chapter two commercial bank and its function.pptx

Commercial bank and it function and importance

1. Commercial banks Chapter 2

2. General Definition A commercial bank is a financial institution which serves as a mechanism for transmission of money and as a financial intermediary.

3. Definition Banking means accepting, for the purpose of lending or investing, the deposit of money from public, repayable on demand or withdrawable by cheque, draft, order or otherwise. (Banking Co. Ord. 1962) A banker is one who in the ordinary course of his business, receives money which he repays by honoring cheques of persons from whom or for whose accounts he receives it. (Dr. H.L. Hart)

4. Commercial Banks Involves in making profit by investing other’s money. Plays vital role in shaping the economic destiny of a country. Collect scattered saving of people and make available for society desirable and economically beneficial purpose. They are intermediate party between those who have surplus money and a person who needs that. The difference of lending and advancing interest rate is source of profit for it. Contribute to he growth and stability of economy as well as to the welfare of population.

5. Commercial Banking In Pakistan In era of 1960s A large number of privately owned banks dominated the market. These banks were sponsored by large business houses who used these banks for their own funding needs. Their scope of operation was restricted to major urban cities. In era of 1970s All commercial banks were nationalized in 1974. Fifteen privately owned banks were consolidated into four nationalized commercial banks namely Habib Bank Ltd., United bank Ltd.; Muslim commercial bank Ltd.; Allied bank Ltd. Rapid branch expansion was under-taken to improve the coverage of banking services. The politically motivated heavy lending aggravated the risk and earning scenario of the commercial banks. 1990 and onwards Foreign banks consolidated their position in the market at the expense of inefficient Nationalized Commercial Banks. Profit and loss sharing scheme was introduced. Financial market expanded as brokerage houses, leasing, modarabas, investment banks entered the market. The private sector was allowed to enter into the banking business. Muslim Commercial Bank and Allied Bank of Pakistan were privatized. Prudential regulations were introduced. Foreign and private sector banks started emphasizing on retail banking.

6. Primary functions Receiving/accepting deposits First primary function Receive from general public. General public deposits their saving for safety and to earn profit on their savings Banks pay interest on deposits to depositors. Banks offer different kinds of accounts for deposits, like; current account, saving accounts, fixed deposits account, foreign currency accounts and many others. Advancing Loans Second primary function Banks borrow (accepting deposits) money to lend it for productivity purpose and lend it to needy people. Banks charge interest on loans. They advance to those who need it for trade and production or who needs to meet their need like daughter’s marriage, son’s higher education, purchasing vehicle or houses and etc. There are different types of loans according to term and issue like; overdraft, cash credit, short term and long term and many more.

7. Smart cards and Credit Cards A smart card has a specially embedded microprocessor, which is a computer processor on a microchip. If you look on the side of the card, there is a gold pad under which lies the microprocessor. A credit card, on the other hand, has a magnetic strip without anything on its inside.

8. Scheduled bank It is also called member bank. It is registered with central bank of the state. Bank becomes member of money market after registration. It enjoys different rights and privileges provided by central bank. To be a schedule bank commercial bank has to fulfill all conditions which are imposed by central bank. In Pakistan a commercial bank has to deposit 5% of its total demand deposits with the SBP as security money. Commercial banks are liable to submit weekly transaction report to SBP. In Pakistan almost all commercial banks are scheduled bank

9. Advantages of scheduled bank Guidelines and support by CB in every situation. Can obtain necessary information of money market from CB Can avail privileges of getting loan on reasonable term from CB in different periods. Can deal with in foreign exchange with necessary permission of CB. Have stability and continuity of business. There is very low chance for failure. CB stand for Central Bank

10. Relationship between scheduled bank and Central Bank CB act as bank of a Scheduled Banks. ( can take loans by rediscounting bills) CB act as clearing house for Scheduled Banks.( facilitate settlement among the members bank) CB act as lender of last resort to all Scheduled Banks. ( get financial assistance at the time of need) CB act as a friend and guider for Scheduled Banks. ( it is essential for sound banking system in a country) Scheduled Banks help central bank to control the volume of credit in the country by following CB guideless and instructions CB stand for Central Bank

11. Importance/ role of commercial bank General Public Encourage saving Opportunity to earn profit on surplus Provides investment opportunity with advice at grassroot. Safe custody of their surplus money Help public to make assets Assist them in their life to achieve different task like ; payment of zakat , applying for hajj, processing visa and passport and etc. For Businessmen Provide business opportunity at grassroot BY PROVODING LOANS ON DIFFERENT TEERM AND CONDITIONS. Advice and assist them in different plans , project and expansion of business. Make business man life easy ( providing different online services) For government Assistance to government Economic prosperity Act as agent ( collect revenue, zakat taxes etc. ) Create special funds Account Public debts

12. Importance/ role of commercial bank in economic development of the country Trade development ( capital, technical assistance and other facilities) Agricultural development (different loans plan available to meet needs) Industrial development Capital formation( increase in number of production unit, technology, plant and machinery.) Development in foreign trade ( issuing LC, arranging For. Ex.) Transfer of money More production ( strengthening capital structure and division of labor) Development of transport

13. Importance/ role of commercial bank in economic development of the country Increase in employment Credit Creation Financial Advice Increase in investment Success of Monetary Policy Use of modern Technology Export Promotion Cell

14. CREDIT CREATION “Bank is the factory of creating Credit” (Reynold) “Loans creates deposits and deposits create loans” (Hartley)

15. Credit creation It is most outstanding function of modern banks. The commercial banks create multiple expansion of their bank deposits. ( Credit manufacturer) The notes and currency is not only form of money but also include credit money. Credit money creates purchasing power. Every bank is required by law to keep 20% of its total deposits in the form of cash reserve. The tendency on the part of commercial banks to expand their demand deposits as a multiple of their excess cash reserve is called creation of money.

16. Assumptions: Credit creation Fresh /New/Primary deposit. All payment and receipt made through banks or by cheques. No leakage in the credit create. No credit control policy adopted by central bank Cash reserve ratio remains same i.e. 20% by law.

17. Credit creation system Banks Total Deposits Reserve Ratio Cash Reserve Credit Creation A 5000 20% 1000 4000 B 4000 20% 800 3200 C 3200 20% 640 2560 D 2560 20% 512 2048 Different banks ……. …… …… …… TOTAL 25000 - 5,000 20,000

18. Formula of credit creation Total deposit= primary deposit * 1/ 20% = 5000*1/20% = Rs. 25,000

19. Chain of multiple credit creation

20. Effects of credit creation in Banks’s Balance sheets

21. Method of Credit Creation Advancing Loans Purchase of Securities/ By Making Investment Discounting Bills

22. Limitations of Credit Creation Cash Reserve Central bank Policy Willingness to borrow Habit of customers Shortage of securities Primary deposits Political condition Economic condition Effect of religion Rotten banking system Types of deposits Change in reserve ratio