Analysing Risk Management in Banks: Evidence of Bank Efficiency

British Journal of Economics, Finance and Management Sciences 1 March 2017, Vol. 13 (2)

The Nature and Extent of the Reciprocal Obligations Involved in the Banker/Customer Relationship Stanyo Dinov Abstract The current paper explores the banker/customer relationship and its historical development. Based on statuary and case law, it outlines the definitions of banker and customer, the duration of their relationship and their individual rights and obligations. Recent changes of the relationship and the differences, resulting from court decisions in England and Scotland regarding their obligations, are also presented. The article also trays to predict the possible changes to the banker/customer relationship in the near future. The most important conclusions, as well as possible further developments, are outlined at the end.

Keywords: BEA, CCA, JCR, BPS, ATM systems I. Introduction The relationship between the banker and the customer has changed over time, so it is not easy to predict the nature of this relationship in the near future. Recent rapid technological development has raised many questions about customers‟ privacy and protection. Therefore, there is still a need to closely examine the legal aspects of this relationship from the past to the present, in order to find the best approach to its future context. II. Definition, nature and formation of reciprocal obligation

1. Definition The banker/customer relationship consists of two sides. A banker, according to the Bills of Exchange Act (BEA) 1882 s 2, „includes a body of persons whether incorporated or not who carry on the business of banking‟.i Case law defines „banking business‟ via three principles:  it can change from time to time;ii  financial institution engaging in banking business differ from one to another by jurisdictions;iii and  the institution should be engaged in banking business.iv The customer, the second party of the relationship, is determined from the case Commissioners of Taxation v England Scotland and Australia Bank Ltd [1920] AC 683 as a person for whom the bank performs a casual service, such as cashing a cheque, or a person who has an account of his own at the bank. Both definitions outline one of the features of the banker/customer relationship, namely that it can change over time. Nevertheless, they do not provide enough information for the relationship between these two parties. Hence, in order to understand this relationship, its nature should be explored.

2. Nature The relationship between a banker and a customer can be defined via the nature of its obligations. It is a relationship of mutual duties and obligations.v Normally it has been presumed that the bank has not been the custodian of the customer‟s money,vi and the relationship is not fiduciary,vii but as such one between a

British Journal of Economics, Finance and Management Sciences 2 March 2017, Vol. 13 (2) debtor and a creditor.viii A bank is commonly a financial advisor,ix and the nature of its relations to the customers continually evolve,x consequently, it cannot be explained through as a debtor-creditor relationship.xi It is prima facie the duty of the debtor to effect payment.xii The relationship is contractual and as Paget states: „It consists of a general contract, which is the base of all transactions, together with a special contract which arise only when the relationship is brought into being in relation to specific transaction or banking services‟.xiii Assuming this, the rights and obligations of both parties, with certain exceptions, will be determined upon the signing of the contract.xiv

3. Duration of the banker/customer relationship It is recognised, that the bank/customer relationship, and the duty of the bank to exercise the same degree of care of the customer and skills as a reasonable bank, begins: with the opening of a bank account;xv when the bank agrees to act as a customer‟s agent in banking transactions; or when the bank agrees certain defence vis-à-vis to third party.xvi The assumption that the banker/customer relationship begins at the time of opening an account has been overridden by case law with the bank‟s acceptance to collect money from the client, or to open an account.xvii Otherwise, it may accrue by mutual agreement, unilateral action from the side of the bank, from the part of the customer, or by operation of the law.xviii So, in Woods v Martins Bank Ltd [1959] 1 QB 55, 73, despite the fact that the customer did not have an account with the bank, the court decided that a special relationship was created when the bank manager agreed to provide financial advice to the customer. Relevant to the case was not the fact that the customer did not have an account with the bank, but the proximity of both parties to create a relationship. Although it is relatively clear when the banker/customer relationship starts, it still not firmly defined when it ends.xix The relationship may be terminated: by agreement between the parties; by unilateral act; or by death of the customer.xx

4. Obligations on the banker/customer As already mentioned, the banker/customer relationship constitutes a sui generis contract incorporating elements of a number of specific contracts for specific services which banks habitually do, but are not bound to provide,xxi or which can occur in particular circumstances.xxii There is a debate as to which services belong to which category,xxiii nevertheless it is relatively clear that the second category will continually increase with the time.xxiv Basically, a banker/customer relationship includes reciprocal obligations on both sides. On the one hand, the duty of the bank towards the customer is a legal one arising out of a contract, and not merely a moral one.xxv The bank has:  an obligation to provide a duty of confidentiality;

 a duty to deal in the customer‟s interest and care and

 duties arising from the contractual terms.xxvi The banker is bound by these obligations. On the other hand, the customer is liable:  for the express duties negotiated between the both parties;

