A retrospective look at Bangladesh's financial sector
Mahmud Hossain Opu/Dhaka Tribune
Forrest Cookson
Publish : 15 Nov 2021, 08:50 PMUpdate : 14 Feb 2022, 03:11 PM
The Bangladesh economy is recovering from the Covid-19 pandemic.
The challenges to ensure a smooth successful emergence from this terrible 18 months are formidable.
In particular, the financial sector has been under great stress. Virtually all enterprises suffered a sharp sudden decline in demand for their products, resulting in reduced profitability and difficulty in repaying loans.
In addition, the world economy is experiencing increased inflation in food and energy prices and these increases are slowly driving up prices of almost everything.
The world’s logistics systems, including Bangladesh are in disarray.
Key to full recovery to rapid economic growth is the condition and performance of the financial system.
The behavior of the financial system is based o n Bangladesh Bank’s actions, the uncertainties and risk facing enterprises, and recognition of the real impact of the pandemic on the economy.
Financial system 101
The financial system comprises the banks, the non-banking financial institutions, the capital market, and the insurance industry.
It has three important regulatory institutions responsible for establishing and implementing laws and regulations.
These are Bangladesh Bank responsible for the banks and the non-bank financial institutions; the Bangladesh Securities and Exchange Commission responsible for regulating the behavior of public companies and overseeing markets where the shares of public companies are traded; and the Insurance Development and Regulatory Authority of Bangladesh that regulate insurance companies to insure obligations can be met.
The financial system undertakes to accomplish several tasks:
· To provide safe organizations to hold savings of people and companies
· To maintain a payment system to provide efficient and safe means of carrying out financial transactions
· To collect savings and provide loans to companies for investment [increasing the capacity for production of goods and services] and funding operations [managing the difference in the time an enterprise pays for inputs and receives funds from sales]
· To manage a market for transactions with foreigners
· To regulate a market for the purchase and sale of government securities
· To provide insurance against adverse events [death, fire, etc.]
The first note looks at the banking sector.
The central task of the financial system is to gather the savings of many persons and pass these resources on to persons that wish to invest.
Savers reduce their current consumption to have more in the future [for consumption in the future or to pass on to children.] Savers have lots of options for what to do with their money. One important choice is to place the money in a bank; the bank is generally safe and will pay interest if you leave it under the control of the bank.
Bangladesh Bank establishes rules to ensure safety of the depositor’s money.
Those who want to invest apply to the bank for a loan.
The bank assesses whether the potential borrower will repay the loan and if satisfied that this is likely, will offer a loan at an interest rate that covers the costs of the bank, a profit for the bank owners, and takes account of the risk that the borrower will default.
Imagine that the interest earned on deposits is fixed by the bankers; then the appropriate lending rate will be different for each borrower, varying with the risk.
Borrowers with a record of repaying their loans will be offered a lower interest rate than the offer rate for borrowers who are judged riskier.
If the banks feel that there are a lot of good loans then they find the resources to make these loans either by attracting more deposits or by borrowing from the central bank.
If the banking sector needs more funds then the rate paid for deposits increases to induce people to save more.
If the banks feel that there are more funds available for lending than they can use then the deposit rate is lowered to reduce the availability of loanable funds.
In the short run the bank will purchase more government securities driving down the interest rate.
In this way the market for loans adjusts the deposit rate until roughly the amount of saving through deposits equals the volume of loans.
If banks borrow from the central bank then as deposits rise the central bank will be repaid.
In this way there is really no fixed lending rate, it depends on the risk assessments made by the bank.
For simplicity banks may establish risk levels and place a loan applicant into one of those categories but it is not possible to establish a lending rate with massive market distortions.
Complications
There are many complications that arise from the actions of the central bank, but the main function of the banks is to direct savings by depositors to the borrowers with the highest return loan proposal.
The bank assesses the likely return from the proposed project and if this is greater than the calculated price of the loan the bank will lend the money.
For example, the bank may assess that the minimum rate they need is 8% but the expected return of the project is 13%.
The bank would offer the loan at say 10%. If the minimum rate the bank needs is 9% (this second loan is riskier than the first example) and the expected return of the project is 9% and would be unlikely to make the loan.
Lending rates are always linked to risk and there is always a lending rate that properly prices the loan.
The Bangladesh banking system, as controlled by the central bank, does not recognize this idea.
The central bank stipulates the number of risk categories by limiting the allowed spread of lending rate.
