MODULE 1

ORIGIN, STRUCTURE & FUNCTIONS OF BANKING

INSTITUTIONS IN INDIA

INTRODUCTION

• The word ‘Bank’ has been derived from the Greek word ‘Banque’ which means ‘a
Bench’.
• Both the word ‘Bank’ and ‘Bankrupt’ are said to have their origin from the word
‘Banque’.
• In Medieval Europe, moneylenders and money chargers who can be called early bankers,
used to display their coins and transact business on the bench.
• There are others, who believe that the word ‘bank’ is originally derived from the German
word ‘back’ meaning a joint–stock fund. As the Germans occupied Italy , the word was
Italized, the word ‘back’ became ‘banco’ and finally it became ‘Bank’ under the English.
• Banks were considered as a backbone to the financial system to the country, and it also
play an important role in economic development of nation. Banks primary function is to
include accepting deposits & using these deposits for binding purpose.
• Since that time money – changing was important function of bank.
• In ancient India, there were persons who carried on the business of money lending and
banking.
• In modern India – both organised and unorganized sectors of money market existed.
• But organized money market institutions have made sufficient progress and playing
important role.
• Among organized sector of money market, commercial banks and cooperative banks have
been there for many decades.

HISTORY OF BANKING SYSTEM IN INDIA

• Banking was in existence in India during Vedic times (from 2000 BC TO 1400 BC).
• During early Aryan days Money lending was practiced. During those days, money lending
was considered as one of the four honest callings, the other three being ‘tillage, trading
and harvesting’.
• There are references of lending and banking in two epics namely Mahabharata and
Ramayana which are concerned with the events of life which took place between 1000 and
700 BC. During that period banking has become a full–fledged business.
• In modern era the function which banks are performing out of which most of these
functions are already performed by the bankers in the Smriti period, such as; accepting of
deposits, granting secured and unsecured loans, acting as their customers baille, granting
loan to kings in times of grave crisis, acting as the treasurer and banker to the state and
issuing and managing the currency of the country.
• During the Mughal period,’ indigenous banking was in its prime. The system of currency
and coinage in operation at that time rendered money lending a highly profitable business.
This was a period in which indigenous bankers enjoyed a pre-eminent position in society,
being the sole source of finance to the community. The rulers and government also mostly
depended on them and appointed them as revenue collectors. However, there was a great
fall in the banking system during this period as the Muslims regarded taking of interest as
a sin.
• Modern banking started in India only from the beginning of the 19th century. The earliest
commercial banks were started in India by the employees of the East India Company.
These banks were known as ‘Agency House’. Banking in India in modern sense originated
in the last decade of 18th century when Bank of Hindustan was first established in 1770.
Three Presidencies Banks viz. Bank of Calcutta, Bank of Bombay, and Bank of
Madras were established. Bank of Calcutta renamed as Bank of Bengal in 1809.These
 three presidency Banks were amalgamated & formed Imperial Bank of India on 27th
January 1921. This Imperial Bank of India after independence again renamed and
became State Bank of India in 1955; State Bank of India is the largest and oldest Bank
of India.
• Pursuant to the provision of the State Bank of India (Subsidiary Banks) Act of 1959, the
following banks were constituted as subsidiaries of the State Bank of India- State Bank of
Bikaner, Bank of Indore, State Bank of Hyderabad, State Bank of Saurashtra. On 1st
January the State Bank of Jaipur and State Bank of Bikaner were amalgamated to form
State Bank of Bikaner and Jaipur.

BANK CRISIS

Banking in India experienced severe set–back during the period 1913-17 , as 108 banks failed
and another 373 banks failed in 1922-36, which was again followed the failure of 620 banks
in 1937- 48.

Cooperative banks started functioning in India 1904 with the sole aims to finance agriculture.
The cooperative banks are now on a three tier basis, namely, - (i) Primary Cooperative Banks
at the village level; (ii) Central Cooperative Banks at the district level ;(iii) State cooperative
Bank at State level.

The establishment of Reserve Bank of India in the year 1935 marked as the beginning of a
new era in history of Indian banking system. The Banking regulation act 1949 gave wide
power to the Reserve Bank of India to regulate, supervise and develop the banking system.

British Era

During British Era, the merchants started Union Bank of Calcutta in 1869, initially it was
started as joint stock association but later it came into partnership with other.

In 1881 in Fizalabad first Indian joint stock bank which was Oudh Commercial Bank came
into action but it was failed in 1958. The next which was established in 1894 in Lahore was
the Punjab National Bank, which has been in existence to the present and is now the second
largest Bank in India.
The banking system of India in the early 20th was not enough developed that it can give a
strong fight to the presidency banks and foreign exchange banks which were well updated
with the technology and capital resources.

The Swadeshi Movement inspired the establishment of banks in periods between 1906 and
1911. Bank of India, Corporation Bank, Indian Bank, Bank of Baroda, Canara Bank and
Central Bank of India are some banks which are established during that time and are
functioning very smoothly.

Post Independence

The entry activities of Private Sector and Foreign Banks were restricted through Branch
licensing and regulation norms.

Steps taken by Indian Government to regulate Banking are: - RBI was nationalized on
January, 1949 under the terms of RBI. In 1949 the Banking Regulation Act was enacted. The
Banking Regulation Act, 1949 also have a provision that the no new bank or branch of any
existing bank could be opened without a license issued by an RBI. No two banks could have
common Directors.

NATIONALIZATION

Indian Banking history can be traced to 19th century. During the colonial era many Indian
banks were founded either by the Presley States or by wealthy individuals. The primary aim
of most of the banks was to cater financial needs of trade and industry in that locality. During
this period the banking services became the privilege of big business firms and wealthy
individuals. Masses were denied easy credit and banking services. Agriculture and rural
small scale industries did not have access to credit facilities and banking services. They
depended on village money lenders and other private financiers to fund their activities.
These local financial prodders exploited the rural population by charging enormous
interest rates and harsh repayment conditions.

Nationalization of banks in India by then Indian Prime Minister Indira Gandhi wrote a
new chapter in Indian Banking history. The nationalized banks in India were compelled to
focus on rural and agricultural sectors as a part of their social responsibility. Their
resources were utilized to empower farmers and agricultural laborers in order to free them
from the clutches of money lenders.
Nationalization of banks in India was done in two phases. The first phase of nationalization
started in 1955 when the erstwhile Imperial Bank of India became State Bank of India
with an Act of parliament. During 1959, seven subsidiaries were nationalized and
associated with State Bank of India one by one. This heralded a new beginning in Indian
banking system. The State Bank group became the largest bank in India serving 90 million
customers with a network of over 9000 branches in nook and corners of the country.

