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Sept, 2011

BANKING Banking means the accepting, for the purpose of lending or investment, of deposits of money from the public, repayable on demand or otherwise, and withdraw able by cheques, drafts, order or otherwise. The word Bank is derived from German Word Back which means Join Stock Fund. Later on German occupied major part of Italy, the word Back was Italianized into Bank

EARLY GROWTH: People used to keep their valuables with the Reputable persons. Lend food/cattles/Money against valuables as security and also pay interest on them. In the human society: Men realized the importance of money as a medium of Exchange. Found the necessity of Controlling or Regulating Agencies.

Controlling systems were introduced by some State Heads for the benefit of people.

The Banking was Originated:

14th Century in Barcelona. When GERMAN PUBLIC BANK was formed in 1401 comprising the operation Discounting, Deposits and Transfer Of money.

By the 16th Century the Bank of Amsterdam was formed in 1609 and also got the Guarantee by the State. Some more Public Banks were found in Venice, Milan, Hamburg and Nuremburg by the 16th Century. The Bank of Hamburg was formed in 1690 with the business of accepting deposits of Silver or of foreign money and to run accounts on these deposits.

Bank successfully provided the great services to the Merchants as well as the Countries until 1873, when it was merged with the Reich Bank. BANKING BRITAIN: STRUCTURE STARTED IN

Lombardy Merchants came to England in 14th Century and settled in the city of London, now called Lombardy Street.

Resourceful that even Kings had to depend on them for loans. Church was firmly against usury (lending money at high interest). Also involved in money changing and foreign trades. *The Business of change of money was so profitable that King Edward-III established the Office of Royal Exchanger for changing foreign money at a profit for the Benefit of the Crown.

This setup gave a tremendous boost to foreign trade, the merchants from different Countries even from America brought their riches (valuable Possessions) and started to convert part of their riches in cash.

*In 1640 the confidence of merchants shook, when King Charles-1 Seized 130,000/-Pounds and bullion left for safe custody with merchants at Royal Mint.

Business was taken over by the Gold Smiths, who were only dealing in Gold and Silver.

Gold Smiths gave the facilities of SafeKeeping of the valuables and cash to their customers.
They issued the receipts or notes to their depositors. They were called Gold Smiths Notes.

Over a period of time, Gold Smiths discovered that large sum of money were left in their custody. Started LENDING money to other persons for fixed period at a Considerable High Rate of Interest. Encourage their depositors by offering a Part of Profit earned on their deposits. Started issuing Cheque Books for the attraction of their customers.

*In 1672, however, English Banking faced a great crisis when Charles-2 borrowed huge sums of money from Gold Smiths and later refused to pay them back. A number of Gold SmithBanker formed themselves into a Corporation in 1695, know as Bank of England and got the right to issue Notes Payable.


By 1700, the Bank of England was not only issuing Notes but also conducting Accounts for Customers. In 1853, the reduction is stamp duty on personal cheques gave further impetus (force) for cheque currency and they became very popular with customers.
In 1854 the Joint Stock Companies Act opened an era of Corporations. In the succeeding years Joint Stock Banks became very common.

In 1918 came into being Eleven Clearing Banks. BANKING IN PAKISTAN : At the time of independence, there were practically no industries.

Pakistan was producing, only Food Grains and Agricultural Raw Material and was being Exported from Pakistan.
487 offices of Scheduled Banks in the Territories now constituting Pakistan.

Commercial Banking facilities were provided fairly well here.

New country without resources, it was very difficult for Pakistan to run its own Banking System immediately.
Accordance to Indian Independence Act of 1947, an expert committee recommended that the Reserve Bank of India should continue to function in Pakistan until 30th September, 1948.

It was also settled between Pakistan and India the problems of time and demand liability, coinage, currencies, exchange etc. Pakistan would take over the management of Public Debt and Exchange Control from Reserve Bank of India on 1st April, 1948. The Independence Plan was announced in June, 1947 the Hindus Residing in the territories now comprising Pakistan started transferring their Assets to India.

Banks including those have their registered offices in Pakistan, transferred them to India in order to bring a collapse of new state. By June 1948, the number of offices of Schedule Banks in Pakistan declined from 487 to 195. At that time, only 19 Small Branch offices of Foreign Banks were solely in the Export of Crop from Pakistan.

TWO Pakistani Institutions i.e Habib Bank and Australasia Bank.

The panic of uncertain future shook the confidence of the people. The Government, therefore, promulgated the Banking Companies Ordinance, 1947 to safeguard the interest of both the Banks and Customers.

The Imperial Bank of India which had been acting as the Agent of Reserve Bank of India closed down most of its offices in Pakistan, and also Indian Bank was not willing to accept the token amount and securities of Government of Pakistan on the Plea that these securities were not marketable. To add the difficulties, the Indian Government with held Pakistans Share of Rs=75/- crore in cash balance held by them at the time of Partition.

