Banking What is a Bank? · a Bank is Defined

8/14/2019 Banking What is a Bank? a Bank is Defined

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Banking

What is a Bank? A bank is defined as a commercial institution licensed as areceiver of deposits and giver of loans both short and long term

Section 5(1)(b) of the Banking Regulation Act, 1949 definesbanking as, the accepting for the purpose of lending or investment, ofdeposits from the public, repayable on demand or otherwise, andwithdrawal by cheque, draft, order or otherwise. Section 5(1)( c) defines a banking company as, any companywhich transacts the business of banking in India.

Banking involves therefore: The borrowing, raising or taking up of money; The lending or advancing of money either with or without security; The drawing, making, accepting, discounting buying, selling,collecting and dealing in bills of exchange, hundis, promissory notes,coupons, drafts, bills of lading, railway receipts, warrants, debentures,certificates, scrips and other instruments and securities whethertransferable or negotiable or not; The granting and issuing of letters of credit, travelers chequesand circulars notes; The buying and selling of foreign exchange including bank notes; The buying and selling of bullion and specie; The acquiring, holding, issuing on commission, underwriting anddealing in stocks, funds, shares, debentures, bonds, obligations,securities and investments of all kinds; The purchasing and selling of bonds, scrips or other forms ofsecurities on behalf of constituents or others, the negotiating of loansand advances; The receiving of all kinds of bonds or valuables on deposit or forsafe custody or otherwise; The providing of safe deposit vaults; The collecting and transmitting of money and securities; Carrying on and transacting every kind of guarantee andindemnity business; Managing, selling and realizing any property which may form the

security or part of the security for any loans or advances or which maybe connected with any such security; Acting as agents for any government or local authority or anyother person or persons; Contracting for public or private loans and negotiating and issuingthe same; The effecting, insuring, guaranteeing, underwriting, participatingin managing and carrying out of any issue, public or private, municipal


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or other loans or of shares, stock, debentures or debenture stock of anycompany, corporation or association and the lending of money for thepurpose of any such issue; Undertaking and executing trusts; Undertaking the administration of estates as executor, trustee or

otherwise; Establishing, supporting and aiding institutions funds, trusts etc.for the benefit of its present employees and granting money forcharitable purposes; Acquiring, constructing and maintaining any building for its ownpurpose; Selling, improving, managing, developing, exchanging, leasing,mortgaging or disposing its property; Doing all such things that are incidental or conducive to thepromotion or advancement of its business; Doing all other business specified by the Central Government asthe lawful business of a banking company. Leasing and factoring hasbeen specified as permissible for banks by the Central Government.

Prohibited ActivitiesThere are some activities banks are not allowed to do.The Banking Regulation Act prohibits banks from: Engaging directly or indirectly in trading activities andundertaking trading risks. Buying or selling or bartering of goods directly or indirectly.However, a bank can realize securities given to it or held by it for aloan, if need arises for the realization of the amount lent. Any activity that may be in direct conflict with their other work.This includes acting as brokers on the stock exchange or in the moneymarket or in trading goods. Engaging on its own account alone or with others in wholesale orretail trade including import or export trade. Acquiring or purchasing any immovable property or any interestexcept as necessary for the purpose of conducting its business or ofhousing or providing amenities for its staff or for its own use. Otherwiseit should not be held for more than seven years. This period may beextended by the Reserve Bank by another five years if it is satisfiedthat this extension is in the interest of the depositors. Acquiring or holding any part of the share capital of, or otherwisehave a direct interest in any financial, commercial, agricultural or otherundertaking. Engaging in any trade or buying, selling or bartering of goods forothers except in connection with undertaking the administration ofestates as executor, trustee or otherwise. Holding shares in any company whether as pledgee or mortgagee


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or absolute owner of an amount exceeding 30 percent of the paid upcapital of that company or 30 percent of its own share capital andreserves whichever is less. Investing in a subsidiary company, financial services company,financial institution, stock or other exchange where the investment

exceeds 10 percent of the banks paid up capital and reserves.Investment in all such companies should not exceed 20 percent of thebanks paid up capital and reserves. Participating in equity of financial services ventures includingstock exchanges without obtaining the prior approval of RBI.

SubsidiaryBanking companies may form a subsidiary company, after obtainingthe prior approval of the RBI for: Undertaking of any business permitted for a banking company. Carrying on the business of banking exclusively outside India Undertaking of such businesses which, in the opinion of theReserve Bank, would be conducive to the spread of banking in India Transacting leasing business and or investing in shares ofequipment leasing companies

Services rendered by banks Acceptance of deposits; Provision of credit; Collection of cheques, demand drafts, bills of exchange,promissory notes, hundis and foreign documentary and clean bills; Purchase of local and foreign currency documentary/ clean bills,negotiation of bills under inland and foreign letters of credit, advising ofinland and foreign letters of credit established by branches andcorrespondents; Carrying out standing instructions for payments; Issuance of performance and financial guarantees; Keeping in safe custody deeds and securities; Purchase and sale of securities; Remittance of funds; Collection of interest on securities, dividend on shares andcollection of bills; Credit transfers; Issue of travelers cheques and gift cheques; Acting as executors and trustees; Issuance of credit cards; Underwriting, acting as bankers to new issues and as bankers forrefunds.

Banker and Customer


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Banker Section 3 of the Negotiable Instruments Act says that the termbankerincludes any person acting as a banker. Dr.Herbert Hart, in his book Law of Banking says, a banker isone who in the ordinary course of his business, honors cheques drawn

upon him by persons from and for whom he receives money on currentaccount. Halsburys Laws of England defines a banker as an individual,partnership or corporation whose sole predominating business isbanking, that is the receipt of money on current account or depositaccount and the payment of cheques drawn by and the collection ofcheques paid in by a customer. Sir John Paget says in his book, The Law of Banking, no personor body corporate or otherwise can be a banker who does not (1) takedeposit accounts, (2) take current accounts, (3) issue and pay chequesand (4) collect cheques crossed and uncrossed for its customers.Headds that, one claiming to be a banker must profess himself to beone, and the public must accept him as such; his main business mustbe that of banking from which generally he should be able to earn hisliving.

Customer Sir John Paget says, to constitute a customer, there must besome recognizable course or habit of dealing in the nature of regularbanking business.. it is difficult to reconcile the idea of a singletransaction with that of a customer. It was held in Mathews vs WilliamBrown & Co (1894) that to constitute a customer , he should have somesort of an account with the bank. The initial transaction in opening anaccount did not set up the relation of a banker and customer, and therehad to be some measure of continuity and custom. This came to beknown as the Duration Theory. The duration theory was set aside by Justice Bailhache in Ladbrokevs. Todd (1914) wherein it was stated, The relation of banker andcustomer begins as soon as the first cheque is paid in and accepted forcollection and not merely when it is paid.Lord Dunedin observed,customer signifies a relationship in which the duration is not of theessence. In General Western Railway C. vs. London and County Banking Co.Ltd., it was stated, A customer is a person who has some sort ofaccount, either deposit or current or some similar relation with a bankand from this it follows that any person may become a customer byopening a deposit or current account or having some similar relationwith a bank. In Central Bank of India vs. Gopinathan Nair, the Kerala High Courtstated, a customer is a person who has the habit of resorting to the


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same place or person to do business.

It should be noted: A single transaction may constitute a customer. The customer should have an account

Some frequency in transactions is expected. The dealing must be of a banking nature. The customer need not be a person but can be a company, asociety or other legal entity.

