Economics Ch#05 1

FAROOQ KHAN
Contact#0333-2446951

Miss UROOJ

Economy of
Pakistan

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FINANCIAL SECTOR OF PAKISTAN

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Banks
Bank definition by kinley’s.

“An establishment which makes to individual such advances of money or

other needs of payments as may be required and safely made and to
which individual entrust money or means of payment when not required
for use by them”.

Types of banks are as under:

• Scheduled bank
• Non-scheduled bank

SCHEDULED BANK:

Scheduled bank means enlisted bank. It means that the bank

which is enlisted as a recognized bank with the central bank is known as
scheduled bank.

Every scheduled bank has to fulfill certain conditions. In Pakistan

all scheduled banks must keep at least 5% of their total deposit as
reserve with the State Bank of Pakistan. They also required to submit
weekly returns to the State Bank Of Pakistan.

Non-Scheduled Bank:
Such banks that are not enlisted in the schedule of the central
bank is called non-scheduled bank. These banks don’t fulfill the required
qualifications of a scheduled bank as prescribed by the central bank.

STRUCTURAL CLASIFICATION:

Banks can be classified on the basis of their structure. Which are

as under.

a) Branch Banking:

Under branch banking system, banking business is carried

on through a network of branches in the same town or country under
the guidance and control of 1 single head office. These branches may
also be located in side and outside of the country. This system of

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banking was originated in U.K. Now a days this system is followed by

many countries of the world including Pakistan.

b) Unit Banking:

Under unit banking system the banking operations are

carried through a single office without any branch. Remittances and
foreign exchange etc are dealt through correspondence between banks
of two places. The U.S.A is the home of unit banking.

OPERATIONAL CLASSIFICATION OF BANKS:

On the basis of nature of operation, banks can be classified into 2
categories.

a) Correspondent Banks:

The unit banks having no branch as are linked together by

correspondent bank system. Under this system, a unit bank of a village
or small town deposit a portion of its cash reserve with another bank in
the nearest city. And this superior bank of city also deposits with
another greater bank of big city. These unit banks are linked through
correspondence. Remittances of funds of home and foreign trade
transactions are made through these correspondence banks. No doubt
the unit banks are completely independent of each other but they are
connected with one another through correspondence systems.

b) Specialized Banks:

The bank which perform s one or more special functions is known

as specialized banks. As for example an agricultural bank takes up the
special responsibility of financing agricultural activities. Industrial bank
specially finance the industrial undertakings. Japan is the home of
specialized banks where different types of specialized banks are working
with their special functions.
The specialized bank plays important role in the economic
development of a country, specially of a developing country like PAK.
In our country, Agricultural development bank of Pakistan is
helping financially in the development of agricultural sector of our
economy.

FUNCTIONAL CLASSIFICATION OF BANKS:

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Functional classification of banks may be summarized as follows:

• Central bank
• Commercial bank
• Industrial bank
• Exchange bank
• Agricultural bank
• Cooperative bank
• Mortgage bank
• Savings bank

Exchange Bank:

Exchange bank deals mainly in the finance of the foreign trade

of the country. It deals in foreign exchange. On the other hand, the
main function of such bank is to buy and sell foreign currencies,
rather titles to foreign currencies in the form of bills of exchange,
drafts telegraphic transfer etc. it purchases the bills of exchange
which arise in the connection with import and export trade of the
country and they deal in exchange .

Cooperative Banks:

This type of bank is organized mutually by the persons of

similar occupations within the objectives of providing banking and
credit facilities to the members. Generally in every country,
government patronizes CO-operative banks in order to encourage the
cultivators, fishermen workers in the factories etc.

Mortgage Banks:

Mortgage banks advances long term credits against securities of

immovable properties like, agricultural land, building and
machineries etc. Generally credit is given to the agriculturalist, small
industries or house builders. This type of bank is essential in an
underdeveloped country where capital supply is very limited. In our
country, H.B.F.C is functioning as mortgage bank providing long term
loans to house builders against securities of building and land
property.

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Savings bank:

Such bank provides facilities to the people to save money. This

type of bank in established with the objective of promoting the thrift
or saving habits among the people of small incomes. It takes deposits
from the public and lends the collected funds to the traders.
Depositors are allowed to withdraw money from their deposits twice in
a week. Post offices in Pakistan carryon the functions of the savings
banks. And of course commercial and other banks also accept saving
deposits.

Industrial Bank:

Such institution specializes in financing industry. It provides long

term credit to people who carry on industrial enterprises. IDBP and
PICIC are the examples if this bank.

