Commercial Banking

BY: Sir Salman Jawaid

 Commercial Banking
BY: Sir Salman Jawaid

Commercial Banks:
“Banking means the accepting, for the purpose of lending or investment, of
deposits of money from the public, repayable on demand or otherwise and
withdrawable by cheques, drafts, order or otherwise.”
The Banking Companies Ordinance
1962 Section 5 ( b )

1. These banks are privately-owned, profit seeking financial institutions.

2. They are the basic units of the banking system and differ mainly from other financial institutions in that they
allow funds, deposited with them, to be transferred by means of cheques from one person to another.
3. Examples: Muslim Commercial Bank, Allied Bank, Habib Bank etc.

Services of Commercial Banks:

a) Accepting deposits
b) Providing a convenient means of making payments.
c) Lending to customers
d) Providing other services

a) Accepting deposits:
Commercial Banks accept deposits from customers for banking into the
following accounts:

i) savings account – this is an accounts which encourages people to save and earn interest and from which can be
withdrawn when needed. No recommendation is needed to open account. Account holder is given a passbook for all
the deposits into and withdrawals from the account. Money can be deposited and withdrawn anytime although
withdrawal at a branch or ATM is limited to a certain amount.

It earns lower interest than the fixed deposit account. Account holder need not to pay bank charges for operating
account. It is suitable for individual who wishes to save small sums of money.

ii) fixed deposit account – this is an account into which money is deposited, with the intention of keeping it in the
bank for a specified period of time, to earn interest. No recommendation is required to open account. Account
holder is given a fixed deposit certificate which can presented for payment upon expiry date.

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Amount deposited remains fixed and can only be withdrawn when the specified period expires unless the depositor is
willing to forgo interest. It suitable to businessman who has excess funds.

iii) current account – this is an account from which money can be withdrawn for payments by means of cheques and
ATM cards. Other services available to the current account holder include overdraft, standing order, direct debiting
and credit transfer services. Recommendation is required to open this account. Cash and cheques can be deposited
anytime and withdrawals notice can be made by means of cheques. It does not earns interest.

Account holder has to pay bank charges. It is useful to the businessman who needs a convenient and safe method of
facilitating his receipts and payments.

b) Providing a convenient means of making payments:

i) cheques – the commercial bank acts as agent for payment for its current account holder who, through use of
cheques, authorizes his bank to pay cash or transfer money from his account to that of his payee.

Advantages:

It is a convenient method.

It is safe

It serves as record of receipts and payments.

Relatively cheap means of making payments.

ii) standing orders – these are orders to a banker to pay regularly a fixed sum of money from one’s current account in
order to settle recurring payments like mortgage repayments etc

Advantages:

Regular commitments are met punctually

Debtors need not to remember due dates for payments.

Creditors need not to send reminders for paymet.

iii) Direct debiting

The bank may provide direct debiting facilities for payments of varying amount at irregular intervals. Such payments
have to be authorized by buyer. This differs from standing orders in that it the creditor who give payment instructions
and not the debtor. The amount and date of payment is not fixed.

Advantage:

Prompt settlement of debts for the creditor.

iv) Credit transfer system

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 A current account holder can instruct his bank to pay directly into the bank account of payee. The bank will debit his
account and credit the account of payee.

Advantages:

Convenient for both – Payer and Payee as the payer is spared with the trouble of writing as posting several cheques
and the payee need not to go to the bank to cash the cheque.

Economical – The payer pays the stamp duty for only one cheque and he also saves on postage.

Safe – no risk of cheque getting lost and cheque being dishonored.

v) Remittances

Remittances is the sending of money from one place to another without actual physical movement of cash.

a) Bankers’ cheque: It is a bank’s cheque drawn upon itself. It can be used for payments of any amount with in the
same town.

b) Bank draft: It is an unconditional order in writing drawn

by one bank to another bank requesting the drawee bank to
pay a certain sum of money to a third party.

c) Mail Transfer: It is a written instruction given by a

remitting bank to its branch or an agent bank by the
remitting bank to pay a certain sum of money to a third
party.

d) Telegraphic transfer: It is an instruction that is cabled or

telexed to a branch or agent bank by remitting bank to pay a
certain sum of money to a third party.

c) Lending to Customers:
Commercial banks lend money to the customers in the following ways:

i) By extending a direct loan in which the borrower’s bank account is credited with the amount of the loan and
interest is paid on the full loan.

ii) By giving overdraft facilities to its customers who are able to withdraw more than the amount deposited in their
current accounts making prior arrangements with the bank. Interest is charged on the amount overdrawn.

iii) By discounting bills of their customers.

Reasons for lending:

i) It knows from the experience that only a small portion of its customers’ deposits is withdrawn as cash at any one
time.

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ii) The cash reserves can be used profitably by investing or lending cash to its customers.

d) Providing other services:

i) Agency services

Besides being an agent for payment and receipt for its current account holders, bank also provides business
investment advisory services, buys and sells investments and collects dividends.

The bank may offer tax consultant services and may act as an executer or trustee of real estate or property.

