1. Banking
B-Com Part 2 Banking- Finance Notes
Q.1. Define Bank and explain that banking system of a country helps in its
economic development.
OR
Write short notes on, * Industrial Bank, * Agricultural Bank, * Cooperative
Bank, * Exchange Bank, * Mortgage Bank, * Savings Bank
Meaning of Bank
It is generally said that the word "BANK" has been originated in Italy. In
the middle of 12th century there was a great financial crisis in Italy due to
war. To meet the war expenses, the government of that period imposed a
forced subscribed loan on citizens of the country at the interest of 5% per
annum. Such loans were known as Compara, Mintuo etc. The most common
name was Monte. In Germany the word Monte was named as Bank or Banke.
According to some writers, the word Bank has been derived from the word
Banke.
It is also said that the word Bank has been derived from the word Banco
which means a banch. The Jews money lenders in Italy used to transact
their business sitting on banches at different market places. When any of
them used to feel to meet his obligations, his banco or banch would be
broken by the angry creditors. The word Bankrupt seems to be originated
from broken banco. Since, the banking system has been originated from
money lending business, it is rightly argued that the word Bank has been
originated from the world banco.
Today the word bank is used as a comprehensive term for a number
institutions carrying on certain kinds of financial business. In practice, the
work Bank means which borrows money from one class of people and again
lends money to another class of people for interest or profit.
Definition of Bank

2. Bank is defined in many ways by various authors in the books on economics
and commerce. It is very difficult to define a bank, because a bank
performs multifarious functions. Different kinds of bank having different
functions may be defined in different ways according to their functions.
The evolution of different type of banks, each specialization in a particular
field, gives emphasis on each and every kind of bank. A general and
comprehensive definition to cover all types of banking institutions would be
unscientific and probably impossible. Each type of bank should have its own
definition explaining its specialized functions. Legislators have understood
this difficulty and that is why the Bill of Exchange Act 1882 (England)
defines thus A bank includes a body of persons, whether incorporated or
not, who carry on the business of banking.
From this definition it is clear to us that any institution which performs the
various banking functions may be termed as bank. But in practice it is found
that many banking functions vary from time to time and country to country.
It is not possible on the part of a single bank to perform all the banking
functions at the time. So there originated numbers of specialized banks
with the objective of performing one or more functions. As for example,
Central Bank, Commercial Bank, Industrial Bank, Agricultural Bank, Co-
operative Bank etc., are in the practical field.
Dr. Herbert L. Hart has defined a Banker as A Banker is one who in the
ordinary courses of business honours cheques drawn upon him by persons for
whome he receives money on current account. According to Sir John Paget
No one and no body corporate and otherwise can be a Banker who does not
(i) take deposit accounts (ii) take current accounts (iii) issue and pay
cheques drawn upon himself (iv) collect cheques crossed and uncrossed for
his customers.
Hilton Banking Commission defines Bank or Banker in the following words:
Every person, firm or company using in the description or its title, Bank or
Banker or Banking and accepting deposits of money subject to withdrawal by
cheque, draft or order.
Banking Ordinance 1962 (Pakistan) defines Banking as Accepting for the
purpose of lending or investment of deposits of money from public,
repayable on demand or otherwise and withdrawal by cheque, draft, order
or otherwise. Vise Sec. 5(1) and 5(B) Banking Co's Ordinance, 1962.

3. In view of the above definitions, a simple and short definition can be given
as Bank is an institution which deals in money and credit. According to this
precise definition A bank accepts deposits of money in savings and current
accounts at lower rate of interest or profit and gives on credit to needy
persons and businessmen at a higher rate of interest or profit. It also
transfers money for the clients from one city or country to another and
also performs various other agency services for earnings.
Importance of Banking
Bank play a significant role in the economic development. The overall
economic of a country is absolutely dependent on the efficient banking
system. Industrial, agricultural and commercial progress of a country is not
possible without a good banking system. The importance of banking may be
stated as follows:
1. Capital Formation
Economic development depends upon the division of economic resources from
consumption to capital formation. Capital grows out of savings. Banks play
the prime role in accumulating capital by collecting the scatered savings of
the people. Thus banks render a valuable service towards the development
of a country by encouraging the growth of capital.
2. Inexpensive Media of Exchange
Modern Banking provides inexpensive media of exchange. Issuing of currency
notes is a great achievement of modern banking. In addition the cheques
issued on the banks are frequently used instead of money in transacting
business. Thus the cheques economise the use of currency notes.
3. Development of Trade and Industry
Bank utilise their collected funds by advancing loans to commercial and
industrial undertakings. In respect of foreign trade also, banks render a
valuable service by issuing letter of credit etc.

