The Structure of Financial System of Bangladesh – Essay

The Structure of Financial System of Bangladesh Introduction: Financial system is a system which tones up the savings-investment process of a country.

Financial system plays a significant role in the economic development of a country. Theimportance of an efficient financial sector lies in the fact that, it ensures domestic resourcesmobilization, generation of savings, and investments in productive sectors. In fact, it is thesystem by which a country’s most profitable and efficient projects are systematically andcontinuously directed to the most productive sources of future growth.The financial systemnot only transfers funds from savers to investors, it also selects projects which will yield thehighest returns, accumulates sufficient quantities of capital to fund the range of investmentprojects across economic activities, accounts for price risks across assets, monitor performance,and enforce contracts. According to the McKinnon- Shaw hypothesis (1973), the conventionalwisdom is that flexibility and efficiency of the financial system are crucial to the growth anddevelopment of a market economy.A comprehensive study by King and Levine (1993) fromacross 119 developed and developing countries over the 1960-1989 period provides compellingevidence that economic growth is dramatically dependent on the size of financial sector, creditto private sector and enterprises and interest rates.

The larger the financial sector in thecontext of the overall economy, the greater the share of lending by depository rather thancentral banks, and the greater the share of credit to private sector rather than public sector, thegreater is the rate of economic growth.Major Components of a Financial System and their roles: Financial System in Bangladesh Money Market 1. Bangladesh Bank 2. All Banks 3. Non-Bankfinancialinstitutions 4. Money Changers 5.

Credit ratingagencies Capital Market A. Securities Market 1. Securities &ExchangeCommission 2. StockExchanges: DSE,CSE 3. InvestmentCorporation of Bangladesh 4. MerchantBank B. Insurance,pension &provident fund 1.

Controller of Insurance 2. General andlife insurancecompanies 3. GovernmentPension Scheme 4. CentralProvidentFund 5Private sectorpension funds(typically small) Microfinance 1.

Non-GovernmentOrganizations(NGOs) 2. PalliKarmoShahayokFoundation (PKSF) 3. Grameen Bank 4. BangladeshRuralDevelopmentBoard 5.

Other non-government anddevelopmentorganizations. Source: Policy Analysis Unit (PAU), Bangladesh Bank. Recent Developments in Financial Sector of Bangladesh: Automation and Technological Development: Banking sector experienced remarkable progress in respect of automation in functioning in last several years. For the pro-active and forward-visioning approach of Bangladesh Bank, numbers of automation initiatives have been implemented in banking sector.These initiatives include: •To create a disciplined environment for borrowing, the automated Credit Information Bureau (CIB) service provides credit related information for prospective and existing borrowers. With this improved and efficient system, risk management will be more effective.

Banks and financial institutions may furnish credit information to CIB database 24 by 7 around the year; and they can access credit reports from CIB online instantly. •L/C Monitoring System has been introduced for preservation and using the all necessary information regarding L/C by the banks through BB website.This system allows the authorized users of banks to upload and download their L/C information. • In terms of article 36(3) of Bangladesh Bank Order, 1972, all scheduled banks are subject to submit Weekly Statement of Position as at the close of business on every Thursday to the Department of Off-site Supervision. This statement now is submitted through on-line using the web upload service of BB website within o3 (three) working days after the reporting date which is much more time and labor efficient that the earlier manual system.

The e-Returns service has been introduced which is An Online Portal Service for Scheduled Banks to submit Electronic Returns using predefined template for the purpose of Macro Economy Analysis through related BB Departments. •Online Export Monitoring System is used for monitoring export of Bangladesh. Through this service, Banks and AD Branches of Banks issue & reports export report. •Bangladesh Automated Clearing House (BACH) started to work by replacing the ancient manual clearing system which allows the inter-bank cheques and similar type instruments to be to settled in instant manner. Electronic Fund Transfer (EFT) has been introduced which facilitates the banks to make bulk payments instantly and using least paper and manpower. •The initiation of Mobile Banking has been one of the most noteworthy advancement in banking. Through this system, franchises of banks through mobile operators can provide banking service to even the remotest corner of the country. •Almost every commercial bank is now using their own core banking solution which has made banking very faster and efficient.

