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Banking Operations and Management

WHAT IS BANKING? WHY IS IT ESSENTIAL FOR A NATION? DISCUSS BANKING ENVIRONMENT IN PAKISTAN.

Adeel Sajjad MBA (Evening) 2nd Semester Karachi University Business School

What is Banking
Banking system is a crucial component of the global economy accounting for trillions in assets worldwide. Banks are just one part of the world of financial institutions, standing alongside investment banks, insurance companies, finance companies, investment managers and other companies that profit from the creation and flow of money. As financial intermediaries, banks stand between depositors who supply capital and borrowers who demand capital. Given the importance in economy and individual wealth that rests on banks, it is also among the most stringently regulated businesses in the world.

Basic Functions:

Accept Deposits / Make Loans


At the fundamental level banks accept deposits from customers, raise capital from investors or lenders and then use that money to make loans, buy securities and provide other financial services to customers. These loans are then used by individuals and organizations to expand their operations, which in turn leads to more deposited funds that make their way to banks.

Provide Safety
Banks also provide security and convenience to their customers. At inception, part of the primary purpose of banks was to offer customers security for their money. This was back in a time when an individual's wealth consisted of actual gold and silver coins, but to a large extent this function is still relevant. With banks, consumers no longer need to keep large amounts of currency on hand; transactions can be treated with checks, debit cards or credit cards, instead. Many banks maintain vaults and rent out space to customers, in the form of safe deposit boxes with subsidiary services.

Act as Payment Agents


Banks also serve as payment agents within a country and between nations. Not only does banks issue debit cards that allow account holders to pay for goods with the swipe of a card, they can also arrange wire transfers with other institutions. Banks underwrite financial transactions by lending their reputation and credibility to the transaction in the form of banking instruments such as checks, pay orders, demand draft etc. As payment agents, banks make commercial transactions much more convenient.

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Why is it Essential for a Nation


Role of Banks in an Economy:

Settle Payments
Every day there are millions of financial transactions through banking channel, some conducted with paper currency, but countless done with checks, wire transfers and various types of electronic payments. Banks play a valuable role in the settling these payments, ensuring that proper accounts are credited or debited, in the proper amounts and with relatively little delay.

Credit Intermediation
Banks play a major role as financial intermediaries. Banks collect money from depositors, in essence borrowing the money, and then concurrently lending it to other borrowers, generating a chain of debts.

Maturity Transformation
Maturity transformation is fundamental to what banks do on daily basis. Many investors are willing to invest on short term basis, but several projects require long-term financial commitments. What banks do is borrow short-term, in the form of demand deposits and shortterm certificates of deposit, but lend long-term. By doing this, banks transform debts with very short maturities (deposits) into credits with very long maturities (loans), and collect the difference in the rates as profit. However, they are also exposed to the risk that short-term funding costs may rise much faster than they can recoup through lending.

Money Creation
One of the most vital roles of banks is in money creation achieved through fractional reserve banking. In this system only a fraction of bank deposits are backed by actual cash-on-hand and are available for withdrawal. This is done to expand the economy by freeing up capital that can be loaned out to other parties.

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Discuss Banking Environment in Pakistan


The Banking sector is an integral part of the countrys financial services industry. In Pakistan, the sector witnessed sustained growth in 2012-13. Competition is relatively high, especially after the challenging capital adequacy benchmarks set by the State Bank of Pakistan to nourish a stable banking system. Attracting foreign investment and winning profitable customers are the only options left to banks for survival. A significant shift of focus from industrial lending to consumer products has allowed the banks to enjoy enormous spreads. The banking sector has now diversified its product base and carried out a lot of innovation. They have expanded their outreach to agriculture, SMEs, mortgage financing and consumer financing. Not only that this diversified lending portfolio mitigates risks but it also raises the purchasing power of a large segment of population that was completely shut out from credit markets.

