Chapter 5 Banking Operations – CS Professional Banking Law and Practice Notes is designed strictly as per the latest syllabus and exam pattern.
Banking Operations – CS Professional Banking Law and Practice Study Material
Question 1.
A banker is under a strict obligation not to disclose the status of its customers’ accounts to any third party. There are certain exceptions to this rule. What are these exceptions? (June 2008, 5 marks)
Answer:
Bank is legally duty bound to observe secrecy about the account and the affairs of the customer. In following circumstances banks will be justified in disclosing the facts about the customers account:
(a) With express or implied consent of the customers;
(b) Under compulsion of law i.e., under Income Tax, Sales Tax and/or Court orders including police cases.
(c) With a view to protect the bank’s own interest in respect of the said orders when the bank is called upon to do so.
(d) Duty to the public to disclose in the interest of the nation-if the customer was dealing against the interest of the nation; and
(e) While giving opinion to a fellow banker.
Question 2.
What are the obligations of a customer to the banker? (Dec 2008, 5 marks)
Answer :
Obligations of a customer to the banker:
- The customer is not supposed to draw a cheque without maintaining sufficient balance with his bank. In case, the balance is not sufficient, customer is bound to make some kind of arrangement which will enable his banker to honour the cheque.
- The customer is obliged to issue a cheque in such a manner as to prevent any alteration in it. It is expected that the customer exercises reasonable care in drawing a cheque so as to avoid misleading the bank or to facilitate material alteration.
- Customer is obliged to pay reasonable charges to the bank for the services rendered by the bank.
- Customer is required to make demand on the banker for repayment of deposit.
Question 3.
Attempt the following:
How does the relationship of banker and customer terminate? In what way is terminates by process of law? (June 2009, 5 marks)
Answer:
Termination of relationship of banker and customer: The termination of relationship may be voluntary by the bank or the customer or by the process of law. The customer has a right to close a customer’s account on demand which must be met, if otherwise in order. If it is a deposit account however, the bank would except as a very special case, insist on due notice.
The of relationship of the banker and the customer also terminates by the process of law such as:
(a) Death
(b) Bankruptcy of the customer
(c) Winding up by either party
(d) Insanity of the customer
(e) Receipt of garnishee order of a court attaching the entire balance in the account of the customer.
Question 4.
Attempt the following:
(i) List the documents required by banks as per the know your customer (KYC) norms while opening accounts of companies.
(ii) “Bank acts as a trustee to its customers.” Elaborate. (Dec 2009, 5 marks each)
Answer :
(i) List of documents required by banks as per the know your customer (KYC) norms while opening accounts of companies.
| Features | Documents |
Accounts of companies
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(ii) “Bank acts as a trustee to its customers”
Bank acts as a trustee at the request of his customer. If a customer keeps certain valuables or securities with the Bank for safe keeping or deposits certain money for a specific purpose, the Banker besides becoming bailee s also a trustee.
In the case of Subramanya Pillai and others v. Palai Central Bank Ltd., certain persons deposited ₹ 2,000/- each in the Bank as guarantee money to purchase cars. The Bank failed before they could get the vehicles. The court was of the view that the Bank acted here as a trustee and that the money should be refunded from the Bank’s assets on the basis of preferential debt.
Question 5.
The Reserve Bank of India reportedly imposed fines totaling ₹ 49.5 crore on 22 private and public sector banks in July, 2013 for violating KYC/anti-money laundering norms. In order to avoid such recurrence, what policy framework do you suggest for banks? (June 2014, 5 marks)
Answer:
The banks should follow Know Your Customer’ (KYC) Guidelines or procedure as issued by the RBI. RBI had advised banks that:
- No account is opened in anonymous or fictitious/benami name(s).
- Bank will not open an account or close an existing account if the bank is unable to verify the identity or obtain documents required by it due to non-cooperation of the customer.
