Sources of Industrial Finance

Q.4. What are the various sources of industrial finances? OR
Write a short notes on Price Mechanism.
Sources of Industrial Finance
Industrial Finance may be required for short period or for long period. It may be raised by investment of proprietors as ownership funds or by borrowings. The various sources of finance may be broadly classified as under:
1. Ownership Funds
It includes owner’s investment as sole proprietor or partners of a firm. In companies it is raised by issue of shares, ploughing back of profits, depreciation policy, dividend policy, reorganization and price mechanism.
2. Borrowed Funds
There are external sources of business. It includes borrowings from relatives and other sources by sole owners and partners of business. In companies borrowed funds include debentures public deposits, banks, insurance companies and special financial institutions.
Ownership Funds
1. Shares
The share capital of a company is dividend into small units called shares. A person who buys a share is called the shareholder or member of the company.
The share capital forms a part of proprietary or ownership funds and used for financing the long-term requirements, the fixed capital and the fixed part of the regular working capital. It need not be repaid during the time of the company.
2. Ploughing Back of Profits
Like all individuals, companies also save a portion of their profits to be used to meet future needs. When the profits earned by a company, instead of being fully distributed to shareholders in the form of dividends, a portion is retained in the business as additional capital, it is known as ploughing back of profits.
Advantages of Ploughing Back Policy
(i). It improves the financial position of the company and frees it from the clutches of other financers.
(ii). This policy of self-financing enables the company to increase the profits by replacing its equipments. It can thus maintain a stable value of dividends in spite of the transfer of a portion of profits to reserve.
(iii). It also helps the company to earn more profits and pass on the benefits to the shareholders who can sell the shares at a premium.
Disadvantages of Ploughing Back Policy
The policy of ploughing back of profits must be implemented with cases. Otherwise, the company has to face the disadvantages of this policy.
(i). This may result in over capitalization, if the directors are over-zealous.
(ii). If the rate of divident is reduced due to this policy, the shareholders get disappointed.
(iii). The retained profits may not be used for the benefits for the company and diverted to some other companies.
(iv). The directors may manipulate the value of shares in the stock exchange. The declaration of low rate of dividend result in the fell of values of shares. The directors may buy the shares by taking advantage of low prices. Later, they may increase the rate of dividend and dispose of the shares in the market, when the prices rise.
3. Depreciation Policy
Depreciation is permanent decrease in the value of an asset through wear and tear in use or passage of time. It represents permanent fall in the market value of the asset. A good management policy, provides for adequate depreciation on its assets. Adequate depreciation charge is made with a view to recover through current earnings the original investment in the assets.
4. Dividend Policy
A good company always provides for all its liabilities before paying dividend to its shareholders. It is a part of a sound financial policy that company must try to establish a stable dividend rate. Frequent charges in the rates are likely to affect the values of shares on the stock exchange and effects the reputation of company in due course. For maintaining a stable dividend rate, the management is justified if does not pay dividends during the first few years in the case of new company which requires funds for development and financial stability.
The dividend may be paid in cash or by issue of bonus shares according to the availability of liquid assets and the extent of under capitalization existing in the company.
5. Reorganization
Reorganization of a company is done when it is in financial difficulties or when it is desired to like advantage of certain favourable conditions in the market. Reorganization may be internal or external.
Internal Reorganization: In internal reorganization the share capital is reorganized. A portion of capital is also cancelled to wipe out the capital losses.
External Reorganization: It takes place when a company goes into liquidation and a new company is formed with the value of assets and liabilities suitable adjusted.
6. Price Mechanism
The selling prices of the product is so fixed as to include a small fractional sum to sover the cost of future expansion. The additional sum so collected while realizing the sale proceeds of the product, is allowed to accumulate and is set aside for meeting the additional capital requirements. Under this method, the product becomes costly. This policy can be successfully employed only by a concern or which has monopoly in the matter of production and sale. If this policy is carried to its extremes and permanently to earn maximum profits, the concern may loose even in existing market.