Pakistans Banking Sector can be classified under following broad categories


Category State Bank of Pakistan Nationalized Scheduled Banks Description Central Bank and the Autonomous and Governing Body for all banking operations in the country. These deal primarily in industries of banking and capital markets. They offer a host of unique policies, banking training, services and products which include loans, credit cards, savings and consumer banking. Banks engage in channeling funds from depositors to lenders against the primary objective of acquiring profit i.e. Bank Spread. These concentrate primarily on International Trade Finance, Innovative Credit Orientation and Plastic Money. Investment Banks act as underwriter or agent serving as intermediary between an issuer of securities and the investing public. These banks are created with specific interest thus specializing and catering to a particular sector industry.

Private Scheduled Banks

Foreign Banks Development/ Cooperative/ Investment Banks Specialized Banks

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Role of Central Bank


Like a Central Bank in any developing country, State Bank of Pakistan (SBP) performs both traditional and development functions to achieve macro-economic goals. The traditional functions, which are generally performed by central banks all over the world, may be classified into two groups: a) Primary functions: include issue of notes, regulation and supervision of the financial system, bankers bank, lender of the last resort, banker to Government, and conduct of monetary policy b) Secondary functions: include the agency functions like management of public debt, management of foreign exchange, etc. Other functions like advising the government on policy matters and maintaining close relationships with international financial institutions. The non-traditional or promotional functions, performed by the State Bank include development of financial framework, institutionalization of savings and investment, provision of training facilities to bankers, and provision of credit to priority sectors. The State Bank has also been playing an active part in the process of islamization of the banking system.

Current Scenario and Recent Developments

Risk Management System


Currently Banks are in implementation phase of new Capital Accord (Basel II) whereby capital adequacy requirements have been made more risk-oriented by linking capital to operational risk and changing the risk measurement approaches for credit and market risks. However, due to present risk management systems in Pakistan at primary stage, its implementation is going to be challenging. Similarly, the banking institutions are also required to carry out stress testing, a technique used around the globe by financial institutions to assess risk exposures across the institution and to estimate the changes in the value of the portfolio, if exposed to various risk factors. Initially, SBP has advised banks to carry out the simple sensitivity analysis keeping in the view the varying levels of skill and available resources among banks; however, going forward more sophisticated techniques will be adopted.

Financing Infrastructure Development


In Pakistan, the conventional form of financing infrastructure projects only through Public Sector Development Program has resulted in congestions and bottlenecks that have raised the need to find alternative way of fostering private-public partnership in the areas of infrastructure development. After success of private sector in infrastructure development, local banking industry is undertaking different modes of infrastructure financing and the associated risk management systems.

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Development of Liability Products


It should be noted that although new products have been introduced in preceding three years on asset side including consumer finance, SME finance, etc.; little attention has been given to developing and innovating the liability products. The stagnant financial savings in the economy for last few years is an outcome of this neglect and this has raised the need to design the lucrative savings products in the country so as to look after the interest of the small savers and mobilize their savings in an efficient way. Initiative in this regard, taken by NBFIs in recent past is gradually making its way to banking sector as well.

E-Banking
Small and medium banks are now offering on-line services to their customers. Large banks with more expanded branch network and number of customers are moving expeditiously, optimally utilizing the E-banking network. The ATM penetration ratio is still quite low in Pakistan and the efforts are needed to not only further expand the ATM network more aggressively but also to improve upon the security standards.

Islamic Banking
Islamic banking is emerging in Pakistans banking system. More and more banks are seeking license to commence Islamic banking operations. At present five full fledged Islamic banks are operating in Pakistan and 14 which operate Islamic window. A number of conventional banks aim to grow or spin off their existing Islamic windows, while new entrants are expected. However, 56 per cent of the Islamic industry's 1,161 branches are in the five largest cities, leaving smaller cities underserved. Islamic Banking is in the development phase and significant growth in guidance of SBP is anticipated in this sector in near future.

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