In the following salient features of the State Bank of Pakistan to control the banking system are discussed which are mainly instruments used in Pakistan since all the conventional control techniques are not applicable in developing countries: • Bank rate This is the rate at which the State Bank buys or discounts bills of exchange and other commercial papers. This is also the basic interest rate. All the other interest rates in the banking system, like the deposit rate paid by the banks to their depositors and the rates at which bank lend for short and long periods, are tied to it. With any change in the bank rate, similar changes take place in the entire interest rate structure of the banking system. • Cash Reserve Requirement All scheduled banks are required to deposit a certain percentage of their total liquid assets with the State Bank. Technically, the government can bring about a change in reserve requirement but normally the State Bank exercises this authority on the government’s behalf. A rise in the cash reserve requirements restricts the bank’s lending operations while a fall can encourage them to advance more credit. • Selective Credit Control The State Bank usually have considerable authority to control the composition of bank credit. SBP can direct banks regarding the distribution of credit between different sectors and uses, between long term and short-term loans, margin requirements for advances against certain types of assets and the interest to be charged on different types of advances and from different borrowers. • Credit Ceiling A credit ceiling for the banking system as a whole or for each individual bank, can exercise some influence over the total volume of credit though not on its direction or use. • Liquidity Ratio This is the ratio between a bank’s liquid resources and its total liabilities. While a low liquidity ratio may lower public confidence in the banking system and may also allow banks to liquidate their investments in government securities to finance credit expansion, a high ratio adversely affects the credit flow in the economy and the overall profitability of the bank. • Open market operations This consists of the purchase and sale of securities by the State Bank in the open market. The quantity of cash in the money market increases with the purchase of securities whereas their sale has contra-dictionary effect. • Credit Quota The State Bank can also limit its own lending to banks by fixing a credit quota for each bank and borrowing over and above the limit may carry a higher interest rate. In Pakistan, in addition to these instruments, the State Bank of Pakistan also offers informal advice, guidance, and persuasion to banks in various matters. Such informal control may have become fairly important particularly after the nationalization of banks and the consequent unification of their operating policies. Q.2 What are the negotiable instruments? Discuss in detail. Ans. NEGOTIABLE INSTRUMENTS Under the Negotiable Instruments Act, 1881 “a negotiable instrument means a promissory note, bill of exchange or cheque payable either to order or to bearer”. However, in general terms a Negotiable Instrument is one which is, by a legally recognized custom of trade of law, transferable by delivery or by endorsement and delivery in such circumstances that (a) the holder of it for the time being may sue on it in his own name; and (b) the property in it passes, free from equities, to a bona fide transferee for value, notwithstanding any defect with title of the transferor”. CHARACTERISTICS • Negotiable instruments are transferable from person to person like cash. In other words, the property attributed to these instruments passes from one person to another, either by endorsement or by delivery. • The transferee of a negotiable instrument is entitled by law to sue on the instrument in his own name in case of dishonour. • A bona fide transferee of a negotiable instrument for value takes if free from all defects in the title of his transferor. This is the main difference between negotiable instrument and other subjects or ordering transfer. KINDS There are three main kinds of negotiable instrument: • Bills of exchange; • Cheques; • Promissory notes; These are discussed in detail as under: BILLS OF EXCHANGE “An instrument in writing, containing an unconditional order, signed by the maker, directing a certain person, to pay certain sum of money, only to or to the order of a certain person, or to the bearer of the instrument”. Characteristics are: • It must be in writing. • It must be singed by the maker. • It must contain an unconditional order.

