Term Paper of Retail Banking

1. Central Banking
Session 1

2. Definitions
1. A central bank being generally recognized as a bank which constitutes the
apex of the monetary and banking structure of its country and which
performs as best as it can, in the national economic interest. – M. H. Dekock
2. The central bank is the organ of government that undertakes the major
financial operations of the government and by its conduct of these operations
and by other means influences the behavior of financial institutions so as to
support the economic policy of the government. - Prof. R.S. Sayers
3. Every Central Bank has one function. It operates to control economy, supply
of money and credit. – Samuelson
4. Central Bank may be defined as an institution which is charged with the
responsibility of managing the expansion and contraction of the volume of
money in the interest of general public welfare. - Kent

3. Origin and Evolution of Central Banking
• The first central bank of the world was ‘The Ricks Bank of
Sweden’ established in 1656 long after the emergence of
commercial banking.
• Upto 1920 even there were many countries having no central
bank.
• The 1920 summit of Brazil decided to establish central bank in
each of the country the world. The first central bank of the
Indian subcontinent was found in 1935 with the Reserve Bank
of India.

4. Some Important Central Banks of the World
Central Bank Year Nature
The Ricks Bank of
Sweden
1656 First established as private.
Got national status in 1668
Bank of England 1694 First organized central bank of
the world

5. Some Important Central Banks of the World (contd.)
Central Bank Year Nature
Bank of France 1800 Established as private in
collaboration with the Govt.
Nationalized in 1945
Bank of Netherland 1814 Established as private with
strong control from the Govt.

6. Some Important Central Banks of the World (contd.)
Central Bank Year Nature
Bank of Norway 1817 Established as private
with strong control from
the Govt.
National Bank of
Denmark
1818 Established as private
with strong control from
the Govt. First name was
Bank of Kopen-hegen

7. Some Important Central Banks of the World (contd.)
Central Bank Year Nature
Bank of Spain 1856 Established as private
with strong control from
the Govt.
National Russia(Current
name ‘The Goss bank’)
1860 Established as private
in collaboration with the
Govt. Nationalized in
1917.

8. Some Important Central Banks of the World (contd.)
Central Bank Year Nature
Doice Bundace
Bank (Zermany)
1875 Previous name was ‘Riks Bank
of Zermany’ Established as
private with strong control from
the Govt.
Bank of Japan 1882 Established as private in
collaboration with full
Government control from the
very beginning.

9. Some Important Central Banks of the World (contd.)
Central Bank Year Nature
Bank of Italy 1893 Established as private.
Got sole right to issue
note in 1926
Swiss National
Bank
1907 Established as joint
venture of private and
public ownership

10. Some Important Central Banks of the World (contd.)
Central Bank Year Nature
The Federal
Reserve System
1913 Combination of 12
regional Federal
Reserve Bank
Bank of China 1928 Established as private.
Nationalized in 1949

11. Some Important Central Banks of the World (contd.)
Central Bank Year Nature
Marfej Bankasi
(Turkey)
1931 Established as
public.Previous name
was ‘Central Bank of
the Republic of Turkey.
Bank of Canada 1934 Established as private.
Nationalized in 1938.

12. Some Important Central Banks of the World (contd.)
Central Bank Year Nature
Reserve Bank of India 1935 Established as colonial bank.
Nationalized in 1938.
State Bank of
Pakistan
1948 Established as joint venture
of private and public
ownership

13. Some Important Central Banks of the World (contd.)
Central Bank Year Nature
Central Bank of Egypt 1961 Previous name was
‘National bank of Egypt’
Established as private.
Nationalized later on
Bank Markaji (Iran) 1961 Established as private.
Nationalized in 1979.

14. Some Important Central Banks of the World (contd.)
Central Bank Year Nature
The Benkoda
Brazil
1965 Established as joint
venture of private and
public ownership
Bangladesh Bank 1971 Established as public
bank from the
beginning.

