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  • 1. Banking B-Com Part 2 Banking- Finance NotesQ.1. Define Bank and explain that banking system of a country helps in itseconomic development.ORWrite short notes on, * Industrial Bank, * Agricultural Bank, * CooperativeBank, * Exchange Bank, * Mortgage Bank, * Savings BankMeaning of BankIt is generally said that the word "BANK" has been originated in Italy. Inthe middle of 12th century there was a great financial crisis in Italy due towar. To meet the war expenses, the government of that period imposed aforced subscribed loan on citizens of the country at the interest of 5% perannum. Such loans were known as Compara, Mintuo etc. The most commonname 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 wordBanke.It is also said that the word Bank has been derived from the word Bancowhich means a banch. The Jews money lenders in Italy used to transacttheir business sitting on banches at different market places. When any ofthem used to feel to meet his obligations, his banco or banch would bebroken by the angry creditors. The word Bankrupt seems to be originatedfrom broken banco. Since, the banking system has been originated frommoney lending business, it is rightly argued that the word Bank has beenoriginated from the world banco.Today the word bank is used as a comprehensive term for a numberinstitutions carrying on certain kinds of financial business. In practice, thework Bank means which borrows money from one class of people and againlends money to another class of people for interest or profit.Definition of Bank
  • 2. Bank is defined in many ways by various authors in the books on economicsand commerce. It is very difficult to define a bank, because a bankperforms multifarious functions. Different kinds of bank having differentfunctions may be defined in different ways according to their functions.The evolution of different type of banks, each specialization in a particularfield, gives emphasis on each and every kind of bank. A general andcomprehensive definition to cover all types of banking institutions would beunscientific and probably impossible. Each type of bank should have its owndefinition explaining its specialized functions. Legislators have understoodthis difficulty and that is why the Bill of Exchange Act 1882 (England)defines thus A bank includes a body of persons, whether incorporated ornot, who carry on the business of banking.From this definition it is clear to us that any institution which performs thevarious banking functions may be termed as bank. But in practice it is foundthat 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 bankingfunctions at the time. So there originated numbers of specialized bankswith 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 theordinary courses of business honours cheques drawn upon him by persons forwhome he receives money on current account. According to Sir John PagetNo 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 paycheques drawn upon himself (iv) collect cheques crossed and uncrossed forhis 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 orBanker or Banking and accepting deposits of money subject to withdrawal bycheque, draft or order.Banking Ordinance 1962 (Pakistan) defines Banking as Accepting for thepurpose of lending or investment of deposits of money from public,repayable on demand or otherwise and withdrawal by cheque, draft, orderor otherwise. Vise Sec. 5(1) and 5(B) Banking Cos Ordinance, 1962.
  • 3. In view of the above definitions, a simple and short definition can be givenas Bank is an institution which deals in money and credit. According to thisprecise definition A bank accepts deposits of money in savings and currentaccounts at lower rate of interest or profit and gives on credit to needypersons and businessmen at a higher rate of interest or profit. It alsotransfers money for the clients from one city or country to another andalso performs various other agency services for earnings.Importance of BankingBank play a significant role in the economic development. The overalleconomic of a country is absolutely dependent on the efficient bankingsystem. Industrial, agricultural and commercial progress of a country is notpossible without a good banking system. The importance of banking may bestated as follows:1. Capital FormationEconomic development depends upon the division of economic resources fromconsumption to capital formation. Capital grows out of savings. Banks playthe prime role in accumulating capital by collecting the scatered savings ofthe people. Thus banks render a valuable service towards the developmentof a country by encouraging the growth of capital.2. Inexpensive Media of ExchangeModern Banking provides inexpensive media of exchange. Issuing of currencynotes is a great achievement of modern banking. In addition the chequesissued on the banks are frequently used instead of money in transactingbusiness. Thus the cheques economise the use of currency notes.3. Development of Trade and IndustryBank utilise their collected funds by advancing loans to commercial andindustrial undertakings. In respect of foreign trade also, banks render avaluable service by issuing letter of credit etc.