Banks are required to frame their KYC policy incorporating the following four key elements:
- Customer acceptance policy;
- Customer identification procedures;
- Monitoring of transactions;
- Risk management.
Question 6.
Explain the circumstances under which a banker is permitted to close an account without instructions from the customers. (Dec 2014, 10 marks)
Answer:
In a Banker Customer relationship, the Banker is required to follow the instructions given by the customer pertaining to the account including instructions to close the account. However the banker is permitted to close the account without the instructions from the client. The Banker would close the account as per requirement of law which permits or directs that the Banker-Customer relationship be terminated. The banker can close the account under some circumstances. Such circumstances are:
(a) Account has not been operated for a very long period and the Banker feels that he no longer needs the account.
(b) Bank finds the customer undesirable i.e. the customer conducts the account in an unsatisfactory manner such as issuance of cheques without maintaining sufficient balance, or has forged cheques, bills or other instruments in his dealings with the bank.
(c) One of the holders in the account is declared as incompetent to contract. Since the account was opened by more than one holder under their signatures, the instructions to operate the account would also have been given with their joint consent. Thus in case of lunacy or insolvency of one of the joint holders the operations in the account will be stopped.
(d) The customer is a defaulter on some advances granted by the bank and the banker has exercised his right of Lien and set-off under which the balance in the account has become nil.
(e) The account holder becomes a Lunatic or a person of unsound mind, he is not permitted to enter into contract u/s 11 of the Indian Contract Act.
(f) An individual is declared insolvent/bankrupt or a company is wound up under provision of law.
(g) It has received Garnishee order from the Income Tax authorities.
(h) In case of death of a bank account holder.
However, in case the banker decides to close the account he will have to follow certain rules and will have the following obligations:
(a) In most cases in order to minimize frauds in inoperative accounts the Banker would first mark the account as dormant and various stringent rules with senior person authentication and customer’s personal identification are followed.
(b) Give sufficient notice in writing to the customer. In case the customer does not respond, another reminder should be sent.
(c) The customer should be given an opportunity to represent his case on why the account should not be closed.
(d) After giving sufficient notice if the customer does not respond or the customer is not traceable, the banker would transfer the balance to “Unclaimed Deposit Account”.
(e) Bank can refuse to accept credits in the account or issue a new cheque book.
(f) However Bank would be under an obligation to honor all cheques issued by the customer. In case the banker dishonors any cheque he would be liable for damages under Section 31 of the Negotiable Instruments Act.
Question 7.
A banker has different relationship in various capacities with customers. Explain these relationships in brief. (Dec 2014, 5 marks)
Answer:
A banker has different relationship in various capacities with customers, some of such relationships have been discussed below:
1. Relationship as Debtor and Creditor: On the opening of an account the banker assumes the position of debtor. He is not depository or trustee of the customer’s money because the money over to the banker becomes a debt due from him to the customer. Banker’s relationship with the customer is reversed as soon as the customer’s account is overdrawn. Banker becomes creditor of the customer who has taken a loan from the banker and continues in that capacity till the loan is repaid.
2. Banker as a Bailor/Bailee: 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.
The person delivering the goods is called the bailer and the person to whom the goods are delivered is called the bailee. Banks secure their loans and advances .by obtaining tangible securities. In certain cases banks hold the physical possession of secured goods (pledge) – cash credit against inventories; valuables-gold jewels (gold loans); bonds and shares (loans against shares and financial instruments). In such loans and advances, the collateral securities are held by banks and the relationship between banks and customers are that of bailee (bank) and bailer, (borrowing customer).
3. Banker as a Lessor/Lessee: Section 105 of Transfer & Property Act’ deals with lease, lessor, lessee. In case of safe deposit locker accounts, the banker and customer relationship of lessor/lessee is applicable.
Banks lease the safe deposit lockers (bank’s immovable property) to the clients on hire basis. Banks allow their locker account holders the right to enjoy (make use of) the property for a specific period against payment of rent.
