Banking is an integral part of our financial lives, and the banker customer relationship is the

foundation of the banking system. This relationship is built on trust, mutual understanding,
and a contractual agreement. When a person opens a bank account in the bank and the banker
gives his acceptance for the account, it binds the banker and customer in the contractual
relationship.
The bank and customer are two different terms that are related to the bank. The person doing
the banking business is called a banker and the person who is connected with the bank, either
depositing his money or taking a loan from the bank is called a bank customer. The
relationship between banker and customer can be of various types because it totally depends
upon the activities, products and services provided by the banker to the customer.
The Banking Regulations Act 1949, Sec.5 (b) defines the term banking as “Banking means
accepting, for the purpose of lending or investment, of deposits of money from the public
repayable on demand or otherwise and withdrawable by cheque, draft, and order or
otherwise.
The bank works as the intermediary between two people where one wants to save his money
and others need money. This process also helps the bank to gain some profit and make the
relationship between banker and customer. This process creates different rights and duties of
bankers against the customer and rights and duties of customers against the bank which make
the banker and customer relationship stronger.
The term Customer has not been defined by any act. In simple words, a customer is a person
to whom you extend your services in return of consideration. A customer is a person who
maintains an account with the bank without taking into consideration the duration and
frequency of operation of his account. Those who do not maintain any account relationship
with the bank but frequently visit branch of a bank for availing banking facilities such as for
purchasing a draft, encashing a cheque, etc. Technically they are not customers, as they do
not maintain any account with the bank branch.

Debtor and Creditor Relationship:

When a customer opens an account with a bank, they enter into a debtor and creditor
relationship. By depositing money into their account, the customer becomes a creditor as they
are lending their money to the bank. The bank, in turn, becomes a debtor and owes the
customer the amount deposited. The bank can utilize the deposited funds as per its discretion,
and the customer can withdraw the funds on demand.

On the other hand, when a customer borrows money from the bank, they become a debtor,
and the bank becomes a creditor. In this scenario, the bank lends money to the customer, and
the customer is obligated to repay the loan in accordance with the agreed terms and
conditions.

Trustee – Beneficiary:
A trustee is an individual responsible for a property or an organization on behalf of another
individual or a third party. The trustee is expected to make profitable decisions for the entity
under their authorization. This relationship is a legal one, where the trustee is completely
responsible for the maintenance, performance, and profitability of the trust under their
guidance.
A beneficiary is any person who gains an advantage and/or profits from something.
This relationship works out in the following scenarios:

1. Customer Deposits Money for a Specific Purpose:

When a customer deposits money for a specific purpose, the banker acts as a trustee,
and the customer is the beneficiary. The banker is required to employ the funds for the
purpose for which they were deposited.
2. Banker as Trustee for Cheque Collection:
The banker becomes a trustee whenever they undertake to collect cheques on behalf
of customers. After realizing the cheques, the banker must credit the proceeds to the
customer's account. Once the amount is credited, the relationship changes, and the
banker becomes a debtor while the customer becomes the creditor.
3. Customer Deposits Securities and Valuables for Safe Custody:
When a customer deposits securities and valuables for safe custody with the banker,
the banker is a trustee. Upon the customer's demand, the banker must return the
securities to the customer, who is the beneficiary.
4. Banker as Trustee for Debenture Amounts in Companies:
In the case of companies, when they receive debenture amounts from the public, the
banker acts as one of the trustees of the company. The banker is responsible for
reviewing the value of the assets against which the debentures are issued. Therefore,
the banker has a duty to supervise the property of the company for which they are a
trustee.

Principal-Agent Relationship in Banking:

In banking, the relationship between a banker and a customer can be seen as a principal-agent
relationship. The customer (the principal) gives the bank (the agent) the authority to manage
their money and assets.

