Money Market

Money Market is an integral part of a country's financial market. In this part of the financial market, short-term loanable funds are traded among the financial institutions. Usually, these transactions are carried out at market-based prices i.e., interest rates. However, financial institutions trade their short-term surplus funds even at the central bank policy rates. Shariah compliant financial institutions trade their short-term surplus funds at mudaraba profit rates declared among themselves. At the same profit rate, they can borrow from Bangladesh Bank. Banks, having liquidity surplus provide short-term loans and liquidity deficit banks borrow the funds at market-based profit rates. Beside the common borrowing-lending process banks can collect funds by discounting their financial instruments like deposit certificates, bills, treasury bills and treasury bonds even. A vibrant money market can ensure free flow of funds at a reasonable rate. These short-term lending rates are also used as reference rates in other fund markets.

The money market in Bangladesh is in its transitional stage. The various constituent parts of it are in the process of formation, while continuous efforts are being made to develop appropriate and adequate instruments to be traded in the market. At present, government treasury bills of varying maturity, Bangladesh Bank Bills and Certificates of Deposits etc in limited supply are available for trading in the market. However, the short-term credit market of the banking sector experienced a tremendous growth since liberation. In 1999, a total of about 6000 branches of the scheduled banks provided short-term credit throughout the country in the form of cash credit, overdraft and demand loan. The rates of interest are determined by the individual banks and as such the market is quite competitive. Each bank maintains its liquidity and supply of fund is arranged throughout the country with the help of an interconnected network of branches. bangladesh bank as central bank of the country exercises its role in this market through the use of instruments such as bank rate, open market operations and changes in statutory liquidity requirements.

The money market of Bangladesh has improved gradually. Since liberation, fund flow has increased in multiple folds and the money market has developed from its scope, depth and size through use of short-term credit, overdraft facility and cash credit. Since the late 1980s, private sector banks made the money market more competitive. It results in evolving a competitive interest or profit rate through market driven demand and supply of funds. At the end of June 2021, about 10, 788 bank branches created both fund demand and fund supply.

Although at the beginning of the 1980s, steps were taken to make the country's banking sector competitive money by denationalisation of two nationalised banks and establishment of some private banks, the continuation of restricted regime acted as a deterrent factor for the functioning of market-based activities. Absence of instrument was also a major problem towards this end. However, these steps added a new dimension in competition among the banks particularly, in mobilising and deployment of deposit reflecting economic cost. With this development money market, for the first time assumed the characteristics of a competitive structure in the country. Later on, government allowed a large number of banks and non-bank financial institutions both domestically and foreign owned, to operate in the country. This created a scope for vibrant money market in the country.

It may be noted that before 1990, in its true sense there was no money market in the country as majority of the economic activities were directly or indirectly under the control of state authority. Bangladesh Bank was the ultimate and only source of finance for the banks to meet their crises and the role of Bangladesh Bank was to ensure the supply of fund in the economy. The Financial Sector Reform Programme (FSRP), initiated in January 1990 opened up the opportunities for the development of a virtual vibrant money market by removing many of the long-established restrictions and bottlenecks. Deregulation of lending activities and interest rates, abolishment of priority lending culture and liberal general refinance arrangements from Bangladesh Bank created a ground for market based financial activities in the country. In addition to these, a comprehensive study programme was undertaken by the FSRP team to explore the possibility of introducing market bases instrument in the country. Subsequently, after amendment of Bangladesh Bank Order, new money market instruments such Bangladesh Bank bills of 91-days and 30-days maturity were introduced. In 2021, 7-Day BB Bill and 14-Day BB Bill are also available in the money market. Besides some new government treasury bills with different maturities were also introduced to accelerate the pace of development of money market in the country. Bangladesh Bank also introduced certificate of deposits (CDs) in limited scale for the banks. Thus, money market started its journey to play a catalytic role for the development of the country. Simultaneous steps for trade and exchange rate liberalisation added a new dimension to these developments.

Introduction of secondary market for government securities in FY 2003 is a major event in the history of money market in Bangladesh. To facilitate development of secondary market, Repo and reverse repo were introduced for the banks and financial institutions. For effective liquidity management the banks collateralised by the government securities use these facilities. Moreover, for the first time Primary Dealers (PDs) were appointed to deal in securities both in primary and secondary market. At present (up to 2021) twenty-two primary dealers are operating in the market.

Constituents of money market Despite a large-scale expansion of banking sector as well as non-bank financial institutions, the country's money market is still segmented into two groups: formal and informal. The formal institutions (up to 2021) include the Bangladesh Bank (Bangladesh Bank Order 1972) at the apex, 6 states owned commercial banks (President order 1972), 42 domestic and 9 foreign private commercial banks(formed during 1983 to 2021), 3 specialised (development) banks (formed during 1973 to 2018), 35 NON-BANK FINANCIAL INSTITUTIONS, a number of non-scheduled banks. Informal institutions comprised mainly the moneylenders and small co-operative organisations, which are not under the control of the central bank. The four distinct components of organised segment of money market of Bangladesh are the inter-bank market, Call money market, Market for Repo and Reverse Repo, and Bill market. In addition, 2 stock exchanges, one central depository, 66 merchant banks, 51 asset management companies, 12 securities custodians and 8 credit rating agencies under Bangladesh Securities and Exchange Commission (BSEC) and 35 life insurance and 46 general insurance companies under Insurance Development and Regulatory Authority (IDRA) are also assisting money market.

Inter-bank market operates within a limited scale in the form of inter bank deposits and borrowings and has virtually no fixed price fixing mechanism. Traditionally, scheduled commercial banks lend to each other when they are in need of temporary funds. Sometimes, banks also keep a part of their resources to other banks as deposits and borrow as and when needed against the lien of those deposits. Small banks usually keep their funds as deposits with large banks for safety.

