COURSE

GUIDE

BFN 301
PRACTICE OF BANKING

Course Team Dr. Abdullahi S. Araga & Mrs. Temi Olajide-Arise

(Course Developers/Writers) – NOUN
Prof. Odi Nwankwo (Course Editor) - Kogi State
University
Mrs. Olakunbi Lawal (Course Coordinator) –
NOUN
Dr. O. J. Onwe (Programme Leader) – NOUN

NATIONAL OPEN UNIVERSITY OF NIGERIA

BFN 301 COURSE GUIDE

© 2018 by NOUN Press

National Open University of Nigeria
Headquarters
University Village
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Nnamdi Azikiwe Expressway
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Lagos Office
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e-mail: [email protected]
URL: www.nou.edu.ng

All rights reserved. No part of this book may be reproduced, in any

form or by any means, without permission in writing from the publisher.

Published by National Open University of Nigeria

Printed 2018

ISBN: 978-978-8521-451-4

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BFN 301 COURSE GUIDE

CONTENT PAGE

Introduction………………………………………………… iv
What you will Learn in this Course ………………………. iv
Course Aims………………………………………………. iv
Course Objectives………………………………………… v
Working Through this Course ……………………............ v
Course Materials ……………….. …………………….… v
Study Units……………………………………………….. vi
Set Text Books …………………………………................ vii
Assignment File…………………………………………... vii
Presentation Schedule…………………………………….. vii
Assessment………………………………………………… viii
Final Examination and Grading ………………………… ix
How to get the most from this Course…………………….. ix
Tutors and Tutorials……………………………………….. x
Summary…………………………………………………… x

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BFN 301 COURSE GUIDE

INTRODUCTION

BFN 301: Practice of Banking is a three credit course for students

offering B.Sc. Banking and Finance in the School of Management
Sciences. The course consists of eighteen (18) units, that is, three (3)
modules of six (6) units for each module. The material has been
developed to suit undergraduate students in Banking and Finance at the
National Open University of Nigeria (NOUN) by using an approach that
analyzes practice of banking. A student who successfully completes the
course will surely be in a better position to handle the intricacies of
practical banking operations.

The course guide tells you briefly what the course is about, what course
materials you will be using and how you can work your way through
these materials. It suggests some general guidelines for the amount of
time you are likely to spend on each unit of the course in order to
complete it successfully. It also gives you some guidance on your tutor-
marked assignments. Detailed information on tutor-marked assignment
is found in the separate assignment file which will be available in due
course.

WHAT YOU WILL LEARN IN THIS COURSE

This course will introduce you to some fundamental aspects of financial

systems generally. It also includes: Banking Operations in Nigeria;
Types of Banking Operations in Nigeria; Banker and Customer
Relationship; Accounts of Customers; Specialize Bank Accounts of
Customers; Negotiable Instruments; Duties of Paying Banker and
Collecting Banker; Other Services offered by Banks; Relationships with
Limited Liabilities Companies: Loans and Advances; Bankruptcy;
Securities for Bankers Advances; Securities and Loan Recovery; Land
and Security; Life Policies and Shares as Collaterals; Shares Guarantees;
Debentures; Other Forms of Securities; and Guarantees for Loans and
Advances

COURSE AIMS

The course aims, among others, are to give you understanding of the
intricacies of financial systems and how to apply such knowledge in
managing financial institutions and their operations. The course will
help you to appreciate types of banks in operations in the country,
models of commercial banking after the abolition of universal banking
in the country, relationships between customers and the banks and forms
of collateral securities that can be accepted by banks for loans and
advances, among others topics.

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BFN 301 COURSE GUIDE

The aims of the course will be achieved by:

(i) Discussing Banking Operations in Nigeria;

(ii) Mentioning and Explaining Types of Banking Operations in
Nigeria;
(iii) Explaining Banker and Customer relationship;
(iv) Identifying and Discussing Accounts of Customers;
(v) Mentioning and Explaining Specialize Accounts of Customers;
(vi) Listing and Discussing Negotiable Instruments;
(vii) Listing the Duties of Paying and Collecting Bankers;
(viii) Mentioning and explaining Other Services of Banks;
(ix) Discussing Relationships with Limited Liability Companies in
relations to Loans and Advances;
(x) Discussing Bankruptcy;
(xi) Mentioning and Discussing Securities for Bank Advances;
(xii) Discussing Securities and Loan Recovery;
(xiii) Discussing Land and Security;
(xiv) Explaining Life Policies and Shares as Collaterals;
(xv) Discussing Shares Guarantees;
(xvi) Explaining Debentures;
(xvii) Mentioning and Discussing Other Forms of Securities; and
(xviii) Discussing Guarantees for Loans and Advances.

COURSE OBJECTIVES

By the end of this course, you should be able to:

(i) Discuss Banking Operations in Nigeria;

(ii) Mention and Explain Types of Banking Operations in Nigeria;
(iii) Explain Banker and Customer relationship;
(iv) Identify and Discuss Accounts of Customers;
(v) Mention and Explain Specialize Accounts of Customers;
(vi) List and Discuss Negotiable Instruments;
(vii) List the Duties of Paying and Collecting Bankers;
(viii) Mention and explain Other Services of Banks;
(ix) Discuss Relationships with Limited Liability Companies in
relations to Loans and Advances;
(x) Discuss Bankruptcy;
(xi) Mention and Discuss Securities for Bank Advances;
(xii) Discuss Securities and Loan Recovery;
(xiii) Discuss Land and Security;
(xiv) Explain Life Policies and Shares as Collaterals;
(xv) Discuss Shares Guarantees;
(xvi) Explain Debentures;
(xvii) Mention and Discuss Other Forms of Securities; and
(xviii) Discuss Guarantees for Loans and Advances.

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BFN 301 COURSE GUIDE

WORKING THROUGH THIS COURSE

To complete this course, you are required to read all study units, attempt
all the tutor marked assignments and study the principles and practice of
lending and credit administration in this material provided by the
National Open University of Nigeria (NOUN). You will also need to
undertake practical exercises for which you need access to a personal
computer. Each unit contains self-assessment exercises, and at certain
points during the course, you will be expected to submit assignments. At
the end of the course is a final examination. The course should take you
about a total of 17 weeks to complete. Below are the components of the
course, what you have to do, and how you should allocate your time to
each unit in order to complete the course successfully on time.

COURSE MATERIALS

Major components of the course are:

(i) Course Guide

(ii) Study Units
(iii) Textbooks
(iv) Assignment file

STUDY UNITS

The study units in this course are as follows:

Module 1

Unit 1: Banking Operations in Nigeria

Unit 2: Types of Banking Operations in Nigeria
Unit 3: Banker and Customer Relationship
Unit 4: Accounts of Customers
Unit 5: Specialize Bank Accounts of Customers
Unit 6: Negotiable Instruments and Cheques

Module 2

Unit 1: Bills of Exchange and Promissory Notes

Unit 2: Duties of Paying Banker and Collecting Banker
Unit 3: Bank Lending to Limited Liabilities Companies
Unit 4: Securities and Loan Recovery
Unit 5: Securities for Bankers Advances
Unit 6: Land and Security

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BFN 301 COURSE GUIDE

Module 3

Unit 1: Shares as Collateral Securities for Bank Advances

Unit 2: Negotiable and Non-negotiable Securities
Unit 3: Mortgage and Debentures
Unit 4: Produce and Goods as Securities
Unit 5: Guarantees for Loans and Advances
Unit 6: Bankruptcy

ASSIGNMENT FILE

In this course, you will find all the details of the work you must submit
to your tutor for marking. The marks you obtain for these assignments
will count towards the final mark you obtain for this course. Further
information on assignments will be found in the assignment file itself
and later in the section on assessment in this course guide. There are 18
tutor-marked assignments in this course; which you are expected to
attempt all of them.

PRESENTATION SCHEDULE

The presentation schedule included in your course materials gives you

the important dates for this year for the completion of tutor-marked
assignments (TMAs) and attending tutorials. Remember, you are
required to submit all your assignments by the due date. You should
guard against falling behind in your work.

ASSESSMENTS

There are two aspects to the assessment of the course: first is the tutor-
marked assignments; and second is a written examination. In tackling
the assignments, you are expected to apply information, knowledge and
techniques gathered during the course. The assignments must be
submitted to your tutor for formal assessment in accordance with the
deadlines stated in the Presentation Schedule and the Assignment File.
The work you submit to your tutor will count for 30% of your total
course mark. At the end of the course, you will need to sit for a final
written examination of ‘three hours’ duration. This examination will
also count for 70% of your total course mark.

TUTOR-MARKED ASSIGNMENT (TMAs)

There are fifteen tutor-marked assignments in this course and you are
advised to attempt all. Aside from the course material provided, you are
advised to read and research widely using other references (under
further reading) which will give you a broader viewpoint and may

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BFN 301 COURSE GUIDE

provide a deeper understanding of the subject. Ensure all completed

assignments are submitted on schedule before set deadlines. If for any
reasons, you cannot complete your work on time, contact your tutor
before the assignment is due to discuss the possibility of an extension.
Unless in exceptional circumstances, extensions may not be granted
after the due date for the submission of the assignments.

FINAL EXAMINATION AND GRADING

The final examination for this course will be of three-hour duration and
have a value of 70% of the total course grade. All areas of the course
will be assessed and the examination will consist of questions, which
reflect the type of self-testing, practice exercises and tutor-marked
problems you have previously encountered. All areas of the course will
be assessed. Utilise the time between the conclusion of the last study
unit and sitting for the examination to revise the entire course. You may
find it useful to review your self-assessment tests, tutor-marked
assignments and comments on them before the examination.

COURSE MARKING SCHEME

The work you submit will count for 30% of your total course mark. At
the end of the course, you will be required to sit for a final examination,
which will also count for 70% of your total mark. The table below
shows how the actual course marking is broken down.

ASSESSMENT MARKS

Assignments (TMAs): 4 assignments, best 3 will be used for the

Continuous Assessment, which will constitute a total of 30%. Final
Examination of 70% for overall course marks. Total of Continuous
Assessment and Final Examination is 100% for the Course.

14.0 ASSIGNMENT FILE

Table 1: Guide on Assignment Activity

Unit Unit Title of work Week’s activity

Assessment
1 Banking Operations in Nigeria 1
2 Types of Banking Operations in Nigeria 1
3 Bank and Customer Relationship 1
4 Accounts of Customers 1
5 Specialize Accounts of Customers 1
6 Negotiable Instruments and Cheques 1
7 Bills of Exchange and Promissory Notes 1
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BFN 301 COURSE GUIDE

8 Duties of Paying Bankers and Collecting 1

Bankers
9 Bank Lending to Limited Liabilities 1
Companies
10 Securities and Loan Recovery 1
11 Securities for Bankers Advances 1
12 Land and Security 1
13 Shares as Collateral Securities for Bank 1
Advances
14 Shares Guarantees 1
15 Debentures 1
16 Produce and Goods as Securities 1
17 Guarantees for Loans and Advances 1
18 Bankruptcy 1
Revision Total 18

TUTORS AND TUTORIALS

There are 15 hours of tutorials provided in support of this course. You

will be notified of the dates, times and location of these tutorials,
together with the names and phone numbers of your tutor, as soon as
you are allocated a tutorial group. Your tutor will mark and comment on
your assignments, keep a close watch on your progress and on any
difficulties you might encounter as they would provide assistance to you
during the course. You must submit your tutor-marked assignments to
your tutor well before the due date (at least two working days are
required). They will be marked by your tutor and returned to you as
soon as possible. Do not hesitate to contact your tutor by telephone, e-
mail, or discussion group if you need help.

The following might be circumstances in which you would find help

necessary, when you:

• do not understand any part of the study units or the assigned

readings.
• have difficulty with the self-tests or exercises.
• have a question or problem with an assignment with your tutor’s
comment on an assignment or with the grading of an assignment.

You should try your possible best to attend the tutorials. This is the only
chance to have face-to-face contact with your tutor and to ask questions
which are answered instantly.

You can raise any problem encountered in the course of your study. To
gain the maximum benefit from course tutorials, prepare a question list

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BFN 301 COURSE GUIDE

before attending them. You will learn a lot from participations in

discussions.

SUMMARY

BFN 30: Practice of Banking intends to expose the undergraduate

students to the fundamentals of banking practices, bank and customer
relationships, accounts of customers, services of various types of banks,
and securities being accepted for loans and advances. Upon completing
the course, you will be equipped with the necessary knowledge of
banking system required to produce a good research work in banking
and finance. We hope you enjoy your acquaintances with the National
Open University of Nigeria (NOUN). We wish you every success in the
future.

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 MAIN
COURSE

CONTENT PAGE

Module 1…………………………………………………. 1

Unit 1: Banking Operations in Nigeria…………………... 1

Unit 2: Types of Banking Operations in Nigeria………… 25
Unit 3: Banker and Customer Relationship…………….... 41
Unit 4: Accounts of Customers…………………………... 65
Unit 5: Specialize Bank Accounts of Customers………… 75
Unit 6: Negotiable Instruments and Cheques……………. 89

Module 2…………………………………………………. 101

Unit 1: Bills of Exchange and Promissory Notes………… 101

Unit 2: Duties of Paying Banker and Collecting Banker… 121
Unit 3: Bank Lending to Limited Liabilities Companies… 132
Unit 4: Securities and Loan Recovery……………………. 145
Unit 5: Securities for Bankers Advances…………………. 156
Unit 6: Land and Security………………………………… 162

Module 3…………………………………………………. 168

Unit 1: Shares as Collateral Securities for Bank Advances

Unit 2: Negotiable and Non-negotiable Securities………. 168
Unit 3: Mortgage and Debentures………………………… 172
Unit 4: Produce and Goods as Securities…………………. 185
Unit 5: Guarantees for Loans and Advances……………… 195
Unit 6: Bankruptcy………………………………………... 205
BFN 301 MODULE 1

MODULE 1

Unit 1 Banking Operations in Nigeria

Unit 2 Types of Banking Operations in Nigeria
Unit 3 Banker and Customer Relationship
Unit 4 Accounts of Customers
Unit 5 Specialize Bank Accounts of Customers
Unit 6 Negotiable Instruments and Cheques

UNIT 1 BANKING OPERATIONS IN NIGERIA

CONTENTS

1.0 Introduction
2.0 Objectives
3.0 Main content
3.1 Inception of Commercial Banking System in Nigerian
Economy
3.2 Establishment of Central Banking in Nigeria
3.3 Operational Positions of Banks in the Economy
3.4 Recent Consolidation in the Banking Industry
4.0 Conclusion
5.0 Summary
6.0 Tutor-marked Assignment
7.0 References/Further Reading

1.0 INTRODUCTION

The Nigerian economy like any other country around the world is
fraught with operations of various financial institutions and the most
influential ones are the various banking institutions. This is because of
their strategic role in financial intermediation side other peculiar
functions which they render to the growth and development of the
economy. In this initial study unit of the material, we shall discuss
banking institutions in the Nigerian economy.

2.0 OBJECTIVES

At the end of this study unit, you should be able to:

• discuss the historical development of commercial banks in

Nigeria
• trace the development of the Central Bank of Nigeria
• discuss the operational position of banks in the economy
• discuss the recent consolidation in the banking industry.

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BFN 301 PRACTICE OF BANKING

3.0 MAIN CONTENT

3.1 Inception of Commercial Banking System in Nigerian

Economy

In 1892 the African Banking Corporation as Nigeria's first bank was

established. Banking legislation never existed until 1952, at which point
Nigeria had three foreign banks such as the British Bank for West Africa
(BBWA), Barclays Bank, and the British and French Bank and two
indigenous banks, the National Bank of Nigeria and the African
Continental Bank with a collective total of forty branches.

A Banking Ordinance of 1952 was used to establish standards, required

reserve funds, established bank examinations, and provided for
assistance to indigenous banks.
The British colonial officials brought the West African Currency Board
into the banking scene in 1912. The Board was established to enhance
financing the export trade of foreign firms in the West African sub-
region in addition to the issuance of a West African currency convertible
to British pounds sterling. However, the colonial masters introduced
discriminating measures against the growth of financial transactions in
the country. These policies barred local investment of reserves,
discouraged deposit expansion, precluded discretion for monetary
management, and lack of deliberate measures to train Nigerians in
developing indigenous financial institutions.

In 1952 several Nigerian members of the Federal House of Assembly

called for the establishment of a central bank to facilitate economic
development. In spite of the fact that the motion was defeated, the
colonial administration appointed a Bank of England official to study
the issue. As expected the official so appointed advised against a central
bank, hinging it on his doubt whether such a bank can be effective in an
undeveloped capital market such as was the case in the country’s
economy. In 1957 the Colonial Office sponsored another study that
paved the way for the establishment of a Nigerian central bank.

In the same year (1957), the Colonial Office introduced a Nigerian

currency, the Nigerian pound which value was pegged at par with the
pound sterling until the British currency was devaluation in 1967. The
Nigerian pound was converted in 1973 to a decimal currency, the Naira
(N), equivalent to two old Nigerian pounds. The smallest unit of the new
currency was the kobo, 100 of which was equaled 1 Naira. The naira,
which exchanged for US$1.52 in January 1973 and again in March 1982
(or N0.67 = US$1), despite the floating exchange rate, depreciated
relative to the United States dollar in the 1980s. The average exchange
rate in 1990 was N8.004 = US$1. Nevertheless, depreciation of the

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BFN 301 MODULE 1

Naira accelerated after the introduction of the World Bank induced

Structural Adjustment Programme (SAP), which resulted in the
inception of a second-tier foreign exchange market in the Nigerian
economy in September 1986.

SELF-ASSESSMENT EXERCISE 1

Discuss briefly the evolution of banking in Nigeria.

3.2 Establishment of Central Banking in Nigeria

The Central Bank of Nigeria (CBN), which was established in 1957 as a

statutorily banking institution independent of the federal government
until 1968, began operations on July 1, 1959. The struggle over the
relationship between the government and the Central Bank lasted for a
decade until a 1968 military decree granted authority over banking and
monetary policy to the Federal Executive Council.

The role of the Central Bank, which was similar to that of central banks
in North America and Western Europe, hinged around operations such
as to:

i) establish the Nigerian currency;

ii) control and regulate the banking system;
iii) serve as banker to other banks in Nigeria;
iv) carry out the government's economic policy in the monetary field.

The intended economic policies to be discharged by the Central Bank of

Nigeria included:

a) controlling of bank credit growth;

b) establishing credit distribution by sector;
c) fixing cash reserve requirements for commercial banks;
d) determination of rediscount rates, that is, interest rates the Central
Bank charged commercial and merchant banks; and
e) establishing the ratio of banks' long-term assets to deposits.

It is instructive to note that any changes in Central Bank restrictions on

credit and monetary expansion affected total demand and income in the
economy. For example, in 1988, as inflation accelerated, the Central
Bank tried to restrain monetary growth.

During the civil war in the country between 1967 and 1970, the
government established limits on repatriation of dividends and profits,
reduced foreign travel allowances for Nigerian citizens, the size of
allowances to overseas public offices, required official permission for all

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BFN 301 PRACTICE OF BANKING

foreign payments, which were and later suspended. In January 1968, the
government issued new currency notes to replace those in circulation.
Although in 1970 the Central Bank advised against dismantling of
import and financial constraints too soon after the war, the oil boom
soon permitted Nigeria to relax restrictions.

In 1997, the Federal Government of Nigeria enacted the CBN

(Amendment Decree No. 3 and Banks and other Financial Institutions
[BOFI (Amended)] Decree No. 4 in 1997 to remove completely the
limited autonomy which the Bank enjoyed in its operations as the apex
bank in the banking industry since 1991. The 1997 amendments brought
the CBN back under the supervision of the Ministry of Finance. The
Decree made CBN directly responsible to the Minister of Finance with
respect to the supervision and control of bank and other financial
institutions, while extending the supervisory role of the bank to other
specialised Banks and Financial Institutions.

The amendment placed enormous powers on the Ministry of Finance

while leaving the CBN with a subjugated role in the monitoring of the
financial institutions with little room for the Bank to exercise
discretionary powers. The current legal framework within which the
CBN operates is the CBN (Amendment) Decree No. 37 of 1998 which
repealed the CBN (Amended) Decree No. 3 of 1997. The Decree
provides a measure of operational autonomy for the CBN to carry out its
traditional functions and enhances its versatility.

Furthermore, the regulatory powers of the CBN were strengthened by

the Banks and other Financial Institutions (Amendment) Decree No. 38
of 1998 which repealed BOFI (Amendments) Decree No. 4 of 1997.
Through the amendments, the CBN may vary or revoke any condition
subject to which a license was granted or may impose fresh or additional
condition to the granting of a license to transact banking business in the
country.

By the Decree, the CBN's powers on banks, specifically those relating to

withdrawal of licenses of distressed banks and appointment of
liquidators of these banks, including the NDIC was restored. The CBN
has also taken responsibility for nurturing the money and capital
markets. In furtherance of this, the CBN introduced treasury bills in
1960, treasury certificate in 1968, and facilitated the establishment of
Lagos Stock Exchange in 1961 and the capital issue committee now
known as the Securities & Exchange Committee in the early 1970s.

SELF-ASSESSMENT EXERCISE 2

Identify the role of the central bank in Nigerian economy.

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BFN 301 MODULE 1

3.3 Operational Positions of Banks in the Economy

On the basis of available records, the three largest commercial banks

(Bank of British West Africa, Barclays Bank, and the British and French
Bank) held about one-third of total bank deposits. In 1973 the federal
government undertook to acquire a 40-percent equity ownership of the
three largest foreign banks. In 1976, under the second Nigerian
Enterprises Promotion Decree requiring 60-percent indigenous holdings,
the federal government acquired an additional 20-percent holding in the
three largest foreign banks and 60-percent ownership in the other
foreign banks. Yet indigenization did not change the management,
control, and lending orientation toward international trade, particularly
of foreign companies and their Nigerian subsidiaries of foreign banks.

At the end of 1988, the banking system in the country consisted of the
following

i) Central Bank of Nigeria;

ii) Forty-two (42) commercial banks; and
iii) Twenty four (24) merchant banks,

The above scenario is an indicative of a substantial increase since 1986

at the inception of economic liberalization policy of the then military
government. The prevailing economic liberalization policy paved the
way for the following:

a) Merchant banks were allowed to open chequeing accounts for

corporations only and could not accept deposits below N50,000;
b) Commercial and merchant banks together had 1,500 branches in
1988, up from 1,000 in 1984.

In 1988 commercial banks had assets of N52.2 billion compared to

N12.6 billion for merchant banks in early 1988. In the fiscal year 1990
the government expended N503 million into establishing community
banks with the intent of encouraging the development of community
development associations, cooperative societies, farmers' groups,
patriotic unions, and trade groups, among other objectives, particularly
in rural areas.

Furthermore, there existed in the economy other banking institutions

which were mainly government-owned specialized development banks
such as:

i) Nigerian Industrial Development Bank;

ii) Nigerian Bank for Commerce and Industry;
iii) Nigerian Agricultural Bank;

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BFN 301 PRACTICE OF BANKING

iv) Federal Savings Banks; and

v) Federal Mortgage Bank.

In relation to the development banking regulation, there was an enquiry

by the then colonial administration to investigate banking practice in
Nigeria. The G. D. Paton Report which emanated from the enquiry
formed the basis for the first Banking Ordinance of 1952. The ordinance
was designed to ensure orderly commercial banking operations and to
prevent the establishment of unviable banks. A draft legislation for the
establishment of Central Bank of Nigeria was presented to the House of
Representatives in March, 1958. The Act was fully implemented on 1
July, 1959 when the Central Bank of Nigeria came into full operations;
at the twilight of the colonial administration.

The Central Bank Act, 1958 (as amended) and the Banking Decree 1969
(as amended) constituted the legal framework within which the CBN
operates and regulates banks. The wide range of economic liberalization
and deregulation measures following the adoption, in 1986, of a
Structural Adjustment Programme (SAP) resulted in the emergence of
more banks and other financial intermediaries. Decree 24 and 25 of
1991 were, therefore, enacted to strengthen and extend the powers of
CBN to cover the new institutions in order to enhance the effectiveness
of monetary policy, regulation and supervision of banks as well as non-
banking financial institutions.

SELF-ASSESSMENT EXERCISE 3

Enumerate the specialized banks that existed in the Nigerian Economy

in the past.

3.4 Recent Consolidation in the Banking Industry

There was consolidation of commercial banks in 2006, which reduced

the number of these banks operating in the country to only 25. The list
of such banks is given below (Figure 1.1).

Figure 1.1: Commercial Banks after Consolidation (as at January 1st

2006) in Nigeria
S/n Name of Bank S/N Name of Bank
1) Access Bank (14) Oceanic Bank
2) Afribank (15) Platinum Bank
3) Diamond Bank (16) Skye Bank
4) EcoBank (17) Spring Bank
5) Equitorial Trust Bank (18) Stanbic Bank
6) First City Monument Bank (19) Standard
Chartered Bank

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BFN 301 MODULE 1

7) Fidelity Bank (20) United Bank of

Africa
8) First Bank Plc (21) Sterling Bank
9) First Inland Bank (22) Union Bank
10) Guaranty Trust Bank (23) Unity Bank
11) IBTC-Chartered Bank (24) Wema Bank
12) Intercontinental Bank (25) Zenith Bank Plc.
13) Nigeria International Bank

Source: Nairaland Forum (2013). The 25 Consolidated Commercial

Banks in Nigeria (http://www.nairaland.com/5117/25-consolidated-
banks-nigeria).

There was the 2009 banking reform which also reduced the number of
commercial banks in the country, as shown below on Figure 1.2.

Figure1.2: List of Commercial Banks after 2009 Reforms in Nigeria

S/n Name of Bank S/n Name of
Bank
1) Access Bank – (acquired Intercontinental Bank) (16) Enterprise
Bank Limited*
2) Diamond Bank (formally
Spring Bank)
3) ECObank Nigeria – (acquired Oceanic Bank) (17) Keystone
Bank*
4) Fidelity Bank . (formally
Bank PHB)
5) First Bank Plc (18) Mainstreet
Bank Limited*
6) First City Monument Bank – (acquired FinBank) (formally
Afribank)
7) Guaranty Trust Bank (19) Standard
Chartered Bank**
8) IBTC-Chartered Bank (20) Citi Bank**

9) Standard Chartered Bank (21) Jaiz Bank

(Islamic bank)***
10) Sterling Bank – (acquired Equitorial Trust Bank) (22) Heritage
Bank***
11) Union Bank
12) United Bank of Africa
13) Unity Bank
14) Wema Bank
15) Zenith Bank Plc

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BFN 301 PRACTICE OF BANKING

Source: Wikipedia (2013). List of Commercial Banks in Nigeria

*Acquired by CBN after the Reforms in 2009. **Foreign banks in
Nigeria. *** Banks established in 2013

The figure above shows that there are only 18 local commercial banks,
two foreign banks and one Islamic bank after the 2009 reform in the
industry. In addition, there are two merchant banks namely FSDH
Merchant bank and Rand Merchant bank operating in the country from
January 2013.

4.0 CONCLUSION

The inception of banking institutions in Nigeria is traceable to 1892

when the African Banking Corporation was established. Banking
legislation never existed until 1952, at which point Nigeria had three
foreign banks such as the Bank of British West Africa, Barclays Bank,
and the British and French Bank and two indigenous banks, the National
Bank of Nigeria and the African Continental Bank with a collective total
of forty branches. In the subsequent developments comes the
establishment of the apex bank in the country. In the intervening period
before now, many indigenous banks sprang, While some of the first
generation banks still exist till today, so many banks came on board only
to collapse after some period of time as a result of self-inflicted
problems as well as forced consolidation.

5.0 SUMMARY

In this study unit, we discussed banks in Nigeria and in the process

analyzed the inception of commercial banking system in Nigerian
economy, establishment of central banking in Nigeria, operational
position of banks in the economy, and recent consolidation in the
banking industry. In the next study unit, we shall discuss types of
banking operations in Nigeria.

6.0 TUTOR-MARKED ASSIGNMENT

1. Trace the development of commercial and central banking in

Nigeria.
2. Identify the existing commercial banks after the 2009 banking
reform in Nigeria.

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BFN 301 MODULE 1

7.0 REFERENCES AND MATERIALS FOR FURTHER

READING

Central Bank of Nigeria (2013). History of the Central Bank of Nigeria,

retrieved from http://www.cenbank.org/AboutCBN/history.asp

History of Banking in Nigeria: 1892 – 2010, retrieved from

http://www.icr.stakescapital.com/research_int/background/nigeria
n_banking_industry.html

Prani, J. (2013). The History of Nigeria banking system. Retrieved from

http://answers.yahoo.com/question/index?qid=1006052015333

Nairaland Forum (2013). The 25 Consolidated Commercial Banks in

Nigeria. Retrieved from http://www.nairaland.com/5117/25-
consolidated-banks-nigeria

Wikipedia (2013). List of Commercial Banks in Nigeria. Retrieved from

http://en.wikipedia.org/wiki/List_of_banks_in_Nigeria;

9
BFN 301 PRACTICE OF BANKING

UNIT 2 TYPES OF BANKING OPERATIONS IN NIGERIA

CONTENTS

1.0 Introduction
2.0 Objectives
3.0 Main content
3.1 Commercial Banks
3.1.1 Regional Banking Model
3.1.2 National Banking Model
3.1.3 International Banking Model
3.2 Merchant Banks
3.2.1 Operational Guidelines for Merchant Banks
3.2.2 Minimum Standards for Merchant Banks
3.3 Development Banks
3.3.1 Bank of Industry
3.3.2 Bank of Agriculture
3.3.3 Federal Mortgage Bank of Nigeria
3.4 Non-Interest Banking
3.4.1 Categorisation and Permissible Transactions of Non-
Interest Banking
3.4.2 Establishment and Operation of an Islamic Subsidiary
Window or Branch of a Conventional Bank
3.4.3 Conduct of Business Standards
3.4.4 Prudential Requirements and Management of Risk
Exposure
3.4.5 Other Operational Regulations
3.5 Microfinance Banks
3.5.1 Categorization of Microfinance Banks
3.5.2 Ownership of Microfinance Banks
3.5.3 Participation of Existing Financial Institutions In
Microfinance Activities
4.0 Conclusion
5.0 Summary
6.0 Tutor-marked Assignment
7.0 References and Materials for Further Reading

1.0 INTRODUCTION

In the initial study unit of the material, we discussed banking operations

in the Nigerian economy. There are various types of banks that operate
in any economy and Nigeria is not an exception. Such types include
commercial banks which have been categorized into international,
national and regional banks, merchant banks that have sprang up after
the abolition of the universal banking regime, development banks,
mortgage bank, microfinance banks, and in recent time, non-interest

10
BFN 301 MODULE 1

bank which is known as Islamic banking. In this study unit, we shall

discuss all these types of banking systems.

2.0 OBJECTIVES

At the end of this unit, you should be able to:

• list and discuss three types of commercial banks in existence in

Nigeria
• mention and discuss various types of development banks in
operations in Nigeria
• discuss the peculiar functions of merchant banks
• explain the need for the establishment of microfinance banks
• discuss the rationale for the operations of Non-Islamic banking.

3.0 MAIN CONTENT

3.1 Commercial Banks

The CBN banking regulation guideline titled Regulation on the Scope of

Banking Activities and Ancillary Matters, No. 3, 2010 abolished the
universal banking regime and enumerated the following regulations for
the commercial banking operations in Nigeria.

A commercial banking license shall confer on an operator of the license,

the authority to undertake the following banking business activities and
no other:

a. Take deposits and maintain current and saving accounts form.

b. Provide retail banking services, including mortgage products.
c. Provide finance and credit facilities.
d. Deal in foreign exchange and provide foreign exchange services,
subject to the requirements of the Foreign Exchange (Monitoring
and Miscellaneous Provisions, etc.) Act Cap. F35 Laws of the
Federation of Nigeria 2004, any other law and CBN Regulations
made pursuant thereto;
e. Act as a settlement bank, subject to CBN approval;
f. Provide treasury management services including but not limited
to the provision of money market, fixed income, and foreign
exchange investment on behalf of clients, subject to the approval
of the CBN;
g. Provide custodial services;
h. Provide financial advisory services incidental to commercial
banking business which do not require regulatory filings with the
Securities and Exchange Commission such as: advising on
financing and business strategies and structures, conducting

11
BFN 301 PRACTICE OF BANKING

research and economic intelligence services, building financial

models, writing business plans, conducting private placements,
arranging loan syndications and advising on project structures;
i) Invest in non-convertible debt instruments and, subject to CBN
approval, enter into derivative transactions;
j) Undertake fixed income trading, where duly licensed to act
Undertake fixed income trading, where duly licensed to act as a
Primary Dealer/ Market Maker to trade in securities such as
Federal Government bonds, treasury bills, treasury certificates
and such other debt certificates as may be prescribed by the CBN
from time to time;
k) Provide non-interest banking services subject to CBN approval;
and
l) Such other activities as may be prescribed in writing by the CBN
from time to time.

No commercial bank shall be permitted to carry out the following

business activities:

a. Insurance underwriting;
b. Loss adjusting services;
c. Re-insurance services;
d. Asset Management services;
e. Issuing House and Capital Market underwriting services;
f. Investment in equity or hybrid-equity instruments, save and
except for the investments permissible under BOFIA;
g. Proprietary trading, save as permitted by these Regulations;
h. Provision of financial advisory other than in accordance with
provisions in Section 3(h) and (i) any other business activities
that may be restricted by the CBN from time to time

By virtue of the CBN banking regulation guideline titled "Regulation on

the Scope of Banking Activities and Ancillary Matters, No. 3, 2010"
which abolished the universal banking regime, three models of
commercial banking operations came into inception such s identified
and explained below.

3.1.1 Regional Banking Model

A Commercial Bank with regional banking authorisation shall be

entitled to carry on its banking business operations within a minimum of
six (6) and a maximum of twelve (12) contiguous States of the
Federation, lying within not more than two (2) Geo-Political Zones of
the Federation, as well as within the Federal Capital Territory.

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BFN 301 MODULE 1

A Commercial Bank authorised to conduct business on a regional basis

shall as from the date hereof, and as prescribed from time to time by the
CBN:

a) Maintain a minimum paid-up share capital of Ten Billion Naira

(N10,000,000,000.00) or such other amount as may be prescribed
by the CBN from time to time.
b) Comply with all prudential guidelines and regulations issued by
the CBN on the required level of capital adequacy, liquidity and
cash reserve.
c) Be precluded from carrying out settlement bank activities.
d) Observe all applicable corporate governance standards as may be
prescribed by the CBN and other relevant financial service sector
regulatory authorities in Nigeria.
e) Design, comply with and implement an internal control
framework and reports in accordance with the standard that the
CBN may prescribe from time to time;
f) Through its Board of Directors report on the implementation and
effectiveness of its internal control framework to the CBN within
four months after the end of its financial year;
g) design, comply with and implement a risk management
framework which ensures that the Regional Commercial Bank
has an appropriate reporting structure, quality, procedure and
technology to effectively and adequately identify, measure,
monitor and report risks to the CBN, in accordance with any
guidelines, circulars or regulations as prescribed by the CBN
from time to time.
h) Without prejudice to the standards prescribed from time to time
by the Nigerian Accounting Standards Board, be required to
maintain its books and financial statements in accordance with
the IFRS accounting standards, subject to the provisions of
Section 28 of BOFIA.

3.1.2 National Banking Model

A Commercial Bank with national banking authorisation shall be

entitled to carry on its banking business operations within every State of
the Federation.

A Commercial Bank authorised to conduct business on a national basis

shall:

a. Maintain a minimum paid-up share capital of Twenty Five

Billion Naira (N25,000,000,000.00) or such other amount as may
be prescribed by the CBN from time to time.

13
BFN 301 PRACTICE OF BANKING

b. Comply with all prudential guidelines and regulations issued by

the CBN on the required level of capital adequacy, liquidity and
cash reserve..
c. Observe all applicable corporate governance standards as
prescribed by the CBN and other financial service sector
regulatory authorities in Nigeria.
d. Design, comply with and implement an internal control
framework and reports in accordance with the standard that the
CBN may prescribe from time to time.
e. Through its Board of Directors report on the implementation and
effectiveness of its internal control framework to the CBN within
four months after the end of its financial year.
f. Design, comply with and implement a risk management
framework which ensures that the National Commercial Bank has
an appropriate reporting structure, quality, procedure and
technology to effectively and adequately identify, measure,
monitor and report risks to the CBN, in accordance with any
guidelines, circulars or regulations as prescribed by the CBN
from time to time.

And without prejudice to the standards prescribed from time to time by

the Nigerian Accounting Standards Board, be required to maintain its
books and financial statements in accordance with the IFRS accounting
standards, subject to the provisions of Section 28 of BOFIA.

The regulation resulted in the inception of the following commercial

banks as national banks:

i) Stanbic IBTC Bank Plc;

ii) Standard Chartered Bank Limited;
iii) Sterling Bank Plc;
iv) Unity Bank Plc;
v) Citi Bank Limited;
vi) Afribank Plc; and
vii) Ecobank Nigeria Plc

3.1.3 International Banking Model

A Commercial Bank with international banking authorisation shall be

entitled to carry on its banking business operations within all the States
of the Federation, as well as to establish and maintain offshore banking
operations injurisdictions of its choice, subject to the approval of the
CBN and compliance with regulatory requirements of host country.

14
BFN 301 MODULE 1

A Commercial Bank authorised to conduct business on an international

basis shall:

a. Maintain a minimum paid-up share capital of Fifty Billion Naira

(N50,000,000,000.00) or such other amount as may be prescribed
by the CBN from time to time.
b. Comply with all prudential guidelines and regulations issued by
the CBN on the required level of capital adequacy, liquidity and
cash reserve.
c. Observe all applicable corporate governance standards as
prescribed by the CBN and other financial service sector
regulatory authorities in Nigeria.
d. Design, comply with and implement an internal control
framework and reports in accordance with the standards that the
CBN may prescribe from time to time.
e. Through its Board of Directors report on the implementation and
effectiveness of its internal control framework to the CBN within
four months after the end of its financial year.
f. Be required to design, comply with and implement a risk
management framework which ensures that the International
Commercial Bank has an appropriate reporting structure, quality,
procedure and technology to effectively and adequately identify,
measure, monitor and report risks to the CBN, in accordance with
any guidelines, circulars or regulations as prescribed by the CBN
from time to time.
g. Without prejudice to the standards prescribed from time to time
by the Nigerian Accounting Standards Board, be required to
maintain its books and financial statements in accordance with
the IFRS accounting standards.

The regulation resulted in the inception of the following commercial

banks as international banks:

i) Zenith Bank Plc;

ii) Guaranty Trust Bank Plc;
iii) United Bank for Africa Plc;
iv) First Bank of Nigeria Plc;
v) Access Bank Plc;
vi) Diamond Bank Plc;
vii) Fidelity Bank Plc;
viii) Skye Bank Plc;
ix) First City Monument Bank Plc;
x) Bank PHB Plc; and
xi) Union Bank of Nigeria Plc.

15
 BFN 301 PRACTICE OF BANKING

SELF-ASSESSMENT EXERCISE 1

Mention and explain the three types of commercial banks in operation in

Nigeria.

3.2 Merchant Banks

Presently there are two merchant banks in Nigeria namely Rand

Merchant Bank and FSDH Merchant Bank; both commencing banking
operations in the year 2013.

3.2.1 Operational Guidelines for Merchant Banks

The operational guidelines for merchant banks operations in the country,

which are wholesale side of banking, according CBN regulations in
2010, include the following:

i. Take deposits from any natural or legal person, in an amount not

below the sum of [One Hundred Million Naira]
[N100,000,000.00] per tranche, or such other minimum amount
as may be prescribed by the CBN from time to time;
ii. Provide finance and credit facilities to non-retail customers;
iii. Deal in foreign exchange and provide foreign exchange services,
subject to the requirements of the Foreign Exchange (Monitoring
& Miscellaneous Provisions, etc.) Act Cap. F35 Laws of the
Federation of Nigeria 2004, or any other laws and CBN
Regulations made pursuant thereto;
iv. Act as issuing house, or otherwise manage, arrange or coordinate
the issuance of securities, for or on behalf of any person, subject
to the provisions of BOFIA;
v. Provide underwriting services with respect to equity issuance of
securities, subject to the provisions of BOFIA, and prior
notification in writing to the CBN;
vi. Provide treasury management services including the provision of
money market, fixed income, and foreign exchange investment
on behalf of clients;
vii. Provide financial, consultancy and advisory services relating to
corporate and investment matters, for a fee;

viii. Provide asset management services, including fund and portfolio

management services, act as a dealer of securities for its own
account, and for the account of Permitted Activities.

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BFN 301 MODULE 1

Merchant Banks are not permitted to carry out the following business
activities:

a) Accept any deposit withdrawable by cheques;

b) Grant retail loans or engage in any form of retail banking;
c) Hold for more than six months any equity interest acquired in a
company while managing an equity issue, subject to the provision
of BOFIA;
d) Provide Insurance underwriting services, Loss adjusting services,
Re-insurance services, and such other insurance related services;
and
e) Any other business activities that may be restricted by the CBN
from time to time.

3.2.2 Minimum Standards for Merchant Banks

A Merchant Bank shall:

i) Maintain a minimum paid-up share capital of [Fifteen Billion

Naira] [15,000,000,000.00] or such other amount as may be
prescribed by the CBN from time to time.

ii) Comply with all prudential guidelines and regulations issued by

the CBN on the required level of capital adequacy, liquidity and
cash reserve.

iii) Observe all applicable corporate governance standards as may be

prescribed by the CBN and other financial service sector
regulatory authorities in Nigeria.

iv) Design, comply with and implement an internal control

framework in accordance with the standard that the CBN may
prescribe from time to time.

v) through its Board of Directors report on the implementation and

effectiveness of its internal control framework to the CBN within
four months after the end of its financial year and the auditors of
the Merchant Bank shall be required to include a statement in the
annual Audit Report of the Merchant Bank as to the existence,
adequacy and effectiveness or otherwise of such internal control
systems.

vi) Design, comply with and implement a risk management

framework which ensures that the Merchant Bank has an
appropriate reporting structure, quality, procedure and technology
to effectively and adequately identify, measure, monitor and

17
BFN 301 PRACTICE OF BANKING

report risks to the CBN, in accordance with any guidelines,

circulars or regulations as prescribed by the CBN from time to
time.

vii) Without prejudice to the standards prescribed from time to time

by the Nigerian Accounting Standards Board, be required to
maintain its books and financial statements in accordance with
the IFRS accounting standards, subject to the provisions of
Section 28 of BOFIA.

SELF-ASSESSMENT EXERCISE 2

What are the operational guidelines for running merchant banks in the
country?

3.3 Development Banks

Development banks are the special banks that have been established by
the government to undertake special tasks of development in the
economy such as providing loanable funds for long-term and medium-
term to the various industrial undertaking undertakings in the country.
Hence they aid the expansion of the economy towards the growth and
development of the nation. The various ones in existence are for
manufacturing sector, agricultural sector, housing sector and small scale
industries industrial sector in order to boost industrialization of the
economy. The notable ones among them are identified and discussed
below.

3.3.1 Bank of Industry

This was set up to help boost the work operations of the industrial
sector, especially, to aid the firms operating in the manufacturing and
mining sectors of the economy. It makes loan available to large, medium
and small enterprises. The bank inherited the assets and liabilities of the
Nigeria Industrial Development Bank, Nigeria Bank of Commerce and
Industry, and National Economic Reconstruction Fund (NERFUND).

The Bank performs the following functions:

1. It is to provide loan in the form of long term and medium terms

or share participation;
2. It is to make fund available for re-investment by causing the
transfer of share and securities;
3. It is to sponsor and underwrite any issues and conversion of
shares and securities;
4. Guaranteeing loans and obligations;

18
BFN 301 MODULE 1

5. Furnishing managerial and technical advisor services;

6. Give out loans to finance small and medium term investments;
7. Lease out equipment to the customers;
8. Give financial advice to their clients
9. Help to promote industrial projects
10. Promoting and developing viable projects f0r investment
11. It is to give consultancy services through financial and technical
advices.
12. It is to support the implementation of projects financed by the
bank
13. It fosters the development of capital markets in Nigeria, by
encouraging prospective borrowers to be listed on the stock
exchange.

3.3.2 Bank of Agriculture

The bank took over the assets and liabilities of the defunct Nigerian
Agricultural, Cooperative and Rural Development Bank. In general
terms, the bank has been established to make loan available to existing
and prospective farmers that are willing to farm and have their landed
property but do not have the financial power to buy crops, fertilizers and
farm machines to produce in large quantity.

