The Banker Customer Relationship

Before getting into the details of the banker customer relationship, it is important to
discuss what a bank is and who qualify to be a bank customer.

There are many definitions of banks. We have commercial banks, Investments banks,
Merchant banks, Central Banks, The World Bank e.t.c. In our definition of a bank and
the customer, we will concentrate on the most common type of a bank, the commercial
bank. Commercial banks are unique not only because they form the backbone of the
world’s financial system but also because their products and services cut across
merchant and investment banking services. Central Banks and the world bank are
discussed elsewhere in this book.

What is a bank?

Section 2(1) of the Banking Act defines a bank as ‘a company which carries on, or
proposes to carry on, banking business in Kenya and includes the Co-operative Bank of
Kenya Limited but does not include the Central Bank’. This definition raises another
question: What is Banking Business?

The above section of the Act proceeds to define banking business as:

i) The accepting from members of the public of money on deposit repayable on

demand or at the expiry of a fixed period or after notice;
ii) The accepting from members of the public of money on current account and
payment on and acceptance of cheques; and
iii) The employing of money held on deposit or on current account, or any part of the
money, by lending, investment or in any other manner for the account and at the
risk of the person so employing the money;

The definition leaves out money transfer, which is another basic service offered by
banks to their customers. The subject is comprehensively covered under the topic on
payment systems. However, banks have diversified their products and services to
include financial advisory, investment management, pensions and stock broking

Who is a bank Customer

The definition of who qualifies or does not qualify to be a bank customer is of paramount
importance to bankers since the Cheques Act requires that amongst other things, a
bank proves that it collect a cheque for a customer before being cleared on a charge of
conversion. So who is a bank customer?

In United Dominions Trust v Kirkwood, 1966, the judge decided that the following
persons qualify to be bank customers.

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 a. Those who hold accounts with the bank.

b. Persons who seek other services from the bank.

He however clarified that there is no requirement on the number of transactions that

must have passed through that account and there is no requirement as to the duration
for which the account should have existed. In addition, where there were discussions
between the parties aimed at reaching a decision whether or not to open an account,
the banker customer relationship is deemed to commence at the beginning of the
negotiations.

The Know your Customer Principle

The Know your Customer principle (KYC) is followed worldwide wherever a

Banker/Customer Relationship Exists. Banks are required by law to obtain and keep up
to date , detailed information on the identity and affairs of their customers – whether
account holders or walk-in/one off transaction clients. The first opportunity to obtain
information regarding a customer is presented when the customer is opening his/her
account. A bank has to establish the client’s true identity beyond any reasonable doubt
for the purpose of ensuring that it is not dealing with an impostor, a fraudster or a
fictitious person. Failure to identify a customer satisfactorily exposes a bank to the risk
of being held liable in conversion to the true owner of a cheque on the grounds of
negligence while opening the account in case the customer banks a stolen cheque into
his account. The KYC requirement does not stop once the customer has opened the
account. Banks are required to maintain relations with customers and monitor
transactions and any changes in customers’ particulars and status on an ongoing basis
and act on any irregularities or suspicious activities.

The Central Bank of Kenya has reinforced this legal requirement under CBK prudential
guideline number 8 (Proceeds of crime and anti-money laundering regulations) where
banks are required to properly identify clients and monitor transactions for purposes of
detecting proceeds of money laundering, criminal and terrorism related activities.

KYC requirements do not require banks to query everything about clients. It just
requires that banks exercise due diligence and prudence while opening accounts and
monitor account transactions for any suspicious, inconsistent or unusual activity.

Money Laundering

The KYC subject would be incomplete if it was discussed without mention of money
laundering since both subjects are closely related.

Money laundering can be described as the act of engaging, directly or indirectly, in a

transaction that involves proceeds of any unlawful activity with the intention of

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disguising the true source or disposition of the funds in order to make the funds appear
legitimate. Unlawful activity includes both the sophisticated large criminal networks and
the so called ordinary crimes. Examples includes the following and the list is by no
means exhaustive:

• Drug trafficking

• Terrorism

• Theft/burglary

• Forgery

• Counterfeiting

• Stolen goods

• Extortion/blackmail

• Fraud

• Tax evasion (distinct from tax avoidance or tax minimization which may be
permissible)

• Black market currency deals

In brief the intention of money laundering syndicates is to achieve one or all of the
following:

• Concealing the true source of funds.