The second phase of nationalization started in 1969 with the nationalization of 14 major
commercial banks in India with effect from the midnight of July 19, 1969 by promulgating
the Banking Companies (Acquisition and Transfer of Undertakings) Ordinance, 1969,
which became an act in August 1969. In 1980, 6 more commercial banks were
nationalized and became public sector banks. After this period the Public Sector
Undertaking banks expanded their reach and grew in leaps and bounds. The nationalized
banks in India expanded their branches and spread their activities across the country. The
PSU banks introduced new schemes and programs to cater all sections of the society. Thus
the nationalization of Banks in India helped the masses to avail banking services at affordable
cost.
Objectives

• Class to mass banking

• Social Welfare
• Controlling Private Monopolies
• Expansion of Banking
• Reducing Regional Imbalance
• Priority Sector Lending
• Developing Banking Habits
• Increase in efficiency and profit

Demerits and Limitations

• Inadequate banking facilities

• Limited resources mobilized and allocated
• Political and Administrative Interference
• Increased expenditure
• Lowered efficiency and profits
• Weak infrastructure
• Poor competitiveness

Bank Nationalization Case ---- RC Cooper v. Union of India AIR 1970 SC

564

FACTS –

Pandit Jawarharlal Nehru believed in Fabian Socialism. In the year 1948, the proposal to
nationalize the banking sector had been actively debated upon by the All India Congress
Committee (A.I.C.C.). The first Finance Minister of India, R.K. Shanmugham Shetty, was
strongly in favour of nationalizing the Imperial Bank of India, but Sardar Vallabhbhai Patel
had stopped him from doing so due to certain political reasons. However, very soon, in the
year 1955, the Imperial Bank of India, was nationalized under the State Bank of India Act
and 7 of its subsidiaries too were taken over the by the Government.

Morarji Desai’s main argument was that the amount of compensation which was going to be
paid to these banks, which amounted to Rs.85 crores, could be simply used to accelerate the
 economy of the country. Another argument that Mr. Desai had put forward was that the credit
could be diverted towards the social sectors, simply by controlling the banks by amending the
banking laws of the country.

The then Acting President of India, Justice M. Hidyatullah, issued an Ordinance just two days
before the monsoon session of the Parliament was going to start. The name of the Ordinance
was ‘Banking Companies (Acquisition and Transfer of Property) Ordinance of 1969’.

After the news of the promulgation of the Ordinance reached Mr. Cooper, who was not only
the then Director of the Central Bank of India Ltd., but also held shares in Central Bank of
India, Bank of Baroda Ltd. and Bank of India Ltd., he filed a Writ petition under Article 32 of
the Constitution of India, before the Supreme Court of India, stating that his Fundamental
Rights had been violated by the promulgation of the Ordinance.

Issues raised

The following issues had been raised by Mr. Cooper, through his advocate, Mr. Palkhiwala,
which are as follows-

1. Whether a shareholder could file a Writ petition for the violation of his
Fundamental Rights, when the company in which he is a shareholder is acquired
by the Government?

2. Whether the Ordinance in question had been properly made or not?

3. Whether the Act was within the jurisdiction of the Parliament to get formulated or
not?

4. Whether the impugned Act was violative of Article 19(1) (g) and Article 31(2) of
the Constitution of India or not?

5. Whether the method of ascertaining the compensation was valid or not?

Arguments submitted
Petitioner:

1. The first argument submitted by Mr. Palkhiwala regarding the maintainability of the petition
was that the petition was maintainable, on the pretext that the petition was being filed by Mr.
 Cooper in his individual capacity as a citizen of India and not as a representative of his
company. Since a company is not a citizen within the ambit of the Indian Citizenship Act,
1955, so, it can’t claim any Fundamental Right under the Constitution, of which Mr. Cooper
was eligible by virtue of being a citizen.

2. According to Article 123, the President is empowered to pass any Ordinance, if he feels that
there is an absolute necessity and when both the Houses of the Parliament are not in session.
On the basis of this contention, we may see that the Ordinance was promulgated just two
days before the monsoon session of the Parliament, so there was no necessity to promulgate
the same. Thus, in contravention of this provision, the Supreme Court was empowered to
strike it down.

3. The third argument was regarding the competency of the Parliament to pass the Act. It was
stated that the Seventh Schedule contained the three Lists, which demarcated the limit of
jurisdiction for both the Central as well as the State Governments. The Union List contained
entries upon which only the Central Government was empowered to make laws, the State List
contained entries upon which only the State Governments were empowered to make laws and
lastly, the Concurrent List contained entries upon which both the Central and State
Governments could make laws, subject to the Doctrine of Repugnancy. The argument, thus,
stated that the Central Government was entitled to make laws on ‘banking’ only as defined
under Section 5 (b) of the Banking Regulation Act of 1949, as Entry 45 of the Union List
empowered it to do so. Moreover, it was argued that by virtue of Entry 42 of the Concurrent
List, the Legislature was empowered only to make laws in order to effectuate Entry 45 in the
Union List. Thus, on the basis of these logics, it was said that the Parliament was not
empowered at all to pass the impugned Act.

4. At that time, Right to Property was considered to be a Fundamental Right under Article
19(1)(f), which was later omitted after the Judgement of Keshavananda Bharati’s case.
However, when the present case had been instituted, the Right was officially recognized and
so it was said that it violated Article 19 (1) (g) Article 31 (2) (the whole article has been
repealed now) which dealt with compulsory acquisition of property.

5. Lastly and not the least, the Achilles’ heel of this whole Act was the provision for
compensation, which was argued to be entirely ‘draconian’ and extremely irrational and
illogical. The compensation, which would not be paid in cash, but, in Government securities,
 which in turn were payable after 10 years, was completely biased in its approach, with an aim
to harass the public and also, to give an undue benefit to the Government.

Respondent:

1. The first argument of the respondent was regarding the maintainability of the Writ petition
and it said that the said petition was not maintainable, as the same was being filed to claim
the Rights in the name of a company, which, as we have seen, does not fall under the
definition of a citizen as per the Indian Citizenship Act, 1955.

2. The next argument was regarding the question about the President’s power to promulgate the
Ordinance. It was contended that the power of the President to promulgate the Ordinance was
completely subjective in nature, as the words ‘if he felt’ were used and also, he was not
answerable to anyone for the reason of his actions done during his term of office. Thus, the
argument of the invalidity of the Ordinance was condemned.

3. The other argument, regarding the competence of the Parliament was that the Court must
understand that there was an obligation upon the State to achieve a socialistic society, with
principles of egalitarianism and where no inequality existed. Considering this definition, the
argument was that the Court should interpret the term ‘banking’ in the widest possible way,
so as to include all the activities that could be included by the respondent.

4. The fourth argument was regarding the mutual exclusivity of the Fundamental Rights from
one another, as held in the case of A. K. Gopalan Vs. State of Madras and stated that the Act
was not violative of Article 19 (1) (g), as it fell within the ambit of Article 31 of the
Constitution.

Judgment
On the 2nd of February, 1970, the landmark judgment, by a majority of 10:1 was delivered
by the Supreme Court of India. Except Justice A.N. Ray, the other Judges gave the following
judgment that a shareholder was not entitled to move to the Supreme Court for enforcing the
Fundamental Rights in the name of his company, until and unless the action which was being
complained of, directly or indirectly violated the petitioner’s Fundamental Rights as well.

