Banking & Finance

By. Prof Riaz Ahmed Mian

Central
Bank
(Monetary Policy + SBP)

By. Prof Riaz Ahmed Mian

 Monetary Policy

Prof. Riaz Ahmed Mian, HCBF, University of the Punjab

 Monetary Policy
Meanings:
Monetary Policy refers to all those steps
that the central bank of the country takes
to influence, manage and control the
supply of credit and to regulate the
volume of credit in the economy.

Prof. Riaz Ahmed Mian, HCBF, University of the Punjab

1
 Monetary Policy contd

Explanation:
The basic rule is that too much of a
good thing is also bad. So credit,
investment and expenditure are no doubt
extremely essential for a healthy economy
but they must be put under some limits.
Excess of all these variable could produce
harmful effects over the economy.

Prof. Riaz Ahmed Mian, HCBF, University of the Punjab

2
 Objectives of
Monetary Policy

Prof. Riaz Ahmed Mian, HCBF, University of the Punjab

3
 Objectives of Monetary Policy
Underdeveloped Countries:
Meanings:
Under develop countries or LDCs
(Less Developed Countries) are those
countries which are either extremely
backward or which are in the process of
development.

4
 Underdeveloped Countries contd

1. To Achieve Full Employment

2. To Have High Efficiency
3. To Have Large Scale Resource
Mobilisation
4. To Increase Exports
5. To Have High Investments
6. To Provide Price and Exchange
Stability
7. To Have Efficient Allocation and
Utilisation of Resources
8. To Accelerate Economic Growth
(contd..)
Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 5
 Underdeveloped Countries contd

9. To Raise Living Standards

According to SBP Act, 1956,

The bank is required to regulate and
foster the growth of the monetary and credit
system to ensure monetary stability and to
secure full utilisation of countrys productive
resources.

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 Developed Countries
Meanings:
Developed countries include Japan,
USA. Germany etc. The economy of these
countries is characterise by high per
capita income, high rate of growth,
savings and capital formation, high living
standards, sound infrastructure and
institutions etc.

Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 7

 Developed Countries contd

1. To Have High Aggregate Demand without

Inflation
2. Eradicating Inflationary and Deflationary
Gaps
3. High Research/Further Development
4. Providing Assistance to Other Countries
5. Gaining Monetary Control over Others

Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 8

 Tools of Monetary Policy

Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 9

 Tools of Monetary Policy
I. Quantitative Tools
II. Qualitative Tools

Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 10

 Tools of Monetary Policy contd

I. Quantitative Tools:
These tools are of such nature that
they produce effects on whole of the
economy without any distinction.

Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 11

 I. Open Market Operations (OMO)

Meanings:
Open Market Operations may be
defined as purchase and sale of
government securities in the open
market by the central bank. This is
basically done with the objective of
influencing the monetary assets of
commercial bank.

Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 12

 Open Market Operations (OMO) contd

Functions:
Buying Securities: State bank can buy
securities either from the commercial bank or
from public.

Selling Securities: Securities can be sold

either to banks or to public.

Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 13

 Open Market Operations (OMO) contd

Result:
When central bank buys securities from
commercial banks, it pays them in money. This
increases cash reserves of the commercial bank
and hence their lending power increases.
When it sells securities, it hands over
securities to commercial banks. Commercial
banks pay cash to central bank. This reduces the
commercial banks cash reserves and their
lending power is reduced.
Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 14
 Effects on Interest Rate
When securities are purchased by the
central bank then commercial banks end up
with excessive cash reserves. In order to
attract borrowers and investors they lower
their interest rates.

Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 15

 Effects on Interest Rate contd

When securities are sold, this results

in reduced cash reserves with commercial
banks. If there is high demand for loans
from borrowers and investors, the interest
rate and hence cost of borrowing rises.

Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 16

Purpose of Open Market Operations
1. To administer and maintain the prices of
government securities.
2. To create suitable climate for the
floatation of new loans.
3. To activate the money market.
4. To manage gold inflows and outflows.
5. To create climate in which other tools of
monetary policy i.e., bank rate could be
used effectively.
6. To avoid sudden fluctuation in the
money market.
7. To support government credit. 17
 Limitations / Assumptions
1. Undeveloped Market:
For effective Open Market Operations
the money and capital markets must be fully
developed.

Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 18

 Limitations / Assumptions contd

2. Excessive Cash Reserves:

The basic rational of open market
operations is to decrease cash balances of
commercial banks so as to reduce their lending
power.

Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 19

 Limitations / Assumptions contd

3. Availability of Securities:
For Open Market Operations to be
effective, there must be ample and adequate
securities. The central bank purchases
securities at high prices in order to stimulate
economy and to push it out of depression or
slump. On the other hand, it sells securities in
order to check inflation however for all this
there must be adequate amount of securities
i.e., the total amount of securities must form
some considerable proportion of the total
excessive cash reserves. 20
Prof. Riaz Ahmed Mian, HCBF, University of the Punjab
 Limitations / Assumptions contd

4. Economic Climate :
The economic climate of the country
also determines the effectiveness of Open
Market Operations.

Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 21

 Limitations / Assumptions contd

5. Willingness of Borrowers :
The investors and borrowers attitude
is an important factor that can disturb the
central bank plans based on open market
operations. If the borrowers are
discouraged and disappointed and they have
become pessimist about future then they will
not like to borrow or to make investment.

Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 22

 Limitations / Assumptions contd

6. Willingness of Bankers :
The bankers attitude also plays a role
in deciding the fate of open market
operations.

7. Borrowings of Central Bank:

The borrowings of the central bank
neutralise the effects of open market
operations.

Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 23

 Open Market Operations with
Reference to Pakistan
In Pakistan the money and capital
markets are not fully developed. Open Market
Operations are not widely used as a chief
instrument of monetary policy. There have
been sales and purchases of government
securities by the central bank, but these were
basically done to provide timely assistance to
bank.

Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 24

 II. Bank Rate:
Bank rate is another quantitative tool
of monetary policy. Bank rate is the rate at
which central bank is willing to rediscount
first class bills of exchange of commercial
banks or is willing to advance loans against
approved securities. This rate is also called
discount rate.

Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 25

 Other Objectives:
1. To reduce consumption expenditure and
to generate savings.
2. To improve the countrys balance of
payment position. This is done by encouraging
the inflows of foreign funds and by restricting
outflows.
3. To reduce inflationary trends in the
economy by reducing credit creating potential
of commercial banks.

Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 26

 Assumptions & Limitations :
1. Development of Capital and Money
Markets
2. Availability of Bills
3. Economic Climate
4. Borrowers Attitude:
If due to bright future prospects, the
borrowers and investors are determined to
borrow, whatever the cost, then increase in
bank rate is unlikely to contract the supply of
credit.
Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 27
 Assumptions & Limitations contd

5. Lenders Attitude:
The lenders attitude can also help or
hinder central bank to produce desire results. If
following their own priorities, commercial
banks keep on advancing loans despite higher
bank rate then such a credit control policy will
be a failure.

Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 28

 Assumptions & Limitations contd

6. Absence of Excessive Cash Reserves:

In order that bank rate policy be
effective and fruitful, commercial banks must
not be maintaining excessive cash reserves
with themselves. In such a case, they will have
to rediscount bill of exchange whenever they
feel need of extra reserves. Then they will be
directly affected by the changes in the bank
rate.

Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 29

 Assumptions & Limitations contd

7. Relationship between Rates:

For bank rate policy to be affective,
there must be active relation between inter
bank rates and open market rates. If changes in
discount rates and other inter bank rates brings
any affect on open market rates then bank rate
policy cant be used as an effective weapon to
curtail credit creating powers of commercial
banks.

Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 30

 III. Cash Reserve Requirements :
It is a well known fact that every
commercial bank is required to hold certain
amount of cash reserves with the central
bank. This amount is expressed as a certain
percentage of banks time and demand
liabilities. This percentage is called cash
reserve ratio.

Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 31

 IV. Liquidity Ratio :
The cash reserve requirements which are
discussed above, is a part of the overall
liquidity ratio.
The liquidity ratio is defined as follows:
It means the percentage of total
demand and time liabilities which
commercial banks must keep in the form of
cash, gold or approved securities.

Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 32

 V. Special Deposits:
Meanings: Besides reserve requirements, the
central bank may call additional reserve from
commercial banks. Such deposits are called
special deposits and they are expressed as a
percentage of banks liabilities. These deposits
are other than operational deposits and some
interest is paid on these deposits.

Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 33

 Qualitative Tools:
Quantitative weapons which have been
just discussed are of such nature that they
cause affects the whole of banking system.
They affect the whole economy without any
distinction. Apart from these controls, there are
some other weapons which can be used in such
a way that only certain required sectors of the
economy are affected. Such weapons are called
selective or qualitative credit control weapons.

Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 34

 Qualitative Tools contd

I. Credit Rationing:
Central bank does so by rediscounting bills or by
providing loans and funds. Credit rationing can be
used to control credit supply. In this method, the
central bank specifies a maximum limit to which it is
prepared to accommodate commercial banks in
financial pressure. Under this method central bank can
adopt following ways.
1. It can restrict the amount of loan that a
commercial bank can obtain from central bank.
2. It may refuse to rediscount bills beyond certain
amount.

Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 35

 Qualitative Tools contd

II. Credit Ceiling:

Credit ceiling is another qualitative
credit control weapon. Under this central bank
specifies the maximum supply of credit to the
economy during a particular period.

Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 36

 Qualitative Tools contd

III. Moral Persuasion:

A friendly and polite type of credit
control is called moral persuasion. Here
instead of specifying a particular limit and
imposing penalties, central bank requests the
commercial banks to follow the general
monetary policy and credit control guidance.

Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 37

 Qualitative Tools contd

IV. Direct Action:

When the commercial banks continue to avoid
the instruction of central bank, the central bank can
take direct action against them.
Through direct actions the central bank restricts
commercial banks from expanding credit. Direct
action can be taken in any of the following ways:
Central bank may refuse to rediscount bills of
exchange of the defaulting commercial banks.
Or it may not provide direct financial
assistance, advances and loans to such
commercial banks which do not follow the general
monetary policy.
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 Qualitative Tools contd

V. Advertisement:
From time to time for general as well as
for specific purposes, the central bank
publicises the objectives and goals of monetary
policy. This can also increase the efficiency of
the whole banking and financial infrastructure.

Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 39

 Limitations of Monetary Policy
1. Absence of Developed Banking System:
The monetary policy is effective only
when practised in a developed economy
where money and capital markets are
working efficiently.

Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 40

 Limitations of Monetary Policy contd

2. Not Applicable for Foreign Banks:

Another limitation is that central
bank cant always exercise its extensive and
special powers against all banks especially
against foreign banks.

Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 41

 Limitations of Monetary Policy contd

3. Conflicting Objectives:
Sometimes the situation is such that
monetary policy is required to achieve two
conflicting objectives. For instance if an
underdeveloped country is experiencing
high rate of inflation then economic
development and price stability both are
needed at the same moment.

Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 42

 Limitations of Monetary Policy contd

4. Large-Scale Deficit Financing:

Monetary policy is also affected by the
size of the Public Sectors, Borrowing
Requirements (PSBR) or by Public Sector
Debt Repayment (PSDR). Where the
government is borrowing heavily and running
a budget deficit, monetary policy will find it
difficult to achieve the objective of controlling
credit in the economy.

Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 43

 Limitations of Monetary Policy contd

5. Position of Bank Reserve:

If commercial banks are holding
excessive amount of reserves with themselves
then monetary policy cant effectively work.

Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 44

 Limitations of Monetary Policy contd

6. Economic Situation:
Economic situation also determines the
success of monetary policy. If monetary
situation is stable and businessman is
optimistic about the future, he will continue to
borrow from banks despite the high cost of
borrowing.

Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 45

Establishment, Management
& Functions of the State
Bank of Pakistan

46
 Establishment, Management & Functions
of the State Bank of Pakistan

1. The History:
The Reserve Bank of India was directed
to perform all functions of the Central Bank of
Pakistan until Sep. 1948.