either with or without the words “not negotiable” and/or the words “and Co” in between. to pay on demand or at a fixed or determinable future time. a certain sum of money only. It may be made by two or more persons and they may be liable thereon jointly and severally. If in addition to general crossing. PARTIES There are generally three parties to a Bill of Exchange: • Drawer: Drawer is the person giving the order. CHEQUE “A cheque is defined as a bill of exchange drawn on a specified banker and not expressed to be payable otherwise than on demand”. to or to the order of a certain person or to the bearer of the instrument” No precise form is necessary but the above definition lays down that the following are the essentials of a Promissory Note: • • • • • • It must be an unconditional written promise. Crossing is of two types. and Economic Advantage. the sum promised in a Promissory Note can be made payable by stated installments. • Order cheque This is a cheque (a) which is expressed to be so payable or (b) which is expressed to be payable to a particular person. to the effect that it would be honoured when presented for payment. To appraise an industrial project. The Promissory Note may be made by two or more makers who may be liable thereon jointly and severally. In view of the above. with or without the words “not negotiable”.• It must direct a certain person to pay a certain amount of money to a certain person or his order or to bearer. General crossing which consists of drawing two parallel transverse lines. it is not entitled to any days of grace. it is always drawn on a banker. • Crossing: This is a device adopted by the business community and sanctioned by law. The following matters have to be looked into by a banker most carefully to ensure safety of the money: . is also written on the face of the instrument. PROMISSORY NOTES “This is an instrument in writing (not being a bank note or currency note) containing an unconditional undertaking signed by the maker. Financial advantage. • Payee or Endorsee: Payee or Endorsee is the person named in the instrument to whom or to whose order the money is directed to be paid. SAFETY The baker must be very careful while financing various projects because if the ventures which he is financing are not viable then he will lose not only the bank’s money but is likely to bring hardship to a large number of depositors. It must be singed by the maker called “promiser”.3 As a banker how would you appraise an industrial project? Support your answer with arguments. it is payable to bearer on demand (unless crossed). the bakers has to do a great deal of thinking and homework before he allows finances for a certain venture. VARIETIES • Open cheque: This can be presented to the banker on whom they are drawn and paid by them “over the counter”. Q. A Promissory Note is incomplete untill it has been delivered to the payee or the bearer. across the fact of cheque. A cheque is a peculiar type of negotiable instrument which resembles a bill of exchange in particulars but does not so resemble in other. Thus: • • • • • • a cheque does not require acceptance. without containing words prohibiting transfer or indicating that it shall not be transferable or (c) which is expressed to be payable to the order of a certain person. according to is tenor. • Drawee: Drawee is the person to whom the order is addressed. it is a bill of exchange drawn on a banker which is payable on demand. which has the effect of making cheques payable to a bank only or to a particular bank in an account with such bank. In general term. it is called special crossing”. The five basic principles are: • • • • • Safety. • It must be properly stamped. a banker has to make sure that five basic prerequisites are fulfilled before taking decision. The money should be payable to or to the order of a certain person or to the bearer of the Promissory Note. It must contain a promise to pay a certain sum in money only. the name of specified banker to whom the cheque is to be payable. Maintaining wide dispersal. The amount promised in the Promissory Note must be payable on demand or at a fixed or a determinable future time. but for immediate payment. It must be kept in mind that the depositor place their money at the disposal of the bankers because they are sure of its safety. Ans. • Marked cheque This means a cheque which is “marked” or certified by the banker on whom it is drawn. Moreover. it is not intended for circulation. Maintaining liquidity.

A really detailed understanding of letter of credit is necessary for all those who are engaged in international trade. 90 days document against acceptance basis. • Unconfirmed letter of credit. such confirmation constitutes a definite undertaking of such bank. etc. • Capacity to honour their commitments and management ability are other factors which have to be considered. • Previous record of their relationship with the baker has also to be considered. and (ii) acceptance letter of credit in which type facility in payment is allowed to the buyer i. payment of salaries and keeping adequate amount for financing future investments.e. A documentary credit is an understanding by a bank at the request of its customer. 