  • 4. 4. Reservoirs of FundsBanks acts as the reservoirs of money in the country. In times ofeconomic, crisis the bankers come forward to help the Government bypurchasing the Government securities or by advancing loans.5. Transfer of FundsBanks facilitate the transfer of funds from one place to another safely andat a very cheap cost through bank drafts, mail transfers, telegraphictransfer, travellers cheque etc.6. Dealing in Foreign ExchangeBanks deal in foreign exchange by purchasing and selling foreign currenciesand by issuing letters of credit. Foreign remittances of funds are possibleonly through banks.7. Money Market OperationsThe structure and ups and downs of money market in the country arelargely dependent on the bankers activities. Under the guidance of thecentral bank all the banks in the country do their best for the soundmanagement of money market.8. Service to CustomersBanks perform various agency services on behalf of their customers. Theycollect or make payments of bills of exchange, dividend, insurance premiumetc, on behalf of their customers. They act as the trustees ore executorsof documents etc. They also extend financial advises to their customers.Functions of Modern BankThe following is the list of functions or services rendered by a modern
  • 5. 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 oftheir 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 behalfof its customers.17. The bank makes payments and collects in respect of subscriptions,insurance premiums, rents, salaries etc, and also receives pension dividendsand payment of utilities bills on behalf of their customers.
  • 6. 18. Bank advances loans and extend financial advices to its customers.19. Bank Discounts Bills.20. Bank purchases and sells stock exchange securities.Qualities of Good Banking SystemEvery bank is a dealer in money and credit. It generally deals in withothers money and not with its own money. It takes deposits from the publicand 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 havesome qualities in operating its functions efficiently and successfully. Thequalities of good banking may be summarized as below"1. Adequate CapitalA banker must have adequate amount of capital. A large scale operationand execution of various functions of a modern bank require large amount ofcapital at the initial stage. Thus, without sufficient capital no large scalebanking can flourish.2. Good ReputationReputation is the most important factor in the progress of a bank. To besuccessful, a bank must have ample reputation in the money market.Reputation of a bank depends upon the qualifications of the directors andon the efficiency of management and workers.3. Liquidity.Money which is dealt in by a bank is not its own, so a banker must alwayskeep himself ready to meet the claims of his depositors. He should keepsufficient amount of cash reserve and should keep some assets in such away that these can be encashed at any moment. He should not block his
  • 7. fund by advancing loans for long periods rather he should always prefershort term credits.4. Security and SafetyIn respect of advancing loans safety should be the main guiding principle fora bank. The loans advanced by the banker must be secured. The persons towhom the advance is to be made, must be studied carefully before thelending of money. According to R.S. Sayers, The good banker is one whocan distinguish the sound from the unsound borrower.5. EconomyEconomy in expenditure should be maintained for the proper operation ofbanking business. A good banker will always try to maximise his profit at aminimum cost.6. Effective PublicityA bank should adopt various scientific methods of advertisement for theproper publicity of business.7. LocalizationGood locality of a bank is another quality. The bank should be located inthe business centre so that it can flourish its business successfully.8. SpecialityTo be successful, a bank should be specialized in any one or more fields ofbanking. An agricultural bank always aim at financing the formers foragricultural purposes. Industrial bank provides long terms credits to theindustries. The individual commercial banks are also specialized in differentfields of banking.
  • 8. 9. Good Show within the OfficeThe bank office should be well equiped with modern aminities proper sittingarrangement should be made within the bank office for its customers.10. Good Personnel and EfficiencyThe officers and the employees of the bank must be efficient in theirwork. They should be well trained in different fields of banking.Furthermore they should be well behaved and polite in the manner and mustpossess pleasing personality.Classification of BanksThe 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 ClassificationBanks 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 BankingUnder branch banking system, banking business is carried on through anetwork of branches in the same town or country under the guidance andcontrol of one single head office. These branches may also be located inoutside of the country. This system of banking was originated in the UnitedKingdom. Now-a-days this system if followed by many countries of theworld including Pakistan.
