bound to return an equivalent by paying a similar
sum to that deposited with him when he is asked for it.
When a sum of money is deposit in the bank, the bank cannot pay back the amount
voluntarily anytime at its own will. It is important that the depositor, who is the creditor in

11

AIR 1970 Ker. 74

(1848) 2 HLC 28

12

this case, must make a demand for the repayment of the amount deposited with the bank.
He accepts the deposited sum with an additional obligation to honour the customers
cheques. Returning of deposited amount by the bank voluntarily by closing the account may
lead to dishonour of some of the cheques issued by the depositor and subsequently, it may
even harm his reputation. Furthermore, according to the definition of banking under
Banking Regulation Act,13 the deposits are repayable on demand or otherwise. Demand by
the creditor of the deposited money, therefore, is essential for the refund of the same.
Deposit made by a customer with his banker in this regard, differs substantially from an
ordinary debt. A banker, therefore, is not an ordinary debtor.
The demand by the creditor to the banker must be made at the proper place and proper
time. A commercial bank maybe having a number of branches. However, the depositor
enters into relationship with only that branch where he has got his account opened on his
name. Generally, customers demand for the repayment of deposit must be made at that
particular branch of the bank concerned otherwise the banker is not bound to honour his
commitment. However, he may make special arrangements with the banker for the
repayment of the deposit at some other branch. For example, in case of bank drafts,
travellers cheques etc. the branch receiving the money undertakes to repay it at a specified
branch or any branch of the bank.
The demand must be made during banking hours on working days of the bank. Also,
according to the statutory definition of banking, deposits are withdrawable by cheques,
drafts, order or otherwise. Therefore, the demand for the refund of money deposited must
be made through a cheque or an order and not verbally or telephonic conversation or
message or in any such manner.
It is, however, pertinent to note that the debtor & creditor relationship between the banker
and the customer is an inter-changeable one and the roles are often reversed a person
becomes the customer of the banker. As we all know that, lending money is an essential
function of the bank. The resources mobilized by banks are utilized for lending activities.
When customer borrows money from the banker, he owes the same to the bank. In such
cases when bank lends loans or advances to the customer, the banker is the creditor and

13

Supra note 6

the customer is the debtor. The relationship in the first case, i.e. of a person depositing
money with the bank reverses when he borrows money from the bank. Therefore, when it
comes to loans and advances, it is the creditor-debtor relationship which prevails between
the banker and the customer. The upcoming chapters will dwell on the types of loans and
advances, general principles by which they are governed and above all, the legal aspects of
banker-customer relation pertaining to loans and advances.

TYPES OF LOANS AND ADVANCES

14
According to Banking Regulation Act, 1949, loans and advances granted by banks can be
classified as:

a) secured loans
b) unsecured loans
A secured loan refers to a loan made by taking assets as security and the market value of
such assets needs to be more than the amount of loan at anytime till the repayment of the
loan.15
An unsecured loan is a loan which is granted by the banker without requiring any security.
Advances made against the personal security of borrower, discounting of bills and advances
made against guarantee fall under this category. Thus, unsecured advances are lent on the
basis of the credit standing of the borrower, i.e. character, capacity and capital of the
borrower.16 The following kinds of loans and advances are considered important:
1. Demand Loan

Loans which have no stated maturity period are called demand loans. Such loans are to be
repaid on demand.17 In a demand loan account, the entire amount is paid to the debtor at
one time, either in cash or by transfer to his savings or current account. No subsequent
debit is ordinarily allowed except by way of interest, incidental charges, insurance

14

Supra note 4 at S. 5
Supra note 1 at 133
16
Ibid
17
Dr. Gurusamy, Banking Theory- Law and Practice, 228 (Tata Mcgraw Hill Education Private Limited, 2nd
edition, 2010)
15

premiums, or expenses incurred for the protection of the security. Interest is charged on the
debit balance, usually with monthly rests unless there is an arrangement to the contrary. No
cheque book is issued. The security may be personal or in the form of shares, Govt. paper,
fixed deposit receipt, life insurance policies, goods, etc.

2. Term Loan

Loans which are granted for a certain period of time are known as term loans. Term loans
are usually provided for medium and long-terms and are repayable in installments.18 They
may last between one and ten years and may also range from 20 to 30 years in some cases.
The period of term loans is arrived at on the basis of the estimated future earnings or cash
flow of the borrower.19 Term loans usually involve an unfixed interest rate which would add
to the balance to be repaid. Term loans are generally granted for fixed capital requirements
such as investment in plant and equipment, land and building, etc. Such loans may be
required for setting up new projects or expansion or modernization of the plant and
equipment. Advances granted for purchasing land, building, flat or apartment house are
term loans.

3. Overdraft

An overdraft is said to have occurred when money is withdrawn from a bank account and
the available balance goes below zero. In such a situation, the account is said to have been
overdrawn. It is a fluctuating account wherein the balance sometimes may be in credit and
at other times in debit. If there is a prior agreement with the account provider for an
overdraft, and the amount overdrawn is within the authorized overdraft limit, then interest
is normally charged at the agreed rate. If the negative balance exceeds the agreed terms,
then additional fees may be charged and higher interest rates may apply. The banker insists
on securities such as shares, debentures, Government papers, life insurance policies, etc.
Besides, personal security plays an important role in the extension of overdraft facility
Overdraft facilities are allowed in current accounts only. In other words, opening of an
overdraft account requires that a current account will have to be formally opened. Whereas
in a current account cheques are honoured if the balance is in credit, the overdraft

18

Ibid
Ibid

19

arrangement enables a customer to draw over and above his own balance up to the extent
of the limit stipulated. There is no restriction, unlike in the case of regular loans, on drawing
more than once. In fact, as many drawings and repayments are permitted as the customer
would desire, provided the total amount overdrawn, i.e. the debit balance at any time does
not exceed the agreed limit. Like in the case of a demand loan account, the security in an
overdraft account may be either personal or tangible. The tangible security may be in the
form of shares, government paper, life insurance policies, fixed deposit receipts etc. i.e.
paper securities. A cheque book is issued in an overdraft account.