Currency in Pakistan badly felt. It was agreed between the Government of India and Pakistan to advance the date from 30th September, 1948 to 30th June, 1948; up to which date the Reserve Bank of India could serve as the Monetary Authority in Pakistan. In order to overcome the problems of banking system, an Expert Committee was appointed to recommend to establish a Central Bank for Pakistan.

The foreign expert advised that due to acute shortage of qualified staff the establishment of a Central Bank was not practicable; but he recommended a Currency Board. There were contrary to Recommendations. But the Government of Pakistan decided to establish a Full-Fledged Central Bank.


Consequently the Governor Gernal of Pakistan and father of the Nation, Quaid-I-Azam Muhammad Ali Jinnah, inaugurated the State Bank of Pakistan on July 1st, 1948 and SBP order was promulgated on May 12th, 1948 and assumed full control of Banking and currency in Pakistan.


IMPORTANT TASK FOR SBP : To issue of currency notes and withdrawal of Reserve Bank of India Notes: Pakistani notes were issued in October 1948 in the denominations of Rupees 5, 10 and 100. By August 1949, the SBP withdraw the Reserve Bank of India notes of value of Rs=125.02 Crores notes by replacing Pakistan notes.

Despite this effort Government of Pakistan inscribed notes of value of Rs=51.57 Crores were still in circulation. Total Pakistan Claim on Assets of the issue Department of Reserve Bank of India amounted to Rs=176.59 Crores. However, the Reserve Bank of India transferred Assets of Value of Rs=127.67 Crores only to SBP.


Central Bank of the country, the State Bank of Pakistan addressed itself with the equally urgent task of creating a National Banking System. In order to attain this goal it provided every help and encouragement to Habib Bank to expend its network of Branches and also recommended to Government the establishment of a new Bank. As a result NBP came into being in 1949; and by 1952 it became strong enough to take over the agency function from Imperial Bank of India.

TYPES OF BANKS 1- State Bank of Pakistan

Operates as the controller of money market.

Provides the policy guidelines and ensures that the money market operates on sound professional basis.


2- Pakistani Commercial Banks Most effective mobilizers of savings. Providing short term financial support to trade, commerce and industry. Upto December 31, 1973 - 14 Pakistani Commercial banks. Nationalisation Act- 1974 reorganized and merged into five banks.

Policy of liberalisation of economyGovernment decided to disinvest and start privatization of banks. 3- Exchange Banks Foreign banks accept Indian banks carrying out their business in Pakistan are commonly known as Exchange Bank.

About twenty foreign banks are operating their function with a network of about 83 branches in Pakistan.

Foreign banks are bond to operate their functions in Pakistan within the limits imposed by SBP. 4- Cooperative Banks The objects of the cooperative banks are: oPromotion of thrift (economy). oSelf-help and mutual aid amongst agriculturist and others with common economic needs so as to bring about better living, better business and better methods of production etc.

5- Cooperative Credit Societies The societies have been formed to promote thrift and self-help. Provide short term loans to agriculturists, artisans and persons of limited means. Affiliated with provincial cooperative banks.


6-Saving Banks The objective of saving bank is to accept the saving from persons and invest them in various Government development projects.

7-Discount Houses Provide short term accommodation against the discounting of treasury bills and other approved securities. New development in Pakistans money market.

8-Micro Finance Institutions Micro & Small loan for very poors to promote the living of standard of common person. THE STATE BANK OF PAKISTAN- THE CENTRAL BANK Central Bank of Pakistan was established on July01, 1948, under the State Bank of Pakistan Order, 1948.

According to SBP Act, 1956, the State Bank of Pakistan is charged with:

Monetary and credit systems of Pakistan.

Foster (forward) its growth in the best national interest. Securing monetary stability. Utilization of the countrys productive resources.

Orthodox (standard) central banking functions with well-recognized developmental roles According to Section 4 of the State Bank of Pakistan Act, 1956 it had a mixed ownership wherein 51% of the paid up capital of Rs. 10 crores was held by the Federal Government and 49% by private sector.


In January 1974, the Federal Government assumed ownership of all privately held shares. Central Board of Directors comprising of:

One or More Deputy Governors Seven Directors

Responsible for formulation and monitoring the monetary and credit policy.

Determine the expansion of liquidity, the Bank is to take into account the Federal Governments targets for growth and inflation.
Responsibility of coordinating monetary and exchange policies. fiscal,


The Functions of State Bank of Pakistan Governed by the State Bank of Pakistan Act, 1956. Discharge its duties efficiently and successfully

Some of the functions which involved public dealing have been transferred to State Bank of Pakistan Banking Services Corporation from January, 2, 2002.

The State Bank of Pakistan will continue performing its four basic functions (i) Framing and operation of monetary policy (ii) Regulations and supervision of banks and financial institutions (iii) Foreign exchange management and

(iv) Settlements of payments and accounts. The basic functions performed by SBP are now discussed in brief.

