PAYING BANKER AND COLLECTING BANKER - Banking regulation and operations (BRO)

Notes 12 Pages

Savitribai Phule Pune University

Bachelor of Business Administration

AYK

Contributed by

Alpa Yash Khare

FACULTY NAME: Mrs NALINI.N
COLLEGENAME: MES INSTITUTE OF MANAGEMENT
SUB:BANKING REGULATION AND OPERATION

UNIT -4
PAYING BANKER AND COLLECTING BANKER

PAYING BANKER
The paying banker is the bank whose name is printed on a given cheque. This bank pays the
specified amount by the cheque to the collecting banker and withdraws that amount from the
customer's account. This is only done if the customer has sufficient funds within their account
in order to enable the transaction.
It is also the duty of the paying banker to examine the cheque and ensure that it has been
properly signed, the endorsements are correct and that the cheque is generally in order. In the
case of bills, it is part of the paying banker's duty from instruction by the customer to pay
them. Otherwise the banker is not legally required to do so. The paying banker is considered
a party to a given cheque as they are considered the drawee; however a bill is merely left with
the banker to take care of and has no part in it.

Meaning of Paying Banker
A Paying banker is one who is a drawee of a cheque. He takes the responsibility of making
payment on a cheque to the true owner. Any wrong payment will make the paying banker
liable to the true owner of cheque and also to the drawer of the cheque (one who has drawn
the cheque).
Payment in due course (Section 10)
Section 10 of the Negotiable Instruments Act, 1881 clearly mentions the manner in which the
paying banker should make payment on a cheque when presented to him and demanded
payment.
Section 10 defines "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”.

Precautions of paying banker
1. Proper Form: On receiving the cheque, the paying banker must see that the cheque must
be in the proper form as supplied by the banker. The cheque should not be torn or mutilated.
2. Place of presentment of Cheque: The paying banker must see the account against which
the cheque has been drawn is maintained in the same branch. If the cheque is drawn against
an account which is maintained in some other branch of the bank, the paying banker should
refuse to pay the amount.
3. Date of the Cheque: The paying banker must be cautious regarding the time of
presentation and payment date of the cheque. A cheque must be presented for payment within
the normal business hours of the bank. Moreover, the banker must see the date for payment.
Because a cheque can be honoured only on the date of payment as mentioned on the cheque
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or within three months from that date. At the same time, a cheque without date or a post-
dated cheque before the due date cannot be paid.
4. Words & figures: Another aspect that the paying banker must observe is that the amount
of the cheque must be written both in figures and in words and they must be similar.
5. Alteration & Over writing: The paying banker must be cautious about the material
alteration of the cheque. Material alteration means altering the contents of the cheque to make
it invalid. If such material alteration is visible, the banker can make the payment of the
cheque only after getting full signature of the customer at the places of material alteration.
6. Verification of Drawer’s Signature: Signature of the customer is another important
aspect where the banker must exercise due care. The signature of the customer on the cheque
must be similar with the specimen signature that he has given at the time of opening the
account.
7. Open cheque or crossed cheque: The paying banker must also see whether the cheque is
an open cheque or a crossed cheque and accordingly make the payment. The paying banker
must also be careful about the validity of the endorsement, if any, on the cheque.
8. Sufficiency of Funds: The banker should see whether the credit balance in the customer’s
account is sufficient to pay the cheque or not. If there is an over draft agreement, then should
see that the limit is not exceeded. The banker should not make part payment of the cheque.
The banker should pay either full amount or refuse payment.

Duties and Responsibilities of a Paying Banker
Section 31 of the Negotiable Instruments Act provides that " the drawee of a cheque having
sufficient funds of the drawer in his hands, properly applicable to the payment of such cheque
must pay the cheque when duly required to do so, and in default of such payment must
compensate the drawer for any loss or damage caused by such default.”

