AIOU 1414 Fundamentals of Money and Banking Solved Assignment 2 Spring 2025
AIOU 1414 Assignment 2
Q1. What is a bank? Explain the functions of commercial banks in detail.(20 Marks)
A bank is a financial institution that provides a range of services, including accepting deposits, granting loans, facilitating payments, and managing investments. Banks play a crucial role in the economy by ensuring the smooth functioning of financial transactions and providing credit to businesses and individuals.
Functions of Commercial Banks:
Commercial banks are the backbone of the banking system, focusing on profit-making activities while serving the public. Their primary functions include:
1. Accepting Deposits
Commercial banks collect funds from individuals and businesses in the form of various types of deposits, such as savings accounts, fixed deposits, and current accounts.
These deposits help customers store money securely while earning interest on savings.
2. Providing Loans and Advances
One of the key functions of commercial banks is lending money to individuals, businesses, and organizations.
They offer loans such as personal loans, business loans, mortgages, and overdrafts.
Banks charge interest on these loans, which is their primary source of revenue.
3. Credit Creation
When banks lend money, they contribute to economic growth by expanding the purchasing power of borrowers.
By creating credit, commercial banks help businesses invest in projects and consumers make large purchases.
4. Facilitating Payments and Transactions
Banks provide various payment methods, including online transfers, credit/debit cards, checks, and electronic payments.
They ensure smooth and secure financial transactions, both domestically and internationally.
5. Foreign Exchange Transactions
Many commercial banks engage in currency exchange services, helping individuals and businesses deal with foreign currencies.
They facilitate international trade by providing foreign exchange services and managing risks associated with currency fluctuations.
6. Investment Services
Commercial banks offer investment opportunities such as mutual funds, bonds, and stock market investments.
They guide customers in making financial decisions to maximize returns.
7. Risk Management and Advisory Services
Banks help businesses and individuals manage financial risks through insurance products, hedging strategies, and financial advisory services.
They provide expert advice on financial planning, investment portfolios, and economic trends.
8. Safeguarding Valuables
Many commercial banks provide safe deposit lockers for customers to store important documents, jewelry, and other valuables securely.
In summary, commercial banks play a vital role in the economy by providing essential financial services. Their ability to accept deposits, grant loans, facilitate transactions, and support businesses makes them indispensable in maintaining economic stability and growth.
Q2. What are the different types of bank accounts offered by commercial banks to their clients?(20 Marks)
1. Savings Account: Ideal for individuals who want to save money while earning interest. It usually has a limit on withdrawals per month.
2. Current Account: Designed for businesses and professionals who need frequent transactions. It typically offers no interest but allows unlimited withdrawals.
3. Fixed Deposit Account (FD): A savings option where money is deposited for a fixed period at a higher interest rate.
4. Recurring Deposit Account (RD): Allows individuals to save regularly by depositing a fixed amount each month for a specified tenure.
5. Joint Account: Shared by two or more individuals, often used by families or business partners.
6. Salary Account: Provided by banks to employees where their monthly salary is deposited.
7. Foreign Currency Account: Used for holding money in foreign currencies, useful for businesses dealing internationally.
8. Student Account: A specialized account tailored for students with lower fees and specific benefits.
9. Pension Account: Designed for pensioners to receive their retirement benefits.
Q3. Explain in detail the concept of the five Cs of credit and the process of obtaining the bank loan.(20 Marks)
The Five Cs of Credit are fundamental principles that lenders use to evaluate a borrower’s creditworthiness when applying for a loan. Each “C” represents a key factor in the decision-making process:
1. Character: This refers to the borrower’s credit history and overall financial responsibility. Lenders assess factors like credit scores, past loan repayments, and financial reputation to determine if the borrower is reliable.
2. Capacity: Capacity measures a borrower’s ability to repay a loan based on income, current financial obligations, and employment history. Lenders analyze debt-to-income (DTI) ratio to ensure that the borrower has sufficient income to meet loan payments.
3. Capital: This represents the borrower’s personal investment in the venture or purpose for which the loan is being sought. Having significant personal assets or savings shows commitment and financial responsibility, reducing the lender’s risk.
4. Collateral: Collateral is any asset or valuable property that the borrower offers as security for the loan. If the borrower fails to repay, the lender can seize the collateral to recover the loan amount. Common collateral includes real estate, vehicles, and investments.
5. Conditions: This refers to external factors that may impact the borrower’s ability to repay, such as economic conditions, industry trends, or loan terms (interest rates, repayment period). Lenders also consider the purpose of the loan and whether it aligns with their lending policies.