1. State Bank as a Bank of Issue. The State Bank has the sole right to issue notes except one rupee note and subsidiary coins which are issued by the Government The Bank adopted the Proportional reserve System for the issue of notes up to December, 19. The level of currency backing y gold bullion, foreign securities is now fixed at Rs 1200 million through an Ordinance in December 1965 This system of rote issue is known as Minimum Reserve System..

The size of notes issue reflects the public demand for money.

The amount of notes in circulation can be increased to meet the public demand and are adjusted according to the general level of prices and economic activity in the country.
The assets of the Issue Department are always equal to liabilities

2. Framing and Operation of Monetary Policy. The State Bank of Pakistan frames and operates the monetary policy. Monetary policy is conducted by the SBP to regulate and control the volume of money and credit supply in the country in order to achieve specific economic objectives such as price stability reducing unemployment etc.

The main instruments of monetary policy are I. Open Market Operations II. Changing the Reserve Requirement and III. Changing the Discount Rate. Open Market Operations - It includes the technique use for expanding or
contracting the money supply in the country. - By buying the Govt., securities in the open market the SB expands the money supply and by selling securities it contracts the money supply in the country.

Changing the Reserve Requirements. -The State Bank of Pakistan also controls the money supply in the country by changing cash reserve requirements of the commercial banks. - An increase in the cash reserve ratio reduces the excess reserves of the bank and curtails the powers of the banks to advance loans. -The decrease in the cash reserve ratio increases the cash reserves of the commercial banks which increases the capacity of the banks to advance more loans.

-The SBP now requires the scheduled banks to maintain atleast 3.5% of demand and time liabilities with it. Changing the Discount Rate. -The bank rate is the rate of interest at which the SBP discounts the first class bills of exchange. - The rise in the l rate pushes up the cost of borrowing of commercial banks and reduces money supply in the country. -A decrease in the bank rate works in the opposite direction. -Presently SBP reduces discount rate to12%.

3. Regulations and Supervision of Banks. The State Bank of Pakistan has full powers to supervise and control the banking system in the country. The regulatory powers relate to the licensing of banks and their branch expansion liquidity of assets of the banks management and methods of working of the banks amalgamation and reconstruction and liquidation of banks, inspection of banks etc.

4. Foreign Exchange Management. The State Bank of Pakistan acts as a custodian of foreign exchange reserves manages exchange control and external value of the rupee and acts as the agent of the government in respect of Pakistans membership of the IMF. An important aspect of foreign exchange management is that all foreign exchange transactions are made at the official rate of exchange. It also maintains the exchange value of the rupee in terms of other major currencies of the world.

5. State Bank as a Clearing House. The State of Pakistan acts as a clearing house for the commercial banks. A clearing house is a place where the representatives of commercial banks meet each day to exchange cheques drawn on each other and then settle the differences owed to each other State Bank thus helps the commercial banks in making millions of payments by a minimum of transactions.

6. Adviser to Government. The SBP also acts as adviser to government in all financial matters. SBP is directly involved in the money and foreign exchange markets it therefore tenders advice on all economic matters. Also provides advice to commercial banks and other financial institutions and to commerce and industry in general.

7. Lender of Last Resort. The State Bank of Pakistan is the lender of last resort for the commercial banks. If at any time, the banks are short of cash reserves, the SBP comes to their rescue. It provides cash to the commercial banks by rediscounting bills of exchange, Treasury bills. The SBP, thus, helps and maintains liquidity and solvency of the commercial banks.

8. State Bank and Economic Growth. The State Bank is playing a significant role in facilitating and fostering economic development and growth of the banking system and other financial institutions in the country. The main development promotional activities of the Bank are as follows:(a) The development of the capital market in the country owes a great deal to the efforts made by the State Bank.

(b) Under the State Banks Export Finance Scheme, the commercial banks provide finance to the exporters at the concessional rate; (c) The State Bank has helped in the establishment of specialized credit institutions for meeting the medium and long term credit needs of the various sectors of the economy.


Functions Bank of Issue: SBP sole authority of the issue of bank notes for Rs.5, Rs.10, Rs.20, Rs.50, Rs.100, Rs.500, Rs.1000 & Rs.5,000. Issue of the notes should be backed by aproportional reserve system. Reserve system includes gold coins, gold bullion, silver bullion, approved securities, SDRs, and approved foreign exchange. The Government of Pakistan has retained with it the prerogative (right) of issuing the

Transferring of government funds from one account to another or from one place to another. Advance money to Government without any collateral, security, but repayable not later than three months. Adviser and Agent to the Government: Makes recommendations on economic, financial and monetary matters; agricultural credit; industrial finance; exchange control; mobilization of savings; and planning and development etc.