The Reserve Bank of India to be the sole

currency note issuing authority for Pakistan
until Sep. 1948.
(contd)
Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 47
 The History contd

The Indian currency notes will be valid

and they will remain legal tender in Pakistan
until Sep. 30, 1948. The Pakistan government
will issue its own currency from Oct. 1, 1948.

The Indian coins will be valid and they

will remain legal tender in Pakistan for at least
one year from the date of issuances of
Pakistani coins. The Pakistan government will
issue its own coins from Oct. 1, 1948.
(contd)
Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 48
 The History contd

The Reserve Bank of India will transfer

the Pakistans share of 75 crore to Govt. of
Pakistan till Sep. 30, 1948.

Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 49

 Establishment of the State Bank of Pakistan

On Dec. 30, 1948 the British

Government's commission distributed the
Bank of India's reserves between Pakistan and
India as 30 percent for Pakistan and 70 percent
for India. The share of Pakistan was Rs. 75
crore. Irrespective of the provisions of the
Monetary system and Reserve Bank Order
1947.
(contd)

Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 50

 Establishment of the State Bank of Pakistan contd

The Reserve Bank of India did not

perform its function with diligence and good
faith for Pakistan. Also this Bank refused to
transfer Rs.550 million which Pakistan was
entitled to receive as the proportionate share of
assets of undivided India. Further the losses
incurred in the transition to independence
which were amounting to Rs. 23 crore were
taken from Pakistan's share.
(contd)
Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 51
 Establishment of the State Bank of Pakistan contd

Governor General of Pakistan Quaid-e-

Azam Muhammad Ali Jinnah issued the order
of the establishment of SBP on 12May, 1948.

This order is known as the State Bank

of Pakistan Order, 1948 and under this order
the SBP started its operations on July 1, 1948.

Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 52

 Objectives (Under 1948 Order)

Regulating the issue of bank currency

notes and keeping the reserves with the view to
securing monetary stability in Pakistan and
generally to operate the currency and credit
system of the country to its advantage.
(contd)

Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 53

 Objectives (Under 1948 Order) contd

Regulate the monetary and credit

system of Pakistan and to foster its growth in
the best national interest with the view to
securing monetary stability and the fuller
utilisation of the countries productive
resources.

So the SBP has twofold objectives i.e.,

issuance of the currency notes and the
advanced objective of leading the country
towards development and prosperity.
Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 54
 The Laws Governing SBP

The powers, functions, operations and

administration of the SBP are governed and
directed by the SBP Act, 1956 and the Banking
Companies Ordinance 1962.

(contd)

Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 55

 The Laws Governing SBP contd

Functions / Role of the SBP

1. Issue of Currency Notes

Currency Note Issue Offices:
The SBP has 3 offices of currency notes
issue situated at Karachi, Lahore and
Peshawar. Apart from this currency chests are
situated all over the country. The currency
chests remain in the custody of the National
Bank of Pakistan or the Treasury Officers.

Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 56

 Functions / Role of the SBP contd

2. Banker to the Government

3. Bankers Bank

Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 57

 Functions / Role of the SBP contd

4. SBP as Clearing House

By acting as a clearing house the SBP /
NIFT introduces flexibility in the banking
operations and also remains informed about
the liquidity position of various banks.

SBP / NIFT helps commercial banks to

settle inter-bank transactions with the
minimum use of cash.
(contd)

Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 58

 SBP as Clearing House contd

By acting as a clearing house, SBP /

NIFT also keeps a check on unwanted and
harmful competition among commercial
banks.

The clearing house function of the SBP

also helps the commercial banks, in times
of need and crisis. They can help one
another by deferring early payments.

Prof. Riaz Ahmed Mian, HCBF, University of the Punjab 59

 Functions / Role of the SBP contd
5. Advisor to Government
6. Lender of Last Resort
7. SBP as Controller of Credit
1. Open Market Operations
2. Bank Rate Policy
3. Changes in Reserves Ratio
4. Changes in Margin Requirements
5. Change in Liquidity Ratio
6. Moral Persuasion
7. Publicity
Also in 1972, a National Credit Consultative
Council (NCCC) was setup for the purpose of
monitoring and controlling credit.
-----THE END----- 60
thank U

Best of Luck