Islamic Finance

Q.3. Define Modaraba. Discuss the various types of Modaraba. OR
Define Musharika. Discuss the various types of Musharika.
OR
What do you mean by Qarz-e-Hasana? Discuss in the light of Holy Quran and Hadith.
Introduction
Islam, being a complete religion, has prohibited “riba” or “interest”, in all forms and manifestations in the absence of any blueprint or a workable model of interest free economic system, utmost care with collected gradualness will have to be exercised to bring about a smooth switchover without disrupting the process of capital formation.
Basically, the task of Islamising the financial system revolves around, institutional arrangements, which, on the other hand, reconcile the freedom of the individual with the optimum use of total resources and on the other, do not conflict with the Islamic tenets of equity and fairness. It appears that financial system is based on principles of profit and loss sharing may meet these requirements. While this may cleanse the financial system from the evil of “riba”. Its total elimination will be possible only when the savers earn their income out of “halal” activity and the entrepreneurs do not cross the limits of “halal” business and “halal” profits. Again, an Islamic system would be as much in need of optimum capital formation as any other economic system, be it capitalist or socialist or mixed economy.
As an Islamic state, Pakistan has embarked on the task of building a socio-economic order based on the principles of equity and justice enshrined in the Islamic concept of “Al-Adl-Wal-Ahsan”. A beginning in this direction has been made by introducing Zakat and Ushr in the personal level and eliminating interest from financial transactions at the institutional level.
Modaraba
Modaraba is a form of contract a subscriber (Rabulmal) participates with his money and the manager (Modarib) with his efforts and skills, after setting aside the agreed share of Modarib the profits earned on investments are distributed among the subscribers.
In simple words Modaraba means a business in which a subscriber participates with his money and the manager, as “Modarib” participates with his efforts and skills and profits on investment made out of the Modaraba Funds are distributed among the subscribers. Thus, it is a concept of Islamic finance through which one partner or more participate with funds and another with his skill and efforts in some trade, business and industry permitted by Islam. They are who participates with his efforts assumes the role of manager, while the provider of funds becomes the beneficial owner. In modern terminology, a “modaraba” is akin to the concept of mutual finds minus its unIslamic features. The concept of mutual fund has gained widespread acceptance in the country as is evidenced by the success of N.I.T units and I.C.P Mutual Funds.
Characteristics of Modaraba
1. Under Modaraba Capital of one is combined with the labour of the other to earn something.
2. Both Muslim and non-Muslim can carry business under Modaraba.
3. A special contract is executed for a particular business under Modaraba.
4. A contract for Modaraba may also be verbal.
5. Islam has provided more safety and security to the invested capital in Modaraba as compared to the modern partnership business.
6. Distribution of profit is decided mutually by the subscriber (Rab-ul-Mal) and the manager (Mubarib) that what would be the principle for distributing the profit between themselves.
Types of Modaraba
Modaraba can be broadly classified into two types:
1. Multiple Modaraba
A Modaraba having more than one specific purpose or objective. A company for instance, may float a multipurpose modaraba e.g., for finding a transport service, operating an automobile factory or workship and providing services as packers.
2. Specific Purpose Modaraba
A Modaraba for a specific purpose such as getting up cement plant or building and selling houses, or commercial buildings or industrial structures etc.
For the purpose of regulating the floating and operations of modaraba, a law known as Modaraba Companies and Modaraba (Floatation and Control) Ordinance, 1980, has already been promulgated by the Federal Government.
Musharika
The word “Musharika” is derived from Arabic word “Shirakat” which means sharing or working together., enjoying equitable participatory and managerial rights and sharing all liabilities and accountability in the equitable proportions. It is a conscious cooperation between two or more persons arising out of free consent and in mutual interest to achieve pre-determined and mutually agreed goals towards which they must work collectively, contribute to collective effort in equitable proportions and share the results success or disaster, in proportions commensurate with their respective contributions to collective efforts, which may comprise of investment of capital, human efforts and skills in varying proportions.
Kinds of Musharika
There are following kinds of Musharika (Shirakat)
1. Shirakat Wajuh
A shirakat under which two or more persons be associated as partners, even without token participation in investment of capital and human effort, with a view to enhancing the public image of the enterprise because of their high standing in the market and/or in society, which could help the enterprise in completing preconditions for rapid take-off and in achieving vigorous expansion in sales.
2. Shirakatul Ainan
Under this all partners contribute to collective efforts in mutually agreed proportions and share the liabilities and accountability for operating results in proportions to their respective contributions. This is also the most common and most feasible form of partnership.
3. Shirakatul Abadan
Under this two or more persons may work towards achieving predetermined and mutually agreed business goals by pooling in their physical and/or mutual labour but without pooling in capital investment. It is obvious that such form of shirakat is feasible only for such business operations whose capital intensity is nil or virtually zero. It is also known shirakatul sinnaia. Under this share of profit may be equal or unequal as agreed among the shariks.
4. Shirakatul Mufawaza
It is a partnership entrancing all monetary resources of the parties to the contract. In equal numbers and involving mutual agency and surety ship on the part of the partners. All partners are jointly and severely liable for the debts of the firm and each partner acts as the agent of the firm, which is also the spirit of the existing Partnership Act. In the contract of shirakatul Mufawaizat only Muslim can participate with other Muslim shariks only and not otherwise.
5. Shirakatul Mazural
It is share cropping, under which land belonging to one person is tilled by another and the produce is shared.
6. Shirakatul Milk
It is the kind of co-ownership due to joint possession of property acquired through inheritance.
Musharika in Banking
Musharika provide working capital funds for industrial and commercial enterprise. Working capital funds are invested in trade, agriculture, purchase of raw material, etc. In case of “Musharika” relationship between banks and customer is of participants and not of creditor and debtor.
Qarz-e-Hasana
Whenever, a man needs money for consumptional purposes, which he hopes to be able to repay at some future time, Islam enjoins that the money should be provided by his more fortunate, neighbour, friends or acquaintances without any interest leaving the debtor to return the money at his convenience. This type of credit is called the worthy credit “qarz-e-hasana” in Islamic terminology.
Qarz-e-hasana has been described in Holy Quran:
If the debtor is suffering from poverty, he must be relaxed to pay Sadaqah or charity, it is very much desirable by Allah.
As mentioned above, Qarz-e-hasana is not given for a specified period, therefore, it is not demanded by the creditor to refund, instead, the debtor is allowed to return the money as he becomes capable of doing this. Holy Quran warns the debtor that as soon as he becomes capable to return the loan, he must refund it to the creditor otherwise he will commit a great sin.
In accordance with a Hadith of Prophet Muhammad (PBUH):
Despite the acquisition of capability of capability to pay Qarz-e-Hasana delaying the payment of the right or receipt is a great sin.
Islam appreciates extension of Qarz-e-hasana and it is declared as ”Loan to Allah” because Allah is the only authority to reward this goodness and the reward given by Allah is the biggest of all rewards given in this world.

