Money Banking and Finance

MONEY BANKING & FINANCE
Q#1:
WHAT IS BARTER SYSTEM? WHAT ARE
INCONVENIENCES OF BARTER SYSTEM?

Barter system
Barter is a system in which goods or services are directly exchanged with the goods or
services without the use of money.
Barter system is suitable only when people have few needs and money system does not exist
in the economy.
Inconveniences / difficulties/ hindrances /barriers / of barter system

Followings are the difficulties that were faced in barter system.
1. Lack of coincidence of wants
2. Lack of common measure of value
3. Lack of subdivision
4. Lack of store of value
5. Difficulty in future payments (credit)
6. Difficulty in transfer of wealth
7. Difficulty in tax collection
8. Lack of specialization
9. Difficulty in budgeting
Barter is possible only when there is double coincidence of wants. The main defect of barter
is that there is lack of coincidence of wants.
Example
If a person has surplus rice and he wants to exchange it with wheat. He will have to
find a person who has surplus wheat as well as he needs rice.
Written by; Ahmed

BANKING
Raza (MBA, ACMA) providing quality education OF ACCOUNTING, MBF, ITB B.LAW, AUDITING AND
0334 5040190, 0313 5040191
Page # 1
In barter system it is very difficult to measure the value of goods because there is no
standard measure for the valuation of goods
Example
A man who has rice may assign the value to his 1kg rice as equal to 2 kg wheat. But the other
person may assign a value to his 1 kg wheat as equal to 3 kg rice.
In barter system another problem arises when the goods that are exchanged cannot be
subdivided into small parts (units)
Example
If a person has a cow and he wants to exchange it with a goat. It is clear that a cow has more
value than a goat. The problem is what a part of cow is to be given in exchange of goat. The
transaction is impossible because cow cannot be sub-divided.
In barter system it is very difficult to store the commodities like fruit, vegetables and animal
skins. It means that one cannot secure his future by storing commodities.
In barter system it is very difficult to lend (
) goods to other people because at the
time of repayment commodities may loss their value so credit transitions are impossible.
Example
A person borrowed (
) a goat for one month but at the time of return the goat may
fall sick and lose her value, so the payments in future under barter are difficult.
Under barter system it is very difficult to transfer moveable and immovable from property
from one place to another place
Example
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 2
If a person has to transfer 100 goats from Faisalabad to Lahore, It would be very difficult for
him to transfer them.
Another difficulty which arises under barter is that the tax cannot be collected in form of
goods. If the tax is collected they will lose their value with the passage of time.
Under the barter it is very difficult to attain specialization in their fields, because the people
remain busy in meeting their own needs and they do not focus on effective (
utilization (
) of resources.
Budgeting is an art of estimating of estimating (
) future expenses and revenues.
Under the barter system it is very difficult to estimate future expenses and incomes
Imperial learning institute

(Near Madina college for boys, sheikhupura road Faisalabad)
Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 3
Q#2: WHAT IS BARTER SYSTEM? HOW MONEY REMOVED

BARRIERS OF BARTER SYSTEM?
Barter system
Barter is a system in which goods or services are directly exchanged with the goods or
services without the use of money.
Barter system is suitable only when people have few needs and money system does not exist
in the economy.
Removal of Inconveniences / difficulties/ hindrances /barriers / of barter

system
Followings are the difficulties that were faced in barter system.

Money has removed this difficulty by serving as a medium of exchange. Anyone can sell his
goods for money and can buy goods against money.
Example
Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 4
In barter system it was very difficult to measure the value of goods because there was
no standard measure for the valuation of goods but money has provided a standard
measure. The value of goods can be measured in terms of money.
Money has removed the difficulty of subdivision of goods into small parts because money
has made easy to buy goods of both high and low value without wasting. In barter system goo
often lose their value after indivisibility.
Money has removed the difficulty of storing wealth. Money can be stored easily and is a best
medium to store savings.

In barter system it was very difficult to lend (
) goods to other people because at the
time of repayment commodities may loss their value. But in money economy debts can be
returned in monetary units so there is no possibility of lose of value
Under barter system it was very difficult to transfer moveable and immovable from property
from one place to another place but now with the help of money a person can sale his
property from one place can buy similar property at some other place
In money economy there is no difficulty in collection of taxes because they are collected in
money form but in barter system it was very difficult to collect and store the tax collections.
Under the barter it is very difficult to attain specialization in their fields, because the people
remain busy in meeting their own needs and they do not focus on effective (
utilization (
Written by; Ahmed
BANKING
) of resources.
0334 5040190, 0313 5040191
Page # 5

Budgeting is an art of estimating of estimating (
) future expenses and revenues.
Money has made easy to estimate the future incomes and expenses in terms of money

Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 6
Q#3
DEFINE MONEY. WHAT ARE THE FUNCTIONS OF MONEY?
OR
DEFINE MONEY. HOW MONEY HAS FACILITATED ECONOMY?
OR
DEFINE MONEY. WHAT ARE THE ADVANTAGES OF MONEY?
Money has facilitated economy by providing the following functions

1. Medium of exchange
2. Measure of value
3. Future payments
4. Budgeting
5. Economic activities
6. Transfer of wealth
7. Store of wealth
8. Determination of national income
9. Liquidity of wealth
10. Promote to foreign exchange
11. Market mechanism
12. Basis of credit creation
1. Medium of exchange
Money acts as a medium of exchange between the buyer and seller. Money is used to make
payments for goods and services. Goods can sold for money and that money can be used to
purchase goods.
2. Measure of value
Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 7
Value of different goods and services can be measured in Monterey terms, in the same as we
can measure weight in kg and distance in KM.
3. Future payments
Future payments can be easily determined with the help of money. One can borrow loans
from banks and other financial institutions in form of money and repayment can be made as
well in form of money.
4. Budgeting
Money helps government and companies in preparation of budgeting. Incomes and expenses
are estimated and recorded in terms of money
5. Economic activities
All type of economic activities such as investments, savings, credit are made in terms of
money. Money has played a vital role in economic growth of a society.
6. Transfer of wealth
With the help of money wealth can be transferred easily form one place to another place. One
can sold his property at one place against money and he can buy similar at some other place
7. Store of wealth
Wealth can be stored easily in form of money. One can save his wealth by converting it in
money.
8. Determination of national income
With the help of money, it becomes easy to determine the income generated by a nation. It
also helps in determination of Gross Domestic Product of a country.
9. Liquidity of wealth.
Liquidity means conversion of property in form of cash. Wealth or property can be converted
in liquid from with the help of money.
10. Promote to foreign trade
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 8
Money has played a vital role in the growth of foreign trade. Foreign investments are made in
terms of money. Payments and receipts of other countries are made in terms of money.
11. Market mechanism
Market mechanism is based on the demand, supply and price of the goods. Demand
and supply are the two major factors of market which work only because of money.
Money is the only factor which determines the price, demand and supply of goods.
12. Basis of credit creation
Banks create credit on the basis of cash deposits in banks. So it is not possible for
banks to create credit without the help of money.

Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 9
Q#4 what are the different kinds of money? Or what are the different stages in the
evolution of money? Or what is the origin and growth of money?
Different forms of money
On the basis of evolution the money is classified in five main types
1. Commodity money
2. Metallic money
3. Paper money
4. Credit money
5. Electronic money
1. Commodity money
In commodity money, different commodities have been used as money like cattle (
),
Goats, Horses, animal skins, arrows. Commodity money was used in barter system in which
goods were exchanged with other goods and services
Problems of commodity money
It was found that commodity money was not best to make payments due to the following
problems.
23. Lack of divisibility
24. Lack of transferability
2. Metallic money
Metallic money consists of gold coins, silver coins, nickel coins. In our country coins of Rs
five, two and one are the metallic money. Metallic money cannot be eliminated from
economy. It is playing vital role in the economy. Metallic money is of three kinds.
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 10
i.
Full bodied money
ii.
Token money
iii.
Tender money
i.
Full bodied money
In full bodied money, the metallic value of coin is equal to their face value. Full bodied
money is also called standard money or natural money. The gold silver and nickel are
considered as full bodied money. Now such money is not used anywhere in the world.
ii.
Token money
In token money the face value of coin is higher than the metallic value. They are usually
made of silver, copper or nickel. In Pakistan full bodied money does not exist only token is
used.
iii.
Tender money
Any currency which is generally acceptable in discharge of debts is called tender money it
can be made of paper or metal. If someone offers tender money against debts, nobody can
refuse to take it. Tender money has two types
a. Limited tender money
b. Unlimited tender money
a. Limited tender money

Coins of small denominations are called limited tender money. Such as coins of RS 1, 2 and
5.
b. Unlimited tender money
Coins of large denominations are called unlimited tender money. Notes of Rs 5, 10, 50, 100,
500, 1000, 5000 are called unlimited tender money.
3. Paper money
Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 11
Paper money consists of notes issued by the state bank of Pakistan. The paper money is of
different denominations, colors and sizes. Paper money is more convenient than any other
form of currency.
4. Bank money
Bank money includes cheques, bills of exchange, and drafts. Bank money is playing a vital
role in the economic development. Because varies transactions are settled without the use of
paper money. Bank money is safer than any other form of money. but bank money also have
some defects.
Dishonor of cheque may delay payments
Uneducated may not know the best use of cheque
Cheque is not a legal tender; one can refuse to take it against the settlements of debts.
5. Electronic money
With the development of computers and its application, the business and business
transactions are changing very fast. Now a days most of the transactions take place through
electronic money. People prefer to use debit cards and credit cards instead of paper money or
bank money. With the passage of time electronic money may diminish the use of paper
money.

Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 12
Q#5 what are the qualities of good money?

Good money should have the following qualities.
1. Acceptability
2. Transferability
3. Stability
4. Storability
5. Recognizable
6. Malleability
7. Divisibility
8. Durability
9. Economy
10. Elasticity
11. Homogeneity
1. Acceptability
Good money should have the quality of general acceptability. General acceptability means
every person must accept it for the settlement of payments. It should be accepted for purchase
and sale of goods.
2. Transferability
Good money is easily transferable from one place to another for doing business and making
payments. Paper money is easy to transfer from one place to another place because it has
minimum possible weight.
3. Stability
Value of money should remain stable. If value of money is changing or fluctuating day by
day than it would not be considered reliable.
4. Storability
The money should be storable. Value of money should not depreciate with time. If money
material is perishable it will lose its value in few days. Paper money has quality of storability.
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 13
5. Recognizable
The money should be easily recognizable so that the holder of money may not confuse about
the value of money. For example if every note has the same color it will not be easily
recognizable. Paper money is easily recognizable because notes of different value have
different color.
6. Malleability
The material which is used for making money should be malleable. The material which
cannot be melted is not fit for making coins. The gold, silver, copper and nickel coins are
malleable
7. Divisibility
Divisibly means ability to divide into small units without losing its value. Good money
should be divisible. In barter system, commodity money was not divisible into small units.
Thats why it was replaced by the paper money.
8. Durability
The material used in making money should be durable and long lasting. Coins do not wear
quickly, so the quality of money remains stable.
9. Economical
Good money should be economical. Economical means low cost of printing and more value.
If there is heavy cost on issuing money that is not good money.
10. Elasticity
Supply of money should be elastic. Elastic means whenever it is needed, supply of money
can be increased or decreased. Paper money has the quality of elasticity
11. Homogeneity
Homogeneity means the money should be identical. So that there is no ambiguity to the
holder of money
Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 14
Q #6 what are the merits and demerits of paper money?