This loan facility for agricultural undertakings usually last for a

minimum of five to fifteen years. The statutory functions of this bank,
among others, include the following:

1. Grant loans for agricultural productions and storage distribution

and marketing of agricultural products.
2. Granting direct loans to individual farmers and corporative
societies or other bodies provided the projects are viable and
there is an adequate security.
3. It engages in other activities to promote agricultural productions.
4. It helps to boost food supply in the economy and provide safety
to the storage of farm produce.

3.3.3 Federal Mortgage Bank of Nigeria

This development bank has been established to take care of development

of the housing sector of the economy. The statutory functions of this
bank, among others, which include the following.

1. Provision of long term credit facilities to mortgage Institutions.

2. Encouragement and promotions of development of mortgage
institutions at state and local level.

19
BFN 301 PRACTICE OF BANKING

3. Supervision and control of the activities of mortgage institutions

in Nigeria.
4. Carrying out research on mortgage finance activities and housing
patterns and standard of offering financial advice to companies
engaged in building and materials selling.
5. It is saddled with the responsibility of controlling primary
mortgage institutions.
6. It is to raise the necessary fund through acceptance of savings and
deposit from the public and investing society.
7. Promotion of housing fund through payments of interest rate.
8. Granting of loans and advances for the purpose of constructing
dwelling places.
9. Looking after of old houses and seeing to their repairs of existing
houses.
10. This supervises other building societies

SELF-ASSESSMENT EXERCISE 3

List the types of development banks operating in the country. What are
their respective functions?

3.4 Non-Interest Banking

The Islamic banking or non-interest banking operations (e.g. Jaiz

International) in Nigeria are carried out under the CBN guidelines,
which are being adhered to by those corporate entities that engage in this
type of banking genre.

3.4.1 Categorisation and Permissible Transactions of Non-Interest

Banking

Non-interest banking and finance models are broadly categorized into

two:

1. Non-interest banking and finance based on Islamic commercial

jurisprudence; and
2. Non-interest banking and finance based on any other established
non-interest principle.

Islamic banking as one of the models of non-interest banking, serves the

same purpose of providing financial services as do conventional
financial institutions save that it operates in accordance with principles
and rules of Islamic commercial jurisprudence that generally recognizes
profit and loss sharing and the prohibition of interest, as a model.

20
BFN 301 MODULE 1

There are other non- permissible transactions which include those

involving any of the following considerations:

i) uncertainty or ambiguity relating to the subject matter, terms or

conditions;
ii) gambling;
iii) speculation;
iv) unjust enrichment;
v) exploitation/unfair trade practices;
vi) dealings in pork, alcohol, arms & ammunition, pornography; and
vii) other transactions, products, goods or services which are not
compliant with the rules and principles of Islamic commercial
jurisprudence.

SELF-ASSESSMENT EXERCISE

Explain the term Islamic banking. Mention the areas of non- permissible
transactions under Islamic banking operations.

All the operational guidelines for the establishment and running of

Islamic banks are based the:

i) Non-Interest banking regime under Section 33 (1) (b) of the CBN

Act 2007;
ii) Sections 23(1) 52; 55(2); 59(1)(a); 61 of Banks and Other
Financial Institutions Act (BOFIA) 1991 (as amended) and
Section 4(1)(c) of the Regulation on the Scope of Banking
Activities and Ancillary Matters, No. 3, 2010’ and
iii) It shall be read together with the provisions of other relevant
sections of BOFIA 1991 (as amended), the CBN Act 2007,
Companies and Allied Matters Act (CAMA) 1990 (as amended)
and circulars/guidelines issued by the CBN from time to time.

3.4.2 Establishment and Operation of an Islamic Subsidiary

Window or Branch of a Conventional Bank

The regulations for Establishment and Operation of an Islamic

Subsidiary Window or Branch of a Conventional Bank are as follows:

1. Conventional banks and other financial institutions operating in

Nigeria may offer or sell products and services in line with the
principles under this model through subsidiaries, windows or
branches only.

21
BFN 301 PRACTICE OF BANKING

2. An Islamic subsidiary of a conventional bank or financial

institution shall be established in line with the licensing
requirements for the establishment of a full fledged non-interest
financial institution.

3. An Islamic window or branch of a conventional bank or financial

institution shall be established and operated in line with the
guidelines on windows/branches issued by the CBN.

4. CBN Advisory Council of Experts.

There shall be an advisory body to be called CBN Advisory Council of

Experts (ACE) to advise the CBN on matters relating to the effective
regulation and supervision of IIFS in Nigeria. The qualification, duties,
responsibilities etc of members of the Council are contained in
guidelines to be issued by the CBN.

3.4.3 Conduct of Business Standards

1. Branding

Branding is in line with the provisions of Section 39 (1) of BOFIA 1991

(as amended), the registered or licensed name of an Islamic bank shall
not include the word "Islamic", except with the consent of the Governor
of the CBN. Islamic bank shall, however, be recognized by a uniform
symbol designed by the CBN. All the signages and promotional
materials of Islamic bank shall bear this symbol to facilitate recognition
by customers and the general public.

2. Approval of Contracts, Products and Services

All contracts, products and services offered or proposed to be offered by

Islamic bank shall be reviewed and approved by each institution's ACE.
The introduction of new products/services shall require the prior written
approval of the CBN.

3. Product Literature

An Islamic bank shall state in its product literature/marketing materials

the ACE (indicating names of all the members) that certified the product
or services being offered.

4. Profit Sharing Investment Accounts

i) An Islamic bank shall ensure that relevant disclosures are made

to Profit Sharing Investment Accounts (PSIA) holders in a timely

22
BFN 301 MODULE 1

and effective manner and also ensure the proper implementation

of investment contracts.

ii) An Islamic bank shall inform its prospective PSIA client(s)

operating under profit-sharing, loss-bearing contracts, in writing
that the risk of loss rests with the client(s) and that the institution
will not share in the loss unless there is proven negligence or
misconduct for which the institution is responsible.

iii) Islamic bank with PSIAs may maintain a Profit Equalization

Reserve (PER) which would serve as an income smoothing
mechanism and risk mitigation tool to hedge against volatility of
returns to investment account holders. They may also maintain an
Investment Risk Reserve (IRR) to cushion against future losses
for PSIA holders.

iv) The basis for computing the amounts to be appropriated to the

PER and IRR should be pre-defined and disclosed.

5. Audit, Accounting and Disclosure Requirements

i) All Islamic bank shall comply with relevant provisions of the

circular issued by the CBN on disclosure requirement by
financial institutions and other disclosure requirements contained
in CAMA 1990 (amended) and BOFIA 1991 (as amended).

ii) In addition, they shall comply with the relevant standards on

disclosure issued by standards-setting organisations including:
Accounting and Auditing Organisation for Islamic Financial
Institutions (AAOIFI); Islamic Financial Services Board (IFSB);
and Nigerian Accounting Standards Board (NASB).

iii) All Islamic banks shall comply with the requirements of section
29 of BOFIA 1991 (as amended) and applicable
guidelines/directives issued by the CBN as well as the relevant
provisions of CAMA 1990 (as amended) regarding the
appointment, re-appointment, resignation, rotation, change and
removal of auditors.

iv) All Islamic banks shall comply with the Generally Accepted
Accounting Principles (GAAP) codified in local standards issued
by the NASB and the International Financial Reporting Standards
(IFRS)/International Accounting Standards (IAS). For
transactions, products and activities not covered by these
standards, the relevant provisions of the financial accounting and
auditing standards issued by the AAOIFI shall apply.

23
BFN 301 PRACTICE OF BANKING

v) Where there is a conflict between the local and international

standards, the provisions of the local standard(s) issued by NASB
shall apply to the extent of the inconsistency. All Islamic banks
shall have an internal review and audit mechanism to examine
and evaluate on periodic basis the extent of compliance with the
rules and principles pertinent to this model.

3.4.4 Prudential Requirements and Management of Risk Exposure

1. Minimum Capital Adequacy Ratio

All Islamic banks shall maintain a minimum Capital Adequacy Ratio

(CAR) as may be prescribed by the CBN from time to time. The
minimum Capital Adequacy Ratio (CAR) for Islamic banks shall be
consistent with the prevailing CAR as may be prescribed for
conventional banks and financial institutions by the CBN from time to
time.

2. Liquidity Management

i) All Islamic banks are required to put in place appropriate

policies, strategies and procedures which ensure that they
maintain adequate liquidity at all times to fund their operations.

ii) Islamic banks shall not invest their funds in interest-bearing

securities or activities. They are required to invest their funds in
eligible instruments for the purpose of meeting the CBN
prescribed minimum liquidity ratio. Liquid assets shall be held in
line with the provision of section 15 of BOFIA 1991 (as
amended), provided they comply with the principles under this
model.

iii) All Islamic banks are expected to comply with other prudential
requirements on exposure and concentration limits as may be
prescribed by the CBN from time to time and standards of best
practices.

iv) All Islamic banks are required to put in place appropriate

policies, systems and procedures to identify, measure, monitor
and control their risk exposures. In addition, they are required to
put in place a risk management system that recognizes the unique
risks faced by Islamic banks such as displaced commercial,
fiduciary, transparency, reputational, equity investment and rate
of return risks.

24
BFN 301 MODULE 1

iv) Further details and guidance are provided in documents issued by

the CBN and international standard setting organizations
including:

a) CBN Prudential Guidelines;

b) Risk Management Guidelines issued by the Basel
Committee on Banking Supervision; and
c) IFSB Guiding Principles of Risk Management for
Institutions Offering only Islamic Financial Services.

3.4.5 Other Operational Regulations

1. Cross-Selling of Products/Services and Shared Facilities

The Islamic subsidiaries, windows or branches may operate using the

existing facilities or branch network of the conventional bank. The
subsidiary, window or branch shall however, not sell products/services
that do not comply with the principles under this model.

2. Execution of Service Level Agreements in Respect of Shared

Services

Conventional banks or other financial institutions with Islamic

subsidiaries, branches or windows shall execute Service Level
Agreements (SLA) in respect of shared services with their subsidiaries,
branches or windows.

3. Intra-Group Transactions and Exposures

All transactions and exposures between an Islamic subsidiary, window

or branch of a financial institution and the parent shall be in accordance
with the principles and practices under this model.

SELF-ASSESSMENT EXERCISE 4

Discuss the term Non-Interest banking.

List the types of transactions that they can undertake in Nigeria.

3.5 Microfinance Banks

3.5.1 Categorization of Microfinance Banks

The National Microfinance Policy Framework for Nigeria of July 12th

2011 provides the following categorization of Microfinance Banks in the
country.

25
BFN 301 PRACTICE OF BANKING

Category 1: Unit Microfinance Bank

A Unit Microfinance Bank is authorized to operate in one location. It

shall be required to have a minimum paid up capital of N20 million
(twenty million Naira) and is prohibited from having branches and cash
centres.

Category 2: State Microfinance Bank

A State Microfinance Bank is authorized to operate in one State or the

Federal Capital Territory (FCT). It shall be required to have a minimum
paid up capital of N100 million (one hundred million Naira) and is
allowed to open branches within the same State or the FCT, subject to
prior written approval by the CBN for each new branch.

Category 3: National Microfinance Bank

A National Microfinance Bank is authorized to operate in more than one

State including the FCT. It shall be required to have a minimum paid up
capital of N2 billion (two billion Naira), and is allowed to open branches
in all States of the Federation and the FCT, subject to prior written
approval by the CBN.

There are steps involved in Transformation Path of microfinance banks

such as follows.
i. A Unit MFB that intends to transform to a State MFB shall be
required to surrender its license and obtain a State MFB license, subject
to fulfilling stipulated requirements.

ii. A State MFB that intends to transform to a National MFB must have
at least 5 branches which are spread across the Local Government Areas
in the State. This is to ensure that the MFB has gained experience
necessary to manage a National MFB. It shall also be required to
surrender its license and fulfill other stipulated requirements.

3.5.2 Ownership of Microfinance Banks

i. Microfinance Banks can be established by individuals, groups of

individuals, community development associations, private
corporate entities, NGO-MFIs, or foreign investors.

ii. No individual, group of individuals, their proxies or corporate

entities, and/or their subsidiaries, shall own controlling interest in
more than one MFB, except as approved by the Central Bank of
Nigeria.

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BFN 301 MODULE 1

3.5.3 Participation of Existing Financial Institutions in

Microfinance Activities

1. Deposit Money Banks:

Deposit Money Bank (DMB) wishing to engage in microfinance

services can continue to do so through a designated Department/Unit
and/or offer microfinance as a financial product. Nothing prevents the
Holding Company having a DMB as a subsidiary from investing in or
owning an MFB.

2. Non-Governmental Organization-Micro Finance Institutions

(NGO-MFIs):

This policy recognizes the existence of credit-only, membership-based

microfinance institutions, which are not required to come under the
regulatory and supervisory purview of the CBN. They are however
supervised by the appropriate Ministry. Such institutions shall engage in
the provision of microcredit to their targeted population but shall not
mobilize deposits from the general public.
The registered NGO-MFIs shall be required to forward periodic returns
on their activities to the CBN primarily for statistical purposes. NGO-
MFIs wishing to obtain operating licenses as Microfinance Banks shall
be required to meet the stipulated provisions in the Regulatory and
Supervisory Guidelines for MFBs in Nigeria.

3. Transformation of the Existing NGO-MFIs and Financial

Cooperatives:

An existing NGO-MFI or Financial Cooperative which intend to operate

as MFB can either incorporate a subsidiary MFB while still carrying out
its NGO operations or transform to a MFB. Such institutions must
obtain operating licence and shall be required to meet the stipulated
provisions in the revised Regulatory and Supervisory Guidelines for
MFBs.

SELF-ASSESSMENT EXERCISE 5

i. Discuss the term microfinance bank.

ii. What are the peculiar functions of the microfinance banks?

4.0 SUMMARY

There are many types of banks that are in operation in Nigerian

economy. We have seen from the discussion that such banks include:
commercial banks that have just come out of universal banking regime,

27
BFN 301 PRACTICE OF BANKING

thus necessitating the establishment of some merchant banks;

development banks established by the government to take care of
development of the economy in various sectors. In other countries of the
world, the non-interest banks are called Islamic banks, which imply that
the non-interest banks in Nigeria are simply Islamic banks.

5.0 CONCLUSION

In the course of analysis in this study unit, we discussed types of bank

operating in Nigeria. In the course of the discussion, we espoused on
banking genres such as: Commercial banks; merchant banks;
Development Banks (Bank of Industry, Bank of Agriculture, Federal
Mortgage Bank of Nigeria); Commercial banks; merchant banks;
Development Banks (Bank of Industry, Bank of Agriculture, Federal
Mortgage Bank of Nigeria); Non-Interest Banking; and Microfinance
Banks. In the next study unit, we shall discuss banker and customer
relationship.

6.0 TUTOR-MARKED ASSIGNMENT

1. Mention and discuss the various types of banks that operate in the
Nigerian economy.
2. Explain Non-Interest banking. What are the areas of difference
between this type of bank and commercial banks?

7.0 REFERENCES AND MATERIALS FOR FURTHER

READING

Central Bank of Nigeria (2013). History of the Central Bank of Nigeria,

retrieved from http://www.cenbank.org/AboutCBN/history.asp

History of Banking in Nigeria: 1892 – 2010, retrieved from

http://www.icr.stakescapital.com/research_int/background/nigeria
n_banking_industry.html

Prani, J. (2013). The History of Nigeria banking system. Retrieved from

http://answers.yahoo.com/question/index?qid=1006052015333

Nairaland Forum (2013). The 25 Consolidated Commercial Banks in

Nigeria. Retrieved from http://www.nairaland.com/5117/25-
consolidated-banks-nigeria

Shekhar, K.C. & Shekhar, L. (2007). Banking Theory and Practice, (19th
ed.). New Delhi: Vikas Publishing House PVT Ltd.

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BFN 301 MODULE 1

UNIT 3 BANKER AND CUSTOMER RELATIONSHIP

CONTENTS

1.0 Introduction
2.0 Objectives
3.0 Main content
3.1 Nature of Banker-Customer Relationship
3.2 Meaning of a Banker and a Customer
3.2.1 Who is a Banker?
3.2.2 Who is a Customer?
3.3 Relationship between a Banker and a Customer
3.4 Important Areas of Banker-Customer Relationship
4.0 Conclusion
5.0 Summary
6.0 Tutor-marked Assignment
7.0 References/Further Reading

1.0 INTRODUCTION

There exists a peculiar relationship between the banks and their

customers. This relationship has been described in various ways. The
various views on such relationship is indicative of the fact that banks
cannot exist without customers and customers cannot transact banking
business without banking institutions. This makes this relationship a
mutual one and very beneficial to both parties. Therefore, in this initial
study unit of the material, we shall discuss banker and customer
relationship.

2.0 OBJECTIVES

At the end of this study unit, you should be able to:

• discuss the nature of relationship of banker and customer

• differentiate between a Banker and a Customer
• discuss the relationship between a banker and customer
• identify important areas of banker-customer relationship.

3.0 MAIN CONTENT

3.1 Nature of Banker-Customer Relationship

Banker customer relationship is contractual in which a person entrusts

valuable items with another person with an intention that such items
shall be retrieved on demand from the keeper by the person who so
entrusts.

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BFN 301 PRACTICE OF BANKING

This implies that the banker is the one who is entrusted with monetary
items and other valuables, which the person who so entrusts such items,
called customer, wishes to retrieve them on demand in course of dealing
with the banker.

Since the relationship is on contractual basis, it is hinged on certain

terms and conditions. For instance, the customer has the right to collect
his deposit such as money on demand personally or through his proxy.
Thus the banker too is under obligation to pay so long the proxy is duly
authorized by the customer. Somehow, the relationship has some
trappings of creditor /debtor relationship. Thus the customer is the
creditor who has the right of demand on the monetary value in account
from the banker.

The banker is invariably indebted to the customer as long as the banker

is keeping the customer’s monetary value and other valuable items. The
relationship is also fiducial, and therefore, the banker is duty bound not
to leak the terms and conditions governing the relationship to a third
party, particularly without customer’s knowledge and consent. In related
terms, the items being kept with the banker should not be released to a
third party without due authorization by the customer.
Fundamentally, the relationship between a banker and customer comes
into existence when the banker agrees to open an account in the
name of the customer. The relationship between bank and customer is
based on simple contract, which takes effect from the moment a
transaction is initiated by the customer and the banker accepts to keep
account for the customer (Patel, 2012).

SELF-ASSESSMENT EXERCISE 1

Discuss briefly the nature of banker-customer relationship.

3.2 Meaning of a Banker and a Customer

3.2.1 Who Is a Banker?

In terms of popular definition, Herbet L. Hart posits that:

A banker or a bank is a person or a company carrying on the business

of receiving money, and collecting drafts, for customers, subject to the
obligation of honouring cheques drawn upon them from time to time
by the customers to the extent of the amounts available on their current
accounts.

According to this definition, the essential function of a banker is the

acceptance of deposits of funds withdrawable on demand. Sir John Paget

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BFN 301 MODULE 1

states that no one can be a banker who does not take deposit accounts,
take current accounts, issue and pay cheques, crossed and uncrossed, for
customers. He further adds that if the banking business carried on by any
person is subsidiary to some other business, then such a person cannot
be regarded as a banker.

Section 3 of the Negotiable Instruments Act of 1881, which corresponds

with Section 2 of the Bills of Exchange Act of 1882, it states that the
term 'banker' includes persons, or a corporation, or a company acting as
bankers. According to the Banking Company Ordinance 1962,
banking has been defined as accepting for the purpose of
lending or investment of deposits of money from public
repayable o n d e m a n d o r o t h e r w i s e a n d w i t h d r a w a l s b y
c h e q u e s , draft or order.

Under Section 5(1) of the Banking Regulation Act, 1949, a banking

company is defined as "any company which transacts the business of
'banking'." Under Section 5(1)(b) 'banking' means accepting for the
purpose of lending or investment, deposits of money from the public,
repayable on demand or otherwise, and withdrawable by cheque, draft,
order or otherwise.

3.2.2 Who Is a Customer?

In simple terms, a customer is such a person to whom the bank extends

its services in return for consideration. In broad terms, 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. In
other words, the customer is a person who maintains a regular account
with the bank without taking into consideration the duration and
frequency of operation of his account.

In order to qualifier as a customer of any bank the individual should

have an account with the bank. The individual should deal with the bank
in its nature of regular banking business. He should deal with the bank
without consideration of the duration and frequency of operation of his
account. The relationship between banker and customer is of utmost
importance.

The legal decisions on the matter are very valuable herein. Thus in
Great Western Railway Company Vs. London and County Banking
Company, a customer was defined as a person who has some sort of an
account, either deposit or current account, or some similar relation with
a banker. It implies that any person or corporate body may become a
customer by opening a deposit account or current account, or by
negotiating art advance on current or loan account.

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BFN 301 PRACTICE OF BANKING

According to Sir John Paget, to constitute a customer there must be

some recognizable course or habit of dealing in the nature of regular
banking business.

As far as the condition that the transaction should be the nature of

regular banking business is concerned there is unanimity. A casual
transaction like encashment of a cheque cannot be considered to
constitute a person as a customer of a bank. But it is difficult to
reconcile with the idea of Sir John Paget when he states that, there must
be some recognizable course or habit of dealing in order to constitute a
person as a customer of a bank. According to this view, a single
transaction will not constitute a customer.

A more acceptable view on definition of customer of a bank was

expressed in Ladbrok Vs Todd. According to the Learned Judge:

The relation of banker and customer begins as soon as the first cheque
is paid in and accepted for collection. It is no necessary that the person
should have drawn on any money or even that he should be in position
draw any money.

Therefore, neither the number of transactions nor the period during

which business has been conducted between the parties is material in
determining whether or not a person is a customer.

The same view was expressed in the case of Commissioners of Taxation

Vs English, Scottish and Australian Bank Ltd. The Learned Judge
observed:

The word 'customer' signifies a relationship in which duration is not of

essence. A person whose money has been accepted by the bank on the
footing that they undertake to honour cheques up to the amount standing
to his credit is a customer of the bank in the sense of the statute
irrespective of whether his connection is of long or short standing. The
contrast is not between a habitual and a newcomer but between a person
for whom the bank performs a casual service, e.g., cashing a cheque for
a person introduced by one of their customers, and a person who has an
account
of his own at the bank.

Hence mere opening of an account will constitute a person as a customer

of a bank, irrespective of whether the connection is of long or short
standing over a period of time.

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BFN 301 MODULE 1

SELF-ASSESSMENT EXERCISE 2

i. Differentiate between a banker and a customer.

ii. What constitutes a “customer” of a bank?

3.3 Relationship between a Banker and a Customer

In terms of the nature of relationship that exists between a banker and

customer, John Paget holds that “The relation of a banker and a
customer is primarily that of debtor and creditor the respective position
been determined by the existing state of the account.” The customer
becomes a creditor and the banker becomes debtor when money is
deposited in the bank account. The relationship becomes opposite when
a customer becomes debtor and bank becomes creditor at the instance
when loan is advanced.

When a customer deposits money in a bank the relationship of debtor

and creditor is established. When a customer pays in money to the credit
of his account, the banker becomes the debtor and when a bank grants
loan or other credit facilities to the customer, relationship is reversed
when a customer becomes the creditor by depositing funds in his
account, but when the banker makes a loan to a customer the position is
reversed, as the customer is then the debtor and the banker the creditor.

The money which a banker receives from a customer is at the free

disposal of the banker; he may preserve it in his till, invest it in some
security, or lend it out to another customer; but the customer retains the
right to demand back a similar amount, or to draw cheques upon the
banker up to that sum, the cheques being payable either to the customer
himself or to some other person. The customer may also accept bills and
arrange with the banker that they be charged to his account at maturity,
or he may, in certain cases, make arrangements for the banker to accept
bills on his behalf.

In order to constitute for a person to constitute a customer, Lord Davey

held posited in Great Western Railway v. London and County Banking;
Co. (1901, A.C. 414) that: " I think there must be some sort of account,
either a deposit or a current account or some similar relation." When
money has lain dormant with a banker for six years, the Statute of
Limitations no doubt applies, as in an ordinary case of debtor and
creditor, but a banker never takes advantage of the statute, and is always
ready to repay the money upon the demand of the customer or of his
legal representatives. (See Statute Of Limitations, Unclaimed balances)

If a customer leaves with his banker a parcel of securities for safe

custody, the banker's position is that of a bailee, and his liability depends

33
BFN 301 PRACTICE OF BANKING

to a certain extent, upon whether he undertakes the duty gratuitously or

for reward. The difference between a banker as a debtor to his customer
and as a bailee may be explained with illustration as follows: Ahmadu
Bello pays in N200,000 to the credit of his account, the banker becomes
Bello's debtor and is liable to repay to Bello on demand, but until the
demand is made the banker can do what he desires with the money, and
nevertheless, the N200,000 which is ultimately repaid to Bello is not,
of course, the same money that was originally handed to the bank by
Bello (example does not adequately portray bailee).

3.4 Important Areas of Banker-Customer Relationship

According to Akrani, G. (2012), the relationship between banker and

customer is mainly that of a debtor and creditor. However, they also
share other relationships. The banker-customer relationship is that of a:
Debtor and Creditor; Pledger and Pledgee; Licensor and Licensee;
Bailor and Bailee; Hypothecator and Hypothecatee, Trustee and
Beneficiary; Agent and Principal; and Advisor and Client, among other
miscellaneous relationships. Discussed below are important banker-
customer relationships.

1. Relationship of Debtor and Creditor

When a customer opens an account with a bank and if the account has a
credit balance, then the relationship is that of debtor (banker / bank) and
creditor (customer).

In case of savings / fixed deposit / current account (with credit balance),

the banker is the debtor, and the customer is the creditor. This is because
the banker owes money to the customer. The customer has the right to
demand back his money whenever he wants it from the banker, and the
banker must repay the balance to the customer.

In case of loan / advance accounts, (the) banker is the creditor, and the
customer is the debtor because the customer owes money to the banker.
The banker can demand the repayment of loan/advance on the due date,
and the customer has to repay the debt. A customer remains a creditor
until there is credit balance in his account with the banker. A customer
(creditor) does not get any charge over the assets of the banker (debtor).
The customer's status is that of an unsecured creditor of the banker.
The debtor-creditor relationship of banker and customer differs from
other commercial debts in the following ways:

34
BFN 301 MODULE 1

a) The creditor (the customer) must demand payment

On his own, the debtor (banker) will not repay the debt. However, in
case of fixed deposits, the bank must inform a customer about maturity.

b) The creditor must demand the payment at the right time and
place

The depositor or creditor must demand the payment at the branch of the
bank, where he has opened the account. However, today, some banks
allow payment at all their branches and ATM centres. The depositor
must demand the payment at the right time (during the working hours)
and on the date of maturity in the case of fixed deposits. Today, banks
also allow pre-mature withdrawals.

c) The creditor must make the demand for payment in a proper

manner

The demand must be in form of cheques; withdrawal slips, or pay order.

Now-a-days, banks allow e-banking, ATM, mobile-banking, etc.

2. Relationship of Pledger and Pledgee

The relationship between customer and banker can be that of Pledger

and Pledgee. This happens when customer pledges (promises) certain
assets or security with the bank in order to get a loan. In this case, the
customer becomes the Pledger, and the bank becomes the Pledgee.
Under this agreement, the assets or security will remain with the bank
until (the) customer repays the loan.

3. Relationship of Licensor and Licensee

The relationship between banker and customer can be that of a Licensor

and Licensee. This happens when the banker gives a sale deposit locker
to the customer. So, the banker will become the Licensor, and the
customer will become the Licensee.

4. Relationship of Bailor and Bailee

The relationship between banker and customer can be that of Bailor and
Bailee.

i. Bailment is a contract for delivering goods by one party to

another to be held in trust for a specific period and returned when
the purpose is ended.
ii. Bailor is the party that delivers property to another.

35
BFN 301 PRACTICE OF BANKING

iii. Bailee is the party to whom the property is delivered.

Therefore, when a customer gives a sealed box to the bank for safe
keeping, the customer became the bailor, and the bank became the
bailee.

5. Relationship of Hypothecator and Hypothecatee

The relationship between customer and banker can be that of

Hypothecator and Hypothe(c)atee. This happens when the customer
hypothecates (pledges) certain movable or non-movable property or
assets with the banker in order to get a loan. In this case, the customer
became (becomes) the Hypothecator, and the Banker became (becomes)
the Hypothecatee. [Not Clear]

Hypothecation is not to be confused with pledge because unlike pledge

(where both the property in and possession of the goods are transferred
to the lender), the goods hypothecated are accepted by the banker
(hypothecatee) as security for the debt of the customer (hypothecator)
but the banker does not retain the property in the goods nor possession
of the goods. A written letter of acknowledgement by the customer is
therefore needed to avow that the customer is holding the goods for the
banker as bailee. Notwithstanding, the bank still depend on the
credibility of the customer.

6. Relationship of Trustee and Beneficiary

A trustee holds property for the beneficiary, and the profit earned from
this property belongs to the beneficiary. If the customer deposits
securities or valuables with the banker for safe custody, banker becomes
a trustee of his customer. The customer is the beneficiary so the
ownership remains with the customer. (Not good enough)

[A customer (trustee) may entrust a security or valuables with a bank for

the purpose of safekeeping usually for the benefit of the customer or a
third-party (beneficiary). The banker in this case is the trustee and the
customer or third-party is the beneficiary]

7. Relationship of Agent and Principal

The banker acts as an agent of the customer (principal) by providing the

following agency services:

i. Buying and selling securities on his behalf,

ii. Collection of cheques, dividends, bills or promissory notes on his
behalf, and

36
BFN 301 MODULE 1

iii. Acting as a trustee, attorney, executor, correspondent or

representative of a customer.

Banker as an agent performs many other functions such as payment of

insurance premium, electricity and gas bills, handling tax problems, etc.

8. Relationship of Advisor and Client

When a customer invests in securities the banker acts as an advisor. The

advice can be given officially or unofficially. While giving advice the
banker has to take maximum care and caution. Here, the banker is an
Advisor, and the customer is a Client.
[A customer may approach the bank for financial or investment advice
or opinion whether officially or unofficially, the banker here becomes
the advisor and the customer, the client. Caution must be taken however
to not give negligent investment advice even to a person who is yet to be
a customer as a wrong advice may result in an action of damages against
the bank and it will stand as in the case of Woods vs Martins Bank
Limited (1958)]

Miscellaneous banker-customer relationships include the following:

a) Obligation to honour cheques

In as much as there is sufficient balance in the account of the customer,

the banker must honour all his cheques. The cheques must be complete
and in proper order. They must be presented within six months from the
date of issue. However, the banker can refuse to honour the cheques
only in certain cases.

b) Secrecy of Customer's Account

When a customer opens an account in a bank, the banker must not give
information about the customer's account to others [without the implied
or express permission of the customer unless in some few exceptional
cases which will be discussed later].

c) Banker's right to claim incidental charges

A banker has a right to charge a commission, interest or other charges

for the various services given by him to the customer. For e.g. an
overdraft facility.

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BFN 301 PRACTICE OF BANKING

d) Law of limitation on bank deposits

Under the law of limitation, generally, a customer gives up the right to

recover the amount due at a banker if he has not operated his account
since last 10 years.

SELF-ASSESSMENT EXERCISE 3

List and explain the important areas of banker-customer relationship.

3.5 Special Features of the Relationship

1. Appropriation of Payments

When money is paid in by the customer, or when the banker receives

money from third parties for credit to the customer. The customer has a
right to say that it should be placed to a particular account, or should be
applied in payment of a particular debt or in meeting certain cheques or
bills. The banker is bound to appropriate it accordingly, irrespective of
the state of accounts between them. But if the customer does not make
any specific appropriation, the banker can appropriate, and apply the
payment even to a statute-barred debt. When the method of
appropriation is communicated to the customer, it becomes irrevocable.

In case there is a current account, and neither the banker nor the
customer makes any specific appropriation, then any successive
payments will be appropriated in accordance with the Rule in Clayton's
Case. According to this Rule, it is the first sum paid in that is first paid
out. Thus, it is the first item on the debit side that is discharged or
reduced by the first item on the credit side. It should be noted that the
Rule applies only to a current or running account.

2. Banker's Right of Set-Off

As far as the banker's right of set-off is concerned, there is a conflict of

judicial opinions. In Garnett Vs Mckervan, it was held that in the
absence of a special agreement to the contrary, a banker might set-off a
customer's credit balance against a debt due to him from the customer,
and that there was no legal obligation on a bank to give notice to a
customer about its intention to combine accounts.
Nevertheless, in Greenhalgh and Sons vs Union Bank of Manchester,
the Learned Judge observed: “If the banker agrees with his customer to
open two accounts or more; he has not in my opinion, without the assent
of the customer, any right to move either assets or liabilities from one
account to the other; the very basis of his agreement with his customer is
that the two accounts shall be kept separate".
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BFN 301 MODULE 1

In view of these disagreeing judicial pronouncements, the banker can be

on the safer side by entering into an agreement with the customer
authorizing the banker to combine the accounts at any time without
notice and to return cheques which, as a result of such an action, would
overdraw the combined account.

Nonetheless, in cases such as the death or bankruptcy of the customer, in

order to recover the net amount owing to him, the banker can exercise
the right of set-off without notice even in the absence of an agreement.

At the same time, it may be noted that the right of set-off cannot be
exercised by the banker if he has made some agreement, express or
implied, to keep the accounts separate. This has been laid down in
Halesovven Presswork and Assemblies Ltd. Vs Westminster Bank Ltd.

Another point to be noted in this connection is that the banker cannot

exercise his right of set-off if the accounts are not in the same right. For
instance, the banker cannot set-off the credit balance on a partner's
account against a debt due on the partnership firm's account and vice
versa. Further, the banker cannot combine a trust account with the
personal account of the customer.

Again, the right of set-off applies only to existing debts and not to
contingent liabilities. Thus in Jefftyes Vs Agra and Masterman's Bank
Ltd., the Learned Judge observed "You cannot retain a sum of money
which is actually due against a sum of money which is only becoming
due at a future date".

Furthermore, the right of set-off does not apply where the customer has
deposited an amount taking a loan from a third party on condition that
the money is repayable if not used for a particular purpose, the bank
having been notified of this condition and where the customer is unable
to utilize the loan due to liquidation, as was decided in Quistclose
Investments Ltd. Vs Rolls Razar Ltd. (involuntary liquidation) and
Other.

3. Banker's Obligation to Honour His Customer's Cheques

Section 31 of the Negotiable Instruments Act, 1881 imposes a statutory

obligation upon the banker to honour the cheques of his customer drawn
against his current account so long as his balance is sufficient to allow
the banker to do so, and provided the cheques are presented within a
reasonable time after their ostensible date of issue. The Section runs as
follows:

"The drawee of a cheque having sufficient funds of the drawer in his

39
BFN 301 PRACTICE OF BANKING

hands, properly applicable to the payment of such cheque must pay the
cheque when duly required so to do and in default of such payment must
compensate the drawer for any loss or damage, caused by such default."

The statutory obligation may be extended by an agreement, express or

implied, to the amount of overdraft agreed upon. But after giving
sufficient notice, a banker can withdraw any overdraft limit already
granted. In Rouse vs Bradford Banking Company, wherein it was held
that "it may be that an overdraft does not prevent the bank who has
agreed to give it, from at any time giving notice that it is no longer to
continue and they must be paid their money". But if the bankers "have
agreed to give an overdraft, they cannot refuse to honour cheques, or
drafts, within the limit of that overdraft, which have been drawn and put
into circulation before any notice is given to the customer that the limit
is withdrawn".

Previous to dishonouring a customer's cheque the banker must ascertain

that prevailing circumstances permit him to do so. Otherwise, he will be
liable to pay damages to the customer for injuring his credit. A
businessman can recover substantial damages without pleading and
proving actual damage, as was the case in Robin Vs Steward. But in the
case of a non-trading customer, only nominal damages will be awarded
unless the damages are alleged and proved as special damages, as in the
instance of Gibbons vs Westminster Bank Ltd. In this connection, it may
be mentioned that the accidental dishonour of a cheque for a small
amount constitutes greater damage to the credit of the customer than the
dishonour of a cheque for a larger amount, a view which was held in
Davidson vs Barclays Bank Ltd.

In addition, when computing the customer's balance, the banker need

take into account his credit balance only at the branch on which the
cheque is drawn. Though the bank had the right to combine several
accounts of the customer, the customer had no right to insist that the
bank combine different accounts in determining whether a cheque on an
account may be dishonoured. The following passage from Halsbury's
Laws of England is relevant herein:

Unless precluded by agreement, express or implied from the course of

business, the bank is entitled to combine different accounts in his own
right even though at different branches of the same bank, and to treat the
balance, if any, as the only amount standing to his credit....

The customer, however, has not the equivalent right, and cannot utilize
a credit balance at one branch for the purpose of drawing cheques on
another branch where he has no account or where his account is
overdrawn."

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BFN 301 MODULE 1

In the absence of an express or implied agreement giving the customer a

right to draw cheques against uncleared items, the banker is entitled to
return such cheques with the answer 'effects not cleared', as Way held in
Underwood Vs Barclays Bank Ltd. Here, It should be remembered that
an implied agreement would arise from some established course of
business. Thus, if the banker has been following the practice of
honouring his customer's cheques drawn against uncleared items, he
cannot, return cheques with the answer 'effects not cleared' without
reasonable notice.

The duty of the banker to honour his customers cheques, unless

improperly drawn, does not apply to bills of exchange accepted by the
customer and made payable by the banker. Here too, an implied
agreement would arise from some established course of business.

The liability of a banker for wrongful dishonour of a cheque is only to

the drawer and not the payee of the cheque. When a point arose for
consideration in terms of whether a company, which is the holder of the
cheque, can hold the drawee bank liable, Section 31 of the Negotiable
Instruments Act, which deals with the liability of the drawee of a cheque
becomes relevant. The said Section refers to the liability of the drawee
to the drawer and not to the payee of the cheque.

There is no provision in the Negotiable Instruments Act that the drawee

is much liable on the instrument, the only exception being under Section
31 in the case of a drawee of a cheque having sufficient funds of the
customer in his hands, and even then, the liability is only towards the
drawer and not the payee.

4. Banker's Duty to Maintain Secrecy of the Customer's

Account

Due the peculiarly private character of transactions between the banker

and the customer, the banker should not divulge the state of the
customer's account to third parties, except on reasonable and proper
causes. If the banker fails in his duty, he will be liable for damages,
which may be substantial if the credit of the customer has suffered
serious injury. According to Sir John Paget, this duty of the banker to
maintain secrecy does not end even with the closing of the customer's
account.

Further, it has been laid down in Tournier vs National Provincial bank

of England that this secrecy applies not only to information derived by
the banker from the customer himself or from his account, but also to
information concerning the customer's credit that may come into the
banker’s possession in his capacity as a banker. In the instant case, a

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BFN 301 PRACTICE OF BANKING

customer of the National Provincial Bank drew a cheque in favour of

Tournier who, in turn, endorsed it in favour of a third party who had an
account with another bank. On return of the cheque to the National
Provincial Bank, the manager of the bank wanted to know to whom the
cheque was paid. The manager was told that the person was a book-
maker Tournier sued the National Provincial Bank on the ground that
the manager disclosed information that Tournier was a book-maker. The
Court held that the disclosure constituted a breach' of duty on the pan
[part] of the National Provincial Bank towards Tournier.

However, the duty to maintain secrecy is not absolute, but qualified. The
following qualifications have been cited as examples by the Learned
Judge in the Tournier case quoted above.

1. Where disclosure is under compulsion of law

2. Where there is a duty towards the public to disclose
3. Where the interests of the bank require disclosure
4. Where the disclosure is made in accordance with the express or
implied consent of the customer

In addition to the above qualifications, bankers have a practice of

sharing opinions with one another concerning the creditworthiness of
customers. In such cases, the banker should confine himself to general
statements and not disclose the details of the account, unless specifically
authorized to do so.

It is also important that the banker should not make statements which
may make him liable for defamation or fraudulent misrepresentation. If
the banker makes any statement knowing it to be false and if any third
party suffers a loss for having relied on the statement, the banker will be
held liable to the third party to whom the information is given.

Till recently, it was believed that as far as a banker's liability to a third

party was concerned, he could not be held liable for any false
information given negligently since there was no contractual
relationship between the banker and a non-customer. But the decision in
Hedley Byrne and Co Ltd vs Heller and Partners Ltd. indicates that
action may be taken for professional negligence if third parties suffer
financial loss due to their reliance on the professional skill and judgment
of persons with whom they do not have a contractual or fiduciary
relationship.

According to the facts of this case, before entering into a transaction

with A, the plaintiffs sought a reference to A's standing from A's
bankers. The bankers provided the reference, stating therein that they
accepted no responsibility for its accuracy. The reference proved to be

42
BFN 301 MODULE 1

misleading and the bankers had been negligent. As a result of the loss
suffered by the plaintiffs, they sued the bankers for negligence. The
House of Lords held:

(a) that the bankers could be held liable for negligence contained in a
reference but
(b) that the disclaimer of liability in the reference exonerated them
from liability on the particular facts of the case.

In the absence of an 'express’ authority from the customer concerned the

banker should decline to give any information in response to enquiries
from an outsider who is not a banker. While declining to give
information, care should be taken to see that he does not state anything
which is likely to injure his customer's credit.

5. Banker's Lien

Another feature of the relationship between the banker and the customer
is the banker's right of lien over securities that may come into the
banker's possession in the normal course of business. A 'lien' may be
defined as the right to retain property belonging to a debtor until he has
discharged the debt due to the retainer of the property.

A distinction may be made between a 'general lien' and a 'particular lien'.

A 'particular lien' confers the right to retain the goods in respect of a
particular debt involved in connection with a particular transaction. A
'general lien' confers the right to retain goods not only in respect of debts
incurred in connection with a particular transaction but also in respect of
any general balance arising out of the general dealing between the two
parties.

Banker's lien is a general lien. It has been held in Brandao Vs Barnett

that bankers have a general lien on all securities deposited with them as
bankers by a customer, unless there is an express contract, or
circumstances that show an implied contract, inconsistent with the lien.

Relatedly, in the same judgment, a banker's lien has been defined as an

implied pledge. An ordinary lien does not imply a power of sale, but a
pledge does. However a banker's right of sale is generally regarded as
extending to fully negotiable securities only. It is not clear whether the
banker's right of sale extends to securities which are not fully negotiable.
Most cases concerning lien have applied to negotiable securities and, in
the absence of legal decision on the matter, it seems advisable to regard
a banker's lien on nonnegotiable securities as conferring only a right to
retain them until his demands have been satisfied.

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BFN 301 PRACTICE OF BANKING

There are cases where the banker cannot exercise his right of lien such
as follows.

1. In the case of securities deposited with the banker purely for safe
custody, the banker is acting as a bailee and has no lien over such
articles.

2. In the case of funds and securities specifically appropriated, the

banker cannot exercise his right of lien because there is an
express contract inconsistent with the lien.

3. A bank has no right of lien on money deposited or credit balance

earmarked by the customer for a specific purpose, although the
right of lien applies if the bank has no express or implied notice
of the purpose of the deposit.

4. Right of lien is not exercisable where documents or valuables are

left with the banker inadvertently. But where the securities are
left with the banker even after the loan for which the securities
were given as collateral is repaid, right of lien is exercisable over
them. By leaving the securities with the banker, the customer is
supposed to have redeposited them with the banker, as was held
by the House of Lords in the case of London and Globe Finance
Corporation.

5. A general lien cannot arise in respect of property of a customer

pledged as security for a particular debt.

6. The banker cannot exercise his right of lien in respect of property

coming in by mistake, or which is placed with the bank to cover
an advance that is not granted, as was held in Lucas Vs Dorrien.

7. No lien arises for an advance of a specific amount for a definite

period until the due date.

8. No lien arises in case the credit and liability do not exist in the
same right. Thus, the banker cannot exercise his right of lien over
the securities or funds of a partner in respect of a debt due from
the partnership firm.

9. The banker cannot exercise his right of lien over a separate

account maintained by the customer, known to the banker as a
Trust Account.

10. No lien arises over properties for which the customer has no title.

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BFN 301 MODULE 1

6. Banker’s Right to charge Interest and commission

A banker is entitled to charge interest on loans, either by express

agreement or by right of custom or usage of trade. He is also allowed to
charge compound interest unless there is an agreement to the contrary.

In the absence of an express agreement, or without due notice, a banker

is not entitled to debit his charges at any other than the customary dates.
And if the banker dishonours his customer's cheques owing to lack of
funds by reason of his having done so, he may be held for unjustifiable
dishonour.