Working Capital

Q.2. What do you mean by working capital. State its importance in business? Introduction
Adequacy of working capital rises the credit standing of the concern. Such a concern can buy goods on better terms and reduce the cost of production on account of receipt of cash discounts.
A concern is sure to fail, if there is no adequate supply of materials or cash. Nowadays production is carried on in anticipation of demand. There is a time between the point of supply of raw material and the ultimate realization of the sale proceeds of finished products. A large amount of working capital is required to keep the business moving continuously. Many new businesses are floated very well in the beginning but are unable to run properly usually because of inadequacy of working capital.
Kinds of Working Capital
Working capital a short term finance is of two types:
1. Initial Working Capital
It is the amount required to meet all current expenses the early development of business. This period may vary in different types of business according to their nature.
2. Regular Working Capital
It is the amount required after the business has been established as a going concern. The regular capital consists of two parts
(a) Fixed
(b) Variable
(a). Fixed Working Capital is the minimum amount of working capital required to carry on normal business operations. Every business has to maintain a minimum inventory of raw materials work in process, finished goods, etc. It always requires short term finance for making certain regular payments such as purchases, salaries, wages and rent etc.
(b). Variable Working Capital part of working capital is also known as seasonal or special working capital. It is the additional amount required during busy seasons on emergencies or under certain abnormal conditions such as in cases of rising prices, strikes and lock-out etc.
Factors Governing Short-Term Or Working Capital
1. Nature of Business
It is an important feature of determining the amount of working capital. Trading concerns requires large amount of working capital since their investment in current assets such as bills and book debts, etc., is more than that in fixed assets. Manufacturing units engaged in producing producer’s goods require lesser proportion of working capital. Public utilities like transport, electricity corporations, etc., need relatively little amount of working capital.
2. Size of Business
Small size business needs relatively large amount of working capital than a larger business.
3. Conversion of Working Capital
The speed with which working capital changes its form also affects the amount of working capital needed. If cash is converted into inventory into bills and books debts and bills into cash within a short time, the business can be managed with a small amount of working capital.
4. Turnover
Where there is a rapid turnover, it is possible to carry on business with comparatively limited amount of working capital.
5. Terms of Trade
A concern which makes purchases in on credit and sells for cash only, requires a smaller amount of working capital.
6. Cash Flow
When inflow of cash is greater than its outflow, a smaller amount of working capital is required.
7. Seasonal Variations
If the demand and/or supply are seasonal and widely fluctuate, more working capital is needed.
8. Absence of Coordination
The absence of coordination in the policies of production and distribution of goods may result in higher demand for working capital.
9. Transport Facilities
If means of transport facilities and communication available are not adequate and satisfactory the business concern is faced to maintain a large amount of stock of goods. This needs higher amount of working capital

