The Role of the Central Bank and theBanker–Customer Relationship

About the Author

Sreshta Ann John is a 4th-year student at Government Law College, Thiruvananthapuram. She is also a participant in the Banking Law Certificate Course offered by LJRF.

Acknowledgment

I would like to express my sincere gratitude to the co-ordinators and faculty for their guidance and support in completing this assignment on The Role of the Central Bank and the Banker–Customer Relationship. I am also thankful to my family and peers for their encouragement throughout the process. This work hasgiven me the opportunity to deepen my understanding of the subject.

Abstract

The central bank plays a pivotal role in regulating the monetary system, maintaining financial stability, and supervising commercial banks. In India, the Reserve Bank of India (RBI) is the central bank entrusted with these responsibilities under the RBI Act, 1934 and Banking Regulation Act, 1949. At the same time, the banker-customer relationship forms the foundation of banking transactions, characterized by multiple dimensions such as debtor-creditor, trustee-beneficiary, agent-principal, and even bailee-bailor relationships. This paper critically examines the functions of the central bank, explores the dynamic banker-customer relationship through statutory frameworks and judicial precedents, and highlights contemporary challenges in light of digital banking, consumer protection, and financial inclusion.

Introduction

Banking is both an economic necessity and a legal relationship. The soundness of the banking system is central to economic stability, and its proper functioning rests on two interlinked pillars i.e., the regulatory role of the central bank and the banker–customer relationship at the transactional level. The former ensures systemic stability through monetary control and supervision, while the latter sustains micro-level trust, duty, and accountability. Together, they
form a symbiotic relationship between macroeconomic governance and microeconomic trust. As the Supreme Court of India has observed, banks are not mere commercial enterprises but “trustees of public funds,” carrying a public duty beyond profit-making.

Reserve Bank of India

The Reserve Bank of India (RBI) was established under the RBI Act, 1934 and commenced operations in 1935. Initially a privately owned institution, it was nationalized in 1949. Since then, it has evolved into the apex monetary authority, lender of last resort, and regulator of banks and non-banking financial institutions. The key functions of RBI include:

i. Monetary Authority as RBI formulates and implements monetary policy to maintain price
stability while ensuring growth (RBI Act, 1934, s. 45Z).
ii. Issuer of Currency as RBI has the exclusive power to issue banknotes under s.22 of the
RBI Act.
iii. Regulator of Banks as RBI supervises commercial banks under the Banking Regulation
Act, 1949.
iv. Lender of Last Resort as RBI provides emergency liquidity support to banks facing crises.
v. Foreign Exchange Management as RBI administers FEMA, 1999 to maintain external
trade stability.
vi. Consumer Protection & Financial Inclusion as RBI oversees mechanisms like the
Banking Ombudsman Scheme and promotes inclusion through Jan Dhan Yojana and
digital payment regulations.

Central Bank and Judicial Recognition

The regulatory powers and responsibilities of the Reserve Bank of India (RBI) and the legal character of banker customer relationships have been shaped significantly through judicial interpretation. In Jayantilal N. Mistry v. Reserve Bank of India, (2016) 3 SCC 525, the Supreme Court addressed whether the RBI could withhold information sought under the Right to Information Act on the ground of confidentiality. The facts involved multiple RTI
applications seeking inspection reports, audit findings, and other regulatory documents relating to various banks. The RBI refused, citing fiduciary obligations under Section 8(1)(e) of the RTI Act. The central issue was whether the RBI as a regulator owed confidentiality to banks. The Court held that the RBI does not hold such information in a fiduciary capacity. Rather, as a statutory regulator it acts in public interest. It therefore owes a duty of transparency and must disclose information that furthers accountability in the banking sector. The judgment reinforced the idea that regulatory bodies cannot use confidentiality as a shield to avoid scrutiny.

The Supreme Court similarly emphasised the binding nature of RBI instructions in Peerless General Finance & Investment Co. Ltd. v. Reserve Bank of India, (1992) 2 SCC 343. In this case, Peerless challenged the validity of certain directions issued by the RBI regulating deposit schemes. The issue before the Court was whether RBI directives, issued in exercise of its statutory powers, were merely advisory or had the force of law. Examining the statutory
scheme under the RBI Act, the Court held that RBI directions are issued in public interest andare binding on financial institutions. The judgment recognised the RBI as an expert body entrusted with the stability of the financial system, and therefore its policy decisions are entitled to judicial deference unless shown to be arbitrary or unreasonable.