Ratio Decidendi
 The major findings of the Court in the present case are as follows-

1. The major contribution of this case was the overruling of the ‘Mutual Exclusivity Theory’
which had been practiced for 20 years till this case happened, from A. K Gopalan Vs. State of
Madras. The Court held that just on the basis of technicalities, it can’t reject a petition which
clearly shows that the Fundamental Rights of the citizens are being violated. Just because a
Legislative action was also violating the Rights of the company didn’t mean that the Court
was not having the jurisdiction to protect the Rights of the shareholder of the company as
well. The Court also struck down the ‘Object’ test and laid down the ‘Effect’ test. The Effect
test would now look into the Effect of any particular legislative Act, rather than looking at the
objective with which it had been formulated. Thus, if any Act of the Legislature, even at a
remote stage, violated the Fundamental Rights of the citizens, then, it was liable to be struck
down.

2. As far as whether the Ordinance was promulgated properly or not, to this the Court said that
since the Ordinance had already been converted into an Act, so it was unnecessary for the
Court to discuss the same. The Court said that the same had become a question for
academicians to ponder upon, but not for the present case.

3. As far as the arguments regarding the Parliament’s competence to acquire banking companies
was concerned, the Court, very interestingly, rejected both the petitioner’s as well as the
respondent’s arguments. The Court said that the term property included all the Rights,
liabilities, assets, etc., which were associated with the property. The power of the Parliament
to acquire any banking company was an independent power of the Parliament and it required
no separate Legislation to be enacted first under List II and List III.

4. The Court declared the Act to be clearly violative of the Article 31, as Article 31 talked about
compensation for the acquired property. Now, the term ‘compensation’ meant complete
indemnification to the person, whose property was being acquired. Since it was frankly clear
from the objectives of the Act that equal indemnification was not going to be provided and
also, after applying the test of severability, as the Act was not independent enough to stand
alone without the part in question, so it was liable to be struck down.

5. The Court, however, for the contention of Articles 19(1)(g) held that the Act was not
violative of Article 19(1)(g), as the State had the complete Right to partially or completely
monopolize any business that it felt to.
6. However, the Court discovered that the Act was in clear violation of Article 14. This was
held on the basis of the following reason that the concerned Act barred the 14 banks carrying
out banking activities within the country, however, other banks, including the foreign banks,
had not been stopped from doing so. The Supreme Court, thus, held the Act to be ‘flagrantly
practicing discrimination’ and thus, held it to be violative of Article 14.

Justice A.N. Ray was the only Judge who gave the dissenting opinion. He gave the following
points-

1. The only way in which the Ordinance passing power of the President could be challenged
was on the basis of malafide and corrupt intentions. The fact that the Ordinance had been
promulgated just two days before the session of the Parliament began, indicated that the same
had been passed legitimately, although in a haste.

2. There was considerable speculation in the country regarding Government’s intention with
regard to nationalization of banks during few days immediately before the Ordinance.

3. The reason is obvious that in matters of policy, just as Parliament is the master of its
province, similarly the President is the supreme and sole judge of his satisfaction on such
policy matters on the advice of the Government.

4. He dismissed the petitions upon various other reasons and thus, declared the petitions to fail.

5. A shareholder can’t approach the Court for the violation of his Rights, which at the end were
associated with a company, which by virtue of being a non-citizen, and did not possess the
Right to claim Fundamental Rights.

6. The ‘mutual exclusivity theory’, as propounded in the A. K. Gopalan case, was upheld by
him.

However, there were indeed two things upon which he agreed with the majority and they
were-

1. That the impugned Act was not violative of Article 19 (1) (g) of the Constitution
of India, inhibiting the freedom to carry on any trade or business.
 2. That the Parliament was competent enough to pass the impugned Act, related to
the acquisition of banking.

The majority Judgment, which was given by 10 out of the 11 Judges, was drafted by Justice J.
C. Shah for himself and on behalf of the other 9 Judges who were for the majority opinion.
The dissenting order was drafted by Justice A. N. Ray. Thus, the Judgment was passed by a
10:1 majority in this particular case.

LIBERALISATION AND GLOBALISATION

Number of small private banks were granted license by the government due to the policies of
liberalization in the early 1990s. Due to Globalization more and more Banks are receiving the
benefits and also expanding at an incredible faster pace, publicly owned Banks handle more
than 80% of the Banking Business in India and rest in the hand of private sector Banks.
However, Banking in both the government and private sector is being revolutionized by this
latest phenomenon called ‘Globalization’.

NARASIMHAM COMMITTEE 1991

Narasimham is arguably the most powerful banker in post-independence India. The reports
produced by the two Committees he chaired — the Narasimham Committee on Financial
System (1991) and the Narasimham Committee on Banking Sector Reforms (1998) —
remain the foundational documents for any discussion of banking sector reforms and banking
policy. He is also credited with laying the groundwork for historic events such as bank
mergers, the emergence of new-generation private banks, and asset reconstruction firms.

The 1st Narasimham Committee was set up by Manmohan Singh as India’s Finance Minister
on 14th August 1991.A nine member committee was set up under the chairmanship of M.
Narasimham, a former Governor of Reserve Bank of India. The Committee submitted its
Report to the Finance Minister in November 1991. The Narasimham committee (1991)
assumed that commercial banks' financial resources came from the general public and were
held in trust by the banks and that the bank funds were to be used to the greatest extent
possible for the benefit of depositors. This assumption implied that even the government had
no business jeopardizing the solvency, health, and efficiency of nationalized banks under the
guise of using bank funds for social banking, poverty alleviation, and so on.

The Narasimham committee set out to effect three major changes in India's banking sector:

• Assuring a certain level of operational flexibility.

• Banks have internal autonomy in their decision-making processes.
• Increased professionalism in banking operations.

Recommendations of Narasimham Committee I

Reduction in SLR and CLR

• The committee recommended that the higher proportions of the Statutory Liquidity
Ratio (SLR) and Cash Reserve Ratio (CRR) be reduced.
• At the time, both of these ratios were extremely high. The SLR was 38.5 percent at
the time, and the CRR was 15%.
• Because of the large amount of SLR and CRR, the bank's resources were locked up
for government use.
• It was a hindrance to the bank's productivity, so the committee recommended a
gradual reduction.
• SLR should be reduced from 38.5 percent to 25 percent, and CRR should be reduced
from 15 percent to 3 to 5 percent.

Phasing out Directed Credit Programme

• Since nationalization, the government of India has implemented directed credit

programs. The committee recommended that this program be phased out.
• This program compelled banks to set aside funds for the needy and poor sectors at
concessional interest rates.
• Because it was reducing bank profitability, the committee recommended that this
program be discontinued.
Determination of Interest Rate

• The committee believed that interest rates in India were regulated and controlled by
the government.
• The interest rate should be determined based on market forces such as the demand for
and supply of funds.
• As a result, the committee recommended eliminating government interest rate
controls and gradually phasing out concessional interest rates for the priority sector.

