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16
For students of Finance and Banking
The Application of Monetary Policy: Rules, Discretion & Central Bank’s Autonomy

The debate about whether monetary policy decisions should be governed by rules or discretion has a long history. However, neither pure discretion nor fixed adherence to an intermediate monetary target has proved satisfactory. In their place several countries are moving toward a regime in which there is a clear target for the ultimate objective of monetary policy, together with a statement of the authorities decision making practices that is as open and transparent as possible.

We notice three broad phases in the approach to policy making in the postwar period. Until about the late 1960s, it was taken for granted, that formulating monetary policy required a substantial amount of discretion. From the early 1970s until the 1980s, there was a growing emphasis on rules. By the late 1980s; however, there was a swing away from rule based policy regimes. The relationship between intermediate targets and ultimate objectives became more variable under the influence of financial liberalization and innovation. In recent years it seems most central banks have recognized the need for a return to greater discretion in the use of monetary instruments.

In this context, it is necessary to provide the definition of a few terms, because the same expressions may be used to mean different things by different authors. Central banks use policy instruments to pursue ultimate policy objectives. Along the way, they are concerned with intermediate variables which are part of the policy transmission process as well as with indicator variables, which may provide information about the impact of policy, without themselves being part of the transmission mechanism.
Rules are generally taken to require the authorities to use the instruments of monetary policy to achieve a given predetermined path for an intermediate variable (usually a monetary aggregate). Intermediate variables are those which the, monetary authorities may attempt to target because of their presumed relationship with the ultimate objectives of monetary policy. The most common example of an intermediate variable is the money stock or credit stock. To the extent that growth in monetary aggregates is stably related to the ultimate objective of monetary policy (the steady growth of the nominal value of output) and to the extent that it is more feasible to control the money stock than nominal output, it makes sense to direct policy instruments towards the achievement of an intermediate variable.

Indicator variables can be defined as those that have information value about the impact of instrument on policy outcomes but are not themselves an object of control. In fact the whole range of economic quantities has a bearing on monetary policy decisions. They can include variables that in another context may be viewed as intermediate target. For example the growth of money stock can be regarded as object to be controlled. It can also be regarded as one indicator (among others) of the potential strength of demand in the economy. This underlines an important point just because a monetary variable is not used as an object of control does not mean that it does not play an important role in evaluating the stance of monetary policy.

Other indicator variables are those that convey information about the future of the economy, and the balance between inflationary and recessionary forces. They include all variables relating to the current and prospective level of real economic activity [GDP growth, industrial production, retail sales, consumer and business spending surveys, etc.]. They also include cost and price indicators [wages, import costs, consumer and producer price indices] and expectation indices, including expectations derived from financial variables such as the shape of the yield curve.

The distinction between whether variables are to be treated as indicators or intermediate targets is crucial to the distinction between rules and discretion. However, the distinction between rules and discretion is not straightforward, and, hence deserves some clarification.

The use of discretion in monetary policy is clearly not intended to imply randomness in decision making. A discretionary policy action usually reflects a systematic response by policy authorities, taken in the light of their objectives and their perceptions as to how the economy will respond to particular economic stimuli.

Arguments for discretion in the formulation and implementation of policy:

First, economics is subject to both supply shocks and demand shocks. The appropriate monetary policy response will be quite different in the two cases. If the authorities can identify the nature of different shocks, they will be able to improve welfare by exercising discretion in how they respond to them.

A second argument for discretion lies in the fact that the speed with which an economy returns to price stability following an inflationary or deflationary shock has implications for output and employment. The use of discretion may enable the central bank to tolerate some overshooting of the monetary targets to allow the return to price stability to take place in a more orderly manner.

A third argument for discretion is that the structure of the economy is changing through time in ways that cannot easily be predicted in advance. The relationship between intermediate variables and the ultimate objectives of policy can be affected by technical developments. Under such circumstances discretion, rather than a set rules, could be more appropriate.

Arguments for rules
One view is that, in a democracy, discretion from decision making should be removed from individuals and vested in rules and laws. Perhaps the more important economic argument for rule is that there is fundamentally stable relationship between an intermediate variable (a monetary aggregate) and the ultimate objective of monetary policy (the growth of nominal income). The benefits of discretion are, therefore small, since it is not possible to improve much of the outcome generated by adopting a stable money growth target. On the other hand, so the argument goes, the costs of discretion are potentially large

A subsidiary argument for rules is that financial markets operate most efficiently in the presence of certainty. If in addition to the inherent uncertainties generated by outside economic shocks, there are uncertainties about the authorities’ policy response, the difficulties faced by markets will be compounded. This argument has been formalized in the literature on the time consistency problem and the value of rules that pre-commit the authorities to a particular course of action.

The arguments in favor of rules are based more on the quality of discretionary action, than on discretion per se. it may be argued that discretionary monetary policy is subject to two systematic sources of adverse bias: too little, too late. For example, there will be greater willingness to lower interest rates than to raise them.

The Central Bank Independence: Rationale and Reality
One of the primary tenets of accepted central banking thought has been the importance of keeping central banks politically independent. No other aspect of central banking has evoked more attention and discussion than the advocacy of central bank independence of political authority. The concept of an independent central bank separates the power to create money form the power to spend money (vested in the executive). Hence, the strongest argument for an independent central bank rests on the view that subjecting the central bank to more political pressure would impart an inflationary bias to monetary policy. In the view of many observers, politicians in a democratic society are short sighted, because they are driven by the need to win their next election and they are unlikely to focus in long run objectives, such as promoting a stable price level. Instead they will seek short run solutions to problems even if the short run solutions have undesirable long run effects. A politically insulted central bank is more likely to be concerned with long run objectives and thus be a defender of a sound currency and a stable price. Putting the central bank under the control of the government is considered dangerous because the central bank can be used to facilitate financing large budget deficits and thus this help out might lead to a more inflationary bias in the economy. An independent central bank is better able to resist this pressure from government expenditure without raising taxes. An independent central bank largely removed from political pressure is needed to ensure justice to those who lose from inflation.

Another argument for central bank independence is that conduct of monetary policy is too important to leave to politicians who may have lack of expertise at making hard decisions on issues of great economic importance, such as reforming the banking system, or reducing the budget deficit. The crucial parameters like price level and exchange rate under no circumstances should be transferred into political control variable. But the removal of monetary policy form the political sphere is itself a political act. There seems to be an even stronger case for independent central bank in the developing countries given the greater frequency and arbitrariness of political change coupled with the politicization of finance .Recent research demonstrates that political instability causes instability at the central bank too, although the spillover varies across countries and type of political traditions. These are hard question which have not been addressed in the debate on central bank independence.

The Case against Independence of Central Bank
Proponents of control of central bank by government argue that it is undemocratic to have monetary policy (which affects everyone in the economy) formulated by an elite group responsible to none. The public holds the president or parliament responsible for the economic well being of the country, yet they lack control over the government agency, the central bank that may well be the most important factor in determining the health of the economy. Monetary policy involves difficult decisions that need a long run point of view. The public holds the government responsible for the economic conditions that result from all the policies followed by government. Hence the government should have control over monetary policy. It seems to be undemocratic to say that elected officials, in a parliamentary democracy, should not be trusted to judge monetary policy.

Monetary and fiscal policies should be integrated and adequate integration cannot be achieved merely by a process of informal consultation. Rather it requires that the central bank be part of the administration. Giving the government control over the central bank need not necessarily weaken its influence, but might even strengthen it. If it were a part of the administration, the central bank counsel would then be better heeded by the government.

However, there is yet no consensus on whether an independent central bank is a good idea, although public support for independence of central bank seems to have been growing in various countries of the world.

The for and against arguments for independence of central bank may give the misleading impression that the choice is between two irreconcilable extremes. But this is not so. Even if the central bank were to lose its formal independence and become a part of government administration, there could still be an attempt to keep it out of partisan politics.

Professor Rafiqul Islam
Faculty of Business & Economics
Daffodil International University
Published in "The Financial Express"
Wednesday, January 22,2014

17
For students of Finance and Banking
The Application of Monetary Policy: Rules, Discretion & Central Bank’s Autonomy

The debate about whether monetary policy decisions should be governed by rules or discretion has a long history. However, neither pure discretion nor fixed adherence to an intermediate monetary target has proved satisfactory. In their place several countries are moving toward a regime in which there is a clear target for the ultimate objective of monetary policy, together with a statement of the authorities decision making practices that is as open and transparent as possible.

We notice three broad phases in the approach to policy making in the postwar period. Until about the late 1960s, it was taken for granted, that formulating monetary policy required a substantial amount of discretion. From the early 1970s until the 1980s, there was a growing emphasis on rules. By the late 1980s; however, there was a swing away from rule based policy regimes. The relationship between intermediate targets and ultimate objectives became more variable under the influence of financial liberalization and innovation. In recent years it seems most central banks have recognized the need for a return to greater discretion in the use of monetary instruments.

In this context, it is necessary to provide the definition of a few terms, because the same expressions may be used to mean different things by different authors. Central banks use policy instruments to pursue ultimate policy objectives. Along the way, they are concerned with intermediate variables which are part of the policy transmission process as well as with indicator variables, which may provide information about the impact of policy, without themselves being part of the transmission mechanism.
Rules are generally taken to require the authorities to use the instruments of monetary policy to achieve a given predetermined path for an intermediate variable (usually a monetary aggregate). Intermediate variables are those which the, monetary authorities may attempt to target because of their presumed relationship with the ultimate objectives of monetary policy. The most common example of an intermediate variable is the money stock or credit stock. To the extent that growth in monetary aggregates is stably related to the ultimate objective of monetary policy (the steady growth of the nominal value of output) and to the extent that it is more feasible to control the money stock than nominal output, it makes sense to direct policy instruments towards the achievement of an intermediate variable.

Indicator variables can be defined as those that have information value about the impact of instrument on policy outcomes but are not themselves an object of control. In fact the whole range of economic quantities has a bearing on monetary policy decisions. They can include variables that in another context may be viewed as intermediate target. For example the growth of money stock can be regarded as object to be controlled. It can also be regarded as one indicator (among others) of the potential strength of demand in the economy. This underlines an important point just because a monetary variable is not used as an object of control does not mean that it does not play an important role in evaluating the stance of monetary policy.

Other indicator variables are those that convey information about the future of the economy, and the balance between inflationary and recessionary forces. They include all variables relating to the current and prospective level of real economic activity [GDP growth, industrial production, retail sales, consumer and business spending surveys, etc.]. They also include cost and price indicators [wages, import costs, consumer and producer price indices] and expectation indices, including expectations derived from financial variables such as the shape of the yield curve.

The distinction between whether variables are to be treated as indicators or intermediate targets is crucial to the distinction between rules and discretion. However, the distinction between rules and discretion is not straightforward, and, hence deserves some clarification.

The use of discretion in monetary policy is clearly not intended to imply randomness in decision making. A discretionary policy action usually reflects a systematic response by policy authorities, taken in the light of their objectives and their perceptions as to how the economy will respond to particular economic stimuli.

Arguments for discretion in the formulation and implementation of policy:

First, economics is subject to both supply shocks and demand shocks. The appropriate monetary policy response will be quite different in the two cases. If the authorities can identify the nature of different shocks, they will be able to improve welfare by exercising discretion in how they respond to them.

A second argument for discretion lies in the fact that the speed with which an economy returns to price stability following an inflationary or deflationary shock has implications for output and employment. The use of discretion may enable the central bank to tolerate some overshooting of the monetary targets to allow the return to price stability to take place in a more orderly manner.

A third argument for discretion is that the structure of the economy is changing through time in ways that cannot easily be predicted in advance. The relationship between intermediate variables and the ultimate objectives of policy can be affected by technical developments. Under such circumstances discretion, rather than a set rules, could be more appropriate.

Arguments for rules
One view is that, in a democracy, discretion from decision making should be removed from individuals and vested in rules and laws. Perhaps the more important economic argument for rule is that there is fundamentally stable relationship between an intermediate variable (a monetary aggregate) and the ultimate objective of monetary policy (the growth of nominal income). The benefits of discretion are, therefore small, since it is not possible to improve much of the outcome generated by adopting a stable money growth target. On the other hand, so the argument goes, the costs of discretion are potentially large

A subsidiary argument for rules is that financial markets operate most efficiently in the presence of certainty. If in addition to the inherent uncertainties generated by outside economic shocks, there are uncertainties about the authorities’ policy response, the difficulties faced by markets will be compounded. This argument has been formalized in the literature on the time consistency problem and the value of rules that pre-commit the authorities to a particular course of action.

The arguments in favor of rules are based more on the quality of discretionary action, than on discretion per se. it may be argued that discretionary monetary policy is subject to two systematic sources of adverse bias: too little, too late. For example, there will be greater willingness to lower interest rates than to raise them.

The Central Bank Independence: Rationale and Reality
One of the primary tenets of accepted central banking thought has been the importance of keeping central banks politically independent. No other aspect of central banking has evoked more attention and discussion than the advocacy of central bank independence of political authority. The concept of an independent central bank separates the power to create money form the power to spend money (vested in the executive). Hence, the strongest argument for an independent central bank rests on the view that subjecting the central bank to more political pressure would impart an inflationary bias to monetary policy. In the view of many observers, politicians in a democratic society are short sighted, because they are driven by the need to win their next election and they are unlikely to focus in long run objectives, such as promoting a stable price level. Instead they will seek short run solutions to problems even if the short run solutions have undesirable long run effects. A politically insulted central bank is more likely to be concerned with long run objectives and thus be a defender of a sound currency and a stable price. Putting the central bank under the control of the government is considered dangerous because the central bank can be used to facilitate financing large budget deficits and thus this help out might lead to a more inflationary bias in the economy. An independent central bank is better able to resist this pressure from government expenditure without raising taxes. An independent central bank largely removed from political pressure is needed to ensure justice to those who lose from inflation.

Another argument for central bank independence is that conduct of monetary policy is too important to leave to politicians who may have lack of expertise at making hard decisions on issues of great economic importance, such as reforming the banking system, or reducing the budget deficit. The crucial parameters like price level and exchange rate under no circumstances should be transferred into political control variable. But the removal of monetary policy form the political sphere is itself a political act. There seems to be an even stronger case for independent central bank in the developing countries given the greater frequency and arbitrariness of political change coupled with the politicization of finance .Recent research demonstrates that political instability causes instability at the central bank too, although the spillover varies across countries and type of political traditions. These are hard question which have not been addressed in the debate on central bank independence.

The Case against Independence of Central Bank
Proponents of control of central bank by government argue that it is undemocratic to have monetary policy (which affects everyone in the economy) formulated by an elite group responsible to none. The public holds the president or parliament responsible for the economic well being of the country, yet they lack control over the government agency, the central bank that may well be the most important factor in determining the health of the economy. Monetary policy involves difficult decisions that need a long run point of view. The public holds the government responsible for the economic conditions that result from all the policies followed by government. Hence the government should have control over monetary policy. It seems to be undemocratic to say that elected officials, in a parliamentary democracy, should not be trusted to judge monetary policy.

Monetary and fiscal policies should be integrated and adequate integration cannot be achieved merely by a process of informal consultation. Rather it requires that the central bank be part of the administration. Giving the government control over the central bank need not necessarily weaken its influence, but might even strengthen it. If it were a part of the administration, the central bank counsel would then be better heeded by the government.

However, there is yet no consensus on whether an independent central bank is a good idea, although public support for independence of central bank seems to have been growing in various countries of the world.

The for and against arguments for independence of central bank may give the misleading impression that the choice is between two irreconcilable extremes. But this is not so. Even if the central bank were to lose its formal independence and become a part of government administration, there could still be an attempt to keep it out of partisan politics.

Professor Rafiqul Islam
Faculty of Business & Economics
Daffodil International University
Published in "The Financial Express"
Wednesday, January 22,2014

18
Real Estate / Monetary Policy
« on: February 05, 2019, 04:22:32 PM »
Professor Rafiqul Islam
Department of Business Administration
Faculty of Business & Entrepreneurship
Daffodil International University (DIU)

Money, Monetary Policy and Central Bank Functions: Bangladesh Perspectives

Any discussion on monetary policy requires some understanding of the importance of money, financial markets and financial institutions. Money, credit or the whole structure of financial institutions can contribute greatly to improvement of standard of living in society but it does so only indirectly by helping man to become much more productive. Money in the modern economy is viewed as lubricant that greases the wheel of economic activity. Without money, the transactions that make up our daily economic routine would be extremely difficult and so is saving and investment. Money also plays a key role in influencing the behavior of the economy as a whole and performance of the financial institutions and markets.

More specifically changes in the supply of money and credit can affect how rapidly the economy grows, the level of employment and the rate of inflation and these in turn can affect the value of financial assets held by individuals and financial institutions.As a matter of fact to appreciate the importance of money in an economic system, it is instructive to speculate on what the economy might be without money.For one thing without money individuals in the economy would have to devote more time to buying what they want and selling what they do not want, the introduction of money has simplified matters.

Workers are now paid in money which they can use to pay for their goods and services. Money is the medium of exchange. Besides this, money serves as a medium of measuring the value and also facilitates deferred payments.The importance of money becomes more obvious in its relevance to financial institutions and markets. Money contributes to economic development and growth by stipulating both saving and investment and facilitating transfer of funds from savers to borrowers who want to undertake investment projects, who do not have their own money to do so. Financial markets give savers a variety of ways to lend to borrowers, thereby increasing the volume of both savings and investment and encouraging economic growth.

People who save are not often the same people who can see and exploit profitable investment opportunities. The introduction of money, however permits the separation of the act of investment from the act of saving. Money makes it possible for a person to invest without first refraining from consumption (saving) and likewise makes it possible for a person to save without also investing. People who are not fortunate enough to have their own savings now can invest. Monetary policies of the central bank are transmitted through the financial institutions. Hence, financial institutions have sprung up- such as commercial banks, saving banks, saving banks & loan associations, credit unions, insurance companies, etc.

Meaning of Monetary Policy
Monetary policy refers to the tools used by government through the Central Bank to conduct the supply of money. Dr. Paul Einzing defined monetary policy as the attitude of the political authority towards the monetary system of the community under its control. It comprises all measures applied by monetary authorities to produce a deliberate impact on the nature and volume of money in circulation. According to Harry Jonson, Monetary policy is the policy employing the central banks control of the supply of money as an instrument for achieving the objectives of general economic policy.

The Conduct of Monetary Policy
No central bank can avoid involvement with the conduct of monetary policy. This is because the conduct of monetary policy must involve the setting of short term interest rates and this is done by central bank by using its own role in the money markets, exploiting its position as banker to the rest of the banking system. ln fact six basic goals are mentioned with regard to the objectives of monetary policy: (1) high employment, (2) economic growth, (3) price stability, (4) interest rate stability, (5) stability of financial markets, (6) stability of foreign exchange market [Stanley and Eakins, 2000] Monetary policies are formulated and implemented in order to achieve certain objectives or goals which are stated below.