1. Role of the Banker (Agent):

The banker acts on the customer's behalf to handle tasks like paying bills, managing
assets, or making investments. The banker must always act in the customer's best
interest, using care and skill in managing their assets.
2. Role of the Customer (Principal):
The customer has control over their assets and makes the final decisions. The
customer also needs to keep the bank updated on important changes, like changes in
contact info or assets.
3. Fiduciary Duty:
The banker must always act ethically, prioritizing the customer’s interests over their
own. This ensures responsible management of the customer’s assets.
4. Investment and Updates:
The bank should manage the customer’s investments carefully, balancing risk and
return, and providing regular updates on performance.
5. Authority:
The customer can give explicit instructions (expressed authority) or implied
permission (implied authority) for how their assets should be managed.

Lessor and Lessee Relationship:

A lease of immovable property is an agreement where the owner (lessor) gives someone
else (lessee) the right to use and enjoy their property for a specific period of time or forever.
In exchange, the lessee agrees to pay a price, which could be money, a share of crops,
services, or something else of value, either periodically or at specific times. When a bank
provides safe deposit lockers to its customers, it assumes the role of a lesser, and the
customer becomes the lessee. The bank leases its immovable property, i.e., the safe deposit
locker, to the customer for a specified period. The customer pays rent for the locker, and the
bank is responsible for maintaining the security and integrity of the locker. Bank has the right
to break-open the locker in case the locker holder defaults in payment of rent. Banks do not
assume any liability or responsibility in case of any damage to the contents kept in the locker.
Banks do not insure the contents kept in the lockers by customers.

Bailor – Bailee:
A "bailment" is the delivery of goods by one person to another for some purpose, upon a
contract that they shall, when the purpose is accomplished, be returned or otherwise disposed
of according to the directions of the person delivering them. A bailor is a person who
entrusts a piece of property to another person (the bailee). The bailee does not have
ownership of the property but is responsible for its care and safekeeping.

1. Bank as Bailee:
When a customer borrows money from a bank against security under pledge, the bank
is regarded not only as a pledgee but also as a bailee. In this case, the bank must take
care of the pledged security until it is returned to the customer.
2. Safe Deposit Vaults:
Goods kept in a safe deposit vault do not fall under the concept of bailment. In such
cases, the customer is keeping the goods in the vault secretly, and the bank is not
considered a bailee. The banker is not aware of the nature of the goods.
3. Responsibilities as Bailee:
The banker will act as a bailee only when goods are entrusted to them for a specific
purpose. As a bailee, the banker is responsible for the protection of the goods and
must be fully aware of the nature of the items entrusted.
4. Maintenance Expenses:
Any expenses incurred for the maintenance of the security or goods are to be borne by
the customer.

Pledger and Pledgee Relationship: Sec-174

In situations where a customer pledges assets or securities as collateral for a loan, the bank
acts as a pledgee, and the customer becomes the pledger. The customer pledges their assets to
secure the loan, and the bank holds the assets as collateral. If the customer defaults on the
loan, the bank has the right to take possession of and sell the pledged assets to recover the
outstanding amount.

Advisor and Client Relationship:

Banks often provide advisory services to their customers regarding investments, financial
planning, and other related matters. In this advisor and client relationship, the bank acts as an
advisor, offering guidance and recommendations based on the customer’s financial goals and
risk tolerance. The customer relies on the bank’s expertise to make informed decisions
regarding their finances.
RIGHTS OF BANKER:
-RIGHT TO LIEN: (BANKER’S LIEN)

 The concept of lien is an important aspect of the Indian Contract Act, 1872(ICA),
which governs the rights and obligations arising from contracts in India.
 A lien is a legal right or interest that a lender or creditor has in the property of a
borrower or debtor, granted until the debt obligation is satisfied.
 The right of lien is the right available to bailee as per the ICA.
 The bailee has the right to lien, which means the bailee can take back the possession
of the goods bailed by the bailor until the charges are paid in respect of the goods.
 This right would be applicable when there is a legal contract between the parties, i.e.,
a contract of bailment.