Business Finance

Q.1. Discuss the principles of financing. OR
State the importance and sources of short-term finance.
Introduction
Finance is required for business for the purpose of production and distribution of goods and services. No business, big or small can be run without finance. It is the life blood of business organizations. Money is needed to start the business. It is required to keep the business going and to expand the business. For production of goods and services we need material, machines, space, energy and technical know-how. For all these things we require finance. Finance is also needed for getting the goods from producer to consumer. The wholesaler and retailers need money for buying goods from different sources. Even consumer wants money to meet his requirements.
In modern large scale business with complex methods of production and distribution finance is used for various purposes. It is necessary for buying fixed assets such as, building, machinery, raw materials, labour and other expenses to convert the raw material into finished goods. It is also needed for meeting the other business operating expenses.
Finance may be defined as the provision of money at time it is needed. By business finance we mean finance needed by the business in different situations.
According to George Terry “Finance consists of providing and utilizing the money, capital rights, credit and funds of any kind which are employed in the operation of an enterprise.” So business finance means investing borrowing and spending of money in proper manner for the operation of business. Importance of finance cannot be ignored for the success of business. No business can run smoothly without the finance. There is always a need of sufficient amount of capital to achieve the desired results from the business operation.
In olden days not much finance was needed owing to the limited and simple nature of production and distribution of goods. Today the modern business operation became more complex due to specialization, division of labour and mechanization to produce goods at large scale. Goods are now produced in anticipation of demand. This has increased the importance of finance in the modern business.
Principals of Financing
Generally, business finance is obtained by two means. Firstly, the owner of business himself introduces capital to form a business, Secondly, finance is obtained through borrowing from the people outside the organisation who provide finance on the basis of the principals of safety, profitability and liquidity. These principals are described below:
1. Principal of Profitability
An investor must employ funds in useful and profitable channels. He must think many times that money invested in a business should not become bad or uncollectable. He should not lend to a borrower with whom remuneration may be much, but also equally risky. On the other hand lender should prefer a borrower who is offering a higher rate of interest or profit on comparatively lesser risk.
2. Principal of Safety
The money which will be employed must be secured. Therefore, an investor must be very careful and ensure that his money is in safe hands where the risk of losses does not exist. He must ensure that the borrower is a person of character and will repay the money borrowed, including the profit or interest thereon. He must also see the capacity of borrower to repay the money borrowed. He must also consider whether amount invested for is reasonable in relation to the borrower’s own investment.
3. Principle of Easy Recovery
An investor must consider the possibility of easy recovery of funds invested in a business. He always invest money where he is assured of the immediate recovery. Investment in company shares and loans from banks and financial institutions are the examples of investment on the basis of this principle.
Types of Finance
On the basis of the purpose for which capital is required, finance may be classified into long term finance and short term finance.
Long Term Finance
The long term finance refers to the amount required for acquiring fixed assets like machinery, land, building, furniture and equipments etc. These assets remain in use for a long period and to acquire these long term finance is needed which is sunk in the business permanently or for a long term and is not available for immediate conversion into cash.
The amount of long term capital required by a concern depends on the nature and size of the business. Long term finance is utilized for establishing a new business or for expanding an existing business and to replace the old fixed assets by new assets or to acquire the benefits of new inventions, methods and technologies. Long term capital is invested for ten or more years.
Short Term Finance
It is required for day to day working of the business. It is required for the purchase of raw materials and for the payment of manufacturing, establishment, selling and distribution expenses. It is also required for holding convertible assets like stock of merchandise, receivables, and cash etc. In the course of business these assets are used again and again for the earning of profit. The finance required for this purpose is invested for a shorter period is known as short term finance or working capital. It represents the total investment in current assets such as cash, stock, receivables etc., minus current liabilities.
Medium Term Finance
Some economists give another classification if finance as “Medium Term Finance”. According to them finance required for the duration range from one year to ten years may be termed as Medium Term Finance.
Sources of Long Term Finance
The Long Term Finance must be basically provided by the owners of the concern since it is the amount which is permanently sunk in the business. To acquire fixed assets of the business long term finance can be divided into two parts:
1. Corporate Financing
In a company, the long term finance is raised by issue of shares. Additional fixed capital required when the business expands, is raised by means of long-term borrowings, such as the issuance of debenture, floatation of mudarba, accepting public deposits, borrowing from bank and other financial institutions and ploughing back of profits.
2. Non-Corporate Financing
This financing refers to the sole proprietorship and partnership, etc. In sole proprietorship business, long term finance is provided by the sole trader himself. In and partners may also acquire long term loan from their friends and relatives.
Sources of Short Term Finance
Such finance is required for acquiring the current assets of business and meeting the operating expenses of business. A business concern must have sufficient funds to carry on its current operations. The sources from which short term finance or working capital is derived are of utmost importance. For short term business needs are financed either out of internal sources or external borrowings. The extent to which external sources can be relied upon depends on various factors such as stability of the profit of the concern, its goodwill and credit standing in the market, the amount of cash readily available at any time, etc. Following are the main sources of short term capital.
Internal Sources
The initial working capital or short term capital is financed by the proprietorship of the business concern. Emergency requirements must be financed from internal sources, i.e., by utilization of the reserve funds built up by the concern.
External Sources
1. Trade Credit
It is a common practice of business community that they allow credit facilities to each other on open account for shorter periods ranging from 10 days to 90 days. In accounting it terms “trade creditors” or “accounts receivables” indicate sellers and buyers respectively.
Trade credit help in maintaining the flow of business smoothly. The manufacturer buys raw materials and many services on credit terms and sells the finished goods to wholesalers on credit. The wholesaler sells the merchandise to retailers on open account and the retailers to the same for their customers i.e., the consumers.
2. Commercial Banks
Commercial Banks offer short-term loans and advances to business concern during busy seasons. Banks also provide credit facilities by discounting Bill of exchange and granting overdraft.
3. Commercial Credit House
The concerns allow short term loans or credit on the basis of pledge or martgage or property of needy business concerns.
4. Public Deposits
Sometimes companies arrange short term finance by inviting public to deposit their savings with them. They usually offer a rate of interest higher than the bank rate.
5. Private Loans
Generally to meet emergency requirements sole proprietors and partnerships obtain short term finance from their friends and relatives.
6. Financial Institutions
In certain situations financial corporations and development banks also provide short term credit or loans to industrial and commercial concerns Agricultural Development Bank, Industrial Development Bank, Small Industries Corporations are the examples of such financial institutions.
7. Loan by Partners
Partnership firms may obtain loans from their partners to meet the short term needs.
8. Loans from Directors
Some companies have provisions for obtaining loans from directors for short term financial requirements.
9. Government Loans
In some special situations government also provide short term loans to traders. In some cases only certain types of small business concerns, unable to secure the needed loans through private channels are provided financial help by the government.

