INTRODUCTION TO BANKING

AND FINANCE

Lecturer:
Abdinasir Ahmed Ali (BIT, MFB, )

Email:/FB [email protected]

Tell: 0615024949

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Chapter five

Theory of central banking

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 Learning objectives

 To understand the crucial role of central

banks in the financial sector

 To describe the main functions of the

central bank

 To understand the monetary policy

functions of central banks

To discuss the arguments for and against

an independent central bank
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 5.1 Introduction

The core functions of central banks in

any countries are: to manage
monetary policy with the aim of
achieving price stability; to prevent
liquidity crises, situations of money
market disorders and financial crises;
and to ensure the smooth functioning
of the payments system.

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5.2 What are the main functions
of a central bank?

A central bank can generally be defined as a

financial institution responsible for overseeing the
monetary system for a nation, or a group of nations,
with the goal of fostering economic growth without
inflation

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 Continue….
 The central bank controls the issue of notes and coins
(legal tender).
It has the power to control the amount of credit-money
created by banks.
A central bank should also have some control over non-
bank financial intermediaries that provide credit
Encompassing both parts 2 and 3, the central bank should
effectively use the relevant
tools and instruments of monetary policy in order to
control:
a) credit expansion;
b) liquidity; and
c) the money supply of an economy
The central bank should oversee the financial sector in
order to prevent crises and act as a lender-of-last-resort
A central bank acts as the government’s banker
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 Functions of Central Bank

Central Bank

Traditional Non-Traditional
Functions Functions

Primary Secondary
Functions Functions

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 Functions of Central Bank
• Traditional Functions : Which are generally
performed by central banks all over the world,
are classified into two groups;
– Primary Functions: including issue of notes,
regulation of financial system, and conduct of
monetary policy
– Secondary Functions: including management of
public debt, management of foreign exchange,
advising the government on policy matters, and
maintaining close relationships with the
international financial institutions
• Non-Traditional Functions: these functions are
performed by the State Bank include
development of financial frame work,
provision of training facilities to bankers, and
provision of credit to priority sectors. 1-8
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 Primary Functions

• Sole authority to issue notes

• Issue Department
– Karachi, Lahore, Peshawar, Quetta
• Banking Department
• Conduct of monitory policy & credit policy
• Supervision of financial system
• Banker’s Bank
– Services to the scheduled banks
• Reserves of scheduled banks
• Demand & time liabilities of scheduled banks
• Excess reserves
• Clearing House
• Remittance Facility at concessional rates
• Banker to Government
• Lender of the last Resort
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 Secondary Functions

• Public Debt Management

– Subscribing federal and provisional govt. securities at the
time of their issue
– Sale/purchase and interest payments of prize bonds &some
saving schemes
• Management of foreign Exchange
• Foreign Exchange Reserves
• Foreign Exchange control
• Foreign Exchange Rate Stability
• Advisor to Government
• Help in monetary policy, Economic & Foreign exchange policy,
fiscal policy (imports & exports)
• Relationship with international Financial Institutions
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 Non-Traditional Functions

• Development of the Banking System

• Training facilities to Bankers
• Institute of Bankers
• Training Department
• Development of specialized Financial
Institutions.
• Credit to priority sectors
• Credit for agriculture
• Export Finance Scheme

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 5.3 How does monetary policy
work?

There are five major forms of economic policy (or,

more strictly macroeconomic policy) conducted by
governments that are of relevance,

Monetary policy;
fiscal policy;
exchange rate policy;
prices and incomes policy;
and national debt
management policy.

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1. Monetary policy is concerned with the
actions taken by central banks to influence
the availability and cost of money and
credit by controlling some measure (or
measures) of the money supply and/or the
level and structure of interest rates.
2. Fiscal policy relates to changes in the
level and structure of government
spending and taxation designed to
influence the economy
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Exchange rate policy involves the targeting of
a particular value of a country’s currency
exchange rate thereby influencing the flows
within the balance of payments.
In some countries it may be used in conjunction
with other measures such as exchange controls,
import tariffs and quotas

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 Continue….

Arranging deals in investments and arranging

regulated mortgage activities
 Advising on regulated mortgage contracts
 Entering into and administering a regulated
mortgage contract
 Establishing and managing collective investment
schemes (for example investment funds and mutual
funds)
 Establishing and managing pension schemes
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 2.3 Banking services

Modern banks offer a wide range of financial

services, including:

 Payment services
 Deposit and lending services
 Investment, pensions and insurance
services
 E-banking

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 2.3.1 Payment services

A payment system can be defined as any organized

arrangement for transferring value between its
participants
These payment flows reflect a variety of transactions:
for goods and services as well as financial assets.