General Relationship The relationship is that of a debtor and creditor. The positionwill depend on whether the bank has lent money or accepted deposits. The banker is not a mere depository or trustee. A depositoryreceives a sealed packet and undertakes to return it unopened. Banksdo this but it is a secondary function. The banker is a bailee (customer bailor) when the customerdeposits valuables, bonds or other documents with the bank. As thecustodian of the customers assets, the banker is liable for any losssuffered by the customer due to his negligence. The opening of an account by a customer and the bankeraccepting this involves a contractual relationship with rights andobligations both for the banker and the customer. The banker has to afford the facility to the customer to draw fundsfrom his account in the bank by issue of cheques. Demand necessary in case of debt from the banker. This meansthe depositor has to demand his money as the banker will not in theordinary course of events return the deposit unless it is asked for. The banker is an agent of the customer for remittances, collectionof cheques and payments on his behalf. The banker is a lessor when he leases safe deposit lockers to acustomer. The banker is a trustee with regard to safe custody depositsdeposited with the bank. The banker is a consultant when he advises customers. Under the Indian Limitation Act 1963, to file a suit to recovermoney deposited by a customer when it is payable on demand is threeyears from the date of demand. With regard to fixed deposits it is threeyears from the date the receipt is produced for payment. Banks are liable for thefts or embezzlement by employeescommitted during the course of the banks business. It is irrelevantwhether it was done for the benefit of the employer or not. The banker acts as an agent of his customer and performs severalagency functions for the convenience of customers such as thecollection of cheques.


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Refusal by the banker not to provide service to a customer is notproper even if the customer owes money that has not been repaid. A banker can combine one or more accounts kept by a customerin his own right unless he is under obligation to keep them separate.However, a banker cannot combine a customers personal account with

a joint account. The right to combine two or more accounts is notapplicable to contingent or future debts. The customer has no right to treat two accounts as one orcombine them.

Obligations Banks have an obligation to honor cheques drawn on it if thecustomer has sufficient funds. It is also obliged to honor cheques uptothe overdraft limit of a customer. The obligation is extinguished by agarnishee order from the court Banks are obliged to maintain secrecy of client accounts. Thereare times when information may be divulged. The banker may giveinformation: When he is statutorily required to do so. With express or implied consent of the customer. To other banks. This is known as common courtesy betweenbanks. In this case apart from making general statements no specificinformation such as balances and the like are given. If it is in the banks interest. If the disclosure is in public/ national interest. Banker is bound to act according to the directions given by thecustomer. If no directions are given the banker should act according tohow he is expected to act. Care should be taken to ensure that the information given isgeneral and only facts that are evident should be revealed. The bankershould avoid giving opinions.

LienLien means the right (of a creditor) to retain (in the absence of anagreement to the contrary) goods and securities owned by the debtorbailed (given as security) to the bank until the loan due from thedebtor is repaid. The creditor (bank) has the right to retain the securityof the debtor but not to sell it. The lien may be particular or general.

Particular Lien A craftsman can retain those goods on which he has spent time,effort and money until he is paid.

General Lien General lien gives the banker the right to retain goods and


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securities entrusted to him in his capacity as a banker and in theabsence of a contract inconsistent with the right of lien (Section 171 ofthe Indian Contracts Act, 1872). It extends to all goods placed with himas a banker by his customer which are not specifically identified foranother purpose. He cannot exercise general lien if:

The goods and securities have been entrusted to the banker as atrustee or an agent. A contract exists between the banker and the customer that isinconsistent with the bankers right of general lien. A bankers lien is more than a general lien. It is an implied pledgeand he has the power to sell the goods in case of default. The right of lien is conferred upon the banker by the IndianContract Act and as a consequence no separate agreement is required.To be safe though the banker should take a letter of lien stating thatthe goods/ securities are entrusted as security for a loan existing andfuture and that the banker can exercise his lien on them. The bankercan also sell the goods if the customer defaults. It should however be noted that the right of lien can be exercisedonly on goods standing in the name of the borrower and not jointly withothers. The banker can exercise his right of lien on securities remaining inhis possession after the loan for which they were lodged is repaid bythe customer, if no contract to the contrary exists. In such cases thereis a presumption that the customer has re-offered the same securitiesas a cover for any other advance outstanding or to be takensubsequently.

There are exceptions: The banker has no lien on valuables entrusted to the banker as abailee or trustee. There is no lien on documents deposited for a special purpose orwith specific instruction that the proceeds are to be utilised for aspecific purpose. The bankers general lien is displaced by circumstances that showan implied agreement inconsistent with the right of general lien. The banker has no lien on securities left with the bankernegligently or inadvertently. The banker cannot exercise his lien on securities deposited as atrustee in respect of his personal loan. If the banker is not aware thatthey do not belong to the customer, his lien is not affected. The bankers right of lien extends over goods and securitieshanded over to the banker. Money deposited in the bank and creditbalance in the account does not fall in the category of goods andsecurities. The banker can therefore use his right of setoff as opposedto lien with regard to money deposited with him.


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The right can be exercised on the customers property only andnot on joint accounts the debtor has. The banker cannot exercise the right when the debt has notmatured or on stolen goods. The banker cannot exercise lien when he can exercise set off.

Right of set-off This enables a debtor to set off a debt owed to him by a creditorbefore the latter recovers a debt due to him from the debtor. Banks possess the right of set-off. Banks can combine twoaccounts in the name of the same customer and set off the debitbalance in one account with the credit balance in the other. The funds must belong to the customer. The right of set-off can be exercised if there is no agreementexpress or implied that is contrary to this right. It can be exercised onlyafter a notice is served on the customer intimating the customer thatthe banker intends to exercise the right of set-off. To be on the safeside bankers take a letter of set-off from the customer authorizing thebank to exercise the right of set-off without giving him any notice.

Automatic right of set off Death of the customer. When a customer becomes insolvent. Garnishee order issued on the customers account by court. When a notice of assignment of credit balance to someone elsehas been given by the customer to the banker. When a notice of second mortgage has been received by thebank on the securities already charged to the bank.

There are some conditions: The accounts must be in the same name and in the same right(the capacity of the account holder must be the same). Funds held in trust accounts are deemed to be in different rights. The right can be exercised in respect of debts due and not inrespect of future or contingent debts. The amount of debts must be certain and absolute. The banker may exercise this right at his discretion. The banker has right to exercise this right before a garnisheeorder is made effective. There must be no agreement to the contrary.

Right of Appropriation In the normal course of business, a banker receives paymentsfrom customers. If customers have more than one account or has taken more than


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one loan, the customer has the right to direct his banker against whichdebt the payment should be appropriated. If the customer does notadvise and there is more than one debt outstanding in the name of thecustomer, the bank can exercise its right and apply it in payment ofany debt. The banker can even apply it against time barred debts.

However, once an appropriation has been made it cannot be reversed Section 59 of the Indian Contract 1872 states the right ofappropriation is vested in the debtor. He can appropriate the payment by an express intimation orunder circumstances implying that the payment is to be applied to thedischarge of some particular debt. If the creditor accepts this, it must be applied accordingly. Money received should first be set off against interest. Section 60 of the Indian Contract Act states that if the debtordoes not intimate or there is no circumstance indicating how thepayment is to be applied, the right of appropriation is vested in thecreditor. Section 61 of the Indian Contract Act states that where neitherparty makes any appropriation, the payment shall be applied indischarge of the debts in order of time. If the debts are of equalstanding, the payment should be applied in discharge of eachproportionately. Any payment made by a debtor should be applied in the firstinstance towards satisfaction of interest and thereafter towardsprincipal unless there is an agreement to the contrary. If a customer has a single account and he deposits and withdrawsmoney from it regularly, the order in which the credit entry will set offthe debit entry is in the chronological order. This is known as Claytonsrule and is based on the judgment made in the Clayton case.

Right to charge interest As a creditor the banker has the implied right to charge interest onthe advances granted to the customer. Bankers normally chargeinterest monthly. There may be an agreement otherwise in which casethe manner agreed will determine how interest is to be charged.

Right to charge service charges Banks charge customers if their balance is below a stipulatedamount, for the usage of ATMs (Automated Teller Machines) andwithdrawals. Banks are free to charge these but the Reserve Bank of Indiaexpects banks to advise their customers of this at the time of openingthe account and advise them when changes are being made.

Period of limitation


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The period of limitation for the refund of bank deposits is threeyears from the date a customer makes a demand for his money. Withregard to fixed deposits, the limitation is from the date it matures.

