Chapter Three

Operational Procedures of Commercial Banks

2.1 Introduction
You have already learnt that the main banking activities consist of acceptance of deposit from the public for
the purpose of lending to businessmen and others who may seek loans. Money may be needed in future for
various purposes like medical treatment in case of illness in the family, expenses on account of marriage, or
for higher studies of the children, or to celebrate religious festivals, etc. On the other hand, the objective of
depositing money in a bank account may either be to save it for future needs, or to provide safety to it, or to
invest it in case a higher rate of return is offered.

The money saved to meet future needs may be kept at home. But will it be safe at home? It may be stolen.
Moreover, the money saved will remain idle at home without any return. So people keep their savings with
someone where it will be safe and earn a return. Bank is such a place where money once deposited remains
safe and also earns interest. In this lesson, we shall learn about the types of deposit accounts that can be
opened in a bank, and also discuss how a savings bank account can be opened, operated, and closed.

2.2 Types and Procedures of Opening and Operating Bank Deposit Accounts

There are different types of deposit accounts which are suitable for different purposes. You may now be
interested to know what is to be done before money can be deposited in a bank account and also before it
can be withdrawn from the bank. It is obvious that one needs to open an account with the bank and deposit
money before it can be withdrawn from the account.

The money needed for future expenses are saved out of the present income. The saved money can be kept at
home but there is risk of loss by fire and theft. Further it may not bring any return to one who has saved it.
The saved money is kept with someone where its safety and return is guaranteed. We have studied in the
earlier lesson that a bank is a place where money deposited is kept safe and earns interest on it. Bank
deposits serve different purposes for different people. Bank offers the facility of opening various types of
accounts where a depositor can deposit money saved by him/her.
The banker collects cash from customer and uses the money for different purposes. Depending on the
agreement between the two parties, the banker makes payment to the customer. To be on the safest side,
both parties should have specified agreement among themselves.

Keeping in view these differences, banks offer the facility of opening different types of deposit accounts by
people to suit their purpose and convenience. On the basis of purpose they serve, bank deposit accounts may
be classified as follows: Savings Bank Account; Current Deposit Account; and Fixed Deposit Account. Let us
briefly note the nature of these accounts.

A) Savings Bank Account

If a person has limited income and wants to save money for future needs, the Saving Bank Account is most
suited for his purpose. This type of account can be opened with a minimum initial deposit that varies from
bank to bank. Money can be deposited any time in this account. Withdrawals can be made either by signing a
withdrawal form or by issuing a cheque or by using ATM card. Normally banks put some restriction on the
number of withdrawal from this account. Interest is allowed on the balance of deposit in the account. The
rate of interest on savings bank account varies from bank to bank and also changes from time to time. A
minimum balance has to be maintained in the account as prescribed by the bank.

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 Procedure of Opening Saving bank account
To open a savings bank account in a commercial bank, you have to first decide what amount of money you
would like to deposit initially. You may enquire and find out from the nearest bank the minimum amount to
be deposited while opening a savings bank account. You have to deposit at least that amount or more, if you
want. On entering a bank (any branch of a bank) you will find a counter for enquiry (or a counter with: ‘May I
help you’ board). Having known the minimum amount to be deposited, you should ask for a form of
application for opening Savings Bank Account. You are not required to pay anything for it. You should then
take the following steps:
i. Filling up the application Form

The application form has to be filled up giving the following necessary information available free of cost at
the bank: Name of the person (applicant); His/her occupation; Residential Address; Specimen signature of
the applicant; and Name, address, account number and signature of the person introducing the applicant

Besides the above information the applicant has to give an undertaking that s/he would observe the rules
and regulations of the bank, which are in force. At the end of the application form, you have to put your
signature. (In some banks it is required to attach two passport size photographs of the applicant along with
the application.)
ii. Proper Introduction
A bank may require that a person known to the bank should introduce the applicant. It may be convenient to
be introduced by a person having already an account in that bank. Some banks may accept the attested copy
of Passport or Driving License, if any, of the applicant. In that case personal introduction is not necessary.
Introduction is required to prevent the possibility of opening of account by an undesirable person.
iii. Specimen Signature
The applicant has to put his/her specimen signatures at the blank space provided on the application form for
that purpose. In addition, specimen signatures have to be put separately on a card on which a photograph of
the applicant may be pasted, along with his/her name and account number.

After the above steps have been taken and the officer concerned is satisfied that the application form is in
order, money is to be deposited at the cash counter after filling in printed ‘Pay-in-slip’. An account number
will then be allotted and written on the application form as well as the card having your specimen signatures.
At the same time you will be issued a Passbook with the initial deposit recorded in it. All future deposits and
withdrawals will also be entered in the passbook, and it will remain with you. If you want to use cheques for
withdrawal or payment of money out of your deposits, a cheque book will be issued on your request. A
cheque form is a printed form in which you may issue an order to the bank to pay the amount specified in it
to a person.

 Procedure for Operating Savings Bank Account

Once you have opened the account, you must also know how to operate the account. In other words, you
have to know the procedure to be followed for further deposits to be made in the account and for
withdrawing money from the account.