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 Types of cashless payments

Cheques are widely used as a means of payment for goods and

services.
Cheque payments are known as debit transfers because they are
written requests to debit the payee’s account.

Credit transfers (or Bank Giro Credits) are payment where the
customer instructs their bank to transfer funds directly to the
beneficiary's bank account.
Consumers use bank giro transfer payments to pay invoices or to
send payment in advance for products ordered.

Standing orders are instructions from the customer(accountholder)

to the bank to pay a fixed amount at regular intervals into the
account of another individual or company

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 Continue…….

Plastic cards : include credit cards, debit cards,

cheque guarantee cards,travel and entertainment
cards, shop cards and ‘smart’ or ‘chip’ cards.

plastic cards do not act themselves as a payment

mechanism – they help to identify the customers and
assist in creating either a paper or electronic payment.

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 Credit cards
Credit cards provide holders with a pre-arranged credit
limit to use for purchases at retail stores and other
outlets.

The retailer pays the credit card company a commission

on every sale made via credit cards and the consumer
obtains free credit if the bill is paid off before a certain
date.

If the bill is not fully paid off then it attracts interest.

Visa and MasterCard are the two most important bank-

owned credit card organizations.
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 Debit cards Cheque guarantee
cards
Debit cards are issued directly by banks and allow customers to
withdraw money from their accounts. They can also be used to
obtain cash and other information when used through automated
teller machines (ATMs).

Cheque guarantee cards were first introduced because of

retailers’ reluctance to accept personal cheques.

Travel and entertainment cards (or charge cards) provide

payment facilities and allow repayment to be deferred until the end
of the month, but they do not provide interest-free credit.
Unlike credit cards, all bills have to be repaid at the end of the
month and no rollover is allowed.

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 2.3.2 Deposit and lending services

Current or checking accounts that typically pay no (or

low) rates of interest and are used mainly for payments.

Time or savings deposits that involve depositing funds

for a set period of time for a pre-determined or variable
rate of interest.

Banks offer an extensive range of such savings products,

from standard fixed term and fixed deposit rate to
variable term with variable rates.

Typically deposits that can be withdrawn on demand pay lower

rates than those deposited in the bank for a set period.
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Consumer loans and mortgages are
commonly offered by Consumer loans can be
unsecured (that is no collateral is requested;
banks to their retail customers.

such loans are usually up to a certain amount of money

and for a short to medium time period: up to £25,000
and repaid over five years UK)

secured on property (typically from £20,000 to £100,000

and repaid over ten years in the UK)

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2.3.3 Investment, pensions and
insurance services

Investment products offered to retail

customers include various securities
related products including mutual funds
(known as unit trusts in the UK),

Investment in company stocks and various

other securities-related products (such as
savings bonds).

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 Pensions and insurance services

Pensions are nowadays widely offered by many banks.

Pension services provide retirement income (in
the form of annuities) to those contributing to
pension plans.

Contributions paid into the pension fund are

invested in long-term investments with the
individual making contributions receiving a
pension on retirement.
.

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 Insurance products
Insurance products protect individuals (policyholders)
from various adverse events. Policyholders pay
regular premiums and the insurer promises
compensation if the specific insured event occurs.

There are two main types of insurance – life insurance

and general (or property and casualty) insurance.

• It includes home, travel, medical, auto and various

other types of insurance.

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 2.3.4 E-banking

 E-money includes reloadable electronic money

instruments in the form of stored value cards and
electronic tokens stored in computer memory.

 Remote payments are payment instruments that

allow (remote) access to a customer’s account.

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 Figure 2.2 A definition of e-banking

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2.4 Current issues in banking

 Structural and conduct deregulation

 Supervisory re-regulation
 Competition
 Financial innovation and the adoption of new
technologies

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2.5 Responses to the forces of change

• Mergers and Acquisitions

• Conglomeration
• Globalization
• Disintermediation
• securitization

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Revision questions and problems

1 What is a deposit-taking institution?

2 Define a payment system.
Describe the main characteristics of different types of plastic
cards.
4 What is e-banking?
5 What are the main forces that generate trends in the
banking sector?
6 Outline the differences between deregulation and re-
regulation of the banking
sector.
7 What are the most common motives for M&As?
8 Define the disintermediation process. 1-31
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 THANK YOU

See you next week IN SHA ALLAH

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