4. Cash Credit

Cash credit is a short-term cash loan given to big business firms.20 A bank provides this type
of funding, but only after the required security is given to secure the loan. Once a security
for repayment has been given, the business that receives the loan can continuously draw
from the bank up to a certain specified amount. In India, banks offer cash credit accounts to
businesses to finance their working capital requirements. The cash credit account is similar
to current accounts as it is a running account with cheque book facility. But unlike ordinary
current accounts, which are supposed to be overdrawn only occasionally, the cash credit
account is supposed to be overdrawn almost continuously. The extent of overdrawing is
limited to the cash credit limit sanctioned by the concerned bank. This sanction is based on
an assessment of the maximum working capital requirement of the organization minus the
margin. The organization finances the margin amount from its own funds.
Generally, a cash credit account is secured by a charge on the current assets of the
organization which maybe a pledge or hypothecation. It is normally granted against the
security of goods e.g. raw materials, stock in process, finished goods and also against the
security of book-debts. With periodical review and with favourable factors, a cash credit
limit is allowed for years together if there is a good turnover both in the account and in the
goods.21 The principal advantages of a cash credit account to a borrower are:

a) He may operate the account within the stipulated limit as and when required and can
save interest by reducing the debit balance whenever he is in a position to do so.

20

Id. at 226
Id. at 227

21

b) He can also provide alternative securities from time to time in conformity with the
terms of the advance and according to his own requirements.

5. Call Money or Short-period Loans

Call money or short period loans are those type of loans which are provided to businessmen
for very short periods of time which maybe a day, two days or at the most fifteen days. It is
primarily for this reason such loans are known as call money. One of the features of this
type of lending is that the bank can recall the loans without giving any prior notice to the
borrowers. Call loans are mostly extended by one bank to another to meet the short-term
requirements of the cash.22 These loans carry either no interest or very low rate of interest.
Besides businessmen, such loans are also advanced to brokers, middlemen and discount
houses.23 The high liquidity nature of the loans gives the banker dual advantage of liquidity
as well as profitability, thereby bringing sizeable income to the bank.24

6. Bills Purchased and Discounted

Bill discounting constitutes an important type of lending made by banks. Banks discount
genuine commercial treasury bills.25 Loan amount constitutes the face value of the bill
minus the discount charges. Discount constitutes the income earned by the bank. The
banker gets back the money lent on or before the bill period. A strong bill market presence
is required for a strong and healthy money. 26 Bills are of two types: clean bills and
documentary bills. Clean bills have no documents accompanying them whereas
documentary bills are accompanied by documents of title such as railway receipts or bill of
lading. 27 Banker verifies the financial standing of the drawee. Both in respect of bills
purchased and discounted, the banker holds the bill till the maturity date of the bill.28





22

Id. at 225
Ibid
24
Ibid
25 Id. at 229
26
Ibid
27
Ibid
28
Ibid
23

10

7. Clean Loans

Clean loans are essentially unsecured loans. A banker extends credit facility for a short
period after taking into consideration the net liquid resources of the borrower.29 Loan is
granted on the basis of three Cs of the borrower: character, capacity and capital.30 In this
type of loan, banks insist on personal guarantees of the borrower.

8. Housing Loans
An important form of loan provided by a modern banker is housing finance. Housing loans
constitute a major segment of deployment of funds by a banker.31 In fact, a substantial
portion of the earnings of a bank emanates from the housing finance activities undertaken
by a bank.32
9. Loans to Small Borrowers

These kind of loans are advances to small borrowers like common man and self-employed
persons like doctors, engineers, etc. Such loans are advanced by banks under the umbrella
of social sector lending.33 The purpose of granting such loans is to assist the weaker
sections of the society in improving their standards of living. Loans are granted on the
strength of borrowers credit standing and capacity.
10. Hire Purchase and Lease Financing
Hire purchase finance takes the form of advances granted to parties to finance hire
purchase businesses such as transport vehicles, machinery and consumer goods. Banks in
the modern times have also stared lending to leasing companies.
11. Consumer Credit
Bank credit granted to consumers for their personal needs be it purchase of refrigerators,
cars, television, computer, repair work, settlement of phone and electricity bills, is known as
consumer credit. Such loans are advanced to respectable customers in lump sum and are
repayable by installments within couple of years. These loans are also known as retail

29

Id. at 227
Ibid
31
Id. at 228
32
Ibid
33
Id. at 229
30

11

loans. Under the 20-point Economic Program, the scope of consumer credit was extended
to cover marriages, funeral and associated religious ceremonies.34
12. Consortium Advances

Consortium advances mean advancing loans to a borrower by two or more Banks jointly by
forming a Consortium. This will help the banks to consolidate the appraisal benefit of
different banks and reduce the risks and also help the banks to keep the exposure within
the permissible limit. RBI & NABARD have also insisted on the banks to make advances
under consortium to large size public sector units. Joint appraisal, control and monitoring
will facilitate the exchange of valuable information among the banks. Usually, a bank with a
higher share leads the consortium. On many occasions, a District Central Bank or a Bank
situated in the vicinity of the area of the borrowing unit is selected as Lead Bank. The Lead
Bank facilitates to carry out operation of account, day to day operations, monitoring, looks
after the custody of the pledged stock and supervises recovery process. There is no
restriction on the number of banks for participation in consortium.
13. Participation Certificates
A participant certificate is an instrument through which a banker, who has granted credit to
its borrowers, can share it with other institutions having surplus funds.35 A bank gets finance
from other banks in respect of loans already granted.