Operating a bank account means dealing with the bank when the account holder deposits money into the
bank and withdraws money from it. A special feature of operating the bank account is that each transaction
of deposit/withdrawal is supported by a separate slip or document. Hence a customer is required to make
use of:
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 a. Pay-in-slip form for depositing cash or cheque in the bank account;
b. Cheque or withdrawal slips for withdrawing the money from the bank.

 Deposit in the Saving Account

You have already used ‘Pay-in-slip’ for deposit of the initial amount while opening your account. It is a printed
form, which you get in the bank with perforated counterfoils used for depositing cash or cheque. It contains
information in respect of the name of account holder, amount deposited, and the signature of the person
depositing it. On the receipt of money, the cashier signs and stamps the pay-in-slip and the counterfoil. The
counterfoil is given back to the depositor which serves as a proof of deposit. The counterfoil must be kept
safe for future reference. Some banks prescribe and supply separate slips of different colors for depositing
cash and cheques, drafts etc., while others supply the same type of slip for depositing cash and cheques. In
case the deposit is made in cash, the particulars of different denominations of currency notes are to be given.
The main foil is retained by the bank and the other part of the foil known as counterfoil is returned to the
depositor.

 Withdrawal from Deposit Account

You deposit your savings for use in future. The need for money may arise any time. So you should know how
to get back your money from the bank.

Whenever the account-holder wants to withdraw money from his account, s/he can either withdraw the
amount by filling up a withdrawal form or by issuing a cheque. Withdrawal can also be made from the
depositor's account when he or she issues cheques in the name of some other person or party. When money
is withdrawn either by presenting withdrawal form or cheque in favor of the account holder, it is known as
cash withdrawal. Let us know the procedure for withdrawal of money from your account. Money can be
withdrawn by using:
a) Withdrawal form b) Cheque c) ATM card

a. Withdrawal Form: Every bank has printed withdrawal forms, which can be used by accountholders to
withdraw cash from deposit accounts.
b. Cheque: As an account-holder you can withdraw cash from your savings bank account either by filling in
and signing a withdrawal form or by issuing a cheque. Withdrawal forms can be used only by the account-
holder, no one else. Cheques can also be issued for payment to other parties. Thus, a cheque issued to
another person can be either encashed by him/her at the bank, or deposited in his account in some other
bank to be collected on his behalf.
c. ATM Card: Banks issue ATM card to its depositors for easy withdrawal of money from their accounts. This
card is used for withdrawal of money from saving and current deposit account through Automated Teller
Machine (ATM). It is a magnetic card, which can be operated by using a particular secrete number. It is
the most convenient system of withdrawal of money.

 Teller Counters: To facilitate quick transaction, banks provide teller counters to withdraw money from
the deposit account. There are two types of teller counters:
i) Manual teller counter; and ii) Automatic teller counter.

In manual teller counters banks generally allow withdrawal of money from the savings accounts for amount
up to a limit. The cheque or withdrawal form is presented at the counter and payment is made after verifying
the balance in the account, and tallying the specimen signature of the account holder.

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In automatic teller counters ATMs are installed to handle cash transactions 24 hours without any break.
There is no need to appoint anybody to verify your balance, compare the specimen signature or hand over or
take over the cash. Let us learn how an ATM machine operates.

When a bank installs ATMs, it gives a magnetic card along with a secret code number to every accountholder.
This code number is called Personal Identification Number (PIN). When a cardholder wants to withdraw or
deposit money, first s/he has to establish his identity to operate the ATM by mentioning his PIN. When an
ATM card is inserted into the machine it asks for the PIN. The PIN can be entered either by using the
keyboard or touching the screen of the machine.

Once the identity is established then money can either be deposited or withdrawn simply by following the
instruction given by the machine. For deposit of cash it is required to keep the amount in a special envelop,
which is available at the ATM center. After sealing the envelope and writing the necessary information on it,
the envelope will be kept near a slit. Then on pressing the deposit button the envelope will automatically be
entered into the machine. The bank officials will collect those envelops at regular interval and credit the
amount in the respective accounts. Similarly, withdrawal of money can be made by pressing or touching the
withdrawal button and then mentioning the amount of money required. The exact amount of money will be
made available to you instantly through the outlet.
 Payment of Interest
Interest at the rate of about 5% per annum is allowed on the credit balance of the saving bank account
though the rate of interest keeps changing with the instructions of the National Bank. Interest is calculated on
the minimum balance held in the account during the period starting from the 10th day to the last day of each
calendar month.

B) Current Deposit Account (Demand Account)

Big businessmen, companies and institutions such as schools, colleges, and hospitals have to make payment
through their bank accounts. Since there are restrictions on number of withdrawals from savings bank
account, that type of account is not suitable for them. They need to have an account from which withdrawal
can be made any number of times. Banks open current account for them. Like savings bank account, this
account also requires certain minimum amount of deposit while opening the account. On this deposit bank
does not pay any interest on the balances. Rather the accountholder pays certain amount each year as
operational charge.