Agent to buying and selling approved foreign exchange from authorized dealers in Pakistan. Subscriptions for Government loans and payment of interest or return on the national or provincial debts and issue and discounting of Treasury Bills etc. Bankers Bank Obligatory for all the scheduled banks in Pakistan to maintain with SBP a minimum reserve of 7 percent of their demand and 0 percent of time liability as the close of

Scheduled banks are entitled to rediscount facilities from State Bank against Government securities, 90 days maturity trade bills and agriculture bills. Sole authority to process application from banks for opening branches or for changing the location. Sole discretion to determine the amount of authorized and paid up capital. Controller of Credit and Banking Rate Quantitative and qualitative methods.

Exchange Control Full control on both the visible and invisible payments. Exchange for business, travel, medical treatment and education etc. BANKER-CUSTOMER RELATION BANKER J. W. Gilbert- A banker is a dealer in capital, or more properly, a dealer in money. He is an intermediate party between the borrower and the lender. He borrows of one party and lends to another.

Dr. Herbert L. Haret- A person or company carrying on the business of receiving moneys and collecting drafts, for customers subject to the obligation of honouring cheques drawn upon them from time to time by the customers to the extent of the amount available on their current accounts.
Sir John Paget- that no person or body corporate or otherwise, can be a banker who does not (1) take deposit accounts (2) take current accounts, (3) issue and pay cheques and (4) collects cheques crossed and uncrossed for his customer

Functions of Bankers The Bank undertakes to receive money and collect bills for its customers account. Proceeds so received are not to be held in trust for the customer, but the bank borrows the proceeds and undertakes to repay them within banking hours . Customer on his part undertakes to exercise reasonable care in executing his written orders so as not to mislead the bank or to
facilitate forgery. Modern banking companies perform functions all

Banking Companies Ordinance, 1962. Section 5(b&c): Banking means the accepting, for the purpose of lending or investment, of deposits of money from the public, repayable on demand or otherwise, and withdrawable by cheque, draft, order or otherwise; Banking company means any company which transacts the business of banking in Pakistan.

Section 7 of the Banking Companies Ordinance, 1962, authorises banking companies to engage in various forms of business, including the following: Borrowing and lending of money. Discounting bills of exchange and other Negotiable Instruments. Buying and selling bullion and foreign exchange. Granting letters of credit to the customers. Receiving valuables for safe custody. Underwriting and dealing in stocks,

shares, debentures and other securities on behalf of the customers and others. Acting as agent to customers; undertaking and executing trust. Carrying on guarantees and indemnities business. Dealing with any property that may come to it as security in satisfaction of its outstanding claims. Acting as Modaraba Company. Undertaking the administration of estates as executors, trustee or otherwise.

CUSTOMER Person or company which buys goods/services. Any person or body corporate is a customer when it is opening a current or deposit account, or when negotiates on advance on his account, or a loan account. Sir John Paget - to constitute a customer, there must be some recognisable course of habit of dealing in the nature of regular banking business. Lord Davey remarked that a customer is a

person who has some sort of account, either deposit or current account or some similar relation a banker. A person becomes a customer the moment the bank receives the money or cheque and agrees to open an account. According to the current banking practice, only those person are said to be customers who maintain a regular bank account, without taking into consideration the duration and frequency of operation of their accounts.

Qualifications of a Customer Relationship of the banker and the customer is purely a contractual one. Basic Points for Qualifications: Should not be minor, must have attained the age of majority. Minor is allowed to become a customer, according to Section 3 of the Majority Act, 1875. A person is said to be of sound mind for the purpose of making a contract if at the time when he makes it, he is capable of understanding it and of forming a rational

Shall not have been debarred (disqualified) from entering into any contract under any law, like undischarged bankrupt, proclaimed offender, and alien enemy. Rights and Duties of a Customer Towards the Banker Rights: To draw cheques against his credit balance. To sue the bank for the cost, loss and damages when his cheque is wrongly dishonoured. To sue when the banker has not maintained the secrecy of his account.

To claim for and receive the profit / return on his deposit as promised by the bank. Duties: Present the cheques for payment and collection within the business banking time. Cheque and other instruments should be presented for payment within a reasonable time from the date of their issue. Should keep his cheque book under lock and key.
Should draw the cheques very carefully and in such a way that there is no room left for any

General Relationship Relationship between banker and customer is in fact that of a debtor (banker) and creditor (customer) or wise versa. Not that of Principle and Agent. Law of limitation will operate from the date when demand is made. Other Relationships:
Bailer and Bailee: - A bailment is delivery of goods by one person to another for some purpose, upon a contract. Banker provides safe-custody facilities to his customers for their valuables, the relationship becomes that of Bailor (customer) and Bailee (banker).

Principle and Agent: Banker performs agency services he becomes agent of his customer . Services includes collection of cheques and other negotiable instruments etc., and payment of premium / fees. Pawner /Pawnee, Mortgagor and Mortgagee: Customer pledges goods and documents with the bank as security for an advance, customer becomes the Pawner, and the banker becomes the Pawnee.

Advance to the customer is made against security of immovable property, the relationship becomes that of Mortgagor (customer) and Mortgagee (banker).