For a small fee, the bank will take care of personal property and documents by providing safe deposit facilities.

Some banks may arrange for various types of insurance desired by the customers.

ii) Foreign Exchange services:

Banks sell foreign currency, issue travellers’ cheques and arrange for letter of credit abroad for their customers.
Foreign currencies purchases are limited by Exchange Control Regulations.

They also finance foreign trade through discounting bills of exchange and issuing letters of credit.

iii) Night safe facilities:

Businessman can make use of night safe facilities to deposit their daily takings after closing hours. The money is put
into a locked bag which is dropped into the night safe, located outside the bank and goes through a chute leading to
the vault.

When the bank reopens, the bag is opened with the businessman’s key and the amount of money is credited to the
account.

iv) Safe deposit boxes:

The bank rents out safe deposit boxes to customers who wants to keep valuables like jewellary.

v) Credit card:

Credit cards like AMEX, VISA AND MASTER CARD are issued by banks to enable holders to make credit purchases
at local and overseas establishments which accept these cards. The credit card holder is informed by monthly
statements the amount he has taken and the due date for making payment.

For the use of this credit facility, bank charges interest on the outstanding balance.

vi) Automated Teller Machines (ATM)

Banks provide ATMs to their savings and current account holders. This facility enables the customers to perform
banking transactions anytime time 24 hours . Withdrawal limit per is 25,000 PKR in Pakistan. Besides providing cash
these machines also entertain bank balance inquiries, statement of accounts, requests for cheque books etc.

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 vii) Telebanking:

Customers can pay the bills or make loan repayments to pre-

authorized corporations, cheque bank balances, order cheque books
through the use of telephones. Telebanking operates 24 hours a day
anywhere via the push – button telephone linked with bank’s
computer center.

viii) Bank Grio System:

Bank Grio system can be used for making payments. When an

employer pays his employees’ salaries through bank grio, a list of
salaries together with the bank account numbers of the employees is
handed over to the bank. A cheque of the total sum is issues by the
employer and the individual accounts are credited accordingly.

According to the Banking Tribunal Ordinance of 1984, following are some other functions:

a) Commercial banks act as agents for any government or local authority or any other person , the carrying on
of agency business Example: Subscription of shares
b) Acting as “Modarba Company under the the provisions of Modaraba Companies ordinance of 1980.
c) Purchase or Acquisition in the normal course of its business any property, trade marks or copy rights with or
without buy back guarantee.
d) Helping Hajj Pilgrims in submission of Hajj Aplications
e) Providing E banking services
f) Collecting Utility services bills like Gas / electricity etc

Role of Commercial Bank in the development of a country:

If the banking system in a country is effective, efficient and disciplined, it brings about a rapid growth in various
sectors of the economy.

a) Banks promote capital formation: They play an important role in raising of the financial resources. They encourage
savings by giving various types of incentives to the servers. Thus mobilizing savings at far off places. They not only
store houses of the country’s wealth but also provide stream of resources necessary for economic development.

b) Investment in new enterprises: Business man normally hesitate to invest their money in risky enterprises.
Commercial banks generally provide short and medium term enterprises. For example personal and business loans
offered by banks in Pakistan.

c) Promotion of trade and industry: The use of bank draft, bills of exchange, credit cards have revolutionalized both
national and international trade.

d) Development of agriculture: The commercial banks particularly in developing countries are now providing credit
for the promotion of agriculture and small scale industries in the rural areas.

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e) Balanced development of different regions: They help in transferring surplus capital goods from developed regions
to less developed regions. The traders, industrialists of less developed regions are able to get adequate capital for
meeting their business needs.

f) Influencing economic activities: They have a direct influence on:

i) Availability of credit

ii) Rate of interest

If commercial banks are able to increase the amount of money in circulation through credit creation or lowering the
rate of interest, it directly affects economic development.

f) Implementation of monetary policy: The central bank of the country controls and regulates the volume of credit
through active cooperation of banking system. It helps in bringing price stability and promotes economic
development growth within shortest period of time.

g) Monetization of the economy: The commercial banks by opening branches in the rural areas of the country are
reducing the exchange of good through barter. The use of money has gradually increased the volume of production of
goods.

h) Export promotion cell: The provide information about trade industry both to the customers inside and outside the
country.

Role of Banking in 21st Century:

Virtual Banking: Installments of ATM, Credit cards, debit cards, internet banking and online transfer facility have
greatly influenced the development of the credit.

Classification of Banks:
A) Classification on the basis of functions:

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 1. Central Bank: Every civilized country has now its own central bank. The primary function of a central bank is to
regulate the flow of money and credit in order to promote efficiency, stability and growth in the country.

2. Commercial Banks: They are those banks which are engaged in performing the routine
duties of banking business. They collect surplus money from the people. They loans and
advances in the form of overdrafts, cash advances and credits.

3. Exchange Banks: They mainly deal with international trade. These banks take the
responsibility of settlement of foreign exchange and arrange foreign business.

Example: National bank of Pakistan.

