1.

USES OF BANK FUNDS

1. Non – profitable uses 2. Profitable uses

a) Dead stock b. Cash a. Loans b. Investment

Reserve

→ Cash reserve with the central → Money at call → Govt. → Treasure

Bank & short Notice securities Bill

→ Cash Reserve with the Bank → Advances to → Provisional → Treasure

customer & local Govt. Notes
Bond

→ Discounting → Foreign → Treasure

Bill of Exchange govt. Bond Bond

→ Cash credit → Other

securities

→ Over draft → Cooperate

securities

There are two methods for the investment of bank funds namely:

1. Non-Profitable ways.

2. Profitable ways.

1. Non-Profitable ways:

The uses which do not give any yield to bankers are known as Non-Profitable uses. However, this method helps
the bank in earning profits indirectly.

The Non-Profitable ways include:

a. Purchase of Assets b. Cash Reserve

a. Purchase Of Assets:

Dead stock (Purchase of Assets) includes the investments made by the banks on bank premises, furniture and
fixture etc. These items are very necessary to conduct the banking business. The building must be capable of
high accommodation and impressive, because it serves a means of advertisement. It is said that an impressive
appearance attracts good customer. But in spite of all these significances, the bank should not use too much of
its money on these things, because cash at hand is always preferable. Dead stock cannot be disposed off
whenever desired, because it is not easily marketable and further, the sale of these brings the bank into
disrepute.

b. Cash Reserve:

Cash reserves include two reserves:

1. Cash reserves with the Central Bank.

2. Cash reserves within the Bank.

i. Cash Reserves with the Central Banks:

 Every commercial bank is required either by law or costume to keep a certain percentage of their time and
demand liabilities with the Central Bank.

ii. Cash Reserves within the Bank:

This money is kept with the bank to meet any demand obligations. This is kept in the form of metallic coins and
currency notes.

2. Profitable Ways:

There are the ways which earn direct profit for the bank. Like an ordinary investor, the bank invests money. For
that purpose, it will considers all the principles and precautions while investing the money.

The Profitable ways include:

a. Loans b. Investment

a. Loans:

Banks lend their funds in the following ways:

1. Money at call and Short notice (Call Loans):

Money at call and short notice are extremely short period loans made by a bank to speculators and brokers in the
money market and the capital market. This type of loans may be called back at any time or which can be realized
at a short period. This is the second lien of defnce because the banks can depend on such advances in
emergencies. Such types of advances are not very common in developing countries.

2. Advances to Customer:

The bank generally provides short term loans for commercial purposes. It is not the function of commercial banks
to give long term loans for investment. These loans are mostly provided by specialized financial institutions like of
IDBP. PICIC etc. Before making loans and advances, the bank carefully considers the safety of the loan, margin
of profit and its prompt repayment. The commercial banks are now a days making advances for medium term
loans ranging form 1 to 5 years.

3. Discounted Bill of Exchange:

The discounting of a bill refers to making the payment of a bill of exchange before its maturity. The banks get
money after the maturity date of a bill. Bill discounting is a highly earning liquid asset for a bank. It provides safe
employment of available funds. There is certainly of repayment in it. It is also free from price fluctuations.

4. Cash Credit:

This system was introduce din Scotland. In Pakistan, this method of advancing loans is very common and all the
banks advances loans under this system. This term is used to describe an arrangement under which the bank
allows customers to borrow money from the bank against collaterals up to a certain limit. A minimum amount is
fixed on which the customers pay interest even if he does not use that amount. The customer need not take the
whole advances at a time. Now a days this system is dying out as cash credit is being replaced by the simple
letter of credit.

5. Over Draft:

A customer requiring temporary accommodation may be allowed to over-draw his current account usually against
collateral securities. The borrower pays interest only of the amount actually used by him. Bank overdrafts are
usually for a short period. The overdraft facility is provided to the holders of current account. This is the bed
means of temporary accommodation.

B. Investment:

Investments refer to buying shares, bonds, debentures, treasury bills in the open market.

