Short Assignment on Financial System of Bangladesh.

1. Green University of Bangladesh
Assignment On
“The Financial System of Bangladesh”
Submitted To:
Prof. Dr. Golam Ahmed Faruqui
Dean, Faculty of Business Studies
Green University of Bangladesh
Submitted By:
Md. Sazidul Islam
ID: 181005046
MBA (B)
Course Title: Financial Management
Date of Submission: April 2018

2. The Financial System of Bangladesh
Introduction: 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.
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.
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 offinance is the mode offinance wheresavers areto 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. Capitalmarket: Theprimary segment ofcapital market is operatedthroughprivateandpublic
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

3. 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 ExchangeMarket: Towardsliberalization offoreignexchangetransactions,anumber
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-residentsin the industrial sectorandportfolio investments ofnon-residentsthroughstock
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.
Regulators of the Financial System:
Central Bank: Bangladesh Bank acts as the Central Bank of Bangladesh which was established on
December16, 1971throughthe enactment ofBangladeshBank Order 1972-President’s OrderNo.
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 forwardlookingcentral bankwith competent and committed professionalsofhigh
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-
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 andensurea 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:

4.  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).
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/corporatebonds.AseparatedepartmentofBBperformstheoperational
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.
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 exportcredit andagricultural lending, thereis no interest ratecap onlending
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.
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, reducemoral hazardin the financial sectorandprovide 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

5. 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.
Economic basis of FinancialSystem: The true economicbasis offinancial 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 inPortfolio Management:FIs holdlargesize 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. Their
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 is comprised of three broad fragmented sectors:
o Formal Sector
o Semi-Formal Sector
o 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
orany otherenactedfinancial regulator.This sectoris mainly representedbySpecialized 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.
The informal sector includes private intermediaries which are completely unregulated.