4. Savings Banks: Savings banks are those banks which collect and keep small savings of
public. They are called thrift promoting institutions. The saving banks invest the funds in
the safest government securities.

Example: Pakistan Post office serves as saving bank as well.

5. Agricultural Banks: They provide short term credit to farmers.

Example: Agricultural Development bank of Pakistan.

6. Industrial Banks: Since they have long term deposits, they provide long term loans.

Example: Industrial Development bank

B) Classification of the banks on the basis of ownership:

1. Public sector banks: Owned by government

Example: National bank of Pakistan

2. Private sector banks:

Example: MCB, Allied bank, SCB

3. Cooperative banks: They provide short term and medium term loans for rural development.

C) Classification on the basis of domicile:

Domestic: Registered and incorporated in a country

Foreign: Origin and head offices in a foreign country

D) Scheduled and non scheduled banks:

1. Scheduled banks which have paid up capital reserves of not less than Rs. 5 million in Pakistan. They are the
members of the clearing house managed and supervised by SBP.

2. Non scheduled banks are those which are not included in the second schedule of Sate Bank of Pakistan Act of 1956.
They have minimum paid up capital value of Rs. 50,000 but does not exceed Rs. 5 million.

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Credit

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 The word ‘Credit’ is derived from a Latin word ‘Credo’ which means I Trust you

“An exchange which is complete after the expiry of a certain period of time after payment.”

- GIDE

Credit is explained as the sale of goods and services and money claims in the present in return for a promise to pay in
future. The promise is usually based on the confidence and on the belief that the debtor whether a person or a
business or government unit will be able and willing to pay on demand or at some future date.

Credit is the right to receive payment or the obligation to make payment on demand or at some future time n account
of an immediate transfer of goods.

Functions of Credit:
Credit is the foundation upon which the economic structure of the countries both developing and developed countries
is strengthening.

1. Economy in the use of metal: Credit instruments are used as a medium of exchange in place of metallic coins.
There is thus savings of precious metals. Moreover, the use of credit instruments in all business transactions is more
effective and convenient than any other form of money.

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2. Provision of working capital: If an industrialist is
short of spending power when the production is going
on, he can finance the industry by obtaining credit from
the banks. His cash flow becomes better.

3. Sales of Bonds: If the prospects of invested capital are

bright and the profits are being earned left and right,
the firm can repay the interest as well as principle
amount easily at specified date out of profit earned
during course of production.

4. Case of young firm: Credit enables entrepreneur of

young firm to develop its resources at a rapid speed
which otherwise would not have been possible.

5. Large scale production: The institutions of credit have provided a ready flow of money to the industrialist. When
the requirement of capital accumulation is me, production is increased on large scale. Cost of production decreases.

6. Shifting of capital to productive hands: There are people who have surplus money with themselves. Instead of
keeping money idle in their safe deposits, they lend it to financial institutions. Credit thus makes it possible the
shifting of money to those people who can use it productively.

7. Entrance of New Entrepreneur: Credit makes possible for the entrance of the new talent in the business
enterprise. If a person has less capital on his own but has all the qualities of a good entrepreneur, he can setup new
firms and develop modern techniques of production and the thus resources of the country are affectively utilized.

8. Purchase of goods: Credit makes it easy and convenient to the consumer to purchase or hire durable goods. A
consumer / customer acquire goods from the dealers with an obligation to pay in future either by installments of
lump sum payment. Credit provides opportunity to the consumer to use and enjoy more goods which otherwise
would not have been possible if the payments are to be made in cash.

9) International payments: International payments especially through bills of exchange, have been greatly facilitated.
There is no need now to import or export gold for settlement of business transactions.

10. State Revenue: If government expenditure is in excess of its current revenue, it can meet the deficit by the sale of
bonds. Thus timely needs of the state are satisfactorily met through credit.

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 Dangers of credit:
1. Over issue of credit: The expansion of credit beyond safe limits usually results in over
investment, over production and the rise in prices. The contraction of credit generally leads to
recession and depression in the economy. Boom or depression periods have their own evil effects
on the economy.

2. Bad debt: If an individual consumer, a businessman or a nation is not careful in the use of
borrowed money and rash and reckless enterprises which prove failure and the loans will not be paid
to credit institutions which will create panic in the monetary circles and the whole super structure of
credit collapse.

Example: Recent economic crises in the US economy has been attributed to the bad debts.

3. Inefficient business concerns: Another inherent danger of credit is that money may accumulate in the hands of
those entrepreneurs who are financially weak and running economic concerns. In case if they are pushed into
bankruptcy, all the firms which have trade relations with them will suffer.

4. Monopolistic exploitation: If large amount of money is placed at the disposal of individuals of companies, there is
danger of combines and monopolistic exploitation. The monopolist can adopt unfair methods in business dealings.

5. Borrowing by the government: Government may take loans in order to meet their financial obligations / deficits.
A government may spend borrowed money in extravagant and lavish manner. If the citizens are vigilant, they will
lose confidence in the credibility of the state.

Banking – By: Sir Salman Jawaid

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