Banking operations involve several rights, obligations, and legal principles that govern how banks deal with customer accounts. Many students preparing for banking examinations such as JAIIB, CAIIB, CCP, Bank Promotion, or any financial sector competitive exam often struggle with two extremely important concepts:
- Banker’s Right of Set-Off
- Right of Appropriation (Sections 59, 60, 61 of the Indian Contract Act)
Although these terms appear technical, they are extremely simple once understood with real-life scenarios. This article provides a thoroughly detailed, example-rich, easy-to-understand explanation of all these concepts.
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Introduction to the Topic
The concept of the Banker’s Right of Set-Off is one of the most powerful rights available to a bank. It enables the bank to adjust or “set off” a customer’s credit balance against the same customer’s debit balance. In simple terms, if a customer owes money to the bank and at the same time holds money in another account with the bank, the bank has the right to adjust these two amounts.
This principle plays a significant role in banking operations, especially when customers default on loans or fail to make payments on time. It is also a favorite area for examiners because it applies not just legally but also operationally. The same goes for the Right of Appropriation, which defines how payments received from customers are applied when multiple loans or dues exist.
Understanding these concepts thoroughly will help you both in exams and in practical banking.
What is Banker’s Right of Set-Off?
The Banker’s Right of Set-Off allows the bank to combine and adjust the balances from different accounts of the same customer. For example, if a customer has a savings account with a balance and at the same time has an overdue loan, the bank can legally transfer money from the savings account to recover the overdue loan amount.
In simple words: The bank can use your money to recover its money, but only under specific conditions described below.
Important Features:
- It must be a legal debt.
- The debt must be due and payable (overdue).
- Both accounts must belong to the same person in the same capacity.
- Bank usually issues a notice before exercising the right.
This right is not automatic. It must follow rules, conditions, and procedures which we will detail next.
Mutual Debtor–Creditor Relationship Explained
For the Right of Set-Off to apply, there must be a “mutual” debtor–creditor relationship between the bank and the customer. Mutual means both parties must have opposite obligations toward each other at the same time.
Example:
- If you have money in a savings account → The Bank becomes the Debtor, and You become the Creditor.
- If you have taken a loan → You become the Debtor, and the Bank becomes the Creditor.
Since both relationships exist simultaneously between the same parties, the bank legally has the option to “set off” amounts.
Overdue Condition: Why It Is Mandatory
The bank cannot exercise the Right of Set-Off arbitrarily. The loan must be overdue. That means the customer must have failed to pay the installment or amount due.
The bank cannot set off:
- Future installments
- Installments not yet due
- Amounts payable at a later date
Only overdue amounts can be recovered using this right.
Practical Example to Understand Set-Off
Let us consider a simple example:
- Loan Overdue: ₹15,000
- Customer’s Savings Account Balance: ₹12,000
The bank may issue a formal notice and then debit ₹12,000 from the savings account to adjust against the overdue loan. After adjustment, the remaining loan overdue will be:
₹3,000 only.
This is a perfect operational example of how set-off works.
When Set-Off Cannot Be Applied
The bank cannot arbitrarily force set-off. Certain restrictions apply.
Situations where Set-Off is NOT allowed:
- Joint Account vs Individual Loan:
Money from A+B joint account cannot be used to recover A’s personal loan. - Capacity Issue:
If a person operates one account as a Trustee and another as an Individual, the bank cannot mix the capacities. - Fixed Deposits under Lien or Lock-In:
If an FD is already under lien or security for another loan, set-off may not apply. - Future dues:
The bank cannot adjust amounts for installments that are not yet due.
Notice Requirement: When and Why?
The bank should normally give a notice before exercising the Right of Set-Off.
This ensures transparency and prevents cheque dishonour due to unexpected debits.
Notice is essential because:
- The customer must know before money is debited.
- The customer must get a chance to regularize the loan.
- It avoids disputes and litigation.
However, there are exceptions where notice is not required.
Exceptions: When No Notice Is Required
There are special situations where the bank can directly exercise the Right of Set-Off without prior notice.
- Customer is declared insolvent by the court.
- Borrower dies and accounts are frozen.
- Fraud or suspicious activity detected.
- Garnishee Order or government attachment order is received.
These situations give immediate rights to the bank to protect its interest.
Partnership Firm Rules
Partnership firms follow different rules because partners have unlimited liability.
This means the personal assets of partners can be used to meet firm liabilities.
Example:
If a firm owes ₹1,00,000 to the bank and the partners have the following balances:
- Partner A Savings = ₹10,000
- Partner B Savings = ₹10,000
- Partner C Savings = ₹15,000
The bank can set-off these balances to recover the firm’s liability.
What Cannot Be Set-Off in Partnership?
Set-off is NOT allowed in the following situation:
If Partner A has a personal loan, the bank cannot set off this personal loan using funds from the firm’s account unless the firm has explicitly given a guarantee.
The capacity must always match.
Set-Off Against Guarantor: How It Works
When a guarantor signs the guarantee document, they promise to pay if the borrower defaults.
Process:
- The borrower defaults.
- The bank issues a demand notice to the guarantor.
- The guarantee is invoked.
- The bank may adjust guarantor’s accounts using set-off.
This happens only after formal invocation of the guarantee.
Right of Appropriation (Sections 59–61)
When a customer has multiple loan accounts and makes a payment, the question arises:
Which loan should this payment be adjusted against?
This is where the Right of Appropriation comes into play.
Section 59 – Debtor Chooses the Application
If the customer instructs the bank to credit the payment to a specific loan, the bank must follow the instruction.
Section 60 – Debtor Silent → Creditor Chooses
If the customer gives no instructions, then the bank can choose where to appropriate the payment.
Section 61 – Neither Specifies → FIFO Rule
If neither party specifies, the payment is applied to the oldest outstanding debt first.
This is also known as the First In, First Out (FIFO) rule.
Conclusion
The Banker’s Right of Set-Off and the Right of Appropriation are some of the most essential banking principles tested in examinations and applied in day-to-day banking operations. Understanding the conditions, restrictions, exceptions, partnership implications, and guarantor liabilities helps you answer complex MCQs as well as understand real-life banking cases.
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