An Essay on

Analyzing and Identifying Financial Stability Risk in Bangladesh

Course Name: Central Banking: Regulations and Supervision
Course Code: B-406
Submitted to:
Md. Asif Nawaz
Assistant Professor
Department of Banking and Insurance
University of Dhaka

Submitted by:
Isteaq ahamed
ID: 23-089
Section: B
Batch: 23rd
Department of Banking and Insurance
University of Dhaka

Submission Date: 05 February 2021

Table of Contents
Introduction ..................................................................................................................................... 3
Identifying and monitoring risk of macro economy ....................................................................... 4
The house hold sector ................................................................................................................. 4
The corporate sector .................................................................................................................... 5
The government sectors .............................................................................................................. 5
External Factors .......................................................................................................................... 6
The monitoring and identifying risk to financial institution ........................................................... 7
Key types of risks to individual financial institution .................................................................. 7
Financial Markets............................................................................................................................ 9
Prices and yields ......................................................................................................................... 9
Spreads ........................................................................................................................................ 9
Libor rate ..................................................................................................................................... 9
Conclusion .................................................................................................................................... 10
Introduction
Banks and financial institution are the hearts of an economy. To keep an economy financially
stable these intuitions should be monitored regularly. There is a certain risk involving in the
macroeconomy and to identify and monitor these risk, the central bank often checks balance sheets
of different groups of economic agents. Over-indebtedness of the household sector, corporate
sector, government sector and the external sector could lead to a financial imbalance in the
economy. In this essay how central bank identifies and monitors financial institution to keep
financial stability in the market are discussed. The central bank plays an important role in keeping
financial stability in the market.
Identifying and monitoring the risk of the macroeconomy
Macroeconomics is the branch of economics that studies the behaviour and performance of an
economy as a whole. It focuses on the aggregate changes in the economy such as unemployment,
growth rate, gross domestic product and inflation. These mistakes are hard to identify and it brings
risk to an economy. There is a certain risk involving in the macroeconomy and to identify and
monitor these risk, the central bank often checks balance sheets of different groups of economic
agents. Over-indebtedness of the household sector, corporate sector, government sector and
external sector could lead to a financial imbalance in the economy

The household sector

The household sector includes the entire population of society. It includes all of the consumption-
seeking members of society. Central bank analyzes household debt to GDP to realize the
vulnerability in the household market. From analyzing last 10 years performance in the household
sector central bank can anticipate the condition of the market.

Figure 1.1: Household the debt to GDP

In figure 1.1 has shown the percentage of household debt as a percentage of GDP. Data on
household debt might come from various sources, including loans granted to individuals and
households by financial institutions and comprehensive household surveys. From these data, the
central bank can identify the situation of the household sector in Bangladesh.

The corporate sector

The corporate sector is the business sector in an economy which consists every business firms and
institution. The central bank has to monitor and identify corporate sector regularly to bring
financial stability in the market. Many events occur in the corporate sector which central bank
have to monitor. Large corporate investment, corporate debts, financial ratios such as debt to
income, debt to capital are the major things which central bank have to monitor. From analyzing
last 10 years performance in corporate sector central bank can anticipate the condition of the
market.

Chart Title
45
40
35
30
25
20
15
10
5
0
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Figure 1.2: Corporate debt to GDP

The government sectors

The central bank needs to assess the public debts or the debt which the government is liable. To
monitor and identify risk central bank have to assess the debt of the government. To bring financial
stability public debts should be reduced. From analyzing last 10 years performance in government
sector central bank can anticipate the condition of the market.
 Chart Title
50
45
40
35
30
25
20
15
10
5
0
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Figure 1.3: Government debt to GDP

External Factors
A fast rise in debt owed to external creditors can also represent a grave threat to financial stability.
In a fixed exchange rate regime, if the central bank does not have enough reserves to satisfy those
wishing to pull their capital out, then it might be forced to allow the currency to be devalued.