• Disguising funds from a crime so that they appear legitimate.

• Disguising the ultimate disposition of funds.

• Assisting in moving money that constitutes proceeds of criminal activity.

In monitoring money laundering activities, it is not the size of a transaction or the

frequency only but its about whether or not its unusual and/or inconsistent with a
customer’s normal turnover or the information provided during account opening. This,
coupled with a customer’s unwillingness to provide reasonable information to the bank
should always ring the alarm bells.

Despite the variety of methods employed, the laundering process is accomplished in

three stages. The stages may comprise numerous transactions by the launderers that
could alert an institution of the criminal activity.

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Placement

The physical disposal of the initial proceeds derived from illegal activity. Examples
includes

• Depositing small amounts of cash into several bank accounts to avoid detection

• Buying travellers' cheques, international money orders, foreign currency, bank

drafts or other instruments with the cash

• Buying single premium life assurance policies

• Buying high-value property or business assets.

Layering

Separating illicit proceeds from their source by creating complex layers of financial
transactions designed to disguise the audit trail and provide anonymity. Examples
includes:

• Paying large credit card debts from an account funded by criminal money

• Electronic funds transfer between non-existent companies

• Depositing or clearing foreign bank drafts and travellers' cheques

• Purchase and sale of stocks and shares.

Integration

The provision of apparent legitimacy to criminally derived wealth. Once the layering
process has succeeded, an integration scheme places the laundered proceeds back
into the economy in such a way that they re-enter the financial system appearing as
normal business funds. Examples include:

• Redeeming a single premium life policy purchased with dirty money for cash.

• Loan transaction where the loan is secured on a criminally funded asset.

• Early cancellation of car insurance policies involving refunds of premiums.

• Sale of legitimate businesses purchased with the proceeds of criminal money.

• Sale of property initially purchased with the proceeds of criminal money.

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LOAN BACK

Loan back is ideally not a stage in money laundering by itself but is a tactic mainly used
either at the layering or integration stage. It takes the form of a large loan being sought
and when asked for security, the customer offers as collateral a cash deposit either
directly or through another bank locally or offshore. The attraction of 100% cash security
may make the lender easily gullible and the illegally obtained money is ‘cleaned’. It may
also take the form of a genuine loan sought by a client for purchase of a fixed asset.
The loan is later pre-paid using the illegal proceeds with the criminal either retaining the
asset for income generation purposes or disposing the same and re-investing the funds
in another asset.

The basic steps may occur as separate and distinct phases. Alternatively, they may
occur simultaneously or, more commonly, they may overlap. How the basic steps are
used depends on the available laundering mechanisms and the requirements of the
criminal organizations.

Relationships Between the bank and the customer

Debtor Creditor Relationship

This relationship exists at all times after the customer opens an account. Whenever the
account is in credit, the customer is the creditor while the bank is the debtor. The roles
are reversed when the bank lends the customer by way of a loan or an overdraft where
the bank becomes the creditor with the customer becoming its debtor. The relationship
is unique since unlike a normal debtor-creditor relationship, where the debtor seeks out
the creditor when he intends to settle the debt, the bank customer always seeks out the
bank whether his account is in debit or in credit.

Agent Principal Relationship

While opening an account, the customer appoints the bank as his agent. In this case,
the normal relationship between a principal and agent exists. The duties of a bank
towards its customer and those of the customer towards his bank are discussed below.

Bailor Bailee Relationship

This relationship exists when a customer deposits his valuables with the bank for safe
custody. The bank acts as the bailee while the customer is the bailor. The bank is under
duty to exercise due care while handling the deposited items.

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Mortgagor-Mortgagee Relationship

In ordinary use, the word mortgage refers to a loan to purchase a house. However, in
legal terminology, the term mortgage refers to the agreement that grants the lender
rights over the property, A mortgagor-mortgagee relationship therefore exists where a
bank customer grants the bank rights over his property to the bank in order to secure an
advance. The customer is referred to as the mortgagor (grantor of the rights) while the
bank is referred to as the mortgagee.