Or
What are the advantages and disadvantages of paper money?
Paper money
Money made up of paper is called paper money. It consists of the notes issued by the central
bank. In Pakistan notes of Rs 5 to 5000 are the examples of paper money
Advantages of paper money

Following are the advantages of paper money
1. Economical
2. Easy handling
3. Easy counting
4. Emergency needs
5. Metal savings
6. Easy transfer
7. Easy payment
8. Uniform quality
9. High value in small bulk
10. Stability
11. Recognizable
12. Storability
13. Advantage for banks
1. Economical
Printing cost of paper money is less than the minting charges of metallic money. Paper
money is cheaper than the metallic money. A large quantity of paper money can be issued at
very low cost
2. Easy handling
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 15
Paper money has lesser weight than metallic money. It is easy to handle paper money than
coins.
3. Easy counting
Paper money is easy to count than the metallic money. The counting of coins in larger sum in
coins takes more time. Paper money takes lesser time than the metallic money.
4. Emergency needs
Paper money is friend in peace and war. Central bank can increase the supply of paper money
for meeting the economic needs.
5. Metal saving
Metal saving is possible when paper money is used rather than metallic money. Metals like
gold and silver can be used for other productive purpose.
6. Easy transfer
Transfer of paper money is easy and cheaper than metallic money because it is light weight
and takes less space
7. Easy payment
Payments of larger sums are easy and cheaper than the metallic money because paper money
is easy to count and easy to transfer.
8. Uniform quality
Paper money has a also a uniform quality and holder of the paper money does not suffer lose
because old and new notes have the same value
9. High value in small bulk
Paper money contains high value in small quantity as compared to the metallic money.
10. Stability
Paper money is more stable in value but the value of coins do not remain stable due to wear
and tear. The value of coins changes with the passage of time.
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 16
11. Recognizable
Paper money of every denomination is easily recognizable because of its different size, color
and design.
12. Storability
Paper money is easy to store because of more value in light weight. It takes less space so that
a large sum can be stored in small space even in pockets.
13. Advantage for banks
Banks have the great advantage of paper money they can easily count paper money buy using
counting machines.
Disadvantages of paper money

1. Inflation
2. Limited acceptability
3. Danger of cancellation
4. Short life
5. Instability of exchange rate
6. Less confidence
1. Inflation
Printing of paper money is easy. In time of need government may over issue currency
notes. This over issue may cause inflation which increases the prices of goods and
decreases the value of money.
2. Limited acceptability
Paper money has limited acceptability. It is acceptable only in the domestic country
and in other countries of the world it is not acceptable.
3. Danger of cancellation
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 17
There is always a danger of cancellation. If government canceled the paper money

then holder of money just has the worthless piece of paper.
4. Short life
Paper money is less durable than the metallic money. Paper money can be easily
destroyed by fire, water or heat. So life of paper money is less than coins.
5. Instability of exchange rate
Exchange rate means the rate at which the domestic money is exchanged with the
foreign money. Value of paper money depends upon the fluctuations. The instability
of exchange rate directly affects the foreign trade.
6. Less confidence
As value of paper money is less stable and it has no real value in it. So people have
less confidence in paper money.

Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 18
Q #7
What are the methods of note issue?
There are the following methods of note issue
1. Fixed fiduciary system
2. Proportional reserve system
3. Modified proportional reserve system / exchange management
4. Minimum reserve system
1. Fixed fiduciary system

According to this principle, central bank can issue notes up to a certain limit by keeping
government securities. If any time central bank wants to issue more notes, then the notes
must be issued by keeping 100% gold reserve.
Advantages
i.
No danger of over issue
Under this system there is no danger of over issue of notes because 100% gold reserves are
kept
ii.
No danger of inflation
There are no chances of inflation because money can be converted into gold at any time
Disadvantages
i.
Inelastic
In emergency, if there is gold is not available government cannot issue notes.

ii.
Unnecessary lock up of gold
Large amount of gold is locked that can be used for other productive purposes.
Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 19
2. Proportional reserve system

Under this system central bank keeps certain percentage of note issue in form of gold reserve.
This ratio may be different in every country. In Pakistan this ratio is 30%.
Advantages
i.
Elastic
Under this system central bank can increase the supply of money easily whenever needed
ii.
No lock of Gold
Under this system, a large amount of gold is not locked. Gold can be used for other
productive purposes.
iii.
Emergency needs
This system is very helpful in emergency needs of currency.

Disadvantages
i.
Danger of over issue
There is always danger of over issue of notes

ii.
Danger of inflation
There is always danger of inflation due to over issue of notes

3. Modified proportional reserve system / exchange management
Under this system, central bank keeps certain percentage of note issue in form of gold,
foreign bills of exchange, foreign currency at some other country where gold system is used.
This system is used in many countries.
Advantages
i.
Elastic system
Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 20
Central bank can increase supply of money easily.

ii.
No lock of Gold
Under this system, a large amount of gold is not locked. Gold can be used for other
productive purposes.
Disadvantages
i.
Lock up of foreign exchange
Under this system a large amount of foreign currency is locked up in unproductive sector.
ii.
Over issue
There is always danger of over issue of currency notes
4. Fixed minimum reserve system

Under this system central bank keeps only a fixed amount of gold or silver reserves against
whatever amount of note issue.
Advantages
i.
Elastic
This system is highly elastic because central bank can issue a large amount of notes by
keeping small reserve
ii.
No lock up of gold
A large amount of gold is not locked up that can be used for productive purpose
Disadvantages
i.
Over issue
In this system, there is a great danger of over issue.

ii.
Currency value
Under this system, central bank may fail to stable the price level.
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 21
Q #8
What is inflation? What are the measures to control inflation?
Inflation
Inflation is a process in which there is continuous increase in general price level and there is
continuous decrease in money value. Inflation is a situation where demand of goods and
services exceeds available supply of goods.
The main measures used to control the inflation are;
1. Monetary measures
2. Fiscal measures
3. Other measures
1. Monetary measures
Monetary measures are adopted by the central bank to control the supply of money.
i.
Bank rate policy
Bank rate or discount rate is the rate at which central bank lend loans to commercial banks.
Whenever central bank wants to control the inflation it increases the bank rate which help in
reducing borrowings from commercial banks and inflation may be controlled.
ii.
Open market operation
In open market operation central bank sales or purchases the securities in open market. If
there is inflation in the country the central bank sells the securities which reduce the supply of
money. So that inflation may be controlled.
iii.
Variable reserve ratio
In order to control inflation, the central bank increases the reserve ratio due to which more
funds of commercial banks are kept with the central bank. So the borrowings from
commercial bank deceases and inflation may be decreased.
iv.
Credit rationing
Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 22
Under this policy central bank advices commercial banks to stop issuing loans for some time.
In this way inflation may be controlled.
v.
Monetary reforms
The government can order commercial banks to exchange old notes by new one. In this way a
large amount of money can be blocked for some time. Repayment should be made after
achieving the objective.
2. Fiscal measures
Fiscal measures are based on the demand management. Central bank may raise or lower
down the demand by controlling expenditures.
i.
Decrease in tax rate
In order to control inflation, central bank may decrease the tax rate. Resultantly industrialists
increase the level of production which reduces the price level.
ii.
Decrease in government expenditures
In government decreases expenditures on unproductive purposes the inflation is automatically

controlled
iii.
Deficit financing
In order to control inflation the government should avoid from deficit financing
3. Other methods
i.
Increase the supply of goods
If the supply of goods is equal to the demand in the market, Inflation will be automatically
controlled
ii.
Population planning
Control on population by adopting different measures of family planning. It will reduce the
demand of goods which will help in controlling price level.
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 23
iii.
Political stability
If there is political stability in country, it will encourage investment and increase in

production which may help in controlling prices
iv.
Smuggling of goods.
Shortage of supply is normally due to the smuggling of goods. If govt take actions to control
smuggling it will help in controlling price level.
v.
Price control policy
The government should adopt strict price control policy against the profiteers and hoarders.
So that inflation can be controlled

Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 24
Q #9
What is deflation? What are the measures to control deflation?
Deflation
Deflation is a situation in which prices, output and employment are falling down. Inflation
and deflation both are harmful for the economy but the deflation is more harmful. It creates
hurdle on path of economic growth.
According to the Philips deflation is a period during which level of prices declines and the
value of money increases
Causes of deflation
1. Decrease in money supply
The main reason of deflation is decrease in money supply. Sufficient money supply is
necessary to meet the economic need.
2. Strict banking policy
Sometimes, restriction on lending is imposed by the central bank to decrease the money
supply. This policy may decrease the investments.
3. High taxes
Sometimes government levied high taxes due to which the purchasing power of the people is
also decreased and the result is deflation in economy
4. Excess production
If goods are produced more than the demand, then it also becomes the cause of deflation and
prices are decreased
5. No storage facility
If businessmen have no storage facility than they are bound to sell goods even at low prices,
which may cause deflation
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 25
6. Excess saving
In case of inflation, commercial banks promote savings but unnecessary promotion of saving
May leads towards the deflation.
7. Heavy imports
Imports in large scale quantity are also the cause of deflation. Due to increase in imports the
supply is also increased which is the cause of deflation
8. Decrease in exports
If exports are decreased, the goods and services will be increased in the market, hence price
will be decreased.
9. Decrease in demand
Decrease in demand of goods and services is another cause of deflation. Demand may be
decreased due to the fall in income.
10. Decrease in government expenditures
Sometimes the government decreases expenditures due to which demand for goods is also
decreased.
11. Increasing cost
Increasing cost of production also becomes the reason for deflation. People may not have
buying power to purchase costly goods.
12. Lower profits
The lower profit rate is also the cause of deflation. Businessmen cut their profits to retain in
the market a stage becomes when the profit becomes zero. Business at this stage may decide
to stop production
13. High bank rate
An increase bank rate may also cause deflation. Increase in bank rate decreases the
borrowings which decreases the money supply. Decreases in money supply cause deflation.
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 26
14. Sale of securities

Sale of securities (shares and bonds) is also the cause of deflation. The people may like to
invest their savings in shares due to this their purchasing power is decreased and they can buy
fewer goods
Measure / methods to control deflation

1. Increase in supply of money
To control deflation, supply of money in the country can be increased. Central bank should
issue currency notes to meet the economic needs. when the supply is increased the demand
for goods and services is also increased
2. Increase in wages
Increase in wages also helps decreasing deflation. The purchasing power of the people will be
increased which will increase the demand of goods.
3. Decrease in reserve ratio
Decrease in reserve ratio also helps in controlling deflation. It increases the borrowings from
commercial bank. Increase in borrowings increases the demand and price level.
4. Control on production
Production of different commodities should be controlled and there should be equilibrium in
demand and supply. Control on production helps controlling production
5. Decrease in interest rate
The rate of interest on loans should be decreased. Loans should be provided to the producers
to increase the production and investment level. This will increase the incomes of people.
Demand for goods will be increased and deflation will be decreased.
6. Increase in private investments
The government should provide facilities to the industrialists to increase investment in
country. By setting up new industries, the employment opportunities will be increased,
incomes of people will also be increased which help to control inflation
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 27
7. Tax reduction
Government should reduce the taxes which will increase the incomes of people. Increase in
incomes increases the demand for goods and services which helps controlling inflation
8. Increase in exports
The excess supply of goods can be exported to control deflation. Increase in exports
encourages producers for more production which helps in decreasing deflationary pressure.
9. Increase in investments
Deflation can be controlled through new investments. The production and employment
increases due to new investments. The use of idle money decreases the deflation
10. Fixed prices
Deflation can also be controlled by fixing the price of goods and services. Government may
appoint a price commission who supervises the price level so that the producer is not
discouraged.
11. Public works
Government may start public works to eliminate the deflation. The amount is transferred
from government to public. The demand for the goods and services is increased and there is
increase in production.

Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 28
Q# 10
Critically examine the fishers quantity theory of
money (Or)
Explain and criticize the fishers equation of
exchange.
Statement of theory
This theory was introduced by the Irving Fisher. According Irving fisher, other things
remaining the same as the quantity of money in circulation increases, the price level also
increases in direct proportion and the value of money decreases and vice versa.
Fisher equation of exchange
P=
P = general price level
M = Quantity of money
V= Velocity of circulation of M
M = Quantity of credit money
V= Velocity of circulation of M
T = Total value of goods bought and sold
Explanation
Quantity theory of money can be explained with the help of following example
M = 100 Rs
Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 29
M = 200 Rs
V=3
T = 90 goods
(
P=
) (
= 10 Rs per good
If the supply of money is doubled
P=
(
P=
) (
= 20 Rs per good
If the supply of money is halved
P=
P=
) (
= 05 Rs per good
Conclusion
Thus it is clear that if the supply of money is doubled, the price level will also be doubled and
the value of money is one halved. Similarly if the supply of money is halved, the price level
of money is doubled.
Assumptions of theory
1. Full employment
Theory assumes that there is full employment in the economy. It states that all the factors of
production are fully utilized no resource are idle
2. Velocity of money is constant

It is assumed that the velocity of circulation of money remains unchanged in short run
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 30
3. Volume of trade
It is also assumed that the volume of trade remains constant in the short period because
method of production and habits of consumer remain unchanged
4. Constant relationship between M and M

There must be constant relationship between M and credit money M
5. Price level is passive factor

P should be affected by the other factors but should not affect other factors
6. Short period
This theory applied to the changes in price level only in short period
Criticism on theory
1. Other things may not remain same
The drawback of this theory is that other things are assumed to be unchanged. But in reality it
is not possible that the factors in an economy remain unchanged
2. Variables are not independent

The various variables in the equation are not independent. The factors have great influence on
each other. In this equation p is assumed to be passive factors which do not affect other
factors but in reality when price level is increased, it increases the profit rate and promotes
trade
3. No proportionate change
This theory assumes that if quantity of money is doubled, the prices are also doubled, this
assumption is wrong. There is no proportionate change in the money and prices
4. Ignores the rate of interest
Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 31
This theory ignores the influence of rate of interest on the quantity of money. An
increase in the quantity of money is due to the decrease in interest rates.
5. Fails to explain trade cycle

This theory is failed to explain the trade cycle. According to this theory, if the
quantity of money is doubled the price level will also be doubled. During 1929
1933 the quantity of money was increased but it fails to increase price level.
The depression was not eliminated. So theory has failed to explain the causes of
trade cycle
6. Full employment
This theory assumes full employment in an economy which is not possible at all
7. Static theory
The quantity theory of money is a static theory. The world is dynamic and things are
changing at fast speed. The ups and down in an economy cannot be explained with the help
of this theory.
(650 words)

Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 32
Q #11
What is trade cycle? What phases of trade cycle?
Trade cycle
Fluctuations (ups and down) in economic activities of a country is called trade cycle. These
changes or ups and down may be positive or negative. The duration of trade cycle may vary
from 5 years to ten years or above.
Phases of trade cycle

Trade cycle is composed of four phases which are given below
1. Depression / slum / trough
2. Recovery
3. Boom / peak
4. Recession
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 33
1. Depression
Depression is the most fearful stage of trade cycle. In the period of depression there is fall in
national income, employment, prices, and production. Cost of production is higher than the
sale price. During this phase of trade cycle factories are closed and workers become jobless.
Features of depression
o low production
o low prices
o low employment
o low profit margin
o decrease in demand
o low interest rate
o low borrowings
2. Recovery
Recovery is a stage of economy where demand of goods starts increasing. Profit margin start
rising because cost of production fall below the general price level. New investments are
made in different productive activities or businesses. At this stage unemployment level start
decreasing.
Features of recovery
There is increase in level of production
Increase in demand
There is decrease in cost of production
Increase in public borrowings
Improvement in level of employment
Rise in Investment opportunities
Improvement in business profit
3. Boom / peak
It is a stage of economy where business activities attain maximum best level. After some time
economy moves from recovery to boom, At this stage national income, demand of goods,
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 34
level of production and employment level is growing rapidly. This is an ideal stage of an
economy
Features of boom
High level of profit
Ideal level of national income
Maximum production
Low cost of production
Rapid increase in demand of goods
Growth in public borrowings
Low rate of unemployment
Ideal investment opportunities
4. Recession
This is the level of economy where economic activities starts falling down. At this stage
economy moves from boom to recession and investments, employment, production starts
reducing. There is shrinkage in profit margin because cost of production exceeds the sale
price, due to this poor firms close their business while other reduce their production.
Features of recession
Decrease in production
Fall in employment level
Shrinkage in profit margin
Decrease in public borrowings
Decrease in demand
Decrease in price of product
Cut down in national income
Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 35
Q #12What are the causes/ reasons of trade cycle also explain

remedies of trade cycle?
Causes of trade cycle
Trade cycle is affected by the two factors that are;
A. Internal factors
1. Under consumption
There is to much saving in the boom period. This reduces the price level. The price start
increasing but wages do not increase proportionately. The income of rich start increasing at
higher rate but incomes of poor do not increase as compared to the price level; the result is
that the demand for consumption goods decreases.
2. Unsold stock
Trade cycle is the result of inventories ( closing stock). There is excess of goods and services
but people are unable to buy goods of their own choices due to their low incomes. Unsold
stock results in depression
3. Imports
Imports are also the reason for depression. When the goods are imported, it increases the
supply of goods. Increase in supply of goods decreases the price level
4. Liquid assets
Liquid assets are includes coins, paper money, bonds and shares. Increase in liquid assets
leads economy toward boom. The increase in liquid assets increases the investments, in this
way the stock exchange activities will flourish and economy leads towards prosperity
5. Unfilled orders
Unfilled orders means the demand of goods is higher and the supply is low the manufacturers
are unable to meet the demand of customers. Increase in demand encourages the
manufacturers to produce more which leads toward boom.
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 36
6. Reserves / excessive profits

The retained profits are the source of capital but excessive reserves or profits are kept idle
that is the wastage of funds. During the boom period, this policy is bad because it leads
towards the depression.
7. Over capitalization
The capitalization of profits is desirable for meeting emergency needs. if all the profit of the
company is capitalized and company do not pay dividend on shares. It may discourage
investment which causes the depression.
8. Trade union
Trade union also becomes the cause of depression. They demand more wages which
increases cost and resultantly price level rise. The increase in price level decreases the
demand of product.
9. Investments
The changes in investment rates affects the trade cycle. High investment rate increase brings
boom in economy. If investment rate is low it will cause depression.
External factors
10.War
War is a major factor which affects trade cycle. The war brings damages to the country; fall
in investments and incomes, employment and price level. War becomes the reason of
depression.
11.Population
Population increases the aggregate demand of products which raises the price level higher.
High price brings the inflation. Investment and income level falls. There will be depression in
the economy
12.Migration
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 37
The increase and decrease in migration affects the demand. Decreases in population due to
migration, deceases the demand of products. The supply of goods exceeds the demand which
brings depression
On the other hand if there is increases in population due to migration. The demand of goods
is high and the supply is low. More demand encourage investors to produce more which
brings boom in the economy
13. Innovations
Innovations brings boom in the economy. When a new business is started or a new product is
introduced, it increases the demand for that product. This may encourage the investments in
new business which brings boom in the economy.
14.Invention
Invention means discovery of new methods of productions, new machinery or material.
Inventions reduce the cost of production which increases the competition and investment.
This result in boom
15.Weather
The weather also affects the produce of agriculture sector. In bad weather conditions there is
low yield of crops. The demand is the same but the output is low so the price level goes up.
16.Government purchases
When government purchases goods from supplier it increases the demand which leads
towards the boom and if government do not purchases goods, it reduces the demand of goods
which result in depression.
17.Export surplus
Exports surplus is then, when exports are more than the imports. Exports surplus brings the
prosperity in economy
What are the remedies to control trade cycle?

Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 38
Trade cycle can be controlled by applying following methods

A. Monitory policy
B. Fiscal policy
C. International measures
A. Monitory policy
1. Bank rate
Bank rate means, rate at which central bank discounts the bill of commercial bank. The
central bank can increase bank rate when there is boom and can decreases when there is
depression in economy. Increase and decreases in bank rate control the borrowings.
2. Market operation
The central bank can increase or decrease the money supply by open market operation. If
central bank wants to increase the money supply, it buys bonds, treasury bills and other
securities. If central bank wants to decrease the supply of money, it starts selling bonds,
treasury bills and other securities. The purpose of open market operation is to control the
supply of money.
3. Reserve ratio
The central bank can increase or decrease the reserve ratio. Central bank keeps reserve with
central bank. During depression this ratio can be decreased and in boom period reserve ratio
is increased.
4. Selective control
The central bank can provide credit to one sector at low rate and other sector at high rate. The
commercial can refuse to grant loans for non productive purposes. The main purpose is to
regulate the supply of money and to ensure the effective use of money.
B. Fiscal policy
5. Public work
Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 39
Government may start the public work program during depression. Government may start
construction and development of various projects. Public development projects helps to
control trade cycle.
6. Taxes
The government can increases the tax rate to control supply of money. The tax rate can be
increased to reduce the supply of money and if there is shortage of money supply. Then tax
rates can be decreased.
7. Budget
Surplus budget can be prepared in boom period and deficit budget is prepared in depression.
Government can use the budgetary measures to control trade cycle
8. Public debt
Government should borrow loans in depression to meet the various needs. In case of boom
the debt should be repaid. The government can overcome crises by public debts.
9. Imports
Government should promote imports during the boom period but when there is depression;
imports should be restricted or reduced.
10. Government purchase
Government should purchase goods during the depression. Government purchases plays an
important role to control the depression.
C. International measures
11. Production control
The production of goods can be controlled at international level because goods produced in
excess of demand can create problem. Producers can fix the quota at international level. In
this way trade cycle can be controlled
12. Buffer stock
Buffer stock can be kept in warehouses. When production is low the suppliers can met the
demand from surplus stock.
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 40
13. Investment control

The government may increase investment in less developed areas. Excess In any sector may
lead toward depression. There is a great need for the equal investment in all the sectors of
economy
Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 41
Q #13
What are the features of trade cycle?
1. Phases
Trade cycle has four phases
i.
Boom
It is a period of good trade

ii.
Recession
It is period in which there is a downward trend in business activities

iii.
Depression
It is a period of bad trade

iv.
Recovery
It is a period in which economic activities start rising up

2. Cyclic effect (following nature)
Phases of trade cycle follow each other. Boom follows depression and depression follows
boom. The factors which generate boom automatically generate recession and depression and
so on. The trade cycle is completed in this way.
3. Time period
Time period for the completion of trade cycle is not fixed. It may last for 5, 10, 15, 20 even it
can be of fifty years.
4. International in nature
Trade does not affect economy only at national level, but it also effect the other countries
through foreign exchange.
5. Rhythm change
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 42
It means that all the sectors of economy moves in the same direction. If there is boom in one
sector the other would also move upward. It is no possible to have boom in one economy and
depression in other sector
6.
Difference in intensity
Difference in intensity means that the effect of every phase is different on different sectors
7. Not of equal length
All the phases of trade cycle are not of equal length for example boom may last for ten years
and depression may last for 4 years. Length of every phase of trade cycle depends on the
economic conditions of economy.
8. Slow recovery
The recovery phase of economy is slow and the fall in economic activities is sharp.
9. Important phases
Out of four phases boom and depression are very important phases.
10. widespread
When trade cycle takes place in any economy their effect spread to all other sectors of
economy.
11. Social effects
Phases of trade cycle have their effect on society. Facilities are available in boom period and
hoarding, smuggling is found in depression period.

Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 43
Q #14 What is bank? What are the types of banks? (Or) what are the
classifications of bank?
Bank
Bank is a financial institution which borrows savings from general public at lower rate and
lends it to the other people at higher rate of interest.
Kinds of bank
Following are the types of bank;
1. Central bank
A bank which supervises the activities of banking in Pakistan is called central bank. In
Pakistan state bank of Pakistan is the central bank. Main purpose of the central bank is not to
earn profit but it work for the welfare of the society. Central bank has the right to issue notes.
Central bank is also called bank of banks.
2. Commercial bank
A bank which accepts deposits from general public and lends them to the other people to earn
profit is called commercial bank. The main aim of commercial bank is to earn profit. it also
provides the services of agency to his clients. Examples of commercial banks are; national
bank of Pakistan, Habib bank limited, Allied bank limited, united bank limited etc.
3. Industrial bank
The main purpose of industrial bank is to provide credit facility for setting up and running
industries in country. In Pakistan, Industrial development bank and other financial institutions
are providing loans to the different industries.
4. Agricultural bank
These banks provide short term and long term loans to the farmers so that they can purchase
seeds, fertilizers, tractor and other agricultural equipments.
5. Exchange bank
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 44
A bank which buys and sells foreign currency to facilitate imports and exports is called
exchange bank. In Pakistan commercial bank deals in foreign exchange.
6. Savings bank
A bank which collects the savings of the people having low income and pay interest on it is
called saving bank. Such bank is formed to encourage saving habits of people. In Pakistan no
such bank exists but saving account can be opened in post office
7. Investment banks
Bank which buys and sells shares, debentures and bonds is called investment bank.
Investment banks also grant loan for the purchase of shares and other securities. Investment
Corporation of Pakistan are national investment trust are the examples of investment banks.
8. Consumers bank
The main purpose of these banks is to provide credit facility to the consumers to purchase
goods. City bank is performing services of consumer bank in Pakistan.
9. Mortgage bank
This provides loan against land and building for short and long period. House building
Finance Corporation is working as mortgage bank in Pakistan.
10. School banks
These banks provided the banking facility to the schools students. No bank in Pakistan is
providing facility to the students of school. However in European countries these banks are
providing banking facility to the students.
11. Co operative bank
These banks are formed to work for the welfare of society. Their aim is not to earn profit.
These banks provide credit facility to the farmers of small income.
12. Consortium bank
A bank which is formed and run by some other banks is called consortium bank. These banks
provide long term loan loans to large scale companies. In Pakistan no such bank exists.
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 45
13. Labor bank

These banks are opened by trade unions of laborers. The main purpose of this bank is to
manage workers fund, like pension fund, provident fund etc in a better way.
14. Islamic bank
It is an interest free bank which is working under the principles of Islam. Islamic banks are
working under the profit &loss sharing principle. Meezan bank is the example of the Islamic
bank in Pakistan.

Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 46
Q#15
What is a commercial bank? What are the functions
of commercial bank?
Commercial bank
Commercial bank is the most popular form of bank. They are established for the purpose of
earning profit. Commercial bank receives deposits from the individuals, firms and companies
at lower rate and lends it to those people who have need it at higher rate of interest. The
difference of rate is the profit of bank.
FUNCTIONS OF COMMERCIAL BANK

A commercial bank performs various functions that are classified into;
A) Primary functions
B) Secondary functions
C) General utility functions
A) Primary functions
Primary or main function of commercial bank is of accepting deposits and making loans to
needy people
1. Accepting deposits
This is the main function of commercial bank to collect surplus money from the people and
businessman. For this purpose commercial bank has introduced following types of accounts
i.
Saving account
Commercial banks offer saving account for the people who have small savings. Interest is
paid on saving deposits from 6% to 11%. Account holder is not allowed to made frequent
withdrawals.
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 47
ii.
Current account
Current account is usually offered to the businessmen because they can withdraw and deposit
money several times a day. Inertest is not allowed by bank on this account. Traders and
businessmen maintain such type of account.
iii.
Fixed deposit account / term deposit account
In term deposit account the amount cannot be withdrawn before the expiry of specified
(fixed) time. High rate of interest is paid on fixed deposit account. Such type of account is
usually maintained by the people who have surplus money.
iv.
Foreign currency account
This account is opened in foreign currency. Account holder cannot deposit local currency in
this account. Foreign currency account can be opened in form of saving account, current
account or fixed deposit account
v.
Profit and loss account
Those people who do not want to earn interest on their deposit, they can deposit their money
in profit and loss account. Bank pays profit or loss on the amount of deposit that may be
different from one period to other period
2. Advancing loans
Advancing loans is the main function of the commercial bank. The amount of deposits is used
to advance loans to other people. Bank charges high rate of interest on the amount of loan.
These loans can be of short, medium and long period
Bank provide loan in the following ways
i.
Loan
Commercial bank offer short medium and long term loans against the securities.
ii.
Cash credit
Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 48
Cash credit is an agreement between bank and its client to borrow money up to a specified
limit. The period of cash credit may consist of days and months. Interest is charged only on
the amount withdrawn
iii.
Overdraft
Overdraft is a very short term credit facility. Bank allows his trustworthy customers to draw
more than the deposit. Bank charges higher interest rate on the amount of overdraft.
iv.
Discounting of bill
Bank provides money to the holder of bill of exchange after deducting charges of discounting
of bill. Amount of discount is the income for bank.
B) Secondary functions
These functions can be divided in agency function and general utility function
1. Agency function
Bank works for his customer as his agent. As a agent bank provide following customers to his
customers.
i.
Collection and payment of cheque
This is important function of commercial bank to collect and make payment of cheques
ii.
Purchase and sale of public securities
Commercial bank also buys and sells securities (shares and debenture) on the behalf of his
customer. Bank charge his commission for providing such services.
iii.
Financial advisor
Bank gives on demand valuable advices to his customer on various financial matters
iv.
Execution of standing orders
Bank also executes the instructions and settles those transactions that are of regular nature.
For example payment of rent, insurance and utility bills etc.
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 49
v.
Transfer of funds
Bank also transfers money from one place to another place by means of bank draft,
telephonic transfer and cheques. Bank performs this function on the orders of his customer.
vi.
Deduction of zakat
Bank deducts amounts of zakat from customers account on the behalf of government
Such amount is transferred to the general zakat fund.
2. General utility function
Bank also provide general utility function to his customers some of them are given below
i.
Locker facility
Bank also provides locker facility to his customer for the safe custody of valuable goods like
jewelry, shares, securities etc. bank charges his services charges.
ii.
Foreign exchange
Bank also deals in foreign exchange. It converts local currency in to foreign currency and
vice versa on customer demand.
iii.
Relief fund
Bank performs the function of collecting money as a charity from general for the relief of
victims of earthquake and war effected people
iv.
24 hour cash services
In this modern money economy commercial banks provide the facility of 24 hour cash
services. Customer can withdraw money from ATM machines at any time
(834 words)
Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 50
Q#16
Explain the role of commercial bank in economic
development of country
Or
Explain the importance of commercial bank.

Commercial bank
Commercial bank is the most popular form of bank. They are established for the purpose of
earning profit. Commercial bank receives deposits from the individuals, firms and companies
at lower rate and lends it to those people who need it at higher rate of interest. The difference
of rate is the profit of bank.
Role of bank in economic development

Commercial banks are playing vital role in the economic development of country. Few of
them are given below
1. Promoting savings
Commercial bank are playing vital role in the promotion savings. They are offering different
types of deposit accounts with attractive interest rates to increase savings.
2. Promoting investments
Commercial banks do not keep the collected money idle with them; they lend it to the
businessmen for investment purpose which increases the production and employment level
3. Transfer of funds
Commercial bank also provides the facility to transfer money from one place to another place
which makes the transactions safer and leads to the growth of trade
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 51
4. Industrial development
Commercial bank provides short and long term loans to the industrialist. Bank also gives
valuable advices to them.
5. Increase in employment
Commercial bank grants loans to different sectors of business, such as Trade, commerce,
agriculture and transport to expand the business activities which increases the level of
employment in country.
6. Construction of houses
Bank provides credit facility to their customer for the construction or purchases of house.
Bank provide short term loan for repairing and long term loans for the purchase of land and
constriction of houses.
7. Credit creation
Commercial banks are called the factories of credit. They create credit from the deposits.
Through the credit creation process commercial bank provides funds to the various sectors of
economy
8. Capital formation
Capital formation means increase in number of production units. Capital formation depends
upon the amount of investment and savings. Commercial bank can increase the capital
formation by granting loans to the productive sectors
9. Export promotion cell

Commercial banks are also playing an important role in the growth of export. It has
established exports promotion cells for the guidance and information to the exporters
10. Agricultural development
Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 52
Economic development is not only based on the development of industry but it also depends
on the agricultural. Commercial banks are advancing loans to the farmers on small medium
and long terms to purchase seeds, machinery, and other equipments.
11.Development of transport
The commercial bank financed the transport scheme through Punjab ministers scheme. It has
reduced the unemployment on one hand and increased the transportation facility on the other
hand.
12.Financial advices
Commercial bank also gives financial advices to their customers to promote their business,
besides credit facility
13.Construction of houses
Commercial bank provides loans for the construction projects. It grants short term loans for
repairing and long term loans for the construction of houses.
14.Assistance to government
It also grants loans to the government for the development projects. The commercial bank
share the government for the economic stability
15.Economic prosperity
Economic growth depends upon the development of banking system. A sound banking
system promotes economic status of people by providing loans on the lenient terms and
conditions.
16.Development of foreign trade

Commercial bank help the importers and exporters by providing them foreign exchange, it
also issues letter of credit to ensure the payment.
17.More production
Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 53
A good banking system increases the production capabilities of the country by growing
capital formation and proper labour division
18.Modern technology
The use of modern technology Is possible only when the banking system is developed as it is
the main source of their funds
19.Collection of zakat
Commercial deducts amount of zakat from depositor account on the behalf of government
and distribute the same among the deserving people
20.Use of idle funds

The idle funds of individuals and firms are get utilized through the commercial bank. This
helps in expansion of production capacity of a country

Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 54
Q#17
What is the process of credit creation? What are the limitations
on the powers of bank to create credit? (Or) Commercial banks are the
factories of credit, explain. (Or) How does the commercial bank create
credit what are its limitations? (Or) Loans are the children of deposits and
deposits are the children of loans. Discuss
Credit creation
Commercial banks are the factories of credit. It is the most important function of the
commercial bank. Commercial banks create credit by providing loans. The amount of loan is
not paid directly to the customer. The amount is deposited in the borrower account. The
borrower can withdraw amount by issuing cheque. Thus loans create deposit and deposit
create loan.
Assumptions
1. Many banks
It is assumed that there are many banks that are working in the country and they are
cooperating with each other for the purpose of credit creation.
2. Same cash ratio
It is assumed that the cash reserve ratio is the same for every bank that may be 20%.
3. Bank transaction
It is also assumed that the money taken as loan must be deposited in the same or other bank.
The loan given by the second bank must be deposited into the third bank and so on
4. Initial deposit
There must be initial deposit in every bank by the customer. This initial deposit is the basis of
credit creation.
5. Many borrowers
Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 55
It is assumed that there are many borrowers and the bank gives them loan against the
securities
Process of credit creation

The process of credit creation can be explained with the help of examples
Suppose, Bank A receives RS 1000 as a deposit from customer, the bank keeps 20% of
deposit and lends 80% of deposit to Mr. X.
The position of Bank A after credit creation is as follows
Balance sheet of Bank A
Liabilities
Amount Assets
Amount
Deposits
1000
Cash reserve
200
Loan to Mr. X
800
Total
1000
Total
1000
We now assume that the Mr. X makes Payment of Rs 800 to Mr. Y by cheque. Mr. Y
deposited his cheque in his account in Bank B. Bank B receives Rs. 800 as deposit and after
keeping 20% reserve he lends the remaining 80% as loan to Mr. Z. The balance sheet of Bank
B after giving loan is as follows.
Balance sheet of Bank B
Liabilities
Amount Assets
Amount
Deposits
800
Cash reserve
160
Loan to Mr. z
640
Total
800
Total
800
The process is not yet completed, it will continue further. The whole process can be
explained as follows.
Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 56
Bank
Primary deposit
Reserves 20%
Credit creation
1000
200
800
800
160
640
640
L28
512
512
102
409
----
----
----
-----
----
----
------
----
----
------
----
----
-------
----
----
Total
5000
1000
4000
This table shows that if the bank have initial deposit of 1000 and reserve ratio is 20% then
bank create credit of Rs 4000 and the total demand deposit is Rs 5000 which is equal to the
initial deposit of Rs 1000 and credit creation of Rs 4000
Formula of credit creation

The amount of credit creation can also be calculated with the help of formula
= 5000
Limitation of credit creation

The capacity of bank to create credit depends upon the following factors
1. Withdrawals
Credit creation depends on the deposits. If a borrower withdraws a part or entire amount
loaned to him the bank will not be able to create credit.
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 57
2. Cash reserve
The commercial bank keeps a large portion of cash as reserve for making the payment of
cheque. If the reserve ratio is high the bank cannot crate much credit.
3. Proper securities
Bank grants loan against a proper security, if the proper security is not available the
commercial bank cannot create credit
4. Business conditions
People only borrow loans when there are good business conditions. In worst business
condition people hesitate to take loan, thus it becomes the hurdle in credit creation.
5. Willingness to borrow
Commercial bank can create credit only if customers are willing to borrow but if they are not
willing to borrow commercial bank cannot create credit.
6. Policy of lending
Commercial banks are not independent in connection with lending. They have to follow the
policies of central bank. The central bank impose restriction on the commercial bank to create
credit
7. Primary deposit
Credit creation depends upon the primary deposit. If people are not in habit to deposit their
savings in bank, then the central bank cannot create credit

Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 58
Q#18
Explain the relationship between banker and customer. (Or) What are the
types of relationship between banker and customer? (Or) explain the
nature of relationship between the banker and customer
Banker
J.W Gilbert says that A banker is a dealer in capital or, more properly, a dealer in money.
He is an intermediate party between the borrower and the lender. He borrows from one party
and lends to another.
In simple words banker can be defined as a person who receives money and accepts the
cheque drawn upon him by customer. A banker also collects and pays drafts, dividend and
bill of exchange.
Customer
Justice Lindley says customer is a person who has some sort of account either deposit or
current account or some sort of similar relation with a banker
Relationship
The relationship of banker and customer is primarily of debtor and creditor with a superadded obligation on the part of banker to accept the customers cheque, if the account is in
credit.
Relationship of debtor and creditor

