Bangladesh’s central bank was established from the beginning of Bangladesh out of the remnants of the State Bank of Pakistan, which had of course a large branch in the eastern half of the country.
When independence was achieved in 1971 the Reserve Bank of India offered to send a large contingent of central bankers to help establish Bangladesh Bank.
This offer was turned down and the bank’s staff were recruited from the old employees of the State Bank of Pakistan.
At the start of the liberation war many Bangladeshis were working for the State Bank of Pakistan in Karachi, but eventually got back to Bangladesh and most joined Bangladesh Bank.
Looking back over the past fifty years Bangladesh Bank has been the most successful government institution.
For most of the period it achieved its main responsibility and held down the rate of inflation, particularly over the past 30 years.
Around 1990, Bangladesh Bank initiated the financial sector reform program establishing rules covering the operation of commercial banks, improved the instruments for monetary policy, deregulated interest rates, required the banks to account correctly for non-performing loans, created the Credit Information Bureau, established a Masters Degree program in BIBM, worked to establish the money loan courts, worked to pass a bankruptcy law and associated courts, shifted the balance of the banking sector from the state owned banks to a substantial number of private banks, improved the IT department of the bank, and significantly deregulated the controls over foreign currency transactions.
Bangladesh Bank, by 1993, had become substantially independent from the Ministry of Finance, which limited itself to occasional actions dealing with state owned banks.
Gradually over the past decade the Ministry of Finance has encroached on the independence of the central bank.
On matters of setting interest rates, rules for rescheduling non-performing loans (NPLs), setting the exchange rate, allowing forbearance on commercial banks with respect to provision requirements, and approvals of directors of private banks, Bangladesh Bank has much less authority than ten years ago.
The literature on central banking generally argues for the independence of the central bank.
The risk of a central bank that is directly under the control of the Government is that the political authority will undertake dangerous actions.
For example, in Turkey today in the face of a high inflation rate and a rapidly depreciating currency the political authority is forcing the central bank to lower interest rates.
Many governments have forced the central bank to finance large government deficits by printing money.
Political authorities sometimes intervene to protect a commercial bank friendly to such authorities when the bank refuses to follow central bank direction.
These types of intervention by the political authority lead to the recognition that good governance requires an independent central bank.
More importantly, interference may distort the direction of lending from good loans to poor loans, reducing the growth of the economy.
Of these two problems: political authority sponsoring poor monetary policy is not a serious issue.
The second, micro political interference is a serious problem in Bangladesh.
NPLs may be allowed to remain uncollected if reduced to tolerable levels would add 1.25-1.75% to the GDP growth rate.
There are two points to be made.
First, the political authority sets the objectives of the central bank, but then lets the achievement of such objectives be the province of the central bank.
Second, generally the government will either prescribe the system for managing the exchange rate or will set the exchange rate itself.
Central banks operate within a set of instructions given by the political authority, but these instructions are very high level, leaving details to the central bank.
The central bank may politely tell the government some target is impossible but otherwise will accept the national targets.
But all central banks believe they have responsibility for maintaining a low inflation rate, maintaining an efficient payment system and ensuring the safety of the depositors funds.
In Bangladesh, as in the United States the central bank is told to achieve two things: Keep inflation low and support economic growth [in the United States this is expressed as maintaining a low unemployment rate.]
The exchange rate system or level in the United States is set by the Treasury Department not the Federal Reserve.
Bangladesh has theoretically a floating exchange rate but in fact the Ministry of Finance has sought to control the XR.
But in fiscal year 2021-22, the controls broke down and a true float commenced.
Challenges
Bangladesh Bank has handled the exchange rate issues as well as it could, although it has been surprisingly willing to accept the multiple exchange rate system that has emerged.
Due to export subsidies there are different exchange rates for different exports and for remittances for which another subsidy is in place.
The IMF is being understanding about this since multiple exchange rates are a real no-no.
As Bangladesh graduates it will not be able to continue such a system; which is good as these methods introduce massive distortions in the economy.
But Bangladesh Bank should be fighting against such subsidies.
When the central bank was established there was an order, in effect a law, that legally established its powers.
After amendments the bank was under the control of the board.