The bank employs its fund in the following types of investment:

1. Government Securities:

They are referred to gold edged securities because they are the safest investments. They are of the following
kinds.

a. Treasury Bill:

Federal governments issue these bills trough their central banks for a period ranging from 3 to 12 months. Their
face value runs into millions of rupees.
b. Treasury notes/coupons:

They are also issued through the central bank. They are different from the treasury bill in that they are long term
investment and are issued for a period ranging from one (1) year to seven (7) years.

c. Treasury Bonds:

They are issued for a very long period ranging from 25 to 50 years. In the U.S they are very common.

2. Provincial and Local Government Bonds:

Provincial and Local government needs funds to carry out their day-to-day functions. Therefore they issue bonds
to raise needed funds. The commercial banks heavily invest in them because income from them is Tax-free.
These bonds may be both short-term and long-term.

3. Foreign Government’s Bonds:

Foreign governments raise funds by issuing bonds on the international markets. The commercial banks prefer
them because they are extremely secured, carry good rate of interest and yield foreign exchange.

4. Other Securities:

Other securities include bonds or debentures issued by the following government institutions:

i. Municipal Corporation

ii. Municipal Committees and Board

iii. Public utility corporations, as electricity, gas, communication companies and water boards.

iv. Other governments and semi-government institutions and banks.

v. Port trust etc.

Commercial bank invests in all of them because they are also secured and offer fairly large interest rates.

5. Corporate Securities:

Public limited companies float their shares and bonds through Stock Exchanges. Commercial bank purchases
them provided the company is financially sound and its business is progressive. Although they are long-term
investment but can be sold any time on the Stock Exchange.
 [Link] MODES OF FINANCING

Islamic Banking
(Products)

Debt Based/ Semi Debt

Equity Based
trade based Based

Musawamah
Murabahah Salam Istisna Musharakah Mudarabah Ijarah

The Commission for Transformation of Financial System set up in the State Bank pursuant to
the Supreme Court judgment on Riba in December 1999 approved essentials of seven Islamic modes
of financing. The recently established SBP Shariah Board has reviewed and approved the same.
Following are brief definitions of these seven Islamic modes of financing. (The details of their
essentials or the guidelines governing them can be downloaded from the SBP website).

1. MURABAHA: Murabaha means a sale of goods by a person to another under an agreement

whereby the seller is obliged to disclose to the buyer the cost of goods sold either on cash basis or
deferred payment basis and a margin of profit included in the sale price of the goods agreed to be
sold.

2. MUSAWAMAH: Musawamah is a general kind of sale in which price of the commodity to be

traded is stipulated between the seller and the buyer without any reference to the price paid or cost
incurred by the former. Thus it is different from Murabaha in respect of pricing formula. Unlike
Murabaha, the seller in Musawamah is not obliged to reveal his cost. All other conditions relevant to
Murabaha are valid for Musawamah as well. Musawamah can be an ideal mode where the seller is
not in a position to ascertain precisely the costs of commodities that he is offering to sell.

3. IJARAH: In Ijarah the corpus of leased commodity remains in the ownership of the lessor.
Anything which cannot be used without consuming the same cannot be leased out like money,
edibles, fuel, etc. Only such assets that are owned by the lessor can be leased out except that a sub-
lease is affected by the lessee with the express permission of the lessor.

4. SALAM: Salam means a kind of sale whereby the seller undertakes to supply specific goods to a
buyer at a future date in consideration of a price fully paid in advance at the time the contract of sale
is made.

5. MUSHARAKA: Musharaka means relationship established under a contract by the mutual consent
of the parties for sharing of profits and losses from a joint enterprise or venture.

6. MUDARABA: Mudaraba means an arrangement in which a person participates with his money
and another with his efforts and shall include banks, unit trusts, mutual funds or any other
institutions or persons by whatever name called.

7. ISTISNA: Istisna is an exceptional mode of sale, at an agreed price, whereby the buyer placed an
order to manufacture, assemble or contract, or cause so to do anything to be delivered at a future
date.
 [Link] OF CENTRAL BANK
As the central bank of the country, the function of The State Bank of Pakistan has been define
in chapter IV of The state Bank of Pakistan. Act 1956, according to which it carries out the following
functions:

1: BANKER TO THE GOVERNMENT. The central bank of Pakistan acts as a financer of the e
government, it is a government’s banker not only collect and pay money on behalf of
government, but it also manages public debts. It keeps government funds in the custody free
of interest. On other hand it provides loan facility to the government without limitation of
amount and time. It is the fiscal agent of the government and The State Bank of Pakistan is to
designing the fiscal policy for the country, finally it act as a financial advice of the government.

a) BANK OF ISSUE (Monopoly of Note Issue). The necessity of maintaining uniformity in

currency circulation and meeting the legitimate currency requirement of business and the
general public, this privilege of issuing currency and bank note in a country has been with
its Central bank almost everywhere in the world. In this capacity, Section 24 of The State
Bank of Pakistan Act 1956 had declared The State Bank of Pakistan has the sole authority
of the issue of bank note.