Structural Reorganization of Banking Sector

• The Narasimham committee (1991) proposed a significant reduction in the number of

public sector banks through mergers and acquisitions to increase efficiency in banking
operations.
• Three or four large banks, including SBI, should take on an international flavor.
• Eight to ten banks should be national banks with a widespread network of branches
across the country.
• The remainder should remain as regional banks with operations limited to a specific
region.
• The RBI should allow the establishment of new private-sector banks as long as they
meet the minimum start-up capital and other requirements.
• The government should declare that no more banks will be nationalized.
• Foreign banks are permitted to open branches in India, either wholly-owned or as
subsidiaries. This would increase productivity.
• Foreign banks and Indian banks are permitted to form joint ventures in merchant and
investment banking.
• Since the country already had a network of rural and semi-urban branches, the system
of licensing branches with the goal of spreading the banking habit should be phased
out. Banks should be allowed to open branches wherever they see fit.

Establishment of ARF Tribunal

• In those days, the proportion of bad debts and Non-Performing Assets (NPA) of
public sector banks and development financial institutions was very concerning.
• The committee proposed the creation of an Asset Reconstruction Fund (ARF).
 • This fund will assume a portion of the banks' and financial institutions' bad and
doubtful debts. It would assist banks in getting rid of bad debts.

Removal of Dual Control

• Banks were under the dual control of the Reserve Bank of India (RBI) and the
Ministry of Finance's Banking Division at the time.
• It considered and recommended that the RBI be the sole primary regulator of banking
in India.

More Freedom to Banks

In order to improve the workings of banks, the Narasimham committee (1991) recommended
that:

• Each bank is free and autonomous.

• Every bank should pursue radical changes in working technology and culture in order
to become internally competitive and to keep up with the wide-ranging innovations
that are taking place.
• Over-regulation and over-administration should be avoided, and internal audits and
inspections should rely on more.
• The various guidelines issued by the government or the RBI regarding internal
administration should be considered in the context of the bank's independence and
autonomy.
• The appointment of the bank's CEO and board of directors should be based on
professionalism and integrity rather than political considerations.

Major Recommendations:

• Reduction in the Statutory Liquidity Ratio

• Reduction in the Cash Reserve Ratio
• Redefining the priority sector
• Deregulation of the Interest Rate
• Asset Classification and defining the Non-Performing Assets
• Improve transparency in the banking system
• Tribunals for recovery of Loans
 • Tackling doubtful debts
• Restructuring the banks
• Allow entry of the new private Banks

The 2nd Narasimham Committee was set up by P. Chidambaram as Finance Minister

of India in December 1997. It is also known as the Committee on Banking Sector
Reforms. The Committee submitted the report to the Finance Minister in April 1998.

Major Recommendations:

Greater autonomy was proposed for the public sector banks – in both
ownership & management Merger of the strong banks
Raising the capital adequacy ratio to 9% by 2000 and 10% by 2002
Need for zero non-performing assets for all Indian banks
A need for creation of Asset Reconstruction Funds or Asset Reconstruction
Companies
Entry of Foreign Banks
Computerization process in public sector banks
Universal Banking

Impact:

o Banking Sector Reforms' opened the gates to the private sector

o & to foreign banks which in turn significantly increased the level of
competition. Asset reconstruction co.
o DRT, Act
o SARFAESI , Act
o Introduction of Basel Norms
o Redefining of priority sectors
o Merger of the week banks with the stronger banks.
o Modernization and computerization
o Virtual Banking
o Universal Banking etc
 MODULE – 2

BANKER CUSTOMER RELATIONSHIPS: LEGAL ISSUES

INTRODUCTION

Relation between banker and customer is consensual depending on express or implied

contract between two. Thereby a contractual relation springs between banker and customer.
In case of banking where a person asks the banker to open an account for him and the bankers
acceptance thereof, constitutes implied contract of relationship.

Relation of banker and customer depends upon the service given by the banker. Thus the
relationship between a banker and customer is the transactional relationship.

DEFINITION OF BANKER

A person who is doing business is called a banker. But it is not easy to define the term
‘Banker’ because a banker performs multifarious functions.

First: a banker must be a man of wisdom; he deals with other money but, with his own mental
faculties.

Second: a banker is not only acting as a depositor, agent but also a financial advice.

The bill of exchange of Act of 1882 defines the banker, “Banker includes a body of persons
whether incorporated or not who carry on the business of banking”.

Section 3 of Negotiable Instruments Act states that term banker includes a person or a
corporation or a company acting as a banker”.

Dr. Herbert Hart says: A banker is one who in the ordinary course of business, honors
cheques drawn upon him by persons from and for whom he receives money on current
account.

Halsbury ’s 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.”

United Dominion Trust Ltd v. Kirkwood(1966)1 All ER 968

Lord Denninng delivering the judgment and stating the characteristics of a banker stated;

• “There are therefore two characteristics usually found in bankers today they accept money

• From and collect cheques from their customer. They honour cheques or order drawn on
them by their customers; Accordingly these two characteristics carry with them a third, they
keep current account or something of that nature in their books in which the credit and debit
are entered”.

The Banking Regulations Act, 1949 does not define the term ‘banker’ but defines what
banking is?

As per Sec.5 (b) of the B R Act “Banking' means accepting, for the purpose of lending or
investment, of deposits of money from the public repayable on demand or otherwise and
withdrawable by cheque, draft, order or otherwise."

Sec.5(c) of BR Act defines "banking company" as a company that transacts the business of
banking in India. Since a banker or a banking company undertakes banking related activities
we can derive the meaning of banker or a banking company from Sec 5(b) as a body
corporate that:
(a) Accepts deposits from public.
(b) Lends or
(c) Invests the money so collected by way of deposits.
(d) Allows withdrawals of deposits on demand or by any other means.

DEFINITION OF CUSTOMER

The term ‘customer’ of a bank is not defined by law. Ordinarily, a person who has an account
in a bank is considered as customer.

Sir John Paget’s view “to constitute a customer there must be some recognizable course or
habit of dealing in the nature of regular banking business.”

This definition of a customer of a bank lays emphasis on the duration of the dealings between
the banker and the customer and is, therefore, called the ‘duration theory’.
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.”

Great Western Railway Co. v. London and County Banking Co. Ltd H.L A.C. 414

Where a bank had cashed cheques for about twenty years for a man who had no account with
the bank. Both the trial judge and the Court of Appeal held that he was a customer, but the
House of Lords took the opposite view.

Commissioners of Taxation v. English, Scottish & Australian Bank Limited (1920) AC

683 - It was stipulated that "continues dealing" was not of the essence, and that a "customer"
relationship began immediately when an account was opened and cheques paid in for
collection.

According to Dr. Hart, “a customer is one who has an account with a banker or for whom
banker habitually undertakes to act as such.” Supporting this view point , the Kerala high
court also observed in the case of central Bank of India ltd. Bombay v. V. Gopinathan Nair.
“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 transaction are concerned he is a person whose
money has been accepted on the footing that banker will honour up to the amount standing to
his credit, irrespective of his connection being of short or long standing.”

The classic exposition of the nature of the bank – customer relationship in Joachimson v.
Swiss Bank Corp by Lord Justice Atkin gives a lucid account of the basic common law duties
of bank towards its customer. His Lordship stated:

“The bank undertakes to receive money and to collect bills for its customer’s account. The
proceeds so received are not to be held in trust for the customer, but the bank borrows the
proceeds and undertakes to repay them. The promise to repay is to repay at the branch of the
bank where the account is kept and during banking hours.”