The Goals of Monetary Policy

High Employment
High employment is an important goal for two reasons: (1) the alternative situation of high unemployment causes human misery, with families suffering From financial distress, loss of personal self-respect and increase incrime and (2) when unemployment is high, the economy has not only idle workers, but also idle resources like closed factories, unused equipment which results
in loss of output. However, the goal for high employment should not seek an unemployment level of zero but rather a level above zero consistent with full employment at which the demand for labor equals the supply of labor.This level is called the natural level of unemployment.

Economic Growth
The goalof steady economic growth is related to high employment- growth because businesses are more likely to invest in capital equipment to increase productive activity and economic growth when unemployment is low. Conversely, if unemployment is high and factories are idle, it does not pay for firms to invest in additional plants and equipment. Although the two goals are specificallyrelated, policies can be specifically aimed at promoting economic growth by directly encouraging firms to invest or by encouraging people to save, which provides more funds for firms to invest.In fact this is the stated purpose of so-called supply-side economic policies, which are intended to spur economic growth by providing tax incentives for businesses to invest in factories and equipment and for tax payers to save more.

Price stability
Stable price level is considered as a goal of monetary policy. Price stability is desirable because a rising price level creates uncertainty in an economy and may hamper economic growth. For example,the information provided by prices of goods and services is harderto interpretwhen the overall level of prices is changing which complicates decision making for consumers, businesses and government. A growing body of evidence suggests that inflation leads to lower economic growth. Inflation also makes it hard for the future to plan. For example it is more difficult to decide how much fund should be put aside to provide for a child'scollege education in an inflationary environment. Further, inflation may strain a country’s social fabric.

Interest Rate Stability
Interest rate stability may be desirable because fluctuations in interest rates can create uncertainty and make it harder to plan for the future. Fluctuations in interest rates that affect consumers' willingness to buy houses, for example, make it more difficult for customers to decide when to purchase a house and construction firms to plan how many houses to build. Upward movements in interest rates may also create hostility by the affected groups in society.

Stability in Financial Markets
Financial crises can interfere with the ability of financial markets to channel funds to people with productive investment opportunities, thereby leading to a sharp contraction in economic activity. The promotion of a more stable financial system in which financial crises are avoided is thus an important goalfor a central bank.

The stability of financial markets is also fostered by interest rate stability, because fluctuations in interest rates create great uncertainty for financial institutions. An increase in interest rates produces large capital tosses on long term bonds and mortgages, losses that can cause the failure of the financial institutions holding them.

Stability in the Foreign Exchange market
Withincreasing importance of international trade, exchange rate policy has become a major consideration of monetary policy. A rise in the value of currency will make that country’s exports more expensive to foreign countries, and a fall in the value of currency will make imports more expensive.In addition, preventing large changes in the value of a currency makes it easier for firms and individuals purchasing selling goods abroad to plan ahead. Stabilizing extreme movements in the value of a currency in the foreign exchange market is thus viewed as a worthy goal of monetary policy.

Maintenance of balance of payments equilibrium
Balance of payments of a country sometime may be deficit and sometime surplus. A persistent deficit in the balance of payments of a country may be a cause of concern forthatcountry.A surplus, under certain circumstances, may also cause problems. Maintenance of an appropriate balance of payments,through properconductof monetarypolicy,becomes an added responsibilityof a central bank.



The Conflict among Goals
Although many of the goals mentioned are consistent with each other, high employment and economic growth, interest rate stability and financial market stability, this is not always the case. These objectives are not necessarily compatible. The goal ofprice stability often conflicts with the goals of interest rate stability and high employment in the short run (but probably not in the long run). For example, when the economy is expanding and unemployment is falling, both interest rates and inflation starts to rise. If the central bank tries to prevent a rise in interest rates to prevent inflation, this may cause the economy to overheat and stimulate inflation. But if a central bank prevent inflation, in the short run unemployment may rise. The conflict among goals may thus present central banks with some hard choices.

The Application of Monetary Policy: Rules versus Discretion

The debate about whether monetary policy decisions should be governed by rules or discretion has a long history. However, neither pure discretion nor fixed adherence to an intermediate monetary target has proved satisfactory. In their place several countries are moving toward a regime in which there is a clear target for the ultimate objective of monetary policy, together with a statement of the authorities'decisionmaking practices that is as open and transparent as possible.

We notice three broad phases in the approach to policy making in the postwar period. Until about the late 1960s, it was taken for granted, that formulating monetary policy required a substantial amount of discretion. From the early 1970s untilthe 1980s, there was a growing emphasis on rules. By the late 1980s; however,there was a swing away from rule based policy regimes. The relationship between intermediate targets and ultimate objectives became more variable under the influence of financial liberalization and innovation. In recent years, it seems most central banks have recognized the need for a return to greater discretion in the use of monetary instruments.

ln this context, it is necessary toprovide the definition of a fewterms,because the same expressions may be used to mean different things by different authors. Central banks use policy instruments to pursue ultimate policy objectives. Along the way, they are concerned with intermediate variables, which are part of the policy transmission process, as well as with indicator variables which may provide information about the impact of policy, without themselves being part of the transmission mechanism

Rules are generally taken to require the authorities to use the instruments of monetary policy to achieve a given predetermined path for an intermediate variable (usually a monetary aggregate). Intermediate variables are those which the monetary authorities may attempt to target because of their presumed relationshipwith the ultimate objectives of monetary policy.The most common example of an intermediate variable is the money stock or credit stock. To the extent that growth in monetary aggregates is stably related to the ultimate objective of monetary policy (the steady growth of the nominal value of output) and to the extent that it is more feasible to control the money stock than nominal output, it makes sense to direct policy instruments towards the achievement of an intermediate variable.

Indicator variables can be defined as those that have information value about the impact of instrument on policy outcomes, but are not themselves an object of control. In fact the whole range” of economic quantities has a bearing on monetary policy decisions. They can include variables that in another context may be viewed as intermediate target. For example the growth of money stock can be regarded as object to be controlled. It can also be regarded as one indicator (among others) of the potential strength of demand in the economy. This underlines an important point: just because a monetary variable is not used as an object of control does not mean that it does not play an important role in evaluating the stance of monetary policy.


Other indicator variables are those that convey information about the future of the economy, and the balance between inflationary and recessionary forces. They include all variables relating to the current and prospective level of real economic activity [GDP growth, industrial production, Retail sales, consumer and business spending surveys, etc. They also include cost and price indicators [wages, import costs, consumer and producer price indices] and expectation indices, including expectations derived from financialvariables such as the shape of the yield curve.

The distinction between whether variables are to be treated as indicators or intermediate targets is crucial to the distinction between rules and discretion. However, the distinction between rules and discretion is not straightforward, and, hence deserves some clarification. The use of discretion in monetary policy is clearly not intended to imply randomness in decision making. A discretionary policy action usually reflects a systematic response by policy authorities, taken in the light of their objectives, and their perceptions as to how the economy will respond to particular economic stimuli.

Arguments for discretion in the formulation and implementation of policy:

First economics is subject to both supply shocks and demand shocks. The appropriate monetary policy response will be quite different in the two cases. If the authorities can identify the nature of different shocks, they will be able to improve welfare by exercising discretion in how they respond to them.

A second argument for discretion lies in the fact that the speed with which an economy returns to price stability following an inflationary or deflationary shock has implications for output and employment. The use of discretion may enable the central bank to tolerate some overshooting of the monetary targets, to allow the return to price stability to take place in a more orderly manner.

A third argument for discretion is that the structure of the economy is changing through time in ways that cannot easily be predicted in advance. The relationship between intermediate variables and the ultimate objectives of policy can be affected by technical developments. Under such circumstances discretion, rather than a set rules, could be more appropriate.

Arguments for rules

One is the Libertarian principle that, in a democracy, discretion from decision making should be removed from individuals and vested in rules and laws. Perhaps the more important economic argument for rule is that there is fundamentally stable relationship between an intermediate variable ( a monetary aggreg4te ) and the ultimate objective of monetary policy (the growth of nominal income ).The benefits of discretion are, therefore small, since it is not possible to improve much on the outcome generated by adopting a stable money growth target. On the other hand, so the argument goes, the costs of discretion are potentially large
A subsidiary argument for rules is that financial markets operate most efficiently in the presence of certainty. If in addition to the inherent uncertainties generated by outside economic shocks, there are uncertainties about the authority’s policyresponse, the difficulties faced by markets will be compounded. This argument has been formalized in the literature on the time consistencyproblem and the value of rules that "pre-commit" the authorities to a particular course of action ( Kydland and Prescott,1977).

The arguments in favor of rules are based more on the quality of discretionary action, than on discretion per se. It may be argued that discretionary monetary policy is subject to two systematic sources of adverse bias: "too little, too late ". For example, there will be greater willingness to lower interest rates than to raise them (Kohn, 1993)


Functions of Bangladesh Bank: The Central Bank of Bangladesh

Bangladesh Bank Carries out the following main functions as the country’s Central Bank:

    Formulating monetary and credit policies.
    Managing currency issue and regulatory payment system.
    Managing foreign exchange reserves and regulating the foreign exchange market.
    Regulating and supervising banks and financial institutions.
    Advising the government on interactions and impact of fiscal, monetary and other economic functions.
    Achieving balance of payments equilibrium.

Towards performing the above functions, the commitment of BB to diverse stakeholders are as follows:

1.   For the Nation:The BB shall catalyze and support socially responsible and environmentally sustainable development initiatives including financial inclusion of underserved productive sectors and bringing in needed new dimensions in financial markets and institutions to facilitate broad based growth in output, employment and income for rapid poverty eradication and inclusive economic and social progress.

2.   For the Government: The BB adopt and implement monetary and credit policies conforming withnational priorities in coordination with fiscal and other macroeconomic objectives. The BB shall also optimize foreign exchange revenues and returns thereon, maintain stability in financial markets curbing excessive volatility and provide analysis and advice to the government on issues in economic management and development.

3.   For Depositors in Banks and Financial Institutions, Investors and in Financial Assets: The BB shall ensure safety of deposits in licensed banks and financial institutions with onsite and offsite supervision of their authorities and with adequate financial information disclosure requirements, besides insuring small deposits. The BB should maintain an interest rate structure that provides fair returns on financial assets while also supporting growth in the real sector and should also promote and support development of markets in bonds and securities.

4.   For Banks and Financial Institutions in Bangladesh:The BB shall provide prudential regulatory risk management and disclosure framework to protect solvency and liquidity of the overall financial system, acting as lender of last resort in and when needed.

Strategic Action Plan of BB 2010-2014

Strategies are means to achieving goals. Ten strategies have been identified by Bangladesh Bank to address the possible development and change. All BB departments/branch offices will drill down the strategies into performance management system (PMS). The strategies are mentioned below without any in-depth study about the outcome of these strategies. These is scope for research about the strategic plan.

•   Strategy: 01Revisit the current monetary policy framework to ensure continuing effectiveness of monetary policies.

•   Strategy: 02 Strengthen regulatory and supervisory framework to enhance financial sector resilience and stability.

•   Strategy: 03 further deepen financial markets in Bangladesh.

•   Strategy: 04 financial inclusion and borrowing of access.

•   Strategy: 05 Develop more efficient currency management and payment system.

•   Strategy: 06 Strengthen revenue management capabilities.

•   Strategy: 07 Enhance regulatory and supervisory framework against money laundering.

•   Strategy: 08 Introduce separate comprehensive guidance and supervision for Islamic Banking.

•   Strategy: 09 Develop more efficient management of government domestic debt.

•   Strategy: 10 Full automation of Credit Information Bureau (CIB)

Critical success factors (CSF) are the most vital elements or activities in strategic planning process that are important for strategies to be successful. Some CSF are mentioned below:
External CSF
    Rules of law, good governance, social and political stability.
    Quick, efficient process of commercial dispute settlement.
    Sustained level of confidence of the stakeholders on financial system.
    Central Bank autonomy and operational independence.
Internal CSF
    Efficient involvement and ownership of management and strategic planning.
    Efficient Communication, coordination and logistic support.
    Focus on weak areas in values, culture and behavior.
    Adequate efforts and opportunities for expertise development.
    Efficient knowledge management.
    Failure to attract best people in the market and retention.
    Understanding of staff’s capabilities and proper development.
    Implementation of business continuity plans including process reengineering.
To be continued………………


19
Financial Issues / Monetary Policy
« on: February 05, 2019, 04:22:03 PM »
Professor Rafiqul Islam
Department of Business Administration
Faculty of Business & Entrepreneurship
Daffodil International University (DIU)

Money, Monetary Policy and Central Bank Functions: Bangladesh Perspectives

Any discussion on monetary policy requires some understanding of the importance of money, financial markets and financial institutions. Money, credit or the whole structure of financial institutions can contribute greatly to improvement of standard of living in society but it does so only indirectly by helping man to become much more productive. Money in the modern economy is viewed as lubricant that greases the wheel of economic activity. Without money, the transactions that make up our daily economic routine would be extremely difficult and so is saving and investment. Money also plays a key role in influencing the behavior of the economy as a whole and performance of the financial institutions and markets.

More specifically changes in the supply of money and credit can affect how rapidly the economy grows, the level of employment and the rate of inflation and these in turn can affect the value of financial assets held by individuals and financial institutions.As a matter of fact to appreciate the importance of money in an economic system, it is instructive to speculate on what the economy might be without money.For one thing without money individuals in the economy would have to devote more time to buying what they want and selling what they do not want, the introduction of money has simplified matters.

Workers are now paid in money which they can use to pay for their goods and services. Money is the medium of exchange. Besides this, money serves as a medium of measuring the value and also facilitates deferred payments.The importance of money becomes more obvious in its relevance to financial institutions and markets. Money contributes to economic development and good by stipulating both saving and investment and facilitating transfer of funds from savers to borrowers who want to undertake investment projects, who do not have their own money to do so. Financial markets give savers a variety of ways to lend to borrowers, thereby increasing the volume of both savings and investment and encouraging economic growth.

People who save are not often the same people who can see and exploit profitable investment opportunities. The introduction of money, however permits the separation of the act of investment from the act of saving. Money makes it possible for a person to invest without first refraining from consumption (saving) and likewise makes it possible for a person to save without also investing. People who are not fortunate enough to have their own savings now can invest. Monetary policies of the central bank are transmitted through the financial institutions. Hence, financial institutions have sprung up- such as commercial banks, saving banks, saving banks & loan associations, credit unions, insurance companies, etc.

Meaning of Monetary Policy
Monetary policy refers to the tools used by government through the Central Bank to conduct the supply of money. Dr. Paul Einzing defined monetary policy as the attitude of the political authority towards the monetary system of the community under its control. It comprises all measures applied by monetary authorities to produce a deliberate impact on the nature and volume of money in circulation. According to Harry Jonson, Monetary policy is the policy employing the central banks control of the supply of money as an instrument for achieving the objectives of general economic policy.

The Conduct of Monetary Policy
No central bank can avoidinvolvement with the conduct of monetary policy. This isbecause the conduct of monetary policy must involve the setting of short term interest rates andthis is done by central bank by using its own role in the money markets, exploiting its positionas banker to the rest of the banking system.ln fact six basic goals are mentioned with regard to the objectives of monetary policy: (1) high employment, (2) economic growth, (3) price stability, (4) interest rate stability, (5) stability of financial markets, (6) stability of foreign exchange market [Stanley and Eakins, 2000] Monetary policies are formulated and implemented in order to achieve certain objectives or goals which are stated below.


The Goals of Monetary Policy

High Employment
High employment is an important goal for two reasons: (1) the alternative situation of high unemployment causes human misery, with families suffering From financial distress, loss of personal self-respect and increase incrime and (2) when unemployment is high, the economy has not only idle workers, but also idle resources like closed factories, unused equipment which results
in loss of output. However, the goal for high employment should not seek an unemployment level of zero but rather a level above zero consistent with full employment at which the demand for labor equals the supply of labor.This level is called the natural level of unemployment.

Economic Growth
The goalof steady economic growth is related to high employment- growth because businesses are more likely to invest in capital equipment to increase productive activity and economic growth when unemployment is low. Conversely, if unemployment is high and factories are idle, it does not pay for firms to invest in additional plants and equipment. Although the two goals are specificallyrelated, policies can be specifically aimed at promoting economic growth by directly encouraging firms to invest or by encouraging people to save, which provides more funds for firms to invest.In fact this is the stated purpose of so-called supply-side economic policies, which are intended to spur economic growth by providing tax incentives for businesses to invest in factories and equipment and for tax payers to save more.

Price stability
Stable price level is considered as a goal of monetary policy. Price stability is desirable because a rising price level creates uncertainty in an economy and may hamper economic growth. For example,the information provided by prices of goods and services is harderto interpretwhen the overall level of prices is changing which complicates decision making for consumers, businesses and government. A growing body of evidence suggests that inflation leads to lower economic growth. Inflation also makes it hard for the future to plan. For example it is more difficult to decide how much fund should be put aside to provide for a child'scollege education in an inflationary environment. Further, inflation may strain a country’s social fabric.

Interest Rate Stability
Interest rate stability may be desirable because fluctuations in interest rates can create uncertainty and make it harder to plan for the future. Fluctuations in interest rates that affect consumers' willingness to buy houses, for example, make it more difficult for customers to decide when to purchase a house and construction firms to plan how many houses to build. Upward movements in interest rates may also create hostility by the affected groups in society.

Stability in Financial Markets
Financial crises can interfere with the ability of financial markets to channel funds to people with productive investment opportunities, thereby leading to a sharp contraction in economic activity. The promotion of a more stable financial system in which financial crises are avoided is thus an important goalfor a central bank.

The stability of financial markets is also fostered by interest rate stability, because fluctuations in interest rates create great uncertainty for financial institutions. An increase in interest rates produces large capital tosses on long term bonds and mortgages, losses that can cause the failure of the financial institutions holding them.

Stability in the Foreign Exchange market
Withincreasing importance of international trade, exchange rate policy has become a major consideration of monetary policy. A rise in the value of currency will make that country’s exports more expensive to foreign countries, and a fall in the value of currency will make imports more expensive.In addition, preventing large changes in the value of a currency makes it easier for firms and individuals purchasing selling goods abroad to plan ahead. Stabilizing extreme movements in the value of a currency in the foreign exchange market is thus viewed as a worthy goal of monetary policy.

Maintenance of balance of payments equilibrium
Balance of payments of a country sometime may be deficit and sometime surplus. A persistent deficit in the balance of payments of a country may be a cause of concern forthatcountry.A surplus, under certain circumstances, may also cause problems. Maintenance of an appropriate balance of payments,through properconductof monetarypolicy,becomes an added responsibilityof a central bank.



