CHAPTER # 2

EVOLUTION OF BANKS IN PAKISTAN

There are different opinions that how the word ‘Bank’ originated. Some of the author’s opinion
that this word is derived from the word ‘Bancus’ or Banque’, which means a bench. The
explanation of this origin is attributed to the fact that the Jews in Lombard transacted the
business of money exchange on benches in the market place; and when the business failed, the
people destroyed the ‘bench’. Incidentally the word ‘Bankrupt’s said to have evolved from this
practice.

Some of the authors are of opinion that the word ‘Bank’ is derived from the German word back,
which means ‘joint stock fund’. Later on when the German occupied major part of the Italy the
word ‘Back’ was italicized into ‘Back’.

In fact human left the need of bank when it begins to realize the importance of money as a
medium of exchange. Perhaps it where the Babylonian who developed banking system as early
as 2000 BC. At that time temples were used as banks because of their prevalent respect. During
the rule of king Hamurabi (1788 – 1686 BC) the founder of Babylonians Empire, loans were
started being granted for interest. The borrower has to provide guarantee or he had to pledge his
goods or valuables. King Hamurabi drew up a code wherein he laid down standards rules for
procedures for banking operations by temples and great landowners. Also in Greece, the temples
were used as banks, where the people deposited their money and other valuables for safe custody
and security. In Europe with the ‘revival of civilization’ (Renaissance) in the middle of twelve
century, trade and commerce started expanding and this development compelled the business
community to borrow the money from the Hebrew money lenders on high rates of interest and
usury. Seeing the great demand, these moneylenders started organizing themselves and bank
started up at the principle seaports of southern Europe. Soon Venice and Geneva became the
most important money markets of the time and banking though different from its present form,
flourished. What we know as ‘modern banking’ originated in the 14th century in Barcelona.1

2.1 Definitions of Bank

“Bank”

"A financial institution, which deals with money and credit. It accepts

Deposits from individuals, firms and companies at a lower rate of

Interest and gives at higher rate of interest to those who need them.”2

A financial establishment which uses money deposited by customers for investment, pays it out
when required, makes loan at interest, exchanges currency, etc.

J.W Gilbert in his principles and practice banking defines a banker in these words:

“A banker is dealer in capital or more properly, a dealer in money. He is intermediate party

between the borrower and the lender. He borrows of one and lends to another”.3

Sir John Paget defines banker in these terms:

“That no person or body, corporate or otherwise, can be a banker who does not

 Take deposits accounts.

 Take current accounts,

 Issue and pay Cheques and

 Collect Cheques crossed and uncrossed for his customers”4 (The law of Banking by
Sir John Paged, page 51).

The American defined the term banker in a very broad sense as under:

“By banking, we mean the business of dealing in credits and by a ‘Bank’ we include
every person, firm or company having a place of business where credits are opened by deposits
of collection of money or currency. Subjects to be paid or remitted on Cheques or order, money
is advanced or loaned on stocks, bonds, bullion, bill of exchange, promissory notes are received
for discount or sale”.5
2.2 Evolution of Banking in Pakistan

The first phase in evolution of banking in Pakistan sees very hard days for the whole banking
sector. Starting virtually from scratch in 1947, the country today possesses a full range of
banking and financial institutions to cope with various needs of the economy.

The area now constituting Pakistan was, relatively speaking, fairly well provided with banking
facilities in undivided India, in March 1947 there were 3496 offices of Indian scheduled banks
out of which as many as 487 were situated in territories now constituting Pakistan.

The Reserve bank of India was the central banking authority in India. At the time of partition it
was decided that in the interest of smooth transition it should continue to function in newly
emerging state of Pakistan, until 30th Sep.1948.

In 1947 due to uncertainty and unsuitability the banking sector suffer heavy losses.

This resulted in a negative effect on baking service in Pakistan. The banks, which had their
registered offices in Pakistan, transferred them to India. In an effort to bring about the collapse of
the new state by pushing a deliberate policy of withdrawals the Indian bank offices closed
quickly. Those banks, which stayed, operated only in name pending the winding up of their
business. The number of scheduled banks thus declined form 487 branches before independence
to only 195 branches by 30th June1948.5

2.3 Banking Growth during (1948-1970)

In this tense situation, a committee was immediately setup to formulate a scheme of central
banking legislation for Pakistan. Many specialists were of the opinion that in view of the acute
shortage of trained staff, any idea of establishing a central bank was I impractical and the best
that could be attempted was the setting up of a currency board until such times as sufficient staff
could be organize to operate a central bank.