Obligation of Paying Banker to Honour Cheques
The paying banker is under an obligation to honour cheques subject to the fact that certain
conditions are satisfied.
1. There must be sufficient funds in the customer’s account and only in the account on which
the cheque is drawn. The amounts in the credit of the customer’s account in other branches
will not be considered.
2. The funds should be properly applicable to the payment of such cheques.
3. The cheque should be properly drawn and should not be irregular or ambiguous.
4. Cheques should be presented during the banking hours of the bank.
5. Cheques should be presented for payment within a reasonable time. They should be
presented within three months of their issue. Usually, cheques presented after three months of
their issue are considered stale.

Statutory Protection to Paying Banker
1. Protection in case of order cheque : In case of an order cheque, Section -85(1) provides
statutory protection to the paying banker as follows : "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". However, two conditions must be fulfilled to avail of such protection.
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(a) Endorsement must be regular : To avail of the statutory protection, the banker must
confirm that the endorsement is regular.
(b) Payment must be made in Due Course : The paying banker must make payment in due
course. If not, the paying banker will be deprived of statutory protection.

2. Protection in case of Bearer Cheque :
Section -85(2) provides protection to the paying banker in respect of bearer cheques as
follows : "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 blank appearing thereon and notwithstanding that any such endorsement
purports to restrict or exclude further negotiation".
This section implies that a cheque originally issued as a bearer cheque remains always bearer.
In other words it retains its bearer character irrespective of whether it bears endorsement in
full or in blank or whether any endorsement restricts further negotiation or not. So the banks
are not required to verify the regularity of the endorsement on bearer cheque, even if the
instruments bears endorsement in full. The banker shall free from any liability (discharged) if
he makes payment of an uncrossed bearer cheque to the bearer in due course. If such cheque
is a stolen one and the banker makes its payment without the knowledge of such theft, he will
be discharged of his obligation and will be protected under Section -85(2).

3. Protection in case of Crossed cheque :
The paying banker has to make payment of the crossed cheques as per the instruction of the
drawer reflected through the crossing.
If it is done, he is protected by Section -128. This section states "Where the banker on whom
a crossed cheque is drawn has paid the same in due course, the banker paying the cheque
and (in case such cheque has come to the hands of the payee) the drawer thereof shall
respectively be entitled to the same rights, and be placed in if the amount of the cheque had
been paid to and received by the true owner thereof".
It is clear that the banker who makes payment of a crossed cheque is by the Section -128
given protection if he fulfills two requirements
(a) That he has made payment in deuce course under Section -10 i.e. in good faith and
without negligence and according to the apparent tenor of the cheque, and
(b)That the payment has been made in accordance with the requirement of crossing (Section -
126), i.e. through any banker in case of general crossing and through the specified banker in
case of special crossing.
Thus, the paying banker is free from any liability on a crossed cheque even if the payment
was received by the collecting banker on behalf of a person who was not a true owner. For
example, a cheque in favour of X is stolen by Y. He endorses it in his own favour by forging
the signature of X and deposits it in his bank for collection . In this case, the paying banker
shall be discharged if he makes payment as mentioned above and shall not be liable to pay
the same to X, the true owner of the cheque. The drawer of the cheque is also discharged
since protection is also granted to him under this Section. There is, however, one limitation to
the protection granted under this Section. If the banker cannot avail of the protection granted
by other Section of the Act, the protection under Section -128 shall not be available to him.
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For example, if the paying bankers makes payment of a cheque crossed with (a) Irregular
endorsement or (b) A material alteration or (c) Forged signature of the drawer, he loses
statutory protection granted to him under the Act for these lapses on his part. Hence he
cannot avail of the statutory protection under Section -1289, even if he pays the cheque in
accordance with the crossing.

Payment in due course :
Analysis of section 10 reveals that the following conditions must be satisfies before a
payment of a negotiable instrument can be called as a payment in due course.
1. Payment in accordance with apparent tenor: When a paying banker receives cheques,
he has to carefully go through the instructions given by the drawer. For example, if the
drawer has issued a cheque dated 10th June 2000, Payment cannot be made before the date. If
the cheque is crossed, then the banker cannot make payment across the counter.
2. In good faith: The paying banker will make payment to a person whose ownership is
certain. In other words, the person presenting the cheque creates absolute good faith in the
minds of the banker regarding the ownership.
3. Without negligence: The paying banker has to go through the contents of cheque before
making payment. If the cheque contains any alteration, overwriting or cancellation, payment
cannot be made. Sometimes, the cheque may also contain " material alteration”.
4. To the person in possession: Paying banker can make payment to a holder in due course
only when he is in possession of the instrument. Possession is a must for a holder in due
course. For a holder it is not a must. Thus, a paying banker should make payment only to that
person who is in possession and presents the cheque for payment.
5. Circumstances: Even though the person presenting the cheque may fulfills all conditions,
but still creates a doubt in the minds of the paying banker at the time of making payment, the
paying banker must get it clarified before making payment. There are instances where the
amount of the cheque and the status of the presenting the cheque are inconsistent.