For the convenience of the accountholders banks also allow withdrawal of amounts in excess of the balance
of deposit. This facility is known as overdraft facility. It is allowed to some specific customers and up to a
certain limit subject to previous agreement with the bank concerned.
In current account, a customer can withdraw or deposit money any number of times s/he desires. Current
account is suitable to those persons who either deposit or make payments frequently. It is thus suitable for
business people and institutions which have frequent dealings with the bank. Bank permits overdraft facility
on current account. In view of this facility, the banks do not pay any interest on current accounts.

Sometimes, banks charge some amount from the current account holder as fees for the services extended.
Current account holders have to maintain a minimum amount of Birr as balance in the account. Such
accounts are normally operated through cheques. Special features of the current account are:
1) It provides convenience of operation as certain facilities are associated with current account. The
objective is not to mobilize saving through such account.
2) The current account has an operating cost. There are bank charges for the services provided to the
holder of current accounts.
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 3) Banks do not pay any interest on such accounts.

 Procedures for Opening Current account

The procedure for opening a current account is the same as that of saving bank account. To open a current
account, one has to fill up the prescribed application form giving all the information required by bank. The
applicant must be introduced by a person known to the bank and operating current account with it. The
specimen signature of the person who will operate the account must also be put on a separate card. After
completing all the formalities, the applicant is given an account number to be mentioned at the time of
withdrawing money or depositing any amount in the account.
 Procedure for Operating Current account
Unlike saving bank account money can be withdrawn any number of times from this account. Money can also
be deposited in current account as many times as the depositor desires. With the permission of the bank, a
depositor can withdraw money in excess of what s/he has deposited in the bank. This facility is known as
overdraft facility and is normally granted only to current account holder. The steps for operating the current
account, as far as depositing money is concerned, is the same as in the case of saving bank account. Similarly,
the steps for withdrawing money or making payment from the account through the issue of cheques are also
the same as with saving bank account.
Table 1: Distinction between Current Account and Saving Bank Account
Basis of Current account Saving bank account
No.
Difference
1) Operation of Current account is mainly opened Saving bank account is mainly
accounts and operated by business firms opened by individuals and salaried
and institutions. people.
2) Withdrawals Deposits and withdrawals can be Withdrawals are not permitted as
made frequently. There is no limit frequent as in case of current
to its frequency. account.
3) Interest No interest is paid by bank on Interest is paid on saving bank
such account. account though the rate of interest
happens to be low.
4) Overdraft Overdraft facility is available. No such facility is allowed.

5) Service charges Service charges are payable. No service charges payable.

C) Fixed Deposit Account (Time Deposit Account)

It is also known as term deposit account. Money deposited in fixed deposit account ranges for a stated period
of time (for example, starting from 30 days to more than 3 years). At the end of the specified period, the
depositor may either withdraw the money or renew the deposit further for a specified period. Banks pay
interest on fixed deposit depending upon the period for which the deposit is kept with the bank. People who
want safety, prefer a reasonable rate of return and do not believe in taking risk, go for fixed deposit accounts.

Many time people want to save money for long period. If money is deposited in savings bank account, banks
allow a lower rate of interest. Therefore, money is deposited in a fixed deposit account to earn an interest at
a higher rate.

 Procedure of Opening and Operating Fixed Deposit account

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For opening a fixed deposit account, a depositor is required to fill up an application form in which s/he has to
mention his own particulars, such as name, father’s name, residential address, etc. The amount of deposit
and the period for which deposit is to be made also needs to be mentioned. S/He has also to give specimen of
his signature. When the bank is satisfied with the formalities, the depositor is asked to deposit the amount.
After the deposit of the amount, the bank issues a fixed deposit receipt. A fixed deposit receipt is an
acknowledgement of receipt of the sum of money specified therein. The fixed deposit receipt mentions the
amount, period, rate of interest and the amount to be paid on maturity.
 Rate of Interest Payment on fixed deposit
The rate of interest and other terms and conditions regulating fixed deposits are determined by the National
Bank for all commercial banks. The National Bank keeps on revising the rate of interest from time to time.

Though the interest is payable on the maturity of fixed deposit account, banks may pay interest quarterly or
half yearly also. In case the bank pays interest before maturity, the amount of such interest is transferred to
depositor’s saving bank account. Normally the interest on fixed deposit is compounded in case the depositor
does not withdraw the interest. If the fixed deposit is renewed, the interest on it is also compounded. When
the depositor fails to claim the deposit on due date and later on desires to renew the deposit, the bank may
renew it from the date of maturity. In such a situation the depositor does not lose the interest.
 Payment of fixed deposits before maturity date
Fixed deposits are normally payable on maturity. In case the depositor requires the money before the due
date, he or she makes a request to the bank for its payment. The bank may consider such a request and make
payment of the fixed deposit. When the payment of fixed deposit is made before the date of maturity, the
depositor loses interest.