ACCOUNTS OF CUSTOMERS:GENERAL -By opening an account with a bank a person becomes its customer. -Reference / introduction may be required by the bank before opening account. 1. INTRODUCTION AND PRELIMINARY INVESTIGATION Banker should determine the prospective customers integrity, respectability, occupation and nature of business. Should obtain photocopy of CNIC and also
verify it with original of both customer &

Preliminary investigation is necessary because of following reasons: Avoid Frauds: Because the person can use the account operations for fraudulent purpose. If any such person happens to be an undischarged bankrupt, the banker may face awkward position. Safeguard against unintended overdrafts:
By mistaken amount can be credited to wrong customers account. Under these type of circumstances, customers character/ reference is most important.

Negligence: If a bank does not make the necessary investigation, the bank may deprived (leave without) of statutory (legal) protection to a clearing banker. In such a case the banker will be deemed to have acted negligently. Inquiries about clients: A banker should inquiries about the addresses of customer and about its credit worthness from other financial institutions.

2. SPECIMEN SIGNATURES Customers signature on the cheques is considered as his authority for the payment of cheques drawn on the bank. Bankers always get the specimen signatures of the customer in their presence. If a cheque presented to a bank with the doubtful signatures, the bank reserves the right to return the cheque with remarks signature differs.
If the customer signs in a language other than in English or Urdu, the banker must get fill the

Vernacular form is a type of indemnity from the customer not to make bank officer responsible in case of misverification. In case of Illiteracy person following additional formalities/ documents may be completed:
Obtain three(3) attested photographs- one with account opening form, one with specimen signature card & one with cheque book. On signature card & account opening form, left hand thumb expression in case of male & right hand thumb expression in case of female.

Payment will be made on personal appearance along with witness. Such account holder can not issue cheque to third party. 3. MARRIED WOMEN Reserves all rights to operator a account as any mature person of the society. 4. PARDANASHIN WOMEN A household woman either observing pardah or not, is known as Pardanashin woman. For a literate woman, account opening is not a problem.

But in case of illiterate woman, the banker must clarify the customer before the opening of account for the requirement of photographs and the verification of identity at the time of payment. 5-MINORs ACCOUNT According to Law any person under the age of 18 years is considered as minor.
Section 3 of Majority Act, 1875, if a competent court of law appoints a guardian of this person or property before his eighteen year, the majority extends to the age of 21 years.

Section 11 of the Contract Act, 1872, has declared a minor incompetent to enter into contract. However, a competent person as guardian can made a contract for the benefit of a minor. The account will continue to be operated by the guardian even after the minor attains the age of majority. However, the partnership Act, 1932, has authorised the admission of minor into the benefits of partnership with the consent of all partners. Till the majority of the minor, he or she can not held liable for any loss or debt.


A- Death of the Customer -Section 122-A of Negotiable Instruments Act, 1881 reads: The duty and authority of a banker to pay a cheque drawn on him by his customer are determined by (i) Countermand of payment (ii) Notice of customers death (iii) Notice of adjudication of the customer as an insolvent. -Banker cannot make payment on the cheque after receiving the notice of customers death. -Banker must confirm the death of the customer after receiving notice.
-A credit balance up to Rs.30,000 can be paid to legal heirs on indemnity signed by all heirs and witness by two good customers.77

B- LUNACY (MINTAL ILLNESS) OF CUSTOMER Section 11 of the Contract act, 1872, has debarred all persons of unsound mind from contracting. The banker should stop all debit operations on the account after confirming the information about the lunacy of his customer. The bank should allow the operation of account if a court of law issue the certificate of sanity.

C- INSOLVENCY (BANKRUPT) OF CUSTOMER Section 122-A of the Negotiable Instruments Act, 1881, has authorised a banker to determine the payment of a customers cheque with regard to his insolvency proceedings. D- JOINT ACCOUNT The account of two or more persons who are neither partners nor trustees. Bank will allow the operation on the instructions by all signatories.

In Husband v. Davis (1851) Justice Maulent said: It is a general rule that a man may pay debt to one of the several persons with whom he has contracted jointly. In case of a banker be cannot do so; but that rises from the particular contract which exists between him and his customer. It is a part of the Law of Merchants that a banker shall not pay to one of several jointly interested without the consent of the others, except by an express agreement.

STOP-PAYMENT IN A JOINT ACCOUNT Any one joint holder may stop payment of a cheque. Removal of the stop-payment should be signed by all the joint holders. Mandate given to one or more persons to draw on a joint account is automatically revoked by the death, bankrupt or insanity of either or any of the account holders. SURVIVORSHIP Authorised to operate the account by the survivor even in
case of the death of one or more of the joint account 81 holders.

JOINT ACCOUNT OF HUSBAND AND WIFE When a joint account is opened by a husband and wife, it will indicate the intention of the deceased for the payment of the balance in the event of death of any one of them. BANKRUPT OF JOINT ACCOUNT HOLDER The bankruptcy of one or more of the joint account holders, the operation on the account should be immediately stopped.

