3. Role of State Bank of Pakistan
Open Market Operation
Inflation Control
Capital reserve ratio
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4. State Bank of Pakistan
The State Bank of Pakistan (SBP) uses various monetary policy tools,
including Open Market Operations (OMOs) and capital reserve ratio, to
achieve its objectives of maintaining price stability, promoting
economic growth, and ensuring financial stability.
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5. The Traditional
Functions
The traditional functions performed
by the state bank of Pakistan can be
classified in two groups, which are
I. The Primary Functions
II. The Secondary Functions
6. The primary Functions
The primary functions of the state bank include:
• regulation and supervision of the financial system
• issuing of notes
• conduct of monetary policy.
• They also include the functions of state bank as the
banker’s bank, the lender of the last resort, and the
banker to government.
7. The Secondary Functions:
The secondary functions of the state bank include
the agency functions.
• The agency functions include functions like
Management of public debt
Management of foreign exchange
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8. • Other functions like the maintaining close
relationships with international financial institutions, and
advising the government on policy matters
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9. Open Market Operations:
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Open Market Operation, any of the purchases and sales
of government securities and sometimes commercial
paper by the central banking authority for the purpose of
regulating the money supply and credit conditions on a
continuous basis.
Open-market operations can also be used to stabilize the
prices of government securities, an aim that conflicts at
times with the credit policies of the central bank.
10. Open market operations are one of three tools used by the Fed to
affect the availability of money and credit.
The term refers to a central bank buying or selling securities in the
open market to influence the money supply.
The Fed uses open market operations to manipulate interest rates,
starting with the federal funds rate used in interbank loans.
Buying securities adds money to the system, lowers rates, makes
loans easier to obtain, and increases economic activity.
Selling securities removes money from the system, raises rates,
makes loans more expensive, and decreases economic activity.
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11. How Open Market Operations Work
It’s important to understand that the Federal Reserve can buy or sell
securities, including government securities like Treasury bonds. These
buy-and-sell transactions are the “operations.”
The term “open market” refers to the fact that the Fed doesn’t buy
securities directly from the U.S. Treasury. Instead, securities dealers
compete on the open market based on price, submitting bids or offer to the
Trading Desk of the New York Fed through an electronic auction system.
The use of open market operations as a monetary policy tool ultimately
helps the Fed pursue its dual mandate —maximizing employment, and
promoting stable prices—by influencing the supply of reserves in the
banking system, which leads to interest rate changes.
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12. Types of OMO
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The two types of open market activities are permanent open
market operations and transient open market operations.
Permanent Open Market Operations (POMO):
These involve the central bank of any country selling and
buying securities or treasuries on the open market in order to
change the money supply. It is a means of influencing the
economy.
13. Types of OMO
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Temporary Open Market Operations:
These are used to add or subtract reserves from or into the
banking system on a short-term basis. Repurchase
agreements, also known as Repos or reverse repurchase
agreements, or RRPs, are used for short-term open market
transactions.
14. Advantages of OMO
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The main advantages of open market operations are as
follows:
• This tool allows the central bank considerable flexibility in
the timing and scope of monetary policy activities.
• Open market operations also allow the government to avoid
the economic effects and market inefficiencies of more
direct control measures.
• The central bank can maintain inflation at a certain range,
which allows for steady growth while preventing an
uncontrolled increase in the prices of goods and services.
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Advantages of OMO
• When buyers of bonds deposit their money to a central
bank, it increases its reserve while lowering the capacity of
banks to offer credit.
• It also allows the central bank to control the money supply
in the economy directly. Using OMO, adequate liquidity can
be maintained in the banking system, and excess liquidity
prevented.
• This monetary policy tool also helps to check the value of
the domestic currency against foreign currencies.
16. Inflation Control:
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• The objective of SBP’s monetary policy is to achieve
price stability by controlling inflation close to its annual
and medium-term targets set by the government. At the
same time, SBP also aims to ensure financial stability,
particularly the smooth functioning of the financial
market and the payment system.
17. Understanding the Roots of
Inflation in Pakistan
Inflation in Pakistan is a complex issue that has several root
causes. Some of the major causes of inflation in Pakistan
include:
• Overpopulation and the demand-supply gap
• Shortage of electricity and gas
• Political instability and weak governance
• Currency devaluation and high inflation expectations
• Trade deficit and external shocks
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18. How to control inflation in
Pakistan?
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To control inflation in Pakistan, the government can
implement several fiscal policy measures, including:
• reducing government spending
• increasing taxes and duties
• implementing price controls
• encouraging investment and economic growth.
19. Role of monetary policy in
controlling inflation in Pakistan?
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Monetary policy is the primary tool used by the central bank
to control inflation in Pakistan. The State Bank of Pakistan
can use various monetary policy tools, including increasing
interest rates, reducing the money supply, and regulating
credit and lending, to control inflation.
20. Capital Reserve Ratio:
The capital reserve ratio is the percentage of a bank's total deposits that must be
held as reserves in the central bank. The SBP uses the capital reserve ratio as a tool
to control the money supply in the economy. By increasing the capital reserve ratio,
the SBP reduces the amount of money that banks can lend, thereby reducing the
money supply and controlling inflation. Conversely, by reducing the capital reserve
ratio, the SBP increases the amount of money that banks can lend, thereby
increasing the money supply and stimulating economic growth.
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21. The amount specified as the CRR is held in cash and cash
equivalents, is stored in bank vaults or parked with the
Reserve Bank of India. The aim here is to ensure that banks
do not run out of cash to meet the payment demands of their
depositors. CRR is a crucial monetary policy tool and is used
for controlling money supply in an economy.
CRR specifications give greater control to the central bank
over money supply. Commercial banks have to hold only
some specified part of the total deposits as reserves. This is
called fractional reserve banking.
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22. How Does Cash Reserve Ratio Work?
The cash reserve ratio is the portion of the cash that the central banks ask respective
commercial banking institutions to keep aside and not use for lending or investment
purposes. The minimum portion of the money to be held on to is known as the
reserve requirement. The commercial banking institutions might reserve the cash in
their vaults or deposit it with the central banks.
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24. Example
Suppose the Federal Reserve specifies the CRR as 9%. In such a scenario, a
banking institution with a deposit of $100 million can easily calculate the reserve
requirement to put in their vault or deposit with the Reserve.
Reserve Requirement= CRR * Deposits
= 9/100*100 million
= 9 million
Thus, the banks would require holding on to $9 million, which would further be
unavailable for lending and investment purposes.
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25. Cash reserve requirement (CRR):
CRR is the proportion of banks’ applicable time
and demand liabilities (TDLs) that they are required to hold in
the form of cash with the SBP on fortnightly average basis
(cash in vault of banks is not accounted for meeting the CRR
requirement in Pakistan.); while maintaining a (lower)
minimum reserve level with the central bank on daily basis
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26. Importance
• The reserve ratio helps banks and lenders obtain base rates at which they would
lend money to loan seekers. As the rate fixed by the central banks is the same for
all lenders, the national credit market becomes more trusted and transparent.
• Ensuring some liquid money is the main purpose of CRR, while its secondary
objective is to allow the central bank to control rates and liquidity in the economy.
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