Role of Central Bank in a Developing Economy: A Study on Bangladesh Bank

Abstract

The Central Bank is the apex institution in the financial system of every economy. Unlike the developed countries, in most of the developing economies, Central Banks shoulder a larger array of responsibilities. Bangladesh Bank being the Central Bank of Bangladesh has been entrusted with functions with a view to stabilizing domestic and external monetary value and promoting and maintaining a high level of production, employment and real income in the country. To achieve these objectives, Bangladesh Bank anchored on multi-dimensional functions. It incorporated a wide range of reform measures and adopted a host of development activities also. The study aims at critically evaluating the role of Bangladesh Bank in a developing economy like Bangladesh. It is strongly argued that the Central Banks of the developing countries should undertake promotional functions along with the traditional functions. The specific rationales of the promotional role and the prospective avenues through which the Bank can proceed with development initiatives have been explored in this dissertation. Attempts have been made here to trace the structure, functions and growth trends of Bangladesh Bank. Formulation and implementation of Monetary Policy is one of the key functions of Bangladesh Bank like any other Central Bank of the world. The Monetary Policy of the Bank has been analyzed in this thesis in terms of the policy targets, intermediate targets and the employed instruments. The evolving role of Bangladesh Bank as a banker of the banks has been analyzed categorically. Attempts have been made to unearth the role; Bangladesh Bank plays towards the Government. The reforms, which the Bank embarked upon at times, have been critically evaluated in the dissertation. Attempts have also been made to examine the promotional functions of Bangladesh Bank. For the above mentioned analysis, time series data have been used under a blend of methods consisting of content analysis, historical and storytelling, etc. in the framework of a case study. The analysis is primarily quantitative, though qualitative method has also been applied. In this research, growth rates like Simple Growth Rate (SGR) and different ratios have frequently been used as measuring indicators. Except these rates and ratios, percentage share of some variables in relation to some measure of National Income or in respect to some other variables have commonly been used throughout the research. The rationales of the Central Bank’s promotional role, identified in this study are basically and mostly the characteristics of the developing country’s backward financial system, where the unique position of the Central Bank assume the added responsibility of developmental role. Among the characteristics of the developing economies the generally existing dualism of traditional and modern sector, undue concentration of banking business risks, the narrowness of the long-term capital market, inadequate commercial bank financing in some vital but apparently not credit-worthy sectors are significant. The study organized the promotional functions in seven areas like fostering the growth of the banking system and institution building, acting as a bank for the general public, ensuring supply of long-term capital to different sectors, financing the underserved sectors, pursuing selective credit policy to channel credit to a particular real market, widening the functional scope of the commercial banking system and playing catalytic and innovative role in the reorientation of goals and objectives of financial institutions towards socially responsible lending practices along with providing guidelines for the planners, publishing financial sector information, promoting research and providing training for the bank officials. A nine member Board of Directors Chaired by the Governor directs the affairs and business of Bangladesh Bank. All of the members of the Board are nominated by the government. The traditional functions of Bangladesh Bank are akin to those of any other Central Bank of the world. Starting from the Bangladesh Bank Order 1972 to the Bangladesh Bank (Amendment) Act 2003 and thereafter the functions were made broader-based. Growth trends of the balance sheets of the banking department and the issue department have been analyzed in this dissertation. Monetary Policy in Bangladesh is formulated around price stability and economic growth rates as the basic policy targets. Bangladesh Bank pursues the Policy within a framework of monetary targeting where levels and growth paths of reserve money and broad money are projected and monitored as operating target and intermediate target respectively. The instruments in the Monetary Policy include Bank Rate, Repurchase Agreement (Repo) and reverse repo interest rates of Bangladesh Bank, the Cash Reserve Requirement (CRR), Statutory Liquidity Ratio (SLR), credit control and credit rationing. The growth of broad