Learning Objective

• Historical background central banking• Definition of central bank and state bank• What is assets structure of central bank?• What are reasons to establish State Bank

of Pakistan?• What are roles and functions of SBP?

Definition of Central Bank

“Institutions that regulate the environment in which private banks operate and to

make sure the controlled supply of Money”.

History of Central Bank

• First World War– Large withdrawals from Banks– Rigidity & Lack of Supply of currency– Own central Bank

• SBP was established in July 1,1948.• Constitution

– Not for profit motive– Central board of Directors

• One Governor• One Deputy Governor• Nine directors

– SBP• 14 Departments• 5000 employees

Assets Structure

• The assets structure of the central bank differ from country to country. In some country central bank are nationalized.

• Example: Bank of France(1800) is nationalized, The Federal Reserve System of America is Private. SBP (1948), The Bank of Japan(1948) have the mixed system etc.

Organization

The organization of Federal Bank reserve system comprises 5 agencies or group of agencies:

• The Board of Governors.• The Federal Open Market Committee.• The Federal Advisory Council.• The Federal Reserve Bank & their branches.• Member Banks of Federal Reserve System.

Functions of Central Bank

• Sole Right of Note Issue– Uniformity

– Monopoly Power

– Public Confidence

• Bankers, Agents and Adviser to the Government.– As Banker

– As Financial Agent

– As Advisor

• Banker to Commercial Banks– Holds Cash Reserves & Deposits– Rediscount Bills of Exchange– Creation of Credit

Functions of Central Bank• Controller of Credit

– Strategies • Stability in internal Price level of the Country• Stability in Exchange Rates• The money Market

– Main Instruments• Bank Rates• Open Market Operations• Cash Reserve Ratio

• Clearing Agents– Advantages

• Use of cash• Strengthens the Banking System• Fully informed about Liquidity Position

• Custodian of Cash Reserves• Development Role• Other Functions

– Maintain relation with international Agencies– Provides Training Facilities– Conduct Seminars, Surveys and Publishes Annual Reports

Responsibilities of Central Bank

• Central bank as a Government banker.

• Bank as a agent of Government

• Bank as a financial Adviser.

Central Bank as

Government’s Banker

Bank as Agent of the Government

Bank As a Financial Advisor

Monetary Policy

Monetary Policy is the deliberate exercise of the monetary authority’s power to induce expansion & contraction in the money supply.

Promoting High Employment

Achieving Steady Economic Growth

Stable price as a Goal

Stability in Interest Rate

Promoting a more Stable Financial Markets

Stability in the Foreign Exchange Market

Objectives of Monetary Policy

Tools of Monetary Policy Tools of Monetary Policy

Quantitative Controls

•Open Market Operations•Variation in Bank Rate•Credit Rationing•Varying Reserve Requirements

Qualitative Controls

•Varying Margins Requirements•Consumer’s Credit Rationing•Use of Moral Persuasion•Direct Action

1: Open Market Operations

Basic instruments:

o Open market operations.

o Discount policy.

o Changing in reserves requirements

Effects Of Open Market

• On reserves of commercial banks.

• On interest rates.

• During inflation.

• During depression

• On balance of payments.

Limitations of Open Market

• Money and capital market not developed.• Excessive cash reserves.• Attitude of the people.• Cash ratio.• Bank credit is interest inelastic.• Less effective during depression.

Discount policy/bank rate policy

“Discount policy refers to the “conditions under which banks are permitted 2

borrow from the Central Banks discount window including the rate of interest

charged on these loans”.

2: Discount Rate

“Discount rate refers to that official rate at which the central bank of a country is prepared to discount or more correctly to say rediscount the first class bills of

exchange”

Importance of Discount Rate

Importance of discount rate lies in:-• Market is more or less directly influenced

by discount rate.• If the money market is well organized &the

economy structure of the country is fairly elastic, a rise in discount rate is generally followed by an increase in the market rate.

• A fall in bank rate is followed by a decrease in market rate.

Different B/w Discount Rate & Market Rate

Discount Rate:• It is also called as a Bank

Rate.• It is fixed arbitrarily by the

central bank on any fixed day of the weak.

• It is minimum rate which is charged by the central bank for discounting 1st class bills of exchange.

Market Rate:

• It is rate at which the money market is willing to discount bills of exchange.

• It is established by the interaction of forces of supply & demand for the bills of exchange by the joint stock, discount houses, etc.

CONTINUE

Affects of Bank Rate Policy

1. Change in the discount rate shows direction of the central banks policy.

2. Effect the future market rates such as the rates charged by discount houses, the rates charged on advances to customers etc.

CONTINUE

Continue….

3. The lowering or increasing in bank rate has far reaching results on trade, industry, employment, production, income and prices.

Continue…1. Central bank raises bank rate.2. Money market interest rate increases.3. Decline in borrowing by business

people.4. Fall in out put, employment and

income.

The lowering of bank rate has opposite effects on the economy if it is operating at less then full employment.

Limitations Of Discount Policy

• When bank rate increases then market rate also increases & vise versa.