  • 9. (b) Unit BankingUnder unit banking system the banking operations are carried through asingle office without any branch. Remittances and foreign exchange etc,are dealt through correspondence between banks of two places. The U.S.Ais the home of unit banking.Advantages of Branch Banking1. Large Scale OperationBranch banking system enjoys all the advantages of large scale operation.Proper division of labour is applied successfully and the employees becomespecialized in different banking fields.2. Economy of ReservesUnder this type of banking, the funds can easily be transferred from onebranch to another. So full economy in maintaining cash reserve can besecured by a banking having number of branches.3. Remittances of FundsThis system facilitates easy remittances of funds from one place toanother through its number of branches in different places.4. Spreading Risk GeographicallyThe bank having many branches can spread its risk geographically orterritorially. In case of losses incurred by branch in an area can be offsetby profits of the branches of other areas.5. Parity in the Rate of InterestBy making easy movement of funds from one place to another branchbanking system can maintain parity in the rate of interest in differentparts of the same country or of the world.
  • 10. 6. Wise Banking PolicyThe bank can formulate a wise banking policy. As it has got a good numberof branches throughout the country. It can study money and credit positioncorrectly. Loans and advances are made on merits and not on otherconsideration. Applications for large amount of loan are passed on to thehigher authorities in head office.7. Investment of Idle FundsUnder branch banking system a branch can transfer its idle funds to otherbranches where this can be invested on profitable terms.8. Foreign ExchangeAs it has got foreign branches it is easier to operate foreign exchange fora branch banking.9. Superior Management and Personnel TrainingBranch banking system having large scale operations attracts superiorpersonnel and offers wide scope for the training of the personnel.Disadvantages of Branch BankingThe critics of the branch banking mentioned the following disadvantages:1. Loose Control and ManagementUnder branch banking system, it becomes very difficult for a single headoffice to manage and control a number of branches much effectively.2. Red Tapism
  • 11. Red-Tapism and delay is common due to lack of sufficient authority tobranch 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 EmployeesDue to large number of branches the relationship between the employersand employees is not close and cordial.4. Late DecisionA branch banking a large organisation, can take neither quick decision norprompt action in case of emergencies.5. Concentration of Financial LesourcesIn branch banking system large financial resources are concentrated in thehands of small number of authorities of bank.Advantages of Unit Banking1. Easy Management and ControlUnder unit banking system, it becomes very easy for a single office tomanage and control efficiently.2. Close Management and Workers RelationshipUnder unit banking system, there prevails a close and cordial relationshipbetween employer and employees.3. Quick DecisionThe owners or the management of unit banks can take quick decision and
  • 12. prompt action in times of emergencies.4. Use of Local ResourcesLocal financial resources are used for local development.5. Lesser Fraud and IrregularitiesDue to the less scattered affairs of the bank, there are very littlepossibilities of fraud and irregularities.Disadvantages of Unit Banking1. Limited Size of OperationUnit bank business can not be operated on large scale because of its limitedarea. Being the small organisation, division of labour can not be applied.2. No Economy of ReservesUnder 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 ResourcesA unit bank has limited financial resources so it is not able to provide fulland adequate banking facilities to the industry and trade of the area.4. Investment of Idle FundsA unit bank having no other branches, can not utilize its idle funds inprofitable ways.5. Disparity in the Rate of Interest
  • 13. Under the system, there prevails a great disparity in the rate of interestin the same country as the management of different banks are separatefrom each other.Operational Classification of BanksOn the basis of nature of operation, banks can be classified into thefollowing two categories.(a). Correspondent BanksThe unit banks, having no branch are linked together by correspondent banksystem. Under this system, a unit bank of a village or small town deposits aportion of its cash reserve with another bank in the nearest city. And thissuperior bank of city also deposits with another greater bank of big city.These unit banks are linked through correspondence. Remittances of fundsof home and foreign trade transactions are made through thesecorrespondent banks. The unit banks are completely independent of eachother no doubt, but these are connected with one another throughcorrespondent system.(b). Specialized BanksThe bank which performs one or more special functions is known asspecialized bank. As for example an agricultural bank takes up the specialresponsibility of financing agricultural activities. Industrial banks speciallyfinance the industrial undertakings. Japan is the home of specialized bankswhere different types of specialized banks are working with their specialfunctions.The specialized banks have a great role in the economic development of acountry, specially of a developing country like Pakistan.In our country, Agricultural Development Bank of Pakistan is helpingfinancially in the development of agricultural sector of our economy. TheIndustrial Development Bank of Pakistan is another specialized bank who isfinancing large scale industries in Pakistan.