ACCOUNTS OF SPECIAL CUSTOMERS There are certain classes of persons to make valid agreements, which are subject to certain recognized restrictions. Partnership Account O Partnership- The relation which subsists (keep going) between persons carrying on a business in common with a view of profit. O Partnership is the relation between persons who have agreed to share the profits of the business carried on by all or any of them acting for all. O Individual is called Partner/ Collective group is called a Firm.

Section 58 of the Partnership Act, 1932, requires that every firm should be a registered with the Registrar of firms. oUnregistered firm is not maintainable. A partner of a firm cannot sue his unregistered firm for damages for wrongful dismissal or for share of profit. oBanker should always open a firms account in the firms name and get the account opening form signed by all the partner. oAll the particulars of the all partners should be recorded. oOperation of account authority must be with the consent of all partners.

Operation of Firms Account - According to Section19 of the Partnership Act, 1932, every partner in a firm has an implied power to bind his co-partners by drawing and indorsing of cheques the drawing, accepting and indorsing of bills of exchange, and making and indorsing of promissory notes. - Every partner has an implied authority also to countermand payment of any cheque drawn on the firms account. - Banker is bound to comply to comply with the instructions issued by every partner. - Account opening form should be signed by all partners along with
clear instructions for its operation also duly signed by all partners. 85

- Specimen signatures of the persons authorized to operate account. Borrowing by a Partnership Firm A partner in a trading firm has the implied authority to borrow for the partnership firm and bind his partners for such borrowings in the ordinary course of business, and it follows, almost necessarily, that he should have power to pledge partnership property as a security for advance A banker will not only rely on the authority to a partner, but he will also obtain the signatures of all partners on any deposit, letter, charge and security documents.

Signatures of all partners become the concurrence of all the partners in the proposed borrowing. Letter of Partnership/ concurrence contains an admission of joint- and-several liabilities which will be very useful in the event of personal liability of the partners arising on the debt. Law of Banking The mere fact that the firm has had the benefit borrowed by a partner, will not render the firm liable to pay it. If money be lent to a partner on his individual credit, the fact that it is applied in discharge of the firm will not enable the lender to sue the firm for its payme

Admission of New Partners O Section 31 of the Partnership Act provides that an incoming partner does not becomes liable to the creditors of the firm for anything done before he/ she becomes a partner. O However, by an express agreement at the time of admission, he/ she can become liable to such debt. O Operation of account should not stop at the time of admission of new partner.
O Fresh letter with fresh instructions for future operations duly signed by all partner may be required by banker. O If the new partner is not agreed to take old liability than the old liabilities will be adjusted by old partners, and fresh withdrawals will be for new firm.

O New partner will has to sign his agreement to the retention of existing tangible securities covering the borrowing of the new firm. Retirement of Partner If the contract permit that the partnership can be carried out even after the retirement of any of the partners. Otherwise with the retirement of the any partner, the business cannot carry on. Section 32 of the Partnership Act lays down that unless expressly agreed, a retired partner is liable for the debts already incurred, and he remains liable for the future acts of the firm till the time he gives the notice of his retirement.

What is risk? The chinese hyeroglif risk consists of two components: Danger Opportunity Variability that can be quantified in terms of probabilities. (reserving variability that cannot be quantified at all for uncertainty) Risk is everywhere future cannot be predicted The intuitive commonsense of Risk- Reward coupling No risk; no reward Taking on more risk is sensible only if it results in greater likelihood of greater reward!

Appetite for risk determines what reward one seeks And the good news is Risk can be Managed The Risk Management Process Identify Risk Exposures
Measure and Estimate Risk Exposures Find ways to Shift or Trade Risks Assess Costs and Benefits of Risk Mgmt nstruments Form a Risk Management Strategy Avoid Mitigate Transfer Keep Evaluate Performance

Assess Effects of Exposures


General definitions Uncertainty vs risk Subjective / objective probabilities Speculative / pure How to measure risk?
Probability / magnitude / exposure
Systematic vs residual risk

Maximal vs average losses Absolute vs relative risk

Systemic risk is a specific term used in finance, it means the market risk or the risk that cannot be diversified away, as opposed to "idiosyncratic risk", which is specific to individual stocks.

How to classify risks? General classification of risks Nature / political / transportation /


Commercial Property / production / trade / Financial Investment: lost opportunity (e.g. due to no hedging), direct losses, lower return Purchasing power of money: inflation, currency, liquidity Main types of financial risks Market risk Interest rate / currency / equity / commodity Credit risk Sovereign / corporate / personal Liquidity risk Market / funding

Operational risk System & control / management failure / human error Event risk Lessons for risk management Integrated approach to different types of risks Portfolio view Accounting for derivatives Market microstructure Role of regulators and self-regulating organizations Financial risk management Avoid? But you cannot earn money without taking on risks

Reserves: esp. banks Diversification But: only nonsystematic risk Hedging Usually, using derivatives Insurance: for exogenous low-probability events Otherwise bad incentives Evaluation based on risk-adjusted performance Strategic risk management: enterprise-wide policy towards risks Identification / Measurement / Management / Monitoring

Plan of the course Classification of risks Derivatives and financial engineering Measuring volatility Market risk Liquidity risk Credit risk Operational risk Legal risk, Regulation risk, and Reputation risk, Business risk, and Strategic risk.