This regulatory authority was reaffirmed in ICICI Bank v. Official Liquidator of APS Star Industries Ltd., (2010) 10 SCC 1, where the Court examined whether the RBI could regulate the functioning of banks even where liquidation proceedings were pending. The dispute involved the transfer of non-performing assets (NPAs) by ICICI Bank to a securitisation company, which was challenged by the Official Liquidator. The issue was whether RBI’s guidelines permitting such transfers were legally enforceable. The Supreme Court upheld the RBI’s power to frame policies to ensure banking stability and held that such guidelines bind all banks. The judgment recognised that the RBI must be allowed operational flexibility to regulate complex financial markets in the nation’s economic interest.

Thus, the RBI is not a mere regulator but a constitutional trustee of financial stability.

Role of the Central Bank

The central bank serves as the monetary authority and regulator of financial institutions. In India, this role is vested in the Reserve Bank of India (RBI) under the RBI Act, 1934. Globally, central banks such as the Federal Reserve and the European Central Bank perform comparable roles.

A. Monetary Policy Implementation

The central bank steers economic activity through interest rates, reserve requirements, and open market operations. In India, the Monetary Policy Committee (MPC), established under Section 45ZB of the RBI Act, determines the repo and reverse repo rates. These decisions directly influence commercial banks’ lending and deposit practices, thereby shaping the customer experience.

B. Lender of Last Resort

During liquidity crises, the central bank acts as the lender of last resort to prevent systemic collapse. The doctrine, theorized by Walter Bagehot in the 19th century, was applied globally during the 2008 financial crisis when central banks injected emergency liquidity. Similarly, during the COVID-19 pandemic, RBI’s targeted long-term repo operations stabilized markets and reassured depositors.

C. Regulatory and Supervisory Authority

The RBI issues binding directives, master circulars, and prudential norms governing banks. The Master Circular on Customer Service in Banks (2015) codified grievance redressal and transparency requirements. Central banks also enforce capital adequacy norms under the Basel III framework, mitigating systemic risk.

D. Financial Stability and Inclusion

Beyond regulation, central banks pursue developmental objectives. RBI’s support for the Pradhan Mantri Jan Dhan Yojana (2014), coupled with simplified KYC norms, demonstrates how regulation can advance financial inclusion. By linking millions of households to formal banking, the RBI reinforced both trust and systemic resilience.

The Banker–Customer Relationship

While central banks regulate from above, the banker–customer relationship determines the functioning of day-to-day banking. Courts have elaborated this relationship across jurisdictions, defining its multifaceted character.

A. Debtor–Creditor Relationship

The foundational principle governing deposits and loans is that the relationship between a bank and its customer is primarily that of debtor and creditor. In Foley v. Hill (1848) 2 HL Cas 28, the House of Lords held that once money is deposited, the bank becomes its owner and merely owes an obligation to repay on demand. This is contrary to the notion that bankers are trustees. This principle was further refined in Joachimson v. Swiss Bank Corporation [1921] 3 K.B.110 (Eng.), where the Court held that the bank’s duty to repay arises only when the customer makes a proper demand at the branch where the account is held. These cases establish that a bank’s obligation is contractual and arises only upon demand, shaping banking jurisprudence.

B. Bailor–Bailee Relationship

In situations where customers deposit valuables for safe custody, such as locker services, the relationship becomes one of bailor and bailee under Section 148 of the Indian Contract Act,The Supreme Court in Punjab National Bank v. K.B. Shetty 1991 AIR 2140 (SC), dealing with missing locker contents, held that banks owe a high duty of care and may be liable for negligence in locker services. Similarly, in UCO Bank v. Hem C. Sarkar, [1990] 2 S.C.R. 709, the Court held that banks take charge of goods, articles and securities as bailee.

