The financial system of Bangladesh

The financial system of Bangladesh

Financial System of Bangladesh

Introduction: Financial system of Bangladesh is getting emerged with the assistance of Bangladesh Bank, powered by Bangladesh Bank Order 1972, which is now acting as regulatory body of financial institutes. Under the guardianship of Bangladesh Bank, 56 scheduled banks and 31 non-bank financial institutes are working actively in the country. For protecting the interest of general depositors, it is important to regulate the financial institutes extensively so that payment of depositors may be made on demand. We have to keep in mind one thing that contagious factor may be worked in the financial system of Bangladesh in the case of arising bank run to a particular bank. In that case, the economy of the county may be fragile. Consequently we will experience the negative growth of the economy in our country. So a severe challenge we might face if we cannot ensure a substantial financial system in the country.

Definition of Financial System: The financial system is a set of institutional arrangement through which financial surpluses in the economy are mobilized from surplus units and transferred to deficit spenders.

Different types of finance: Before going to put forth the definition of financial system, first we have to know how many modes of finance may be available in an economy. One is rudimentary finance; another is indirect finance and the other is direct finance. Rudimentary finance is the mode of finance where financial instrument is absent due to not having financial instrument to spend in a particular investment unit. Here per capita investment is low. On the other hand direct mode of finance is the mode of finance where savers are to find out those who are willing to invest. However, it is very difficult for a saver to discover an investor to invest in a business with a particular amount despite getting a businessman in a particular field. Consequently indirect mode of finance makes its room by bringing intermediary organizations between savers and investors by accumulating small depositors ‘savings in a pool.

Problem: Principal agent problem is the main problem in view of nature of some people in the country. Banks are that organization where bankers deal with money of others. Therefore it is the prime responsibility of the bankers to look after the management of moneys effectively and efficiently. Another thing is that bankers themselves are not far away from greed. So they need to be very stringent to uphold ethical value at any adverse situation. From that point of view banks and non-bank financial institutes are to be regulated for the sake of the financial system of Bangladesh.

 The financial market in Bangladesh is mainly of following types:

  1. Money Market: The primary money market is comprised of banks, FIs and primary dealers as intermediaries and savings & lending instruments, treasury bills as instruments. There are currently 15 primary dealers (12 banks and 3 FIs) in Bangladesh. The only active secondary market is overnight call money market which is participated by the scheduled banks and FIs. The money market in Bangladesh is regulated by Bangladesh Bank (BB), the Central Bank of Bangladesh.
  2. Capital market: The primary segment of capital market is operated through private and public offering of equity and bond instruments. The secondary segment of capital market is institutionalized by two (02) stock exchanges-Dhaka Stock Exchange and Chittagong Stock Exchange. The instruments in these exchanges are equity securities (shares), debentures, corporate bonds and treasury bonds. The capital market in Bangladesh is governed by Securities and Commission (SEC).
  3. Foreign Exchange Market:Towards liberalization of foreign exchange transactions, a number of measures were adopted since 1990s. Bangladeshi currency, the taka, was declared convertible on current account transactions (as on 24 March 1994), in terms of Article VIII of IMF Article of Agreement (1994). As Taka is not convertible in capital account, resident owned capital is not freely transferable abroad. Repatriation of profits or disinvestment proceeds on non-resident FDI and portfolio investment inflows are permitted freely. Direct investments of non-residents in the industrial sector and portfolio investments of non-residents through stock exchanges are repatriable abroad, as also are capital gains and profits/dividends thereon. Investment abroad of resident-owned capital is subject to prior Bangladesh Bank approval, which is allowed only sparingly. Bangladesh adopted Floating Exchange Rate regime since 31 May 2003. Under the regime, BB does not interfere in the determination of exchange rate, but operates the monetary policy prudently for minimizing extreme swings in exchange rate to avoid adverse repercussion on the domestic economy. The exchange rate is being determined in the market on the basis of market demand and supply forces of the respective currencies. In the forex market banks are free to buy and sale foreign currency in the spot and also in the forward markets. However, to avoid any unusual volatility in the exchange rate, Bangladesh Bank, the regulator of foreign exchange market remains vigilant over the developments in the foreign exchange market and intervenes by buying and selling foreign currencies whenever it deems necessary to maintain stability in the foreign exchange market.