The banker is also entitled to charge commission for service rendered to

his customer.

7. Garnishee Orders

A garnishee order' is an order of the Court obtained by the Judgment

creditor attaching funds in the hands of a third party who owes [the]
judgment creditor money, warning the third party (the Garnishee) not to
release money attached until directed by the Court to do so. For
instance, if A obtains judgment in respect of a debt due to him from B,
A may apply to the Court for a garnishee order attaching the funds in B's
bank account.

Before issuing an absolute garnishee order, a garnishee order nisi, is

issued to the banker. In the case of a garnishee order nisi, although the
order attaching the funds in the hands of the banker (the garnishee), an
opportunity is given to the banker to show cause why the funds should
not be handed over to the judgment creditor. On the banker failing to
show sufficient cause, the order is made absolute. The banker should not
pay over funds until the order is made absolute since he has no authority
for payment under an order nisi.

When a garnishee order is served on a banker, he should attach all funds

due or accruing due. The term 'accruing due' means debts already
incurred, but payable at a future date. It does not include debts which do
not exist at the time the order is served. In the case of a current or
savings bank account, although it might appear that a debt is not due
until a demand for a repayment is made, the garnishee order itself
operates as a demand for a repayment that is sufficient to render any
money held in that account immediately repayable, as was held in the
Joachinison Case. Thus, a current/savings bank account is attachable by
a garnishee order. Similarly, a deposit account repayable on demand is
attachable by a garnishee order.

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BFN 301 PRACTICE OF BANKING

Further, the following kinds of deposits are attachable:

i) A deposit repayable on fixed notice, provided the notice has been

given before the order is received. However, under Section 38 of
the Administration of Justice Act, 1956, a deposit account in
England is attachable by a garnishee order, notwithstanding any
condition about return of the receipt or the absence of a notice.

ii) A deposit repayable on a fixed date. In this case it is a debt

accruing due.

Therefore, when the banker is served with a garnishee order, he should

stop operations on the accounts of the customer. It must remain dormant
until the order is discharged. Nevertheless, the banker can open a new
account and operate it during the garnishee proceedings. The new
account is not attachable by the garnishee order as it attaches only debts
due or accruing due on the date when the order is served, and not future
debts. Relatedly, in the case of a limited garnishee order (where the sum
attachable is specified), the banker can transfer any credit balance to a
new account with the consent of the customer, and this new account can
be allowed to be operated freely.

Before paying the amount in accordance with a garnishee order, a

banker is entitled to deduct all debts due to him on the date of the order
from the customer's credit balance. For this purpose, he can combine all
the accounts of his customer. But he is neither entitled to retain moneys
against contingent liabilities nor is he entitled to transfer the balance in
the current account to a loan account in order to defeat a garnishee
order.

In England, the Court, by issuing a writ, commands the sheriff to seize

the goods and bring them to the Court. Therefore in England, as soon as
the garnishee order is served, the attaching creditor becomes a secured
creditor. When pursuant to the order of attachment or by the coercive
process, the moneys attached are actually brought into the Court.
As long as the attachment order is of a prohibitory nature, the creditor
may not have any rights or security in the property; once the moneys are
brought into the Court, the attaching creditor is entitled to insist that
those moneys should be handed over to him in satisfaction of decree.

In Halsbuty's Laws of England, the judgment creditor is entitled to insist

on payment to himself by the garnishee. The attaching creditor, having
taken steps to obtain payment against the decree, cannot be told that the
Court is holding moneys for the debtor, more so when the garnishee
obtains complete discharge by making payment in the Court. In the
result, the attaching creditor is held to be secured creditor.

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BFN 301 MODULE 1

In situation where funds are not attached by a garnishee order, the

following prevail.

a) Funds coming into the banker's hands subsequent to the receipt of

the garnishee order are not attached. This is because a garnishee
order attaches funds due or accruing due as on the date of the
garnishee order. It may be noted here that the date of attachment
is material and not the date on which the application for
attachment is made. In other words, the attachment of the debt
due, to the judgment debtor is not illegal because application for
attachment is made before it became due.

The date of attachment, not the date on which the application

for attachment was made, was material if the debt was due by the
date on which the attachment was effected, there could not be any
valid objection
against the same, simply because the application for its
attachment was made before it became due.

b) A joint account is not attached by a garnishee order, provided the

order is issued against only one of the account holder.

The decision in Macdonald Vs Tacquash Gold Mines Co., in which a

view was taken that a debt, legal or equitable, owing by a garnishee to a
judgment debtor, should not be a debt due to him jointly with another
person.

c) A partnership firm's account is not attached by a garnishee order

provided the order is issued against only one of the partners.

d) In the case of an overdrawn account of a customer, the garnishee

order will not attach funds even though the customer has not
reached the agreed limit of overdraft when the order is served.

e) If a garnishee order does not correctly designate the judgment

debtor and the account which he has with the bank, funds are not
attached.

f) For amounts credited as cash in respect of uncleared items, it is

doubtful whether they are attached by a garnishee order. In Jones
Vs Coventry, it was held that they were attached by a garnishee
order. However, in view of a later decision in Underwood Vs
Barclays Bank, the earlier decision does not appear to hold good.
The latter decision recognized the banker's right to return cheques
drawn against uncleared items in the absence of a contract,
express or implied, to the contrary.

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BFN 301 PRACTICE OF BANKING

In another a case, the decision in Fern Vs Bishop & Co. Ltd. and
Another was upheld the decision in Underwood Vs Barclays Bank. In
this case, a garnishee order was served on the debtor's bank for an
amount of £806. The debtor's credit balance was £4,998, including
£4,700 representing a cheque paid in for collection but not collected.
The bank, having deducted the bank charges due to it, opened a new
account for the £4,700 and left £218 to meet the judgment debt.

The Learned Judge stated that the question was whether at the time the
garnishee order was served, the sum of £4,700 constituted a debt owed
by the bank to the judgment debtor, whether the bank was holding the
cheque in question as a holder for value. It was held in Undenvood Vs
Barclays Bank that for a bank to become a holder for value there had to
be a contract between the banker and the customer, express or implied,
that the latter might draw against cheques which were not cleared. There
was no evidence of such a contract in the above menstioned case.

As regards proving such a contract, if there were an express agreement,

the bank would be duty-bound to disclose the fact to the judgment
cre
ditor, when served with a garnishee order nisi. But if such an
agreement were to be implied from a course of conduct, it would be
wrong for a banker L to offer details of a customer's banking
transactions to any judgment creditor, who could use the machinery of
discovery under the control of the Court. In the above case, this had not
been done. Thus the garnishee order was made absolute in the sum of
£218.

g) Until recently it was considered that a garnishee order could not

attach a debt owing in a foreign currency. But the decision in
Choice Investments Ltd. Vs Jemnimon & Midland Bank Ltd
indicates that a garnishee order could even attach a credit balance
maintained in a foreign currency. In this case the question was
whether the garnishee order issued against the bank could attach
funds in a US dollars Deposit Account maintained by the
judgment debtor in England.

The Learned Judge outlined the procedure to be followed is thus that

...as soon as the garnishee order nisi it operates to 'freeze 'the sum in the
hands of the bank, in this way; they must, as soon as reasonably
practicable, in the ordinary course of business, put a 'stop order' in the
requisite amount of US dollars. It should be such a number of dollars as,
if realized at the time of the stop order, would realize the amount of the
sterling judgment-at the buying rate of sterling ruling at the time of the
stop order. The bank should not make a transfer into sterling at that

48
BFN 301 MODULE 1

stage. But, if and when the garnishee order is made absolute, the bank
should exchange that stopped amount from dollars into sterling so far as
is necessary to meet the sterling judgment debt and pay over that amount
to the judgment creditor. But if and so far as the stopped amount (owing
to exchange fluctuations) is more than enough to meet the judgment
debt, the bank must release the balance from the stop order and have it
available to the customer on demand. If the stopped amount is, when the
garnishee order is made absolute, by virtue of exchange fluctuations,
insufficient to satisfy the judgment, remaining funds with the banks are
not affected.

8. Banker - Customer Relationship in the Context of Bankers' Book

Evidence Act

As observed earlier, a banker has to disclose the state f a customer's

account under an order from a Court of law. Before the enactment of the
Bankers' Book Evidence Act, 1891, a banker had to produce the actual
books of accounts whenever he was summoned to do so by any of the
parties to the suit. But the Bankers' Book$ Evidence Act provides that a
certified copy of any entry in a banker's book shall in all legal
proceedings be received as prima facie evidence of such entry, and of
the matters, transactions and accounts recorded therein. Section 4 of the
Act holds that:

A certified copy of any entry in a banker's book shall in all legal

proceedings be received as prima facie evidence, of the existence of
such entry, and shall be admitted as evidence of the matters, transactions
and accounts therein recorded in every case where, and to the same
extent as, the original entry itself is now by law admissible, but not
further or otherwise.

Furthermore, Section 5 of the Act provides that a banker or officer shall

not, in any legal proceedings to which the bank is not a party, be
compelled to produce any banker's book, the contents of which can be
proved under the Act, or to appear as a witness to prove the matters,
transactions and accounts therein recorded, unless by order of the Court
or a Judge made for a special cause. At the same time, if the bank is not
a party in the action and if the Court is not satisfied that the certified
copies produced are true copies of the accounts maintained by the bank,
it is open to the Court to direct the bank authorities to produce the
original books.

A 'certified copy' has been defined by the Act as a copy of any entry in
the books of a bank together with the certificate written at the foot of
such copy that it is a true copy of such entry, that such entry is contained
in one of the ordinary books of the banker, and that such book is still in

49
BFN 301 PRACTICE OF BANKING

the custody of the bank. The term "Banker's Books" includes ledgers,
day books, cash books, accounts books and all other books used in the
ordinary business of the bank.

A court or judge may also give any party to a legal proceeding leave to
inspect and take copies of any entries in a banker's books. The relevant
provision is contained in Section 6 of the Act which says:

i) On the application of any party to a legal proceeding, the court or

Judge may order that such party be at liberty to inspect and take
copies of any entries in a banker's books for any of the purposes
of such proceeding, or may order the bank to prepare and
produce, within a time period to be specified in the order,
certified copies of all such entries that are to be found in the
books of the bank relevant to the matters in issue in such
proceeding, and such further certificate shall be dated and
subscribed in a manner hereinbefore directed in reference to
certified copies.

ii) An order under this or the preceding Section may be made with
or without summoning the bank, and shall be served on the bank
three clear days (exclusive of bank holidays) before the same is to
be obeyed, unless the court or judge directs otherwise.

iii) The bank may, at any time before the time limited for obedience
to any such order as aforesaid, either offer to produce their books
at the trial, or give notice of their intention to show cause against
such order, and thereupon the same shall not be enforced without
further order.

In application under the Bankers' Book Evidence Act for an order upon
a bank to supply a certified copy of the entries in respect of one of its
customers for a particular periods may be allowed because it being a
third party document, the same ought not to be allowed to be produced
by this process unless special circumstances are shown. It may be noted
here that if the bank is a party in the action, it can be compelled to
produce its actual books under sub-poena.

Nevertheless, the exemption granted to bankers from producing their

books under the Act in any legal proceeding to which the bank is not a
party does not hold good in case of a police investigation.
An officer in charge of a police station can, by a written order, call upon
a person to produce any documents which the police officer thinks
relevant to the investigation he is carrying on. In other words, a police
investigation is not a legal proceeding in the sense in which the term is
employed in Section 5 of the Bankers' Book Evidence Act, on the

50
BFN 301 MODULE 1

ground that a police investigation has nothing to do with evidence in its

legal sense, which is the essence of legal proceeding.

Another important point to be noted here is that a certified copy of an

entry in a banker's books is only prima facie evidence, and not
conclusive evidence.

According to some observation by Leamor a cases imply that while the

Bankers Evidence Act recognizes certified copies admissible by law as
evidence, such admissibility is only to the same extent as the original
entry itself, not further or otherwise. By reason of Section 34 of the
Evidence Act, the original entries alone would not be sufficient by
themselves to charge any person with liability and so, copies produced
under Section 4 of the Bankers' Book Evidence Act cannot by
themselves be sufficient to charge any person with liability.

SELF- ASSESSMENT EXERCISE 4

Differentiate Banker’s Lien and Garnishee Order.

4.0 CONCLUSION

Banker-customer relationship is the contractual type of relationship in

which a person entrusts valuable items with another person with an
intention that such items shall be retrieved on demand from the keeper
by the person who so entrusts. Therefore, it is the banker who is
entrusted with monetary items and other valuables, which the person
who so entrusts such items, called customer, wishes to retrieve them on
demand in course of dealing with the banker. Since the relationship is on
contractual basis, it is hinged on certain terms and conditions, which
must be adhered to by both parties.

5.0 SUMMARY

In this course of analysis in this study unit, we discussed issues such as

the Nature of Banker-Customer Relationship, Meaning of a Banker and
a Customer, distinction between a Banker and a Customer, Relationship
between a Banker and a Customer, and Important Areas of Banker-
Customer Relationships. In the next study unit, we shall discuss bank
accounts of customers.

6.0 TUTOR-MARKED ASSIGNMENT

1. Different between a banker and a customer.

2. Mention and explain important areas of banker-customer
relationship.

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BFN 301 PRACTICE OF BANKING

7.0 REFERENCES/FURTHER READING

Akrani, G. (2012). Banker-Customer Relationship. http://kalyan-

city.blogspot.com/2012/ 04/banker-customer-relationship-
explained.html

Fraser, D. R., Gup, B. E. & Kolari, J.W. (1995). Commercial Banking:

The Management of Risk, New York: Western Publishing
Company.

Patel, M. (2012). Banker Custmoer Relationship.

http://www.slideshare.net/MitikaAnjel/ banker-customer-
relationship-14004440

Shekhar, K. C. and Shekhar, L. (2007). Banking Theory and Practice,

(7th ed.). New Delhi: Vikas Publishing House PVT Limited.

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BFN 301 MODULE 1

UNIT 4: BANK ACCOUNTS OF CUSTOMERS

CONTENTS

1.0 Introduction
2.0 Objectives
3.0 Main content
3.1 Meaning of Bank Account
3.2 Types of Bank Account of Customers
3.3 Precautions to be Taken While Opening Bank Accounts
for Customers
3.4 Special Types of Customers
4.0 Conclusion
5.0 Summary
6.0 Tutor-Marked Assignment
7.0 References/Further Reading

1.0 INTRODUCTION

In the preceding unit, we discussed the relationship between the banks

and their customers. The basis of such relationship is rooted in the
various accounts being held by the customers with the banks. There are
various forms of bank accounts that the banks do maintain for their
customers. Such various forms of bank accounts, therefore, constitute
the subject of discussion in this study unit of the material.

2.0 OBJECTIVES

At the end of this study unit, you should be able to:

• discuss the meaning of bank account

• mention and discuss various types of bank accounts.

3.0 MAIN CONTENT

3.1 Meaning of Bank Account

A bank account is a financial account between a bank customer and a

financial institution. A bank account can be a deposit account, a credit
card, or any other type of account offered by a financial institution. The
financial transactions which have occurred within a given period of time
on a bank account are reported to the customer on a bank statement and
the balance of the account at any point in time is the financial position of
the customer with the institution. a fund that a customer has entrusted to
a bank and from which the customer can make withdrawals.

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BFN 301 PRACTICE OF BANKING

Bank accounts may have a positive, or credit balance, where the bank
owes money to the customer; or a negative, or debit balance, where the
customer owes the bank money. Broadly, some accounts are opened
with the purpose of holding credit balances over a period of time, which
are referred to as deposit accounts. Some other accounts are opened with
the purpose of holding debit balances such as the loan accounts. Some
accounts can be switched between credit and debit balances.
Some of the customers’ bank accounts are categorized by the function
inherent in them rather than on the basis of the nature of the balances
they hold, such as the savings accounts. In general terms, all banks have
their own names for the various accounts which they open for
customers.

SELF-ASSESSMENT EXERCISE 1

Discuss the meaning of a bank account.

3.2 Types of Bank Account of Customers

Generally, commercial banks offer a wide variety of accounts. Such

accounts can be broadly divided into some distinct types: savings
accounts, basic chequeing accounts, interest-bearing chequeing
accounts, money market deposit accounts, and certificates of deposit,
among others. All such accounts are in most cases insured by the
appropriate deposit insurance corporations in some economies, based on
lower and upper limits of the amount of balances in the customers’
accounts depending on the practices in the economies around the world.
Most banks offer all of these types of accounts, offering the customers a
wide range of choice in terms of their desirability. This is because the
desire of individuals dictates the type of bank they may choose to open
with the banks. The common types of bank accounts are identified and
discussed as follows:

1. Savings Accounts

These are intended to provide an incentive for you to save money. You
can make deposits and withdrawals, but usually can’t write cheques.
They usually pay an interest rate that’s higher than a chequeing account,
but lower than a money market account. Some savings accounts have a
passbook, in which transactions are logged in a small booklet that you
keep, while others have a monthly or quarterly statement detailing the
transactions. Some savings accounts charge a fee if your balance falls
below a specified minimum.

In essence, a savings account is one in which customers save their

monthly savings and they are not like the current account. Although the

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BFN 301 MODULE 1

money is available at any time for the customer to withdraw, but money
is not as frequently deposited or withdrawn from it like the current
account. Therefore, banks offer a meager interest rate for the money
held in this account.

2. Basic Chequeing Accounts

These are sometimes also called current accounts, and they offer a
limited set of services at a low cost. The customer as the account owner
will be able to perform basic functions, such as cheque writing, but they
lack some of the features of more comprehensive accounts. Such
accounts usually attract no interest, and they may restrict or impose
additional fees for excessive activity, such as writing more than a certain
number of cheques per month.

SELF-ASSESSMENT EXERCISE 2

Differentiate between savings account and chequeing account.

3. Interest-Bearing Chequeing Accounts

In contrast to the chequeing accounts, these offer a more comprehensive

set of services, but usually at a higher cost. Also, unlike a basic
chequeing account, the customers are usually able to write an unlimited
number of cheques. Such accounts are sometimes referred to as
negotiable order of withdrawal (NOW) accounts. The interest rate often
depends on how large the balance in the account is, and most charge a
monthly service fee if your balance falls below a preset level.

4. Time Deposit Account

These are also known as certificates of deposit, because the account

holder has agreed to keep the money in the account for a specified
amount of time, anywhere from three months to six years. Due to the
fact that the money will be inaccessible, the account holder is rewarded
with a higher interest rate, with the rate increasing as the duration
increases. There is a substantial penalty for early withdrawal, so that the
holder will be discouraged from embarking on this option but only
prepared if you think you might need the money before the time period
is over (the maturity date).

5. Deposit Account

Deposit account is one in which the customer deposits a small sum of

money (usually a few hundred or thousands) every month. The bank
accepts a deposit every month and at the end of the deposit period

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BFN 301 PRACTICE OF BANKING

(usually 12 months or higher) the bank would return the money

deposited with them along with a good interest.

6. Fixed Deposit

Fixed Deposit Account is one in which the customer deposits a big sum
of money (Usually a few thousands and upwards. There is actually no
limit to the amount of money you can deposit in a FD) for a fixed
duration of time at least 3 months or higher. Since you agree to keep the
money deposited with the bank for a fixed/agreed upon duration, the
bank gives you a very good interest as payment for keeping the deposit.
Chequeing Accounts are also called as Current Accounts. A chequeing
account is one in which customers keep some money and use it for their
day to day transactions. The money in this account does not earn any
interest and is available for usage to the customer at all times. These are
the 4 main types of accounts provided by banks.

7. Loan Account

This is an account that is normally opened for a customer by a bank at

the instance of granting of a loan facility by the bank. The amount of the
loan is credited to the customer’s current account and similarly debited
to the loan account. An arrangement is subsequently made for the
customer to repay the loan, usually over a stated period of time, with
interest additionally being paid on the outstanding amount.

Loan accounts can be opened only for Approved/Active clients and

groups. Fees can be charged to loan accounts in three ways, both at time
of account creation and after.

i. Fees are inherited from the product definition. The benefactor can
remove one or more of these fees for a particular account. If a fee
is removed from an account, it does not affect other accounts.
ii. Predefined fees (not yet associated with the account) can be
selected and attached to the account.
iii. Miscellaneous fees (one time charge) can be charged to an
account. The user specifies the amount, which is added in the
next payment.

SELF-ASSESSMENT EXERCISE 3

Differentiate between deposit account and loan account.

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BFN 301 MODULE 1

8. Joint Account

This is a bank account that is shared by two or more individuals. Any

individual who is a member of the joint account can withdraw from the
account and deposit to it. Usually, joint accounts are shared between
close relatives such as husbands and wives or business partners. In other
words, being a bank or brokerage account that is shared between two or
more individuals, joint accounts are most likely to be used between
relatives, couples or business partners who have a level of familiarity
and trust for each other, as this type of account typically allows anyone
named on the account to access funds within it.

Joint accounts are often created in order to avoid probate. If two

individuals open a joint account and one of them dies, the other person
is entitled to the remaining balance and liable for the debt of that
account. Sometimes a temporary joint account is opened by two parties
entering into a transaction where one party needs a security for the
fulfillment of the transaction and the other party has to pay the sum
(deposit), being the security for the other party. Any payment from the
joint account, or return of the deposit from the joint account, will only
be possible if both parties sign a joint written instruction to the bank. It
is not possible that only one of the parties gives instruction for payments
of the joint account.

Some banks are not very interested in opening temporary joint accounts,
as they are normally used for one transaction only. Therefore, there are
specialised parties or companies taking care of such accounts as trustees.
A temporary joint account is normally closed after the transaction for
which it was opened has been concluded. Temporary joint accounts are
used in transactions in which large sums of money are involved as an
alternative to letters of credit or escrow accounts.[

Joint accounts can be established on a permanent basis, such as an

account between a couple where their salaries are deposited, or may be
temporary, such as an account between two parties who contribute funds
for a short-term purpose. In the event of a death of one of the account
holders, the remaining account holders will have sole access to the
funds, as well as any debts associated with the account.

Joint holders of an account are regarded in law as together making up

the 'owner.' Any action against them (pertaining to that account) is made
against jointly and not individually (severally). Two types of joint
accounts are:

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BFN 301 PRACTICE OF BANKING

(a) Joint-tenancy account

This is the joint account that is owned usually by a married couple in

which either owner may individually exercise full rights to make
deposits or withdrawals on his or her signatures. In case of either
owner’s death, the survivor automatically takes the sole control of
account assets without probate.

(b) Tenants-in-common account

This is usually owned by two or more business partners or directors in

which signatures of all owners are required to exercise certain rights
such as making withdrawals. In case of one or more owners' death the
other owner(s) may take control of account assets only in accordance
with the terms of agreement entered between them before such
eventuality. A company account operated by two or more signatories as
a means of accounting control or security is not a joint account in the
legal sense.

SELF-ASSESSMENT EXERCISE 3

Discuss the nature of a Joint Account, pointing out the various types of
this bank account.

3.3 Precautions to Be Taken While Opening Bank Accounts for

Customers

Previous to opening an account, the banker should obtain references

from respectable 'parties about the proposed customer's integrity and
respectability. By allowing a person to open an account without
satisfactory reference, the banker could be inviting unpleasant
consequences.

The implications of allowing a person to open an account without

satisfactory reference involve the following.

1. By obtaining possession of a cheque book, a dishonest person

may use it for nefarious purposes.
2. He may happen to be undischarged bankrupt, in which case the
banker would be facing serious consequences.
3. The banker may inadvertently allow an overdraft' which can be
realized only if the customer is solvent.
4. Omission to make enquiries regarding a customer before opening
an account in that person's name is likely to make the banker
guilty of negligence. In this connection, the observations made in
Ladbroke Vs Todd are relevant herein.

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BFN 301 MODULE 1

According to these observations, the bank acted negligently, for they did
not make the enquiries which ordinary, reasonable people should make
when opening an account. Furthermore, it was not obligatory upon a
bank to make enquiries regarding the respectability of a customer in
order to avail itself of the protection given under Section 131 of the
Negotiable Instruments Act.

Nevertheless, in the more recent case of Union of India Vs National

Overseas and Grindlays Bank (1978), the Court observed;

The modem banking requires that a constituent should either be known

to the banker or should be properly introduced. The bank owed a duty to
make enquiries directed to discover whether a new constituent might use
the account for any fraudulent purposes The underlying object of the
bank insisting on producing reliable reference is only to find out, if
possible, whether the new constituent is a genuine party or an
impersonator or a fraudulent rogue....

...(however) the burden of establishing good faith and absence of

negligence is on the defendant. The bank has to establish that they acted
without negligence not only in the receipt of the payment of the cheque
amount but even earlier at the time of opening the account.

In short, the safer course for the banker would be to obtain references
for the respectability and integrity of a proposed customer before
opening an account. As a matter of fact, it is customary for the banks in
Nigeria to insist that it is only customers whose current bank accounts
operative in the last six months that can be used as referees for opening
a new account.

3.4 Special Types of Customers

1. Lunatics

A contract by a lunatic is void, although he can enter into valid contracts

during lucid intervals. Hence a banker should not knowingly open an
account in the name of a person of unsound mind. For instance, if a
lunatic draws a cheque and the party taking the instrument is aware of
the incapacity, the cheque is unenforceable against the Person so
drawing. However, a banker honouring such a cheque in good faith and
without negligence can debit it to the customer's account. If, on the other
hand, the banker has received notice of the customer's lunacy, or If he
has knowledge of it, he will be liable for all cheques honoured by him.
Therefore, as soon as the banker comes to know of the lunacy of the
customer he must an operations on the account.

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BFN 301 PRACTICE OF BANKING

2. Drunkards

A sane man who is delirious from fever or who is so drunk that he

cannot understand the terms of a contract or form a rational judgment
about its effects on his interest, cannot contract while such disorientation
or drunkenness lasts. Thus a contract by a drunken person is void. But it
should be remembered that ordinary drunkenness is not sufficient to
make a contract void. He must be so intoxicated as to be incapable of
understanding the nature and effect of the contract on his interests.
Therefore, when a customer presents a cheque across the counter when
drunk, the banker, to be on the safe side, should see that the payment is
witnessed.

3. Undercharged bankrupts

The banker should not open an account in the name of an undischarged

bankrupt. If he finds that a customer is an undischarged bankrupt, he
must stop operations on the account at once and inform the Official
Assignee of it.

4. Minors

Any person who is under the age of 18 years is a minor. However, if a

guardian has been appointed before attaining the age of 18 years, the age
of majority is extended to the date when he completes 21 years of age. A
minor is not competent to contract and all his contracts are void.

The banker runs no risk in opening an account in the name of a minor so

long as the account is kept in credit. But if the banker grants an overdraft
to a minor, the latter cannot be sued for repayment since the transaction
is void. Furthermore, the banker cannot avail himself of any security
lodged by the minor to secure his debt. So it is advisable to open an
account in the name of parent or guardian. In the absence of such an
arrangement, the banker should neither allow an overdraft nor allow the
minor to draw against uncleared items.

A minor may act as an agent, but the banker should obtain written
instructions from the principal regarding the power. A minor may also
be a partner; but he cannot be held personally liable for the debts of the
partnership firm.

A minor is not bound by a negotiable instrument given by him. This is

true even if the instrument was given by the minor for necessaries
supplied to him. But of course, the supplier may sue on the original
consideration to be reimbursed from the minor's assets for necessaries
supplied. If a minor makes, draws or endorses a negotiable instrument,

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BFN 301 MODULE 1

the holder will not be entitled to enforce it against him, although the
holder can proceed against all the other parties except the minor. A
minor can become payee by process of law and enforce payment of the
amount of a negotiable instrument. Execution of a joint promissory note
by a minor will not affect the liability of the co-executants.

5. Married women

A banker may open an account in the name of a married woman. She

can enter into contracts and bind her separate estate. However, in the
case of an overdraft granted to a married woman, the banker has no
remedy against her unless she has separate estate. The husband too
cannot be made liable for such debts unless the banker has obtained his
personal guarantee, or the loan has been granted for the purpose of her
necessaries of life. Further, the banker has no personal remedy against a
married woman.

6. Agents

A banker may open an account in the name of a person who is acting as

the agent of another person. The account should be considered as the
personal account of the agent. The banker has no authority to question
his power to deal with the funds in the account unless it becomes
obvious that the agent is guilty of breach of trust.

However if a person is only authorized to act behalf of the principal, the

banker should verify the authorization. If he has been appointed under a
power of attorney, the banker should carefully examine the letter of
attorney to confirm the powers conferred by the document on the
agent. On receiving notice of the principal's death, insanity or
bankruptcy, the banker must suspend all operations on the account.

7. Executors and Administrators

Bankers generally open executorship or administration account before

getting probate or letter of administration in order to provide funds for
the estate duty, because in the absence of payment of this duty, probate
or letter of administration will not be granted. However, before
advancing money, the banker should satisfy himself that the persons
applying for the accommodation are the proper persons. Further, since a
banker cannot hold securities deposited by the deceased against such an
advance (Farhall Vs Far/tall), a personal undertaking must be taken m
the executors or administrators, making them jointly and severally liable
in case of default to repay the advance from the assets of the deceased.
The banker should not transfer any credit balance on the account of the
deceased in the name of the executors or administrators until the probate

61
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or letter of administration has been produced. On producing the probate

or letter of administration. the banker should make note of any details
that may affect the account.

A banker opening an account for executors or administrators should see

that they are not unduly prolonging the realization of the business,
unless the in the Will authorizes them to continue the business.
Otherwise, the banker may be held liable for breach of trust. Even when
the Will authorizes the continuation of the business, the banker should
see that all the creditors of the deceased have been satisfied, or else he
should see that they have given their assent before granting any advance
In case of failure, the creditors who have not given their assent may
claim payment of their debts in priority to the bank.

Before allowing the executors/administrators to operate on the account, it

is desirable to obtain a mandate, signed by all the
executors/administrators, laying down the manner in which the bills and
cheques are to be signed and endorsed, and holding all of them jointly
and severally liable for any overdraft It may be pointed out here that any
one executor can effectively countermand payment of a cheque even
where all executors are required to sign cheques together. So also, where
the mandate authorizes either of two executors to operations on the
account one of them can stop payment of a cheque signed by his co-
executor.

Further executors/administrators, except in special circumstances, have

no power to delegate their authority to operate on the account to any
outside parties. Hence a banker should not accept such a mandate.

On the death of an executor/administrator, his powers are vested in his

co-executors/co-administrators, unless otherwise provided for in the
Will. If he is the sole executor, his duties are vested in an executor
whom he may nominate. But if he is the sole administrator, a fresh letter
of administration must be applied for.

The banker should be careful to stop operations 011 an overdrawn

account as soon as he receives notice of the death of an
executor/administrator, in case the overdraft is secured by the personal
liability of the deceased.

In case of bankruptcy of an executor/administrator, ' the banker need not

stop since it does not terminate his appointment. In case of lunacy of an
executor/administrator, his authority is terminated, and the banker
should not honour cheques signed by such an executor/administrator
without the consent of the remaining executors/administrators.

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8. Partnership

While opening an account in the name of a partnership firm, the banker

should obtain a mandate signed by all the partners containing
information regarding the nature of the firm's business, the names and
addresses of all the partners, the names and addresses of those who are
authorized to operate on the account together with their specimen
signatures, and the extent of their authority. It is also advisable to
examine the partnership deed to note whether there are any special
regulations regarding the bank account, borrowing powers, etc. Where a
third party is authorized to operate the account, the mandate should
clearly state whether the third party has the authority to overdraw the
account.

Any partner has an implied power to stop payment of a cheque drawn on

the firm's account and the banker is bound to comply with the
instruction of the partner. So also, any one or more partners may cancel
the authority given to operate on the account, and in that case, the
banker should not honour cheques drawn by such an authority. Every
partner in a commercial partnership (trading Inn) has implied authority
to bind the firm by making, drawing, signing, endorsing, accepting,
negotiating and discounting negotiable instruments in the name, and on
account of, the partnership. He also has authority to borrow money.
However, the banker should not honour cheques or other instruments
signed by a partner whom the bank mandate does not authorize to sign
on behalf of the firm. The power of a partner to borrow is also
dependent on the instructions in the mandate.

A partner in a non-trading firm has no implied authority to borrow, to

make or to issue negotiable instruments, although he may sign cheques.
Therefore, the banker should get the signature of all the partners in a
non-trading firm for all transactions involving advances to the firm,
discounting or the negotiation of bills of exchange. Another implied
authority of a partner in a commercial partnership is his power to pledge
the firm's properties. But this implied power is confined to those
transactions incidental to the firm's ordinary course of business. Hence,
the safe course for the banker to take would be to get the assent of all the
partners.

A partner has no implied power to bind his co-partners by deed.

Therefore, the banker should see that he gets the assent of all the
partners when immovable properties of the firm are mortgaged as
otherwise, the banker will get only an equitable title and not a valid legal
title.

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BFN 301 PRACTICE OF BANKING

It may be mentioned here that the implied authority of a partner to bind

the firm does not extend to guarantees. A partner cannot bind the firm
by giving a guarantee on behalf of the firm, unless it is customary for
that firm. A partner cannot bind the firm by opening an account in his
own name on behalf of the firm unless he is expressly authorized to do
so by all the partners. The banker should not accept cheques payable to
the firm for the credit of the private account of a partner. When such a
cheque is presented, the banker should make enquiries. Failure to do this
will deprive the banker of his statutory protection.

When a new partner is admitted to the firm, the banker need not stop the
account, provided the account shows a credit balance. However, the
banker should obtain a new mandate signed by all the partners,
including the new partner. But when the partnership account shows a
debit balance, the banker should stop the old account and open a new
account. A new mandate should also be obtained. The banker may take
an agreement signed by the new partner undertaking liability in respect
of the outstanding debts of the firm.

When one of the partners dies, the partnership firm stands dissolved.
The banker can, however, continue the account. The remaining partners
are entitled to any balance on the partnership account. They can give the
banker a valid discharge for it. In case the partnership account shows a
debit balance, the account should be stopped to fix the liability of the
deceased. The rule applies even when cheques are signed by the
deceased partner.

In the event of insolvency of a partner, the solvent partners have a right

to operate the partnership account in connection with the winding-up of
the business. However, if the partnership firm is indebted to the bank,
the account should be stopped and a new account should be opened in
order to avoid the Rule in Clayton's Case. The banker should not
honour cheques drawn by the insolvent partner. Cheques drawn before
adjudging hi insolvent may be honoured by the banker. However, it is
advisable to obtain the confirmation of the other partners.

In case of retirement of a partner, the retiring partner will continue to be

liable to the banker till the banker is served with a notice of the
retirement. On receiving such a notice, the banker should take a new
mandate from the continuing partners. If the partnership account shows
a debit balance, the account should be stopped in order to avoid the
application of the Rule in Clayton's Case.

In case of lunacy of a partner, the partnership firm does not stand

dissolved. However, upon the application of a fellow partner, the Court
may order a dissolution. On such a dissolution, the banker may allow the

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BFN 301 MODULE 1

other partners to continue the account if it shows a credit balance. If, on

the other hand, the account shows a debit balance, the banker should
stop the account.

Alterations in the constitution of a firm will affect any charges which

may have been given on the partnership property. Therefore, the banker
should obtain a new mortgage deed signed by all the new and continuing
partners.

9. Joint Stock Companies

While opening an account in the name of a joint stock company, the

banker should ascertain the powers of its directors and managers from
the Articles and Memorandum of Association. The banker should also
examine the company's Certificate to Commence Business. He should
further ask for an authenticated copy of the resolution appointing him as
the banker. This should be accompanied by a mandate in the usual form,
containing information such as the names of the persons authorized to
sign cheques and other documents, their specimen signatures, the extent
of their authority, etc.

The company should be instructed to inform the banker of any variation

in the appointment of directors and other officers concerned. Such
notification should be accompanied by a duly signed copy of the
resolution effecting such a change.

A trading company has implied powers to borrow it and pledge the

property of the company to such an extent as may be reasonable and
necessary for carrying out the objects stated in the Objects Clause of the
e Memorandum. If the Memorandum limits the borrowing powers to a
fixed amount, the banker should strictly adhere to it. The banker also
should see whether or not the Articles of Association impose any-
limitation on the directors' powers to pledge the property, or to borrow
money. In the case of a non-trading company, borrowing powers would
be expressly given in the Memorandum of Association.

A banker lending money need not enquire about the purpose for which
the company is taking the loan. If the loan is misapplied, it cannot be
avoided, provided the banker has acted in good faith and without
knowledge of the intended misapplication. However, where the banker
is asked to lend money for a purpose outside the company's powers, he
should not grant it.

On receiving notice of the passing of a resolution to wind up the

company, or of the presentation of a petition to wind up the company,
the banker should immediately suspend all operations on the account.

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BFN 301 PRACTICE OF BANKING

10. Local authorities

The banker should be very careful while opening the account of local
authorities. Local authorities are trustees of the public funds which they
control. Hence the banker should exercise as much care as he would do
with any other trust account.

The relevant statute creating the authority should be examined to

ascertain the powers given to it. The banker should keep himself within
the strict limits laid therein.

11. Trust Accounts

Prior to opening an account in the name of a trust, the banker should

carefully examine the Trust Deed and ascertain matters such as the
power of the trustees to delegate their powers to any one or more of
them, their power to borrow money and the manner of operating on the
account in case of death or insolvency of a trustee. It may be noted here
that unless the Trust Deed gives authority to the trustees to delegate their
powers, they cannot do so. Consequently, in the absence of an express
provision in the Trust Deed to the contrary, the banker should honour
only these cheques that are signed by all the trustees.

Even when an account is opened without describing it as a trust account,

and the banker comes to know that it is a trust account, he should not
allow the customer to draw money for a purpose obviously inconsistent
with the customer's duty as a trustee. However, this does not mean that
the banker should act as a detective.

Where a customer has more than one account, the banker need not
necessarily presume that one of them is a trust account. In some cases,
the very title of the account may indicate that it is a trust account. For
instance, the opening of an account under the title is clearly a trust
account. In such cases, if the banker has information that the account is a
trust account, he cannot escape liability merely on the ground that there
is no indication of the fact in the title of the account. For instance, the
opening of an account under a title does not describe the account as a
trust account. It only shows that the account is a private account with
reference to a particular transaction.

However, the banker should pay regard to the circumstances, or to any

information showing that the account is a trust account. Furthermore, the
opening o account under a title does not necessarily describe the account
as a trust account; it may mean an account belonging to the name as
ascribed to the title consisting of funds brought in by the holders.
However, if the title means that account has been opened by Quest to be

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drawn on by Quotex, then it is a trust account.

It was held in John vs Dodwell that if a customer had one bank account
in his personal name and another in the trust name, a transfer of money
from the trust account to the personal account should put the banker on
enquiry. This is particularly important when the transferee account
happens to be overdrawn. The banker could be held liable for breach of
trust; if it can be proved that he derived some benefit out of t transfer.

The banker should not credit the trustee's private account with cheques
drawn in favour of the trust. Again, the banker is not entitled to use his
right of set-off between the trustee's private account and the trust
account. But if he has no notice of the character of the accounts, he may
exercise his right of set-off. Further, the banker should not grant an
advance against trust securities on a trustee's private account.

Except the Trust Deed gives express power to the trustee to borrow and
pledge trust property, the banker should note that the trustee is not
entitled to borrow money or give any security. But if the Deed gives
express power to the trustee to borrow money by mortgaging trust
property, he may do so.

On receipt of notice of the death of one of the trustees, the banker should
ascertain from the Trust Deed whether or not the surviving trustees are
entitled to act without the appointment of a new trustee. If a new trustee
is required, the banker should stop all operations on the account until a
new trustee is appointed.

Where a trustee becomes an insolvent, it does not involve the trust

property. The trust property belongs to the beneficiaries, and the private
creditors of the trustee have no right to claim it. The trustee's right to
deal with trust property, for the purpose of trusteeship, is also not
affected unless the Trust Deed provides otherwise. On receipt of the
notice of the trustee, operations on the account by that trustee should be
suspended.

12. Unincorporated Bodies

While opening an account in the name of unincorporated bodies like

clubs, committees, associations, etc., the banker should ask for an
authenticated copy of the resolution appointing him as the banker. A
mandate containing the names of authorized to operate on the account
along with their specimen signatures should also be obtained. Since it
has no legal personality, it should be remembered that an unincorporated
body cannot be held responsible for any liabilities incurred by its
officials. Relatedly, the persons authorized to sign cheques cannot be

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BFN 301 PRACTICE OF BANKING

held personally liability for any overdraft in case, in signing the cheques,
they clearly indicate that they are acting in their representative capacity
and not in their individual capacity. Nevertheless, if the account is
opened and operated in the style Koleosho A/C, then the banker is
entitled to consider it as a personal account of Koleosho.

13. Joint Accounts

When opening an account in the joint names of two or more persons, the
banker should get written instructions signed by all the account holders
regarding the names of the persons authorized to operate on the account
and the extent of their authority. In the absence of such instructions, the
banker should honour only those cheques which are signed by all the
account holders.

The authority to operate on the account may be given to an outsider. It

may, however, be noted here that one of the joint account holders
authorized to operate on the account does not have the power to delegate
his power to an outsider. The authority given to any person to operate on
the account may be revoked by any joint account holder. When the
banker is given notice of such revocation, he should act accordingly.
Death, bankruptcy or insanity of the person authorized to operate on the
account automatically revokes the authority. Similarly, the authority is
automatically revoked by the death, bankruptcy or insanity of the person
giving the authority.

Until recently, it was considered that an innocent joint account holder

had no remedy against a bank for breach of mandate instructions caused
by the forgery of another joint account holder. This was based on the
decision in Brewer Vs Westminster Bank Ltd. In this case, the co-holder
of a joint account had forged the plaintiff's signature. It was held that
both parties to the joint account had to be parties to the proceedings. The
actual plaintiff would thereby be affected by the misconduct of the
deemed co-plaintiff and also by the rule that a party could not rely on his
own misconduct. The position now, however, appears to be different in
view of the decision in Caralin Vs Cyprus Finance Corporation
(London) Ltd.

According to the facts of above case, a joint account was opened by a

husband and wife and the mandate clearly specified "both to sign". The
bank negligently allowed the husband to transfer funds from the joint
account to an account in his personal name without the wife signing the
withdrawal instruction. Thereupon the wife proceeded against the bank
for breach of mandate instructions and for restoration of funds in the
joint account. The bank argued that the contract with the bank relating to

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the joint account was with both the wife and the husband, that neither of
them had any separate rights and the wife could not sue by herself. This
argument was not accepted and it was held that the bank did not only
have an obligation to the account holders jointly, but it also had an
independent obligation to each of them that it would not honour
withdrawal instructions unless signed by both joint account holders.

It is always advisable for the banker to see that the joint account
mandate deals with the question of survivorship. However, as a general
rule, it may be stated that the survivor/s are entitled to any balance in the
joint account. On receiving notice of the death of a joint account holder,
the banker should not honour cheques bearing the signature of the
deceased, although there is no objection in honouring cheques signed by
all the surviving parties. On the death of all the joint account holders, the
balance, if any, is payable to the legal representatives of the person who
dies last.

When the joint account shows a debit balance, the banker can proceed
against the deceased only if the mandate includes an undertaking by the
parties to be jointly and severally liable. In the absence of such a
provision, the estate of the deceased becomes free from liability. If the
banker has the power to claim against the estate of the deceased, he
should immediately suspend all operations on the account on the death
of the party. Otherwise, the Rule in Clayton's Case will operate.

In the case of lunacy of a joint account holder, the banker should stop
operations on the account until he gets joint instructions from the other
account holders and the Receiver or Committee in Lunacy.

On receipt of a notice of insolvency of a joint account holder, pending

joint instructions from the solvent account holders and the Trustee in
Insolvency the account should be stopped. As in the case of the death of
one or more joint account holders, here too the banker can proceed
against the estate of the insolvent only if the mandate includes an
undertaking by the parties to be jointly and severally liable.

As regards a joint account in the name of a husband and wife, the

balance cannot be claimed by the widow, unless it can be proved that the
husband opened the account with the deliberate intention of making a
provision for his wife, as was held in Marshall Vs Coutwell and Foley
Vs Foley If the banker has been given express instructions to pay the
balance to the survivor, his position would be more secure. So it is
always advisable for the banker to take written instructions regarding the
disposal of the balance in case of death of either party. However, if the
wife dies first, and even the intention of the parties is not clear, the
banker is justified in paying the balance to the husband.

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14. Fixed Deposits

In addition to accepting money on current/savings bank accounts,

bankers receive money on deposit accounts undertaking to repay the
amounts on the expiry of a specified period, or subject to a notice.
Bankers generally prefer deposits which are repayable after the expiry of
a specified period. Such deposits are known as "Fixed Deposits".

