Banking

INTRODUCTION TO BANKING
The term bank or banking is one of those terms that are increasingly being used in
business language. With growing importance of the financial sector of a country.
Banks are considered to be the major role players.

DEFINITION
A bank is an institution that deals in money. But this definition does not cover all
the aspects of banking business as it includes all persons dealing in money, which
is not true to be more perfect we can say that

“A bank is an organized house which borrows money from the people for the sake
of providing loan or services of monitory nature to businessmen or need person.”

EXPLANATION
An institution that accepts money of the people or organizations in the form of
deposits and does its business is called a bank. Banking system of a country refers
to the working process followed by the banking institutions. It is identify through
the relationship between the apex banks.

Origin of Banking
ORIGIN OF BANKING
It is very difficult to trace out the exact origin of banks. It is said that the evolution
of banking business is as old as the concept of money. Crowther in his book AN
OUTLINE OF MONEY says that the present day banker has three a sectors
merchants, money lenders and gold smiths. A modern bank is something of these.
It is believed that goldsmiths and grocers of primitive days started keeping
deposits of valuables and jewelries people on the basis of their sound financial
position in the community. They charged a certain amount from the depositors for
the service rendered in keeping and preserving the valuables in safe custody. But
they soon realized that only a small portion of metal and valuable deposited were
taken bark by the people even at the expiry of the stipulated period. They
 therefore began to make profit by lending a part of these deposits. In case of
lending, it was not always gold or silver, but issued their receipts which would
pass among the people as if they were gold just like cheques in modern banks.
The present day banks are performing the same functions as performed by the
money lenders and goldsmiths of older days. Therefore it is believed that
goldsmiths and moneylenders are the ancestors of banks.

Word “BANK”
The derivation of the World Bank has been differently given by different authors.
Same authors think that the word “BANK” has been derived from the Italian
word “BANCHI” or “BANCHERII”. The payable used in Italian Business
Houses. Some believe that it is derived from the German word “BANCK”
meaning heap or mounds. The first public bank of Venice established on 1157 is
considered as the first ever Public Bank.

KINDS OF BANKS
Some important types of banks are as follows

i. Central Banks.
This bank is of great significance in the banking system of a country. Central Bank
is considered as the Bank of government and directly or indirectly controls the
activities of all the banks operating in the country. State Bank of Pakistan is the
central bank of Pakistan.
ii. Commercial Bank
This is another most important type of the banking system. It is main function is to
receive deposits, advance loans and discounting of bills.

iii. Industrial Bank

These type of banks provide loans to industries. Generally these banks advance
loans for long periods.

iv. Agricultural Bank

The main functions of these banks is to provide loans for long and short periods to
the agriculturists. Long period loans are used for acquisition of and improvement
 f land while a short period loan is used for purchasing seeds manures and for
current expenditure.

v. Exchange Bank
These banks deal in foreign currencies in the form of bill of exchange, drafts,
telegraphic transfers etc. They buy and sell foreign currencies.

vi. Saving Bank

Saving Banks provide incentives to people of small means to save money. These
banks provide monetary facilities to the people.

vii. Land Mortgage Banks

These banks are meant to provide loans to agricultural by mortgaging their lands.
An agricultural has to mortgage his land if he nts to take loan from this
particular type of a bank.

viii. Co-Operative Bank

Such type of banks are usually run by co-operative societies through its members.
These are non- scheduled banks. They are meant for the benefits of the society
and its members.

IMPORTANCE OF A BANK
IMPORTANCE OF A BANK
The importance of the banking system to an economy no emphasis. A
well-organized banking system provides liquidity and mobility to the financial
resources available in the economy. It helps the economy in the following
regards.

1. BRING ECONOMIC STABILITY IN THE COUNTRY

The banks play a prominent role in providing stability to a country economically.
It helps in getting out of depression or inflation. During depression the banks
follow a cheap money policy and generate money income which pushes up the
consumption level and the economy gets price support to reactivate production
units and the produced level is enhanced which raises the employment level. The
investment rises to stimulate saving and to expand which further increases
 employment opportunities. Similarly the banks specially the central banks take
certain measures to control inflation in the economy. The central bank through it
is well adjusted monitory policy stabilizes the internal price level and thus
facilitates economic & development in the country.

2. CO-ORDINATION AMONG ALL THE UNITS

The banking system maintains a coordination among all the units which are
engaged in banking functions. It consists of collecting of surplus money from the
people and lending them to the entrepreneurs who utilize it for productive
purposes. Creating a country wide circulation of money through remittance
facilities. Activating idle money to make them productive Provide finance by
credit accommodation to different sectors of the economy.

3. ENCOURAGE SAVING
The banks encourage saving by providing safe custody and making it a source of
income to the persons who save. The people having surplus money arising out of
saving deposit it with the banks. The banks pay them interest and get them relief
from burden of safety and other risks.

4. ACCERATE INVESTMENT
The banks constitute constitute a source of accelerating investment in the
economy. The funds collected from the depositors are used for financing
development projects in the public and private sectors and for granting loans and
advance for raising the production level of the country.

5. CAPITAL FORMATION
In any plan of economic development capital occupies a place of pivotal
importance. Without capital nothing can be achieved effectively. Banks
obimulate capital formation in the country. Savings of the people is capitalized
through lending by banks.

6. CREATION OF MONEY
Banks create money in the sense that through credit granted to entrepreneurs,
whether to the private or government agents they increase supply of money
which they manage because of inflow of fund through deposits. The development
agencies manage to bridge the gap between the income and expenditure and thus
 the development work continues undisturbed

7. FACILITATE TRADE
The banks facilitate trade by furnish information regarding financial stability and
dealings of the parties in the market to customers. They provide remittance facility
to the entrepreneurs and help them in the settlement of transactions even at far
places.

ACCEPTANCE OF DEPOSITS
Acceptance of deposits is perhaps the major functions that a commercial bank
performs. It accumulates the scattered savings of the individuals and offers them
attractive incentives to make deposits in the form of profit. The bank accepts three
types of deposits from the public.