Banking in Pakistan

Q.4. What do you know about the development of banking in Pakistan. Introduction
Pakistan came into being as a state of Muslims in the Sub-Continent on 14th August, 1947. Pakistani banks follow the British pattern of banking system (Branch Banking). Before independence, there were 44 banks having 631 branches in the areas of Pakistan including east Pakistan (Now Bangladesh) and only 487 offices in the territories now comprising Pakistan.
At the time Pakistan was producing food grains and other agricultural raw material exports. There were particularly no important industries and agricultural produces were mostly being exported. However commercial banking facilities were provided fairly well here. But shortly after independence, the number of banks and their branches as the Hindu bankers migrated to India from Pakistan. In addition majority of Hindus residing in the territories now constitute Pakistan started transfering their assets to India. By 30th June, 1948, the number of offices of scheduled banks in Pakistan declined from 487 to only 195. Then this country faced a great banking crices.
There were 19 non-Indian foreign banks with the status of small branch offices which were engaged financing of exports of Pakistani crops. There were only two Pakistani banks i.e., Habib Bank which transfered its office from Bombay to Karachi and The Australasia Bank which was in existance in the Pakistani territory. There was a panic of uncertain economic future which shook the confidence of the people. The Government, therefore, promulgated the Banking Companies Ordinance, 1947, to safeguard the interest of both the bankers and the public.
Under the prevailing critical situation at that time the Father of Nation Hazrat Quaid-e-Azam Muhammad Ali Jinnah and his fellows in the Government felt much the need of sound was taken and the State Bank of Pakistan was established on 1st July, 1948.
After the opening the State Bank of Pakistan took initiative for the development of banking system. Many new commercial banks were established and they increased the number of their branches day by day. For the growth and development of agricultural and industrial sector specialized banks and other financial institutions were also setup and now the network of bank branches covers a very large segment of national economy. By June 1988 the number of bank branch office has increased to more than 7100 which are spreaded over in every nook and corner of Pakistan.
Nationalization of Banks
The Government of Pakistan nationalized all the Pakistani banks on June, 1974. The ownership, management and control of these banks stood transfered to and vasted in the Federal Government. The shareholders were compensated by 15 years Federal Government bonds.
By December 31, 1973, there were 14 scheduled Pakistani commercial banks with 3323 offices all over the country and 74 offices in foreign countries. Inspite of this tremendous growth and development of commercial banks and their prominent role of financing in the country’s economy, it was felt that these banks failed to ensure that the resources flow in those sectors of economy where they would produces goods and services needed badly by a very large number of people in Pakistan. Therefore the nationalization of banks was considered necessary. On January 01, 1974, Pakistani Banks were nationalized under the bank (Nationalization) Act, 1974, with following objectives.
1. To provide the fair distribution of credit. All the sector of economy will enjoy the credit facility.
2. The encourage and stimulate the effective nationalization of savings in the country.
3. To provide social justice in the country by proper allocation of credit and financial resources to different classes of the society.
4. To enable the Government to use the capital concentrated in the hands of a few rich bankers for the repaid economic development of the country and the more urgent social welfare projects.
5. To co-ordinate the banking policy in various areas of feasible joint activity without eliminating healthy competition among banks.
According to section 5 of this Act the State Bank of Pakistan; Industrial Development Bank of Pakistan, The Punjab Provincial Cooperative Bank and all commercial banks incorporated in Pakistan and carrying banking business in Pakistan or abroad have been nationalized and the number was brought down to five.
Banking Council
For coordinating the planning and operations of banks and monitoring the cost of operation the Pakistan Banking Council was set up under section 9 of the Bank (Nationalization) Act 1974.
The nationalized banks made good progress in expending the banking services in the nooks and corners of Pakistan despite very low level of domestic savings and heavy dependence on foreign borrowings. The number of branches which stood at 3397 on December 31, 1973, reached about more than 7,000 by June, 1988. Similarly, the bank deposits which stood at 1925 crores of 1973 reached the high mark of Rs. 23,867 crores by June, 1988.
Organization of Pakistani Banking
Pakistani banking system was expended remarkably and it can be compared with banking system of any developing country of the world. At present the banking structure in Pakistan comprises of the following:
1. Central Banking
State Bank of Pakistan is the central bank of the country with its offices at Karachi, Hyderabad and Sukkur in Sindh; Rawalpindi, Lahore, Faisalabad, Gujranwala, Sialkot and Multan in Punjab; Peshawar in N.W.F.P and Quetta in Balochistan. Central Office is located in Islamabad.
2. Commercial Banking
Commercial banks have been the most effective mobilizors of savings and have been providing short term requirements of working capital to trade, commerce and industry. After nationalization commercial banks have been providing short term finance to agricultural sector also.
After the nationalization in 1974 all the 14 commercial banks were reorganized and merged into the following five banks:

• National Bank of Pakistan
• Habib Bank Limited
• United Bank Limited
• Muslim Commercial Bank Limited
• Allied Bank of Pakistan Limited

The other banks were merged in these banks. Bank of Bahawalpur was merged with the National Bank of Pakistan; Habib Bank (Overseas) Limited, and Standard Bank Limited were merged with Habib Bank Limited; Premier Bank Limited with Muslim Commercial Bank Limited; Commerce Bank Limited with United Bank Limited and Sarhad Bank Limited and Pak Bank Limited with Australasia Bank Limited and renamed as the Allied Bank of Pakistan Limited.
3. Exchange Bank
Foreign bank generally have been engaged in financing the foreign trade but they are fully authorised to discharge normal banking functions including the acceptance of deposits from public. At present there are eighteen foreign banks with 64 branches. They are located in Karachi and other commercial cities of Pakistan. The State Bank of Pakistan does not allow them to open branches in small towns in the interior of the country.
4. Savings Banks
Post Office Savings Bank is the only Saving Bank in the country. It is controlled by the Government of Pakistan. It accepts deposits from public and invest them in various Government projects.
5. Co-operative Banks
Generally there are three systems of cooperative banking in Pakistan. They consist of primary cooperative societies at the base; Central Cooperative Banks and Banking Unions in the middle and Provincial Cooperative Banks at the top. There are four Provincial Cooperative Banks, one each in Punjab, Sindh, N.W.F.P and Balochistan; 52 central cooperative banks and Banking Unions and above 28,000 primary Agricultural and credit societies.
These cooperative banks are integrated taking a very active part in the promotion of thirft, self help and mutual aid among agriculturalists and others with common economic needs as as to bring about better living, business and production.
6. Specialized Financing Institutions
These institutions are Government sponsored corporations. The main objective of these institutions is to stimulate the development of country’s economy by providing capital resources and technical advice to industrial and commercial and agricultural sectors. They provide long term and medium term credit to these sectors.

Bill of Exchange

Q.3. Discuss the different types of bill. Definition and Salient Features
According to Negotiable Instrument Act a Bill of Exchange is “An instrument in writing containing an unconditional order, signed by the maker directing a certain person to pay on demand or at a fixed or determinable future time, a certain sum of money only to, or to the order of a certain person or to the bearer of the instrument.