When a person deposits money with the banker on a fixed deposit, a

'Deposit Receipt' is given to him by way of acknowledgment for the
amount deposited. This document is usually marked -not negotiable",
which means that it cannot be transferred by mere endorsement' and
delivery. It was held in Evans Vs National Provincial Bank of England
that payment to a person wrongfully dealing with even a signed deposit
receipt was no discharge to the bank, unless the depositor was estopped
by his conduct from disputing such payment.

However, the deposit receipt can be assigned provided due notice of

assignment is given to the banker. But it may be noted here that the
banker would be entitled to recover from the deposit amount any motley
owing to him from the depositor at the time of receipt of such a notice.

In some cases, the banker may make the signing of the deposit receipt a
prerequisite to the withdrawal of money. Nevertheless, the banker
cannot refuse payment in case of loss of deposit receipt. He can pay the
amount safely after obtaining an ordinary indemnity from the customer.
It may be noted here that the deposit receipt, being a non-negotiable
instrument, will not get a valid title for any holder other than the
customer.

A deposit receipt has been held to be a good subject of donation mortis

causa (i.e., a gift made in contemplation of death and to take effect only
in the event of death).

A depositor is not legally entitled to draw cheques against fixed

deposits. But in the case of deposit accounts repayable on demand, there
is a conflict of judicial opinions. In Hopkins vs Abbot, it was held that
cheques could be drawn against deposit accounts repayable on demand.
On the other hand, according to Dr. H.L. Hart and Sir John Paget, a
depositor is probably not entitled to draw cheques against deposit
accounts repayable on demand. Some banks have a cheque form printed
on the back of the deposit receipt. This, however, does not change the
nature of the deposit account.

A fixed deposit is attachable by a garnishee order since the order

attaches funds due or accruing due.

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BFN 301 MODULE 1

In case of insolvency of a depositor, the amount should go to the

Official Assignee. In case of death of the depositor, the amount should
go to his personal representatives.

Fixed deposit accounts may be opened in the name of minors and they
can give a valid discharge for the deposit amount repaid to them.

Fixed deposit accounts may be opened in the name of joint parties. Here,
all the parties should combine in withdrawal. In the case of death of one
or more of the parties, the property passes on to the survivor/s. When the
deposit is in the joint names of husband and wife, as mentioned earlier,
this rule does not apply. On the death of the husband, the property does
not pass on to the widow unless it can be proved that the husband
opened the account with the deliberate intention of making a provision
for his wife in case of his untimely death. In Nagarajamma vs State
Bank of India, it was held that a
fixed deposit in the joint names of a husband and wife payable to either
or survivor would not, on the death of the husband, constitute a gift by
the husband to his wife. The decision was followed in Guru Datta vs
Ram Dana. If, however, the wife dies first, in the absence of any
express instruction to the contrary, the property passes on to the
husband.

Deposit receipts given by bankers are exempted from stamp duty

In the case of a fixed deposit account, the law of limitation begins to run
from the expiry of the fixed period. If the account is a deposit account
repayable after the expiry of a specified period's notice of withdrawal,
the law of limitation begins to operate immediately after the money is
due to be repaid. If the account is a deposit account repayable on
demand, the law begins to operate from the date when a demand for
repayment has been made by the depositor.

SELF-ASSESSMENT EXERCISE 4

Mention special categories of bank customers and outline the

precautions to be adopted in dealing with opening of their accounts.

4.0 CONCLUSION

Bank accounts opened and maintained by the customers form the basis
of banker-customer relationship. There are many types of bank accounts
that customers do have with their banks. Some of such accounts are
interest bearing accounts while some other ones attract charges –
commission on turnover - by the banks. Some bank accounts are
normally opened jointly for some parties such as husbands and wives

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while some are maintained by partners in partnership businesses. The

other type is the account that banks require their customers to open
when they are granted loan facilities. There are fundamental precautions
to b taken into considerations when opening and dealing with accounts
of special categories of bank customers.

5.0 SUMMARY

We have discussed, in this study unit, various accounts which customers

can open and maintain with the banks,. Issues discussed include
meaning of bank account and types of bank account of customers, which
snowballed into analysis of bank accounts such as: savings accounts;
basic chequeing accounts; interest-bearing chequeing accounts; time
deposit account; deposit account; fixed deposit; loan account; joint
account; precautions to be taken while opening bank accounts for
customers; and special types of customers. In the next study unit, we
shall discuss specialized bank accounts of customers.

6.0 TUTOR-MARKED ASSIGNEMENT

1. Different between savings account and chequeing account.

2. Discuss the nature of a joint account, pointing out the various
types of this bank account.

7.0 REFERENCES/FURTHER READING

Fraser, D. R., Gup, B. E. & Kolari, J.W. (1995). Commercial Banking:

The Management of Risk, New York: Western Publishing
Company

Shekhar, K. C. & Shekhar, L. (2007). Banking Theory and Practice,

(7th ed.). New Delhi: Vikas Publishing House PVT Limited.

Vaughan, K. (2013). Joint Account: Good, bad or ugly. Retrieved from

http://www.punchng.com/feature/adam-eve/joint-accounts-good-
bad-or-ugly/
Business Dictionary.com
(http://www.businessdictionary.com/definition/joint-
account.html)

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UNIT 5 SPECIALISE BANK ACCOUNTS OF CUSTOMERS

CONTENTS

1.0 Introduction
2.0 Objectives
3.0 Main content
3.1 Money Market Account
3.2 Tax-Free Savings Account
3.3 Special Tax-Free Savings Account
4.0 Conclusion
5.0 Summary
6.0 Tutor-marked Assignment
7.0 References/Further Reading

1.0 INTRODUCTION

In the preceding unit, we discussed some bank accounts of customers in

which various types of such accounts were identified and analyzed. In
this study unit, we shall identify the various forms of specialized bank
accounts that banks do maintain for their customers. Such specialize
forms of bank accounts, therefore, constitute the subject of discussion in
this study unit.

2.0 OBJECTIVES

At the end of this study unit, you should be able to:

• discuss the meaning of money market account

• explain tax-free saving account
• discuss special tax-free saving account.

3.0 MAIN CONTENT

3.1 Money Market Account

A money market account (MMA) or money market deposit account is a

financial account that pays interest based on current interest rates in the
money markets. Essentially, therefore, it is an account that typically has
a relatively high rate of interest and requires a higher minimum balance
in order to qualify for earning interest or avoiding monthly fees. It is a
kind of investment strategy which is similar to, and meant to compete
with, a money market fund offered by a brokerage. Nevertheless, these
types of account are not related.

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BFN 301 PRACTICE OF BANKING

In other words, the account is an interest-bearing type of account that

typically pays a higher interest rate than a savings account, but it
provides the account holder with limited cheque-writing facility.
Therefore, a money market account offers the account holder some
benefits which are typical like those of current and savings accounts.
However, this type of account is likely to require a higher balance than a
savings account, and it is normally insured just like other bank accounts.
Money market accounts are widely available, and are maintained by
some banks and other financial institutions. They are able to offer a
higher interest rate by requiring a higher minimum balance, and by
placing restrictions on the number of withdrawals the account holder
may take over a given period of time. Such restriction makes these
accounts less liquid than a current account. Nevertheless, they are more
liquid than bonds.

Just like the interest that is being earned on current and savings
accounts, the interest earned on a money market account is subject to
taxes. The account holders do not have to buy shares in a money market
account, as interest being earned on deposits in these accounts is similar
to the interest earned on current and savings accounts. The banks that
offer such money market accounts normally take a low-risk approach
when investing their deposits in financial instruments such as certificates
of deposit, government securities, and commercial papers.

SELF-ASSESSMENT EXERCISE 1

Explain the nature of money market account.

3.2 Tax-Free Savings Account

The Tax-Free Savings Account is an account that is characterized by tax

benefits for saving in country such as Canada. The benefits such as
investment income, including capital gains and dividends and, as
accrued to this type of account is not subject to taxes, even at the time of
withdrawal. Contributions to tax-free savings account are not deductible
for income tax purposes.

This account is regarded an investment option for Canadian residents

that are 18 years and above who are interested in maintaining such a
saving account. Normally, the account-holder can contribute a certain
amount every year. The income earned on contributions to such
accounts is not subject to taxes. The flexible structure inherent in this
type of account allows the holder to withdraw money from the account
at any time, free of taxes. This implies that the account-holder is at
liberty to withdraw any amount out of the balance in the account, and is
devoid of charges such as capital gains and or withdrawal taxes.

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BFN 301 MODULE 1

Another interesting feature of this account is its mechanism in the design

which involves the carry-over aspect. This implies that any unused space
under the amount specified as cap can be carried forward to subsequent
years, without any upward limit. In Canada where this is the practice,
The specified annual contribution limit is normally indexed to the
Consumer Price Index (CPI), in some multiple increments; this is
employed as mechanism in order to account for inflation.

In essence, the Tax-Free Savings Account is an account that is flexible,

registered, general-purpose savings medium that allows the Canadians to
earn tax-free investment income, which is more easily employed to meet
lifetime savings needs. The account particularly complements existing
registered savings plans like the Registered Retirement Savings Plans
(RRSP) and the Registered Education Savings Plans (RESP) in Canada.

The mechanism of the Tax-Free Savings Account functions as follows

1. The starting age for opening of and contributions to such an

account is eighteen (18) years.
2. There’s no maximum age limit to contributing to such an
account; a customer can continue to invest even after the age of
71.
3. Investors can contribute a maximum of $5,500 in the year 2014
as defined by regulation, which has been changing on yearly
basis.
4. When a customer has not contributed in the past, or did not meet
maximum contributions in any given year, he/she can catch up on
unused contributions, up to the $31,000 limit as of this calendar
year.
The ideal way to keep track of a customer’s unused contribution
is to check out his/her notice of assessment.
5. A customer is normally advised to be careful not to over-
contribute or he/she will incur tax penalties equal to 1% of the
highest excess amount in the month and for each month of such
excess contribution.
6. A customer can withdraw money at any time without penalty or
tax consequences. Nevertheless, he/she can’t re-contribute that
amount in the same calendar year. In the event that a customer
only needs the funds for a short time and plan to replace them
quickly, the best strategy is to make the withdrawal late in the
calendar year so he/she can re-contribute from first day the month
in the following year.
7. Withdrawals from the account do not impact any government
benefits or assistance programs such as child tax benefits, old age
security or other guaranteed income supplements. This means

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low-income earners can generate tax-free income without it

affecting their support.
8. The account is not just a cash account. It can be structured so the
customer can invest in various media such as, bonds, mutual
funds, stocks and exchange-traded funds, among other options.
9. Deductions from the account are not tax deductible. However, the
customer can double up on tax-free income generation by
opening a second account in the spouse’s name.
10. For those on a limited budget, the best way to keep up with
contributions is to set up an automatic monthly withdrawal plan.

SELF-ASSESSMENT EXERCISE 2

Explain the nature of Tax-Free Savings Account.

3.3 Tax-Exempted Special Savings Account

This type of account is being operated in the United Kingdom. The Tax-
Exempted Special Savings Account (TESSA) scheme was introduced in
1990 and operative in 1991 in the UK which is meant to be a low-risk
complement to the personal equity plan designed to be attractive to a
wider range of savers. An individual age of 18 years and above was able
to open a Tax-Exempted Special Savings Account (TESSA) with a
bank, building society other financial institution from 1 January 1991 to
5 April 1999.

A specific requirement was the presentation of the applicant's national

insurance number, facilitating identification to taxation, for the purpose
of ensuring only one TESSA (tax-free) account investment could be
operated by the individual per year. Interest on the TESSA was free
from UK income tax. The favourable tax treatment of a TESSA lasted
for 5 years, and it was possible to invest up to £9,000, with a maximum
investment of £3,000 invested in the first year and £1,800 in each of the
second to fifth years. Nevertheless, if the maximum was invested in the
first four years, only £600 could be added in the fifth year. Withdrawals
were permitted within the first 5 years: tax relief was clawed back if any
of the invested capital was taken out; withdrawals of interest did not
trigger a claw back of the tax relief.

A follow-on Tax-Exempted Special Savings Accounts were introduced

in 1995 to permit all of the capital, but not the tax-free interest, from an
original TESSA to be 'rolled over' into a new TESSA. Other than
permitting all of the capital in the original account to be invested in the
first year, which could easily exceed the usual £3,000 first-year limit, a
'follow-on' Tax-Exempted Special Savings Account was subject to the
same conditions as any other TESSA.

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The Tax-Exempted Special Savings Accounts (TESSAs) were replaced

from 1999 by Individual Savings Accounts (ISAs). The final TESSAs
matured on 5 April 2004, but the original capital, but not the tax-free
interest, could again be 'rolled over' into a new notional income tax-free
investment through the use of a Tax-Exempted Special Savings Account
only Individual Savings Account (TOISA). The account TOISA was a
form of cash Individual Savings Account which can be opened using
either capital that was originally invested in a TESSA and that has not
been withdrawn, or with funds transferred from another TOISA.

From 6 April 2007 there was no practical difference between TOISAs

and cash ISAs and transfers into cash ISAs have been permitted. On 5
April 2008, TOISAs ceased being legally distinct and are now
completely interchangeable with cash Individual Savings Account.

The rules governing tax-exempt savings accounts can be summed up as

strict but simple. By observing the inherent rules governing the TESSA
and the interest being earned by the fund of the savers become entirely
tax free. This implies that by breaking the rules the tax authority would
call for its share.

Basically, most of the rule-following is normally done by the financial

institution that operates the account. So by trying to deposit more than
the maximum allowed, the excess will be rejected. Nevertheless, the
differences between the rules on Tax-Exempted Special Savings
Accounts and those governing personal equity plans need to be properly
understood.

There are strict limits to the amount you can invest in your TESSA. If it
is your first Account, you can deposit the sum of £3,000 in year one and
then increase it to pounds 1,800 in each of the following four years, to a
total of pounds £9,000.

Furthermore, at the end of the five-year term you can open a follow-up
TESSA and pay in all the capital, but not the interest, from your first
account. If that is the full £9,000 you cannot make any further deposits
until the end of the second five-year term. However, if the total deposits
(excluding the interest) in your first Tessa come to less than £3,000 you
can top up a second TESSA to this £3,000 level in the first year.

In order to allow time for financial planning, the rules allow up to six
months between the date your first TESSA matures and the start of a
second TESSA. This allows you to roll over the full £9,000. However,
you cannot touch the capital during the life of a TESSA without
forfeiting the tax-free status, you can take some of the interest but

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subject to the limit of the amount you would have earned if the account
had been an ordinary taxable type.

Assuming you have £1,000 in your TESSA and the interest rate is 5 per
cent, you will earn £50 interest, credited to your account. On an ordinary
savings account, £12 of this would be taken in tax, that is, 24 per cent of
£50, thus leaving you with £38. Basically, since this is a tax-exempt
account, no money is handed over to the Exchequer. Instead, you can
draw the £38, retaining the £12 in the account until it is five years.

SELF-ASSESSMENT EXERCISE 3

Explain briefly the nature of Tax-Exempted Savings Account.

4.0 CONCLUSION

There are some specialize bank accounts that can be opened and
maintained by the customers which form part of the basis of banker-
customer relationship. These specialize banks may not be tenable in
Nigeria but they are very much in use in other countries such as US and
UK. Such accounts include money market account, tax-free savings
account, and special tax-free savings account, which enjoy distinct
privileges as conferred on the customers that maintain them with their
bankers.

5.0 SUMMARY

In this course of the analysis on bank accounts, we have discussed, in

this study unit, various types of specialize accounts which customers can
open and maintain with the commercial banks and building societies in
US and UK. Such discussions include: Money Market Account; Tax-
Free Savings Account; and Special Tax-Free Savings Account. In the
next study unit, we shall discuss negotiable instruments: cheques,
promissory notes and bills of exchange.

6.0 TUTOR-MARKED ASSIGNMENT

Enumerate three types of special accounts that customers can open and
maintain with their banks.

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BFN 301 MODULE 1

7.0 REFERENCES AND MATERIALS FOR FURTHER

READING

Dlabay, Les R.; Burrow, James L. & Brad, Brad (2009). Intro to
Business. Mason, Ohio: South-Western Cengage Learning.
p. 482. ISBN 978-0-538-44561-0.

Finance Glossary (2014). Tax Exempt Special Savings Account.

Retrieved from http://www.finance-glossary.com/define/Tax-
Exempt-Special-Savings-Account/1403/0/T

Fraser, D. R., Gup, B. E. & Kolari, J.W. (1995). Commercial Banking:

The Management of Risk, New York: Western Publishing
Company

InvestorGuide (2013). Different Types of Bank Accounts. Retrieved

from http://www.investorguide.com/article/11655/types-of-
accounts-typically-offered-by-banks-igu/
Money Market Account as retrieved from
http://www.investopedia.com/terms/m/moneymarketaccount.asp

Oxford Reference (2014). Tax Exempt Special Savings Account.

Retrieved from
http://www.oxfordreference.com/view/10.1093/oi/authority.2011
0803102303186

Shekhar, K. C. and Shekhar, L. (2007). Banking Theory and Practice, 7th

Edition, New Delhi: Vikas Publishing House PVT Limited.

Wikipedia, the free encyclopedia;-

http://en.wikipedia.org/wiki/Bank_account

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UNIT 6 NEGOTIABLE INSTRUMENTS AND CHEQUES

CONTENTS

1.0 Introduction
2.0 Objectives
3.0 Main Content
3.1 Nature of Negotiable Instruments
3.1.1 Meaning of Negotiable Instrument
3.1.2 Requirements of Negotiability of Negotiable
Instruments
3.2 Cheques
3.2.1 Meaning of Cheque
3.2.2 Differences between a Cheque and a Bill of
Exchange
3.2.3 Crossing of Cheques
3.2.4 Persons Authorised to Cross or to Open Crossed
Cheques
3.2.5 Cheque Endorsements
3.2.6 Marking of Cheques
3.3 Holder and Holder in Due Course
3.3.1 Holder of a Negotiable Instrument
3.3.2 Holder in Due Course of a Negotiable Instrument
3.4 Liability of the Drawer for Dishonour of Cheques
4.0 Conclusion
5.0 Summary
6.0 Tutor-marked Assignment
7.0 References/Further Reading

1.0 INTRODUCTION

In the last unit, we discussed some forms of specialize bank accounts of

customers in which various types of such accounts were identified and
analyzed. In this study unit, we shall discuss the nature of negotiable
instruments. In the course of this analysis, we shall also espouse on
instrument such as cheques which constitutes a basic form of negotiable
instruments.

2.0 OBJECTIVES

At the end of this study unit, you should be able to:

• discuss the nature of negotiable instruments

• explain the nature of cheque as a form of negotiable instruments.

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BFN 301 MODULE 1

3.0 MAIN CONTENT

3.1 Nature of Negotiable Instruments

3.1.1 Meaning of Negotiable Instrument

In simple terms, a negotiable instrument is a document guaranteeing the

payment of a specific amount of money, either on demand, or at a set
time with the payer named on the negotiable instrument. This implies
that it is a document contemplated by a contract, which warrants the
payment of money without condition which may be paid on demand or
at a future date.

In another perspective, a negotiable instrument is a written instrument,

signed by the maker or drawer of the instrument, that contains an
unconditional promise or order to pay an exact sum of money (with or
without interest in a specified amount or at a specified rate) on demand
or at an exact future time to a specific person, or to order, or to its
bearer.

In other words, negotiable instruments are written orders or

unconditional promises to pay a fixed sum of money on demand or at a
certain time. Promissory notes, bills of exchange, cheques, drafts, and
certificates of deposit are all examples of negotiable instruments.
Negotiable instruments may be transferred from one person to another,
who is known as a holder in due course. Upon transfer, also called
negotiation of the instrument, the holder in due course obtains full legal
title to the instrument. Negotiable instruments may be transferred by
delivery or by endorsement and delivery.

Since money is promised to be paid, the instrument itself can be used by

the holder in due course as a store of value. The instrument can be
transferred to a third party and it is the holder of the instrument who will
ultimately get paid by the payer on the instrument. Transfers can happen
at less than the face value of the instrument and this is known as
discounting, this may happen for example if there is doubt about the
payer's ability to pay. Due to the nature of the negotiable instrument as
store of value, most countries passed laws specifically related to
negotiable instruments.

One type of negotiable instrument, called a promissory note, involves

only two parties, the maker of the note and the payee, or the party to
whom the note is payable. With a promissory note, the maker promises
to pay a certain amount to the payee. Another type of negotiable
instrument, called a bill of exchange, involves three parties. The party
who drafts the bill of exchange is known as the drawer. The party who is

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called on to make payment is known as the drawee, and the party to

whom payment is to be made is known as the payee. A cheque is an
example of a bill of exchange, where the individual or business writing
the cheque is the drawer, the bank is the drawee, and the person or
business to whom the cheque is made out is the payee.

To be valid, a negotiable instrument must meet four requirements. First,

it must be in writing and signed by the maker or drawee. Second, it must
contain an unconditional promise (promissory note) or order (bill of
exchange) to pay a certain sum of money and no other promise except as
authorized by the Uniform Commercial Code (UCC). Third, it must be
payable on demand or at a definite time. Finally, it must be payable
either to order or to bearer.

A negotiable instrument is said to be dishonored when, upon

presentation, payment or acceptance has been refused. To qualify as a
holder in due course, an individual or business must have taken the
negotiable instrument before it was overdue and without notice that it
had been previously dishonored, if such was the case. The negotiable
instrument must also be complete and regular upon its face; that is, all of
the necessary information must be present. The holder must also take the
instrument in good faith and for value. At the time it was negotiated, the
holder in due course must have had no notice of an infirmity in the
instrument or a defect in the title of the person negotiating it.

If these conditions are met, then the holder in due course generally holds
the instrument free from any defect of title of prior parties involved with
the instrument. The holder in due course may enforce payment of the
instrument for the full amount against all parties liable thereon, free
from any defenses available to prior parties among themselves.

Negotiable instruments may be endorsed in various ways, and some

negotiable instruments do not require any endorsement. If a negotiable
instrument is a bearer instrument, then it may be negotiated by simply
delivering it from one person to another with no endorsement required.
Such negotiable instruments typically have a blank endorsement
consisting of a person's name only. If the negotiable instrument is an
order instrument, then the payee must first endorse it and deliver it
before negotiation is complete. For example, if the instrument says, "Pay
to the order of Jane Smith," then it is an order instrument and Jane Smith
must endorse it and then deliver it to the payer or drawee.

Endorsements such as "Pay to the order of Jane Smith" are known as

special endorsements and have the effect of making the instrument an
order instrument rather than a bearer instrument. Restrictive
endorsements ("Pay to Jane Smith only") and qualified endorsements

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BFN 301 MODULE 1

("Pay without recourse to the order of Jane Smith") also have the effect
of requiring the payee to endorse the negotiable instrument. Qualified
endorsements also affect the nature of implied warranties associated
with endorsement.

Under the UCC, an unqualified endorser who receives payment or

consideration for a negotiable instrument provides a series of implied
warranties to the transferee and any subsequent holder in due course. An
unqualified endorser warranties that he or she has good title to the
instrument or represents a person with title, and that the transfer is
otherwise rightful. The endorser also warranties that all signatures are
genuine or authorized, that the instrument has not been materially
altered, that no defense of any prior party is good against the endorser,
and that the endorser has no knowledge of any insolvency proceeding
involving the payer.

Other issues concerning negotiable instruments are also covered in

Article 3 of the UCC. In the case of a forgery, the negotiable instrument
becomes inoperative. Antedated or past-dated instruments are not
invalid, provided the dating was not done for fraudulent or illegal
purposes. Negotiable instruments that have been materially altered
without the permission of all parties involved are void. But a holder in
due course who is not party to the material alteration can enforce
payment according to the instrument's original terms. Also covered in
Article 3 are interpretations of contradictions that may appear from time
to time in negotiable instruments.

SELF-ASSESSMENT EXERCISE I

Explain the term negotiable instrument.

3.1.2 Requirements of Negotiability of Negotiable Instruments

For an instrument to qualify as negotiable, it must meet requirements

such as being: in writing; signed by the maker or the drawer; an
unconditional promise or order to pay; stated in a fixed amount of
money; payable on demand or at a definite future date; and payable to
order or to a bearer. In general terms, the negotiability of an instrument
revolves around the following elements:

1. Signatures

For an instrument to be negotiable, it must be signed by the maker or

drawer. A signature may be any symbol made by the maker or drawer
with the inherent intention to serve as a signature.

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2. Unconditional

This is based on promise or Order. Therefore, a negotiable instrument

must contain an express order or promise to pay. A mere
acknowledgment of a debt is not sufficient as evidence of an affirmative
undertaking on the part of the debtor to repay the debt. The exception to
this rule is a Certificate of Deposit.

Unconditional promise or order holds that a promise or order is

unconditional (and, therefore, not negotiable) if it states:

(i) an express condition to payment,

(ii) that the promise or order is subject to or governed by another
writing, or
(iii) that the rights or obligations with respect to the promise or order
are stated in another writing.

3. A Fixed Amount

Another requirement of negotiability is that negotiable instruments must

state a fixed amount of money for payment. Fixed amount for payment
means an amount that can be determined in relation to the face value of
the instrument. This requirement applies only to the principal amount of
money.

The instrument can reference an outside source to determine the rate of

interest in the case of negotiation for payment before due date. Payable
in money means the medium of exchange authorized or adopted by the
country of origin, which can easily be converted into foreign currency.

4. Time for Payment

There are obvious scenarios that are considered herein such as identified
and discussed below.

i) Payment on Demand

An instrument is made payable on demand, “at sight,” or “upon

presentation” if it is subject to payment immediately upon being
presented to the payer or drawee. Nevertheless, if there is no time for
payment specified, a negotiable instrument is presumed to be payable on
demand.

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ii) Payment at a Definite Time

An instrument is payable at a definite time if it states that it is payable

(a) on a specified date, (b) within a definite period of time, or (c) on a
date or at a time readily ascertainable at the time the promise or order is
made. Such instruments are frequently referred to as time instruments.

iii) Acceleration Clause

A clause that permits a payee or other holder of a time instrument to

demand payment of the entire amount or balance due, with interest, if a
certain event occurs, such as default in the payment of an installment
when due.

iv) Extension Clause:

A clause in a time instrument that permits the date of maturity to be

extended.

v) Order Instrument

A negotiable instrument that is payable “to the order of” an identified

person or “to” an
identifiable person “or order.”

vi) Bearer Instrument

It is a negotiable instrument payable “to bearer” or to “cash,” rather than

to an identifiable payee. Bearer refers to the person possessing a bearer
instrument. Any instrument made payable in a manner such as follows is
a bearer instrument:

(a) “Payable to the order of bearer”;

(b) “Payable to Adejo Hamid or bearer”;
(c) “Payable to bearer”;
(d) “Pay cash”; or
(e) “Pay to the order of cash.”

SELF-ASSESSMENT EXERCISE 2

What are the requirements for negotiability of negotiable instruments?

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3.1.3 Liability Associated with Negotiable Instruments

There are two kinds of liability associated with negotiable instruments:

1) Signature Liability

Those who sign negotiable instruments are potentially liable for

payment of the amount stated on the instrument. Makers and acceptors
(drawees) that promise to pay an instrument when it is presented for
payment at a later time are primarily liable. Drawers and endorsers are
secondarily liable only if the instrument is properly and timely
presented, the instrument is dishonored, and timely notice of dishonor is
given to the secondarily liable party.

2) Warranty Liability

Warranty liability extends to both signers and non-signers. It falls into

two categories; transfer of liability, and presentment liability.

i) Transfer Of Liability

One who transfers an instrument for consideration makes the following

warranties to all subsequent transferees and holders who take the
instrument in good faith:

a) The transferor is entitled to enforce the instrument.

b) All signatures are authentic and authorized.
c) The instrument has not been altered.
d) The instrument is not subject to a defense or claim of any party
that can be asserted against the transferor.
e) The transferor has no knowledge of any insolvency proceedings
against the maker, the acceptor, or the drawer of the instrument.

ii) Presentment Liability

A person who presents an instrument for payment or acceptance makes

the following presentment warranties to any other person who in good
faith pays or accepts the instrument.

a. The person obtaining payment or acceptance is entitled to enforce

the instrument or is authorized to obtain payment or acceptance
on behalf of a person who is entitled to enforce the instrument
(there are no missing or unauthorized endorsements).
b. The instrument has not been altered.
c. The person obtaining payment or acceptance has no knowledge
that the signature of the drawer of the instrument is unauthorized.

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The world’s daily transactions are carried out through negotiable

instruments. This implies that every entrepreneur or business entity must
be familiar with the basic types of negotiable instruments, their proper
transfer, the responsibilities of the parties to such instruments, and
factors that may affect their value.

3.1.4 Types of Negotiable Instruments

There are four types of negotiable instruments:

1. Bank drafts

Bank draft is an instrument which falls under a classification of

"promises to pay." Draft is an unconditional order to pay by which the
party creating the draft (the drawer) orders another party (the drawee),
typically a bank, to pay money to a third party (the payee).

Several other drafts include; i) Time Draft, a draft payable at a time

certain; ii) Sight Draft, a draft payable on presentment; and iii) Trade
Acceptance, a draft that is drawn by a seller of goods ordering the buyer
to pay a specified sum of money to the seller, usually at a specified
future time. The buyer accepts the draft by signing and returning it to
the seller.

2. Cheques

The cheque is also an instrument which falls under a classification of

"promises to pay." Cheque is a draft which involves ordering a drawee
bank to pay the amount written on it (face value) and payable to the
payee on demand. In other words, a Cheque is an instrument which
compels the drawer (or the maker) to pay a fixed sum of money to
another person (the payee) on demand or at a specified future time.

3. Promissory Notes

A promissory note is a written promise made by one person (the maker)

to another (usually the payee) payable either on demand or at a definite
time.

4. Certificates of Deposit

A certificate of deposit (CD) is a type of note issued when a party

deposits money with a bank, with the bank promising to repay the
money, with interest, on a certain date. In other words, a certificate of
deposit is a note by which a bank or similar financial institution

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acknowledges the receipt of money from a party and promises to repay

the money, plus interest, to the party on a certain date.

SELF-ASSESSMENT EXERCISE 3

Mention and explain briefly various types of negotiable instrument.

3.2 Cheques

3.2.1 Meaning of Cheque

In simple terms, a cheque is a form of bill of exchange that is normally

drawn on a specified bank carrying the name of the payee and payable
on demand. As a form of bill of exchange, a cheque is monetary
instrument in writing containing an unconditional order, signed by the
drawer directing a named bank to pay a certain sum of money only, to
the payee or to the order of the payee or to the bearer of the instrument.

A cheque is not invalid merely on the ground that it is ante-dated or

post-dated, or that it bears a date of a public holiday. A cheque not dated
at all is also valid. Any holder of the cheque, including the banker, may
insert a date. Nevertheless, bankers generally return undated cheques.
According to the decision in Dalton vs Grifiths, a banker is not bound to
honour undated cheques. An ante-dated cheque is one which bears a
date earlier than the date of issue. A banker cannot refuse payment of a
cheque merely on the ground that it is ante-dated.

A post-dated cheque is one which bears a date later than the date of
issue. A post-dated cheque is a negotiable instrument. An example may
make the point clear. 'A' gives 'B' a post-dated cheque. Before the due
date 'B', gives it to 'C' in payment of a debt. 'C' takes the cheque in good
faith. 'A' stops payment of the cheque because of 'B's failure to fulfil his
contract. Nevertheless, 'C' acquires a good title to the cheque and when
the due date arrives, he can sue 'A' for the amount.

Based on above definitions, it follows that an instrument to be called a

'cheque' must fulfill the following conditions:

1) The instrument must be in writing. Legally speaking, the writing

may be done by means of Printed characters, computer,
typewriter, or by pen or pencil. But bankers generally do not
honour cheques drawn in pencil, unless confirmed by the drawer.
This is because it is easy to make unauthorized alterations when a
cheque is drawn in pencil.

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2) The instrument must contain an unconditional order.

For instance, if the banker is ordered to pay a certain amount,
provided the payee fulfills certain conditions, it cannot be
considered as a 'cheque' since the order is a conditional one.
However, if such instructions are addressed to the payee and not
to the banker, the order to pay may be regarded as an
unconditional one.

3) The maker must sign the instrument. In order to be a valid

'cheque', the instrument must contain the signature of the drawer.
In the case of an illiterate person, his/her thumb impression will
be sufficient. Pencil signatures are discouraged by the banker,
although it is legally permissible. So also, signatures impressed
on the cheque by means of rubber stamps generally not permitted.

4) The order to pay must be addressed to a banker and that banker

must be a specified one. In other words, the instrument should not
only be drawn on a banker, but also on a 'specified' banker.

5) The order must be for a 'certain sum of money only'. The term
'money' implies legal tender currency. Thus, if the order is for
something other than legal tender currency, the instrument will
not be considered a 'cheque'. Further, the sum of money must be
certain. Here, it may be pointed out that the amount should be
considered as a 'certain amount' even when the cheque is drawn
in a foreign currency. Also, the amount is certain even when it is
payable with interest at a given rate up to the date of happening
of a fixed future event.

6) The instrument must be payable to or to the order of a certain

person or to the bearer. It follows that if a cheque is not payable
to the bearer, the payee must be named or otherwise indicated
with reasonable certainty. He may be designated as the holder of
an office. Further, the payee need not be a human being. It can be
a legal person, that is, a company or business entity.

7) Amount must be payable on demand.

SELF-ASSESSMENT EXERCISE 4

Mention the conditions that must be fulfilled by an instrument to be

called a cheque.

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3.2.2 Differences between a Cheque and a Bill of Exchange

1) A bill of exchange may be drawn on any person, and the person

need not necessarily be a banker. On the other hand, a cheque is a
bill of exchange drawn on a 'specified banker'.

2) A bill of exchange may be made payable on the expiry of a

certain period after the date. But a cheque is not expressed to be
payable otherwise than on demand.

3) Acceptance is necessary in the case of a bill of exchange. It is not

so in the case of a cheque.

4) 'Days of Grace' are allowed in the case of time bills. But in the
case of cheques, days of grace are not allowed.

5) Cheques may be crossed. A bill of exchange cannot be crossed.

6) The payment of a cheque should be suspended on the receipt of

notice of death or insolvency of the drawer. This is not the case
with a bill of exchange.

3.2.3 Crossing of Cheques

The Negotiable Instruments Act, 1881 recognises 'crossing' of cheques.

A crossing is a direction to the paying banker that the cheque should be
paid only to a banker and if the name of the banker is mentioned in the
crossing, only to that banker. In other words, the holder of a crossed
cheque is not entitled to cash the cheque across the counter. This ensures
the safety of payment by means of cheques.

There are two kinds of crossing, viz., 'general crossing' and 'special
crossing'.

1. General Crossing

Section 123 of the Negotiable Instruments Act defines a general

crossing as follows:

Where a cheque bears across its face an addition of the words and
company or any abbreviation thereof between two parallel transverse
lines, or of two parallel transverse lines simply with or without the
words 'not negotiable' that addition shall be deemed a crossing and the
cheque shall be deemed to be crossed generally.

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Two parallel, transverse lines are the essential part of a general crossing.
The words 'and company', 'account payee', 'payee's account', 'account
payee only', 'not negotiable', etc., do not, in the absence of two parallel
transverse lines, constitute general crossing.

When a cheque is crossed generally, the paying banker should not make
payment except through a banker. The addition of the words "account
payee" or "payee's account" to the crossing increases the safety of the
cheque. Such words, however, cannot strictly be considered additions to
the crossing. The paying banker's position remains practically the same,
and they are intended to warn the collecting banker that the amount
should be collected only for the benefit of the account of the payee.

The words "not negotiable" also do not place any additional

responsibility on the paying banker. The words merely act as a warning
that the transferee of such a cheque shall not be capable of acquiring a
better title to it than was possessed by his immediate transferor, and no
duty is imposed on the paying banker to enquire into the title of the
holder. The "not negotiable" crossing does not make the cheque non-
transferable. Nevertheless, the transferee does not get a better title than
that of the transferor, as was held in Great Western Railway Company
Vs London and County Banking Co.

2. Special Crossing

Section 124 of the negotiable Instruments Act defines a 'special crossing'

as follows:

Where a cheque bears across the face an addition of the name of a

banker with or without the words 'not negotiable', that addition shall be
deemed to be crossing and the cheque shall be deemed to be crossed
specially to that banker

A special crossing warns the paying banker that the amount of the
cheque should be handed over only to the bank whose name is
mentioned in the crossing. It is not necessary that there should be two
parallel transverse lines in the case of a special crossing. The name of a
bank is sufficient to constitute a special crossing. A specially crossed
cheque may be made more secure by the addition of such words as
'account payee', negotiable' etc., the significance of which is explained
in the preceding section.

SELF-ASSESSMENT EXERCISE 4

Differentiate between general crossing and special crossing of cheques.

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3.2.4 Persons Authorised to Cross or to Open Crossed Cheques

Section 125 of the Negotiable Instruments Act, which corresponds with

Section 77 of the Bill of Exchange Act, lays down that:

i) A cheque may be crossed generally or specially by the drawer.

ii) Where a cheque is uncrossed, the holder may cross it generally or
specially.
iii) Where a cheque is crossed generally or specially, the holder may
add the words not negotiable.
iv) Where a cheque is crossed specially the banker to whom it is
crossed may again cross it specially to another banker, his agent,
for collection.
v) Where an uncrossed cheque or a cheque crossed generally is sent
to the banker for collection, he may cross it specially to himself".

It should, however, be noted that in the last case, such crossing does not
enable the collecting banker to avail himself of the statutory protection
against being sued for conversion.

The drawer alone has the right to open a crossed cheque by writing the
words "please pay cash" and adding his signature to it. It should be
noted here that this method of opening a crossing does not have any
legal authority behind it. It is dependent on the custom of bankers. As
observed by Sheldon, if the drawer's opening and signature are forged,
and the forger succeeded in cashing the cheque, the banker would
undoubtedly be unable to debit his customer, and would also be liable to
the true owner.

3.2.5 Cheque Endorsements

An 'endorsement' is the signature of the drawer or holder of a negotiable

instrument for the purpose of negotiation. In terms of Section 15 of the
Negotiable Instruments Act, when the maker or holder of a negotiable
instrument signs the same otherwise than as such maker, for the purpose
of negotiation, on the back or face thereof or on a slip of paper annexed
thereto, or signs it for the same purpose a stamped paper intended to be
completed as a negotiable instrument, he is said to endorse the same,
and is called the endorser. Thus an endorsement may be made either on
the face or back of the instrument or on a slip of paper annexed thereto,
although it is generally made on the back of the instrument. The slip of
paper annexed to the instrument for the purpose of making the
endorsement is known as "allonge".

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1. Significance of Endorsements

When a cheque is endorsed and delivered, the endorsee or transferee

gets a valid title to it. He, in turn, can negotiate the cheque to anyone he
likes, provided his endorser does not restrict further endorsements.

The transferor, by his act of endorsing the cheque, warrants to his

immediate transferee or to any subsequent holder, that when the cheque
left his hands he had a good title to it, that it was a genuine one in every
particular at the time of his endorsement, and that any endorsements on
it previous to his own were genuine endorsements. Thus, if the cheque is
dishonoured, the holder can sue any or all of the previous parties, and
recover the amount of the cheque from any or all the previous parties.

When, however, a cheque is endorsed back to an earlier endorser, the

intermediate parties are not liable to him; technically known as
'negotiation back'. For instance, 'A' endorses a cheque to 'B'; 'B' to 'C';
'C' to 'D'; 'D' to `E' and `E' back to 'A'. The cheque is thus 'negotiated
back' to 'A', and 'A' is now the holder of the cheque. If the cheque is
dishonoured 'A' can sue `E', 'D', 'C' or 'B'. Nevertheless, he himself is
liable to `E', 'D', 'C' and 'B' as the original endorser. Hence, if 'A' is
allowed to sue `E', 'D', 'C' or 'B', they, in turn, can sue 'A'. In order to
prevent this action, 'A' is not allowed to sue the intermediate parties. 'A'
can further negotiate the cheque if he cancels the endorsements of the
intermediate parties, namely 'E', 'D', 'C' and `E'. This is technically
known as "taking up of a bill".

2. Kinds of Endorsements

There are different kinds of endorsements such as endorsements in

blank, endorsements in full, restrictive endorsements, partial
endorsements and conditional endorsements.

i) An Endorsement In Blank

It is also otherwise known as a `general endorsement', it specifies no

endorsee. The endorser merely attaches his signature. The cheque then
becomes payable to the bearer. When the endorsement specifies the
person to whom, or to whose order, the cheque is payable, it becomes a
`full endorsement', otherwise known as a 'special endorsement'. For
instance, if a cheque is payable to 'A' or order, and he simply puts his
signature on the back of the instrument, the endorsement is an
`endorsement in blank' - the cheque becomes payable to the bearer.

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ii) Endorsement In Blank

Suppose 'A' specifies the name of the endorsee as 'B' above his
signature, then the endorsement is an 'endorsement in full'. Any holder
of a cheque with an endorsement in blank may convert it into an
endorsement in full. Under Section 49 of the Negotiable Instruments
Act, a holder of a cheque endorsed in blank may convert it into an
endorsement in full by writing a direction above the endorser's signature
to pay the instrument to another person or to his order. Here, the
transferor stands to gain by the endorsement in that he transfers the
instrument without incurring the liabilities of an endorser.

For instance, a cheque is originally payable to 'A' or order. 'A' endorses

the cheque in blank and delivers it to 'B'. The cheque is payable to the
bearer. However, if 'B' adds the words "pay to C or order" above the
signature of 'A', the endorsement becomes an endorsement in full. The
cheque is then payable to 'C' or order. It is important to note here that 'B'
is not liable on the instrument since this endorsement acts as an
endorsement in full from 'A' to 'C'.

iii) Restrictive Endorsement

A 'restrictive endorsement' is one which prohibits further negotiation of

the cheque, or which expresses that it is a mere authority to deal with the
instrument as thereby directed and not a transfer of ownership thereof.
For example, if the cheque is endorsed "Pay 'X'. only" or "Pay 'X' for the
account of 'A" or "Pay 'X' or order for collection" or "the within must be
credited to 'X' or "Pay 'X' for my use", it becomes a restrictive
endorsement.

A restrictive endorsement gives the endorsee the right to receive

payment of the cheque and to sue any party thereto which his endorser
could have sued; but gives him no right to transfer his rights to an
endorsee unless it expressly authorizes him to do so. Where a restrictive
endorsement authorizes further transfer, all subsequent endorsees take
the cheque with the same rights, subject to the same liabilities as the first
endorsee under the restrictive endorsement.

iv) Partial Endorsement

A 'partial endorsement' is one which purports to transfer to the endorsee

only a part of the amount payable. In terms of Section 56 of the
Negotiable Instruments Act, a partial endorsement does not operate as a
negotiation of the instrument.

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v) Conditional Endorsement

A 'conditional endorsement' excludes the liability of the endorser. Thus,

if an endorser wants to get rid of his liability in the event of the cheque
being dishonoured, he can do so by writing the words 'sans
recourse'(i.e., without recourse to me) after his endorsement. Here the
endorser excludes his liability on the instrument Thus, if 'A' endorses the
cheque with the addition of the words 'without recourse to me',
subsequent endorsees cannot proceed against 'A' in case the instrument
is dishonoured.

By the same token, in terms of Clause 2 of Section 22 of the Negotiable

Instruments Act, where such an instrument is negotiated back to 'A', all
intermediate endorsers are liable to him. For instance, 'A' endorses a
cheque with the words 'without recourse to me' to 'B', 'B' endorses it to
'C', 'C' to '1D' and 'D' to 'E'. Here, 'A' is not liable on the instrument to
'B', 'C', 'D' or `E'. If, however, the cheque is negotiated back to 'A', 'B',
'C', 'D' and `E' are liable to him.

A conditional endorsement may make the liability of the endorser

dependent on the occurrence of a contingent event, or may make the
right of the endorser to receive payment in respect of the instrument
dependent on the occurrence of such an event. Such conditions may
either be 'conditions precedent' or 'conditions subsequent'. In the case of
a condition Precedent the right to recover the amount does not pass on to
the endorsee until the condition is fulfilled. For instance, where a cheque
is endorsed with a condition 'pay 'A' on his marrying 'X', it is a condition
precedent. 'A' gets title to the cheque only if he marries 'X'.