Dishonour of Cheque
The bank should pay the amount mentioned on the cheque as soon as it is presented. If the
amount of cheque is paid by the bank to the payee, the cheque is said to be honored. If the
bank refuses to pay the amount of cheque, then the cheque is said to be dishonored. Thus the
dishonored of the cheque means the refusal by the bank to pay the amount of cheque to the
payee. It is a condition in which the bank does not pay the amount of the cheque to the payee.
In fact, when the drawer draws the cheque without following all the rules of issuing cheque
or when he/she draws the cheque exceeding the bank balance then the bank dishonors the
cheque.

CONDITIONS FOR DISHONOUR OF A CHEQUE BY A PAYING BANKER
1. If the date is not written or written incorrectly or the date given is of three months before or
if the advance date is given.
2. If the name of the payee is not written or not written clearly.
3. If the ordered or crossed cheques are transferred without proper endorsement and delivery.
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4. If the amount is not written in words and figures or written incorrectly or if the amount
written in words and figures does not match with each other.
5. If the alteration made on the cheque is not proved by the drawer giving signature.
6. If the account number is not mentioned or if it is not clear or if it is not mentioned clearly.
7. If the signature is not given or if the signature given in the cheque does not match with the
signature given on the signature specification card kept by the bank.
8. If the amount mentioned on the cheque is more than the amount that the drawer has in his
bank account or if as per bank's rule the minimum balance in the account of the drawer
cannot remain.
9. If the cheque is overwritten.
10. If the cheque is not found in proper condition or it is found wet, torn or spotted.
11. If the drawer has given order to the bank to stop payment of the cheque.
12. If the bank has got the information regarding the death or insolvency or lunacy of the
drawer of depositor.
13. If the court of law orders the bank to stop payment of the cheque.
14. If the bank balance remains shortage on account of not collecting the cheque deposited.
15. If the drawer has closed his/her account before presenting the cheque.

Grounds for refusing payment of a customer’s cheque
Dishonoring a cheque is different from refusing payment on a cheque. Dishonour takes place
when there is defect in the instrument or when there are insufficient funds in the accounts.
Refusing payment of a cheque takes place on the happening of certain events. We can see the
grounds under which a bank refuses payment.
1. Countermanding of payment: When a customer after having issued the cheque to third
party, instructs the banker to stop payment on the cheque before the instrument is presented,
it is called countermanding of payment. It is the responsibility of the customer to inform the
banker before the payment is affected.
2. Death of customer: Notice of death of customer has to be given by the close relative of
the deceased. On receipt of the notice, banker will close the account and any cheque received
thereafter, payment will be refused.
3. Insolvency of the customer: When the court adjudged the customer of a bank as
insolvent, the account of that customer will be taken over by an official assignee appointed by
the court. Hence, any cheque received thereafter will be refused payment.
4. Lunacy(Mental Illness): When a customer is of unsound mind, hi’ account cannot be
operated. But the lunacy of the customer has to be certified by a doctor and the nature of the
lunacy must also be stated. If it is of a temporary nature, the account may be suspended till
such time the lunacy is cured. But when the lunacy is of a permanent nature, on the advice of
the doctor, the account will lobe closed and cheques received thereafter will be refused
payment.
5. Garnishee order: Here, the court gives order to the bank to close the account of the
customer partially or completely and according to that order cheques will be refused
payment.
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6. Closing of account voluntarily: When the customer on his own accord, closes the
account by giving a written declaration, the bank will close the account. But, the customer
has to surrender all the unused cheques and the passbook. The banker will close the account
after arriving at the balance. The amount will be paid to the customer.
7. Assigning the entire balance to a third party: When a customer gives in writing to the
bank to assign his entire credit balance to a third parties’ account, the bank will close the
account automatically.
8. Undesirable customer: When a customer issues cheques frequently with insufficient
funds, these are dishonored causing embarrassment, both to the banker and customer. Such a
customer will be intimated by the banker to close the account, failing which the banker on his
own will close the account and will send the balance, if any, to the customer.
9. Partnership firms, companies and institutions: Their account will be operated
according to the bye-law. In the case of death of a partner, winding up of companies or
dissolution of institutions, the account will be closed.
10. In public interest: When a banker comes to know that the account holder is building an
account by cheating the public, he may close the account by giving notice to the party. The
bank does this in the interest of the public and prevents the public from incurring any
monetary loss. The responsibility of a collecting banker is to collect the amount specified on
a cheque and/or bill from a paying banker. This amount is then deposited into the customer's
account. No banker is under any legal obligation to collect money from other banks via
cheques given by the customer, however most modern banks do perform this service.

