There are different methods of money notes issuing adopted by different countries of the world at different times.

The most important of them are as under. 1. Fixed Fiduciary System : Under fixed fiduciary system, the government fixes a fixed amount of notes without keeping any metallic reserve. But this portion of currency must be backed by government securities, which is called fiduciary Limit. The notes issued other than fiduciary limit must be fully backed by gold or silver reserves. This system was introduced in England in 1844 in the Bank charter Act of 1844. Norway and Japan also adopted this method . This system acted as a brake on the undue expansion of currency and credit in the time of prosperity. This system also provides security for the convertibility of notes. (i) Safety: This method of note issue provides safety to notes issued and acts as brake, which also provides safety to currency value. (ii) Stability: This system not only provides value stability but also provides economic stability, which is helpful for regulating internal prices and exchange rate. 2. Proportional Reserve System: Under this system the central bank is required to keep only a certain percentage of notes issued in the form of gold or silver. The reserve proportion is usually from 30% to 40%. It means a central bank can issue Rs. 100 note after keeping gold silver valuing Rs. 30 or 40. This method of currency regulation is the most affordable system of the present time and is widely used in many countries. It was first of all adopted by Germany in 1876 and followed with modifications by U.S.A in 1914. (i) Elasticity: This system is more elastic than fixed Fiduciary system . For example, if bank obtains, Rs. 40 worth of gold, it can issue Rs. 100 note under the proportional Reserve system. Whereas under fixed Fiduciary system the bank can issue note of Rs. 40 only, once the fiduciary limit reached. (ii) Safety: The reserve maintains in this method serves as a safeguard against excessive note issue and inflation can be checked. 3. Minimum Reserve System: Fixed minimum reserve system allows the central bank to keep only a fixed amount of reserve against whatever the amount of note issue. The reserve is in the form of gold, silver and-foreign exchange or in the form of any of these types of things. This method -is being used in Pakistan after December 1965. India is also applying it since 1957. South Africa has adopted it in 1930. Holland has been issuing notes under this method for many years. (i) Elastic: This system is much elastic than above stated methods of note issue which can meet the ever-changing needs of the money by the govt. (ii) Economical: Because a fixed amount of gold, silver or foreign exchange is to be maintained as fixed minimum reserve, therefore it becomes much economical and government can also change the fixed minimum reserve at anytime.

Functions of State Bank of Pakistan The State Bank of Pakistan (SBP) is the central bank of Pakistan. While its constitution, as originally laid down in the State Bank of Pakistan Order 1948, remained basically unchanged until January 1, 1974, when the bank was nationalized, the scope of its functions was considerably enlarged. The State Bank of Pakistan Act 1956, with subsequent amendments, forms the basis of its operations today. The headquarters are located in the financial capital of Pakistan, Karachi with its second headquarters in the capital, Islamabad. 1. Banker to the Government: As banker to the government, SBP A. B. C. D. E. Receives deposits (taxes, fees, fines, etc.) on behalf of the federal government. Disburses payments (tax refunds, interest, etc.) on behalf of the federal government. Manages the national debt buys, sells, and cashes government securities and pay interest/profit on them. Lends money to the federal government as needed.

2. Banker to Banks: As banker to the scheduled banks, SBP: A. Holds deposits made by them as a part of their required reserves5% at this time. B. Lends them funds as a lender of the last resort to meet their pressing needs by discounting their bills of exchange and other 3. Acts as a Clearing House: Provides facilities, physical and/or electronic, to scheduled banks to clear cheques and other claims drawn against each other deposited by their customers for collection by adding up what they owe or owed them and transfer funds from their accounts at SBP.

[Link] of Banks and other Financial Institutions: One of the fundamental responsibilities of the State Bank is regulation and supervision of the financial system to ensure its soundness and stability as well as to protect the interests of depositors. The banking activities are now being monitored through a system of off-site surveillance and on-site inspection and supervision. Off-site surveillance is conducted through regular checking of various returns regularly received from the different banks. On other hand, on-site inspection is undertaken by the State Bank in the premises of the concerned banks when required. 5. Issuer of Paper Currency: State Bank has the sole authority to issue paper notes. It has the prime responsibility to control its supply in order to ensure a stable price of money, i.e., its value or purchasing power. Its notes, however, are not convertible into gold or silver.

