MONEY AND BANKING IN

Sixth Edition

S.A. Meenai

Revised and Expanded by Javed A. Ansari

OXPOttD UNIVERSITY PRESS Contents

List of Figures ix List of Tables x How to Use this Book • xi Preface (To the First Edition) . xiii Preface (To the Sixth Edition) xiv Abbreviations xv

PART ONE: MONETARY THEORY AND POLICY

1 Money: Its Nature and Functions 2 1.1 Defining and Measuring Money 2 1.2 The State 's Definition of Money 3

2 Monetary Theory: The Classical Model 5 2.1 Assumptions 5 2.2 Quantity Theory of Money 5 2.3 Money and the Real Economy 7 2.4 Interest Rate Determination in the Classical Model . 9

3 The Marxist Theory of Money and Finance 11 3.1 The Value Form 11 3.2 The Functions of Money 12 3.3 The Marxist Theory of Interest 13 3.4 Money and Crisis 14

4 Monetary Theory: The Keynesian Orthodox Model 15 4.1 Keynes and Classical 'Macroeconomics' . 15 4.2 Keynes' Money Demand Function 16 4.3 The IS-LM World 18 4.4 The Orthodox Keynesian Macroeconomic Policy 24 4.5 Full Employment of Capital and Need for a Zero Interest Rate 27

5 Modern Neo Classical Monetary Theory 29 5.1 Monetarism 29 5.2 New Classical Economics and Real Business Cycle Theory . 31 5.3 New Keynesianism ' 34 5.4 Representative Agent Macroeconomics 37 VI CONTENTS

6 Post Keynesian and Stock Flow Consistency Approaches to Monetary Policy 41 6.1 Post Keynesianism 41 6.2 Stock-flow Consistency Approaches 43

7 Managing Money 48 7.1 Making Money in Capitalist Financial Systems 48 7.2 Money Multiplier and Credit Multiplier 49 7.3 Who Rules? The or Commercial ? 51

8 The Theory of Monetary Policy 54 8.1 Monetary Policy Objectives - 54 8.2 Intermediate Targets 55 8.3 Instruments of Monetary Policy 58 8.4 Limitations of Monetary Policy 63 8.5 The Theory of Monetary Policy in the Twenty First Century 64 8.6 Fallacies in the 's Theory of Monetary Policy 70

9 The Theory of Inflation 72 9.1 The Value of Money 72 9.2 . The Costs of Inflation ' 72 9.3 Business Cycle Theory—Inflation, Recession and Depression 73 9.4 The Neo Marxist Theory of Stagflation and Financialization 78 9.5 The State Bank's Policy Stance on Inflation 82

10 Money and International Finance 87 10.1 Foreign Exchange Market 87 10.2 Foreign Exchange Regimes 88 10.3 International Adjustment 89 10.4 Understanding Financial Globalization - The Post Bretton Woods Order 91 10.5 IMF in the International Financial System 93

PART TWO: MONEY AND BANKING IN PAKISTAN

11 Historical Background 98

12 Pakistan's Financial Development 1949-2002 114 12.1 Theory of Financial Development 114 12.2 Financial Sector Development in Pakistan . 116 12.3 An Overdeveloped Financial Sector? 119 12.4 Conclusion 122

13 State Bank of Pakistan 123 13.1 Operational Mandates ~ 123 13.2 Structure and Operations 125 13.3 Relationship with the Government 131 CONTENTS VU

13.4 Implications of State Bank Autonomy for Pakistan 133 .13.5 Evaluating Performance 138

14 Commercial Banks 141 14.1 Historical Background 141 14.2 Structure of Balance Sheet of Commercial Banks 142 14.3 Performance of Commercial Banks . 147 14.4 Bank Legislation 152 14.5 Implications of Adherence to the Basel II Framework 158 14.6 Sector Strategy 161

15 Development Finance Institutions 164 15.1 Origins and Theory 164 15.2 Evaluating DF1 Performance 166 15.3 DFIs in Pakistan 168 15.4 Assessing Financial Performance 172 15.5 Assessing Developmental Impact 176 15.6 The New DFIs 179

16 Financial Markets in Pakistan 181 16.1 Money Market 181 16.2 Market for Foreign Exchange 184 16.3 Equity Market 187 16.4 Bond Market 196 16.5 Non-Bank Financial Intermediaries 198 16.6 Overall Performance of NBFCs . 212 16.7 Informal Financial Markets 212 16.8 Conclusion 215

17 External Balances 217 17.1 The Overall External Balance * 217 17.2 The Current Account Balance 218 17.3 Capital and Financial Accounts • 220 17.4 External Debt , 222 17.5 Exchange Rate Management 224

18 Co-operative Banking 229 18.1 History and Background 229 18.2 Structure of Assets and Liabilities - 229 18.3 The Future . 232

19 The Insurance Industry 234 Vlll CONTENTS

20 Islamic Banking 238 20.1 The Rationale for the Prohibition of Interest 238 20.2 The Islamic Banking Movement in Pakistan 238 20.3 The 2008 Deobandi Fatwa on-Islamic Banking 241 20.4 The Performance of Islamic Banks 242 20.5 Islamic Banking Regulatory Framework 245 Appendix: A Review of Taqi Usmani's classical text on Islamic finance 246

21 The Payment and Settlement System in Pakistan 249 21.1 ATM Network and E-Banking 250

22 Monetary Policy in Pakistan 1947-2009 253 22.1 Monetary Policy: A Period Analysis 253 22.1.1 1947-1958 253 22.1.2 1959-1972 254 22.1.3 1972-1977 255 22.1.4 1978-1988 257 22.1.5 1988-1999 " 258 22.1.6 2000-2009 260 22.2 Failure of Market-based Monetary Policy 261 22.3 Explaining Monetary Policy Failure 265 22.4 An Alternative to Market-based Monetary Policy 282 Appendix: Financialization and the Global 288 Crisis of 2008-2010: Implications for Pakistan

Index 294