1. Debtor and creditor
The relationship of banker and customer is of debtor and creditor. When an account is
opened, banker becomes the debtor of is customer. And customer becomes the creditor of his
banker. When the account of customer is out of credit the relationship ends.
2. Principal and agent
Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 59
The relationship between banker and customer is of principal and agent. The customer is
principal and banker is agent at the time of collection of cheque and bill of exchange.
Moreover banker also purchases and sale shares as an agent.
3. Financer and financee

The banker is called financer and customer is known as financee. Banker grants loans to his
customer to meet the cash requirements
4. Bailor and Bailee
The customer becomes Bailor at the time of delivery of valuable goods for the safe custody.
The banker acts as Bailee when he receives goods from customer
5. Pledger and pledgee
The customer can become Pledger at that time of providing security of moveable property for
obtaining loan. And banker becomes pledgee when he grants loans against security.
6. Mortgager and mortgagee
The customer becomes mortgager at that time when he obtains loan against immovable
property and banker becomes mortgagee when he grants loan against immovable property.
7. Author and trustee
Banker acts as trustee for a customer who keeps valuable & documents for the safe custody.
The customer becomes the author.
8. Reference and referee
The customer becomes reference and banker becomes referee when banker is asked to
comment on financial position of customer. The banker as referee can submit favorable and
unfavorable reports to other bank.
9. Lessor and lessee
When the bank provides finance to his customer on the basis of lease, the relationship
becomes of Lessor and lessee. The bank is Lessor and customer is lessee
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 60
10. Adviser and advisee

The banker becomes advisor and customer becomes advisee. Bank gives valuable advices to
his customer about the financial matters of business.
11. Licenser and licensee / banker as a trustee
Banker works as licensor / trustee when he keeps the valuable or document of customer for
the safe custody.
12. Banker as beneficiary
When banker receives money from customer and uses it in various sectors for his benefit he
becomes beneficiary.
13. Modarab and Amal
When banker provides finance to his customer on the agreement of Modaraba, the
relationship becomes that of Modarab and Amal. The banker is Modarab and customer is
Amal.
14. Hirer and owner
When goods are delivered to the customer on hire purchase agreement, the banker becomes
the owner and customer becomes the hirer of the same.
15. Pawnor and Pawnee
When a customer keeps his goods or documents with banker as security for the payment of
debt or the performance of promise, the relationship becomes of Pawnor and Pawnee. The
customer becomes Pawnor and banker becomes Pawnee.
16. Correspondent and respondent
Bank issues traveler cheque, letter of credit and credit cards to customer that can be used in
international market for making payments. Banker becomes correspondent and customer
becomes respondent.
17. Indemnifier and indemnity holder
Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 61
When the banker promises his customer to compensate for the loss suffered by him, the
banker becomes indemnifier and customer becomes indemnity holder.
18. Testator and executor
When a banker is asked to execute the will of his customer after his death, the banker
becomes executor and banker becomes executor.

Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 62
Q#19
What are the circumstances under which the relationship
between banker and customer comes to an end?
Or
What are the reasons of termination of relationship between
banker and customer?
1. Insanity of customer
When a customer loss his senses permanently or in other words when a person becomes of
unsound mind the banker closes his account and the relationship comes to an end
2. Insolvency of customer
When a customer is declared insolvent and he is unable to pay his debts. The relationship
comes to an end and banker stops withdrawals from account.
3. Death of customer
The relationship is atomically terminated on the death of customer. Credit in account is paid
to the heir of customer
4. Unsatisfactory working of bank

The customer may close his account, if he is not satisfied with the working of bank.
5. Order of court
A court may order to stop withdrawals from account. Due to breach of contract, other part is
compensated by court.
6. Notice by banker
Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 63
A banker can terminate the relationship by sending a notice to customer, if he finds that his
customer is involved in illegal activities.
7. Notice by customer
A customer can send notice to the banker about the termination of relationship, when he is
not satisfied with the performance of banker
8. Unsatisfactory operation
A banker may close the account, if the customer is not obeying the rules of operating account.
9. Assignment of account
A customer may assign the whole amount in the account to the other party by giving notice to
the banker. When the amount is transferred the relationship between banker and customer
comes to an end
10.Loss of confidence
If a customer is not satisfied with the financial position of bank he may close his bank
account to avoid any type of loss
11.Low profit
If banker pays low profit or interest and charges more interest than a customer may chose to
close his account
12.Change of residence
A customer may terminate his relationship due to change of residence. Customer may shift
his account to the nearest branch of his destination
13.Insufficient balance
When a customer used to draw cheque and does not have credit in his account, banker may
close his account after giving notice
14.Banking hours not observed

Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 64
When a customer used to present his cheque after banking hours, banker may close his
account after giving notice
15.Winding up of company
When a company is wounded up by the order of court, no payment of cheque is made. Thus
relationship between banker and company comes to an end

Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 65
Q#20
What are the rights and duties of banker and customer
explain them in detail.
Rights of customer
1. Right to draw cheque
A customer has right to issue cheque for taking money if he has sufficient balance in his
account. Customer can also withdraw cheque against debit balance if agreement of overdraft
is made
2. Right to receive bank statement
Every customer has a right to receive bank statement containing details about the withdrawals
and deposits.
3. Right to receive cheque book
A customer has right to receive cheque book at the time of opening bank account so that he
can withdraw cash from account
4. Right to Claim for damages
Customer has right to claim for the damages from bank when he dishonors cheque without
any reason
5. Right to Claim for damages for not maintaining privacy
Privacy of customer account must be maintained, if banker do not maintain the privacy the
customer has right to claim for the damages.
6. Right of correction
A customer has right of rectification of errors made by the banker while debiting and
crediting his account.
Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 66
Duties of customer
1. Banking hours
A customer should present cheque during the banking hours. If he present cheque after
banking hours, banker is not responsible for making payment
2. Presentation of cheque
It is the duty of customer to submit his cheque within the time. The life of cheque is six
months from the date of issue
3. Protection of cheque book
It is the duty of customer to keep the cheque book in safe custody so that no one can misuse
it.
4. Report about theft
It is the duty of customer to inform banker, when cheque book or a cheque is lost to avoid
misuse.
5. Filling of cheque book
It is the duty of customer to fill the cheque with care. If any error or mistake is made the
banker may refuse to make the payment
Rights of banker
1. Right to claim charges
Banker has right to claim charges and commission for the services provided to the customer.
2. Right to Charge compound interest
It is the right of bank to charge compound interest on the amount of overdraft according to
the terms and conditions agreed between the parties.
3. Right to retain securities
Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 67
It is the right of bank to retain the securities until the customer pays amount of debt. If
customer fails to pay the amount of debt, the banker has right to sell the securities.
4. Right to adjust debit balance
It is the right of banker to adjust the amount of overdraft as soon as the customer deposit
some cash in his account
Duties of banker
1. Payment of cheque
It is the duty of banker to make the payment of cheque drawn on him. The cheque must be
drawn properly and presented within the time
2. Secrecy
It is the duty to banker to maintain the privacy of customers account.
3. Standing orders
It is the duty of banker to obey the standing orders in making payments. Such as rent rate and
taxes that are paid after the regular intervals
4. Safe custody
It is the duty of banker to take reasonable care of goods that are deposited for the safe custody
5. Trustee
While acting as trustee, a banker must work according to the terms and conditions of
agreement.

Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 68
Q#21
Define central bank. Explain the function of central
bank
Introduction
Central bank has the central position in the banking system. It controls the activities and
system of other banks. Main purpose of central bank is not to earn profit. It works for the
welfare of society. Central bank has sole authority to issue notes. It works as banker of banks
and banker to government. In Pakistan, state bank of Pakistan is acting as central bank
Definition
An institution which is charged with the responsibility of managing the expansion and
contraction of the volume of money in the interest of welfare of economy
Functions of commercial bank

1. Monopoly of note issue
Central bank has the sole authority to issue currency notes. No other bank has authority to
issue notes. In Pakistan, state bank of Pakistan issues currency notes.
The purpose of sole authority is;
i.
To bring uniformity in currency notes
ii.
To control over printing of notes
iii.
To regulate currency according to the demand
2. Banker to the government

Central bank performs several functions on the behalf of government. It gives all those
facilities to government that commercial gives to the public
Following are the functions that are performed by the central bank to facilitate government
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 69
i.
Keeping deposits
Central bank keeps deposits of federal and provincial government. It makes payments on the
behalf of government. Central bank does not pay interest on government deposits
ii.
Fiscal agent
As a fiscal agent the central bank grants loans to the government and makes investments in
the treasury bills and other long term securities
iii.
Foreign loans
Central bank also makes arrangement to get foreign loans on the behalf of government
iv.
Financial advisor
It advices government on all financial matters such as controlling the inflation or deflation
and valuation of currency
v.
Transfer of capital
Central bank is also responsible for transferring the funds of government form one place to
another place.
3. Bankers bank
Central bank is the banker of commercial banks and performs the followings functions to
facilitate commercial banks.
i.
Custodian of cash reserve
Central bank keeps a certain percentage of deposits of commercial bank as cash reserve; the
amount is kept in safe custody
ii.
Clearing house
Central bank acts as the clearing house for commercial banks. All scheduled banks have their
accounts with central bank so the mutual obligation of banks are settled simple by passing
debit and credit entries in their accounts.
iii.
Lender of last resort
Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 70
Central bank is the supreme bank of a country if a commercial bank is suffering from crises,
central bank grants loans to the commercial banks.
iv.
Opening of new bank
New bank or branch cannot be opened without the permission of central bank.
v.
Growth of bank
Central bank is responsible for the growth of banking system in country.
4. Control of foreign exchange

Central bank is responsible for the management of foreign exchange. Central bank maintains
the silver, gold and foreign currency reserves in country.
5. Controlling of credit
It is the duty of central bank to maintain and regulate the supply of money according to the
economic needs. If there is depression in economy, central bank expands the supply of
money. If there is inflation in country, central bank aims at contracting the supply of money.
6. Exchange rate stability

Central bank fixes the exchange rate of domestic currency in terms of foreign currency. It
tries to bring stability in exchange rates
7. Development role
Sometimes the central bank takes the responsibility to enhance economic growth. Central
bank develops money markets and capital markets. It introduces the export promotion
schemes to increase the volume of exports. Facilities are provided to promote investment in
various sectors of economy
8. Miscellaneous functions
i.
Staff training
Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 71
The central bank establishes training institutes and also provides modern training of banking
to the staff.
ii.
Saving habits
Central bank makes and plans and adopts the various methods to promote the habits of
savings among the people of country.
iii.
Representative of government
Central bank acts as the representative of government for international institutions, like IMF
and World Bank.
iv.
Membership fee
If the government wants to be the member of international institutions, central banks pays
membership fee on the behalf of government.
v.
Financial reports
Central bank publishes various reports which give the real picture of economy
(729)

Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 72
Q#22 Differentiate central bank and commercial bank.

Difference between central bank and commercial bank
Central bank
Commercial bank
1. Formation
Central bank is formed under an act of
Commercial bank is formed under companies
parliament or ordinance
ordinance 1984
2. Ownership
share capital of central bank may be owned by The share capital of the commercial bank is owned
the commercial bank and central bank
by the people
3. Management
The management and employees of central
bank is appointed by the government
Employees of commercial bank are appointed by the

board of the directors
4. Object
The main object of the central bank is welfare The main object of commercial bank is to earn profit
of society and economic development
5. Issuance of notes
Commercial bank cannot issue currency notes
Commercial bank has sole authority to issue It can issue plastic money like debit cards, credit
notes.
cards and cherubs
6. Branches
Central bank only has inland branches it
cannot form its branches in other countries
Commercial bank has both foreign and national

branches
7. Number of bank
There is only one central bank in every country
8. Account
Written by; Ahmed
BANKING
There are many commercial banks in every bank
General public, companies and firms can
opens
0334 5040190, 0313 5040191
Page # 73
Government and commercial bank can open account in commercial bank

their account in central bank
9. Winding up
Central bank cannot closed up even if it is The commercial bank can be closed if it is
working on loss
continuously suffering losses
10. Transfer of funds

Central bank transfer funds of commercial Commercial bank transfer funds of their customers
banks and government
11. Discounting of bill
It discounts the bills of the customer
It discounts the bill of commercial bank

12. Advisor
Financial advices the commercial bank and The commercial bank give advices to their
government on financial matters
13. Nature of account
customers on financial matters
Commercial bank opens account of their customer
Central opens account of government under under heads of saving, current , PLS, and fixed
the various heads of accounts
deposit account
14. money market

Central bank is the leader of money market
It is the member of money market
15. credit controller

It controls credit by using various methods
The commercial bank creates credit according to

money available
16. Foreign payments

It makes the foreign payment on the behalf of It makes foreign payments on the behalf of his
government
customer
17. Discount of bill

It discounts the bill of commercial banks
18. Evening Banking
It discounts the bill of customers.