Types of Liens :
Under the Indian Contract Act, 1872, there are primarily two types of liens:

 General Lien
o Section 171 of the ICA states about General Lien.
o A general lien allows a creditor to retain possession of a debtor's property until
the debt owed by the debtor is paid.
o This type of lien is not limited to a specific debt and can be applied to any
amount owed to the creditor. General liens are typically applicable to certain
professions, such as:
 Bankers
 Factors (agents who sell goods)
 Wharfingers (individuals who own or operate a wharf)
 Attorneys
 Particular Lien
o It is defined under Section 170 of the ICA.
o A particular lien, on the other hand, allows a creditor to retain possession of a
specific item of property until the debt related to that particular item is paid.
o This type of lien is more restrictive than a general lien and is often seen in
situations involving:
 Repairers of goods
 Bailees (individuals who temporarily take possession of goods)

The banker’s right to lien is predicated on the idea that a bank should be able to recover the
amount owed to it by selling the debtor’s goods that are in its possession. This recovery can
only occur after a reasonable time and notice have been provided to the debtor. In other
words, a bank has the right to retain the goods and securities of a customer until the customer
settles their dues with the bank. If the customer fails to repay the debt, the bank can sell these
goods after giving due notice to the customer, as per the law.

The goods and securities subject to a banker’s lien are those that the banker has acquired
during the ordinary course of business. This lien is an implicit agreement between the bank
and the customer, granting the bank the right to hold the customer’s property until the debt is
cleared.

The scope of assets that can be held under a banker’s lien is broad. These typically include:
  Deposits: Fixed deposits or other similar deposits that can be retained until the
maturity of a loan.
 Securities: Stocks, bonds and other marketable securities that may be in the bank’s
custody.
 Documents: Important documents like title deeds, held for safekeeping but which can
be used as security.

Circumstances for exercising general lien:

1) No agreement inconsistent with the right of lien.
2) Property must be possessed in his capacity as a banker.
3) Possession should be lawfully obtained.
4) Property should not be entrusted to the banker for a specific purpose.
Exceptions- banker has no general lien
1) On safe custody deposits.
2) On securities or bills of exchange entrusted for specific purpose.
3) On articles left by mistake or negligence.
4) On deposit account.
5) On stolen bond.
6) Until due date of the loan.
7) On trust account.
8) On title deeds of immovable properties.

-RIGHT TO CHARGE, INTEREST, COMMISSION, AND BROKERAGE:

A banker grants loans and advances to customers and charges interest on the same.
The banker usually debits the customer’s account when the customer fails to pay the interest
amount every month. After three months, the interest is added to the principal amount, and
interest is then charged on the new principal amount. Similarly, for services like collecting
cheques, dividends, and interest warrants, the banker can charge commission and brokerage
fees.

-RIGHT TO CLOSE THE ACCOUNT OF UNDESIRABLE CUSTOMERS:

An undesirable customer is one who frequently issues cheques that bounce or get
dishonored. This affects the reputation of the banker. In such cases, after giving due notice to
the customer, the banker has the right to close the account.

-RIGHT OF APPROPRIATION UNDER BANKERS' RIGHTS:

The right of appropriation allows a banker to apply payments made by a customer towards
any of the customer’s outstanding debts or obligations. This right is important when a
customer has multiple debts with the bank, and the bank receives a payment from the
customer without any specific instruction on how the payment should be applied.
In such cases, the banker can choose how to apply the payment—whether towards the loan,
interest, or other charges the customer owes. The banker has the discretion to appropriate the
payment in a way that best protects the bank's interest.

OBLIGATIONS OF BANKER:
In addition to the general relationships, there are certain special considerations and
obligations that arise in the banker and customer relationship. Let’s explore these special
aspects:

Maintaining Records:
Banks are required to maintain accurate records of their customers’ accounts and
transactions. This includes keeping track of account balances, transaction history, and other
relevant information. The customer has the right to access their account records and seek
clarification on any discrepancies or concerns.

Maintaining Confidentiality:
Banks are bound by strict confidentiality obligations to protect the privacy and confidentiality
of customer information. They are required to maintain the confidentiality of customer
accounts, transactions, and other sensitive information. The bank cannot disclose customer
information to third parties without the customer’s consent, except as required by law or
regulatory authorities.

