Bank being the custodian of public money cannot act negligently in disbursing credit facility to the accused or identified loan defaulter- pointing out the argument in the global context

Bank being the custodian of public money cannot act negligently in disbursing credit facility to the accused or identified loan defaulter- pointing out the

argument in the global context

An Assignment Paper (II) Submitted to Barrister Arife Billah (Lecturer, North South University, Dhaka) for the Degree of BBA in the School of Business

Arafat Islam ID: 111 0247 030

Course: LAW200 (Business Law) Section: 1, Semester: Fall 2014

10 December, 2014

i

Declaration

i. No portion of the work referred to in this assignment paper has been submitted for

another degree or qualification of this or any other University or other Institution of

Learning.

And

ii. Copyright in the text of this assignment paper rests with the Author. Copies (by any

process) either in full, or of extracts, may be made only in accordance with

instructions given by the Author. This page must from part of any such copies made.

Further copies (by any process) of copies made in accordance with such instructions

may not be made without the permission (in writing) of the Author.

The ownership of any Intellectual property rights, which may be described in this

paper, is vested in the North South University, Dhaka, subject to any prior agreement

to the contrary, and may not be made available for use by third parties without the

written permissions of the University, which will prescribe the terms and conditions

of any such agreement.

ii

Acknowledgement

First of all I would like to thank Almighty Allah. Without His bless I would not be able to

complete this paper within due time. Then in this earth I deeply thank my father MD. Nazrul

Islam for his continuous help and motivation in completing this paper. Each and every confusion

I faced, he removed that with his deliberate knowledge. Then I would like to thank my course

instructor Barrister Arife Billah for giving me the opportunity to learn and share. Then thanks to

all of those people who were directly and indirectly involved with this paper.

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Title: “Bank being the custodian of public money cannot act negligently in disbursing credit

facility to the accused or identified loan defaulter- pointing out the argument in the global

context.”

Abstract

This essay discusses the fact that banks (whether public or private or retail or commercial or

investment) have some responsibilities towards the public. They cannot act negligently and must

bear some ethical rules. Being the custodian of public money, it is them who need to posse the

sense to protect public wealth. Thinking from legal perspective, 1bank is an officially chartered

institution empowered to receive deposits, make loans, and provide checking and savings

account services, all at a profit. In the United States banks must be organized under strict

requirements by either the Federal or a state government. Banks receive funds for loans from the

Federal Reserve System provided they meet safe standards of operation and have sufficient

financial reserves. Bank accounts are insured up to $100,000 per account by the Federal Deposit

Insurance Corporation. Most banks are so-called "commercial" banks with broad powers. In the

East and Midwest there are some "savings" banks which are basically mutual banks owned by

the depositors, concentrate on savings accounts, and place their funds in such safe investments as

government bonds. Savings and Loan Associations have been allowed to perform some banking

services under so-called deregulation in 1981, but are not full-service commercial banks and lack

strict regulation. Mortgage loan brokers, and thrift institutions (often industrial loan companies)

are not banks and do not have insurance and governmental control. Severe losses to customers of

1 (n.d.). Retrieved December 9, 2014, from The Free Dictionary by Farlex: http://legal-dictionary.thefreedictionary.com/bank

iv

these institutions have occurred in times of economic contraction or due to insider profiteering or

outright fraud. Credit Unions are not banks, but are fairly safe since they are operated by the

members of the industry, union or profession of the depositors and borrowers. So it is seen that

banks posse the role of the custodian of public money and wealth. There is a saying that with

great powers come great responsibility. Here banks have that great power so they must have

great responsibility as well. It is a common phenomenon that banks give loans and before that

they check the worthiness of the loan. But do they actually judge the worthiness of how they

should be? If we think that they do then we couldn’t find the greatest loan defaulting cases on

this earth. However, we still can assume that there were no faults from the banks perspective and

still there is the situation of defaulting and unfortunately banks give loan to the same party or

parties that have the defaulting case before. So according to public rights how ethical this act is?

Is this even legally correct? These types of questions’ answer would be found in this paper from

the global perspective as banks are no more a local factor anymore. Because of globalization one

decision in one area affects another reason as well where the bank has another branch. First of all

a common definition of a bank is presented in this paper followed by the legal definition. Then

the responsibilities of a bank are described followed by the legal bindings. Analytical discussions

are there with some global examples. Finally the paper is concluded with personal opinions.

Keywords: banks as public custodian, banks, financial institutions, global economic crisis and

banks, banks’ negligence, credit default, loan, global loan defaulting.