Thus we find the following important features of a bill of exchange:
1. The order to pay a bill must be unconditional one.
2. The order to pay must be made in writing on the bill.
3. The bill must be signed by the drawer of the bill. Without signature of the drawer the bill will not be genuine one.
4. The order to pay under a bill must be addressed to a certain person which, of course, includes ndividuals, firm, company, corporation etc.
5. The amount to be paid under a bill must be certain one.
6. The money under a bill must be paid in legal tender currency.
7. The amount should be payable to or to the order of a specified person or to the bearer of the instrument.
8. The amount should be payable either on demand or at a fixed determinable future time.
9. The bill must be duly stamped.
10. The other formalities like dating, stating the names of the parties concerned etc. must be observed.
Parties to a Bill of Exchange
Following are the various parties related to a bill transaction
a. The Drawer
The person who draws the bill and puts his signature on it is known as the drawer of the bill. He is also called the “maker” of the bill.
b. The Drawee
The person on whom the bill is drawn is called as the drawee of the bill.
c. The Acceptor
The person who accepts the bill is known as the acceptor of the bill. Usually, the drawee accepts the bill. But sometimes, a third party may also accept a bill on behalf of the drawee. The acceptor puts down his signature across the bill showing his acceptance.
d. The Payee
The person to whom the amount of bill is to be paid is known as payee of the bill. The drawer may make the bill payable to himself or to any other person he likes.
e. The Endorsee
The holder of the bill may endorse the bill in favour of someone else known as endorsee. The person who endorses the bill is called endorser.
f. The Holder
The person who holds the bill and is entitled to realise the amount of the bill from the drawee is known as holder of the bill.
Types of Bills
Bills may be of the following types:
a. Inland Bills
Inland bill means the bill which is drawn and payable within the same country. Thus, the bill which is drawn in Pakistan and will also be paid in Pakistan is termed as an inland bill.
b. Foreign Bill
The bill which is drawn in one country and accepted and payable in another country is known as a foreign bill.
c. Accommodation Bill
The bill which is drawn and accepted by the parties concerned for their mutual accommodation with a view to raise money by negotiating it, is known as an accommodation bill. The parties concerned bind themselves as the drawer and the acceptor without any valuable consideration.
d. Demand Bill
The bill which is payable “on demand” or “on presentation” or “at sight” is known as demand bill.
e. Time Bill
The bill which is payable at a fixed or a determinable future time is known as time bill. The time bill may further be classified as following:
After Date Bill
The bill whose tenure is counted from the date of drawing it is known as after date bill.
Sight Bill
The bill whose date of payment is counted from the date of acceptance is known as after sight bill.
f. Documentary Bill
When a bill is accompanied by shipping documents like, Bill of Lading, Invoice, Insurance Policy relating to goods against which the bill is drawn, is then known as a documentary bill.
g. Sent Bill Or Bills for Collection
When bills are handed over to a bander by his customer in order that they may be collected when due and the proceeds credited to the customer’s account. They are called as Bills for Collection.
h. Bills Negotiated
The bills for which the banker has given the value at once, without waiting for the proceeds after collection.
i. Bills in Set
When bills of exchange are drawn in two or more parts, they are called “bills in set”. The foreign bills are generally drawn in sets of two or three. The each of the set is on a seperate piece of paper, but all parts are worded exactly in the same language except that the parts are numbered as “The 1st of exchange”, “2nd of exchange” etc.
j. Bills Retired
When a bill is withdrawn from circulation or taken back before it is due, it is known as “retired bill”.
Discounting of Bills
A time bill is payable on future date and the holder of the bill is to wait for a specific period of time to receive the amount of the bill. But the modern commercial banks are providing the facilitates of discounting of bill to the holder to have money earlier. For discounting of bill, the bank purchases the bill from the holder at a reduced rate before maturing of the bill and receives the amount of the bill from the acceptor on due date. The reduction in the value of bill at the time of purchase by bank is known as “discount” and it is charged on the basis of interest rate. Thus, discounting of bill is a sort of short term credit given to the holder of the bill by a banker and the discount forms the profit to him.
Discounting of bill very useful from the point of view of traders and bankers. It benefits the importer, exporter and bankers equally. The exporter or seller can get immidiate cash as soon as he handed over the goods to the transporters. The importer or buyer gets enough time to sell the goods after having received it. The bankers earn a lot by effecting these transactions.
Precautions in Discounting a Bill of Exchange
Like advancing other loans and credit, discounting of bills also is a very risky job on the part of the banker. He must be careful and cautious with discounting the bill of exchange and must take the following precautions are measures in discounting of bills:
1. He should examine financial standing of the holder and acceptor of the bill. If the parties concerned have bank accounts with him, the banker can easily learn their financial stability. If there is no such account with him, the banker should refer to the bank where they have got account to know their financial position.
2. The banker is also to examine the financial status of other parties engaged in the bill.
3. The banker should see whether the acceptor dishonoured any other bill in past time.
4. Th banker should satisfy himself whether the bill is a bonafied trade bill which is accepted for value received in course of business. The banker should, as for as possible, avoid the accommodation bills.
5. The banker should examine the bill whether all the formalities as of date, stamp, signature etc, have been compiled with.
6. He must see whether the bill is capable of being endorsed. If so, the banker should see whether the bill is duly endorsed by the payee.
Presentation of Bills
Bill has to be presented first of all before the drawee for acceptance and again in due date it is to be presented before the acceptor for the payment. Thus, presentation of bill may be of two types viz,
1. Presentation for Acceptance
2. Presentation for Payment
1. Presentation for Acceptance
Presentation for acceptance is made not only for the acceptance of the bill but also to fix-up the time, place etc., for the payment. In case of time bill, where the tenure of the bill is clearly stated, the bill is presented for acceptance of the drawee to confirm the stipulated time for payment.
A bill should be presented for acceptance within a reasonable tenure after the drawing or negotiation of the bill.
2. Presentation for Payment
If refers to presentation of a bill before the draw or acceptor or before the agent of the drawee or acceptor for the payment of the bill on due date. The presentation for payment is subject to the following rules:

• In case of “demand bill”, the bill must be presented within a seasonable time after its drawing or endorsement as the case may be,
• In case of time bill, the bill should be presented for payment on the due date.
• The bill should be presented for payment during the business hours of working days.
• The bill should be presented for payment at the proper place. The term proper place may refer to any one of the following

(i) The place mentioned in the bill for payment.
(ii) Where no specific place is mentioned in the bill, the address of the drawee or acceptor.
(iii) Where no address is given, of any place where the drawee or acceptor can be found including his residence.

Central Banking

Q.2. Define Central Bank. State the origin and growth of central bank. OR
What is credit control, explain the various methods of credit control followed by the central bank of a country?

Definition of Central Bank
In every country, there is a principal bank who is responsible for guidance and regulation of the financial system in the country. Such type of bank is known as Central Bank.
A Central Bank may be defined as
The principle banking institution of a country operating under some degree of state control and entrusted with the special responsibility of maintaining economic equilibrium and stability in the prices and in the over all interest of the country.
Nature of Central Bank
From the above definition we find the following main features of Central Bank:
1. The Central Bank is the principle banking institution of a country.
2. It is operated under some degree of state control. But in practice, the structure of central banks vary from country to country. In U.K. and France, the bank of England and Bank of France are solely owned, managed controlled by the state on the other hand, Federal Reserve System, the Central Bank of the U.S.A is owned, managed and controlled by the private share holders. Of course, there are some central banks which are owned, managed and controlled jointly by the Government and the private share holders. e.g., State Bank of Pakistan before nationalisation 1974.
3. The Central Bank is entrusted with the responsibility of maintaining economic equilibrium and stability in prices by controlling money supply and volume of credit with in the country.
4. A central bank does its works not for making profit but in the overall interest of the country.
5. The central bank is reservoir of credit. All other banks can look to it for accomodation.
Functions of Central Bank
The central bank is the pivote of all the banking system. The chief functions of a central bank may be described as follows:
1. Issuing Notes
The central bank has the sole responsibility and monopoly of issuing notes within the country. It is the sole currency authority. The central bank is required to keep a certain percentage of gold reserves against issue of notes. Usually, it keeps 30% to 40% gold as reserve. It undertakes expansion and contraction of the currency alongwith business demand. Money supply is raised by issuing notes. On the other hand, it can decrease money supply by selling government securities. By enjoining monopoly of note issue it gives uniformity to the system of note issue in the country.
2. Governments Banker
The central bank acts as a financer of the government of the government. It is a government banker not only collecting and paying money on behalf of the government but it also manages the public debts. It keeps the government funds in the custody free of interest. On the other hand it gives loans to the government without limitation of amount. It is the fiscal agent of the government. It helps the government in designing a fiscal policy for the country so its also plays the role of financial adviser to the government.
3. Banker’s Bank
It acts as the custodian of cash reserves or balances deposited compulsorily by the scheduled banks. Either by law or custom the member banks are to keep certain portion of their deposits with the central bank as reserve. For example in our country the scheduled or commercial banks are to keep cash reserve with State Bank of Pakistan to the extent of 5% of their deposits. Central Bank also provides short term credit to commercial banks by rediscounting first class bills and other securities. So it plays the role of banker’s bank.
4. Management of Gold Standard
Where the currency of a country is on gold standard, it is the responsibility of the central bank to manage the gold standard in order to control the stability of exchange rate. It regulates and checks the movement of gold in the country. The management of gold standard is not so vital and important these days.
5. Credit Control
It is another important function of central bank. It controls the flow of credit in accordance with the needs of business in the country. Credit plays an important role as the medium of exchange, so its expansion or contractors effects the price level in the country. In order to maintain stability in the price level, central bank controls the volume of credit. Usually, it controls credit by changing bank rate, purchasing and selling securities and by changing reserve rates of the member banks. In this way central bank attempts to control the volume of credit and stablishes the business conditions in the country.
6. Clearing House
It is the Clearing House of the bankers. Under this function central bank of facilitates the settlement of bills and cheques of other banks.
7. Exchange Control
It is the responsibility of the central bank of control foreign exchange and maintain the rate of exchange. It purchases and sells approved foreign currencies at the current or fixed rate. It also acts as the custodian of foreign exchange reserve.
8. Lender of Last Resort
As lender of last resort, it is implicit that the central bank assumes the responsibility of meeting directly or indirectly all reasonable demands for accommodation by commercial banks in the times of difficulties and crises. If any commercial bank faces any serious financial difficulty for any reason, it is central bank who comes forward to help it.
9. Custodian of National Reserve
The Central Bank acts as the trustee of the entire economy of the country and thus keeps in its custody all national reserves in form of gold, silver and securities.
Credit Control
Credit plays an important role in maintaining and changing the price level as medium of exchange. It is the responsibility of the central bank to regulate the volume of credit and its direction to maintain stability in the price level.
Following are the main objectives of credit control by central bank
1. Safe Guarding the Gold Reserves
The central bank adopts various measures of credit control to safe guard the gold reserves against internal and external drains.
2. Stability in Price Level