Forms used in the Operation of Bank Account

Immediately after opening the account the customer is supplied free of charge with the following:

i) The Pay-in-slip ii) The Cheque Book, and iii) The Pass-book

i) The Pay-in-slip: Every deposit made by the customer in cash or cheques or bills must be accompanied by
this book. This book contains slips with perforated counterfoils. Separate slips are to be made out for cash
and cheques. Some banks have devised different forms, while others made use of the same form with
provisions for both. The form is to be filled by the depositor and the bank, after receipt of the cash or
cheques, puts the date-stamp and the counterfoil is initiated by responsible officer and serves as a record
for the customer. It is also preferable for the customer to record on the back of the counter foil the
source of receipt so that he will be in a position to explain the credits in the Pass Book. The slip retained
by the banker becomes the basis for making necessary entries in the ledger.
ii) Cheque Book: It consists of some blank forms. As per the rules and regulations, the customer is expected
to draw the cheques only in the forms provided by the banker. To prevent the misuse of cheque forms
the banker enters the amount number on each cheque and book is issued only after obtaining the
signature of the customer.

iii) Pass Book: A pass-book is nothing but a copy of the account of the customer as it appears in the bank’s
ledger. All the amounts deposited are credited and the cheques paid against the account are debited. The
balance is shown from time to time.
Closing of a Bank Account

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The relationship between a banker and its customer is a contractual one and continues as long as both of
them so desire. The relationship may be terminated by either of them by giving notice of his intention to the
other party. Moreover, the banker is bound to suspend payment out of the customer’s account under the
compulsions of law. The rights and obligations of a banker in this regard are as follows:
1. At the Request of the Customer: If a customer directs the banker in writing to close his account, the
banker is bound to comply with such direction. The latter need not ask the reasons for the former’s
direction. The account must be closed with immediate effect and the customer is required to return the
unused cheques and passbook.

2. Inoperative Account: If an account remains unoperated for a very long period, the banker may request the
customer to withdraw the money. Such step is taken on the presumption that the customer no longer
needs the account. If the customer could not be traced after reasonable effort, the banker usually
transfers the balance to an “Unclaimed Deposit Account”, and the account is closed. The balance is paid
to the customer as and when he is traced.
3. At the Instance of the Banker: The banker is also competent to terminate his relationship with the
customer if it finds that the latter is no more a desirable customer. The banker takes this extreme step in
circumstances when the customer is guilty of conducting his account in an unsatisfactory manner, i.e., if
the customer is convicted for forging cheques or bills or if s/he issues cheques without sufficient funds or
does not fulfill her/his commitment to pay back the loans or overdrafts, etc. The banker should take the
following steps for closing such an account:
a) The banker should give to the customer due notice of its intention to close the account and request
him to withdraw the balance standing to his credit. This notice should give sufficient time to the
customer to make alternate arrangements. The banker should not; on its own, close the account
without such notice or transfer the same to any other branch.
b) If the customer does not close the account on receipt of the aforesaid notice, the banker should give
another notice intimating the exact date by which the account be closed otherwise the banker itself
will close the account. During this notice period the banker can safely refuse further credit from the
customer and can also refuse to issue fresh cheque book to him. Such steps will not make it liable to
the customer and will begin with the intention of the notice to close account by a specified date.

The banker should, however, not refuse to honor the cheques issued by the customer, so long as his account
has a credit balance which will suffice to pay the cheque. If the banker dishonor any cheque without sufficient
reasons, it will be held liable to pay damages to its customer.
c) In case of default by the customer to close the account, the banker should close the account and send
the money by draft to the customer. It will not be liable for dishonoring cheques presented for
payment subsequently.
4. On Receipt of the Notice of Death of a Customer: When the banker receives notice of death of the
customer, it must stop the operation of the account because the authority of the customer terminates as
he dies.

5. On the Insanity of the Customer: If a banker receives a notice regarding the insanity of his customer, he is
bound to stop payments from his account.
6. On Insolvency of the Customer: The relationship between the banker and its customer is also affected if
the customer becomes insolvent or the corporate customer goes into liquidation. The credit balance of
the customer is transferred to the official receiver of the insolvent customer.

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7. On Receipt of an Order from the Court, the banker is bound to suspend payment from the account of the
customer. If the order prohibits the payment of a specified sum from the account, the banker may honor
the cheques out of the remainder amount.
8. On Receiving Notice of Assignment: When the banker has received a notice of assignment of the credit
balance in the account of a customer to a third party, the banker is bound to pay the same amount to the
said third party.

2.3 Legal Aspects of Entries in Customer Pass Books and Accounts

 Meaning of Pass Book

Pass book is an important book in the operation of a bank account. It contains a copy of the customer's
ledger account as it appears in the banker’s books. It is an exact extract or copy of the customer’s account in
the bank's ledger, as on a particular date. In other words, it is a record of dealings between the customer and
the bank. As it passes periodically between the banker and the customer, it is called a "Pass Book."

The bank provides the account holder a small and handy book in which it records all the transactions of

deposits and withdrawals. This book is known as pass book. Pass book in reality is a copy of the account-
holder’s ledger account maintained by the bank. Where the banking operations are computerized the bank
issues a computerized sheet for withdrawal and deposit by the customer, or a pass book in which records of
deposit and withdrawal are made by the computer.