GENERAL PRINCIPLES OF LOANS AND ADVANCES

Lending constitutes a fundamental function of a banker. While lending money, banks
consider several factors. Risk being an inherent factor in lending calls for adoption of certain
principles by the banks which would help them in mitigating such risk factor. The lending
policy of a bank depends on the prevailing macro-economic and micro-economic conditions
prevailing in the economy.36 Banks always aim at profitable deployment of their funds37. For
this purpose, it is essential that the bank officials posses qualities like foresightedness,

34

Id. at 230
Supra note 1 at 135
36
Supra note 17 at 220
37
Ibid
35

12

practical experience, and the capacity to make correct estimates.38 To make lending an ideal
one, a banker has to keep in view the following underlying principles of lending:

1. Principle of Safety

Safety is the fundamental principle underlying the lending policy of banks. The banks deal
with funds entrusted to them by the depositors, and that itself casts an obligation upon
them to ensure safety of the funds which they lend. The term safety means that the
borrowers should be in a position to repay the loan along with interest.39 Bankers cannot
afford to overlook the safety principle while making decisions relating to investment of its
surplus funds. Safety factor underlines the fact whether the borrower will be in a position to
repay the loan along with the interest at the stipulated time. For this purpose, the banker
has to ensure that the borrower has the capacity and willingness to return the money on
demand. Capacity of the borrower depends upon his assets and the success of his
business. 40 The willingness to repay depends upon the honesty and character of the
borrower. 41 If, for example, the borrower invests the money in an unproductive or
speculative venture, or if the borrower himself is dishonest, the advance would be in
jeopardy. Similarly, if the borrower suffers losses in his business due to his incompetence,
money recovery may become difficult. The banker ensures that the money advanced by him
goes to the right borrower and is utilized in such a way that it will remain safe throughout,
and after serving a useful purpose in the trade or industry where it is employed, is repaid
with interest.

2. Principle of Liquidity

Liquidity refers to bankers ability to meet customers claim for cash on demand. It denotes
the capacity of a banker to honour all its obligations. 42 Since the borrowed funds are
employed in business by the banker, he needs to ensure liquidity while lending money. In
case of any need, the banker must be able to convert the assets into cash quickly. 43

38

Id. at 221
Supra note 1 at 130
40
Ibid
41
Ibid
42
Ibid
43
Ibid
39

13

Depositors build up reputation in a bank on the basis of liquidity.44 Further, liquidity is also
needed to maintain public confidence. This would enable the bank to be in position of
repaying the deposits of customer on demand and also ensure its solvency.

3. Principle of Security

Another principle which the banker should consider is the value and the nature of the
security offered for obtaining loan.45 Any valuable property given in support of loans or
advances is known as security.46 Security recognized by a banker as a loan cover needs to be
adequate, readily marketable, easy to handle and free from encumbrance.47 According to
this principle, banks should always lend against sound security. Security gives bankers the
advantage of insurance or a cushion against any possible contingency of default committed
by the borrower. 48 Security of lending automatically ensures liquidity of lending too.
Security of lending is considered from the view point of the borrowers character, capacity
and capital.49

4. Principle of Profitability

According to the principle of profitability, the lending must yield profits for the
organization.50 In order to make its lending profitable, it should be the bankers practice to
charge different rates of interests on the different type of advances.51 Profitability rallies
towards accomplishing the cardinal principles of safety and liquidity of funds invested by
banks.52 Banks should lend funds in such a way so as to secure for itself an adequate and
permanent income.53 The objective of the bank must be to earn maximum profits.54 Hence,
the bank should make efforts to lend for productive purposes and further it should make
sure that loans and advances are not made for speculative purposes.

44

Ibid
Supra note 17 at 222
46
Supra note 1 at 131
47
Ibid
48
Supra note 17 at 223
49
Ibid
50
Ibid
51
Ibid
52
Ibid
53
Ibid
54
Ibid
45

14

5. Principle of Purpose

This principle implies that bank advances loans only for productive purposes with a definite
source of repayment. 55 Also, the purpose should be short-termed so that it ensures
liquidity. Before lending, the banker should enquire the customer about the purpose of
borrowing. Loans advanced for productive purposes would increase the earnings thereby
assuring repayment. 56 Advancing loans for unproductive purposes such as personal
expenses of marriage, other social functions and ceremonies, pleasure tours, repayment of
previous loan is likely to create lot of uncertainty about recovering them. The principle of
purpose aims at discouraging loans for such unproductive purposes and ensures that loans
are used only for productive purposes.

6. Principle of Diversity

Another important principle of good lending is the diversification of loans. As every loan
carries its own risk, it is always better to give advances for different purposes so as to
spread the risk.57 It is unsafe to advance loans to a particular area or field of business. The
banker in order to safeguard his interest against unforeseen contingencies, follows the
principle of do not keep all the eggs in one basket.58 The spread and the diversified lending
help mitigate the risk of loss. The advantage of the spread is that the non recovery due to
slump in one sector will be counterbalanced by the accelerated collection from the vibrant
sector of the economy. This way the risk in lending can be diversified.

7. Financial Standing of the Borrower

A Banker should not ignore the repaying capacity of the borrower.59 This greatly depends on
the character, capacity and financial standing of the borrower. 60 A borrower maybe
financially sound but his integrity might be questionable. In such a case, the chances of
repayment become remote. It is very difficult to judge the character of the borrower.61
Borrowers with good paying capacity may not be honest in repayment. The repaying

55

Ibid
Supra note 1 at 131
57
Supra note 17 at 224
58
Supra note 1 at 131
59
Id. at 132
60
Ibid
61
Ibid
56

15

capacity of farmers and small producers are not easily assessed.62

8. Principle of Marketability

While lending, the banker should ensure that the security accepted for advance is easily
marketable.63 This would help the bank save itself from situation of loss due to non-saleable
nature of the security. For this purpose, the bank may lend against first class securities or in
debentures of a well reputed firm.

