Banking Notes B.COm Part 2!

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* Introduction of Banking System

* Central Banking

* Bill of Exchange

* Banking in Pakistan

Q.1. Define Bank and explain that banking system of a country helps in its economic development.


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 Banke.

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 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

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

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.


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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.

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.


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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

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

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.

(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.


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(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 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.


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Q.2. Define Central Bank. State the origin and growth of central bank.


What is credit control, explain the various methods of credit control followed by the central bank of a country?

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

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.



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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.

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.


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.

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 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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Q.3. Discuss the different types of bill.

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

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

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.


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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.

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


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.



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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.

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

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.