4. 4. Reservoirs of Funds
Banks acts as the reservoirs of money in the country. In times of
economic, crisis the bankers come forward to help the Government by
purchasing the Government securities or by advancing loans.
5. Transfer of Funds
Banks facilitate the transfer of funds from one place to another safely and
at a very cheap cost through bank drafts, mail transfers, telegraphic
transfer, travellers cheque etc.
6. Dealing in Foreign Exchange
Banks deal in foreign exchange by purchasing and selling foreign currencies
and by issuing letters of credit. Foreign remittances of funds are possible
only through banks.
7. Money Market Operations
The structure and ups and downs of money market in the country are
largely dependent on the bankers activities. Under the guidance of the
central bank all the banks in the country do their best for the sound
management of money market.
8. Service to Customers
Banks perform various agency services on behalf of their customers. They
collect or make payments of bills of exchange, dividend, insurance premium
etc, on behalf of their customers. They act as the trustees ore executors
of documents etc. They also extend financial advises to their customers.
Functions of Modern Bank
The following is the list of functions or services rendered by a modern

5. bank:
1. Bank provides inexpensive media of exchange through its cheques etc.
2. Bank keeps deposits of public.
3. Bank finances trade and industry.
4. Bank keeps in capital formation by economic savings.
5. Bank acts as Reservoir of funds.
6. Bank deals in foreign exchange and finances foreign trade.
7. Central Bank issues notes and controls money supply.
8. Central Bank controls credites, exchange and the money market.
9. All the banks participate in the development of money market.
10. Bank facilitates the transfer of funds from one place to another.
11. Specialized banks helps in the development of agriculture and industry.
12. Banks acts as the custodian of customers valuables.
13. Bank acts as underwriters for raising capital or loan by Government,
Public Bodies and Campanies.
14. Bank acts as trustees and Executor of will and documents on behalf of
their customers.
15. Bank acts as the correspondent and representative of its customers,
other banks and financial institutions.
16. The Bank collects and makes payments of Bills of Exchange on behalf
of its customers.
17. The bank makes payments and collects in respect of subscriptions,
insurance premiums, rents, salaries etc, and also receives pension dividends
and payment of utilities bills on behalf of their customers.

6. 18. Bank advances loans and extend financial advices to its customers.
19. Bank Discounts Bills.
20. Bank purchases and sells stock exchange securities.
Qualities of Good Banking System
Every bank is a dealer in money and credit. It generally deals in with
others money and not with its own money. It takes deposits from the public
and again lends to its customers for the sake of interest or profit.
Thus, the operation of banking business is very risky one. A bank must have
some qualities in operating its functions efficiently and successfully. The
qualities of good banking may be summarized as below"
1. Adequate Capital
A banker must have adequate amount of capital. A large scale operation
and execution of various functions of a modern bank require large amount of
capital at the initial stage. Thus, without sufficient capital no large scale
banking can flourish.
2. Good Reputation
Reputation is the most important factor in the progress of a bank. To be
successful, a bank must have ample reputation in the money market.
Reputation of a bank depends upon the qualifications of the directors and
on the efficiency of management and workers.
3. Liquidity.
Money which is dealt in by a bank is not its own, so a banker must always
keep himself ready to meet the claims of his depositors. He should keep
sufficient amount of cash reserve and should keep some assets in such a
way that these can be encashed at any moment. He should not block his

7. fund by advancing loans for long periods rather he should always prefer
short term credits.
4. Security and Safety
In respect of advancing loans safety should be the main guiding principle for
a bank. The loans advanced by the banker must be secured. The persons to
whom the advance is to be made, must be studied carefully before the
lending of money. According to R.S. Sayers, The good banker is one who
can distinguish the sound from the unsound borrower.
5. Economy
Economy in expenditure should be maintained for the proper operation of
banking business. A good banker will always try to maximise his profit at a
minimum cost.
6. Effective Publicity
A bank should adopt various scientific methods of advertisement for the
proper publicity of business.
7. Localization
Good locality of a bank is another quality. The bank should be located in
the business centre so that it can flourish its business successfully.
8. Speciality
To be successful, a bank should be specialized in any one or more fields of
banking. An agricultural bank always aim at financing the formers for
agricultural purposes. Industrial bank provides long terms credits to the
industries. The individual commercial banks are also specialized in different
fields of banking.