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Table of Contents

Introduction………………………………………………………………………………. 7-9

Conceptual Definition of a Bank…………………………………………………………. 9-10

Legal Definition of a Bank……………………………………………………………….. 10

Bank Customer Relationship……………………………………………………………... 11-12

Duties of the Bank……………………………………………………………………….. 12-16

Banks and the Banking Code……………………………………………………………. 16-17

General Obligations of the Bank…………………………………………………………. 18-19

How Banks Raise Capital? – An answer needed to prove the main custodianship of public money……………………………………………………………………………..

19-23

The factors a bank sees before sanctioning a loan to a borrower…………………………

23-24

Global Context:

Is money really safe in Banks? – An example from Cyprus……………………………...

25-26

Bangladesh example and the effects- Sonali Bank and Hallmark Scandal………………. 27-28

Conclusion and Recommendations………………………………………………………. 28-29

Bibliography……………………………………………………………………………… 29-31

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ABBREVIATIONS

CB = Central Bank

FED = Federal Reserve

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Introduction

A bank is a financial intermediary that accepts deposits and channels those deposits into lending

activities, either directly by loaning or indirectly through capital markets. A bank links customers

that have capital deficits and customers with capital surpluses. Due to their importance in the

financial system and influence on national economies, banks are highly regulated in most

countries. Most nations have institutionalized a system known as fractional reserve banking,

under which banks hold liquid assets equal to only a portion of their current liabilities. In

addition to other regulations intended to ensure liquidity, banks are generally subject to

minimum capital requirements based on an international set of capital standards, known as the

Basel Accords. Banking in its modern sense evolved in the 14th century in the rich cities of

Renaissance Italy but in many ways was a continuation of ideas and concepts of credit and

lending that had its roots in the ancient world. In the history of banking, a number of banking

dynasties—notably the Medicis, the Fuggers, the Welsers, the Berenbergs, and the Rothschilds—

have played a central role over many centuries. The oldest existing retail bank is Monte dei

Paschi di Siena, while the oldest existing merchant bank is Berenberg Bank. From financial

pespective we can describe Bank as a financial institution licensed as a receiver of deposits.

There are two types of banks: commercial/retail banks and investment banks. In most countries,

banks are regulated by the national government or central bank.

Commercial banks are mainly concerned with managing withdrawals and deposits as well as

supplying short-term loans to individuals and small businesses. Consumers primarily use these

banks for basic checking and savings accounts, certificates of deposit and sometimes for home

mortgages. Investment banks focus on providing services such as underwriting and corporate

reorganization to institutional clients.

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While many banks have a brick-and-mortar and online presence, some banks have only an online

presence. Online-only banks often offer consumers higher interest rates and lower fees.

Convenience, interest rates and fees are the driving factors in consumers' decisions of which

bank to do business with. As an alternative to banks, consumers can opt to use a credit union.

Banks give different types of credit facility to public or government. Credit Facility is an

agreement with bank that enables a person or organization to be taken credit or borrow money

when it is needed. All types of credit facilities may broadly be classified into two groups on the

basis of Funding such as 1. Fund Base Credit like Loan ( refers to credit facility that is repayable

in a definite period), Cash Credit (refers to credit facility in which borrower can borrow any time

with in the agreed limit for certain period for their working capital need), Over Draft (allows a

current account holder to withdraw in excess of their credit balance up to a sanctioned limit),

Packing Credit (a credit facility which sanctioned to an exporter in the Pre-Shipment stage),

Bill Discounted , Bill Purchased , Advance against hypothecation of Vehicles ( Transport Loan) ,

House Building Loan , Consumer Loan , Agriculture Loan -Farming -Non Farming , Consortium

Loan , Lease Financing , Hire Purchase , Import Financing – Loan Against Imported

Merchandise (LIM) – Payment Against Document (PAD) and 2. Non Fund Base credit like

Letter Of Credit, Bank Guarantee, Buyer Credit, Suppliers Credit etc.

Before giving this financial facility a bank judges the worthiness and validity of an applicant.

However, not all the calculation results in correct afterwards. Loan defaulters occur and banks

take necessary steps then. Unfortunately it is true that although banks found an applicant that

previously defaulted and still give financial facility which is against the basic banking rules and

ethics as well. Defaulting means in finance that a failure to meet the legal obligations (or

conditions) of a loan, for example when a home buyer fails to make a mortgage payment, or

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when a corporation or government fails to pay a bond which has reached maturity. A national or

sovereign default is the failure or refusal of a government to repay its national debt. So in general

we can expect that banks will stop giving the credit facilities to the potential defaulter or who

have previously defaulted and bear the potentiality to default again. It should be the main act of

the banks. As the money banks use to provide different types of loans and financial facilities

come from the banks’ customer accounts. Here the customers are the common people or even the

government itself. In fact government also receives money from the public in general. So the

responsibility of protecting the publics’ money comes into question. Banks cannot act willingly

or illegally or whatever the way they want for giving the credit facility as they hold the reserve of

public wealth and if anything goes wrong it is the people or the customer of the banks who have

to bear the consequences.