“The privilege of note issue was almost everywhere associated with the
Origin and development of central bank. Infact until the beginning of the
twentieth century, they are generally known as the bank of issue.”
----- PROF. DECOCK -----
Methods of Issuing Note:
 Partial Fiduciary Issue.
 Maximum Fiduciary Issue.
 Old America System.
 Proportional Reserve System.
 Minimum Reserve system.
 b) CREDIT CONTROL. The term credit control refers to the control of the lending policies of
commercial banks by the central bank.

“Monetary policy (credit control) is the deliberate exercise of the monetary

authority`s power to induce expansion or contraction in the money supply.”
----- SPANCER -----

The most important function of the central bank is to control credit in the economy. The
statutory authorities for control credit by the Central bank of Pakistan is embodies in the
central bank of Pakistan Act 1956, and Banking Company Ordinance 1962. The central
bank of Pakistan, Act provides special power to direct regulate the operations of
commercial bank through traditional weapons, like bank rate, open market operation, etc.
these weapons are also known as METHODS OF CREDIT CONTROL.

c) CUSTODIAN OF FOREIGN EXCHANGE. Because of foreign trade different currency of

the different country is received by the businessmen, it is the responsibility of a Central
bank to pay the local currency equivalent to the foreign exchange that he had earned. In
this manner the Central bank is a custodian of the foreign exchange.

At present, Government of Pakistan has imposed exchange control in the country according
to which exporters deposit their foreign exchange earnings in the State Bank and get local
currency in exchange for it; whereas importers get foreign exchange from the State Bank
in accordance with the import policy of the Government.

d) DETERMINATION OF EXCHANGE RATE:

The central bank is responsible for the determination of exchange rates. It fixes the
exchange rates of the domestic currency in terms of foreign currencies. It holds these rates
in keeping with its obligations as a member of the International Monetary Fund and tries to
bring stability in foreign exchange rates.

e) CUSTODIAN OF GOLD AND SILVER. State bank is also the custodian gold and silver
reserves of our country. It sells and purchase them in the international market ever it
requires doing so.

f) DEVELOPMENT OF FINANCIAL INSTITUTIONS. The central bank is responsible to

develop financial institutions, which play a vital role in industrial, agricultural and capital
development of the country. It also facilitate the establishment and running of money
markets and stock exchanges. In Pakistan, it helps establish National Bank of Pakistan, and
provide million of rupees to Agricultural Development of Pakistan and other DFIs
(development financial institutions).

g) ADVISOR TO THE GOVERNMENT

It enjoys special control in monetary and fiscal matters. It is the most well informed body
about economic indicators so it can best help the government in planning new economic
policies for the uplift of economy.

2: BANKER`s BANK
a) LENDER OF THE LAST RESORT & CUSTODIAN OF CASH RESERVES. According to
section 36 of the Act 1956, The State Bank of Pakistan is the banker’s bank and lender of
the last resort. It gives short term loans accommodation to commercial banks mostly by re-
discounting their bills of exchange. This function facilitates the commercial banks to
discharge its liabilities and prevents to go bankruptcy.

It act as the custodian of cash reserves or balance deposited compulsorily by the schedule
commercial bank, either by law or custom the members bank must keep a certain part
 (5%) of their total deposits with the central bank as reserve. For their future prospective
central bank also provides short-term credit to scheduled commercial banks by
rediscounting the first class bill of exchange and other securities, particularly during the
period of difficulty.