4. Banker as Trustee: Ordinarily, a banker is a debtor of his customer in respect of the deposits made by the latter, but in certain circumstances he acts as a trustee also. A trustee holds money or assets and performs certain functions for the benefit of some other person called the beneficiary.
5. Banker as Agent: A banker acts as an agent of his customer and performs a number of agency functions for the convenience of his customers. For example, he buys or sells securities on behalf of his customer, collects cheques on his behalf and makes payment of various dues of his customers, e.g. insurance premium, etc. The range of such agency functions has become much wider and the banks are now rendering large number of agency services of diverse nature. For example, some banks have established Tax Services Departments to take up the tax problems of their customers.
Question 8.
Is it compulsory to open the account in banks with initial deposit as cash only? Examine. (June 2015, 4 marks)
Answer:
- Customers offer initial deposit in cash and fulfill certain relative formalities which complete the relationship for opening the account in banks.
- Normally, banks require customers to deposit an initial amount in the bank.
- Legally it is not compulsory to open the account with cash only; the initial entry may be by collecting instrument payable to the customer.
- As per practice, the banks open the account by reflecting cash entry in the account.
- Further, certain banks allow opening of bank accounts without any minimum deposit.
- Example, there is no requirement for any initial deposit for opening a Basic Savings Bank Deposit Account under Pradhan Mantri Jan Dhan Yojana.
Question 9.
Answer the following question in brief:
State any two exclusive rights of bankers. (June 2015, 1 mark)
Answer:
1. Right of Appropriation: Under Section 59 to 61 of the Indian Contract Act, 1872 the banker is given the rights of appropriation. So, if a customer has multiple loans and Deposit accounts and the customer deposits some funds without intimating the account where the money is deposited, the banker can on its own decides the account in which the said funds are to be credited.
2. Right of General Lien: Banker is also given a right of general lien. Under the general lien, the banker can unless there is a contract to the contrary, retain the goods/securities till all the debts granted to the customer are paid off.
Question 10.
Define‘customer’ with special reference to banking and KYC policy/norms. (June 2015, 5 marks)
Answer:
Ordinarily, a person who has an account in a bank is considered as customer. The Kerala High Court observed in the case of Central Bank of India Vs. Gopinathan Nair and others (AIR, 1979, Kerala (74)) “Broadly speaking, a customer is a person who has the habit of resorting to the same place or person to do business.
Thus, far as banking transactions are concerned, he is a person whose money has been accepted on the footing that banker will honor up to the amount standing to his credit, irrespective of his connection being of short or long standing.”
For the purpose of KYC policy/norms, a Customer is defined as:
- A person or entity that maintains an account and/or has a business relationship with the bank.
- One on whose behalf the account is maintained {i.e. the beneficial owner).
- Beneficiaries of transactions conducted by professional intermediaries, such as stock brokers, Chartered Accountants, Solicitors etc. as permitted under the law and
- Any person or entity connected with a financial transaction which can pose significant reputational or other risks to the bank, say a wire transfer or issue of a high value demand draft as a single transaction.
Question 11.
Banks are required to freeze the accounts of customers on the orders of the government/enforcement authorities. During the currency of such orders, a term deposit gets matured. What procedure should be followed by the bank in such cases? Explain. (Dec 2015, 5 marks)
Answer:
The issue of such frozen accounts was examined in consultation with Indian Banks’ Association and Banks are advised to follow the procedure detailed below in the case of Term Deposit Accounts frozen by the enforcement authorities:
(i) A request letter may be obtained from the customer on maturity. While obtaining the request letter from the depositor for renewal, banks should also advise him to indicate the term for which the deposit is to be renewed. In case the depositor does not exercise his option of choosing the term for renewal, banks may renew the same for a term equal to the original term,
(ii) No new receipt is required to be issued. However, suitable note may be made regarding renewal in the deposit ledger,
(iii) Renewal of deposit may be advised by registered letter/speed post/courier service to the concerned Government Department under advice to the depositor. In the advice to the depositor, the rate of interest at which the deposit is renewed should also be mentioned,
(iv) Where the overdue period does not exceed 14 days on the date of receipt of the request letter, renewal may be done from the date of maturity. If it exceeds 14 days, banks may pay interest for the overdue period as per the policy adopted by them, and keep it in a separate interest free sub-account which should be released when the original fixed deposit is released.