9. Principle of Value Stability

The bank should lend against those securities which command a stable value in the
market.64 Any wide fluctuation in the market value of security is likely to cause huge loss to
the banks in the event of sale of such security to realize the proceeds of the loan.

10. Principle of National Interest, Suitability, etc.

Interest of the nation is an important principle of lending. Even when an advance satisfies all
the aforesaid principles, it may still not be suitable. The advance may be at loggerheads with
the national interest. The RBI, in this regard, has issued a directive prohibiting banks to
allow particular types of loans and advances. The law and order situation at the place where
the borrower carries on his business may not be satisfactory. There may be other reasons of
like nature for which it may not be suitable for the bank to grant loans. In the changing
concept of banking, factors such as purpose of the advance, viability of the proposal and
national interest are assuming a greater importance than security, especially in advances to
agriculture, small industries, small borrowers, and export-oriented industries.

LOANS AND ADVANCES: LEGAL DIMENSIONS

The risk factor attached to granting of loans and advances by the banks inherently gives rise
to legal dimensions and implications. Legal implications arising out of loans and advances
are spread across various statutory provisions, RBI guidelines as well as the common law
principles. The prominent legal dimensions in India in connection with loans and advances
are hereby discussed as follows:

62

Ibid
Supra note 17 at 224
64
Ibid
63

16

1. BANKING REGULATION ACT: In terms of Section 20(1) of the Banking Regulation Act, a
bank cannot grant any loans and advances on the security of its own shares. Section 20(1)
also lays down the restrictions on loans and advances to the directors and the firms in which
they hold substantial interest. Where any loan or advance granted by a banking company is
in the form of a commitment for granting the loan, steps shall be taken to recover the
amount due to the banking company on account of the loan and advance alongwith
interest, if any, due thereon.65 No loan or advance or any part thereof shall be remitted
without the prior approval of the RBI and any remission without such approval shall be
void.66 Where such loan or advance has not been repaid to the banking company within the
stipulated period, then the person, if he is a Director of such banking company, on the date
of expiry of the said period, be deemed to have vacated his office on the said date.67

The Reserve Bank, if satisfied that it is essential or expedient in the interest of public or of
depositors or banking policy, may determine the policy in relation to the advances to be
followed by banking companies in general or by any banking company in particular. When
the policy has been determined, then all banking companies or the banking company
concerned, shall be bound by the policy as determined.68 In this connection, the Reserve
Bank has the power to give directions to banking companies regarding the following:

a) Purpose of advances
b) Margins to be maintained in respect of loans and advances
c) Maximum amount of advances or other financial accommodation having regard to
the paid-up capital, reserves and deposits
d) Rate of interest and other terms and conditions in respect of advances69

Every banking company shall comply with any directions given to it by the Reserve Bank.70
Purchase of or discount of bills from directors and their concerns is reckoned as loans and
advances for the purpose of Section 20 of the Act.71

65

Supra note 4 at S. 20(2)

S. 20(3)
67
S. 20(4)
68
S. 21(1)
69
S. 21(2)
70
S. 21(3)
71
Master Circular DBOD. No. Dir. BC. 6/13.03.00/2010-11 dated July 1, 2011 available at http://www.rbi.org.in
66

17

2. RESERVE BANK GUIDELINES: According to the guidelines issued by RBI, 72 banking

companies may grant advances to customers against the security of shares, debentures or
bonds subject to the following conditions:

a) Purpose of the Loan- Loan against shares, debentures and bonds may be granted to
customers to meet contingencies and personal needs or for subscribing to new or
rights issues of shares, debentures, bonds or for purchase in the secondary market,
against the security of shares, debentures or bonds held by the borrowers.

b) Amount of advance- Loans against the security of shares, debentures and bonds
should not exceed the limit of Rupees ten lakhs per individual if the securities are
held in physical form and Rupees twenty lakhs per individual if the securities are held
in dematerialised form.

c) Margin- Banks should maintain a minimum margin of 50% of the market value of
equity shares or convertible debentures held in physical form. In the case of shares
or convertible debentures held in dematerialised form, a minimum margin of 25
percent should be maintained. These are minimum margin stipulations and banks
may stipulate higher margins for shares whether held in physical form or
dematerialised form. The margin requirements for advances against preference
shares or non-convertible debentures and bonds may be determined by the banks
themselves.

d) Lending policy- Each bank should formulate with the approval of their Board of
Directors a Loan Policy for grant of advances to individuals against shares,
debentures or bonds keeping in view the RBI guidelines. Banks should obtain a
declaration from the borrower indicating the extent of loans availed of by him from
other banks as input for credit evaluation. It would also be necessary to ensure that
such accommodation from different banks is not obtained against shares of a single
company or a group of companies. As a prudential measure, each bank may also
consider laying down appropriate aggregate sub-limits of such advances.

