Evolution of Banking Law & Practice

The society has a general understanding on what a bank is, it is a concept engrained in most people’s mind involving an institution and money. This generally accepted perception simplifies the identification of a bank in the general population. The law, in different jurisdictions around the world has however failed to make substantive definitions of a bank.

The difficulty arises due to the difficulty in distinguishing banks from other institutions undertaking financial practices. This ambiguity and the resulting disparity has resulted in different legislations defining a bank in their own context and meaning, the definition of a bank varies subject to the objectives and variations in different financial practices across different Jurisdictions. [1]

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Halsbury’s Laws of England defines a banker as: [2]‘a person or company carrying on the business of receiving money’s, 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.’

The Supreme Court of the United States in the Austen[3] case defined a bank as:

“A bank is an institution, usually incorporated with power to issue its promissory notes intended to circulate as money (known as bank notes); or to receive the money of others on general deposit, to form a joint fund that shall be used by the institution, for its own benefit, for one or more of the purposes of making temporary loans and discounts; of dealing in notes, foreign and domestic bills of exchange, coin, bullion, credits, and the remission of money; or with both these powers, and with the privileges, in addition to these basic powers, of receiving special deposits and making collections for the holders of negotiable paper, if the institution sees fit to engage in such business.”

In the Uniform Commercial Code,[4]a bank is defined as a person engaged in the business of banking, including a savings bank, savings and loan association, credit union, or trust company.

The Banking Act of Kenya 1991[5] Defines a Bank as; a company which carries on, or proposes to carry on, banking business in Kenya but does not include the Central Bank of Kenya.

The definition is interesting. By excluding the Central Bank of Kenya 1984[6], it has given the CBK autonomy to be governed by the Central Bank of Kenya Act, the exemption aims to ease the objectives of the bank as the central regulating body in the country

It further defines banking business as;

1. the accepting from members of the public of money on deposit repayable on demand or at the expiry of a fixed period or after notice;
2. the accepting from members of the public of money on current account and payment on and acceptance of cheques; and
3. the employing of money held on deposit or on current account, or any part of the money, by lending, investment or in any other manner for the account and at the risk of the person so employing the money.

It is apparent that there are similarities in the definition of a Bank and in commonwealth countries and other jurisdictions. Accepting of deposits, holing current accounts and the use of the depositor’s money for investment give a general and basic understanding of what a bank is.

Under common law the earliest attempt to define a bank was made in the landmark case of United Dominion Trust v Kirkwood[7]. The case involved the defendant who was the managing director of a company that financed the purchase of cars through loans from the plaintiff. The defendants argued that the plaintiff was not registered under the Money lender’s Act 1900 and 1927, and so were not entitled to recover the money or enforce the security of the loans. The plaintiffs claimed that as bankers they were exempted from the provisions of the money lenders Acts.The Main issue for determination was the status of UDT. Mocatta J held: “Words banking and banker may bear different shades of meaning at different periods of history and their meaning may not be uniform today, in countries of different habits and of different degrees of civilisation”

This holding emphasizes that the definition of a bank is a matter of context.

On appeal, Lord Denning[8] held in favour of the plaintiff’s. He described a bank as;

“An establishment for the custody of money received from, or on behalf of, its customers. Its essential duty is to pay their drafts on it: its profits arise from the use of money left unemployed by them.” Lord Denning defined the characteristics of a bank in accordance with the banking practices: They accept money from, and collect cheques for, their customers and place them to their credit, they honour cheques or orders drawn on them by their customers when presented to payment and debit customers accordingly, they keep current accounts or something of that nature, in their books in which the credit and debits are entered.

These guidelines set out by Lord Denning made a profound effect in the banking industry that eventually became accepted principles under common law.

It is important to note that banking practices have changed as they are not rigid, and constantly evolve with time and circumstances. The principles laid down by Lord Denning set a foundation for subsequent principles and legislation to be built on.

In District Savings Bank Ltd ex parte coe[9]Turner LJ held that a savings bank was not considered to be carrying on a banking business as it did not operate current accounts albeit it provided some banking services. And as such its business differed from ordinary banking practices.