60. The beneficiary of such credit has a double assurance of getting his money. LETTER OF CREDIT Ans.4 Write notes on the following:1. TYPES • Revocable credit. the banker must always keep in mind that he has to create conditions of financial advantage. but the transaction is being conducted directly between the importer and exporter. The issuing bank. He must see that from his available funds he advances them to a wide range of sector. both importer and exporter may be not known to each other. ECONOMIC ADVANTAGE • The bankers have always keep in sight the overall nature of economic and social objectives of development in the country. The confirmed credit eliminated practically all the risks to the seller. which is also known as Documentary Credit. (i) sight letter of credit which means that the payment is to be made on demand or on presentment of bill of exchange. A credit which contains a condition that the credit amount is to be renewed or reinstated automatically in stated circumstances without the . In this type. Dispersal of advances is very necessary from the point of security as well. When an issuing bank authorizes or requests another bank to confirm its irrevocable credit and the latter has added its confirmation. payment to dividend to shareholders. The reason is that buyer is not prepared to pay an additional charge for confirming the credit or it may effect on the cost of the goods by the seller. The usual way in which this is effected by an irrevocable letter of credit which may be confirmed in certain cases. MAINTAINING LIQUIDITY • This means ability to convert assets into ready cash. in addition to that of the issuing bank. an importer. payment on 30. • Sight and acceptance letter of credit There are two categories of credit in connection with payment. to pay an exporter or accept the exporter’s term bill of exchange in respect of goods consigned to the importer when satisfactory documents including evidence of shipment and all other documents required under the terms of the credit are produced at a named place within a specified period. FINANCIAL ADVANTAGE • A banker needs sufficient amount of banking spread over the year so that he can meet expenses which he has to meet in regard to interest paid to customers. then they use the services of a bank through a letter of credit. An irrevocable credit constitutes a definite undertaking of the issuing bank. The banker should always be hesitant to advance finances to customers for purchase of fixed assets because this kind of asset cannot be changed into liquid assets when needed. the banker can without any fear of the future consequences provide finance. The banker must ensure that his funds are not invested in specific sector like textile industry. Q. A revocable credit gives no undertaking to the exporter that payment will actually be made because it may be cancelled or amended at any time without prior notice to the beneficiary. • Revolving credit. the undertaking by his bank and the issuing bank. MAINTAINING WIDE DISPERSAL • The dispersal of the amount of advances should be broadly based so that a large number of borrowing customers may benefit from the financing. Banking itself is a business and therefore. In export and import. The majority of credits covering international trade are irrevocable credits but most of them are not confirmed. these credit are carried with undertaking by the opening bank but not confirmed by the advising bank. If a party has been a client for a long period of time and his previous record shows that he has honoured his commitments in the past. • Irrevocable letter of credit. because it reduces the risk of recovery when something goes wrong in one particular sector. meeting the expenses and overhead. provided that the stipulated documents are presented according to the terms and conditions of the credit.• Character of the person or persons desirous of obtaining finances. • The financial viability of the project is another factor because a party may have large resources at his disposal and also have management capabilities but the project which he proposes is doomed from the beginning because it is not financially viable. A letter of credit is a satisfactory way of ensuring payment before control of the goods is surrendered. When an importer is not particularly well known to an exporter.. provided that the stipulated documents are presented and that the terms and conditions of credit are complied with. The banker must make sure that the money he is lending is not blocked for a long period of time so that it can be lent to other people. He must be the kind of person who can be trusted with the amount being provided to him. in case of irrevocable credit gives a binding or definite undertaking to the beneficiary that he will pay against documents or that the bills drawn in compliance with the terms of credit will be honoured. • Confirmed letter of credit. A businessman may not have unlimited financial resources but his capacity to manage investments may be of a high order in which case the task of the bank becomes easy. heavy engineering or agriculture. For this purpose he has got to think in terms of economic advantage of the nation as a whole upper most in his mind and see that the projects financed by him are in line with national objectives.

• Restrictive Endorsement: This prohibits further negotiation of the instrument i. This can be given also on the face of an instrument.5 Discuss the steps taken by the Government of Pakistan to develop interest free banking system so far. Ans.individuals .official payees . • All the contracts. • Conditional Endorsement: This makes the transfer of the instrument from the endorser to the endorsee after the fulfillment of stated conditions. Pakistan becomes the only country. etc. the endorser takes the liability of acceptance or payment of the endorsed instrument when it falls due. Inspite of early interest shown in the problems of devising and implementing an economic system based on Islam no significant developments took place until 1999 when the President of Pakistan announced that Council of Islamic Ideology should prepare a plan so that interest can be eliminated from the economy within three years. LATEST DEVELOPMENT In the recent past.agents for individuals . societies and association.e. Q. 2. It should be given for the purpose of negotiation which has been defined in section 14 of the Negotiable Instrument Act. • Partial Endorsement: This purports to transfer to the endorsee only a part of the amount payable on a bill of exchange or promissory note. Bankers in Pakistan accept endorsements in the following forms: • Endorsements by: . clarified that as a result of the verdict given by the Supreme Court. In Full. banks. amongst the Muslim states.joint payees . where the