BANKING SYSTEM AND MONETARY POLICIES

There is no uniformity among the economists about the origin of the word "Banking" The
term bank is derived from the Latin word "Bancus" which refers to the bench on which the
banker would keep their money and his records. Some persons trace its origin to the French
word "Banque" and the Italian word "Banka" which means a bench for keeping, lending, and
exchanging of money or coins in the marketplace by money lenders and money changers.
During the early periods, private individuals mostly did the banking business. As a public
enterprise, banking made its first appearance in Italy in 1157, when the "Bank of Venice"
was established. Following its establishment, the Bank of Barcelona and Bank of Genoa
were established in 1401 and 1407 respectively. They used to exchange money, receive
deposits, and discount bills of exchange.

MEANING OF BANK
A bank is a financial institution that deals with money and credit. It accepts deposits from
the public in a different account and provides loans to needy persons. The bank is a bridge
which fills the gap between the surplus and the deficit amount of money. It is the
manufacturer as well as the trader of money.
According to the World Bank, “Banks are financial institutions that accept funds in the
form of deposits repayable on demand or short notice.”

According to Crowther,” A banker is a dealer in debts the banker’s business is to take the
debts of other people to offer his own in exchange and theory to create money.”

ROLES OR IMPORTANCE OF THE BANKING SYSTEM

1. Mobility of saving
One of the major roles of the banking system is to collect saving from the general public and
mobilize them in business sectors. The collected money is lent to productive sectors. It is
called the mobilization of saving.

2.Mobilization of the economy

There was no use of money in barter system to accelerate trade and commerce, first of all,
monetization of the economy is essential. People maintain their savings in banks and
withdraw it when they need it. This helps in mobilization of the economy.

3.Capital formation
The process of capital formation begins with saving. People save in the bank, productive
sectors demand it and use to purchase capital equipment, to produce goods and services are
thereby to create income.
4. Creation of employment opportunity
Establishment of banks and financial institutions creates direct and indirect employment
opportunities. The bank needs employees who create direct employment. Banks provide loan
to the business sector which needs regular manpower to run it. So, banks create indirect
employment.

5. To manage foreign trade and payments

Due to the introduction of foreign trade, businessmen can import and export goods and
services in the global market. Financial transactions related to import and export are
managed through banks.

6. Remittance of money
The development of the banking system also facilitates for the remittance of money. People
send and receive money from different parts of the world only because of a good banking
system.

7. To meet government expenditures

In developing countries like Nepal, the development expenditure of the government is more
than the revenue collected. So, the excess amount borrowed from various sources and the
bank is one of them.

8.Poverty alleviation
Banks create different types of direct and indirect employment. They also facilitate credit to
invest in production. This helps in poverty reduction in the country.

CLASSIFICATION OF BANKS
1. Central bank
There is one central bank in each country. The name of the central bank of Nepal I’d Nepal
Rastra bank which was established on 14th Baisakh, 2013 B.S.

2. Commercial bank
A commercial bank is established to earn a profit. The oldest commercial bank of Nepal is
Nepal bank limited. There are altogether 20 commercial banks in Nepal.

3. Development banks
Development banks mostly invest in long term development activities. There are 17
development Bank in Nepal.

4. Saving bank
Saving banks are established to facilitate deposit in remote areas.
5. Exchange bank
Exchange bank is established to operate a foreign exchange in the country. There is no such
bank in Nepal.

6. Rural Development Bank

Rural development banks are established in order to uplift the living standard of poor people
who are engaged in agriculture. This bank provides a loan at a very low rate of interest.

CENTRAL BANK
The central bank is the supreme bank of a country. It is the monetary authority. It is the
apex for monetary and banking structure of the country. In every nation, a central bank is
established in order to arrange for the circulation of currency throughout the country, develop
the financial sector and stability in the exchange rate. Nepal Rastra Bank is the central bank
of Nepal which was established on 14th Baisakh 2013 B.S. It is because of the banker of the
banks which keeps the cash revenue of commercial banks.

FUNCTIONS OF THE CENTRAL BANK

1. The monopoly of note issue
The primary function of a central bank is to issue notes in the country. It has the monopoly
right of issuing bank notes subject to certain safeguard (deposits of gold and silver) imposed
by the law. In Nepal, Nepal Rastra bank issues the notes under proportional revenue system.