The questions as to whether the institution should be only a currency board or a full-fledged
central bank had exercised the mind of the Pakistan government since independence. Through, it
was realized that the shortage of trained personal to run the central bank would present serious
difficulty in view of the tangible advantages that a central bank enjoyed over currency board, the
government ultimately decided to take the bold step of setting up a full fledged central banking
authority. Among other factors, which led to this decision, there was the fact the banking
facilities in the country had been totally disrupted and there was an urgent need for their
rehabilitation, which a central ban alone could meet. As there was hardly any time to pass as Act,
an order was drafted, known as the state bank of Pakistan order, which was promulgated by the
government of Pakistan on 12th may 1948. The state bank declared open on July 1, 1948 by the
father of the nation.

One of the first tasks of the state bank was to arrange for the replacement of the Reserve bank of
India notes, which had continued to circulate in Pakistan during the transitional period, by
Pakistan currency.

The first Pakistan notes were issued in October 1948 in the denominations of Rs. 5, 10 & 100.

An equally urgent task, which the new central bank had to address itself, was the creation of a
national banking system. To this end, while extending every help and encouragement to Habib
Bank to expand its organization, the state bank recommended the setting up of a new banking
institution to serve both as an agent to the state bank recommended the setting up of a new
banking institution to serve both as an agent of the state bank as well as the spearhead of its
credit polices.

Accordingly the NATIONAL BANK OF PAKITSN was setup under an ordinance in November
1949. It started with six offices in the former East Pakistan. In view of the special role assigned
to the new institution, contrary to traditional practices the Governor of the state bank was
appointed to head its board of Director in 1950. Under the fostering care of the state bank and the
support of the government, the new institution developed rapidly. By using its special powers,
the state bank made liberal advances to the new bank to help it expand credit facilities in the
country. By 1952, the National bank of India. Shortly, afterwards, in November 1952, the
governor of the state bank ceased to function as the president of National bank of Pakistan.

With a view to broadening the institutional framework of the financial system, the state bank also
sponsored the establishment of specialized credit institutions in the filed of agriculture and
industry. Banking companies (control) act was passed in December 1948 specifically
empowering the state bank to control the operations of banking companies in Pakistan.

Moreover realizing that the most serious limitation on the expansion of banking services in
Pakistan was the lack of trained personal, the state bank sponsored a banking training scheme,
which was repeated after year and turned out a large number of bankers.

As the Commercial Banking facilities continued to expand, a new Pakistani bank, the National
Commercial Bank was established and registered as a scheduled bank. In the filed of industrial
finance a new institution known as the industrial credit and investment cooperation was set up.

The year 1958 marked the completion of the first decade of the working of the State Bank of
Pakistan. When it was established there were only 195 bank offices in existence. At the end of
June 1958 their number had increased to 307, of which Pakistani banks accounted for 232
against 25 in mid 1948. Moreover at the end of June 1958. Pakistani banks held 60% of the total
banks deposits, and were responsible for 65 of total bank credit.

When the Ayub Government took over in 1958, the banking and monetary scene was
significantly affected by Developments such as the liberalization of imports, transfer of business
in food grains to the private sector, and the firming up of commodity markets. The demand of
funds picked up and there was a substantial expansion of bank credit to the private sector. The
pace of expansion in the institutional frame work of the country’s banking system quickened and
a new Pakistani, bank, namely the United Bank Limited was established.

Owning the five years 1960-65, the credit structure in Pakistan made rapid progress. The bank
extended its network by opening six new offices located at Chitagong, Peshawar, Quetta,
Khulna, Layallpur and Rawalpindi. The number of scheduled bank offices rose from 430 at the
end of June 1960 to 1591 in June 1965. Several new banks were added to the list of scheduled
banks.

Two principal additions were the commerce bank, and the standard bank. The number of
scheduled banks, which stood at 29 in June 1960 rose to 36 by June 1965.
Under the impact of economic growth and dear scope of private enterprises, bank credit to the
private sector rose from Rs. 1,458 millions to Rs. 5759 million. Thus the total expansion in bank
credit to the private sector during this period amounted to Rs. 4300 million, which gave a annual
expansion of Rs. 860 million compared to the annual average increase of Rs. 144 million over
the preceding five years. Banks deposits increased from Rs. 2,493 million to Rs. 6883 million
during the five years period ended June 1965 compared to Rs. 231 million in the proceeding five
years. Time deposits during this period increased from Rs. 946 million to Rs. 3228 million,
where demand deposits rose from Rs. 1997 million to Rs 3655 million. The increase in time
deposits was particularly rapid. The ratio of time deposits to total deposits in June 1965 stood at
49.6 percent age as against 32.01 percent age five years earlier. Another salient feature of
banking development during this period was that since the rate of increase in bank deposits
lagged behind the rate of expansion in bank credit, the banked has to depend increasingly on
central bank finance. They borrowing from the state bank rose from Rs. 11 million in June 1960
to Rs. 1688 million in June 1965. Owing keen demand for bank credit, bank’s investments could
not increase as rapidly as their advances. Their investments totaled to Rs. 1,874 million at the
end of June 1965 compared to Rs. 1,231 million in June 1960. Investments which were almost
equal to their advances in June 1960 were only about one third of the advances in June 1965.