Fixed Deposit Account

Money in this account is accepted for a fixed period of time and cannot be
withdrawn before the expiry of that period.

Current Account
The deposits can withdraw money from this account whenever he wants to. The
banks generally grant no interest

CENTRAL BANK
CENTRAL BANK
A banking system of a country without a central bank at the top in like a human
body without a head. In the words of R.P. Ke e

“Central bank is an ins tution charged with the responsibility of managing the
entire monitory and banking affairs of the country in the nation’s interest.”

The Central bank is generally recognized as a bank which constitutes the apex of
its monitory structure, controls, directs and equalates the activities of other banks
operating in the economy. A central bank has direct dealings with the
governments and other banks. It is a separate branch of banking having distinct
 functions quite different from other banks. It operates not for profit sake. But
with an objective of bring in economic prosperity to the people and ensuring
economic stability in the country.

Functions of a Central Bank

A Central bank performs many important and essential functions which are
described as follows:

MONOPOLY OF NOTE ISSUE

Formerly in certain countries, many banks issued their own notes. This resulted in
uncontrolled confusion. Hence, gradually the right of note issue was withdrawn
from ordinary banks. Note issue became the sole privilege of the central bank.
Today the central bank in every country enjoys the exclusive privilege of bank
note issue.

BANK TO THE GOVERNMENT

This function of a central bank may be studied under the following two heads.

As Banker To The Government

As governments banker, the central bank keep the deposits or banking accounts of
government departments boards and enterprises. It advances short term loans to
the government in anticipation of collection of taxes or the raising of loans from
the public. It also makes extra- ordinary advances during depression, war or other
national emergencies.

As An Agent Of The Government

As an agent of the government the central bank is often entrusted with the
management of the public debt and issue of new loans and treasury bills on behalf
of the government. Moreover the central bank is the fiscal agent to the
government and receives taxes and other payments into its account. On this
account, On the other hand it levies certain charges on the customer for the
services rendered by it.

Saving / Profit & Loss Sharing Account

All the banks in Pakistan nearly have started accepting deposits only under Profit
and Loss Sharing Accounts where the deposi ors share in profit and loss instead of
getting interest (Commonly known as Profit).

ADVANCING LOANS
The second important function of a commercial bank is to advance loans. The
banks advance certain types of loans to their customers such as:

Ordinary Loans
Here the banks give a specified sum of money to a person or firm against some
collateral security. The loan money is credited to the account of the customer and
he can withdraw the money according to his requirements.

NON-COMMERCIAL FUNCTIONS
The non-commercial functions of the commercial banks are as follows.
 i. Agency Functions
Commercial banks act as the agents of their customers and perform agency
functions as transfer of funds from one place to another. Collecting customer’s
funds and crediting the same to their accounts. Purchase and Sale of shares and
securities, collecting dividends on the shares of the customers and payments of
insurance premium on policies of the customers.

ii. Purchase and Sale of Foreign Exchange

The bank also carries on the business of buying and selling of foreign currencies
Ordin rily their functions is performed by specialized banks known as Foreign
Exchange Banks.

iii. Financing Internal & Foreign Trade

The bank finances internal and foreign trade through discounting of exchange of
bills. This discounting business greatly finances the movement of internal and
foreign trade.

iv. Creation of Credit

When the bank grants loan to its customers it opens an ac out in the borrowers
name and credits the amount of the loan. Since the deposits of the bank circulate
as money the creation of such deposits lead to a net increase in the money stock
of the economy. This is known as Creation of Credit

v. Miscellaneous Functions
Bank performs different kinds of various services other than described above such
as collect utility of bills on behalf of Government and other authorities. Provide
valuable advice to customers about trade and business provide information about
sale and purchase of shares and act according to Government policy like
deduction of Zakat and Islamic blessing System etc.

Central Bank – Credit

The modern economy is a credit economy. Credit is the life-blood of modern
business. Accordingly control of credit is essential for stability and orderly growth
of an economy. There are two types of controls used by the central banks in
modern time for regulating bank advances.
i. Quantitive or General Control
ii. Quantitive or Selective Credit Controls
These are discussed below
 i. Quantitive or General Control.
The aim of Quantitive Controls is to regulate the amount of bank advances i.e. to
make the banks lend more or lend less. Some of the controls are

a. Manipulation of Bank Rate

The bank rate is the rate at which the central bank of a country is willing discounts
the first class bills. It is thus the rate of discount of the central bank. If the central
bank wants to control credit, it will raise the bank rate. As a result the market rate
will go up. Borrowing will consequently be discouraged. Those who hold stocks
of commodities with borrowed money will unload their stocks, since as a result of
the rise in the interest. They will repay their loans thus t e raising of bank rate will
lead to a contraction of credit.

b. Open Market Operations

The term open market operations in the wider sense means purchase or sale of any
kind of papers in which it deals like government securities or any other trade
securities etc. In practice this term is used to identify the purchase and sale of
government securities by the central bank. When the central bank sells securities in
the open market it receives payments in the form of a cheque on one of the
commercial banks. If the purchaser is a bank the cheque is drawn against the
purchasing bank. In both cases the result is the same. The cash balance of the bank
in question which it keeps with the central bank is to that extent reduced with the
reduction of its cash the commercial bank has to reduce its loading. Thus credit
contracts.

c. Varying Reserve Ratio

The varying reserve ratio method is comparative a new method of credit control
used by central banks in recent times. The minimum balance to be maintained by
the member banks with the central banks are fixed by law and he central bank is
given statutory power to change these minimum reserves. Variations of reserve
requirements affect the liquidity position of the banks and hence their ability to
lend. It reduces the excess reserves of member banks for potential credit
expansions.

d. Credit Rationing
Credit rationing means restrictions placed by the central bank on demands for
accommodation made upon it during times of monetary stringency and declining
gold reserves. The credit is rationed by limiting the amount available to each
applicant. Further the central bank restrict its discount to bills maturing after short
periods.

ii. Quantitive or Selective Controls

In this regard the following methods are used.

