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Banking

Introduction of Banking System

Q.1. Define Bank and explain that banking system of a country helps in its economic
development.
OR
Write short notes on, * Industrial Bank, * Agricultural Bank, * Cooperative Bank, *
Exchange Bank, * Mortgage Bank, * Savings Bank

Meaning of Bank
It is generally said that the word "BANK" has been originated in Italy. In the middle of 12th century
there was a great financial crisis in Italy due to war. To meet the war expenses, the government
of that period imposed a forced subscribed loan on citizens of the country at the interest of 5%
per annum. Such loans were known as Compara, Mintuo etc. The most common name
was Monte. In Germany the word Monte was named as Bank or Banke. According to some
writers, the word Bank has been derived from the word Bank.
It is also said that the word Bank has been derived from the word Banco which means a banch.
The Jews money lenders in Italy used to transact their business sitting on banches at different
market places. When any of them used to feel to meet his obligations, his banco or banch would
be broken by the angry creditors. The word Bankrupt seems to be originated from broken banco.
Since, the banking system has been originated from money lending business, it is rightly argued
that the word Bank has been originated from the world banco.
Today the word bank is used as a comprehensive term for a number institutions carrying on
certain kinds of financial business. In practice, the work Bank means which borrows money from
one class of people and again lends money to another class of people for interest or profit.

Definition of Bank
Bank is defined in many ways by various authors in the books on economics and commerce. It is
very difficult to define a bank, because a bank performs multifarious functions. Different kinds of
bank having different functions may be defined in different ways according to their functions. The
evolution of different type of banks, each specialization in a particular field, gives emphasis on
each and every kind of bank. A general and comprehensive definition to cover all types of
banking institutions would be unscientific and probably impossible. Each type of bank should
have its own definition explaining its specialized functions. Legislators have understood this
difficulty and that is why the Bill of Exchange Act 1882 (England) defines thus A bank includes a
body of persons, whether incorporated or not, who carry on the business of banking.
From this definition it is clear to us that any institution which performs the various banking
functions may be termed as bank. But in practice it is found that many banking functions vary
from time to time and country to country. It is not possible on the part of a single bank to perform
all the banking functions at the time. So there originated numbers of specialized banks with the
objective of performing one or more functions. As for example, Central Bank, Commercial Bank,
Industrial Bank, Agricultural Bank, Co-operative Bank etc., are in the practical field.
Dr. Herbert L. Hart has defined a Banker as A Banker is one who in the ordinary courses of
business honours cheques drawn upon him by persons for whome he receives money on current
account. According to Sir John Paget No one and no body corporate and otherwise can be a

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Banker who does not (i) take deposit accounts (ii) take current accounts(iii) issue and pay
cheques drawn upon himself (iv) collect cheques crossed and uncrossed for his customers.
Hilton Banking Commission defines Bank or Banker in the following words:
Every person, firm or company using in the description or its title, Bank or Banker or Banking and
accepting deposits of money subject to withdrawal by cheque, draft or order.
Banking Ordinance 1962 (Pakistan) defines Banking as Accepting for the purpose of lending or
investment of deposits of money from public, repayable on demand or otherwise and withdrawal
by cheque, draft, order or otherwise. Vise Sec. 5(1) and 5(B) Banking Co's Ordinance, 1962.
In view of the above definitions, a simple and short definition can be given as Bank is an
institution which deals in money and credit. According to this precise definition A bank accepts
deposits of money in savings and current accounts at lower rate of interest or profit and gives on
credit to needy persons and businessmen at a higher rate of interest or profit. It also transfers
money for the clients from one city or country to another and also performs various other agency
services for earnings.

Importance of Banking
Bank play a significant role in the economic development. The overall economic of a country is
absolutely dependent on the efficient banking system. Industrial, agricultural and commercial
progress of a country is not possible without a good banking system. The importance of banking
may be stated as follows:

1. Capital Formation
Economic development depends upon the division of economic resources from consumption to
capital formation. Capital grows out of savings. Banks play the prime role in accumulating capital
by collecting the scatered savings of the people. Thus banks render a valuable service towards
the development of a country by encouraging the growth of capital.

2. Inexpensive Media of Exchange

Modern Banking provides inexpensive media of exchange. Issuing of currency notes is a great
achievement of modern banking. In addition the cheques issued on the banks are frequently used
instead of money in transacting business. Thus the cheques economise the use of currency
notes.

3. Development of Trade and Industry

Bank utilise their collected funds by advancing loans to commercial and industrial undertakings.
In respect of foreign trade also, banks render a valuable service by issuing letter of credit etc.

4. Reservoirs of Funds
Banks acts as the reservoirs of money in the country. In times of economic, crisis the bankers
come forward to help the Government by purchasing the Government securities or by advancing
loans.

5. Transfer of Funds
Banks facilitate the transfer of funds from one place to another safely and at a very cheap cost
through bank drafts, mail transfers, telegraphic transfer, travellers cheque etc.

6. Dealing in Foreign Exchange

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Banks deal in foreign exchange by purchasing and selling foreign currencies and by issuing
letters of credit. Foreign remittances of funds are possible only through banks.