The commercial banks provide evening banking
Central bank does not provide evening banking services to customers.
Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 74
Q#23
What are the objectives of monetary policy? Also
explain the tolls of monetary policy
Monetary policy
The primary function of central bank is to control money and credit supply. Central bank can
increase and decrease the money supply according to the economic needs of country. In
Pakistan the state bank of Pakistan is controlling the supply of money. The management of
the flow of money is called monetary policy or credit policy.
Definition
According to the prof. Spencer: monitory policy is the purposeful exercise of the monetary
authoritys power to make expansion or contraction in the money supply
Objectives of monetary policy

Objectives of monetary policy may vary from one country to other country depending upon
the economic needs.
Following are the main objectives of monetary policy.
1. Employment
The main objective of monetary policy is to raise the level of employment in country. It
create more opportunities of employment in less developed countries
2. Price stability
The main objective of monetary policy is to maintain the price level at reasonable level.
Inflation and deflation can be avoided by controlling price level. Central bank can control
inflation by decreasing the supply of money and deflation can be controlled by increasing
supply of money
3. Increase in investment
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 75
Investment level can be increased with the help of monetary policy. Central bank can aim to
promote both foreign and domestic investments.
4. Increase in production
Central bank can increase level of production by granting loans to manufacturers at low
interest rates.
5. Exchange stability
Monetary policy aims to maintain the exchange rate at stable level. Exchange rate stability
is essential for the smooth flow of international trade.
6. Control on inflation
The main objective of monetary policy is to control inflation. Excess money supply is one of
the reasons of inflation. Central bank can control inflation by controlling the supply of
money.
7. Control on deflation
Deflation can be controlled by expanding the supply of money. Unnecessary contraction of
supply of money is one of reasons of deflation. Central bank can increase money supply with
the help of monetary policy.
8. Stability in capital market
The development of country depends upon the development of capital market. Central bank
can create stability in capital market with the help of monetary policy.
9. Foreign value of currency
Foreign value of currency can be maintained at stable level with the help of monetary policy
which leads towards growth in international trade.
10. Control on trade cycle
Trade cycle exists when there are fluctuations in the production, employment and price level.
Trade cycle can be controlled by controlling credit in economy with the help of monetary
policy.
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 76
11. Economic growth

Monetary policy aims to promote rapid growth in national income and per capita income. It
requires the best utilization of resources.
12. Control on speculation
The commodity and stock markets are the speculation places. An artificial demand is cratered
due to which small investor suffers lose. Speculation increases the price level that can be
controlled with the help of monetary policy. Central bank imposes restriction on giving loans
to the speculators
13. Living standard
Living standard of people can be improved with the help of monetary policy by increasing
the purchasing power of money.

Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 77
Tools of monetary policy or
instruments of monetary policy
Or how central bank control credit Or what are the methods to

control credit?
Tools of monetary policy
Tools of monetary policy can be divided in to two main parts.
A. Quantitative methods
B. Qualitative methods
A. Quantitative methods
1. Bank rate policy

The bank rate or the discount rate is the rate of interest at which central bank lends loan to the
commercial bank. When central wants contraction in supply of money it may increase the
interest rate due to which the borrowings from the commercial bank decrease. When the
central bank wants to increase the supply of money it decreases the interest rate which
encourage the borrowings
2. Open market operation
The buying and selling of government securities by central bank in market is called open
market operation when central bank wants the contraction in supply of money, it sells
securities. When central bank wants expansion in supply of money it buys government
securities.
3. Reserve ratio
The portion of the reserves that is to be kept with the central bank is called reserve ratio.
When the reserve ratio is increases the supply of money is decreased. When the reserve ratio
is decreased the supply of money is increased.
4. Credit limit
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 78
Under this scheme, central bank limits the maximum amount of landings of commercial
bank. Commercial banks are not allowed to grant loan more than the fixed limit
5. Credit rationing
The method of credit control is applied by the central bank in times of financial crises. The
central bank rations the credit of every commercial bank. It fixes the amount that each
member bank can draw by rediscounting the bills of exchange.
B. Qualitative methods
1. Margin requirement
Central bank can control credit by changing margin. if the margin requirement is increased,
then people cannot take more loans. But if margin requirement is decreased people can take
more loans.
2. Direct action
Central can take direct action if the commercial banks are not following the monetary policy.
It may refuse to grant loans or impose penalty on them.
3. Control on consumer credit
According to this technique, the central bank may apply some strict restrictions on
consumers credit. It may increase the interest rate or may shorten the period of repayment.
4. Publicity
The central bank may convince the borrowers and lenders through publication of annual
reports and weekly statements about the specific policy.

Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 79
Q#24
What is the difference between cheque, bills of exchange
and promissory note?
Basis
Bills
of Promissory
exchange
1 Definition
Cheque
note
Bills of exchange is an Promissory note is an Cheque is an instrument

instrument
in
writing instrument
in
which which is used to withdraw
which contains order of debtor promises to pay a money from bank

payment by creditor to certain
debtor
In
2 parties
case
amount
to
creditor
of
bill
of In case of promissory In case of cheque there
exchange there are three note there are two parties are
parties, drawer drawee maker and payee
three
parties
depositor, bank and payee
and payee.
3 Acceptance
Acceptance by drawee is There is no need of In case of cheque there is

necessary.
acceptance
no need of acceptance, as
it
is
order
by
the
customer.
4 Discounting
Bills of exchange can be Promissory note cannot Cheque

discounted from bank
5 Grace days
be discounted
cannot
be
discounted
Three grace days are Three grace days are In case of cheque no
allowed to make payment allowed to make payment grace days are allowed
for making payment
6 Area
Promissory note can be Promissory

inland or foreign
7 stamp
generally inland
Pasting of Stamp on bills Pasting of

of exchange is legally promissory
required
8 Nature
note
is Cheque is drawn on only

depositors bank
Stamp on No stamp is required to

note
is paste on cheque
legally required
It is an unconditional It is an unconditional Cheque
Written by; Ahmed

BANKING
is
0334 5040190, 0313 5040191
Page # 80
an
order
for
making promise for payment
unconditional order for
payment
In
9 liability
case
making payment
of
Bills
of In case of promissory In case of cheque it is the
exchange it is the liability note it is the liability of liability of bank to make

of drawee to make the drawer
payment
make
the payment
payment
Noting Noting charges are paid Noting charges are not Noting charges are not
10
in case of dishonor of paid in case of dishonor paid in case of dishonor
charges
bills of exchange
11
to
of promissory note
of cheque
Printed A bills of exchange can A promissory note can be A cheque is always drawn
be drawn on simple or drawn
form
printed paper
12 Crossing
simple
printed paper
or on printed paper that is

provided by the bank
Bills of exchange cannot Promissory note cannot Cheque can be crossed

be crossed
13 Payee
on
In
case
be crossed
of
bills
of In case of promissory In case of cheque the
exhnage the drawer and note the drawee and the drawer and the payee may
the payee may be same payee
person
14 Default
In
case
may
be
same be same person
person
of
bills
of In
case
of
bills
of In case of cheque the
exchange the drawee is exchange the drawer is bank is responsible to

responsible to make the responsible to make the make payment than the
payment
15 Trust
In
case
exchange
payment
of
bills
the
drawer is responsible
of In case of promissory In case of cheque the
people note people shows less people
shows
more
shows less confidence as confidence as compared confidence as compared

compared to the cheque
to the cheque and bills of to the bills of exchange

exchange
16
payment
Stop Payment
exchange
of
bills
cannot
stopped
Written by; Ahmed

BANKING
and promissory note
of Payment of promissory Payment of cheque can be

be note cannot be stopped
stopped on the orders of

depositor
0334 5040190, 0313 5040191
Page # 81
17 Period
Period
for
payment
of
making Payment period is written Cheque can be cashed

bills
of on the note
exchange is written on it
within the period of six

months from the date of
issue
Bills of exchange is less Promissory note is less Cheque is more popular
18 Use
used than cheque and used than the bills of than the bill and note
more used than the note
19 Drawer
Drawer of bill is always a Drawer of the note is Drawer of the cheque is

seller
20 drawee
exchange and cheque
always buyer
always an account holder
Drawee of bills is always Drawee of note is always Drawee

a buyer
a seller
of
cheque
always a bank

Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 82
is
Q#25
Describe the parties of letter of credit; also explain the
procedure for opening letter of credit.
Letter of credit
According to the Mr. Frank henius letter of credit is a written document issued by the buyers
bank authorizing the seller to draw in accordance with the certain terms and conditions.
Parties of letter of credit
1. Importer / Applicant
Applicant is the importer of goods. He requests his bank to issue letter of credit in the favour
of exporter.
2. Issuing bank
The bank which issues letter of credit in favour of exporter is called issuing bank. It is also
called importers bank.
3. Exporter
The person who exports goods to the importer is called exporter. In other words the person in
whose favour the letter of credit is opened is called exporter.
4. Paying bank
It is bank which makes the payment to the exporter after receiving the letter of credit
Procedure of opening letter of credit

1. Sales contract
Importer of one country makes an agreement with exporter of other country to purchase
goods. When the terms and conditions about the price, quantity and quality are decided the
contract between the parties takes place. The importer then informs his bank to open letter of
credit.
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 83
2. Performa invoice
The banker may ask importer to provide the Performa invoice which contains the details
about the goods that are to be imported.
3. Import license
The banker may ask applicant to provide import license. Import license is issued by the
government.
4. Application form
Application form is also known as application and agreement for L.C. It contains all
necessary details about the terms and conditions of sale. It is signed by the applicant.
5. Margin requirement
Margin requirement is generally fixed by the state bank of Pakistan. It is from 10% to 40% of
the total amount for which the L.C is opened. Importer will have to deposit this amount to the
issuing bank. It is refundable amount
6. Issuance of L.C
The issuing bank informs paying bank that the letter of credit has been issued. Three copies
are prepared one copy is kept buy the issuing bank for its own record. The remaining two
copies are sent to the paying bank. The paying bank keeps the second copy and sends the
third copy to the exporter.
7. Information to the seller
The paying bank informs the seller that the letter of credit has been issued. The seller than
sends goods to the importer and provide the shipping documents to the paying bank. The
bank checks the documents and sends them to the issuing bank.
8. Payment to the seller
When the paying bank is satisfied with the documents provided by the exporter he makes the
payment to the exporter.
9. Collection of documents
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 84
The issuing bank collects shipping documents from paying bank. The issuing bank examines
the documents before giving it to the importer
10. Collection of money
The issuing bank collects money from the importer before giving him shipping documents.
11. Receipt of goods
After making the payment the importer collects documents from issuing bank. He submits
these documents to the shipping company to receive goods. Then he can receive goods from
the shipping company, in this way the transaction of import is completed.

Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 85
Q#26
What are the types of letter of credit?
1. Revocable letter of credit
A letter of credit that can be cancelled by importer or bank at any time due to any reason is
called revocable letter of credit. This type of letter of credit is not usually acceptable by the
businessmen.
2. Irrevocable L.C
A letter of credit that cannot be cancelled before payment is called irrevocable letter of credit.
This types of letter of credit gives full protection to both the parties. Irrevocable L.C is more
popular than the revocable L.C.
3. Confirmed L.C
If the exporters bank confirms the L.C and takes the liability to make payment to the
exporter in case of nonpayment by importers bank, it is called confirmed L.C
4. Unconfirmed L.C
If the exporters bank does not takes the liability of payment in case of nonpayment by the
importers bank. It is called unconfirmed L.C. it is suitable when the financial position of
importer is poor and exporter do not know the issuing bank.
5. Documentary L.C
The L.C in which there is condition that the exporter will submit shipping documents for
receiving money, is called documentary L.C
6. Clean L.C
The L.C in which there is no condition that the exporter will submit shipping documents for
receiving money, is called clean L.C
7. Fixed L.C
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 86
A fixed L.C is that which is issued for a particular transaction. This L.C is automatically
cancelled after the completion of transaction.
8. Revolving L.C
Revolving L.C is issued for the payment of fixed amount but after the completion of
transaction it is automatically cancelled.
9. Transferable L.C
The L.C, in which the exporter (beneficiary) has the right to transfer it to the third party, is
called transferable L.C.
10. Nontransferable L.C
The L.C which cannot be transferred by the exporter to any other person is called
nontransferable L.C
11. Red clause L.C
In this L.C, the exporters bank provide loan to the exporter for packing and transportation of
goods before the shipment of goods. The statement containing the details of order is written
with the red ink.
12. Green clause L.C
In this L.C, the exporters bank provide loan to the exporter for not only packing and
transportation but also for the storage of goods as well. The statement containing the details
of order is written with the green ink.
13. Freely negotiable L.C
Under this letter of credit the exporter can get the money by showing the concerned
documents to any bank.
14. Back to back L.C
Under this L.C there are two separate credits the first document is issued in the favour of
seller who is middleman. On the basis of first L.C the middleman requests his bank to issue
second letter of credit in favour of actual supplier.
15. Omnibus L.C
Under this L.C the exporter can get the funds just after the shipment of goods for further
dealing. The movable and immovable property of exporter is given to banker as security
against loan
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 87
Q #27
What is business finance? What are the main types of
business finance?
Business Finance
Business finance is the flow of capital and credit that makes the business possible. Finance
includes raising of funds through debt or equity finance.
Business finance is the life blood of every business. In sole proprietorship and partnership
less amount of finance is needed. Due to small scale of business, but in companies large
amount of finance is required because of large size of business activities.
Definition
According to B.O wheeler business finance is the concerned with the acquisition and
utilization of capital funds in meeting the financial needs and overall objectives of the
business.
Types of business finance

Business finance can be categorized into the two main heads
1. On the basis of time
2. On the basis of source
A. Short term finance

Short term finance is obtained for the period of one year or less than one year. it is obtained
to meet the day to day operating expenses of business such as payment to creditors, wages,
salaries, utility bills etc,
Following are some forms of short term finance
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 88
a. Bank overdraft
Bank allows its customer who has current in the bank to withdraw more than the credit in the
account. This loan facility is given to meet the daily cash needs. The bank charges interest on
overdraft.
b. Cash credit
It is very common form of short term finance. Borrower can obtain loan against the security
of goods. The borrower is allowed to withdraw cash within the limit specified by the bank.
The interest is charged on the amount withdrawn.
c. Discounting of bills
Another form of short term loan is the discounting of bill. The bank purchases the bill of
exchange and provides finance to the customer. The bank get back the amount of loan on the
maturity of bill
d. Trade credit
Trade credit is allowed by the seller to the buyer. The goods and services are supplied on the
credit and the amount is collected as per agreement.
e. Advances from customers
Sometimes the business gets advance payments from their customers and agents. These
advances are not loan, yet they are a source of finance.
B. Medium term finance

Medium term finance is obtained to meet medium term needs that can be from 1 year to 5
year. The following are the sources of medium term finance.
1. Commercial banks
Commercial banks are the main source of medium term loan. Loans are generally provided
against the security of assets. Businessman can use the amount of loan to meet the business
needs.
2. Loan from financial institutions
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 89
Businessman cal obtain loan from financial institutions other than bank, IDBP, ICP, NDFC
are proving credit facility to the businessmen
3. Debentures
Joint stock companies can obtain loan by issuing debentures. Debenture is an instrument
issued by company to obtain loan from general public.
4. Life insurance policy
The insurance companies provide medium term loan to its policyholders out of premium
received.
C. Long term finance

Long term finance is obtained to invest in the fixed asset like land, building, plant and
machinery. Long term loan can be for a period longer than ten years. Following are the main
source of business finance
1. Equity shares
The equity share is the most important source of long term finance. Joint Stock Company can
issue shares for fund raising. Amount of shares is paid back only on the winding up of the
company.
2. Use of profits
Every company maintains reserve out of its profit that can be used for the development and
expansion of business. It is a useful source of getting extra capital for building and expansion
of business.
3. Issue of right shares
A public company can increase its capital by issuing right shares. Existing share holders are
offered to buy shares in proportion to the shares held.
Company can obtain loan from financial institutions like IDBP, NDFC etc.
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 90
5. Leasing
Leasing is now a popular form of long term finance. A business may get plant equipment,
land. The business in this way uses the asset which it does not own. Businessman has to pay
the regular installments.

On the basis of source, the business finance has two types
1. Equity finance
Equity finance is also known as the owner finance. The finance which is provided by the
owner from his personal source is called equity finance. Owner may provide long term or
short term finance.
2. Debt finance
The second source of fund raising is the credit financing or debt financing. Most of the
business is not in a position to finance all the funds from personal sources, so they can obtain
loan from financial institutions and banks. Loans can be obtained for short medium and long
terms.

Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 91
Q #28
What is business finance? What are the main types of
business finance?
Business Finance
Business finance is the flow of capital and credit that makes the business possible. Finance
includes raising of funds through debt or equity finance.
Business finance is the life blood of every business. In sole proprietorship and partnership
less amount of finance is needed. Due to small scale of business, but in companies large
amount of finance is required because of large size of business activities.
Definition
According to B.O wheeler business finance is the concerned with the acquisition and
utilization of capital funds in meeting the financial needs and overall objectives of the
business.
Types of business finance

Business finance can be categorized into the two main heads
D. Short term finance

Short term finance is obtained for the period of one year or less than one year. it is obtained
to meet the day to day operating expenses of business such as payment to creditors, wages,
salaries, utility bills etc,
Following are some forms of short term finance
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 92
f. Bank overdraft
Bank allows its customer who has current in the bank to withdraw more than the credit in the
account. This loan facility is given to meet the daily cash needs. The bank charges interest on
overdraft.
g. Cash credit
It is very common form of short term finance. Borrower can obtain loan against the security
of goods. The borrower is allowed to withdraw cash within the limit specified by the bank.
The interest is charged on the amount withdrawn.
h. Discounting of bills
Another form of short term loan is the discounting of bill. The bank purchases the bill of
exchange and provides finance to the customer. The bank get back the amount of loan on the
maturity of bill
i. Trade credit
Trade credit is allowed by the seller to the buyer. The goods and services are supplied on the
credit and the amount is collected as per agreement.
j. Advances from customers
Sometimes the business gets advance payments from their customers and agents. These
advances are not loan, yet they are a source of finance.
E. Medium term finance

Medium term finance is obtained to meet medium term needs that can be from 1 year to 5
year. The following are the sources of medium term finance.
5. Commercial banks
Commercial banks are the main source of medium term loan. Loans are generally provided
against the security of assets. Businessman can use the amount of loan to meet the business
needs.
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 93
Businessman cal obtain loan from financial institutions other than bank, IDBP, ICP, NDFC
are proving credit facility to the businessmen
7. Debentures
Joint stock companies can obtain loan by issuing debentures. Debenture is an instrument
issued by company to obtain loan from general public.
8. Life insurance policy
The insurance companies provide medium term loan to its policyholders out of premium
received.
F. Long term finance

Long term finance is obtained to invest in the fixed asset like land, building, plant and
machinery. Long term loan can be for a period longer than ten years. Following are the main
source of business finance
6. Equity shares
The equity share is the most important source of long term finance. Joint Stock Company can
issue shares for fund raising. Amount of shares is paid back only on the winding up of the
company.
7. Use of profits
Every company maintains reserve out of its profit that can be used for the development and
expansion of business. It is a useful source of getting extra capital for building and expansion
of business.
8. Issue of right shares
A public company can increase its capital by issuing right shares. Existing share holders are
offered to buy shares in proportion to the shares held.
Company can obtain loan from financial institutions like IDBP, NDFC etc.
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 94
10. Leasing
Leasing is now a popular form of long term finance. A business may get plant equipment,
land. The business in this way uses the asset which it does not own. Businessman has to pay
the regular installments.

On the basis of source, the business finance has two types
3. Equity finance
owner from his personal source is called equity finance. Owner may provide long term or
short term finance.
4. Debt finance
The second source of fund raising is the credit financing or debt financing. Most of the
business is not in a position to finance all the funds from personal sources, so they can obtain
loan from financial institutions and banks. Loans can be obtained for short medium and long
terms.

Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 95
Q #29
Define owner (equity) and debt finance. What are the advantages
and disadvantages of debt and equity finance?
(Or)
What are the sources of business finance? Explain the merits and
demerits.
There are two main sources of business finance
A. Equity / owner finance
B. Debt finance
A. Equity finance
owners from their personal resources is called equity finance. It is also known as internal
equity or internal finance. This finance is generally provided for meeting the short term and
long term financial needs.
Merits of Equity Finance

1. Long term capital
The equity finance is a long term capital available to the business. Repayment of capital is
made only on the winding up of the business.
2. No interest
Equity finance is free from the payment of interest. The business concern has not to pay the
inertest charges on equity capital.
3. Repayment of funds
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 96
There is no need of repayment as the finance is provided by the owner from his personal
resources.
4. High rate of profit
Equity finance provide high rate of profit as there is no fixed interest payment so the rate of
profit is high.
5. Minimum losses
There is minimum loss to owners during depression. The interest on loan increases the losses.
In case of equity finance there is no interst so losses remain low.
6. Freedom of control
The owners of business enjoy the freedom of control because one man can claim his right on
the assets of the company.
7. Full profit
In case of equity finance, the owners of business enjoy and share full profit of business they
are free from the loan payment and interest payment.
8. Low operating cost
In case of equity of finance the operating cost is low as there is no burden of interest.
9. Financial base
The equity finance provides a sound financial base to the capital structure of a business by
reducing the financial risk.
10. Liquidation of business
In case of liquidation of business, the assets of the business remain with the owners.
11. Financial worries
It is a benefit of equity finance that there are no financial worries of borrowing when the
supply of money is short and interest rate is high.
12. Attention to business
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 97
In case of equity finance, the owner of the business enjoy the freedom of control because they
are free from the tension of interest an repayment of loan, so they can pay full attention to the
business.
Demerits of Equity Finance

1. High rate of tax
The rate of profit is high as interest is not charged. When profit is high, the rate of tax is also
high. The government earns more income.
2. No innovation
The owner do not invests his money in risky business. They work on the basis of their
experience; they do not start the new and risky business, so there is no innovation.
3. No advantage of debt
If a company only invests equity finance it cannot enjoy the benefit of debt finance. Owner
may loss the opportunity to obtain the loan at low interest rate.
4. Deficiency of capital
There is possibility of deficiency of capital because owner invests from his limited resources.
Business may feel problem in making payments due to the shortage of capital
5. Low rate of return
When owner uses their own capital for the investment in business, it avoids taking risky
projects. The return on safe investment is normally low.
6. No aggressiveness of management
A firm without management shows aggressiveness in managing the business affairs, which
result in low return on investment.
7. Over capitalization
If a company issues more equity shares than actually required by it, then it is likely to result
in over capitalization, which may create problem for the company.
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 98
Debt Financing
Debt financing is the second main source for the fund rising. Amount of capital can be
borrowed from creditors. It is also known as credit financing. Most of the businesses are not
able to finance all of the capital from their own resources, so they can enter into an agreement
with the lenders and banks to obtain loans.
Merits of debt financing

1. Expansion of business
The business activities can be expanded easily due to the large capital. Borrowed amount
helps the business to start the production at large scale which results in low cost of
production.
2. No interference of creditors
Creditors cannot interfere in the affairs of business. The owners of business design policies
for the utilization of the borrowed amount.
3. More profit
The business concern with the help of borrowed capital can earn more profit, as the rate of
return on borrowed amount is higher than the rate of interest.
4. Urgent cash requirement
The business can take the short term loans for meeting the urgent funds requirement.
5. Solvency of business
The debt financing provides the solvency to the business. The funds are available to meet the
obligations on due date.
6. More innovation
Innovation demands huge funds. Debt financing provide funds for innovation.
7. Low interest
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 99
In case of debt financing the interest charged on debt is lower than the rate of return paid to
the shareholders in form of dividend
8. Flexible finance policy
Debt financing enable the management to frame a flexible financing policy. Whenever they
want to expand the business they can raise funds by obtaining loan.
Demerits of debt financing