  • 14. Functional Classification Of BanksBanks may be classified according to their functions. Different kinds ofbanks, with different functions may be summarized as follows:(a) Central BankA central bank is the most important institution in the banking system of acountry established with the objective of regulating the banking andmonetary system of the country. It issues notes and currencies within thecountry and is entrusted with responsibility of maintaining the price level inthe country stable. It acts as banker to the Government and it directly orindirectly controls the activities of all other banks. State Bank of Pakistanis Central Bank of our country.(b) Commercial BankSuch type of bank is cheerfully engaged in financing internal trade. It dealsin short term credit. It takes deposit from public through different type ofdeposit accounts and invests that collected fund in advances and loan ofshort period to the trading and commercial undertaking. This type of bankis familiar in most of the world. In our country, for example, National Bankof Pakistan, Habib Bank Limited, United Bank Limited, Muslim CommercialBank Limited and Allied Bank Limited are the commercial banks.(c) Industrial BankSuch institution specialises in financing industry. It provides long termcredit to people who carry on industrial enterprises. Industrial DevelopmentBank of Pakistan (IDBP) and Pakistan Industrial Credit and InvestmentCorporation (PICIC) are the examples of industrial banks.(d) Agricultural BankSuch bank provides long and short term finance to agriculturists for their
  • 15. agricultural purposes. Long term capital is required for acquisition andimprovement of land and purchase of heavy machinery and equipments.Short period capital is required by the farmers for current expenditure onseed, manures, wages etc. Agricultural Development Bank of Pakistan(ADBP) is the best example of agricultural bank in our country who provideslong term, medium term and short term loans to the agriculturists.(e) Exchange BankExchange bank deals mainly in the finance of the foreign trade of thecountry. It deals in foreign exchange. On otherwards, the main function ofsuch bank is to buy and sell foreign currencies, rather titles to foreigncurrencies in the form of bills of exchange, drafts, telegraphic transfersetc. It purchases the bill of exchange which arise in connection with theimport and export trade of the country and they deal in exchange. Theexchange banks liquidate the international indebtiness by exporting andimporting precious metals and securities, if necessary, they purchase bills inthe international money market and deposit them with their banking agentsinbig commercial centres like London, Paris, New York etc. They draw andsell their own drafts on these deposit accounts.(f) Cooperative BankThis type of bank is organised mutually by the persons of similaroccupations within the objectives of providing banking and credit facilitiesto the members. Generally in every country. Government patronises co-operative banks in order to encourage the cultivators, fisherman, workers inthe factories etc.(g) Mortgage BankMortgage bank advances long term credits against securities of immovableproperties like, agricultural lands, buildings and machinaries etc. Generally,credit is give to the agriculturist, small industries or house builders. Thistype of bank is essential in an under developed country where capital supplyis very limited. In our country, House Building Finance Corporation isfunctioning as mortgage bank providing long term loans to house buildersagainst securities of building and land property.
