An Overview of Financial and Banking System of Bangladesh:

Structure, Functions, Main Differences between Banks & NBFIs and

the Role of Bangladesh Bank

Basic Concepts:
Finance: Finance is the provision or mobilization of funds from surplus economic units
to deficit economic units. The core function of financial institutions is to transfer fund
from savers to borrowers.

Surplus Units Funds

Deficit Units

Surplus Units: Surplus units are those economic units whose incomes are greater than
their expenditures. They are the net savers.
Deficit Units: Deficit units are those economic units whose expenditures are greater than
their incomes. They are basically net borrowers.

Modes of mobilizing/financing the fund: Mobilization of fund from savers to borrowers

can be done through two ways.
1. Direct Finance: This flow of fund without any intermediary or middleman.
2. Indirect Finance: In this case fund from surplus units is transferred to deficit
units through intermediary. In bank financing this mode is used to flow the funds.
Following is a diagram of

Depositors Bank (As Borrowers

intermediary)

Financial System
Financial system can be defined as a set of institutional arrangements through which
financial surpluses in the economy are mobilized from surplus units and transferred to
deficit spenders.

Alternatively, financial system is a system, which deals with the supply and utilization of
funds to different economic units in most efficient manner within the institutional
framework on most favorable terms & conditions.
The main components of any financial system are-

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 1. Financial Institutions/Intermediaries
2. Financial Instruments
3. Financial Markets

(1) Financial Institutions/Intermediaries

They receive request from the surplus and deficit units on what securities to be purchased
or sold, and they use this information to match up the demand of buyers and sellers of
funds. The modern name of financial institution is financial intermediary (FI), because it
mediates or stands between ultimate borrowers and ultimate lenders.

The financial system of Bangladesh is comprised of three broad fragmented sectors:

1. Formal Sector,
2. Semi-Formal Sector,
3. Informal Sector.

The sectors have been categorized in accordance with their degree of regulation.
The formal sector includes all regulated institutions like Banks, Non-Bank Financial
Institutions (FIs), Insurance Companies, Capital Market Intermediaries like Brokerage
Houses, Merchant Banks etc.; Micro Finance Institutions (MFIs).

The semi formal sector includes those institutions which are regulated otherwise but do
not fall under the jurisdiction of Central Bank, Insurance Authority, Securities and
Exchange Commission or any other enacted financial regulator. This sector is mainly
represented by Specialized Financial Institutions like House Building Finance
Corporation (HBFC), Palli Karma Sahayak Foundation (PKSF), Samabay Bank,
Grameen Bank etc., Non Governmental Organizations (NGOs) and discrete government
programs.

The informal sector includes private intermediaries which are completely unregulated.

The Formal Financial sectors are dominated by the following two categories. They are:
(A) Banking financial institutions
(B) Non-banking financial institutions

To be a bank as a financial institution must render two services simultaneously. The two
services are:
(I) Core services, which include taking deposits and providing loans.
(II) Ancillary services such as bill taking, school fee taking, L/C operation etc.

In Bangladesh banking system is unproportionately higher than the security market.

Banking financial institutions are classified into two categories. They are-
(i) Commercial banks: All State-owned Commercial Banks (SOCBs), Private
Commercial Banks (PCBs) and Foreign Commercial Banks (FCBs) are
clubbed under this category.

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 (ii) Specialized banks: Bangladesh Krishi Bank (BKB), Bangladesh Development
Bank Limited (BDBL), Rajshahi Krishi Unnayan Bank (RAKUB) and BASIC
are under this head.

Difference between Banks & NBFIs

 NBFIs cannot issue cheques, pay-orders or demand drafts.
 NBFIs cannot receive demand deposits,
 NBFIs cannot be involved in foreign exchange financing,
 NBFIs can conduct their business operations with diversified financing modes
like syndicated financing, bridge financing, lease financing, securitization
instruments, private placement of equity etc.
Bottom Line: Liability of Banks is money but liability of NBFIs is other than money

Bangladesh Bank
• Bangladesh Bank acts as the Central Bank of Bangladesh which was established
on December 16, 1972 through the enactment of Bangladesh Bank Order 1972-
President’s Order No. 127 of 1972 (Amended in 2003).
• BB has a 9 members Board of Directors headed by the Governor who is the Chief
Executive Officer of it.
• BB has 40 departments and 9 branch offices.