7. Money Market Operations

The structure and ups and downs of money market in the country are largely dependent on the
bankers activities. Under the guidance of the central bank all the banks in the country do their
best for the sound management of money market.

8. Service to Customers
Banks perform various agency services on behalf of their customers. They collect or make
payments of bills of exchange, dividend, insurance premium etc, on behalf of their customers.
They act as the trustees ore executors of documents etc. They also extend financial advises to
their customers.

Functions of Modern Bank

The following is the list of functions or services rendered by a modern bank:
1. Bank provides inexpensive media of exchange through its cheques etc.
2. Bank keeps deposits of public.
3. Bank finances trade and industry.
4. Bank keeps in capital formation by economic savings.
5. Bank acts as Reservoir of funds.
6. Bank deals in foreign exchange and finances foreign trade.
7. Central Bank issues notes and controls money supply.
8. Central Bank controls credites, exchange and the money market.
9. All the banks participate in the development of money market.
10. Bank facilitates the transfer of funds from one place to another.
11. Specialized banks helps in the development of agriculture and industry.
12. Banks acts as the custodian of customers valuables.
13. Bank acts as underwriters for raising capital or loan by Government, Public Bodies and
Campanies.
14. Bank acts as trustees and Executor of will and documents on behalf of their customers.
15. Bank acts as the correspondent and representative of its customers, other banks and
financial institutions.
16. The Bank collects and makes payments of Bills of Exchange on behalf of its customers.
17. The bank makes payments and collects in respect of subscriptions, insurance premiums,
rents, salaries etc, and also receives pension dividends and payment of utilities bills on behalf of
their customers.
18. Bank advances loans and extend financial advices to its customers.
19. Bank Discounts Bills.
20. Bank purchases and sells stock exchange securities.

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Qualities of Good Banking System

Every bank is a dealer in money and credit. It generally deals in with others money and not with
its own money. It takes deposits from the public and again lends to its customers for the sake of
interest or profit.
Thus, the operation of banking business is very risky one. A bank must have some qualities in
operating its functions efficiently and successfully. The qualities of good banking may be
summarized as below"

1. Adequate Capital
A banker must have adequate amount of capital. A large scale operation and execution of various
functions of a modern bank require large amount of capital at the initial stage. Thus, without
sufficient capital no large scale banking can flourish.

2. Good Reputation
Reputation is the most important factor in the progress of a bank. To be successful, a bank must
have ample reputation in the money market. Reputation of a bank depends upon the
qualifications of the directors and on the efficiency of management and workers.

3. Liquidity.
Money which is dealt in by a bank is not its own, so a banker must always keep himself ready to
meet the claims of his depositors. He should keep sufficient amount of cash reserve and should
keep some assets in such a way that these can be encashed at any moment. He should not block
his fund by advancing loans for long periods rather he should always prefer short term credits.

4. Security and Safety

In respect of advancing loans safety should be the main guiding principle for a bank. The loans
advanced by the banker must be secured. The persons to whom the advance is to be made,
must be studied carefully before the lending of money. According to R.S. Sayers, The good
banker is one who can distinguish the sound from the unsound borrower.

5. Economy
Economy in expenditure should be maintained for the proper operation of banking business. A
good banker will always try to maximise his profit at a minimum cost.

6. Effective Publicity
A bank should adopt various scientific methods of advertisement for the proper publicity of
business.

7. Localization
Good locality of a bank is another quality. The bank should be located in the business centre so
that it can flourish its business successfully.

8. Speciality

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To be successful, a bank should be specialized in any one or more fields of banking. An
agricultural bank always aim at financing the formers for agricultural purposes. Industrial bank
provides long terms credits to the industries. The individual commercial banks are also
specialized in different fields of banking.

9. Good Show within the Office

The bank office should be well equiped with modern aminities proper sitting arrangement should
be made within the bank office for its customers.

10. Good Personnel and Efficiency

The officers and the employees of the bank must be efficient in their work. They should be well
trained in different fields of banking. Furthermore they should be well behaved and polite in the
manner and must possess pleasing personality.

Classification of Banks
The banks can be classified on the following three basis:
1. Structural Classification of banking.
2. Operational Classification of banks.
3. Functional Classification of banks.
1. Structural Classification
Banks can be classified on the basis of their structure or constitution. According to structural
classification, banking may be classified as (a) Branch Banking (b) Unit Banking

(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 one single head office. These
branches may also be located in outside of the country. This system of banking was originated in
the United Kingdom. Now-a-days this system if 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.

Advantages of Branch Banking

1. Large Scale Operation
Branch banking system enjoys all the advantages of large scale operation. Proper division of
labour is applied successfully and the employees become specialized in different banking fields.

2. Economy of Reserves
Under this type of banking, the funds can easily be transferred from one branch to another. So full
economy in maintaining cash reserve can be secured by a banking having number of branches.

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3. Remittances of Funds
This system facilitates easy remittances of funds from one place to another through its number of
branches in different places.

4. Spreading Risk Geographically

The bank having many branches can spread its risk geographically or territorially. In case of
losses incurred by branch in an area can be offset by profits of the branches of other areas.