The financial system of Bangladesh

Regulators of the Financial System

Central Bank
Bangladesh Bank acts as the Central Bank of Bangladesh which was established on December 16, 1971 through the enactment of Bangladesh Bank Order 1972- President’s Order No. 127 of 1972 (Amended in 2003). The general superintendence and direction of the affairs and business of BB have been entrusted to a 9 members’ Board of Directors which is headed by the Governor who is the Chief Executive Officer of this institution as well. BB has 40 departments and 9 branch offices. In Strategic Plan (2010-2014), the vision of BB has been stated as, “To develop continually as a forward looking central bank with competent and committed professionals of high ethical standards, conducting monetary management and financial sector supervision to maintain price stability and financial system robustness, supporting rapid broad based inclusive economic growth, employment generation and poverty eradication in Bangladesh”.
The main functions of BB are (Section 7A of BB Order, 1972) –

  1. to formulate and implement monetary policy;
  2. to formulate and implement intervention policies in the foreign exchange market;
  3. to give advice to the Government on the interaction of monetary policy with fiscal and exchange rate policy, on the impact of various policy measures on the economy and to propose legislative measures it considers necessary or appropriate to attain its objectives and perform its functions;
  4. to hold and manage the official foreign reserves of Bangladesh;
  5. to promote, regulate and ensure a secure and efficient payment system, including the issue of bank notes;

to regulate and supervise banking companies and financial institutions.

Core Policies of Central Bank

Monetary policy

The main objectives of monetary policy of Bangladesh Bank are:

  • Price stability both internal & external
  • Sustainable growth & development
  • High employment
  • Economic and efficient use of resources
  • Stability of financial & payment system

Bangladesh Bank declares the monetary policy by issuing Monetary Policy Statement (MPS) twice (January and July) in a year. The tools and instruments for implementation of monetary policy in Bangladesh are Bank Rate, Open Market Operations (OMO), Repurchase agreements (Repo) & Reverse Repo, Statutory Reserve Requirements (SLR & CRR).

The financial system of Bangladesh

Reserve Management Strategy
Bangladesh Bank maintains the foreign exchange reserve of the country in different currencies to minimize the risk emerging from widespread fluctuation in exchange rate of major currencies and very irregular movement in interest rates in the global money market. BB has established Nostro account arrangements with different Central Banks. Funds accumulated in these accounts are invested in Treasury bills, repos and other government papers in the respective currencies. It also makes investment in the form of short term deposits with different high rated and reputed commercial banks and purchase of high rated sovereign/supranational/corporate bonds. A separate department of BB performs the operational functions regarding investment which is guided by investment policy set by the BB’s Investment Committee headed by a Deputy Governor. The underlying principle of the investment policy is to ensure the optimum return on investment with minimum market risk.

The financial system of Bangladesh

Interest Rate Policy
Under the Financial sector reform program, a flexible interest policy was formulated. According to that, banks are free to charge/fix their deposit (Bank /Financial Institutes) and Lending (Bank /Financial Institutes) rates other than Export Credit.  At present, except Pre-shipment export credit and agricultural lending, there is no interest rate cap on lending for banks. Yet, banks can differentiate interest rate up to 3% considering comparative risk elements involved among borrowers in same lending category. With progressive deregulation of interest rates, banks have been advised to announce the mid-rate of the limit (if any) for different sectors and the banks may change interest 1.5% more or less than the announced mid-rate on the basis of the comparative credit risk. Banks upload their deposit and lending interest rate in their respective website.

Capital Adequacy for Banks and FIs
With a view to strengthening the capital base of banks & FIs, Basel-II Accord has been introduced in both of these sectors. For banks, full implementation of Basel-II was started in January 01, 2010 (Guidelines on Risk Based Capital Adequacy for banks). Now, scheduled banks in Bangladesh are required to maintain Tk. 4 billion or 10% of Total Risk Weighted Assets as capital, whichever is higher. For FIs, full implementation of Basel-II has been started in January 01, 2012 (Prudential Guidelines on Capital Adequacy and Market Discipline (CAMD) for Financial Institutions). Now, FIs in Bangladesh are required to maintain Tk. 1 billion or 10% of Total Risk Weighted Assets as capital, whichever is higher.