Obligation To Honour Cheques:

The bank is responsible to accept the Cheque of the customer that is equivalent to the amount
present in the account. There are some necessary conditions which must be fullled by the
Cheque. Lack of these conditions can lead to the dishonour of cheques. Some important
conditions are:
 Proper format of the Cheque
 Correctly signed by the person
 Properly presented in the bank
 There must be an available balance in the bank account.

BANK GURANTEE:

Guarantee means to give surety or assume responsibility. It is an agreement to answer for

the debt of another in case he makes default. Section 126 of the Indian Contract Act, 1872
provides that a "contract of guarantee" is a contract to perform the promise, or discharge
the liability, of a third person in case of his default.

 Three parties are involved in the contract of guarantee.

o Surety: The person who gives the guarantee is called the surety. The liability
of the surety is secondary, i.e., he has to pay only if the principal debtor fails
to discharge his obligation to pay.
o Principal debtor: The person in respect of whose default the guarantee is
given is the principal debtor.
o Creditor: The person to whom the guarantee is given called the creditor.

A guarantee is either in the format of writing or of oral.

A bank guarantee is a financial instrument issued by a bank or financial institution on behalf

of a client, ensuring the payment of a specified amount to a third party in case the client
defaults on a particular obligation or fails to fulfill the terms of a contract. It serves as a
promise by the bank to cover a loss or financial risk incurred by the third party in the event of
non-performance by the client.

Bank guarantees are commonly used in various fields, including trade, construction, and
government projects, where there is a need to ensure the performance, delivery, or financial
commitment of one party. In this arrangement, the bank acts as a surety and guarantees the
payment of a debt or the fulfillment of a contractual obligation, providing security to the
beneficiary.

Types of Bank Guarantees

There are several types of bank guarantees, each designed to cover different kinds of risk:

1. Performance Bank Guarantee (PBG): This guarantee is issued to ensure the

performance of a contract. If the party fails to execute the contract as per the agreed
terms, the bank will pay the specified amount to the beneficiary.
2. Financial Bank Guarantee: This guarantees the payment of a debt or the financial
obligation of the client. It is commonly used when the client has a financial
commitment, such as a loan repayment, and needs to assure the lender of repayment.
3. Advance Payment Guarantee: This type of guarantee is provided to secure advance
payments made by the buyer to the seller. If the seller fails to execute the contract or
deliver the goods as agreed, the bank guarantees the refund of the advance.
4. Bid Bond Guarantee: Issued during a tendering process, this guarantee ensures that
the bidder will accept the contract if selected. If the bidder refuses, the bank pays a
specified amount to the contracting authority.
5. Customs and Excise Guarantee: This guarantee is provided to ensure that any
customs duties or excise taxes owed by an importer or exporter are paid to the
authorities.
6. Payment Guarantee: This guarantees the payment of sums due for goods or services
delivered, ensuring the beneficiary that they will receive the agreed amount even if
the buyer fails to pay.

Process of Issuing a Bank Guarantee:

1. Application: The applicant (usually the party requiring the guarantee) submits a
request to the bank, specifying the amount, nature of the guarantee, and the
beneficiary.
2. Review and Assessment: The bank assesses the applicant’s financial status,
creditworthiness, and the nature of the transaction. This may involve a thorough
examination of financial statements, contracts, and business history.
3. Issuance of Guarantee: If the bank is satisfied with the applicant’s financial
standing, it issues the bank guarantee, which will specify the terms and conditions,
including the amount, validity period, and any particular terms required by the
beneficiary.
4. Beneficiary’s Claim: If the applicant fails to fulfill their obligations under the
contract, the beneficiary can present a claim to the bank for the payment amount
specified in the guarantee.
5. Settlement of Claim: Upon receiving the claim, the bank evaluates the circumstances
and, if the conditions are met, disburses the guaranteed amount to the beneficiary.
Characteristics of a Bank Guarantee