In the case of a condition subsequent, the right of the endorsee is

defeated on the fulfillment of the condition. For instance, where a
cheque is endorsed with a condition ‘pay 'A' or order unless before
payment, the cheque is countermanded", it is a condition subsequent.
The endorsee does not get a title if, before payment, the condition is
fulfilled.

When an endorser extends his own liability by stipulating in the

endorsement that he waives presentment or notice of dishonour, it is
known as a 'facultative endorsement'. When an endorser does not want
the endorsee or any other holder to incur any expense on his account on
the instrument, the endorsement is sans frais. In this connection, an
important difference between conditional and restrictive endorsement
may be noted. In the former case, the negotiability of the instrument is
not affected. In the latter case, the negotiability of the instrument is
restricted.

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3.2.6 Marking of Cheques

There is a usage among bankers to mark a cheque 'good'. This marking

indicates that at the time of marking, the paying banker had sufficient
funds of the drawer to meet the cheque. Here, the question arises
whether the paying banker, by marking a cheque 'good', undertakes to
honour it when presented. It depends on whether the cheque is marked
'good' at the request of the drawer, or of the holder, or of another banker.

When the drawer requests his bank to mark the cheque good, he may do
so. The bank is then entitled to retain money to meet the cheque, and he
is justified in dishonouring other cheques where the balance is
insufficient. In other words, the bank is justified in regarding the cheque
as constructively paid. Once a marked cheque has left the drawer's
possession, he is not entitled to countermand its payment. Such a cheque
must be paid when presented notwithstanding the death, bankruptcy or
insanity of the drawer, or by the service of a garnishee order.

As observed by Sheldon, the practice of marking a cheque is undesirable

and should be discouraged. The better course would be to debit the
customer at once with any cheque marked 'good' at his request, and
credit the amount to a suspense account, which should be debited when
the cheque is presented for payment. Or, the banker may issue a draft on
demand against debit of the cheque to the customer.

Marking a cheque at the request of the payee or holder does not place
any liability on the paying banker. Such a marking only means that at
the time of marking, the banker had sufficient funds to meet the cheque.
When a banker marks a cheque at the fellow bank for clearance
purposes, the paying banker is undertaking an obligation to honour it. In
Goodwin vs Roberts, was held that a custom had grown among bankers
of marking cheques as 'good' for purposes of clearing by which they
bound to one another. Thus, marking a cheque for clearance purposes
entitles the paying banker to earmark the necessary funds to meet the
cheque.

According to Sir John Paget, such marking constitutes a constructive

payment or appropriation to a specific person, though not directly
indicated by the customer. Here again, the customer has no right to
countermand payment of the cheque. Also, the marking is not affected
by the death, bankruptcy, or lunacy of the drawer, or by the service of a
garnishee order.

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3.3 Holder and Holder In Due Course

3.3.1 Holder of a Negotiable Instrument

In terms of Section 8 of the Negotiable Instruments Act, the holder of a

promissory note, bill of exchange or cheque means any person entitled
in his own name to the possession thereof and to receive or recover the
amount due thereon from the parties thereto.

Thus, the holder of a negotiable instrument is a person who is legally

entitled to recover the amount from the parties of the instrument and
who is in possession of the instrument. Here the Indian Law makes a
slight departure from the English Law. Under the Bills of Exchange Act,
a holder means the payee or endorsee of a bill or note, who is in
possession of it, or the bearer thereof In terms of this definition, the
holder need not necessarily be a lawful holder. For instance, the finder
of a cheque duly endorsed as payable to bearer is a holder. But
according to the Negotiable Instruments Act, 'holder in due course' as
follows:

3.3.2 Holder in Due Course of a Negotiable Instrument

Section 9 of the Negotiable Instruments Act defines a ‘holder in due

course’ as follows:

Holder in due course means any person who for consideration became
the possessor of a promissory note, bill of exchange or cheque if payable
to bearer; or the payee or endorsee thereof if payable to order, before the
amount mentioned in it became payable, and without having sufficient
cause to believe that any defect existed in the title of the person from
whom he derived his title.

Thus, a holder in due course is a person who:

1. Is in possession of the instrument as defined in Section 8;

2. Obtains possession of the instrument before maturity;
3. Obtains possession of the instrument for valuable consideration
(valuable consideration in the case of a negotiable instrument is
always presumed until proved to the contrary);
4. Is a holder without sufficient cause to believe that any defect
existed in the title of the person from whom he received his title.

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Here again, the Negotiable Instruments Act differs slightly from the
Bills of Exchange Act. According to Section 29 of the Bills of Exchange
Act:

A holder in due course is a holder who has taken a bill complete and
regular on the face of it, under the following conditions; namely, (a) that
he became the holder of it before it was overdue and without notice that
it had been previously dishonoured if such was the fact, (b) that he took
the bill in good faith and for value, and that at the time the bill was
negotiated to him he had no notice of any defect in the title of the person
who negotiated it.

From the above definition, it can be see that a person who takes an
instrument in good faith is a holder in due course, irrespective of
whether he negligently or not. In other words, the fact that a person has
not exercised great caution or has not been negligent is in sufficient to
dispute the title of the hold of a negotiable instrument, provided he has
acted in good faith. Thus, according to the Negotiable Instruments Act, a
person is expected to take an instrument with reasonable care and
without negligence.

A holder in due course obtains absolute title, even if he takes the

instrument from a thief. All the previous parties to the instrument are
liable to him. An exception to this general rule may be found when the
instrument bears a forged signature of the true owner. The transferee of
such an instrument does not get a valid title except in the case of an
estoppel.

3.4 Liability of the Drawer for Dishonour of Cheques

According to Negotiable Instruments Act, if a cheque is returned unpaid

by a bank due to insufficiency of funds in the account of the drawer, or
because the amount of the cheque exceeds the arrangement between the
drawer person and the banker, then proceedings can be initiated against
negligent the drawer of the dishonoured cheque. It involves a penalty of
imprisonment. In order to make the drawer liable as above, proper
procedures should be followed.

Section 138 draws a presumption that one commits the offence if he

issues the cheque dishonestly. It, therefore, appears that where the
drawer of a cheque gives notice to the holder before presentation of the
cheque to the bank for payment and gives 'stop payment' instruction to
the bank and the cheque is dishonoured with the remarks 'refer to
drawer' or 'instruction to stop payment' or 'not sufficient funds', then the
dishonest intentions of the drawer are established and Section 138 would
be applicable.

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The above analysis also highlights the risk involved in accepting post-
dated cheques from debtors/ borrowers in discharge of their liabilities. It
is, however, pointed out in some quarters that an appropriate
undertaking by a debtor/borrower to the effect that he/she will not give
any 'stop payment' instruction to the bank, that he/she will not close the
bank account without prior written permission of the lender that he/she
will not issue any notice to the lender requesting postponement of the
presentation of the cheque for payment, giving an unqualified right to
the holder in due course of the cheque to take legal action under Section
138 of the Negotiable Instruments Act in the event of the dishonour of
the cheque, will be proper safeguard while accepting postdated cheques.

Such an undertaking will, in all probability, act as an effective check

against the debtor/borrower in giving any notice for the Postponement of
the presentation of the cheque for payment. This is because the debtor/
borrower cannot accept the benefit of an instrument and at the same time
reject any conditions attached to it. This is all the more important since
there is a likelihood for misinterpretation of the above judgment to suit
the requirements of unscrupulous debtors/borrowers who endeavour to
delay their liabilities.

4.0 CONCLUSION

From our discussion in this unit, we have stated that a negotiable

instrument refers to a written document guaranteeing the payment of a
specific amount of money, either on demand, or at a set time with the
payer named on the negotiable instrument. Therefore, a cheque is one of
such instruments that is amenable for baking transactions. There are
mainly two types of cheques such as open cheques and crossed cheques
with several variations. Customers of banks and banks themselves are
bound by some regulations regarding the use and acceptance of cheques.
Therefore, bankers in particular are to be diligent when dealing in
customers’ cheques in the normal course of banking business.

5.0 SUMMARY

In this study unit, we have discussed negotiable instruments and cheques

while the analyses borders on: nature of negotiable instruments;
meaning of negotiable instrument; requirements of negotiability of
negotiable instruments; meaning of cheque; differences between a
cheque and a bill of exchange; crossing of cheques; persons authorised
to cross or to open crossed cheques; cheque endorsements; marking of
cheques; holder and holder in due course; holder of a negotiable
instrument; holder in due course of a negotiable instrument; and liability
of the drawer for dishonour of cheques.

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In the next study unit, we shall discuss negotiable instruments: cheques,

promissory notes and bills of exchange.

6.0 TUTOR-MARKED ASSIGNEMENT

1. What is a negotiable instrument?

2. Give reasons why cheques are regarded as negotiable instrument.

7.0 REFERENCES/FURTHER READING

Dlabay, Les R.; Burrow, James L. & Brad, Brad (2009). Intro to
Business. Mason, Ohio: South-Western Cengage Learning.
p. 482. ISBN 978-0-538-44561-0.

Fraser, D. R., Gup, B. E. & Kolari, J.W. (1995). Commercial Banking:

The Management of Risk. New York: Western Publishing
Company

Money Market Account as retrieved from

http://www.investopedia.com/terms/m/moneymarketaccount.asp

Shekhar, K. C. & Shekhar, L. (2007). Banking Theory and Practice. (7th

ed.). New Delhi: Vikas Publishing House PVT Limited.

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MODULE 2

Unit 1 Promissory Notes and Bills of Exchange

Unit 2 Duties of Paying Banker and Collecting Banker
Unit 3 Bank Lending to Limited Liabilities Companies
Unit 4 Securities and Loan Recovery
Unit 5 Securities for Bankers Advances
Unit 6 Land and Security

UNIT 1 PROMISSORY NOTES AND BILLS OF

EXCHANGE

CONTENTS

1.0 Introduction
2.0 Objectives
3.0 Main Content
3.1 Promissory Notes
3.1.1 Definition of a Promissory Note
3.1.2 Kinds of Promissory Notes
3.1.3 Legal Considerations
3.2 Bills of Exchange
3.2.1 Definition of Bills of Exchange
3.2.1 Negotiation and Endorsement of Bill of Exchange
4.0 Conclusion
5.0 Summary
6.0 Tutor-marked Assignment
7.0 References/Further Reading

1.0 INTRODUCTION

In the preceding unit, we discussed some forms of negotiable

instruments and in the process, we did analyze the nature of negotiable
instruments and cheques. There are other prominent types of negotiable
instruments such as bills of exchange and promissory notes. In the
course of the analysis in this unit, we shall espouse on instruments such
as promissory notes and bills of exchange.

2.0 OBJECTIVES

At the end of this study unit, you should be able to:

• discuss the nature of promissory notes

• explain the nature of bills of exchange.

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3.0 MAIN CONTENT

3.1 Promissory Notes

3.1.1 Definition of a Promissory Note

Section 4 of the Negotiable Instruments Act defines a 'promissory note'

thus:

A promissory note is an instrument in writing (not being a Banknote or

currency note) containing an unconditional undertaking, signed by the
maker; to pay a certain sum of money only to or to the order of a certain
person, or to the order of the instrument.

Thus, just like the case of a bill of exchange, a promissory note must be
in writing and must be unconditional. Further, a promissory note must
be signed by the maker. It must be for a certain amount of money only.
It must be payable to or to the order of a certain person.

Section 5 of the Negotiable Instruments Act further espouses further on

the instrument thus:

A promise to pay is not conditional within the meaning of this Section

and Section 4, by reason of the time for payment of the amount or any
installment thereof being expressed to be on the lapse of a certain period
after the occurrence of a specified event which, according to the
expectation of mankind is certain to happen, although the time of its
happening may be uncertain.

Furthermore, the sum payable may be certain within the meaning of this
Section and Section 4, although it includes future interest or is payable
at an indicated rate of exchange, or is according to the course of
exchange, and although the instrument provides that on default of
payment of an installment the balance unpaid shall become due.

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3.1.2 Kinds of Promissory Notes

1. Promissory Note Payable on Demand

2. Promissory Note Payable after Date with Interest

SELF-ASSESSMENT EXERCISE 1

Explain the term Promissory Note and identify its peculiarities.

3.1.3 Legal Considerations

1. The words "whenever you demand" do not make the

undertaking a conditional one

Such words do not make the obligation of the executant of the

instrument conditional upon the actual demand being made by the
person in whose favour the instrument is executed. The obligation arises
as soon as the instrument is executed and those words are inserted
merely in recognition of this obligation with a view to emphasizing that
the amount should be payable immediately or forthwith. The implication
these words is the same as "I promise to pay you on demand" and if the
latter words do not have the effect of restricting negotiability, the former
cannot have that effect.

Section 4 of Negotiable Instruments Act does not say that the name of
the payee must be specified in the words of the promise nor does it say
that the payee must be specified in any particular part of the instrument.

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Nevertheless, the name of the payee might be set out on any part of the
instrument, and as long as it appears clearly on the instrument taken as a
whole that the instrument specified the payee with certainty, and the
other ingredients of the definition were satisfied, it must be held to be a
promissory note.

Section 4 of Negotiable Instruments Act provides that:

A document which is only a receipt enumerating the terms on

which the amount is to be refunded must be distinguished from a
document which is a promissory note. At the same time,
an acknowledgment of receipt of the amount will not
exclude the document from the category of a promissory note.

According to Section 4 of the Negotiable Instruments Act, the essential

ingredients of a promissory note are:

(i) that the promise to pay must be unconditional;

(ii) that the note must be in writing and signed by the maker;
(iii) that the promise to pay must be for a certain sum of money; and
(iv) that the promise to pay must be to or to the order of a certain
person or to the bearer of the instrument.

Furthermore, the above Section also shows that an acknowledgment of

receipt of amount which is specified on the Promissory Note does not
take away the document from the category of a promissory note. It is
instructive to note that where a promissory note is executed by the
managing partner of a firm, the other partners are also liable thereunder
as makers.

For instance, if a promissory note is executed on behalf of a firm by its

managing partner in renewal of prior promise on the strength of the fact
that the promisee endorses the same, for consideration, in favour of the
endorsee. If the endorsee files a suit against the endorser, the managing
partner as well as all the other partners of the firm are liable for any
breach. In view of Sections 5,18,19 and 22 of the Partnership Act, every
partner was liable jointly with all other partners, and also severally, for
all acts of the firm done while a partner. Hence since the document is
executed by the managing partner, and since the monies drawn were
utilized for the purpose of the firm, every partner is liable.

According to Section 16(2) of the Negotiable Instruments Act, the

endorsee would stand on the same footing as the payee, and under
Section 50 of the Act, the endorsement of a negotiable instrument
followed by delivery would transfer the property therein to the endorsee
with the right to further negotiation. Nevertheless, the endorsement may

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by express words, restrict or exclude such right or may merely constitute

the endorsee an agent to endorse the instrument, to receive its contents
for the endorser or for some other specified person. Once there is no
such restriction, the endorsee is entitled to protection from the partners
of the firm for the amount due from those liable under the promissory
note as makers.

2. A person who is not a holder of a promissory note is not entitled

to sue for the amount due thereon

According to Section 78 of the Negotiable Instruments Act, payment of

the amount due on a promissory note, in order to discharge the maker or
acceptor, must be made to the holder of the instrument. The Act defines
a "holder" to mean a person entitled in his own name to the possession
thereof and to receive or recover the amount due thereon from the
parties thereto.

3. The liability on a promissory note is not affected by the body of

the promissory note and the signature of the executant being in
different ink

This implies that it is immaterial if the body of the promissory note and
the signature of the executant are in different ink.

4. The assignor of a promissory note has a duty to indemnify the

maker who is put to loss on account of the fraudulent act of the
former

In the case of whether the assignor has a duty to indemnify the maker of
a promissory note, if an allegation has been in which rendered the claim
based on the same unenforceable. The status is that if the maker of a
promissory note is made liable, he cannot proceed against the endorser
as if the latter was a surety as the liability under the note is always and
ultimately that of the maker.

And where the endorser negotiates a promissory note for the full value
without giving credit to any payment that he might have received from
the maker which is endorsed on the note, the case is one where the payee
or the endorser fraudulently negotiates the note for the full value.

Therefore, the holder in due course in such an event cannot be prevented

from collecting the money due on the promissory note according to its
tenor and that, If the maker is put to loss on account of the fraudulent act
of the payee or endorser his remedy would be only in the nature of
damages and not amounting to an equitable claim of indemnity The
maker who is in the position of principal debtor not having any right of

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indemnity against the original payee or endorser would not have any
right to proceed against the latter.

5. Negligence of the maker of a promissory note and the loss

suffered by the endorsee

The above implies that where the maker of a promissory note fails to get
partial discharge of the principal amount endorsed on the promissory
note, and where and endorsee has no knowledge about the partial
discharge, the maker will become liable to pay the endorsee the entire
amount under the same. Although the maker may take appropriate steps
for refund of the said amount from the original payee, he will have to
suffer for the consequential losses against the endorsee.

6. Any alteration of a promissory note by the promisee inserting the

rate of interest would amount to material alteration vitiating the
instrument

Even though the law provides that Where a promissory note does not
express the rate of interest payable thereon, six per cent interest shall be
payable under Section 80 of the Negotiable Instruments Act, any
alteration on the instrument would amount to material alteration,
vitiating the instrument.

Section 20 of the Negotiable Instruments Act allows for filling up the

endorse as regards the rate of interest. According to Section 20 of the
Act, where one person signs and delivers to another, a paper stamped in
accordance with the law relating to negotiable instruments either wholly
blank or having written thereon an incomplete instrument, he thereby
gives prima facie authority to the holder thereof to make or complete, as
the case may be, not exceeding the amount covered by the stamp.

Nevertheless, Section 80 of the Act provides that where no rate of

interest is mentioned, six per cent would be deemed to be the rate of
interest payable, and therefore, a endorsee, which did not mention the
rate of interest payable thereon, could not be said to be an incomplete
instrument and consequently, a promisee had no authority to fill up the
instrument with regard to the rate of interest. If he did so, it would
amount to material alteration.

7. Negotiable instruments must come into existence only for the

purpose of recording an agreement to pay money and nothing
more, though, of course, they may state the consideration

A document is not a promissory note if the last sentence of the document

promised the performance of an act in addition to the payment of

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money. Negotiable instruments must come into existence only for the
purpose of recording an agreement to pay money and nothing more,
though, of course, they may state the consideration.

More often than not bankers often grant credit facilities on the basis of
documents which contain a promise to pay money on stated dates. Some
of these documents are lengthy, and the banker has to ensure that they
do not contain any provision which may take them out of the category of
promissory notes, as otherwise the banker may find that he will be
unable to enforce rights against the concerned parties.

SELF-ASSESSMENT EXERCISE 2

Enumerate some legal considerations in relation to the use of

Promissory Note.

3.2 Bills Of Exchange

3.2.1 Definition of Bills of Exchange

A bill of exchange or "draft" is a written order by the drawer to the

drawee to pay money to the payee. A common type of bill of exchange
is the cheque, which we have discussed in the preceding study unit,
defined as a bill of exchange drawn on a banker and payable on demand.
Bills of exchange are used primarily in international trade, and are
written orders by one person to his bank to pay the bearer a specific sum
on a specific date. Prior to the advent of paper currency, bills of
exchange were a common means of exchange. They are not used as
often in the modern business transactions.

According to the Bill of Exchange of 1933, a bill of exchange is

essentially an order made by one person to another to pay money to a
third person. A bill of exchange requires in its inception three parties—
the drawer, the drawee, and the payee. The person who draws the bill is
called the drawer. He gives the order to pay money to the third party.
The party upon whom the bill is drawn is called the drawee. He is the
person to whom the bill is addressed and who is ordered to pay. He
becomes an acceptor when he indicates his willingness to pay the bill.
The party in whose favour the bill is drawn or is payable is called the
payee.

The parties to a bill of exchange need not all be distinct persons. Thus,
the drawer may draw on himself payable to his own order. A bill of
exchange may be endorsed by the payee in favour of a third party, who
may in turn endorse it to a fourth, and so on indefinitely. The "holder in
due course" may claim the amount of the bill against the drawee and all

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previous endorsers, regardless of any counterclaims that may have

disabled the previous payee or endorser from doing so. This is what is
meant by saying that a bill is negotiable. In some cases a bill is marked
"not negotiable" such as in crossing of cheques. Therefore, it can still be
transferred to a third party, but the third party can have no better right
than the transferor.

The Bills of Exchange Act defines bill of exchange and some other
negotiable instruments as follows:

1. The Act defines a bill of exchange as: “an unconditional order in

writing, addressed by one person to another, signed by the person
giving it, requiring the person to whom it is addressed to pay on
demand, or at a fixed or determinable future time, a sum certain
in money to or to the order of a specified person, or to bearer.”
2. The Act defines a cheque as: “a bill of exchange drawn on a
banker payable on demand.”
3. The Act defines a promissory note as: “an unconditional
promise in writing made by one person to another, signed by the
maker, engaging to pay on demand, or at a fixed or determinable
future time, a sum certain in money to or to the order of a
specified person or to bearer.”

SELF-ASSESSMENT EXERCISE 3

Explain the term bill of exchange.

3.2.1 Negotiation and Endorsement of Bill of Exchange

Persons other than the original obligor and obligee can become parties to
a negotiable instrument. The most common manner in which this is done
is by placing one's signature on the instrument. If the person who signs
does so with the intention of obtaining payment of the instrument or
acquiring or transferring rights to the instrument, the signature is called
an endorsement.

There are five types of endorsements, which are mentioned and

explained as follows:

i) Special Endorsement

An endorsement which purports to transfer the instrument to a specified

person is a special endorsement – for example, "Pay to the order of
Nnamani."

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ii) Endorsement in Blank

An endorsement by the payee or holder which does not contain any

additional notation (thus purporting to make the instrument payable to
bearer) is an endorsement in blank or blank endorsement

iii) Restrictive Endorsement

An endorsement which purports to require that the funds be applied in a

certain manner (for example, "for deposit only", "for collection") is a
restrictive endorsement; and,

iv) Qualified Endorsement

An endorsement purporting to disclaim retroactive liability is called a

qualified endorsement (through the inscription of the words "without
recourse" as part of the endorsement on the instrument or in allonge to
the instrument).

v) An endorsement purporting to add terms and conditions is called a

conditional endorsement, for example, "Pay to the order of
Ademulegun, if he clears my farmland on “May 30th , 2014".

If a note or draft is negotiated to a person who acquires the instrument in

good faith; for value; and without notice of any defences to payment, the
transferee is a holder in due course and can enforce the instrument
without being subject to defences which the maker of the instrument
would be able to assert against the original payee, except for certain real
defences.

Such real defences include the following:

(1) forgery of the instrument;

(2) fraud as to the nature of the instrument being signed;
(3) alteration of the instrument;
(4) incapacity of the signer to contract;
(5) infancy of the signer;
(6) duress;
(7) discharge in bankruptcy; and
(8) the running of a statute of limitations as to the validity of the
instrument.

The holder-in-due-course rule is a rebuttable presumption that makes the

free transfer of negotiable instruments feasible in the modern economy.
A person or entity purchasing an instrument in the ordinary course of
business can reasonably expect that it will be paid when presented to,

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and not subject to dishonor by, the maker, without involving itself in a
dispute between the maker and the person to whom the instrument was
first issued. This can be contrasted to the lesser rights and obligations
accruing to mere holders.

SELF-ASSESSMENT EXERCISE 4

Enumerate and explain the various types of endorsement in respect of

Bill of Exchange.

4.0 CONCLUSION

From our discussion in this unit, you have appreciated the fact that
promissory note and bill of exchange share the same nature with all
other negotiable instruments. Promissory Note just like the Bill of
Exchange involves a written order by one person to his bank to pay the
bearer a specific sum on a specific date. They are both contractual
obligations and therefore, re governed by some legal rules and
regulations, which must be taken into consideration whenever bankers
are dealing with them.

5.0 SUMMARY

In this course of analysis in this study unit, we have discussed other

negotiable instruments such as Promissory Note and Bill of Exchange in
terms of: definition of a promissory note; kinds of promissory notes;
legal considerations; bills of exchange; definition of bills of exchange;
and negotiation and endorsement of bill of exchange. In the next study
unit, we shall discuss duties of paying bankers and collecting bankers.

6.0 TUTOR-MARKED ASSIGNEMENT

1. Define Bill of Exchange and Promissory Note.

2. Differentiate between Promissory Note and Bill of Exchange.

7.0 REFERENCES AND MATERIALS FOR FURTHER

READING

Dlabay, Les R.; Burrow, James L. & Brad, Brad (2009). Intro to
Business. Mason, Ohio: South-Western Cengage Learning.
p. 482. ISBN 978-0-538-44561-0.

Fraser, D. R., Gup, B. E. & Kolari, J.W. (1995). Commercial Banking:

The Management of Risk. New York: Western Publishing
Company.

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Money Market Account as retrieved from

http://www.investopedia.com/terms/m/moneymarketaccount.asp

Shekhar, K. C. & Shekhar, L. (2007). Banking Theory and Practice. (7th

ed.). New Delhi: Vikas Publishing House PVT Limited.

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UNIT 2: DUTIES OF PAYING BANKERS AND

COLLECTING BANKERS

CONTENTS

1.0 Introduction
2.0 Objectives
3.0 Main Content
3.1 Negotiable Instruments
3.2 Paying Banker
3.2.1 Paying Bankers’ Duties & Responsibilities.
3.2.2 Important Considerations for Payment Of Cheques
3.2.3 Circumstances under Which a Banker is Justified in
Refusing Payment of a Cheque Drawn on Him
3.2.4 Protection Given to a Paying Banker
3.2.5 Payment in Due Course
3.2.6 Money Paid by Mistake
3.3 Collecting Banker
3.3.1duties and Responsibilities of Collecting Bankers
3.3.2 Collecting Banker’s Protection
4.0 Conclusion
5.0 Summary
6.0 Tutor-marked Assignment
7.0 References/Further Reading

1.0 INTRODUCTION

In the preceding unit, we discussed negotiable instruments such as

promissory notes and bills of Exchange. In this study unit, we shall
discuss the responsibilities of both paying and collecting bankers in
negotiable instruments like cheques, bank drafts, promissory notes and
bills of Exchange in the normal course of the banking operations.

2.0 OBJECTIVES

At the end of this study unit, you should be able to:

• discuss the nature of negotiable instruments

• explain the nature of cheque as a form of negotiable instruments.

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3.0 MAIN CONTENT

3.1 Negotiable Instruments

In this subsection of the unit, we have to revise the realm of negotiable

instruments. On the basis of section 13 of the negotiable instrument Act.
1881, “A negotiable instrument means a promissory note, bill of
exchange or cheque payable either to order or to bearer,” which also
involves a Banker’s draft. Such negotiable instruments as discussed in
earlier study unit include the following:

1. Promissory Note

A promissory note is an instrument in writing containing an

unconditional under taking signed by the maker to pay on demand or at
a fixed or determinable future time a certain sum of money only to, or to
the order of a certain person, or to the bearer of the instrument.

2. Bill of Exchange

A bill of exchange is an instrument in writing containing

an unconditional order signed by the maker directing a certain person to
pay on demand or at a fixed or determinable future time a certain sum of
money only to or the order of a certain person or to the bearer of the
instrument.

3. Cheque

A cheque is an unconditional order of the drawer in writing bearing a

date, to the Banker maintaining his account to pay on demand, to a
named person, his order or bearer, a certain specified sum of money,
expressed in both figures and words.

4. Bank Draft

A bank draft is an unconditional order to pay by which the party creating

the draft, that is the drawer, orders another party, that is the drawee,
typically a bank, to pay money to a third party, that is the payee.

5. Quasi Negotiable instruments: There are some instruments

which are Quasi Negotiable instruments in nature. These are
instruments which are in practice, treated negotiable for certain
events only and are so regarded by usage and custom. Some of
these are documents of title of goods and property while others
are documents of value. Such as, bill of lading, railway receipts,

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stock and share certificates, debentures, dividend warrants,

interest coupons and treasury bills.

SELF-ASSESSMENT EXERCISE 1

Enumerate and explain various types of negotiable instruments.

3.2 Paying Banker

The paying banker is one who undertakes to pay various types of

instruments representing money on behalf of his customer or his own
behalf from the drawers of such instruments, some of which are
negotiable instruments as provided for in the negotiable instruments Act
1881 while some other ones are quasi negotiable instruments.

3.2.1 Paying Bankers’ Duties and Responsibilities

A banker on whom the cheque is drawn should pay the cheque, when it
is presented for payment. It is his obligation to make payment for his
customers on the strength of cheques presented to the bank to the extent
of the fund available and the existence of no legal bar for payment. The
paying banker should use reasonable care and diligence in paying a
cheque so as to abstain from any action likely to damage his customers’
credit reputation.

At the time of making payment for the customers, the bankers should
observe the following very carefully:

i. Verification of signature of the drawer.

ii. Verification of the genuineness of the instrument.
iii. Payment not stopped by the account holder.
iv. Holders title on the cheque is valid.
v. Account is not dormant one.
vi. Account holder is not bankrupt, deceased and insane.
vii. Account is not under subject of liquidation process.
viii. No ‘Guernsey Order’ is issued by count.
ix. Properly endorsed.
x. Cheque is not drawn beyond limit fixed by the drawer is respect
of amount.
xi. Instrument being presented is crossed.
xii. Instrument is not state or postdated.
xiii. No material alteration is made.
xiv. Sufficient balance in the account.

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SELF-ASSESSMENT EXERCISE 2

Enumerate the considerations for making payments by the banks.

3.2.2 Important Considerations for Payment of Cheques

There are important considerations to be observed while honouring

customer's cheques up to the amount of credit balance in his account, or
up to the limit of any agreed overdraft. Such considerations include the
following:

1. The cheque must be in the proper form

It must satisfy the conditions specified in the Negotiable Instruments

Act such as:

i) Section 6: A cheque is a bill of exchange drawn on a specified banker

and not expressed to be payable otherwise than on demand.
ii) Section 5: A bill of exchange is an instrument in writing containing
an unconditional order, signed by the maker, directing a
certain person to pay a certain sum of money only, to or to
the order of, a certain person or to the bearer of the
instrument.

A promise or order to pay is not conditional within the meaning of this

Section and Section 4, by reason of the time for payment of the amount,
or any installment thereof, being expressed to be payable on the lapse of
a certain period or after the occurrence of a specified event.

The sum payable may be certain within the meaning of this Section and
Section 4, although it includes future interest or is payable at an
indicated rate of exchange, and the instrument provides that, on default
of payment of an installment, the balance unpaid shall become due.

2. Drawer's signature must correspond with the specimen

signature

The signature of the drawer on the cheque must correspond with the
specimen signature obtained by the banker at the time of opening the
account. The question of negligence on the part of the customer, such as
leaving the cheque book carelessly, would afford no defence to the bank
where the signature – or where two persons are authorized to operate on
the account, either the signatures or one of the signatures to the cheque
is not genuine.

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3. The cheque must not be either stale or postdated

A stale cheque is one which has been in circulation over an

unreasonably long period. The custom of bankers in this respect varies.
Generally a cheque is considered as stale when it has been in circulation
for more than six months and bankers return such cheques for the
drawer's confirmation. A postdated cheque is one which bears a date
later than the one on which the cheque is actually drawn.

A banker should not pay a postdated cheque before it is due for

payment. As posited by Sir John Paget, a banker who pays a postdated
cheque before the ostensible date stands a very poor chance of being
able to debit his customer with it in any conceivable circumstances if the
customer chooses to object to be debited. It is to be noted that a banker
honouring a postdated cheque will lose his statutory protection.
Relatedly, Sheldon has pointed out the following dangers in honouring a
postdated cheque:

(a) If a person finds a postdated cheque and is able to get it cashed

by the drawee banker before the date written on the cheque, the
banker will be liable to the drawer for the amount.

(b) If a banker pays a postdated cheque, and dishonours other

cheques, which would otherwise have been paid, he will be liable
to his customer for damage to his credit.

(c) If a banker holds a postdated cheque pending the arrival of the

due date, the customer may fail in the meantime. And the banker
cannot debit his customer's account with a postdated cheque on
arrival of its due date if the customer stops payment of it before
such date.

4. The amount should be expressed in words, or in words and

figures which should agree

Bankers generally pay cheques bearing the amount in words only, but
return cheques bearing the amount in figures only marked 'amount
required in words'. When the amount in words differs from that in
figures, a banker is justified in returning it marked 'words and figures
differ'.

However, Section 18 of the Negotiable Instruments Act provides that

where there is a difference between the amount in words and the amount
in figures, the amount in words is the amount payable.

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5. The banker should be careful when mutilated cheques are

presented for payment

A cheque is mutilated when it has been cut or torn, or when a part of it is

missing. Mutilation may be accidental or intentional. When it is
accidental, the banker should get the drawer's confirmation before
honouring it. In the latter case, the banker should refuse payment.
Otherwise, the drawer can refuse to be debited with such a cheque.
Hence the banker should return such a cheque marked mutilated cheque
or mutilation requires confirmation.

6. Material alterations must be confirmed by the drawer

An alteration which in any way alters materially or substantially the

operation of the instrument and the liabilities of the parties thereto,
irrespective of whether or not the change is prejudicial to the payee, is
material. This includes alteration of the date, the crossing, the place of
payment, the amount and the name of the payee.

In terms of Section 87 of the Negotiable Instruments Act:

Any material alteration to a negotiable instrument renders the same void

as against anyone who is a party thereto at the time of making such
alteration, and does not consent thereto, unless it was made in order to
curly out the common intention of the original parties; and any such
alteration, if made by an endorsee, discharges his endorser from all
liability to him in respect of the consideration thereof.

Hence, this implies that material alterations make a cheque void. Hence
a banker honouring a cheque with material alterations is not allowed to
debit his customer's account or else, he should make sure that material
alterations are confirmed by the drawer. In case the cheque is signed by
more than one person, material alterations should be confirmed by the
signature of all the persons.

When either party to a joint account has authority to sign cheques alone,
the signature of one is sufficient; and that need not necessarily be the
one who originally signed the cheque. In case of corporate bodies,
alterations should be confirmed not only by the Secretary but by all the
signatories, unless the Secretary alone has the power to issue and sign
cheques for the company.

The drawer may convert an order cheque into a bearer cheque by

substituting the word 'bearer' for order. However, only the drawer has
such a power and any such alteration should be confirmed by him. In the
case of a bearer cheque, any holder may alter it to an order cheque.

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Here, the drawer's confirmation is not necessary.

Alteration of the name of the branch at which the cheque is payable, the
opening of crossing, deletion of the words 'not negotiable', alteration of
the amount payable, the date of payment, etc. should be confirmed the
drawer’s signature. To be on the safe side, it is advisable for the paying
banker to make sure that all alterations are confirmed by the full
signature of the drawer.

A paying banker honouring cheque which has been materially altered,

without the drawer's confirmation, cannot debit the drawer's amount.
However, this general rule is subject to one important qualification. A
banker is justified in honouring a cheque that bears a non-apparent
alteration.

7. The cheque must be properly endorsed

In the case of a bearer cheque, endorsement is not legally necessary. In

the case of an order cheque, endorsement is necessary. An order cheque
may be made payable to the bearer by an endorsement in blank. Further,
a cheque originally expressed to be payable to bearer always remains a
bearer cheque. This is expressly laid down in the Negotiable
Instruments Act. Under Section 85 of the Act:

Where a cheque is originally expressed to be payable to bearer the

drawee is discharged by payment in due course to the bearer thereof
notwithstanding any endorsement whether in full or in blank that any
such endorsement purports to restrict or exclude further negotiation.

Before honouring a cheque, the paying banker should see that the
endorsements on the cheque are regular. Certain general rules regarding
endorsements have been discussed in a preceding study unit. Let us
recap the rules as follows:

i) The endorsement must literally follow the spelling of the payee's

or endorsee's name as used by the drawer or endorser,
irrespective of whether or not it is wrongly spelt.

ii) According to Sir John Paget, the paying banker is justified in

returning the cheque marked 'endorsement illegible' or
'endorsement requires confirmation that the oriental characters
represent the equivalent of the name of the person whose
endorsement is necessary'. The certified translation of a notary
public may be accepted.

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iii) A banker is justified in returning cheques bearing an endorsement

that includes a courtesy title. In other words, an endorsement
should be in the form of ordinary signature of the payee or
endorsee. Also, complimentary prefixes, suffixes, and other
courtesy titles do not form art of endorsements. Such
endorsements are considered regular in certain countries.

iv) In the case of fictitious payees, no endorsement is required. Such

cheques are generally considered to be bearer cheques. For
instance, when the payee is named 'Father Christmas', no
endorsement is required.

8. The paying banker must not pay a cheque in a manner

inconsistent with the directions contained in the crossing

Where a cheque is crossed generally, the banker on whom it is drawn

shall pot pay it otherwise than to a banker. Where the cheque is crossed
specially, payment shall be made only to the banker to whom it is
crossed, or his agent for collection. The addition of the words 'not
negotiable', 'account payee' etc. does not materially affect the position of
the paying banker.

SEL-ASSESSMENT EXERCISE 3

Enumerate the important considerations for payment of cheques.

3.2.3 Circumstances under Which a Banker Is Justified in

Refusing Payment of a Cheque Drawn On Him

A banker's obligation to honour his customer's cheques is terminated on

the occurrence of any one of the following events:

At the instance of a notice from the customer to stop payment

(countermanding payment):

a) The banker should obtain instructions in writing concerning the

drawer stopping the payment of a cheque. Such instructions
should contain the number, the date, the amount and the name of
the payee of the cheque, and should be signed by the drawer. The
payment of a cheque can be countermanded by one of the several
partners, trustees or executors. So also, when cheques are to be
signed by any of the two directors of a joint stock company, its
payment can be stopped by any director.

b) When a banker honours a cheque, the payment of which has been

stopped by the drawer through written instructions, the banker

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will have to bear any loss arising therefrom.

c) A banker should not stop payment of a cheque in relying on

instructions by telephone or telegram. At best, he may return the
cheque marked 'payment countermanded by telegram/telephone;
payment postponed pending confirmation, present again'.
Meanwhile, the banker should try to obtain the drawer's written
confirmation.

d) The paying banker owes no duty to a holder of a cheque

concerning stop payment instructions from him. As such he
should not rely on the instructions from a holder that the cheque
has been lost should request the holder to obtain written
instructions from the drawer. If the cheque presented in the
meanwhile, he may return cheque as in the case of
countermanding payment by telegram. However, he should be
careful to ensure that he does not damage customer's credit
reputation.

e) If the holder of an order cheque, having lost it, informs the

banker that he has not endorsed it, payment should be refused
because the presentee must be claiming through forged
endorsement. If the banker pays such a cheque, he may be held
liable for not acting in good faith and for negligence.

f) Payment of cheques may be stopped by the banker at the instance

of the following:

i) Notice of the customer's death.

ii) Notice of the customer's insanity
iii) Notice of the customer's bankruptcy
iv) Knowledge of any defect in the title of the person presenting the
cheque.
v) Notice of an assignment by the customer of the available credit
balance (on the receipt of such a notice, the customer's credit
balance ceases to belong to him).
vi) Notice of a garnishee order
vii) In the case of trust accounts, knowledge that the customer
contemplates breach of trust.
viii) In addition, a holder is not entitled to receive money unless the
cheque is presented at the branch during business hours at which
the customer's account is kept.

SELF-ASSESSMENT EXERCISE 4

Enumerate the circumstances under which a banker is justified in

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refusing payment of a cheque drawn on him.

3.2.4 Protection Given to a Paying Banker

1. Crossed Cheques

Under Section 128 of the Negotiable Instruments Act, protection is

given to a paying banker in the case of payment of crossed cheques. The
Section runs as follows:

Where the banker on whom a crossed cheque has paid the same in due
course, the banker paying the cheque, and in case such cheque has come
into the hands of the payee, the drawee thereof shall respectively be
entitled to the same rights, and be placed in the same position as they
would respectively be entitled to and placed as if the amount of the
cheque had been paid to and received by the true owner thereof.

This implies that protection is given to a paying banker in the case of

crossed cheques, if he has paid in due course.

2. Uncrossed Cheques

Section 85 of the Negotiable Instruments Act extends protection to the

paying banker in the case of uncrossed cheques. Here too, he is
discharged by payment in due course. The Section runs as:

i) Where a cheque payable to order purports to be endorsed by or

on behalf of the payee, the drawee is discharged by payment in
due course.

ii) Where a cheque is originally expressed to be payable to bearer;

the drawee is discharged by payment in due course to the bearer
thereof notwithstanding any endorsement whether in full or in
blank appearing thereon, and notwithstanding that any such
endorsement purports to restrict or exclude further negotiation.

3. Demand Drafts

The Act protects a paying bank in the case of demand drafts also. In
terms of the Act:

Where any draft, that is, an order to pay money drawn by one office af a
bank upon another office of the same bank for a sum of money payable
to order on demand purports to be endorsed by or on behalf of the payee,
the bank is discharged by payment in due course.

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3.2.5 Payment In Due Course

The paying banker can claim protection only on payment in due course
of a cheque or draft. Therefore, let us examine the meaning of the term
'payment in due course'.

In terms of Section 10 of the Negotiation Instruments Act:

Payment in due course means payment in accordance with the apparent

tenor of the instrument, in good faith and without negligence to any
person in possession thereof under circumstances which do not afford a
reasonable ground for believing that he is not entitled to receive
payment of the amount therein mentioned.

Thus, in order to constitute 'payment in due course', the paying banker

must see that the following conditions are fulfilled:

a) Payment must be in accordance with the apparent Tenor of

the Instrument

In other words, payment must be in accordance with the intention of the

parties as it appears on the face of the instrument. For instance, when the
paying banker disregards the crossing and pays cash across the counter,
the payment cannot be considered 'payment in due course'. Here the
banker disregards the intention of the drawer by way of crossing
appearing on the face of the instrument. Again, where a banker pays a
postdated cheque before the ostensible date of issue, the payment cannot
be considered a 'payment in due course'. Here again the paying banker
disregards the intention appearing on the face of the instrument.

b) Payment must be in good faith and without negligence

The banker's negligence may be found in the case of payment of a

cheque bearing a forged signature of the drawer, which clearly differs
from the specimen signature supplied to him. Even when the signature
of the drawer is cleverly forged and if it is similar to the specimen
signature supplied to the paying banker in every respect, it depends on
the circumstances of that particular case to conclude categorically
whether he is liable for negligence.

It is for the customer to establish affirmatively that the signature on the

disputed cheque is not that of the customer but a forgery. The following
considerations are important:

i) If the drawer's signature is forged or unauthorized, however

clever the forgery is, the banker cannot debit his customer's

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account in case he pays the amount unless he establishes adoption

or estoppels;

ii) What amounts to adoption or estoppel is dependent on the

circumstances of each case;

iii) In order to make the customer liable for the loss, negligence on
his part must be intimately connected with the transaction itself
and must have been the proximate cause of the loss;

iv) The banker cannot set up either estoppel or adoption if his own
conduct or negligence has occasioned or contributed to the loss,
the well settled principle being that where two innocent parties
must suffer for the fraud of a third party, he whose negligence
facilitated the fraud should suffer.

In Wealden Woodlands (Kent) Ltd. Vs National Westminster Bank Ltd,

the decision is that a bank which pays forged cheques cannot resist the
customer's request for the amount to be credited on the grounds that the
customer had failed to note the payment from its bank statement, and
was therefore deemed to have adopted the payment.

The Learned Judge in the case, however, implied that the bank's defence
might be available if the customer was in some way culpable. In the
instant case also, a trusted director had forged the signature of another
director on cheques over a period of 9 months.

Rejecting the bank’s claim that the customer was estopped from
recovery payments on the forged cheques, the Learned Judge observed
that the customer was under no obligation examine his bank statements,
and that failure on the part of the customer to draw inferences from
those statement would not constitute negligence on his part, so that
could be estopped from claiming the amounts paid forged cheques from
the bank.

c) Payment must be made under circumstances which do not

afford a reasonable ground for believing that the person
presenting the cheque is not entitled to receive payment of the
amount mentioned therein

The paying banker, before making payment, should make sure that the
person presenting the cheque is entitled to receive the amount. For
instance, where the paying banker pay a cheque, the payment of which
has been countermanded by the drawer, the payment cannot be
considered ‘payment in due course even if the person presenting it is not
the true owner, provided the banker pays it under circumstances which

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do not afford a reasonable ground for believing that the person

presenting it is not entitled to receive the amount.

3.2.6 Money Paid by Mistake

The following are important considerations in respect of money paid by

mistake:

1. In a situation where a paying banker pays money by mistake,

cannot recover the amount. If money was paid under, a mistake
of law, the banker cannot recover it, as has been held in Holt Vs
Markham. For instance, if a person pays a debt in ignorance of
the law of limitation; the mistake is a mistake of law, and the
money is not recoverable.