Termination of Relationship

The banker customer relationship terminates on: Voluntary termination. Death of the customer Bankruptcy of the customer Liquidation of the company Insanity of the customer

BANK CUSTOMERS

A customer is one who has an account with a bank. Customers may beminors, married women, pardanashin women, illiterates, lunatics,trustees, executors and administrators, power of attorney holders, jointaccount holders, proprietorships, Hindu undivided families,partnerships, limited companies, clubs, societies and charitableinstitutions. They may also be non-residents and foreigners.

Minors A minor is someone who is under 18 years of age. If a minor has acourt appointed guardian he/ she will remain a minor till the age of 21. In the case of a Hindu minor, the natural guardian is the father and

then the mother. This does not include stepfathers/ stepmothers. Inregard to a minor married girl, her husband shall be the naturalguardian. If the father becomes a sanyasi (Hindu holy man) or does notremain a Hindu he will not remain a guardian. A Hindu father may appoint a guardian. Such a guardian will act afterthe death of the parents. The court may appoint a guardian if, in the courts opinion, the fatheris unfit be a guardian. The Supreme Court has held that a mother can act as the naturalguardian if the father is not in actual charge of the affairs of the minorbecause of his indifference or because of an agreement with the

mother. The Reserve Bank has advised banks to permit the opening of minorsaccounts (fixed, saving and recurring deposit accounts) with themother as the guardian even if the father of the minor is alive. TheSupreme Court in Githa Hariharan & another held that and after himdoes not mean after the death of the father but refers to the fathersabsence from the care of the minors property. Banks must have inplace safeguards to ensure that the accounts are never overdrawn and


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always remain in credit. The Contract Act 1872 states that a minor is not capable of enteringinto a valid contract. A contract for the supply of necessaries of life to aminor is, however, a valid contract. A minor can repudiate all othercontracts. A banker must therefore be careful in his dealings with

minors. If a minor enters into a contract representing himself as a major andthen refuses to honor the contract on the grounds that he is a minor,the minor has to restore the benefits he got through the contract. Savings accounts (not current accounts) may be opened in the nameof minors. This may be: In the name of the minor to be operated upon by the guardian. In the name of the minor to be operated by himself if he is 12 yearsold or more. Two minors above the age of 12 can operate a jointaccount At the time of opening the account, the date of birth of the minor isrecorded. When the minor reaches maturity, the minors account in theguardians name should be closed and the balance should be paid tothe accountholder or the balance should be transferred to a newaccount If the father of a Hindu minor dies, his mother becomes the naturalguardian. If the mother dies also during his minority there would beeither a guardian appointed by the will of the mother (natural guardian)or a guardian will be appointed by court. Banks would return thebalance in the account to that guardian. In the case of Muslim minors mothers cannot sign as guardians. If a minor dies, the guardian can withdraw the balance in theaccount. If it is a joint account the balance will be at the absolutedisposal of the guardian. If the guardian dies the balance can be paid to the minor aftermaturity or to the natural guardian. There is no risk in opening an account in the name of a minor so longas it is not overdrawn. Bankers cannot recover money due if there is aloan or an overdraft as it is ab initio invalid. If a minor has pledgedassets for a loan, the banker cannot possess these assets, as thepledge is invalid. If an advance is granted to a minor on the guarantee of a third party,this advance cannot be recovered from the guarantor also as thecontract between the creditor (banker) and the principal debtor (minor)is invalid. Minors can draw, endorse or negotiate cheques and bills but cannotbe held liable or sued if these are not honored. A minor can be admitted to a partnership with the consent of theother partners but he will not be liable for losses. He must within 6


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months of becoming a major repudiate his liability as a partner.Otherwise he can be held liable for the debts of the partnership. A minor can be an agent but he cannot be held responsible to hisprincipal.

Married Women A married woman may enter into a valid contract. She may open abank account. With regard to debts taken the husband will not be liable unless theloan is taken with his consent and authority or it is for the necessariesof life.Pardanashin Woman As a pardanashin women is normally completely secluded and doesnot generally deal with the public at large, it is presumed that:1. Any contract that she enters may have been subject to undueinfluence and2. The contract may not have been made freely and with fullunderstanding of the contract. To enforce the contract the other person will have to prove that thelimitations mentioned above do not exist.

Illiterate Persons Accounts may be opened for illiterate persons. As they cannot sign their names their thumb impressions are usuallytaken. These should be attested by a person known to the bank.

Normally illiterate persons are not given cheque books. To withdrawmoney the account holder is expected to come in person and affix histhumb impression in the presence of a bank official for identification. There is no legal bar in two illiterate persons having a joint account. Ideally account opening forms should have a clause wherein it isstated that the terms of account opening and banking has beenexplained to the account holder. The account holder should affix histhumbprint in the presence of a witness/ official.

Lunatics Lunatics and persons of unsound mind are not competent to enter

into a valid contract. Accounts should not be opened for persons of unsound mind. If abanker has discounted a bill written, accepted or endorsed by a personof unsound mind, the banker can realize the money only if he canprove that he was not aware of the lunacy of the other person. All transactions in the account of a person declared to be of unsoundmind must be suspended when a banker receives notice that anaccount holder is of unsound mind.


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If an account holder becomes senile or of unsound mind, he shouldnot be permitted to handle his account.

Trustee A trustee is a person on whom confidence is reposed. Trusts are formed by a document called the trust deed. Bankers should examine the trust deed thoroughly and determine thepowers vested in the trustees. Trustees are usually expected to actjointly. They are not permitted to delegate their powers unless the trustdeed permits them to do so. If there are two or more trustees, there must be clear instructions onwho may operate the account. If one or more trustees dies or retires, the authority vested in theremaining trustees will be as stated in the trust deed. When all thetrustees are dead, new trustees may be appointed by court. The insolvency of a trustee does not affect the trust property and acreditor cannot recover his claim from the trust. The banker must safeguard the interest of the beneficiaries.Otherwise he may have to compensate them for any fraud on the partof the trustee. Trustees may borrow from banks and pledge or mortgage trustproperty only if the trust deed confers these powers on them.

Executors and Administrators Executors are persons appointed by the will of a person to managehis estate after his death. The powers and authority of an executor is

derived from the will and he has to act in accordance with thedirections given in the will. Administrators are appointed by the court to manage the estate of adeceased person. The administrator is appointed by the court througha letter of administration, which will detail his authority. They are expected to realize the assets of the deceased person andpay off his debts. On the death of an account holder, all payments from his accountmust be stopped. The executor may be allowed to operate the accountafter he has had the will probated. The administrator can operate theaccount after he has received the letter of administration.

An account will normally be opened in the name of the executor/administrator and styled, MNO executors to the estate of DEFdeceased. If two executors/ administrators are appointed, they will have a jointinterest in the estate of the deceased. This interest cannot be divided. With regard to bank accounts they should jointly agree on how it is tobe operated. If this is revoked, they should sign jointly or the bankershould take a fresh letter of authority.


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The banker must be careful to ensure there is no misappropriation.He should not permit transfers to the personal accounts of executors/administrators. If an executor/ administrator dies and he is one of the jointsignatories of an account, cheques issued should not be dishonored

because his powers are vested in the surviving executors/administrators. Bankers cannot exercise their right of set off of the deceaseds debitbalance against the creditor balance in the executors personalaccount. If the executor requires a loan to make payments before receipt ofthe probate, the advances are made on the personal security of theexecutor. After probate is granted, the executor may pledge specific assets toobtain an overdraft unless the will specifically forbids it. If a loan is given all the executors should sign the documents.