Consequences of wrongful dishonor of customer’s cheque
If a banker, without justification, dishonours his customer’s cheque, the banker makes
himself liable to compensate the customer for any loss or damage. The words ‘loss or
damage’ used in Section 31, not only mean the pecuniary loss but also loss of credit or injury
to reputation of the customer.
Thus, if the customer is a trader or a business man, the damages may be substantial. But, a
non-trader is not entitled to recover substantial damages for the wrongful dishonour of his
cheque.
Thus, a non-trader may be awarded only nominal damages because of the absence of any
special loss. In assessing the damages for injury to credit, the Courts give due consideration
to various factors, such as financial position and business reputation of the customer and the
customs of the trade to which he may belong.

LENDING OPERATIONS
After accepting deposits from the customer, a bank goes for lending or for investment in
different types of securities, such as government, company etc. For deposits received under
savings account and fixed deposits, the bank has to pay an agreed interest rate. This, the bank
has to pay only from its earnings. On the investments, the bank earns a good return.
Similarly, when the bank lends, it earns a higher interest rate. From out of the return on
investments and from the interest earned on loans, the bank will be able to offer interest for
the deposits, The difference between the interest offered on deposits, and the interest earned
on lending will be the profit of the bank.
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One of the primary functions of the commercial banks is ‘Lending’. A banker should be very
cautious in lending, because he is not lending money out of his own capital. The money lent
comes from the deposits received from the public. These deposits are mostly repayable on
demand. Hence while lending money, a banker should follow a very cautious policy.