Pass book is used to record all dealings of receipts and payments between banker and customer. It contains
an exact copy of the account in his banker ledger and is so named because it passes frequently to and from
between the banker and the customer. The object of a pass book is to inform the customer from time to time
the condition of his account as it appears on the books of the bank. It not only enables him to discover errors
to his prejudice but also supplied evidence in his favor in the event of the litigation or dispute with the bank.
In this way it protects him against the carelessness or fraud of the bank.

 Legal Position of Entries in the Pass Book

It is difficult to define precisely the decisive legal effects of entries shown in the pass book. When it is issued
to customer and if he does not raise any objection, obviously it becomes “account stated” or settled account”
between him and the banker. But, the legal position is different from country to country and there has been a
conflict of opinion regarding conclusiveness of the pass book regarding entries made therein. The proper
function of a pass book is to constitute a conclusive, unquestionable record of the transactions between
banker and customer, and it should be recognized as such. However, some other authors stated that entries
in the pass book are not conclusive evidence of their correctness, in stating the position of customer’s
account. They are subject to alteration on the basis of real facts.
 Effect of Entries in the Pass Book
The entries wrongly made or included in the pass book may be favorable or advantageous either to the
customer or to the banker. So the wrong entries can be divided into two types: (1) entries favorable to
customer, and (2) entries favorable to banker.
(1) Entries Favorable to Customer: The account of a customer may sometimes show a wrong credit
balance, which may be due to:
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a) Duplication of credit entries, or
b) Crediting of higher amounts, or

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 c) Omission of any debit entry, or
d) Crediting the amount belonging to another customer
If any entry is made by bank in favor of the customer, the bank can rectify it by due notice to the customer.
The customer after such notice cannot withdraw such money. But as long as it is not corrected, the customer
acting in good faith can rely on it as the “stated correct account”. Entry advantageous to the customer may be
used as evidence against the banker. The pass book belongs to the customer and the entries made in it by the
bank are statements on which the customer is entitled to act.
(2) Entries Favorable to Banker: Entries that are favorable to a banker arise when a credit entry has been
totally omitted or wrongly stated, or any debit entry has been wrongly made in the customer’s account.
The legal position in this regard is stated below:
a) The customer can get the mistake rectified as soon as it is detected. This right exists even after he
returns the pass book. He can recover the wrong debited amount or the credit which is omitted.
b) However, the customer will not be entitled to get the mistake rectified if it is proved that: the customer
was negligent; the entries in the pass book constitute a settled account; and the position of the banker
has been subsequently altered to its prejudice.

It is doubtful as to what act or omission on the part of the customer amount to settlement of an account or
negligence in regard thereto. Entries made in the pass book favoring the bank, under a mistake, cannot be
treated as settled account even though customer fails to find out the mistakes. They are liable for correction
when forgeries or mistakes are brought to notice. If the customer knowing that some of his cheques are
forged does not immediately inform the banker, then he is taken to be guilty of negligence an accordingly he
cannot question the correctness of the entries in the Pass book.

Now-a-days many banks follow the practice of getting the pass book balance confirmed by the customer in
writing. It is, however, essential for the banker to be cautious and accurate in posting the entries in the pass
book.

2.4 Negotiable Instruments

When people write cheques, they fill in the required information- the date, the payee (entity to whom the
check is payable), and the amount, in numbers and words- and sign their names. To most people, that check is
payment for goods, services, or their obligations, and will end up as cash in someone’s pocket or a credit to
someone’s account. Conversely, when people receive checks for others, they expect these checks to be
exchanged for cash at the teller window or credited to their bank accounts.

An instrument is a document of title to money. Exchange of goods and services is the basis of every business
activity. Goods are bought and sold for cash as well as on credit. All these transactions require flow of cash
either immediately or after a certain time. In modern business, large numbers of transactions involving huge
sums of money take place every day. It is quite inconvenient as well as risky for either party to make and
receive payments in cash. Therefore, it is a common practice for businessmen to make use of certain
documents as means of making payment.

The word negotiable means ‘transferable by delivery’; that means “transferable from one person to another in
return for consideration” and the word ‘instruments’ means a written document by which a right is created in
favor of a person. Thus, the term “negotiable instruments” literally refers to a document containing rights that
can be transferred by delivery (i.e. written document transferable by delivery). Article 715(1) of Ethiopian
Commercial Code of 1960 defines the term negotiable instruments as any document incorporating a right to
an entitlement in such a manner that it is not possible to enforce or transfer the right separately from the
instrument.
Thus, the legal definition of negotiable instrument is documents in which the right to be paid a certain amount
of money is incorporated. It is not possible to enforce or transfer the right incorporated separately from the
documents. The holder of the document is entitled to the right incorporated in the document, provided that
he/she is a lawful possessor.