2. The underlying principle is that all persons are expected to know

the law, and ignorance thereof is no defence in a Court of Law.
But when money is paid under a mistake of fact, the banker has,
in general, a right to recover the amount. However, it must be
shown that the mistake was one of fact between the payer and the
receiver, and the mistake arose out of the actual transaction
between the payer and the receiver.

3. It may be pointed out here that if the person receiving the money
was aware that he was not entitled to the money, the banker's
right of recovery is of indisputable. Nevertheless, if the recipient
acted bonafide and the banker does not find out the mistake until
the recipient has altered his position, it appears that the banker
cannot recover the money.

For instance, if money was paid to and received by an innocent party as

an agent, and he, before receiving notice of the mistake, has transferred
money to the principal, the banker's right altered. Another instance of
alteration of the recipient's position can be found where postponement of
notice to the recipient has prevented him from giving due notice of the
dishonour to the persons liable on the instrument.

4. Money paid under a mistake of fact between the banker and the
recipient cannot be recovered if it was paid to an innocent holder
in respect of a negotiable instrument. However, the payment of a
cheque bearing a forged signature followed by a genuine
endorsement is made to an innocent holder; the banker has a right
of recovery, provided the mistake is pointed out to the recipient at
once, before his position may have been altered to his detriment.
5. When the mistake of fact lies between the banker and the drawer
of a cheque, the banker cannot recover the money paid to an

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innocent holder. For instance, where a banker discovers, after

paying a cheque, that the drawer had no funds in his account, he
cannot recover the money from an innocent holder, even if the
latter has not left bank premises. The payment is complete as
soon as the money is placed on the bank counter and the recipient
has touched it. The mistake is not between the banker and the
holder of the cheque.

6. Where a banker receives money from a third party for crediting to

a customer's account and has credited the same in his account, the
banker cannot, without the authority of the customer, reverse the
credit entry made in the account and pay back the money to the
person who has deposited it, even though he might have
deposited it by mistake.

7. When the amount overpaid is received by the bank on behalf of a

customer for crediting to his account, and has credited the same,
it becomes money of the constituent. While the customer may be
under liability to refund the money so credited, the banker cannot
reverse the credit without the consent of the customer. Since it is
received correctly for crediting the account of the customer, there
is no mistake on the part of the bank in crediting this money to
that account.

8. Payment of a stopped cheque in error. In case a paying banker

pays a stopped cheque in error, he will have a right of recourse
under the doctrine that payment was made under 'a mistake of
fact', as was held in Barclays Bank Ltd. Vs Simson & Cook Ltd.

Exceptions to such right of recourse hold under the following

circumstances:

a) Where payment was of a negotiable instrument which had

been negotiated;
b) Where the payee has altered his position as a consequence
of the payment;
c) Where the "mistaken fact" was not made as between the
payer and the receiver; and
d) Where the fact was not material.

9. Payment of domiciled bills. When a drawee accepts a bill of

exchange elsewhere than at his place of business or private
address the bill is said to be domiciled at the place of payment. A
banker is under no obligation to pay bills made payable at the
bank by the customer, unless the banker has expressly or through
implication agree to pay bills domiciled with him.

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9. Basically, bankers take a mandate from the customer before

agreeing to pay bills domiciled with him. This mandate includes
an undertaking by the customer that he will not hold the banker
liable in case the bill bears a forged endorsement. This is
especially important since a banker has no statutory protection
against forged endorsements on domiciled bills.

10. The conditions governing the payment of bills are, by and large,
similar to those applicable to the payment of cheques. Therefore,
the banker should satisfy himself regarding the correctness in
form, regularity of endorsements, genuineness of the acceptor's
signature, etc. However, it is not the duty of the banker to see
whether the signature of the drawer is genuine. It is the duty of
the acceptor to make sure that the signature of the drawer is
genuine.

SELF-ASSESSMENT EXERCISE 5

Enumerate the important considerations in respect of money paid by

mistake.

3.3 Collecting Banker

The Collecting Banker is one who undertakes to collect various types of

instruments representing money in favour of his customer or his own
behalf from the drawers of such instruments, some of which are
negotiable instruments as provided for in the negotiable instruments Act.

3.3.1 Duties and Responsibilities of Collecting Bankers

1. Acting as agent

While collecting an instrument, whether for credit to customer’s account

or for himself, the banker works as agent of his customer. As an agent
he has generally to take such steps and precautions to protect the interest
or his customer as a man of ordinary prudence would take to safe-guard
his own interest.

2. Scrutinizing the instruments

This is in areas of name of the holder, branch name, date, amount in

world and figure, any cutting without signature, material alteration of
any to be checked carefully.

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3. Checking the endorsement

Bankers has to check the instrument whether it has been endorsed

properly.

4. Presenting the instrument in due time

It is the responsibility of the collecting bank to present the instrument in

due time to the paying bank.

5. Collecting the proceeds in the payee’s account

It is the duty of collecting banks to collect and credit the proceeds of the
instruments to the proper/correct account.

6. Notice of dishonor and returning the instruments

If any instrument is dishonored by the paying bank it should be

communicated to the customer on the business day following the
receipt of the unpaid instruments.

SELF-ASSESSMENT EXERCISE 6

Enumerate the responsibilities of collecting bakers.

3.3.2 Collecting Banker’s Protection

In terms of Section 131 of the Negotiable Instruments Act, a banker,

while collecting crossed cheques, is given protection. According to this
Section:

A banker who has in good faith and without negligence received

payment of a cheque crossed generally or specially to himself shall not,
in case the title of the cheque proves defective incur any liability to the
true owner of the cheque by reason of having received such payment.

A banker receives payment of a crossed cheque for a customer within

the meaning of this Section, notwithstanding that he credits his
customer's account with the amount of the cheque before receiving
payment thereof.

I) Conditions Precedent to Protection of Collecting Bankers include

the following:

The above section protects a collecting banker when he collects a

crossed cheque bearing a forged endorsement, or in respect of which the

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customer has no title or a defective title. It may be noted here that to

claim protection, the collecting banker must strictly comply with the
provisions of the Section. These conditions are identified and discussed
below.

1. The Collecting Banker Should Act in Good Faith and

Without Negligence

The most important point for a banker to remember when he is

collecting cheques is that he must act in good faith and without
negligence. A thing is deemed to be done in good faith when it is done
honestly. But Section 131 of Negotiable Instruments Act also requires
him to act without negligence. Thus the question of negligence is
important to decide whether or not a collecting banker can claim
statutory protection.

Generally, it may be said that the question of negligence does not arise
when the banker is dealing with third parties. Negligence arises only
when there is a duty to act without negligence. In general, it may be
stated that a banker owes no such duty to a third party. Nevertheless, the
position of a collecting banker is different. As observed by Sir John
Paget, the assumption of this duty towards a stranger must be regarded
as part of the price paid by bankers for statutory protection. As such, in
case of a dispute, the collecting banker has to prove that he has acted
without negligence in order to get protection under the Act.

It is difficult to define the term 'negligence'. In W Wall Bank & Co. Ltd
Vs Westminster Bank Ltd., the Learned Judge observed that `negligence
is the doing of that which a reasonable man under all the circumstances
of the particular case in which he is acting would not do, or the failure to
do something which a reasonable man under those circumstances would
do. This definition does not convey a clear idea regarding the basis of
negligence. The term `negligence' has been widely interpreted by the
Courts. Hence it would be better to examine the term in the light of the
various judicial decisions.

2. Examination of endorsements

The collecting banker must satisfy himself that all the endorsements on
the cheque are regular. In Bavins Junr and Sims Vs London and South
Western Bank, it was held that the collecting banker was negligent in not
detecting that an endorsement and a signature to a receipt did not
correspond with the name of the payee.

If the endorsement is a per pro endorsement, or an endorsement put on

delegated authority, the banker is on enquiry as to the agent's power, and

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collection of a cheque without authority may involve the banker in

liability for any loss that may ensue, as was decided in Bissel & Co. Vs
Fox Brothers & Co.

Relatedly, in Crumplin vs The London Joint Stock Bank, it was held that
the words per pro and the fact that the bank did not make enquiries was
not complete evidence of negligence on the part of the bank. However,
to be on the safer side, it is advisable for the collecting banker to get a
proper written authority in case of an endorsement made by an agent.

3. Collection of a cheque made payable to a company for the

private account of an official endorsing the same

In Savory vs Lloyds Bank, it was held that the collection of a company's

cheque for a private account without obtaining a satisfactory explanation
would deprive the banker of statutory protection.

4. Collection of cheques drawn per pro on behalf of a firm and

made payable to the person so signing

In Midland Bank Ltd vs Reckit and Others, it was held that the bank was
negligent in not making enquiries before crediting, to the private account
of an attorney, the proceeds of cheques drawn by him under his power
of attorney.

Furthermore, in Lloyds Bank Ltd vs Chartered Bank Ltd., the collecting

banker was held guilty of negligence for the same reason. Here, the
chief accountant of Lloyds Bank drew- certain cheques under authority
and made them payable to the Chartered Bank, where he had a private
account. The cheques were handed over to Chartered Bank for collecting
them to his private account.

5. Collection of cheques payable to a partnership firm for the

private account of a partner

In Bevan Vs National Bank Ltd it was held that the collecting banker
was guilty of negligence in collecting cheques made payable to a
partnership firm for the private account of a partner.

6. Collection of cheques payable to a customer in his official

capacity for his private account

For instance, a cheque made payable to `Mr Gupta, Income Tax

Commissioner' should not be collected for the private account of Mr
Gupta.

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7. Collection of cheques where the customer is the endorsee and

not the payee (third party cheques)

In collecting such cheques, the collecting banker should be extremely

careful to safeguard the interests of the true owner. The collecting
banker would be held liable for negligence if he fails to verify the
genuineness of the endorsement of the payee.

Section 10 and 85 (1) of the Negotiable Instruments Act provides that in

view of the guarantee given by the collecting banker as to the reliability
of the endorsement, the bank would be justified ex facie in accepting it
and acting on that basis.

The collecting banker should take the least precaution to verify

endorsement of a cheque. In United Australia vs Barclays Bank Ltd.,
Lord Atkin observed that "in these days every bank clerk sees the red
light when a company's cheque is endorsed by a company official into
an account which is not the company's".

This not only applies to cases of companies or persons standing in a

fiduciary position, but also to cheques drawn in favour of an
incorporated company which has purportedly endorsed the cheque in
favour of another incorporated company due to the reason that every
credit and debit by cheques, for or against, is normally expected to find a
place in the accounts, and the usual way a company acts, is that when it
receives, it also makes payment by cheques and not through
endorsement, as in this case.

The Court considered decided cases in Lloyds Bank Ltd Vs Savory and
Co., Motor Trader Guarantee Corporation Vs Midland bank ltd held that
the question of good faith and negligence was a question of fact in the
light of the material in each case. In the instant case, the collecting
banker had not shown that he had acted in good faith and without
negligence in making the collection on the basis of the guarantee of the
forged endorsement.

7. Collection of cheques involving large amounts incompatible

with the customer's income, for his private account

In the case of Lloyds Bank Ltd. vs Chartered Bank Ltd., it was held that
the absence of enquiry on the source of a sudden increase in payment
was negligence on the part of the collecting banker. In the instant case, a
clerk of the plaintiff bank was entrusted with defendant bank, for the
credit of a small joint account of himself and his wife, bank drafts for
large amounts drawn in favour of Lloyds Bank. In such cases, it would
be advisable for the collecting banker to make reasonable enquiries. His

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failure to make reasonable enquiries, coupled with other circumstances,

may be considered as evidence of negligence.

8. Collection of cheques endorsed to the customer without

obtaining guarantee for the endorsement of the payee

Where a banker had collected cheques endorsed to his customer without

obtaining guarantee for the endorsement of the payee, he would be held
liable for negligence.

A banker should always take care to ask the payee the truth about the
endorsement made by customers to know the true payees of cheques and
drafts of their customers before making payments.

9. Alleged contributory negligence of the true owner is not a

defence for negligence of the collecting banker

However negligent the true owner may be, it can be no excuse for the
person who converts the article that he should be let off from his liability
due to negligence by the true owner. Nevertheless, negligence should
not be confused with the plea of estoppels.

In this consideration, the details of Lumsden and Co. vs London Trustee

Savings Bank would be of interest since it is the first reported case in
which it has been held that when awarding damages against a collecting
bank in respect of the conversion of the proceeds of cheques paid in by a
customer, to which the customer was not entitled, it is proper to take into
account the plaintiff's own negligence. As a result, the loss may be
apportioned between the plaintiff and the defendant bank.

10. Reference for the respectability of a new customer

Negligence of a collecting banker may refer back to the opening of an

account. In other words, if the collecting banker fails to make
satisfactory enquiries about a customer at the time of opening of an
account in his name, he may be held guilty of negligence. As far back as
1903, it was held in Turner vs London and Provincial Bank Ltd. that
carelessness in opening an account was one of the circumstances of the
collecting banker's negligence. The decision was similar in Ladbroke Vs
Todd. Here, the bank failed to make satisfactory references regarding the
position or character of the customer before opening an account in his
name, and was subsequently held guilty of negligence. Of course,

Nevertheless, in Commissioners of Taxation Vs English, Scottish and

Australian Bank, the bank successfully contested liability in spite of
apparent absence of enquiry regarding its customer. In the instant case,

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the Learned Judge observed: "it is not a question of negligence in

opening an account, though the circumstances connected with the
opening of an account may shed light on the question of whether there
was negligence in collecting a cheque".

The observations made by the Learned Judge in the case of Lumsden

and Co. vs London Trustee Savings Bank, referred to earlier, may also
be noted in this connection:

...in the unsatisfactory position of a customer and a referee both newly

arrived from abroad and to that extent liable to be more of an unknown
entity, no attempt was made to obtain independent confirmation of
Brown's identity by, for example, a request for the production of his
passport. Last, but by no means least, there was the failure to enquire
further when Dr Blake failed to give any banker as a referee despite an
express and very necessary request for this information. This above all
facilitated the assumption of a fictitious personality, buttressed by a
fraudulent reference.

11. Collection of cheques crossed 'account payee' for persons

other than the payee named

A cheque crossed 'account payee' should be collected only for the

account of the payee named, as was held in Akrokerri (Atlantic) Mines
Ltd. vs Economic Bank and Morrison Vs London County and
Westminster Bank Ltd. Again. In Underwood (AL.) Ltd. Vs Bank of
Liverpool and Martins, it was observed that while this addition did not
affect the negotiability of an order or bearer cheque, yet, when such a
cheque was paid into the account of a person who was not the payee, the
banker should be put on enquiry. However, where a banker is collecting
such a cheque for another banker, he cannot be expected to make such
enquiries.

12. Collection of cheques crossed 'not negotiable'

According to certain quarters, a collecting banker is guilty of negligence

when he collects cheques crossed 'not negotiable' for someone other than
the payee concerned. However, in Penmount Estates Ltd. Vs National
Provincial Bank Ltd., it was held that the bank was not guilty of
negligence in crediting to a solicitor's account a 'not negotiable' crossed
cheque payable to a third party. Further, in the case of Crumplin Vs
London Joint Stock Bank Ltd., it was held that a 'not negotiable' crossing
is merely one factor among others to be considered in deciding whether
the collecting banker had been negligent, and in the circumstances of the
instant case, there had been no negligence.

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13. Collection of 'not transferable' cheques

A collecting banker is guilty of negligence when he collects a 'not

transferable' cheque for any person other than the payee. For instance, a
cheque payable to Shonibare Ojoba should be collected only for the
account of Shonibare Ojoba.

II. Protection only for Crossed Cheques

Protection under Section 131 applies only to cheques crossed before

they reach the collecting banker. If the cheque is crossed by the
collecting banker, he cannot claim protection, and may be held liable to
the true owner in a suit for conversion. Hence it is always advisable for
him to require his customers to cross all cheques paid in for collection.

III. Cheques Should be Collected for a Customer

Section 131 applies only to crossed cheques collected for a customer.

Therefore, if the banker collects cheques for any person other than a
customer, he cannot claim protection, and he will be held liable to the
true owner in case the title of the person for whom he collects the
cheques proves defective.

Here a question arises as to whether or not the banker can claim

protection when he has received Payment of a crossed cheque for
himself as a 'holder for value'. In terms of Section 131, the banker can
claim protection only when he has received payment for a customer.
Nevertheless, where a banker collects a cheque payable to himself, but
accompanied by a direction that the proceeds should be credited to a
customer, he receives payment for a customer, as was decided in Lloyds
Bank Ltd. Vs Chartered Bank Ltd. But in a situation where the banker
takes a cheque as an independent holder, he cannot claim protection, for
instance, if the collecting banker pays cash across the counter and
collects the cheque later on. Here the banker is collecting the cheque for
himself, and as such, he is precluded from claiming protection.

Explanation given to Section 131 of the Negotiable Instruments Act

clearly lays down that a banker can claim protection notwithstanding
that he credits his customer's account with the amount of the cheque
before receiving payment thereof. But the banker should not allow the
customer to draw against the amounts of such cheques before receiving
payment. By mere crediting of such cheques as cash does not give the
customer an immediate right to draw against the items. There must be,
in addition, some definite agreement, express or implied, that the
customer may draw against such cheques before clearance, as was
decided in Underwood Vs Barclays Bank Ltd.

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IV) Banker as a Holder for Value

There are certain instances when the banker can undoubtedly be

considered a holder for value. The following instances have been
pointed out by Sheldon, where the banker is collecting the proceeds of a
cheque for himself, and not receiving payment for a customer:

i) When the banker gives cash in exchange for a cheque drawn on

another banker.
ii) When the banker credits his customer with the amount of the
cheque as soon as it is paid in, and allows him to draw at once
against the amount.
iii) When the cheque is expressly paid to reduce the amount of an
overdraft.

V) Collection of Bills

The legal protection given to a collecting banker applies only in the case
of collection of crossed cheques. Hence, while collecting a customer's
bills of exchange, the banker does not get this protection. He may be
held liable for collecting a bill on which the customer's title proves
defective. A banker may further be held liable if he fails to perform his
duties in connection with presentment for acceptance and payment of
bills.

VI) Collecting Banker and Presentment for Acceptance

When a banker receives an unaccepted bill for presentation on behalf of

a customer, he should present it for acceptance as early as possible. This
is advisable in his own interest because, on acceptance, he obtains an
additional security, and if acceptance is refused, he can initiate legal
action against the parties concerned wherever such a course is
applicable, for example, in the case of a discounted bill.

Furthermore, the banker is expected to exercise reasonable care and skill

in safeguarding his customer's interests. Thus, if the customer suffers a
loss owing to the banker's failure to present a bill for acceptance or for
payment, the banker may be held responsible. Wherever possible, the
banker should present the bill on the day of receipt itself. Where this is
not possible, it must be presented within a reasonable time. In this
connection, the Rule regarding excuse for delay in presentment for
acceptance (or payment) may be mentioned.

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According to of Section 75 of Negotiable Instruments Act:

Delay in presentment for acceptance or payment is excused if the delay

is caused by circumstances beyond the control of the holder, and not
imputable to his default, misconduct or negligence. When the cause of
delay ceases to operate, presentment must be made within a reasonable
time.

It may be noted that the banker must not take a qualified acceptance
without the consent of his principal.

VII) Rules Regarding Presentment for Acceptance

Section 61 of the Negotiable Instruments Act lays down the provisions

governing presentment for acceptance. In terms of this Section:

1) A bill of exchange payable after sight must, if no time or place is

specified therein for presentment, be presented to the drawee
thereof for acceptance, if he can after reasonable search, be
found, by a person entitled to demand acceptance, within a
reasonable time after it is drawn, and in business hours on a
business day In default of such presentment, no party thereto is
liable thereon to the person making such default.

2) If the bill is directed to the drawee at a particular place, it must be

presented at that place; and if at the due date for presentment he
cannot, after reasonable search be found therein, the bill is
dishonoured.

3) Where authorized by agreement or usage, a presentment through

the post office by means of a registered letter is sufficient."

Presentment for acceptance is excused where the drawee cannot be

found after reasonable search, or where the drawee is a fictitious person,
or where the drawee is incapable of contracting, or where, although
presentment is irregular, acceptance has been refused on some other
grounds.

Bills payable on demand, or on a fixed date, need not be presented for

acceptance. But presentment for acceptance is necessary in the case of:

(a) a bill payable after sight; and

(b) a bill in which there is an express stipulation that it shall be
presented for acceptance before it is presented for payment.

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However, as mentioned earlier, it is always desirable to get a bill

accepted as early as possible even when presentment for acceptance in
optional.

VIII) To whom Bills should be presented for Acceptance

The banker should present a bill for acceptance to:

1) The person directed to pay the bill (i.e., drawee) or his authorized
agent.
2) All the drawees, in case there are several drawees, unless any one
of them has the proper authority to accept it on behalf of all.
3) The legal representatives, if the drawee is dead.
4) The Official Receiver, if the drawee has been declared an
insolvent.

Where a bill is addressed to more than one drawee, the banker should
present it to each of the drawees, unless one has proper authority to
accept it on behalf of all. Otherwise, the bill binds only those who accept
it. When a bill is dishonoured by non-acceptance, the banker should
immediately return it to the customer.

IX) Collecting Banker and Presentment for Payment

It is the duty of the collecting banker to present a bill entrusted with him
for collection according to the rules laid down in the Negotiable
Instruments Act. The relevant provisions are as follows.

1. Promissory notes, bills of exchange and cheques must be

presented for payment to the maker, acceptor or drawee thereof
respectively, by or on behalf of the holder as hereinafter
provided. On default of such presentment, the other parties
thereto are not liable thereon to such holder. Where authorized by
agreement or usage, a presentment through post office by means
of a registered letter is sufficient. (Section 64)

2. Presentment for payment must be made during the usual hours of

business, and, if at a banker's, within banking hours. (Section 65)

1. A promissory note or bill of exchange made payable at a

specified period after date or sight thereof must be presented for
payment at maturity. (Section 66)

4. A promissory note, bill of exchange or cheque made, drawn or

accepted payable at a specified place and not elsewhere must, in
order to charge any party thereto, be presented for payment at

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that place. (Section 68)

5. A promissory note or bill of exchange made, drawn or accepted

payable at a specified place must, in order to charge the maker or
drawee thereof, be presented for payment at that place. (Section
69)

6. A promissory note or bill of exchange not made payable as

mentioned in Sections 68 and 69 must be presented for payment
at the place of business (if any), or at the usual residence of the
drawee or acceptor thereof, as the case may be. (Section 70)

7. If the maker, drawee or acceptor of a negotiable instrument has

no known place of business or fixed residence and no place is
specified in the instrument for presentment for acceptance or
payment, such presentment may be made to him in person
wherever he can be found. (Section 71)

8. Subject to the provisions of Section 31, a negotiable instrument

must be presented for payment to the authorized agent of the
drawee, maker or acceptor. as the case may be, or where the
drawee, maker or acceptor has died, to his legal representative, or
where he has been declared insolvent, to his assignee. (Section
74)

9. Delay in presentment for acceptance or payment is excused if the

delay is caused by circumstances beyond the control of the
holder, and not imputable to his default, misconduct or
negligence. When the cause of delay ceases to operate,
presentment must be made within a reasonable time. (Section 75
A)

10. No presentment for payment is necessary, and the instrument is

dishonoured at the due date for presentment, in any of the
following cases:

(a) if the maker, drawer or acceptor intentionally prevents the

presentment of the instrument, or, the instrument being payable at
his place of business, he closes such place on a business day
during business hours, or if the instrument is payable at some
other specified place, neither he nor any person authorized to pay
it attends at such place during the usual business hours, or if the
instrument not being payable at any specified place, he cannot be
found after due search;

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(b) as against any party sought to be charged therewith, if he has

engaged to pay notwithstanding non-presentment;

(c) as against any party, if, after maturity, with knowledge that the
instrument has not been presented, he makes a part payment on
account of the amount due on the instrument, or promises to pay
the amount due thereon in whole or in part, or otherwise waives
his right to take advantage of any default in presentment for
payment;

(d) as against the drawer, if the drawer could not suffer damage from
the want of such presentment.(Section 76)

8. When a bill of exchange accepted payable at a specified bank has

been duly presented there for payment and dishonoured, if the
banker so negligently or improperly keeps, deals with or delivers
back such bill as to cause loss to the holder, he must compensate
the holder for such loss. (Section 77)

4.0 CONCLUSION

From our discussion in this unit, we have stated that a paying banker has
responsibility in paying the customers on the strength of instruments
presented while the collecting banker ensures that it collects proceeds of
instrument on behalf of the customers. In the process of performing such
duties for the customers, the bankers have to observe the relevant legal
obligations so that they can be protected by the law as established in the
Negotiable Instruments Act.

5.0 SUMMARY

In this course of analysis in this study unit, we have discussed bankers in

respect of their position towards their customers and such analysis
borders on: paying bankers’ duties and responsibilities; important
considerations for payment of cheques; circumstances under which a
banker is justified in refusing payment of a cheque drawn on him;
protection given to a paying banker; payment in due course; money paid
by mistake; collecting banker; duties and responsibilities of collecting
bankers; and collecting banker’s protection. In the next study unit, we
shall discuss relationships with limited liabilities companies.

6.0 TUTOR-MARKED ASSIGNEMENT

1. Differentiate between a Paying Banker and a Collecting Banker.

2. What are the forms of protection available to a banker while
collecting crossed cheques, according to Section 131 of the
Negotiable Instruments Act.

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7.0 REFERENCES/FURTHER READING

Dlabay, Les R.; Burrow, James L. & Brad, Brad (2009). Intro to
Business. Mason, Ohio: South-Western Cengage Learning.
p. 482. ISBN 978-0-538-44561-0.

Fraser, D. R., Gup, B. E. & Kolari, J.W. (1995). Commercial Banking:

The Management of Risk. New York: Western Publishing
Company.

Money Market Account as retrieved from

http://www.investopedia.com/terms/m/moneymarketaccount.asp

Raghunandan, B. V. (2010). Paying Banker and Collecting Banker.

Retrieved from http://www.slideshare.net/1954bvr/paying-
banker-and-collecting-bankerbvraghunandan

Shekhar, K. C. and Shekhar, L. (2007). Banking Theory and Practice.

(7th ed.). New Delhi: Vikas Publishing House PVT Limited.

Somashekar, N. T. (2009). Banking. New Delhi: New Age

International (P) Limited, Publishers.

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UNIT 3 BANK LENDING TO LIMITED LIABILITIES

COMPANIES

CONTENTS

1.0 Introduction
2.0 Objectives
3.0 Main Content
3.1 Principles of Bank Lending
3.2 Methods of Granting Advances
4.0 Conclusion
5.0 Summary
6.0 Tutor-Marked Assignment
7.0 References/Further Reading

1.0 INTRODUCTION

In the previous study unit, we discussed the duties and responsibilities of

paying and collecting bankers regarding dealing with their customers,
which include corporate bodies. In the same vein, banks do deal with
limited liability companies in area of lending of funds for the corporate
bodies’ operational needs. In this study unit, therefore, we shall also
espouse on various forms of loans and advances being offered by banks
to corporate bodies.

2.0 OBJECTIVES

At the end of this study unit, you should be able to:

• mention and discuss the principles of bank lending

• list and discuss methods of granting advances.

3.0 MAIN CONTENT

3.1 Principles of Bank Lending

There are some precautions to be taken by a banker, and the principles

to be taken into consideration while granting advances to corporate
bodies. In this section of the study unit, the discussion is on the general
principles to be borne in mind by a banker while granting advances.

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1. Liquidity

Liquidity implies the ability to produce cash on demand. A bank mainly

utilizes its deposits for the purpose of granting advances. These deposits
are repayable on demand or on the expiry of a specified period. In either
case, the banker must be ready to meet these liabilities whenever
necessary. As such, he has many outstanding contracts for the future
delivery of money. In case of failure, he will suffer in his credit, which
can affect the very foundation of bank. There will be operational shock
of such a failure, but it will also be transmitted to the other links of the
banking system, thereby precipitating nation-wide bank failures.

Nevertheless, the presence of the deposit insurance system tends to

minimize the danger of panicky withdrawals. However, the banker
should always bear in mind that he is the guardian of a very delicate
mechanism which paves the way for future economic development of
the country and any failure and bank run by customers will create
monetary disequilibrium with all the grave implications for the economy
and the country’s monetary system.

Hence the importance of ensuring that the advances granted by the

banker are as liquid as possible cannot be over-emphasized. Advances
granted by a banker by way of discounting first class bills of exchange
satisfy this principle of “shiftability”. The apex bank of the country
extends rediscounting facilities to first class bills, and this enables the
banker to obtain funds in case of emergencies. In some other cases,
“shiftability” principle may not be readily available. Nevertheless,
bankers can insist on securities which are shiftable without loss, in order
to cover the advances granted such as the government securities.

2. Profitability

Banks essentially operate as commercial ventures. The fact is that

excessive and unjustifiable profits can only be at the cost of the
customer, insofar as higher lending rates push up production costs, and
in the ultimate analysis, adversely affect society in general. At the same
time, the fact remains that while strong operating profits allow for full
prudential provisioning, high net profits allow for allocation to capital
and reserves, which is essential for any bank to maintain its competitive
viability and expand its lending operations. Furthermore, the
shareholders of a bank are entitled to reasonable dividends. In addition,
the depositors have to be compensated with reasonable returns on their
deposits. All this implies that it is necessary for the banks to make sure
that their lending operations are sufficiently profitable.

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3. Safety and Security

Banks are supposed to ensure that the borrower has the ability and will
to repay the advances as per contractual agreement. Relatedly, before
granting a secured advance, banks should carefully consider the margin
of safety offered by the security concerned and possibilities of
fluctuations in its value. When it is an unsecured advance, its repayment
depends on the creditworthiness of the borrower, and that of the
guarantor, wherever applicable. As such, the fundamental principles
which the banker should consider in the case of unsecured advances are
Character, Capacity and Capital (the popular Cs of lending), which have
been decoded as in other terms as Reliability, Responsibility and
Resources (known as three Rs) of the borrower and the guarantor.

4. Purpose

Banks are to carefully examine the purpose for which the advance has
been applied for. In case the advance is intended to be utilized for
productive purposes, it could be reasonably anticipated that cash flows
arising from such productive activities will result in prompt repayment.
However, the banker has to be careful to monitor the exact purpose for
which the advance is actually utilized. There is always the possibility
that the advance, once granted, may be diverted for purposes other than
that indicated by the borrower at the time of application. Thus, there
should be proper provisions for effective post credit supervision.

5. Social Responsibility

Regardless of the major preoccupation of the banks as essentially

commercial ventures, banks should not forget the fact that it is not
enough that only corporate bodies of means that are granted bank credits
and loans. The important thing is that through productive effort bank
finance should make enterprises creditworthy, and turn them into body
corporate of means. Hence, technical competence of the borrower,
operational flexibility and economic viability of the project rather than
the security which the borrower can offer, should be considered in
evaluating a loan proposal.

Identification of priority sectors in the economy for the purpose of

extending bank credit should be considered as a positive development in
the banking system, aimed at effectively discharging bank’s
responsibility towards the society; in line with the apex bank’s (CBN)
directive on sectoral allocations of credits with priority to agriculture
and the SMEs. However, social responsibility pre-occupation should not
deter the banks from paying adequate attention to the qualitative aspects
of lending.

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6. Industrial and Geographical Diversification

Banks should also aim at spreading the advances as widely as possible

over different industries and different localities in line with spartial
distribution of industries and regional development. Relatedly, the
essence is enable the banks to compensate any losses which might arise
as a result of unanticipated factors adversely affecting particular
industries and particular localities. Hence, banks with viable branches
are in a favourable position to discharge this responsibility effectively.

SELF-ASSESSMENT EXERCISE 1

Explain bank lending in relation to the relationships that exist between

banks and limited liability companies.

3.2 Methods of Granting Advances

The main methods of granting advances may be classified as: Cash

Credits; Overdrafts; Bills Discounting; Issuance of Letters of Credit; and
Loans. All these are discussed as follows.

1. Cash Credit

Under cash credit method, the banker allows the customer to borrow up
to a certain amount. Under this arrangement, the borrower is required to
provide security in the form of pledge or hypothecation of tangible
securities. In some cases, the limit is granted on the guarantees furnished
by sureties acceptable to the banker. Basically, it is not necessary for the
borrower to avail of the full cash credit limit in one installment. The
borrower can avail of the facility according to his requirements subject
to the condition that the total amount availed should not exceed the
granted limit. The borrower is also allowed to credit any surplus cash in
his possession.

Interest is charged only on the amount actually utilized by the customer.

But banks considers it as losing interest on the unutilized funds since the
entire cash credit limit is placed at the disposal of the customer
irrespective of whether the beneficiary utilizes it or not. To compensate
this, it is usual for the banks to incorporate a 'minimum interest clause'
in the agreement with the customer in terms of which a certain rate of
interest is payable on the unutilized portion of the cash credit limit.

2. Overdrafts

Overdraft facility involves granting advances over and above credit

balances in the accounts of the corporate entities. In order to enjoy an

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overdraft facility, the borrower has to have an existing current account.

Hence, account is allowed to be overdrawn up to a certain limit. The
borrower has to pay interest only on the amount actually overdrawn and
only for the period during which it is utilized. Similarly, the interest
chargeable on the facility depends on negotiation between the bank and
the customer.

At the end of the financial year, the borrower is required to wipe off the
debit balance in the current account, that is, the account has to be
brought back to credit balance; but it also depends on the period of the
overdraft. Thus, an overdraft is a short term credit facility. However the
facility is usually renewed after the utilization of the previous one or at
the beginning of the next financial year. This 'rolling over' practice has
the effect of an overdraft providing at least medium term credit facility
to the customer.

3. Bills Discounting

This window of opportunity for a facility or granting advances is also a

short term facility intended to provide loanable funds or current working
capital. Herein, the banker advances money on the security of bills of
exchange after deducting a certain percentage, technically known as
'discount', from the face value of the bill. The deduction in terms
represents interest on the loanable facility. This provision of financial
accommodation is heavily favoured by conservative bankers according
to whom the earning assets of a commercial bank should consist mainly
of short term self-liquidating productive loans.

Such bill from a reputable company is considered as genuine

commercial bill of exchange, and it is regarded to be a self-liquidating
paper since it liquidates itself automatically out of the sale of the goods
covered by such a bill. Furthermore, besides discounting of bills of
exchange, a bank also purchases such bills outright at face value from
their customers, less bank charges. Such purchase of bills is normally
confined to bills payable on demand.

4. Issue of Letters of Credit

The use of the letters of credit is related to international trade, that is,
trade between countries for financing the transactions. According to the
International Chamber of Commerce, a letter of credit is:

Any arrangement however named or described whereby a bank (the

issuing bank) acting at the request and in accordance with the
instructions of a customer (the applicant of the credit) is to make
payment to or to the order of a third party (the beneficiary) or is to pay

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accept or negotiate bills of exchange (drafts) drawn by the beneficiary,

or authorize such payments to be made or such drafts to be paid,
accepted or negotiated, by another bank, against stipulated documents
and compliance with stipulated terms and conditions.

Hence, when a stipulation is incorporated in the sale contract that the

goods shall be paid by a banker's letter of credit, the seller need not
worry whether the goods will be cleared by the buyer on arrival at the
destination, and the buyer need not lock up his funds by making
payment in advance. Basically, a commercial letter of credit substitutes
the creditworthiness of the importer by the creditworthiness of the
banker issuing the letter of credit, since it is a promise by the bank to
pay or accept the bill, provided the exporter (the beneficiary) fulfills the
terms and conditions set out in the credit.

I) Parties to a Letter Of Credit

The parties to a letter of credit are identified and discussed as follows.

The parties to letter of credit include the buyer, the beneficiary, the
issuing bank, the notifying bank, the negotiating bank, the confirming
bank and the paying bank.

i) The buyer as the importer applies to the bank for opening a letter
of credit. The bank may or may not require the buyer to secure
the letter of credit by providing sufficient deposits/acceptable
securities to protect its own interests. It depends on the
confidence that the bank has over the buyer applying for the letter
of credit.

ii) The seller as the exporter is the beneficiary of the letter of credit.
The bank issuing the letter of credit assures the seller that the
conditions of the credit will be met provided the relevant
documents are produced and the terms and conditions set out in
the credit are strictly complied with.

iii) The bank which issues the letter of credit at the request of the
buyer is the issuing bank. The issuing bank must be well known
and acceptable to the seller. The buyer gives instructions
regarding the terms and conditions of the credit.

iv) The notifying bank is the correspondent bank that is situated

in the same place as the seller, and advises the credit to the seller.
But by notifying bank does not commit itself to any liability
under the credit. Generally, the services of a notifying bank are
utilized when the credit is advised to the seller through a cable
message. Such a message will be in code language and the

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notifying bank authenticates the message by decoding it.

v) The negotiating bank is the bank which negotiates the bills or

drafts under the letter of credit. Generally, the same bank will act
as the notifying bank and the negotiating bank. The negotiating
bank has to see that the documents negotiated conform strictly to
the terms and conditions of the credit.

vi) The Confirming Bank: Basically, the seller insists that the credit
must be confirmed by a bank in his own country. Such a bank is
known as the confirming bank. The advantage of this
confirmation from the point of view of the seller is that he is
assured of the payment as soon as the documents are presented at
his own centre. The primary liability lies with the confirming
bank, provided the seller fulfills the terms and conditions of the
credit. As far as the seller is concerned, he can proceed against
either the confirming bank or the issuing bank or both.

vii) The paying bank is the bank on which the bill or raft is drawn. It
can be the issuing bank, the notifying bank or the confirming
bank.

SELF-ASSESSMENT EXERCISE 2

Mention and explain parties to a Letter of Credit.

II) Credit contract between the buyer and the issuing bank, and
sale contract between the buyer and the seller

A credit contract between the buyer and the issuing bank should be
clearly distinguished from a sale contract between the buyer and the
seller. A letter of credit is independent of, and unqualified by, the
contract of sale or underlying transaction. Therefore, there is no
obligation on the part of the issuing bank to ensure strict performance of
the terms and conditions of the sale contract between the buyer and the
seller. The issuing or confirming bank only has to see that it adheres
strictly to the terms and conditions laid down in the letter of credit
application.

III) Irrevocable letter of credit and bank guarantee

Opening of a confirmed letter of credit constitutes a bargain between the

bank and the vendor of the goods, which imposes upon the bank an
absolute obligation to pay irrespective of any dispute there might be
between the parties as to whether the goods are up to the contract or not.
The letter of credit is independent of and unqualified by, the contract of

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sale or underlying transaction. A vendor of goods selling against a

confirmed letter of credit is selling under the assurance that nothing will
prevent him from receiving the price. Payment under the irrevocable
letter of credit does not depend on the performance of obligation on the
part of the vendor except those which the letter of credit expressly
imposes.

On the other hand, a bank guarantee has a dual aspect. It is not merely a
contract between the bank and the beneficiary of the guarantee; it is also
a security given to the beneficiary by a third party In seeking to enforce
a bank guarantee, the beneficiary of the guarantee, in effect, seeks to
realize the security furnished by the third party, and the party has,
therefore, locus standi to challenge the enforcement of the guarantee.
Unless there is some act of omission or commission on the part of the
third party, payment of a bank guarantee does not become due.

IV) Uniform Customs and Practice

In order to avoid difference in interpretation of letter of credit terms, the

International Chamber of Commerce has formulated a set of rules to
guide banks in the use of documentary letter of credit. Although the first
attempt in this direction was made as early as 1933, the latest version is
contained in Publication No. 290 which came into operation from 1st
October 1975.

It is instructive to note that the 'Uniform Customs and Practice' for

documentary credit is not a law as such. The parties have voluntarily to
apply the set of rules. But banks in many countries around the world
adhere collectively to the rules laid down in Uniform Customs and
Practice'. Banks in some other countries adhere individually to them.
Banks in these countries expressly state that letters of credit issued by
them are in accordance with Uniform Customs and Practice, Publication
No. 290.

5. Loans

Loan as a term is popularly used to designate the granting of an advance

in lump sum, generally on the basis of securities acceptable to the
banker. The distinguishing feature of a loan is that interest on it is
payable on the entire amount, whether it is fully utilized or not. It is
granted for a definite period and the borrower is given the facility to
repay it in one lump sum or in installments. To the banks, the operating
cost of a loan is lower as compared to a cash credit or an overdraft. This
method of granting an advance has the advantage of strengthening the
financial discipline in the use of bank credit because it involves follow
up, supervision and control as being made more effective as compared
to cash credits and overdrafts.
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SELF-ASSESSMENT EXERCISE 3

Mention and explain types of credits that bank make available to limited
liability companies.

4.0 CONCLUSION

From our discussion in this unit, we have identified and discussed

principles of bank lending to corporate bodies which include liquidity,
profitability, security, and purpose, among others. Forms of lending to
corporate bodies include loans, overdraft, discounting and purchasing
bills of exchange, and issuance and honouring of letters of credit.

5.0 SUMMARY

In this course of analysis in this study unit, we have discussed bank

lending to limited liability companies and in the process we have
analyzed principles of bank lending and methods of granting advances.
In the next study unit, we shall discuss securities and loan recovery.

6.0 TUTOR-MARKED ASSIGNMENT

1. What is bank lending, and what are the principles guiding such
banking operations?
2. What are the various types of bank lending facilities available for
the use of corporate entities for enhancing their operations?

7.0 REFERENCES/FURTHER READING

Dlabay, Les R.; Burrow, James L. & Brad, Brad (2009). Intro to
Business. Mason, Ohio: South-Western Cengage Learning.
p. 482. ISBN 978-0-538-44561-0.

Fraser, D. R., Gup, B. E. & Kolari, J.W. (1995). Commercial Banking:

The Management of Risk. New York: Western Publishing
Company.

Money Market Account as retrieved from

http://www.investopedia.com/terms/m/moneymarketaccount.asp

Shekhar, K. C. & Shekhar, L. (2007). Banking Theory and Practice. (7th

ed.). New Delhi: Vikas Publishing House PVT Limited.

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UNIT 4: SECURITIES AND LOAN RECOVERY

CONTENTS

1.0 Introduction
2.0 Objectives
3.0 Main Content
3.1 Securities and Loan Recovery
3.2 Property for Collateral Security
3.3 Valuables for Collateral Security
3.4 Personal Guarantee in Place of Security
4.0 Conclusion
5.0 Summary
6.0 Tutor-marked Assignment
7.0 References/Further Reading

1.0 INTRODUCTION

In the last study unit, we discussed bank lending to limited liabilities

companies. Secured Loans are loans that are backed by collateral
securities as pledged by the loan beneficiaries. This is because banks as
lenders of funds always require some securities which are often called
(collateral) to safeguard their funds. These collaterals could be in form
of a building, land, share certificate of a reputable company. Personal
assets like cars and jewelries, as well as letter of set-off. Therefore, the
discussion in this unit revolves around the issue of securities for secured
advances by banks to their customers.

2.0 OBJECTIVES

At the end of this study unit, you should be able to:

• Discuss securities and loan recovery

• Mention and discuss types of property for collateral security
• List and explain types of valuables for collateral security
• Discuss personal guarantee in place of security

3.0 MAIN CONTENT

3.1 Securities and Loan Recovery

The issue of collateral security for loans from the commercial banks is
very pertinent in securing such credit facilities by enterprises. The
pledge of collateral security gives the bank as lender the right to seize
and sell the assets designated as loan collateral, using the proceeds of the

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sale to offset the outstanding funds which the borrower could not pay
back.

The use of collateralization for a loan gives the bank as lender a

satisfactory leverage or advantage over the borrower. This is due to the
fact that when specific assets may be at stake, a borrower would feel
more obligated to strive hard to repay the fund involved in loan facility
and thus avoiding losing the valuable operational assets.

The basic purpose for banks’ desire to insist on taking collateral security
is to enable them to precisely identify which borrower’s assets are
subject to seizure and sale. It is important in using the device to
document for all other creditors to believe that the bank has a legal claim
to those assets in the event of non-performance on a loan.

It is used to ensure the safety of the funds committed into loan facility
by the bank; the funds which actually belong to depositors. For these
reasons banks do not comprise the issue of collateral security when
considering lending their funds to business entities.

Therefore, in this chapter the analysis is focused on the various types of

property that can be accepted by the commercial banks as collateral
security by entrepreneurs and business entities before they can secure
loan facilities.

SELF ASSESSMENT EXERCISE 1

Discuss securities in relation to loan recovery.