money in Bangladesh has been found erratic. In FY2011, broad money growth rate was 21.34 percent which was lower than the 22.44 percent growth rate recorded in Fiscal Year 2010, but higher than the growth rate of 19.17 percent in Fiscal Year 2009. Without a few exceptions, the actual growth rate of broad money was higher than its projected growth rate. In the composition of reserve money ‘Net Foreign Assets (NFA)’ always held a big share. As NFA remains practically outside the control of Bangladesh Bank, the large share of NFA in the reserve money composition implies substantially limited control of Bangladesh Bank over broad money. The second largest source of reserve money ‘Net Credit to Government’ derives mainly from Government budget deficits and thus manifests fiscal dominance. It was found that, during the period of 1970s, Bangladesh Bank pursued an easy Monetary Policy to support the nationalized corporations and to reconstruct and rehabilitate the war-torn infrastructure. Prior to 1990, the Policy was based on a method of direct control over various instruments. Since the adoption of Financial Sector Reform Program in 1989-90, the policy stance has been gradually shifted towards indirect control. Until the earlier months of FY2005, Bangladesh Bank continued with the growth supportive accommodative monetary stance. Inflationary pressure caused by supply shocks in the world market and depreciation of Taka against major currencies and an adverse trend in the current account balance drove the Bangladesh Bank to switch from the accommodative to a tightened Monetary Policy stance from the third quarter of FY05. Bangladesh entered into a floating exchange rate regime effective from May 31, 2003. The transition to floating exchange rate regime proved smooth in Bangladesh. The study found unorganized money market, narrow security market; external factors, lack of central bank independence, etc. are posing limitations to the efficacy of Monetary Policy of Bangladesh Bank. As a banker of the banks, Bangladesh Bank was found to address all the major aspects of the financial system of the economy. It formulated many regulations, policies, guidelines and adopted different measures. These were also revised occasionally to upgrade to international standard and to meet the changing need of time. The functions of Bangladesh Bank towards the banks have been included into nine groups in the present study. Bangladesh Bank undertakes various functions on behalf of the Government obligated by the Bangladesh Bank Order 1972. The most important one among the functions is debt management. The Bank has a separate department namely Debt Management Department at its head office. There is a high profile Cash and Debt Management Committee (CDMC) for this purpose. The Bank provides advances to the Government mainly to meet budget deficits. It provides ‘ways and means’ loan to the Government, undertakes sale and purchase of various Treasury Bills, NSD certificates and various bonds and collects revenue on behalf of the Government. Bangladesh Bank performs the Government’s treasury functions. It provides advices to the Government on financial and economic issues whenever called upon to do so. The reforms undertaken in the banking sector of Bangladesh have multi-dimensional background weaved by economic, historic and conditionality factors. Broadly the reform measures include interest rate deregulation, implementation of new system of loan classification and provisioning, new capital adequacy requirement, new supervision, operational and management tools, and lastly, reforms in the legal framework. It was revealed from the analysis of the reform measures that, the objectives of the initiatives remained largely unfulfilled and in some cases the situation deteriorated instead of improving. Price competition situation was deteriorated in the post-reform period. The reform measures could not generate better efficiency in resource allocation to productive sectors. It is found that, quality of loan portfolio was not enhanced significantly. Comparing to the neighboring countries, the percentage ratio of NPLs to total loans was found to be the highest with huge margin in Bangladesh. The banks were found continuously failing to maintain the required level of provisions against their classified loans. It was also found that, loan classification norms of Bangladesh are not up to the international standard in terms of length of overdue. But the requirement for provisioning fixed by Bangladesh Bank is consistent with international standard. The indicators employed under the CAMELS framework indicate overall institutional inefficiency especially for the NCBs and the DFIs. Flaws in the reform design and sequencing, ineffective and weak legal framework, supervisory and regulatory forbearance of Bangladesh Bank, ownership conflict of the reform programmed, lack of commitment on the part of the Government, even in some cases Government-led distortions were found to be the main causes for the poor