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“Law Master’s” Publication
“Introduction to Banking”
Prof. S.D. Bhosale
(..1..)
Introduction of Banking
QUESTION BANK
1. Define Bank. Explain the relation between the bank and the customer.
2. Define Banking. Explain banker's duty to maintain secrecy. What are the exceptions to
this rule?
3 What is the Bank? Explain the duties of the Banker.
4. What is Banking? What is the nature of the Bank and customer’s relationship?
5. What is customer? Discuss the relationship between banker and customer.
6. Write a detailed note on the Banker’s duty of maintaining secrecy.
7. Define Bank. Explain the banker’s duty of honour cheque.
8. Write a detailed note on the law relating to the banker-customer relationship,
emphasizing the mutual rights and duties of bankers and customers.
9. Define bank? What are the statutory duties of bank towards its customers?
Short Notes
1. Banker's right to lien.
2. principle of good faith.
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“Law Master’s” Publication
“Introduction to Banking”
Prof. S.D. Bhosale
Contents
I. Introduction to Banking:-
Banking is a fundamental pillar of modern economic systems. It plays a pivotal role
in facilitating financial transactions and supporting the growth and stability of economies
worldwide. It encompasses various financial services, including deposit-taking, lending,
investment, and currency exchange. Banks serve as intermediaries between individuals,
businesses, and governments, managing the flow of funds and providing essential services
that underpin economic activities. The growth of a nation depends upon a robust banking
system.
II. Evolution of banking:-
The history of banking can be traced back thousands of years, with the concept of
banking evolving alongside the development of trade, currency, and economic systems.
We will discuss its evaluation in brief as follows-
The evolution of the banking system is a tale of human ingenuity, economic necessity,
and the ever-changing landscape of finance. Spanning thousands of years, this journey has
transformed from rudimentary exchange systems to our sophisticated, interconnected
global network.
A. Evaluation of Banking in the world:-
1. Ancient Beginnings (2000 BCE - 1 CE):-
The roots of the banking business can be traced back to ancient Mesopotamia, where
temples and palaces acted as early depositories for valuable assets. These institutions
safeguarded treasures and offered loans to farmers and traders. In parallel, ancient Egypt
developed a system of storing commodities in granaries, creating a rudimentary form of
banking.
2. Greek and Roman Influence (5th Century BCE - 5th Century CE):
In Greece, temples served as repositories for wealth, while Rome saw the rise of
moneylenders who provided banking services to merchants and citizens. These early
models laid the groundwork for more formalised banking systems.
3. Medieval Banking (5th - 15th Century):
The Italian city-states of Florence and Venice became epicenters of early modern
banking. Families like the Medici and the Fuggers established powerful banking dynasties.
The Knights Templar, a Christian military order, developed a banking system to fund their
activities during the Crusades.
4. Emergence of Public Banks (16th - 18th Century):
The Bank of Amsterdam (1609) and the Bank of England (1694) marked significant
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“Law Master’s” Publication
“Introduction to Banking”
Prof. S.D. Bhosale
milestones in banking history. The former, a municipal institution, allowed depositors to
withdraw and deposit money, essentially acting as a central bank. The Bank of England,
established to finance a war, is often considered the first modern central bank.
5. The Industrial Revolution and Growth of Banking (19th Century):
The Industrial Revolution fueled economic expansion, leading to the proliferation of
private and commercial banks. Branch banking, where a single bank operated multiple
branches, became a prevalent model during this period.
In the 20th Century, Computers and the internet transformed banking, giving rise to
online banking, ATMs, and electronic transfers. This digital revolution democratized
access to financial services, making it more suitable and accessible for a wider audience.
B. History of banking in India:-
The history of banking in India dates back over 200 years. The earliest banks were
indigenous establishments, often family-run, dealing primarily in money lending and
trading. However, the formal banking sector began with the establishment of the Bank of
Hindostan in 1770, followed by the General Bank of India in 1786.
The British East India Company was important in shaping India's modern banking
system. In 1806, it established the Bank of Calcutta, which later became the Bank of
Bengal. This was followed by the Bank of Bombay (1840) and the Bank of Madras (1843).