6. Exchange Rate Management and Balance of Payment: The Bank is responsible to keep the exchange rate of the rupee at an appropriate level and prevent it from wide fluctuations in order to maintain competitiveness of our exports and maintain stability in the foreign exchange market. As the custodian of countrys external reserves, it is responsible for management of the foreign exchange reserves. 7. Developmental Role of SBP: The Banks participation in the development process has been widened in the form of rehabilitation of banking system, development of new financial institutions and debt instruments in order to promote financial intermediation, establishment of Development Financial Institutions, directing the use of credit according to selected development priorities, providing subsidized credit, and development of the capital market. 8. Non-traditional Role: The non-traditional or promotional functions, performed by the State Bank include development of financial framework, institutionalization of savings and investment, provision of training facilities to bankers, and provision of credit to priority sectors. The State Bank also has been playing an active part in the process of Islamization of the banking system. 9. To Formulate and Implement the Monetary Policy: The Bank is also in charge of conducting monetary policy which means changing the supply of money in the economy. The tools of the monetary policy are: [Link] the monetary base: This directly changes the total amount of money circulating in the economy. The State Bank can use open market operations to change the monetary base. The Bank would buy/sell bonds in exchange for hard currency. When the central bank sells government bonds it receives hard currency in payment, thus reducing the money supply. b. Changing the reserve requirements: Monetary policy can be implemented by changing the proportion of total assets that banks must hold in reserve with SBP. Banks only maintain a small portion of their assets as cash available for immediate withdrawal; the rest is invested in illiquid assets like mortgages and loans. c. Changing the discount rate: Banks borrow money from the State Bank by cashing or discounting credit instruments, such as bills of exchange. By raising the discount rate SBP discourages banks to borrow money. If and when the goal is to increase the money supply, the Bank lowers its discount rate to encourage borrowing by the banks and, thus, helps increasing the money supply.

History of SBP The main idea goes like this. The Governments were always under war with someone else and incurred huge expenditure. So, people were worried that govts would default. The Govts faced both credibility and time consistency issues (whether govt will honor its debts). Hence, central banks were set up that served as institutions to lend to governments. The central banks in turn solved both the credibility and time consistency issues. Hence, it was a win-win situation for both The Government gained credibility that it would not default and Central banks got privileged rights to be the banker to the government. Before independence on 14 August 1947, during British colonial regime the Reserve Bank of India was the central bank for both India and Pakistan. On 30 December 1948 the British Government's commission distributed the Reserve Bank of India's reserves between Pakistan and India -30 percent (750 M gold) for Pakistan and 70 percent for India. The losses incurred in the transition to independence were taken from Pakistan's share (a total of 230 million). In May, 1948 Muhammad Ali Jinnah (Founder of Pakistan) took steps to establish the State Bank of Pakistan immediately. These were implemented in June 1948, and the State Bank of Pakistan commenced operation on July 1, 1948. The State Bank of Pakistan also performs both the traditional and developmental functions to achieve macroeconomic goals. The traditional functions, may be classified into two groups: 1) The primary functions including issue of notes, regulation and supervision of the financial system, bankers bank, lender of the last resort, banker to Government, and conduct of monetary policy. 2) The secondary functions including the agency functions like management of public debt, management of foreign exchange, etc., and other functions like advising the government on policy matters and maintaining close relationships with international financial institutions. The non-traditional or promotional functions, performed by the State Bank include development of financial framework, institutionalization of savings and investment, provision of training facilities to bankers, and provision of credit to priority sectors. The State Bank also has been playing an active part in the process of islamisation of the banking system. WHAT ARE THE INSTRUMENTS OF MONETARY POLICY? Fiduciary or paper money is issued by the Central Bank on the basis of computation of estimated demand for cash. Monetary policy guides the Central Banks supply of money in order to achieve the objectives of price stability (or low inflation rate), full employment, and growth in aggregate income. This is necessary because money is a medium of exchange and changes in its demand relative to supply, necessitate spending adjustments. The instruments of monetary policy used by the Central Bank depend on the level of development of the economy, especially its financial sector. The commonly used instruments are discussed below. Reserve Requirement: The Central Bank may require Deposit Money Banks to