The financial system of Bangladesh

Deposit Insurance
The deposit insurance scheme (DIS) was introduced in Bangladesh in August 1984 to act as a safety net for the depositors. All the scheduled banks Bangladesh are the member of this scheme Bank Deposit Insurance Act 2000. The purpose of DIS is to help to increase market discipline, reduce moral hazard in the financial sector and provide safety nets at the minimum cost to the public in the event of bank failure. A Deposit Insurance Trust Fund (DITF) has also been created for providing limited protection (not exceeding Taka 0.01 million) to a small depositor in case of winding up of any bank. The Board of Directors of BB is the Trustee Board for the DITF. BB has adopted a system of risk based deposit insurance premium rates applicable for all scheduled banks effective from January – June 2007. According to new instruction regarding premium rates, problem banks are required to pay 0.09 percent and private banks other than the problem banks and state owned commercial banks are required to pay 0.07 percent where the percent coverage of the deposits is taka one hundred thousand per depositor per bank. With this end in view, BB has already advised the banks for bringing DIS into the notice of the public through displaying the same in their display board.

Insurance Authority
Insurance Development and Regulatory Authority (IDRA) was instituted on January 26, 2011 as the regulator of insurance industry being empowered by Insurance Development and Regulatory Act, 2010 by replacing its predecessor, Chief Controller of Insurance. This institution is operated under Ministry of Finance and a 4 member executive body headed by Chairman is responsible for its general supervision and direction of business. IDRA has been established to make the insurance industry as the premier financial service provider in the country by structuring on an efficient corporate environment, by securing embryonic aspiration of society and by penetrating deep into all segments for high economic growth. The mission of IDRA is to protect the interest of the policy holders and other stakeholders under insurance policy, supervise and regulate the insurance industry effectively, ensure orderly and systematic growth of the insurance industry and for matters connected therewith

The financial system of Bangladesh

Regulator of Capital Market Intermediaries
Securities and Exchange Commission (SEC) performs the functions to regulate the capital market intermediaries and issuance of capital and financial instruments by public limited companies. It was established on June 8, 1993 under the Securities and Exchange Commission Act, 1993. A 5 member commission headed by a Chairman has the overall responsibility to administer securities legislation and the Commission is attached to the Ministry of Finance.
The mission of SEC is to protect the interests of securities investors, to develop and maintain fair, transparent and efficient securities markets and to ensure proper issuance of securities and compliance with securities laws. The main functions of SEC are:

  • Regulating the business of the Stock Exchanges or any other securities market.
  • Registering and regulating the business of stock-brokers, sub-brokers, share transfer agents, merchant bankers and managers of   issues, trustee of trust deeds, registrar of an issue, underwriters, portfolio managers, investment advisers and other intermediaries in the securities market.
  • Registering, monitoring and regulating of collective investment scheme including all forms of mutual funds.
  • Monitoring and regulating all authorized self regulatory organizations in the securities market.
  • Prohibiting fraudulent and unfair trade practices in any securities market.
  • Promoting investors’ education and providing training for intermediaries of the securities market.
  • Prohibiting insider trading in securities.
  • Regulating the substantial acquisition of shares and take-over of companies.
  • Undertaking investigation and inspection, inquiries and audit of any issuer or dealer of securities, the Stock Exchanges and   intermediaries and any self regulatory organization in the securities market.
  • Conducting research and publishing information.