8. 9. Good Show within the Office
The bank office should be well equiped with modern aminities proper sitting
arrangement should be made within the bank office for its customers.
10. Good Personnel and Efficiency
The officers and the employees of the bank must be efficient in their
work. They should be well trained in different fields of banking.
Furthermore they should be well behaved and polite in the manner and must
possess pleasing personality.
Classification of Banks
The banks can be classified on the following three basis:
1. Structural Classification of banking.
2. Operational Classification of banks.
3. Functional Classification of banks.
1. Structural Classification
Banks can be classified on the basis of their structure or constitution.
According to structural classification, banking may be classified as (a)
Branch Banking (b) Unit Banking
(a) Branch Banking
Under branch banking system, banking business is carried on through a
network of branches in the same town or country under the guidance and
control of one single head office. These branches may also be located in
outside of the country. This system of banking was originated in the United
Kingdom. Now-a-days this system if followed by many countries of the
world including Pakistan.

9. (b) Unit Banking
Under unit banking system the banking operations are carried through a
single office without any branch. Remittances and foreign exchange etc,
are dealt through correspondence between banks of two places. The U.S.A
is the home of unit banking.
Advantages of Branch Banking
1. Large Scale Operation
Branch banking system enjoys all the advantages of large scale operation.
Proper division of labour is applied successfully and the employees become
specialized in different banking fields.
2. Economy of Reserves
Under this type of banking, the funds can easily be transferred from one
branch to another. So full economy in maintaining cash reserve can be
secured by a banking having number of branches.
3. Remittances of Funds
This system facilitates easy remittances of funds from one place to
another through its number of branches in different places.
4. Spreading Risk Geographically
The bank having many branches can spread its risk geographically or
territorially. In case of losses incurred by branch in an area can be offset
by profits of the branches of other areas.
5. Parity in the Rate of Interest
By making easy movement of funds from one place to another branch
banking system can maintain parity in the rate of interest in different
parts of the same country or of the world.

10. 6. Wise Banking Policy
The bank can formulate a wise banking policy. As it has got a good number
of branches throughout the country. It can study money and credit position
correctly. Loans and advances are made on merits and not on other
consideration. Applications for large amount of loan are passed on to the
higher authorities in head office.
7. Investment of Idle Funds
Under branch banking system a branch can transfer its idle funds to other
branches where this can be invested on profitable terms.
8. Foreign Exchange
As it has got foreign branches it is easier to operate foreign exchange for
a branch banking.
9. Superior Management and Personnel Training
Branch banking system having large scale operations attracts superior
personnel and offers wide scope for the training of the personnel.
Disadvantages of Branch Banking
The critics of the branch banking mentioned the following disadvantages:
1. Loose Control and Management
Under branch banking system, it becomes very difficult for a single head
office to manage and control a number of branches much effectively.
2. Red Tapism

11. Red-Tapism and delay is common due to lack of sufficient authority to
branch managers. They are also not allowed to stay for long in one branch,
so they do not have the chance of becoming familiar with local needs.
3. Relationship Between Management and the Employees
Due to large number of branches the relationship between the employers
and employees is not close and cordial.
4. Late Decision
A branch banking a large organisation, can take neither quick decision nor
prompt action in case of emergencies.
5. Concentration of Financial Lesources
In branch banking system large financial resources are concentrated in the
hands of small number of authorities of bank.
Advantages of Unit Banking
1. Easy Management and Control
Under unit banking system, it becomes very easy for a single office to
manage and control efficiently.
2. Close Management and Workers Relationship
Under unit banking system, there prevails a close and cordial relationship
between employer and employees.
3. Quick Decision
The owners or the management of unit banks can take quick decision and

12. prompt action in times of emergencies.
4. Use of Local Resources
Local financial resources are used for local development.
5. Lesser Fraud and Irregularities
Due to the less scattered affairs of the bank, there are very little
possibilities of fraud and irregularities.
Disadvantages of Unit Banking
1. Limited Size of Operation
Unit bank business can not be operated on large scale because of its limited
area. Being the small organisation, division of labour can not be applied.
2. No Economy of Reserves
Under unit banking, bank can not transfer its funds to any other branch.
So economy in cash reserve can not be secured under this system.
3. Limited Financial Resources
A unit bank has limited financial resources so it is not able to provide full
and adequate banking facilities to the industry and trade of the area.
4. Investment of Idle Funds
A unit bank having no other branches, can not utilize its idle funds in
profitable ways.
5. Disparity in the Rate of Interest