The purpose of this paper is to state that a bank cannot act negligently while giving loans to

accused or identified defaulters as they are the custodians of public money and they have some

contractual and ethical duties.

Conceptual Definition of a Bank

The definition of the term “bank” was a judicial debate in the past, owing to the lack of a

satisfactory statutory definition2. However, today, reference to judicial interpretations of the said

term would not be necessary, since the Banking Act No. 30 of 1988 [As amended] in Sri Lanka

defines the term “banking business” as:

2 See, Commissioner of Income Tax v. The Bank of Chettinad 47 NLR 25; The Bank of Chettinad v. Commissioner of Income Tax 49 NLR 409 (PC).

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“the business of receiving funds from the public through the acceptance of money

deposits payable upon demand by cheque, draft, order or otherwise, and the use of such

funds either in whole or in part for advances, investments or any other operation either

authorized by law or by customary banking practices”

Legal Definition of a Bank

According to US law for purposes of sections 3582 and 584, the term “bank” means a bank or

trust company incorporated and doing business under the laws of the United States (including

laws relating to the District of Columbia) or of any State, a substantial part of the business of

which consists of receiving deposits and making loans and discounts, or of exercising fiduciary

powers similar to those permitted to national banks under authority of the Comptroller of the

Currency, and which is subject by law to supervision and examination by State, Territorial, or

Federal authority having supervision over banking institutions. Such term also means a domestic

building and loan association.

3 Source (Aug. 16, 1954, ch. 736, 68A Stat. 202; Pub. L. 87–722, § 5,Sept. 28, 1962, 76 Stat. 670; Pub. L. 94–455, title XIX, § 1901(c)(5),Oct. 4, 1976, 90 Stat. 1803.) Amendments 1976—Pub. L. 94–455substituted “or of any State” for “of any State, or of any Territory” after “District of Columbia)” and struck out “Territorial” after “examination by State”. 1962—Pub. L. 87–722substituted “authority of the Comptroller of the Currency” for “section 11(k) of the Federal Reserve Act (38 Stat. 262; 12 U.S.C. 248 (k))”.

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Bank Customer Relationship

The relationship of bank and customer is one of contract4. According to Paget, this relationship

consists of a “general contract”, together with “special contracts”. The former “is basic to all

transactions” and whereas the latter “could arise only as they are brought into being in relation to

specific transactions or banking services”5.

The distinction between general contract on the one hand, and special contracts on the other,

becomes useful when determining the duties and obligations of the bank from the standpoint of

the customer.

Unless contractually bound, banks are generally free to decide whether they will provide

particular services to their customers or not6. A bank is obliged to perform the ordinary services

of banking arising out of the “general contract” sometimes, even without the request of the

customer.

Conversely, in the case of “special contracts”, a bank would not be obliged to perform the

services arising out of such special contract, unless specially agreed between the parties [i.e. the

bank and the customer] which would generally be outside the scope of the “general contract”.

Examples of some services arising out of “special contracts” would most probably include

standing orders, direct debits, banker’s drafts, letters of credit and foreign currency for travel

abroad, etc7.

4 Foley v. Hill (1848) 2 HL Cas 28. 5 M. Hapgood, Paget’s Law of Banking,(13th ed.) London: LexisNexis Butterworths, 2007 at p.145. 6 R. Cranston, Principles of Banking Law,(2nd ed.) Clarendon: Oxford University Press, 2002 at p.130 7 M. Hapgood, Paget’s Law of Banking,(13th ed.) London: LexisNexis Butterworths, 2007 at p.145.

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In most of the circumstances, the relationship of banker and customer would depend “entirely or

mainly upon implied contract”8. Implied terms would be important and necessary for the bank-

customer contracts due to couple of reasons.

The general contracts between banks and their customers would hardly incorporate all the terms

in writing, whereas special contracts may commonly incorporate printed terms and conditions of

the bank9.

It is unlikely that customers would agree to all the terms when entering into a general contract

with their banks, such as opening an account. Moreover, it would be impracticable to reduce all

the terms agreed between the bank and the customer to writing. Above all, there may be implied

terms in the bank-customer contracts, which are peculiar to the banking practice, so that they

cannot be displaced without affecting business efficacy.