2. Government’s banker, agent and advisor

Central bank fulfills the function of bankers, agent, and advisor of the government. The
central bank maintains the banking account of government departments, boards enterprises,
etc. The government purchases securities like treasury bills and sells it through the central
bank. It advises the government to formulate monetary and fiscal policies in the country.

3. Bank of all banks

The central bank is also called the bank of banks of the country. It keeps the cash reserve of
commercial banks. All the commercial banks and other banks have their account in the
central bank. So, it performs as a bankers bank.

4. Lender of the last resort

The central bank is the lender of last resort. It is the ultimate source of funding of
commercial banks. During the hard times of commercial banks, central bank advances loans
to a commercial bank.

5. Provides clearing house facilities

The central bank also acts as the shelter of financial claims of a bank against others. Each
commercial bank maintains its bank in the central bank. The central bank clears each other's
claims of their respective accounts.
6. Custodian of the foreign currency and Metallic reserve
The central bank is the custodian of the national reserves of foreign currencies. It keeps and
manages the foreign exchange reserve of the country. It purchases and sells foreign on behalf
of the government. It is the custodian of metallic reserves like gold, silver, and other
expensive metals.

7. Control of credit
Credit control refers to the arrangement of credit according to the requirement of the
economy. The central bank controls credit by using credit control instruments such as open
market operation, changes in the statutory reserve requirement of banks, bank rate policy,
control over interest, etc.

8. Foreign exchange control

The central bank of any country holds the absolute right to regulate and control foreign
exchange operations. The foreign exchange rate is determined with the help of demand for
and supply of the foreign currencies under flexible exchange system. Likewise, the exchange
rate Is determined with a mutual agreement under the fixed as exchange regime of system.

9. Development function
A. Publication of rate and information

B. Helps to develop the money market and capital market by providing guidance, regulation,
supervision, and monitoring

C. Promotion of agriculture sector

D. Promotion of trade sector

E. Promotion of individual sector

F. To achieve high and sustainable economic growth

G. Reducing poverty

H. Maintain relation with international financial institutions.

COMMERCIAL BANK
A commercial bank is an institution that provides services such as accepting deposits,
providing business loans, offering basic investment products (money), etc. Commercial
banks also refer to a bank or a division of large banks which more specifically deals with
deposits and loan services provided to a corporation or large or middle size business.
Commercial banks are generally established with a profit motive to finance the commercial
sector of the country.
The first commercial bank in Nepal (First bank in Nepal), Nepal bank limited was
established in the year 1994 B.S. This Is a major milestone in the history of Nepal as the
country entered into the official financial system after its establishment. A commercial bank
performs various functions like accepting money, lending, inter-financial institution
relationship, cash management, treasury management, processing payments, etc.

FUNCTION OF A COMMERCIAL BANK:

A. Primary functions
1. Accepting deposits
The first important function of a commercial bank is to accept deposits in different accounts.
The main forms of deposits accepted by the commercial banks are as follows:

a. Demand deposit
A demand deposit is also known as the current account deposit. It is generally maintenance
by traders and businessman who have to make a number of payments every day.

b. Saving deposit
This account is generally maintained by the low-income people and those who do not need to
withdraw money frequently. There are certain restrictions of time and frequency while
withdrawing from this deposit.

c. Fixed deposit
Fixed deposits are also known as time deposits. In this account, money is deposited for a
fixed period of time and can not be withdrawn until the maturity period. The interest rate is
very high in this deposit.

2. Providing loans
The banks earn profit by giving the amount deposited in it in the form of loans. Since the
bank creates credit with its deposits, it is called the manufacturer of credit. The bank charges
interest on loans which is usually higher than that offered on deposits. The main forms of
loans provided by commercial banks are as follows:
a. Cash credit
It is a type of loan which is given to borrower against his/her current assets such as shares,
stocks, bonds, etc loans are also provided on the basis of security deposit.

b. Overdraft
Sometimes the commercial banks provide overdraft facilities to its customers through which
they are allowed to withdraw more than their deposits. Interest is charged to the customers on
the overdrawn amount.

c. Loans and advances

These are generally long term loans which are provided by the bank to individuals and
institutions against adequate securities like gold, silver, government and non-government
securities that are easily traded, etc.

d. Call loans
Such loans are very short period loans. They are given for some days or weeks. Higher rate
of interest is charged on such loans.