13. Under the system, there prevails a great disparity in the rate of interest
in the same country as the management of different banks are separate
from each other.
Operational Classification of Banks
On the basis of nature of operation, banks can be classified into the
following two categories.
(a). Correspondent Banks
The unit banks, having no branch are linked together by correspondent bank
system. Under this system, a unit bank of a village or small town deposits a
portion of its cash reserve with another bank in the nearest city. And this
superior bank of city also deposits with another greater bank of big city.
These unit banks are linked through correspondence. Remittances of funds
of home and foreign trade transactions are made through these
correspondent banks. The unit banks are completely independent of each
other no doubt, but these are connected with one another through
correspondent system.
(b). Specialized Banks
The bank which performs one or more special functions is known as
specialized bank. As for example an agricultural bank takes up the special
responsibility of financing agricultural activities. Industrial banks specially
finance the industrial undertakings. Japan is the home of specialized banks
where different types of specialized banks are working with their special
functions.
The specialized banks have a great role in the economic development of a
country, specially of a developing country like Pakistan.
In our country, Agricultural Development Bank of Pakistan is helping
financially in the development of agricultural sector of our economy. The
Industrial Development Bank of Pakistan is another specialized bank who is
financing large scale industries in Pakistan.

14. Functional Classification Of Banks
Banks may be classified according to their functions. Different kinds of
banks, with different functions may be summarized as follows:
(a) Central Bank
A central bank is the most important institution in the banking system of a
country established with the objective of regulating the banking and
monetary system of the country. It issues notes and currencies within the
country and is entrusted with responsibility of maintaining the price level in
the country stable. It acts as banker to the Government and it directly or
indirectly controls the activities of all other banks. State Bank of Pakistan
is Central Bank of our country.
(b) Commercial Bank
Such type of bank is cheerfully engaged in financing internal trade. It deals
in short term credit. It takes deposit from public through different type of
deposit accounts and invests that collected fund in advances and loan of
short period to the trading and commercial undertaking. This type of bank
is familiar in most of the world. In our country, for example, National Bank
of Pakistan, Habib Bank Limited, United Bank Limited, Muslim Commercial
Bank Limited and Allied Bank Limited are the commercial banks.
(c) Industrial Bank
Such institution specialises in financing industry. It provides long term
credit to people who carry on industrial enterprises. Industrial Development
Bank of Pakistan (IDBP) and Pakistan Industrial Credit and Investment
Corporation (PICIC) are the examples of industrial banks.
(d) Agricultural Bank
Such bank provides long and short term finance to agriculturists for their

15. agricultural purposes. Long term capital is required for acquisition and
improvement of land and purchase of heavy machinery and equipments.
Short period capital is required by the farmers for current expenditure on
seed, manures, wages etc. Agricultural Development Bank of Pakistan
(ADBP) is the best example of agricultural bank in our country who provides
long term, medium term and short term loans to the agriculturists.
(e) Exchange Bank
Exchange bank deals mainly in the finance of the foreign trade of the
country. It deals in foreign exchange. On otherwards, the main function of
such bank is to buy and sell foreign currencies, rather titles to foreign
currencies in the form of bills of exchange, drafts, telegraphic transfers
etc. It purchases the bill of exchange which arise in connection with the
import and export trade of the country and they deal in exchange. The
exchange banks liquidate the international indebtiness by exporting and
importing precious metals and securities, if necessary, they purchase bills in
the international money market and deposit them with their banking agents
inbig commercial centres like London, Paris, New York etc. They draw and
sell their own drafts on these deposit accounts.
(f) Cooperative Bank
This type of bank is organised mutually by the persons of similar
occupations within the objectives of providing banking and credit facilities
to the members. Generally in every country. Government patronises co-
operative banks in order to encourage the cultivators, fisherman, workers in
the factories etc.
(g) Mortgage Bank
Mortgage bank advances long term credits against securities of immovable
properties like, agricultural lands, buildings and machinaries etc. Generally,
credit is give to the agriculturist, small industries or house builders. This
type of bank is essential in an under developed country where capital supply
is very limited. In our country, House Building Finance Corporation is
functioning as mortgage bank providing long term loans to house builders
against securities of building and land property.