The rights that could be incorporated in negotiable instruments may be rights for payment of money arising
out of various contracts such as the contract of loan, sale, lease, or any other contract performed by payment
of a certain amount of money. Such rights may also arise from ownership in companies or loan made to the
government or to a share company. The rights that are incorporated in negotiable instruments may be rights
to receive goods under voyage or deposited in a warehouse. According to this provision, the holder of
negotiable instruments can transfer the rights incorporated in the instrument by transferring the instrument.

2.4.1 Types of Negotiable Instruments in Ethiopia

Based on the purpose and rights incorporated in the instruments, Article 715(2) of the Commercial Code of
Ethiopia categorizes negotiable instruments into three main types, i.e., Commercial Instruments (bills of
exchange, promissory notes, checks, travelers cheques); [Transferable] Securities (shares or stocks, bonds);
and Documents of Title to Goods (bills of lading and other types of way bills, warehouse goods’ deposit
certificates).
a) Commercial Instruments
Commercial instruments are negotiable instruments incorporating rights for payment of a specified amount of
money. They are issued and negotiated on the basis and with the purpose of performing an obligation that can
be performed by payment of a certain amount of money. Hence, they are used as a substitute for money.
These are bills of exchange, promissory notes, cheques, travelers’ cheques and warehouse goods deposit
certificates as the types of commercial instruments recognized under the Ethiopian law.

b) Transferable Securities
Securities are negotiable instruments incorporating rights for payment of money. The sources of such rights
may be investments made in companies or loans provided to the government or its subdivisions through
purchase of government bonds and treasury bills or to companies through the purchase of debentures. A
person who invests in a company is entitled to share in the profits of the company if any, i.e., s/he has the
right to receive dividends and to share in the assets of the company where the company is dissolved, as per
Art. 345. On the other hand, the person who has purchased a government bond or a treasury bill or a
company bond, also called a debenture, acquires the right to receive repayment of the money he has given on
loan plus interest.

However, all securities are not negotiable instruments. What makes securities negotiable instruments is their
transferability according to rules of negotiation. Therefore, if it cannot be negotiated, it is difficult to circulate
as money. Bonds, stocks and transferable shares are instances of securities which are negotiable instruments
considered.
c) Documents of Title to Goods
These are negotiable instruments containing rights of ownership over goods that are being transported or
goods which are warehoused and which enable their holders to receive such goods. Refer Arts 571-576 and
610-619 of the Commercial Code regarding documents of title to goods under voyage and Arts 2814-2824 of
the Civil Code regarding documents of title to goods warehoused.

2.4.2 Common Types of Negotiable Instruments (For Further Understanding)

Whether writing is an instrument, that is, whether possession of it is recognized as carrying with it, the right to
the specified sum of money or security for money depends on mercantile usage and on statute, and the list of
instruments is not closed. In practice, instruments as a class usually possess distinctive characteristics without
which writing is unlikely to be given recognition as an instrument. Thus, the document is traditionally concise
and no greater in size than enables it to be conveniently carried and transferred; its terms are limited to
payment obligations, security for payment (if given) and the right to exchange it for the specified bonds or
debentures. Given that a document is an instrument, the next question is whether it is negotiable or non-
negotiable, which again depends on mercantile usage and statute/law.
There are two categories of negotiable instruments, (i) instruments negotiable by law, and (ii) instruments
negotiable by usage or custom of trade (part of civil law).
i. The Instruments Negotiable by Law
There are three common types of negotiable instruments by law. These are:
1. Promissory Note 3. Cheques
2. Bill of Exchange
ii. The Instruments Negotiable by Custom of Trade

There are certain other instruments which have acquired the characteristics of negotiability by the usage or
custom of trade. These are called Quasi Negotiable Instruments. such as dividend warrants; share
warrants; and bearer debentures. It is often in accordance with the custom of the place.

Note: Since these negotiable instruments (i.e. No. ii above) are not common in Ethiopian case, we will discuss
only instruments negotiable by law.

 Promissory Notes
Promissory note is a written promise to pay a sum in money on demand or at a definite time. Promissory note
is an instrument in writing containing an unconditional undertaking by the maker to pay a certain sum of
money only to or to the order of a certain person, or to the bearer of the instrument.

The simplest form of a credit instrument is the promissory note, pro-note, and is a written promise from
debtor or buyer or borrower to pay a certain sum of money to the creditor or his order. It is what we call IOU
(I owe you) that is an acknowledgment of debt and an obligation to repay. The note involves, in writing,
containing an unconditional promise signed by the maker promising to pay a certain sum of money only to a
specified person or bearer on a specified date. Two or more persons may make a promissory note and they
may be liable thereon jointly and severally.

To make more clearly, the promissory note, that is, a document in which A promises to pay a sum of money to
B, is of long standing as a credit instrument. However, the creditor might find it inconvenient to collect
payment himself at the due date and might wish to appoint an agent for that purpose. If the note provided
simply for payment by A to B, then in any proceedings B's agent would have to produce a formal authority
from B to collect payment. Nevertheless, if the note itself provided for payment to B or his nominee, or to B or
other producer (i.e. holder) of the note, then A could not contest the right of the producer to collect payment,
for ‘A’ himself had provided for it in the terms of his undertaking.
This definition gives the following essential features:
 The instrument must be in writing.
 Mere acknowledgement of debt is not sufficient.
 There must be an undertaking of promise to pay.
  An IOU (I Owe You), therefore, is not a promise to pay.
The promise to pay must be unconditional. Because, a conditional promise destroy the negotiable character of
an otherwise negotiable instrument. But a promise to pay at a particular place or after a specified time-or on
the happening of an event certain to happen is not conditional. For example “I promise to pay Br 99,500 ten
days after Dr. Biruk’s retirement” is not conditional.