 Independent Obligation: A bank guarantee is independent of the underlying contract

between the applicant and the beneficiary. This means that the bank's responsibility is
separate from the performance or non-performance of the primary agreement.
 Unconditional Payment: Most bank guarantees are unconditional, meaning the bank
must make the payment upon demand, provided the terms and conditions of the
guarantee are met.
 Time-bound: Bank guarantees are typically valid for a set period. If the conditions of
the guarantee are not invoked within the validity period, the guarantee expires.
 Non-negotiable: Bank guarantees are not transferable or negotiable, which
distinguishes them from letters of credit and other financial instruments.
 A bank guarantee can be either continuing or specific, depending on the nature of
the agreement and the terms set forth in the guarantee. Here’s how they differ:

Continuing or Specific Bank Guarantee:

A continuing bank guarantee is one where the bank guarantees a series of future
transactions or obligations over a period of time. It is not limited to a single transaction but
covers a continuing obligation between the applicant (the principal debtor) and the
beneficiary. A specific bank guarantee is limited to a single transaction or a single set of
obligations. The guarantee only applies to a particular contract or event, and once the specific
obligation is fulfilled or the transaction is completed, the guarantee is no longer valid.

LETTER OF CREDIT:
A letter of credit is a form of payment commonly used in global trade in which a bank gives a
monetary promise to businesses that import and export commodities. Both exports and
imports are possible with a letter of credit. Businesses doing business globally must engage
with unfamiliar suppliers and must have a guarantee of payment before proceeding with any
transaction.

Letter of credit (L/C) is a type of “documentary credit” or a “non-fund based credit”. It is a

document issued by a bank or financial institution at the request of a buyer whereby the bank
or financial institution gives assurance of payment to a seller if the terms and conditions
specified in the document are fulfilled. This means that Letter of Credit is a promise made by
Bank to pay to exporter / seller on behalf of importer / buyer. The seller receives the payment
only when all the requirements specified in the L/C are met including the documents,
delivery dates, product specification, etc.

Thus, a Letter of Credit has three parties:

1. Buyer / Importer: Also known as Opener, as he opens the credit

2. Bank / Financial Institution: Also known as Issuer, as it opens the letter of credit
3. Seller / Exporter : Also known as beneficiary as credit is opened in favour of him.
Types of Letter of Credit:
There are several types of Letter of Credit on the basis of various levels of security they grant
to the beneficiary (seller/exporter).

Irrevocable Letter of Credit:

An irrevocable Letter of Credit cannot be modified or cancelled without the agreement of all
the three parties.

Revocable Letter of Credit:

Revocable letter of credit may be modified or even cancelled by the issuing bank at any time
and without notice to the beneficiary. Such L/Cs are rare now a days as they give maximum
flexibility to the buyers but involve risk to the seller.

Confirmed Irrevocable Letter of Credit:

In this type of L/C, there are two banks involved: the Issuing Bank (which is the buyer’s
bank) and the Confirming Bank (which is usually the seller’s bank or another bank in the
seller’s country). The Confirming Bank adds its guarantee to the L/C, meaning it promises
to pay the seller (the beneficiary) if the buyer doesn't fulfill their obligations. The
Confirming Bank is a safety net for the seller. Even if the buyer’s bank (the Issuing Bank)
fails or doesn’t pay, the Confirming Bank will make sure the seller gets paid. This type of
L/C reduces the risk of dealing with a foreign bank and gives the seller more confidence
because they are backed by a domestic bank.
Unconfirmed Irrevocable Letter of Credit:
In this type of L/C, there is only one bank involved – the Issuing Bank (the buyer’s bank).
The Advisory Bank (usually the seller’s bank) just acts as a messenger and verifies the
authenticity of the L/C but does not guarantee payment. The seller relies completely on the
buyer’s bank (the Issuing Bank) to pay them, and there’s no backup from any domestic bank
in the seller's countryThe risk here is higher for the seller because they are depending on a
foreign bank without any additional guarantee.

Revolving Letter of Credit:

A revolving Letter of Credit is used in the case of regular business transactions between the
buyer and the seller. The L/C is issued only once but remains valid for a stated period of time
for a number of transactions without issuing another L/C. The Revolving L/C can be either
revocable or irrevocable.