RELATIONSHIP BETWEEN A BANKER AND CUSTOMER

Can be divided into two types:

1. General relationship
2. Special relationship

DEBTOR - CREDITOR RELATIONSHIP

“The basic relationship between banker and customer is that of debtor and creditor. Where a
banking account is in credit, which we may regard as being the normal case, the banker is the
debtor.”

• Relationship between the customer having a deposit account and the banker is:
• Depositor is the lender and the banker is the borrower.
• Depositor is the creditor and the banker is the debtor.
• The money handed over to the bank is a debt.

Folley v. Hill (1848) 2 H.L. CAS. 28  According to Lord Cottenham : ‘Money paid
into a banker’s is money known by the principal to be placed there for the purpose of being
under the control of the banker; it is then the banker’s money; he is known to deal with it as
his own; he makes what profit he can, which profit he retains to himself… he has contracted,
having received that money to repay to the principal when demanded a sum equivalent to that
paid into his hands’ . Lord Atkin also supported the view.

Joachimson v. Swiss Bank Corporation (1921) 3 K.B.110  In case of a debt due from a
bank, an express demand for repayment by the customer is necessary.

CREDITOR-DEBTOR RELATIONSHIP

When the customer avails a loan or an advance then his relationship with the banker
undergoes a change to what it is when he is a deposit holder.

Since the funds are lent to the customer, he becomes the borrower and the banker becomes
the lender. The relation is the creditor-debtor relation, the customer being a debtor and the
banker a  creditor.

BANKER AS TRUSTEE

Sec. 3 of the Indian Trust Act, 1882 defines the term trustee as one to whom property is
entrusted to be administered for the benefit of another. Section 3 of Specific Relief Act,1963
states that trustee includes every person holding expressly, by implication or constructively a
fiduciary character. In Canara Bank v. Canara Sales Corporation , the Supreme Court held
that there is always an element of trust between the bank and its customer.

As per Sec. 15 of the Indian Trust Act, 1882, “ A trustee is bound to deal with the trust –
property as carefully as a man of ordinary prudence would deal with such property if it were
 his own; and, in the absence of a contract to the contrary, a trustee so dealing is not
responsible for the loss, destruction or deterioration of the trust – property.

A trustee has right to reimbursement of expenses under Sec.32 of the Indian Trust Act.

A trustee holds money or assets and performs certain functions for the benefit of some
other person called the beneficiary. The relationship between the banker and his customer as
a trustee and beneficiary depends upon the specific instructions given by the latter to the
farmer regarding the purpose of use of the money or documents entrusted to the bank.

Examples:

• When a bank receives a cheque from the customer for collection from another bank,
the bank becomes a trustee till the amount of cheque is realized.
• Bank appointed as a receiver
• Unspent balance
• Money deposited without any instructions for its disposal or pending further
instructions.

CASE LAWS

1. New Bank of India v. Peary Lal AIR 1962 SC 1003

In this case, plaintiff delivered certain amounts of money to the bank of Lahore for
transmission to the bank’s branch at Calcutta with instructions to await the directions of
plaintiff regarding the opening of the account for keeping the same in fixed deposit or
otherwise in Calcutta branch.

But the plaintiff never gave any instructions for opening any account fixed deposit or
otherwise with respect to the amount after they reached Calcutta. The question that arose for
determination, in that case, was whether the bank was a trustee for that amount or whether the
relationship was that of mere creditor and debtor.

Justice Shah speaking for the Supreme Court held that after the purpose for which the money
was entrusted was carried out, in the absence of the further instructions, the defendant did not
cease to be a trustee. Here, the fact that bank purported to open a fixed deposit account, in the
 name of the plaintiff was held to be inconsequential as it was done without the consent of the
plaintiff.

2. Official Assignee of Madras v. JW Iron, 8 (MLT) 99

A remittance was sent to a banker with instructions to purchase shares in a certain company.
The bank bought some share, but before completing the rest of the purchase it failed. It was
held that the bank stood in the position of the trustee to the remitter and therefore, he was
entitled to a refund of the unspent balance of the amount.

3. Official Assignee v. Natesam Pillai

In the case of the Official Assignee v. Natesam Pillai it was held that where the amount was
credited in anamath or suspense account to await instructions of the creditor as regards their
disposal and the regular procedure of giving the passbook was not followed by the bank nor
any agreement with respect to payment of interest on deposit is entered into by the parties,
the amounts must be deemed to have been received by the bank in fiduciary capacity and not
as between bank and its customer.
Another important observation that was made in this case was that the mere fact that the
plaintiff had no prior transaction with the bank is not sufficient to warrant the presumption of
the fiduciary relationship.

PRINCIPAL-AGENT

Sec.182 of ‘The Indian Contract Act, 1872’ defines “an agent” as a person employed to do
any act for another or to represent another in dealings with third persons. The person for
whom such act is done or who is so represented is called “the Principal”. A banker acts as an
agent of his customer and performs a number of agency functions for the convenience of
his customers.

When a banker undertakes agency services such as collection of cheques, drafts and bills,
collection of interests and dividends on securities payment on premium and subscriptions,
purchase and sale of securities etc., for a customer, he becomes the agent and the customer
becomes the principal.

As an agent, the banker owes some duties to the customer. They are :
 i. He is required to act in accordance with the instructions of the principal i.e
the customer.
ii. He is bound to return to the customer all the incomes which he earns as an
agent of the customer.

Banks also abides by the standing instructions given by its customers. In all such cases banks
acts as an agent of its customer.

CASE LAWS:

1. Bank of India v. The Official Liquidator –

It was held that when customer sends cheques for collection to the banker, the latter’s
role becomes as an agent of the customer.
2. In the matter of Tranvancore National & Quilon Bank Ltd, the court held that the
money held apart by the bank as the property of his customers does not form part of
the banker’s assets on liquidation.
3. In Estate of SN Firm v. Natesan Pillai, moneys were paid by the customer for the
purposes of effecting a specific transaction and were credited in suspense account.
The bank failed and the question arose whether the customer was entitled to any
preferential payment.

BAILOR –BAILEE RELATIONSHIP

Section 148 of Indian Contract Act, 1872, defines bailment, bailor, and bailee. A bailment is
the delivery of goods by one person to another for some purpose upon a contract. As per the
contract, the goods should when the purpose is accomplished, be returned or disposed off as
per the directions of the person delivering the goods.

• Person/ party that entrusts goods to a bailee is called a bailor

• Person/ party to whom goods are entrusted/ delivered for a certain purpose viz. as a
custody or for repair, without transferring the ownership rights, is called a bailee.
• Act by which goods are delivered to a bailee for a certain purpose without transfer of
ownership is called as bailment.

In case of ‘safe custody facility’, the bank accepts responsibility of the safe custody of the
sealed boxes and packets. The banker can open such box only on the duty authorized
instructions of that customer. The legal relationship that arises in case of safe custody is that
of bailment. The customer, who deposits the things in the box for safe custody with the bank,
becomes the ‘bailor’ and the bank becomes the ‘ bailee’.