In this way central bank serve as a lender of the last resort to other schedule commercial
banks.

b) COUNSELING SERVICES. The central bank offers precious advice and counseling
services. In the light of its experts opinions and advice commercial bank to formulate and
readjust their policies according to the current economic situation of the market.

c) REDISCOUNTING OF BILL OF EXCHANGE. Another valuable service performed by the

central bank is to rediscount bill of exchange. The scheduled commercial banks discount
the bills of exchange of its client, because of shortage of cash.

d) CLEARING HOUSE.
“Clearing house is an institution where banks exchange cheques deposited
with them and settle their balances with each other.”
----- JAMES PHILIPS -----

Finally one of the most important duties of the central bank on behalf of the commercial
banks is set an intermediary of the settlement of claims on cheques by different
commercial banks on each other. For example, person A issue a cheque in the name of
another person, B. both of them have different bank accounts in different banks. Person B
will take that cheque and deposit it in his own bank account. That bank will now act upon
the cheque by taking it to the central bank

to get it cleared so that the money is properly transferred. Thus, all claims are settled in
the Clearing House section of SBP.

e) COUNSELING SERVICES. The central bank offers precious advice and counseling
services. In the light of its expert opinions and advice scheduled commercial banks
formulate, re-adjust and revise their policies according to the current economic situations.

f) TRAINING PROGRAMS. The central bank establishes various training centers, training
institutions and training programs for its employees to improve their banking skills. For
example, Institute of Bankers Pakistan.

[Link] OF A COMMERCIAL BANKS

 The function of the commercial banks can be classified into two broad categories namely,
Primary and Subsidiary / Secondary functions.

The primary functions include:

1. Receipt of deposit.
2. Lending of money / Advancing loans.

The secondary functions include:

1. Agency services.
2. General utility services / Public utility services.

PRIMARY FUNCTIONS:
Every commercial bank performs the following primary functions:

1: RECEIPT OF DEPOSIT
The most important function of a commercial bank is to receive deposit of the individuals,
public institution, households and traders and receives cheque drawn upon them. All other
function of a commercial bank is based on this function. Bank accepts deposit from those who
have surplus money in their hand but they are unable to use it in a profitable business. The
commercial banks provide an opportunity to the general public to make a good use of their
saving by depositing them in the bank. In order to attract general public and to persuade
people to deposit money in bank, usually three different types of accounts are maintained by
commercial banks.

 Current Account / Demand Deposit.

 Fixed Account / Time Deposit / Term Deposit
 Saving Account.

2: LENDING OF MONEY/ ADVANCING LOANS

This is another main function of commercial banks and by doing this credit money is created
by the bank. Loans are given against securities at a certain fixed rate of interest. Short-term
credit or loans are provided to businessmen, farmers, and industrialist etc. Loans are given on
short-term basis because a major portion of the loans given out comes from current account.
By doing this bank influences the total money supply in the country in the following ways:

 Cash Credit.
 Loans.
 Discounting of Bills.
 Overdrafts.

SUBSIDIARY / SECONDARY FUNCTIONS:

 Due to severe competition among the commercial banks, the deposit rates and the lending
rates tend to be the same with all banks. So a bank has no other alternative but to increase the
volume of business by attracting more and more customers to achieve its objectives. It performs
various secondary functions in order to retain the existing customers and to attract the new
customers. These services are discussed below:

1: AGENCY SERVICES:
A commercial bank also as an agent on behalf of its customers. As an agent commercial bank
performs the following functions:

 Collection of Cheques
It acts as agents to its customers in the collection and payment of cheques, bills and
promissory notes.

 ATM & CDM Service

Through automated teller machine (ATM) and CDM cash deposit machine, the bank use
computerized counter to provide 24 hours cash service.

 Collection of Dividends
The bank provides a very useful service in the collection of dividends or interest earned on
shares held by its customers.

 Purchase or Sale of Securities

The customer, purchases or sales authorize the bank securities on his behalf and thus adds
another benefit to its portfolio.

 Executing of Standing Instruction

The customer may order in writing to his bank to make payments of regularly recurring nature
to an individual or firm by debiting them to his account. The bank will make payments and
charge a small commission. The payments will be stopped on written instructions of the
customer only.

 Zakat Deduction
According to Islamic philosophy 2.5% is deducted from the annual savings of the Muslim
customers for performing this function commercial bank act as an agent for both Government
and customers. This is a yearly function and it calculated on the 1 st Ramadan.

