Banking Law and Practice

Legal Environment of Banking

Definitions: Banking: Under section: 5(h & c) of Banking Companies Ordinance 1963 Banking means
(a) Accepting deposits from public for the purpose of lending & investment. (b) Payable on demand, withdrawal by cheque, draft, order or otherwise.

Banking Company: Any company which transacts the business of banking in Pakistan. Banker: u/s: 3 of Negotiable Instrument Act 1881 Banker is a person who is receiving money
from customers and investing advancing that money to others.

Function of Banks:
Under section: 7 of Banking Companies Ordinance 1963; Bankers can engage in following Business activities. (1) (2) (3) (4) (5) (6) (7) (8) (9) Borrowing and lending money Discounting, collecting bills of exchange Buying & selling bullion & foreign exchange. Issuing Letter of Credit to the customers Receiving valuables for safe custody Underwriting & dealing in stocks, shares, other securities on behalf of the customer. Carrying out guarantees & indemnities business Dealing with property which is a security Acting as a Modarba company.

Customer
Definition: A person becomes a customer when he, (a) Opens an account. (b) Maintains a regular account without taking into consideration the duration and frequency of operation of the account.

Rights of Customer towards the Banker

(a) To draw cheques against his credit balance. (b) To receive bank statement. If there is over crediting or over-debiting in his account he has the right to get it corrected. (c) To sue the bank for cost, damages, loss when the cheque is wrongly debited (d) To sue if the bank has not maintained the secrecy of the account.

Duties of a Customer:
(a) Customer must present the cheque to the bank during business hours. (b) Under section: 84 of Negotiable Instrument Act customer should see cheques & other instruments are presented for payment within due time. A cheque becomes stale if presented six month from the date on which it becomes due. (c) Cheque book should be kept under lock & key. If customer fails in his duty he is to be held responsible for negligence. (d) Cheques are to be drawn very carefully so that there are no room for fraudulent alterations and additions.

General Relationship between Bank & Customer.

(A) Debtor and creditor Relation: The relation between banker & customer is that of a debtor and creditor. Fuley Vs Hall (1848) in this reported case the customer maintained that a principal/agent relationship exist between customer & Banker. The bank is agent of the customer & as such the customer has the right to inquire where his money deposit has been invested by the bank. The court ruled that a debtor creditor relation exist between the bank & customer. The Bank is free to invest or lend the money deposited in whatever way it seems fit without any interference from the depositor/customer. (B) Bailor and Bailee: A contract of bailment can exist between the banker & customer. Examples: (1) Customer renting out a locker in a bank. (2) Car lease finance. (C) Principal and Agent: Contract of agency is possible between bank & customer. Example: (1) Payment of premium to insurance companies. (2) Collection of utility bills. (3) Fees of schools & universities.

(D) Pawner and Pawnee: when lending a bank secures the collateral through pledge, charge or hypothecation (E) Right of Lien: A right available to a bank to withhold deliver of security or property, to its customer till bank charges, interest or other dues are paid. When right of lien can be exercised: (1) Property of customer must come to the banker as a customer (2) No entrustment for any special purpose. (3) Banker should obtain possession legally. (4) No agreement between the bank & customer should be inconsistent with the right of lien. (F) Right of Set-Off:

Bankers Duty of Secrecy.

Customer, banker relation is confidential. Bank must maintain secrecy about the state of his customers account. Banking Companies Ordinance 1962. Under section: 33-A banker is to maintain complete secrecy and fidelity relating to the operations of customers account. Banks (Nationalization) Act 1974: under section 12(1)

Obligation to maintain secrecy may not be considered essential on following occasions:(1) Under Compulsion of Law: (a) Under section: 6 of Bankers Book Evidence Act 1891 a banker is permitted to give evidence by producing certified copies of the relevant parts of the entries. (b) Under section: 165 of Criminal Procedure Code (Cr.P C): An investigating Police officer requires searching the record of a bank. Provided permission has been taken from Session Judge. (c) With the prior approval of an Income Tax Commissioner an income tax officer can inspect the books of a bank. (d) In the interest of a Bank: When a bank is filling a suit against the customer for the recovery of loans, charges, overdraft account; bank can disclose the nature of the account. (e) Under an express or implied contract between the bank and customer, account information can be given to third party.

Principles and Forms of Lending

Five principles to be observed while advancing money to borrows: (1) Safety: while lending a banker must ensure that the funds being given to a borrower are safe. That these will be returned along with interest/mark up. A borrower must have the following positive characteristics which would entitle him for the loan. (a) Character: Must be honest. Past record of a borrower; His business history is the best indicator of his integrity & future conduct. (b) Capacity: Whether a borrower has the managerial capacity to run the business for which he is demanding the loan. (c) Capital: Money invested by the borrower is the best indicator of his own confidence in the business. The volume of borrowers equity is an important factor. (d) Conditions: What is the industrial/trade sector in which the borrower is working? Whether there is boom in the sector. What are the prospects (e) Cash flow: Is a good indicator of a businesss financial health. (2) Liquidity: means the possibility of recovering the advances in times of emergency. The borrower must have enough money to return it to the bank at a short notice. (3) Dispersal: Loans to be granted to different sectors according to demand. There should be a broad distribution of loan. Exposure to one sector should be avoided. (4) Security: for the loan must be evaluated carefully. Its market value must be ascertained properly. (5) Remuneration: A banker must make sufficient earnings to cover (a) return payable to depositors. (b) Salaries of the staff. (c) Overhead expenses. (d) Dividends to share holders.

Forms of Lending
(1) Cash Finance/Running Finance Facility (2) Overdraft (3) Term Finance (a) Bridge Finance (b) Participation Loan

Securities for Advances

Classification of Securities
(A) Personal Guarantee or Intangible Security (B) Tangible Security: can be realized from sale or transfer. Examples; shares, stock, land building, goods. (C) Movable Security: Which can be legally & physically in possession of the bank? TDR (Term Deposit Receipt), goods, machinery. (D) Immovable Security: Legal possession, right to take over is entrusted to the lending bank. Physical possession remains with the bank. (A) Pledge: (B) Mortgage: (C) Charge:

Assignments:
(1) Explain in detail the different forms of lending which Banks offer to their customers? (2) Explain the concept of Charge by comparing it with mortgage.