72

Ibid

18

3. LIEN: The right of lien is conferred upon the banker by the Indian Contract Act. A lien is
the right to retain the property belonging to a debtor until he has discharged the debt due
to the retainer of the property. A lien is merely a right to retain and is lost when possession
is lost. Under Section 171 of the Indian Contract Act, 73 bankers, in the absence of an
agreement to the contrary, can retain as a security for a general balance of account any
goods and securities banked to them. It extends to all securities placed in their hands as
bankers by the customers. The leading case on this subject is Brandao v. Barnett.74 In this
case the bankers lien was described by Lord Campbell as follows:

Bankers most undoubtedly have a general lien on al 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 line.....
The banker possesses the right of general lien on all the goods and securities entrusted to
him capacity as a banker and in the absence of a contract inconsistent with the right of line.
Thus he cannot exercise his right of general lien if -
a) the goods and securities have been entrusted to the banker as a trustee or an agent
of the customer, and
b) a contract-express or implied-exists between the customer and the banker which is
inconsistent with the bankers right of general lien. In other words, if the goods or
securities are entrusted for some specific purpose, the banker cannot have a lien
over them.
A bankers right of lien is more than a general lien. It confers upon him the power to sell the
goods and securities in case of default by the customer. Such right of lien resembles a
pledge and is usually called an implied pledge. The banker, therefore, enjoys the privileges
of a pledge and can dispose of the securities after giving proper notice to the customer.
The right of lien can be exercised on goods or other securities standing in the name of the

73

Indian Contract Act, 1872 (Act 9 of 1872), S. 171: General line of bankers, factors, wharfingers, attorneys and
policy-brokers
Bankers, factors, wharfingers, attorneys of a High Court and policy-brokers may, in the absence of a contract
to the contrary, retain as a security for a general balance of account, any goods bailed to them; but no other
persons have a right to retain, as a security for such balance, goods bailed to them, unless there is an express
contract to that effect.
74
(1846) 12 Cl & Fin 787 HL

19

borrower only and not jointly with others. For example, in case the securities are held in the
joint names of two or more persons, the banker cannot exercise his right of general lien in
respect of a debt due from a single person.
The banker is also entitled to exercise the right of general lien in respect of the customers
obligation as a surety and to retain the security offered by him for a loan obtained by him
for his personal use and which has been repaid. In Stephen v. Chandra Mohan and Ors.75 the
loan agreement authorized the bank to treat the ornaments not only as a security for that
loan transaction, but also for any other transactions or liability existing or to be incurred in
future. As the liability of the surety was joint and several with that of the principal debtor,
such liability also came within the ambit of the above provision of the agreement.
4. APPROPRIATION: In the course of his usual business, a banker receives payments from
his customer. If the latter has more than one account or has taken more than one loan from
the banker, the question of appropriation of the money subsequently deposited by him
naturally arises. Section 59 to 61 of the Indian Contract Act, 1872 contain provisions
regarding the right of appropriation of payments in such cases.
According to Section 59, such right of appropriation is vested in the debtor who makes a
payment to his creditor to whom he owes several debts. He can appropriate the payment to
his creditor to whom he owes several debts. He can appropriate the payment by:

a) an express intimation, or
b) under circumstances implying that the payment is to be applied accordingly.

If the debtor does not intimate or there is no other circumstances indicating to which debt
the payment is to be applied, the right of appropriation is vested in the creditor. He may
apply it at his discretion to any lawful debt actually due and payable to him from the
debtor. 76 Further, where neither party makes any appropriation, the payment shall be
applied in discharge of the debts in order of time. If the debts are of equal standing the
payment shall applied in discharge of each proportionately.77 In the case of M/s Kharavela

75

(1990) 68 CompCas 636 Ker.

Supra note 73 at S. 60
77
S. 61
76

20

Industries Pvt. Ltd. v. Orissa State Financial Corporation,78 the question arose whether the
payment made by the debtors was to be adjusted first towards the principal or interest in
his absence of any stipulation regarding appropriation of payments in he loan agreement.
The Court held that in the case of debt due with interest, any payment made by the debtor
in the first instance is to be applied towards satisfaction of interest and thereafter towards
the principal unless there is an agreements to the contrary.
In case a customer has a single account and he deposits and withdraws money from it
frequently, the order in which the credit entry will set off the debit money will be the
chronological order, as decided in the Devaynes v. Noble,79 famously known as the Claytons
Rule. The rule derived from the Claytons case is of great practical significance to the
bankers. In case of death, retirement or insolvency of a partner of a firm, the existing debt
due from the firm is adjusted or set off by subsequent credit made in the deceased, retired
or insolvent partner and may ultimately suffer the loss if the debt cannot be recovered from
the remaining partners.
Therefore, to avoid the operation of the rule given in the Claytons case, the bank closes the
old account of the firm and opens a new open in the name of the reconstituted firm. Thus,
the liability of the deceased, retired or insolvent partner, as the case may be, at the time of
his death, retirement or insolvency is determined and he may be held liable for the same.
Subsequent deposits made by surviving or solvent partners will not be applicable to
discharge the same.
5. SET-OFF: The right of set-off is a statutory right80 which enables a debtor to take into

78

AIR 1985 Ori. 153

(1816) 35 ER 781
80
Code of Civil Procedure, 1908 (Act 5 of 1908), O. VIII, R. 6: Particulars of set-off to be given in written
statement.
(1) Where in a suit for the recovery of money the defendant claims to set-off against the plaintiff's demand
any ascertained sum of money legally recoverable by him from the plaintiff, not exceeding the pecuniary limits
of the jurisdiction of the Court, and both parties fill the same character as they fill in the plaintiff's suit, the
defendant may, at the first hearing of the suit, but not afterwards unless permitted by the Court, presents a
written statement containing the particulars of the debt sought to be set-off.
(2) Effect of set-offThe written statement shall have the same effect as a plaint in a cross-suit so as to enable
the Court to pronounce a final judgment in respect both of the original claim and of the set-off: but this shall
not affect the lien, upon the amount decreed, of any pleader in respect of the costs payable to him under the
decree.