outcome. To attain developmental objectives, Bangladesh Bank adopts mainly a financial inclusion approach. It has been found playing development role in the areas of agriculture, industry, Small and Medium Enterprises (SME) and women entrepreneurship, export, customer interest protection, automation of the banking system, green banking, etc. From FY 2011-2012, Bangladesh Bank obligated the banks to set annual agricultural/rural credit disbursement target at 2.5% of their total loans and advances. In FY 2010-11, disbursement of refinance facility in agriculture was TK. 1.86 billion and the outstanding amount of refinance in the same year was TK. 56.03 billion. The Bank launched refinance scheme for the sharecroppers, extended agricultural credit at concessional four percent interest rate to encourage domestic production of pulse, spices, lentils and oilseeds, and promoted crop diversification. It facilitated establishment of agro product-processing industries in the country. The Bank introduced opening of a bank account by a farmer by keeping only ten taka as initial deposit. As a result, financial inclusion as percentage of adult population increased from 65.33 percent in 2004 to 87.23 percent in 2010. Bangladesh Bank is trying to encourage investments in the risky but prospective agro-based/food processing and IT sector projects and to provide term finance for infrastructure and other investment projects and to promote private sector entrepreneurs in the development of capital projects. To promote Small and Medium Enterprises (SME) a new department namely ‘SME and Special Programmes Department’ has been established in Bangladesh Bank. In 2010 the Bank formulated the “SME Credit Policy and Programs, 2010”. At present the Bank with the help of Government and different development partners, is implementing five refinance schemes. Till 30 September 2012, Taka 25.72 billion has been refinanced against 32,018 SMEs. For women entrepreneurship development, Bangladesh Bank directed the banks and financial institutions to put highest priority in receiving loan application from small and medium women entrepreneurs and settle the loan disbursement process within very reasonable time. Bangladesh Bank allocated at least 15 percent of total Bangladesh Bank refinance fund for women entrepreneurs at a reduced rate of ten percent. In FY 2011, SME loan facilities of TK. 20.48 billion have been extended to women entrepreneurs. At present Bangladesh Bank is implementing Export Development Fund (EDF) to enhance export through facilitating access to financing in foreign exchange for input procurements by manufacturer-exporters. The Bank raised the fund to USD 400 million. The Bank introduced Deposit Insurance Scheme and created a Deposit Insurance Trust Fund (DITF) to protect the interest of the customers of the banking sector. The Bank established ‘Customers’ Interest Protection Centre’ (CIPC) at its head office and at the branch offices and advised the banks to set up a "Complaint Cell" in each bank. Upto September 2012, 79 percent of the complaints received through CIPC have been resolved. Recently Bangladesh Bank has established a new department namely ‘Financial Integrity and Customer Services Department’ at its head office for dealing with complaints of the customers of the banks and financial institutions more easily and quickly. Bangladesh Bank launched some initiatives to make the banking system modern technology based, efficient and secure. The Bank initiated green banking practices in the financial sector of Bangladesh. As of October 2012, Taka 838.4 million has been refinanced to environment friendly green projects. In the financial inclusion approach the Bank facilitated opening bank accounts for hardcore poor, unemployed youth, freedom fighters, and beneficiaries under social security program, distressed people, small life insurance policy holder and aila affected people by depositing small amount of money ranging from Taka ten to one hundred only. The Bank also took steps to make the banking services easily accessible to the physically handicapped people. The inclusive approach followed by the Bank is a very timely one. But the measures so far taken are yet to be fully able to address the demand side problems of the financially excluded sections of the population. It seemed that, Bangladesh Bank is over burdened with numerous objectives and functions to carry on satisfactorily with the existing capacity. The functions and objectives may be curtailed to reasonable level. The Bank should try to address the demand side problems of the financially excluded sections of the population. It should follow a comprehensive and well-coordinated development agenda to be more effective. A central authority for collecting and publishing banking sector related data should be raised. A well articulated co-ordination between Monetary Policy and Fiscal Policy is warranted. Substantial independence is a pre-condition for Bangladesh Bank to perform its expected role effectively.