Fundamentals of Banking

Chapter - 1

Topics Covered in this chapter

OPENING WORDS

WHAT IS MEANT BY BANK?

WHAT IS MEANT BY BANKING?

WHAT IS MEANT BY BANKER?

WHAT IS MEANT BY CUSTOMER?

OBJECTIVE OF A BANK

CHARACTERISTICS OF BANKING BUSINESS

FUNCTIONS OF BANK

CLASSIFICATION OF BANK

BANK SYSTEM AROUND THE WORLD

GENERAL RELATIONSHIP BETWEEN BANKER AND CUSTOMER:

OBLIGATIONS OF A BANKER

GARNISHEE ORDER
OPENING WORDS:

According to some economists, the word ‘Bank’ has been derived from the German word
‘Banc’ which means a joint stock firm while others say that it has been derived from the
Italian word ‘Banco’ which means a heap or mound. Perhaps the word ‘Banc’ or ‘Banco’ was
used to denote the accumulation of securities or money with a joint stock firm which later
on with the passage of time came to be known as ‘bank’.

There is still another group of people who believe that the word ‘Bank’ has been derived
from the Greek word ’BANQUE’ which means a bench.

Bank is a financial institution or body, which accepts money through different types of
deposit accounts and schemes and allocates credit to borrowers and influence interest
rates and engages in international finance & trade.

The International Accounting Standard Committee (IASC) in its IAS-30 defines the term
‘Bank” as follows:
“Bank includes all financial institutions, one of whose principal activities is to take deposit &
borrow with the objective of lending & investing & which are within the scope of banki8ng or
similar legislation.”

Like other business organizations it also aims to earn profit as its ultimate goal. Unlike
others, bank doesn’t produce goods for sale, it produces services in exchange of which it
earns several service charges & fees. The more a country is enriched with its smoother
banking services the more the country is economically developed. Skilled Bank Personnel can
enhance bank services & thus can create confidence among the people.

So, from the origination of the word ‘Bank’ and its functions and in the modern sense the
term bank we can define.

WHAT IS MEANT BY BANK?

A bank is an establishment which trades with money with the aim to earn profit. It is an
establishment for deposit custody & issue of money and also for granting loans and
discounting bills and facilitating transmission of remittances from one place to another
place.

From the definition of dictionary of Banking & Finance-

“Bank is an organization chartered by the state or federal Govt. Some principal functions of
Banks are:
1. To receive demand deposits & pay customers cheques drawn against them.
2. To receive time deposits & pay interest thereon.
3. To discount notes, make loans and invest in Govt. or other securities.
4. To collect cheques, drafts, notes etc.
5. To issue drafts & Cashier’s cheques.

Tanzina Hossain, M.B.A(D.U), Lecturer, Daffodil International University 1

 6. To certify depositors cheques.
7. When authorized by a chartering Govt. It may act in a fiduciary capacity.

From the definition of new Encyclopedias-

1. A commercial bank is a dealer in money in substitutes of money, cash as cheques or
bills of exchange. --New Encyclopedia Britannica
2. Establishment for custody of money, which it pays on customers order.
-–The New Oxford Encyclopedia Dictionary

From the definition of Finance & Exchange Act:

Bank includes a group of body personnel to carry on the business of banking.
--English Bills of Exchange Act, 1882
A bank is a person or corporation carrying on bona fide banking business.
--English Finance Act, 1915

From the definition authors:

The institution which accepts the cheques of the persons from whom it
collected money in current accounts is called bank.--H.L. Hert
A bank is a firm or institution doing a bonafide banking business.--C. Crowther
A bank is a financial intermediary & dealer in loans & debts.--Cairncross
A bank is an institution which creates money with money.--Coulborn

WHAT IS MEANT BY BANKING?

The term ‘Banking’ is defined as “accepting for the purpose of lending or investment, of
deposits of money from the public, repayable on demand or otherwise, and withdraw able by
cheque, draft, and order or otherwise”.