Duty to Take Reasonable Care – (Section 151 – 152)

Section 152 – (Bailee when not liable for loss, etc., of thing Bailed): “The bailee, in the
absence of any special contract, is not responsible for the loss, destruction or deterioration
of the thing bailed, if he has taken the amount of care of it described in Section 151.”
The reasonable care to be taken by the bailee is an important duty of a bailee. The essence of
a bailment contract lies in the safe returning of the bailed goods, if the reasonable care duty is
waived off then the bailee will not be liable even if he/she has been negligent. The
significance of this provision can be seen in, Central Bank of India v. Grains and Gunny
Agencies[ii], in which the Madhya Pradesh HC held, “Even when discharges himself of
liability due to his negligence, he has to prove that he took as much care as man of ordinary
prudence.”

Bailor can waive-off Duty of Reasonable Care

The phrase , “in absence of any special contract” does not restrict the extent of liability of a
bailee. By reading Section 152 alone, many legal experts interpreted that the reasonable care
duty of bailee can be waived off and by express contract, the bailee cannot be held liable for
negligence. In Bombay Steam Navigation Co. v. Vasudev Baburao Kamat[iv], Bombay HC
held, “By “In any absence of any special contract”, the Act does not expressly prohibit
bailees from avoiding liability for negligence by an express contract for the
same.” Subsequently, even in Lakhaji Dollaji &Co. v. Boorugu Mahadeo
Rajanna[v], where the defendants, as commission agents, on plaintiff’s instruction,
purchased silver bars and negligently lost them. Bombay HC confirmed, “Bailees should be
at liberty to enter bailment contracts as they deem fit. They should be allowed to enter
bailment contracts at risk of the bailor.” “This judgment was confirmed by Punjab &
Haryana HC in SBI v. Quality Bread Factory[vi], where Clause 15 of a bank agreement
read, “No liability on bank for outturn of final goods produced and pledged to bank.” When
there is no special contract, the bailee has to take amount care stipulated under Section 151.
However, by a special contract, a bailee can protect himself from liability in case of
negligence. Thus, the HC allowed the bank appeal and held, “It is open to bailee to contract
himself out of the reasonable care obligation imposed under Section 151.” In my humble
opinion, it is necessary to provide liberty to bailees to insert exempting clauses in bailment
contracts, as it would incentivize the bailees. Any bailee will enter into the contract if he is
assured of no liability even in case of negligence.

Bailor cannot waive-off Duty of Reasonable Care

Reading Sections 151 and 152 together, tell us that the special contract can increase the
standard of care, in which case the bailee shall comply to the increased extent of care and,
cannot discharge liability by observing mere reasonable care. But, the bailee cannot, through
express contract decrease the reasonable standard of care, as that under Section 151 must be
observed. In M. Siddalingappa v. T. Nataraj, where a dry-cleaner’s negligence caused
damage to clothes given to him, Karnataka HC held, “Dry-cleaner cannot contract himself
out of the reasonable care duty imposed by Section 151.” This was further confirmed
in, Mahendra Kumar Chandulal v. CBI, where the appellant had pledged bales of cloth with
the bank. The respondent bailee failed to take utmost care and, four bales of cloth went
missing due to poor inspection. The Gujarat HC held, “The bank is liable despite the
absolving clause of all liability, as diluting the reasonable standard of care is against the
meaning and intent of Section 151.” Further, in Cochin Port Trust v. Associated Cotton
Traders Ltd[x], the bailed goods to the Port Trust were damaged by a fire in their storage.
The Kerala HC held, “Port trust had to take all reasonable measures to ensure protection of
goods.” There will be a floodgate of cases of negligence in care if the duty to take
reasonable care is waived-off, as the bailees will not have any incentive to take care.
Moreover, the presumption in negligence is on the bailee. He must prove that he took all
precautionary measures. In Joseph Travers & Sons Ltd. v. Cooper, Court of Appeal
held, “Bailee must satisfy Court that loss occurred independent to his negligence, and he
took due care.” So, if the reasonable care duty is waived off, the bailees will start to be held
liable even if all measures are taken or for damages caused by events beyond control.
In Balwantlal Chhabildas Mehta v. State Bank of Saurashtra, Gujarat HC
confirmed, “Bailee cannot be held liable if cause of damage is beyond bailee’s
control.” Even, Section 152 discharges liability if bailee took reasonable care. In my opinion,
waiving-off the concerned duty will indeed nullify Section 152.

LESSER –LESSEE RELATIONSHIP

Sec.105 of ‘Transfer of property Act 1882’ defines lease, Lessor, lessee, premium and rent.
(1)The transferor is called the lessor,

(2)The transferee is called the lessee,

(3)The price is called the premium, and

(4) The money, share, service or other thing to be so rendered is called the rent.

Providing safe deposit lockers is as an ancillary service provided by banks to customers.

While providing Safe Deposit Vault/locker facility to their customer’s bank enters into an
agreement with the customer. The agreement is known as “Memorandum of letting”.

Locker Facility and liability of a bank

The relationship between the bank and the customer is that of the lessor and lessee. Bank
lease (hire lockers to their customers) their immovable property to the customer and give
them the right to enjoy such property during specified period i.e during the office/ banking
hours and charge rentals. Bank has the right to break open the locker in case the locker holder
defaults in payment of rent. Banks do not assume any liability or responsibility in case of any
damage to the contents kept in the locker. Banks do not insure the contents kept in the
lockers.

Amitabh Dasgupta v. United Bank of India & Ors (2021) – Irrespective of the value of
the articles placed inside the locker, the bank is under a separate obligation to ensure
that proper procedures are followed while allotting and operating the lockers.

MORTGAGEE AND MORTGAGOR RELATIONSHIP

According to Section 58 of the Transfer of Property Act, 1882, a mortgage is the transfer of
an interest in specific immoveable property for the purpose of securing the payment of money
advanced or to be advanced by way of loan, an existing or future debt or the performance of
an agreement which may give rise to pecuniary liability.

The transferor is called a mortgagor, the transferee a mortgagee. The relation between a
banker as mortgagee and his customer as mortgagor arises when the latter executes a
mortgage deed in respect of his immovable property in favour of the bank or deposits the title
deeds of his property with the bank to create an equitable mortgage as security for an
advance.
PLEDGER AND PLEDGEE (BANK- PLEDGEE OR PAWNEE AND
CUSTOMER- PLEDGER OR PAWNOR):

The relationship between customer and banker can be that of Pledger and Pledgee. This
happens when the customer pledges (promises) certain assets or security with the bank to get
a loan. In this case, the customer becomes the Pledger or Pawnor, and the bank becomes the
Pledgee or Pawnee. Under this agreement, the assets or security will remain with the bank
until a customer repays the loan.