Agricultural Bank:

Such banks providing long and short term finance to the

agriculturalist for their agriculture purpose. Long term capital is
required for acquisition and improvement of land and purchases of
the heavy machinery and equipments. Short period capital is required
by the farmers for the current expenditure on seeds, manures, wages
etc. ADBP is the best example in our country.

CENTRAL BANK:
A central bank may be defined as
“The principle banking institution of a country operating under some
degree of state control and ensure with the special responsibility of
maintaining economic equilibrium and stability in prices and in
overall interest of the country”.

FUNCTIONS OF CENTRAL BANK

1. Monopoly of note issue
Note issue primarily is the main function of a central bank in every
country. These days, in all the countries where there is a central bank
generally it has got the monopoly of the sole right of note issue. In the
beginning this was not the function of central bank, but gradually all the
central bank gas acquires this function.
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There are many advantages of the note issue by central banks some
important ones are as follow:

1. Central bank controls the credit creating power of commercial bank.

By controlling the amount of currency in circulation, the volume of credit
can be controlled to quite a large extent.

2. People have more confidence in the currency issued by the control

bank because it has the protection and recognition of the government.

3. In the event of monopoly of note issue of central bank, there will be

uniformity in the currency system in the country.

4. The currency of the country will be flexible if the central bank of the
country has the monopoly of note issue because central bank can bring
about changes very early in the volume of paper money according to the
needs of business, industry and messes.

5. The system of note issue has some advantages. If the central bank of
the country has the monopoly of note issue, all such advantages will
accrue to the government.

2. Bankers, Agent and Adviser to the Government

As banker to the government, central bank provides all those service and
facilities to the government which public gets from the ordinary banks. It
operates the account of the public enterprise. It mangers government
departmental undertaking and government funds and where there is a
need gives loan to the government. From time to time, central bank
advice the government on monetary, banking and financial matters.

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3. Custodian of Cash Reserve of Commercial Bank

Central bank is the bank of banks. This signifies that it has the same
relationship with the commercial banks in the country that they gave
with their customers. It provides security to their cash reserves, give
them loan at the time of need, gives them advice on financial and
economic matter and work as clearing house among various members
bank.

4. Custodian of Nation’s Reserve of International

Central bank is the custodian of the foreign currency obtained from
various countries. This has become an important function of central
bank. These days, because with its help it can stabilize the external
value of the currency.

5. Lender of The Last Resort

Central bank works as lender of the last resort for commercial banks
because in the time of need it provides them financial assistance and
accommodation. Whenever a commercial bank faces financial crisis,
central bank as lender of the last resort comes to its rescue by advancing
loans and the bank is saved from being failed.

6. Clearing House Function

All commercial bank have their accounts with the central bank.
Therefore, central bank settles the mutual transactions of banks and
thus saves all banks controlling each other individually for setting their
individual transaction.

7. Credit Control
These days, the most important function of a central bank is to control
the volume of credit for bringing about stability in the general price level
and accomplishing various other socio economic objectives. The
significance of this function has increased so much that for property
understanding it. The central bank has acquired the rights and powers of
controlling the entire banking.
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A central bank can adopt various quantitative and qualitative methods

for credit control such as bank rate, open market operation, changes in
reserve ratio selective controls, moral situation etc.

8. Collection of Data
Central banks in almost all the countries collects statistical data
regularly relating to economic aspects of money, credit, foreign exchange,
banking etc. from time to time, committees and commission are
appointed for studying various aspects relating to the aforesaid problem.

9. Central Banking in Developing Countries

The basic problem of underdeveloped countries is the problem of lack of
capital formation whose main causes are lack of saving and investment.
Therefore, central bank can play an important role by promoting capital
formation through mobilizing saving s and encouraging investment.

COMMERCIAL BANKS:
The commercial banking involves in making profit by investing
others (depositor) money and not by investing its own money.
Commercial bank is the most popular and prevalent in all civilized
countries of the world. Majority of banks are operated in commercial
banking systems. The growth of commercial banking is indispensable for
overall economic development of the country. In short commercial banks
collect deposits from the public and invest the collected funds for profit
under the direction and guidance of central bank. They are mainly
engage in financing internal trade but also deals in foreign exchange to
help their customer in their foreign trade.