The Conflict among Goals
Although many of the goals mentioned are consistent with each other, high employment and economic growth, interest rate stability and financial market stability, this is not always the case. These objectives are not necessarily compatible. The goal ofprice stability often conflicts with the goals of interest rate stability and high employment in the short run (but probably not in the long run). For example, when the economy is expanding and unemployment is falling, both interest rates and inflation starts to rise. If the central bank tries to prevent a rise in interest rates to prevent inflation, this may cause the economy to overheat and stimulate inflation. But if a central bank prevent inflation, in the short run unemployment may rise. The conflict among goals may thus present central banks with some hard choices.

The Application of Monetary Policy: Rules versus Discretion

The debate about whether monetary policy decisions should be governed by rules or discretion has a long history. However, neither pure discretion nor fixed adherence to an intermediate monetary target has proved satisfactory. In their place several countries are moving toward a regime in which there is a clear target for the ultimate objective of monetary policy, together with a statement of the authorities'decisionmaking practices that is as open and transparent as possible.

We notice three broad phases in the approach to policy making in the postwar period. Until about the late 1960s, it was taken for granted, that formulating monetary policy required a substantial amount of discretion. From the early 1970s untilthe 1980s, there was a growing emphasis on rules. By the late 1980s; however,there was a swing away from rule based policy regimes. The relationship between intermediate targets and ultimate objectives became more variable under the influence of financial liberalization and innovation. In recent years, it seems most central banks have recognized the need for a return to greater discretion in the use of monetary instruments.

ln this context, it is necessary toprovide the definition of a fewterms,because the same expressions may be used to mean different things by different authors. Central banks use policy instruments to pursue ultimate policy objectives. Along the way, they are concerned with intermediate variables, which are part of the policy transmission process, as well as with indicator variables which may provide information about the impact of policy, without themselves being part of the transmission mechanism

Rules are generally taken to require the authorities to use the instruments of monetary policy to achieve a given predetermined path for an intermediate variable (usually a monetary aggregate). Intermediate variables are those which the monetary authorities may attempt to target because of their presumed relationshipwith the ultimate objectives of monetary policy.The most common example of an intermediate variable is the money stock or credit stock. To the extent that growth in monetary aggregates is stably related to the ultimate objective of monetary policy (the steady growth of the nominal value of output) and to the extent that it is more feasible to control the money stock than nominal output, it makes sense to direct policy instruments towards the achievement of an intermediate variable.

Indicator variables can be defined as those that have information value about the impact of instrument on policy outcomes, but are not themselves an object of control. In fact the whole range” of economic quantities has a bearing on monetary policy decisions. They can include variables that in another context may be viewed as intermediate target. For example the growth of money stock can be regarded as object to be controlled. It can also be regarded as one indicator (among others) of the potential strength of demand in the economy. This underlines an important point: just because a monetary variable is not used as an object of control does not mean that it does not play an important role in evaluating the stance of monetary policy.


Other indicator variables are those that convey information about the future of the economy, and the balance between inflationary and recessionary forces. They include all variables relating to the current and prospective level of real economic activity [GDP growth, industrial production, Retail sales, consumer and business spending surveys, etc. They also include cost and price indicators [wages, import costs, consumer and producer price indices] and expectation indices, including expectations derived from financialvariables such as the shape of the yield curve.

The distinction between whether variables are to be treated as indicators or intermediate targets is crucial to the distinction between rules and discretion. However, the distinction between rules and discretion is not straightforward, and, hence deserves some clarification. The use of discretion in monetary policy is clearly not intended to imply randomness in decision making. A discretionary policy action usually reflects a systematic response by policy authorities, taken in the light of their objectives, and their perceptions as to how the economy will respond to particular economic stimuli.

Arguments for discretion in the formulation and implementation of policy:

First economics is subject to both supply shocks and demand shocks. The appropriate monetary policy response will be quite different in the two cases. If the authorities can identify the nature of different shocks, they will be able to improve welfare by exercising discretion in how they respond to them.

A second argument for discretion lies in the fact that the speed with which an economy returns to price stability following an inflationary or deflationary shock has implications for output and employment. The use of discretion may enable the central bank to tolerate some overshooting of the monetary targets, to allow the return to price stability to take place in a more orderly manner.

A third argument for discretion is that the structure of the economy is changing through time in ways that cannot easily be predicted in advance. The relationship between intermediate variables and the ultimate objectives of policy can be affected by technical developments. Under such circumstances discretion, rather than a set rules, could be more appropriate.

Arguments for rules

One is the Libertarian principle that, in a democracy, discretion from decision making should be removed from individuals and vested in rules and laws. Perhaps the more important economic argument for rule is that there is fundamentally stable relationship between an intermediate variable ( a monetary aggreg4te ) and the ultimate objective of monetary policy (the growth of nominal income ).The benefits of discretion are, therefore small, since it is not possible to improve much on the outcome generated by adopting a stable money growth target. On the other hand, so the argument goes, the costs of discretion are potentially large
A subsidiary argument for rules is that financial markets operate most efficiently in the presence of certainty. If in addition to the inherent uncertainties generated by outside economic shocks, there are uncertainties about the authority’s policyresponse, the difficulties faced by markets will be compounded. This argument has been formalized in the literature on the time consistencyproblem and the value of rules that "pre-commit" the authorities to a particular course of action ( Kydland and Prescott,1977).

The arguments in favor of rules are based more on the quality of discretionary action, than on discretion per se. It may be argued that discretionary monetary policy is subject to two systematic sources of adverse bias: "too little, too late ". For example, there will be greater willingness to lower interest rates than to raise them (Kohn, 1993)


Functions of Bangladesh Bank: The Central Bank of Bangladesh

Bangladesh Bank Carries out the following main functions as the country’s Central Bank:

    Formulating monetary and credit policies.
    Managing currency issue and regulatory payment system.
    Managing foreign exchange reserves and regulating the foreign exchange market.
    Regulating and supervising banks and financial institutions.
    Advising the government on interactions and impact of fiscal, monetary and other economic functions.
    Achieving balance of payments equilibrium.

Towards performing the above functions, the commitment of BB to diverse stakeholders are as follows:

1.   For the Nation:The BB shall catalyze and support socially responsible and environmentally sustainable development initiatives including financial inclusion of underserved productive sectors and bringing in needed new dimensions in financial markets and institutions to facilitate broad based growth in output, employment and income for rapid poverty eradication and inclusive economic and social progress.

2.   For the Government: The BB adopt and implement monetary and credit policies conforming withnational priorities in coordination with fiscal and other macroeconomic objectives. The BB shall also optimize foreign exchange revenues and returns thereon, maintain stability in financial markets curbing excessive volatility and provide analysis and advice to the government on issues in economic management and development.

3.   For Depositors in Banks and Financial Institutions, Investors and in Financial Assets: The BB shall ensure safety of deposits in licensed banks and financial institutions with onsite and offsite supervision of their authorities and with adequate financial information disclosure requirements, besides insuring small deposits. The BB should maintain an interest rate structure that provides fair returns on financial assets while also supporting growth in the real sector and should also promote and support development of markets in bonds and securities.

4.   For Banks and Financial Institutions in Bangladesh:The BB shall provide prudential regulatory risk management and disclosure framework to protect solvency and liquidity of the overall financial system, acting as lender of last resort in and when needed.

Strategic Action Plan of BB 2010-2014

Strategies are means to achieving goals. Ten strategies have been identified by Bangladesh Bank to address the possible development and change. All BB departments/branch offices will drill down the strategies into performance management system (PMS). The strategies are mentioned below without any in-depth study about the outcome of these strategies. These is scope for research about the strategic plan.

•   Strategy: 01Revisit the current monetary policy framework to ensure continuing effectiveness of monetary policies.

•   Strategy: 02 Strengthen regulatory and supervisory framework to enhance financial sector resilience and stability.

•   Strategy: 03 further deepen financial markets in Bangladesh.

•   Strategy: 04 financial inclusion and borrowing of access.

•   Strategy: 05 Develop more efficient currency management and payment system.

•   Strategy: 06 Strengthen revenue management capabilities.

•   Strategy: 07 Enhance regulatory and supervisory framework against money laundering.

•   Strategy: 08 Introduce separate comprehensive guidance and supervision for Islamic Banking.

•   Strategy: 09 Develop more efficient management of government domestic debt.

•   Strategy: 10 Full automation of Credit Information Bureau (CIB)

Critical success factors (CSF) are the most vital elements or activities in strategic planning process that are important for strategies to be successful. Some CSF are mentioned below:
External CSF
    Rules of law, good governance, social and political stability.
    Quick, efficient process of commercial dispute settlement.
    Sustained level of confidence of the stakeholders on financial system.
    Central Bank autonomy and operational independence.
Internal CSF
    Efficient involvement and ownership of management and strategic planning.
    Efficient Communication, coordination and logistic support.
    Focus on weak areas in values, culture and behavior.
    Adequate efforts and opportunities for expertise development.
    Efficient knowledge management.
    Failure to attract best people in the market and retention.
    Understanding of staff’s capabilities and proper development.
    Implementation of business continuity plans including process reengineering.
To be continued………………


20
BBA Discussion Forum / Monetary Policy
« on: February 05, 2019, 04:21:24 PM »
Professor Rafiqul Islam
Department of Business Administration
Faculty of Business & Entrepreneurship
Daffodil International University (DIU)

Money, Monetary Policy and Central Bank Functions: Bangladesh Perspectives

Any discussion on monetary policy requires some understanding of the importance of money, financial markets and financial institutions. Money, credit or the whole structure of financial institutions can contribute greatly to improvement of standard of living in society but it does so only indirectly by helping man to become much more productive. Money in the modern economy is viewed as lubricant that greases the wheel of economic activity. Without money, the transactions that make up our daily economic routine would be extremely difficult and so is saving and investment. Money also plays a key role in influencing the behavior of the economy as a whole and performance of the financial institutions and markets.

More specifically changes in the supply of money and credit can affect how rapidly the economy grows, the level of employment and the rate of inflation and these in turn can affect the value of financial assets held by individuals and financial institutions.As a matter of fact to appreciate the importance of money in an economic system, it is instructive to speculate on what the economy might be without money.For one thing without money individuals in the economy would have to devote more time to buying what they want and selling what they do not want, the introduction of money has simplified matters.

Workers are now paid in money which they can use to pay for their goods and services. Money is the medium of exchange. Besides this, money serves as a medium of measuring the value and also facilitates deferred payments.The importance of money becomes more obvious in its relevance to financial institutions and markets. Money contributes to economic development and good by stipulating both saving and investment and facilitating transfer of funds from savers to borrowers who want to undertake investment projects, who do not have their own money to do so. Financial markets give savers a variety of ways to lend to borrowers, thereby increasing the volume of both savings and investment and encouraging economic growth.

People who save are not often the same people who can see and exploit profitable investment opportunities. The introduction of money, however permits the separation of the act of investment from the act of saving. Money makes it possible for a person to invest without first refraining from consumption (saving) and likewise makes it possible for a person to save without also investing. People who are not fortunate enough to have their own savings now can invest. Monetary policies of the central bank are transmitted through the financial institutions. Hence, financial institutions have sprung up- such as commercial banks, saving banks, saving banks & loan associations, credit unions, insurance companies, etc.

Meaning of Monetary Policy
Monetary policy refers to the tools used by government through the Central Bank to conduct the supply of money. Dr. Paul Einzing defined monetary policy as the attitude of the political authority towards the monetary system of the community under its control. It comprises all measures applied by monetary authorities to produce a deliberate impact on the nature and volume of money in circulation. According to Harry Jonson, Monetary policy is the policy employing the central banks control of the supply of money as an instrument for achieving the objectives of general economic policy.

The Conduct of Monetary Policy
No central bank can avoidinvolvement with the conduct of monetary policy. This isbecause the conduct of monetary policy must involve the setting of short term interest rates andthis is done by central bank by using its own role in the money markets, exploiting its positionas banker to the rest of the banking system.ln fact six basic goals are mentioned with regard to the objectives of monetary policy: (1) high employment, (2) economic growth, (3) price stability, (4) interest rate stability, (5) stability of financial markets, (6) stability of foreign exchange market [Stanley and Eakins, 2000] Monetary policies are formulated and implemented in order to achieve certain objectives or goals which are stated below.


The Goals of Monetary Policy

High Employment
High employment is an important goal for two reasons: (1) the alternative situation of high unemployment causes human misery, with families suffering From financial distress, loss of personal self-respect and increase incrime and (2) when unemployment is high, the economy has not only idle workers, but also idle resources like closed factories, unused equipment which results
in loss of output. However, the goal for high employment should not seek an unemployment level of zero but rather a level above zero consistent with full employment at which the demand for labor equals the supply of labor.This level is called the natural level of unemployment.

Economic Growth
The goalof steady economic growth is related to high employment- growth because businesses are more likely to invest in capital equipment to increase productive activity and economic growth when unemployment is low. Conversely, if unemployment is high and factories are idle, it does not pay for firms to invest in additional plants and equipment. Although the two goals are specificallyrelated, policies can be specifically aimed at promoting economic growth by directly encouraging firms to invest or by encouraging people to save, which provides more funds for firms to invest.In fact this is the stated purpose of so-called supply-side economic policies, which are intended to spur economic growth by providing tax incentives for businesses to invest in factories and equipment and for tax payers to save more.

Price stability
Stable price level is considered as a goal of monetary policy. Price stability is desirable because a rising price level creates uncertainty in an economy and may hamper economic growth. For example,the information provided by prices of goods and services is harderto interpretwhen the overall level of prices is changing which complicates decision making for consumers, businesses and government. A growing body of evidence suggests that inflation leads to lower economic growth. Inflation also makes it hard for the future to plan. For example it is more difficult to decide how much fund should be put aside to provide for a child'scollege education in an inflationary environment. Further, inflation may strain a country’s social fabric.

Interest Rate Stability
Interest rate stability may be desirable because fluctuations in interest rates can create uncertainty and make it harder to plan for the future. Fluctuations in interest rates that affect consumers' willingness to buy houses, for example, make it more difficult for customers to decide when to purchase a house and construction firms to plan how many houses to build. Upward movements in interest rates may also create hostility by the affected groups in society.

Stability in Financial Markets
Financial crises can interfere with the ability of financial markets to channel funds to people with productive investment opportunities, thereby leading to a sharp contraction in economic activity. The promotion of a more stable financial system in which financial crises are avoided is thus an important goalfor a central bank.

The stability of financial markets is also fostered by interest rate stability, because fluctuations in interest rates create great uncertainty for financial institutions. An increase in interest rates produces large capital tosses on long term bonds and mortgages, losses that can cause the failure of the financial institutions holding them.

Stability in the Foreign Exchange market
Withincreasing importance of international trade, exchange rate policy has become a major consideration of monetary policy. A rise in the value of currency will make that country’s exports more expensive to foreign countries, and a fall in the value of currency will make imports more expensive.In addition, preventing large changes in the value of a currency makes it easier for firms and individuals purchasing selling goods abroad to plan ahead. Stabilizing extreme movements in the value of a currency in the foreign exchange market is thus viewed as a worthy goal of monetary policy.

Maintenance of balance of payments equilibrium
Balance of payments of a country sometime may be deficit and sometime surplus. A persistent deficit in the balance of payments of a country may be a cause of concern forthatcountry.A surplus, under certain circumstances, may also cause problems. Maintenance of an appropriate balance of payments,through properconductof monetarypolicy,becomes an added responsibilityof a central bank.



The Conflict among Goals
Although many of the goals mentioned are consistent with each other, high employment and economic growth, interest rate stability and financial market stability, this is not always the case. These objectives are not necessarily compatible. The goal ofprice stability often conflicts with the goals of interest rate stability and high employment in the short run (but probably not in the long run). For example, when the economy is expanding and unemployment is falling, both interest rates and inflation starts to rise. If the central bank tries to prevent a rise in interest rates to prevent inflation, this may cause the economy to overheat and stimulate inflation. But if a central bank prevent inflation, in the short run unemployment may rise. The conflict among goals may thus present central banks with some hard choices.

The Application of Monetary Policy: Rules versus Discretion

The debate about whether monetary policy decisions should be governed by rules or discretion has a long history. However, neither pure discretion nor fixed adherence to an intermediate monetary target has proved satisfactory. In their place several countries are moving toward a regime in which there is a clear target for the ultimate objective of monetary policy, together with a statement of the authorities'decisionmaking practices that is as open and transparent as possible.

We notice three broad phases in the approach to policy making in the postwar period. Until about the late 1960s, it was taken for granted, that formulating monetary policy required a substantial amount of discretion. From the early 1970s untilthe 1980s, there was a growing emphasis on rules. By the late 1980s; however,there was a swing away from rule based policy regimes. The relationship between intermediate targets and ultimate objectives became more variable under the influence of financial liberalization and innovation. In recent years, it seems most central banks have recognized the need for a return to greater discretion in the use of monetary instruments.

ln this context, it is necessary toprovide the definition of a fewterms,because the same expressions may be used to mean different things by different authors. Central banks use policy instruments to pursue ultimate policy objectives. Along the way, they are concerned with intermediate variables, which are part of the policy transmission process, as well as with indicator variables which may provide information about the impact of policy, without themselves being part of the transmission mechanism

Rules are generally taken to require the authorities to use the instruments of monetary policy to achieve a given predetermined path for an intermediate variable (usually a monetary aggregate). Intermediate variables are those which the monetary authorities may attempt to target because of their presumed relationshipwith the ultimate objectives of monetary policy.The most common example of an intermediate variable is the money stock or credit stock. To the extent that growth in monetary aggregates is stably related to the ultimate objective of monetary policy (the steady growth of the nominal value of output) and to the extent that it is more feasible to control the money stock than nominal output, it makes sense to direct policy instruments towards the achievement of an intermediate variable.

Indicator variables can be defined as those that have information value about the impact of instrument on policy outcomes, but are not themselves an object of control. In fact the whole range” of economic quantities has a bearing on monetary policy decisions. They can include variables that in another context may be viewed as intermediate target. For example the growth of money stock can be regarded as object to be controlled. It can also be regarded as one indicator (among others) of the potential strength of demand in the economy. This underlines an important point: just because a monetary variable is not used as an object of control does not mean that it does not play an important role in evaluating the stance of monetary policy.


Other indicator variables are those that convey information about the future of the economy, and the balance between inflationary and recessionary forces. They include all variables relating to the current and prospective level of real economic activity [GDP growth, industrial production, Retail sales, consumer and business spending surveys, etc. They also include cost and price indicators [wages, import costs, consumer and producer price indices] and expectation indices, including expectations derived from financialvariables such as the shape of the yield curve.

The distinction between whether variables are to be treated as indicators or intermediate targets is crucial to the distinction between rules and discretion. However, the distinction between rules and discretion is not straightforward, and, hence deserves some clarification. The use of discretion in monetary policy is clearly not intended to imply randomness in decision making. A discretionary policy action usually reflects a systematic response by policy authorities, taken in the light of their objectives, and their perceptions as to how the economy will respond to particular economic stimuli.