Usage of plastic money has much more increased in daily life transactions.Full or partial online banking is now being practiced by almost every bank. Inauguration of internet trading in both of the bourses (DSE & CSE) in the country is the most significant advancement for capital market in last several years. Micro Finance Institutions submit their reports to the regulator through the Online Report Submission Tools for MFIs. Institutional Development: Through the Central Bank Strengthening Project, there have been a good number of achievements regarding the institutional development in BB which can be observed below: •The implementation of Enterprise Resource Planning (ERP) as been a big step in automation of operational structure of BB. •The establishment of Enterprise Data Warehouse (under process) will bring the whole banking and FI industry under a single network through which data sharing, reporting and supervision will enter in a new horizon.

•Bangladesh Bank now possesses the most informative and resourceful website of the country regarding economic and financial information. •Internal networking system with required online communication facilities have been developed and in operation for the officers of BB. BB has hosted number of international seminars on different economic and financial issues over last several years.

MRA was established in 2006 for bringing NGO-MFIs under supervision. For the proactive role of MRA, this sector (MFI) is now in a good shape regarding the accountability and regulation. For abolishing anomaly and fetching discipline in insurance industry, IDRA was established in 2011. In one year, IDRA has taken number of appreciable steps to regularize this industry.After the massive crash of local bourses in 2010-2011, the executive body of SEC was redesigned in full and some good results have come after that.

Regulatory Development: Banking and FI industries have experienced diversified regulatory development over last few years: •Full implementation of Basel-II (International capital adequacy standard) accord has been in effect in both banking and FI industry. •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. •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. SEC has updated Public Issue Rules, 2006 and Mutual Fund Rules, 2001.Apart from that, numbers of AMCs, merchant banks and are Mutual Funds are permitted by SEC which has increased the participation of institutional investors. The trend of capital market research has been upward which indicates the potential of analytical investment decision.

Insurance Act 2010 was formulated to meet demand of concurrent time for shifting the insurance industry in a better shape. Apart from that, several initiatives have been undertaken by IDRA for prohibiting the malpractices in the industry regarding insurance commission, agent, premium etc and corporate governance issues.Annual Report2010-2011 : Financial Markets Bangladesh Bank (BB) remained proactive to ensure domestic resource mobilization, generation of savings and investments in productive sectors so that country’s most profitable and efficient projects are systematically and continuously directed to the most productive sources of future growth. To achieve greater efficiency, stability and transparency in the financial sector, the ongoing reform was continued in FY11.

However, the short-term and long-term credit markets of the country experienced a tremendous growth in FY11 due to expansionary economic activities of the country. With theincreased demand for domestic credit as the economy paced up to theexpected buoyant economic growth coupled with heavy outflows for imports and other external payments, put the banks into liquidity pressure from December 2010. Moreover, unauthorized investment of the banks in the unproductive sector also played role to put the banks into liquidity pressure.Despite the uptrend in inflationary pressure Bangladesh Bank has been providing liquidity facility to the banks in respect of increased demand in the money market as well as taking supervisory and credit policies to rectify unbalanced lending practices in banks including monitoring and enforcing of prudent advance-deposit ratios and good forward looking liquidity management and of regulatory ceilings on capital market exposures, tightening loan monitoring requirements to discourage diversion of credit to unauthorized and unproductive uses.Lending interest rate caps imposed earlier in the backdrop of global slowdownbeing no longer tenable in the changed context of high and rising demand, phase out of these caps was initiated in March 2011, starting with loans other than industrial term loans and loans for export, agriculture and essential imports. Capital Market Investment Financing in Bangladesh: Moderate Role of Capital MarketThe dominance of term loans in investment financing implies low equity stake and risk exposure of the owners, with disproportionately high incidence of risk on the lending banks and financial institutions, including liquidity risk arising from the funding of these long-term loans with typically short-term deposits.

