Chapter 1

Introduction of the Business Sector

1.1 Overview of Banking: There are different opinions that how the word Bank originated. Some of the authors opinion that this word is derived from the word Bancus or Banque, which means a bench. The explanation of this origin is attributed to the fact that the Jews in Lombard transacted the business of money exchange on benches in the market place; and when the business failed, the people destroyed the bench. Incidentally the word Bankrupts said to have evolved from this practice. Mankind has always been seeking security and protection. In fact he felt the need of bank when it began to realize the importance of money as a medium of exchange. This need has led him to scientific and technological development on one hand and banking development on the other. In modern times the banking has become so necessary that if is excluded from any economic system the whole business and economic world will collapse. Finance is now the life blood of trade, commerce and industry and banking sector acts as the backbone of modern business.

1.2 Evolution of Banking: Human felt the need of bank when it begins to realize the importance of money as a medium of exchange. Perhaps it where the Babylonian developed banking system as early as 2000 BC. At that time temples were used as banks because of their prevalent respect. During the rule of king Hamurabi(1788 1686 BC) the founder of Babylonians Empire, loans were started being granted for interest. The borrower had to provide guarantee or he had to pledge his goods or valuables. King Hamurabi drew up a code wherein he laid down standards rules for procedures for banking operations by temples and great landowners. Also in Greece, the temples were used as banks, where the people deposited their money and other valuables for safe custody and security. In Europe with the revival of civilization (Renaissance) in the middle of twelve century, trade and commerce started expanding and this development compelled the business community to borrow the money from the Hebrew money lenders on high rates of interest and usury. Seeing the great demand, these moneylenders started organizing themselves and bank started up at the principle seaports of southern Europe. Soon Venice and Geneva became the most important money markets of the time and banking though different from its present form, flourished. What we know as modern banking originated in the 14th century in Barcelona.

Chapter 1

1.2.1 Definitions of Bank: Bank "A financial institution which deals with money and credit. It accepts Deposits from individuals, firms and companies at a lower rate of Interest and gives at higher rate of interest to those who need them.2. A financial establishment which uses money deposited by customers for investment, pays it out when required, makes loan at interest, exchanges currency, etc. J.W Gilbert in his principles and practice banking defines a banker in these words: A banker is dealer in capital or more properly, a dealer in money. He is intermediate party between the borrower and the lender. He borrows of one and lends to another.3 The American defined the term banker in a very broad sense as under: By banking, we mean the business of dealing in credits and by a Bank we include every person, firm or company having a place of business where credits are opened by deposits of collection of money or currency. Subjects to be paid or remitted on Cheques or order, money is advanced or loaned on stocks, bonds, bullion, bill of exchange, promissory notes are received for discount or sale.

1.2.2 Evolution of Banking in Pakistan The first phase in evolution of banking in Pakistan sees very hard days for the whole banking sector. Starting virtually from scratch in 1947, the country today possesses a full range of banking and financial institutions to cope with various needs of the economy. The area now constituting Pakistan was, relatively speaking, fairly well provided with banking facilities in undivided India, in March 1947 there were 3496 offices of Indian scheduled banks out of which as many as 487 were situated in territories now constituting Pakistan. 2

Chapter 1 The Reserve bank of India was the central banking authority in India. At the time of partition it was decided that in the interest of smooth transition it should continue to function in newly emerging state of Pakistan, until 30th Sep.1948. In 1947 due to uncertainty and unsuitability the banking sector suffer heavy losses. This resulted in a negative effect on baking service in Pakistan. The banks, which had their registered offices in Pakistan, transferred them to India. In an effort to bring about the collapse of the new state by pushing a deliberate policy of withdrawals the Indian bank offices closed quickly. Those banks, which stayed, operated only in name pending the winding up of their business. The number of scheduled banks thus declined form 487 branches before independence to only 195 branches by 30th June1948.5

1.2.3 Banking Growth during (1948-1970) In this tense situation, a committee was immediately setup to formulate a scheme of central banking legislation for Pakistan. Many specialists were of the opinion that in view of the acute shortage of trained staff, any idea of establishing a central bank was I impractical and the best that could be attempted was the setting up of a currency board until such times as sufficient staff could be organize to operate a central bank. The questions as to whether the institution should be only a currency board or a full-fledged central bank had exercised the mind of the Pakistan government since independence. Through, it was realized that the shortage of trained personal to run the central bank would present serious difficulty in view of the tangible advantages that a central bank enjoyed over currency board, the government ultimately decided to take the bold step of setting up a fully fledged central banking authority. Among other factors, which led to this decision, there was the fact the banking facilities in the country had been totally disrupted and there was an urgent need for their rehabilitation, which a central bank alone could meet. As there was hardly any time to pass as Act, an order was drafted, known as the state bank of Pakistan order, which was promulgated by the government of Pakistan on 12th may 1948. The state bank declared open on July 1, 1948 by the father of the nation. 1.2.4 Banking Reforms 1972 After the assumption of office by a new government in 1971, May 1972 different reforms were introduced to make the banks more responsive to the requirements of economics growth with social justice. The reforms aimed at bringing about a more purposeful and equitable distribution of bank credit, improving the 3

Chapter 1 soundness and efficiency of the banks, and securing greater social accountability of the banking system as a whole. The role of the banking system had been truly spectacular in mobilizing savings of the community and meeting the credit needs of the economy. But at the same time, the banks had generally neglected their role in promoting social justice and had failed to play an effective role in ensuring a wider and more equitable dispersal of the benefits of economic growth. In particular the inter locking of ownership with commercial and industrial interests had led to the misuse of bank resources. There was a heavy concentration of credit in big accounts and in urban area. Credit facilities for agriculture, small business, newly emerging exports and housing had remained obviously inadequate while the banks indulged in capital financing in few selected business sectors and issued guarantees on behalf of favored clients, term clients, term financing facilities for industry were wholly absent. Under the banking reforms introduced in May 1972 the state bank of Pakistan was accorded wider powers. It was authorized to remove directors or managerial personnel, if necessary and supersede the board of directors of a banking company and appoint administrators during the period of such super session. It was also empowered to nominate directors on the board of every bank. As regard bank directors, it was provided that anyone defaulting in meeting his obligations to bank would forfeit his directorship. Moreover, it was laid down that no person could serve as director of a bank for more than six years continuously. Each bank was required to have a paid up capital of not less than 5 percentage of its deposits to be progressively build up to 10 percent over a period of time. The banks were also required to transfer 10 percentage of their profit their reserves every years after the reserve became equal to the paid up capital. With a view to diversity the ownership of the banks, the banks were required to raise new capital from the market. Unsecured loans to directors, their families or firms and companies, were totally prohibited. The bank reforms also brought about the establishment of new institutions to achieve new objectives.