16. (h) Savings Bank
Such banks provides facilities to people to save money. This type of bank is
established with the objective of promoting the thrift or saving habits
among the people of small incomes. It takes deposits from the public and
lands the collected funds to traders. Depositers are allowed to withdraw
money from their deposits twice in a week. Post offices in Pakistan carry on
functions of saving bank. Of course commercial and other bank also accept
saving deposits.
Q.2. Define Central Bank. State the origin and growth of central bank.
OR
What is credit control, explain the various methods of credit control
followed by the central bank of a country?
Definition of Central Bank
In every country, there is a principal bank who is responsible for guidance
and regulation of the financial system in the country. Such type of bank is
known as Central Bank.
A Central Bank may be defined as
The principle banking institution of a country operating under some degree
of state control and entrusted with the special responsibility of maintaining
economic equilibrium and stability in the prices and in the over all interest
of the country.
Nature of Central Bank
From the above definition we find the following main features of Central
Bank:

17. 1. The Central Bank is the principle banking institution of a country.
2. It is operated under some degree of state control. But in practice, the
structure of central banks vary from country to country. In U.K. and
France, the bank of England and Bank of France are solely owned, managed
controlled by the state on the other hand, Federal Reserve System, the
Central Bank of the U.S.A is owned, managed and controlled by the private
share holders. Of course, there are some central banks which are owned,
managed and controlled jointly by the Government and the private share
holders. e.g., State Bank of Pakistan before nationalisation 1974.
3. The Central Bank is entrusted with the responsibility of maintaining
economic equilibrium and stability in prices by controlling money supply and
volume of credit with in the country.
4. A central bank does its works not for making profit but in the overall
interest of the country.
5. The central bank is reservoir of credit. All other banks can look to it
for accomodation.
Functions of Central Bank
The central bank is the pivote of all the banking system. The chief
functions of a central bank may be described as follows:
1. Issuing Notes
The central bank has the sole responsibility and monopoly of issuing notes
within the country. It is the sole currency authority. The central bank is
required to keep a certain percentage of gold reserves against issue of
notes. Usually, it keeps 30% to 40% gold as reserve. It undertakes

18. expansion and contraction of the currency alongwith business demand.
Money supply is raised by issuing notes. On the other hand, it can decrease
money supply by selling government securities. By enjoining monopoly of note
issue it gives uniformity to the system of note issue in the country.
2. Governments Banker
The central bank acts as a financer of the government of the government.
It is a government banker not only collecting and paying money on behalf of
the government but it also manages the public debts. It keeps the
government funds in the custody free of interest. On the other hand it
gives loans to the government without limitation of amount. It is the fiscal
agent of the government. It helps the government in designing a fiscal
policy for the country so its also plays the role of financial adviser to the
government.
3. Banker's Bank
It acts as the custodian of cash reserves or balances deposited compulsorily
by the scheduled banks. Either by law or custom the member banks are to
keep certain portion of their deposits with the central bank as reserve. For
example in our country the scheduled or commercial banks are to keep cash
reserve with State Bank of Pakistan to the extent of 5% of their deposits.
Central Bank also provides short term credit to commercial banks by
rediscounting first class bills and other securities. So it plays the role of
banker's bank.
4. Management of Gold Standard
Where the currency of a country is on gold standard, it is the
responsibility of the central bank to manage the gold standard in order to
control the stability of exchange rate. It regulates and checks the
movement of gold in the country. The management of gold standard is not

19. so vital and important these days.
5. Credit Control
It is another important function of central bank. It controls the flow of
credit in accordance with the needs of business in the country. Credit plays
an important role as the medium of exchange, so its expansion or
contractors effects the price level in the country. In order to maintain
stability in the price level, central bank controls the volume of credit.
Usually, it controls credit by changing bank rate, purchasing and selling
securities and by changing reserve rates of the member banks. In this way
central bank attempts to control the volume of credit and stablishes the
business conditions in the country.
6. Clearing House
It is the Clearing House of the bankers. Under this function central bank
of facilitates the settlement of bills and cheques of other banks.
7. Exchange Control
It is the responsibility of the central bank of control foreign exchange and
maintain the rate of exchange. It purchases and sells approved foreign
currencies at the current or fixed rate. It also acts as the custodian of
foreign exchange reserve.
8. Lender of Last Resort
As lender of last resort, it is implicit that the central bank assumes the
responsibility of meeting directly or indirectly all reasonable demands for
accommodation by commercial banks in the times of difficulties and crises.
If any commercial bank faces any serious financial difficulty for any