5. Parity in the Rate of Interest

By making easy movement of funds from one place to another branch banking system can
maintain parity in the rate of interest in different parts of the same country or of the world.

6. Wise Banking Policy

The bank can formulate a wise banking policy. As it has got a good number of branches
throughout the country. It can study money and credit position correctly. Loans and advances are
made on merits and not on other consideration. Applications for large amount of loan are passed
on to the higher authorities in head office.

7. Investment of Idle Funds

Under branch banking system a branch can transfer its idle funds to other branches where this
can be invested on profitable terms.

8. Foreign Exchange
As it has got foreign branches it is easier to operate foreign exchange for a branch banking.

9. Superior Management and Personnel Training

Branch banking system having large scale operations attracts superior personnel and offers wide
scope for the training of the personnel.

Disadvantages of Branch Banking

The critics of the branch banking mentioned the following disadvantages:

1. Loose Control and Management

Under branch banking system, it becomes very difficult for a single head office to manage and
control a number of branches much effectively.

2. Red Tapism
Red-Tapism and delay is common due to lack of sufficient authority to branch managers. They
are also not allowed to stay for long in one branch, so they do not have the chance of becoming
familiar with local needs.

3. Relationship Between Management and the Employees

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Due to large number of branches the relationship between the employers and employees is not
close and cordial.

4. Late Decision
A branch banking a large organisation, can take neither quick decision nor prompt action in case
of emergencies.

5. Concentration of Financial Lesources

In branch banking system large financial resources are concentrated in the hands of small
number of authorities of bank.

Advantages of Unit Banking

1. Easy Management and Control
Under unit banking system, it becomes very easy for a single office to manage and control
efficiently.

2. Close Management and Workers Relationship

Under unit banking system, there prevails a close and cordial relationship between employer and
employees.

3. Quick Decision
The owners or the management of unit banks can take quick decision and prompt action in times
of emergencies.

4. Use of Local Resources

Local financial resources are used for local development.

5. Lesser Fraud and Irregularities

Due to the less scattered affairs of the bank, there are very little possibilities of fraud and
irregularities.

Disadvantages of Unit Banking

1. Limited Size of Operation
Unit bank business can not be operated on large scale because of its limited area. Being the
small organisation, division of labour can not be applied.

2. No Economy of Reserves
Under unit banking, bank can not transfer its funds to any other branch. So economy in cash
reserve can not be secured under this system.

3. Limited Financial Resources

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A unit bank has limited financial resources so it is not able to provide full and adequate banking
facilities to the industry and trade of the area.

4. Investment of Idle Funds

A unit bank having no other branches, can not utilize its idle funds in profitable ways.

5. Disparity in the Rate of Interest

Under the system, there prevails a great disparity in the rate of interest in the same country as the
management of different banks are separate from each other.

Operational Classification of Banks

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

(a). Correspondent Banks

The unit banks, having no branch are linked together by correspondent bank system. Under this
system, a unit bank of a village or small town deposits 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 correspondent banks. The unit banks are
completely independent of each other no doubt, but these are connected with one another
through correspondent system.

(b). Specialized Banks

The bank which performs one or more special functions is known as specialized bank. As for
example an agricultural bank takes up the special responsibility of financing agricultural activities.
Industrial banks 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 banks have a great role in the economic development of a country, specially of a
developing country like Pakistan.
In our country, Agricultural Development Bank of Pakistan is helping financially in the
development of agricultural sector of our economy. The Industrial Development Bank of Pakistan
is another specialized bank who is financing large scale industries in Pakistan.

Functional Classification Of Banks

Banks may be classified according to their functions. Different kinds of banks, with different
functions may be summarized as follows:

(a) Central Bank

A central bank is the most important institution in the banking system of a country established
with the objective of regulating the banking and monetary system of the country. It issues notes
and currencies within the country and is entrusted with responsibility of maintaining the price level
in the country stable. It acts as banker to the Government and it directly or indirectly controls the
activities of all other banks. State Bank of Pakistan is Central Bank of our country.

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(b) Commercial Bank
Such type of bank is cheerfully engaged in financing internal trade. It deals in short term credit. It
takes deposit from public through different type of deposit accounts and invests that collected
fund in advances and loan of short period to the trading and commercial undertaking. This type of
bank is familiar in most of the world. In our country, for example, National Bank of Pakistan,
Habib Bank Limited, United Bank Limited, Muslim Commercial Bank Limited and Allied Bank
Limited are the commercial banks.

(c) Industrial Bank

Such institution specialises in financing industry. It provides long term credit to people who carry
on industrial enterprises. Industrial Development Bank of Pakistan (IDBP) and Pakistan Industrial
Credit and Investment Corporation (PICIC) are the examples of industrial banks.

(d) Agricultural Bank

Such bank provides long and short term finance to agriculturists for their agricultural purposes.
Long term capital is required for acquisition and improvement of land and purchase of heavy
machinery and equipments. Short period capital is required by the farmers for current expenditure
on seed, manures, wages etc. Agricultural Development Bank of Pakistan (ADBP) is the best
example of agricultural bank in our country who provides long term, medium term and short term
loans to the agriculturists.