79

21

account a debt owed to him by a creditor, before the latter could recover the debt due to
him from the debtor. In other words, the mutual claims of debtor and creditor are adjusted
together and only the remainder amount is payable by the debtor. A banker, like other
debtors, possesses this 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 account with the credit
balance in the other. This right of set-off can be exercised by the banker if there is no
agreement-express or implied-contrary to his right and after a notice is served on the
customer intimating the latter about the formers intention exercise the right of set-off. To
be on the safer side, the banker takes a letter of set-off from the customer authorizing the
banker to exercise the right of set-off without giving him any notice.
The right of set-off can be exercised in respect of debts due and not in respect of future or
contingent debts. A debt not yet due cannot be set off against a debt already due. For
example, a banker cannot set-off a debt due to him upon a loan account repayable on
demand or at a certain future date against credit balance on current account for until
demand or arrival of the due date the loan is not due for payment. Similarly, the banker has
no right to set off a deposit balance against the depositors contingent liability on current
discounted bills but in the event of customers insolvency, the banker has a right to set off
credit balance on the account against the contingent liability on any bill he has discounted
for the customer.
Where a borrower has lodged securities as cover for an advance and if the banker applied
the amount in satisfaction of the amount due and is left with a surplus, he has a right of set-
off against the surplus for an overdraft on another account even though maintained at
another branch of the same bank.
In the case of stopped accounts, the right of set-off becomes available to a banker
automatically. An account is stopped when a customer dies or is declared insolvent or
insane, or by the service of a garnishee order. In such an event all the accounts of the
customer in the same right must be immediately combined in order to ascertain how much
is due to or from the customers estate. Where a garnishee order is served in respect of a
customer having more than one account in his own right, the banker has the right to first

(3) The rules relating to a written statement by a defendant apply to a written statement in answer to a claim
of set-off.

22

exercise the right of set-off before accounting to the judgment creditor.

It is essential that the debts due from both the parties to each other must be definitely
ascertainable otherwise the right of set-off cannot be exercised. For example, a banker
cannot set off credit balance in the account of a guarantor of a loan account till his liability
as a guarantor is determined. If the guarantee is on demand, no debt in a owing by the
guarantor payable until the demand is made and accordingly until then there can be no
right of set off. As soon as the demand is made the right of set-off can be exercised.
6. CHARGING INTEREST AND COMMISSION: It is the implied right of the Banker to charge a
reasonable commission for its services to the customer and interest on loans advanced. The
right to charge interest may be either by express agreement or by banking custom. The right
to charge interest ceases on the death or insolvency of the customer. Simple interest is paid
in the case of debts due to others. But in the case of bankers unless there is an agreement
to the contrary, the customer has to pay the interest once in a quarter. Where it is not paid
in cash it will be added to the principal and it amounts to compound interest. Bankers
likewise make half-yearly interest payments on the deposit they receive.

Bank charges are levied in the case of overdrafts, cash credit and current accounts but not in
the case of savings accounts. Where the customer maintains large balance in the current
account, bankers waive these charges, since it is profitable to have large balances without
interest.
7. RECOVERY OF LOANS BY DEBT RECOVERY TRIBUNAL: Recovery of Debts Due to Banks
and Financial Institutions Act, 1993 was enacted with a view to provide for the
establishment of Debts Recovery Tribunals for expeditious adjudication and recovery of
debts81 due to banks and financial institutions. To ensure expeditious adjudication and
recovery of dues of banks and financial institutions, remove legal anomalies and strengthen
the Recovery Tribunals, the said Act was amended in the years 1995, 2000 and 2004. The

81

Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (Act 2 of 1993) S. 2(g); Debt means
any liability (inclusive of interest) which is claimed as due from any person by a bank of a financial institution
or by a consortium of banks or financial institutions during the course of any business activity undertaken by
the bank or the financial institution or the consortium under any law for the time being in force, in cash or
otherwise, whether secured or unsecured, or assigned, or whether payable under a decree or order of any civil
court or any arbitration award or otherwise or under a mortgage and subsisting on, and legally recoverable on,
the date of the application.

23

salient features of the Act include the establishment of Debt Recovery Tribunal and Debt
Recovery Appellate Tribunal,

82

their composition,

83

jurisdiction and powers

84

and

procedure.85 The modes of recovery of debts comprised under this Act are:
a) Attachment and sale of movable and immovable property of defendant;
b) Arrest of the defendant and his detention in prison; and
c) Appointment of receiver for the movable and immovable properties of defendant.86

Under the Act of 1993, Debt Recovery Tribunals (DRTs) were set up for recovery of loans of
banks and financial institutions. This led to speedy recovery of loans in about 1 years time
as against the average time of 5 to 7 years required in civil suits. While initially the DRTs
performed well, their progress suffered as they got overburdened with the huge volume of
cases referred to them. In order to speed up the process of recovery from Non-Performing
Assets (NPAs),87 the Securitization and Reconstruction of Financial Assets and Enforcement
of Security Interest Act (SARFAESI) Act was enacted in 2002 for regulating securitization and
reconstruction of financial assets and enforcing security interest by secured creditors. The
SARFAESI Act empowers banks and financial institutions to recover non-performing assets
without the intervention of the Court. The Act provides for three modes for recovery of
non-performing assets, namely:

a) Securitization88
b) Asset Reconstruction89

82

Ss. 3 & 8 respectively

Ss. 4 & 9 respectively
84
Ss. 17-18
85
Ss. 19-24
86
S. 25
87
SARFAESI Act, 2002 (54 of 2002), S. 2(o): "Non-performing asset" means an asset or account of a borrower,
which has been classified by a bank or financial institution as sub-standard, doubtful or loss asset,-
(a) in case such bank or financial institution is administered or regulated
by any authority or body established, constituted or appointed by any law for the time being in force, in
accordance with the directions or guidelines relating to assets classifications issued by such authority or body;
(b) in any other case, in accordance with the directions or guidelines relating to assets classifications issued by
the Reserve Bank;
88
S. 2(z): "Securitisation" means acquisition of financial assets by any securitisation company or reconstruction
company from any originator, whether by raising of funds by such securitisation company or reconstruction
company from qualified institutional buyers by issue of security receipts representing undivided interest in
such financial assets or otherwise;
83