20. reason, it is central bank who comes forward to help it.
9. Custodian of National Reserve
The Central Bank acts as the trustee of the entire economy of the country
and thus keeps in its custody all national reserves in form of gold, silver
and securities.
Credit Control
Credit plays an important role in maintaining and changing the price level as
medium of exchange. It is the responsibility of the central bank to regulate
the volume of credit and its direction to maintain stability in the price
level.
Following are the main objectives of credit control by central bank
1. Safe Guarding the Gold Reserves
The central bank adopts various measures of credit control to safe guard
the gold reserves against internal and external drains.
2. Stability in Price Level
Credit control provides stability in price level in the country.
3. Exchange Stability
Another objective of credit control is to achieve the stability of foreign
exchange rate. If the foreign exchange rate is stabilized, it indicates the
stable economic conditions of the country.

21. 4. Stability in Investment and Production
Control of credit by central bank also provides stability in the investments
and production by making price level stable.
'5. Cooperation
Control of credit is done to promote cooperation with other countries for
the purpose of maintaining world economic stability.
Methods Or Techniques of Credit Control
The central bank usually controls the volume of credit through the two
types of methods, quantilative and quantitative.
1. Bank Rate Policy
It is also known Discount Rate Policy. Bank rate is the rate of interest
which is charged by the central bank on rediscounting the first class bills
of exchange and advancing loans against approved securities. This facility is
provided to other banks.
Importance
The bank rate is different than the money market interest rate. The
charges in bank rate are followed by other banks in the country in changing
their interest rate. If the bank rate is raised by central bank, other rates
of money also go up. Conversely, the market rate of interest and other
rates go down, when central bank decreases its bank rate. These changes
effect the supply of and demand for money. Borrowing is discouraged when
the rate of interest increases and encouraged when the rate decreases.

22. Effects of Changes in Bank Rate
The changes in the bank rate may cause the following effects.
a. Changes in Deposit Volume
When the central bank increases the bank rate, commercial banks also
increase the rate of interest and consequently the deposits of the banks
also increase. Conversely, when bank rate is decreased the deposits of
commercial bank also decrease.
b. Controls the Borrowings
When the bank rate is raised, the rate of interest and discount of other
banks goes up margin of profit falls and it discourages the businessmen to
borrow money and thus the volume of loans and discounting of bills is
minimised. On the other hand a fall in the bank rate encourages loans and
bill discounting.
c. Changes in the Prices of Shares and Securities
A rise in bank rate makes shares and securities in the market cheaper and
conversely, by a fall in the bank rate, shares and securities becomes
dearer.
d. Changes in the Volume of Speculative Business
A rise in the bank rate restricts the volume of credit and discourages
speculative business. But the volume of speculative business is expended due
to the increase in the credit supply.

23. e. Changes in the Foreign Trade
A rise in the bank rate encourages export and discourages import. A fall in
the bank rate encourages import and discourages export. When the bank
rate is raised, the demand for home currency goes up and the demand for
home currency falls with in the bank rate.
f. Changes in Balance of Payment
Due to rise in the export trade, a rise in bank rate causes a favourable
balance of payment. But a fall in bank rate causes an unfavourable balance
of payment.
2. Open Market Operation
The open market operation means the buying and selling of securities by the
central bank in order to influence the money and credit supply in the
country. This technique is effective upto some extent in both conditions of
inflation and deflation.
3. Change in Reserve Ration
The member banks of central bank are required either by law or custom to
keep a certain percentage of their deposits with the central bank. It is
called as Cash Reserve Ratio. The central bank may controls credit by
changing the reserve ratio. When the reserve ratio is increased the
member banks to some extent are discouraged to bank money. When this
ratio is falls, the member banks are encouraged to expend credit.
Clearing House