These three banks merged in 1921 to form the Imperial Bank of India.
In 1935, the Reserve Bank of India (RBI) was established as the nation's central
banking authority, taking over the functions of the Imperial Bank in 1955. The RBI became
the cornerstone of India's monetary policy and regulator of the banking sector.
Post-independence, the government nationalized major banks in two phases (1969 and
1980) to promote financial inclusion and control private ownership. This led to the creation
of large public sector banks, ensuring banking services reached even remote areas.
In the 1990s, economic reforms brought liberalisation, allowing private and foreign
banks to operate in India. This spurred competition and modernisation in the banking
sector.
Today, India boasts a diverse banking landscape, including public sector banks,
private sector banks, foreign banks, cooperative banks, and regional rural banks.
Technological advancements have brought about digital banking, making financial
services more accessible to a wider population. The UPI payment system has created a
history in the Indian Banking system and is a beacon for the whole world.
III. What is Banking?
We will discuss some definitions of bank and banking business as follows-
1. The Indian Banking Regulation Act, 1949 defines a "bank" under S. 5 (b) as:
"A banking company means any company which transacts the banking business in India."
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“Law Master’s” Publication
“Introduction to Banking”
Prof. S.D. Bhosale
S. 5 (b) of the Act describes the banking business as “accepting for the purpose of lending
or investment of deposits of amounts from the public, repayable on demand or otherwise,
and withdrawal by cheque, draft, and order, or otherwise.”
2. According to the Indian Companies Act, “bank is a financial institution which accepts
money from the public for the purpose of lending or investment of deposit of money from
the public repayable on demand or otherwise, and withdrawable by cheque, draft or
otherwise”.
3. According to Manmohan Singh (Former Prime Minister of India and Economist):
"A bank is an institution that provides a safe and secure place for people to deposit their
IV. Nature of Indian Banking business:-
The nature of the Indian banking business is multifaceted and dynamic, reflecting
the country's diverse economic landscape and financial needs. These characteristics make
the Indian banking system different from the banking systems in other countries. Here are
some key aspects that define the peculiar nature of Indian banking:
1. Diversity of Banks:-
A mix of public sector banks, private sector banks, foreign banks, cooperative banks,
and regional rural banks characterises India's banking sector. This diversity fosters
competition and provides customers with a range of options for their banking needs.
2. Regulated by the Reserve Bank of India (RBI):-
As India's central bank, the RBI holds significant regulatory authority over the banking
sector. It formulates and implements monetary policies, supervises banks, and ensures the
stability and soundness of the financial system.
3. Focus on Financial Inclusion:-
Given India's diverse population and varying levels of economic development, banks
play a crucial role in financial inclusion. They strive to bring banking services to
underserved and remote areas and offer basic services and products to all segments of
society.
4. Government Ownership and Control:
The Indian government has a significant stake in major public sector banks. However,
there has been a gradual shift towards privatization and increasing the role of private and
foreign banks in recent years.
5. Technology-Driven Transformation:
Indian banks have embraced technological advancements, leading to the proliferation of
digital banking services. Internet banking, mobile banking, UPI payment systems, and
1 In One of his speaches
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“Law Master’s” Publication
“Introduction to Banking”
Prof. S.D. Bhosale
digital wallets have become common, enhancing accessibility and convenience for
customers.
6. Retail Banking Dominance:
Retail banking, which serves individuals and small businesses, forms the backbone of
the Indian banking sector. This includes services like savings and current accounts, loans,
credit cards, and other retail-oriented financial products.
7. Corporate Banking and MSME Focus:
Banks in India also play a pivotal role in supporting corporate and industrial sectors,
providing loans, trade finance, working capital, and other financial services to large
corporations as well as micro, small, and medium enterprises (MSMEs).
8. Risk Management and Prudential Norms:
Banks in India operate under stringent prudential norms and risk management practices
set by the RBI. This ensures the stability and solvency of the banking system, protecting
depositors' interests.