a. Varying Margin Requirement

The central bank controls credit by varying margin requirements. While lending
money against securities the bank keeps a certain margin. They do not advance
money to the full value of the security pledges for the loan. If it is desired to curtail
bank advances the central bank may issue directions that a higher margin be kept.
The raising of margin requirements is designed to check speculative in the stock
market.

b. Regulation of Consumer Credit

A part from credit for trade and industry a great deal of credit in development
countries at any time may be for durable consumer goods like houses, motor cars,
refrigerator etc. on purchase or installment credit system. Central seek to control
such credit in several ways. E.g. by regulat ng the minimum down payments in
specified goods. by fixing the coverage of selective con umer goods by regulating
the maximum maturities on all installments credits.

c. Direct Action
Direct action implies measures like refusal on the part of the central bank to
rediscount for the banks whose credit policy is not in accordance with the wishes
of the central bank or whose borrowings are excessive in relation to their capital
and reserves.

d. Moral Sausion
The central bank may request and persuade member banks to refrain from
increasing their loans for speculative or non-essential activities.

e. Publicity
The method of publicity is used by issuing of weekly statistics, periodical review
 of the money market conditions, public finances, trade & industry the issue of
weekly statements of assets & liabilities in the form of balance sheets.

BANKER’S BANK
Broadly speaking the central bank acts as a bankers bank in three capacities.

i. As the Custodian of Cash Reserves

In every country its commercial bank keep a certain percentage of their cash
reserves with the central bank. Inf ct the establishment of central bank makes it
possible for the banking system to secure the advantages of centralized cash
reserves.

ii. As Lender of the Last Resort

As a lender of the last resort in times of emergencies the central bank gives
financial accommodation to commercial banks by rediscounting by bills. The
monopoly of note issue and centralization of cash reserves with the central bank
increase its capacity of growing credit and thus to rediscount the bills as the lender
of last resort.

iii. As a Bank of Central Clearance

The central bank act as a clearing house for member banks. As the central becomes
the custodian of cash reserves of commerce was banks it is an easy and logical step
for it to act as a settlement bank or clearing house for other banks as the claims of
banks against one another are settle by simple transfers from and to other accounts.

CONTROL OF CREDIT
By far the most important of all central banks in modern times is that of controlling
credit operations of commercial banks i.e. regulating the volume and direction of
bank loan. On the level or volume of credit depend largely the level employment
and the level of prices in a country?

Maintenance of Exchange Rates

Another important function of a central bank is to keep stable the foreign value of
the home currency. A stable exchange rate is necessary to encourage foreign trade
and inflow of foreign investment which is so essential for accelerating the pace of
economic growth particularly underdeveloped countries.
Custodian of Cash Reserves
It is the central bank which serves as the custodian of a nation’s reserves of gold and
foreign exchange. It is the duty to take appropriate measures to safeguard these
reserves.

Credit Instruments
CREDIT INSTRUMENTS
Credit Instruments are the documents describing details of credit and debit. Credit
Instruments provide a written eans for future reference describing terms and
conditions of any debt and loan. Credit Instruments may be an order for payment
of money to a specified person or it may be a promise to pay the loan. Credit
Instruments generally in use are cheques, bills of exchanges, bank overdraft etc.

KINDS OF CREDIT INSTRUMENTS

There are two broad kinds of Credit Instruments.

1. Negotiable Instruments
According to the negotiable instruments Act under Section 13-A, A negotiable
instrument means a cheque promissory note and a bill of exchange which are
payable to the bearer of the instrument or the person to be ordered.
Features of Negotiable Instruments
i. It must be unconditional
ii. It must be in writing
iii. It is payable on demand or the period for the payment which is determined.

2. Non-Negotiable Instruments
Non-Negotiable Instruments cannot be transferred or the documents which are
restricted to transfer by the issuer e.g. Money Order, Postal Order, Shares
Certificate etc. Such documents appears at the name of the beneficiary and the
payments are made only to those persons to whom the instruments are made
payable.

Cheque
CHEQUE
Section B of the Act defines a cheque s, ’A bill of exchange drawn on a specified
banker and not expressed to be payable otherwise than on demand.’’ A cheque is a
bill of exchange but a bill of exchange often is not a cheque. A cheque is always
payable on demand. The person drawing or making the cheque must e a customer
of the bank and must be having the required find as deposit with the bank.

PARTIES TO A CHEQUE
The parties to a heque are

Drawer
He is the maker of the cheque. He must be the holder of the account at the bank
and must sign the cheque as per specimen signature.

Drawee
He is the banker with whom the A/C is maintained by the drawer of the cheque.

Payee
He is a person named in the cheque to whom or to whose order the payment is to be
made.

ESSENTIALS OF A CHEQUE
A cheque must have the following features / essentials.
i. It must be in writing but should not be written by a pencil.
ii. It must be an unconditional order to pay. The drawer must not pay any
condition for the payment of cheque.
iii. It must be signed by the person giving it.
iv. Cheque must be drawn upon a banker not else.
v. It must be for the payment of a certain sum of money only.
vi. Amount of money must be written in figures and words.
vii. The cheque must be payable on demand.

Kinds of Cheque
TYPES / KINDS OF A CHEQUE
Cheque may be of different types. Some of them are

Order Cheque
Order Cheque is a which is expressed to be so payable or which is expressed to be
payable to a particular person without containing words prohibiting transfer or
indicating that it will not be transferable.

Open Cheque
They are payable in cash at the counter of the banks to the bearer of the cheque.

Crossed Cheque
These type f cheques are not en cashed at the counter but which can be collected
only by a bank from the drawer bank. But these days an individual can also draw a
crossed cheque for the purpose of safety and security in certain cases.

Bearer Cheque
A bearer cheque is that which can be cashed for the bank by the bearer of the
cheque. Any person who is in possession of a bearer cheque can cash it
without any difficulty.