Power of Attorney Holder A customer may give another his power of attorney to operate hisbank account. It is a general notice and an authority. It is different from an ordinarymandate to operate a bank account. The power of attorney holder is an agent of the account holder andacts in his name. This may be special or specific (to operate the bank account or otherspecific powers like the sale of property) or general (which may givethe holder authority to act on the customers behalf for many activitiesincluding banking). The power of attorney should be stamped and registered with theRegistrar of Documents or attested by a notary public. It must be in force at the time the bank account is operated. The attorney holder must be acting within the scope of authoritygiven to him. The power of attorney holder must be properly identified and hisaddress should be verified. As far as possible account the principal should sign the accountopening form. If the power of attorney permits the holder to open

accounts he may do so. However, confirmation from the principalshould be obtained before actual operation. The account should be opened in the name of the principal with theheadingABC (principal) by DEF (agent/ power of attorney holder). It is not necessary to use the word constituted attorney. If it is signed per pro ABC, it means that the holder has the limitedauthority to sign cheques. It must be ensured that the power of attorney does not contain


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conditions or events on it that will make it difficult for the banker. Acondition such as, during my absence from India indicates that on hisreturn the power of attorney would be cancelled. The difficulty could bethat the bank would not know when exactly the person returned. A power of attorney holder cannot delegate his powers/ authority to

another. A power of attorney is cancelled: If the principal cancels the power of attorney If the purpose for which it has been given ends. If the principal dies or in some other way loses the ability to enter intoa contract (unsound mind)

Joint Account A joint account is in the name of more than one person. The application for the joint account must be signed by all thepersons opening the account. Banks should examine every request to open joint accounts carefully.In particular the purpose, the nature of business and the financialstatus of the holders. Clear instructions must be procured regarding the manner ofoperation which may be: By all the depositors jointly; By either or survivor; By former or survivor; By the depositor jointly or by the survivor. It should be clearly stated as to who may operate the account andstate their authority. If this is not given then only cheques signed by allthe persons in whose name the account stands should be honored. A joint account holder who is authorized to operate the accountcannot by himself appoint an agent to operate the account. Any joint account holder (even one not authorized to operate theaccount) can stop payment of a cheque. The full name of the account should be given on all documents sentto the bank even if the account is operated by one or some of the jointaccount holders. The banker must take a mandate to determine who are permitted tooverdraw the account.

The authority to operate the account can be revoked by any of thejoint holders. It is automatically revoked if any of the joint holders dies,becomes bankrupt or of unsound mind. In these situations all chequesmust be stopped. The banker must be given clear instructions with regard towithdrawal of securities in the joint account and the powers of jointaccount holders to pledge these securities. If one or more of the jointholders becomes insolvent, the mandate jointly given by them to the


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banker ceases to operate. No payments from the account should bepermitted in order to determine the liability of the person who hasbecome insolvent. Payments may be made only on the instructions ofall the joint account holders and the receiver of the insolvent accountholder.

The application form should have a clause stating to whom thebalance is payable in the event of the death of an account holder/account holders. This may be a specific person or the survivor. Thisinstruction can be revoked by any of the account holders. In that casethe amount will be payable on the discharge of all the joint accountholders. On the death of a joint holder: If there is no agreement to the contrary, his representative and thesurviving joint holder/s are jointly entitled to claim money from thebank. If all the joint holders die, the legal representatives of all of themcan jointly claim the amount (section 45 of the Indian Contract Act1872). Where an account is opened either or survivor, the banker is notbound to repay the amount to the representatives of the deceased andthe survivor jointly. It permits him to repay the amount to the survivor.The banker should also not honor cheques drawn by the deceased jointholder without obtaining the concurrence of the surviving joint holders. If the joint account has a debit balance, the account should be closedto determine the liability of the deceased joint holder. If not the rule inClaytons case will become applicable. If the banker pays the balance to the survivor/s he gets gooddischarge (if it is accordance with the mandate of the joint accountholders. He need not investigate whether the survivor is entitled to theamount in question. The legal heirs of the deceased will need to movethe court if they wish to claim the balance or a part of it. Joint holders may together nominate a person who should receive themoney should all of them dies.

Proprietorships A proprietorship, though the account of an individual, is the accounthe maintains for a commercial enterprise that he owns. It is not important that the proprietor alone operates the account. He

can permit/ authorize others to do so too.

Hindu undivided family A Hindu undivided family possesses ancestral property and carries onancestral business. All the members (coparceners) are descended from a commonancestor. Ownership of the assets (property) passes onto the members of the


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family. In those families governed by the Mitakshara School of Indian lawevery male member acquires an interest in the joint property on birth. After the passing of the Hindu Succession Act the share of a deceasedcoparcener is divisible among his wife, daughters and other female

members as defined in the act. The family business and assets are managed by the eldest malemember. He is known as the karta. The karta has an implied authorityto take a loan, execute the required documents and pledge securitieson behalf of the family for the sake of the business. It is recommendedthough that either all the family members sign the documents or theyauthorize the karta in writing. This is to avoid disputes at a later stage. The karta is permitted to borrow only for purposes beneficial to thefamily. Coparceners liability for loans granted is limited to the extent of theirinterest in the joint property. If, however, they along with the kartaratify the loan, then they become personally liable. If there is a minor coparcener, his guardian must sign the documentson his behalf. When he reaches 18, he should sign again to signify hisassent to the undertaking given by the adult coparceners. The account is normally opened in the name of the karta or in thename of the HUF business. The account is operated by the karta or authorized coparceners.

Partnership A partnership is the relation between persons who have agreed toshare the profits of the business carried on by all of them acting forall. A partnership is established by an agreement. This may be oral orwritten. As several bodies expect the partnership to be registered andto avoid ambiguity it is better partnership agreements are written. The minimum number of partners in a firm cannot be less than two. The number of partners should not exceed the statutory limit. Apartnership firm of more than 10 persons carrying on banking businessor more than 20 persons carrying on any other business is illegal unlessit is registered under the Companies Act 1956 or is a Hindu undividedfamily or formed in pursuance of some other law. If the partnership

exceeds this limit it is illegal and it cannot enter into a contract or suein its own name. If a partner joins or leaves the partnership, the old partnership endsand a new one comes into place unless there is an agreement ofcontinuity. A minor may be admitted into a partnership provided there are twoothers since a minor cannot enter into a legal contract. A partnership account must always be opened in the name of the firm


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and not in the name of the individual partner/ partners. At the time of opening a bank account, the application form should besigned by all the partners or by those authorized by the partners. In thelatter case there should be a resolution signed by all the partners. If a partner is out of the country the other partners can open an

account. To be safe operations should not be allowed until the partnerreturns and signs the account opening documents. Specimen signatures of all the partners must be procured. The bank should take a letter signed by all the partners that has: The names and addresses of the partners, The nature of business undertaken and The names of the partners who will operate the account. The authority for a partner to operate the account can be revoked byany of the partners by giving notice to the banker. In that circumstancethe banker must stop payment of cheques signed by that partner.Though the banker may pay cheques signed by all the partners, it isrecommended that a fresh mandate signed by all the partners besought. A partner can also stop the payment of a cheque signed by any otherpartner of the firm. Furthermore sleeping partners and partners whoare not authorized to operate the bank account can also revoke theauthority of other partners and issue instructions to the bank. In suchcases a fresh mandate from the partners should be sought. A partner authorized to operate the account cannot delegate hisauthority to another person without the consent in writing by all thepartners. If a cheque payable to the partnership is endorsed by a partner and isdeposited by him to be credited to his personal account, thetransaction should be done only after checking with all the otherpartners. A partner acts as an agent of the partnership for the purpose of thebusiness of the partnership (firm) and thus binds the partnership by hisacts and deeds. This authority is called implied authority. Every partner is liable both individually and jointly with other partnersfor all the acts of the firm or instruments executed provided they weredone: In the name of the firm and In connection with the business of the firmEven one partner can bind the firm for the debts incurred by him onbehalf of the firm. To bind the firm the signature should state thelegend for and on behalf of the firm Just stating XYZ, Partner ABC &Co is not sufficient. If a partner does something which is not related to the kind ofbusiness carried on by the firm, other partners will not be liable forlosses/ debts incurred.


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A partner has the power to borrow on behalf of the firm to carry onthe firms business. Such a debt will be binding on the firm and all thepartners. If however the partners powers are limited and he is notpermitted to manage the affairs of the firm, then he does not possessthe power to borrow.