Arguments for discretion in the formulation and implementation of policy:

First economics is subject to both supply shocks and demand shocks. The appropriate monetary policy response will be quite different in the two cases. If the authorities can identify the nature of different shocks, they will be able to improve welfare by exercising discretion in how they respond to them.

A second argument for discretion lies in the fact that the speed with which an economy returns to price stability following an inflationary or deflationary shock has implications for output and employment. The use of discretion may enable the central bank to tolerate some overshooting of the monetary targets, to allow the return to price stability to take place in a more orderly manner.

A third argument for discretion is that the structure of the economy is changing through time in ways that cannot easily be predicted in advance. The relationship between intermediate variables and the ultimate objectives of policy can be affected by technical developments. Under such circumstances discretion, rather than a set rules, could be more appropriate.

Arguments for rules

One is the Libertarian principle that, in a democracy, discretion from decision making should be removed from individuals and vested in rules and laws. Perhaps the more important economic argument for rule is that there is fundamentally stable relationship between an intermediate variable ( a monetary aggreg4te ) and the ultimate objective of monetary policy (the growth of nominal income ).The benefits of discretion are, therefore small, since it is not possible to improve much on the outcome generated by adopting a stable money growth target. On the other hand, so the argument goes, the costs of discretion are potentially large
A subsidiary argument for rules is that financial markets operate most efficiently in the presence of certainty. If in addition to the inherent uncertainties generated by outside economic shocks, there are uncertainties about the authority’s policyresponse, the difficulties faced by markets will be compounded. This argument has been formalized in the literature on the time consistencyproblem and the value of rules that "pre-commit" the authorities to a particular course of action ( Kydland and Prescott,1977).

The arguments in favor of rules are based more on the quality of discretionary action, than on discretion per se. It may be argued that discretionary monetary policy is subject to two systematic sources of adverse bias: "too little, too late ". For example, there will be greater willingness to lower interest rates than to raise them (Kohn, 1993)


Functions of Bangladesh Bank: The Central Bank of Bangladesh

Bangladesh Bank Carries out the following main functions as the country’s Central Bank:

    Formulating monetary and credit policies.
    Managing currency issue and regulatory payment system.
    Managing foreign exchange reserves and regulating the foreign exchange market.
    Regulating and supervising banks and financial institutions.
    Advising the government on interactions and impact of fiscal, monetary and other economic functions.
    Achieving balance of payments equilibrium.

Towards performing the above functions, the commitment of BB to diverse stakeholders are as follows:

1.   For the Nation:The BB shall catalyze and support socially responsible and environmentally sustainable development initiatives including financial inclusion of underserved productive sectors and bringing in needed new dimensions in financial markets and institutions to facilitate broad based growth in output, employment and income for rapid poverty eradication and inclusive economic and social progress.

2.   For the Government: The BB adopt and implement monetary and credit policies conforming withnational priorities in coordination with fiscal and other macroeconomic objectives. The BB shall also optimize foreign exchange revenues and returns thereon, maintain stability in financial markets curbing excessive volatility and provide analysis and advice to the government on issues in economic management and development.

3.   For Depositors in Banks and Financial Institutions, Investors and in Financial Assets: The BB shall ensure safety of deposits in licensed banks and financial institutions with onsite and offsite supervision of their authorities and with adequate financial information disclosure requirements, besides insuring small deposits. The BB should maintain an interest rate structure that provides fair returns on financial assets while also supporting growth in the real sector and should also promote and support development of markets in bonds and securities.

4.   For Banks and Financial Institutions in Bangladesh:The BB shall provide prudential regulatory risk management and disclosure framework to protect solvency and liquidity of the overall financial system, acting as lender of last resort in and when needed.

Strategic Action Plan of BB 2010-2014

Strategies are means to achieving goals. Ten strategies have been identified by Bangladesh Bank to address the possible development and change. All BB departments/branch offices will drill down the strategies into performance management system (PMS). The strategies are mentioned below without any in-depth study about the outcome of these strategies. These is scope for research about the strategic plan.

•   Strategy: 01Revisit the current monetary policy framework to ensure continuing effectiveness of monetary policies.

•   Strategy: 02 Strengthen regulatory and supervisory framework to enhance financial sector resilience and stability.

•   Strategy: 03 further deepen financial markets in Bangladesh.

•   Strategy: 04 financial inclusion and borrowing of access.

•   Strategy: 05 Develop more efficient currency management and payment system.

•   Strategy: 06 Strengthen revenue management capabilities.

•   Strategy: 07 Enhance regulatory and supervisory framework against money laundering.

•   Strategy: 08 Introduce separate comprehensive guidance and supervision for Islamic Banking.

•   Strategy: 09 Develop more efficient management of government domestic debt.

•   Strategy: 10 Full automation of Credit Information Bureau (CIB)

Critical success factors (CSF) are the most vital elements or activities in strategic planning process that are important for strategies to be successful. Some CSF are mentioned below:
External CSF
    Rules of law, good governance, social and political stability.
    Quick, efficient process of commercial dispute settlement.
    Sustained level of confidence of the stakeholders on financial system.
    Central Bank autonomy and operational independence.
Internal CSF
    Efficient involvement and ownership of management and strategic planning.
    Efficient Communication, coordination and logistic support.
    Focus on weak areas in values, culture and behavior.
    Adequate efforts and opportunities for expertise development.
    Efficient knowledge management.
    Failure to attract best people in the market and retention.
    Understanding of staff’s capabilities and proper development.
    Implementation of business continuity plans including process reengineering.
To be continued………………


21
MBA Discussion Forum / Monetary Policy
« on: February 05, 2019, 04:20:52 PM »
Professor Rafiqul Islam
Department of Business Administration
Faculty of Business & Entrepreneurship
Daffodil International University (DIU)

Money, Monetary Policy and Central Bank Functions: Bangladesh Perspectives

Any discussion on monetary policy requires some understanding of the importance of money, financial markets and financial institutions. Money, credit or the whole structure of financial institutions can contribute greatly to improvement of standard of living in society but it does so only indirectly by helping man to become much more productive. Money in the modern economy is viewed as lubricant that greases the wheel of economic activity. Without money, the transactions that make up our daily economic routine would be extremely difficult and so is saving and investment. Money also plays a key role in influencing the behavior of the economy as a whole and performance of the financial institutions and markets.

More specifically changes in the supply of money and credit can affect how rapidly the economy grows, the level of employment and the rate of inflation and these in turn can affect the value of financial assets held by individuals and financial institutions.As a matter of fact to appreciate the importance of money in an economic system, it is instructive to speculate on what the economy might be without money.For one thing without money individuals in the economy would have to devote more time to buying what they want and selling what they do not want, the introduction of money has simplified matters.

Workers are now paid in money which they can use to pay for their goods and services. Money is the medium of exchange. Besides this, money serves as a medium of measuring the value and also facilitates deferred payments.The importance of money becomes more obvious in its relevance to financial institutions and markets. Money contributes to economic development and good by stipulating both saving and investment and facilitating transfer of funds from savers to borrowers who want to undertake investment projects, who do not have their own money to do so. Financial markets give savers a variety of ways to lend to borrowers, thereby increasing the volume of both savings and investment and encouraging economic growth.

People who save are not often the same people who can see and exploit profitable investment opportunities. The introduction of money, however permits the separation of the act of investment from the act of saving. Money makes it possible for a person to invest without first refraining from consumption (saving) and likewise makes it possible for a person to save without also investing. People who are not fortunate enough to have their own savings now can invest. Monetary policies of the central bank are transmitted through the financial institutions. Hence, financial institutions have sprung up- such as commercial banks, saving banks, saving banks & loan associations, credit unions, insurance companies, etc.

Meaning of Monetary Policy
Monetary policy refers to the tools used by government through the Central Bank to conduct the supply of money. Dr. Paul Einzing defined monetary policy as the attitude of the political authority towards the monetary system of the community under its control. It comprises all measures applied by monetary authorities to produce a deliberate impact on the nature and volume of money in circulation. According to Harry Jonson, Monetary policy is the policy employing the central banks control of the supply of money as an instrument for achieving the objectives of general economic policy.

The Conduct of Monetary Policy
No central bank can avoidinvolvement with the conduct of monetary policy. This isbecause the conduct of monetary policy must involve the setting of short term interest rates andthis is done by central bank by using its own role in the money markets, exploiting its positionas banker to the rest of the banking system.ln fact six basic goals are mentioned with regard to the objectives of monetary policy: (1) high employment, (2) economic growth, (3) price stability, (4) interest rate stability, (5) stability of financial markets, (6) stability of foreign exchange market [Stanley and Eakins, 2000] Monetary policies are formulated and implemented in order to achieve certain objectives or goals which are stated below.


The Goals of Monetary Policy

High Employment
High employment is an important goal for two reasons: (1) the alternative situation of high unemployment causes human misery, with families suffering From financial distress, loss of personal self-respect and increase incrime and (2) when unemployment is high, the economy has not only idle workers, but also idle resources like closed factories, unused equipment which results
in loss of output. However, the goal for high employment should not seek an unemployment level of zero but rather a level above zero consistent with full employment at which the demand for labor equals the supply of labor.This level is called the natural level of unemployment.

Economic Growth
The goalof steady economic growth is related to high employment- growth because businesses are more likely to invest in capital equipment to increase productive activity and economic growth when unemployment is low. Conversely, if unemployment is high and factories are idle, it does not pay for firms to invest in additional plants and equipment. Although the two goals are specificallyrelated, policies can be specifically aimed at promoting economic growth by directly encouraging firms to invest or by encouraging people to save, which provides more funds for firms to invest.In fact this is the stated purpose of so-called supply-side economic policies, which are intended to spur economic growth by providing tax incentives for businesses to invest in factories and equipment and for tax payers to save more.

Price stability
Stable price level is considered as a goal of monetary policy. Price stability is desirable because a rising price level creates uncertainty in an economy and may hamper economic growth. For example,the information provided by prices of goods and services is harderto interpretwhen the overall level of prices is changing which complicates decision making for consumers, businesses and government. A growing body of evidence suggests that inflation leads to lower economic growth. Inflation also makes it hard for the future to plan. For example it is more difficult to decide how much fund should be put aside to provide for a child'scollege education in an inflationary environment. Further, inflation may strain a country’s social fabric.

Interest Rate Stability
Interest rate stability may be desirable because fluctuations in interest rates can create uncertainty and make it harder to plan for the future. Fluctuations in interest rates that affect consumers' willingness to buy houses, for example, make it more difficult for customers to decide when to purchase a house and construction firms to plan how many houses to build. Upward movements in interest rates may also create hostility by the affected groups in society.

Stability in Financial Markets
Financial crises can interfere with the ability of financial markets to channel funds to people with productive investment opportunities, thereby leading to a sharp contraction in economic activity. The promotion of a more stable financial system in which financial crises are avoided is thus an important goalfor a central bank.

The stability of financial markets is also fostered by interest rate stability, because fluctuations in interest rates create great uncertainty for financial institutions. An increase in interest rates produces large capital tosses on long term bonds and mortgages, losses that can cause the failure of the financial institutions holding them.

Stability in the Foreign Exchange market
Withincreasing importance of international trade, exchange rate policy has become a major consideration of monetary policy. A rise in the value of currency will make that country’s exports more expensive to foreign countries, and a fall in the value of currency will make imports more expensive.In addition, preventing large changes in the value of a currency makes it easier for firms and individuals purchasing selling goods abroad to plan ahead. Stabilizing extreme movements in the value of a currency in the foreign exchange market is thus viewed as a worthy goal of monetary policy.

Maintenance of balance of payments equilibrium
Balance of payments of a country sometime may be deficit and sometime surplus. A persistent deficit in the balance of payments of a country may be a cause of concern forthatcountry.A surplus, under certain circumstances, may also cause problems. Maintenance of an appropriate balance of payments,through properconductof monetarypolicy,becomes an added responsibilityof a central bank.



The Conflict among Goals
Although many of the goals mentioned are consistent with each other, high employment and economic growth, interest rate stability and financial market stability, this is not always the case. These objectives are not necessarily compatible. The goal ofprice stability often conflicts with the goals of interest rate stability and high employment in the short run (but probably not in the long run). For example, when the economy is expanding and unemployment is falling, both interest rates and inflation starts to rise. If the central bank tries to prevent a rise in interest rates to prevent inflation, this may cause the economy to overheat and stimulate inflation. But if a central bank prevent inflation, in the short run unemployment may rise. The conflict among goals may thus present central banks with some hard choices.

The Application of Monetary Policy: Rules versus Discretion

The debate about whether monetary policy decisions should be governed by rules or discretion has a long history. However, neither pure discretion nor fixed adherence to an intermediate monetary target has proved satisfactory. In their place several countries are moving toward a regime in which there is a clear target for the ultimate objective of monetary policy, together with a statement of the authorities'decisionmaking practices that is as open and transparent as possible.

We notice three broad phases in the approach to policy making in the postwar period. Until about the late 1960s, it was taken for granted, that formulating monetary policy required a substantial amount of discretion. From the early 1970s untilthe 1980s, there was a growing emphasis on rules. By the late 1980s; however,there was a swing away from rule based policy regimes. The relationship between intermediate targets and ultimate objectives became more variable under the influence of financial liberalization and innovation. In recent years, it seems most central banks have recognized the need for a return to greater discretion in the use of monetary instruments.

ln this context, it is necessary toprovide the definition of a fewterms,because the same expressions may be used to mean different things by different authors. Central banks use policy instruments to pursue ultimate policy objectives. Along the way, they are concerned with intermediate variables, which are part of the policy transmission process, as well as with indicator variables which may provide information about the impact of policy, without themselves being part of the transmission mechanism

Rules are generally taken to require the authorities to use the instruments of monetary policy to achieve a given predetermined path for an intermediate variable (usually a monetary aggregate). Intermediate variables are those which the monetary authorities may attempt to target because of their presumed relationshipwith the ultimate objectives of monetary policy.The most common example of an intermediate variable is the money stock or credit stock. To the extent that growth in monetary aggregates is stably related to the ultimate objective of monetary policy (the steady growth of the nominal value of output) and to the extent that it is more feasible to control the money stock than nominal output, it makes sense to direct policy instruments towards the achievement of an intermediate variable.

Indicator variables can be defined as those that have information value about the impact of instrument on policy outcomes, but are not themselves an object of control. In fact the whole range” of economic quantities has a bearing on monetary policy decisions. They can include variables that in another context may be viewed as intermediate target. For example the growth of money stock can be regarded as object to be controlled. It can also be regarded as one indicator (among others) of the potential strength of demand in the economy. This underlines an important point: just because a monetary variable is not used as an object of control does not mean that it does not play an important role in evaluating the stance of monetary policy.


Other indicator variables are those that convey information about the future of the economy, and the balance between inflationary and recessionary forces. They include all variables relating to the current and prospective level of real economic activity [GDP growth, industrial production, Retail sales, consumer and business spending surveys, etc. They also include cost and price indicators [wages, import costs, consumer and producer price indices] and expectation indices, including expectations derived from financialvariables such as the shape of the yield curve.

The distinction between whether variables are to be treated as indicators or intermediate targets is crucial to the distinction between rules and discretion. However, the distinction between rules and discretion is not straightforward, and, hence deserves some clarification. The use of discretion in monetary policy is clearly not intended to imply randomness in decision making. A discretionary policy action usually reflects a systematic response by policy authorities, taken in the light of their objectives, and their perceptions as to how the economy will respond to particular economic stimuli.

Arguments for discretion in the formulation and implementation of policy:

First economics is subject to both supply shocks and demand shocks. The appropriate monetary policy response will be quite different in the two cases. If the authorities can identify the nature of different shocks, they will be able to improve welfare by exercising discretion in how they respond to them.

A second argument for discretion lies in the fact that the speed with which an economy returns to price stability following an inflationary or deflationary shock has implications for output and employment. The use of discretion may enable the central bank to tolerate some overshooting of the monetary targets, to allow the return to price stability to take place in a more orderly manner.

A third argument for discretion is that the structure of the economy is changing through time in ways that cannot easily be predicted in advance. The relationship between intermediate variables and the ultimate objectives of policy can be affected by technical developments. Under such circumstances discretion, rather than a set rules, could be more appropriate.

Arguments for rules

One is the Libertarian principle that, in a democracy, discretion from decision making should be removed from individuals and vested in rules and laws. Perhaps the more important economic argument for rule is that there is fundamentally stable relationship between an intermediate variable ( a monetary aggreg4te ) and the ultimate objective of monetary policy (the growth of nominal income ).The benefits of discretion are, therefore small, since it is not possible to improve much on the outcome generated by adopting a stable money growth target. On the other hand, so the argument goes, the costs of discretion are potentially large
A subsidiary argument for rules is that financial markets operate most efficiently in the presence of certainty. If in addition to the inherent uncertainties generated by outside economic shocks, there are uncertainties about the authority’s policyresponse, the difficulties faced by markets will be compounded. This argument has been formalized in the literature on the time consistencyproblem and the value of rules that "pre-commit" the authorities to a particular course of action ( Kydland and Prescott,1977).

The arguments in favor of rules are based more on the quality of discretionary action, than on discretion per se. It may be argued that discretionary monetary policy is subject to two systematic sources of adverse bias: "too little, too late ". For example, there will be greater willingness to lower interest rates than to raise them (Kohn, 1993)


Functions of Bangladesh Bank: The Central Bank of Bangladesh

Bangladesh Bank Carries out the following main functions as the country’s Central Bank:

    Formulating monetary and credit policies.
    Managing currency issue and regulatory payment system.
    Managing foreign exchange reserves and regulating the foreign exchange market.
    Regulating and supervising banks and financial institutions.
    Advising the government on interactions and impact of fiscal, monetary and other economic functions.
    Achieving balance of payments equilibrium.

Towards performing the above functions, the commitment of BB to diverse stakeholders are as follows:

1.   For the Nation:The BB shall catalyze and support socially responsible and environmentally sustainable development initiatives including financial inclusion of underserved productive sectors and bringing in needed new dimensions in financial markets and institutions to facilitate broad based growth in output, employment and income for rapid poverty eradication and inclusive economic and social progress.

2.   For the Government: The BB adopt and implement monetary and credit policies conforming withnational priorities in coordination with fiscal and other macroeconomic objectives. The BB shall also optimize foreign exchange revenues and returns thereon, maintain stability in financial markets curbing excessive volatility and provide analysis and advice to the government on issues in economic management and development.

3.   For Depositors in Banks and Financial Institutions, Investors and in Financial Assets: The BB shall ensure safety of deposits in licensed banks and financial institutions with onsite and offsite supervision of their authorities and with adequate financial information disclosure requirements, besides insuring small deposits. The BB should maintain an interest rate structure that provides fair returns on financial assets while also supporting growth in the real sector and should also promote and support development of markets in bonds and securities.

4.   For Banks and Financial Institutions in Bangladesh:The BB shall provide prudential regulatory risk management and disclosure framework to protect solvency and liquidity of the overall financial system, acting as lender of last resort in and when needed.