 Under Writing
The companies float their shares with the help of commercial banks. Commercial banks issue
share application to the general public and receive share’s application along with money on
the behalf on the company

2: GENERAL UTILITY / PULIC UTILITY SERVICES:

Under this category, the commercial banks perform the following functions:

 Transfer of Money
Commercial bank plays a significant role in transferring the money from one country, city or
company to another. This service is reliable, quick, safe and inexpensive. Now, these days
mostly the banks transfer money

 Custodian Services
A commercial bank receives securities, documents and valuable articles like gold and jewellery
for safe custody. Here the bank acts only as the custodian of the valuables belonging to the
customers. It receives them from the customer and returns them when demanded.

 Issuing Letter of Credit (L/C)

Bank issue letters of credit, which help the businessmen to purchase goods from distant places
on credit. The bills drawn by the creditors (i.e. the seller) are accepted by the concerned
banks or their agents. Banks also issue traveller`s cheque.

 Collection of Utility Bills

Commercial banks on the behalf of government collect utility bills from the general public. In
this way it becomes convenient for the masses to pay off the utility bills in time.
 Special Services
Some special are as follows:
i. Receipt of Zakat.
ii. Receipt of Ushr.
iii. Hajj Application.
iv. Receipt of Donation.

5. Foreign Exchange
 Definition:

The term foreign exchange is used in the narrow as well as in the broad sense. In the
narrow sense foreign exchange simply means the money of a foreign country. For
example, Japanese’s Yen is a foreign exchange to a Pakistani and Pakistani rupee is a
foreign exchange to Japanese.

In the broader sense the word foreign exchange is related to the exchange methods and
mechanism through which the payments in connection with international trade are made.

According to H.E. Evitt;

“The means and methods by which rights to wealth expressed in terms of the currency of
one country are converted into rights to wealth in terms of the currency of another
country are known as foreign exchange”.

Hartley Whither defines foreign exchange as,

“A mechanism by which international indebtedness is settled between one country and

another”.

What is Rate of Exchange?

The rate of exchange is the ratio at which one country’s currency can be exchanged for
another.

If one American dollar can buy Pakistan’s eighty rupees, the rate of exchange for a dollar
and a rupee would be:

1 US $ = Rs.80
1 Pak Re. = $ 0.0125

Factors Influencing the Rate of Exchange

Introduction:
In the long run the rate of exchange is more or less stable. However in the short run, there are a number of
factors which influence the demand for and supply of foreign exchange and cause fluctuations in the exchange
rate. The principal factors causing short term fluctuations are in brief as under:

1. Trade Movement:
Changes in the volume of exports and imports of goods between two countries in foreign market may lead to
fluctuations in the rate of exchange.

2. Capital Flows:
Movement of capital from one country to another also influences the rate of exchange. For example if there is
a flow of capital from America to Pakistan for investment in shares or in the shape of loans the demand for
Pakistani rupee will go up in the foreign exchange market. As a result the rate of exchange of Pakistani rupee
in terms of American dollar can rise.

3. Speculation:
Rate of exchange is also affected by speculation in the foreign exchange market. If the speculators expect the
value of foreign currency to rise they begin to buy foreign currency in order to sell it in future to earn profit.
By doing so they become the cause of increase in the demand of foreign currency. The rate of exchange will
be in favour of foreign currency and against home currency.

4. Monetary Policy:
The monetary policy developed by the central bank of the country also affects the rate of exchange. If the
central bank devises such a policy that it controls inflation, the rate of exchange of the local currency would
improve and if the policy is not proved to achieve such objective the rate of exchange gets down.

5. Business Conditions:
Business conditions are the result of production, business cycle, employment, balance of payment, inflation
and government policies. If business conditions are poor, the rate of exchange will fall and vice versa.

6. Influence of Stock Exchange:

The functions of stock exchange include buying and selling of stocks, shares and bonds offering investment
opportunities and mobilization of capital. The stock exchange is the index of a country’s economy. Inflow of
foreign currency on the stock exchange, that is, foreign buying of shares and securities pushes the foreign
exchange rate high.

7. Foreign Loans:
Foreign loans go a long way in strengthening local currency. However, if these loans are not properly utilized
and spent on non development work the local currency does not become strong and the government finds
itself in a difficult situation when due date for the repayment of the loan falls.