The liability of a partner is unlimited unless he is a limited partner. At dissolution the debts of the firm shall be settled out of the assetsof the firm and the surplus is to be applied to paying the debts of thepartners. If the partners are also indebted, the personal assets of thepartners should be applied first to meet the claims of their individualcreditors. The remaining should be used to meet the dues to thecreditors of the firm. If however the documents are signed by thepartners individually as well as jointly (as a partner) creditors of thefirm can recover their debts simultaneously. The joint and several liability of partners continue till:1. All the debts of the firm are paid2. The constitution of the partnership changes due to death, retirementor insolvency of a partner. If a partner dies the partnership ends if there is no agreement to thecontrary. The heirs of the partner do not automatically becomemembers. They have a right to the deceaseds share of the partnershipassets. On the dissolution of the partnership arising from the death of apartner, the firms bank account should be closed. This is importantsince if the account is overdrawn the liability of the individual partnerswould need to be determined. If the firm is not dissolved, a new account should be opened in thename of the reconstituted firm. When a partner retires, his liability to outside parties (including thebank) ceases in respect of all transactions entered into after hisretirement. If the banker is not informed, the retiring partner willcontinue to be liable. If a partner becomes insolvent the partnership comes to an end. Theinsolvent partner ceases to be a partner from the date he is declaredinsolvent and will not be liable for transactions entered into after thatdate. An insolvent partners cheques written before his becoming declaredinsolvent should be paid only after getting confirmation from all otherpartners. As soon as a partner is declared insolvent, the account should beclosed and a new account should be opened.

Limited Companies Limited companies are legal entities under the law. They are viewedas persons and are entitled to enter into contracts, own property, sue


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in their own name and do all acts that an individual may do. A publiclimited company has to have a minimum of seven members. There isno maximum. On the other hand a private limited company has to haveatleast two members. It cannot have more than fifty members. Thisexcludes those in the employment of the company during the period of

share allotment. Banks must examine the companys memorandum and articles ofassociation to determine what it may or may not do. The certificate of incorporation and certificate of commencement ofbusiness must be examined as these provide conclusive proof that thecompany is incorporated and is permitted to do business. A privatelimited company is not required to obtain a certificate ofcommencement of business. The memorandum of association is the document that details theconstitution of the company. It contains the name of the company, itsauthorized share capital, its objects, the amount it may borrow and theliability of the members. The objects clause is important as anycontract entered into contrary to the objects is unenforceable. The articles of association detail the rules and regulations relating toits internal (day to day) management such as the powers of directors. Along with an application to open a bank account, the company mustfurnish a board resolution that approves the opening of the bankaccount and how the account should be operated and by whom. The amount a company can borrow is stated in its memorandum ofassociation. If the company wishes to borrow more, the excess must beapproved by the members in a general meeting. The maximum thatmay be borrowed is stipulated by Section 293 (1) d of the CompaniesAct 1956. If directors borrow money without authorization and the money isused by the company, the company is bound to repay the money. Banks must ensure that borrowings are only for purposes mentionedin the memorandum of association. The bank must obtain a certified copy of the resolution to borrow. The board must also pass a resolution that the borrowing is within itslimits. If collaterals are taken for loans/ advances, a charge must be createdwith the registrar of joint stock companies within 30 days. While granting a loan, it is important to check whether there are priorcharges (which may be fixed or floating) as these can have a prior rightover the charge being created. If a director of the company has his personal account with the bankand he endorses and deposits cheques drawn on the company to hispersonal account, the banker must ascertain the nature of the deposit.

Clubs, Societies and Charitable Institutions


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When clubs, societies and charitable institution open accounts withbanks, it should be ensured that they are incorporated. These organizations are governed by their byelaws or its constitutionwhich will detail how they are to operate. A resolution of the managing committee is required to open a bank

account. This should detail who are the signatories and the manner theaccount should be operated. Before permitting a society or club to borrow it should be ensured theborrowing is permitted. If the person appointed to operate the account dies or resigns,operation should stop till the society/ club nominates another person. Care should be ensured that an authorized signatory does notendorse and bank club/ society cheques into his own account.

Non-Resident The Foreign Exchange Management Act defines a resident and statesthat all others are non-residents.

A person resident in India is:(i) A person residing in India for more than one hundred and eighty twodays during the course of the preceding financial year but does notinclude:(A) A person who has gone out of India or stays outside India, in eithercase (a) for or on taking up employment outside India, or(b) for carrying on a business or vocation outside India, or

(c) for any other purpose in such circumstances as would indicate hisintention to stay outside India for an uncertain period.(B) A person who has come to India or stays in India, in either caseother than:(a) for or on taking up employment in India, or(b) for carrying on a business or vocation in India, or(c) for any other purpose in such circumstances as would indicate hisintention to stay in India for an uncertain period;(ii) Any person or corporate body registered or incorporated in India.(iii) An office, branch or agency in India owned or controlled by aperson resident outside India.

(iv) An office, branch or agency in India outside India owned orcontrolled by a person resident in India.

A person resident outside India is a person who is not resident in Indiai.e. a person who stays outside India or has otherwise gone out of India.(a) for or on taking up employment outside India, or(b) for carrying on a business or vocation outside India, or(c) for any other purpose, in such circumstances as would indicate his


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intention to stay outside India for an uncertain period.

This includes: An Indian citizen residing abroad for employment, business, vocationor for any other business. Persons of Indian origin holding a passport issued by a foreigncountry residing abroad. An Indian government servant posted abroad. An Indian government servant deputed abroad on assignments withforeign governments or international agencies. An officer of the State government/ public sector deputed abroad on atemporary assignment. An Indian student who goes abroad to study. An Indian student who takes up a job after studies in a foreignuniversity

Persons of Indian origin In 2002 the Government of India created a new category calledPersons of Indian Origin (PIO). A PIO is a foreign citizen not being a citizen of Pakistan, Bangladeshand other countries as may be specified by the Central Governmentfrom time to time if:(i) he/ she at any time held an Indian passport; or(ii) he/ she or either of his parents or grand parents or great grandparents was born in and permanently resident in India as defined in theGovernment of India Act 1935 and other territories that became part of

India thereafter provided neither was at any time a citizen of Pakistan,Bangladesh and other countries as may be specified by the CentralGovernment from time to time.(iii) he/ she is a spouse of a citizen of India or a person of Indian origincovered under (i) or (ii) above. Facilities available to a PIO He does not require a visa to visit India. He does not need to register if his stay in India does not exceed 180days. If a PIOs continuous stay exceeds 180 days he/ she will have to gethimself/ herself registered within 30 days of the expiry of 180 days with

the concerned Foreigners Registration Officer at the districtheadquarters where the PIO is residing. A PIO holder enjoys parity with NRIs in respect of all facilitiesavailable to the latter in the economic , financial and educational fieldsexcept in matters relating to the acquisition of agricultural/ plantationproperties. No parity is allowed in the sphere of political rights.

Dual Citizenship


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On December 22, 2003 the Citizenship (Amendment) Act 2003 waspassed permitting nationals of certain countries dual citizenshipprovided they are of Indian origin. In this context Indian origin will mean a citizen of another countrywho is eligible to become a citizen of India at the time of

commencement of the constitution or belonged to a territory thatbecame a part of India after August 15, 1947. The act does not coverthose people who, at any time , were citizens of Pakistan, Bangladeshor any other country which the government may notify in the officialgazette. Those who acquire citizenship will be known as an overseas citizenof India. An overseas citizen of India is defined as a person who:(i) is of Indian origin being a citizen of a specified country,(ii) or/ was a citizen of India immediately before becoming a citizen of aspecified country and is registered as an overseas citizen of India bythe Central Government.(iii) an overseas citizen will not be entitled to the rights conferred on acitizen of India and will not have the right to equality of opportunity inmatters of public employment, will not have voting rights and also willnot be eligible to be a member of either the Lok Sabha or the RajyaSabha. Dual citizenship has been extended to people of Indian origin living inAustralia, Canada, Finland, France, Greece, Ireland, Israel, Italy, theNetherlands, New Zealand, Portugal, Republic of Cyprus, Sweden,Switzerland, UK and the United States of America. It is proposed tooffer this to those in all countries. No person who has been deprived of his Indian citizenship will beregistered as an overseas citizen of India except by an order of theGovernment. They will not be required to have a visa while visiting India and canbuy property and enjoy equality with non resident Indians ineconomic, financial and educational fields. The fee to secure Indian overseas citizenship is Rs. 12,500. Of this$25 would be non refundable if the application is turned down.