(e) Exchange Bank

Exchange bank deals mainly in the finance of the foreign trade of the country. It deals in foreign
exchange. On otherwards, 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 transfers etc.
It purchases the bill of exchange which arise in connection with the import and export trade of the
country and they deal in exchange. The exchange banks liquidate the international indebtiness by
exporting and importing precious metals and securities, if necessary, they purchase bills in the
international money market and deposit them with their banking agents inbig commercial centres
like London, Paris, New York etc. They draw and sell their own drafts on these deposit accounts.

(f) Cooperative Bank

This type of bank is organised mutually by the persons of similar occupations within the
objectives of providing banking and credit facilities to the members. Generally in every country.
Government patronises co-operative banks in order to encourage the cultivators, fisherman,
workers in the factories etc.

(g) Mortgage Bank

Mortgage bank advances long term credits against securities of immovable properties like,
agricultural lands, buildings and machinaries etc. Generally, credit is give to the agriculturist,
small industries or house builders. This type of bank is essential in an under developed country
where capital supply is very limited. In our country, House Building Finance Corporation is
functioning as mortgage bank providing long term loans to house builders against securities of
building and land property.

(h) Savings Bank

Such banks provides facilities to people to save money. This type of bank is established with the
objective of promoting the thrift or saving habits among the people of small incomes. It takes

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deposits from the public and lands the collected funds to traders. Depositers are allowed to
withdraw money from their deposits twice in a week. Post offices in Pakistan carry on functions of
saving bank. Of course commercial and other bank also accept saving deposits.

Definition of Central Bank

In every country, there is a principal bank who is responsible for guidance and regulation of the
financial system in the country. Such type of bank is known as Central Bank.
A Central Bank may be defined as
The principle banking institution of a country operating under some degree of state control and
entrusted with the special responsibility of maintaining economic equilibrium and stability in the
prices and in the over all interest of the country.

Nature of Central Bank

From the above definition we find the following main features of Central Bank:

1. The Central Bank is the principle banking institution of a country.

2. It is operated under some degree of state control. But in practice, the structure of central banks
vary from country to country. In U.K. and France, the bank of England and Bank of France are
solely owned, managed controlled by the state on the other hand, Federal Reserve System, the
Central Bank of the U.S.A is owned, managed and controlled by the private share holders. Of
course, there are some central banks which are owned, managed and controlled jointly by the
Government and the private share holders. e.g., State Bank of Pakistan before nationalisation
1974.
3. The Central Bank is entrusted with the responsibility of maintaining economic equilibrium and
stability in prices by controlling money supply and volume of credit with in the country.
4. A central bank does its works not for making profit but in the overall interest of the country.
5. The central bank is reservoir of credit. All other banks can look to it for accomodation.

Functions of Central Bank

The central bank is the pivote of all the banking system. The chief functions of a central bank may
be described as follows:

1. Issuing Notes
The central bank has the sole responsibility and monopoly of issuing notes within the country. It is
the sole currency authority. The central bank is required to keep a certain percentage of gold
reserves against issue of notes. Usually, it keeps 30% to 40% gold as reserve. It undertakes
expansion and contraction of the currency alongwith business demand. Money supply is raised
by issuing notes. On the other hand, it can decrease money supply by selling government
securities. By enjoining monopoly of note issue it gives uniformity to the system of note issue in
the country.

2. Governments Banker

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The central bank acts as a financer of the government of the government. It is a government
banker not only collecting and paying money on behalf of the government but it also manages the
public debts. It keeps the government funds in the custody free of interest. On the other hand it
gives loans to the government without limitation of amount. It is the fiscal agent of the
government. It helps the government in designing a fiscal policy for the country so its also plays
the role of financial adviser to the government.

3. Banker's Bank
It acts as the custodian of cash reserves or balances deposited compulsorily by the scheduled
banks. Either by law or custom the member banks are to keep certain portion of their deposits
with the central bank as reserve. For example in our country the scheduled or commercial banks
are to keep cash reserve with State Bank of Pakistan to the extent of 5% of their deposits. Central
Bank also provides short term credit to commercial banks by rediscounting first class bills and
other securities. So it plays the role of banker's bank.

4. Management of Gold Standard

Where the currency of a country is on gold standard, it is the responsibility of the central bank to
manage the gold standard in order to control the stability of exchange rate. It regulates and
checks the movement of gold in the country. The management of gold standard is not so vital and
important these days.

5. Credit Control
It is another important function of central bank. It controls the flow of credit in accordance with the
needs of business in the country. Credit plays an important role as the medium of exchange, so
its expansion or contractors effects the price level in the country. In order to maintain stability in
the price level, central bank controls the volume of credit. Usually, it controls credit by changing
bank rate, purchasing and selling securities and by changing reserve rates of the member banks.
In this way central bank attempts to control the volume of credit and stablishes the business
conditions in the country.

6. Clearing House
It is the Clearing House of the bankers. Under this function central bank of facilitates the
settlement of bills and cheques of other banks.