Duties of the Bank

The classic exposition of the nature of the bank-customer relationship in Joachimsonv. Swiss Bank

Corp10. by Lord Justice Atkin gives a lucid account of the basic common law duties of a bank towards its

customer, arising out of the general contract between the bank and the customer. His Lordship stated:

The bank undertakes to receive money and to collect bills for its customer’s account. The

proceeds so received are not to be held in trust for the customer, but the bank borrows the

proceeds and undertakes to repay them. The promise to repay is to repay at the branch of the

bank where the account is kept, and during banking hours. It includes a promise to repay any 8 Joachimson v. Swiss Bank Corp.[1921] 3 KB 110 at 117. 9 M. Hapgood, Paget’s Law of Banking,(10th ed. Indian) London: Butterworths, 1989 at p.159.Seealso, R. Cranston, Principles of Banking Law,(2nd ed.) Clarendon: Oxford University Press, 2002 atp.133. 10 [1921] 3 KB 110.

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part of the amount due against the written order of the customer addressed to the bank at the

branch, and as such written orders may be outstanding in the ordinary course of business for

two or three days, it is a term of the contract that the bank will not cease to do business with the

customer, except upon reasonable notice. The customer on his part undertakes to exercise

reasonable care in exercising his written orders as not to mislead the bank or to facilitate

forgery. I think it is necessarily a term of such a contract that the bank is not liable to pay the

customer the full amount of his balance until he demands payment from the bank at the branch at

which the current account is kept.” 11

Accordingly, the main duty of a bank towards its customer is to repay the money borrowed from

the customer. However, this duty is subject to certain conditions aimed at realities of banking

practice and business efficacy. It is an implied term in the contract between the bank and its

customer that the bank is not liable to repay the customer until demand is made for repayment.

Until then, there is no presently due debt owed by the bank to the customer. Although, an oral

demand would be technically sufficient to be termed as a valid demand, the normal practice

adopted by banks is to consider a cheque or passbook as a demand, apart from the e-banking and

mobile-banking methods.

It had been observed in the past that “the consequence of justifying the customer in demanding

repayment at any branch of the bank, irrespective of where his account is kept would be a

subversion of the established and legally recognized principles of banking12. Hence, the customer

was required to make the demand for repayment from the bank at the branch where the

customer’s account was maintained. However, as seen in the present context, banks may contract

with its customers so as to enable the customers to withdraw money or make demand for

11 [1921] 3 KB 110 at 127. 12 See, M. Hapgood, Paget’s Law of Banking,(10th ed. Indian) London: Butterworths, 1989 at p.162.

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repayment from any branch of the bank. In such circumstances, there would be an added

obligation created on the banks to conform to what they have contracted with their customers.

A bank’s obligation for repayment to the customer arises only during banking hours. However,

this may extend to a reasonable margin after the bank’s advertised closing time13. Certain banks

do now open specified branches on public holidays and this may create a contractual duty on

such banks to transact business on public holidays at branches which have announced banking

hours on such holidays.

The bank-customer relationship had been historically held as essentially a debtor-creditor

relationship14. However, the nature and consequences of the bank-customer relationship differs

largely from the contractual relationship between an ordinary debtor and creditor. Even, in the

decision of Foley v. Hill 15where it was held that the bank-customer relationship is essentially a

debtor-creditor relationship, Lord Cottenham observed that:

“money placed in the custody of a banker is, to all intents and purposes, the money of the

banker, to do with it as he pleases; he is guilty of no breach of trust in employing it; he is

not answerable to the principal if he puts it into jeopardy, if he engages in a hazardous

speculation; he is not bound to keep it or deal with it as the property of his principal; but

he is, of course, answerable for the amount, because he has contracted, having received

that money, to repay to the principal, when demanded, a sum equivalent to that paid into

his hands”16

13 Baines v. National Provincial Bank Ltd.(1927) 96 LJKB 801. 14 Foley v. Hill [1848] 2 HL Cas 28, 9 ER 1002. 15 2 HL Cas 28, 9 ER 1002. 16 at 9 ER 1005-1006.

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In Joachimson v. Swiss Bank Corp. 17Lord Justice Atkin rejected altogether the contention that

the relationship of bank and customer is that of debtor and creditor with superadded obligations,

and that the customer enjoys the right of a lender to sue for his debt whenever he pleases. Lord

Justice Bankes reached the same decision as Lord Justice Atkin, whilst adhering to the notion of

implied superadded obligations. However, it has been submitted that Lord Justice Atkin’s

concept of a single contract is the more convincing one and that it is the said concept which has

prevailed over the time.18

Ross Cranston contends that;

“Even on its own terms the debtor-creditor characterization did not accord 100 percent

with reality.”……..“Rather, it was established in number of cases that the obligation of

the bank was not a debt pure and simple, such that the customer could sue for it without

warning, but rather a debt for which demand had to be made, and at the branch at which

the account was kept.” 19

The law now recognizes that the relationship of bank and customer is not merely that of debtor

and creditor with superadded obligations, especially in the forte of the modern banking practice.