HYPOTHECATOR AND HYPOTHECATEE (BANK- HYPOTHECATEE

AND CUSTOMER- HYPOTHECATOR):

The relationship between customer and banker can be that of Hypothecator and
Hypothecatee. This happens when the customer hypothecates certain movable or non-
movable property or assets with the banker to get a loan. In this case, the customer became
the Hypothecator, and the Banker became the Hypothecatee.
TERMINATION OF THE RELATIONSHIP BETWEEN A BANKER AND A
CUSTOMER:

It would thus be observed that the banker customer relationship is a transaction relationship.
The relationship between a bank and a customer ceases on:

(a) The death, insolvency, lunacy of the customer;

(b) The customer closing the account i.e. Voluntary termination;
(c) Liquidation of the company;
(d) The closing of the account by the bank after giving due notice;
(e) The completion of the contract or the specific transaction;
(f) Lends to the borrower; or
(g) Invests the money so collected by way of deposits.

BANKERS’ SPECIAL RELATIONSHIP:

Normally, the customer operates his bank account. There are many situations in one’s life
where an individual possessing property, bank accounts, etc. may not be in a position to
perform his duties due to reasons like being abroad, ill, old, etc. In such situations, if the
transaction requires the presence of an individual who is not able to be present personally,
then the only way out is to give the powers to act on behalf of the individual to another
person. This is when a Power of Attorney deed is to be created. It is very common these days
to give the powers to a trustworthy person to conduct the registrations, or sale or rent out, etc.
if you are busy with your other schedules.

For a banking operation, the customer may authorize, for his convenience, an agent or
nominee to operate on his account. Such authority is given either by way of a Mandate Letter
or Power of Attorney. By mandate letter, the particular banker is informed that certain powers
have been delegated whereas a power of attorney acts as a general notice and authority.

MANDATE LETTERS:

A letter of the mandate is addressed by a customer to the bank informing that powers to
operate the account (ordinary deposit account) have been delegated by the customer (the
mandator) to a particular person (the mandatory). Such letters of mandate do not attract stamp
duty.
As far as possible, branches should require customers to execute powers of attorney when
they desire to authorize their agent or nominee to operate on their account on a more or less
permanent basis. The procedure of obtaining mandate letters instead of powers of attorney
should, as far as possible, be limited to operations on ordinary credit accounts.

POWER OF ATTORNEY:

A Power of Attorney is a legal document by which one person gives the right to perform or
powers of transacting in matters relating to a property, banking, legal and judicial
proceedings, tax payments, etc. to another person due to certain reasons like being out of the
country, or getting old, or not able to look after one’s duties in those matters, etc. Power of
Attorney is an authority given by a written formal instrument whereby one person termed the
donor or principal authorizes another person termed the done, attorney, or agent to act on his
behalf.

POWERS OF ATTORNEY ON BANK ACCOUNTS:

A power of attorney may be special or general. A special power of attorney authorizes a

person to act in a single transaction whereas authority to act in more than one transaction
such as a bank account or generally, is a general power of attorney. The power of attorney is
a stamped document. The power to operate an account will not include, by itself, a power to
overdraw or borrow money. Authority or power to borrow by the attorney should
definitely/explicitly be stated/embodied in the instrument. Drawing on an overdraft account is
borrowing.

Types of Power of Attorney: Power of Attorney can be of mainly two types;

1. GENERAL POWER OF ATTORNEY:

A person can give another person a complete general right or power to act lawfully
concerning his property or bank accounts or tax payments, or registration work or to sue a
third party, etc. It is commonly termed as General Power of Attorney.
Either you can give a General Power of Attorney for all your properties, banking transactions,
tax matters, registration, legal disputes, and court matters, etc. or you can give general power
to anyone category like only for all property matters or only for all Banking processes, etc.
This type of power is very wide and has a lot of risks if the attorney is not a trustworthy
person.

2. SPECIAL POWER OF ATTORNEY:

The other type of power granted is the special power which means it is granted for only a
specific task or work. A special power of attorney is to be made by a person when any
particular task or act is to be done. Once the particular act is completed the special power of
attorney comes to an end. This is generally used when you want to rent out your property or
appear for the registration of any property or appear in a court on behalf of the Principal or to
appear before the Tax authorities etc.

DUTIES OF A BANKER & CUSTOMER

Duty to maintain secrecy

• This duty is also referred to as duty of non-disclosure.

• A bank owes a duty to its customer not to divulge information about its customers to
third parties.
• Not an absolute duty but an essential duty
• Tournier v. National Provincial Board Union Bank of England (1924])1 KB 461
This case is important for laying down qualifications on the duty of the banker to
observe the secrecy of the account of the customer and thereby limiting the legal duty
of the banker.
The exceptions are: I) Where disclosure is made under compulsion of law, ii) Where there is
a duty to the public to disclose, iii) Where the interests of the bank requires disclosure and;
iv) Where the disclosure is made by the express or implied consent of the customer.
Customary/Statutory Banking Law
• Both in banking customs as well as statutes, there is a standardized, recognized
obligation of secrecy.
 • The SBI Act, 1955 – Section 44
• The Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970 &
1980- Section 13
• The Credit Information Companies (Regulation) Act, 2005 - section 29
• The Public Financial Institutions (Obligation as to Fidelity and Secrecy) Act, 1983 –
section 3
• The Payment and Settlement Systems Act , 2007 – section 22
• The Reserve Bank of India regulations and guidelines
• The Indian Banks Association (IBA) established a body called the Banking Codes
and Standards Board of India to evolve a set of voluntary norms which banks would
enforce on their own.

A banker will be justified in disclosing information about his customer’s account on
reasonable and proper occasions only as stated below:
• Under the Income- Tax Act, 1961.According to Section 131.
• Under Companies Act, if Inspector is appointed by the Central Government.
Registrar may conduct inquiry and investigations.
• Section 133 of Income Tax Act,1961
• Under the Banking Regulation Act, 1949
• By order of the Court under the Banker’s Books Evidence Act, 1891.
• Under the Reserve Bank of India Act, 1934- section 45 B
• Under the Foreign Exchange Management Act, 1999 (section 10 , Section 12 of this
Act empowers the officer of the Directorate of Enforcement and the Reserve Bank
to investigate any contravention under the Act.)
• Under the Industrial Development Bank of India Act, 1964. (sub-section 1A of
Section 29 of this Act)
• Section 12 of the Prevention of Money Laundering Act, 2002

Duty to honour cheques:

As 'banking' means accepting of deposits withdrawable by cheque, draft, order or
otherwise, the banker is duty bound to honour cheques issued by the customers on their
accounts.
Sec. 31 of the Negotiable Instruments Act, 1881 specifies the liability of drawee of cheque.
Sec. 31 “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
so to do, and, in default of such payment, must compensate the drawer for any loss or damage
caused by such
Duty to honour cheques ceases on receipt of: (a) Stop payment instructions from the account
holder. (b)Notice about the death of the drawer. (c) A garnishee order attaching the balance in
the account or an income-tax attachment order received by the banker. (d)Drawer of the
cheque becoming insolvent and/or a lunatic at the time of drawing the cheque fault.”

RIGHTS OF A BANKER
• Right of general lien
• Right of set-off
• Right of appropriation

RIGHT OF GENERAL LIEN

Lien means the right of the creditor to retain the goods and securities owned by the debtor
until the debt due from him is repaid It is a legal claim by one person on the property of
another as security for payment of a debt.