7. Exchange Control
It is the responsibility of the central bank of control foreign exchange and maintain the rate of
exchange. It purchases and sells approved foreign currencies at the current or fixed rate. It also
acts as the custodian of foreign exchange reserve.

8. Lender of Last Resort

As lender of last resort, it is implicit that the central bank assumes the responsibility of meeting
directly or indirectly all reasonable demands for accommodation by commercial banks in the
times of difficulties and crises. If any commercial bank faces any serious financial difficulty for any
reason, it is central bank who comes forward to help it.

9. Custodian of National Reserve

The Central Bank acts as the trustee of the entire economy of the country and thus keeps in its
custody all national reserves in form of gold, silver and securities.

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Credit Control
Credit plays an important role in maintaining and changing the price level as medium of
exchange. It is the responsibility of the central bank to regulate the volume of credit and its
direction to maintain stability in the price level.
Following are the main objectives of credit control by central bank

1. Safe Guarding the Gold Reserves

The central bank adopts various measures of credit control to safe guard the gold reserves
against internal and external drains.

2. Stability in Price Level

Credit control provides stability in price level in the country.

3. Exchange Stability
Another objective of credit control is to achieve the stability of foreign exchange rate. If the foreign
exchange rate is stabilized, it indicates the stable economic conditions of the country.

4. Stability in Investment and Production

Control of credit by central bank also provides stability in the investments and production by
making price level stable.

'5. Cooperation
Control of credit is done to promote cooperation with other countries for the purpose of
maintaining world economic stability.

Methods Or Techniques of Credit Control

The central bank usually controls the volume of credit through the two types of methods,
quantilative and quantitative.

1. Bank Rate Policy

It is also known Discount Rate Policy. Bank rate is the rate of interest which is charged by the
central bank on rediscounting the first class bills of exchange and advancing loans against
approved securities. This facility is provided to other banks.

Importance
The bank rate is different than the money market interest rate. The charges in bank rate are
followed by other banks in the country in changing their interest rate. If the bank rate is raised by
central bank, other rates of money also go up. Conversely, the market rate of interest and other
rates go down, when central bank decreases its bank rate. These changes effect the supply of
and demand for money. Borrowing is discouraged when the rate of interest increases and
encouraged when the rate decreases.

Effects of Changes in Bank Rate

The changes in the bank rate may cause the following effects.

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a. Changes in Deposit Volume
When the central bank increases the bank rate, commercial banks also increase the rate of
interest and consequently the deposits of the banks also increase. Conversely, when bank rate is
decreased the deposits of commercial bank also decrease.

b. Controls the Borrowings

When the bank rate is raised, the rate of interest and discount of other banks goes up margin of
profit falls and it discourages the businessmen to borrow money and thus the volume of loans
and discounting of bills is minimised. On the other hand a fall in the bank rate encourages loans
and bill discounting.

c. Changes in the Prices of Shares and Securities

A rise in bank rate makes shares and securities in the market cheaper and conversely, by a fall in
the bank rate, shares and securities becomes dearer.

d. Changes in the Volume of Speculative Business

A rise in the bank rate restricts the volume of credit and discourages speculative business. But
the volume of speculative business is expended due to the increase in the credit supply.

e. Changes in the Foreign Trade

A rise in the bank rate encourages export and discourages import. A fall in the bank rate
encourages import and discourages export. When the bank rate is raised, the demand for home
currency goes up and the demand for home currency falls with in the bank rate.

f. Changes in Balance of Payment

Due to rise in the export trade, a rise in bank rate causes a favourable balance of payment. But a
fall in bank rate causes an unfavourable balance of payment.

2. Open Market Operation

The open market operation means the buying and selling of securities by the central bank in
order to influence the money and credit supply in the country. This technique is effective upto
some extent in both conditions of inflation and deflation.

3. Change in Reserve Ration

The member banks of central bank are required either by law or custom to keep a certain
percentage of their deposits with the central bank. It is called as Cash Reserve Ratio. The central
bank may controls credit by changing the reserve ratio. When the reserve ratio is increased the
member banks to some extent are discouraged to bank money. When this ratio is falls, the
member banks are encouraged to expend credit.

Clearing House
The central bank manages and supervises the clearing house to facilitate the clearing of cheques
between banks. Every banker usually receives number of cheques drawn on other banks from his
customers as deposits. In other words banks receives cheques drawn on other banks from their

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account holders. As a result, there arises inter bank indebtedness. For example National Bank of
Pakistan receives deposit of cheques worth Rs. 6,000/= drawn on Habib Bank Limited, Habib
Bank on the other hand, receives cheques worth Rs. 5,000/= drawn on National Bank of
Pakistan. Thus National Bank owes Rs. 5,000/= to Habib Bank and Habib Bank owes Rs. 6,000/=
to National Bank.
Inter bank indebtednesses are settle through a central organisation known as Clearing House. "A
clearing house is a general organisation of banks of a given place, having for its main purpose,
the off setting of cross obligations in the form of cheques. The indebtednesses of the member
banks are settled only by paying the differences. Generally central bank of the country performs
the function of clearing house. In Pakistan, State Bank of Pakistan performs the duty of clearing
house.