Foreigners Foreigners are citizens of another country who are not of Indiandescent. Foreigners residing and working in India may open bank accounts. Others may open accounts for a short period of time. Prior to opening an account the passport and other documents shouldbe checked.


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KNOW YOUR CUSTOMER

It is important, in these days of drugs smuggling, terrorism, financial fraud, money

laundering and arms dealing that banks know whom their customers are. Banks must be

comfortable with the bona fides and the integrity of their customers. The need increasesas external people like general selling agents introduce a number of customers. Apart

from this, in order to develop a long- term relationship, it is an imperative that the banker

knows as much as possible about his customer.

What does this mean?

It means that a banker should know his customers. He should know about their business

and as far as possible the nature of their earnings and their moral standing.

This is why it is recommended that persons known to the bank recommend prospectivecustomers. Even though the introducers cannot be sued or otherwise held responsible, the

introducers have a moral responsibility.

A banker loses the statutory protection available under section 131 of the Negotiable

Instruments Act if it is proved that he was negligent while opening an account.

Actually, this is also reinforced by the concept of relationship banking. How can you

offer your client exceptional service if you do not know what he requires? You need to be

able to anticipate his requirements. You can do this only if you know your customer well.

The second reason is on borrowing customers. It would be very short sighted to lend to

someone you do not know.

Although there was some laxity regarding the enforcement of the Know Your customer

(KYC) imperative, recent happenings such as terrorism, money laundering and drug

smuggling has brought the need of KYC to everyones focus.

Headquarters of banks, governments and by extension central banks are insisting on

KYC policies being strictly adhered to.

Reserve Bank of India

In India, The Reserve Bank of India has been issuing guidelines on KYC regularly.

Some of the more important instructions are mentioned below.

It was instructed:

In August 1976 that applicants for demand drafts, travelers cheques and money transfers

should affix their Permanent Account Number (PAN) on the application for transactions

of Rs. 10,000 and above.

In November 1987 it was stated that cash should not be accepted for retirement of


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import bills. It was also stated that there must be a reasonable time (say 6 months)

between the time an introducer opens his account and introduces a prospective account

holder. Introduction of an account should enable the proper identification of the person

opening the account so that the person can be traced if the account is misused.

In April 1991, banks were instructed that travelers cheques, demand drafts, mailtransfers and telegraphic transfers for Rs. 50,000 and above should be by debit to the

customers account or against cheques only and not against cash.

In August 1992 banks were advised to adhere to the prescribed norms and safeguards

while opening accounts.

In December 1992 banks were asked to ensure that when customers withdrew amounts

from their cash credit/ overdraft accounts that funds were not diverted for the acquisition

of fixed assets, investments in associate companies and acquisition of shares and other

capital market investments.

In September 1993, banks were asked to be vigilant and ensure proper end use of bankfunds. They were to keep vigil over heavy cash withdrawals by account holders that may

be disproportionate to their normal trade/ business requirements. They were also asked to

question unusual trends.

In November 1993 on account of fraudulent encashment of interest/ dividend warrants

banks were asked to not open accounts without proper introduction.

In December 1993 banks were asked to seek customer identification while opening

accounts including the obtaining of photographs of customers.

In April 1994 the RBI clarified that photographs must be obtained for both residents and

non- residents and for those authorized to operate accounts. In September 1994 on account of fraudulent operations in deposit accounts, banks were

asked to examine every request for opening joint accounts very carefully. Generally

crossed cheques and payable to order were to be collected only on proper endorsement.

Banks were also asked to exercise care in the collection of cheques of large amounts and

ensure that joint accounts are not used for benami transactions.

In May 1995 banks were asked to introduce a system of close watch of new deposit

accounts and monitor cash withdrawals and deposits for Rs. 10 lakhs and above in deposit,

cash credit and overdraft accounts.

In September 1995 banks were asked to report to the RBI all transactions of Rs. 10 lakhs

and above.

In December 2001, banks were asked to keep a watchful eye on transactions that may be

by terrorist organizations.

In April 2002 banks were instructed to freeze accounts of individuals and entities

identified by the Security Council Sanctions Committee of the United Nations.

In May 2002, Banks were asked to ensure no new accounts were opened by banned


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organizations.

In August 2002, the Reserve Bank reinforced its instructions stating:

The key principle of the know your customer procedure should be the identification of

an individual/ corporate opening an account. This should entail an introductory reference

from an existing account holder/ person known to the bank. The board of directors must have in place adequate procedures to verify the bona fide

identification of individuals. There should also be processes to monitor transactions of a

suspicious nature.

This instruction raised the requirement of giving PAN to transactions of Rs. 50,000 or

more (earlier it was Rs. 10,000 August 1976).

There must be good control systems plus audits and checks to ensure the bank adheres to

its KYC policies.

There should be a system at branch level to ensure that lists of terrorist entities are

circulated so that accounts/ transactions are not opened/ consummated. Transactions of a suspicious nature must be reported to the appropriate authorities.

It should be ensured that all the laws are adhered to.

In May 2004, it was stated that information collected from the customer for KYC

purposes should not be used for cross selling.

In recent years on account of the proliferation of banks and their opening branches in

locations that they had no branches before, it has been difficult to adhere strictly to KYC

guidelines. In these instances, introductions by prominent citizens and individuals known

to the bank are considered acceptable. The concern is usually with respect to accounts

introduced by outsiders retained for this purpose who are remunerated on the basis of thenumber of accounts they introduce. The consensus in these days of intensive competition

is that this is an acceptable risk if proper documentation to verify the antecedents of the

person is taken.

In November 2004, the RBI issued comprehensive guidelines. These reiterated that the

objective of Know Your Customer (KYC) guidelines is to prevent banks from being

used, intentionally or unintentionally, by criminal elements for money laundering

activities or for the financing of terrorism. KYC procedures also enable banks to know /

understand their customers and their financial dealings better which in turn help them

manage their risks prudently. The guidelines are applicable to foreign currency accounts /

transactions and to all new accounts. .

Banks have been asked to frame their KYC policies incorporating the following four key

elements:

Customer Acceptance Policy

Customer Identification Procedures

Monitoring of Transactions


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Risk management

For the purpose of KYC policy, a customer has been 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). This includesbeneficiaries 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

reputation or other risks to the bank, such as a wire transfer or issue of a high value

demand draft as a single transaction.

Know Your Customer (KYC) procedure is to be the key principle for identification of

an individual / corporate opening an account. The customer identification should entail

verification through an introductory reference from an existing account holder / a person

known to the bank or on the basis of documents provided by the customer. The Board of Directors of the banks are to have in place adequate policies that establish

procedures to verify the bona fide identification of the individual / corporate opening an

account. Policies to establish processes and procedures to monitor transactions of a

suspicious nature in accounts and systems of conducting due diligence and reporting of

such transactions must be in place.