9. Global Integration:
Indian banks, both public and private, have expanded their presence globally. They
operate branches and subsidiaries in various countries, facilitating international trade and
financial services.
10. Social and Developmental Functions:
Indian banks have a broader societal role, participating in various government-led
schemes and initiatives related to agriculture, education, housing, and poverty alleviation.
They also provide support for infrastructural development.
In summary, the nature of Indian banking reflects a balance between traditional
practices and modernization, driven by regulatory oversight, technological innovation, and
a commitment to financial inclusion and economic development. This dynamic
environment positions Indian banks to continue evolving and adapting to the changing
needs of the Indian economy and its diverse population.
V. Structure of Indian Banking System:-
The Indian banking system is a complex network of various types of banks and
financial institutions that play crucial roles in the country's financial sector. Here is an
overview of the structure of the Indian banking system:
1. Reserve Bank of India (RBI):
The RBI is the central bank of India, and it regulates and supervises the entire
banking system in the country. It formulates and implements monetary policies, issues
currency, regulates and supervises banks, and acts as a lender of last resort.
2. Scheduled Commercial Banks:
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“Law Master’s” Publication
“Introduction to Banking”
Prof. S.D. Bhosale
These are banks that are included in the Second Schedule of the Reserve Bank of
India Act, 1934. They can be further classified into two categories:
(i) Public Sector Banks (PSBs):
These are banks where the government owns the majority of the stake. Examples
include State Bank of India (SBI), Punjab National Bank (PNB), Bank of Baroda (BOB),
etc.
(ii) Private Sector Banks:
These are banks where private individuals or corporations own the majority of the
stake. Examples include HDFC Bank, ICICI Bank, Axis Bank, etc.
3. Foreign Banks:
These are banks headquartered in foreign countries but operate in India. They are
regulated by their home countries' RBI and banking authorities. Examples include
Citibank, Standard Chartered, and HSBC.
4. Regional Rural Banks (RRBs):
These banks were established to provide credit and other facilities to small and
marginal farmers, agricultural labourers, and rural artisans. They operate at the regional
level in different states and are jointly owned by the central government, state government,
and sponsor banks.
5. Cooperative Banks:
Urban Cooperative Banks (UCBs): These banks operate primarily in urban and semi-
urban areas. They are regulated by both the RBI and the National Bank for Agriculture and
Rural Development (NABARD).
State Cooperative Banks (SCBs) and District Central Cooperative Banks (DCCBs):
These banks operate at the state and district levels. They primarily focus on the cooperative
credit structure in rural areas.
6. Payments Banks:
These are a new category of banks introduced by the RBI to promote financial
inclusion. They can provide a limited range of banking services, such as accepting deposits
and facilitating payments, but cannot lend money.
7. Small Finance Banks:
These banks were established with the goal of furthering financial inclusion by
primarily catering to the unserved and underserved sections of the population, including
small businesses and unorganized sector entities.
8. Non-Banking Financial Companies (NBFCs):
Although not part of the traditional banking system, NBFCs play a significant role
in India's financial sector. They provide a wide range of financial services, including loans,
advances, acquisition of shares, debentures, etc.
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“Introduction to Banking”
Prof. S.D. Bhosale
9. Development Finance Institutions (DFIs):
These are institutions that provide long-term finance for industries and
infrastructure projects. They include institutions like the Industrial Development Bank of
India (IDBI) and the National Bank for Agriculture and Rural Development (NABARD).
VI. Who is a customer of a bank?
A bank customer is a person or entity with an account or using a bank's products
and services. This includes individuals, businesses, and other organisations.
To be considered a customer of a bank, a person or entity must have a relationship
with the bank. This relationship can be established in a number of ways, including:
1. Opening a bank account
2. Applying for a loan or credit card
3. Using a debit or credit card issued by the bank
4. Using a bank's online or mobile banking services
5. Depositing money into a bank account
6. Writing a check drawn on a bank account
VII. Relation of the bank and customer:-
The connection between a banker and a customer is intricate and multifaceted,
encompassing various roles and responsibilities. This relationship is characterised by
several legal and ethical frameworks, each carrying its own set of duties and expectations.