The maker must sign the instrument. In the case of an illiterate, he/she may fix his/her thumb mark or any
other mark. The signature may be indicated by a facsimile/copy or by stamping the name.

The promise to pay must be a certain sum of money in legal tender. For example, a promise to pay Br
99,500.00 and such other sums as may become due is not a promissory note. But where the promise is to pay
the money at a specified rate of interest is considered as certain sum of money.
The payee must be certain. Usually promissory notes bear date and place but they are not required under the
law.
The following are the essentials in the issuance of a promissory note.
1. The Instrument of document must be in writing: An oral promise to pay money is not a promissory note. It
includes typing, printing and other methods of reproducing words in a visible form.
2. It contains a promise to pay: - The promise to pay must be expressed in the instrument. A mere
acknowledgment of indebtedness without promise to pay is not a promissory note. For example, ‘Ato
Kebede, I owe you Birr 200 (two hundred birr) only.’ This writing does not constitute an instrument. The
reason is Ato Kebede merely acknowledges debt of 200 Birr and he does not promise to pay.
3. The promise to pay must be unconditional: The promise to pay must be without any condition. It is only an
instrument containing an unconditional promise to pay. “I promise to pay Ato Sirak Gebru Birr 10,000 (Ten
thousand Birr) Seven days after my marriage with W/t Roman.” This instrument does not constitute a pro-
note. The reason is that the promise to pay is conditional. It promises to pay Ato Sirak Br 10,000 if he
marries to W/t Roman. He may or may not marry Roman, so the above instrument contains conditional
undertaking to pay.
4. The person promising to pay must put his signature on the instrument. The person undertaking to pay
money must sign the instrument. Without his/her signature the instrument is incomplete and has no effect
at all. If the maker is illiterate, he has to put his thumb impression on the instrument in the presence of
witnesses.
5. The maker must be certain: The instrument must clearly state or indicate the person liable to pay. Two or
more persons may make a promissory note, jointly and severally.
6. The sum payable must be certain: The amount payable must be clearly stated in the document. There
should be no scope for addition or subtractions. In other words, the amount payable must be certain.
Consider the following examples:
a) “I promise to pay W/ro Ayelech Birr 500/five hundred birr/and all other sums which shall be due to
her”
b) “I promise to pay Ato Hailu Birr 900/Nine hundred Birr/ first deducting there out any money which
he may owe me.”
The above two instruments (a and b) are not pro-notes; the reason is the amount payable is not certain. In the
first case the amount to be added to Birr 500 is not certain or definite. In the second case the amount to be
subtracted is not definite.
7. The instrument must contain a promise to pay money only: If an instrument contains a promise to do
something besides a promise to pay money, it is not a promissory note.
 “I promise to pay Ato Bekalu Birr 1000 /one thousand birr/ and to deliver to him my black horse on 9 th
January 1996.”
The above instrument is not a promissory note as it contains a promise to deliver a horse besides a
promise to pay money.
8. The payee must be certain: The person to whom the money is to be paid must be clearly stated in the
instrument.
9. The instrument must be properly stamped: The stamp must be made as per the regulation of the country.

 Bills of Exchange
Bill of exchange is an order by a seller to a buyer or by a creditor to a debtor to pay a certain sum of money to
himself or to bearer or to another person. It is an instrument in writing containing an unconditional order,
signed by the maker or drawer ordering the drawee to pay a certain sum of money only to a specified person
or bearer on a specified date. A bill of exchange is also defined as ‘an instrument in writing containing an
unconditional order, signed by the maker, directing a certain person to pay a certain sum of money only to or
to the order of a certain person, or to the bearer of the instrument’.

Suppose Rediet has given a loan of Br 10,000 to Samson, in which Samson has to return. Now, Rediet also has
to give some money to Tariku. In this case, Rediet can make a document directing Samson to make payment
up to Br 10,000 to Tariku on demand or after expiry of a specified period. This document is called a bill of
exchange, which can be transferred to some other person’s name by Tariku.

Parties to a bill of exchange: There are three parties to a bill of exchange: drawer, drawee and payee.
1. A Drawer is the person who draws the bill (who writes the bill or who is giving the order.)
2. A Drawee is the person on whom the bill of exchange is drawn. The person to whom the order is
addressed is called a drawee. It the party on whom the bill is drawn.
3. A Payee is the person to whom an amount is payable or to whom the money is to be paid (i.e. the
person to whom the value of the bill is to be paid).

Suppose that BB in Milan wished to pay SS in London for goods bought by BB from SS. The following procedure
could be adopted.