interest has been outlawed from all segments of the economy. in addition to the signature of the endorser. according to its apparent tenor. transaction. will continue to remain in force as before until new laws are replace the old laws for which a time frame has been given by the Judgement itself which is June 2001.. it specifies.joint stock companies . Classes of endorsement are: • Blank & Full endorsement: In Blank.public bodies. The government has.illiterate persons .executors and administrators . it consists of the bare signature of the endorser and the instrument so endorsed becomes payable to bearer. The Council in June 1980 gave its formal report to the Government in which attempted to lay down the guidelines for the reorientation of financing operations of commercial banks in the . the endorser is liable to compensate the holder for the loss or damage which he may sustain on account of such dishonour. • If the endorsed instrument is dishonored. the endorser of these instruments is only a surety for the principal debtor and his liability is secondary and conditional. A credit which revolves in relation to time is for more usual and practical instrument. 1881. obligations to the foreign government. A credit revolve around amount or around time. arrangements and laws would remain so till such time that the modified arrangements were worked out in the light of the recommendations of the commission for transformation to be set up in the State Bank of Pakistan. HISTORICAL REVIEW The need for elimination of Riba from the economy and ordering Pakistan’s economic life according to the teachings of Islam was voiced by experts soon after independence in 1947.. the Appellate Bench of the Supreme Court has pronounced its verdict upholding the earlier Judgement of the Shariat Court declaring all interest (Riba) based transactions as un-Islamic. • Formation of a committee of experts in the Ministry of Law to recommend legislative changes required to support the new arrangements and to suggest amendments in other laws to bring them in conformity with the requirements of Islamic Law.clubs. ENDORSEMENT An endorsement means the writing of a person’s name on the back of a negotiable instrument. It has no particular form of words and can be given on a piece of paper annexed to a negotiable instrument. 2001 in Pakistan.need for further specific amendment.trustees . the person to whom or to whose order the instrument is payable. however. • “Sans Recourse” Endorsement: When an endorser wants to exclude his liability to the endorsee or subsequent holder he indicates it clearly on the instrument by writing the words “SANS RECOURSE” or “Without Recourse”. The Bench has declared that all laws dealing with payment of interest as un-Islamic which shall cease to effect from June 30. The liabilities of an endorser are: • like the drawer of a bill of exchange or cheque. agreements. The Judgement of the Appellate Bench of the Supreme Court on Riba is the latest development in interest free banking in Pakistan and in the right direction for doing away with the present exploitative economic and banking system.married women . • Formation of a task force in the Ministry of Finance to study and suggest methods for domestic borrowings by the government which will be in conformity with the requirements of Islamic Law. • By endorsing the negotiable instrument. All laws currently applicable to financial contracts. etc. . financial institutions and other entities remained unaffected by the Judgement of the Shariat Appellate Bench on Riba. The salient features are: • Establishment of a commission for transformation in the State Bank of Pakistan that will be responsible for developing and preparing the groundwork for such methods of financial dealings as will be in conformity with the principles of Islam. the endorsee has no power to transfer this rights to any one further. With this historic Judgement.firms .

Purchase of trade bills. • Eight Step (1985) All finances provided by banking companies to all entities including individuals were charged to non-interest system as contended in the 12 prescribed modes.friendsmania. .htm#ixzz1DT8kgcj3 .country in such a way that the system will be in accordance with the tenets of Islam. • Fourth Step (1982) The system of House Building Finance on rent sharing based by commercial banks was introduced. Interest free counters were opened at all branches of commercial banks. public sector corporations and public or private sector and joint stock companies were to be only given in one of the 12 non-interest modes prescribed the State Bank.Purchase and sale of goods by banks on mark up basis. • Fifth Step (1983) The Hire-Purchase financing scheme on rent sharing bases was introduced.Financing for development of property on the basis of a development charge. (Murabaha) . • Ninth Step (1985) The banks were prohibited from accepting any interest bearing deposits Read more: MBA Banking Law and Practice http://www.Purchase of participation term certificates and modaraba certificates . • Sixth Step (1984) All banking companies were allowed to make finances on the following 12 modes of financing allowed by the State Bank: .Qard-e-Hasana .Musharika . ICP & HBFC were rescheduled on a non-interest based system.Equity participation and purchase of shares . As far the implementation of the non-Interest Banking system a gradual progressive method was adopted: • First Step (1979) Operations of NIT. .Rent sharing.Loans with Service charge .Hire purchase . • Second Step (1981) A system of PLS saving accounts was introduced. • Seventh Step (1985) All finances provided by banking companies to federal and provincial governments. • Third Step (1981) On Participation Term Certificates arrangements the commercial banks were allowed to provide finances to limited customers.Leasing .Purchase of movable/immovable property by banks with buy-back agreements .net/forum/mba-notes-assignments/27549.

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