In the Re Shields Estate[10],the court emphasized on the use of deposits by customers with the aim of making profit. The essence of trade, or business is not in not essential to be found in the mode of in which it disposes of the money which is deposited with it but by the means in which money belonging to others is received.[11]

In the case of Bank of Chettinad Ltd of Colombo v inland Revenue Commissioners of Colombo[12]the privy council said that the test for determining whether a branch of a non-resident bank could itself be described as a bank was whether it:

‘Carried on as its principal business the accepting of deposits of money on current accounts or otherwise, subject to withdrawal by cheque, draft or order.’

Under UK law, the ability to operate current accounts is essential. It is the material evidence of the link between the bank and a customer. It also forms the foundation basis of the relationship and defines the terms of conduct and practice. Current accounts are also a useful tool for taxation and accountability as they give a detailed record of an individual’s financial status and transaction.

Contrast can be observed between the definition of a bank under Section 2 of the Banking Act 2009 and the UCC[13], the UCC defines a bank as’a person engaged in the business of banking, including a savings bank, savings and loan association, credit union, or trust company.’

The former defines a Bank as an institution which has permission under Part 4 of the Financial Services and Markets Act 2000 to carry on the regulated activity of accepting deposits (within the meaning of section 22 of that Act, taken with Schedule 2 and any order under section 22). It however lists exception:

(a) a building society (within the meaning of section 119 of the Building Societies Act 1986),

(b) a credit union within the meaning of section 31 of the Credit Unions Act 1979, or

(c) any other class of institution excluded by an order made by the Treasury.

A Credit Union is a bank in the United States, unlike in the UK where the Act expressly exempts it. This shows the difficulty in coming up with a uniform definition due to a difference in jurisdiction, policies, laws and banking practices. The sovereignty of country allows it to regulate its borders at its discretion making a unified definition almost impossible.

To fully understand the issue, it is prudent to look at the historical approach to banking. The Money Lender’s Act 1900 and 1927 provided exemptions to person’s who undertook banking business under the Money Lender’s Act. It gave ambiguous description of a bank or banker to be any: ‘any person bonafide carrying on the business of Banking’.[14]Section 2 of The Bills of Exchange Act 1882 provides the term bank to include: ‘any Body of persons, whether incorporated or not, who carry out the business of Banking’

Section 2 of the Banking Act 2009 emphasizes on regulation of banking activities relating to accepting deposits (within the meaning of section 22 of that Act, taken with Schedule 2 and any order under section 22. [15]The statutory definition differs from the common school of thought by putting emphasis on a licenced institution. This shows regulation is an integral part in all jurisdictions in today’s banking system.

A bank as an institution enjoys, a degree protection from the law, section 4 of the Cheques Act 1957 absolves bankers from liability from the true owner when they carry out transactions for a customer who has a defective title. Section 80 of the Bills of Exchange Act 1882 protects the Bank in the event a crossed cheque drawn in good faith and without negligence is paid to the payee. This limited liability facilitates transactions, if banks were held liable for every defective transaction carried out in good faith then the banking business would come to a halt.

In summary, a bank can therefore be defined as an institution licensed to collect deposit and perform financial transactions, including honouring cheques, running current accounts, and using deposits to make profit.

Banking business

The history of Banking business in the UK can be traced back to the 17^th Century where Goldsmith bankers who begun to develop basic principles of banks as deposit takers and money-lenders.[16]

Banking business is the regulated activities carried out by an institution. These activities have to be regulated in order to protect customers and the financial market.

Banking practices are not constant, their definitions differ with time. Competition from other financial institutions has led to the expansion of the scope of banking activities beyond the core objectives of the bank due to the entrance of financial institutions into the market that was originally the preserve of banks.[17] Under common Law definition the courts have established three cardinal principles relating to banking business. Banking business Changes with time, varies with respect to jurisdiction; and Is influenced by public opinion[18].Banking business and practices evolve with time, subject to change in order to meet market requirements and customer demands. Banks must adapt and widen their scope in order to be profitable and stay relevant.

