Is there any reason that the balance of funds in a deceased customers account could not be used to payoff a past due loan with the bank? The funds are retirement deposits (pension) I've never had this come up before.

Once the owner is deceased, the funds below to the owner's estate or to designated beneficiaries on the account. The Bank would have to make a claim against the estate just like all the other creditors.

I'd be talking with legal counsel before trying to exercise setoff rights in this situation.