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 to pay a reasonable price for the received service;

 to fulfil his obligation as to the express terms of the contract; and

 to take reasonable care to prevent forgery and to notify the bank of suspected forged cheques on his account.xxvii Regarding the obligations of the bank, banks first have a general duty of confidentiality. Exceptions arise only where:  the disclosure is under compulsion by law;xxviii

 the disclosure is in the public interest;xxix

 the interest of the bank requires disclosure;xxx or

 where there is a customer‟s agreement to the disclosure.xxxi The duty of confidentiality comes after the banker/customer relationship is established and continues after the customer‟s death, whether the account is in credit or overdrawn.xxxii It includes information concerning the bank‟s customer and his affairs, which it acquires as his banker.xxxiii This duty should comply with the law of the land.xxxiv Secondly, the bank‟s duties of care include:  protection of agents such as directors and partners from fraud in issuing cheques and other payment orders;  other statutory protections in favour of the paying and the collecting bank depend on the absence of negligence or cross negligence;

 giving financial or investment advice and

 explaining the effect of security documents.xxxv In the case of bank insolvency, the customer‟s care is not entitled to assert any property. Unlike company law, where he is regarded as unsecured general creditor, whose claim to those of preferential and secured creditors. The customer can claim up to the sum of his deposit. In England, the duty of care that was based on the constitutive trust in the banker/customer relationship was imposed on banks,xxxvi whereas in Scotland a person occupying a fiduciary position enjoys personal advantages and is a constructive trustee of the profit made.xxxvii Concerning the third obligation, the banker is bound to advise the customer on contractual terms. This includes giving „advice on all financial matters‟ „with reasonable care and skill‟xxxviii and providing references for customers.xxxix A bank giving a reference without its customer‟s consent, or giving an inaccurate reference, is potentially liable for breach of contract and for libel.xl For instance, in London Joint Stock Bank v Macmillan and Arthurxli the court decided that customer is bound to take usual and reasonable precautions to prevent forgery, and negligence on his side is a breach of the duty of care which is owed to his banker. The duty of care which the bank owes depends on the degree of proximity between the parties creating the relationship, from which arises the normal obligation to advise with care and skill.xlii The bank is not obliged to advise a party who seeks advice intended for a third party.xliii Nevertheless, the reciprocal obligations of the banker/customer relationship can be influenced by a third party. In the close relationship between a customer and the members of his family, both parties are vulnerable, because each could easily affect or manipulate the other against his personal will. In the case

British Journal of Economics, Finance and Management Sciences 4 March 2017, Vol. 13 (2) of Lloyds Bank v Bundy [1975] QB 326, the customer of the bank took responsibility for the debts of his son. The court decided, going by the bank‟s duty to protect the customer‟s interests, that it was an obligation of the bank to inform him about the potential risk. In a contrary case, Barclays Bank v O’Brien [1994] 1 AC 180, the customer used the personal relationship with his wife to trick her into signing a contract regarding the mortgage of their home. The decision of the court confirmed that the bank was obliged to make Mrs. O’Brien aware of the conditions and risks in the contract she signed. In a similar case, Mumford and Smith v Bank of Scotland (1996) SLT 392, the court held that the decision in O’Brien could be reconciled with the principle of Scots law and the court came to the same conclusion but for different reasons. The court based its decision on the obligation of „good faith‟ which refers to the duty of giving a customer certain advice. The positions of the courts in both leading judgments was contrary to the previous case law in Scotland, where in Young v Clydesdale Bank Plc (1889) 17 R 231 the court determined that the creditor is under no duty to give information about the debtor‟s indebtedness and the banker is entitled to assume that the customer is informed about the obligation which he undertakes.xliv Likewise, in Royal Bank of Scotland v Greenshields 1914 S.C. 266f., the court held that: „A bank-agent is entitled to assume that an intending guarantor has made himself fully acquainted with the financial position of the customer whose debt he is about to guarantee. And the bank-agent is not bound to make any disclosure whatever regarding the customer's indebtedness to the bank.‟ It can be seen from these cases that the trend in courts decisions, which previously supported the banks, has changed in favour of the customer. In London Joint Stock Bank Ltd v Macmillan and Arthurxlv the court decided that it is the customer‟s duty to exercise care over his account, and not the bank‟s responsibility to watch out for dishonest payments. However, in a similar case, a court in Scotland recently decided that it is an obligation of the bank to record dishonest payments.xlvi This obligation is included in legislation, in the Consumer Credit Act (CCA) 1972 and 2006. This last case does not apply in England and therefore, as a general principle it is held to the customer‟s duty to inform the bank of any extraordinary changes to his account. Nevertheless, the courts take into consideration the individual circumstances of each case and the option for the customer not to be informed about changes to his account is considered. In Barclays Bank plc v O’Brien [1994] 1 AC 180, HL it was held that the wife of the account holder „needs to show only that the bank knew that she was a wife living with her husband and that the transaction was not on its face to her financial advantage‟.