DISHONOUR OF A CHEQU
DISHONOUR OF A CHEQUE
The relation between a banker and his customer is that of a debtor and a creditor.
Money deposited will always belong to the customer and the bank will be bound to
return its equivalent to the customer or to any person to his order. But in certain
cases a banker refuses to honor his customer cheque. When the payment of the
cheque is refused by the bank, it is said to be dishonored.

REASONS FOR DISHONOUR

A cheque may be dishonored under the following circumstances.
i. When balance to the credit of the customer is insufficient to meet the cheque.
ii. When money deposited cannot be withdrawn on demand in the case of fixed
deposit.
 iii. When the customer closes the account before the cheque is presented for
encashment.
iv. When the cheque is not properly drawn.
v. If the cheque is crossed but presented on counter for the payment.
vi. When the cheque is postdated.
vii. If death information of the A/C holder is received.
viii. If the A/C holder is declared insolvent by the law.
ix. If the A/C holder has stopped the payment.
x. If the signature on the cheque is different with the specimen signature.
xi. If the amount written in figures is diff rent from the amount written in words.
xii. If the cheque is presented for payment at a branch other than the one where
the customer has the account.

ENDORSEMENT
ENDORSEMENT
The word Endorsement has been derive from the latin word ‘’Indorsum’’ which
means ‘’On the back’’. Anything written or printed on the back of a deed or
instruments is called endorsement. When the member or holder signs his name on
the negotiable instrument for the purpose of negotiation i.e. direction to pay the
amount to another person is called Endorsement. Section 15 of the Negotiable
Instrument Act 1881 defines Endorsement as When the maker or holder of a
negotiable instrument sign the same, otherwise than as such maker for the purpose
of negotiation on the back or face therefore on a slip of paper or so signs for the
same purpose a stamp paper intended to be completed as a negotiable instrument
he is said to endorse the same and he is called the endorse.

KINDS OF ENDORSEMENT
Different kinds of Endorsement are as follows.

i. Blank or General Endorsement

When the endorser simply put his signature on the back of the instrument without
specifying the name of the endorsee, it is said to be general endorsement. The
holder can convert it n full endorsement by writing the name of the payee above
the signature of the endorsee.
 ii. Special or Full Endorsement
It specifies in addition to the signature of the endorser the person to whom or to
whose order the instrument is payable.

iii. Restrictive Endorsement

An endorsement which prohibited further negotiation of the instrument is called
restrictive endorsement. For instance if a cheque is endorsed saying “Pay A only”
or “Pay A for A/C of B” the endorsed has no power to transfer his right further.

iv. Partial Endorsement

An endorsement which makes the trans er of the instrument from the endorser to the
endorsee after the fulfillment of stated conditions is called Partial Endorsement.

Sans Recourse
When a person wants to exclude his liability to the endorse or any subsequent holder
in case of dishonor of the instrument. The Endorser fees himself from his liability
on a negotiable instrument by writing the words SANS RECOURSE after the name
of the endorsee. He should make it clear that his endorsee or the holder should not
look to him for payment in case of the dishonor of the instrument. The endorsee
may refuse to take an instrument with such an endorsement.

CROSSING OF A CHEQUE
CROSSING OF A CHEQUE
A Crossing is a direction to the paying banker that the cheque should be paid only is
a specified banker named in crossing. A cheque is said to be crossed when it bears
across it is face the transfers lines without any words on them. Crossing prevents
the cheque from being cashed by anyone except the payee. This ensures safety of
payment by means of cheques. It affords security and protection to the true corner.
Cheques are crossed in order to avoid losses arising from open cheques. However it
does not affect the negotiability of a cheque.

BILL OF EXCHANGE
BILL OF EXCHANGE
A bill of exchange is a written acknowledgment of a debt. It is written by the credit
 and accepted by the debtor. Section 5 of the Act define a bill of exchange as ‘’An
instrument in writing containing an unconditional order, signed by the makers
directing a certain person to pay a certain sum of money only to, or to the order of
a certain person or to the bearer of the instrument.

Kinds of bill of exchange

A bill of exchange is of the following types.

i. Inland Bill
A bill of exchange which is drawn in a country and is payable anywhere in the
same is called an Inland Bill. For example if a bill is drawn in Pakistan and is
payable in any city of the country it will be considered as an Inl nd Bill.

ii. Foreign Bill

If a bill is drawn in one country but is payable in any other country, this type of bill
of exchange is called a foreign bill. For example it has been drawn by a
businessman in Pakistan in the name of other business an living in Japan, the
payment of the bill of exchange will be among the two businessman of different
nations therefore this kind of bill of exchange is called Foreign Bill.

iii. Commercial Bill

A bill which is drawn for business purposes is called a Commercial bill. Sometimes
a businessman does not pay in cash but issues a bill which is payable in some
future date such type of a bill is called a Commercial Bill.
 iv. Accommodation Bill
An accommodation bill is a bill whereof the acceptor according to the terms of the
instrument stands as a surety for some other person who may or may not be a
party thereto.

v.Time Bill
These are such type of bills which are payable on demand on some specified dates.
These specified dates may be of present or future.

vi. Demand Bill

The bills which are payable on demand are called demand bills. Such type of bills
are generally used for specific purposes.

Parties to a bill of exchange

The parties to a bill of exchange are
i. The Drawer who prepares the bill.
ii. The Drawee in whose name the bill has been drawn.
iii. The Payee to whom the bill has to be paid.
iv. The Endorsee to whom the bill has been transferred by way of
endorsement by the payee.

Essentials of a bill of exchange

The following are the essentials of a bill of exchange.
i. It ust be in writing.
ii. It must be an unconditional order to pay.
iii. It must be signed by the maker.
iv. It must be addressed by one person to another.
v. It must be written for some certain sum of money.
vi. It must be payable on demand.
NOTING OF THE BILL
When the bill of exchange is dishonored by the party, the holder of the bill has a
legal right to take action against them. In this regard he prepares a type of Public
Notice. It is known as Notary Public which is attached along with the bill and is
again presented for repayment. Usually this entry of the bill is made on a separate
attached with the bill. If the payment is not made i.e. refused again then the date of
the presentation the reference of the register with his signature is entered in the
notice. This is called Notice of the Bill.