Strategic Action Plan of BB 2010-2014

Strategies are means to achieving goals. Ten strategies have been identified by Bangladesh Bank to address the possible development and change. All BB departments/branch offices will drill down the strategies into performance management system (PMS). The strategies are mentioned below without any in-depth study about the outcome of these strategies. These is scope for research about the strategic plan.

•   Strategy: 01Revisit the current monetary policy framework to ensure continuing effectiveness of monetary policies.

•   Strategy: 02 Strengthen regulatory and supervisory framework to enhance financial sector resilience and stability.

•   Strategy: 03 further deepen financial markets in Bangladesh.

•   Strategy: 04 financial inclusion and borrowing of access.

•   Strategy: 05 Develop more efficient currency management and payment system.

•   Strategy: 06 Strengthen revenue management capabilities.

•   Strategy: 07 Enhance regulatory and supervisory framework against money laundering.

•   Strategy: 08 Introduce separate comprehensive guidance and supervision for Islamic Banking.

•   Strategy: 09 Develop more efficient management of government domestic debt.

•   Strategy: 10 Full automation of Credit Information Bureau (CIB)

Critical success factors (CSF) are the most vital elements or activities in strategic planning process that are important for strategies to be successful. Some CSF are mentioned below:
External CSF
    Rules of law, good governance, social and political stability.
    Quick, efficient process of commercial dispute settlement.
    Sustained level of confidence of the stakeholders on financial system.
    Central Bank autonomy and operational independence.
Internal CSF
    Efficient involvement and ownership of management and strategic planning.
    Efficient Communication, coordination and logistic support.
    Focus on weak areas in values, culture and behavior.
    Adequate efforts and opportunities for expertise development.
    Efficient knowledge management.
    Failure to attract best people in the market and retention.
    Understanding of staff’s capabilities and proper development.
    Implementation of business continuity plans including process reengineering.
To be continued………………


22
Business & Entrepreneurship / Monetary Policy
« on: February 05, 2019, 04:19:36 PM »
FYI

23
MBA Discussion Forum / Social Entrepreneur & Social Enterprises
« on: August 02, 2017, 04:39:41 PM »
Social Entrepreneur & Social Enterprises

Social Entrepreneur
A social entrepreneur is someone who recognizes a social problem and uses entrepreneurial principles to organize, create, and manage a venture to make social change (a social venture).

Whereas a business entrepreneur typically measures performance in profit and return, a social entrepreneur focuses on creating social capital. Thus, the main aim of social entrepreneurship is to further social and environmental goals.

However, whilst social entrepreneurs are most commonly associated with the voluntary and not-for-profit sectors, this need not necessarily be incompatible with making a profit.
Social entrepreneurs share some common traits:
   An unwavering belief in the innate capacity of all people to contribute meaningfully to economic and social development
   A driving passion to make that happen.
   A practical but innovative stance to a social problem, often using market principles and forces, coupled with dogged determination that allows them to break away from constraints imposed by ideology or field of discipline, and pushes them to take risks that others wouldn't dare.
   Zeal to measure and monitor their impact. Entrepreneurs have high standards, particularly in relation to their own organization’s efforts and in response to the communities with which they engage. Data, both quantitative and qualitative, are their key tools, guiding continuous feedback and improvement.
   A healthy impatience. Social Entrepreneurs cannot sit back and wait for change to happen – they are the change drivers.

A social entrepreneur is a leader or pragmatic visionary with following objectives:
   Achievement of large scale, systemic and sustainable social change through a new invention, a different approach, a more rigorous application of known technologies or strategies, or a combination of these.
   Focusing first and foremost on the social and/or ecological value creation and tries to optimize the financial value creation.
   Innovating by finding a new product, a new service, or a new approach to a social problem.
   Continuously refining and adapting approach in response to feedback.
   Combining the characteristics represented by Richard Branson and Mother Teresa.

What is a Social Enterprise?
Social enterprises are social mission driven organizations which apply market-based strategies to achieve a social purpose. The movement includes both non-profits that use business models to pursue their mission and for-profits whose primary purposes are social. Their aim is to accomplish targets that are social and/or environmental as well as financial: is often referred to as the triple bottom line. Many commercial businesses would consider themselves to have social objectives, but social enterprises are distinctive because their social or environmental purpose remains central to their operation.
Social enterprises may also be defined as: “Business with primarily social objectives whose surpluses are principally reinvested for that purpose in the business or community, rather than being driven by the need to maximize profit for shareholders and owners.’’

About organizational models of Social Enterprises
Leveraged non-profit ventures: The entrepreneur sets up a non-profit organization to drive the adoption of an innovation that addresses a market or government failure. In doing so, the entrepreneur engages a cross section of society, including private and public organizations, to drive forward the innovation through a multiplier effect. Leveraged non-profit ventures continuously depend on outside philanthropic funding, but their longer term sustainability is often enhanced given that the partners have a vested interest in the continuation of the venture.
Hybrid non-profit ventures: The entrepreneur sets up a non-profit organization but the model includes some degree of cost-recovery through the sale of goods and services to a cross section of institutions, public and private, as well as to target population groups. Often, the entrepreneur sets up several legal entities to accommodate the earning of an income and the charitable expenditures in an optimal structure. To be able to sustain the transformation activities in full and address the needs of clients, who are often poor or marginalized from society, the entrepreneur must mobilize other sources of funding from the public and/or philanthropic sectors. Such funds can be in the form of grants or loans, and even quasi-equity.
Social business ventures: The entrepreneur sets up a for-profit entity or business to provide a social or ecological product or service. While profits are ideally generated, the main aim is not to maximize financial returns for shareholders but to grow the social venture and reach more people in need. Wealth accumulation is not a priority and profits are reinvested in the enterprise to fund expansion. The entrepreneur of a social business venture seeks investors who are interested in combining financial and social returns on their investments.

Who are Social Entrepreneurs?
Social entrepreneurs are individuals with innovative solutions to society’s most pressing social problems. They are ambitious and persistent, tackling major social issues and offering new ideas for wide-scale change.
Rather than leaving societal needs to the government or business sectors, social entrepreneurs find what is not working and solve the problem by changing the system, spreading the solution, and persuading entire societies to take new leaps.
Social entrepreneurs often seem to be possessed by their ideas, committing their lives to changing the direction of their field. They are both visionaries and ultimate realists, concerned with the practical implementation of their vision above all else.

Each social entrepreneur presents ideas that are user-friendly, understandable, ethical, and engage widespread support in order to maximize the number of local people that will stand up, seize their idea, and implement with it. In other words, every leading social entrepreneur is a mass recruiter of local change makers, role model proving that citizens who channel their passion into action can do almost anything.
Over the past two decades, the citizen sector has discovered what the business sector learned long ago: There is nothing as powerful as a new idea in the hands of a first-class entrepreneur.




24
BBA Discussion Forum / Social Entrepreneur & Social Enterprises
« on: August 02, 2017, 04:35:19 PM »
Social Entrepreneur & Social Enterprises
Social Entrepreneur
A social entrepreneur is someone who recognizes a social problem and uses entrepreneurial principles to organize, create, and manage a venture to make social change (a social venture).

Whereas a business entrepreneur typically measures performance in profit and return, a social entrepreneur focuses on creating social capital. Thus, the main aim of social entrepreneurship is to further social and environmental goals.

However, whilst social entrepreneurs are most commonly associated with the voluntary and not-for-profit sectors, this need not necessarily be incompatible with making a profit.
Social entrepreneurs share some common traits:
   An unwavering belief in the innate capacity of all people to contribute meaningfully to economic and social development
   A driving passion to make that happen.
   A practical but innovative stance to a social problem, often using market principles and forces, coupled with dogged determination that allows them to break away from constraints imposed by ideology or field of discipline, and pushes them to take risks that others wouldn't dare.
   Zeal to measure and monitor their impact. Entrepreneurs have high standards, particularly in relation to their own organization’s efforts and in response to the communities with which they engage. Data, both quantitative and qualitative, are their key tools, guiding continuous feedback and improvement.
   A healthy impatience. Social Entrepreneurs cannot sit back and wait for change to happen – they are the change drivers.

A social entrepreneur is a leader or pragmatic visionary with following objectives:
   Achievement of large scale, systemic and sustainable social change through a new invention, a different approach, a more rigorous application of known technologies or strategies, or a combination of these.
   Focusing first and foremost on the social and/or ecological value creation and tries to optimize the financial value creation.
   Innovating by finding a new product, a new service, or a new approach to a social problem.
   Continuously refining and adapting approach in response to feedback.
   Combining the characteristics represented by Richard Branson and Mother Teresa.

What is a Social Enterprise?
Social enterprises are social mission driven organizations which apply market-based strategies to achieve a social purpose. The movement includes both non-profits that use business models to pursue their mission and for-profits whose primary purposes are social. Their aim is to accomplish targets that are social and/or environmental as well as financial: is often referred to as the triple bottom line. Many commercial businesses would consider themselves to have social objectives, but social enterprises are distinctive because their social or environmental purpose remains central to their operation.
Social enterprises may also be defined as: “Business with primarily social objectives whose surpluses are principally reinvested for that purpose in the business or community, rather than being driven by the need to maximize profit for shareholders and owners.’’

About organizational models of Social Enterprises
Leveraged non-profit ventures: The entrepreneur sets up a non-profit organization to drive the adoption of an innovation that addresses a market or government failure. In doing so, the entrepreneur engages a cross section of society, including private and public organizations, to drive forward the innovation through a multiplier effect. Leveraged non-profit ventures continuously depend on outside philanthropic funding, but their longer term sustainability is often enhanced given that the partners have a vested interest in the continuation of the venture.
Hybrid non-profit ventures: The entrepreneur sets up a non-profit organization but the model includes some degree of cost-recovery through the sale of goods and services to a cross section of institutions, public and private, as well as to target population groups. Often, the entrepreneur sets up several legal entities to accommodate the earning of an income and the charitable expenditures in an optimal structure. To be able to sustain the transformation activities in full and address the needs of clients, who are often poor or marginalized from society, the entrepreneur must mobilize other sources of funding from the public and/or philanthropic sectors. Such funds can be in the form of grants or loans, and even quasi-equity.
Social business ventures: The entrepreneur sets up a for-profit entity or business to provide a social or ecological product or service. While profits are ideally generated, the main aim is not to maximize financial returns for shareholders but to grow the social venture and reach more people in need. Wealth accumulation is not a priority and profits are reinvested in the enterprise to fund expansion. The entrepreneur of a social business venture seeks investors who are interested in combining financial and social returns on their investments.

Who are Social Entrepreneurs?
Social entrepreneurs are individuals with innovative solutions to society’s most pressing social problems. They are ambitious and persistent, tackling major social issues and offering new ideas for wide-scale change.
Rather than leaving societal needs to the government or business sectors, social entrepreneurs find what is not working and solve the problem by changing the system, spreading the solution, and persuading entire societies to take new leaps.
Social entrepreneurs often seem to be possessed by their ideas, committing their lives to changing the direction of their field. They are both visionaries and ultimate realists, concerned with the practical implementation of their vision above all else.

Each social entrepreneur presents ideas that are user-friendly, understandable, ethical, and engage widespread support in order to maximize the number of local people that will stand up, seize their idea, and implement with it. In other words, every leading social entrepreneur is a mass recruiter of local change makers, role model proving that citizens who channel their passion into action can do almost anything.
Over the past two decades, the citizen sector has discovered what the business sector learned long ago: There is nothing as powerful as a new idea in the hands of a first-class entrepreneur.




25
Students of Finance & Banking may find this article useful

A survey of the pattern of Bank Evolution and the Business of Banking
Introduction:
Modern economic and financial heritage begins with the coming of democratic capitalism, around the time of Adam Smith (1776). Under this system, the state does not interfere in economic affairs unnecessarily, removes barriers to competition, and in general, does not prevent and discourage any one willing to work hard enough –and who also has access to capital—from becoming a capitalist.
Some hundred years after Adam Smith, England was at the peak of its power. Politically, it ruled 25% of the earth’s surface and population, the British economy was by far the strongest and most developed in the world. The rest of Europe was not all that important. There was, however, some competition from America that fancied itself as rising economic power. Otherwise, the horizon was comparatively free of competition. British industry and British Finance were very secure in their respective positions [Smith and Walter, 2003]
English financial markets had made it all possible according to Walter Bagehot. England’s economic glory was based on the supply and accessibility of capital. In poor countries there were no financial resources any way, and in most European countries money stuck to the aristocrats and land owners and was unavailable to the market .But in England, there was a place in the city of London--- called Lombard Street--- where money could be obtained upon good security or upon good prospects of probable gain [Bagehot, 1873].
By the early 1900s, New Work was beginning to emerge as world’s leading financial centre. During this time Wall Street became an important financial centre. After World War 1, American Prosperity continued, While Europe’s did not. Banks Had a busy time, raising money for corporations, foreign governments and investment companies and making large loans to investors buying securities. Banks were then ‘Universal’, i.e, they were free to participate in commercial banking (lending) and investment banking, which at the time meant the underwriting, Distribution and trading of securities in financial markets. Many of the large banks were also involved in substantial amount of investment business. There was trade to finance all over the world, especially in such mineral-rich areas as Latin America and Australia. There were securities new issues (underwritings) to perform for foreign clients which in the years prior to 1929 crashed. The stock market crash 1992 was a global event --- markets crashed everywhere--- all at the same time, and the volume of foreign selling orders was very high. The Great Depression followed. There were three prominent results from these events.     
First were Deposit Insurance System and the glass –Stegall Provision of the Act, Which completely separated commercial banking from securities activities. Second was the depression itself which led to a 30-year period of banking being confirmed to basic, slow-growing deposit-taking and loan making with a limited local market only. Third was the Rising Importance of government in deciding financial matters, especially during the post-year recovery period. There was little for banks or securities firms to do until the late 1950s and early 1960s.
By then, international business had resumed its rigorous expansion and US banks also increased their activities abroad. The Euro-dollar market and Euro-bond market followed this expansion process. Also, the banks and investment banks were also re- attracted to international capital market transactions. Most large businesses are now effectively global, especially financial businesses. Banking and capital market services have proliferated, and numerous new competitors have emerged on the scene many of which are not banks at all. New regulations are constantly being introduced and old ones changed. Telecommunications provides an easy of access to information. 

Operational Definition of a Bank:
A simple operational definition of a bank is that: A bank is an institution whose current operations consist in granting loans and receiving deposits from the public. This is the definition regulators use when they decide whether a financial intermediary has to submit to the prevailing prudential regulations for banks. This definition has the merit of insisting on the core activities of banks, namely deposits and loans. It may be noted that many words of this definition are important.
--- The word current is important because most industrial or commercial firms occasionally lend money to their customers (or borrow from their suppliers). Even if it is recurrent, this lending activity called “trade credit” is only complementary to the core activity of these firms.
---The fact that both loans and Deposits are offered is important because it is the combination of lending and borrowing that is typical of commercial banks. Banks finance a significant proportion to their loans through the deposits of public. This is the main explanation of the fragility of banking system and the justification of banking regulation.
--- Finally, the term “public” emphasizes that banks provide unique  services( liquidity ansd means of payment) to the general public. However, the public is not, in contrast with professional investors, armed to assess the safety and soundness of financial institutions, to assess whether individuals’ interests are well preserved by banks. Moreover, in the current situation a public good (access to a safe and efficient payment system) is provided by private institutions (commercial banks). These two reasons: protection of depositors and the safety and efficiency of the payment system have traditionally justified public intervention in banking activities [Freixas and Rocket,1999]   
The existence of banks is justified by the role they play in the process of resource allocation, and more especially in the allocation of capital. As Merton (1993) states “A well developed smoothly functioning financial system facilitates the efficient life-cycle allocation of household consumption and the efficient allocation of physical capital to its most productive use in the business performed by banks alone. These functions are sufficiently stable to apply generically, from Italy’s Renaissance to today’s world sufficiently stable to apply generically, form Italy’s Renaissance to today’s world [freixas and Rochet, 1999]. Nevertheless, financial market has evolved and financial innovations have emerged at a spectacular rate in the last two decades. In addition, the development of security markets has led to a functional differentiation, with financial markets providing some of the services financial intermediaries used to offer exclusively. Thus, for example, it is as simple today for a firm involved in international trade to hedge exchange rate risk through a future market as through a bank contract.  prior to the development of futures markets, one would have tended to think that this was a functional characteristic of bank’s activity.
Today, some economists and bankers draw attention to developmental role of commercial banks. But the “developmental role” might not, prima facie, be seen as a characteristic of purely commercial banks which are historically involved in collection of deposits and provision of working capital. Nevertheless, it is felt that even in the case of such traditional commercial banks the attitude and philosophy of bank management has changed to great extent. The commercial banks are considered an essential instrument of national endeavor. The nature of their lending practices and the channelization of working funds would in themselves influence the pattern of national development. In many developing countries, there is a talk of social obligations of commercial banks.
Commercial banking is changing rapidly. Both the nature of business and the structure of the industry have changed dramatically in the last quarter century. While the economic role of commercial banks have varied little over time, the nature of commercial banks and competing financial institutions is constantly changing. Savings and loans and credit unions, brokerage firms, insurance companies and general stores now offer products and services traditionally associated with commercial banks. Commercial banks, in turn offer a variety of insurance, real estate and investment banking services they were once denied. The term bank today refers as much to the range of services traditionally offered by depository institutions as to the specific type of institution. However, although commercial banks remain the single most important intermediary in most countries, the business they do and the structure of industry is not the same in all countries.



Business of Banking:
According to Paget’s Law of Banking, There is no exhaustive definition of ‘ Bank’ as par common Law. However, the usual characteristics are:
A. The conduct of current accounts;
B. The payment of cheques drawn on banks;
C. The Collection of cheques for customer.
These characteristics, however, are not equivalent to a definition, and these are also not the only characteristics. A ‘bank’ may be better described with reference to its permitted business. Although, traditionally, the main business of banks is acceptance of deposits and lending, the banks have now spread their wings far and wide in to
 Many allied and even unrelated activities. These are summarized below: [IIBF, 2005]
A
•   Borrowing, raising or taking up of money;
•   Drawing, making, accepting, discounting, buying, selling, controlling and dealing in bills of exchange, Hundis, promissory notes, coupons, draft, bills of lading, railway receipts, warrants debentures, certificates, scripts and other instruments and securities whether transferable or negotiable or not;
•   Granting and issuing of letters of credit, ‘Traveler’s cheques and circular notes;
•   Buying and selling dealing in bullion and specie;
•   Buying and selling of foreign exchange;
•   Acquiring, holding, issuing on commission, underwriting and dealing in stocks, funds, shares, debentures, debenture stocks bonds and securities and investment of all kinds;
•   Purchasing and selling of bonds, scrip’s and other forms of securities on behalf of constituents or others;
•   Negotiation on loans or advances;
•   Receiving of all kinds of bonds, scrip’s or valuables on deposits or for safe custody or otherwise;
•   Providing of safe deposit vaults;
•   Collecting and Transmitting of money and securities.