The salient features of this definition are as follows:

I. A banking company must perform both of the essential functions-

a. Accepting of deposits, and
b. lending or investing the same
II. The phrase ‘deposit of money from the public’ is significant. The banker accepts
deposits of money and not of anything else.
III. It also specifies the time and mode of withdrawal of deposits. The deposited money
should be repayable to the depositor on demand made by the latter or according to
the agreement reached between the two parties.

Definition of Banking:
1. Banking is a business of a banker, keeping or management of a bank. -–The Oxford
English Dictionary
2. Banking means the accepting for the purpose of lending or investment of deposit of
money from the public, repayable on demand or otherwise and withdrawal by cheque,
draft, order or otherwise. --Indian Banking Companies Act, 1949

Tanzina Hossain, M.B.A(D.U), Lecturer, Daffodil International University 2

 WHAT IS MEANT BY BANKER?

‘Banker’ means a person transacting the business of accepting for the purposes of lending or
investment of deposits of money from the public, repayable on demand or otherwise and
withdrawable by cheque, draft, order or otherwise, and includes any post office savings
Bank.

Any person carrying on the business of banking is a banker. --British Stamp

Act 1881
Banker includes a body of persons whether incorporated or not, who carrying on
business of banking. --English Bills of Exchange Act, 1882
Banker includes any person transacting the business of accepting, for the
purpose of lending or investment, of deposits of money from the public,
repayable on demand or otherwise and withdrawable by check, draft, order or
otherwise, and includes any post office savings Bank. --Negotiable Instrument
Act-1881,section 3(b)
A banker is a dealer indebts of his own and of other people.–Professor Crowther

WHAT IS MEANT BY CUSTOMER?

There is no statutory definition of a ‘customer’ and one must turn to case law if any legal
guidance is required as to what features need to be present to constitute a person being
considered a customer of a bank. The negotiable Instruments act has not clearly defined a
‘customer’, but it appears from Section-131 of the Act that constituents of the bank who
maintain some type of account(s) with him duly introduced for the purpose of having a
certain amount of deposits therein withdrawable by cheques or by any other means, are
customers. In common practice the term ‘customer’ means a person who has an account with
the bank. More recently, however, where a bank gave investment advice to a person who was
not in an account at the time, the court held that nevertheless the bank had incurred
responsibilities to him, as to a customer.

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”.

Broadly speaking, a customer is a person who has the habit of resorting to the same place or
person to do business. So far 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. Thus, a
person who has a bank account in his name and for whom the banker undertakes to provide
the facilities as a banker is considered to be a customer. A single deposit in the account will
be sufficient to designate a person as customer of the banker.

It may be said, therefore, that a person becomes a customer as soon as a business

relationship is established. It is not necessary for the account to have been open for a long

Tanzina Hossain, M.B.A(D.U), Lecturer, Daffodil International University 3

period of time, or for the business to be conducted over a regular period. In fact, two
conditions seem to be important for becoming a customer of a bank. These are as follows:
I. a bank account-savings, current or fixed deposit-must be opened in his name by making
necessary deposit of money, and

II. the dealing between the banker and the customer must be of the nature of banking
business.
A customer of a banker need not necessarily be a person. A firm, joint stock company,
a society or any separate legal entity may be a customer.

OBJECTIVE OF A BANK:

A bank establishes with various objectives. The objectives are stated below:

From View Points of Bank From View Points of Govt. From View Points of Banks
Owners Clients
Earning Profits Issue of Notes & Deposits
Currencies
Goodwill Capital Formation Safety
Raising Efficiency Capital Investment & Advisors & Consultants
Industrialization
Rendering Services Money Market Control Representative or
Trustee
Investment of Capital Employment Raising Living Standard
Advise on Financial
Matters

CHARACTERISTICS OF BANKING BUSINESS:

A bank has different characteristics. Some characteristics are similar to other business
which is regarded as general characteristics. On the other hand, some characteristics are
different from the other business which is regarded as unique characteristics. They are
given below:

General Characteristics like other business:

1. Ownership
2. Formation
3. Legal Entity
4. Profit Earning

Unique Characteristics as banking business:

1. Service Selling Agencies

2. Sources of Investment

Tanzina Hossain, M.B.A(D.U), Lecturer, Daffodil International University 4

 3. Trader of interest
4. Work With Confidence
5. Maintain Secrecy
6. Intermediation Between Surplus Savers And Deficit Savers
7. Business Inventory
8. Trader of Credit
9. Money Transfer
10. Agent of Client
11. Safe Keeper
12. Financial Solvency
13. Capital formation
14. Source of Credit for Government

FUNCTIONS OF BANK:

Banks perform the following two types of functions:

Micro Functions:
1. Receiving Deposit
2. Allowing Interest
3. Extension of Credit & Receiving Interest
4. Creation of Credit Deposit
5. Creating Medium of Exchange
6. Giving Cheques
7. Formation of Capital
8. Issuing Notes
9. Circulation of Money
10. Act as a Trustee
11. Exchange Negotiable Instruments.

Macro Functions:
1. Investment of Capital
2. Role in the Economic
3. Transmission of Money
4. Safe Custody of Money
5. Consultancy
6. Employment
7. Controlling Money Market
8. Credit Control
9. Agricultural Development
10. To Set Up Relation
11. Regional Development
12. Formation of Money Market
13. Help in Import & Export
14. Act as a Treasurer of Govt.

Tanzina Hossain, M.B.A(D.U), Lecturer, Daffodil International University 5

 15. Discounting of bill of exchange, Bank Drafts etc.
CLASSIFICATION OF BANKS

Bank

On the basis of On the basis of On the basis of On the basis of

ownership function organizational scheduling
structure

State owned bank Central Bank Unit bank Scheduled bank

Private ownership bank Commercial bank Branch bank Non scheduled
Govt. and private joint Co-operative bank Chain bank bank
ownership bank Agricultural bank Group bank
Autonomous bank Industrial bank Mixed bank
Exchange bank
Investment bank
Merchant bank
Savings bank
Import and export bank
Consumer bank
Transportation bank
Small and cottage industries
bank
Mortgage bank
Mixed bank
Grameen bank
Indigenous bank
Regional bank
Community development bank
International bank

Tanzina Hossain, M.B.A(D.U), Lecturer, Daffodil International University 6

 BANK SYSTEM AROUND THE WORLD:

Around the world the managerial process of banks share some similarities. But with the
different patterns of Govt. system, Banks may exist in several ways while performing its
duties:

Current Commercial Banking System can be classified as follows:

A. Anglo-American Banking System

B. German Universal Banking System

C. Japanese Main Banking System

D. Indian Lead Banking System

A. ANGLO-AMERICAN BANKING SYSTEM:

This system is used in most of the countries of the world. The basic difference is
overviewed incase of commercial banks and investment banks. It means no commercial bank
can operate investment banking.
Also there is no provision for allotting shares for the depositors & Clients of the bank.
The relationship exists only incase of creditors relationship & client relationship not incase
of owner relationship.

B. GERMAN UNIVERSAL BANKING SYSTEM:

It system is used in Germany. There is no difference in commercial & investment banking
under this system.
It can enjoy involvement in any type of business activity related to banking. There is a
provision of 40% share holding privilege for the clients under this system.
Clients can monitor the banking system in two ways:

1. As Creditor
2. As Owner/ Director

C. JAPANESE MAIN BANKING SYSTEM:

It emphasizes on relationship banking. This system allows participating in corporate
ownership. This is a hybrid of investment banking & commercial Banking.
There is a provision of 5% share purchasing power of other banks. Like the German System
it allows to monitor the bank as creditor & as director/owner.