  • 16. (h) Savings BankSuch banks provides facilities to people to save money. This type of bank isestablished with the objective of promoting the thrift or saving habitsamong the people of small incomes. It takes deposits from the public andlands the collected funds to traders. Depositers are allowed to withdrawmoney from their deposits twice in a week. Post offices in Pakistan carry onfunctions of saving bank. Of course commercial and other bank also acceptsaving deposits.Q.2. Define Central Bank. State the origin and growth of central bank.ORWhat is credit control, explain the various methods of credit controlfollowed by the central bank of a country?Definition of Central BankIn every country, there is a principal bank who is responsible for guidanceand regulation of the financial system in the country. Such type of bank isknown as Central Bank.A Central Bank may be defined asThe principle banking institution of a country operating under some degreeof state control and entrusted with the special responsibility of maintainingeconomic equilibrium and stability in the prices and in the over all interestof the country.Nature of Central BankFrom the above definition we find the following main features of CentralBank:
  • 17. 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, thestructure of central banks vary from country to country. In U.K. andFrance, the bank of England and Bank of France are solely owned, managedcontrolled by the state on the other hand, Federal Reserve System, theCentral Bank of the U.S.A is owned, managed and controlled by the privateshare holders. Of course, there are some central banks which are owned,managed and controlled jointly by the Government and the private shareholders. e.g., State Bank of Pakistan before nationalisation 1974.3. The Central Bank is entrusted with the responsibility of maintainingeconomic equilibrium and stability in prices by controlling money supply andvolume of credit with in the country.4. A central bank does its works not for making profit but in the overallinterest of the country.5. The central bank is reservoir of credit. All other banks can look to itfor accomodation.Functions of Central BankThe central bank is the pivote of all the banking system. The chieffunctions of a central bank may be described as follows:1. Issuing NotesThe central bank has the sole responsibility and monopoly of issuing noteswithin the country. It is the sole currency authority. The central bank isrequired to keep a certain percentage of gold reserves against issue ofnotes. Usually, it keeps 30% to 40% gold as reserve. It undertakes
  • 18. expansion and contraction of the currency alongwith business demand.Money supply is raised by issuing notes. On the other hand, it can decreasemoney supply by selling government securities. By enjoining monopoly of noteissue it gives uniformity to the system of note issue in the country.2. Governments BankerThe 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 ofthe government but it also manages the public debts. It keeps thegovernment funds in the custody free of interest. On the other hand itgives loans to the government without limitation of amount. It is the fiscalagent of the government. It helps the government in designing a fiscalpolicy for the country so its also plays the role of financial adviser to thegovernment.3. Bankers BankIt acts as the custodian of cash reserves or balances deposited compulsorilyby the scheduled banks. Either by law or custom the member banks are tokeep certain portion of their deposits with the central bank as reserve. Forexample in our country the scheduled or commercial banks are to keep cashreserve with State Bank of Pakistan to the extent of 5% of their deposits.Central Bank also provides short term credit to commercial banks byrediscounting first class bills and other securities. So it plays the role ofbankers bank.4. Management of Gold StandardWhere the currency of a country is on gold standard, it is theresponsibility of the central bank to manage the gold standard in order tocontrol the stability of exchange rate. It regulates and checks themovement of gold in the country. The management of gold standard is not
  • 19. so vital and important these days.5. Credit ControlIt is another important function of central bank. It controls the flow ofcredit in accordance with the needs of business in the country. Credit playsan important role as the medium of exchange, so its expansion orcontractors effects the price level in the country. In order to maintainstability in the price level, central bank controls the volume of credit.Usually, it controls credit by changing bank rate, purchasing and sellingsecurities and by changing reserve rates of the member banks. In this waycentral bank attempts to control the volume of credit and stablishes thebusiness conditions in the country.6. Clearing HouseIt is the Clearing House of the bankers. Under this function central bankof facilitates the settlement of bills and cheques of other banks.7. Exchange ControlIt is the responsibility of the central bank of control foreign exchange andmaintain the rate of exchange. It purchases and sells approved foreigncurrencies at the current or fixed rate. It also acts as the custodian offoreign exchange reserve.8. Lender of Last ResortAs lender of last resort, it is implicit that the central bank assumes theresponsibility of meeting directly or indirectly all reasonable demands foraccommodation by commercial banks in the times of difficulties and crises.If any commercial bank faces any serious financial difficulty for any
  • 20. reason, it is central bank who comes forward to help it.9. Custodian of National ReserveThe Central Bank acts as the trustee of the entire economy of the countryand thus keeps in its custody all national reserves in form of gold, silverand securities.Credit ControlCredit plays an important role in maintaining and changing the price level asmedium of exchange. It is the responsibility of the central bank to regulatethe volume of credit and its direction to maintain stability in the pricelevel.Following are the main objectives of credit control by central bank1. Safe Guarding the Gold ReservesThe central bank adopts various measures of credit control to safe guardthe gold reserves against internal and external drains.2. Stability in Price LevelCredit control provides stability in price level in the country.3. Exchange StabilityAnother objective of credit control is to achieve the stability of foreignexchange rate. If the foreign exchange rate is stabilized, it indicates thestable economic conditions of the country.