24

c) Enforcement of Security Interest

Secured creditors are given the power to take possession of the securities in the event of
default and sell such securities for the purpose of recovery of the loan. The Act provides for
enforcement of Security interest by a secured creditor without intervention of the court, in
cases of default in repayment of installments and non-compliance with the notice period of
60 days after the declaration of the loan as a non-performing asset. It has become easy in
most of the cases for the banks to recover their dues under SARFAESI Act. Under the Act,
the Bank classifies the loan account as NPA as per the RBI guidelines, gives a demand
notice 90 asking the borrower(s) to pay the entire outstanding amount, deals with the
objections if any from the borrower(s),91 takes symbolic possession of the property under
section 13(4),92 proceeds with taking the physical possession of the property with the police

89

S. 2(b): "Asset reconstruction" means acquisition by any securitisation company or reconstruction company
of any right or interest of any bank or financial institution in any financial assistance for the purpose of
realisation of such financial assistance;
90
S. 13(2): Where any borrower, who is under a liability to a secured creditor under a security agreement,
makes any default in repayment of secured debt or any instalment thereof, and his account in respect of such
debt is classified by the secured creditor as non-performing asset, then, the secured creditor may require the
borrower by notice in writing to discharge in full his liabilities to the secured creditor within sixty days from the
date of notice failing which the secured creditor shall be entitled to exercise all or any of the rights under sub-
section (4).
91
S. 13(3A): If, on receipt of the notice under sub-section (2), the borrower makes any representation or raises
any objection, the secured creditor shall consider such representation or objection and if the secured creditor
comes to the conclusion that such representation or objection is not acceptable or tenable, he shall
communicate within one week of receipt of such representation or objection the reasons for non-acceptance
of the representation or objection to the borrower:
92
S. 13(4): In case the borrower fails to discharge his liability in full within the period specified in sub-section
(2), the secured creditor may take recourse to one or more of the following measures to recover his secured
debt, namely:--
a) take possession of the secured assets of the borrower including the right to transfer by way of lease,
assignment or sale for realising the secured asset;
b) take over the management of the business of the borrower including the right to transfer by way of
lease, assignment or sale for realising the secured asset:
PROVIDED that the right to transfer by way of lease, assignment or sale shall be exercised only where
the substantial part of the business of the borrower is held as security for the debt: PROVIDED
FURTHER that where the management of whole of the business or part of the business is severable,
the secured creditor shall take over the management of such business of the borrower which is
relatable to the security for the debt.
c) appoint any person (hereafter referred to as the manager), to manage the secured assets the
possession of which has been taken over by the secured creditor;
d) require at any time by notice in writing, any person who has acquired any of the secured assets from
the borrower and from whom any money is due or may become due to the borrower, to pay the
secured creditor, so much of the money as is sufficient to pay the secured debt.

25

assistance, etc. under section 1493 if there is resistance in taking physical possession of the
property and then, proceeds with auctioning the property in accordance with the provisions
of the Act and the rules connected herewith. Unless the bank is at fault at the time of
sanctioning the loan or unless the bank commits procedural irregularity, in most of the
cases, bank succeeds with its efforts to recover the dues under SARFAESI Act, 2002.
8. RECOVERY THROUGH LOK ADALATS
Dues recovery for loans, credit cards and cheque bounces by banks in India time and again
has been a dicey issue. Filing civil cases in Indias over burdened courts leads to prolonged
litigation and inordinate delay. In such a scenario, apart from DRTs, as previously discussed,
Lok Adalats have also presented a viable alternative for dues recovery. Lok Adalat,
empowered by Article 39-A94 of the Indian Constitution and more recently, by Legal Services
Authority Act, 1987,95 is an Alternative Dispute Resolution (ADR) mechanism in India for
compoundable offences which are organized by the government and presided over by a
judge or a person of respect with legal knowledge. A bank which has a large number of
outstanding cases in the normal courts, can request the Legal Service Authority of a state to
organize a Lok Adalat especially for the unresolved cases, the cost of which is generally
borne by the bank.

93

S. 14: Chief Metropolitan Magistrate or District Magistrate to assist secured creditor in taking possession of
secured asset
(1) Where the possession of any secured assets is required to be taken by the secured creditor or if any of the
secured asset is required to be sold or transferred by the secured creditor under the provisions of this Act, the
secured creditor may, for the purpose of taking possession or control of any such secured asset, request, in
writing, the Chief Metropolitan Magistrate or the District Magistrate within whose jurisdiction any such
secured asset or other documents relating thereto may be situated or found, to take possession thereof, and
the Chief Metropolitan Magistrate or, as the case may be, the District Magistrate shall, on such request being
made to him--
(a) take possession of such asset and documents relating thereto; and
(b) forward such assets and documents to the secured creditor.
(2) For the purpose of securing compliance with the provisions of sub-section (1), the Chief
Metropolitan Magistrate or the District Magistrate may take or cause to be taken such steps and use, or cause
to be used, such force, as may, in his opinion, be necessary.
(3) No act of the Chief Metropolitan Magistrate or the District Magistrate done in pursuance of this section
shall be called in question in any court or before any authority.
94
Art. 39-A: Equal justice and free legal aid
The State shall secure that the operation of the legal system promotes justice, on a basis of equal opportunity,
and shall, in particular, provide free legal aid, by suitable legislation or schemes or in any other way, to ensure
that opportunities for securing justice are not denied to any citizen by reason of economic or other disabilities.
95
Chapters VI (Ss. 19-22) and VI-A (Ss. 22A-22E)