D. INDIAN LEAD BANKING SYSTEM:

At the end of 1960, this system came into focus. It performs some additional duty besides
the available services provided by the banks.
It emphasizes on the increment of deposit amount, equitable allocation of financial
resources on the basis of some criteria to various sectors of economy, to enhance the
investment capacity & skill.

Tanzina Hossain, M.B.A(D.U), Lecturer, Daffodil International University 7

 Under this system the whole country is divided into sub zones & each zone is conducted
under authorized lead bank.
GENERAL RELATIONSHIP BETWEEN BANKER AND CUSTOMER:

The relationship arises between a banker and a customer with the opening of an account by
the customer with a banker. The application for opening an account is considered as a letter
of agreement for establishing the banker-customer relationship. So, there creates
different types of relationship between them. The general relationship between a banker
and its customer on the basis of the types of dealings they undertake between themselves
can be put as follows:

I. Debtor and Creditor

II. Trustee and Beneficiary, and

III. Principal and Agent

I. Debtor and Creditor:

On the opening of an account the banker assumes the position of a debtor. 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. But he does not get any charge over
the assets of his debtor/banker and remains an unsecured creditor of the banker.

Banker’s relationship with the customer is reversed as soon as the customer’s account is
overdrawn. Banker becomes creditor of the customer who has taken a loan from the banker
and continues in that capacity till the loan is repaid.

Though the relationship between a banker and his customer is mainly that of a debtor and
creditor, this relationship differs from similar relationship arising out of ordinary
commercial debts in following respects:

a) Demand for repayment necessary: In case of ordinary commercial debt, the

debtor pays the amount on the specified date or earlier or whenever demanded by
the creditor as per the terms of the contract. But in case of a deposit in the bank,
the debtor/banker is not required to repay the amount on his own accord. It is
essential that the depositor (creditor) must make a demand for the payment of
the deposit in the proper manner.

b) Demand should be made at proper time and place: The demand for repayment
should be made during normal working hours of the bank on a working day.
Moreover, the demand should be made at the branch of the bank where the
customer has his account unless otherwise agreed.

c) Demand must be made in the proper manner: The demand for repayment of
money should be made through a cheque or any other written order as per the

Tanzina Hossain, M.B.A(D.U), Lecturer, Daffodil International University 8

 common usage among the bankers. A verbal or telephonic demand will not be taken
as a proper demand.
II. Trustees and Beneficiary:
The banker acts as a trustee for his customers in those cases where he accepts securities
and other valuables for safe custody. The relationship between the banker and his customer
as a trustee and beneficiary depends upon the specific instructions of each case. The legal
position of the banker as a trustee, therefore, differs from that of a debtor of his
customer. In the former case the money or documents held by him are not treated as his
own and are not available for distribution amongst his general creditors in case of
liquidation.

III. Principal and Agent:

Banker acts as the agent of the customer in those cases where it performs agency
functions such as collection of cheques, bills of exchange purchasing and selling of
securities, payment of insurance premium etc. on behalf of his customer. Some banks have
established Tax Service Departments to take up the tax problems of their customers.

OBLIGATIONS OF A BANKER

The primary relationship between a banker and his customer is that of a debtor and
creditor. Thos relationship imposes the following special obligations on the banker –

1. Obligation to honor the cheques

2. Obligation to maintain secrecy of accounts

1. Obligation to honor cheques:

[

The deposits accepted by a banker are his liabilities repayable on demand or otherwise. The
banker is, therefore, under a statutory obligation to honor his customer’s cheques in the
usual course. Section 31 of the negotiable instruments act, 1881, lays down that, “The
drawee of a cheque having sufficient funds of the drawer in his hands, properly applicable
to the payment of such cheque, must pay the cheque 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.”

So, the banker must honour the customer’s cheque drawn on him provided:-

a. the funds must be sufficient in the hands of the banker.

b. the funds are properly applicable to the payment of the cheque
c. the banker has been duly required to pay

Tanzina Hossain, M.B.A(D.U), Lecturer, Daffodil International University 9

 d. the cheque has been presented within a reasonable time after the
apparent date of its issue,
e. no prohibitory order of the court or any other competent authority
e.g, tax authority etc. is standing against the accounts of the
customer.

