Q.1 How does the State Bank of Pakistan control the banking system of the country?
Answer
Bank rate
This is the rate at which the State Bank buys or discounts bills of exchange and other commercial papers. This is also the basic interest rate. All the other interest rates in the banking system, like the deposit rate paid by the banks to their depositors and the rates at which bank lend for short and long periods, are tied to it. With any change in the bank rate, similar changes take place in the entire interest rate structure of the banking system.Cash Reserve Requirement
All scheduled banks are required to deposit a certain percentage of their total liquid assets with the State Bank. Technically, the government can bring about a change in reserve requirement but normally the State Bank exercises this authority on the government’s behalf. A rise in the cash reserve requirements restricts the bank’s lending operations while a fall can encourage them to advance more credit.Selective Credit Control
The State Bank usually have considerable authority to control the composition of bank credit. SBP can direct banks regarding the distribution of credit between different sectors and uses, between long term and short-term loans, margin requirements for advances against certain types of assets and the interest to be charged on different types of advances and from different borrowers.Credit Ceiling
A credit ceiling for the banking system as a whole or for each individual bank, can exercise some influence over the total volume of credit though not on its direction or use.Liquidity Ratio
This is the ratio between a bank’s liquid resources and its total liabilities. While a low liquidity ratio may lower public confidence in the banking system and may also allow banks to liquidate their investments in government securities to finance credit expansion, a high ratio adversely affects the credit flow in the economy and the overall profitability of the bank.Open market operations
This consists of the purchase and sale of securities by the State Bank in the open market. The quantity of cash in the money market increases with the purchase of securities whereas their sale has contra-dictionary effect.Credit Quota
The State Bank can also limit its own lending to banks by fixing a credit quota for each bank and borrowing over and above the limit may carry a higher interest rate.In Pakistan, in addition to these instruments, the State Bank of Pakistan also offers informal advice, guidance, and persuasion to banks in various matters. Such informal control may have become fairly important particularly after the nationalization of banks and the consequent unification of their operating policies.
Q.2 What are the negotiable instruments? Discuss in detail.
Answer
NEGOTIABLE INSTRUMENTS
Under the Negotiable Instruments Act, 1881 “a negotiable instrument means a promissory note, bill of exchange or cheque payable either to order or to bearer”. However, in general terms a Negotiable Instrument is one which is, by a legally recognized custom of trade of law, transferable by delivery or by endorsement and delivery in such circumstances that (a) the holder of it for the time being may sue on it in his own name; and (b) the property in it passes, free from equities, to a bona fide transferee for value, notwithstanding any defect with title of the transferor”.CHARACTERISTICS
- Negotiable instruments are transferable from person to person like cash. In other words, the property attributed to these instruments passes from one person to another, either by endorsement or by delivery.
- The transferee of a negotiable instrument is entitled by law to sue on the instrument in his own name in case of dishonor.
- A bona fide transferee of a negotiable instrument for value takes if free from all defects in the title of his transferor. This is the main difference between negotiable instrument and other subjects or ordering transfer.
KINDS
There are three main kinds of negotiable instrument:- Bills of exchange;
- Cheques;
- Promissory notes;
BILLS OF EXCHANGE
“An instrument in writing, containing an unconditional order, signed by the maker, directing a certain person, to pay certain sum of money, only to or to the order of a certain person, or to the bearer of the instrument”.Characteristics are:
- It must be in writing.
- It must be singed by the maker.
- It must contain an unconditional order.
- It must direct a certain person to pay a certain amount of money to a certain person or his order or to bearer.
- It must be properly stamped.
PARTIES
There are generally three parties to a Bill of Exchange:- Drawer:Drawer is the person giving the order.
- Drawee: Drawee is the person to whom the order is addressed.
- Payee or Endorsee: Payee or Endorsee is the person named in the instrument to whom or to whose order the money is directed to be paid.
CHEQUE
“A cheque is defined as a bill of exchange drawn on a specified banker and not expressed to be payable otherwise than on demand”.In general term, it is a bill of exchange drawn on a banker which is payable on demand. A cheque is a peculiar type of negotiable instrument which resembles a bill of exchange in particulars but does not so resemble in other. Thus:
- a cheque does not require acceptance;
- it is not intended for circulation;
- but for immediate payment;
- it is not entitled to any days of grace;
- it is always drawn on a banker;
- it is payable to bearer on demand (unless crossed).