15. Features of Central Bank
1. Single Organization
2. Legal Entity
3. Nature of Ownership
4. Difference in Objectives
5. Note issuing bank
6. Guardian of Money Market
7. Relation with the Govt.
8. Banker and Controller of other banks
9. Lender of the Last resort
10. Controller of Foreign Exchange

16. Objectives of Central Bank
1. Maintenance of price stability
2. Credit control
3. Acting as the banker to the Govt.
4. Capital formation and development
5. Note issue
6. Control of the banking system
7. Control of foreign exchange
8. Performing the duty of clearing house
9. Maintaining relations with foreign central banks
10. Ensuring public welfare and national interest.

17. Functions of Central Bank
A. General Function
B. Functions as a banker to the Govt.
C. Functions as banker of banks
D. Development Functions
E. Other Functions

18. General Functions of Central Bank
1. Note Issue
2. Maintenance of the value of currency
3. Control of money market
4. Control of Credit
5. Control of Foreign Exchange

19. Functions as the Banker to the Govt.
1. Maintenance of Govt. Fund
2. Receipt and transfer of Govt. money
3. Handling of Govt. monetary transaction
4. Issue and supervision of Govt. loan
5. Maintaining relationship with foreign banks (on behalf of Govt.)
6. Acting as advisor and agent of the Govt.
7. Coordination with Govt.’s fiscal policy

20. Functions as the Banker of Banks
1. Scheduling of banks
2. Acting as the clearing house
3. Sanctioning of loan to Commercial Banks (CB)
4. Supervising loan activities of CBs
5. Assisting CBs in to recover loans
6. Auditing the accounts of the CBs
7. Collecting a percentage of total deposit of CBs as reserve
8. Acting as advisor and agent

21. Development Functions of Central Bank
1. Development of money market and banking system
2. Development of financial sector
3. Development of foreign trade
4. Development of productive sector

22. Other Functions of Central Bank
1. Economic research
2. Collection and supply of data
3. Review and analysis of economic trend
4. Preparation and publication of report

23. Main functions of Bangladesh Bank (BB)
As par Article 7A of BB Order 1972 and Bangladesh Bank (Amendment) Act, 2003 six
main functions of BB are:
(a) to formulate and implement monetary policy;
(b) to formulate and implement intervention policies in the foreign exchange market;
(c) 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;
(d) to hold and manage the official foreign reserves of Bangladesh;
(e) to promote, regulate and ensure a secure and efficient payment system, including
the issue of bank notes;
(f) to regulate and supervise banking companies and financial institutions.

24. Other function of BB-Chapter 3 (Article 16-23)
• accepting of money on deposit from and the
collection of money for the Govt. and banks
• purchase, sale and rediscount of bills of
exchange, promissory notes, Govt. guaranteed
debentures
• guarantee funds of scheduled bank in agri.
credit
• Keeping of balances with banks in countries
whose currency is approved
• making of loans and advances out of specific
fund
• issuance and purchase of TT DD payable at its
own branches
• making to the Govt. of advances
• purchase and sale of securities of the Govt.
• custody of monies, securities and
other articles of value
• acting as agent to the Govt.
• purchase and sale of gold/ silver/
approved foreign exchange
• making and issue of bank notes
• establish credits and give guarantees
• declaring currency of other country
to be approved foreign exchange
• declaration of bank rate
• functions of the Bank under the
International Financial Organizations
Order
Almost all the functions and business of BB has been ordered in Chapter III of BB Order:

25. Regulatory & Supervisory Functions of BB
Regulatory functions
• BB as the central bank has legal authority to regulate the money market
• BB issues license for banking and non-banking financial businesses
• BB frames regulations for the Banking Companies and Non-bank Financial
Institutions for smooth operation of the Money Market
Supervisory Functions
• BB as the central bank also has legal authority to supervise:
-The Banking Companies &
-Non-bank Financial Institutions
• For ensuring compliance of the regulations and to ensure that banks so not work
recklessly and fraudulently, BB supervise the Banking Companies & Non-bank
Financial Institutions through:
-Offsite supervision mechanism and
-On-site inspection

26. 5 Core Regulatory Policies of Central Bank
A. 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 each 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).

27. 5 Core Regulatory Policies of Central Bank (contd.)
B. Reserve Management Strategy
• BB 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.
• In November 2018, the amount of international reserve remains US $ 31,056 Million
• Assignment:
• https://www.dhakatribune.com/business/2018/09/20/forex-reserves-up-441-in-the-last-10-years
• 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 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.