C. Principal–Agent Relationship

When banks collect cheques, bills, or act on customers’ instructions, they function as agents under Section 182 of the Contract Act. In Indian Bank v. Catholic Syrian Bank, AIR 1981 MAD 129, the dispute concerned negligence in processing collection instruments. The issue was whether the collecting bank had failed to meet the standard of care expected of an agent. The Supreme Court held that banks must exercise due diligence and skill when performing
agency functions and can be held liable if their negligence causes loss to the customer. This judgment highlights that banks, while engaged in agency activities, are bound by fiduciary obligations typical of agent–principal relationships.

D. Fiduciary and Confidentiality Obligations

Perhaps the most significant dimension is fiduciary duty. An essential aspect of the banker–customer relationship is confidentiality, recognised in the landmark English decision Tournier v. National Provincial and Union Bank of England [1924] 1 K.B. 461. The Court held that banks must maintain confidentiality of customer information, subject to four exceptions: (1) disclosure under legal compulsion, (2) disclosure in public interest, (3) disclosure in the bank’s
own interest, and (4) disclosure with customer consent. Indian courts have consistently relied on this principle in determining bank liability in wrongful disclosure cases. This doctrine has been absorbed into Indian banking law and reinforced by RBI’s Code of Bank’s Commitment to Customers (2008).

Modern Developments in the Relationship

i. Digital Banking & FinTech: Customers increasingly interact through electronic platforms, raising issues of cyber security, e-contracts, and liability for fraud.

ii. Data Privacy: With the Digital Personal Data Protection Act, 2023, banks must ensure confidentiality of customer data beyond traditional secrecy norms.

iii. Financial Inclusion: The banker-customer relationship has expanded to marginalized communities through schemes like PMJDY, redefining access to credit and banking rights.

Central Bank Oversight and the Banker–Customer Relationship

Central bank directives directly shape customer rights and duties:

Know Your Customer (KYC) and Anti-Money Laundering (AML): RBI’s Master Direction on KYC (2016) mandates identity verification, balancing security and privacy.
Fair Lending and Disclosure: RBI’s Fair Practices Code (2003) requires transparency in loan terms, preventing predatory practices.
Digital Banking and Cybersecurity: RBI’s Cyber Security Framework in Banks (2016) imposes data security duties, crucial in the era of digital payments and UPI.

Thus, customer protection is not left to contract alone but is enhanced through regulatory oversight.

Challenges in the Contemporary Context

A. Digitalisation and Cybersecurity
The rise of fintech and mobile banking has created vulnerabilities. The RBI Ombudsman Scheme (2017) expanded grievance redressal to digital transactions. Yet, incidents of phishing and UPI fraud demonstrate continuing gaps.

B. Financial Inclusion vs. Compliance Burden
While simplified KYC promotes inclusion, it increases the risk of money laundering. This tension highlights the challenge of balancing accessibility with systemic security.

C. Globalisation and Cross-Border Banking

International banking exposes customers to multiple jurisdictions. For instance, disputes over cross-border transactions often involve overlapping supervisory authorities.

D. Abuse and Consumer Protection

Furthermore, consumer protection and ethical conduct have been highlighted by Indian courts in cases of abusive recovery practices. In ICICI Bank v. Shanti Devi Sharma (2008) 13 SCC 36, the Supreme Court condemned the use of musclemen and coercive collection methods, holding that banks must function with fairness, transparency, and respect for customer rights. Likewise, in State Bank of India v. Shyama Devi AIR 1978 SC 1263, the Court observed t that the bank holds deposits in a position of trust, not just creditors and negligence or misconduct undermines this foundational faith between banker and consumer.

Conclusion

The central bank provides macroeconomic stability, while the banker–customer relationship builds micro-level trust. The interaction of the two determines the credibility of the banking sector. In the digital age, where fintech innovation collides with systemic risk, central banks must ensure strong regulation while banks must preserve transparency and fairness. Future reforms should include integration of data protection laws with banking regulation, expansion of financial literacy programs, and harmonisation of cross-border banking laws. As Justice Krishna Iyer noted, banking is not merely a commercial service but a public trust, and maintaining that trust requires continuous vigilance from regulators and bankers alike.

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