3.2 Property for Collateral Security

Collateral security is the property that is pledged by a loan beneficiary

towards securing the facility. There are basic types of property that the
banks normally insist on taking as collateral security for loan facilities.
These are identified and discussed below.

1. Real Estate

A real property is acceptable in the consideration for a collateral security

on a loan facility. Once the property is accepted by the bank, the bank
can put public notice of a mortgage against a real estate. The bank then
takes action to file with the relevant authority the pledge of the property
for a loan facility from the beneficiary.

In some instances, the bank may have to take out title insurance and
equally insists that the borrower purchases insurance policy to cover any

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future damage from environmental hazards and perils. The bank

receives a first claim on any insurance settlement that is made on the
policy.

The bank will initiate action to determine the real value of the property
once it accepts to advance some funds on loan facility to a borrower.
The basic approaches to the valuation of real estate include the
following.

i. Cost approach:- this involves considering the reproduction cost

of the building and improvements, deducts estimated
depreciation, and adds the value of the land.
ii. Market Data or direct sales comparison approach:- this involves
estimating the value of the subject property based on the
comparable properties’ current selling prices.
iii. The income approach:- this involves the use of discounted value
of the future net operating income streams from the property.
iv. The direct capitalization approach:- this involves the
calculation of the value by dividing an estimate of its average
annual income by a factor called capitalization rate.

2. Personal Property:

The practice is for the banks to accept and take a security interest in
items of property such as motor vehicles, machinery, equipment,
furniture, securities, and other forms of personal property owned by a
borrower.

Once it is accept as a collateral security, a financing statement will be

filed by the bank publicly in those cases where the borrower keeps
possession of any personal property pledged. This requires a pledge
agreement to be prepared may be prepared if the bank or its agent holds
the pledged property. This agreement will give the bank the right to
control that property until the loan is repaid in full.

SELF ASSESSMENT EXERCISE 2

Mention and discuss different types of property for collateral security.

3.3 Valuables for Collateral Security

1. Personal Guarantees

The banks may also accept the pledge of the stock, deposits, or other
personal assets held by the major stockholders or owners of a company.
The borrower will be required to provide agreement on such pledge and

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acceptance between the representative of the borrower and the bank as

may be required for the collateral to secure a business loan for the entity.

The practice is that guarantees are often requested for by the banks in
the cases of lending funds to smaller businesses. This is also required
from corporate entities that have fallen on difficult times. The simple
reason is that the arrangement will give the owners the prod or
considered reason to strive harder so that their firm will prosper and
repay their loan.

2. Accounts Receivable

Another practice is that the banks can accept and take a security interest
in the form of a stated percentage of the face value of accounts
receivable, which involves value of sales on credit, as shown on a
business borrower's balance sheet.

Whenever the borrower's credit customers send in cash to settle their

outstanding debts, such funds or cash payments are applied for the
settlement of the outstanding balance of the borrower's loan. This may to
take the form of mortgaging the receipts of the accounts receivable so
that the payment would be made to the account opened for such money
in the bank’s domain.

The banks often take the necessary measures to evaluate accounts

receivable pledged for the loan facility by the borrower. The main types
of method of evaluation of accounts receivable are accounting
receivable aging and accounting receivable turnover.

3. Factoring

The banks can also purchase the borrowers’ accounts receivable. The
arrangement is that the agreement will be based upon some percentage
of the book value of such debtors. The factoring interest is the difference
between the book value and the discounted value of the accounts
receivable.

The borrower's customers who are the debtors would be required to

make payments direct to the purchasing bank, which happens to the
lender of funds to the firm whose debts the bank has acquired. The
agreement will incorporate the consideration that the borrower promises
to set aside some funds with which to cover some or all of the losses that
the bank may suffer from any unpaid receivables.

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4. Inventory

In this consideration, a bank will lend only a percentage of the estimated

market value of the borrower's inventory, which serves as the collateral
security for the loan facility. The bank could have a floating lien in the
sense that the inventory pledged may be controlled completely by the
borrower.

In the case of the floor planning, the lender takes temporary ownership
of any goods placed in inventory and the borrower sends payments or
sales contracts to the lender as the goods are sold. This arrangement
ensures that the bank as the lender is rest assured that he has a proper
lien on the inventory.
The practice requires that the bank evaluate the inventory. The basic
ways to evaluate the inventory include resale of inventory, inventory
turnover, and inventory converted to accounts receivable.

SELF ASSESSMENT EXERCISE 3

List and explain various types of valuables for collateral security.

3.4 Personal Guarantee In Place Of Security

In the case of the usage and accessibility of guarantees and security

depend on the form of credit being granted or offered by the bank. In
some instances, bank lending tends to be securitized but in the case of
corporate credit, such may be very exceptional. This is due to the
dictates of the market forces of demand and supply of funds. Besides
common practices also contributes to such scenario.

The normal practice is that a bank requires the borrower to make

available some forms of collateral security which will be pledged
whenever a customer makes a request for loan facility. In small loans to
customers, the practice is for the customer to provide a guarantee to the
bank. This involves providing some guarantors who are made to fill
appropriate forms for their preparedness to guarantee the repayment of
the funds granted for the loan facilities.

Therefore, guarantees can be given by individuals or associated

companies to the firms taking the loan facilities. Such guarantors as
pointed out earlier are individuals sign agreements with the banks with
the understanding that they agree to honour any outstanding installments
of the loans in the event of defaults. The extent of the guarantee
undertaken by the guarantors can be limited to a fixed or variable
amount and time.

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More often than not, the security offered in a loan agreement is

considered in relation to the creditworthiness of the borrower.
Nevertheless, in the case of doubt due to the problem of integrity of the
borrower, it may be necessary to demand for some guarantee for the
loan facility from the customer. The guarantees made by individuals
who stand as guarantors are not all that secured or enough due to issue
of integrity.

SELF ASSESSMENT EXERCISE 3

Discuss the use of personal guarantee in place of security for loan

facility from the bank.

4.0 SUMMARY

In pledging collateral security for a loan facility by loan beneficiary, the

bank should be able to understand that there are basic types of property
such as real estate, personal property, accounts receivable, factoring, and
inventory. Banks can also accept personal guarantee in place of
collateral security in relation to small loans to customers.

5.0 CONCLUSION

In this course of analysis in this study unit, we have discussed securities

for ensuring recovering of loans advanced by banks to their customers
and in the process we have analyzed; Securities and Loan Recovery;
Property for Collateral Security; Valuables for Collateral Security; and
Personal Guarantee in Place of Security. In the next study unit, we shall
discuss securities for bankers’ advances.

6.0 TUTOR-MARKED ASSIGNEMENT

1. Mention and explain types of property that can be pledged as

collateral security for a loan facility.

2. Mention and explain types of valuable that can be pledged as

collateral security for a loan facility.

7.0 REFERENCES AND MATERIALS FOR FURTHER

READING

Idam, L. E. (2005). Bank Management in Nigeria: Concepts, Methods

and Processes, Abakaliki: Innarrok Syndicate.

Jessup, P. F. (1980). Modern Bank Management, New York: West

Publishing Company.

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Jhingan, M. L. (2008). Money, Banking, International Trade and Public

Finance, 7th Edition, Delhi: Vrinda Publications (P) Ltd.

Luckett, D.G. (1984). Money and Banking, Singapore: McGraw-Hill

Book Co. International Edition.

Uremadu, S. O. (2000). Bank Management: Basic Issues in Money, Bank

Lending and Credit Administration, Benin City: Precision
Publishers.

Uremadu, S. O. (2004). Core Bank Management: Concepts and

Application, Enugu: Precision Publishers.

Uzoaga, W.O. (1981). Money and Banking in Nigeria, Enugu: Fourth

Dimension Publishers.

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UNIT 5: SECURITIES FOR BANKERS’ ADVANCES

CONTENTS

1.0 Introduction
2.0 Objectives
3.0 Main Content
3.1 Banker’s Lien
3.2 Pledge
3.4 Hypothecation
4.0 Conclusion
5.0 Summary
6.0 Tutor-marked Assignment
7.0 References and Materials for Further Reading

1.0 INTRODUCTION

In the preceding unit, we discussed some forms of advances that banks

grant the corporate for enhancing their operations. Relatedly, therefore,
we shall discuss the forms of securities that are acceptable to the banks
towards securing their funds which their customers are given at the
instance of granting of any facility.

2.0 OBJECTIVES

At the end of this study unit, you should be able to:

• Explain bankers’ lien

• Discuss pledge by loan beneficiary
• Discuss hypothecation as a form of security for a loan

3.0 MAIN CONTENT

3.1 Banker’s Lien

Legally, a lien is a right to retain properties belonging to the debtor until

he has discharged the debt due to the retainer of the properties. A
banker's lien is a general lien, which confers a right to retain properties
in respect of any general balance due by the debtor to the banker.
Bankers have a general lien on all securities deposited with them in their
capacity as bankers by a customer, unless there is an express contract or
circumstances that show an implied contract inconsistent with the lien,
as has been held in Brandao vs Barnett. In the case of lien, banker's right
of sale extends only to fully negotiable securities. In this connection, in
respect of such negotiable securities, the banker may exercise his right
of sale after serving reasonable notice to the customer. In the case of

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securities other than fully negotiable securities, the banker is well

advised to realize them only after getting sanction from a competent
court of law.

SELF ASSESSMENT EXERCISE 1

Explain the term banker’s lien.

3.2 Pledge

A pledge, as a term in relation to collateral security, is a contract

whereby an article is deposited with a bank (lender) as a promise or
security for the repayment of a loan or performance of a promise by the
beneficiary (borrower). In order to complete a contract of pledge,
delivery of the goods to the banker is necessary. Delivery of the title
documents relating to the goods, or the key of the warehouse where the
goods are stored, may be sufficient to create a valid pledge. Basically,
where no possession is given, it is known as 'hypothecation', which will
be discussed subsequently in this study unit.

There are three essential features of a pledge such as: (i) there must be a
bailment of goods, i.e. delivery of goods; (ii) the bailment must be by
way of security; and (iii) the security must be for payment of a debt or
performance of a promise. A pledge gives the pledgee no right of
ownership.

1) Circumstances under which the law permits a pledge by a

non-owner include the following:

a. A mercantile agent can create a valid pledge, provided he is in

possession of the goods, with the consent of the owner. Further, a
valid pledge may be created even when the mercantile agent is
acting without the authority of the owner provided the pledge acts
in good faith.

b. A seller, who is in possession of the goods after the sale may

create a valid pledge, provided the pledgee acts in good faith and
without notice of the sale.

c. A buyer, who is in possession of the goods or of the documents

of title to the goods, before payment of the price, may create a
valid pledge, provided the pledgee acts in good faith and without
notice of the defective title of the pledger.

d. A pledger, who has only a limited interest in the goods which he

pawns can create a valid pledge to the extent of such interest.

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e. One of the joint owners in sole possession of the goods with the
consent of the others may create a valid pledge.

f. A person who is in possession of the goods under a voidable

contract (on the grounds of, say, fraud, misrepresentation,
coercion, etc.) may create a valid pledge provided the contract is
not rescinded at the time of the pledge. However, a thief cannot
create a valid pledge of stolen goods.

The banker may redeliver, for a specific purpose, the goods pledged
with him. A properly drafted 'Trust Letter', clearly indicating the limited
purpose for which the goods are redelivered would be a precaution.
Possession can also continue to be evidenced by the bank's own board
being exhibited at the place of storage.

2) Right of realization of the securities pledged

A pledgee is entitles to the following rights in case of default in payment

of the debt by the pledger:

a. He may file a suit for recovery of the amount due to him, while
retaining the goods pledged.
b. He may file a suit for the sale of the goods pledged and the
realization of the money due to him.
c. He may himself sell the goods pledged after giving reasonable
notice to the pledger notwithstanding any contract to the contrary.
In case the proceeds do not meet the debt fully, he may sue the
pledger for the balance. If there is any surplus, it must be paid
over to the pledger.

3) The banker as a pledgee entitled for any accretion to the

goods pledged

In the absence of any contract to the contrary, the bailee is bound to

deliver to the bailor, or according to his directions, any increase or profit
which may have accrued from the goods bailed.

4) Sale of security pledged without reasonable notice

Sale of securities pledged without reasonable notice is not binding on

the pledger. In case where the pledgee sells the goods without giving
due notice, he will become liable for conversion; but the sale is not
avoided thereby and is not liable to be set aside. It is not compulsory on
the part of the pldgee to sell the goods at any particular time or within a

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reasonable time after the notice is served.

5) Redelivery of goods pledged

Where a pledgee files a suit for the recovery of the debt, he is entitled to
retain the goods; but he is bound to return them on payment of the debt.
The right to sue on the debt assumes that the pledgee is in the position to
redeliver the goods on payment of the debt and therefore, if he has put
himself in a position where he is not able to redeliver the goods, he
cannot obtain a decree. But if he sues on the debt denying the pledge and
it is found that he was given possession of the pledged goods and had
retained the same, the pledger has the right to redeem the goods so
pledged by payment of the debt. If the pledgee is not in position to
redeliver the goods, he cannot have both the payment of the debt and
also the goods.

6) Documents of title and pledge

Where a mercantile agent is without the consent of the owner, in

possession of the goods or documents of title to goods, a pledge made
by him, when acting in the ordinary course of business of a mercantile
agent, shall be as valid as if he were expressly authorized by the owner
of the goods to make the same.

7. Status of Documents of title to goods in relation to pledge

Under Section 2(4) of the Sale of Goods Act, a 'document of title to

goods' is defined as

Bill of lading, dock warrant, warehouse keeper's certificate, railway

receipt, warrant or order for the delivery of goods, and any other
document used in the ordinary course of business as proof of possession
or control of goods or authorizing or purporting to authorize by
endorsement or by delivery, the possessor of the document to transfer or
receive goods thereby represented.

Following are the norms for a transport company to obtain the approval
of the Association:

i) The transport company should not deliver the goods except on

the bank's discharge and instructions for delivery on the original
receipt itself, which should be produced for delivery. A clause to
this effect should appear in the transport company’s receipt.

ii) A transport company’s receipt intended for negotiation with a

bank should not be drawn in the name of the consignee.

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iii) For all damages suffered by a bank as a result of the negligence

of the transport company, the company must be responsible.

SELF ASSESSMENT EXERCISE 2

Enumerate and explain the conditions surrounding the use of a pledge.

3.3 Hypothecation

A 'mortgage of movables' may be defined as a transfer, by way of

security of the general ownership of the chattel, subject to the equity of
redemption of the mortgagor. Mortgage of movables can be made by
mere parole and without transfer of possession. However, a subsequent
mortgagee with possession, in the absence of notice of the previous
mortgage, will get priority over a prior mortgage without possession. In
the strict sense the term 'mortgage' is used only in connection with
immovables. In the case of movables, the terms 'pledge' and
'hypothecation ' are generally used. Where a mortgage of movables is
created by delivery of possession of goods, it is known as a 'pledge', and
where no possession is given it is known as 'hypothecation'.

In the case of hypothecation, a document known as "Letter of

Hypothecation" is executed. This document details the terms under
which the relevant goods are hypothecated. Briefly, the following are
the main contents of the letter of hypothecation are as follows.

(a) Affirmation by the borrower that the goods are free from encumbrances,
that further encumbrances will not be created on them and that he is the
absolute owner of the goods

(b) Undertaking by the borrower that proceeds arising from the sale of the
hypothecated goods will be utilized for the repayment of the advance.

(c) Undertaking by the borrower to meet all expenses relating to the safe
custody of the hypothecated goods and that sufficient margin acceptable
to the banker will be maintained at all times.

(d) Provision to the effect that the banker has the right to take possession of
the hypothecated goods and to realize them in the event of the borrower
making default in the repayment of the advance.

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SELF ASSESSMENT EXERCISE 3

Mention and explain various types of securities.

4.0 SUMMARY

From our discussion in this unit, we have identified and explained

securities that can be accepted by the banks for their customers for
advances. Such securities, as we have discussed, include lien, pledge,
mortgage and hypothecation.

5.0 CONCLUSION

In this course of analysis in this study unit, we have discussed securities

for bankers’ advances and in the process, espoused on: Banker’s Lien;
Pledge; and Hypothecation. In the next study unit, we shall discuss
negotiable instruments: cheques, promissory notes and bills of
exchange.

6.0 TUTOR-MARKED ASSIGNMENT

1. Differentiate between pledge and lien.

2. Enumerate and discuss various securities that can be accepted by
the banks for advances.

7.0 REFERENCES/FURTHER READING

Dlabay, Les R.; Burrow, James L.; Brad, Brad (2009). Intro to Business.
Mason, Ohio: South-Western Cengage Learning. p. 482.
ISBN 978-0-538-44561-0.

Fraser, D. R., Gup, B. E. and Kolari, J.W. (1995). Commercial Banking:

The Management of Risk, New York: Western Publishing
Company

Money Market Account as retrieved from

http://www.investopedia.com/terms/m/moneymarketaccount.asp

Shekhar, K. C. and Shekhar, L. (2007). Banking Theory and Practice, 7th

Edition, New Delhi: Vikas Publishing House PVT Limited.

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UNIT 6 LAND AND SECURITY

CONTENTS

1.0 Introduction
2.0 Objectives
3.0 Main Content
3.1 Nature and Precautions for Taking Land and Building as
Securities
3.2 Terms Associated with Mortgages
3.3 Classification of Mortgages
4.0 Conclusion
5.0 Summary
6.0 Tutor-marked Assignment
7.0 References/Further Reading

1.0 INTRODUCTION

In the previous study unit, we have discussed the issue of securities and
loan recovery. There are instances under which bank advances are given
based on the use of land buildings as collateral securities, which are
made available by the customers as loan beneficiaries. The use of land
and buildings involves pledging some property of the business as
securities while they are regarded as immoveable property. They are
stationery at the particular places where they are located. Hence the
issue of using land and buildings as collateral securities by the
beneficiaries, which the bankers accept for advancing the loanable
funds, constitute the subject of discussion in this study unit.

2.0 OBJECTIVES

At the end of this study unit, you should be able to:

• mention precautions towards accepting land and buildings as

securities by banks
• list and discuss terms associated with mortgages
• mention and explain various kinds of mortgages
• explain the use of debenture.

3.0 MAIN CONTENT

3.1 Nature and Precautions for Taking Land and Building as

Securities

When advancing money on the basis of land and building, the banker is
inadvertently advancing money on the mortgage of the property so

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pledged for the loan. Before, delving into the discussion on mortgage in
relation to land and building as securities, it is pertinent to point out the
following precautions, which must be observed by the bankers.

1. The banker has to comply with the detailed requirements

specified in the extant laws and regulations.

2. The mortgage deed should be meticulously drafted in order to

cover all contingencies that are likely to arise from the
agreement.

3. In some cases, the banker may find himself in a precarious

situation if the title deeds deposited turn out to be defective.

4. Therefore, in such a situation, the deeds can be reclaimed by the

true owner without repayment of the amount advanced, even
though the banker has acted in good faith and without actual or
constructive notice of the defective title.

5. Basically, in some instances, the person holding the title deeds

may only be a mortgagee, in which case he only has the right to
transfer his interest in the property.

6. Realisation of the mortgaged property in case of default by the

borrower is possible only after complying with all the legal
requirements, which may involve some costs and time.

7. Difficulties in valuation of mortgaged property and the

interpretation of the provisions of land tenures (traditional and
government) can further pose some problems for the bankers.

8. In such situations, the banker will have to depend on expert

advice from legal luminaries and estate valuers, which in any
case will involve time and costs.

9. The issue of second mortgages is considered still less satisfactory

as banking securities. The rights of the second mortgagee are
subject to and subordinate to those of the first mortgagee.

10. Regardless of the possibility of a considerable margin between

the mortgage and the mortgageable value, the banker's position is
still not secure.

11. The first mortgagee may add any arrears of interest to the debt in
priority of the second mortgagee.

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12. Furthermore, under certain circumstances, the first mortgagee

may make further advances, which will get priority over the
second mortgagee.

13. Hence, such can only be guarded against by ascertaining the

extent of interest of the first mortgagee by the bankers, and
whether they are under any obligation to make further advances.

SELF-ASSESSMENT EXERCISE 2

Mention the precautions that should be taken by bankers when accepting

land and buildings as securities.

3.2 Terms Associated With Mortgages

1. Immovable Property

When the banker is securing advances with collaterals, the relevant issue
is whether a particular collateral is a movable or an immovable property
as in the case of land and building. It is instructive to note that may be
recalled here that a mortgage can be created only by a transfer of interest
in an immovable property. Basically, this point is relevant for
determining the period of limitation for a suit for declaration of the title
to the property, or for recovery of possession of the property.

2. Mortgagor and Mortgagee

Basically, the person who transfers an interest in a specific immovable

property is known as the mortgagor and the person to whom the interest
is transferred is called the mortgagee.

3. Creation of a Mortgage

Fundamentally, a mortgage may be created either by deposit of title

deeds, by delivery of possession, or by a registered document.

Creating mortgage on an immovable property does not need any

particular form. In broad based terms, for creating a charge on
immovable property no particular form of words is needed; adequate
words of intention may be expressed to make property or fund belonging
to a person charged for payment of a debt mentioned in the deed.
However, in order that a charge may be created, there must be evidence
of intention disclosed by the deed that a specified property or fund
belonging to a person was intended to be made liable to satisfy the debt
due by him.

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SELF-ASSESSMENT EXERCISE 2

Differentiate between mortgagor and mortgagee.

3.3 Classification of Mortgages

There are various types of mortgage as identified and explained as

follows:

1. Simple Mortgage

Where, without delivering possession of the mortgaged property, the

mortgagor binds personally to pay the mortgage money and agrees,
expressly or impliedly that, in the event of his failing to pay according to
the contract, the mortgagee shall have be right to cause the mortgaged
property to be sold and the proceeds of sale to be applied, so far as may
be necessary, in payment of the mortgage money, the transaction is
called a simple mortgage, and the mortgagee a simple mortgagee.

2. Mortgage by Conditional Sale

A mortgage by conditional sale is different from a sale with a condition

to repurchase. In the former case, the transfer is made to constitute a
security for a debt. Relatedly, the right of taking back the property on
payment of the amount due is not lost even though the mortgagor fails to
pay on the appointed day. In the case of a sale with a condition to
repurchase, there is no debt for which the transfer is a security.
Moreover, there is a transfer of all the rights in the property reserving
only a personal right of repurchase, which is lost if not exercised within
the agreed time.

A mortgagee, in the case of a mortgage by conditional sale, has the right

to sue for foreclosure on default of the mortgagor to repay the amount.
A suit to obtain a decree that a mortgagor shall be absolutely debarred of
his right to redeem the mortgaged property is called a 'suit for
foreclosure'.

3. Usufructuary Mortgage

Where the mortgagor delivers possession expressly or by implication

binds myself to deliver possession of mortgaged property to the
mortgagee, and authorizes him to retain such possession until payment
of the mortgage money, and to receive the rents and profits accruing
from the property or any part of such rents and profits and to appropriate
the same in lieu of interest, or in payment of the mortgage money or
partly in lieu of interest and partly in payment of the mortgage money,

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the transaction is called a usufructuary mortgage, and the mortgagee a

usufructuary mortgagee.

Hence, in the case of a usufructuary mortgage, the mortgagor delivers

possession of the mortgaged property. He is entitled to recover
possession of the mortgaged property when he pays back the debt or
when the debt is discharged by rents and profits received.

4. Mortgage by deposit of title deeds

This type of a mortgage is called an Equitable Mortgage. There is no

registration that is required in the case of a 'mortgage by deposit of title
deeds. It is effected merely by deposit of title deeds.

In terms of rights of a mortgagee by deposit of title deeds, all provisions

relating to a simple mortgage are applicable to a mortgage by deposit of
title deeds. Hence there is a personal liability on the mortgagor to pay
the debt. In addition, the mortgagee is allowed to realize the debt by
selling the property with the sanction of the Court.

5. Anomalous mortgage

An 'anomalous mortgage' may arise by a combination of two or more

kinds of mortgages enumerated below, or by usage in particular
localities. An example of such a mortgage may be found in a
combination of a simple mortgage and a usufructuary mortgage. Here, in
addition to the mortgagee's right to appropriate rents and profits against
the amount due, he also has the right to personally realize the debt from
the mortgagor.

SELF-ASSESSMENT EXERCISE 3

Mention and explain various types of mortgage.

4.0 CONCLUSION

From our discussion in this unit, we have stated that mortgage refers to
pledging some specific property for taking loanable funds by the
customers of banks. There are peculiar terms that are associated with
mortagage such as mortgagor and mortagee, movable and immoveable
property, among others. There are also various types of mortgage such
as simple mortgage, mortgage by conditional sale, usufructuary
mortgage, mortgage by deposit of title deeds, and anomalous mortgage.

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5.0 SUMMARY

In this course of analysis in this study unit, we have discussed: meaning

of mortgage; terms associated with mortgages; classification of
mortgages; and debenture. these issues in respect of mortgage will still
be discussed in a subsequent study unit. In the next study unit however,
we shall discuss negotiable instruments: cheques, promissory notes and
bills of exchange.

6.0 TUTOR-MARKED ASSIGNMENT

1. Differentiate between mortgage and debenture.

2. Mention the precautions to be taken by banks while accepting
mortgage as securities for loan.

7.0 REFERENCES/FURTHER READING

Dlabay, Les R.; Burrow, James L. & Brad, Brad (2009). Intro to
Business. Mason, Ohio: South-Western Cengage Learning.
p. 482. ISBN 978-0-538-44561-0.

Fraser, D. R., Gup, B. E. & Kolari, J.W. (1995). Commercial Banking:

The Management of Risk. New York: Western Publishing
Company.

Money Market Account as retrieved from

http://www.investopedia.com/terms/m/moneymarketaccount.asp

Shekhar, K. C. & Shekhar, L. (2007). Banking Theory and Practice. (7th

ed.). New Delhi: Vikas Publishing House PVT Limited.

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MODULE 3

Unit 1 Shares as Collateral Securities for Bank Advances

Unit 2 Negotiable and Non-negotiable Securities
Unit 3 Mortgage and Debentures
Unit 4 Produce and Goods as Securities
Unit 5 Guarantees for Loans and Advances
Unit 6 Bankruptcy

UNIT 1 SHARES AS COLLATERAL SECURITIES FOR

BANK ADVANCES

CONTENTS

1.0 Introduction
2.0 Objectives
3.0 Main Content
3.1 Stock Exchange Securities
3.1.1 Valuation of Stock Exchange Securities
3.1.2 Margin for Stock Exchange Securities
3.1.3 Liquidity of Stock Exchange Securities
3.1.4 Necessity of Written Agreements (Memorandum of
Deposit) On Charging Stock Exchange Securities
4.0 Conclusion
5.0 Summary
6.0 Tutor-marked Assignment
7.0 References/Further Reading

1.0 INTRODUCTION

In the previous study unit, we have discussed the issue of land and
buildings as securities for bank advances which borders on mortgage.
There are instances under which bank advances are given based on the
use of capital market securities such as shares as collateral securities,
which are made available by the customers as loan beneficiaries. The
use of shares involves pledging some investments which are in the
capital stock that are tradable in the capital market. Hence the issue of
shares as collateral securities by the beneficiaries, which the bankers
accept for advancing the loanable funds, constitutes the subject of
discussion in this study unit.

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2.0 OBJECTIVES

At the end of this study unit, you should be able to:

• discuss stock exchange securities

• list and discuss terms associated with stock exchange securities
• differentiate between negotiable and non-negotiable securities.

3.0 MAIN CONTENT

3.1 Stock Exchange Securities

The stock exchange securities include all financial instruments issued by

private enterprises, public enterprises and governments at federal, state
and local levels. Fundamentally, bankers generally consider stock
exchange securities as acceptable securities for advancing funds to the
customers. In the event of necessity, such securities can be traded in the
stock exchange and their funds realized without much difficulty. In
essence, it is comparatively easy to ascertain the value of most stock
exchange securities. It is also easy to determine their title, and above all,
some of these securities are fully negotiable.

3.1.1 Valuation of Stock Exchange Securities

The value of stock exchange securities depends on the category to which

they belong. Basically, the securities issued by industrial and
commercial enterprises rank next to the securities issued by Government
and public enterprises. The valuation of securities issued by industrial
and commercial enterprises depends on a number of factors; these
include: the nature of the security, the stability of the organization that
has issued it, the ease with which such can be realised without loss being
incurred besides the costs for their transactions.

In respect of ascertaining the value of the shares of industrial

enterprises, there are many factors that are to be taken into
consideration. The quotations on shares on stock exchange are often
considered as a safe guide in assessing the value of such securities.
However, it is advisable to supplement stock exchange quotations with
an independent valuation. The past record on the performance of the
enterprises concerned in respect of quoted shares should be taken into
careful consideration. Hence, the banker should ascertain the dividend
records and the balance sheet of the organizations for the past five years,
at least.

In the above respect, shares with steady dividend records are more
acceptable as collateral securities for bank advances. Furthermore, the

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integrity and business acumen of the promoters, the management team

and directors of the enterprise are also of considerable importance in
assessing the acceptability of the company’s shares. Furthermore, the
future prospects of the company in particular and its industry should also
be carefully evaluated. In case of a depression being imminent in such
an industry, the shares of its firms cannot be acceptable as securities for
bank advance.

The preference shares, where they are used as collateral securities for
advances, are more acceptable as compared to ordinary shares.
Nevertheless, preference shares do not carry a preferential right as to the
repayment of capital in relation to the right of the creditors. This implies
that preferential shareholders’ right as to the repayment of capital is
subject to the discharge of all debts owed by the company and payment
of charges ranking prior to the preference shares. A company which has
issued a large number of preference shares may, for all practical
purposes, be considered to have all the risks associated with ordinary
shares.

In the course of valuing ordinary shares, the banker should take into
consideration the aggregate value of such shares which come before
them in ranking for dividend and/or return of capital. For example, the
ordinary stock of a company which has issued no other class of shares
would, other things being equal, be better as banking security than
ordinary shares of a company which has issued numerous preference
shares of large aggregate value.

It is also imperative to ascertain whether or not the shares under

consideration are fully paid up. In the event that they are partly paid-up
shares, due contemplation should be accorded the amount remaining
unpaid. In addition, the banker should ensure make certain that no call
has been made which the holder of the shares has failed to pay.

SELF-ASSESSMENT EXERCISE 1

Discuss the valuation of stock exchange securities.

3.1.2 Margin for Stock Exchange Securities

The market price of a stock exchange security is prone to fluctuations.

Therefore, the banker should insist on adequate margin in order to cover
any possible price fluctuations, which depends on the class of security.
This implies that margin which bankers will insist on varies according to
the type of securities.

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The prices of government securities do not vary widely because such

securities are gilt-edged securities. Nevertheless, changes in the interest
rates have a considerable bearing on their prices. In the event that the
interest rate increases, the value of such securities tends to decrease.
Similarly, the state of trading in the capital market influences the prices
of government securities. During a period of active trade, their prices
tend to increase. Thus, the future course of interest rates and state of
trading on government securities should be carefully studied bankers
while fixing the margin for government securities.

The same considerations apply in the case of state and local government
securities. In respective of debentures of industrial enterprises, this
margin depends on the standing and financial position of the company
issuing them. Nevertheless, the margin for them will generally be higher
as compared to that of Government securities.

The margin required by bankers for shares of industrial enterprises will

be higher than that for government securities or industrial debentures.
Such margin will still be higher in the case of ordinary shares compared
to preference shares. In any case, the margin varies according to the
creditworthiness of the issuing company, its past performance, dividend
records and the future of the particular industry in which the firm is
operating. The stock exchange quotations of such securities are also
taken into consideration. In the case of partially paid shares, the margin
is based on the amount paid up on them. In this connection, it should be
noted that the failure to pay for share on calls whenever they are made
may make the shares liable for forfeiture.

3.1.3 Liquidity of Stock Exchange Securities

The banks should always be careful in selecting shares as securities;

they should only insist on liquid securities as cover for their advances.
Basically, liquidity implies the ability of the securities to be converted
into cash on demand. In other words, liquidity refers to the easy with
which the securities can be traded for cash in the capital market without
loss. For example, the ordinary shares of an industrial enterprise may be
easily traded, but only at a discount. Here, liquidity is possible only at a
loss and hence cannot be considered as a sound banking security.
Bankers should always bear in mind that liquidity should not be
sacrificed for profitability.

3.1.4 Necessity of Written Agreements (Memorandum of Deposit)

on Charging Stock Exchange Securities

In legal terms, a written agreement is not necessary in the case of a

pledge or a mortgage of movable properties. Nevertheless, bankers are

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advised to take written agreements while advancing money on stock

exchange securities. Basically, the mere deposit of securities with the
intention to create a charge thereon will give the banker a charge over
the securities. However, a written agreement, which is regarded as
‘Memorandum of Deposit’ can include certain provisions that are
favourable to the banks.

In respect of the 'Memorandum of Deposit' for shares, there are basic

provisions that pertinent and must be incorporated in it. Such provisions
include the following:

1. Statement specifying that the securities are deposited with the

intention of creating a charge for the purpose of securing any sum
due to the banks.

2. There must be an undertaking by the depositor to maintain a

specified margin.

3. There must be an agreement that the amount due shall be repaid

on demand.

4. There should be an authority to the bank to realize the securities

without obtaining the previous consent of the depositor.

5. There should be a provision that the security shall be a continuing

one.

6. There should be a promise by the depositor to pay any unpaid

installments or calls that may become due on the shares.

7. There should be an agreement that the charge shall cover

amounts due from a survivor, in the case of joint accounts.

8. In the case that the securities are deposited on behalf of a

partnership firm, there should a provision that the banker's
position will not be affected by any change in the constitution of
a partnership firm arising out of the death, insolvency, insanity,
retirement or admission of a partner.

9. In the event that the securities are deposited on behalf of a limited

company, there should be a stipulation that the banker's rights
shall not be affected by any change in the constitution of the
company by reason of amalgamation or absorption.

10. There should be a declaration by the depositor that he has a good

title to the securities deposited.
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11. There should be a schedule as annexure to the memorandum of

deposit showing the details of the securities deposited.

SELF-ASSESSMENT EXERCISE 2

Mention the essentials provisions in respect of Memorandum of Deposit

for shares when being used as securities for bank advances.

4.0 CONCLUSION

From our discussion in this unit, we have stated that capital market
securities such as shares can be taken by the banks for advancing funds
to their customers. However, there are certain precautions that should be
observe by the banks before the acceptance of shares. In accepting
shares as securities, there is the necessity for a written agreement in
form of Memorandum of Deposit. Furthermore, there certain classes of
securities that cannot be accepted as securities for bank advances; these
include shares in private companies, unquoted shares and shares in
foreign companies.

5.0 SUMMARY

In this course of analysis in this study unit, we have discussed stock

market securities in relation to bank advances, and in the process, we
espoused on: stock exchange securities; valuation of stock exchange
securities; margin for stock exchange securities; liquidity of stock
exchange securities; and necessity of written agreements (memorandum
of deposit) on charging stock exchange securities. In the next study unit,
we shall discuss negotiable securities and non-negotiable securities.

6.0 TUTOR-MARKED ASSIGNEMENT

1. Differentiate between Negotiable and Non-Negotiable Securities.

2. Give reasons why some classes of shares cannot be accepted as
securities for bank advances.

7.0 REFERENCES/FURTHER READING

Dlabay, Les R.; Burrow, James L. & Brad, Brad (2009). Intro to
Business. Mason, Ohio: South-Western Cengage Learning.
p. 482. ISBN 978-0-538-44561-0.

Fraser, D. R., Gup, B. E. & Kolari, J.W. (1995). Commercial Banking:

The Management of Risk. New York: Western Publishing
Company.

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BFN 301 PRACTICE OF BANKING

Money Market Account as retrieved from

http://www.investopedia.com/terms/m/moneymarketaccount.asp

Shekhar, K. C. & Shekhar, L. (2007). Banking Theory and Practice. (7th

ed.). New Delhi: Vikas Publishing House PVT Limited.

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UNIT 2: NEGOTIABLE AND NON-NEGOTIABLE

SECURITIES

CONTENTS

1.0 Introduction
2.0 Objectives
3.0 Main Content
3.1 Negotiable Securities
3.2 Non-Negotiable Securities
4.0 Conclusion
5.0 Summary
6.0 Tutor-marked Assignment
7.0 References/Further Reading

1.0 INTRODUCTION

Some of the securities that are accepted by the banks are negotiable
while some others are not negotiable. There are instances under which
bank advances are given based on negotiable instruments such as capital
market securities, as made available by the customers as loan
beneficiaries. The use of non-negotiable securities by loan beneficiaries
should be accepted with caution so that banks do not lose their funds in
the process. Hence the issue of negotiable securities and non-negotiable
securities as collaterals, which the bankers accept for advancing the
loanable funds, constitutes the subject of discussion in this study unit.

2.0 OBJECTIVES

At the end of this study unit, you should be able to:

• discuss negotiable securities for bank advances

• explain non-negotiable securities for bank advances.

3.0 MAIN CONTENT

3.1 Negotiable Securities

Some of the stock exchange securities are fully negotiable. Accordingly

the Negotiable Instruments Act explains that a negotiable instrument
means a promissory note, bill of exchange or cheque payable, either to
order or bearer. Besides these ones, there are other instruments
considered as negotiable instruments which the mercantile custom
judicially recognized. Basically, the transfer of a negotiable instrument
is effected by delivery or by endorsement and delivery, and the property
in a negotiable instrument is acquired by every person who takes it bona

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fide and for value, notwithstanding any defect in the title of the person
from whom he took it.

Securities like bonds payable to bearer, share warrants, and debentures

payable to bearer, among others, are treated as negotiable securities. In
the case of debentures payable to bearer, the custom to treat them as
negotiable by delivery is recognized by the appropriate law.

The negotiable securities are considered ideal as banking securities. The

mere deposit of such securities with intent to pledge gives the banker
complete title to them, with a right of sale implied in a pledge.
Nevertheless, bankers generally take a `Memorandum of Deposit' as
discussed above which is indicative of the purpose of the deposit, and
containing a clause that the security shall be a continuing one.

Furthermore, the banker is often given an express power of sale.

Essentially, therefore, when banks are advancing money on securities
which are negotiable instruments but which are to be transferred by
endorsement and delivery, they should see that they are properly
endorsed in favour of the banks.

SELF-ASSESSMENT EXERCISE 1

Discuss negotiable securities for bank advances.

3.2 Non-Negotiable Securities

Banks do not get a legal title by mere deposit of non-negotiable

securities such as registered shares, registered stocks, inscribed stocks,
etc. Banks can only perfect their security by having it transferred into
their own names. A bank advancing money on the deposit of share
certificates gets only an equitable title.

1. Equitable mortgage

In the case of non-negotiable securities, an equitable mortgage is

effected by:

(a) Deposit of the securities with the intention to create a charge;

(b) Deposit of the securities with a Memorandum of Deposit;
(c) Deposit of the securities with a Memorandum of Deposit and
duly executed blank transfers.

In respect of banker's position, an equitable mortgage is not desirable

due to some defects showing the unsatisfactory nature of an equitable
mortgage. Such defects include the following:

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i) A prior equitable mortgage, effected with or without the banker's

knowledge, will rank before his equitable charge;
ii) The mortgagee may be holding the securities as a trustee, in
which case the beneficiaries of the trust will get a prior equitable
title;
iii) An equitable title will be postponed to a subsequent legal title;
iv) The mortgagor may have only an equitable title to the securities,
which means he cannot pass more than his own equitable title to
the banker; and
v) The company issuing the securities may have a lien over them as
against the registered owner.

Due to the above defects, the banker should not advance money on an
equitable mortgage except on exceptional cases. Furthermore, the bank
should try to protect its interests by giving the issuing company a notice
of lien in duplicate, with a request that the company acknowledges the
notice by endorsing and returning the duplicate. Nevertheless, such a
notice does not obtain for him a priority over a prior equitable title. But,
it still secures priority for the banker over any future advances made by
the company to the shareholder. It also minimizes the possibility of a
mortgagor fraudulently obtaining duplicate copies of his share
certificates and passing a legal title to some other person.

SELF-ASSESSMENT EXERCISE 2

Identify the defects inherent in the unsatisfactory nature of an equitable

mortgage.

4.0 CONCLUSION

From our discussion in this unit, we have stated that we have stated that
some of the collaterals being offered by bank customers for advances are
negotiable while some others are not negotiable. The bank should accept
such non-negotiable instruments with caution so that in the final
analysis, funds advanced out can be recouped without problems, which
can affect the operations of the benefactors.

5.0 SUMMARY

In this course of analysis in this study unit, we have discussed

negotiable securities and non-negotiable securities in relation to the
advances being made by the banks to the customers. In the next study
unit, we shall discuss mortgages and debentures.

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6.0 TUTOR-MARKED ASSIGNEMENT

Differentiate between Negotiable and Non-Negotiable Securities.

7.0 REFERENCES/FURTHER READING

Dlabay, Les R.; Burrow, James L. & Brad, Brad (2009). Intro to
Business. Mason, Ohio: South-Western Cengage Learning.
p. 482. ISBN 978-0-538-44561-0.

Fraser, D. R., Gup, B. E. & Kolari, J.W. (1995). Commercial Banking:

The Management of Risk. New York: Western Publishing
Company.

Money Market Account as retrieved from

http://www.investopedia.com/terms/m/moneymarketaccount.asp

Shekhar, K. C. & Shekhar, L. (2007). Banking Theory and Practice. (7th

ed.). New Delhi: Vikas Publishing House PVT Limited.

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BFN 301 MODULE 3

UNIT 3: MORTGAGES AND DEBENTURES

CONTENTS

1.0 Introduction
2.0 Objectives
3.0 Main Content
3.1 Mortgage
3.1.1 Terms Associated with Mortgages
3.3.2 Classification of Mortgages
3.2 Debenture
4.0 Conclusion
5.0 Summary
6.0 Tutor-marked Assignment
7.0 References/Further Reading

1.0 INTRODUCTION

There are instances under which bank advances are given based on the
use of mortgages and debentures as collateral securities, which are made
available by the customers as loan beneficiaries. The former involves
pledging some property of the business as securities while the latter
involves the use of investment in debentures as collateral for securing
the funds involved in the loan facilities. Hence the issues of mortgages
and debentures as securities for advances constitute the subject of
discussion in this study unit of the material.

2.0 OBJECTIVES

At the end of this study unit, you should be able to:

• discuss the nature of mortgage

• mention and discuss terms associated with mortgages
• mention and explain various kinds of mortgages
• explain the use of debenture.

3.0 MAIN CONTENT

3.1 Mortgage

The term mortgage is regarded as the transfer of an interest in a specific

immovable property for the purpose of securing the payment of money
advanced or to be advanced by way of loan, an existing or future debt,
or the performance of an engagement which may give rise to pecuniary
liability.
Hence, the inherent fundamentals in the above definition of mortgage in

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relation to collateral in lending include:

a. There must be a transfer of interest in an immovable property.

b. The immovable property must be a specific one.
c. The consideration of a mortgage may be either money advanced
or to be advanced by way of a loan, or the performance of a
contract.

SELF-ASSESSMENT EXERCISE 1

Define the term Mortgage in relation to bank facility to a business entity.

3.1.1 Terms Associated with Mortgages

1. Immovable Property

When the banker is securing advances with collaterals, the relevant issue
is whether a particular collateral is a movable or an immovable property.
It is instructive to note that a mortgage can be created only by a transfer
of interest in an immovable property. Basically, this point is relevant for
determining the period of limitation for a suit for declaration of the title
to the property, or for recovery of possession of the property.

2. Mortgagor and Mortgagee

Basically, the person who transfers an interest in a specific immovable

property is known as the mortgagor and the person to whom the interest
is transferred is called the mortgagee.

3. Creation of a Mortgage

Fundamentally, a mortgage may be created either by deposit of title

deeds, by delivery of possession, or by a registered document.

Creating mortgage on an immovable property does not need any

particular form. In broad based terms, for creating a charge on
immovable property no particular form of words is needed; adequate
words of intention may be expressed to make property or fund belonging
to a person charged for payment of a debt mentioned in the deed.
However, in order that a charge may be created, there must be evidence
of intention disclosed by the deed that a specified property or fund
belonging to a person was intended to be made liable to satisfy the debt
due by him.

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SELF-ASSESSMENT EXERCISE 2

Differentiate between mortgagor and mortgagee.

3.3.2 Classification of Mortgages

There are various types of mortgage as identified and explained as

follows:

1. Simple Mortgage

Where, without delivering Possession of the mortgaged property, the

mortgagor binds personally to pay the mortgage money and agrees,
expressly or impliedly that, in the event of his failing to pay according to
the contract, the mortgagee shall have be right to cause the mortgaged
property to be sold and the proceeds of sale to be applied, so far as may
be necessary, in payment of the mortgage money, the Act transaction is
called a simple mortgage, and the mortgagee a simple mortgagee.