28. 5 Core Regulatory Policies of Central Bank (contd.)
C. Interest Rate Policy
• Under the Financial sector reform program, a flexible interest policy was
formulated that:
• banks are free to charge/fix their deposit and Lending rates other than Export Credit.
• 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.

29. 5 Core Regulatory Policies of Central Bank (contd.)
D. Capital Adequacy for Banks
• Basel-III has been introduced with a view to strengthening the capital base of banks
with the goal of promoting a more resilient banking sector.
• The Basel III regulation will be adopted in a phased manner starting from the January
2015, with full implementation of capital ratios from the beginning of 2019.
• Now, scheduled banks in Bangladesh are required to maintain minimum capital of Taka
4 billion or Capital to Risk Weighted Assets Ratio (CRAR) 10%, whichever is higher.
• In addition to minimum CRAR, Capital Conservation Buffer (CCB) of 2.5% of the total
RWA is being introduced which will be maintained in the form of Common Equity Tier-
1 (CET1).
• Besides the minimum requirement all banks have a process for assessing overall
capital adequacy in relation to their risk profile and a strategy for maintaining capital
at an adequate level.

30. 5 Core Regulatory Policies of Central Bank (contd.)
E. 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 under 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.

31. Importance of Central Bank
1. Management of Currency
2. Development of the banking
system
3. Implementation of development
plan
4. Control of the reserve of foreign
currency
5. Maintenance of money value
6. Maintaining the stability of price
level
7. Proper Administration of credit
system
8. Development and promotion of
internal and international trade
9. Assistance to and management of
scheduled banks
10. Agency in favor of Government
11. Development of money market
12. Creation of employment
opportunity
13. Ensuring balanced development of
the economy

32. Differences Between Central Bank and Commercial Bank
Point of Diff. Central Bank Commercial Bank
Definition A bank that are engaged
in control of money and
credit of a country
A bank which deals with
money or money’s worth
with a view to earn profit
Formation Established under the
ordinance issued by the
President.
Established under the
banking act of the
country.

33. Differences Between Central Bank and Commercial Bank (contd.)
Point of Diff. Central Bank Commercial Bank
Ownership Generally owned by the
Govt. or a joint venture of
Govt. & Private
Private, public or joint
ownership. Mostly private
ownership.
Objective Control of banks and
money market
Main objective is to earn
profit

34. Point of Diff. Central Bank Commercial Bank
Relation with
money market
Guardian and controller
of money market
Most active and
dominant member of
money market
Issue of note Sole authority for issuing
note
No authority for issuing
note
Credit control Controls credit extended
by com. banks
Cooperate with the
central bank to Control
credit.
Differences Between Central Bank and Commercial Bank (contd.)

35. Point of Diff. Central Bank Commercial Bank
Control Basically
autonomous
Controlled by the Central bank
Govt. influence Direct influence of
the govt.
No direct influence of the Govt.
in case of private Com. bank
Agency Represents the govt. Agent of the client
Differences Between Central Bank and Commercial Bank (contd.)

36. Point of Diff. Central Bank Commercial Bank
Accepting
Deposits
Accepts Deposits from
the govt. and com. banks
Accepts Deposits from
individuals and institutions
Extending credit Extends credits to the
govt. and com. banks
Extends credits to
individuals and institutions
Status Higher than and above
com. bank
Lower than the central
bank
Differences Between Central Bank and Commercial Bank (contd.)

37. Point of Diff. Central Bank Commercial Bank
Clearing house Provide clearing house
facility to scheduled
banks
Accept clearing house
facility from the central
bank
Submission of
accounts
Submits accounts to
Government
Submits accounts to
central bank.
Maintaining
Reserve
No requirement for
mandatory reserve
Requires mandatory
reserve with central bank
Differences Between Central Bank and Commercial Bank (contd.)