B
1. Acting as agent of government, local authority or any other person and carry on agency business;
2. Contracting for public or private loans and monitoring and issuing the same;
3. Insure, guarantee, underwrite, participating in managing and carrying out of any issue of state, municipal or other loans or of shares, Stock, debentures or debenture stock of companies and lending money for any such purpose of any such issue;
4. Carry out and transact every kind of guarantee and indemnity business;
5. Manage sell and realize any property which may come in its possession in satisfaction of any of its claims;
6. Acquire, hold and deal with any property or any right, title or interest in any such property which may form the security for any loan or advance;
7. Undertake and execute trusts, undertake the administration of estates as executor, trustee or otherwise;
8. Establish, support and aid associations, institutions etc for the benefit of its present employees and may grant money for charitable purpose;
9. Acquire, construct and maintain any building for its own purpose;
10 Do all such things which are incidental or conducive to the promotion or advancement of its business.
11. Do any such business specified by the government as the lawful business of a banking company.

The pattern of Bank Evolution: The Origin of Development of Banking
The evolution of banking exhibits exhibits some fairly clean patterns. Commercial  banks, combining payments functions and financial intermediation, have developed from five main types of institution—payment processors (Examples, Medieval money changers English goldsmiths, public banks of deposits); merchant banks ( examples, Florentine banks, English country banks, U.S. private banks); Securities firms (examples Scriveners, industrial and universal banks); near Banks ( examples, Saving banks, Credit unions; and chartered banks.
Payment Processors and merchant banks began with payments functions. But economies of scope led into intermediation. Customers naturally held their liquid reserves with their payments processors and merchant banks as deposits.
  The Second evolutionary path began with intermediation and added payment functions. This was the case with securities firms and near banks. Part of business of securities fund is to find investment for the customers. Customers keep funds with them waiting to be invested. Offering Payment Services out of these deposits is a natural extension of their business. Merril Lynch’s CMA is a classic example of this process. Customers keep Funds with them in non- transaction deposits; it is natural to offer these customers transaction services. Recent deregulation, in the United States and elsewhere, has removed the regulatory obstacles to their doing so.
In contrast to these stories of evolution, chartered banks were set up from the very beginning as full fledged fractional reserve banks. Government set them up initially as an instrument of public finance. They used them both to finance direct government expenditure…..often on wars….and to finance government projects and programs. Commercial banks remain to this day important purchasers of government debt.
Referring to historical development of depository institutions we notice that banking institutions existed since the days of the earliest human civilization. Consequently, there evolution has spanned the time that organized societies have inhabited the earth. We are making a very brief reference to this development.

Historical Development of commercial Banks: Goldsmith Bankers
Inconveniences associated with barter ultimately led people to use commodities, particularly gold and silver, as money. Both metals were relatively scarce and highly valued. Both were easy to divide in to units of various sizes so that people could make change.
In the earliest times, people used un-coined gold and silver, known as bullion, to make transactions. But by using bullion people exposed themselves to asymmetric information problems. Such problems arose when one party to a transaction processes information that the other party does not have. On the other hand an adverse selection problem was associated with using gold and silver bullion as money: the individual with the greatest incentive to offer bullion in exchange for goods and services were hazard problem also existed when people used billion in exchange for goods and services were those whose bullion contained the least pure gold or silver. On the other hand moral hazards problem also existed when people used bullion as money. Once two parties to an exchange had reached an agreement on how much bullion will be paid for a good or service, the trader offering the bullion had an incentive to reduce the level of purity of the gold or silver before the exchange took place. 
Goldsmiths specialized in reducing the extant of these asymmetric information problems. Parties to a transaction would pay a goldsmith to weigh bullion and to assess its purity. Many goldsmiths would issue the holder of bullion a certificate attesting to the bullion’s weight and gold or silver content. Other goldsmiths went a step further. To provide the the holder of a bullion with ready proof of the bullion’s weight and purity, tjey produced standardized weights of gold or silver that they imprinted with a scale of authenticity. These standardized unites were the earliest coins.

Bullion Deposits and Fractional-Reserve Banking:
Eventually, some goldsmiths simplified the process further by issuing paper notes indicating that the bearer held gold or silver of given weights and purities on deposits with goldsmiths. Then the bearers of these notes could transfer the notes to others in exchange for goods and services. These notes were the first paper money. The gold and silver held on deposits with goldsmiths became the first bank deposit.
Once goldsmiths became depository institutions, it was only a matter of time before they took the final step towards modern banking by becoming lenders. Goldsmiths began to notice that withdrawal of bullions relative to new bullion deposit where fairly predictable. Therefore as long as the goldsmiths held reserves of gold and silver to cover unexpected bullion withdrawal, they could lend paper notes in excess the of the amounts of bullions that they kept at hand .They could charge interest on the loans by requiring repayment in bullion excess the of value of notes that they issued.
By lending funds in excess of the reserves the reserves money (gold and silver bullion) that they actually possessed, these goldsmith banks developed the earliest form of fractional reserve banking. As long as the economic conditions were stable and the goldsmiths managed their accounts wisely, those who held the goldsmith’s notes would be satisfied with this arrangement. But in bad times or in instances when a few goldsmiths overextended themselves, many note holders might show up at the same time demanding the gold or silver bullion leading to bank-runs. These were the earliest bank-runs.   

The Roots of Modern Banking:
The first goldsmith-bankers cannot be traced with certainty to any specific time or place. There is evidence that such activities took place in Mesopotamia sometime during the first millennium B.C. In Ancient Greece goldsmith operations existed in Delphi, Didyma. And Olympia at least as early as the seventh century B.C. By the sixth century B.C., banking was well developed feature of the economy of Athens [Miller and Vanhoose, 2001]
Banking operations also started in the Mediterranean world, in cities such, Jerusalem and further east in Persia. Banking facilitated trade because merchant who shipped goods to far away locations typically need loans to fund their operations. After receiving payment from the purchasers of their goods, the merchants would then repay those who had provided loan financing. These lenders then became known as merchant banks. Merchant banking ultimately became a linchpin of the trade linking the principalities of the Roman Empire.

The Italian Merchant Bankers
The modern term ‘bank’ drivers from the merchant’s bench, or banco, on which money changed hands in the market places of medieval Italy. The Term bankruptcy refers to the “breaking of the bench” that occurred when an Italian merchant banker overextended, then experienced a run on his notes, and failed. During the medieval periods of twelfth and thirteenth centuries AD, merchant banks flourished throughout Italy.
By the time of Italian renaissanance during the fifteenth and sixteenth centuries, merchant bankers such as the medice family of Florence had accumulated enormous wealth and political power. Although these Italian merchant bankers directed some of their wealth to financing the fabulous art of masters such as Michelangelo and Leonardo da vinci, Ultimately, they squandered much of it by building armies and conducting wars over territories and riches.
Others in Europe eventually copied the banking practices of Italian merchant bankers. Merchant banks from the Lombardy region of Italy continued to maintain their merchant banking operations in other European cities like London and Berlin. In London, The Italian merchant banks became such an important institution that the city’s financial dealings were centered around the Lombard Street which even today remains the financial heart of the city. The German central bank, Deutsche Bundesbank, called one interest rate at which it lent funds to private banks the ‘Lombard Rate’. Even after the Italian city states fell in to political disarray, Italian merchant bankers hailing from Genoa financed the activities of the rising Hapsburg Empire of seventeenth and eighteenth century Europe. 
Others in Europe eventually copied the banking practices of the Italian merchant bankers. The banking business took on three key features. First, as in the days of earliest gold smiths, banks took deposits from customers. First, as in days of the earliest goldsmiths, banks took deposits from customers and maintained accounts on their behalf. Second banks managed payments on behalf of customers by collecting and paying checks, notes and other “banking currency”. Finally, like the old merchant banks, these loans and the fees that the banks charged for accounting and deposit services was the banks’ sources of revenue, ultimately, profits. 

The Evoluation of bank activities:
We noted earlier that banking evolved as a combination of financial intermediation and payments. It did so because there were economies of scope between these two activities. Economies of scope have also led banks into various related businesses as indicated below.

Economies of scope related to payments 
While economics of scale result from doing more of the same thing, economics of scope result from doing different, but related, things. A firm can sometimes benefit from branching out in to new lines of business that are closely related to what it is doing already. It may already possess the necessary tools and know-how, making entry in to new lines of business less costly than it would be for a firm starting from scratch. A great deal of innovation is the result of such branching out, and it can be important source of profit. Different lines of business can offer a bank such economies of scope.
One possibility is to offer to process firm’s incoming cheques and to ensure that they clear as quickly as possible. A bank will receive fee for such a service. Since the banks may have much of the needed technology and trained personnel, providing the service will be relatively very expensive.
Banks provide payments service not only to household and business, but also to the financial markets. An efficient and reliable system of settling transactions is essential to the proper functioning of the securities markets. In addition to payments proper, banks provide a variety of related service. They offer cash management services that enable corporations to speed the payments they receive and delay the payments they make.
Banks also provide their customers with foreign exchange to enable them to make payments to other countries. And they also provide credit cards and process credit card accounts for small bank and non bank issuers. The payment system is of great importance to the economy. Payments are an inseparable part of trade in goods and services. The lower the transaction costs of making payments, the more trade there will be and the greater will be the gains from trade. How well the payment system does its job has tremendous effect on the overall efficiency of the economy. Today, with the introduction of payments with credit card, electronic payments and payment of the internet etc., the merchant is guaranteed payment the moment you place the order, the goods can be shipped immediately.
The payment system is also of great importance to financial institutions. For many, the provision of payments services is a substantial source of income. An estimate suggests that in the United States for the 25 largest bank holding companies, between 30% to 40% of their operating revenue came from payments related services (Radecki, 1999). You cannot understand banking without an understanding of this aspect of the business.   
Payments mechanisms are a key element in the structure of financial markets. You cannot make sense of overnight lending or the government securities market without understanding how payments are executed. Furthermore, the increasing globalization of financial markets has transformed the trading of foreign exchange----one part of the payment system---into a growth industry. Worldwide trading volume in foreign exchange reached $ 1.5 trillion a day in 1999.

Economies of Scope Related to Intermediation
In the process of intermediation, banks assess the creditworthiness of borrowers and back their judgment by guaranteeing a return to lenders. Banks can engage in these two activities---assessing creditworthiness and providing guarantees--- without actually intermediating the loan. That is they can broker and guarantee, explicitly or implicitly, direct lending from lender to borrower.

The Security Business
The reason why the securities business is attractive to banks is again economies of scope. There is a great deal of similarity and complementarily between the work involved in financial intermediation and work involved in underwriting trading in publicly traded securities. In particular both intermediation and securities business require the gathering and processing of information on the creditworthiness of borrowers and monitoring their behavior after credit has been extended. Moreover, if a firm is already borrowing from a bank, the bank will be familiar with its creditworthiness and it will be in a good position to help the firm issue securities or to make a market in its securities.
The securities activities of banks, therefore, include the underwriting of new issues, market-making of new issues, advice to firms in putting together mergers and acquisitions, and monitoring and supervising corporate management on behalf of investors. In addition many banks provide trust and custodial services. They manage portfolios of securities for corporations, institutions, and individuals and they manage mutual funds. They hold securities for their clients. They execute the payment of interest and dividend for issuers of stock and bonds, and they execute purchases and issuance of securities in mergers and acquisitions. They monitor compliance with covenants associated with bond issues.

Loan Origination
In underwriting securities, banks assess creditworthiness, but do not provide the funding themselves. There are additional ways in which banks can originate a loan but not fund it. The lead bank in a syndication or participation does this, and so does a bank that pools its loans and sells them in securitization. In all of these cases, banks receive fees for originating the loan, for servicing it and perhaps for guaranteeing it. However, it does not earn an interest rate margin as it would if it were funding the loan itself.

Guarantees
When it underwrites securities, the bank does not provide those investing in securities with any guarantee. In the syndications and securitizations, guarantees are possible, but unusual. In some circumstances, however, banks do provide guarantees. Such guarantees are important in the market for commercial paper.
Commercial paper has a very short maturity, typically 30 days or less. Issuers commonly roll over their commercial paper: that is, they issue new commercial paper to pay off the old as it matures. Lenders are concerned that the issuer, for whatever reason, may be unable to roll over its commercial paper and will therefore default. To protect lenders from this danger, the bank can provide the issuer with a line of credit. The bank promises, if necessary, to lend the issuers the funds to pay off the old paper in effect converting the commercial paper into a bank loan.

Banker’s acceptance
Banker’s acceptance is a variation of commercial paper that involves the bank even more closely in guaranteeing the credit of the customer. The banker’s acceptance is essentially a guaranteed post dated cheque.

Off-Balance-Sheet-Banking
In the 1980s, competition from financial markets made it necessary for banks to shift to more value-added products, which were better adapted to the needs of customers. To do so banks offered more sophisticated liquidity management technique, such as, loan commitments, credit lines and guarantees. They also developed swaps and hedging transactions, and underwrote securities. From an accounting viewpoint, none of these operations correspond to a genuine liability (or asset) for the bank, but only to a random cash flow. This is why they have been classified as off-balance-sheet operations.
Banks earn fee income through guaranteeing commercial paper and from providing banker’s acceptances---that is from credit substitution. Banks are able to substitute their credit in this way because evaluating the credit risk of their customers and monitoring their loan performance are precisely the activities banks are good at. Indeed, helping a customer issue money market paper allows a bank to perform much of its traditional lending functions without usually putting the loan on its own books. Such off-balance-sheet banking has a number of advantages for a bank.
Off-balance-sheet banking effectively increases a bank’s leverage. The bank increases its exposure to credit risk, but because the loan does not appear on its balance sheet, its formal equity-to loan ratio is unaffected. Off-balance-sheet banking also relieves a bank of the liquidity risk involved in funding the loan itself. If the depositors wish to withdraw the fund before the loan is repaid, the bank must somehow find the necessary funds. With off-balance-sheet banking, the bank is no longer responsible for the liquidity of the loan and it no longer bears the associated costs.
The factors that have fostered the growth of off-balance-sheet operations have different natures. Some are related to the bank’s desire to increase their fee income and to decrease their leverage; others are aimed at escaping regulations and taxes. Still the very development of these services shows that firms have a demand for more sophisticated custom-made financial engineering.

Forward Transaction
Banks have extended their activities also into forward transactions. Banks offer forward transactions in foreign exchange. Buying and selling foreign exchange is a natural outgrowth of their foreign exchange business. Banks also offer forward transaction related to interest rates. The most important is the swap. This is an arrangement that allows borrowers to exchange fixed interest payments for payments that fluctuate with current market rates.

Economies of Scope in Marketing
The relationship between a bank and its customers, both depositors and borrowers provides it with an opportunity to sell them other products. Moreover, banks’ branch network may provide service to its customers almost without any additional cost. This is an important part of economies of scope between banking and securities business. When new issues are to be sold to investors, the banks’ branches provide a distribution network and its depositors provide a natural clientele. When depositors-investors hold securities, a bank can help its customers to trade them.
There are opportunities for marketing other products. One that seems natural for marketing to a bank’s customers is insurance. There are no obvious economies of scope between banking and insuring. But a bank need not have to be an insurer in order to sell insurance. It is well placed to sell to its customers insurance policies provided by insurance companies.

Three Key factors in the evolution of banking Industry:
Banks and other financial industries tend to become more profitable as they become larger. Large banks may derive the economies of scale in terms of the following:
Economies of scale
Financial, Operational and reputational Economies
First, there are the financial economies of scale that result from better pooling as the pool becomes larger.  The Liquidity cost of a large bank is lower because the larger volume of transactions allows for more netting of deposits and withdrawals. Because larger banks can be more diversified, they can either make loans that are riskier and so higher yielding. Or they can reduce the ratio of capital to assets. In either case, the bank is more profitable. Recent studies have shown that when the financial economies are taken in to account, bigger is always the better [ Hughes,2000].
Second, there are the operational economies of scale that result from the element of indivisibility of fixed costs. Because fixed costs increase less than proportionally with the size of  bank, the burden is lower for the large banks . The increasing importance of information technology has increased the operational efficiency of scale. Recent studies have found that the minimum efficient scale of bank in terms of operational economies is in the range of $10 billion to $ 20 billion assets [ Mishikin and Strahan].
Third, there are reputational economies of scale: People tend to trust large banks more. Large banks are indeed inherently safer because of the financial economies and operational economies. But they are also more trustworthy, since they have more to loose if they harm their reputation by taking advantage of their customers.   

The competitive Advantage of Large Banks:
Because of these types of economies of scale, large banks should be able to out compete small ones, they should be able to operate at lower cost and to offer their customers better terms---lower lending rates and higher deposit rates. Small banks unable to compete should disappear, either closing down or being taken over by larger banks.
However, there may be limitations to such a process. At some point, economies of scale may be balanced by diseconomies. Large banks become more difficult to control, and the cost of management begins to rise. it is the existence of such diseconomies of scale that guarantee that the  whole banking industry will not be taken over by a single gigantic bank. Technology of communications and regulatory barriers were two principal obstacles in the way to geographic expansion and huge growth of a bank.

Technology of Communications:
Early banks had branches in various towns and cities. However, managing these branches was a perennial problem. Poor communications made control and coordination difficult, and the absence of systematic accounting procedures made it hard to monitor performance. Because they could not consult head office on important decisions, branch managers had a great deal of independence. To protect their own reputation, banks felt obliged to stand behind the actions of their bank managers. So a lazy or dishonest branch manager could, and did, ruin the whole firm. Poor communications remain  barriers to branching until well into the second half of the nineteenth century.