Types of Risk The LIST! Risk: volatility of returns leading to unexpected losses with higher volatility indicating higher risk.

Volatility of returns is directly or indirectly affected by numerous variables called risk factors, and interaction between risk factors. Systematic risk factors categories: Market risk, Credit risk, Liquidity risk, Operational risk, Legal risk, Regulation risk, and Reputation risk, Business risk, and Strategic risk. Market Risk is further subdivided into:
Equity price risk, Interest rate risk, Foreign exchange risk, and Commodity price risk.


Interest rate risk splits into: Trading risk and Gap risk. Model risk. This is the risk in assuming a specific model for the world (problem) for specific analysis. A comprehensive categorization and detailed decomposition helps better capture a companys risk exposure. Limits are: degree of model complexity that can be handled; available technology support; cost and availability of internal and market data. Market Risk and its Components Risk that changes in financial market prices and rates will reduce the dollar value of a security or a portfolio.

General market-risk: The risk that the market as a whole will fall in value. This can have effects on all securities in the market. Other specific types of additional risks a financial product may be affected by, for example: 1. Fixed income products have default risk of the issuer (credit risk). 2. A Fund may be tracking the performance of a certain benchmark; here risk of tracking error is important. 3. Basis risk measures the breakdown in relationship between price of a product and the price of the instrument used to hedge the price exposure.

Market Risk and its Components - Interest- rate Risk Simplest form: Value of fixed-income security will fall due to increase in market interest rate. In a complex portfolio: differences in maturities, nominal values, reset dates of
instruments and cash flows (longs as well as shorts).

Curve risk: The term-structure of interest rate and shifts in it that affect instruments with different maturities differently and create misbalance in longshort positions in a portfolio. Basis risk: Same maturities can have mismatch due to rates being imperfectly correlated. Gap Risk: Risk that arises as a result of the different sensitivities of assets and liabilities to changes in interest rates

Market Risk and its Components Equity Price Risk Simply put, this is the volatility in stock prices, and sensitivity of an instrument or portfolio value to change in the level of broad stock market indices Specific or idiosyncratic risk of equity: characteristics specific to the firm its line of business, quality of its management, breakdown in its production process. As per results of portfolio theory : general market risk cannot be eliminated through diversification while specific risk can be diversified away.

Market Risk and its Components Foreign Exchange Risk Arises from open or imperfectly hedged positions in a particular currency. This exposure can arise from a natural consequence of business operations, not necessarily due to explicitly taking a position in a currency. It can have a pretty drastic impact: sweep away returns, place a firm at a competitive disadvantage, can generate huge operating losses, and in the end inhibit growth and investment. Foreign exchange risk comes from imperfect correlation between
currency prices, international interest rates and domestic interest rates. 102

Market Risk and its Components Commodity Price Risk Price risk of commodities behave different from interest-rate and foreign exchange risk, because commodity prices controlled by few suppliers, which can magnify volatility. Fundamentals affecting commodity prices: market liquidity,
ease and cost of storage (range from gold, electricity, wheat). Commodity prices have higher volatility and show jumps. Classification of commodities: Hard (nonperishable) - Precious metals (Gold, Silver, Platinum), Base metals (Copper, Zinc, Tin) Soft (perishable short shelf life and hard to store) agricultural products (grains, coffee, sugar, OJ) 103 Energy - Oil, gas, electricity

Credit Risk Risk that change in the credit quality of a counterparty will affect the value of a security or a portfolio. Default is the extreme case (counterparty is unable or unwilling to fulfill its obligation) Institutions are also exposed to the risk that a counterparty is downgraded by a rating agency. Credit risk is an issue when the position has a positive replacement value (is an asset) either all the market value of the position (asset) is lost.
more commonly, part of the value of asset that is recovered after a credit event is the recovery value (or recovery rate).104

The amount that is expected to be lost is the loss given default amount. Nature of Credit Risk related with Coupon Bonds and Loans is very different from that of Derivatives. Liquidity Risk Funding liquidity risk: risk in firms ability to raise necessary cash to roll over its debt; to meet the cash, margin or collateral requirements of counterparties; to satisfy capital withdrawals. It is managed by holding cash and cash equivalents, setting credit lines in place, monitoring buying power.
Asset liquidity risk: risk that an institution will not be able to execute a transaction at the prevailing market price because at the time there is no appetite for the deal on the other side of the market.

There can be substantial losses, but this risk is hard to quantify. This affects an institutions ability to manage and hedge market risk, and capacity to fund shortfalls in funding by liquidating assets. Operational Risk Losses incurred due to: Inadequate systems Management failures Faulty control Fraud, and Human Error Basel Committee recognizes and takes Operational risk very seriously - losses from derivatives trading in past decade have been instances of operational risks.

