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Role of Central Banks inEconomic DevelopmentBy

Muhammad Munir Ahmed

PresidentInstitute of Banking and Business

Learning(IBBL)Ex- Chief Manager, SBP Lahore

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Commercial Banks-Brief History

Commercial Banks came first- about 200years there was no central banks andcommercial banks faced the following three

major self contradicting problems as under :1. Liquidity

2. Solvency

3. ProfitabilityWorking of banks was vulnerable to crisis as

every banks was competing with each other.

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Evolution of Central Banking

Issuance of note was another problem because every bankissued its own notes which used to depreciate in case of someproblems with the banks concerned.

Since every commercial bank was working with the primeobjective of Maximizing of Profit there was no institutional help

which used to lead to used to crisis and bank failures. Thiswarranted for establishing a non-profit earning bankinginstitution so as to discipline the activities of self competingcommercial banks.

Thus in every banking system there is centeral bank responsible

for ensuring a sound banking system consistent with thenational objective and priorities. Central banks were given the Monopoly of Note issuance and the

Role of Lender of the last Resort for banks in trouble- thetraditional functions of every central bank around the globe.

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What Central Banks Can Do?

There is controversy among Economistsabout the role central banks could playeffectively

Increase in output Enhancement in Employment Maintenance of Price Stability

Above three manifestations of EconomicDevelopment are self competing- It is arguedthat central banks are better suited for

ensuring Price Stability in the economy

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Functions of Central Banks

Functions of central banks differ in developedand developing countries depending upon thelevel of economic development.

In market-based highly developed economies,central banks are responsible only forensuringPrice Stability. They are tomaintain the price increase(Inflation) in agiven range, and accountable in case ofnon achievement.They work in a market-based environment,no interference from Government, No DebtManagement for the Government.

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Central Banks in DevelopingCountries

Provide a variety of functions as under:

Ensuring Price Stability

Balanced Growth in the EconomyFuller utilization of Economic resources

Working as Debt Manager of the

Government Central Bank of Pakistan(SBP) falls under

this category.

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Misutilisation of SBP Schemes

These schemes became vehicle for Misutilisation ofcredit by influential persons in agriculture andindustry in the Mid- Eighties and were discontinuedin Nineties.

In Nineties, all banks went into Red-Loss Incurringand SBP started Financial Sector Reforms withactive collaboration of IMF and World Bank- apopular discussion point for common day discussion.SBP also became autonomous.

SBP started a merit-based/ market- based bankingsystem in the 21st century which is now one decadeold.

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Achievements of SBP

During the last 63 years SBP emerged as a credibleinstitution in the country.

It succeeded in getting more Autonomy as comparedwith its counterparts in South Asia

It established a merit-based banking system in thecountry equipped with lattest levels of InformationTechnology and Capable HR .

It could be counted among a few successful

oragnisations in the country. It managed to divert flow of credit towards SMEs

and Agricultural to a greater extent.

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Performance of SBP

There are general reservations in the societyabout performance of SBP as under:

IT could not maintain inflation in the country.

The cost of banking service increased largelyas shown by bumper profits of banks.Credit needs of SMEs and Agri/Micro Credit

could not be met in the desired manner.

It could not ensure a reasonable/fair rate ofreturn to Depositors- the life and blood of abanking system

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Challenges for SBP

Monetary Policy vs other economic policies-any slippage on account of Fiscal Policy is tobe borne by Monetary Policy.

Government is the biggest borrower-Amajor problem for autonomous SBP.

Presence of an Elite Culture in the country.

Lack of Market orientation of the economy.