Role of Bangladesh Bank

• To issue notes and coins
• Banker to the Government
- Custodian of the Government
- All payments of the Government are made through it
- Lender of last resort to the Government
- Advisor to the Government on financial matters
- Manages public debt on behalf of the Government
• Banker to the banks (lender of last resort to the banks)
• To formulate and implement monetary policy
• To formulate and implement intervention policies in the foreign exchange market;
• To hold and manage the official foreign reserves of Bangladesh;
• Clearing house operations
• To regulate and supervise banking companies and financial institutions.
BB Monetary Policy Implementation Tools
• Bangladesh Bank declares the monetary policy by issuing Monetary Policy
Statement (MPS) twice (January and July) in a year.

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 • The tools and instruments for implementation of monetary policy of BB are –
- Bank Rate
- Open Market Operations (OMO)
- Repurchase agreements (Repo) & Reverse Repo
- Statutory Reserve Requirements (SLR & CRR)

(2) Financial Instruments

Financial instruments are the evidences of financial claims of one party (holders) against
another party (issuers). Alternatively, financial instruments are the documents with the
help of which funds from surplus units are mobilized to deficit units. There are two broad
types of financial instruments.
(I) Primary or direct financial instruments: These are the financial claims against
real-sector units. These include loans & advances, shares, debentures etc.
(II) Secondary or indirect financial instruments: These are financial claims
against financial institutions or intermediaries. Examples of these are deposits,
mutual fund, unit certificates, certificates of deposit etc.

Financial instruments can also be classified into the following two categories:
(1) Money Market instruments: securities with maturities within one year or
less are referred to as money market instruments. Money markets
instruments are short-term, highly marketable, liquid, low risk debts
instruments.
(2) Capital Market instruments: Securities having maturities more than one
year are called capital market instruments. This includes. Long-term
securities. Securities in the capital market are much more diverse than those
found in the money market.

Money Market Instruments

Treasury Bills: These represent the simplest form of borrowing. The government
raises money by selling bills to public. Investors buy the bills at a discount from the
stated maturity value. At the bills maturity, the holder receives from the government a
payment equal to the face value of the bills. The difference between the purchase
price and ultimate maturity value constitutes the investors earnings. Different
maturity T-bills are available in the markets. Example: 28-day, 91-day, 182-day and
364-day.

Certificate of Deposit: large commercial banks and other depository institutions

issue this as a short-term source of funds. Non-financial corporations often purchase

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 CDs. Generally its denominations is very high, $1 million is more common.
Certificate of deposit is a time deposit with a bank. The time deposit may not be
withdrawn on demand. The bank pays interest and principal to the depositor only at
the end of the fixed term of the CDs.
Commercial Papers: large well-known companies as short-term unsecured debt
notes often issue Commercial papers. It is normally issued to provide liquidity or
finance a firm’s investment. Commercial papers maturities range up to 270 days.

Bankers’ Acceptance: Through this instrument a bank accepting responsibility

for a future payment. It is commonly used for international trade transactions.
Exporters often prefer that banks act as guarantor before sending goods to importer
whose credit rating is not known. The bank therefore facilitates international trade by
stamping ACCEPTANCE on a draft, which obligates payment at a specific point in
time. In turn, the importer will pay the bank what is owed to the exporter along with a
fee to the bank for guaranteeing the payment.

Eurodollars: Eurodollars are currencies deposited in a bank outside the country

of its origin. For example, dollar denominated deposits at foreign banks or foreign
branches of American banks are Eurodollars. Most Eurodollar deposits are for large
sums, and most are time deposit of less than six months maturity.
Repo and Reverse Repo: Repo means repurchase agreements. Dealers sell
government securities to an investor on an overnight basis, with an agreement to buy
back those securities the next day at slightly higher price. The increase in price is the
overnight interest. The Reverse Repo is the mirror image of the Repo.

Federal Funds: Funds in the banks reserve account are called federal funds. The
federal funds market allows depository institutions to effectively lend or borrow
short-term funds from each other at the federal fund rate. In Bangladesh commercial
banks are supposed to keep 18% of their deposit amount to the central bank.

LIBOR Market: The London Inter Bank Offered Rate (LIBOR) is the interest
rate at which large banks in London are willing to lend money themselves. This rate,
which is quoted on dollar-denominated loans, has become the premium short-term
interest rate quoted in the European money market, and it serves as a reference rate
for a wide range of transactions. For example, a corporation might borrow at a
floating rate equal to LIBOR + 2%.

Capital Market Instruments

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Fixed Income Securities
Treasury Notes and Bonds: Government borrows funds in large part by selling
treasury notes and bonds. T-notes maturities range up to 10 years, whereas T-bonds
are issued with maturities range from 10 to 30 years.
Federal Agency Debts: Some government agencies issue their own securities to
finance their activities. These agencies are usually formed to channel credit to a
particular sector of the economy. Some of the agencies are federal home loan bank
(FHLB), federal national mortgage association (FNMA), government national
mortgage association (GNMA), etc.