III. The banker/customer relationship and its extend in the near future The classic notion of the banker/customer relationship has changed in many ways in recent decades. What used to be a personal privilege for the wealthy, having a bank account has become the norm for people today. Through technological developments, traditional services offered in the branch of a bank have been replaced with electronic express contracts, ATM systems, and telephone and online banking. Financial innovation has meant that banks offer a variety of new and sophisticated products and customer services such as financial planning and management, loans and insurance. However, this rapid development that has brought many advantages to customers such as rapid transactions and lending facilities, as well as to the banks in the form of profits, has also raised questions about the legal aspects of banker/customer obligations. The old-fashioned belief that banks deal in the customer‟s best interests has been replaced with the new standard of achieving high revenue. As the Jack Committee Report (JCR) pointed out:

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„The bank manager has perforce moved away from his role as the trusted financial adviser, the “man of business”, to that of the salesman of a whole range of products and services. Automation has further depersonalised the relationship putting it on more formal basis of contract.‟ xlvii Conscious neglect of the duty of care to protect customers‟ interests, in some explicit cases from the recent financial crisis, has opened a debate in society about ethics and „moral hazard‟ values. In this context, reforms within the banking sector have been undertaken in order to protect customers‟ interests. The customer can nowadays rely on the „Banking and Payment Services‟ (BPS) regime and on a variety of general common law and statutory techniques that have been implemented.xlviii However, following the scale of achievements and scandals, minimal regulation and overregulation, it could be said that the banker/customer relationship will be further regulated with an eye to technological development, and issues related to privacy protection will continue to play a vital role in the banker/customer relationship in the near future.

IV. Conclusion The banker/customer relationship has transformed from its traditional appearance into a business relationship like any other.xlix Considering its mutable characteristic, its development in the near future cannot be predicted with certainty, nevertheless issues related to the bank‟s duty of confidentiality and care of the customer‟s interests will still be a matter of public debate and a focus for further legislation.

i In the case of United Dominions Trust Ltd v Kirkwood [1966] 1 QB 783, Lord Diplock said „It is isessential to the business of banking that a banker should accept money from his customers on a running account ... and the banker must also undertake to pay cheques drawn on himself by his customers in favour of third parties up to the amount standing to their credit ...‟. However, as will be seen, this will not always be the case to define the reciprocal obligations of this relationship. ii Woods v Martins Bank Ltd [1959] 1 QB 55. iii Hafton Properties Ltd v McHugh [1987] STC 16, 25, 28-29. iv Cf. Ellinger E./ Lomnicka E./Hare C.V.M. (OUP 2011), Ellinger’s Modern Banking Law, 5th edn., 80; Stafford v Henry (1850) 12 Ir. Eq. 400. v Hapgood M. et al., Paget's Law of Banking, 13th edn. (London 2007), 141. vi Royal Bank of Scotland v Skinner (1931) SLT 382. vii Cf. Foskett v McKeown [2001] 1 AC 102, 127-128; Re Global Trader Europe Ltd [2009] EWHC 602 (Ch), [63]; Dex Asia Ltd v DBS Bank (HK) Ltd [2009] 5HKC 289, [69]-[70]. „Money paid into a bank account belongs legally and beneficially to the bank and not to the account holder‟. E. Ellinger/E. Lomnicka/C.V.M. Hare, (n iv), 120. Bank‟s responsibility as a fiduciary is to act interest of the customer but also in its own interest. According, the essence of the bank- customer contract, the bank has the right to use deposits for its own purposes and to repay an amount, equal to the deposited, with or without the interest, either at once or over a fixed period of time. viii Cf. Foley v Hill (1848) 2 HL, 9 ER 1002, 28; Royal Bank of Scotland v Skinner (n vi). Joachimson v Swiss Bank Corpn [1921] 3KB 110 at 127. A relationship with separated obligations, where the customer enjoyed the right of a lender to sue his debt. The bank undertakes to receive money and to collect bills for its customer‟s account and to repay them. „The customer undertakes to exercise reasonable care in executing his written orders so as not to mislead the bank or to facilitate forgery.‟ ix Crerar, The Law of Banking in Scotland, 2 edt. (Edinburgh 2007), 188. x Cf. Walton v Mascall (1844) 13 M & W 452 at 457-458; Bradford Old Bank Ltd v Sutcliffe [1918] 2 KB 833 at 848. xi Ellinger E. / Lomnicka E./Hare C.V.M., (n iv), 124. xii Macdonld v North of Scotland Bank (1942) SC 369, 1942 SLT 196. xiii Hapgood M. et al., (n v), 145.