hold a fraction (or a combination) of their deposit liabilities (reserves) as vault cash and or deposits with it. Fractional reserve limits the amount of loans banks can make to the domestic economy and thus limit the supply of money. The assumption is that Deposit Money Banks generally maintain a stable relationship between their reserve holdings and the amount of credit they extend to the public. Open Market Operations: The Central Bank buys or sells ((on behalf of the Fiscal Authorities (the Treasury)) securities to the banking and non-banking public (that is in the open market). One such security is Treasury Bills. When the Central Bank sells securities, it reduces the supply of reserves and when it buys (back) securities-by redeeming them-it increases the supply of reserves to the Deposit Money Banks, thus affecting the supply of money. Interest Rate: The Central Bank lends to financially sound Deposit Money Banks at a most favorable rate of interest, called the minimum rediscount rate (MRR). The MRR sets the floor for the interest rate regime in the money market (the nominal anchor rate) and thereby affects the supply of credit, the supply of savings (which affects the supply of reserves and monetary aggregate) and the supply of investment (which affects full employment and GDP). Direct Credit Control: The Central Bank can direct Deposit Money Banks on the maximum percentage or amount of loans (credit ceilings) to different economic sectors or activities, interest rate caps, liquid asset ratio and issue credit guarantee to preferred loans. In this way the available savings is allocated and investment directed in particular directions. Exchange Rate: The balance of payments can be in deficit or in surplus and each of these affect the monetary base, and hence the money supply in one direction or the other. By selling or buying foreign exchange, the Central Bank ensures that the exchange rate is at levels that do not affect domestic money supply in undesired direction, through the balance of payments and the real 3 exchange rate. The real exchange rate when misaligned affects the current account balance because of its impact on external competitiveness. Moral suasion and prudential guidelines are direct supervision or qualitative instruments. The others are quantitative instruments because they have numerical benchmarks. On-off site supervisory Till 1993, regulatory as well as supervisory functions over commercial banks were performed by the Department of Banking Operations and Development (DBOD). Subsequently, a new Department of Banking Supervision (DBS) was set up to take over the supervisory functions relating to the commercial banks from DBOD. For dedicated and integrated supervision over all credit institutions, i.e., banks, development financial institutions and non-banking financial companies, the Board for Financial Supervision (BFS) was set up in November 1994 under the aegis of the Reserve Bank of India. For focussed attention in the area of supervision over non-banking finance companies, Department of Supervision was further bifurcated in August 1997 into Department of

Banking Supervision (DBS) and Department of Non-Banking Supervision (DNBS). These Departments now look after supervision over commercial banks & development financial institutions and non-banking financial companies, respectively. Both these departments now function under the direction of the Board for Financial Supervision (BFS). The Board for Financial Supervision constituted an audit sub-committee in January 1995 with the Vice-Chairman of the Board as its Chairman and two non-official members of BFS as members. The sub-committees main focus is upgradation of the quality of the statutory audit and concurrent / internal audit functions in banks and development financial institutions. On site Inspection On site inspection of banks is carried out on an annual basis. Besides the head office and controlling offices, certain specified branches are covered under inspection so as to ensure a minimum coverage of advances. The Annual Financial Inspection (AFI) focusses on statutorily mandated areas of solvency, liquidity and operational health of the bank. It is based on internationally adopted CAMEL model modified as CAMELS, i.e., capital adequacy, asset quality, management, earning, liquidity and system and control. While the compliance to the inspection findings is followed up in the usual course, the top management of the Reserve Bank addresses supervisory letters to the top management of the banks highlighting the major areas of supervisory concern that need immediate rectification, holds supervisory discussions and draws up an action plan, that can be monitored. All these are followed up vigorously. Indian commercial banks are rated as per supervisory rating model approved by the BFS which is based on CAMELS concept. Off-site Monitoring As part of the new supervisory strategy, a focussed off-site surveillance function was initiated in 1995 for domestic operations of banks. The primary objective of the off site surveillance is to monitor the financial health of banks between two on-site inspections, identifying banks which show financial deterioration and would be a source for supervisory concerns. This acts as a trigger for timely remedial action. During December 1995 first tranche of off-site returns was introduced with five quarterly returns for all commercial banks operating in India and two half yearly returns one each on connected and related lending and profile of ownership, control and management for domestic banks. The second tranche of four quarterly returns for monitoring assetliability management covering liquidity and interest rate risk for domestic currency and

foreign currencies were introduced since June, 1999. The Reserve Bank intends to reduce this periodicity with effect from April 1,2000.