It would be unrealistic to oblige the bank, like the ordinary debtor, to seek out its creditor, or to

repay immediately when due. This would mean repaying by the bank to its customers directly

after the customers had deposited the money into their respective accounts. It would also be

17 [1921] 3 KB 110. 18 M. Hapgood, Paget’s Law of Banking,(13th ed.) London: LexisNexis Butterworths, 2007 at p.149. 19 R. Cranston, Principles of Banking Law,(2nd ed.) Clarendon: Oxford UniversityPress, 2002 at p.132.

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unrealistic to permit customers, like ordinary creditors, to demand repayment of the deposits

from their banks, at any time and any place.20

The distinction between the bank-customer relationship and the relationship that of debtor and

creditor, is indispensable in giving contracts between bank and customer business efficacy.

Lord Justice Bankes observed in Joachimson v. Swiss Bank Corp:21

“It seems to me impossible to imagine the relation between banker and customer, as it

exists today, without the stipulation that, if the customer seeks to withdraw his loan, he

must make application to the banker for it”.

Hence, the jurisprudential basis of the distinction between ordinary debtor-creditor relationship

and bank-customer relationship is rather a one of practical business necessity.22

Banks and the Banking Code

23The Banking Code is a set of rules, regulations and guidelines which set a standard of good

practice with respect to banking practice. The code presents commitments of the bankers to their

customers. The key commitments state that the banks must act fairly and reasonably and will not

mislead the customer in any circumstances. The key commitments promise to give the customer

clear information with respect to his or her bank account including all terms and conditions and

interest rates. The commitment also promises to keep the customer informed about the changes

20 R. Cranston, Principles of Banking Law,(2nd ed.) Clarendon: Oxford University Press, 2002 atp.132. 21 [1921] 3 KB 110at 121. 22 See, R. Cranston, Principles of Banking Law,(2nd ed.) Clarendon: Oxford University Press, 2002 atp.132. 23 What are the obligations between the banker and the customer? (n.d.). Retrieved December 2014, 9, from In Brief: http://www.inbrief.co.uk/personal-finance/bank-obligations-to-customers.htm

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to the charges, terms and conditions by sending regular updates and bank statements. The Code

also obliges the bank to deal with all problems as efficiently as possible. The bank must also

keep all the information private and confidential in order for the customer to exercise secure

banking. All staff must be aware of the commitments stated in the Banking Code and must also

perform them. Given that there is a contractual relationship between the banker and the

customer, the obligations and customer’s rights stated in that contract must be in a clear and

plain language. If there is a significant change in terms and conditions the customers are entitled

to receive a new copy of the terms and conditions so that they are fully aware of the change. The

Banking Code is applicable to personal banking customers. The Business Banking Code applies

to businesses. There is a significant overlap between the contents of the two codes however the

Business Banking Code does not state that the banks will refuse unlimited guarantees. The

Business Code also mentions other provisions which may relate to businesses e.g. international

payments, foreign exchange.

Every bank has its own banking code. In general they hold the same idea that they will act fairly

and similarly to every customer they come across. If bank recognize an accused or identified

loan defaulter and still disburse credit facility out of negligence, this means that they are not

following their code of banking and this is against the law. They are disbursing the credit facility

out of negligence means that they are risking their existing customers’ wealth. This would be a

very unwise, unfair, illegal and unethical act.

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General Obligations of the Bank

Generally it is the bank’s primary obligation to take care of its customers and their wealth and

provide services which are fundamental to the contractual relationship of the banker and the

customer. Further provisions stated in the Banking Code state what services will the bank

provide to its customers as a part of general contractual obligations which are owed to the

customer. For example the bank will help us to choose products or services which meet our

needs and will also give us clear information with regards to services which the bank will

provide to us e.g. joint account customer’s rights and responsibilities and many more. The Bank

will also provide its customers with regular account statements and all information with respect

to running the customer’s account e. g how direct debit works, or cheque payments work etc. If

the customer has a passbook the bank will not be required to send bank statements to the

customer. The Banking Code also contains provisions regarding the means of notification of the

change to the terms and conditions; there should also be a notice period of 30 days which must

be given to the customer. If the change in terms and conditions is advantageous to the customer

such change can be carried out immediately without the need for notice to be submitted to the

customer. The notice period stated in the Banking Code is 30 days however under common law

such notice only needs to be reasonable. What is reasonable is determined by the case law.

It is an implied term of the contract that the bank or the banker is not responsible to repay the

customer for the proceeds borrowed from the customer until the customer officially demands

such a payment. Therefore the customer could not have a claim for debt. This term is the

significant term of the contractual relationship between the banker and the customer.

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There are further duties owed by the bank to the customer e.g. the bank has a duty to protect its

customer from fraud committed by the agents, directors , partners in making payment orders etc.