We will discuss different facets of this relationship:
1. Debtor-Creditor Relationship:
In this capacity, when a customer deposits money in a bank, the bank becomes the
debtor, owing the customer the amount deposited. The customer, in turn, becomes the
creditor, having the right to withdraw their funds on demand.
Ram Ratan Gupta Appellant v. Director of Enforcement, Foreign Exchange
The SC held that it is settled law that the relationship between a banker and a customer qua
money deposited in the bank is that of debtor and creditor.
Valaja Govinda Saravanabavananthan v. The Exchange Bank of India and Africa
The Bombay High Court emphasised that when a customer deposits money with a
bank, the bank acknowledges a debt due to the depositor. The bank's liability to the
customer is that of a debtor to a creditor.
2. Trustee and Beneficiary:
2 AIR 1966 SC 495
3 AIR 1958 BOMBAY 100
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“Introduction to Banking”
Prof. S.D. Bhosale
When customers entrust their funds to a bank, the bank acts as a trustee. The customer
is the beneficiary, relying on the bank to safeguard their money and handle it prudently,
often earning interest in return.
The SC held that the bank is a trustee for the amount deposited to it, and the customer has
the right to payment in full.
3. Principal and Agent:
In various banking transactions, the banker acts as an agent for the customer. For
instance, when a bank invests on behalf of a customer or executes trades, it acts as the
customer's representative, bound by fiduciary duties to act in the customer's best interests.
Valaja Govinda Saravanabavananthan v. The Exchange Bank of India and Africa
The SC Held: The bank may receive a cheque or a bill either as a holder for value or as an
agent for collection. When the bank receives a bill or a cheque as an agent for collection,
it is acting as the customer's agent.
4. Bailor and Bailee Relationship:
When a customer places valuable items, such as documents or jewellery, in a safe deposit
box provided by the bank, the bank becomes the bailee and the customer the bailor. The
bank is responsible for keeping the items secure, and the customer has the right to retrieve
them upon request.
5. Fiduciary Duties:
In all these relationships, the banker has a fiduciary duty to the customer. This means
they are legally bound to act in the customer's best interests, ensuring their funds and assets
are managed responsibly and ethically.
Issue: Was the appellant ("Bank") required to act as agent of the respondent or as bailee
with respect to goods entrusted for delivery against payment?
In this case, the bank received the price of goods on behalf of the customer but failed
to deliver it to him.
The Supreme Court held that the relationship between the Bank and the Customer is not
just of debtor and creditor but is of fiduciary and agency.
Conclusion:
The relationship between a banker and a customer is multifaceted, governed by various
4 AIR 1962 SC 1003
5 AIR 1958 BOMBAY 100
6 AIR 1990 SC 1329
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“Law Master’s” Publication
“Introduction to Banking”
Prof. S.D. Bhosale
legal and ethical frameworks. Both parties have distinct roles and responsibilities, whether
as debtor-creditor, trustee and beneficiary, principal and agent, or bailor and bailee.
VIII. Bankers duties towards customers:-
The relationship between a bank and its customers is founded on trust, with the bank
assuming critical responsibilities to safeguard the financial interests of its clients. Bank and
customers' rights and duties are reciprocal. Two paramount duties banks owe their
customers are maintaining confidentiality and honouring cheques. We will discuss these
duties as follows-
1. Maintaining Secrecy:
Banks are bound by a fiduciary duty to maintain the confidentiality of their customer's
financial information. This duty arises from the banker-customer relationship itself and is
reinforced by various statutes and legal precedents.
Banker's Duty of Secrecy:
The duty of secrecy obliges banks to keep all customer information confidential,
including account balances, transaction history, and personal details. This obligation
extends even after the termination of the banking relationship.