Question 12.
Explain the relationship of a banker and customer in the following transactions :
(i) Loan from the bank
(ii) Safe custody of articles
(iii) Collection of cheques
(iv) Standing instructions
(v) Mortgage. (June 2016, 5 marks)
Answer:
Banker-Customer relationship in the transactions is specified below:
| Item | Transaction | Banker | Customer |
| (i) | Loan from the Bank | Creditor | Debtor |
| (ii) | Safe custody of articles | Bailee | Bailor |
| (iii) | Collection of cheques | Agent | Principal |
| (iv) | Standing instruction | Agent | Principal |
| (v) | Mortgage | Mortgagee | Mortgagor |
Question 13.
Explain what do you understand by the term ‘Money Laundering’. (June 2017, 5 marks)
Answer:
In the Prevention of Money Laundering Act, 2002, money laundering is defined as “any process or activity connected with proceeds of crime including its concealment, possession, acquisition, or use and projecting or claiming it as untainted property.
Laundering means acquiring, owning, possessing or transferring any proceeds (of money) of crime or knowingly entering into any transaction related to proceeds of the crime either directly or indirectly or concealing or aiding in the concealment of the proceeds or gains of crime. It is a process for conversion of money obtained illegally to appear to have originated from legitimate sources. Generally, there are three stages through which money laundering takes place.
(a) The first step is called the Placement: Whereby the cash is deposited in the domestic banks or is used to buy goods such as precious metals, work of art, etc.
(b) The second step is called the Layering: Once the funds enter into the financial system (banks), the funds are converted by transfers to different destinations. This stage is called as layering. At different locations bank accounts are opened and the funds are transferred as quickly as possible (some time breaking into series of small transactions to escape from the limits set up by banks for cash transactions). The movement of fund sometimes spread across countries.
(c) The last stage is called the Integration: In this stage, the launderer attempts to justify that the money obtained through illegal activities is legitimate. Through different methods attempts are made at this stage like using front offices of the companies, using the tax haven and off shore units, using these funds as security for loans raised, etc.
Money laundering is considered as criminal offence in most of the countries.
Question 14.
Comment on the following:
Know Your Customer (KYC) (Dec 2017, 5 marks)
Answer:
Know Your Customer (KYC):
KYC establishes the identity and residential address of the customers by specified documentary evidences. One of the main objectives of KYC procedure is to prevent misuse of the banking system for money laundering and financing of terrorist activities.
The ‘KYC’ guidelines also reinforce the existing practices of some banks and make them compulsory, to be adhered to by all the banks with regard to all their customers who maintain domestic or non-resident rupee or foreign currency accounts with them. All religious trust accounts and non-religious trust accounts are also subject to KYC procedure. RBI had advised banks that:
- No account is opened in anonymous or fictitious/benami name (s).
- Bank will not open an account or close an existing account if the bank is unable to verify the identify or obtain documents required by it due to non cooperation of the borrower.
Question 15.
What are the additional verification methods available for the verification of authenticity of a document submitted for KYC by a prospective customer at branch level ? (Dec 2020, 6 marks)
Answer:
The verification of authentication of a document submitted by a prospective customer must be based on the original documents submitted by such customers, however there are following few additional verification methods available:
1. Income tax department has made available PAN verification facility to a few reputed agencies in India. Therefore, if a customer submits a PAN card it can be verified from the verification facility through the accredited agencies. All banks have a link with such agencies and through such arrangements PAN verification can be done.
2. Authentication, of Aadhar Number already available with the Bank can also done with explicit consent of the customer in applicable cases through the Aadhar data base and biometric data available with Central Identities Data Repository (CIDR).