VARIETIES
- Open cheque:This can be presented to the banker on whom they are drawn and paid by them “over the counter”.
- Crossing:This is a device adopted by the business community and sanctioned by law, which has the effect of making cheques payable to a bank only or to a particular bank in an account with such bank. Crossing is of two types. General crossing which consists of drawing two parallel transverse lines, across the fact of cheque, either with or without the words “not negotiable” and/or the words “and Co” in between. If in addition to general crossing, the name of specified banker to whom the cheque is to be payable, is also written on the face of the instrument, with or without the words “not negotiable”, it is called special crossing”.
- Order cheque :This is a cheque (a) which is expressed to be so payable or (b) which is expressed to be payable to a particular person, without containing words prohibiting transfer or indicating that it shall not be transferable or (c) which is expressed to be payable to the order of a certain person.
- Marked cheque :This means a cheque which is “marked” or certified by the banker on whom it is drawn, to the effect that it would be honored when presented for payment.
PROMISSORY NOTES
“This is an instrument in writing (not being a bank note or currency note) containing an unconditional undertaking signed by the maker, 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”No precise form is necessary but the above definition lays down that the following are the essentials of a Promissory Note:
- It must be an unconditional written promise.
- It must be singed by the maker called “promiser”.
- It must contain a promise to pay a certain sum in money only.
- The money should be payable to or to the order of a certain person or to the bearer of the Promissory Note.
- It may be made by two or more persons and they may be liable thereon jointly and severally.
- The amount promised in the Promissory Note must be payable on demand or at a fixed or a determinable future time.
- A Promissory Note is incomplete until it has been delivered to the payee or the bearer. Moreover, the sum promised in a Promissory Note can be made payable by stated installments. The Promissory Note may be made by two or more makers who may be liable thereon jointly and severally, according to is tenor.
Q.3 As a banker how would you appraise an industrial project? Support your answer with arguments.
Answer
- Safety
- Maintaining liquidity;
- Maintaining wide dispersal;
- Financial advantage; and
- Economic Advantage.
SAFETY
The baker must be very careful while financing various projects because if the ventures which he is financing are not viable then he will lose not only the bank’s money but is likely to bring hardship to a large number of depositors. It must be kept in mind that the depositor place their money at the disposal of the bankers because they are sure of its safety. In view of the above, the bakers has to do a great deal of thinking and homework before he allows finances for a certain venture. The following matters have to be looked into by a banker most carefully to ensure safety of the money:- Character of the person or persons desirous of obtaining finances. He must be the kind of person who can be trusted with the amount being provided to him.
- Previous record of their relationship with the baker has also to be considered. If a party has been a client for a long period of time and his previous record shows that he has honored his commitments in the past, the banker can without any fear of the future consequences provide finance.
- Capacity to honor their commitments and management ability are other factors which have to be considered. A businessman may not have unlimited financial resources but his capacity to manage investments may be of a high order in which case the task of the bank becomes easy.
- The financial viability of the project is another factor because a party may have large resources at his disposal and also have management capabilities but the project which he proposes is doomed from the beginning because it is not financially viable.
MAINTAINING LIQUIDITY
This means ability to convert assets into ready cash. The banker must make sure that the money he is lending is not blocked for a long period of time so that it can be lent to other people. The banker should always be hesitant to advance finances to customers for purchase of fixed assets because this kind of asset cannot be changed into liquid assets when needed.MAINTAINING WIDE DISPERSAL
The dispersal of the amount of advances should be broadly based so that a large number of borrowing customers may benefit from the financing. The banker must ensure that his funds are not invested in specific sector like textile industry, heavy engineering or agriculture, etc. He must see that from his available funds he advances them to a wide range of sector. Dispersal of advances is very necessary from the point of security as well, because it reduces the risk of recovery when something goes wrong in one particular sector.FINANCIAL ADVANTAGE
A banker needs sufficient amount of banking spread over the year so that he can meet expenses which he has to meet in regard to interest paid to customers, payment to dividend to shareholders, meeting the expenses and overhead, payment of salaries and keeping adequate amount for financing future investments. Banking itself is a business and therefore, the banker must always keep in mind that he has to create conditions of financial advantage.ECONOMIC ADVANTAGE
The bankers have always keep in sight the overall nature of economic and social objectives of development in the country. For this purpose he has got to think in terms of economic advantage of the nation as a whole upper most in his mind and see that the projects financed by him are in line with national objectives.