Process of Obtaining a Bank Loan:
To obtain a loan from a bank, borrowers typically follow these steps:
1. Determine Loan Type and Amount: Before applying, the borrower should identify the type of loan (personal, business, mortgage, etc.) and how much funding is needed.
2. Check Eligibility Requirements: Banks set specific criteria for loans, including credit score, income level, and employment status. Borrowers should ensure they meet these requirements.
3. Prepare Documentation: Required documents may include:
- Proof of identity (passport, national ID, etc.)
- Proof of income (salary slips, tax returns, bank statements)
- Credit history report
- Business plans (for business loans)
- Collateral details (if applicable)
4. Submit Loan Application: The borrower completes and submits the application form along with necessary documentation to the bank.
5. Bank’s Review and Evaluation: The bank assesses the application using the Five Cs of Credit, checking financial stability, collateral value, and repayment ability.
6. Approval or Rejection: If the application meets the bank’s criteria, the loan is approved, and terms (interest rate, tenure, repayment schedule) are discussed. If rejected, the bank may provide reasons, such as insufficient income or poor credit history.
7. Loan Agreement and Disbursement: Once approved, the borrower signs an agreement specifying the loan terms. The funds are then transferred to the borrower’s account or directly used for the intended purpose.
8. Repayment and Monitoring: The borrower must make regular payments according to the agreed schedule. Defaulting on payments can lead to penalties or seizure of collateral.
Banks use these steps to ensure responsible lending, and borrowers should carefully evaluate their financial situation before taking a loan.
Q4. Briefly discuss the role and functions of the State Bank of Pakistan.(20 Marks)
The State Bank of Pakistan (SBP) serves as the country's central bank, responsible for regulating monetary policy, maintaining financial stability, and overseeing the banking sector. Its key functions include:
1. Monetary Policy Implementation: Controlling inflation and ensuring economic stability through interest rate adjustments and liquidity management. 2. Regulation of Banks: Supervising financial institutions to ensure a stable and secure banking system. 3. Currency Issuance: Managing the printing and circulation of the Pakistani rupee. 4. Foreign Exchange & Reserves Management: Overseeing exchange rates, foreign reserves, and international trade transactions. 5. Economic Development: Supporting financial inclusion, SME financing, and economic growth initiatives.
The SBP plays a crucial role in shaping Pakistan's economic landscape by ensuring stability and promoting sustainable growth.
Q5. Write a note on the following:(20 Marks)
i. Islamic banking
Islamic banking is a financial system based on Islamic law (Sharia), ensuring ethical and interest-free transactions. It prohibits riba (interest) and promotes risk-sharing, transparency, and fairness. Instead of interest, banks use Mudarabah (profit-sharing) and Musharakah (joint ventures), where profits and losses are shared. Financing methods like Murabaha (cost-plus sales) and Ijarah (leasing) ensure transactions remain asset-backed. Islamic banking also focuses on ethical investments, avoiding industries like alcohol, gambling, and speculation. With global growth, it offers sustainable financial solutions, attracting those who seek responsible and equitable banking aligned with Islamic principles.
ii. Mobile banking
Mobile banking is a digital banking service that allows users to perform financial transactions using their smartphones or tablets. It enables convenient access to banking services such as fund transfers, bill payments, account management, and loan applications without visiting a physical branch. Most banks offer mobile banking through apps or websites, ensuring secure and user-friendly experiences. Features often include balance inquiries, transaction history, and instant notifications for account activity. Some services even integrate biometric authentication for added security. With the rise of digital finance, mobile banking continues to evolve, making financial management more accessible, efficient, and secure for users worldwide.
iii. Internet banking
Internet banking, also known as online banking, is a digital service that allows users to conduct financial transactions through a bank's website. It enables customers to access their accounts, transfer funds, pay bills, and manage finances remotely without visiting a physical branch. Most banks provide secure online platforms with features such as balance inquiries, transaction history, and automated payments. Internet banking enhances convenience by offering 24/7 access and reducing the need for paper-based transactions. With advancements in cybersecurity and digital services, internet banking continues to improve, making financial management more efficient and accessible worldwide.
iv. ZTBL
Zarai Taraqiati Bank Limited (ZTBL) is a leading financial institution in Pakistan that specializes in agricultural banking. It was formerly known as the Agricultural Development Bank of Pakistan (ADBP) and was restructured to better serve the country’s farming community. ZTBL provides financial assistance to farmers, enabling them to invest in modern agricultural techniques, equipment, and infrastructure. The bank offers various loan schemes to support crop production, livestock farming, irrigation systems, and rural development. As a key player in Pakistan’s agricultural sector, ZTBL plays a vital role in enhancing food security and improving the livelihoods of farmers through accessible and affordable financial services.
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