The amount of industrial term loans disbursed by banks and financial institutionsstood at Taka 321. 6 billion, many-fold higher than the amount of Taka 27. 9 billion raised by new capital issues through private placements and public offerings in the capital market in FY11.This indicates the overwhelming preference of bank finance in industrial investment financing. The outstanding balance of industrial term loans of banks and financialinstitutions stood at Taka 685. 1 billion as of end June 2011 was lower than Taka 2853. 9 billion of market capitalization of the securities listed in the Dhaka Stock Exchange.

However, market capitalization of the industries (manufacturing, services and miscellaneous) amounting to Taka 1176. 4 billion was also higher than the outstanding level of industrial term loan financed by the banks and financial institutions.Foreign Exchange Market Bangladesh floated its exchange rate for Taka with effect from 31 May 2003. Under this exchange rate regime, exchange rate is being determined on the basis of demand and supply of the respective currencies. Authorized Dealer banks are now free to set their own rates for inter-bank and customer transactions. However, in order to maintain stability in the foreign exchange market Bangladesh Bank remains vigilant over the developments in the foreign exchange market by closely monitoring buying and selling of foreign exchanges.Despite hefty growth in exports (41. 7 percent) and comparatively lower growth in wage earners remittances (6.

0 percent), Bangladesh Taka witnessed 6. 34 percent depreciation against US dollar in FY11 mainly due to higher import demand. The overall 41. 8 percent growth in imports compared to the previous year because of acceleration in domestic investment activities (which in turn caused huge foreign exchange demand for import of capital goods) and import of food items has widened the trade gap and caused depreciation of Taka against USD.

The weighted average inter-bank rate stood at Taka 74. 15 per USD as of 30 June 2011 against 69. 45 as of 30 June 2010. However Bangladesh Bank continued its role in the foreign exchange market in line with its monetary policy goal to ensure stability in the market. Pre-conditions for Effective Bank Supervision: Public infrastructure is not well developed: Lack of a central land registry to evidence property ownership and to record liens has resulted in fraudulent and duplicate land titles.This raised the potential for multiple and unknown liens on property and marginalized the collateral protection for loans.. Asset valuations are performed but standards for determining and reporting valuations do not exist.

Approximately 200 chartered accountant firms operate in Bangladesh, including representatives of the five large international firms. Companies listed on the stock exchange are required to provide their annual audited annual financial statements to the Securities ; Exchange Commission.Banks report monthly or quarterly, depending on loan size and whether it is in default and are required to obtain information regarding the borrower‘s history during the loan underwriting process Lack of effective market discipline: BB has effectively imposed a moratorium for the entry of new banks.

It has also demonstrated reluctance to let weak banks fail, with prolonged rehabilitation periods for problem banks. Level playing field issues are also present, with Bangladesh Bank authorizing increased loan disbursement limits for the four state owned banks.While the lack of entry and exit weakens market discipline, politically inspired social objectives and direct regulation directly interfere with banksbusiness decisions.

A deposit insurance scheme was established in 1984 and revised in 2004; and all scheduled banks are required to be members of the fund. Conclusion and My Final Evalution Today, almost everyone agrees that the financial system is essential for development of acountry. Improving the financial system can lead to higher growth and reduce the likelihoodand severity of crises.While Bangladesh has achieved relatively high economic growth over thepast years with a distorted financial system and in spite of its governance problems, cross-country experience has shown the importance of financial and institutional development tosustain long-term economic growth.

Faster GDP growth consistent with the poverty reductiongoals cannot be met unless the extent and quality of financial intermediation in Bangladeshadvances significantly.In particular, this would require more competitive banking and non-banking financial sectors capable of reaching out to all sections of the community, rural ;urban, catering to all types of marketable financial service. The pro-active measures taken inthe financial sector in recent years have put salutary impact on the financial system. Hopefully,the on-going reform process in the financial system of Bangladesh will bring more stability andtransparency. In this regard, proper care should be taken in the reform process so that reformsin the financial sector embrace the socio- economic realities in Bangladesh.