Trusts and IMAs are financial products of bank quite different from that of deposits. As mentioned in an earlier column, in deposit accounts there is a creditor (depositor) – debtor (bank) relationship which obliges the bank to pay the deposit upon withdrawal. On the other hand, in trusts and IMAs, the client authorizes the bank to lend his money, with the bank receiving fees and commission, and with the risk of default by the borrower being borne by the client. Theoretically, the bank merely serves as conduit for the lending of the client’s money.
Trusts and IMAs are not exactly the same. Trusts are governed by a trustor-trustee relationship whereas IMAs are classified under a principal-agent relationship. In a trust agreement, the bank is able to lend out the money as a trustee having legal title over the funds, with the trustor or client retaining the beneficial and equitable title over the funds. Thus, the trustee is able to act in his name, subject to the prudential disclosure of his capacity as trustee. In an agency agreement, the agent acts in another’s name, or that of his principal. It is an act in which one person gives to another the power to do something for the principal and in the latter’s name.
This distinction can also be explained in the following illustration. A central bank is different from an ordinary bank because, among other things, it (the central bank) does not accept deposits from the public; it accepts deposits only from banks and from the Government. The central bank may permit the deposit of trust funds being held by the banks because they hold legal title as owner over these funds; but the same treatment cannot be accorded to the IMA funds because the owner of these funds is not the bank but their principals. If IMA funds were to be accepted, it is as if the central bank is accepting deposits from the public.
There is another substantial distinction between the two – as to the required diligence required from the trustee or agent in discharging the trust or agency, as the case may be. In an agency, the agent shall do all that a good father of a family would do, as required by the nature of the business. The phrase “as required by the nature of the business” would mean that in IMAs, the agent will observe that diligence required from banks more than as a good father of a family. This was interpreted to mean no less than the highest degree of diligence by reason of the fact that the banking business is impressed with public interest. If this degree of diligence is already very demanding, an even higher degree is required from the banks in handling trust accounts.
For banks discharging trust functions, the required diligence is called the “prudent man’s rule.” It is a rule for those who are investing the money of others who are thus required to act as a prudent man would act with discretion and intelligence to seek reasonable income, preserve capital and in general avoid speculative investments.
The foregoing considered, if I would ask a bank to invest or lend my money, I would personally prefer a trust agreement rather than an IMA account. In such instance, I should then expect the bank to observe higher standards of diligence under the prudent man’s rule, over that being observed under the good father of the family rule.
The above comments are the personal views of the writer.
His email address is firstname.lastname@example.org