This is too severe and results in low volume of lending for risky loans.
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.
ANALYSISPowered by Froala Editor
A retrospective look at Bangladesh's financial sector
The Bangladesh economy is recovering from the Covid-19 pandemic.
The challenges to ensure a smooth successful emergence from this terrible 18 months are formidable.
In particular, the financial sector has been under great stress. Virtually all enterprises suffered a sharp sudden decline in demand for their products, resulting in reduced profitability and difficulty in repaying loans.
In addition, the world economy is experiencing increased inflation in food and energy prices and these increases are slowly driving up prices of almost everything.
The world’s logistics systems, including Bangladesh are in disarray.
Key to full recovery to rapid economic growth is the condition and performance of the financial system.
The behavior of the financial system is based o n Bangladesh Bank’s actions, the uncertainties and risk facing enterprises, and recognition of the real impact of the pandemic on the economy.
Financial system 101
The financial system comprises the banks, the non-banking financial institutions, the capital market, and the insurance industry.
It has three important regulatory institutions responsible for establishing and implementing laws and regulations.
These are Bangladesh Bank responsible for the banks and the non-bank financial institutions; the Bangladesh Securities and Exchange Commission responsible for regulating the behavior of public companies and overseeing markets where the shares of public companies are traded; and the Insurance Development and Regulatory Authority of Bangladesh that regulate insurance companies to insure obligations can be met.
The financial system undertakes to accomplish several tasks:
· To provide safe organizations to hold savings of people and companies
· To maintain a payment system to provide efficient and safe means of carrying out financial transactions
· To collect savings and provide loans to companies for investment [increasing the capacity for production of goods and services] and funding operations [managing the difference in the time an enterprise pays for inputs and receives funds from sales]
· To manage a market for transactions with foreigners
· To regulate a market for the purchase and sale of government securities
· To provide insurance against adverse events [death, fire, etc.]
The first note looks at the banking sector.
The central task of the financial system is to gather the savings of many persons and pass these resources on to persons that wish to invest.
Savers reduce their current consumption to have more in the future [for consumption in the future or to pass on to children.] Savers have lots of options for what to do with their money. One important choice is to place the money in a bank; the bank is generally safe and will pay interest if you leave it under the control of the bank.
Bangladesh Bank establishes rules to ensure safety of the depositor’s money.
Those who want to invest apply to the bank for a loan.
The bank assesses whether the potential borrower will repay the loan and if satisfied that this is likely, will offer a loan at an interest rate that covers the costs of the bank, a profit for the bank owners, and takes account of the risk that the borrower will default.
Imagine that the interest earned on deposits is fixed by the bankers; then the appropriate lending rate will be different for each borrower, varying with the risk.
Borrowers with a record of repaying their loans will be offered a lower interest rate than the offer rate for borrowers who are judged riskier.
If the banks feel that there are a lot of good loans then they find the resources to make these loans either by attracting more deposits or by borrowing from the central bank.
If the banking sector needs more funds then the rate paid for deposits increases to induce people to save more.
If the banks feel that there are more funds available for lending than they can use then the deposit rate is lowered to reduce the availability of loanable funds.
In the short run the bank will purchase more government securities driving down the interest rate.
In this way the market for loans adjusts the deposit rate until roughly the amount of saving through deposits equals the volume of loans.
If banks borrow from the central bank then as deposits rise the central bank will be repaid.
In this way there is really no fixed lending rate, it depends on the risk assessments made by the bank.
For simplicity banks may establish risk levels and place a loan applicant into one of those categories but it is not possible to establish a lending rate with massive market distortions.
Complications
There are many complications that arise from the actions of the central bank, but the main function of the banks is to direct savings by depositors to the borrowers with the highest return loan proposal.
The bank assesses the likely return from the proposed project and if this is greater than the calculated price of the loan the bank will lend the money.
For example, the bank may assess that the minimum rate they need is 8% but the expected return of the project is 13%.
The bank would offer the loan at say 10%. If the minimum rate the bank needs is 9% (this second loan is riskier than the first example) and the expected return of the project is 9% and would be unlikely to make the loan.
Lending rates are always linked to risk and there is always a lending rate that properly prices the loan.
The Bangladesh banking system, as controlled by the central bank, does not recognize this idea.
The central bank stipulates the number of risk categories by limiting the allowed spread of lending rate.
This is too severe and results in low volume of lending for risky loans.
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.
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