The financial system of Bangladesh

Regulator of Micro Finance Institutions
To bring Non-government Microfinance Institutions (NGO-MFIs) under a regulatory framework, the Government of Bangladesh enacted “Microcredit Regulatory Authority Act, 2006’” (Act no. 32 of 2006) which came into effect from August 27, 2006. Under this Act, the Government established Microcredit Regulatory Authority (MRA) with a view to ensuring transparency and accountability of microcredit activities of the NGO-MFIs in the country. The Authority is empowered and responsible to implement the said act and to bring the microcredit sector of the country under a full-fledged regulatory framework.
MRA’s mission is to ensure transparency and accountability of microfinance operations of NGO-MFIs as well as foster sustainable growth of this sector. In order to achieve its mission, MRA has set itself the

The financial system of Bangladesh

Gain to Lenders and Borrowers

Talking generally , why do surplus units prefers to trend to FIs rather than directly to deficit spenders? In other words, why do they prefer secondary securities to primary securities? The main advantages to ultimate lenders are summed up below:

Low Risk: Lenders are interested in minimizing all kinds of risks of capital and interest loss on loans or financial investments they make. These risks may arise in the form of risk of default or risk of capital loss on stock market asserts. Such risks on secondary securities are far less than on primary securities for individual lenders. How FIs are able to reduce such risks even though they themselves hold primary securities will be explained later. Besides, government regulation of the organization and working major FIs helps in reducing risks of their creditors. Any strengthening of financial system that goes to inspire public confidence in it reduces further any psychological risk suffered by lenders.

Greater Liability: FIs offer much greater liquidity on their secondary securities to their lenders. Demand deposit of banks is perfectly liquid. Even time deposits to be drawn upon subject to certain conditions. Primary securities do not carry any of these features, because primary borrowers need funds for agreed periods to finance their expenditures.

Convenience: Secondary securities sold by FIs are easy to buy, hold and sell. The information cost and transaction cost involved are very low.

Other Services: In addition, they transfer funds, collect cheques for their clients, offer safe deposit vaults and most important of all are the dominant lenders. These other services can be had only when particular kinds of secondary securities carrying them are bought.

The financial system of Bangladesh

Gains to Borrowers:

  • FIs have big pools of funds.
  • Much greater certainly of the availability of funds.
  • Lower interest rate than others.
  • Protect small borrowers from money launders.

The financial system of Bangladesh

Economic basis of Financial System:

The true economic basis of financial system is stated below:

  • Law of Large Number: FIs serve a large pool of borrower and depositors so that there is a gap of transactions among the clients. These creates a trap for the FIs . They get opportunities to siphon off fund from deposit units to shortage units by using the maturity mismatch.
  • Economic of Scale in Portfolio Management: FIs hold large size portfolio having different kinds of product subsequently this mechanism leads to risk diversification and higher economic return of scale. These economies accrue in the following main forms:
  • Reduction of Risk through Portfolio Diversification: The overall risk of large portfolio is diversified and which ultimately generates large returns in given level of risk.
  • Professional Management: The portfolio managers are highly skilled. There professionalism leads to higher returns which could not be achieved in other ways.
  • Indivisibilities and Market Imperfections: The average administration cost of large loans borne by FIs is quite low. Thus, FIs with large asset portfolios can earn interest even on very short term funds and construct the maturity structure of these assets as desired. Small asset holders cannot.
  • Other cost economics: Because of the large volume of business, the fixed cost of establishment, cost of information and various transactions costs are lower per unit of transactions to a FI than to an average house hold wealth owner.

The financial system of Bangladesh

The financial system of Bangladesh is comprised of three broad fragmented sectors:

Formal Sector,
Semi-Formal Sector,
Informal Sector.

The sectors have been categorized in accordance with their degree of regulation.
The formal sector includes all regulated institutions like Banks, Non-Bank Financial Institutions (FIs), Insurance Companies, Capital Market Intermediaries like Brokerage Houses, Merchant Banks etc.; Micro Finance Institutions (MFIs).

The semi formal sector includes those institutions which are regulated otherwise but do not fall under the jurisdiction of Central Bank, Insurance Authority, Securities and Exchange Commission or any other enacted financial regulator. This sector is mainly represented by Specialized Financial Institutions like House Building Finance Corporation (HBFC), Palli Karma Sahayak Foundation (PKSF), Samabay Bank, Grameen Bank etc., Non Governmental Organizations (NGOs and discrete government programs.

Financial Systems of Bangladesh

Source: https://www.bb.org.bd/fnansys/

The financial system of Bangladesh
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