Credit control provides stability in price level in the country.
3. Exchange Stability
Another objective of credit control is to achieve the stability of foreign exchange rate. If the foreign exchange rate is stabilized, it indicates the stable economic conditions of the country.
4. Stability in Investment and Production
Control of credit by central bank also provides stability in the investments and production by making price level stable.
’5. Cooperation
Control of credit is done to promote cooperation with other countries for the purpose of maintaining world economic stability.
Methods Or Techniques of Credit Control
The central bank usually controls the volume of credit through the two types of methods, quantilative and quantitative.
1. Bank Rate Policy
It is also known Discount Rate Policy. Bank rate is the rate of interest which is charged by the central bank on rediscounting the first class bills of exchange and advancing loans against approved securities. This facility is provided to other banks.
Importance
The bank rate is different than the money market interest rate. The charges in bank rate are followed by other banks in the country in changing their interest rate. If the bank rate is raised by central bank, other rates of money also go up. Conversely, the market rate of interest and other rates go down, when central bank decreases its bank rate. These changes effect the supply of and demand for money. Borrowing is discouraged when the rate of interest increases and encouraged when the rate decreases.
Effects of Changes in Bank Rate
The changes in the bank rate may cause the following effects.
a. Changes in Deposit Volume
When the central bank increases the bank rate, commercial banks also increase the rate of interest and consequently the deposits of the banks also increase. Conversely, when bank rate is decreased the deposits of commercial bank also decrease.
b. Controls the Borrowings
When the bank rate is raised, the rate of interest and discount of other banks goes up margin of profit falls and it discourages the businessmen to borrow money and thus the volume of loans and discounting of bills is minimised. On the other hand a fall in the bank rate encourages loans and bill discounting.
c. Changes in the Prices of Shares and Securities
A rise in bank rate makes shares and securities in the market cheaper and conversely, by a fall in the bank rate, shares and securities becomes dearer.
d. Changes in the Volume of Speculative Business
A rise in the bank rate restricts the volume of credit and discourages speculative business. But the volume of speculative business is expended due to the increase in the credit supply.
e. Changes in the Foreign Trade
A rise in the bank rate encourages export and discourages import. A fall in the bank rate encourages import and discourages export. When the bank rate is raised, the demand for home currency goes up and the demand for home currency falls with in the bank rate.
f. Changes in Balance of Payment
Due to rise in the export trade, a rise in bank rate causes a favourable balance of payment. But a fall in bank rate causes an unfavourable balance of payment.
2. Open Market Operation
The open market operation means the buying and selling of securities by the central bank in order to influence the money and credit supply in the country. This technique is effective upto some extent in both conditions of inflation and deflation.
3. Change in Reserve Ration
The member banks of central bank are required either by law or custom to keep a certain percentage of their deposits with the central bank. It is called as Cash Reserve Ratio. The central bank may controls credit by changing the reserve ratio. When the reserve ratio is increased the member banks to some extent are discouraged to bank money. When this ratio is falls, the member banks are encouraged to expend credit.
Clearing House
The central bank manages and supervises the clearing house to facilitate the clearing of cheques between banks. Every banker usually receives number of cheques drawn on other banks from his customers as deposits. In other words banks receives cheques drawn on other banks from their account holders. As a result, there arises inter bank indebtedness. For example National Bank of Pakistan receives deposit of cheques worth Rs. 6,000/= drawn on Habib Bank Limited, Habib Bank on the other hand, receives cheques worth Rs. 5,000/= drawn on National Bank of Pakistan. Thus National Bank owes Rs. 5,000/= to Habib Bank and Habib Bank owes Rs. 6,000/= to National Bank.
Inter bank indebtednesses are settle through a central organisation known as Clearing House. “A clearing house is a general organisation of banks of a given place, having for its main purpose, the off setting of cross obligations in the form of cheques. The indebtednesses of the member banks are settled only by paying the differences. Generally central bank of the country performs the function of clearing house. In Pakistan, State Bank of Pakistan performs the duty of clearing house.
Role of Central Bank in Economic Development
The economic stability of a country is solely dependent on the Central Bank. It is the only financial institution in the country which is responsible for regulating the banking and monetary system of the country. The need of a central bank in a country is essentially felt considering the following services rendered by a central bank for economic development of a developing country.
1. Capital Formation
Economic progress of a country requires adequate amount of capital. Capital is required for agriculture, industrial and commercial development. But in a developing country like Pakistan. It is a chronic problem to procure capital. Central Bank as a national institution plays prime role in capital formation in the interest of the nation as a whole. As the guardian of the money market, it regulates the capital flow in the country in proper form and suitable time.
2. Credit Control
Credit is one of the most important source of financing trade and industry. The central bank as the controller of credit can encourage a particular sector of economy by adopting selective credit control.
3. Developing Banking System
As a guardian of all banks, the central bank works for the development of banking system of the country.
4. Protecting Interest of the Depositors
The central bank protects the interest of the depositors in banks by guiding, controlling and checking the member banks operations in the country.
5. Stability in Prices
The central bank keeps the price level stable in a country by controlling money and credit supply.
6. Advice to the Government
The Central Bank extends valuable suggestions and advices to the Government in respect of economic and monetary policies.
7. Personnel Training
The central bank in some countries provides training facilities to the bank personnel.