  • 21. 4. Stability in Investment and ProductionControl of credit by central bank also provides stability in the investmentsand production by making price level stable.5. CooperationControl of credit is done to promote cooperation with other countries forthe purpose of maintaining world economic stability.Methods Or Techniques of Credit ControlThe central bank usually controls the volume of credit through the twotypes of methods, quantilative and quantitative.1. Bank Rate PolicyIt is also known Discount Rate Policy. Bank rate is the rate of interestwhich is charged by the central bank on rediscounting the first class billsof exchange and advancing loans against approved securities. This facility isprovided to other banks.ImportanceThe bank rate is different than the money market interest rate. Thecharges in bank rate are followed by other banks in the country in changingtheir interest rate. If the bank rate is raised by central bank, other ratesof money also go up. Conversely, the market rate of interest and otherrates go down, when central bank decreases its bank rate. These changeseffect the supply of and demand for money. Borrowing is discouraged whenthe rate of interest increases and encouraged when the rate decreases.
  • 22. Effects of Changes in Bank RateThe changes in the bank rate may cause the following effects.a. Changes in Deposit VolumeWhen the central bank increases the bank rate, commercial banks alsoincrease the rate of interest and consequently the deposits of the banksalso increase. Conversely, when bank rate is decreased the deposits ofcommercial bank also decrease.b. Controls the BorrowingsWhen the bank rate is raised, the rate of interest and discount of otherbanks goes up margin of profit falls and it discourages the businessmen toborrow money and thus the volume of loans and discounting of bills isminimised. On the other hand a fall in the bank rate encourages loans andbill discounting.c. Changes in the Prices of Shares and SecuritiesA rise in bank rate makes shares and securities in the market cheaper andconversely, by a fall in the bank rate, shares and securities becomesdearer.d. Changes in the Volume of Speculative BusinessA rise in the bank rate restricts the volume of credit and discouragesspeculative business. But the volume of speculative business is expended dueto the increase in the credit supply.