Municipal Bonds: state and local governments usually to finance infrastructure

development issue these. Exempt from taxation by the federal government and the
state that issued the bond, provided the investor is a resident of that state. Varying
degrees of default risk, rated similar to corporate debt. Two types of Municipal bonds
are General obligation bonds and Revenue bonds.

Corporate Bonds: Corporate bonds are the means by which private firms borrow
money directly from the public. The bonds are similar in structure to treasury issues-
they typically pay semiannual coupons over their lives and return the face value to the
bondholders at maturity. Corporate bonds are classified in different ways. Some these
are as follows:
 Secured Debt: These securities are classified according to the collateral and the
mortgage used to protect the bondholder. Collateral is a general term that
frequently means securities that are pledged as security for payment of debt.
Mortgage securities are secured by mortgage on the real property of the
borrower. For example, land, building.
 Unsecured Bond (Debenture): This frequently represents unsecured
obligations of the company. A debenture is an unsecured bond, for which no
specific pledge of property is made. Debenture holders only have a claim on
the property not otherwise pledged. In other words, the property that remains
after mortgage and collateral trusts are taken into account.
 Senior Bond: In general, seniority indicates preference in position over other
lenders, and debts are sometimes labeled as senior or junior to indicate
seniority. Some debt is subordinate. In the event of default, holders of
subordinate debt must give preference to other specified creditors.

 Callable Bond: A call provision allows the company to repurchase or “Call”

part or all of the bond issue at sated prices over a specified period. Corporate

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 bonds are usually callable. A bond that, during a certain period, cannot be
redeemed by the issuer is called call-protected bond. During this period of
prohibition, the bond is said to be non-callable bond.
 Convertible Bond: A convertible bond can be swapped for a fixed number of
shares of stock anytime before maturity at the holder’s option. Convertibles are
relatively common, but the number has been decreasing in recent years.

Equity Securities
Equity securities describe several equity instruments, which differ from fixed income
securities because their returns are not contractual. As a result we can receive returns that
are much better or much worse that what we would receive on a bond. There are two
types of equity securities.
(a) Common tock: Common stock represents ownership shares in a corporation.
Features of common stock are voting right, proxy voting, classes of stock,
share proportionally in declared dividends, share proportionally in remaining
assets during liquidation, preemptive right.
(b) Preferred Stock: A class of stock in which the stockholder is entitled to
dividends but unlike on common stock, dividends are a specified percentage
of par or face value. It also has priority over common stockholder in dividends
and distributions in the event of liquidation. Preferred stock does not carry any
voting rights.

Derivative Securities
Derivatives are financial agreements between two parties whose payments are based on,
or derived from the performance of some agreed-upon benchmark. Different forms of
derivative instruments are
 Forwards
 Futures
 Options
 SWAP
In business, derivatives can be powerful speculative securities. For example, companies
often use forwards and exchange listed futures to protect against fluctuations in currency
or commodity prices, thereby helping to manage import trades. Options can serve as
similar purpose; interest rate options such as caps and floors help companies control
financing costs.

(3) Financial Markets

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Financial markets are the markets where financial instruments are bought and sold. It is
mechanism by which borrowers and lenders get together. Financial markets facilitate the
flow of funds from surplus units to deficit units. Financial markets are of two types.
1. Money Market: Money market is that financial market that facilitates the flow
of short-term funds (with maturities of less than one year)
2. Capital Market: Financial market that facilitates the flow of long-term funds
(maturities more than one year) is known as capital market.

Capital Market can be classified into two types. They are-

(a) Primary Market: Primary market is the market where security of a company
is issued for the first time to the general investors. Primary market transaction
provides funds to the initial issuer of the securities. The process of issuing
new securities is called Initial Public Offerings (IPOs).
(b) Secondary Market: The market in securities and other financial assets are
traded among investors after corporations have issued them and public
agencies are called secondary market. Secondary market facilitates the trading
of existing securities. Transaction in this market does not provide anything to
the issuing firm.

Financial Markets may also be divided into two categories, namely

(a) Security Market: Security portion of financial market comprises New Issue
Market (NIM) and Secondary market, which is again composed of stock
exchange (SE) market and over-the-counter market (OTC)
(b) Non-Security Market: Banking and non-banking sector markets are these
category markets.