SOUND PRINCIPLES OF LENDING:
It is a fundamental precept of banking everywhere that advances are made to customers in
reliance on his promise to repay, rather than the security held by the banker. Although all
lending involves some degree of risks, it is necessary for any bank to develop sound and safe
lending policies and new lending techniques in order to keep the risk to a minimum. As such,
the banks are required to follow certain principles of sound lending.
(a) Safety: When a loan or investment is made, the banker will have to ensure that the money
advanced is returned by the borrower along with interest within the stipulated period. This is
possible only when the borrower does not face any risk and strictly adheres to the terms and
conditions of the loan. For this purpose, the banker will have to choose such type of
borrowers who are prompt in repayment of the principal and interest amount.
(b) Liquidity: An asset is said to be liquid when it can be converted into cash within a short
notice, without loss. As the bank is investing or lending the depositors’ money, it has to take
more precaution while doing so. The depositor may demand his/her money at any time and
the bank must be in a position to repay the same.
(c) Purpose: A banker would not throw away money for any purpose for which the borrower
wants. The purpose should be productive so that the money not only remains safe but also
provides a definite source repayment.
(d) Profitability: When a bank is undertaking lending or investment, it has to earn a good
return. The bank has profit as its main business motive. So, while lending or investing the
depositor’s money, the bank must earn higher interest or higher return. If the bank is able to
achieve this, it will be deploying its funds in such ventures which give a higher return.
(e) Shift ability: As the bank is giving loan against the security, in case of bad debts, the
bank must be able to sell the security and realize the loan amount. In some cases, the bank
will not sell the security, but will shift the same to the Central bank which will grant the
commercial bank additional fund against the security. Mostly treasury bills can be shifted to
Central bank and the commercial bank can raise additional funds.
(f) National Interest: The bank must keep in mind national interest while lending or
investing depositor’s money. When a country is facing unemployment, the bank must give
more loans to employment oriented industries, so that the problem of unemployment can be
reduced. Similarly, when a country is faced with food problem, more loans should be given
for agriculture so that, food production can be increased.
(g) Safety Margin: While granting loan against security, the bank will have to keep
sufficient safety margin. This means that a bank will land only unto 50 or 60% of the value of
security as loan by keeping a safety margin of 4 or 50%. For example, when loan is given
against a jewel whose market value is Rest. 10,000/-. the loan amount will be Rest. 6,000/-
and the safety margin Rest. 4,000/- now even if the market value of the jewel fluctuates to
Rest. 9,000/- or Rs.8,000/- still the banker will be able to realize the loan amount in case the
borrower defaults.
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(h) Diversification: As the banker lends or invests, he cannot invest all his resources in a
single industry or with a single borrower. The banker should not keep all the eggs in the same
basket. By choosing a single industry such as iron and steel or sugar, the banker is inviting
more risks. It is likely that these industries may face depression and the banker will find it
difficult to recover the loan or realize his investment.
(i) Law of Limitation Act: A lending banker should also bear in mind the Law of
Limitation Act. According to this Act, a debt will become a bad one after the expiry of three
years from the date of loan. It is applicable to loans and advances granted by banks. Hence,
each and every banker should be very careful in renewing the loan, year after year.
Otherwise, these loans would become bad subsequently.

COLLECTING BANKER
The term ‘Collecting Banker’ refers to the function of receiving cheques by a banker from his
customers for the purpose of collecting the proceeds and crediting them to the respective
customers account, i.e, the banker who is assigned the job of collecting the amount of cheque
from another banker, is called the collecting banker.
A collecting banker is one who undertakes to collect the amount of a cheque for his customer
from the paying banker.
A banker is under no legal obligation to collect cheques drawn upon other banks for a
customer will be satisfied merely with the function of payment of cheque alone. Moreover,
in-the case of crossed cheque, there is no other alternative to collect the cheques except
through some banker. In rendering such service, a banker should be careful, because, he is
answerable to a number of people with whom he has no contractual relationship and any
negligence or carelessness on his part may land him in difficulties.
DUTIES AND RESPONSIBILITIES OF A COLLECTING BANKER
(i) Exercise Reasonable Care and Diligence in his Collection Work: when banker collects
a cheque for his customer, he acts only as an agent of the customer. As an agent, he should
exercise reasonable care, diligence and skill in collection work. He should observe almost
care, care when presenting a cheque or a bill for payment. Reasonable care and diligence
depends upon the circumstances of each case.
(ii) Present the cheque for collection without any delay: the banker must present the
cheque for payment without any delay. If there in delay in presentment, the "customer may
suffer” losses due to the insolvency of the drawer or insufficiency of funds in the account of
the drawer or insolvency of the banker himself. In all such cases. The banker should bear
loss.
(iii)Notice to customer in the case of dishonour of a cheque: if the cheque, he collects, has
been dishonoured, he should inform his customer without any delay. The Negotiable
instruments Act has prescribe a reasonable time for giving the notice of dishonour. If he fails
to do so, and consequently, any loss arises to the customer, the banker has to bear the loss.
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(iv) Present the bill of acceptance at an Early Date: As per Sec: 61 of the Negotiable
Instruments Act, a bill of exchange must be accepted. Acceptance gives an additional
currency to the bill, because, the drawee becomes liable thereon from the date of acceptance.
Moreover, in the case of a bill of exchange payable after sight, acceptance, is absolutely
essential to fix the date of maturity. If banker undertakes to collect bills, it is his duty to
present them for acceptance at early date. Sooner a bill is presented and got accepted, earlier
is its maturity.
(v) Present the bill for Payment: the banker should present bills for payment in proper time
and at proper place. If he fails to do so, and if any loss occurs to the customer, then, the
banker will be liable, According to Sec 66, of the Negotiable Instruments Act a bill must be
presented on maturity. As per Sec.21, sight bills are payable on demand. Sec.22 lays down
that the maturity of the bills is the date on which it is due for payments, to which, 3 days of
grace are added.
(vi) Protest and Note a Foreign bill for Non- Acceptance: in case of dishonour of a bill by
non-payment, it is the duty of the collecting banker to inform the customer immediately.
Generally, he returns the bill to the customer. In the absence of specific instructions,
collecting bankers do not get the- inland bills noted and protested for dishonour, If the bill in
question happens to be a foreign bill; the banker should have it protested and noted by a
Notary Public, and then, forwarded it to the customer.