The extent of a banker's obligation to secrecy is clearly stated in Halsbury's Laws of
"It is an implied term of the contract between a banker and his customer that the banker
will not divulge to third persons without the consent of the customer, express or implied,
either the state of the customer's account or any of his transaction with the bank, or any
information relating to the customer acquired through the keeping of his accounts unless
the banker is compelled to do so by order of a Court or the circumstances give rise to a
public duty of disclosure, or the protection of the banker's own interest requires it".
Madras High Court held that the duty to maintain secrecy is a legal one arising out of a
contract and not merely a moral one.
Exceptions to Secrecy:
While the duty of secrecy is crucial, there are exceptions in cases of legal requirements,
such as court orders, statutory obligations, or instances where the customer has provided
explicit consent for disclosure.
2. Honouring Cheques:-
Cheques are instruments of immense financial importance. They allow customers to
make payments conveniently, and banks are duty-bound to honour valid cheques presented
7 paragraph 445 at page 245 of Second Volume, III Edition,
8 AIR 1965 Mad 266
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“Introduction to Banking”
by their customers.
Bank's Obligation to Honour Cheques:
When a customer draws a cheque on their account, the bank must ensure sufficient
funds cover the amount. If so, the bank is legally obliged to honour the cheque.
Consequences of Dishonouring Cheques:
Dishonouring a cheque due to insufficient funds or other reasons may lead to legal
consequences, including penalties and damage to the bank's reputation.
Consumer Commission, Punjab: Chandigarh, that in the case of the complainant's
application for allotment of the plot, it stood rejected as the cheque accompanying it was
wrongfully dishonoured by the bank. The complainant was deprived of a chance to
participate in drawing lots of plot allotments. The complainant suffered mental harassment
on this account. Compensation is not permissible for speculative loss. However, the
appellant bank was rightly directed to pay Rs. 5,000/- to the complainant for rendering
deficiency in service.
Conclusion:
The duties of maintaining secrecy and honouring cheques are pivotal components of the
banker-customer relationship. Banks are financial service providers and guardians of their
customers' financial well-being. Upholding confidentiality and promptly honouring
cheques ensures compliance with legal obligations and fosters trust, forming the bedrock
of this vital relationship.
Apart from the above rights, the customers get some other rights like access
to their account and their funds, accurate and timely statements, fair and reasonable fees,
the right to dispute errors on their statements, the right to complain to the bank about any
problems they have with the bank's products or services
IX. Banker's rights against customers:-
Banks have specific rights, including the right to lien and set-off, which allow them
to protect their interests in certain situations. These rights are important tools for banks to
recover outstanding debts and secure their financial position. We will discuss these rights
in detail:
1. Right to Lien:
The right to lien allows a bank to retain possession of a customer's property (such
as documents, valuables, or funds) until a debt or obligation owed by the customer is
satisfied. The bank has the right to a general lean on the property of its customers. The
general lien of a banker is the right by which a banker attaches all goods and securities
9 1996(2) CPC
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“Introduction to Banking”
deposited with them as a banker by a customer or by a third person on a customer's account,
Example: If a customer pledges jewellery as collateral for a loan, the bank has a right to
keep possession of the jewellery until the loan is repaid.
Legal Basis: Section 171 of the Indian Contract Act 1872 provides the legal framework
for
the
right
of
lien
in
India.
These rights are important for banks to manage credit risks and ensure the repayment of
loans and outstanding debts. However, it's important to note that these rights are subject to
legal and regulatory limitations, and banks must exercise them within the bounds of
applicable laws and contractual agreements. Customers also have legal recourse if they
believe these rights have been improperly or unfairly applied.
The Supreme Court held that the Bank has the right to divert funds from one firm's
account to pay down another firm’s overdraft.
Facts: In this case, two partnership firms with the same set of partners held two distinct
accounts with the Bank.
The Madras High Court mentioned the requirements of the right as ‘a banker’s lien is the
right to keep articles/goods delivered into his possession in his capacity as a banker and
only if the client to whom they belonged or who had the authority to dispose them of at the
time of delivery is indebted to the banker. The Bank has a lien over all securities it has and
may use them as collateral for the amount the client owes. Only those securities fall under
the purview of the Banker’s lien’.