The financial market in Bangladesh is mainly of following types:

1. Money Market: The primary money market is comprised of banks, FIs and
primary dealers as intermediaries and savings & lending instruments, treasury
bills as instruments. There are currently 15 primary dealers (12 banks and 3 FIs)
in Bangladesh. The only active secondary market is overnight call money market
which is participated by the scheduled banks and FIs. The money market in
Bangladesh is regulated by Bangladesh Bank (BB), the Central Bank of
Bangladesh.
2. Capital market: The primary segment of capital market is operated through
private and public offering of equity and bond instruments. The secondary

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 segment of capital market is institutionalized by two (02) stock exchanges-Dhaka
Stock Exchange and Chittagong Stock Exchange. The instruments in these
exchanges are equity securities (shares), debentures, corporate bonds and treasury
bonds. The capital market in Bangladesh is governed by Securities and
Commission (SEC).
3. Foreign Exchange Market: Towards liberalization of foreign exchange
transactions, a number of measures were adopted since 1990s. Bangladeshi
currency, the taka, was declared convertible on current account transactions (as on
24 March 1994), in terms of Article VIII of IMF Article of Agreement (1994). As
Taka is not convertible in capital account, resident owned capital is not freely
transferable abroad. Repatriation of profits or disinvestment proceeds on non-
resident FDI and portfolio investment inflows are permitted freely. Direct
investments of non-residents in the industrial sector and portfolio investments of
non-residents through stock exchanges are repatriable abroad, as also are capital
gains and profits/dividends thereon. Investment abroad of resident-owned capital
is subject to prior Bangladesh Bank approval, which is allowed only sparingly.
Bangladesh adopted Floating Exchange Rate regime since 31 May 2003. Under
the regime, BB does not interfere in the determination of exchange rate, but
operates the monetary policy prudently for minimizing extreme swings in
exchange rate to avoid adverse repercussion on the domestic economy. The
exchange rate is being determined in the market on the basis of market demand
and supply forces of the respective currencies. In the forex market banks are free
to buy and sale foreign currency in the spot and also in the forward markets.
However, to avoid any unusual volatility in the exchange rate, Bangladesh Bank,
the regulator of foreign exchange market remains vigilant over the developments
in the foreign exchange market and intervenes by buying and selling foreign
currencies whenever it deems necessary to maintain stability in the foreign
exchange market.

Financial Market Participants

The participants of financial market may be classified into FOUR groups according to
their behavior in the market:

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► Investors: Individuals and firms buy financial assets for income. They expect from
holding such assets in the form of dividends and interest. They prefer stability of income.
► Speculators: They hold financial assets to take the benefits of price changes. They
generally buy at lower price and sell at higher price. Professional speculator quite often
trade in the financial market.
► Hedgers: They hold financial assets in order to hedge. “Hedge” occurs when different
types of assets are held in order to have offsetting price management. Higher price of
some securities would offset the lower price.
► Arbitragers: Arbitrage takes place when an asset is bought in one market and
simultaneously sold at higher price in another market.

Central Bank (Bangladesh Bank) is the financial supervisor and regulator for non-
security portion market and Securities and Exchange Commission (SEC) plays the role of
supervisor and regulator for security portion of the financial market.

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 FINANCIAL SYSTEM OF BANGLADESH

BBO 1972
Financial Supervisor/Regulator MRA Act 2006
(BB/SEC/IDRA/MRA)

Financial Institutions Financial Instruments IDRA Act 2010

Financial Markets
SEC Act 1993

BCA Formal Semi-Formal Informal

1991 Money Foreign Capital Security Non-
Market Exchange Market Market Security
Market Market
Banking Insurance MFIs
NBFIs 1. Specialized
Financial Companies (599)
(31) Financial
Institutions (18 life, 44 Excluding
Non-
(47 scheduled, 4 General) Grameen Institutions: Banking
non-scheduled Bank - HBFC Banking
FIA Ins. Act. Primary/ Secondary/
- PKSF
1993 2010 - Samabay Bank Direct Indirect
Capital Mkt. New Issue Secondary
Scheduled Banks - Grameen Bank (Loans & (Deposit, BCA FIA
Intermediaries: Market
1. Commercial Advances, Mutual Fund, Market 1991 1993
- Investment/ 2. NGOs (IPO)
- SOCBs - 4 Merchant
shares, Unit Certificate,
- PCBs-30 Banks (51), Debentures CDs)
(23 conen, 7 Islami) - AMCs (15),
- FCBs - 9) - Stock Exchanges
MRA
2. Specialized - Stock Broker
Act
Contract Act, N.I. Act
(BKB, BDBL, & Dealer TP Act, BBE Act, Organized Over-The-
2006 Stock Counter
RAKUB, BASIC) (DSE 238, MLC Act, BR Act etc
CSE 136) Exchange Market
- Central Depository (DSE, CSE) (OTC)
Non-Scheduled
- Credit Rating
Banks Agencies (5),
- Ansar VDP
- Trustees (9) &
-Karmashanosthan
Custodians (9) Page 11 of 11
- Probashi Kollyan
- ICB
- Jubilee