Role of Central Bank in Economic Development

The economic stability of a country is solely dependent on the Central Bank. It is the only financial
institution in the country which is responsible for regulating the banking and monetary system of
the country. The need of a central bank in a country is essentially felt considering the following
services rendered by a central bank for economic development of a developing country.

1. Capital Formation
Economic progress of a country requires adequate amount of capital. Capital is required for
agriculture, industrial and commercial development. But in a developing country like Pakistan. It is
a chronic problem to procure capital. Central Bank as a national institution plays prime role in
capital formation in the interest of the nation as a whole. As the guardian of the money market, it
regulates the capital flow in the country in proper form and suitable time.

2. Credit Control
Credit is one of the most important source of financing trade and industry. The central bank as
the controller of credit can encourage a particular sector of economy by adopting selective credit
control.

3. Developing Banking System

As a guardian of all banks, the central bank works for the development of banking system of the
country.

4. Protecting Interest of the Depositors

The central bank protects the interest of the depositors in banks by guiding, controlling and
checking the member banks operations in the country.

5. Stability in Prices
The central bank keeps the price level stable in a country by controlling money and credit supply.
6. Advice to the Government
The Central Bank extends valuable suggestions and advices to the Government in respect of
economic and monetary policies.

7. Personnel Training
The central bank in some countries provides training facilities to the bank personnel.

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Bill of Exchange
Definition and Salient Features
According to Negotiable Instrument Act a Bill of Exchange is "An instrument in writing containing
an unconditional order, signed by the maker directing a certain person to pay on demand or at a
fixed or determinable future time, a certain sum of money only to, or to the order of a certain
person or to the bearer of the instrument.
Thus we find the following important features of a bill of exchange:
1. The order to pay a bill must be unconditional one.
2. The order to pay must be made in writing on the bill.
3. The bill must be signed by the drawer of the bill. Without signature of the drawer the bill will not
be genuine one.
4. The order to pay under a bill must be addressed to a certain person which, of course, includes
ndividuals, firm, company, corporation etc.
5. The amount to be paid under a bill must be certain one.
6. The money under a bill must be paid in legal tender currency.
7. The amount should be payable to or to the order of a specified person or to the bearer of the
instrument.
8. The amount should be payable either on demand or at a fixed determinable future time.
9. The bill must be duly stamped.
10. The other formalities like dating, stating the names of the parties concerned etc. must be
observed.

Parties to a Bill of Exchange

Following are the various parties related to a bill transaction

a. The Drawer
The person who draws the bill and puts his signature on it is known as the drawer of the bill. He is
also called the "maker" of the bill.

b. The Drawee
The person on whom the bill is drawn is called as the drawee of the bill.

c. The Acceptor
The person who accepts the bill is known as the acceptor of the bill. Usually, the drawee accepts
the bill. But sometimes, a third party may also accept a bill on behalf of the drawee. The acceptor
puts down his signature across the bill showing his acceptance.

d. The Payee

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The person to whom the amount of bill is to be paid is known as payee of the bill. The drawer
may make the bill payable to himself or to any other person he likes.

e. The Endorsee
The holder of the bill may endorse the bill in favour of someone else known as endorsee. The
person who endorses the bill is called endorser.

f. The Holder
The person who holds the bill and is entitled to realise the amount of the bill from the drawee is
known as holder of the bill.

Types of Bills
Bills may be of the following types:

a. Inland Bills
Inland bill means the bill which is drawn and payable within the same country. Thus, the bill which
is drawn in Pakistan and will also be paid in Pakistan is termed as an inland bill.

b. Foreign Bill
The bill which is drawn in one country and accepted and payable in another country is known as
a foreign bill.

c. Accommodation Bill
The bill which is drawn and accepted by the parties concerned for their mutual accommodation
with a view to raise money by negotiating it, is known as an accommodation bill. The parties
concerned bind themselves as the drawer and the acceptor without any valuable consideration.

d. Demand Bill
The bill which is payable "on demand" or "on presentation" or "at sight" is known as demand bill.

e. Time Bill
The bill which is payable at a fixed or a determinable future time is known as time bill. The time
bill may further be classified as following:

 After Date Bill:

The bill whose tenure is counted from the date of drawing it is known as after date bill.

 Sight Bill:

The bill whose date of payment is counted from the date of acceptance is known as after sight
bill.
f. Documentary Bill

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When a bill is accompanied by shipping documents like, Bill of Lading, Invoice, Insurance Policy
relating to goods against which the bill is drawn, is then known as a documentary bill.

g. Sent Bill Or Bills for Collection

When bills are handed over to a bander by his customer in order that they may be collected when
due and the proceeds credited to the customer's account. They are called as Bills for Collection.

h. Bills Negotiated
The bills for which the banker has given the value at once, without waiting for the proceeds after
collection.

i. Bills in Set
When bills of exchange are drawn in two or more parts, they are called "bills in set". The foreign
bills are generally drawn in sets of two or three. The each of the set is on a seperate piece of
paper, but all parts are worded exactly in the same language except that the parts are numbered
as "The 1st of exchange", "2nd of exchange" etc.

j. Bills Retired
When a bill is withdrawn from circulation or taken back before it is due, it is known as "retired bill".