2. Mortgage by Conditional Sale

A mortgage by conditional sale is different from a sale with a condition

to repurchase. In the former case, the transfer is made to constitute a
security for a debt. Relatedly, the right of taking back the property on
payment of the amount due is not lost even though the mortgagor fails to
pay on the appointed day. In the case of a sale with a condition to
repurchase, there is no debt for which the transfer is a security.
Moreover, there is a transfer of all the rights in the property reserving
only a personal right of repurchase, which is lost if not exercised within
the agreed time.

A mortgagee, in the case of a mortgage by conditional sale, has the right

to sue for foreclosure on default of the mortgagor to repay the amount.
A suit to obtain a decree that a mortgagor shall be absolutely debarred of
his right to redeem the mortgaged property is called a 'suit for
foreclosure'.

3. Usufructuary Mortgage

Where the mortgagor delivers possession expressly or by implication

binds myself to deliver possession of mortgaged property to the
mortgagee, and authorizes him to retain such possession until payment
of the mortgage money, and to receive the rents and profits accruing
from the property or any part of such rents and profits and to appropriate
the same in lieu of interest, or in payment of the mortgage money or
partly in lieu of interest and partly in payment of the mortgage money,

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the transaction is called a usufructuary mortgage, and the mortgagee a

usufructuary mortgagee.

Hence, in the case of a usufructuary mortgage, the mortgagor delivers

possession of the mortgaged property. He is entitled to recover
possession of the mortgaged property when he pays back the debt or
when the debt is discharged by rents and profits received.

4. Mortgage by deposit of title deeds

This type of a mortgage is called an 'Equitable Mortgage'. There is no

registration that is required in the case of a 'mortgage by deposit of title
deeds. It is effected merely by deposit of title deeds.

In terms of rights of a mortgagee by deposit of title deeds, all provisions

relating to a simple mortgage are applicable to a mortgage by deposit of
title deeds. Hence there is a personal liability on the mortgagor to pay
the debt. In addition, the mortgagee is allowed to realize the debt by
selling the property with the sanction of the Court.

5. Anomalous mortgage

An 'anomalous mortgage' may arise by a combination of two or more

kinds of mortgages enumerated below, or by usage in particular
localities. An example of such a mortgage may be found in a
combination of a simple mortgage and a usufructuary mortgage. Here, in
addition to the mortgagee's right to appropriate rents and profits against
the amount due, he also has the right to personally realize the debt from
the mortgagor.

SELF-ASSESSMENT EXERCISE 3

Mention and explain various types of mortgage.

3. Debentures

The value of the debentures issued by corporate bodies or enterprises

depends on their creditworthiness. It is instructive to note that high
interest rates do not, as a rule, indicate their worth but it is also the
prevailing market values that are more important. Nevertheless, some
high yield of debentures may be an indication of their non-suitability as
banking securities.

Prior to accepting debentures, issued by a company, as collateral

securities for advancing money, it is necessary for the bank to take the
following steps to ensure the protection of its own interest:

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1) The bank should ascertain from the company's Memorandum and

Articles of Association whether they are issued in accordance with
its power;
2) He should also ascertain whether the company has issued any
debentures before the present issue;
3) In case a specific prior charge over the property charged to the
banker has been registered, his security will be postponed to that of
the earlier charge;
4) The banker should see that the debentures provide that the company
shall not create any further charge to rank before or pari passu with
the banker's charge; and
5) When a debenture gives a specific charge over
certain assets, it should be accompanied by deeds or other
documents evidencing the title of the company to the property.

4.0 CONCLUSION

From our discussion in this unit, we have stated that mortgage involves
pledging some specific property for taking loanable funds by the
customers of a bank. There are peculiar terms that are associated with
mortagage such as mortgagor and mortagee, movable and immoveable
property, among others. There are also various types of mortgage such
as simple mortgage, mortgage by conditional sale, usufructuary
mortgage, mortgage by deposit of title deeds, and anomalous mortgage.

5.0 SUMMARY

In this course of analysis in this study unit, we have discussed: meaning

of mortgage; terms associated with mortgages; classification of
mortgages; and debenture. In the next study unit, we shall discuss
produce and goods as securities for bank advances.

6.0 TUTOR-MARKED ASSIGNMENT

1. Differentiate between Mortgage and Debenture.

2. Mention the precautions to be taken by banks while accepting
mortgage as securities for loan.

7.0 REFERENCES/FURTHER READING

Dlabay, L.R., Burrow, J.L. & Brad, B. (2009). Intro to Business. Mason,
Ohio: South-Western Cengage Learning. p. 482. ISBN 978-0-538-
44561-0.

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Fraser, D. R., Gup, B.E. & Kolari, J.W. (1995). Commercial Banking:
The Management of Risk. New York: Western Publishing
Company.

Money Market Account as retrieved from

http://www.investopedia.com/terms/m/ moneymarketaccount.asp

Shekhar, K.C. & Shekhar, L. (2007). Banking Theory and Practice. (7th
ed.). New Delhi: Vikas Publishing House PVT Limited.

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UNIT 4 PRODUCE AND GOODS AS SECURITIES

CONTENTS

1.0 Introduction
2.0 Objectives
3.0 Main Content
3.1 Rationale for Taking Produce and Goods as Securities
3.2 Documents of Title to Goods
3.3 Right of Lien and Right of Stoppage in Transit
3.4 Types of Documents Associate with Produce and Goods
4.0 Conclusion
5.0 Summary
6.0 Tutor-Marked Assignment
7.0 References/Further Reading

1.0 INTRODUCTION

In the previous study unit, we have discussed the issue of debentures in

relation to its use as securities for bank advances. There are instances
under which produce and goods can be accepted by banks as securities
for their advances. Hence the issue of produce and good being used as
securities for advances is discussed in this study unit.

2.0 OBJECTIVES

At the end of this study unit, you should be able to:

• discuss the rational for taking produce and goods as securities for
advances
• list and explain documents of title to goods
• differentiate between right of lien and right of stoppage in transit
• mention and explain types of documents associate with produce
and goods.

3.0 MAIN CONTENT

3.1 Rationale for Taking Produce and Goods as Securities

The use of produce and goods as securities arises when a wholesaler is

taking an advance for the purpose of purchasing goods. And the source
of repayment is the sale proceeds of the goods purchased. Therefore, the
banker has the sale of the goods as the source for repayment.

There are some fundamental reasons which inform the acceptance of

produce and goods by banks as securities for their advances to their
customers. Such reasons are identified below.

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i) Produce and goods as securities offer something tangible for the

banker to realize in case of the customer's default.
ii) Produce and goods are easily realizable as compared to
immovable properties.
iii) Produce and goods are comparatively easier to evaluate.
iv) The source for repayment of advances, based on the produce and
goods, is comparatively secure.

On the contrary, the use of produce and goods as securities can be

fraught with problems. Basically, there are certain disadvantages to this
form of security. Such disadvantages are as identified below.

i) Possibilities of deterioration of the goods,

ii) Perpetration of fraud as regards their quality, value and title, and
risk of heavy fluctuations in their value, especially when they are
not necessities of life.

Hence it has been argued that successful loaning against such security
calls for specialized knowledge on the part of the bankers. The
responsibilities of the bankers, therefore, are in the following areas:

1) The first important point is to ascertain the quality of the goods.

2) This kind of security should be accepted only from persons of
business integrity.
3) The banker should try to make an independent examination of the
risk of deterioration is also an equally important point.
4) The nature of the goods should be carefully studied. If the goods
are perishable in nature or are liable to fashion changes, they
cannot be considered as an acceptable banking security.
5) The banker should try to limit his advances to non-perishable
goods in everyday use, capable of ready sale.
6) The banker should be able to make as independent valuation of
the goods. Here too, in certain cases, the banker will find the
services of an expert valuer necessary.
7) He must be able to study the market conditions carefully. The
importance of a careful study of the market conditions is
pertinent, particularly when there are chances of higher market
prices owing to the speculative hoarding of commodities.
Revaluation at short intervals is also necessary.
8) The banker should see that the goods offered as security are
properly insured and stored.
9) The banker has to be careful in cases where the seller reserves his
rights over the goods sold by inserting a suitable clause in the
contract of sale. In some trades, such clauses have been common
for some time and the practice is used frequently in Europe.
(Borden (U.K.) Ltd. Vs Scottish Timber Products Ltd (1979).

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10) The banker should satisfy himself about the title of the goods
pledged. Pledgee of goods does not get a better title than the
seller had unless the owner of the goods, by his conduct is
precluded from denying the seller's authority to sell or pledge.

Basically, certain exceptions to this general rule are laid down in the
Sale of Goods Act. The law recognizes a pledge by a person who is not
the owner but is in possession of the goods under the following
circumstances:

1. In the case of a mercantile agent

2. In the case of one of the joint owners
3. In the case of a person in possession of the goods under a
voidable contract
4. In the case of a buyer who is in possession of the goods before
the payment of purchase price
5. In the case of a seller who is in possession of the goods after sale
6. In the case of a person having a limited interest in the goods

SELF-ASSESSMENT EXERCISE 1

What are the responsibilities of bankers in acceptance of produce and

goods as securities for advances?

3.2 Documents of Title to Goods

Under Section 2(4) of the Sale of Goods Act, 'document of title to goods'
is defined as:

Documents of title to goods include a bill of lading, dock warrant,

warehouse-keeper's certificate, wharfinger's certificate, railway receipt,
warrant or order for the delivery of goods and any other document used
in the ordinary course of business as proof of the possession or control
of goods, authorizing or purporting to authorize, either by endorsement
or by delivery, the possession of the documents to transfer or receive
goods thereby represented.

While lending money on the security of documents of title to goods, the

banker has to carefully consider a number of factors, for instance:

i) The banker should remember that documents of title to goods do

not guarantee the quality or the value of the goods specified
therein.

For instance, in the case of a 'bill of lading' a clause is generally

included to the effect that 'weight and contents unknown'. Here, the

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banker has to depend on the integrity of the person shipping the goods.

ii) Secondly, unlike negotiable securities, title to the goods cannot

be acquired through a person who has stolen the document or
who has otherwise obtained the document without the seller's
assent.

iii) The banker should be careful to distinguish 'documents that give

title to goods' and 'documents that are mere receipts'. Bill of
lading, dock and warehouse-keeper's warrants may be included
under the former while warehouse-keeper's certificates, delivery
orders may be included under the latter.

The above distinction is important because in the event of bankruptcy,

the bona fide possession of a bill of lading or a warehouse-keeper's
warrant by a banker is sufficient to take the goods out of the order and
disposition of the bankrupt. Unless the goods have been registered in his
name, possession of a delivery order or a warehouse-keeper's certificate
is of no avail against the claim of the trustee in bankruptcy to possession
of the goods.

iv) The banker should take sufficient precautionary measures to

minimize the risks as identified above. He should see that the
goods covered by the document of title are properly insured. He
should also insist on a certificate from a reliable packer in order
to ascertain the contents of the packages.

v) In addition, a 'letter of hypothecation' should be taken from the

borrower lodging the documents as security. In fixing the margin,
consideration should be given for accruing charges for storage
and insurance. Above all, the integrity and honesty of the
borrower should be taken into consideration.

SELF-ASSESSMENT EXERCISE 2

What are the factors to be taken into consideration by the banker while
lending money on the security of documents of title to goods?

3.3 Right of Lien and Right of Stoppage in Transit

According to the Sale of Goods Act, an unpaid seller of goods, who is in

possession of them, is entitled to retain possession until payment.
However, he loses his lien when he delivers the goods to a carrier, or
other bailee, for the purpose of transmission to the buyer, without
reserving the right of disposal.

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Under this consideration, the right of lien is, no doubt, lost, but the right
of 'stoppage in transit' will be available. According to this right, an
unpaid seller can prevent the goods from being delivered to the buyer.
This right has been defined as a right possessed by the seller to resume
the possession of goods not paid for, while on the way to the vendee.
This right can only be exercised subject to the provisions of the Sale of
Goods Act, and is lost if the buyer obtains delivery of the document of
title and assigns the same to a bona fide purchaser for value. In reference
to Section 53 of the Sale of Goods Act, it states the following.

1. Subject to the provisions of this Act, the unpaid seller's right of

lien or stoppage in transit is not affected by any sale or other
disposition of the goods which the buyer may have made, unless
the seller has assented thereto.

2. Provided that where a document of title to goods has been issued

or lawfully transferred to any person as buyer or owner of the
goods, and that person transfers the document to a person who
takes the instrument in good faith and for consideration, then, if
such last mentioned transfer was by way of a sale, the unpaid
seller's right of lien or stoppage in transit is defeated.

3. If such last mentioned transfer was by way of pledge or other

disposition for value, the unpaid seller's right of lien or stoppage
in transit can be exercised subject to the right of the transferee.

4. Where the transfer is by way of a pledge, the unpaid seller may

require the pledgee to have the amount secured by the pledge
satisfied in the first instance, as far as possible, out of any other
goods or securities of the buyer in the hands of the pledgee and
available against the buyer.

Hence, it implies that where the pledgee has two or more securities, an
unpaid seller can compel the pledgee to resort to the other security or
securities first.

3.4 Types of Documents Associated with Produce and Goods

1. Bill of Lading

Bill of lading is a document issued by the ship owner, or by the Master

or other agent on his behalf, which states that certain goods have been
shipped on a particular ship and sets out the terms on which such goods
have been delivered to, and received by the ship (Sewell Vs Burdick).

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The bill of lading generally contains a provision to the effect of 'weight

and contents unknown'. Therefore, the banker cannot ascertain the
weight and contents of the packages from a bill of lading. Nevertheless,
the banker may protect himself by insisting on the deposit of the
relevant invoice showing the description and value of the goods along
with the bill of lading.

The relevant certificate from a reputed packer can also be insisted on.
The banker should ascertain whether the goods/packages were shipped
in good order and condition. In which case, a 'clean bill of lading' is
issued. Another point to be considered is whether or not the goods are
covered by appropriate insurance. The banker should make sure that the
insurance policy is attached with the bill of lading. The description of
the goods in the insurance policy should correspond with that in the bill
of lading.

A bill of lading is usually issued in triplicate, and signed by the Master

on behalf of the ship owner. The Master of the ship is allowed to make
delivery of the goods to the person who first presents one of the parts of
the bill of lading, provided such delivery is made in good faith and
without notice of any prior claim to the goods. As a rule, a condition is
included in the bill of lading to the effect that when one of the three bills
is accomplished, the other two are void. To be on the safe side, the
banker should get all the parts of the bill of lading into his own hands.
Where this is not possible, he should give notice of his claim to the ship
owner as soon as possible, or if the goods have already been handed
over to the dock company or warehouse keeper.

It is advisable to get the bill of lading endorsed in blank. A 'letter of

hypothecation' should also be taken. This will protect the banker from
any liability for freight and other charges on the goods. Of course, the
banker is entitled to get delivery of the goods only after paying freight
and other charges.

Sometimes a 'through bill of lading' is issued for the carriage of the

goods partly in the ship of the ship owner and partly by land or in the
ship of another ship owner for an inclusive freight. Such bills should be
accepted by the banker only from reputable customers. Bills of lading
which cover only a part of the journey should never be accepted as
banking security.

The banker is well advised not to accept 'received for shipment bills of
lading' as security. Such bills afford evidence of neither the goods being
shipped, nor the vessel on which they were loaded. The usual bill of
lading is a 'shipped bill of lading' which acknowledges receipt of goods
on board a particular vessel.

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When the goods arrive at the destination, the optimal course for the
banker would be to hand over the bill of lading to a warehouse-keeper,
with instruction to collect the goods and warehouse them in the name of
the banker.

2. Dock and Warehouse Warrants

The 'dock warrant' is a document issued by a dock company stating that

the goods described therein are deliverable to the person named in the
warrant, or to his assignee by endorsement. A warehouse warrant is a
document issued by a warehouse-keeper containing the same statement.
When such warrants are accepted as security, the banker should make it
a point of duty to register himself as the owner of the goods, or should
lodge a 'stop order' with the dock company or warehouse keeper to
prevent unauthorized dealing of the goods. The banker should also take
the general precautions as incorporated in the discussion of ‘Documents
of Title to Goods’.

3. Warehouse-keeper's Certificates

These certificates are mere acknowledgments by warehouse-keepers.

Where the banker advances money on such certificates, he should see
that a delivery order is made out in his favour. For failure to take such
action, he will be unable to obtain possession of the goods and have
them stored in his own name. A warehouse-keeper's certificate is only a
deposit receipt and hence, generally not transferable by law. And when
it is not transferable by law or through legislation, the safe course for the
banker would be to get a certificate made out in the name of the bank
that advances the money.

4. Delivery Order

The 'delivery order' is an order addressed to the warehouse keeper where

the goods are stored to deliver the goods mentioned therein to a
particular person. A banker granting an advance on the security of such
an instrument is well advised to get the goods transferred into his name.
It is instructive to note that the borrower may issue a second delivery
order to another person, and if such a person has no notice of the bank's
claim, he may get delivery of the goods by producing his copy of the
delivery order.

5. Way Bill or Truck Receipt

The banker has operational responsibility to take utmost precautions

while advancing money on the security of these documents. If at all the

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bank is granting an advance on the security of a 'way bill', it should

ensure that that the carrier company which has issued the way bill is in
the approved list of the Nigerian Postal authority, which has the
responsibility of registering all cargo companies in the country. In order
to safeguard the interests of the banks in general, NIPOST has laid down
certain norms for the operations of all cargo companies operating in the
country.

SELF-ASSESSMENT EXERCISE 3

Mention and discuss various types of documents that are associated with
produce and goods.

4.0 CONCLUSION

From our discussion in this unit, we have espoused on the fact that
produces and goods can be taken as securities for bank advances.
Nevertheless, banks should take necessary steps to ensure that they are
not shortchanged or outsmarted by the loan beneficiaries. Therefore,
they should ensure that necessary documentation are carried out on the
agreement and transfer of title and property on such goods and produce.

5.0 SUMMARY

In this course of analysis in this study unit, we have discussed: rationale

for taking produce and goods as securities; documents of title to goods;
right of lien and right of stoppage in transit; and types of documents
associated with produce and goods. In the next study unit, we shall
discuss guarantees for loan and advances.

6.0 TUTOR-MARKED ASSIGNEMENT

1. Differentiate title to goods and right of lien.

2. Mention and discuss types of documents associated with produce
and goods.

7.0 REFERENCES/FURTHER READING

Dlabay, Les R.; Burrow, James L. & Brad, Brad (2009). Intro to
Business. Mason, Ohio: South-Western Cengage Learning.
p. 482. ISBN 978-0-538-44561-0.

Fraser, D. R., Gup, B. E. & Kolari, J.W. (1995). Commercial Banking:

The Management of Risk. New York: Western Publishing
Company.

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BFN 301 MODULE 3

Money Market Account as retrieved from

http://www.investopedia.com/terms/m/moneymarketaccount.asp

Shekhar, K. C. & Shekhar, L. (2007). Banking Theory and Practice. (7th

ed.). New Delhi: Vikas Publishing House PVT Limited.

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UNIT 5 GUARANTEES FOR LOANS AND ADVANCES

CONTENTS

1.0 Introduction
2.0 Objectives
3.0 Main Content
3.1 Meaning of Guarantee
3.1.1 Differentiation between Contract of Guarantee and
Contract of Indemnity
3.1.2 Kinds of Guarantees
3.2 Guarantees as Banker's Security
3.3 Termination of Guarantee
4.0 Conclusion
5.0 Summary
6.0 Tutor-marked Assignment
7.0 References and Materials for Further Reading

1.0 INTRODUCTION

In the previous study unit, we have discussed the use of produce of

goods as securities, just like other collateral securities, for bank
advances to customers. Bankers are generally careful to secure advances
granted by them by insisting on adequate acceptable collateral securities.
However, in some cases the bank may grant advances on the basis of
personal security of the borrower, which is complemented by the
guarantee of some other persons. In this light, such advances to the
customers are not secured. In this study unit, therefore, the discussion is
on the nature and legal aspects of guarantees.

2.0 OBJECTIVES

At the end of this study unit, you should be able to:

• discuss the nature of guarantee for advances

• differentiate between guarantee and indemnity
• mention and explain kinds of guarantee
• identify circumstances that can vitiate the liability a guarantor
• discuss the termination of guarantee.

3.0 MAIN CONTENT

3.1 Meaning of Guarantee

A contract of guarantee is a contract to perform the promise, or

discharge the liability of a third person in case of default. The person

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who gives the guarantee is called the -surety or guarantor, the person for
whom the guarantee is given is called the principal debtor and the
person to whom the guarantee is given is called the creditor. Basically, a
guarantee must be evidenced by a letter accompanied by passport
photograph of the guarantor, in the banking system in Nigeria.

Hence in a contract of guarantee there are three parties such as the

surety, the principal debtor and the creditor. For instance, if Ado
guarantees that Bello will repay the loan granted to him by GT Bank
within a stated period and promises the bank that in case of default on
the part of Bello, Ado himself will repay the loan, it is a contract of
guarantee. Here Ado becomes the surety or the guarantor while Bello is
the principal debtor and GT Bank is the creditor. This implies that the
liability of Ado, the guarantee is dependent on the default of Bello to
repay the loan to GT Bank.

3.1.1 Differentiation between Contract of Guarantee and Contract

of Indemnity

A contract of guarantee is different from the contract of indemnity. A

contract of indemnity is a contract by which one party promises to save
the other from loss caused to him by the conduct of either the promisor
himself, or by the conduct of any other person. For instance, in case of
loss of a railway way bill, the consignee will be required to give an
indemnity bond by which he undertakes to compensate the railway
company for any loss which the latter may have to suffer owing to
delivering the goods without the production of the railway bill. There
are only two parties in a contract of indemnity such as the indemnifier
(or the promisor) and the promisee (or the insured or the party
indemnified).

On the other hand, in a contract of guarantee, there are three parties such
as the guarantor, the principal debtor and the creditor; as have been
identified and discussed above. Basically, the primary liability is that of
the principal debtor. The liability of the guarantor is collateral or
secondary, which is a contingency liability per se. Therefore, the
guarantor's liability only arises only when the principal debtor makes a
default.

In the case of a contract of indemnity, the indemnifier is the only person

who becomes liable to the indemnified if the latter suffers a loss on
account of his doing something at the express desire of the former. A
banker can safeguard his interests against loss arising from non-payment
or non-performance of an obligation either by obtaining a guarantee or
an indemnity from a third party. But in a contract of guarantee, if the
principal debtor defaults by non-payment to the creditor, the guarantor,

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on such payment, is entitled in law to proceed against the principal

debtor in his own right. In the case of a contract of indemnity, the
indemnifier cannot sue third parties in his own name unless there is an
assignment. He has to bring the suit in the name of the indemnified.

The indemnified has the right to recover from the indemnifier:

(a) all damages which the former may be compelled to pay in any
suit in respect of any matter to which the promise to the
indemnifier applies,

(b) all costs which the former may be compelled to pay in bringing
or defending such suits, provided he did not contravene the orders
of the indemnifier or acted in such a way as a prudent man would
not under similar circumstances, and

(c) all amounts which may have been paid under the terms of any
compromise of any such suit.

SELF-ASSESSMENT EXERCISE 1

Differentiate between guarantee and indemnity.

3.1.2 Kinds of Guarantees

Basically, a contract of guarantee may be either (a) simple (specific) or

(b) continuing. In the case of a simple guarantee, it covers only a single
transaction and in the case of a continuing guarantee it extends to a
series of transactions. It is instructive to note herein that a continuing
guarantee may be revoked at any time by the guarantor for future
transactions by due notice to the creditor.

Further, in the absence of any contract to the contrary, the death of the
guarantor operates, as a revocation of a continuing guarantee as regards
future transactions. Nevertheless, the legal representatives of the
deceased guarantor will be liable for all transactions guaranteed by him
before his death.

3.2 Guarantees as Banker's Security

Prior to the acceptance of a guarantee as a security, the banker has to

assess carefully the three Cs, which imply Character, Capacity and
Capital of the guarantor. The initial and continued solvency of the
guarantor and the completeness of the 'guarantee bond' are of special
importance. Bankers generally use printed forms containing detailed
clauses to safeguard their interests. In case of doubt regarding the

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continued solvency of the guarantor, collateral securities are often

insisted upon. So also, in the case of a guarantor with only a fixed
income which is terminating at his death, the banker would be well
advised to take out an insurance policy on the life of the guarantor.

Circumstances under which Guarantor will be discharged from his

Liability include the following:

1. Variance in terms of contract

Any variance, made without the guarantor's consent, in terms of the

contract between the principal debtor and the creditor, discharges the
guarantor as to transactions subsequent to the variance.

2. Release or discharge of the principal debtor

The guarantor is discharged by any contract between the creditor and the
principal debtor by which the principal debtor is released, or by any act
or omission of the creditor, the legal consequence of which is the
discharge of the principal debtor.

Furthermore, it is instructive to note that a release of any property

charged to meet one of the surety's contingent liability will discharge the
co-sureties. In Smith Vs Wood, it was held that the release of the
properties of one of the sureties by the creditor had brought a substantial
alteration in the contract connecting the parties inter se and had also
deprived the co-sureties of the right to have all the properties pledged
which caused the debt to fall on all the properties. Hence, the co-sureties
who had not consented to the alteration were held to be discharged.

Again, the creditor's forbearance to sue does not discharge the surety.
Mere forbearance on the part of the creditor to sue the principal debtor
or to enforce any other remedy against him does not, in the absence of
any provision to the contrary in the guarantee, discharge the surety. But
a release of any property charged to meet the principal debtor's liability
will have the effect of the creditor prejudicing the interests of the surety.

3. Compounds with, gives time to or agrees not to sue, principal

debtor

A contract between the creditor and the principal debtor, by which the
creditor makes a composition with, or promises to give time to, or
promises not to sue the principal debtor, discharges the surety unless the
surety assents to such contract. Relatedly, where a contract to give time
to the principal debtor is made by the creditor with a third person, and
not with the principal debtor, the surety is not discharged.

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4. Creditor's act or omission impairing surety's eventual

remedy

When the creditor carries out any act which is inconsistent with the right
of the surety, or omits to do any act which his duty to the surety requires
him to do, and the eventual remedy of the surety against the principal
debtor is thereby impaired, the surety is discharged.

5. Guarantee obtained either by misrepresentation or by

concealment

Any guarantee which has been obtained by means of either

misrepresentation by the creditor or with his knowledge and assent,
concerning a material part of the transaction is invalid. Any guarantee
which the creditor has obtained by means of keeping silent regarding the
material circumstances is invalid.

In addition, where a person gives a guarantee upon a contract that the

creditor shall not act upon it until another person has joined in it as co-
surety, the guarantee is not valid if that person does not join.

SELF-ASSESSMENT EXERCISE 2

What are the circumstances under which guarantor can be discharged

from his liability?

3.3 Termination of Guarantee

The termination of a guarantee in respect of future transactions takes

place if any of the following events occurs:

1. On receipt of notice of the principal debtor.

2. On the death of the guarantor. It may be repeated here that notice
of the death of the guarantor need not be given to the creditor.
But where the guarantee bond contains a clause that notice of a
certain period must be given to the bank by the legal
representatives of the deceased guarantor, the guarantee will
continue to bind the estate of the deceased guarantor till the
expiry of the notice period.
3. On receipt of notice to the creditor of the guarantor's insolvency.
4. Change in the constitution of the borrower.
5. Notice of demand by the creditor on the guarantor.
6. Notice of revocation by the guarantor to the creditor.

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SELF-ASSESSMENT EXERCISE 3

What are the circumstances that can lead to termination of guarantee?

4.0 CONCLUSION

From our discussion in this unit, we have stated that a guarantee

involves an undertaking by one person to pay amount of loan in the
event the loan beneficiary fails to pay after making use of the funds.
This is different from the issue of indemnity because compensation is
the issue under indemnity. There are circumstances under which the
guarantor’s liability can be vitiated if the necessary precautions are not
taken into consideration while accepting the undertaking by persons who
stand surety for loan beneficiaries.

5.0 SUMMARY

In this course of analysis in this study unit, we have discussed guarantee

for loans and advances, and in the process, we have espoused on:
meaning of guarantee; types of guarantee; guarantees as bankers’
security; and termination of guarantee. In the next study unit, we shall
discuss bankruptcy.

6.0 TUTOR-MARKED ASSIGNEMENT

1. Differentiate between right of lien and right of stoppage in transit.

2. Give reasons which can vitiate guarantor’s liability.

7.0 REFERENCES/FURTHER READING

Dlabay, Les R.; Burrow, James L. & Brad, Brad (2009). Intro to
Business. Mason, Ohio: South-Western Cengage Learning.
p. 482. ISBN 978-0-538-44561-0.

Fraser, D. R., Gup, B. E. & Kolari, J.W. (1995). Commercial Banking:

The Management of Risk. New York: Western Publishing
Company.

Money Market Account as retrieved from

http://www.investopedia.com/terms/m/moneymarketaccount.asp

Shekhar, K. C. & Shekhar, L. (2007). Banking Theory and Practice. (7th

ed.). New Delhi: Vikas Publishing House PVT Limited.

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UNIT 6 BANKRUPTCY

CONTENTS

1.0 Introduction
2.0 Objectives
3.0 Main Content
3.1 Meaning of Bankruptcy
3.2 Financial Distress and Bankruptcy
3.2.1 Financial Distress
3.2.2 Insolvency
3.2.3 Bankruptcy
3.3 Factors That Can Lead to Bankruptcy in Banking Industry
3.4 Bankruptcy and Debt Restructuring
3.4.1 Bankrupt Proceeding to Recover Debts
3.4.2 Proceeding in Individual Bankruptcy to Recover
Debts
4.0 Conclusion
5.0 Summary
6.0 Tutor-Marked Assignment
7.0 References/Further Reading

1.0 INTRODUCTION

In the previous study unit, we have discussed the use of guarantee for
bank loans and advances. In this last study unit, the discussion is on
bankruptcy. Corporate entity like a bank can become bankrupt when it
becomes technically insolvent because it cannot meet the demands of
the depositors due to financial distress. Individuals who owe banks can
also become bankrupt due to obvious reasons. The process for the
recovery of debts when an individual or company becomes bankrupt
forms an integral part of this study unit.

2.0 OBJECTIVES

At the end of this study unit, you should be able to:

• explain bankruptcy
• discuss financial distress in relation to bankruptcy
• differentiate between financial distress and insolvency
• mention and explain factors leading to bankruptcy in banking
industry
• discuss debt restructuring in relation to bankruptcy
• explain process in individual bankruptcy to recover debts.

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3.0 MAIN CONTENT

3.1 Meaning of Bankruptcy

The term bankruptcy refers to a legal status of a company or other

entities such as banks that cannot meet its external financial obligations
or cannot repay the debts it owes to creditors. In most jurisdictions,
bankruptcy is imposed by a court order, which is often initiated by the
debtor. But in the banking industry, the collapse (or bankruptcy) of
banks is normally pronounced by the regulatory authorities who then
take and entrust the administration of their assets and liabilities. For
instance, in Nigeria, the apex bank (CBN) and the Nigeria Deposit
Insurance Corporation (NDIC) have such responsibility. The latter then
dispose of the assets of the bankrupt banks and then pay the depositors.
From above, it implies that bankruptcy means insolvency, can arise from
a condition where a company cannot meet or has difficulty paying off its
financial obligations to its creditors. The chance of financial distress
increases when a firm has high fixed costs, illiquid assets, or revenues
that are sensitive to economic downturns.
A company under financial distress can incur costs related to the
situation, such as more expensive financing, opportunity costs of
projects and less productive employees. The firm's cost of borrowing
additional capital will usually increase, making it more difficult and
expensive to raise the much needed funds. In an effort to satisfy short-
term obligations, management might pass on profitable longer-term
projects. Employees of a distressed firm usually have lower morale and
higher stress caused by the increased chance of bankruptcy, which
would force them out of their jobs. Such workers can be less productive
when under such a burden.

SELF-ASSESSMENT EXERCISE 1

Explain the term bankruptcy.

3.2 FINANCIAL DISTRESS AND BANKRUPTCY

3.2.1Financial Distress

Financial distress occurs when a firm does not have enough cash to meet
its current obligations. During financial distress, a firm must make
decisions such as selling off assets to cover its cash shortfall. These
decisions may erode the value of the firm, and are choices the firm
would not make without the presence of a cash shortfall.

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Firms may deal with financial distress in many ways. In addition to

selling off assets, a firm may also reduce capital spending and research
and development. The firm may also undergo a financial restructuring
by negotiating with banks and other creditors, exchanging its equity for
outstanding debt, and filing for bankruptcy protection or bankruptcy.

3.2.2 Insolvency

A firm will go into bankruptcy when it becomes insolvent, and a firm

can be insolvent in two ways. Stock-based insolvency occurs when the
firm’s debt is greater than the firm’s net assets. As a result, the firm will
have a negative value for its equity. Flow-based insolvency occurs when
the firm’s cash flows drop below its current contractual obligations.

3.2.3 Bankruptcy

When a firm files a voluntary petition for bankruptcy, or is forced into

bankruptcy by an involuntary petition filed against it, a trustee-in-
bankruptcy will be elected by the firm’s creditors to administrate the
liquidation of the firm’s assets. Typically the claims against the firm will
be paid out from the proceeds from selling the assets in the following
order:

Administrative and other expenses for bankruptcy

Wages, salaries and commissions
Government tax claims
Payments for rent on premises
Judgments on claims for employee
Unsecured creditors
Preferred shareholders
Common shareholders

The secured creditors are paid out of the proceeds from the sale of
specific assets. Any amount owed to secured creditors once these
specified assets are liquidated is lumped in with unsecured creditors.
SELF-ASSESSMENT EXERCISE 2

Differentiate between financial distress and insolvency.

3.3 Factors That Can Lead to Bankruptcy in Banking Industry

1. High Government Borrowing:

In respect of government domestic borrowings, commercial banks are

normally required to hold as statutory liquidity reserves (LR) certain
percentage of their deposits in form of government securities, in addition
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to the required cash reserve requirement (CRR), which eat into their
liquidity position.

Participation in the open market operations market by subscribing to

treasury certificates and treasury bills can result in low returns on bank’s
portfolio, dis-intermediation in the banking system because of the
growth of a parallel economy, market segmentation (banks vis-à-vis
non-bank), and dispersion in interest rate structure.

2. Credit Controls

The system of credit ceiling being repressive, as the magnitude of credit

flows to the private sector was determined only after accommodating
public sector credit requirements. In addition, it also tends to
accommodate established borrowers even if they were simply meant to
rollover their loans, as banks were generally not willing to incur the cost
of screening and evaluating new projects.

With these ceilings in place, the practice of accruing interest on infected

loans by banks becomes very damaging. In the event that unrealized
income is liable to taxation, it tends to reduce banks’ ability to augment
their capital base and to extend new loans.

3 . Credit Allocation

Most of the directed credit programmes do result in low rates of returns

and large non-performing loans. It is also difficult to ensure that actual
intended beneficiaries are using the credit facilities. Mandatory credit
targets at concessional rates also reduced the profitability of the banks.

4. Interest Rates

Floors on deposit rates and ceilings on lending rates of commercial

banks discourage savings and the real interest rate on deposits remained
virtually negative for most of the time. This can lead to financial dis-
intermediation.

5. Limited Competition

A limited competition due to entry restrictions (such as abnormal N25

billion for capitalization for commercial banks) on new banks and
restrained activities of foreign banks hampered the development of the
financial system, which affect the banking industry due to non-
availability of inter-bank credits.

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6. Abnormal Overhead Cost

Abnormal overhead cost of operations of commercial banks can led to

financial distress, which can lead to bankruptcy resulting from collapse
of some banks and eventual liquidation.

7. Inefficient Operations

The use of unqualified personnel by commercial banks, and excess staff

strength, the banking operations can lead to serious inefficiency. For
instance, some commercial banks in Nigeria are known to be using
unqualified personnel due to family connection and other sentiments and
the scenario has resulted in inefficiency, loss of funds and eventual
collapse (bankruptcy) in recent years.

8. High Level of Malpractices

Another area that can lead to the collapse of banks, which can spell
bankruptcy is the malpractice in their operations. In the face of some
daunting problems militating against the operational efficiency of the
consolidated banks in Nigeria, for instance, they could not generate
appropriate level of income to meet their external obligations. In order
to boost their income, sharp malpractices by management teams and
boards of the banking entities became rampant in the industry. Such
malpractices were manifested in round-tripping in foreign exchange
transactions, excessive customer charges, falsification of records, and
adoption of unethical methods of poaching customers.

9. Pervasiveness of Insider Related Lending

Some banks in Nigeria, for instance, experienced pervasiveness of

family and related party affiliations even after the consolidation exercise
in the banking industry. Relatedly, there is the problem of lack of
transparency as a result of the diversification in bank ownership after the
consolidation. The situation resulted in huge levels of insider-abuses and
connected lending to members of management and their directors. The
scenario led to the collapse of some consolidated banks in the country.

10. Falsification and Concealment of Material Operational Issues

Pervasiveness in rendition of false operational returns to the regulatory

authorities by the consolidated banks in Nigeria, for instance, coupled
with concealment of vital information from examiners became endemic
in the banking industry. These detrimental practices were used to
prevent timely detection of the unhealthy situations in the operations of

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the banks arising from lack of transparency and pressure to boost

income.

Similarly, pervasiveness in concealment of material issues in banking

operations in areas of high magnitude of frauds, mixing up of family and
business interests, high magnitude of non-performing loans (toxic
assets), and award of bogus allowances to board members can and has
led to the collapse of some banks. Hence these unwholesome banking
practices coupled with poor risk management strategies, ineffective
board audit committees, and inadequate operational and financial
controls have resulted in destroying the fortunes of some banks and
invariably bankruptcy and total collapse.

SELF-ASSESSMENT EXERCISE 3

Enumerate and explain the factors that can lead to bankruptcy in

banking industry.

3.4 Bankruptcy and Debt Restructuring

3.4.1 Bankrupt Proceeding to Recover Debts

The principal focus of modern insolvency or bankruptcy is on business

debt restructuring. Current practices no longer rest on the elimination of
insolvent entities but on the remodeling of the financial and
organisational structure of debtors experiencing financial distress so as
to permit the rehabilitation and continuation of their business (Reifner et
al., 2003; Gerhardt, 2009; Frade, 2010).

An important issue in respect of individual or corporate debts is that, it

is insufficient for banks to merely dismiss debts after a certain period.
Rather, it is important to assess the underlying problems and to
minimise the risk of financial distress reoccurring. Hence banks are
advised to initiate fundamental actions such as:

i) Debt advice;
ii) A supervised rehabilitation period;
iii) Financial education and help to find sources of income towards
repayment of outstanding debts;
iv) Involvement of the bank staff in improving the management and
operations of the debtor company;
v) Advice on cost reduction measures in the debtor company’s
operations; and
vi) Forced divestment of some operations and sale of assets to
generate funds towards resuscitating the bankrupt company.

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In some cases, debt discharge is conditioned by a partial payment

obligation and by a number of requirements concerning the debtor's
behaviour. A bankruptcy regulation may provide for debt settlement
plans that can result in a reduction of the debt (maximally half of the
amount) or an extension of the payment period of maximally five years
(Gerhardt, 2009), but it may not foresee debt discharge.

Fraudulent declaration of bankruptcy can occur on the part of

individuals and companies. Such fraudulent practices in relation to
bankruptcy are regarded as criminal acts under bankruptcy statutes.
Some firms and managers do engage in concealment of assets,
concealment or destruction of documents, conflicts of interest,
fraudulent claims, false statements or declarations, and fee fixing or
redistribution arrangements.

Falsifications on bankruptcy forms often constitute serious crime. The

engagement in multiple filings on bankruptcy is not in and of
themselves criminal, but such action may violate provisions of
bankruptcy regulations. All assets must be disclosed in bankruptcy
schedules whether or not the debtor believes the asset has a net value.
The reason is that once a bankruptcy petition is filed by any company, it
is for the creditors, not the debtor, to decide whether a particular asset
has value. The future ramifications of omitting assets from schedules
can be quite serious for the offending debtor. In some countries, a closed
bankruptcy may be reopened by motion of a creditor or the trustee if a
debtor attempts to later assert ownership of such an "unscheduled asset"
after being discharged of all debt in the bankruptcy.

The trustee may then seize the asset and liquidate it for the benefit of the
(formerly discharged) creditors. Whether or not a concealment of such
an asset should also be considered for prosecution as fraud depends on
the discretion of the judge.

A person or debtor can declare himself or herself bankrupt by lodging a

debtor's petition. A person can also be made bankrupt after a creditor's
petition. All bankrupts are required to lodge a statement of affairs
document with appropriate authorities detailing important information
about their assets and liabilities. A bankruptcy cannot be annulled until
this document has been lodged.

SELF-ASSESSMENT EXERCISE 4

Discuss the bankrupt proceeding to recover debts.

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3.4.2 Proceeding in Individual Bankruptcy to Recover Debts

In the case of individual bankrupt, the realisation of funds in bankruptcy

usually comes from two main sources: the bankrupt's assets and the
bankrupt's income. There may be some certain assets that are protected,
referred to as "protected assets". Such assets include household furniture
and appliances, tools of the trade and vehicles up to a certain value. All
other assets of value will be sold. If a house or car is above a certain
value, the bankrupt can buy the interest back from the estate in order to
keep the asset. If the bankrupt does not do this, the interest vests in the
estate and the trustee is able to take possession of the asset and sell it.
The bankrupt will have to pay income contributions if his or her income
is above a certain threshold. The income contributions liability is
calculated by halving the amount of income that exceeds the threshold.
In the event that the bankrupt fails to pay the contributions due, the
trustee can issue a notice to garnishee the bankrupt's income.

Bankruptcies can be annulled prior to the expiration of the normal

regulated period, which in some cases takes years, if all debts are paid
out in full. Sometimes a bankrupt may be able to raise enough funds to
make an offer of composition to creditors, which would have the effect
of paying the creditor some of the money they are owed. In the event
that the creditor accepts the offer, the bankruptcy can be annulled after
the funds are received.

When the bankruptcy is annulled or the bankrupt has been automatically

discharged, the bankrupt's credit report status will be shown as
"discharged bankrupt" for some years. The number of years varies
depending on the company issuing the report, but the report will
eventually cease to record that information.

4.0 CONCLUSION

Bankruptcy involves a legal status of a companies or individuals in the

event that they cannot meet their external financial obligations or cannot
repay the debts they owe to their creditors. In most cases, bankruptcy is
imposed by a court order, which is often initiated by the debtor.
Financial distress in bank operations can lead to bankruptcy. In the event
of bankruptcy, there is a basic proceeding that should be initiated and
followed towards the recovering of debts either from an individual or a
company that is declared bankrupt.

5.0 SUMMARY

In this course of analysis in this last study unit, we have discussed

bankruptcy, and in the process, we have espoused on: Meaning of

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Bankruptcy; Financial Distress and Bankruptcy; Financial Distress;

Insolvency; Bankruptcy; Factors That Can Lead to Bankruptcy in
Banking Industry; Bankruptcy and Debt Restructuring; Bankrupt
Proceeding to Recover Debts; and Proceeding in Individual Bankruptcy
to Recover Debts.

6.0 TUTOR-MARKED ASSIGNMENT

1. Define bankruptcy and differentiate between financial distress

and insolvency.
2. Discuss the proceedings in recovering of debts in bankruptcy.

7.0 REFERENCES/FURTHER READING

DePamphilis, D. M. (2009). Mergers, Acquisitions, and Other

Restructurings. (5th ed.). Elsevier, Academic Press.

Dlabay, Les R.; Burrow, James L. & Brad, Brad (2009). Intro to
Business. Mason, Ohio: South-Western Cengage Learning.
p. 482. ISBN 978-0-538-44561-0.

Fraser, D. R., Gup, B. E. & Kolari, J.W. (1995). Commercial Banking:

The Management of Risk. New York: Western Publishing
Company.

Money Market Account as retrieved from

http://www.investopedia.com/terms/m/moneymarketaccount.asp

Shekhar, K. C. & Shekhar, L. (2007). Banking Theory and Practice. (7th

ed.). New Delhi: Vikas Publishing House PVT Limited.

Wruck, K. H. (2000). Financial distress, reorganization, and

organizational efficiency, Journal of Financial Economics.
Retrieved from
http://www.sciencedirect.com/science/article/pii/0304405X90900
636.

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