1. Payment of interest
Businessman has to pay the amount of interest on this type of finance, regardless of the
financial position of the business.
2. Business can be sued
If the amount of interest and borrowed amount is not paid at the maturity date, the creditors
may sue the business.
3. losses
In case of loss, the business concern even than has to pay the interest. This increases the
losses of business
4. Repayment of loan
Repayment of loan is the liability of the business that is to be paid on the due date.
Repayment of loan may put the business into the financial difficulty.
5. Dissatisfaction of shareholders
If the company decides to repay the amount of loan out of profits, the payment of dividend to
shareholders is reduced. It creates dissatisfaction among them.
6. Winding up of business
In case of winding up of business, the creditors have the prior claim on the assets of the
business, so the shareholders may suffer loss.
7. Attraction of funds
In times of depression, the rate of return on investment is lower than the rate of interest on
loan. Therefore the new investors will not contribute their funds in the business.
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 100
Q #30
Explain the various types of interest free or non interest
modes of financing (or) explain the Islamic mode of
financing.
Interest free mode of financing
Interest free mode of financing means the financing free from the interest. In Islamic mode
of financing interest in all fields and all ways is prohibited. Following are the main types of
interest free mode of financing
A. Lending mode of financing
B. Trade related mode of financing
C. Investment mode of financing
A. Lending mode of financing
1. Interest free loan with service charges

Under this mode of financing, the bank provides funds free from the interest. The bank
charges only the service charges from the borrower. The rate of service charges is fixed by
the state bank of Pakistan. Interest free loans are generally provided to the small farmers,
small businessmen and salaried persons.
2. Qarze Husna
Under this scheme the loan is provided to the poor people for medical treatment and to the
students who are less than 35 years of age. The students are allowed a grace period of two
years after the completion of studies to repay the amount of loan.
B. Trade related mode of financing
Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 101
The state bank of Pakistan has approved five trade related mode of financing that are given
below
1. Mark up
Mark up is the purchase of goods by the bank and their sale to the client at some mark up
(profit) on differed payment basis. The bank purchases the required goods on the request of
the client and sells these goods to him on the price mutually agreed between the bank and the
client. The agreed price contains the cost plus mark up (profit margin).
2. Mark down
It is the purchase of property by bank from customer with buy back agreement. Under this
scheme, the customer sells his property to the bank with a promise to buy back the same
property from bank on future date. The difference between the purchase price and sale price
is the profit of bank.
3. Hire purchase
The bank purchases the specified goods on the request of customer and hires them to the
customer on the payment of periodical installments. The installments are calculated in such a
manner that the actual price plus bank charges are covered during the fixed period.
4. Leasing
In this mode of financing, one person (lessee) acquires an asset from the other person
(Lessor) for a fixed agreed period of time. The period of lease range from 5 to 20 years,
depending upon the useful life of asset. The lessee will have to pay fixed amount after regular
intervals. The ownership of the property remains with the Lessor.
5. Development charges
In this trade related mode of financing the bank advances money to the customer for the
development of land and property. The bank takes a share in the developed property. The
share in the developed property is named as development charges.
C. Investment modes of financing

Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 102
Following are the five types of investment modes of financing.

1. Musharika
Musharika is an agreement between the bank and his client to participate in the business as a
temporary partner to share profit and losses of the business during a specified period of time.
In this agreement the, business is run by the client and the profits are shared in an agreed
ratio.
Features of Musharika
The funds of the banks on the basis of Musharika are secured
A certain portion of the profit is paid to the client as management fee
The profit is shared according to the agreed ratio.
In case of loss, it is shared by the bank and client according to the financee
provided by them
2. Modaraba
Modaraba is an agreement in which one part invests his funds and the other party with his
knowledge and skills. Profits are shared between the parties in an agreed ratio. In case of loss
the bank which supplies capital bears full loss.
Features of Modaraba
Modaraba must be registered under Modaraba ordinance
Profit is shared in agreed ratio
Modaraba certificate is transferable
Modaraba may be for specific purpose or multi purpose
3. Participation term certificate

The participation term certificate was designed to replace debenture financing in the
financing of industrial investment.
Features
Participation term certificates are transferable.
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 103
Only joint stock company can issue such certificate

Profits are shared in agreed ratio
Losses are shared in the ratio of investment
Certificate holder has right to participate in the meetings of the company
These certificates provide medium and long term finance
4. Equity finance
The bank can participate in equity by purchase of shares of limited companies. The bankers
can become the shareholders instead of creditors.
Features of equity finance
The investors purchase the shares to participate in equity
The profits are distributed as dividend
The banks and financial institutions may become the shareholders
5. Rent sharing
Rent sharing system provides the finance for the purchase or construction of houses. The
financer becomes the joint owner of the property. The principal amount and profit in shape of
rent is received for fixed period.
Features
The bank and customer both contribute their funds
The period of joint ownership is stated in the agreement
The rental value of house is determined on the base of locality and quality of
construction.
The gain on sale of house is shared proportionately.
Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 104
Q #31
What
are
the
advantages
and
disadvantages
of
nationalization of banks in Pakistan

Nationalization
Nationalization means the transfer of ownership, management and control to the state. In
1974, 13 banks were nationalized under nationalization of banks act 1974.
Definition
According to Alan Isaacs; nationalization is the process of bringing the assets of a company
into the ownership of state.
According to the Robert Millard; nationalization is the act of converting the privately owned
resources into the one owned by the central government
Advantages of Nationalization
1. Distribution of credit
Nationalized helped in the fair distribution of credit. Before nationalization the credit was
concentrated in few hands. Nationalization ensured the fair distribution of wealth.
2. Banking management
The government has setup and executive board to look after the administrative work of the
banks. The business of banking has improved due to better management.
3. End of monopoly
There was complete control of few industrialists over the banking system. They used bank
assets and deposits of public for their personal interest. With the nationalization of banks
their monopoly come to an end
4. Benefit to employees
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 105
Before the nationalization the rights of employees were not protected. Employees rights are
protected by the nationalization of banks. They are promoted on merit basis nationalization
increased the job security and job satisfaction.
5. Control over expenses
Nationalization of banks has controlled non- development expenses to a large extent. The
useless expenses on entertainment and advertisement have been reduced which improved the
rate of profit for commercial banks
6. Increase in employment
Nationalization resulted in creation of jobs opportunities for talented and educated people in
the banks. As far as new branches are opened, hundreds of people got employment.
7. Rural bank branches
The nationalized banks have opened many branches in rural areas. It is due to the rural
branches that the idle funds are being used into the productive sectors.
8. Foreign bank branches
The performance of foreign bank branches has also increased; the employees are posted on
the merit basis. Number of branches has also increased to promote banking at international
level.
9. Increase in government income
Before nationalization the income of the bank was gone into the hands of their owners. Now
the income of the banks is transferred to the government treasury which can be used for the
common interest of the nation.
10. Increase in public confidence
Nationalization helped in increasing the public confidence. They do not feel hesitation in
depositing their savings in banks because they know that the banks are working under the
supervision of government.
11. Black money
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 106
Before the nationalization the corrupt officers and traders were used to keep their black
money in banks. But now the protection to black money is not possible because the
government can check the amounts of bank at any time.
12. Control over credit
Commercial bank can create credit, but unnecessary expansion of credit can create inflation.
Nationalization enables the state bank of Pakistan to control the activities of commercial
banks.
13. Economic development
Nationalization increased the resources of the government. The government was in a position
to start long term projects which leads towards the economic development.
14. Development of agricultural sector
Before the nationalization, considerable attention was not given to the agricultural sector.
However after nationalization special attention was given to the agricultural credit, which
helped in development of agricultural sector.
Disadvantages of nationalization
1. Lack of competition
Healthy competition is necessary for the development and promotion. Nationalized banks
were run by the state so less attention was given to effective policies and competition.
2. Corruption and bad debts
Nationalization resulted in high level of corruption by the top management. Credit was
generally misused and in some cases the amount of loan was not returned.
3. Favoritism
Nationalization has resulted in favoritism, incompetent and unqualified staff is appointed.
The favoritism has badly affected the performance of banks
4. Political pressure
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 107
After nationalization the political interference has increased in the bank management has
increased. Loans are granted on political pressure rather than on merit basis.
5. Low efficiency of employees
Nationalization transferred the bank officials into the government officials. There jobs were
fully secured which reduces the efficiency of employees.
6. Unfair distribution of credit
It was announced at the time of nationalization that the unfair distribution of credit should be
eliminated. But in actual, the big capitalist have obtained loan by using their powerful
resources.
7. Complex procedures
After nationalization the procedure of getting loan became complicated, due to which the
needy people and business community could not get loans and the country remained
underdeveloped in many sectors.

Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 108
Q #32
What are the causes of nationalization of banks in
Pakistan?
Causes of nationalization of banks
1. Credit control
Commercial bank can create credit, but unnecessary creation of credit can create problems.
State bank of Pakistan keeps an eye on the credit creation but it has an indirect link.
Commercial banks were creating credit for their personal benefit
2. Distribution of loan
Loans were advanced to the rich people and. The middle class and low class was greatly
ignored which created the class conflicts.
3. Discrimination of sectors
The commercial banks had been advancing most of the loan to the big importers and
exporters. It was ignoring small but important sectors of economy.
4. Loan to relatives
The high ranking bank officials used the bank reserves for their personal benefit. They issued
a large amount to their relatives and the major amount of loan was not returned.
5. Lack of uniformity in rules
There were no consistent and uniform service rules. The promotion and increments were
given on the personal liking and disliking and there was no job security
6. Misuse of credit
The commercial bank issued loans almost blindly. The loans issued were used for speculation
and black marketing.
7. Central bank control
Written by; Ahmed
BANKING
0334 5040190, 0313 5040191
Page # 109
There was ineffective control of state bank of Pakistan for providing loans. They did not care
for the rate of margin requirement and other policies of state bank of Pakistan.
8. Banking profit
Earning of high profit was the first propriety of every bank. Banks were not focusing on the
economic growth. The savings of the people were used for the personal interests of banks not
for the national interest.
9. Overseas branches
The performance of overseas branches was poor; most of them were even working at loss.
10. Wasteful competition
Banks were busy in wasteful competition. They were spending huge amount on the
advertisement and entertainment. There was rush of braches in trading centers but no
branches in rural areas.
11. Protection of black money
The private banks protected the black money; this resulted in the contraction of funds in few
hands. It was failed to check the unfair means of income, even the government was not
allowed to check the balance of such account. Tax collection was not possible on such
accounts.

Written by; Ahmed

BANKING
0334 5040190, 0313 5040191
Page # 110

Money Banking and Finance

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Money Banking and Finance

Uploaded by

Copyright:

Available Formats

MONEY BANKING & FINANCE

WHAT IS BARTER SYSTEM? WHAT ARE

INCONVENIENCES OF BARTER SYSTEM?

Inconveniences / difficulties/ hindrances /barriers / of barter system

Written by; Ahmed

0334 5040190, 0313 5040191

MONEY BANKING & FINANCE

) goods to other people because at the

0334 5040190, 0313 5040191

MONEY BANKING & FINANCE

) future expenses and revenues.

Imperial learning institute

Written by; Ahmed

0334 5040190, 0313 5040191

MONEY BANKING & FINANCE

Q#2: WHAT IS BARTER SYSTEM? HOW MONEY REMOVED

Removal of Inconveniences / difficulties/ hindrances /barriers / of barter

10. Lack of coincidence of wants

11. Lack of common measure of value

Written by; Ahmed

0334 5040190, 0313 5040191

MONEY BANKING & FINANCE

14. Difficulty in future payments (credit)

) goods to other people because at the

0334 5040190, 0313 5040191

MONEY BANKING & FINANCE

18. Difficulty in budgeting

) future expenses and revenues.

Imperial learning institute

Written by; Ahmed

0334 5040190, 0313 5040191

MONEY BANKING & FINANCE

Money has facilitated economy by providing the following functions

Written by; Ahmed

0334 5040190, 0313 5040191

MONEY BANKING & FINANCE

0334 5040190, 0313 5040191

MONEY BANKING & FINANCE

Imperial learning institute

Written by; Ahmed

0334 5040190, 0313 5040191

MONEY BANKING & FINANCE

0334 5040190, 0313 5040191

MONEY BANKING & FINANCE

Full bodied money

Full bodied money

a. Limited tender money

Written by; Ahmed

0334 5040190, 0313 5040191

MONEY BANKING & FINANCE

Dishonor of cheque may delay payments

Uneducated may not know the best use of cheque

Imperial learning institute

Written by; Ahmed

0334 5040190, 0313 5040191

MONEY BANKING & FINANCE

Q#5 what are the qualities of good money?

0334 5040190, 0313 5040191

MONEY BANKING & FINANCE

Written by; Ahmed

0334 5040190, 0313 5040191

MONEY BANKING & FINANCE

Q #6 what are the merits and demerits of paper money?

Advantages of paper money