2. Obligation to maintain secrecy of accounts:

The banker is under an obligation to take utmost care in keeping secrecy about the accounts
of his customers. By keeping secrecy is meant that the account books of the bank will not
be thrown open to the public or Government officials and the banker will take all necessary
precautions to ensure that the state of affairs of a customer’s account is not made known
to others by any means. So, it is obligatory for the banker not to disclose the state of the
customer’s account with it since such disclosure may adversely affect the customer’s credit
and business. This obligation continues after the customer has closed his account with the
banker.

When the banker may disclose the secrecy of the account?

A banker will be justified in disclosing information about his customer’s account on
reasonable and proper occasions only as stated below:

I. Disclosure of information required by Law:

A banker is under statutory obligation to disclose the information relating to his customer’s
account when the law specifically requires him to do so. The banker would, therefore, be
justified in disclosing information to meet the following requirements:

i. Disclosure under the Income Tax Act, 1961

ii. Disclosure under an order of the court

iii. Disclosure under the Companies Act, 1991

iv. Disclosure under the Central Bank Act

v. Disclosure under the Banking Regulation Act, 1949

vi. Disclosure under the Gift Tax act

vii. Disclosure under the Criminal Procedure Code

viii. Disclosure under Foreign Exchange Regulation Act, 1973

ix. Disclosure under the Industrial Development Bank Act

II. Disclosure permitted by the banker’s practices and usages:

Under the following circumstances a banker may disclose the relevant information about his
customer as a banking practice-

i. With express or implied consent of the customer

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 ii. Where banker’s own interest requires

iii. Where credit information is required by other banks or banker’s

reference

III. Disclosure in public Interest:

The banks should be required to give information regarding the financial position of their
customers in public interest in the following cases-

i. When a bank is asked for information by a gov’t official concerning

the commission of a crime and the bank has reasonable cause to

believe, that a crime has been committed and the information in the

bank’s possession may lead to the apprehension of the culprit.

ii. When bank considers that the customer is involved in activities

prejudicial to the interests of the country.

iii. Where the banks book reveal that the customer is contravening the

provisions of any law.

iv. Where sizable funds are received from foreign countries by a

constituent.

GARNISHEE ORDER

The obligation of a banker to honor his customer’s cheques is extinguished on receipt of an

order of the court, known as the Garnishee Order, issued under Order 21, Rule 46 of the
Code of Civil Procedure, 1908.

In case a debtor fails to pay the money due to his creditor, the creditor may apply to the
court to issue a “Garnishee Order” on the debtor’s bank. As a result of this order, the
debtor’s account with bank is to be frozen & the bank cannot make any payment out of the
account defying the order of the court.

In the Garnishee Order-

The creditor, on whose request such order issued, is called “Judgment-Creditor”.

The debtor, whose account is frozen is called ‘’Judgment-Debtor” .

The banker who has the customer’s account is called the “Garnishee”.

Tanzina Hossain, M.B.A(D.U), Lecturer, Daffodil International University 11

The Garnishee Order is issued by the court in two parts:

Order Nisi:
By this order the court-

 asks the banker to freeze the debtor’s account

 asks the banker to explain why the funds in account so freeze should not be used

for payment of Judgment-Creditor.

On receipt of such order the banker is prohibited from paying the amount due to his
customer. He should, therefore, immediately inform the customer so that he can make
necessary arrangement for payment of the debt.

Order Absolute:
After the banker files his explanation, if any, the court may issue the final order, called
Order Absolute. By this order the court directs the banker to pay either the whole or a
part of the funds lying in the account against which Order Nisi has been issued to
Judgment-Creditor.

Tanzina Hossain, M.B.A(D.U), Lecturer, Daffodil International University 12

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