Customer Acceptance Policy (CAP)

There must be a clear customer acceptance policy that lays down explicit criteria for

acceptance of customers. The Customer Acceptance Policy must ensure that explicitguidelines are in place on the following aspects of customer relationship in the bank.

o No account is opened in anonymous or fictitious/ benami name(s);

o Parameters of risk perception are clearly defined in terms of the nature of business

activity, location of customer and his clients, mode of payments, volume of turnover,

social and financial status etc. to enable categorization of customers into low, medium and

high risk (banks may choose any suitable nomenclature viz. level I, level II and level III);

customers requiring very high level of monitoring, e.g. Politically Exposed Persons

(PEPs) may, if considered necessary, be categorized even higher;

o Documentation requirements and other information to be collected in respect of

different categories of customers depending on perceived risk and keeping in mind the

requirements of the Prevention of Money Laundering (PML) Act, 2002 and guidelines

issued by Reserve Bank from time to time;

o Accounts should not be opened nor should an existing account be closed where the bank

is unable to apply appropriate customer due diligence measures i.e. bank is unable to

verify the identity and / or obtain documents required as per the risk categorization due to


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non cooperation of the customer or non reliability of the data / information furnished to

the bank. It may, however, be necessary to have suitable built in safeguards to avoid

harassment of the customer. For example, decision to close an account may be taken at a

reasonably high level after giving due notice to the customer explaining the reasons for

such a decision;o Circumstances, in which a customer is permitted to act on behalf of another person /

entity, should be clearly spelt out in conformity with the established law and practice of

banking as there could be occasions when an account is operated by a mandate holder or

where an account may be opened by an intermediary in a fiduciary capacity;

o There must be checks before opening a new account so as to ensure that the identity of

the customer does not match with any person with known criminal background or with

banned entities such as individual terrorists or terrorist organizations etc.

o Banks should prepare a profile for each new customer based on risk categorization. The

customer profile must contain information relating to the customers identity, social /financial status, nature of business activity, information about his clients business and

their location etc. The nature and extent of due diligence will depend on the risk perceived

by the bank. However, while preparing customer profile banks should take care to seek

only such information from the customer, which is relevant to the risk category and is not

intrusive. The information provided by the customer for KYC compliance while opening

an account is confidential and divulging any details thereof for cross selling or any other

purpose would be in breach of customer confidentiality obligations. Any other

information from the customer should be sought separately with his/ her consent and after

opening the account. Banks are to strictly ensure compliance with their obligations to thecustomer in this regard.

o For the purpose of risk categorizations, individuals (other than high net worth) and

entities whose identities and sources of wealth can be easily identified and transactions in

whose accounts by and large conform to the known profile may be categorized as low

risk. Illustrative examples of low risk customers could be salaried employees whose

salary structures are well defined, people belonging to lower economic strata of the

society whose accounts show small balances and low turnover, Government departments

& Government owned companies, regulators and statutory bodies etc. In such cases, the

policy may require that only the basic requirements of verifying the identity and location

of the customer be met. Customers that are likely to pose a higher than average risk to the

bank may be categorized as medium or high risk depending on customers background,

nature and location of activity, country of origin, sources of funds and his client profile

etc. Banks may apply enhanced due diligence measures based on the risk assessment,

thereby requiring intensive due diligence for higher risk customers, especially those for

whom the sources of funds are not clear. Examples of customers requiring higher due


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diligence may include (a) non-resident customers, (b) high net worth individuals, (c)

trusts, charities, NGOs and organizations receiving donations, (d) companies having close

family shareholding or beneficial ownership, (e) firms with sleeping partners, (f)

politically exposed persons (PEPs) of foreign origin, (g) non-face to face customers, and

(h) those with dubious reputation as per public information available, etc.o It is important to bear in mind that the adoption of customer acceptance policy and its

implementation should not become too restrictive and must not result in denial of banking

services to general public, especially to those, who are financially or socially

disadvantaged.

Customer Identification Procedure (CIP)

The policy approved by the board of banks should clearly spell out the Customer

Identification Procedure to be carried out at different stages i.e. while establishing a

banking relationship; carrying out a financial transaction or when the bank has a doubtabout the authenticity / veracity or the adequacy of the previously obtained customer

identification data. Customer identification means identifying the customer and verifying

his/ her identity by using reliable, independent source documents, data or information.

Banks need to obtain sufficient information necessary to establish, to their satisfaction,

the identity of each new customer, whether regular or occasional, and the purpose of the

intended nature of banking relationship. Being satisfied means that the bank must be able

to satisfy the competent authorities that due diligence was observed based on the risk

profile of the customer in compliance with the extant guidelines in place. Such risk-based

approach is considered necessary to avoid disproportionate cost to banks and aburdensome regime for the customers. Besides risk perception, the nature of information /

documents required would also depend on the type of customer (individual, corporate

etc.).

For customers that are natural persons, the banks should obtain sufficient identification

data to verify the identity of the customer, his address / location, and also his recent

photograph.

For customers that are legal persons or entities, the bank should:

o Verify the legal status of the legal person/ entity through proper and relevant documents;

o Verify that any person purporting to act on behalf of the legal person / entity is so

authorized and identify and verify the identity of that person;

o Understand the ownership and control structure of the customer and determine who are

the natural persons who ultimately control the legal person.

Banks may frame their own internal guidelines based on their experience of dealing with

such persons/entities, normal bankers prudence and the legal requirements as per

established practices.


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It should be noted that wherever banks desire to collect any information about the

customer for a purpose other than KYC requirements, it should not form part of the

account opening form. Such information may be collected separately, purely on a

voluntary basis, after explaining the objectives to the customer and taking his express

approval for the specific uses to which such information could be put. There must be Know Your Customer procedures for existing customers.

Banks are expected to have adopted due diligence and appropriate KYC norms at the

time of opening of accounts in respect of existing customers. However, in case of any

omission, the requisite KYC procedures for customer identification should be completed

at the earliest. Additionally, banks must, on the basis of materiality, apply the KYC

guidelines to all existing accounts.

Transactions in existing accounts should be continuously monitored and any unusual

pattern in the operation of the account should trigger a review of the customer

confidential documentation measures. Banks could apply monetary limits to suchaccounts based on the nature and type of the account. It may however be ensured that all

existing accounts of companies, firms, trusts, charities, religious organizations and other

institutions are subjected to minimum KYC standards which would establish the identity

of the natural/ legal person and those of the beneficial owners. Banks should also

ensure that term/ recurring deposit accounts or accounts of similar nature are treated as

new accounts at the time of renewal and subjected to revised KYC procedures.

Where the bank is unable to apply appropriate KYC measures due to non-furnishing of

information and or/ non-cooperation by the customer, the bank should close the account

or terminate the relationship after issuing due notice to the customer explaining thereasons for taking such a decision. Such decisions need to be taken at a reasonably senior

level.

To ensure that existing small account holders are not inconvenienced and the KYC

procedure is completed in time, banks may limit the application of KYC procedures to

existing accounts where the credit or debit summation for the financial year ended March

31, 2003 is more than Rs.10 lakh or where unusual transactions are suspected.

KYC procedures must applied to all existing accounts of trusts, companies/firms,

religious/charitable organizations and other institutions or where the accounts are opened

through a mandate or power of attorney.

Monitoring of Transactions

Ongoing monitoring is an essential element of effective KYC procedures. Banks can

effectively control and reduce their risk only if they have an understanding of the normal

and reasonable activity of the customer so that they have the means of identifying

transactions that fall outside the regular pattern of activity. However, the extent of


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monitoring will depend on the risk sensitivity of the account.

Banks should pay special attention to all complex, unusually large transactions and all

unusual patterns, which have no apparent economic or visible lawful purpose. The bank

may prescribe threshold limits for a particular category of accounts and pay particular

attention to the transactions which exceed these limits. Transactions that involve large amounts of cash inconsistent with the normal and

expected activity of the customer should particularly attract the attention of the bank.

Very high account turnover inconsistent with the size of the balance maintained may

indicate that funds are being washed through the account. High-risk accounts have to be

subjected to intensified monitoring.

Every bank should set key indicators for such accounts, taking note of the background of

the customer, such as the country of origin, sources of funds, the type of transactions

involved and other risk factors. Banks should put in place a system of periodical review

of risk categorization of accounts and the need for applying enhanced due diligencemeasures.

Banks should ensure that a record of transactions in the accounts is preserved and

maintained as required in terms of section 12 of the PML Act, 2002. It may also be

ensured that transactions of a suspicious nature and / or any other type of transaction

notified under section 12 of the PML Act, 2002, is reported to the appropriate law

enforcement authority.