There are some statutory protections in relation to the bank in the absence of negligence. There is

also a duty of care owed by the bank to the customer when the bank is giving advice on

investments or when the bank gives advice or explains security documentation. However it was

held that the bank is not under a continuing duty to keep the advice under review. In some

circumstances the bank was also held not to have a duty of care to any third parties.

The duties are defined by case law and they constitute duties of care to the bank. Any wider

duties of care will not be accepted or recognized unless they are implied as contractual terms.

And such term will not be implied if they do not comply with the following requirements, these

are that the term is reasonable and equitable, it is necessary in order for the contract to have

business efficacy, the intention to create this term must be obvious and must be clearly expressed

and it must not clash with any other term.

How Banks Raise Capital? – An answer needed to prove the main custodianship of public money

Are banks really the main custodians of public money? Do really their negligent acts affects

public money supply? Statistical answers below try to prove the fact that banks are the important

custodians of public money and any kind of negligent acts harm greatly in public money supply.

So finding the answers I try to solve it inversely by finding how banks raise their capital to show

the weight of public money.

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“How do banks raise capital” is a question that is best understood by looking at the basics of a

bank. Just as a business sells its products or services as its main line of business and thus its

survival; a bank has the business of lending and recovering from customers at the core of its

raison d’etre. To make the question of how do banks raise capital easier, let us think of money as

the raw material for a bank’s business. If a manufacturing firm such as textile business has to

assemble raw materials that start with cotton, a bank has only money that it plans to lend to its

customers as its raw material.

The money that a bank raises to lend is often called the capital. So, how do banks raise capital is

something that has to be understood in this background. Banks have to raise money from sources

in order to have it with them to be lent to customers, from whom they charge a rate of interest

that is higher than that at which they borrow. This accounts for their profit. Since capital is one

of the critical components of a banking business, it is important to understand where all and how

to banks raise capital.

Capital from stakeholders

Banks can do this in a number of ways. The most common, and in fact, a mandatory method of

raising capital is for the organizers (in most cases, these are the stakeholders or founders) of the

bank to put in money from their pockets. Usually, while the amount needed to start a bank varies

from one American state to another, the ratio at which banks get their capital from their

organizers varies between 10 and 15 percent. These organizers are the investors in the bank, and

have a deep interest in the functioning of this lending institution. How do banks raise capital is

understood in a clearer fashion in this context –the greater the ability of the organizers to raise

money, the greater the money the bank can lend out , so that it runs healthily and profitably.

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Raising capital from shareholders

While organizers make up between 10 and 15 percent of the bank’s investment, how to banks

raise capital is understood when it is seen that the reminder of the money is raised from

shareholders. The term ‘shareholder’ implies those who invest in the bank through public

borrowing. The number of shareholders and their individual contributions can vary by a very

wide margin, as can their contribution. As with any other kind of partnership, this kind of

financial relationship too, is such that every stakeholder earns from the profit in proportion to the

investment made.

The markets as lending source for capital

How do banks raise capital is a question that can be answered in another manner. Banks look for

other sources in raising capital. For instance, they can borrow from the financial markets. This

option is usually exercised in free market, capitalist economies, a prime example of which is the

US. In these economies, it is a useful source to have someone borrowing from the markets

because this can be used as a buffer in markets, which by their very nature are volatile and prone

to a lot of flux. When markets are in need of money in case of a crunch, they can always go back

to the banks to which they have lent money. Of course, there are some drawbacks in this system

for both the lender and the borrower. The lender may not be fully sure of getting back money it

has given to banks when it needs it the most, since they normally ask money back from banks

only when it is faced with an emergency, and it is always difficult to get it at such short notice.

For banks, too, there are problems with this kind of option, because they cannot invest this

money on long term plans.

The government as a source of capital

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Getting money from the government is another option for banks when it comes to how do banks

raise capital. In governments in which the free market is less powerful a force to reckon with,

government bonds can be a good source by how do banks raise capital. In economies that are

either fully or partly controlled, as in the case of China or India, government lending can be a

very useful source of how do banks raise capital. This is a lesser possibility in free market,

consumerist economies such as the US, but more common in the countries just mentioned. In

these situations, governments lend banks through bonds and other sureties for a number of

reasons. Since it is not always the consumer who dictates demand, governments lend banks as a

kind of safety valve. When the key sectors of the economy, mostly agriculture in these and other

related countries, face problems, the governments can straightaway approach these banks to

which it has lent capital and direct them to divert the money due to the governments back to the

people in need of the money. In most cases, this is usually a case of money transfer. In other

words, the question of how do banks raise capital needs to be looked at from a different

perspective in some countries.