However, the banker’s lien is subject to any contract to the contrary, and the person
asserting it must show that such a contract exists.
2. Right to Set-Off:-
The right to set off allows a bank to combine or offset mutual debts between itself and a
customer. This means if a customer owes money to the धरणाधधकार bank, the bank can use
funds from the customer's account to offset that debt.
Conditions for Exercise of the Right:
10
In T. N. Mahanta V. United Bank of India (AIR 2002 Gau.1.)
Court Held that the bank cannot exercise the right of lien, on fixed deposits with it, of a customer
who has taken a loan, because a fixed deposit is not deposited as security for a loan given to the
Bank.
11 AIR 1960 PH 1
12 AIR 1945 Mad. 445
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“Law Master’s” Publication
“Introduction to Banking”
(i) There must be mutual debts between the bank and the customer.
(iii) The debts must be in the same currency and in the same right (i.e., they must be of
the same nature).
(iv) The debts must be due and payable.
Example: If a customer has a savings account with a bank and also has an outstanding
loan with the same bank, the bank may use the funds in the savings account to partially or
fully repay the loan.
Legal Basis in India:
Section 171 of the Indian Contract Act of 1872 provides the legal framework for
the right of set-off in India.
The "right of set-off" is a significant legal tool that enables a bank to offset mutual
debts between itself and a customer. This right plays a crucial role in risk management and
debt recovery.
As per S. 171, “Bankers, … etc., in the absence of a contract to the contrary, retain
as a security for a general balance of the account, any goods bailed to them; as a security
for such balance, goods bailed to them, unless there is an express contract to that effect.
The term general balance refers to all sums presently due and payable by the
The Punjab and Haryana High Court held that the right of a bank to apply a deposit to
indebtedness due from the depositor results from the right of set-off, when obtained
between persons occupying the relation of debtor and creditor, and between whom exist
mutual demands, and it is familiar law that mutuality is essential to the validity of set-off.
In order that one demand may be set off against another, both must mutually exist between
the same parties.
In this case, the Court has laid down the distinction between the right of lien and
set-off as follows: strictly speaking, using the word 'lien' in relation to money- though
frequently used- is incorrect. It is confined to securities and property in the Bank's custody.
A distinction is drawn between a Banker's lien on its client’s papers, goods, security, etc.,
and the Bank's right to set off deposits against debts due to it from its depositors. It may
arise from the contract, from mercantile usage, or by operation of law.
The Patna High Court made a clear distinction between a lien and set off in the light of S.
13 Re European Bank 1872-8 Ch App 41
14 AIR 1960 Punjab 632
15 AIR 1944 Pat. 368
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“Law Master’s” Publication
“Introduction to Banking”
171 of the Indian Contract Act. It further held that the banks have a right to merge one or
more accounts of the same customer, but a bank cannot combine a customer’s personal
account with a joint account of another customer.
These cases provide critical insights into the application of the right of set-off in India,
affirming its importance as a tool for banks to manage credit risks and recover outstanding
debts. They establish that for the right of set-off to be exercised, there must be a mutuality
of debts, which must be due and payable. Additionally, they underline that this right is
equitable and can be exercised even in the presence of disputes between the bank and the
customer.
In conclusion, this right empowers banks to offset mutual debts between themselves
and their customers. In essence, it permits the bank to use funds held in the customer's
accounts to satisfy any outstanding debts owed by the customer to the bank. By doing so,
banks can efficiently recover outstanding debts and safeguard their financial interests.
Difference between lien and set-off:-
A banker’s lien differs from the right to set off in that a lien is confined to only the
securities and property that is in the Bank’s custody. A set-off relates to money and may
arise from a contract, mercantile usage, or by the law.
Apart from the above rights, the customer owes some other duties towards
the bank, such as maintaining accurate account information, providing the bank with the
necessary documentation to open and maintain an account, using the bank's products and
services responsibly, reporting any suspected fraud or other suspicious activity to the bank
immediately
By understanding the rights and responsibilities of customers of banks, both banks
and their customers can help to ensure a positive and productive relationship.
*****