26

There are certain advantages in using the forum of Lok Adalats by banks and financial
institutions in compromise settlement of their NPAs. There is no involvement of court fees
when fresh disputes are referred to it. It can take cognizance of any existing suit in the court
as well as look into and adjudicate upon fresh disputes. If no settlement is arrived at, the
parties can continue with court proceedings. Its decrees are final and binding and
enforceable like a court decree. As per the RBI guidelines, banks in India have been advised
to take recourse to Lok Adalats for the recovery of loans of less than Rs. 10 lakh. Indian
banks have increasingly turned to Lok Adalats for dues recovery. The trend which was
started by public-sector banks like the State Bank of India, Bank of Baroda, Punjab National
Bank and Central Bank of India, has been adopted by private banks like ICICI as well. Public
response has been positive towards this mechanism as it is easier to resolve loan issues via
Lok Adalats rather than letting them dawdle in normal courts. The easier and quicker
redressal of cases, more favourable terms of settlement coupled with the legal validity and
enforceability of Lok Adalat decisions have made people adopt Lok Adalats.

CONCLUSION AND SUGGESTIONS
A major chunk of a banks revenue comes from its lending activity. The need for loans and
advances accelerates with the development of the economy and its complexities. Apart
from the economic and social complexities, loans and advances by banks, also carry
numerous legal complexities be it restrictions under Banking Regulation Act or RBI
guidelines, legal rights of bankers in the form of lien, appropriation and set-off or recovery
of debts through debt recovery tribunals under the provisions of Recovery of Debts due to
Banks and Financial Institutions Act or SARFAESI Act. Banks are very particular about refund
of loans from the borrowers whether individuals or business enterprises. The legal position
of banks in respect of recovering loans is of secured creditors and that itself places them on
higher priority when it comes to repay of loans. In the modern day banking, loans can be
recovered through contemporary modes such as securitization, reconstruction and
enforcement of security interest as laid in SARFAESI Act. The legal aspects of loans and
advances are not just confined to aforementioned statutory provisions and common law
principles. While determining the legality and validity of loans, the principles of lending, as
discussed earlier, should also be taken into consideration as these principles are the general
guidelines and the driving force behind granting of loans to customers by the banks.

27

Keeping in view the problems faced by banks as well as customers regarding loans and
advances in the current scenario, it wouldnt be wrong to say that there is a need to amend
the SARFAESI Act. The growing menace of NPAs threatens to destabilize the financial
structure of the nation. It is therefore, important that some reforms are brought in the
existing legal framework. The Act was brought into effect to help banks so that they could
recover their dues from the borrowers. On one hand, it has helped the bankers but on the
other, it has handed them unnecessary power to sell the properties of the owner without
their consent at a price lesser than the market price. This will bring huge losses to the
borrower as the market price of land is presently at an all time high. Many borrowers feel
that they are being harassed by the Bank officials unreasonably and using the provisions of
SARFAESI Act, 2002. They claim that they are not willful defaulters and even if there is
some kind of default, they are willing to correct the same and honour the commitments
agreed upon. While in some cases, the Bank Officials rightly show some kind of interest in
helping the borrowers within the legal frame-work, in others, they act unreasonably and
invoke the provisions of SARFAESI Act, 2002 by classifying the account as Non-performing
Asset even if there is a possibility of regularizing the loan account.
The Act requires banks and financial institutions to consider representations from
borrowers and communicate their response within a period of seven days. This period
should be increased to help the borrowers in timely communicating their response. Further,
the banks should be enabled to enter into settlement or compromise with the borrower and
DRT should be empowered to acknowledge such settlement or compromise. Also, currently,
banks are not empowered to accept any immovable property in realisation of the claim
against the defaulted borrower in the situations where banks are unable to find a buyer for
such assets. The banks should be empowered to accept the immovable property in full or
partial satisfaction of such claim against the defaulting borrower in times when they cannot
find a buyer for the securities. SARFAESI Act, therefore, needs to be updated and amended
to add teeth to the existing legislative framework where the aforesaid suggestions can be
incorporated as provisions which would reasonably and efficaciously used by the lenders as
well as borrowers, thereby ensuring healthy relations between bankers and customers.

28

BOOKS

BIBLIOGRAPHY

1) Dr. Gurusamy, Banking Theory- Law and Practice, 228 (Tata Mcgraw Hill Education
Private Limited, 2nd edition, 2010)
2) O. D. Heggade, Banker Customer Relationship in India (Mohit Publications, New
Delhi, 1st edition, 1994)
3) R. Rajesh & T. Sivagnanasithi, Banking Theory- Law and Practice, 113 (Tata Mcgraw
Hill Publishing Company Limited, New Delhi, 2010)
4) ML Tannan, Tannans Banking Law and Practice in India (LexisNexis India, 23rd
edition, 2010)

STATUTES
1) Banking Regulation Act, 1949 (Act 10 of 1949)
2) Code of Civil Procedure (Act 5 of 1908)
3) Indian Contract Act, 1872 (Act 9 of 1872)
4) Legal Services Authority Act, 1987 (Act 39 of 1987)
5) Recovery of Debts due to Banks and Financial Institutions Act, 1993 (Act 2 of 1993)
6) Securitization and Reconstruction of Financial Assets and Enforcement of Security
Interest Act, 2002 (Act 54 of 2002)

WEB SOURCES
1)

Master Circular DBOD. No. Dir. BC. 6/13.03.00/2010-11 dated July 1, 2011 available
at http://www.rbi.org.in (Visited on October 14, 2012)

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