Yes, We Need A Central Bank!Nida Naeem

Dr.Madiha Sohail

Overview:

Financial System

Central Bank

Functions

Financial Stability

Financial Crisis

Origin of Central Banking

Significance

State Bank of Pakistan

Financial System:

Of a country comprises entities engaged in transactions involving financial instruments in money, capital and foreign exchange markets.

Serves as a strong linkage with the other sectors of economy like external, fiscal and real sectors.

Central Bank:

The apex financial institution in every country is it’s central bank and the state bank of Pakistan functions as our central bank.

Functions of Central Bank:

Conduct of monetary policy: it’s major task is to contribute to sustainable economic growth through maintaining low inflation.

Financial stability oversight: means reducing vulnerability to the financial fragility and preventing the financial crisis.

The relationship of the twin goals i.e price stability and stability of the financial system can be problematic. The two of them can traverse each other’s paths in terms of stability.

The linkage is that the monetary policy transmission is wholly based on the financial system, it should be stable. While, on the other hand maintaining low &

Functions:

Financial fragility:

If there is unsound asset structure of financial institutions (reflecting subsided credit and insider loans), changes in relative prices, including interest rates & exchange rates, that are influenced by viability of regulations & supervision, that facilitates unnecessary risk taking.

Financial Stability:

Means the least possibility fragility in the financial system of the country and its capability to avoid a financial crisis.

The ultimate objective is the avoidance of financial crisis that are likely to cause significant costs to other sectors of the economy.

Significance:

A well functioning financial sector is critical to an economy’s well being because it is so intimately connected to every other sector of the economy through it’s role of providing a host of financial services from facilitating the trading, lodging, diversifying, and pooling of risk; allocating resources; monitoring managers; mobilizing savings; to facilitating the exchange of goods and services.

Financial Crisis:

Also termed as “bank runs” or “banking collapses”.

Term financial is used because with, with today’s financial systems, the source of the crisis could be the capital market or a non-bank financial institution rather than a bank.

In some circumstances, the failure of one or even a few financial institutions might be a part of the normal market mechanism while in some cases, the failure of a single financial institution might create financial crisis.

Systemic financial crisis is when crisis spreads

Avoiding financial instability:

The world has faced a number of business cycles, and although we wish that the cycle could be abolished, most of us are resigned to the fact that expansions cannot go on forever, and they will be followed by a recession.

May these recessions not be frequent or deep, public confidence in the legitimacy of the economic system remains intact.

For example the collapse of the US Banking

Origin of central banking:

Establishment of the federal reserve system in 1913 in direct response to bank runs and financial panics of 1907.

In 1850s and 1860s, the bank of England freely lent to institutions to prevent financial panic.

In 1882, Banque de France providing secured loans to the Paris bourse to avoid speculations in stock market.

State Bank Of Pakistan:

To enhance it’s effectiveness, a credit information bureau CIB was established to keep credit records.

An NBFIs department was established that issued “Rules Of Business” to supervise them.

“Monetary Policy Operational Independence” was given to SBP.

Dissolution of Pakistan Banking Council was done.

Supervisory roles were further enhanced by placement of CAMELS & CAELS framework.

Various monetary management measures were taken to dismantle the system of financial repression & establish a market based mechanism of monetary control.

Credit deposit ratio was introduced.

Caps on lending rates of banks and NBFIs were eliminated t pave the way for implementation of monetary policy indirectly through signals of liquidity & short term interest rate changes.

Banking laws underwent changes e.g various amendments in SBP Act 1956 and other regulatory bodies.