In Banbury v Bank of Montreal[19] Lord Parker Held that offering financial advice was not within the scope of the bank at the time, and establishing whether giving financial advice on investments was part of banking business. This was however overruled by Salmon J[20] when he stated: “The nature of such a business must in each case been matter of fact, and accordingly, cannot be treated as if it were a matter of pure law. What may have been true of the Bank of Montreal in 1918 is not necessarily true of martins Bank in 1958.”

In the event of establishment of a banker-client relationship, a duty of care is owed and as such offering financial advice was within the scope of banking business. With time, it was accepted that offering financial advice constituted part of banking business due to the duty of care that arises from the banker-client relationship.[21]

With respect to jurisdiction it was held that a financial institution that is regarded as engaging in banking business in one jurisdiction is not necessarily so considered elsewhere.[22] , a financial institution that was recognized in another country did not meet the English requirements for a bank as it did not also carry out the requisite activities within the United Kingdom.

According to Irish[23] and Australian[24] authority, an institution that accepts money on deposits from the public for the purpose of relending it carries on banking business, In the absence of current accounts and the chequing system. In contrast, running current accounts is an essential feature of banking business in the United Kingdom and other common law jurisdictions[25].

Reputation also has influenced determining an institutions status as a bank, an institution that is generally known as a bank will carry the assumption that it is engaged in banking business. In the case of United Dominion Trust v Kirkwood[26] although the evidence shown did not prove that UDT was operations were in the current banking practices, Harman L.J in his dissenting judgement stated that the evidence of its reputation of carrying on the business of banking in London was not sufficient. Lord Diplock and Lord Denning took a different policy based approach they held that a reasonably minded commercial man’s perception and acknowledgement of an institution’s banking practice is acceptable. Furthermore, if a city perceived an institution as a bank, it enjoyed certain privileges that came with the title

The regulation of banking business has been a widely-accepted principle in most Jurisdictions.

Historically there was little Legislative control of the banking sector in the UK, the substantive piece of legislation in place at the time was section 4 of the Banking Act 1946:

‘Which gave the Bank authority in the interest of the public to acquire information and make recommendations to bankers and with the authorisation of the treasury give directions to bankers.’ This however changed with the enactment of the Banking Act 1979 and 1987, the new laws introduced regulation of deposit-taking institutions that had to obtain Authorization to Operate.

The permission to operate regulated activities under Section 22 of the Financial Services and Markets Act 2000 is obtained through part IV of the Act.

Section 3 of the Banking Act 1987 prohibited deposit taking by a business without express authorization from the Bank of England. This section is integral in the UK banking as it introduced an authoritative supervisory role over banks carrying out activities within the meaning of banking business. There was little[27] supervisory powers conferred on the Bank of England during this time and the bank justified the success of the London Banking business as a financial hub due to the freedom and flexibility provided in the UK banking sector[28]

The Banking Act of 1987 was eventually repealed and the Financial Services and Markets Act 2000 through section 22 and Schedule two required institutions undertaking banking business, including deposit taking to obtain authorization beforehand.

The First Banking directive by the EU under Article 3 provided that[29]:’Member States shall require credit institutions subject to this Directive to obtain authorization before commencing their activities.’ This Directive influenced the enactment of the Banking Act 1979 and adoption of some of the restrictive measures under section 3 of the Act, these included the need for authorisation before accepting deposits from clients.

The same applies in civil Jurisdictions, in Switzerland, Article 3 (1) of the Federal Act on Banks 1934 and Savings Banks of Switzerland states;

“Banks are required to obtain a licence from the Banking Commission prior to engaging in business operations; they may not register with the Register of Commerce before such licence has been granted.”

However, per Elinger,[30] entities in the United Kingdom do not require a license to engage in banking business. I disagree with this view as the Financial Services and Markets Act 2000 Lists regulated activities which constitute banking business in today’s time. Entities that intend to carry out these activities must obtain permission beforehand. Permission is a license or liberty to do something synonymous to authorization[31].

It is an accepted practice in civil and common law jurisdictions for entities engaging in banking activities to obtain a licence from the relevant authority. The license is essential as it ensure banks operate in acceptable standards. Regulation protects both banker and customer interests. The protection gives depositors confidence to deposit their money for safe keeping and investments among other financial services.