The membership of the Board as amended in 2003 comprises the governor, one deputy governor, three members of the government, and four persons who are not government officials.
Currently of these four non-government members, two are retired officials [a former finance secretary and a former deputy governor], one is a highly respected businessman and there is one vacancy.
Loopholes
Obviously there can never be an independent central bank with such a Board.
There can be no independence without a board comprising a few officials of Bangladesh Bank along with board members who are not nor have been government officials.
A well constituted board would include some retired commercial bankers, some lawyers, chartered accountants, academics and some senior businessmen.
The idea of an independent board is to have members who are not under the influence or control of the government, but who have been successful in their professions and willing to take on this difficult task of directing a central bank.
The central bank board should be headed by the governor, have one deputy governor and seven members who are not currently government officials nor have been in the past.
There should be formulated a set of rules setting eligibility to become a board member and of course a procedure for a financial vetting.
Running the monetary system and carrying out detailed supervision of the banks is a job for trained, experienced professionals.
Bangladesh Bank needs to be independent and its board should not have as members serving or retired officials.
Independence of the central bank can only be based on the national leaders both private and public, accepting that the central bank should be independent.
The highest political authority must accept such independence.
This is often an issue in the United States, when then-president Donald Trump tried to publicly bully the chairman of the Federal Reserve (equivalent to governor) to lower interest rates.
In Turkey the President can have his way, ordering the central bank to follow foolish policies.
There is no ultimate guarantee of central bank independence.
Duties
What are the duties of the board? That is a good question.
Most modern central banks publish the minutes of the board’s meetings giving the decisions that have been made.
This would be a very good practice and would best be accompanied by a press conference conducted by the governor.
Presently, the public has no knowledge of what the board is doing.
The first task of the central bank is to carry out monetary policy.
I assume that there are two parts of this task.
First is the setting of targets that the Bank intends to achieve.
This could be the inflation rate and the increase in the money supply [which concept of money supply we skip here].
These are set with some idea of getting the inflation rate a little lower [ Bangladesh Bank should be trying to get to some level like 3%] and ensuring that the money supply growth is consistent with the government’s target for economic growth.
It is not the business of the central bank what GDP growth rate the government has selected.
But it is the responsibility of the central bank to bring these targets down to specific monetary targets of credit growth and financing of the government deficit.
The second task of monetary policy is to adjust from time to time the instruments of the central bank [holdings of government securities or sales of the Bangladesh Bank bill, repo rate(interest rates at which Bangladesh Bank will lend to the commercial banks), cash reserve requirement and the statutory liquidity rate].
The technicians at the bank will recommend to the board a program, say every quarter, of the actions on the above instruments to be implemented to achieve the target growth of the money supply.
The board will debate this and come to a decision, with a vote taken of the nine members.
That will determine the monetary actions for the following quarter.
The government should have no role in this as the issues are technical and as for risks in these choices, it is the board’s job to make such choices and accept such risks.
There are many other tasks for the board dealing with bank supervision, management of the foreign exchange reserves, issues related to bank security, problem banks, and administrative actions of the central bank.
It is a major job to be a director.
It should be considered a full time job, but no maximum age as retired persons will be an important pool of talent.
Bangladesh Bank should provide two or three bank staff to such board members who will work under the direction of the member.
Salary of board members should be slightly higher than the deputy governor.
The point of all of this is to have a Bangladesh Bank board that is active in the complex policy issues facing the management of the financial system.
The board should comprise men and women of accomplishment and experience who commit to several years of hard work and taking responsibility for the serious issues of formulating and implementing monetary policy as well as guiding the many other responsibilities of the bank.
In conclusion, Bangladesh Bank needs to be independent of the government.
Its staff is experienced, well trained and educated, able to carry out its tasks even better, if it is free to make decisions without political interference.
An independent central bank needs a board that is independent of the government.
There are many people with the knowledge, wisdom, and judgment to guide the central bank in a better way than civil servants.
To achieve this outcome will require a revision of the legislation governing Bangladesh Bank and setting out more transparent monetary policy procedures for formulating and implementing monetary policy.
Forrest Cookson is an economist who has served as the first president of AmCham and has been a consultant for the Bangladesh Bureau of Statistics.