Discounting of Bills
A time bill is payable on future date and the holder of the bill is to wait for a specific period of time
to receive the amount of the bill. But the modern commercial banks are providing the facilitates of
discounting of bill to the holder to have money earlier. For discounting of bill, the bank purchases
the bill from the holder at a reduced rate before maturing of the bill and receives the amount of
the bill from the acceptor on due date. The reduction in the value of bill at the time of purchase by
bank is known as "discount" and it is charged on the basis of interest rate. Thus, discounting of
bill is a sort of short term credit given to the holder of the bill by a banker and the discount forms
the profit to him.
Discounting of bill very useful from the point of view of traders and bankers. It benefits the
importer, exporter and bankers equally. The exporter or seller can get immidiate cash as soon as
he handed over the goods to the transporters. The importer or buyer gets enough time to sell the
goods after having received it. The bankers earn a lot by effecting these transactions.

Precautions in Discounting a Bill of Exchange

Like advancing other loans and credit, discounting of bills also is a very risky job on the part of the
banker. He must be careful and cautious with discounting the bill of exchange and must take the
following precautions are measures in discounting of bills:

1. He should examine financial standing of the holder and acceptor of the bill. If the parties
concerned have bank accounts with him, the banker can easily learn their financial stability. If
there is no such account with him, the banker should refer to the bank where they have got
account to know their financial position.
2. The banker is also to examine the financial status of other parties engaged in the bill.
3. The banker should see whether the acceptor dishonoured any other bill in past time.

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4. Th banker should satisfy himself whether the bill is a bonafied trade bill which is accepted for
value received in course of business. The banker should, as for as possible, avoid the
accommodation bills.
5. The banker should examine the bill whether all the formalities as of date, stamp, signature etc,
have been compiled with.
6. He must see whether the bill is capable of being endorsed. If so, the banker should see
whether the bill is duly endorsed by the payee.

Presentation of Bills
Bill has to be presented first of all before the drawee for acceptance and again in due date it is to
be presented before the acceptor for the payment. Thus, presentation of bill may be of two types
viz,
1. Presentation for Acceptance
2. Presentation for Payment

1. Presentation for Acceptance

Presentation for acceptance is made not only for the acceptance of the bill but also to fix-up the
time, place etc., for the payment. In case of time bill, where the tenure of the bill is clearly stated,
the bill is presented for acceptance of the drawee to confirm the stipulated time for payment.
A bill should be presented for acceptance within a reasonable tenure after the drawing or
negotiation of the bill.

2. Presentation for Payment

If refers to presentation of a bill before the draw or acceptor or before the agent of the drawee or
acceptor for the payment of the bill on due date. The presentation for payment is subject to the
following rules:

 In case of "demand bill", the bill must be presented within a seasonable time after its
drawing or endorsement as the case may be,

 In case of time bill, the bill should be presented for payment on the due date.

 The bill should be presented for payment during the business hours of working days.

 The bill should be presented for payment at the proper place. The term proper place may
refer to any one of the following

(i) The place mentioned in the bill for payment.

(ii) Where no specific place is mentioned in the bill, the address of the drawee or acceptor.
(iii) Where no address is given, of any place where the drawee or acceptor can be found
including his residence.

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Banking in Pakistan
Q.4. What do you know about the development of banking in Pakistan.

Introduction
Pakistan came into being as a state of Muslims in the Sub-Continent on 14th August, 1947.
Pakistani banks follow the British pattern of banking system (Branch Banking). Before
independence, there were 44 banks having 631 branches in the areas of Pakistan including east
Pakistan (Now Bangladesh) and only 487 offices in the territories now comprising Pakistan.
At the time Pakistan was producing food grains and other agricultural raw material exports. There
were particularly no important industries and agricultural produces were mostly being exported.
However commercial banking facilities were provided fairly well here. But shortly after
independence, the number of banks and their branches as the Hindu bankers migrated to India
from Pakistan. In addition majority of Hindus residing in the territories now constitute Pakistan
started transfering their assets to India. By 30th June, 1948, the number of offices of scheduled
banks in Pakistan declined from 487 to only 195. Then this country faced a great banking crices.
There were 19 non-Indian foreign banks with the status of small branch offices which were
engaged financing of exports of Pakistani crops. There were only two Pakistani banks i.e., Habib
Bank which transfered its office from Bombay to Karachi and The Australasia Bank which was in
existance in the Pakistani territory. There was a panic of uncertain economic future which shook
the confidence of the people. The Government, therefore, promulgated the Banking Companies
Ordinance, 1947, to safeguard the interest of both the bankers and the public.
Under the prevailing critical situation at that time the Father of Nation Hazrat Quaid-e-Azam
Muhammad Ali Jinnah and his fellows in the Government felt much the need of sound was taken
and the State Bank of Pakistan was established on 1st July, 1948.
After the opening the State Bank of Pakistan took initiative for the development of banking
system. Many new commercial banks were established and they increased the number of their
branches day by day. For the growth and development of agricultural and industrial sector
specialized banks and other financial institutions were also setup and now the network of bank
branches covers a very large segment of national economy. By June 1988 the number of bank
branch office has increased to more than 7100 which are spreaded over in every nook and corner
of Pakistan.