3. In the case of Electricity Bills/Telephone bills these can also be verified through the service providers by mentioning the consumer number/telephone number as well as through verification software available on online.
4. In case of Companies and Directors, the data submitted by such customers can be verified through the website data of department of Corporate Affairs.
5. In case of certain banks, they employ field personnel who make a visit to the address provided by the prospective customers and physically verify the details provided by such customers.
6. At the time opening a new account/establishing a new relationship the customer will be checked against watch lists provided by international/ National/Local authorities including Central banks and Anti Terrorist Organizations. If the names of such customers match with any of such names in the list, a thorough screening will take place to ensure such accounts are not opened. If such names are detected it must be reported to concerned agencies including RBI.
Question 16.
Explain the following statement in brief on the point of reasoning :
Normally Banks do not grant advance to Trust Accounts. (Dec 2021, 1 mark)
Answer:
- Trustees have to act in accordance with Trust deed and for the sole benefit of the beneficiary of the Trust. Hence, normally Banks do not grant advances to a Trust unless the Trust deed permits the Trustees to borrow loan and charge the assets of the Trust.
- The Bank has to ensure that it does not even inadvertently become a party in the misappropriation of funds.
Question 17.
Explain the following statements in brief on the point of reasoning :
Nomination facility is provided to all Deposit Accounts. (Dec 2021, 1 mark)
Answer:
- It is in pursuance of amendments in Sections 45ZA to 45ZF of Banking Regulation Act, 1949.
- For easy and prompt settlement of claims of legal heirs of deceased constituents.
- To reduce legal costs to the heirs in getting legal representation.
- To inculcate confidence in the minds of deposits.
Question 18.
Answer briefly the following questions:
(a) Why are the Nostro accounts maintained by banks?
(b) A voucher is essentially the backup document/proof for a transaction. How is it important for banking transactions? (June 2022, 2 marks each)
Question 19.
A bank maintains the following accounts:
(i) Individual account of Anil with a balance of ₹ 10,000.
(ii) A joint account of Anil and Bimal with a balance of ₹ 20,000.
(iii) An individual account of Chandan with a balance of ₹ 1,25,000.
(iv) An account of a partnership firm where Anil, Bimal and Chandan are partners with a balance of ₹ 50,000.
(v) A loan account of Anil with a debit balance of ₹ 45,000. The bank has recalled the same as a result of non-payment of interest and installments.
The bank has received the following orders:
- A Court order is received to attach the property of Anil for ₹ 1.50 lakh.
- An order from income-tax department to attach the assets of the partnership firm for ₹ 1,70,000. Explain how the bank will appropriate the amounts in the various accounts. (Dec 2014, 5 marks)
Answer:
1. To fulfill the Court’s order to attach the property of Anil for ₹ 1,50,000. The Bank may use its right of lien and setoff to appropriate the Loan amount up to the available balance in account held individually by Mr. Anil’s i.e. ₹ 10,000. Further, the remaining debit balance in loan account of Mr. Anil i.e. ₹ 35,000 shall be recovered in other ways as the joint account of Partnership accounts cannot be attached for the dues of Mr. Anil.
2. To fulfill the order from Income Tax Department to attach the asset of Partnership firm for ₹ 1,70,000;
The bank may;
(a) Utilize the balance in the account of the partnership firm i.e. ₹ 50,000
(b) Utilize the balance in the joint accounts of Anil and Bimal i.e. ₹ 20,000
(c) Utilize the balance in the Chandan’s account for the remaining amount i.e. ₹ 1,00,000.
This is because the partners are jointly severable liable. Here the question of which of the accounts mentioned i.e. account jointly held by Anil and Bimal or individually held by Chandan above would have priority, the bank is at liberty to use its discretion as the partners are jointly liable and any arrangement or adjustments in the amount appropriated by the bank can be done between the partners privately.