38. Independence of Central Bank
1. Ahsan, A., Skully, M.T. & Wickramanayake, J. (2009), ‘A critical analysis of
Central Bank independence and governance in Australia and Bangladesh’,
Journal of Administration and Governance, vol. 6, Available at SSRN:
http://ssrn.com/abstract=1402634
This paper examined the CBIG positions of two central banks, the
Bangladesh Bank (BB) and the Reserve Bank of Australia (RBA), by
applying Ahsan, Skully & Wickramanayake (2008) CBIG index-model
over 1991 to 2008 .
2. Nawaz, M. A. & Chowdhury, A. U. M. (2014) ‘Bangladesh Bank Independence
and Governance: Lessons from Reserve Bank of Australia’, Journal of Business
Studies, vol. 35, no. 3, pp 209-238, Available at SSRN: https://www.fbs-
du.com/news_event/146648817310.pdf
This paper updated the previous research

39. Independence of Central Bank
• A central bank’s independence means the freedom to pursue its monetary
policies without political or other external influences.
• Some authors explained this in the context of legal, political or other types of
independence, but it was hard to find a comprehensive definition reflecting all
these aspects.
• CBIG (Ahsan, Skully & Wickramanayake 2006, p.60) means that a bank:
• has the legal power to protect itself from external influence,
• has the freedom to set its monetary policy and can implement its objectives without any
political interference,
• can select the appropriate instruments to control the price, inflation, exchange rate
stability, and
• limited accountability to the parliament of the country to keep its activities transparent.

40. The key aspects of Independence
• 6 Key aspects of Central Bank Independence and Governance (CBIG)
as used in the paper:
• Legal,
• political,
• price stability objective,
• foreign exchange rate policy,
• monetary policy and deficit financing,
• accountability and transparency.

41. CBIG (legal)
• CBIG (legal) aspect measures the independence a central
bank is granted in its acts.
• The laws passed by the parliament to make governor of the central
bank independent; CBIG (legal) may improve when governor’s
turnover rate is low
• Another important legal issue is separation of legal obligation of
the central bank to regulate commercial banks; CBIG (legal) may
improve when the supervision of financial institutions is placed
outside the central bank.

42. CBIG (political)
• CBIG (political) measures the government’s political
influence on a central bank.
• Political independence lessens when
• a government has higher number of representatives in the central
bank board; or
• the governor holds a position in the government; or
• the governor is replaced whenever a new government is elected.
• Political instability adversely affects central bank’s activities

43. CBIG (price stability objectives)
• CBIG (price stability objectives) guides a central bank to
maintain price stability as its main monetary policy objective.
• An independent inflation target and timely interest rate
revisions would contribute the central bank achieving its
price stability target.
• Strong relationship has been found between CBIG and
inflation in developed countries, but no association has been
found in some countries as well.

44. CBIG (exchange rate policy)
• CBIG (exchange rate policy) addresses the role of a central bank
under a fixed and a floating rate system.
• The currency market intervention and regulation formulation should
be done by the central bank.
• An independent central bank can better maintain a stable exchange
rate system.
• The evidence suggests that a flexible exchange rate regime, coupled
with an independent monetary authority and inflation targeting, may
perform better than a harder regime.

45. CBIG (monetary policy and deficit financing)
• CBIG (monetary policy and deficit financing) identifies the
central bank’s role in formulating monetary policy, choosing
its final goal and managing government budget financing.
• The ability of the central bank to make all these monetary
policy decisions increases its CBIG.
• Depending on the financial market development, a
government’s deficit budget may have negative impact on
economy as well as on CBIG.

46. CBIG (accountability and transparency)
• CBIG (accountability and transparency) examines the disclosure
requirements of a central bank.
• Regular communication with the public on policy changes, monetary
policy statements, accountability of the governor and auditing of
bank’s activities are essential elements.
• There is disagreement about the type of the autonomy to be
delegated; and the essentiality of accountability and transparency.
• But in general, they are considered important for effective
governance, recommended to be specified in the central bank’s own
legislation.