Regulation of banks in the UK has a come a long way and in the wake of the global financial crisis of 2007-2008.The Prudential Regulation Authority was established as part of the Bank of England through the Financial Services Act 2012 whose primary objective is promote the safety and soundness of the firms it protects.[32]

The supervisory role has become a popular feature in most countries after the global financial crisis. Other countries such as the United States that are plagued with financial crisis adopted an independent supervisory approach to monitor its financial institutions. The Sarbanes-Oaxley Act 2002 was introduced in the wake of the Enron scandal. The Act introduced mandatory supervision by independent external auditors. Some scholars have argued that independent supervision is better as political factors and lobbyist cannot influence it. Others claim that the method is expensive and ineffective in third world countries.[33]

Regulation and supervision is important as it creates a sense of stability and protects the banks and the depositors. The Global financial crisis of 2008 is a testament of what happens when banks overreach.

Banker-Client Relationship

The contractual relationship between bankers and customers is a complex one founded originally upon the customs and usages of bankers. The courts acknowledge these norms and as such they are recognized as implied conditions[34].

The relationship can arise out of implied or express conditions. Implied conditions are established through statutory and judicial instruments. Express conditions arise out of the law of contracts.

As with ‘Bank’ and ‘Banking Business’ there is no definitive definition of the term customer.

The Financial Services and Markets Act 2000[35] defines a customer in relation to an authorized person, means a person who is using, or who is or may be contemplating using, any of the services provided by the authorized person which is a bank within the meaning of the Act.

The definition refers to a relationship arising out of services provided by a bank to its customer. This is a key component to its definition as it was described in the case of Commissioner of Taxation v. English, Scottish and Australian Bank Ltd.[36]A case involving the theft of a cheque payable to the Commissioner of Taxes, paid into an account with the defendant’s bank. Lord Dunedin[37] stated that the word customer signifies a relationship in which duration is not of the essence. A person whose money has been accepted by a bank on the footing that they undertake to honor cheques up to the amount standing is a customer of the bank irrespective of whether his connection is of short or long standing. The contract is not between a habitué and a new comer, but between a person whom the bank performs a casual service, such as for instance, 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.

The opening of an account expressly establishes a banker customer relationship. The transaction involves contractual obligations and as such governed by contract law. Like any other contract, specific conditions must be met for a contract to be valid, one of them being the willingness to enter a legally binding agreement. The question that rises is whether a banker customer relationship can be established through fraudulent means.  In the case of Marfani & Co. Ltd v Midland Bank Ltd[38] the court of Appeal held that a relationship cannot arise if the account was opened by a fraudster who had no intention of getting into Banker-Customer relationship. In Stoney Stanton supplies (Coventry) Ltd v Midland Bank Ltd[39]

In which a A forged the signature of B Ltd’s directors in order to open an account in the company’s name, it was held that no banker customer-relationship existed between B Ltd and the bank[40].

Analysis of these findings from a contractual point of view shows that a relationship did not exist from the beginning, a contract is voidable if one of the parties does not intend to enter the agreement, or if it a misrepresentation occurred. In summation, the same principles that govern the validity of a contract apply to the establishment of a banker customer relationship through opening of an account.

The landmark case that set the precedence in the nature of a banker customer relationship is Folley v Hill & Others[41]. Where a customer opened an account, and deposited 6,117 pounds with an agreement that it would attract an annual interest. After 3 years, no interest was credited and the customer brought an action against the bank to recover all sums owed to him on the grounds that he was either a beneficiary of a trust or the banks principal. The house of Lords refuted this claim and stated that the relationship that arises out of this transaction, is one of a debtor-creditor relationship with an added obligation to repay the money upon demand, and the best course of action would be to instate debt recovery proceedings under common law.

Lord Cottenham said;[42]

“The money paid into the banker’s, is money known by the principal to be placed there for the purpose of being under the control of the banker; it is then the banker’s money; he is known to deal with it as his own; he makes what profit he can, which profit he retains to himself.”

He went on to say that the bank had to ‘repay to the principal, when demanded, a sum equivalent to that paid into his hands.’

Several important factors can be discerned from this judgement.

Firstly, there is a shift of possession when money is deposited to the banker in a current account. The customer lends a certain amount of funds to the banker, that is to be refunded upon demand. The banker can then use the money in whatever means and has no obligation to account for his transactions.