Short Term Debt to Total Reserve Ratio

35.00%

30.00%

25.00%

20.00%
Short Term Debt to
15.00% Total Reserve Ratio

10.00%

5.00%

0.00%
2005 2010 2015 2020

Figure 1.4: External debt to GDP

The monitoring and identifying risk to a financial institution
Risk monitoring is an ongoing process of managing risk. Risk management often has an initial
phase that involves identifying risk, agreeing to treatments and designing controls. Risk
monitoring is the process of tracking risk management execution and continuing to identify and
manage new risks. There are many types of risks associated with a financial institution which
include credit, market, liquidity and operational risks. These risks should be identified and
monitored through these steps.

Key types of risks to an individual financial institution

The four key types of risk are credit, market, liquidity and operational risk. These risks are
associated with financial institution. Central bank has to take necessary steps to manage these risks
in the market. The four key types of risk are described below.

Credit risk: Credit risk is the possibility of a loss resulting from a borrower's failure to repay a loan
or meet contractual obligations. Traditionally, it refers to the risk that a lender may not receive the
owed principal and interest, which results in an interruption of cash flows and increased costs for
collection. Excess cash flows may be written to provide additional cover for credit risk. When a
lender faces heightened credit risk, it can be mitigated via a higher coupon rate, which provides
for greater cash flows.

Market risk: Market risk is the possibility of an investor experiencing losses due to factors that
affect the overall performance of the financial markets in which he or she is involved. Market risk,
also called "systematic risk," cannot be eliminated through diversification, though it can be hedged
against in other ways. Sources of market risk include recessions, political turmoil, changes in
interest rates, natural disasters and terrorist attacks.

Liquidity Risk: Liquidity is the ability of a firm, company, or even an individual to pay its debts
without suffering catastrophic losses. Conversely, liquidity risk stems from the lack of
marketability of an investment that can't be bought or sold quickly enough to prevent or minimize
a loss.

Operational Risk: Operational risk summarizes the uncertainties and hazards a company faces
when it attempts to do its day-to-day business activities within a given field or industry. A type of
business risk, it can result from breakdowns in internal procedures, people and systems—as
opposed to problems incurred from external forces, such as political or economic events, or
inherent to the entire market or market segment, known as systematic risk.
Financial Markets
Financial market indicators can provide useful information on the degree of risk accumulation as
well as the degree of stress and disruption in the financial sector. Indicators of risks in the financial
markets can often be extracted from transaction data in the financial markets, whether they are
movements in prices and yields of financial products or net positions of market players.

Prices and yields

A bond's yield is the discount rate that can be used to make the present value of all of the bond's
cash flows equal to its price. In other words, a bond's price is the sum of the present value of each
cash flow. Each cash flow is present-valued using the same discount factor. This discount factor
is the yield. Unusual movements in price and yields of financial products would signal to the
central bank.

Spreads
A spread can have several meanings in finance. However, they all refer to the difference between
two prices, rates or yields. Spread can also refer to the difference in a trading position – the gap
between a short position (that is, selling) in one futures contract or currency and a long position
(that is, buying) in another. This is officially known as a spread trade. The spread between the
yields of riskier and less risky financial products is also known as a credit spread. When times are
good, the credit spread gets narrow. However, risk accumulation in the economy might also rise.

Libor rate
LIBOR is the benchmark interest rate at which major global banks lend to one another. LIBOR is
administered by the Intercontinental Exchange, which asks major global banks how much they
would charge other banks for short-term loans. The central bank has to be careful about the Libor
rate as the banks need to trade in it.
Conclusion
This essay is about monitoring and identifying the risk associated with financial intuition. The
central bank has monitored and identifies the possible risk in the market for keeping financial
stability. In the macroeconomy, the central bank needs to monitor and identify the risk that
economic agents might be unable to repay their debts. This might be done before-hand by
identifying risks of over-indebtedness among households, firms, and the government, as well as
the over-indebtedness of domestic economic agents to external lenders. On the financial
institutions front, risks to individual banks. There are many kinds of risk associated with the
financial institution and they are very hard to find and observe. The main duty of the central bank
is to observe and monitor these risk carefully.