  • 23. e. Changes in the Foreign TradeA rise in the bank rate encourages export and discourages import. A fall inthe bank rate encourages import and discourages export. When the bankrate is raised, the demand for home currency goes up and the demand forhome currency falls with in the bank rate.f. Changes in Balance of PaymentDue to rise in the export trade, a rise in bank rate causes a favourablebalance of payment. But a fall in bank rate causes an unfavourable balanceof payment.2. Open Market OperationThe open market operation means the buying and selling of securities by thecentral bank in order to influence the money and credit supply in thecountry. This technique is effective upto some extent in both conditions ofinflation and deflation.3. Change in Reserve RationThe member banks of central bank are required either by law or custom tokeep a certain percentage of their deposits with the central bank. It iscalled as Cash Reserve Ratio. The central bank may controls credit bychanging the reserve ratio. When the reserve ratio is increased themember banks to some extent are discouraged to bank money. When thisratio is falls, the member banks are encouraged to expend credit.Clearing House
  • 24. The central bank manages and supervises the clearing house to facilitatethe clearing of cheques between banks. Every banker usually receivesnumber of cheques drawn on other banks from his customers as deposits. Inother words banks receives cheques drawn on other banks from theiraccount holders. As a result, there arises inter bank indebtedness. Forexample 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 owesRs. 6,000/= to National Bank.Inter bank indebtednesses are settle through a central organisation knownas Clearing House. "A clearing house is a general organisation of banks of agiven place, having for its main purpose, the off setting of cross obligationsin the form of cheques. The indebtednesses of the member banks aresettled only by paying the differences. Generally central bank of thecountry performs the function of clearing house. In Pakistan, State Bank ofPakistan performs the duty of clearing house.Role of Central Bank in Economic DevelopmentThe economic stability of a country is solely dependent on the Central Bank.It is the only financial institution in the country which is responsible forregulating the banking and monetary system of the country. The need of acentral bank in a country is essentially felt considering the followingservices rendered by a central bank for economic development of adeveloping country.1. Capital FormationEconomic progress of a country requires adequate amount of capital. Capitalis required for agriculture, industrial and commercial development. But in adeveloping country like Pakistan. It is a chronic problem to procure capital.
  • 25. Central Bank as a national institution plays prime role in capital formation inthe interest of the nation as a whole. As the guardian of the moneymarket, it regulates the capital flow in the country in proper form andsuitable time.2. Credit ControlCredit is one of the most important source of financing trade and industry.The central bank as the controller of credit can encourage a particularsector of economy by adopting selective credit control.3. Developing Banking SystemAs a guardian of all banks, the central bank works for the development ofbanking system of the country.4. Protecting Interest of the DepositorsThe central bank protects the interest of the depositors in banks byguiding, controlling and checking the member banks operations in thecountry.5. Stability in PricesThe central bank keeps the price level stable in a country by controllingmoney and credit supply.6. Advice to the GovernmentThe Central Bank extends valuable suggestions and advices to theGovernment in respect of economic and monetary policies.
  • 26. 7. Personnel TrainingThe central bank in some countries provides training facilities to the bankpersonnel.Q.3. Discuss the different types of bill.Definition and Salient FeaturesAccording to Negotiable Instrument Act a Bill of Exchange is "Aninstrument in writing containing an unconditional order, signed by the makerdirecting a certain person to pay on demand or at a fixed or determinablefuture time, a certain sum of money only to, or to the order of a certainperson 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 ofthe drawer the bill will not be genuine one.4. The order to pay under a bill must be addressed to a certain personwhich, 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 personor to the bearer of the instrument.
  • 27. 8. The amount should be payable either on demand or at a fixeddeterminable future time.9. The bill must be duly stamped.10. The other formalities like dating, stating the names of the partiesconcerned etc. must be observed.Parties to a Bill of ExchangeFollowing are the various parties related to a bill transactiona. The DrawerThe person who draws the bill and puts his signature on it is known as thedrawer of the bill. He is also called the "maker" of the bill.b. The DraweeThe person on whom the bill is drawn is called as the drawee of the bill.c. The AcceptorThe 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 alsoaccept a bill on behalf of the drawee. The acceptor puts down his signatureacross the bill showing his acceptance.d. The PayeeThe person to whom the amount of bill is to be paid is known as payee of