Other ways

How do banks raise capital is to be understood when it one looks at another queer way by which

banks raise capital. In the days of the economic slowdown, some financial companies came to

banks to advise them on how to raise capital. The aim was to get these banks to impart their

experience to these companies on how to liaise with the government and get money from it.

These companies, such as Wells Fargo and Morgan Stanley, had to pay a huge consultancy fee

for these bankers. There were also some financial arrangements by which these banks got a cut

in the amount of money they helped the companies raise! The money that these banks got from

these transactions was put back into the market and other sources, as this too, turned out to be its

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capital in many ways. In this way, how do banks raise capital was a question that was answered

in a very unusual fashion.

So clearly it is observed that a successful bank means a lot of public fund is tied up to it.

Alternatively it can be said that the more custodianship as well as more responsibility as the bank

is running its business in full swing. So if anything bad occurs then not only the bank suffers but

also the people whose money were tied up as the banks were losing their money and getting out

of their business. So only and only for the people a bank cannot act negligently and it results in

huge chain reaction to the public as well.

The factors a bank sees before sanctioning a loan to a borrower

Two major focuses of banking supervision and regulation are the safety and soundness of

financial institutions and compliance with consumer protection laws. To measure the safety and

soundness of a bank, an examiner performs an on-site examination review of the bank's

performance based on its management and financial condition, and its compliance with

regulations.

“CAMELS”

The examiner uses the CAMELS rating system to help measure the safety and soundness of a

bank. Each letter stands for one of the six components of a bank’s condition: capital adequacy,

asset quality, management, earnings, liquidity and sensitivity to market risk. When performing

an examination to determine a bank’s CAMELS rating, instead of reviewing every detail, the

examiner evaluates the overall health of the bank and the ability of the bank to manage risk. A

simple definition of risk is the bank’s ability to collect from borrowers and meet the claims of its

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depositors. A bank that successfully manages risk has clear and concise written policies. It also

has internal controls, such as separation of duties. For example, a bank’s management will assign

one person to make loans and another person to collect loan payments.

5-Cs

A safety and soundness examiner also reviews a bank’s lending activity by rating the quality of a

sample of loans made by the bank. When a bank reviews a loan application, it uses the "5-Cs" to

assess the quality of the applicant. The 5-Cs stand for:

Capacity - measures the borrower’s ability to pay, including borrower’s payment source and

amount of income relative to debt.

Collateral - what are the bank’s options if the loan is not paid? What asset can be turned over

to the bank, what is its market value, and can it be sold easily? A valuable asset might be a house

or a car.

Condition - this refers to the borrower’s circumstances. For example, if a furniture storeowner

is asking for a loan, the banker would be interested in how many chairs and sofas the store is

expected to sell in the area over the next five years.

Capital - the applicant’s assets (house, car, savings) minus liabilities (home mortgage, credit

card balance) represent capital. If liabilities outweigh assets, the borrower might have difficulty

repaying a loan if his regular source of income unexpectedly decreases.

Character - measures the borrower’s willingness to pay, including the borrower’s payment

history, credit report and information from other lenders.

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Global Context

Is money really safe in Banks? – An example from Cyprus

After the people of Cyprus had their money ‘commandeered’ in 2013, this unprecedented event

sent shockwaves throughout the banking system and also the general public. In a weekend, the

Banks had lost the last modicum of trust the public had for them. Even the definition of a bank:

“A safe place to store your money” is now null and void. As a result of this ‘wealth grab’ banks

and governments around the world have done their best to try and calm the public into thinking

that this was just a one off incident and that ‘it won’t happen here’. Here in the UK the

government has spent millions in TV, radio and newspaper advertising campaigns that our

money in the banks is safe and insured up to £85 000.

When this whole Cyprus debacle unfolded I went on record to say that this ‘wealth grab’ was

just a testing ground before there was widespread implementation of it elsewhere. As usual, I got

a lot of flak from financial commentators and other financial professionals saying that it could

never happen in Britain. Well, I haven’t been vindicated yet, but the dominos are starting to fall.

In late 2013 the blue print and legislation that was used in Cyprus was secretly installed into

fabric of the banking systems in Canada, the US, Australia, New Zealand and the UK. This

means that when there is another banking crisis, instead of having a ‘Bail Out’ where the

Governments prop up the banks, there will be a ‘Bail In’ – where a grubby hand will dip into the

personal bank accounts of the public to pay for the mess. The reason for this is that the

Governments no longer have any money, so they are now targeting the only remaining pool of

money of the people.