FUNCTIONS OF COMMERCIAL BANKS:

The functions of a commercial banks are divided into two categories:

i) Primary functions, and

ii) Secondary functions

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i) PRIMARY FUNCTIONS
The primary functions of a commercial bank include:

a) Receiving of deposits; and

b) Advancing loans

a) Receiving of deposits:

It is the 1st primary function of of commercial banks. Banks

receive deposits from public and pay interest. Different kinds of deposits
are given below:
• Fixed deposit account
• Current account
• Saving account

b) Advancing loans:

This is the 2nd primary function of commercial banks. Banks pay

interest on the deposit of the depositors and further provide loans to the
companies and firms. The banks pay interest at a lower rate while receive
interest at higher rate and the difference become the profit of bank.
These loans are of following types.
• On demand loans
• Ordinary loans
• Cash loans
• Over drafts
• By purchase of and discounting bill of exchange

All these loans are of shorter period which are to be repaid in one
year. However, the bankers are also providing long term loans now
a days.

SECONDARY FUNCTIONS:
Secondary functions are s under.

• Public utility services

• Agency services

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PUBLIC UTILITY SERVICES:

Commercial banks provide following services for public utility.

• Credit Instruments:

Bank issue various credit instruments which are considerable

benefit to the business to the business community; e.g cheques, L.C.

• Foreign Exchange:

Bank deals in foreign exchange and facilitates both foreign trade

and foreign exchange.

• Precious Articles:
Bank accepts valuable things like ornaments, documents,
securities, insurance, policy etc from their customer for safe custody.

• Underwriting:

Bank underwrite shares, bands, etc issued by govt. public

bodies or trading corporations.

• Referee:

Bank acts as a referees and provide information relating to the

credit worthiness of their customers.

• Trade Information:

Banks collects useful trade information from their customers.

• 24 Hours Cash Services:

now a days, modern commercial banks used computerized

counter to provide 24 hours cash services through ATM to their
valuable customers.

• Special Services:

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In particular circumstances, bank also provides following

services to their customer and govt.
a) Receipts of Zakat and Usher.
b) Receipts of hajj applications
c) Issuance of Qarz-e-Hasna
d) Fee receipts of educational institutions
e) Receipts of donations

AGENCY SERVICES:

Agency services are as under.

• Collection & payment of cheques:

Commercial bank collect cheques and make payment of

cheques on the behalf of their customers.

• Collection of dividends:

Commercial banks collect dividends and interest on shares on

the behalf of their customers. For this purpose, customer informs the
issuer of security to pay interest or dividends on his account of bank.

• Purchase and sales of security:

If the customers directs his bank to purchase and sale

securities on his behalf, bank will do this by charging commission.

• Agent:

Bank also acts as an agent of customer at home or abroad.

• Execution of standing instruction:

Bank also executes instruction of his customer by charging

nominal charges. For instance, if a person has to pay Rs.600 to
insurance company and Rs.200 as rent every month. Bank will make
monthly payment on the written order of customer.

• Transfer of fund:

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Bank also performs the function of transferring fund from one

place to another by charging nominal commission.

• Trustee:

Bank also acts as trustee on the behalf of customer.

ISLAMIC BANKING:
Islamic banking refers to a system of banking or banking activity that is
consistent with the principles of Islamic law (Sharia) and its practical
application through the development of Islamic economics. Sharia
prohibits the payment of fees for the renting of money (Riba, usury) for
specific terms, as well as investing in businesses that provide goods or
services considered contrary to its principles (Haraam, forbidden). While
these principles were used as the basis for a flourishing economy in
earlier times, it is only in the late 20th century that a number of Islamic
banks were formed to apply these principles to private or semi-private
commercial institutions within the Muslim community.

1st Islamic bank started work in 1916 in Egypt on large scale. In 1972 2 nd
Islamic bank is formed whos name is Naseer Social Bank and its second
branch is formed in 1975.

FEATURES OF THE ISLAMIC BANKING:

Features are as under:

• Prohibition of transaction on the basis of riba.

• Wealth should be directed in the halal channels permitted by
religion.
• Zakat should be deducted from the wealth and given to the needy
persons.
• A fixed charges on capital is unjust.
• Making money out of money is counter to islamic laws.

MUDARABAH
Mudarabah" is a special kind of partnership where one partner gives
money to another for investing it in a commercial enterprise. The
investment comes from the first partner who is called "rabb-ul-mal",
while the management and work is an exclusive responsibility of the
other, who is called "mudarib".
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MUSHAAKAH
A joint enterprise or partnership structure with profit/loss sharing
implications that is used in Islamic finance instead of interest-bearing
loans. Musharakah allows each party involved in a business to share in
the profits and risks. Instead of charging interest as a creditor, the
financier will achieve a return in the form of a portion of the actual
profits earned, according to a predetermined ratio. However, unlike
a traditional creditor, the financier will also share in any losses.

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