Section 171 of Indian Contract Act, 1872 confers the right of general lien to banks. As per
the section “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 the effect.”

Section 6(1)(f) of Banking Regulation Act,1949- 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.

A banker cannot exercise his right of general lien if:

✓ a contract – express or implied

✓ Goods / securities received as a trustee or an agent
✓ Safe custody deposits
 ✓ The banker cannot exercise his right of lien over the securities lodged with him for
securing a loan, before such loan is actually granted to him.
✓ Securities left with the banker negligently.
✓ Banker possesses right of set-off and not lien on money deposited.

In the case of Brahmayya and Co. Vs. K.P.Thangavelu Nadar and others (1956-Madras-
570) that "The lien under Section 171 can be exercised only over property of some one else
and not his own property. Thus when goods are deposited with or securities are placed in the
custody of a bank it would be correct to speak of the rights of the bank over the security or
the goods as a lien because the ownership of the goods or securities would continue to remain
in the customer. But, when moneys are deposited in a bank as a fixed deposit, the ownership
of the moneys passes to the bank and the right of the bank over the moneys lodged with it
would not be really a lien at all. It would be more correct to speak of it as a right of set off or
adjustment."

In the case of Syndicate Bank v. Vijay Kumar and others reported in AIR 1992 SC 1066,
the Honourable Supreme Court had occasion to consider the general lien of Bank to retain the
fixed Deposit Receipts deposited with the Bank as security for the Bank guarantee. In this
case, the Bank was given authority to retain the FDRs so long as any amount on any account
is due from the person to whom the Bank guarantee was given and it was held that the Bank
had a right to set off in respect of the FDRs as there was some amount due to the Bank in
respect of other transactions between the Bank and the customer who had made the fixed
deposits and given the FDRs as security for a Bank guarantee and for any amount on any
account which due from the customer.

Nakulam v.Dep.Gen. Manager,Canara Bank (2013)

The petitioner availed a personal loan of Rs 25,000/- from the Canara Bank on 31.2.2012
agreeing to repay the same with interest in equated monthly installments in a span of three
years. The personal loan was availed on the basis of a demand promissory note executed by
the petitioners in the favour of bank and no security was obtained at time of transaction. The
petitioners also availed gold loan of Rs 85,000/- from Bank on 11.05.2012 on pleading
46.700 gm of gold and agreeing to clear the same with interest on or before 10.05.2013.
 The main issue in the present case was that can the bank retain the gold ornaments offered as
security while availing a loan even after the same is cleared on the premise that the borrower
has not discharged his liability in respect of another loan?

By relying on section 171 of Contract Act and following dictum in Syndicate Banks case to
hold that Bank is entitled to retain as security the gold ornaments pledged till the personal
loan is also cleared.

RIGHT TO SET-OFF

• The right of set off is also known as the right of combination of accounts.
• The set off refers to combining of two or more accounts for final settlement of accounts. In
other words set off is a process where the bank recovers its due loan, to the debit of deposit
account of the borrower.
• This right arises where the customer maintains two or more accounts with the banker, one
which is in credit, with the other in debit. In the exercise of this right, the banker, in effect,
combines two or more accounts of the customer and uses the credit in one to offset the deficit
in another account.
• In other words, the mutual claims of debtor and creditor are adjusted together and only the
remainder amount is payable by the debtor. For example, A has taken an overdraft from his
banker to the extent of Rs. 5,000 and he has a credit balance of Rs. 2,000 in his savings
bank account, the banker can combine both of these accounts and claim the remainder
amount of Rs. 3,000 only.
• The essential condition is that one of such accounts must show a debit balance and the other,
a credit balance.
• For exercising the right of set off all branches of bank is treated as single unit.

Conditions while exercising right of Set - Off:

a) The account should be in the sole name of the customer.

b)The amount of debts must be certain and measurable.

c) There should not be any agreement to the contrary

d) Funds should not be held in trust accounts

e) The right cannot be exercised in respect of future or contingent debts.

f) The banker has the right to exercise this right before a garnishee order is received by it.

Barclays Bank v. Quistclose Investments Ltd. (1968)UKHL 4

Rolls Rozer Ltd .borrowed an amount from Quistclose Investment Ltd. with the specific
purpose of paying the dividend to the shareholders and deposited the same in a
separate account ‘Ordinary Dividend No. 4 Account with Barclays Bank Ltd. and the latter
was also informed about the purpose of this deposit. The company went into liquidation
before the intended dividend could be paid and the banker combined all the accounts of the
company, including the above one. Quistclose Investment Ltd., the creditors of the company,
claimed the repayment of the balance in the above account which the bank refused. It was
finally decided that by opening an account for the specific purpose of paying the dividend a
trust arose in favour of the shareholders. If the latter could not get the funds, the benefit was
to go to the Quistclose Investment Ltd. and to the bank. The banker was thus not entitled to
set-off the debit balance in the company’s account against the credit balance in the above
account against the credit balance in the above account. The balance held in the
clients’ account of an advocate is not deemed to be held in the same capacity in which the
amount is held in his personal account.

In Krishna Kishore Kar v. Untitled Commercial Bank and Another (AIR 1982 Calcutta 62),
the UCO Bank, on the request of its customer K.K. Kar, issued guarantee for Rs. 2 lakhs in
favour of the suppliers of coal guaranteeing payment for coal supplied to him. The customer
executed a counter- guarantee in favour of the Bank and also paid margin money Rs. 1.83
lakhs to the Bank. After fulfilling its obligations under the guarantee, the Bank adjusted Rs.
76,527 due from the customer under different accounts against the margin money deposited
by the customer in exercise of its lien (or alternatively the right of set-off). The High Court
held that the bank was not entitled to appropriate or adjust its claims under Section 171 of
the Contract Act in view of the existence of the counter- guarantee, which constituted a
contract contrary to the right of general lien.
RIGHT OF APPROPRIATION

In case of his usual business, a banker receives payments from his customer. If the latter has
taken more than one loan from the banker, the question of the appropriation of the money
subsequently deposited by him naturally arises. Section 59 to 61 of the Indian Contract Act,
1872 contains provisions regarding the right of appropriation of payments in such case.

Banker’s right of Appropriation

The principle of appropriation also applies to the loans obtained from bank, when there are
two or more debts due to a single customer.

Priority - The general principle is that in case of a debt due with interest, any payment made
by the debtor should be first applied by the bank to the interest and thereafter to the principal
amount, unless there is agreement to the contrary.

Condition Payments - Bank is not bound to accept the payment from the burrower on the
condition proposed by him. But where the condition is accepted, it has to be fulfilled.
For example: Where the customer deposits money to meet the payment of a particular bill
payable by him, bank cannot utilise this money against any other loan/advance account.
Time of Appropriation - Right can be exercised only at the time of a payment. Bank cannot
unilaterally combine all the accounts of customer.

Notice before appropriation - Where the bank decides to appropriate the payment it has to
send a notice to the customer. When appropriation comes to the notice of the customer, it
becomes irrevocable.