Q.4 Write notes on the following:-
Answer
LETTER OF CREDIT
In export and import, both importer and exporter may be not known to each other. When an importer is not particularly well known to an exporter, but the transaction is being conducted directly between the importer and exporter, then they use the services of a bank through a letter of credit, which is also known as Documentary Credit. A letter of credit is a satisfactory way of ensuring payment before control of the goods is surrendered. The usual way in which this is effected by an irrevocable letter of credit which may be confirmed in certain cases. A really detailed understanding of letter of credit is necessary for all those who are engaged in international trade. A documentary credit is an understanding by a bank at the request of its customer, an importer, to pay an exporter or accept the exporter’s term bill of exchange in respect of goods consigned to the importer when satisfactory documents including evidence of shipment and all other documents required under the terms of the credit are produced at a named place within a specified period.TYPES
Revocable credit
A revocable credit gives no undertaking to the exporter that payment will actually be made because it may be cancelled or amended at any time without prior notice to the beneficiary.Irrevocable letter of credit
An irrevocable credit constitutes a definite undertaking of the issuing bank, provided that the stipulated documents are presented and that the terms and conditions of credit are complied with. The issuing bank, in case of irrevocable credit gives a binding or definite undertaking to the beneficiary that he will pay against documents or that the bills drawn in compliance with the terms of credit will be honored.Confirmed letter of credit
When an issuing bank authorizes or requests another bank to confirm its irrevocable credit and the latter has added its confirmation, such confirmation constitutes a definite undertaking of such bank, in addition to that of the issuing bank, provided that the stipulated documents are presented according to the terms and conditions of the credit. The beneficiary of such credit has a double assurance of getting his money, the undertaking by his bank and the issuing bank. The confirmed credit eliminated practically all the risks to the seller.Unconfirmed letter of credit
In this type, these credit are carried with undertaking by the opening bank but not confirmed by the advising bank. The majority of credits covering international trade are irrevocable credits but most of them are not confirmed. The reason is that buyer is not prepared to pay an additional charge for confirming the credit or it may effect on the cost of the goods by the seller.Sight and acceptance letter of credit
There are two categories of credit in connection with payment; (i) sight letter of credit which means that the payment is to be made on demand or on presentment of bill of exchange; and (ii) acceptance letter of credit in which type facility in payment is allowed to the buyer i.e., payment on 30, 60, 90 days document against acceptance basis.Revolving credit
A credit which contains a condition that the credit amount is to be renewed or reinstated automatically in stated circumstances without the need for further specific amendment. A credit revolve around amount or around time. A credit which revolves in relation to time is for more usual and practical instrument.ENDORSEMENT
An endorsement means the writing of a person’s name on the back of a negotiable instrument; This can be given also on the face of an instrument. It has no particular form of words and can be given on a piece of paper annexed to a negotiable instrument. It should be given for the purpose of negotiation which has been defined in section 14 of the Negotiable Instrument Act, 1881.Classes of endorsement are:
Blank & Full endorsement: In Blank, it consists of the bare signature of the endorser and the instrument so endorsed becomes payable to bearer. In Full, it specifies, in addition to the signature of the endorser, the person to whom or to whose order the instrument is payable.
Restrictive Endorsement: This prohibits further negotiation of the instrument i.e., the endorsee has no power to transfer this rights to any one further.
Partial Endorsement: This purports to transfer to the endorsee only a part of the amount payable on a bill of exchange or promissory note.
Conditional Endorsement: This makes the transfer of the instrument from the endorser to the endorsee after the fulfillment of stated conditions.
“Sans Recourse” Endorsement: When an endorser wants to exclude his liability to the endorsee or subsequent holder he indicates it clearly on the instrument by writing the words “SANS RECOURSE” or “Without Recourse”.
Bankers in Pakistan accept endorsements in the following forms:
- Endorsements by:
- individualsThe liabilities of an endorser are:
- married women
- illiterate persons
- agents for individuals
- joint payees
- firms
- joint stock companies
- clubs, societies and association, etc.
- official payees
- executors and administrators
- trustees
- public bodies.
- like the drawer of a bill of exchange or cheque, the endorser of these instruments is only a surety for the principal debtor and his liability is secondary and conditional.
- By endorsing the negotiable instrument, the endorser takes the liability of acceptance or payment of the endorsed instrument when it falls due, according to its apparent tenor.
- If the endorsed instrument is dishonored, the endorser is liable to compensate the holder for the loss or damage which he may sustain on account of such dishonor.