1. BB went to XX, a Milan money-changer, and put him in funds, in lire, for the price and X's charges.
2. X drew a bill, i.e. a written request or instruction on YY, his foreign correspondent in London, requiring
YY to pay the sum named to SS. XX sent this bill to SS.
3. SS presented the bill to YY, who paid him in Pound Sterling.
4. Later, XX and YY, who would have had numerous dealings between themselves, struck a balance on
their account and settled up.

Let us know the various features of a bill of exchange

i. A bill must be in writing, duly signed by its drawer, accepted by its drawee and properly stamped.
ii. It must contain/express an order to pay. Words like ‘please pay Br 5,000/- on demand and oblige’ are not
used.
iii. The order must be unconditional.
iv. The order must be to pay money alone.
v. The sum payable mentioned must be certain or capable of being made certain.
 vi. The parties (i.e. the above three) to a bill must be certain definite individuals. Sometimes the drawer and
payee may be the same person.
The amount of money to be paid must be certain and the payment must be in legal tender. The bill may be
payable to payee or his/her order. Such a bill is called order bill. When it is payable to bearer it is called a
bearer bill.
In general, bill of exchange shall contain:
 The term “Bill of Exchange” in the body of the document with the language used.
 An unconditional order to pay a certain sum in money.
 The date when and the place where the bill is issued.
 The name of the drawee.
 The time and place of payment.
 The name of the payee.
 The signature of the drawer.

Difference between the bill of exchange and a promissory note:

1. In a bill there are three parties, drawer, drawee and payee. In the case of promissory note there are
only two parties, the maker and the payee.
2. The creditor always draws a bill of exchange on the debtor. Promissory note is drawn by the debtor
and given to the creditor.
3. A bill contains an order to pay money. Promissory note contains a promise to pay money.
 Cheques
A cheque is written instrument signed by the accountholder or empowered to pay a certain sum of money to
the other of a designated person. If you have an account in a bank, you can issue a cheque in your own name
or in favor of others, thereby directing the bank to pay the specified amount to the person named in the
cheque. Therefore, a cheque may be regarded as a bill of exchange; the only difference is that the bank is
always the drawee in case of a cheque.

 In general features of all negotiable instruments are: free transferability, good title, always in written
form, unconditional order or promise, certainty of payment, payee, time, etc.
2.5 Management of Commercial Banks
The fundamental objective of bank management is to maximize shareholders’ wealth. This goal is interpreted
to mean maximizing the market value of a firm’s common stock. Wealth maximization, in turn, requires that
managers evaluate the present value of cash flows under uncertainty with larger, near-term cash flows
preferred when evaluated on a risk-adjusted basis.
Commercial banks are the queen of the financial services industry. The monetary wealth of every country –
the life-blood of the country’s economy – flows through commercial banks. Its assets and liabilities are almost
entirely financial and highly liquid. The basic financial structure and business activities render banks and
banking risky subject to sudden failure if not properly managed and greed kept in cheque. Because of the
importance of banking to the economic stability of a country, they are heavily regulated and in some countries
entirely central government own and control. Regulators, whatever country, concentrate on “safety and
soundness” of the individual banks and the banking industry as a whole. Profitability is secondary.
Commercial banks are the most important financial intermediaries in the economy, so it is important to
understand bank management. As discussed in chapter two, Bank Management involves how it manages
assets (loans) and liabilities (deposits) to maximize profits.
1. Liquidity Management - maintaining enough liquid assets to meet obligations to depositors (for cash
withdrawals). It requires two concerns: 1) excess reserves and 2) insufficient reserves. Banks want to
minimize excess reserves. However, if a bank has deficient reserves, there could possibly be a costly
readjustment process. Banks want to hold the optimal amount of excess reserves, but the optimal amount
is NOT zero.
2. Asset Management - managing assets (loan portfolio) to achieve diversification and minimize default
risk/credit risk and interest rate risk. Banks want to manage their assets (loans) to maximize profits by:
a) Assess creditworthiness of loan customers, avoid costly defaults. Banks are usually conservative -
defaults are less than 1% of bank loans. Optimal number of loan defaults is not zero.
b) Purchase securities, subject to banking regulations.
c) Diversify assets-Short and long term securities; Diversity loan portfolio- commercial, auto, student,
mortgage, credit card, etc. Undiversified loan portfolios are exposed to risk. Example: too many real
estate or farm loans in one area are risky.
d) Manage assets to ensure liquidity, holding sufficient liquid assets like T-Bills in case of large deposit
outflows, loss of reserves. T-Bills are so safe and liquid that they are considered "secondary reserves."
Bank has to balance liquidity (holding reserves and T-Bills) against increased earnings from less liquid
assets (holding loans).
3. Liability Management - acquire/attract funds (deposits) at lowest possible cost. A bank can manage its
liability by
 Borrow from other banks at the funds market
 Issue new instruments
 Invest the newly acquired funds using asset management
4. Capital Adequacy Management - maintaining the appropriate net worth to meet federal regulations and
prevent bank failure. It involves managing the bank own capital because having enough capital prevents
going out of business.
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