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xiv However, it should be assumed that in reality both parties are not equal. The customer have to accept the terms and conditions of the bank, which are not negotiable, if he would like to open an account. xv Cf. Great Western Rly Co v London and County Banking Co Ltd (1901) AC 414, 425. A course of dealing which is not distinctly related to banking, or having some years habit of getting crossed cheques exchanged for cash is not sufficient to create a relationship bank-customer. xvi In the last situation the bank operates on behalf of its customer such as borrowing and collecting cheques. xvii Cf. Crerar, (n ix) 187. It starts when the bank stores money or other valuables for clients; Woods v Martins Bank Ltd (n ii) at 63. xviii Ibid. xix Crerar (n ix), 194. xx Hapgood M. et al., (n v), 153. xxi Services such as selling insurance, and providing banker‟s drafts, letters of credit and foreign currency, which the bank is not bound to supply. Libyan Arab Foreign Bank v Bankers Trust Co [1989] QB 728 at 749. The case provided that the contract banker/customer may be governed in part by one and in part by another law. xxii Kpohraror v Woolwich Equitable Building Society (1996) 4 All ER 119. xxiii Libyan Arab Foreign Bank v Bankers Trust Co, (n xxi), [1989] 3 All ER 252 at 269. xxiv Cf. Crerar (n ix), 188. xxv Cf. Hapgood M. et al., (n v), 127; Tournier v National Provincial and Union Bank of England (xxxi). xxvi Burnett v Westminster Bank Ltd [1966] 1 QB 742, [1965] 3 All ER 81. The use of credit card and cheque guarantee is governed by express contract. xxvii Cf. Crerar (n 9), 237; M. Hapgood et al., (n v), 150, 489. London Joint Stock Bank Ltd v Macmillan [1918] AC 777; Greenwood v Martins Bank Ltd [1933] AC 51; Tai Hing Cotton Mill v Chong Hing Ltd [1986] AC 80; The duty of care in the Macmillan case is limited to the drawing of individual cheques. xxviii Cf. Tournier v National Provincial and Union Bank of England (1924) 1KB, 474. Subject to statutory duties of disclosure are: money laundering; giving information to the police or in regard to a customer suspected of a crime; Saha and Anor v HSBC Ltd [2010] EWCA. xxix Cf. Libyan Arab Foreign Bank v Bankers Trust Co, (n xxi), [1989] QB 728; Weld-Blundell v Stephens (1938) 5 LDAB 163 . xxx This also includes the passing of customer‟s personal information to banks in the same group. However, according the Lending Code 22-24 which refers to the Banking Code para. 8.3 where there is a special customer request not to pass this information, it will not be given. Sutherland v Barclays Bank Ltd (1938) 5 LDAB 163. xxxi Cf. Tournier v National Provincial and Union Bank of England (n xxviii) 461; Attorney-General v Guardian Newspapers Ltd (No. 2) [1990] 1 AC 109, 281-282. xxxii Hapgood M. et al., (n v), 158. xxxiii Barclays Bank plc v Taylor [1989] 1 WLR 1066, 1077 (CA). xxxiv Parry Jones v Law Society [1969] 1 Ch. 1, 9. xxxv Hapgood M. et al., (v), 150. xxxvi Cf. Crerar (n ix), 201, 242; Barnes v Addy (1879) 9 Ch App; Selango v United Rubber Estates Ltd v Craddode (Nr 3) [1968] 2ALL ER 1073. However, by later legislation this case was questioned. See Lipkin Gorman v Karnale Ltd [1992] 4 All ER 409. xxxvii Cf. Crerar (n ix), 201, 242; Aberdeen Railway Company v Blaike Bros (1854) 1 Macq. 461 HL; Karak Rubber Estates Ltd v Cradddock [1872] 1 All ER 1210; Smith, A Short Commentary on the Law of Scotland (W Green, 1962), 584. xxxviii Woods v Martins Bank (n ii) 71. xxxix Providing references includes the bank‟s duty to provide information to the customer or to the recipient of the information regarding inaccuracies or falsifications. xl Hapgood M. et al., (n v), 135. xli See (n xxvii). xlii Woods v Martins Bank Ltd (n ii). xliii McInerny v Lloyds Bank Ltd (1973) 2 Lloyd's Rep 389. xliv See http://www.publications.parliament.uk/pa/ld199798/ldjudgmt/jd970612/smit01.htm (9 March 2015). xlv See (n xxvii).

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xlvi James Duncan v American Express Services Europe Ltd [2009] CSIH 1. xlvii JCR, paragraph 2.31. xlviii Ellinger E./Lomnicka E./Hare C.V.M., (iv), 125. xlix Crerar (n ix), 254.