The third plane period witnessed a further expansion of banking facilities in the country the total
number of scheduled banked offices increased from 1,591 at the end of June 1965 to 3133 at the
close of June 1970. During the same bank credit to the private sector rose from Rs. 5,789 million
to Rs. 9492 million. There was also a substantial growth in the bank deposits, which increased
from Rs. 6883 million June 1965 to Rs. 13147 million at the end of June 1970. A remarkable
change occurred during this period related to the composition of deposits. Time deposit becomes
greater than demand deposits forming about 54 percent age of the total deposits. As oppose to
what happened in the previous period, banks were able to finance a mush higher level of credit
expansion without having to increase their borrowings from the central bank.7

2.4 Banking Reforms 1972

After the assumption of office by a new government in 1971, may 1972 different reforms were
introduced to make the banks more responsive to the requirements of economics growth with
social justice. The reforms aimed at bringing about a more purposeful and equitable distribution
of bank credit, improving the soundness and efficiency of the banks, and securing greater social
accountability of the banking system as a whole.

The role of the banking system had been truly spectacular in mobilizing savings of the
community and meeting the credit needs of the economy. But at the same time, the banks had
generally neglected their role in promoting social justice and had failed to play an effective role
in ensuring a wider and more equitable dispersal of the benefits of economic growth. In
particular the inter locking of ownership with commercial and industrial interests had led to the
misuse of bank resources. There was a heavy concentration of credit in big accounts and in urban
area. Credit facilities for agriculture, small business, newly emerging exports and housing had
remained obviously inadequate while the banks indulged in capital financing in few selected
business sectors and issued guarantees on behalf of favored clients, term clients, term financing
facilities for industry were wholly absent.

Under the banking reforms introduced in May 1972 the state bank of Pakistan was accorded
wider powers. It was authorized to remove directors or managerial personnel, if necessary and
supersede the board of directors of a banking company and appoint administrators during the
period of such super session. It was also empowered to nominate directors on the board of every
bank. As regard bank directors, it was provided that anyone defaulting in meeting his obligations
to bank would forfeit his directorship. Moreover, it was laid down that no person could serve as
director of a bank for more than six years continuously. Each bank was required to have a paid
up capital of not less than 5 percent age of its deposits to be progressively build up to 10 percent
age over a period of time. The banks were also required to transfer 10 percentage of their profit
their reserves every years after the reserve became equal to the paid up capital. With a view to
diversity the ownership of the banks, the banks were required to raise new capital from the
market. Unsecured loans to directors, their families or firms and companies, were totally
prohibited.

The bank reforms also brought about the establishment of new institutions to achieve new
objectives.
A national credit consultative was setup under the supervise of the state bank with representation
form the government and the private sector. It was assigned the task of determining of
economy’s annual credit needs within the safe limits of monetary and credit expansion with
reference to the annual development plan. Such a credit plan was to cover the public and private
sectors. Alongside the National credit council and Agricultural Advisory Committee was formed
to allocate agriculture credit for various purposes, to coordinate the operation or the agriculture
credit agencies and to oversee the flow of credit to the designated targets. A standing committee
on exports in general and the new emerging exports in particular, was also established. With a
view to encourage the banks to extend credit to small borrowers, a credit guarantee scheme was
introduced under which the state bank under took to share any bonfire losses incurred by the
commercial banks in case of small loans of advances to agriculture.

At the same time two financing institutions were established. The people’s Finance Corporation
was designed to provide finance to people of small means while the National Development
Finance Corporation was setup of finance public sector owned and managed industries and
enterprises.8

REFRENCES

1 Siddiqi H Israr Law and practice banking in Pakistan.

2 Gilbert J.W principles and practice.

3 Sir Paged John The law of Banking, page 51.

4 Sir Paged John The law of Banking, page 51.