  • 28. the bill. The drawer may make the bill payable to himself or to any otherperson he likes.e. The EndorseeThe holder of the bill may endorse the bill in favour of someone else knownas endorsee. The person who endorses the bill is called endorser.f. The HolderThe person who holds the bill and is entitled to realise the amount of thebill from the drawee is known as holder of the bill.Types of BillsBills may be of the following types:a. Inland BillsInland bill means the bill which is drawn and payable within the samecountry. Thus, the bill which is drawn in Pakistan and will also be paid inPakistan is termed as an inland bill.b. Foreign BillThe bill which is drawn in one country and accepted and payable in anothercountry is known as a foreign bill.c. Accommodation Bill
  • 29. The bill which is drawn and accepted by the parties concerned for theirmutual accommodation with a view to raise money by negotiating it, is knownas an accommodation bill. The parties concerned bind themselves as thedrawer and the acceptor without any valuable consideration.d. Demand BillThe bill which is payable "on demand" or "on presentation" or "at sight" isknown as demand bill.e. Time BillThe bill which is payable at a fixed or a determinable future time is knownas 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 asafter date bill.* Sight Bill:The bill whose date of payment is counted from the date of acceptance isknown as after sight bill.f. Documentary BillWhen 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
  • 30. When bills are handed over to a bander by his customer in order that theymay be collected when due and the proceeds credited to the customersaccount. They are called as Bills for Collection.h. Bills NegotiatedThe bills for which the banker has given the value at once, without waitingfor the proceeds after collection.i. Bills in SetWhen 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 areworded exactly in the same language except that the parts are numberedas "The 1st of exchange", "2nd of exchange" etc.j. Bills RetiredWhen a bill is withdrawn from circulation or taken back before it is due, itis known as "retired bill".Discounting of BillsA time bill is payable on future date and the holder of the bill is to waitfor a specific period of time to receive the amount of the bill. But themodern commercial banks are providing the facilitates of discounting of billto the holder to have money earlier. For discounting of bill, the bankpurchases the bill from the holder at a reduced rate before maturing ofthe 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 knownas "discount" and it is charged on the basis of interest rate. Thus,
  • 31. discounting of bill is a sort of short term credit given to the holder of thebill by a banker and the discount forms the profit to him.Discounting of bill very useful from the point of view of traders andbankers. It benefits the importer, exporter and bankers equally. Theexporter or seller can get immidiate cash as soon as he handed over thegoods to the transporters. The importer or buyer gets enough time to sellthe goods after having received it. The bankers earn a lot by effectingthese transactions.Precautions in Discounting a Bill of ExchangeLike advancing other loans and credit, discounting of bills also is a veryrisky job on the part of the banker. He must be careful and cautious withdiscounting the bill of exchange and must take the following precautions aremeasures in discounting of bills:1. He should examine financial standing of the holder and acceptor of thebill. If the parties concerned have bank accounts with him, the banker caneasily 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 knowtheir financial position.2. The banker is also to examine the financial status of other partiesengaged in the bill.3. The banker should see whether the acceptor dishonoured any other billin past time.4. Th banker should satisfy himself whether the bill is a bonafied trade billwhich is accepted for value received in course of business. The bankershould, as for as possible, avoid the accommodation bills.5. The banker should examine the bill whether all the formalities as of
  • 32. date, stamp, signature etc, have been compiled with.6. He must see whether the bill is capable of being endorsed. If so, thebanker should see whether the bill is duly endorsed by the payee.Presentation of BillsBill has to be presented first of all before the drawee for acceptance andagain in due date it is to be presented before the acceptor for thepayment. Thus, presentation of bill may be of two types viz,1. Presentation for Acceptance2. Presentation for Payment1. Presentation for AcceptancePresentation for acceptance is made not only for the acceptance of the billbut also to fix-up the time, place etc., for the payment. In case of timebill, where the tenure of the bill is clearly stated, the bill is presented foracceptance of the drawee to confirm the stipulated time for payment.A bill should be presented for acceptance within a reasonable tenure afterthe drawing or negotiation of the bill.2. Presentation for PaymentIf refers to presentation of a bill before the draw or acceptor or beforethe agent of the drawee or acceptor for the payment of the bill on duedate. The presentation for payment is subject to the following rules:* In case of "demand bill", the bill must be presented within a seasonable
  • 33. 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 duedate.* The bill should be presented for payment during the business hours ofworking days.* The bill should be presented for payment at the proper place. The termproper 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 thedrawee or acceptor.(iii) Where no address is given, of any place where the drawee or acceptorcan be found including his residence.