PROTESTING OF THE BILL

Sometimes due to refusal of payment a certificate or document is issued by the
notary public containing all the information about the dishonor. This document is
known as protest of the bill.
It contains
i. Attested copy of the bill.
ii. Signature of Notary Public.
iii. The name of the person whose bill was protested.
iv. The date and amount of the protest.
v. The cause of the protest.
vi. The reply of the drawee.
vii. The reason of absence of the drawee and the accepted.
viii. The reason for the non-payment of the bill.
ix. The certificate stamp of the notary public.

Renewal and Retirement of a bill of exchange

RENEWAL OF THE BILL
Sometimes the drawee of the bill is unable to pay the bill on its agreed
date or time. In such a situation the drawee can apply to issue a new
bill subject to certain conditions after the agreement of the drawer. This
issuance of a new bill for some new time is known as renewal of the
bill. After the issuance of the bill the former is considered to be
cancelled. But if the drawee again unable to pay the newly issued bill,
the first bill with all its farmer conditions becomes payable and valid.

RETIREMENT OF THE BILL

Sometimes the drawee pays the bill before the agreed date enjoying the
rebate which is provided to him for prepayment of the bill. This is
known as retirement of the bill. The amount of the rebate depends upon
the time left for payment and the amount for which the bill is drawn.

Rate of Exchange
RATE OF EXCHANGE
The rate at which the currency or monetary unit of one country can be exchanged
with the monetary unit of other country is called the rate of exchange. In other
words, the rate at which a unit of one country exchanges for the currency of
another is the rate of exchange between them. It may be used to denote the system
whereby the trading nations pay off their debts.

Determination of Rate of Exchange

The rate of exchange is determined under the following under the following money
systems as:

Under Gold Standard

If two currencies are on gold stand and their currencies are expressed in terms of
gold i.e. a certain weight of gold then the art of exchange is determined by
reference to the gold contents of the two currencies. Suppose Pakistan and United
States are on gold standard the rupee being equal to 10 grams of gold and dollar
consisting of 50 grams of gold. The rate of exchange between the two countries
will be 1 Rupee = 10/50 = 1/5 $ or 0.20 cents 1 Dollar =50/10=5 Rupees.
Thus the rate of exchange is determined in a direct manner by comparison between
the gold contents of the two countries. This rate of exchange is also known as Mint
Par of Exchange. The actual rate in the foreign exchange market will be slightly
different from the mint par to allow for certain expenses. However the actual rate
of exchange between currencies will not depart much from the mint par and will
move between the two points of export and import of gold. These points are called
Gold Points.

Under Paper Currency Method

This phenomenon of exchange rates determination is also called Purchasing Power
Parity Theory. No country in the world is rich enough to have a free gold
standard. All countries nowadays have paper currencies. According to this theory
the rate of exchange between two countries depend upon the relative purchasing
powers of their respective currencies. Such will be the rate which will equate the
two purchasing powers.
For example if a certain assortment of goods can be purchased for ₤ 1 in Britain and
a Similar assortment of goods with Rs. 16 in Pakistan then the purchasing power of
₤ 1 is equal to the purchasing power of Rs. 16. Thus the rate of exchange according
to purchasing power parity theory will be
₤ 1 = Rs.16

Fluctuation in Rate of Exchange

The rate of exchange fluctuates in the market due to interplay of demand and supply
of currency of a particular country. This is the result of some of the lowing
transactions.

BALANCE OF TRADE
The main reason for fluctuations in the rate of exchange of the currency is the
value of imports and exports of a country. If the value of imports exceeds the
value of exports the rate of exchange will lend downwards and vice versa.

FOREIGN INVESTMENT
Foreign capital investment in a country necessities the payment of dividends or
interest to the investing countries. If the capital absorbing country is not in a
position to pay such claims in foreign currency, the rate of exchange of that
country will definitely fall down.

SERVICE CHARGES
Freight and Insurance expenses also fluctuates the rate of exchange of a country. If
the importing country does not have her own shipping companies the
transportation charges are to be paid to foreign ships. So their urine premium in
case is to be paid to foreign companies. This creates a demand of foreign currency
and if the supply is limited the rate of exchange will fall.
OBJECTIVES OF EXCHANGE CONTROL
The following are some of the objectives of exchange control.
To restore Equilibrium
The chief objective of exchange control is to restore equilibrium in its balance of
payments. If a country finds that its balance of trade has been persistently
unfavorable then it must do something set it right. The balance of payment must
ultimately be made to balance.

To Protest Home Industries

Another objective of exchange control is to protect the home industry from
unfettered competition from abroad if the people at home are more interested in
purchasing foreign goods it will ultimately discourage the local producers to
produce more. It will directly affect the National Income and the domestic Gross
Product of the country.

To Conserve Foreign Reserves

To conserve foreign reserve is another major objective of exchange control. Every
Country needs foreign exchange in order to maintain its stability monetarily in the
present age. Also the countries need foreign exchange to make payments for their
imports and to pay back their debts obligation. For this a country must have
foreign currencies on their hand. If there is a deficiency of the foreign exchange it
is going to affect its liquidity position internationally and its credit rating.

Foreign Exchange
METHODS OF EXCHANGE CONTROL
Paul Enzi is his book exchange controls has mentioned as many as 41 different
methods of exchange control. They can be categorized as
1. Direct Method
2. Indirect Method
They are di cussed here as under.

1. DIRECT METHOD
The direct method is further classified as:
Intervention
For an effective control of foreign exchange rates and the foreign exchange market
 the government usually has a central authority i.e. the Central Bank that has the
complete power to control and regulate the foreign exchange market. Under this
method anybody who either wants to purchase or sell foreign exchange he has to
deal with the central bank. All the selling and purchasing transactions of foreign
exchange are controlled by the central bank which helps it to adjust demand and
supply of foreign exchange according to the need of the country.
Restriction
Exchange restriction is another powerful weapon of exchange control. It refers to
the policy by which the government restricts the supply of its currencies coming
into the exchange market. It is achieved either by one of the following methods.
i. By centralizing all trading in foreign exchange with central bank of the
country.
ii. To prevent the exchange of national currency against foreign currency with
the permission of the government.
iii. By making all foreign exchange transactions through the agency of the
government

Exchange Clearing Agreement

Under this method the countries engaged in trade pay to their respective central
bank the amounts payable to their respective foreign creditors. The central banks
they use the money in offsetting the corresponding claims after fixing the value
of the foreign currencies by common agreement. The basic principle is to offset
international payments so that they have not to be settled through the medium of
the foreign exchange market.

