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Role of Central Banks in Economic Development

By Muhammad Munir Ahmed President Institute of Banking and Business Learning(IBBL) Ex- Chief Manager, SBP Lahore
3/26/13

Commercial Banks-Brief History


Banks came first- about 200 years there was no central banks and commercial banks faced the following three major self contradicting problems as under : 1. Liquidity 2. Solvency 3. Profitability Working of banks was vulnerable to crisis as every banks was competing with each other.
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Commercial

Evolution of Central Banking


Issuance of note was another problem because every bank issued its own notes which used to depreciate in case of some problems with the banks concerned. Since every commercial bank was working with the prime objective of Maximizing of Profit there was no institutional help which used to lead to used to crisis and bank failures. This warranted for establishing a non-profit earning banking institution so as to discipline the activities of self competing commercial banks. Thus in every banking system there is centeral bank responsible for ensuring a sound banking system consistent with the national objective and priorities. Central banks were given the Monopoly of Note issuance and the Role of Lender of the last Resort for banks in trouble- the traditional functions of every central bank around the globe.

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What Central Banks Can Do?


is controversy among Economists about the role central banks could play effectively Increase in output Enhancement in Employment Maintenance of Price Stability Above three manifestations of Economic Development are self competing- It is argued that central banks are better suited for ensuring Price Stability in the economy 3/26/13
There

Functions of Central Banks


Functions

of central banks differ in developed and developing countries depending upon the level of economic development. In market-based highly developed economies, central banks are responsible only for ensuring Price Stability. They are to maintain the price increase(Inflation) in a given range, and accountable in case of non achievement. They work in a market-based environment, no interference from Government, No Debt Management for the Government.
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Central Banks in Developing Countries


Provide a variety of functions as under: Ensuring Price Stability Balanced Growth in the Economy Fuller utilization of Economic resources Working as Debt Manager of the Government Central Bank of Pakistan(SBP) falls under this category.

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Role of SBP in Pakistans Economy


Established on Ist July,1948- about eleven months after IndependenceA unique situation one central bank for two countries who were arch enemies to each other First ten years were spent in re-hablitation of normal banking activities disrupted in the wake of partition of the Sub-Continent In 1959, Credit Inquiry Commission was established to see the flow of credit to different sectors of the economy. The Commission recommended that bank credit needs to be diverted towards Small and Medium Enterprises(SMEs) in all sectors. These recommendations were adopted in 1972-73 and SBP put in place three schemes(1) Export Finance Scheme (2) Scheme for Production Loans and (3)Scheme for Locally Manufactured Machinery under subsidisized lending rates. Since then diverting flow of available bank credit to Priority Sectors has been the main objective of Monetary of SBP.

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Misutilisation of SBP Schemes


These

schemes became vehicle for Misutilisation of credit by influential persons in agriculture and industry in the Mid- Eighties and were discontinued in Nineties. In Nineties, all banks went into Red-Loss Incurring and SBP started Financial Sector Reforms with active collaboration of IMF and World Bank- a popular discussion point for common day discussion. SBP also became autonomous. SBP started a merit-based/ market- based banking system in the 21st century which is now one decade old.
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Achievements of SBP
During

the last 63 years SBP emerged as a credible institution in the country. It succeeded in getting more Autonomy as compared with its counterparts in South Asia It established a merit-based banking system in the country equipped with lattest levels of Information Technology and Capable HR . It could be counted among a few successful oragnisations in the country. It managed to divert flow of credit towards SMEs and Agricultural to a greater extent.
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Performance of SBP
There

are general reservations in the society about performance of SBP as under: IT could not maintain inflation in the country. The cost of banking service increased largely as shown by bumper profits of banks. Credit needs of SMEs and Agri/Micro Credit could not be met in the desired manner. It could not ensure a reasonable/fair rate of return to Depositors- the life and blood of a banking system
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Challenges for SBP


Monetary

Policy vs other economic policiesany slippage on account of Fiscal Policy is to be borne by Monetary Policy. Government is the biggest borrower-A major problem for autonomous SBP. Presence of an Elite Culture in the country. Lack of Market orientation of the economy.
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