B. Secondary function/ Agency functions

Commercial banks collect and pay various credit instruments like cheques, bills of exchange,
promissory note, etc.
1. Remittance of money
Commercial bank helps its customers in transferring money from one place to another
through cheques, draft, etc.

2. Purchase and sale of securities

Commercial banks undertake functions like purchase and sale of various securities on behalf
of their customers.

3. Income receiving and payment

Commercial banks receive dividends, interest on shares and debentures of their customers.
Similarly, they make the payment of insurance premium, rent, income tax periodically.
4. Acting as trustee and Executor
Commercial banks preserve the wills of their customers and execute them after their death.

C. Contingent Function
The contingent function is also called a general utility function. The contingent functions are
as follows:
1. Locker facility
The commercial bank provides the locker facility to its customers. The customers keep their
valuable things like gold, diamond, silver, etc and important documents in the locker for
safety.

2. Traveler’s cheque
Commercial banks issue traveler’s cheque to their customers to help travel without fear of
loss of money.

3. Letter of credit
Letter of credit is issued by the banks to their customers certifying their credit worthiness. It
is very useful in foreign trade.

4.Dealing in foreign exchange

Commercial banks exchange foreign currency of customers with prior approval of the central
bank.

5. Collection of statistics
Commercial banks collect statistics giving important information relating to industry, trade,
and commerce and also publish financial journals.

FINANCIAL MARKET
The market where financial instruments are traded is called financial market. The financial
instruments like a bond, stock, insurance policy, government securities, debentures, etc are
traded in the financial market. It is the brain of the entire economic system. There are two
types of the financial market which are as follows:

A. MONEY MARKET
The market where short-term financial instrument is traded is called the money market. In
this market, the maturity period of the financial instruments is less than one year. For
example, treasury bills, commercial papers, certificates of deposits, etc.

According to the World Bank,” Money market is the market in which short term securities
such as treasury bill, certificate of deposit and commercial bills are traded.”

FEATURES:
1. The maturity period of less than one year is accounted for in the money market.

2. The credit instruments are short term in nature.

3. The institution involved in the money market is a central bank, commercial bank, bill
brokers, etc.

4. Money market generally meets the short term credit needs of the business.

5. The degree of risk is small in the money market because the maturity period is less than
one year.

6. The money market is directly linked with the central bank of the country.

B. CAPITAL MARKET
The market where long term financial instruments are traded is called capital market. This
market makes the fund available for long term investment. For example, for purchasing
capital equipment, fixed assets, power plant, construction of factory building.

According to the World Bank,” Capital market is the market in which long term
financial instruments such as equities and bonds are raised and traded.”

FEATURES:
1. The maturity period is more than one year.
2. The main instruments of capital market are debenture, shares, government securities, etc
which are of long-term nature.
3. The institution involved in the capital market is a stock exchange, development banks,
finance companies, provident fund.
4. The capital market means the long-term credit requirement of the business.
5. There is a higher risk in the capital market because of longer maturity period.
6. There is no close relationship between the central bank and capital market.
Difference between Money Market and Capital Market
Basis Money market Capital market
The money market is the market in Capital market is the market in
which short term securities such as which long term financial
treasury bill, certificate of deposits instruments such as equities and
Meaning and commercial bills are traded bond are raised and traded.
The maturity period is less than The maturity period is more
Maturity period one year is accounted for. than one year.
The credit instruments are short
term in nature such as treasury Its a credit instrument is
bills, commercial paper, certificate debenture, shares, and
Credit instruments of deposit, etc government securities, etc.
The institution involved in the The institution involved in it are
money market are central bank stock exchange development
Institution commercial banks, bill brokers, etc banks, finance companies
Its the purpose of the short term in Its the purpose for the long term
Purpose of loan nature. in nature.
risk The degree of risk is small in it The degree of risk is higher in it.
Relation with the It is directly linked with the central It has no close relationship with
central bank. bank the central bank