How does an LC work?

 The buyer's bank (issuing bank) agrees to pay the seller on a specific date
 The seller's bank (advising bank) forwards documents to the issuing bank
 The issuing bank verifies the documents and makes payment to the seller

LETTER OF UNDERSTANDING:
A Letter of Undertaking (LOU) is one of the most important monetary instruments applied in
foreign trading and credit and is signed by a bank as well as a bank client. This blog seeks to
explain clearly what LOUs are, and their use in international trade and commerce.
Understanding the Letter of Undertaking (LOU):
A letter of undertaking is a written declaration by a bank or any other financial institution that
commits on behalf of clients to meet an obligation owed to others like a foreign supplier or
beneficiary. At its basic meaning, an LOU is an assurance that an issuing bank makes on
behalf of its client’s financial commitment which is required in circumstances when such a
client defaults on payment due to failure to meet such an obligation.

Purpose of Letter of Undertaking

Facilitating International Trade:

LOU helps smooth international trade transactions and deal with international business
partners such as suppliers and buyers alike. When parties are situated in different countries
they make parties confident and trust that they are safe.

Enhancing Creditworthiness:
An LOU improves the client’s borrowing strength as it demonstrates that there is some other
financially viable entity that agrees with paying for clients’ obligations in case they fail to.
This may create better trading conditions and reduce costs.

Providing Assurance:
LOUs assure a beneficiary that his/her payment will be effected as agreed for their goods
and/or services. This forms part of the guarantee that must be done while forming strong
business ties.

USAGE OF LOU:

Import and Export Transactions:

LOUs are typically used in international exchange to facilitate the import and export of
products and services. When an importer purchases goods from a foreign provider, the
provider may additionally request an LOU from the importer’s financial institution, assuring
the dealer of charge.

Tender and Bid Bonds:

LOUs (Letters of Undertaking) are important for big projects and government contracts.
Bidders often include an LOU in their proposal to show the contracting authority that they
have the financial support needed to complete the project. It's a way to reassure the authority
that the bidder can handle the financial responsibilities of the project.

Advance Payments:
LOUs are used to guarantee the compensation of strengthened bills made to a supplier. This
reduces the hazard for the supplier.

Trade Finance:
Banks issue LOUs (Letters of Undertaking) as part of their trade finance services to help with
trade and ensure bills are paid. LOUs are often used along with other trade finance tools like
letters of credit and bills of exchange.

Infrastructure and Construction Projects:

Contractors give LOUs to project owners or government agencies as a promise to complete
projects and meet their financial obligations. It shows they are committed to fulfilling their
responsibilities

Key Components of a LOU:

1. Parties Involved. The LOU identifies the beneficiary, applicant, and issuing financial
institution.
2. Amount and Currency. The LOU specifies the assured amount and the foreign money
for the fee.
3. Expiry Date. An expiration date is certain through which the commitment within the
LOU should be acted upon.
4. Purpose. The LOU outlines the reason for the guarantee, be it for items, services, or
different economic duties.
5. Terms and Conditions. The letter contains phrases and conditions, which may
additionally consist of price phrases, interest charges, and any precise situations
agreed upon.
6. Signatures and Seals. An LOU is a legally binding file requiring the signatures and
seals of authorized representatives from each of the issuing banks and the applicant.

Risks and Challenges Associated with LOUs

1. Misuse and Fraud. Past incidents have highlighted the misuse of LOUs, mainly to
high-profile monetary scandals and elevating concerns about their credibility.
2. Foreign Exchange Risk. Exchange rate fluctuations can have an effect on the price of
gratifying an LOU, impacting pass-border transactions.
3. Compliance and Regulatory Changes. Banks must adhere to evolving regulatory
requirements, that can have an effect on LOU issuance and popularity.
4. Financial Implications. Issuing an LOU may additionally have monetary implications
for the patron, which include collateral necessities or stability renovation with the
issuing bank.