In banking, “set-off” refers to a legal right that allows a bank to offset mutual debts between itself and its customer. It means that when a customer owes money to the bank (e.g., on a loan or credit card) and also has deposits or funds held in the same bank, the bank can use those funds to partially or fully repay the debt owed by the customer. Essentially, the bank is using one account to settle or “offset” the balance of another account.
Here are some key points to understand about set-off in banking:
- Mutual Debts: Set-off can only be applied when there are mutual debts between the bank and the customer. This means that the customer has both a liability (debt owed to the bank) and an asset (funds held in accounts with the same bank).
- Right of Set-off: The right of set-off is typically included in the account terms and conditions or in the contract between the bank and the customer. This contractual provision allows the bank to exercise its right to apply set-off under specific circumstances.
- Automatic Nature: When the conditions for set-off are met, the bank has the right to apply it automatically without seeking the customer’s permission. This is because the customer has already given consent to the bank to exercise this right when opening accounts or availing credit facilities.
- Application of Set-off: The bank will apply set-off by using the funds available in the customer’s deposit accounts to reduce or clear the outstanding debt. The bank will often apply set-off to the oldest debt first unless specified otherwise.
- Types of Accounts: Set-off can be applied across different types of accounts held by the customer within the same banking institution. For example, if a customer has both a savings account and a credit card account with the bank, the bank can set-off the credit card debt using the funds available in the savings account.
- Protection for Customers: While set-off gives the bank the right to use a customer’s funds to repay debts, there are usually certain protections in place. For instance, there may be limitations on the amount that can be set-off, and some jurisdictions may provide additional safeguards to prevent abusive or unfair use of set-off by the bank.
- Bankruptcy and Insolvency: Set-off can be particularly relevant in cases of bankruptcy or insolvency. If a customer becomes insolvent, the bank may be able to use the funds in the customer’s accounts to offset any outstanding debt owed by the customer.
- Notification: When set-off is applied, the bank may notify the customer of the action taken, such as the specific amounts offset and any resulting changes in account balances.
It’s important for customers to read and understand the terms and conditions of their banking agreements to be aware of the bank’s right of set-off. While set-off can be beneficial for banks in managing credit risk, customers should also be cautious to ensure they maintain sufficient funds to cover any outstanding debts and avoid potential issues that may arise due to set-off actions.