8. Banking Influence:
The use of bank drafts, travelers’ cheques , letters of credit, bills of exchange and plastic money (credit cards)
has a bearing on the rate of exchange. Their incoming raises and outgoing drops the rate of exchange.
 6. Characteristics and Functions of Money
Money is the essential monetary transaction that people use every day. Without Money, there will be
no marketing and economy in human kind. Money acts as a fundamental medium of exchange which
clears up both humanity’s past and present obligations. Economists define money as widely accepted
by society and acts as payments for goods and services.

Characteristics of Money:
General Acceptability:
All people should readily accept it.

Divisibility:
Money materials can be easily divisible into small parts / units of different value, without losing its
value.

Portability:
It can be easily transported from one point to another and can be carried around easily.

Durability:
Money can be made of that material that will last for some time e.g. metal /paper, not from
perishable goods.

Homogenius:
Every note or coin of the same value should be exactly the same.

Recognizable:
People can easily recognize that the item is money.

Scarcity:
Material chosen for it should be relatively scarce.

 Functions Of Money:
Medium of Exchange:
Goods and services can be traded with money.

Products are exchanged for money that money can be then used to buy other product.

Store of Value:
It can be saved. Thus, it allows people to save in order to make purchases at a later date.

Unit of Account:
It can also be used to place a value on an item.

Thus the value of goods and services can be measured with money.

Standard for Deferred Payment:

Allows people to lend and borrow.

Someone who wants to buy something now can get it buy borrowing money from some one who
does not want to use it now. That amount can be repaid in future.

It helps people to pay in installments.

 7. TYPES OF FINANCIAL INSTITUTIONS

In today's financial services marketplace, a financial institution exists to provide a wide

variety of deposit, lending and investment products to individuals, businesses or both. While
some financial institutions focus on providing services and accounts for the general public,
others are more likely to serve only certain consumers with more specialized offerings.

To know which financial institution is most appropriate for serving a specific need, it is
important to understand the difference between the types of institutions and the purposes
they serve.

Central Banks
Central banks are the financial institutions responsible for the oversight and management of
all other banks. In the United States, the central bank is the Federal Reserve Bank, which is
responsible for conducting monetary policy and supervision and regulation of financial
institutions.1

Individual consumers do not have direct contact with a central bank; instead, large financial
institutions work directly with the Federal Reserve Bank to provide products and services to
the general public.

Retail and Commercial Banks

Traditionally, retail banks offered products to individual consumers while commercial banks
worked directly with businesses. Currently, the majority of large banks offer deposit accounts,
lending and limited financial advice to both demographics.

Products offered at retail and commercial banks include checking and savings accounts,
certificates of deposit (CDs), personal and mortgage loans, credit cards, and business banking
accounts.

Internet Banks
A newer entrant to the financial institution market are internet banks, which work similarly to
retail banks. Internet banks offer the same products and services as conventional banks, but
they do so through online platforms instead of brick and mortar locations. (For related
reading, see: The Pros and Cons of Internet Banks.)

Credit Unions
Credit unions serve a specific demographic per their field of membership, such as teachers or
members of the military. While products offered resemble retail bank offerings, credit unions
are owned by their members and operate for their benefit.

Savings and Loan Associations

Financial institutions that are mutually held and provide no more than 20% of total lending to
businesses fall under the category of savings and loan associations. Individual consumers use
savings and loan associations for deposit accounts, personal loans, and mortgage lending. 2

Investment Banks and Companies

Investment banks do not take deposits; instead, they help individuals, businesses and
governments raise capital through the issuance of securities. Investment companies, more
commonly known as mutual fund companies, pool funds from individual and institutional
investors to provide them access to the broader securities market.

Brokerage Firms
Brokerage firms assist individuals and institutions in buying and selling securities among
available investors. Customers of brokerage firms can place trades of stocks, bonds, mutual
funds, exchange-traded funds (ETFs), and some alternative investments.
Insurance Companies
Financial institutions that help individuals transfer risk of loss are known as insurance
companies. Individuals and businesses use insurance companies to protect against financial
loss due to death, disability, accidents, property damage, and other misfortunes.

Mortgage Companies
Financial institutions that originate or fund mortgage loans are mortgage companies. While
most mortgage companies serve the individual consumer market, some specialize in lending
options for commercial real estate only.