Nationalization of Banks
The Government of Pakistan nationalized all the Pakistani banks on June, 1974. The ownership,
management and control of these banks stood transfered to and vasted in the Federal
Government. The shareholders were compensated by 15 years Federal Government bonds.
By December 31, 1973, there were 14 scheduled Pakistani commercial banks with 3323 offices
all over the country and 74 offices in foreign countries. Inspite of this tremendous growth and
development of commercial banks and their prominent role of financing in the country's economy,
it was felt that these banks failed to ensure that the resources flow in those sectors of economy
where they would produces goods and services needed badly by a very large number of people
in Pakistan. Therefore the nationalization of banks was considered necessary. On January 01,
1974, Pakistani Banks were nationalized under the bank (Nationalization) Act, 1974, with
following objectives.

1. To provide the fair distribution of credit. All the sector of economy will enjoy the credit facility.
2. The encourage and stimulate the effective nationalization of savings in the country.

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3. To provide social justice in the country by proper allocation of credit and financial resources to
different classes of the society.
4. To enable the Government to use the capital concentrated in the hands of a few rich bankers
for the repaid economic development of the country and the more urgent social welfare projects.
5. To co-ordinate the banking policy in various areas of feasible joint activity without eliminating
healthy competition among banks.
According to section 5 of this Act the State Bank of Pakistan; Industrial Development Bank of
Pakistan, The Punjab Provincial Cooperative Bank and all commercial banks incorporated in
Pakistan and carrying banking business in Pakistan or abroad have been nationalized and the
number was brought down to five.

Banking Council
For coordinating the planning and operations of banks and monitoring the cost of operation the
Pakistan Banking Council was set up under section 9 of the Bank (Nationalization) Act 1974.
The nationalized banks made good progress in expending the banking services in the nooks and
corners of Pakistan despite very low level of domestic savings and heavy dependence on foreign
borrowings. The number of branches which stood at 3397 on December 31, 1973, reached about
more than 7,000 by June, 1988. Similarly, the bank deposits which stood at 1925 crores of 1973
reached the high mark of Rs. 23,867 crores by June, 1988.

Organization of Pakistani Banking

Pakistani banking system was expended remarkably and it can be compared with banking
system of any developing country of the world. At present the banking structure in Pakistan
comprises of the following:

1. Central Banking
State Bank of Pakistan is the central bank of the country with its offices at Karachi, Hyderabad
and Sukkur in Sindh; Rawalpindi, Lahore, Faisalabad, Gujranwala, Sialkot and Multan in Punjab;
Peshawar in N.W.F.P and Quetta in Balochistan. Central Office is located in Islamabad.

2. Commercial Banking
Commercial banks have been the most effective mobilizors of savings and have been providing
short term requirements of working capital to trade, commerce and industry. After nationalization
commercial banks have been providing short term finance to agricultural sector also.
After the nationalization in 1974 all the 14 commercial banks were reorganized and merged into
the following five banks:

 National Bank of Pakistan

 Habib Bank Limited

 United Bank Limited

 Muslim Commercial Bank Limited

 Allied Bank of Pakistan Limited

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The other banks were merged in these banks. Bank of Bahawalpur was merged with the National
Bank of Pakistan; Habib Bank (Overseas) Limited, and Standard Bank Limited were merged with
Habib Bank Limited; Premier Bank Limited with Muslim Commercial Bank Limited; Commerce
Bank Limited with United Bank Limited and Sarhad Bank Limited and Pak Bank Limited with
Australasia Bank Limited and renamed as the Allied Bank of Pakistan Limited.

3. Exchange Bank
Foreign bank generally have been engaged in financing the foreign trade but they are fully
authorised to discharge normal banking functions including the acceptance of deposits from
public. At present there are eighteen foreign banks with 64 branches. They are located in Karachi
and other commercial cities of Pakistan. The State Bank of Pakistan does not allow them to open
branches in small towns in the interior of the country.

4. Savings Banks
Post Office Savings Bank is the only Saving Bank in the country. It is controlled by the
Government of Pakistan. It accepts deposits from public and invest them in various Government
projects.

5. Co-operative Banks
Generally there are three systems of cooperative banking in Pakistan. They consist of primary
cooperative societies at the base; Central Cooperative Banks and Banking Unions in the middle
and Provincial Cooperative Banks at the top. There are four Provincial Cooperative Banks, one
each in Punjab, Sindh, N.W.F.P and Balochistan; 52 central cooperative banks and Banking
Unions and above 28,000 primary Agricultural and credit societies.
These cooperative banks are integrated taking a very active part in the promotion of thirft, self
help and mutual aid among agriculturalists and others with common economic needs as as to
bring about better living, business and production.

6. Specialized Financing Institutions

These institutions are Government sponsored corporations. The main objective of these
institutions is to stimulate the development of country's economy by providing capital resources
and technical advice to industrial and commercial and agricultural sectors. They provide long term
and medium term credit to these sectors.

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