 
   

 


   

26
The Importance of money, Financial Markets and Financial Institutions
A Brief note on the Development and importance of money and credit is relevant to the proper understanding of financial markets and financial institutions.
In any discussion on the importance of money the first question which comes to our mind is what are the real uses of money? Money in its modern from at least, is not anything that we can eat or wear, nor does it provide shelter or entertainment in any direct manner. Similarly, do banks and other lending institutions contribute in any real way to our well-being? The short answer to these questions is that money, credit or the whole structure of financial institutions, can contribute greatly to the standard of living in society, but it does so only indirectly, by helping man to become much more productive. Money in the modern economy is viewed as lubricant that greases the wheel of economic activity. Without money, the transactions that make up our daily economic routine would be extremely difficult and so is saving and investment. Money also plays a key role in influencing the behavior of the economy as a whole and the performance of financial institutions and markets. More specifically, charges in the supply of money and credit can affect how rapidly the economy grows, the level of employment, and the rate of inflation and these in turn can affect the value of financial assets held by individuals and financial institutions.
If we contrast a subsistence economy with highly industrialized economy, we find great differences in material well-being. The standard of living of any community is basically determined by productivity of its people, and the high standard of living of an advanced industrialized country reflects the high level of productivity which has been achieved. This hes been largely the result of specialization. Specialization means that each worker devotes himself to a single occupation such as factory work, farming, teaching or government service, and usually to a specialized task within that occupation. As adam smith long ago demonstrated, such division of labour is a remendous boost to productivity because it makes it possible for each person to concentrate on what he is most fitted for, it encourages the development of a high degree of skill, it saves the waste of time and effort of constantly moving from one job to another, and it stimulates mechanization of tasks and improvement in work methods. But specialization is only possible if each worker can readily exchange his specialized service for the goods and services which he and his family actually need. And the development of specialization is made possible by the parallel development of money, credit and financial institutions.\
As a matter of fact, to appreciate the importance of money in an economic system, it is instructive to speculate on what the economy might be like without money (i.e., a barter economy). For one thing, without money individuals in the economy would have to devote more time to buying what they want and selling what they do not want. They will have less time to work and play. The introduction of money has simplified matters. Workers are paid in money which they can use to pay for their goods and services. Money becomes a medium of exchange. But the most important thing about the medium of exchange is that everyone must be confident that it can be passed on, that it is generally acceptable in trade and other transactions. It is important to emphasize, however, that people use the medium of exchange money not because it has any intrinsic value, but because it can exchange for things to eat, to drink, to wear, and play with.
•   Money is the raw material in banking;
•   In any industry a good manager will start by starting with the raw material;
•   If we do not appreciate the raw material, we will never master its transformation and the end product [Chorafas, 1999]
A person, who is unable to understand the raw material used by his company, will never be able to understand the products which he handles. If he does not know and appreciates the input, he will never learn much about the output. Therefore, he will not be able to sell his products and services to his clients. This is true of banking as of any other industry.
 
The role played by money in modern society may be summed up as follows:
•   A medium of exchange: Money is a means of exchange because it is generally acceptable. Money is a substitute for barter economy. People who trade in goods and services, and financial assets nowadays are willing to accept money in exchange for these items. Barter is a costly activity, because it requires a double coincidence of wants: two individuals must simultaneously be willing and able to make a trade.

•   A unit of measurement: Money functions as a unit of account, which means that people maintain their financial accounts by using money to value goods, services and financial assets. Money makes possible matrices and provides a frame of reference. It also constitutes the basic for double-entry accounting as well as for keeping accounts, profit and loss statements and balance sheets.


•   Raw materials for the banking industry: Without it banks cannot deposits and give loans, hence they cannot act intermediaries.

•   A store of value: Money serves as a store of value. An individual can set money aside today with an intent to purchase items at a later date. Many commodities represent wealth, but the practice is to translate them into a common denominator which is money. The value of money comes with the fact that it is limited in supply. As a store of value and of wealth, money is a key ingredient of capital. Money constitutes the raw material for both the capital market and the money market.

•   Standard of deferred payment: Money serves as a standard of deferred payment. People agree to loan contracts that call for future repayments in terms of money. These contracts defer repayment of a loan until a later date. Parties to the contract agree to meet financial terms specified in terms of money.

The object of government controls: Central banks may regulate money supply and also try to influence interest rates and exchange rates.
•   Money makes it feasible to move remittances from one place to another through networks.
•   Banks do so without transporting bulky commodities or valuable metals over long distance.
Every branch of knowledge has its fundamental discoveries. For example in physics, fire is a fundamental discovery, in politics it is vote and as far as commercial and economic existence of man is concerned, money is the most important discovery.
In modern day context, Money and technology have a common ground, such as plastic money. Similarly, technology is inseparable from modern banking and vice ver. Today or tomorrow a bank must be ready to trade any product from any place, in any exchange and over the counter (OTC). Technology takes the credit for this globalization. We shall elaborate on this point in a different section.

Financial Markets and institutions
The importance of money becomes more obvious in its relevance to Financial Institutions and markets. Money contributes to economic development and growth by stimulating both saving and investment and facilitating transfer of funds from savers to borrowers, who want to undertake investment projects but do not have enough of their own money to do so. Financial Markets give savers variety of ways to lend to borrowers, thereby increasing the volume of both saving and investment and encouraging economic growth. People who save are not often the same people who can see and exploit profitable investment opportunities. The introduction of money, however, permits the separation of the act of investment from the act of saving. Money makes it possible for a person to invest without first refraining from consumption (Saving) and likewise makes it possible for a person to save without also investing. People who are not fortunate enough to have their own savings now can invest.
In a monetary economy, a person simply accumulates in cash because money is a store of value. Through Financial Markets, this surplus fund can be lent to a business firm to invest in new equipment, the equipment it might not have been able to buy if it did not have accesss to borrow funds. Both the saver and Business firm are now better off; the saver receives interest payments, and the business firm expects to get a return over and above the interest cost. And the economy is also better off because the only way an economy can grow is by allocating part of its resources to the creation of new and more productive facilities.
In an advanced economy, this challenging of funds from savers to borrowers through financial markets reaches highly complex dimension. A wide variety of Financial Instruments such as stocks, bonds and mortgages are utilized as devices through which borrowers can gain accesss to the surplus funds of savers. Various markets specialize in trading one or another of these financial instruments.
And Financial Institutions have sprung up such as commercial banks, saving banks, saving and loan associations, credit unions, insurance companies, mutual funds and pension funds that act as intermediaries in transferring funds from ultimate lenders to ultimate borrowers. Such financial intermediaries themselves borrow from saver-lenders and borrower-spenders gain. Savers have the added option of acquiring saving deposits or pension rights which are less risky  than individual stocks or bonds, and business firm borrower can tap large sums of money from a single source. None of this would be possible were it not for the existence of money, the one financial asset that lie at the foundation of the whole super structure.

The primary functions of a financial system
The primary function of a financial system is resource allocation. To accomplish these tasks, financial system performs six basic functions:
1.   Clear and settle payments ( a payment system) to facilate trade and commerce. They provide the primary means of payment like chequing accounts, debit cards.
2.   Aggregate 9pool) and disaggregate wealth and flows of funds so that both large scale and small scale projects can be financed. They gather deposits and other sources of funds, such as savings accounts, CDs, and federal funds etc.
3.   Transfer economic resources over time, space and industries. They make loans to individuals, business and governments in various locations for different maturities.
4.   Accumulate process and disseminate information for decision making purposes. They provide various record keeping services involving the processing, storing and disseminating the financial information.
5.   Provide ways for managing uncertainty and controlling risk. They reduce the uncertainty associated with default, liquidity and interest rate risk, and they sell risk management service.
6.   Provide ways for dealing with incentive and asymmetric information that arise in financial contracting. They monitor borrower’s credit worthiness, signals changes in the credit quality, and provide guarantees such as a banker acceptance.

Judging the Efficiency of a Financial System
We may assess the efficiency of a financial system by using three concepts: allocative efficiency, price efficiency and cost efficiency. [sinkley, 2002]
Allocate Efficiency refers to moving scarce funds to investment projects with the highest returns. Financial markets unimpeded by artificial constraints provide the best method for achieving allocate efficiency. At the micro-economic level, allocate efficiency means that businesses accept all projects that exceed their cost of capital and that households focus on portfolios that offer the highest return for a given level of risk or minimum risk for a given level of return.
 Informational or price efficiency refers to how quickly and accurately security prices reflect existing and new information. In an efficient market, characterized by7 large number of buyers and sellers and free flow of information, security prices reflect all existing information and when new information becomes available,  it is quickly and accurately embodied in share prices.



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Continuation .....
The Roots of Modern Banking:

The first goldsmith-bankers cannot be traced with certainty to any specific time or place. There is evidence that such activities took place in Mesopotamia sometime during the first millennium B.C. In Ancient Greece goldsmith operations existed in Delphi, Didyma. And Olympia at least as early as the seventh century B.C. By the sixth century B.C., banking was well developed feature of the economy of Athens [Miller and Vanhoose, 2001]

Banking operations also started in the Mediterranean world, in cities such, Jerusalem and further east in Persia. Banking facilitated trade because merchant who shipped goods to far away locations typically need loans to fund their operations. After receiving payment from the purchasers of their goods, the merchants would then repay those who had provided loan financing. These lenders then became known as merchant banks. Merchant banking ultimately became a linchpin of the trade linking the principalities of the Roman Empire.

The Italian Merchant Bankers:

The modern term ‘bank’ drivers from the merchant’s bench, or banco, on which money changed hands in the market places of medieval Italy. The Term bankruptcy refers to the “breaking of the bench” that occurred when an Italian merchant banker overextended, then experienced a run on his notes, and failed. During the medieval periods of twelfth and thirteenth centuries AD, merchant banks flourished throughout Italy.

By the time of Italian renaissanance during the fifteenth and sixteenth centuries, merchant bankers such as the medice family of Florence had accumulated enormous wealth and political power. Although these Italian merchant bankers directed some of their wealth to financing the fabulous art of masters such as Michelangelo and Leonardo da vinci, Ultimately, they squandered much of it by building armies and conducting wars over territories and riches.

Others in Europe eventually copied the banking practices of Italian merchant bankers. Merchant banks from the Lombardy region of Italy continued to maintain their merchant banking operations in other European cities like London and Berlin. In London, The Italian merchant banks became such an important institution that the city’s financial dealings were centered around the Lombard Street which even today remains the financial heart of the city. The German central bank, Deutsche Bundesbank, called one interest rate at which it lent funds to private banks the ‘Lombard Rate’. Even after the Italian city states fell in to political disarray, Italian merchant bankers hailing from Genoa financed the activities of the rising Hapsburg Empire of seventeenth and eighteenth century Europe.

Others in Europe eventually copied the banking practices of the Italian merchant bankers. The banking business took on three key features. First, as in the days of earliest gold smiths, banks took deposits from customers. First, as in days of the earliest goldsmiths, banks took deposits from customers and maintained accounts on their behalf. Second banks managed payments on behalf of customers by collecting and paying checks, notes and other “banking currency”. Finally, like the old merchant banks, these loans and the fees that the banks charged for accounting and deposit services was the banks’ sources of revenue, ultimately, profits.
 
The Evolution of bank activities:


We noted earlier that banking evolved as a combination of financial intermediation and payments. It did so because there were economies of scope between these two activities. Economies of scope have also led banks into various related businesses as indicated below.

Economies of scope related to payments:

While economics of scale result from doing more of the same thing, economics of scope result from doing different, but related, things. A firm can sometimes benefit from branching out in to new lines of business that are closely related to what it is doing already. It may already possess the necessary tools and know-how, making entry in to new lines of business less costly than it would be for a firm starting from scratch. A great deal of innovation is the result of such branching out, and it can be important source of profit. Different lines of business can offer a bank such economies of scope.

One possibility is to offer to process firm’s incoming cheques and to ensure that they clear as quickly as possible. A bank will receive fee for such a service. Since the banks may have much of the needed technology and trained personnel, providing the service will be relatively very expensive.

Banks provide payments service not only to household and business, but also to the financial markets. An efficient and reliable system of settling transactions is essential to the proper functioning of the securities markets. In addition to payments proper, banks provide a variety of related service. They offer cash management services that enable corporations to speed the payments they receive and delay the payments they make.

Banks also provide their customers with foreign exchange to enable them to make payments to other countries. And they also provide credit cards and process credit card accounts for small bank and non bank issuers. The payment system is of great importance to the economy. Payments are an inseparable part of trade in goods and services. The lower the transaction costs of making payments, the more trade there will be and the greater will be the gains from trade. How well the payment system does its job has tremendous effect on the overall efficiency of the economy. Today, with the introduction of payments with credit card, electronic payments and payment of the internet etc., the merchant is guaranteed payment the moment you place the order, the goods can be shipped immediately.
 
The payment system is also of great importance to financial institutions. For many, the provision of payments services is a substantial source of income. An estimate suggests that in the United States for the 25 largest bank holding companies, between 30% to 40% of their operating revenue came from payments related services (Radecki, 1999). You cannot understand banking without an understanding of this aspect of the business. 

Payments mechanisms are a key element in the structure of financial markets. You cannot make sense of overnight lending or the government securities market without understanding how payments are executed. Furthermore, the increasing globalization of financial markets has transformed the trading of foreign exchange----one part of the payment system---into a growth industry. Worldwide trading volume in foreign exchange reached $ 1.5 trillion a day in 1999.

Economies of Scope Related to Intermediation :

In the process of intermediation, banks assess the creditworthiness of borrowers and back their judgment by guaranteeing a return to lenders. Banks can engage in these two activities---assessing creditworthiness and providing guarantees--- without actually intermediating the loan. That is they can broker and guarantee, explicitly or implicitly, direct lending from lender to borrower.

The Security Business:
The reason why the securities business is attractive to banks is again economies of scope. There is a great deal of similarity and complementarity between the work involved in financial intermediation and work involved in underwriting trading in publicly traded securities. In particular both intermediation and securities business require the gathering and processing of information on the creditworthiness of borrowers and monitoring their behavior after credit has been extended. Moreover, if a firm is already borrowing from a bank, the bank will be familiar with its creditworthiness and it will be in a good position to help the firm issue securities or to make a market in its securities.

The securities activities of banks, therefore, include the underwriting of new issues, market-making of new issues, advice to firms in putting together mergers and acquisitions, and monitoring and supervising corporate management on behalf of investors. In addition many banks provide trust and custodial services. They manage portfolios of securities for corporations, institutions, and individuals and they manage mutual funds. They hold securities for their clients. They execute the payment of interest and dividend for issuers of stock and bonds, and they execute purchases and issuance of securities in mergers and acquisitions. They monitor compliance with covenants associated with bond issues.

Loan Origination:
In underwriting securities, banks assess creditworthiness, but do not provide the funding themselves. There are additional ways in which banks can originate a loan but not fund it. The lead bank in a syndication or participation does this, and so does a bank that pools its loans and sells them in securitization. In all of these cases, banks receive fees for originating the loan, for servicing it and perhaps for guaranteeing it. However, it does not earn an interest rate margin as it would if it were funding the loan itself.

Guarantees

When it underwrites securities, the bank does not provide those investing in securities with any guarantee. In the syndications and securitizations, guarantees are possible, but unusual. In some circumstances, however, banks do provide guarantees. Such guarantees are important in the market for commercial paper.

Commercial paper has a very short maturity, typically 30 days or less. Issuers commonly roll over their commercial paper: that is, they issue new commercial paper to pay off the old as it matures. Lenders are concerned that the issuer, for whatever reason, may be unable to roll over its commercial paper and will therefore default. To protect lenders from this danger, the bank can provide the issuer with a line of credit. The bank promises, if necessary, to lend the issuers the funds to pay off the old paper in effect converting the commercial paper into a bank loan.

Banker’s acceptance

Banker’s acceptance is a variation of commercial paper that involves the bank even more closely in guaranteeing the credit of the customer. The banker’s acceptance is essentially a guaranteed post dated cheque.

Off-Balance-Sheet-Banking:

In the 1980s, competition from financial markets made it necessary for banks to shift to more value-added products, which were better adapted to the needs of customers. To do so banks offered more sophisticated liquidity management technique, such as, loan commitments, credit lines and guarantees. They also developed swaps and hedging transactions, and underwrote securities. From an accounting viewpoint, none of these operations correspond to a genuine liability (or asset) for the bank, but only to a random cash flow. This is why they have been classified as off-balance-sheet operations.

Banks earn fee income through guaranteeing commercial paper and from providing banker’s acceptances---that is from credit substitution. Banks are able to substitute their credit in this way because evaluating the credit risk of their customers and monitoring their loan performance are precisely the activities banks are good at. Indeed, helping a customer issue money market paper allows a bank to perform much of its traditional lending functions without usually putting the loan on its own books. Such off-balance-sheet banking has a number of advantages for a bank.

Off-balance-sheet banking effectively increases a bank’s leverage. The bank increases its exposure to credit risk, but because the loan does not appear on its balance sheet, its formal equity-to loan ratio is unaffected. Off-balance-sheet banking also relieves a bank of the liquidity risk involved in funding the loan itself. If the depositors wish to withdraw the fund before the loan is repaid, the bank must somehow find the necessary funds. With off-balance-sheet banking, the bank is no longer responsible for the liquidity of the loan and it no longer bears the associated costs.

The factors that have fostered the growth of off-balance-sheet operations have different natures. Some are related to the bank’s desire to increase their fee income and to decrease their leverage; others are aimed at escaping regulations and taxes. Still the very development of these services shows that firms have a demand for more sophisticated custom-made financial engineering.

Forward Transaction
Banks have extended their activities also into forward transactions. Banks offer forward transactions in foreign exchange. Buying and selling foreign exchange is a natural outgrowth of their foreign exchange business. Banks also offer forward transaction related to interest rates. The most important is the swap. This is an arrangement that allows borrowers to exchange fixed interest payments for payments that fluctuate with current market rates.

Economies of Scope in Marketing

The relationship between a bank and its customers, both depositors and borrowers provides it with an opportunity to sell them other products. Moreover, banks’ branch network may provide service to its customers almost without any additional cost. This is an important part of economies of scope between banking and securities business. When new issues are to be sold to investors, the banks’ branches provide a distribution network and its depositors provide a natural clientele. When depositors-investors hold securities, a bank can help its customers to trade them.

There are opportunities for marketing other products. One that seems natural for marketing to a bank’s customers is insurance. There are no obvious economies of scope between banking and insuring. But a bank need not have to be an insurer in order to sell insurance. It is well placed to sell to its customers insurance policies provided by insurance companies.

Three Key factors in the evolution of banking Industry:
 
Banks and other financial industries tend to become more profitable as they become larger. Large banks may derive the economies of scale in terms of the following:

Economies of scale
Financial, Operational and reputational Economies
First, there are the financial economies of scale that result from better pooling as the pool becomes larger.  The Liquidity cost of a large bank is lower because the larger volume of transactions allows for more netting of deposits and withdrawals. Because larger banks can be more diversified, they can either make loans that are riskier and so higher yielding. Or they can reduce the ratio of capital to assets. In either case, the bank is more profitable. Recent studies have shown that when the financial economies are taken in to account, bigger is always the better [ Hughes,2000].

Second, there are the operational economies of scale that result from the element of indivisibility of fixed costs. Because fixed costs increase less than proportionally with the size of  bank, the burden is lower for the large banks . The increasing importance of information technology has increased the operational efficiency of scale. Recent studies have found that the minimum efficient scale of bank in terms of operational economies is in the range of $10 billion to $ 20 billion assets [ Mishikin and Strahan].

Third, there are reputational economies of scale: People tend to trust large banks more. Large banks are indeed inherently safer because of the financial economies and operational economies. But they are also more trustworthy, since they have more to loose if they harm their reputation by taking advantage of their customers.   

The competitive Advantage of Large Banks:
Because of these types of economies of scale, large banks should be able to out compete small ones, they should be able to operate at lower cost and to offer their customers better terms---lower lending rates and higher deposit rates. Small banks unable to compete should disappear, either closing down or being taken over by larger banks.

