In addition to accepting deposits and granting loans, banks perform several services on behalf of customers. When a bank acts on the instructions of a customer and performs certain tasks for consideration or otherwise, the relationship between the bank and the customer becomes that of agent and principal.
This relationship is governed by the Indian Contract Act, 1872, and is an important topic in JAIIB and CAIIB exams, especially in questions related to banker–customer relationship, legal duties, and liabilities.
Meaning of Agent and Principal
According to Section 182 of the Indian Contract Act, 1872, an agent is a person employed to do any act for another or to represent another in dealings with third persons. The person for whom such act is done or who is so represented is called the principal.
In banking transactions:
- Customer = Principal
- Bank = Agent
The bank performs certain functions strictly as per the mandate given by the customer.
When Does Agent–Principal Relationship Arise in Banking?
An agent–principal relationship arises whenever a bank undertakes to act on behalf of the customer and not on its own account. In such cases, the bank does not assume ownership or risk unless expressly agreed.
Common banking situations where the bank acts as an agent include:
- Collection of cheques, drafts, and bills
- Payment of standing instructions such as rent, insurance premium, EMIs, and utility bills
- Purchase and sale of securities
- Acting as executor, trustee, or nominee
- Remittance of funds
- Acting as an agent of RBI or government for certain transactions
Bank as a Collecting Agent
One of the most common examples of agency is when a bank collects cheques and bills for customers. The bank acts as an agent to present the instrument and collect payment.
In such cases:
- The bank is responsible to exercise reasonable care
- The bank is not liable for default of the paying bank unless negligence is proved
- The bank must credit proceeds only after actual realization
This concept is often tested in exam case studies.
Duties of a Bank as an Agent
When acting as an agent, the bank has certain legal duties under the Contract Act. These duties include:
- To act as per the customer’s instructions
- To act with reasonable skill and care
- To not exceed the authority given by the customer
- To render proper accounts when required
- To communicate with the customer in case of difficulty
Failure to perform these duties can make the bank liable for loss caused to the customer.
Rights of a Bank as an Agent
A bank acting as an agent enjoys certain rights, such as:
- Right to receive commission or service charges
- Right to be indemnified for lawful acts done on behalf of the principal
- Right to retain money for expenses incurred
- Right to compensation for injury caused by principal’s negligence
These rights protect the bank while performing agency functions.
Liability of Bank as an Agent
The bank is liable:
- If it acts negligently
- If it acts beyond authority
- If it disobeys lawful instructions
- If it fails to exercise due care
However, the bank is not liable for losses arising due to:
- Acts of third parties
- Circumstances beyond control, unless negligence is involved
Termination of Agent–Principal Relationship
The agency relationship can be terminated by:
- Completion of assigned work
- Revocation by the principal
- Renunciation by the agent
- Death or insanity of principal or agent
- Insolvency of the principal
For exam purposes, remember that termination of agency automatically ends the bank’s authority to act.
Difference Between Agent–Principal and Debtor–Creditor Relationship
In an agent–principal relationship:
- Bank acts on behalf of customer
- Ownership does not transfer
- Bank earns commission
In a debtor–creditor relationship:
- Bank uses customer’s money
- Ownership transfers to bank
- Bank pays interest, if agreed