24. The central bank manages and supervises the clearing house to facilitate
the clearing of cheques between banks. Every banker usually receives
number of cheques drawn on other banks from his customers as deposits. In
other words banks receives cheques drawn on other banks from their
account holders. As a result, there arises inter bank indebtedness. For
example National Bank of Pakistan receives deposit of cheques worth Rs.
6,000/= drawn on Habib Bank Limited, Habib Bank on the other hand,
receives cheques worth Rs. 5,000/= drawn on National Bank of Pakistan.
Thus National Bank owes Rs. 5,000/= to Habib Bank and Habib Bank owes
Rs. 6,000/= to National Bank.
Inter bank indebtednesses are settle through a central organisation known
as Clearing House. "A clearing house is a general organisation of banks of a
given place, having for its main purpose, the off setting of cross obligations
in the form of cheques. The indebtednesses of the member banks are
settled only by paying the differences. Generally central bank of the
country performs the function of clearing house. In Pakistan, State Bank of
Pakistan performs the duty of clearing house.
Role of Central Bank in Economic Development
The economic stability of a country is solely dependent on the Central Bank.
It is the only financial institution in the country which is responsible for
regulating the banking and monetary system of the country. The need of a
central bank in a country is essentially felt considering the following
services rendered by a central bank for economic development of a
developing country.
1. Capital Formation
Economic progress of a country requires adequate amount of capital. Capital
is required for agriculture, industrial and commercial development. But in a
developing country like Pakistan. It is a chronic problem to procure capital.

25. Central Bank as a national institution plays prime role in capital formation in
the interest of the nation as a whole. As the guardian of the money
market, it regulates the capital flow in the country in proper form and
suitable time.
2. Credit Control
Credit is one of the most important source of financing trade and industry.
The central bank as the controller of credit can encourage a particular
sector of economy by adopting selective credit control.
3. Developing Banking System
As a guardian of all banks, the central bank works for the development of
banking system of the country.
4. Protecting Interest of the Depositors
The central bank protects the interest of the depositors in banks by
guiding, controlling and checking the member banks operations in the
country.
5. Stability in Prices
The central bank keeps the price level stable in a country by controlling
money and credit supply.
6. Advice to the Government
The Central Bank extends valuable suggestions and advices to the
Government in respect of economic and monetary policies.

26. 7. Personnel Training
The central bank in some countries provides training facilities to the bank
personnel.
Q.3. Discuss the different types of bill.
Definition and Salient Features
According to Negotiable Instrument Act a Bill of Exchange is "An
instrument in writing containing an unconditional order, signed by the maker
directing a certain person to pay on demand or at a fixed or determinable
future time, a certain sum of money only to, or to the order of a certain
person or to the bearer of the instrument.
Thus we find the following important features of a bill of exchange:
1. The order to pay a bill must be unconditional one.
2. The order to pay must be made in writing on the bill.
3. The bill must be signed by the drawer of the bill. Without signature of
the drawer the bill will not be genuine one.
4. The order to pay under a bill must be addressed to a certain person
which, of course, includes ndividuals, firm, company, corporation etc.
5. The amount to be paid under a bill must be certain one.
6. The money under a bill must be paid in legal tender currency.
7. The amount should be payable to or to the order of a specified person
or to the bearer of the instrument.

27. 8. The amount should be payable either on demand or at a fixed
determinable future time.
9. The bill must be duly stamped.
10. The other formalities like dating, stating the names of the parties
concerned etc. must be observed.
Parties to a Bill of Exchange
Following are the various parties related to a bill transaction
a. The Drawer
The person who draws the bill and puts his signature on it is known as the
drawer of the bill. He is also called the "maker" of the bill.
b. The Drawee
The person on whom the bill is drawn is called as the drawee of the bill.
c. The Acceptor
The person who accepts the bill is known as the acceptor of the bill.
Usually, the drawee accepts the bill. But sometimes, a third party may also
accept a bill on behalf of the drawee. The acceptor puts down his signature
across the bill showing his acceptance.
d. The Payee
The person to whom the amount of bill is to be paid is known as payee of

28. the bill. The drawer may make the bill payable to himself or to any other
person he likes.
e. The Endorsee
The holder of the bill may endorse the bill in favour of someone else known
as endorsee. The person who endorses the bill is called endorser.
f. The Holder
The person who holds the bill and is entitled to realise the amount of the
bill from the drawee is known as holder of the bill.
Types of Bills
Bills may be of the following types:
a. Inland Bills
Inland bill means the bill which is drawn and payable within the same
country. Thus, the bill which is drawn in Pakistan and will also be paid in
Pakistan is termed as an inland bill.
b. Foreign Bill
The bill which is drawn in one country and accepted and payable in another
country is known as a foreign bill.
c. Accommodation Bill