Fraud: a trader or employee falsifies or misrepresents risks incurred in a transaction. Technology risk: Computer system breakdown or malfunction. Human factor: human errors pushing the wrong button, destroying files, entering wrong value for parameters Legal, Regulatory, and Reputation Risk One can incur loss due to legal or regulatory reasons for a variety of reasons. For example: A counterparty may not have legal or regulatory authority to engage in a risk transaction. Legal: a counterparty sues to avoid meeting its obligations on losing money in a transaction.


Regulatory: potential changes in tax laws can impact adversely the market value of a position. Reputation relates closely to legal, regulatory, and operational risk. Accounting scandals that defrauded bondholders, shareholders and employees of many major corporation during the late 1990s. Corporate scandals like those at Enron, WorldCom, Global Crossing. Reputation is very important in finance industry; trust, confidence of customers, creditors, regulators and marketplace is important. These risks are hard to measure, though!


Business and Strategic Risk This is the classic risk of business: demand uncertainty, prices, cost of production, supplier costs & availability. These are managed through core tasks of management choice of channels, products, suppliers, marketing, etc. Challenge: fitting this business risk management within a formal risk management framework; integrally combining market risk, credit risk with business risks. Strategic Risks: Significant investment for which there is high uncertainty and profitability.
Examples in Banking: push toward internet banking,

offering credit cards to new market segment, developing ability for sophisticated credit risk management as a competitive edge. Risk Management and Monitoring Systems It is not about building specialized mathematical models. It is to put deeper risk management roots in an organization build a wider risk culture and literacy. Corporate Governance and Risk Management Environment: Scandals of the early millennium have been a wakeup call for tightening the regulatory environment of publicly traded corporations.

This includes: CEO, CFO responsibilities, Board of Directors composition, duties of compensation committee, audit committee. Risk Management Process: Avoid risk by choosing not to undertake some activities Transfer risk to third parties using insurance, hedging, and outsourcing. Mitigate risk, such as operational risk, through preventive and identifying control measures Accept risk recognizing that undertaking certain risky activities should generate shareholder value. Bottom to Top involvement; Top to Bottom integration.

Delegation Process for Market Risk Authorities Risk Committee of the Board: Approves market-risk tolerance each year; Delegates Authority to Senior risk Committee. Senior risk Committee: Approves market-risk tolerance, stress and performance limits each year; Reviews business unit mandates and new business initiatives; Delegates authority to the CRO and holds in reserves. CRO: Responsible for independent monitoring of limits;

May order position reduced for market, credit, or operational concerns; Holds reserves; Delegates Risk to Heads of Business Heads of Business: Share responsibility for risk of all trading activities; Delegates to Business Unit Manager. Business Unit Manager: Responsible for risk and performance of the business; Must ensure limits are delegated to the traders.

FINANCIAL RISK Financial risk in a banking organization may be defined as possibility that the outcome of an action or event could bring up adverse impacts.

Outcomes could either result in a direct loss of earnings / capital or may result in imposition of constraints on banks ability to meet its business objectives. Constraints pose a risk as these could hinder a bank's ability to conduct its ongoing business or to take benefit of opportunities to enhance its business. Regardless of the sophistication of the measure, banks often distinguish between expected and unexpected losses. Expected losses are those that the bank knows with reasonable certainty will occur (e.g., the expected default rate of corporate loan portfolio or credit card portfolio) and are typically reserved for in some manner.

Unexpected losses are those associated with unforeseen events (e.g. losses resulting from sanctions imposed in the aftermath of nuclear tests). Banks rely on their capital as a buffer to absorb such losses. Risk Management. Risk Management is a discipline at the core of every business and encompasses all the activities of the bank that affect its risk profile. It involves identification, measurement, monitoring and controlling risks to ensure that: 1- The individuals who that take or manage risks clearly understand it. 2- The organizations Risk exposure is within the limits established by Board of Directors.

3- Risk taking Decisions are in line with the business strategy and objectives set by BOD. 4- The expected payoffs compensates for the risks taken 5- Risk taking decisions are explicit and clear. 6- Sufficient capital as a buffer is available to take risk In every financial institution, risk management activities broadly take place simultaneously at following different hierarchy levels: 1- Strategic level: It encompasses risk management functions
performed by senior management and BOD. For instance definition of risks, ascertaining institutions risk appetite, formulating strategy and policies for managing risks and developing systems and controls to optimize risk while operating within risk tolerances.

2- Macro Level: It encompasses risk management within a business area or across business lines. Generally the risk management activities performed by middle management or units devoted to risk reviews fall into this category. 3- Micro Level: It involves On-the-line risk management where risks are actually created. This is the risk management activities performed by individuals who take risk on organizations behalf such as front office and loan origination functions. The risk management in those areas is confined to following operational procedures and guidelines set by management.