2. INDIRECT METHODS
The most commonly used direct method or tool of exchange control is the use of
tariff duties and quotes and other quantative restrictions on the vol me of
international trade. By imposing tariff and quotes the demand for the foreign
currency falls down in the case of restricting the imports.

Rate of Interest
Another method of indirect exchange is the ra e interest. The rate of exchange is the
result of demand and supply of each other currencies arising out of trade and
capital movement. A high rate of interest in a country attracts short term capital
 from other countries that leads to an exchange rate for the currency in te ms of
other currencies goes up.

Direct and Indirect Methods Adopted of

Exchange Control
COMPARISON OF DIRECT & INDIRECT METHODS
These methods of exchange control are known as indirect methods
because they do not control the exchange rate but only influence it. On
the others hands the direct methods of intervention, restriction and
exchange clearing agreements have the effect of directly controlling the
exchange rate or the foreign exchange market.

Balance of Trade
BALANCE OF TRADE
Balance of trade refers to the difference in the value of imports and exports of
commodities only
i.e. visible items only. Movements of goods between countries is known as visible
trade because the movement is open and can be verified by the custom officials
with respect to balance of trade the following terminologies are important.

Balanced Balance of Trade

If during a given years exports and imports of the country are equal the balance of
trade is said to be Balanced.

Favourable Balance of Trade

If the value of exports exceeds the value of imports the country is said to experience
an export surplus or favorable balance of trade.

Un-Favourable Balance of Trade

If the value of imports exceeds the value of its exports the country is said to have a
deficit or an adverse balance of trade.
Balance of Payment
BALANCE OF PAYMENTS
Each nation periodically publishes a set of statistics that summarize for a given
period all economic transactions between its residents and the outside world. This
statistical statement is refe red to as balance of payments. The accounts show how
a nation has financed its international activities during the reporting period. They
also show that what changes have taken place in the nation’s financial claims and
obligations with the rest of the world.

STANDARD PRESENTATION
The IMF has significantly worked with success to standardize the system and the
form of presentation.

B.O.P – DOUBLE ENTRY ACCOUNT

The B.O.P used double entry accounting. Transactions are recorded as credits of the
yield receipts from or claims against foreign owners. Credits are received for
example by exports of merchandise, sale of securities overseas and rendering
services to foreigners. Similarly, debits are recorded of transactions cause payments
to foreigners e.g. importing goods, tourist expenses abroad, purchase of foreign
bonds.

B.O.P – CURRENT ACCOUNT

The Current Account includes merchandise trade in good and International
Services are termed as Invisible trade. There are four basic service components.
Tourism, Investment, Private Sector, Services such as royalties, rent, consulting
and engineering fees etc and Government service such as diplomatic and
buildings and membership fees in international organizations.

B.O.P – CAPITAL ACCOUNT

The capital account has a long term and a short term sector. The long term amount
shows the inflow and outflow of capital commitments which have a maturity
longer than a year. Short term capital movement frequently has a maturity date
from 30-90 days. Long term capital items generally include loans to and from
other governments, financial support for development. Projects abroad and export
financing. Short term capital includes paying for international services, selling
 accounts etc.

Adverse Balance of Payments

METHODS OF CORRECTING AN ADVERSE BALANCE
OF PAYMENTS
Following are some of the methods adopted for correcting and adverse balance of
payments.

Improving the balance of trade through import restrictions &

measures of export promotions
Since balance of payments becomes adverse because of excess imports over
exports, so a country having such a problem must try to check imports either by
total prohibition or by levying import duties so by a quota system. Another method
may be import substitution i.e. trying to produce in the country what it currently
imports. Exports can be stimulated by measures of export promotion granting
subsidies or other concessions to industrialists and exports.

Depreciation of the currency

If a country depreciates its currency it proves very helpful in increasing the
exports of goods. The value of the home currency fall relatively to foreign
currency hence the foreigners are able to buy move goods with the same amount
of their own currency or for the same amount of goods they have to pay less in
terms of their own currency than before.

Devaluation
A country can turn the balance of payments in its favor by devaluating her
currency. In this case also the devalued currency will become cheaper in terms of
the foreign currency and the foreigners will be able to buy move goods by paying
the same amount of their own currency.
The effect is the same as in the case of depreciation.
Deflation
Deflation means construction of currency. If currency is contracted then
according to the quantity theory of money the value of the currency will rise or
the prices will fall. When prices fall the country becomes a good country to buy
 in and not a good country to sell into Exports will also thus increase and imports
will be checked and hence the balance of trade will become favorable.

Exchange Control
Under a system of exchange control, all exporters are asked to surrender their
claims or foreign currencies to the central bank which pays in return the home
currency, which the exporters really want. This available foreign exchange is
rationed by the central bank among the licensed importers. Thus imports are
restricted to the foreign exchange available. There is no danger of more goods
being imported than exported.

International Trade
Some of the reasons that why do trade between different countries occur are
discussed under the following he ds.

NATURAL ENDOWMENTS
Differences in advantages of trade to different countries may arise because of
natural reasons like geographical and climatic conditions. This lead to territorial
division of labor and localization of industry. These different countries specialize
in the production of different things.

HUMAN CAPABILITIES
People in some countries are physically sturdier where as in others they are
intellectually superior. Some have greater skill and dexterity thus the countries.
Which do not possess these qualities try to share with them.