CAPACITY OF COLLECTING BANKER While collecting the instrument on behalf of
the customer, the collecting banker acts
(a) As holder for value
(b) Holder in due course
(c) As agent for collection
(a) As holder for value:
The collecting banker is said to be acting as holder for value.
1. When the collecting banker advances money to the customer before the realization of the
cheques given for collection.
2. When the collecting banker settles the loan amount due from the customer with the cheque
amount given for collection, even before its realization.
3. Where a collecting banker reduces an overdraft with the amount for collection before its
realization.
4. Where a part of the amount is given by the collecting banker to the customer even before
the realization of the cheque.
5. By allowing the customer to draw the full amount of the cheque before its realization

Holder
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According to Section 8 of the Act a person is a holder of a negotiable instrument who is
entitled in his own name (i) to the possession of the instrument, and (ii) to recover or receive
its amount from the parties thereto. It is not every person in possession of the instrument who
is called a holder. To be a holder, the person must be named in the instrument as the payee, or
the endorsee, or he must be the bearer thereof. A person who has obtained possession of an
instrument by theft, or under a forged endorsement, is not a holder. as he is not entitled to
recover the instrument. The holder implies de jure (holder in law) holder and not de facto
(holder in fact) holder. An agent holding an instrument for his principal is not a holder
although he may receive its payment.

Holder in Due Course
Section 9 states that a holder in due course is
(i) a person who for consideration, obtains possession of a negotiable instrument if payable to
bearer, or (ii) the payee or endorsee thereof, if payable to order, before its maturity and
without having sufficient cause to believe that any defect existed in the title of the person
from whom he derived his title.
In order to be a holder in due course, a person must satisfy the following conditions:
1. He must be the holder of the instrument.
2. He should have obtained the instrument for value or consideration.
3. He must have obtained the negotiable instrument before maturity.
4. The instrument should be complete and regular on the face of it.
5. The holder should take the instrument in good faith.
For Example, anyone who accepts a third party cheque is a holder in due course.

In other words, the holder in due course is the holder of a bill who meets certain additional
requirements. The holder in due course has the same rights as the holder for value, but also
holds the bill free from any defect in title of prior parties and free from personal defenses
between previous parties.
On receiving cheques drawn on other banks the customer deposits them in his own bank and
requests the banker to collect them and credit the proceeds to his account. The bank executes
this service for the customer.
After receiving a cheque for collection from the customer, the banker acts as the agent of the
customer, but the banker becomes a holder when pays the amount of the cheque or credits the
amount of the cheque to his customer in anticipation of collection. The banker becomes a
‘holder in due course’ if the conditions attaching to the term are satisfied.
(b) As agent for collection: When the banker undertakes to collect the cheques and credits
the account of the customer only on realization. Thus, in acting as agent for collection, there
is no risk for the collection, there is no risk for the collecting banker whereas in the case of
holder for value, the collecting banker has enormous risks, especially when the cheque is
dishonored or payment has been made to the wrongful owner of the cheque.

STATUTORY PROTECTION OF COLLECTING BANKER
Statutory protection to collecting banker under Section 131 of the Negotiable Instrument Act
According to this Section, "A Banker who has in good faith received payment for a customer
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PAYING BANKER AND COLLECTING BANKER - Banking regulation and operations (BRO)

PAYING BANKER AND COLLECTING BANKER - Banking regulation and operations (BRO)

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