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The thing is, the moment you deposit your cash into the bank, by LAW, it is not yours. It

becomes the banks property. So they can spend, speculate and do anything they want with it. So

when you withdraw your cash they are effectively loaning it back to you at 0% APR. So in

Cyprus a new term was introduced to the public, ‘Capital Controls’. This is where the banks

limited the amount of money the Cypriots could withdraw everyday to just 300 Euros. And right

now, capital controls are slowly finding their way into the UK. Already HSBC customers have

been experiencing Capital Controls when trying to withdraw funds of over £10 000 and in

Nationwide, some people have been severely questioned when trying to withdraw just a few

thousand Pounds. This is only set to get worse.

What hardly anyone has bothered to do is look behind these claims and crunch the numbers. And

the short answer is no. You see, the FSCS is a private company, not a government entity and

there's no pot of money backing up everyone's account. So if someone claims on this, the

compensation is raised by levies (taxes on the public). Being really conservative, if just 10% of

the UK claimed on this...the system would crumble. But realistically, if just 1% of the nation

claimed on this (just 700 000 people), the system wouldn't cope. It's totally ridiculous. So in a

nutshell they are claiming that our money is safe, but if there are any claims, they’ll compensate

you by taxing the nation. The Government are so scared of a bank run (people dashing to the

cash machines to withdraw all of their money) that they're promoting this absolutely everywhere

to try and make the public think everything is ok. Far from it...we're the 3rd most indebted nation

on the planet with our debt increasing by £277 000 per minute and the European Banking

community is about to go bust Also the Yanks have a similar system called the FDIC. This is

even sillier as they actually have a pot of money to draw from, $25 Billion but it's backing $9.3

Trillion.

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Bangladesh example and the effects- Sonali Bank and Hallmark Scandal

In May 2012, a report from the Bangladesh Bank revealed that the Ruposhi Bangla Hotel

Branch of the state - owned Sonali Bank, Bangladesh’s largest commercial bank, illegally

distributed Tk 36.48 billion (US$460 million) in loans between 2010 and 2012. The largest

share, of Tk 26.86 billion (US$340 million), went to the now infamous Hallmark Group. While

the focus has understandably been on Hallmark, their companies also participated in the fraud,

including:

T and Brothers, Tk 6.10 billlion

Paragon Group, Tk 1.47 billion

Nakshi Knit, Tk 660 million

DN Sports, Tk 330 million

Khanjahan Ali, Tk 50 million

This is considered to be the country’s largest banking scandal. It dwarfs previous fraud cases,

such as a Tk 6.2 billion Letter of Credit fraud in Chittagong in 2007, a Tk 5.96 billion fraudulent

withdrawal from Oriental Bank in 2006, and a Tk 3 billion forgery scandal in 2002.

Now the consequences of these acts are far too imaginable. Not only the Sonali bank itself

becomes the victim in the competitive banking industry of Bangladesh, but also the people who

were the depositors. Undoubtedly the bank is going under serious image crises but what

happened to the public money? The recovery of the money is still not satisfactory and public

were then rushing towards the bank to withdraw their money from the account which resulted in

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serious liquidation crises. So the problem was not remaining among the bank but also spread

among the general public. They suffered and still suffering. So this type of corruption and

negligence of the higher authority is not expected.

Conclusion and Recommendations

A bank is a financial intermediary that accepts deposits and channels those deposits into lending

activities, either directly by loaning or indirectly through capital markets. A bank links customers

that have capital deficits and customers with capital surpluses. Banks bear contractual

relationship with their customers where they are agreed on that they would protect their wealth

right at any cost. It is highly unexpected that Banks would violate these regulations. Being a

public money custodian we expect that banks should not behave in negligence while giving

financial facility to potential defaulter or that has previous default history. Because if anything

goes wrong, ultimately it is the general public who suffer at last.

The bank should receive on behalf of its customer cash directly into the customer’s account and

accept cheques and other negotiable instruments for clearing into the customers’ account. The

bank should pay or honor cheques and other withdrawals properly authorized by the customer

during banking hours at the designated business offices of the bank, or any other agreed location

provided there is sufficient funds in the account or agreed overdraft. This also implies the bank

should avoid wrongful dishonor of customer’s cheques. The bank should give reasonable notice

before closing a customer’s account. Though generally one month is acceptable, it is held as

inadequate for a business with complex banking relationship in Prosperity V. Lloyds Bank

(1923). However, some circumstances may warrant the immediate closure where a case of fraud

is established. The bank is duty bound to inform the customer if his signature has been forged on

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a cheque or other instrument – Greenwood V. Martins Bank (1933). The bank should provide the

customer with statements of account regularly for record and reconciliation purpose. They are

not supposed to charge for this service. The bank should pay agreed interest on deposits and any

other agreed returns on financial investments in the account. The bank must ensure that the

customer’s money is safe. The bank must also keep the customer’s account and affairs secret in

line with the qualified conditions in the legal background in Tournier V. National Provincial and

Union Bank of England (1924).

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