STOCK OF CAPITAL
Some countries have large stock of capital goods like U.K, U.S.A, etc. These gives
an opportunity to the underdeveloped countries or those which lack these capital
goods to exchange or trade them through the channel of distribution
internationally.

SPECIALIZATION IN PRODUCTION
A country may have a comparative cost advantage in production in more than one
commodity over other countries but produces only one commodity for the sake of
specialization. It helps in improving the quality of production to a great extent.
Advantages and Disadvantages of International
Trade
ADVANTAGES OF INTERNATIONAL TRADE
Various advantages are named for the countries entering into trade relations on a
international scale such as:

A country may import things which it cannot produce

International trade enables a country to consume things which either cannot be
produced within its borders or production may cost very high. Therefore it
becomes cost cheaper to import from other countries through fore grade.

Maximum utilization of resources

International trade helps a country to utilize its resources to the maximum limit. If a
country does not takes up imports and exports then its resources remain
unexplored. Thus it helps to eliminate the wastage of resources.

Benefit to consumer
Imports and exports of different countries provide opportunities to the consumer to
buy and consume those goods which cannot be produced in their own country.
They therefore get diversity in choices.

Reduces trade fluctuations

By making the size of the market large with large supplies and extensive demand
international trade reduces trade fluctuations. The prices of goods tend to remain
more stable.
​Utilization of Surplus produce
International trade enables different countries to sell their surplus products to other
countries and earn foreign exchange.

Fosters International trade

International trade fosters peace, goodwill and mutual understanding among
nations. Economic interdependence of countries often leads to close cultural
relationship and thus avoid war between them.
DISADVANTAGES OF INTERNATIONAL TRADE
International trade does not always amount to blessings. It has certain drawbacks
also such as:

Import of harmful goods

Foreign trade may lead to import of harmful goods like cigarettes, drugs etc. This
may run the health of the residents of the country. E.g. the people of China
suffered greatly through opium imports.

It may exhaust resources

International trade leads to intensive cultivation of land. Thus it has the
operations of law of diminishing returns in agricultural countries. It also makes
a nation poor by giving too much burden over the resources.

Over Specialization
Over Specialization may be disastrous for a country. A substitute may appear and
ruin the economic lives of millions.

Danger of Starvation
A country might depend for her food mainly on foreign countries. In times of war
there is a serious danger of starvation for such countries.

One country may gain at the expensive of another

One of the serious drawbacks of foreign trade is that one country may gain at the
expense of the due to certain accidental advantages. The Industrial revolution is
great Britain ruined Indian handicrafts during the nineteenth century.

It may lead to war

Foreign trade may lead to war different countries compete with each other in finding
out new markets and sources of raw material for their industries and frequently
come into clash. This was one of the causes of first and Second World War.

Theory of Comparative Costs

INTRODUCTION
The classical theory of International trade commonly known as the principle of
 comparative cost was first enunciated by David Ricardo. The theory went through
many additions improvements and refinements at the hands of economists like
Mill, Cairns & Bastable. An individual is able to perform many tasks but he does
not perform them all. He selects that work which pays him the most. A doctor can
also do the work of a dispenser but he does not do it. The same principle works in
international trade. Considering the climatic conditions, distribution of material
resources, geographical concern, etc. Every country seems to be better suited for
the production of certain articles rather than for others to employ its resources
more remuneratively it will be to the advantages of each country as well as to the
world.

THEORY
In its simplest form the theory may be stated as, ‘’It pays countries to specialize in
the production of those goods in which they possess the greatest comparative
disadvantage.’’

EXPLANATION
Ricardo argued that two countries can gain very well by riding even if one the
countries is having an absolute advantage in the production of both the
commodities over the country. The condition is ‘’provided the extent of absolve
advantage is different in the two commodities in question’’ i.e. the comparative
advantage is greater or comparative is lessees in respect of one good than in that
of the other. In this connection we compare not the cost of production of one
commodity with the other rather we compare the ratio between the costs of
production of the two commodities concerned n one country with the ratio of their
cost of production in the other country.

EXAMPLE
Suppose there are two countries A and B and there are two commodities wheat and
rice. Suppose a unit of labor produces 10 tons of wheat or 20 tons of rice in
country A. The same unit can produce 6 tons of wheat and 18 tons of rice in
country B. According to this situation country A is having an absolute advantage
in the production of both commodities over B. But she is at a greater comparative
advantage in the production of wheat country B is at a disadvantage in both.
 Commodities the comparative disadvantage is less than case of rice. Hence the
ratio would be
In A it is 10 : 20 i.e. 1 : 2
In B it is 06 : 18 i.e. 1 : 3
Therefore, A will specialize in wheat and B in rice and international trade will
become possible and profitable. This is the law of comparative advantage or costs.

Theory of Comparative Advantage

ASSUMPTIONS OF THE THEORY
The comparative cost theory is based on the following assumptions:
i. Labor is regarded as the sole factor of production and the cost of
production only consists of labor cost.
ii. Production is subject to the law of constant returns.
iii. Factors of production are assumed to the perfectly mobile within a
country but immobile between countries.

CRITICISM
The theory of comparative cost is criticized on the following grounds.

Assumption of Constant Cost

The classical economists were of the opinion that additional quantities & a
commodity could be obtained with the same expenditure of cost per unit us
previously But this is not valid assumptions lost ratios are subject to change where
socialization between the two countries has gone a pace.

Some Static Assumptions

The comparative cost theory in a number of static assumptions of fixed costs
industrial production functions between trading countries and fixed supply of land,
labor, capital etc. It cannot be applied 100% to the re l world.

Assumption of perfect mobility inside and immobility outside a

country
This assumption seems to be un-applicable to today’s modern world of
communication and technology the development of cheap quick and safe means of
 transport and communication has broken down this immobility to a great extent.

Short Notes
INTERNATIONAL TRADE
International trade refers to that trade that take place between a country and a
number of countries of the world. In other words we can say that all the trading
activities that take place across the national boundaries are called International or
Foreign trade. It is effect is called balance of payments.