Banks should ensure that its branches:

o Continue to maintain proper record of all cash transactions (deposits and withdrawals)

of Rs.10 lakh and above.o Have an internal monitoring system that has an inbuilt procedure for reporting of large

cash transactions and those of a suspicious nature to controlling/ head office on a

fortnightly basis. Early computerization of branch reporting will facilitate prompt

generation of such reports.

o Report transactions of a suspicious nature to the appropriate law enforcement authorities

designated under the relevant laws governing such activities.

o Have well laid down systems for freezing of suspicious accounts.

o There must be quarterly reporting of suspicious accounts to the audit committee of the

board or the board of directors.

Terrorism Finance

RBI has been circulating lists of terrorist entities notified by the Government of India to

banks so that banks may exercise caution if any transaction is detected with such entities.

There should be a system at the branch level to ensure that such lists are consulted in

order to determine whether a person/organization involved in a prospective or existing


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business relationship appears on such a list. The authority to whom banks may report

accounts suspected to belong to terrorist entities will be advised in consultation with

Government.

Adherence to Foreign Contribution Regulation Act (FCRA), 1976 Banks should also adhere to the instructions on the provisions of the Foreign

Contribution Regulation Act, 1976 cautioning them to open accounts or collect cheques

only in favor of associations that are registered under the Act by the Government of India.

A certificate to the effect that the association is registered with the Government of India

should be obtained from the concerned associations at the time of opening of the account

or collection of cheques.

Branches of banks should be advised to exercise due care to ensure compliance and

desist from opening accounts in the name of banned organizations and those without

requisite registration.

Remittances

Banks must ensure that any remittance of funds by way of demand draft, mail/

telegraphic transfer or any other mode and issue of travelers cheques for value of

Rs50,000 and above is effected by way of debit to the customers account or against

cheques and not against cash payment.

Customer Education

Implementation of KYC procedures requires banks to demand certain information fromcustomers which may be of personal nature or which has hitherto never been called for.

This can sometimes lead to a lot of questioning by the customer as to the motive and

purpose of collecting such information. There is, therefore, a need for banks to prepare

specific literature/ pamphlets etc. so as to educate the customer of the objectives of the

KYC program. The front desk staff needs to be specially trained to handle such situations

while dealing with customers.

Introduction of New Technologies Credit cards/debit cards/smart cards/gift cards

Banks should pay special attention to any money laundering threats that may arise from

new or developing technologies including internet banking that might favor anonymity,

and take measures, if needed, to prevent their use in money laundering schemes.

Many banks are engaged in the business of issuing a variety of electronic cards that are

used by customers for buying goods and services, drawing cash from ATMs, and can be

used for electronic transfer of funds. Further, marketing of these cards is generally done

through the services of agents. Banks should ensure that appropriate KYC procedures are


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duly applied before issuing the cards to the customers. It is also desirable that agents are

also subjected to KYC measures.

Importance of RBI Guidelines

It should be noted that RBI guidelines are issued under Section 35 (A) of the BankingRegulation Act, 1949 and any contravention will attract penalties under the relevant

provisions of the Act. Banks are advised to bring the guidelines to the notice of their

branches and controlling offices.

RBI guidelines also apply to the branches and majority owned subsidiaries located

abroad, especially, in countries that do not or insufficiently apply the Financial Actions

Task Force (FATF) recommendations, to the extent local laws permit. When local

applicable laws and regulations prohibit implementation of these guidelines, that fact

should be brought to the notice of Reserve Bank.

KYC and Lower income Groups

In October 2005, the RBI stated that these guidelines should not be an excuse for banks

to keep the poor away from the banking system. Though the KYC guidelines require an

individual opening a new account to produce a number of identification documents, these

could be done away with for lower income groups. The RBI has asked banks to ensure

that the inability of the lower income group to produce documents to establish their

identity and address does not lead to their financial exclusion and denial of banking

services. A simplified procedure could be provided for opening of account in respect of

those persons who do not intend to keep balances above Rs. 50,000 and whose total creditin one year is not expected to exceed Rs.100,000.

DEPOSIT ACCOUNTS

The acceptance of deposits and maintenance of these deposits is the core activity of

banks. It is arguably the most important function as without deposits banks will not have

funds to invest or lend.

The relationship between a banker and a customer begins when the customer opens an

account and deposits an amount in that account.

As customers have different needs, bankers offer different types of deposit accounts.

Types of deposit accounts

The different types of deposit accounts a customer can place his money in are:

Demand deposits

Fixed or time deposits


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Demand Deposits

Demand deposits are those deposits where the money deposited is available to the

depositor on demand.

There are two types of demand deposit accounts. These are:

Current Accounts. This is defined by the Reserve Bank as a form of demand deposit

wherefrom withdrawals are allowed any number of times depending upon the balance in

the account or upto a particular agreed amount and shall also be deemed to include other

deposit accounts that are neither savings deposit or term deposit.

Savings Accounts. A savings account has been defined as a deposit account ..which

is subject to the restrictions as to the number of withdrawals as also the amounts of

withdrawals permitted by the bank during any specified period.

Call Deposits. These are deposits maintained by banks. These are kept overnight or for a

period of time and are interest earning.

Fixed Deposit

Fixed Deposit. A fixed or time deposit is defined as a deposit received by a bank for a

fixed period and which is withdrawable only after the expiry of the said fixed period and

shall also include deposits such as recurring, cumulative, annuity, reinvestment deposits,

cash certificates and so on.

The manner these accounts operate and their differences are detailed in the ensuing

chapters.

OPENING OF DEPOSIT ACCOUNTS

By opening a deposit account, an individual who has no other account with the bank,

begins a relationship. The beginning of a relationship imposes several obligations on a

banker. He must therefore be careful regarding whose accounts he opens.

An account can be opened by anyone who can enter into a valid contract. Minors may

open an account jointly with their guardians. Bankers may allow minors to open savings

accounts in their single name and operate the account. These will be savings accounts and

minors will not be permitted to overdraw these accounts. This is to inculcate banking

habits.

Who places their funds in deposit accounts?

Deposits are opened by those who have funds in hand. These include:

Individuals;

Sole Proprietorships;


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Hindu Undivided Families (HUF);

Partnerships;

Trusts;

Associations / Societies and Clubs;

Limited Companies.

Persons who are not permitted to open accounts are those who cannot enter into a contract

such as persons of unsound mind.

Introduction

The Reserve Bank of India insists (and it is good banking practice) that those opening

accounts are properly introduced. This becomes even more important in view of terrorism,

frauds and money laundering. The bank must be satisfied that the person who opens an

account is indeed the person he claims to be and is respectable. The banker will get legal protection under Section131 of the Negotiable Instruments Act

(which governs payment and collection of negotiable instruments) only if the bank has

acted in good faith and without negligence. It is presumed that he has not acted without

negligence if he accepts a customer who has not been properly introduced.

The RBI also states that proper identification enables the bank to trace the person later if

required.

Therefore the RBI states that the practice of obtaining proper introduction should not be

treated as a mere formality but as a measure to safeguard against opening of accounts by

undesirables or in fictitious names to deposit unaccounted money.

The account should not normally be opened without a meeting between the bank official

and the customer.

The introduction should be by:

An existing customer. It is required that the individual should be of some standing and

been a customer for at least 6 months. This is to ensure accounts are not opened on the

introduction of new account holders or persons having small and marginal balances. The

RBI recommends this interval to enable the bank to monitor transactions in the account

and satisfy itself that transactions in the introducers account are satisfactory.

A respectable person of the local community known to the bank or the banks staff. This

is often the case when a bank is opening its first branch in a town/ city.

Another bank/ banker. This occurs when a person is new to a location but has been

having a banking relationship with another bank in another city.

Bank managers/ bank staff should be discouraged from giving the introduction. In these

cases, apart from verifying the signatures with the specimen signatures on record, written

c