29. The bill which is drawn and accepted by the parties concerned for their
mutual accommodation with a view to raise money by negotiating it, is known
as an accommodation bill. The parties concerned bind themselves as the
drawer and the acceptor without any valuable consideration.
d. Demand Bill
The bill which is payable "on demand" or "on presentation" or "at sight" is
known as demand bill.
e. Time Bill
The bill which is payable at a fixed or a determinable future time is known
as time bill. The time bill may further be classified as following:
* After Date Bill:
The bill whose tenure is counted from the date of drawing it is known as
after date bill.
* Sight Bill:
The bill whose date of payment is counted from the date of acceptance is
known as after sight bill.
f. Documentary Bill
When a bill is accompanied by shipping documents like, Bill of Lading,
Invoice, Insurance Policy relating to goods against which the bill is drawn,
is then known as a documentary bill.
g. Sent Bill Or Bills for Collection

30. When bills are handed over to a bander by his customer in order that they
may be collected when due and the proceeds credited to the customer's
account. They are called as Bills for Collection.
h. Bills Negotiated
The bills for which the banker has given the value at once, without waiting
for the proceeds after collection.
i. Bills in Set
When bills of exchange are drawn in two or more parts, they are called
"bills in set". The foreign bills are generally drawn in sets of two or three.
The each of the set is on a seperate piece of paper, but all parts are
worded exactly in the same language except that the parts are numbered
as "The 1st of exchange", "2nd of exchange" etc.
j. Bills Retired
When a bill is withdrawn from circulation or taken back before it is due, it
is known as "retired bill".
Discounting of Bills
A time bill is payable on future date and the holder of the bill is to wait
for a specific period of time to receive the amount of the bill. But the
modern commercial banks are providing the facilitates of discounting of bill
to the holder to have money earlier. For discounting of bill, the bank
purchases the bill from the holder at a reduced rate before maturing of
the bill and receives the amount of the bill from the acceptor on due date.
The reduction in the value of bill at the time of purchase by bank is known
as "discount" and it is charged on the basis of interest rate. Thus,

31. discounting of bill is a sort of short term credit given to the holder of the
bill by a banker and the discount forms the profit to him.
Discounting of bill very useful from the point of view of traders and
bankers. It benefits the importer, exporter and bankers equally. The
exporter or seller can get immidiate cash as soon as he handed over the
goods to the transporters. The importer or buyer gets enough time to sell
the goods after having received it. The bankers earn a lot by effecting
these transactions.
Precautions in Discounting a Bill of Exchange
Like advancing other loans and credit, discounting of bills also is a very
risky job on the part of the banker. He must be careful and cautious with
discounting the bill of exchange and must take the following precautions are
measures in discounting of bills:
1. He should examine financial standing of the holder and acceptor of the
bill. If the parties concerned have bank accounts with him, the banker can
easily learn their financial stability. If there is no such account with him,
the banker should refer to the bank where they have got account to know
their financial position.
2. The banker is also to examine the financial status of other parties
engaged in the bill.
3. The banker should see whether the acceptor dishonoured any other bill
in past time.
4. Th banker should satisfy himself whether the bill is a bonafied trade bill
which is accepted for value received in course of business. The banker
should, as for as possible, avoid the accommodation bills.
5. The banker should examine the bill whether all the formalities as of

32. date, stamp, signature etc, have been compiled with.
6. He must see whether the bill is capable of being endorsed. If so, the
banker should see whether the bill is duly endorsed by the payee.
Presentation of Bills
Bill has to be presented first of all before the drawee for acceptance and
again in due date it is to be presented before the acceptor for the
payment. Thus, presentation of bill may be of two types viz,
1. Presentation for Acceptance
2. Presentation for Payment
1. Presentation for Acceptance
Presentation for acceptance is made not only for the acceptance of the bill
but also to fix-up the time, place etc., for the payment. In case of time
bill, where the tenure of the bill is clearly stated, the bill is presented for
acceptance of the drawee to confirm the stipulated time for payment.
A bill should be presented for acceptance within a reasonable tenure after
the drawing or negotiation of the bill.
2. Presentation for Payment
If refers to presentation of a bill before the draw or acceptor or before
the agent of the drawee or acceptor for the payment of the bill on due
date. The presentation for payment is subject to the following rules:
* In case of "demand bill", the bill must be presented within a seasonable

33. time after its drawing or endorsement as the case may be,
* In case of time bill, the bill should be presented for payment on the due
date.
* The bill should be presented for payment during the business hours of
working days.
* The bill should be presented for payment at the proper place. The term
proper place may refer to any one of the following
(i) The place mentioned in the bill for payment.
(ii) Where no specific place is mentioned in the bill, the address of the
drawee or acceptor.
(iii) Where no address is given, of any place where the drawee or acceptor
can be found including his residence.