INTERNAL TRADE
Internal or Domestic or inter-regional trade is the trade between different regions in
the same country. We can also say that all the trading activities that take place
within a country are called internal trade.

ABSOLUTE ADVANTAGE
A country due to its most favorable geographical conditions may have an advantage
in the production of a particular commodity over other countries. This advantage is
known as absolute advantage for that country over rest of the world. The absolute
advantage results in a regular inflow and outflow of goods which gives rise to
International Trade.

COMPARATIVE ADVANTAGE
When a country has an advantage of production and move than one commodity it
prefers to produce only one commodity that is more advantageous for other. This
advantage is calculated by comparing the different commodities that how m h
they paying commodity is selected and the country goes for specializing. This is
known as comparative advantage.​Q.15. Write Short Notes.

PROMISSORY NOTE
The promissory note is one of the simplest forms of the credit instrument. Section 4
of the Act defines a Promissory No e as an INS rumen in writing not being bank
note or a currency note containing an unconditional undertaking signed by the
 maker to pay a certain sum of money only to or to the orders of a certain person to
the bearer of the instrument.

Character is tics of a Promissory Note

The essential characteristics of a promissory note are as follows
i. It is a written document signed as follows.
ii. It contains an unconditional promise to pay.
iii. Besides an acknowledgement a promissory note is an express promise to pay.
iv. Promissory note must always relate to a definite and certain amount of
legal money of the country and not to foreign money.
v. It should not be a bank note or currency note.
vi. No particular from is prescribed for it.
vii. A promissory note is not payable to the bearer on demand.
viii. The person to whom the promise is made must be definite person.
DRAFT
A draft is a cheque drawn by one branch of a bank upon another situated at any
other place required to pay a fixed / certain amount of money to a specified person
or by his order. A bank draft may either by inland or foreign. Drafts are issued by
binders after receiving written and signed applications. The person is required to
remit the required amount of money along with its commission. The banker hands
over the draft to the depositors and sends a credit advice to the branch upon which
the draft is drawn.

Draft is a common media of transferring money from one place to another. They
are of great importance for financing trade, especially foreign trade. The draft is
also known as demand draft.

LETTER OF CREDIT
The letter of credit is a request made by the issuing bank to its correspondent or
agent making the request on demand on any draft on the issuing bank up to the
amount mentioned in the letter of credit. A letter of credit remains enforced for a
fixed date only. They are issued only to the persons who furnish guarantee or
securities or make payment of the full amount there in. The L.C’s are of great
significance in international trade. Especially the importers and exporters
frequently use them. It saves from the trouble of carrying money from place to
place with the risk of loss or theft.

Challenges in Banking Sector of Pakistan

In last few years, banking system in Pakistan has entered into a new phase of
evolution yet facing various issues, where political instability and economic
uncertainty remain the main problem. On one side, banks are making profits,
defaults are on decline and have surplus liquidity in recent years but on the other
side, economic conditions in the country have deteriorated in last two years due to
political instability. Economic growth is an apt indicator for the growth of the
banking sector; Pakistan’s economic expansion has been quite impressive from the
perspective of GDP growth rate in last five years and was even highest in last fifteen
years. Whereas Pakistan’s banking sector remained sound and stable in 2017, with
total assets growing to Rs 18.34 trillion (USD 159.5 billion) from Rs 15.83 trillion in
2016. However, Pakistan’s banking sector profitability declined by three percent to
Rs 39 billion in 2QCY18 mainly due to increased expenses incurred by big banks on
pension and compliance costs.
The big disadvantage of state owned banks now is that government has barred them
from charging high spread (interest rates) on some of government related doubtful
loans thus government tries to keep financial expenses minimum but it impacts the
profitability of the banks. In addition, government owned banks do not write off bad
loans easily due to fear of inquiry by the ​National Accountability Bureau (NAB)​.
There should be an independent committee for investigating the reasons for bad
loans and banks should write off loans on the basis of their recommendation only.
This can also be out-sourced to some third party financial managers so as to mitigate
the risk of inquiries by NAB.
In addition, banks seriously need to improve the corporate governance. We have
seen heavy fine on HBL by the US regulatory authorities and numerous fraud and
embezzlement cases are also investigated in NBP in recent years. SBP and SECP
have to take certain steps in implementing corporate governance in the banks.
Whereas banks should also establish procedures for compliance checks. The SBP
should take measures to put in place and enforce good governance practices to
improve the internal controls and bring about a change in the organizational culture.

Ways to Overcome
These are some strategies that help financial services managers meet the challenges
of doing business in today's market.

1. Attract and retain clients

Banks and financial services firms have to stand out in the crowd by offering
customers something extra.​ Sullivan's company helps financial institutions with
business strategy, planning and marketing. "Make an emotional connection with the
consumer and let them know you understand their financial needs. Then come at
them with solution-based thinking, not product pushing."

2. Know your customer

In a rapidly changing world, financial services providers must be aware that their
customers are changing, too. Consumers are savvier and more aware of their
finances than they were five years ago, according to Sullivan. The best providers
engage customers and learn how their needs are evolving. If a bank or a business has
not looked at its market or its customers to learn "what is going on with them in the
last year, you don't know your customers." Sullivan said.

3. ​Promote confidence in the economy

The economic crisis that began in 2008 is still very fresh in customers' minds. Large
financial institutions collapsed and the government bailed out troubled banks. The
stock market lost value and in much of the country the housing market eroded.
Now financial advisers are called on to provide factual evidence to customers that
the economy is getting stronger.

4. Use technology that customers expect

"Technology has changed the expectations consumers and small businesses have of
their bank," Sullivan said. Clients use information on the Internet to compare
financial service firms. Many more customers are comfortable with managing their
money online and they expect user-friendly tools to do so.

5. Watch your reputation

The financial services world is like high school in some ways: Reputations can be
difficult to control or change. At the moment, consumers are not forgiving many of
the companies that were front and center during the economic crisis.​Financial
services companies that stay focused on customers and their needs will be the
companies customers keep at the top of their "like" list. These companies have to
stay in tune as customers' needs shift and they have to provide workable solutions​.