However, there may be limitations to such a process. At some point, economies of scale may be balanced by diseconomies. Large banks become more difficult to control, and the cost of management begins to rise. it is the existence of such diseconomies of scale that guarantee that the whole banking industry will not be taken over by a single gigantic bank. Technology of communications and regulatory barriers were two principal obstacles in the way to geographic expansion and huge growth of a bank.

Technology of Communications:

Early banks had branches in various towns and cities. However, managing these branches was a perennial problem. Poor communications made control and coordination difficult, and the absence of systematic accounting procedures made it hard to monitor performance. Because they could not consult head office on important decisions, branch managers had a great deal of independence. To protect their own reputation, banks felt obliged to stand behind the actions of their bank managers. So a lazy or dishonest branch manager could, and did, ruin the whole firm. Poor communications remain  barriers to branching until well into the second half of the nineteenth century.

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Introduction:
Modern economic and financial heritage begins with the coming of democratic capitalism, around the time of Adam Smith (1776). Under this system, the state does not interfere in economic affairs unnecessarily, removes barriers to competition, and in general, does not prevent and discourage any one willing to work hard enough –and who also has access to capital—from becoming a capitalist.

Some hundred years after Adam Smith, England was at the peak of its power. Politically, it ruled 25% of the earth’s surface and population, the British economy was by far the strongest and most developed in the world. The rest of Europe was not all that important. There was, however, some competition from America that fancied itself as rising economic power. Otherwise, the horizon was comparatively free of competition. British industry and British Finance were very secure in their respective positions [Smith and Walter, 2003]

English financial markets had made it all possible according to Walter Bagehot. England’s economic glory was based on the supply and accessibility of capital. In poor countries there were no financial resources any way, and in most European countries money stuck to the aristocrats and land owners and was unavailable to the market .But in England, there was a place in the city of London--- called Lombard Street--- where money could be obtained upon good security or upon good prospects of probable gain [Bagehot, 1873].

By the early 1900s, New Work was beginning to emerge as world’s leading financial centre. During this time Wall Street became an important financial centre. After World War 1, American Prosperity continued, While Europe’s did not. Banks Had a busy time, raising money for corporations, foreign governments and investment companies and making large loans to investors buying securities. Banks were then ‘Universal’, i.e, they were free to participate in commercial banking (lending) and investment banking, which at the time meant the underwriting, Distribution and trading of securities in financial markets. Many of the large banks were also involved in substantial amount of investment business. There was trade to finance all over the world, especially in such mineral-rich areas as Latin America and Australia. There were securities new issues (underwritings) to perform for foreign clients which in the years prior to 1929 crashed. The stock market crash 1992 was a global event --- markets crashed everywhere--- all at the same time, and the volume of foreign selling orders was very high. The Great Depression followed. There were three prominent results from these events.     

First were Deposit Insurance System and the glass –Stegall Provision of the Act, Which completely separated commercial banking from securities activities. Second was the depression itself which led to a 30-year period of banking being confirmed to basic, slow-growing deposit-taking and loan making with a limited local market only. Third was the Rising Importance of government in deciding financial matters, especially during the post-year recovery period. There was little for banks or securities firms to do until the late 1950s and early 1960s.

By then, international business had resumed its rigorous expansion and US banks also increased their activities abroad. The Euro-dollar market and Euro-bond market followed this expansion process. Also, the banks and investment banks were also re- attracted to international capital market transactions. Most large businesses are now effectively global, especially financial businesses. Banking and capital market services have proliferated, and numerous new competitors have emerged on the scene many of which are not banks at all. New regulations are constantly being introduced and old ones changed. Telecommunications provides an easy of access to information.
 
Operational Definition of a Bank:
A simple operational definition of a bank is that: A bank is an institution whose current operations consist in granting loans and receiving deposits from the public. This is the definition regulators use when they decide whether a financial intermediary has to submit to the prevailing prudential regulations for banks. This definition has the merit of insisting on the core activities of banks, namely deposits and loans. It may be noted that many words of this definition are important.

--- The word current is important because most industrial or commercial firms occasionally lend money to their customers (or borrow from their suppliers). Even if it is recurrent, this lending activity called “trade credit” is only complementary to the core activity of these firms.
---The fact that both loans and Deposits are offered is important because it is the combination of lending and borrowing that is typical of commercial banks. Banks finance a significant proportion to their loans through the deposits of public. This is the main explanation of the fragility of banking system and the justification of banking regulation.

--- Finally, the term “public” emphasizes that banks provide unique  services( liquidity ansd means of payment) to the general public. However, the public is not, in contrast with professional investors, armed to assess the safety and soundness of financial institutions, to assess whether individuals’ interests are well preserved by banks. Moreover, in the current situation a public good (access to a safe and efficient payment system) is provided by private institutions (commercial banks). These two reasons: protection of depositors and the safety and efficiency of the payment system have traditionally justified public intervention in banking activities [Freixas and Rocket,1999]   

The existence of banks is justified by the role they play in the process of resource allocation, and more specially in the allocation of capital. As merton (1993) states “A well developed smoothly functioning financial system facilitates the efficient life-cycle allocation of household consumption and the efficient allocation of physical capital to its most productive use in the business performed by banks alone. These functions are sufficiently stable to apply generically, from Italy’s Renaissance to today’s world sufficiently stable to apply generically, form Italy’s Renaissance to today’s world [freixas and Rochet, 1999]. Nevertheless, financial market has evolved and financial innovations have emerged at a spectacular rate in the last two decades. In addition, the development of security markets has led to a functional differentiation, with financial markets providing some of the services financial intermediaries used to offer exclusively. Thus, for example, it is as simple today for a firm involved in international trade to hedge exchange rate risk through a future market as through a bank contract.  prior to the development of futures markets, one would have tended to think that this was a functional characteristic of bank’s activity.

Today, some economists and bankers draw attention to developmental role of commercial banks. But the “developmental role” might not, prima facie, be seen as a characteristic of purely commercial banks which are historically involved in collection of deposits and provision of working capital. Nevertheless, it is felt that even in the case of such traditional commercial banks the attitude and philosophy of bank management has changed to great extent. The commercial banks are considered an essential instrument of national endeavor. The nature of their lending practices and the channelization of working funds would in themselves influence the pattern of national development. In many developing countries, there is a talk of social obligations of commercial banks.
Commercial banking is changing rapidly. Both the nature of business and the structure of the industry have changed dramatically in the last quarter century. While the economic role of commercial banks have varied little over time, the nature of commercial banks and competing financial institutions is constantly changing. Savings and loans and credit unions, brokerage firms, insurance companies and general stores now offer products and services traditionally associated with commercial banks. Commercial banks, in turn offer a variety of insurance, real estate and investment banking services they were once denied. The term bank today refers as much to the range of services traditionally offered by depository institutions as to the specific type of institution. However, although commercial banks remain the single most important intermediary in most countries, the business they do and the structure of industry is not the same in all countries.

Business of Banking:
According to paget’s Law of Banking, There is no exhaustive definition of ‘ Bank’ as par common Law. However, the usual characteristics are:
A. The conduct of current accounts;
B. The payment of cheques drawn on banks;
C. The Collection of cheques for customer.
These characteristics, however, are not equivalent  to a definition, and these are also not the only characteristics. A ‘bank’ may be better described with reference to its permitted business. Although, Traditionally, the main business of banks is acceptance of deposits and lending, the banks have now spread their wings far and wide in to


 many allied and even unrelated activities. These are summarized below: [IIBF, 2005]

A
•   Borrowing, raising or taking up of money;
•   Drawing, making, accepting, discounting, buying, selling, controlling and dealing in bills of exchange, Hundis, promissory notes, coupons, draft, bills of lading, railway receipts, warrants debentures, certificates, scripts and other instruments and securities whether transferable or negotiable or not;
•   Granting and issuing of letters of credit, ‘Traveler’s cheques and circular notes;
•   Buying and selling dealing in bullion and specie;
•   Buying and selling of foreign exchange;
•   Acquiring, holding, issuing on commission, underwriting and dealing in stocks, funds, shares, debentures, debenture stocks bonds and securities and investment of all kinds;
•   Purchasing and selling of bonds, scrips and other forms of securities on behalf of constituents or others;
•   Negotiation on loans or advances;
•   Receiving of all kinds of bonds, scrips or valuables on deposits or for safe custody or otherwise;
•   Providing of safe deposit vaults;
•   Collecting and Transmitting of money and securities.

B
1. Acting as agent of government, local authority or any other person and carry on agency business;
2. Contracting for public or private loans and monitoring and issuing the same;
3. Insure, guarantee, underwrite, participating in managing and carrying out of any issue of state, municipal or other loans or of shares, Stock, debentures or debenture stock of companies and lending money for any such purpose of any such issue;
4. Carry out and transact every kind of guarantee and indemnity business;
5. Manage sell and realize any property which may come in its possession in satisfaction of any of its claims;
6. Acquire, hold and deal with any property or any right, title or interest in any such property which may form the security for any loan or advance;
7. Undertake and execute trusts, undertake the administration of estates as executor, trustee or otherwise;
8. Establish, support and aid associations, institutions etc for the benefit of its present employees and may grant money for charitable purpose;
9. Acquire, construct and maintain any building for its own purpose;
10 Do all such things which are incidental or conducive to the promotion or advancement of its business.
11. Do any such business specified by the government as the lawful business of a banking company.

The origin of Development banking:
The evaluation of banking exhibits some fairly clean patterns. Commercial  banks, combining payments functions and financial intermediation, have developed from five main types of institution—payment processors (Examples, Medieval money changers English goldsmiths, public banks of deposits); merchant banks ( examples, Florentine banks, English country banks, U.S. private banks); Securities firms (examples Scriveners, industrial and universal banks); near Banks ( examples, Saving banks, Credit unions; and chartered banks.

Payment Processors and merchant banks began with payments functions. But economies of scope led into intermediation. Customers naturally held their liquid reserves with their payments processors and merchant banks as deposits.
 Second evolutionary path began with intermediation and added payment functions. This was the case with securities firms and near banks. Part of business of securities fund is to find investment for the customers. Customers keep funds with them waiting rto be invested. Offering Payment Services out of these deposits is a natural extension of their business. Merril Lynch’s CMA is a classic example of this process. Customers keep Funds with them in non- transaction deposits; it is natural to offer these customers transaction services. Recent deregulation, in the United States and elsewhere, has removed the regulatory obstacles to their doing so.
In contrast to this stories of evolution, chartered banks were set up from the very beginning as full fledged fractional reserve banks. Government set them up initially as an instrument of public finance. They used them both to finance direct government expenditure…..often on wars….and to finance government projects and programs. Commercial banks remain to this day important purchasers of government debt.

Referring to historical development of depository institutions we notice that banking institutions existed since the days of the earliest human civilization. Consequently, there evolution has spanned the time that organized societies have inhabited the earth. We are making a very brief reference to this development.

Historical Development of commercial Banks: Goldsmith Banks:
Inconveniences associated with barter ultimately led people to use commodities, particularly gold and silver, as money. Both metals were relatively scarce and highly valued. Both were easy to divide in to units of various sizes so that people could make change.
In the earliest times, people used un-coined gold and silver, known as bullion, to make transactions. But by using bullion people exposed themselves to asymmetric information problems. Such problems arise when one party to a transaction processes information that the other party does not have. On the other hand an adverse selection problem was associated with using gold and silver bullion as money: the individual with the greatest incentive to offer bullion in exchange for goods and services were hazard problem also existed when people used billion in exchange for goods and services were those whose bullion coined the least pure gold or silver. On the other hand moral hazards problem also excited when people used bullion as money. Once two parties to an exchange had reached an agreement on how much bullion will be paid for a good or bad service, the tender offering the bullion had an incentive to reduce the level of purity of the gold or silver before the exchange took place. 

Goldsmiths specialized in reducing the extant of these asymmetric information problems. Parts to a transaction would pay a goldsmiths would issue the holder of bullion a certificate attesting to the bullion’s weight and gold or silver content. Other goldsmiths went a step further. To provided standardized weights of gold or silver that they imprinted with a scale of authenticity. These standardized unites were the earliest coins.

Bullion Deposits and Fractional-Reserve Banking:
Eventually, some goldsmiths simplified the process further by issuing Paper notes including that the bearer held  gold or silver of given weights and pictures on deposits with goldsmiths. Then the bearers of these notes could transfer the notes of others in exchange for goods and services. These notes were the first paper money. The gold and silver held on deposits with goldsmiths became the first bank deposit.

Once goldsmiths became depository institutions, it was only a matter of time before they took the final step towards modern banking by becoming lends. Goldsmiths began to notice that withdrawal of bullions relative to new bullion deposit where fairly predictable. Therefore as long as the goldsmiths held reserves of gold and silver to cover unexpected bullion withdrawal, they could lend paper notes in express of amounts of bullions that they kept at hand .They could charge interest on the loans by requiring repayment in bullion excess of value of notes that they issued.

By lending funds in excess of the reserves the reserves money (gold and silver bullion) that they actually possessed, these goldsmith banks developed the earliest form of fractional reserve banking. As long as the economic conditions were stable and the goldsmiths managed their accounts wisely, those who held the goldsmith’s notes would be satisfied with this arrangement. But in bad times or in instances when a few goldsmiths overextended themselves, many note holders might show up at the same time demanding the gold or silver bullion lending to bank-runs. These were the earliest bank-runs.   

To be continued.................

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BBA Discussion Forum / The Formal Credit Analysis Procedure:
« on: August 11, 2016, 01:53:59 PM »
The Formal Credit Analysis Procedure

The formal credit analysis procedure includes a subjective evaluation of the borrower’s request and a detailed review of all financial statements. The loan officer may perform the initial quantitative analysis for the bank manager. The process consists of:

1. Collecting information for credit file such as credit history and performance.
2. Evaluating management, the company and the industry in which it operates, i.e., evaluation of    internal and external factors.
3. Spreading financial statements i.e. financial statement analysis.
4. Projecting the borrower’s cash flow and thus its ability to service the debt.
5. Evaluating collateral or the secondary source of repayment. 
6. Writing a summary analysis and making recommendation.

The credit file contains background information on the borrower, past and present financial statements, pertinent credit reports, and supporting schedules such as an ageing receivables a breakdown of current inventory and equipment, and a summary of insurance coverage. If the customer is a previous borrower, the file should also contain copies of past loan agreement , cash flow projections, collateral agreements and security documents and narrative comments provided by previous loan officers, and copies of all correspondence with the customer. One of the most important aspects of lending is determining the customer’s desire to repay the loan. Although this is critically important, it is difficult to measure. Information in the credit file will give the credit officer information on the customer’s repayment history.

The credit analyst also uses the credit file data to spread the financial statements, project cash flow, and evaluate collateral. An evaluation of management, the company and industry is also needed to ensure safety and soundness of loan. The last step is to submit a written report summarizing the loan request, loan purpose and the borrower’s comparative financial performance with industry standards, and to make a recommendation. The loan officer evaluates the report and discusses any errors, omissions and extensions with the analyst.


30
MBA Discussion Forum / BANKS’ LOAN POLICIES
« on: August 06, 2016, 01:00:14 PM »
The students of Finance and Banking may find this topic relevant for them

BANKS’ LOAN POLICIES
Factors that influence a Banks’ Loan Policies:
The restrictions imposed by statutory law and administrative regulations do not provide answer to many questions. Regarding safe, sound and profitable bank lending, questions regarding the size of loan portfolio, desirable loan maturities, and the types of loans to be made are unanswered. These questions and many others about lending must be answered by each individual bank. Many banks have developed formal written lending policies in recent years. Although written lending policies serve a number of purposes, the most important is that they provide guidance for lending officers and thereby establish a greater degree of uniformity in leading practices. Since lending is important both to the bank and to the community it serves, loan policies must be worked out carefully after considering many factors. For the most part, these same factors determine the size and composition of the secondary reserve and the investment account of a bank. Some of the very important factors are mentioned here and discussed only briefly.

1. Capital Position
2. Risk and Profitability of various types of loans
3. Stability of deposits
4. Economic Conditions
5. Influence of monetary policy and fiscal policy.
6. Ability and experience of bank personnel
7. Credit needs of the area served.

Capital Position:
The capital of a bank serves as cushion for the protection of the depositors’ fund. The size of the capital in relation to deposits influences the amount of risk that a bank can afford to take. Banks with a relatively large capital structure can make loans of longer maturities and greater credit risk.
.
Risks and Profitability of Different Types of loan:
Since earnings are necessary for successful operation of a bank, all banks consider this important factor in formulating loan policy. Some banks may emphasize earnings more than others.Banks with greater need for earnings might adopt more aggressive lending policies than those that do not consider earnings to be paramount. An aggressive lending Policy might call for making a relatively large amount of term or consumer loans, which normally are made at higher rates of interest than short-term business loans.

The stability of Deposits:
The fluctuation and types of deposits must be considered by a bank in formulating its loan policy. After adequate provisions have been made for the primary and secondary reserves, banks can then engage in lending. Even though these two reserves are designed to take care of predictable deposit fluctuations
and loan demands, unpredictable demands force banks to give consideration to the stability of deposits in formulating loan policy.
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Economic Condition:
The economic conditions of the area served by a bank are important in determining its loan policy. A stable economy is more conducive to liberal loan policy than is one that is subject to seasonal and cyclical movements. Deposits of feast or famine economies (weak economies) fluctuate more violently than do deposits in an economy noted for its stability. Consideration must also be given to the national economy. Factors that adversely affect the nation as a whole, if they are of serious magnitude, eventually affect local conditions.
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Monetary and Fiscal policies:
The lending ability of bank is also influenced by monetary and fiscal policies. If monetary and fiscal policies are expansionary and additional reserves are made available to the commercial banking system, the lending ability of bank is increased. Under these conditions banks can have more liberal loan policy than if the opposite situation exists.
The Expertise of Bank Personnel:
The expertise of lending personnel is not insignificant in the establishment of bank loan policy. For example, officers may have considerable ability and experience in business lending but practically none in making real estate loans, while in other banks their specialty may be consumer lending. One of the probable reasons that banks were slow in entering the consumer lending field is the lack of skilled personnel. Some banks may be so specialized in certain fields of lending that their presence may influence the loan policy of other banks.
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The Area Served by Banks:
An obvious factor influencing a commercial bank’s loan policy is the area it serves. The major reason banks are chartered is to serve the credit needs of their communities. If this cannot be done, there is little justification for their existence. Banks are morally bound to extend credit to borrowers who present logical and economically sound loan requests. Banks in areas where the economy predominantly one of cattle raising, for example, cannot turn their back on this type of lending, but should tailor policy to fit the needs of this economic activity.
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To be continued………..
The Tools Commercial Lenders Need and Use.....
The Formal Credit Analysis Procedure…………...
Structuring A Credit Proposal………………….......

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