Duties of the bank towards its customer

Act on the customer’s instructions

As the customer’s agent, the bank is under an obligation to act on all clearly written
instructions from the customer as long as they are issued in accordance with the
existing mandates. The bank is also obligated to exercise due care and act diligently
while executing the customer’s instructions. The instructions could vary depending
on the type of customer but the most common are:

 To receive the customer's money and cheques and other instruments of

collection and credit the same to the specified account.

 To repay the whole / part of the money upon presentation of the customer's
written authority, including cheques drawn by the customer, during banking hours
at the bank where the account is held or at other banks or branches as agreed
subject to:

(i) An existing credit balance (or agreed overdraft facility);

(ii) There is no legal bar to payment e.g. garnishee order or an

injunction/freezing order;

(iii) Customer has not countermanded (cancelled) payment;

(iv) Notice of death, bankruptcy, mental incapability has not been received.

• To give reasonable notice before closing an account. This follows the general
requirement of an agent-principal relationship that the agent should give his
principal sufficient notice before terminating the relationship. Banking practice
has established 30 days as the normal notice period though sophisticated
relationships (for example corporate customers who enjoy a catalogue of banking
facilities) may need a longer notice period. The period is require so that the
customer can be given ample time to make alternative banking arrangements,

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• To abide by any express mandate from his / her customer. The word express
implies written though banks at times act on telephone instructions if they are
able to establish that the caller is indeed the true account holder, that the
instructions are urgent, that the customer is not in a position to deliver written
instructions and that failure to act on the instructions will put the customer into
jeopardy for example cheque stop payment instructions. While acting on any
instructions, the bank needs to ensure that the instructions are issued in
accordance with the existing account operating mandate.

• To render statements of accounts to his customer periodically or upon request.

This duty follows from the general principle of agency law that requires an agent
to keep the principal informed about his affairs with the agent. In the banker
customer contract, the frequency of the statements is normally agreed upon.

• To maintain secrecy in respect of his customers' account and affairs. The Bank
owes a duty to its customers not to divulge information about its customers to
third parties. The duty is however not an absolute one but qualified under the
following circumstances:

Under compulsion by law.

• This exception is meant to enable law enforcing agencies to pursue fraudsters,

money launderers and other criminals. Examples include garnishee orders, court
orders issued under the evidence act and writs of sequestration.

In public interest

• This exception is not clearly spelt out in law but applies where the bank has
knowledge that a customer is involved in illegal activities such as terrorism or
trading with an enemy when the country is at war.

In the Bank’s Interest

• This applies for example where legal proceedings are required to enforce
payments of an overdraft.

With express or implied consent of customer

• The bank is under obligation to obey instructions from a customer to disclose

information about his affairs with the bank to a third party. Examples include
where the bank is responding to a reference or audit enquiry.

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 Customer’s Duty to the bank

 The customer owes the bank a duty to take reasonable care in drawing his
cheques and while issuing other instructions so as to reduce the risk that
the bank will be misled in making a payment which he has not authorized.

 Secondly, the customer has an obligation to inform the bank without delay
if he discovers that cheques or other instructions which purport to be
signed by him have been forged. Kindly note that the customer is
obligated to inform the bank once he discovers the forgery not before.

 The customer has no duty to take precautions in the management of his

business to prevent forged cheques being presented for payment or even
check his bank statements for unauthorized debit items.

 To ensure that there are enough funds in his account before drawing a
cheque.

 To pay reasonable interest and commission and other bank charges. This
draws from the general principle of agency law that gives an agent a right
to reasonable remuneration from the principal.

Termination of the Banker Customer Contract

The banker-customer relationship survives the closure of a bank account since some
duties for example the duty of secrecy remains even after closure of an account.
However, the banker customer contract is terminated in the following three wasys.

By Instruction from the customer

A bank customer can instruct his bank, in writing, to close his account. Such action will
automatically terminate the contact between him and the bank. The bank will be under
an obligation to pay any credit balance as instructed by the customer an the customer
will need to pay off any outstanding debit balance and account closure charges.

Under the bank’s discretion

A bank can, if dissatisfied with the relationship, give notice to close the customer’s
account. Banking practice and case law requires at least a minimum 30 days notice.
However, some customers may need more time to make alternative banking
arrangements.

Under Operation of the law

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This applies when the customer loses his contractual capacity under the following
situations

When he dies or is declared bankrupt insolvent.

When he is mentally incapacitated