A look back at Bangladesh’s financial sector

This is part of a two part series

Bangladesh’s economy is recovering from the Covid-19 pandemic.

The challenges in ensuring a successful and smooth exit from these terrible 18 months are formidable.

In particular, the financial sector has been under severe stress. Virtually all businesses have experienced a sudden sharp drop in demand for their products, resulting in declining profitability and difficulty in repaying loans.

In addition, the global economy is experiencing an increase in food and energy price inflation and these increases are slowly pushing up the prices of almost everything.

The logistics systems of the world, including Bangladesh, are in disarray.

The condition and performance of the financial system is the key to a full recovery to rapid economic growth.

The behavior of the financial system is based on the actions of the Bangladesh Bank, the uncertainties and risks facing businesses, and the recognition of the real impact of the pandemic on the economy.

Financial system 101

The financial system includes banks, non-bank 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 the Bangladesh Bank responsible for banks and non-bank financial institutions; the Bangladesh Securities and Exchange Commission responsible for regulating the behavior of state-owned enterprises and overseeing the markets where shares of state-owned enterprises are traded; and the Bangladesh Insurance Regulatory and Development Authority which regulates insurance companies to ensure that obligations can be met.

The financial system undertakes to accomplish several tasks:

Provide safe organizations to hold the savings of people and businesses

Maintain a payment system to provide efficient and secure means of carrying out financial transactions

Collect savings and provide business loans for investment [increasing the capacity for production of goods and services] and financing operations [managing the difference in the time an enterprise pays for inputs and receives funds from sales]

Manage a market for transactions with foreigners

Regulate a market for the purchase and sale of government securities

Provide insurance against adverse events [death, fire, etc.]

The first note concerns the banking sector.

The central task of the financial system is to collect the savings of many people and to pass these resources on to those who 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 many options for what to do with their money. An important choice is to put the money in a bank; the bank is generally safe and will pay interest if you leave it under the bank’s control.

The Bangladesh Bank establishes rules to ensure the safety of the depositor’s money.

Those who want to invest apply for a loan from the bank.


Read also – A Look Back at Bangladesh’s Financial Sector: Part 2


The bank assesses whether the potential borrower will repay the loan and, if convinced that it is likely, will offer a loan at an interest rate that covers the bank’s costs, a profit for the owners of the bank, and takes into account the risk that the borrower will default.

Imagine that the interest received on deposits is set by the bankers; then the appropriate loan rate will be different for each borrower, varying with the risk.

Borrowers who have already repaid their loans will be offered an interest rate lower than the rate offered for borrowers deemed to be riskier.

If the banks find that there are a lot of good loans, they find the resources to make these loans either by attracting more deposits or by borrowing from the central bank.

If the banking industry needs more funds, the rate paid for deposits increases to encourage people to save more.

If banks feel that there is more funds available for the loan than they can use, the deposit rate is lowered to reduce the availability of loanable funds.

In the short term, the bank will buy more government securities, which will lower the interest rate.

In this way, the loan market adjusts the deposit rate until the amount of savings through deposits is approximately equal to the volume of loans.

If the banks borrow from the central bank, while deposits increase, the central bank will be reimbursed.

This way, there is really no fixed loan rate, it depends on the risk assessments made by the bank.

For the sake of simplicity, banks can establish risk levels and classify a loan seeker into one of these categories, but it is not possible to establish a loan rate with massive market distortions.

Complications

Many complications arise from central bank actions, but the main function of banks is to direct savings from depositors to borrowers with the highest yield loan proposal.

The bank assesses the likely return on the proposed project and if it is higher than the calculated price of the loan, the bank will lend the money.

For example, the bank may assess that the minimum rate it needs is 8% but that the expected return from 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 on the project is 9% and the loan would be unlikely to be granted.

Lending rates are always linked to risk and there is always a lending rate that correctly fixes the price of the loan.

Bangladesh’s banking system, as controlled by the central bank, does not recognize this idea.

The central bank sets the number of risk categories by limiting the authorized spreading of the lending rate.

This is too severe and results in a low volume of loans for risky loans.

Forrest Cookson is an economist who was the first president of AmCham and was a consultant for the Bangladesh Bureau of Statistics.

About Alexander Estrada

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