47. Central Bank’s Independence Index Model
CBIGOverall = w1CBIGLeg + w2CBIGPol + w3CBIGPStab + w4CBIGForx
+w5CBIGMonPol + w6CBIGAccTrans
Where,
CBIGLeg = Legal Index of CBIG
CBIGPol = Political Index of CBIG
CBIGPStab = Price Stability Objectives Index of CBIG
CBIGForx = Exchange Rate Policy Index of CBIG
CBIGMonPol = Monetary Policy and Deficit Financing Index of CBIG
CBIGAccTrans = Accountability and Transparency Index of CBIG
Weight= w1= 5/26; w 2=3/26; w3=3/26; w4=3/26; w5=6/26; w6= 6/26.
The variables are equally weighted

48. Bangladesh Bank and its Independence
• The Bangladesh Bank (BB) is the central bank of Bangladesh. It was established by
the Bangladesh Bank Order (1972) following the country’s independence in 1971.
• It initially functioned like a government department but this changed gradually
over time.
• The first significant move came in 1989 when the Government of Bangladesh
(GOB) adopted a comprehensive Financial Sector Reform Program (FSRP).
• This was a transformation in 1990 from direct quantitative monetary controls to
an indirect method of monetary management.
• More recently the Bangladesh Bank (Amendment) Act, 2003 reduced the
governor’s term of office from five to four years as well as improved CBIG in other
areas,
• For example, it specified that four directors (who are not government officials)
be appointed to the central bank’s management board, placed an emphasis of
its role in domestic price stability, introduced a floating exchange rate, and
formed a coordination council to align the central bank’s policies with those of
the government.

49. BB’s Independence (contd.)
• Another major impact of the 2003 amendments was to introduce a specific set
of objectives for the central bank; something which was absent in the 1972
legislation.
• These objectives include:
• to regulate the issue of the currency and the keeping of reserves;
• to manage the monetary and credit system of Bangladesh with a view to
stabilizing domestic monetary value;
• to preserve the par value of the Bangladesh Taka;
• to promote and maintain a high level of production, employment and real
income in Bangladesh; and
• to foster growth and development of the country’s productive resources for
the national interest.
• These at least suggest that the central bank should seek local price and foreign
exchange rate stability.

50. BB’s Independence (contd.)
• Bangladesh Bank’s CBIG level further improved in 2003 after implementing the
Central Bank Strengthening Project (CBSP).
• As an initiative of the CBSP, a Policy Analysis Unit (PAU) was established in July
2005 to upgrade the Bangladesh Bank’s capacity for research and policy
analysis.
• Since January 2006, the central bank now provides half yearly monetary policy
statements as well as its own research papers to enhance its transparency.
• These publications highlight price stability as the main objective of the
central bank’s monetary policy as well as explain its monetary policy strategy
and implementation tools.

51. Conclusion
• The results indicated that while BB consistently scored poorer than RBA, its
improvements are nevertheless noteworthy.
• Australia’s experience offers some ideas for further improvement for BB. In particular,
BB’s CBIG could be greatly enhanced by
• extending the governor’s term of office;
• shifting the power to appoint and dismiss its governor from the government to the
parliament;
• assigning its prudential supervision of commercial banks to a separate independent agency;
and
• reducing the government representation on the central bank board.
• Similarly, RBA’s model of an independent monetary policy, better communication and
reporting strategies and its accountability to the parliament may also enhance the CBIG
in BB.
• So, while there are considerable differences between Bangladesh and Australia, the
RBA’s operation nevertheless offers a number of ideas which would be useful for the
government of Bangladesh to consider.

52. Recent Regulatory Developments of BB
• Basel-III has been introduced in a phased manner starting from the
January 2015, with full implementation of capital ratios from the
beginning of 2019.
• Guidelines on Environmental and Climate Change Risk Management
for banks and FIs have been circulated. Policy guidelines on Green
Banking also have been issued.
• Guidelines on Stress Testing for banks and FIs have been issued
which is aimed to assess the resilience of banks and FIs under
different adverse situations.
• Number of Policy initiatives for Financial Inclusion has been
undertaken.
• Banks have been asked to build up separate Risk Management Unit
for comprehensive and intensive risk management.

53. Recent Regulatory Developments (contd.)
• Banks have been instructed to create separate subsidiary for capital
market operations and capital market operations of banks are now
minutely monitored.
• Supervision has been intensified to increase the participation of banks in
Corporate Social Responsibility (CSR).
• For the efficient and timely action of BB, foreign exchange reserve of
Bangladesh did not face any adversity during global financial turmoil of
2007-09.
• To meet international standard on Anti Money Laundering
(AML)/Combating Financing of Terrorism (CFT) issues, guidelines for
Money Changers, Insurance Companies and Postal Remittance have
already been circulated.
• TERM Paper