MEANING OF MONETARY POLICY

Monetary policy is defined as the policy formulated by the central bank of a country to
control and regulate the money supply. In other words, monetary policy is concerned with
the management of the money supply in an economy. Monetary policy is formulated and
implemented by the central bank. Since 'Nepal Rastra Bank' is the Central Bank of Nepal, it
formulates and implements monetary policy in Nepal. The definition of monetary policy
given by notable economists are as follows:
According to N.G. Mankiw, "Monetary policy is the setting of the money supply by
policymakers in the central bank."
In the view of Edward Shapiro, "Monetary policy is concerned with government's attempt
to provide more stable economy by regulating the rate of growth of the money supply."
Monetary policy is one of the important macroeconomic policies. It is practiced by the
monetary authority or central bank to achieve predetermined objectives through the changes
in money supply, credit, and interest rate in the economy. The main objectives of monetary
policy are as follows:
 • Generate employment opportunities
• Price stability (controlling inflation and deflation)
• Achieve a higher economic growth rate
• Achieve a favorable balance of payment
• Exchange rate stability
• Reduce trade deficit
• Reduce poverty and economic inequality
• Development of banking and financial institutions.

TYPES OF MONETARY POLICY

There are two types of monetary policies which are explained as follows:

I. EXPANSIONARY MONETARY POLICY:

An expansionary monetary policy is an action taken by the central bank to increase the
money supply. The central bank can use its tools, individually or collectively to expand the
supply of money. The central bank can purchase treasury bills and bonds in the open market,
decrease the bank rate or discount rate and reduce the required reserve ratio to increase the
money supply in the economy. The expansionary monetary policy is formulated during the
economic depression and deflationary period.

II. CONTRACTIONARY MONETARY POLICY:

Contractionary monetary policy is the opposite of expansionary monetary policy. It is an action
taken by the central bank to decrease the money supply. Central Bank can use its tools,
individually or collectively to decrease the supply of money. The central bank can sell treasury
bills and bonds in the open market, increase the bank rate or discount rate and increase the
required reserve ratio to decrease the money supply in the economy. The contractionary
monetary policy is formulated during the inflationary period.

STATUS OF COMMERCIAL AND DEVELOPMENT BANKS IN NEPAL

In Nepal, the financial sector has been expanding rapidly in recent years. Access to the
banking sector is increasing throughout the country. Financial services are being rural-
oriented and based on information technology. The share of bad loans is the lowest in South
Asia. Due to the effective implementation and improvement of the policy for the
development of the financial sector, access to finance has been increasing and financial
transactions are also expanding rapidly. Up to mid-March 2021, a total number of 139 banks
and financial institutions are in operation including 20 commercial banks, 17 development
banks, 17 finance companies, 57 microfinance companies, and 1 infrastructure development
bank.
The branch expansion of banks and financial institutions has progressed significantly in
recent years. There are altogether 10,430 branches of banks and financial institutions.
Bagmati province has the largest number of branches, i.e., 2,677, and Karnali province has
the lowest number of branches, i.e., 406.
The province-wise branches of commercial banks and development banks are given in the
table below:
Table: Status of commercial and development banks in Nepal

The table shows the province-wise distribution of branches of commercial banks and
development banks in Nepal. There is a total of 4,632 branches of 20 commercial banks in
Nepal. Among them, the highest number of branches are in the Bagmati province while the
lowest number of branches are in Karnali province. In the Bagmati zone, there are 35.42
percent branches of commercial banks, while in the Karnali province, there are only 4.12
percent branches of commercial banks. It shows that there is a highly unequal distribution of
branches of commercial banks in Nepal. On the other hand, there are 1,069 branches of 17
development banks in Nepal.

The highest number of branches of development banks are also in Bagmati province. The total
number of branches of development banks in Bagmati province is 293. It is 27.40 percent of
the total. The lowest number of branches of development banks are also in Karnali province.
It is 1.59 percent of the total. The province-wise distribution of branches of development banks
is also highly unequal. It is clear that most of the branches of both commercial banks and
development banks are concentrated in the Bagmati province.