• Effective influence of volume of credit in developing country .

• Regulating the volume of bank reserves .

• Little effect on the cash reserves of the bank.

• Undeveloped and unorganized bill markets in country

• Rise in the interest shows monetary policy is lighter, Lowering indicates easier monetary policy.

3: Changing in Legal Reserve Requirements

4: Credit Rationing

Qualitative Controls

• Varying Margin Requirements

• Consumer’s Credit Rationing

• Use of Moral Persuasion

• Direct Action

Central Bank as Custodian of Cash Reserves

• Legal Reserves of Member Bank• Use as a Monetary Policy

– Advantages of Reserve Requirement• Immediate Impact

• Equal Effect

• Easy to Interpret

• Useful in Emergencies

– Shortcomings in the use of Percentage Reserve Requirements

• Defect in planning by Bank Management

• Less Flexibility

Clearance House

Definition:

“It is an association of commercial banks set up in a given locality for the purpose of interchange & settlement of credit claims”.

History of Clearance House

1. Rapid growth in banking after World War(2).

2. Widely increase in cheques payments.

Merits of Clearance Houses• Mutual obligations of

commercial banks are economical and safe.

• Provide opportunities to commercial banks to set off inter bank debits.

• Carry out monetary policy in the best interest of country.

• Provides an opportunity 2 promote interests of member banks.

• Effective device for preventing destructive & undesirable competition.

• Member banks assist to tide over timely crisis.

Role of Central Bank in Underdeveloped Money Market

Money market consists of all the institutions which are engaged in the borrowing and lending of the short term funds.

Members of money market

Central banks.Commercial banks.Co-operative banks.Saving banks.Specialized financial institutionDiscount housesStock exchanges.

Main measures of Central Bank to improve the conditions of under developed money market

• Commercial bank.• Saving banks.• Co-operative banks.• Assistance to specialized

financial institution.• Credit targets.• Export finance scheme.• Treasury bills.• Commercial borrowing.• Monetary and credit policy

STATE BANK OF PAKISTAN

HISTORY OF STATE BANK OF PAKISTAN (SBP)

(1948)

History of SBP• To establish central bank of Pakistan so it have independent

currency and banking system.• The transitional arrangement of having one Central Bank for two

independent countries was promulgated by Governor General of undivided India on August 14, 1947 by an order called Monetary System and Reserve Bank Order 1947.

• The main provisions of “ The Pakistan Monetary System & Reserve Bank Order1947” were as follow:– Sole note issuing authority till October 1, 1948

– Indian note remain legal tender till 30th September,1948

– Transfer the assets of value equal to Pakistani note

– Issuance of Coins

– Reserve Bank of India perform Full functions of Central Bank in Pakistan up to September 30,1948.

Establishment of State Bank of Pakistan

• Face serious Banking situation• Wholesale Migration of the banking staff to India• Refuse to give Rs.55 Caror• Decided to establish its own currency authority• Issued order by Quid-e-Azam to establishment of SBP on 1st of

July,1948• SBP order 1948

– Regulating the issue of bank notes& keeping the reserves with a view to seeking monetary stability in Pakistan & generally to cooperate the currency & credit system of the country to its advantage.

• SBP banking Act 1956 which requires the Bank– To regulate the monetary & credit system of Pakistan & to foster its

growth in the best national interest with a view to securing stability for full utilization of the country productive resources.”

• SBP also be entrusted with the prosperity, stability & growth of domestic economy.

Establishment of State Bank of Pakistan

• Share Capital– 51% From Central Government & 49% From private sector– Only permanent citizens of Pakistan allowed to purchase the share

of Bank• Constitution

– Not for profit motive– Central board of Directors

• One Governor• One Deputy Governor• Nine directors

– SBP• 14 Departments• 5000 employees

– Departments• Accounts• Administration

Banking Services Corporation

Function which SBP had been performing and involved public dealings have been transferred to the State Bank of Pakistan Banking Services Corporation. The new corporation has started functioning from 22nd Jan, 2002 as a subsidiary organization to SBP.

Its paid up capital was 1 billion RS.

Function of Banking Services

• Revenue collection.

• Maintain the accounts of Federal and Provisional Government and local bodies.

• Work as clearing houses of commercial banks.

• Manage public debt, sale & purchases of prize bonds and treasury bills.

Role Of State Bank In Economic Development

Since 1st July, 1948 SBP is performing traditional, developmental & promotional functions:

• Traditional functions.• Building up sound

banking system.• Assistance to

specialized financial institutions.

• Promotion of exert finance.

• Credit targets.• Exchange control.• Training facilities.• Proper interest rate

structure.• Ensuring internal

price stability.

Framework of SBP

• Wide powers to central board.

• Change in reserve requirements.

• Advice to Government.

• Supervision of FDI’s.• Recoveries of arrears

as land revenue.• Establishment of

monetary & fiscal policies coordination board.

Instruments of Credit control

Quantitative Control:• Bank rate.• Open market

operations.• Variable Reserve

Req.• Credit rationing.• Credit targets.

Qualitative Control:• Moral Persuasion.• Direct Action.