Secondly the nature of the relationship differs with different circumstances As Lord Brougham took this into account and stated:[43]

“It is a totally different thing if we are to take into consideration certain acts that are often performed by a banker, and which put him in a totally different capacity, for he may, in addition to his position of banker, make himself an agent or a trustee towards a cestui que trust“.

In today’s banking practices the scope of the banking business has widened with time. Customers deposit valuable items for safe keeping with banks, a bailment relationship arises where the bank is a bailer and the customer is a bailee, in this situation, a banker has no authority to use the items kept in his care for his own use. This situation can be contrasted with the debtor-creditor relationship discussed above, there is fundamental difference in circumstances. Another example is with standing orders, when a customer instructs his bank to make payments to a third party, an agency relationship arises with the client as the principal and the banker as the agent.

The Banker Customer relationship gives rise to fiduciary duties. Fiduciary relationships arise when a party places trust in and relies on the other because he or she is reasonably entitled to do so in the circumstances, or because the reliant party is in a position of vulnerability, subordination or information inequality.[44]

This vulnerability Gives rise to the duty of Loyalty. A customer expects a bank to prioritize their interests and avoid situations that invite a conflict of interest. As the saying goes, a customer always comes first. This happened in Woods v Martin’s Bank Limited[45] where the bank advised one of its clients to invest in one of the banks customers facing financial difficulties. The bank may have unconscionably shifted a bad risk from itself to the customer who provided the security or guarantee[46]

In Bristol v West Building Society v Mothew[47] a case that involved a solicitor who represented the building society and the borrower and failed to inform the building society that the borrower had secured a second mortgage on the property. Millet LJ defined the nature and role of a fiduciary by stating[48]

“A fiduciary is someone who has undertaken to act on or on behalf of another in a particular matter in circumstances which give rise to a relationship of trust and confidence. The distinguishing obligation of a fiduciary is the obligation of loyalty. .A fiduciary must act in good faith; he must not make profit out of his trust; he may not act for his own benefit or the benefit of a third person without the informed consent of his principal.”

This definition is concise and touches on the defining characteristics of a fiduciary relationship. A bank must exercise his activities on behalf of the customer in good faith with the client’s best interest. This obligation under common law is intended to protect customers who are not cognisant with banking transactions and investments. In the absence of it, customers would be prone to manipulation.

In the event of a breach of a fiduciary duty, a customer may claim a breach of duty of care. Such an implication can arise either at common law or by virtue section 13 of the Supply of Goods and services Act 1982 which states that within the ordinary course of business the supplier will carry out the service with reasonable care and skill.[49]

The confidential nature of a Banker-Client relationship is a traditionally known concept. The same is seen today in caveats in correspondence between Banks and Clients.

In Tournier v.National Provincial and Union Bank of England,[50]a bank manager disclosed the gambling habits of one of its clients to his employers that eventually led to the termination of his employment. The Plaintiff brought an action for breach of the duty confidentiality. The court held that the bank owes a duty of secrecy to the customer. Atkin LJ particularly said the duty of secrecy must extend to at least to all the transactions that go through the account and that duty extended beyond the period when an account was closed or ceases to be an active account.

This duty however comes into conflict with the duty to disclose to the public. The banks have a duty to disclose information on accounts that are involved in illegal transactions and against public interest and peace.

The three panel Judge was unanimous in this conclusion. Bankes LJ[51] said that danger to the state or duty to the public may supersede the duty of the Agent to his principal. Scrutton LJ[52] added on this by saying a bank may disclose the customer’s account and affairs to prevent frauds and crimes and finally Atkin LJ[53] summed it up by stating that the right to disclose exists to the extent to which it is reasonably necessary for protecting the Bank, or persons interested, or the public, against fraud of crime.

Conclusion

The definition of Banks and Banking practices has proved to be elusive for some time. Similarities can be made with the law with the acceptance that banking practices are as Dynamic as the laws that govern them. A definitive approach is not necessary. Bankers and legislators should refine and improve on practices in a progressive manner. Strict compliance to regulation is essential to maintain a healthy financial market and avoid scandals arising from banking malpractice.

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