Non-bank financial institutions also take part in inter-bank market operations in Bangladesh by way of lending their fund to the deficit banks. The inter-bank transactions are concentrated mainly in Dhaka city but may also be found in other parts of the country. As part of fund management, branch offices of banks, which can not send their surplus funds to their respective head offices, usually keep them in their nearest big branch or in other banks and draw the funds back as and when needed.

Inter-bank transactions, although constitute an integral part of money market, comprise a small portion of total banking activities. Inter-bank deposits as percent of total deposits varied between 2 and 5 percent during 1986-99. This indicator was between 1.6 and 2.5 percent during the FSRP period of 1990-96. However, in the 2001-2010 period, the average inter-bank deposit amount was 3.4 percent of the total deposits, which decreased to 2.4 percent in the 2011-2020 period. At the end of June 2020, the total amount of inter-bank deposits was Tk 400.5 billion, which is 2.5 percent of the total deposits in the same period. At the end of June 2020, excess liquidity in the banking sector increased to Tk 1.4 trillion due to low credit demand grounded from the Covid pandemic.

The deposit resources of banks registered an increase of Tk 122.6 billion or a yearly average growth of 22% during the period between June 1986 to June 1991 and 18% during June 1991- June 1998. That the money market is not much developed in Bangladesh is depicted from the growth pattern of deposits of the country.

Certificate of deposit was introduced as a money market instrument in Bangladesh in 1983. Its objective was to strengthen the money market and bring idle funds, including those arising from black money and unearned incomes, within the fold of the banking system. The Bearer of Certificate of Deposits (BCD) with a fixed maturity is issued by and payable at the bank to Bangladeshi nationals, firms and companies. The certificate does not contain the name of the purchaser or holder. The interest rate is not fixed as in the case of other deposit resources accepted by the banks at present.

The interest is determined on the date of issue of CDs based on the demand and supply of funds in the money market. The difference between the face value of CDs and the prepaid interest is received by the bank from the purchaser of CDs at the time of issue. The bearer of CDs can sell the same to another purchaser. The bank maintains no record other than the Certificate No., rate of interest allowed, and the date of sale and encashment. A bank does not issue certificate of deposits for the value exceeding the limit prescribed for it by the Bangladesh Bank.

Some important changes are also discernible in interbank market during FY 2000 to 2010. The Certificate of deposit had already been discontinued. Deposit resources of the banks registered an increase of over 30% on an average during this period indicating increased financial deepening of the country. Because of emergence of a very active call market and opening up of the scope of secondary market for bill/bond, the importance of interbank market in traditional sense lost its importance which is reflected in lower volume of transaction in this market.

Call money market is the most sensitive part of money market, in which a good number of players from the banking as well as the non-bank financial sector actively participate on a regular basis. Initially, this market developed as an inter-bank market where the banks in temporary deficit of cash resorted to borrowing from other banks having surplus funds. As banks were in the public sector until the beginning of the 1980s, the Bangladesh Bank provided them with liberal refinance facilities at concessional rates. There was hardly any need for raising funds from the call money market during this period. Moreover, administered interest rate regime, easy availability of borrowing from central bank and its directive to provide credit to priority sectors were the major impediments in development of a call money market in the country. Notwithstanding the fact, banks participated in a limited scale in the call money market mainly to wipe out the temporary mismatch in their assets and liabilities.

A turning point was the denationalisation of Uttara and Pubali Bank in 1983 and 1984 respectively and the government decision to allow private banks to operate in the country. Formation of private banks during the 1980s provided new opportunities to develop this segment of money market. In 1985, two investment companies and in 1989, one leasing company were allowed to participate in the call money market. At present, all banks including specialised ones and non-bank financial institutions are allowed to participate in this market.

Basic features the transactions of call money market are mainly Dhaka based. Since, the head offices of all banks and financial institutions are located in Dhaka, the branches of the banks and financial institutions from all over the country remit their excess funds to their respective head offices at Dhaka for investment. The head offices, after meeting their usual liquidity requirement invest the surplus funds in the call money market.

As there is no brokerage house or intermediary organisation, the transactions in call money market usually take place on the basis of bilateral negotiations. Since call loans are made on clean basis, ie, without any security, lending institutions/banks are always cautious in the selection of borrowing banks/institutions.

Foreign banks are the main source of liquidity in the call money market. Cost of funds for foreign banks are very low as compared to the indigenous banks and as such they can hold a substantial amount of excess liquidity for lending in the call money market. In case of borrowing, they are also at a very advantageous situation as compared to the local banks. Foreign banks have in their portfolio lower amount of non-performing loans compared to domestic private banks and nationalised banks. Local private banks appear to be the regular borrowers in the call money market.

Information systems of banks in Bangladesh are outdated. Market players therefore, do not know much about the demand for and supply of fund. Banks and financial institutions having surplus funds take advantage of the market imperfection of domestic deficit banks.

Bangladesh Bank has circulated some guidelines to the lending and borrowing banks and financial institutions regarding operations in the call money market. Although it is not compulsory for banks to participate in the call market, they are advised to provide call loans considering liquidity, solvency and sources of repayment of borrowings by the borrowing institutions.

The demand for and supply of funds in the call market remains volatile throughout the year with some occasional turbulence. The transactions and the rate of interest are largely linked with government treasury bill market, seasonality in demand for bank loans, central bank's monetary policy, variation in discount rate, open market operations, changes in statutory reserve requirements, excess liquidity position of the banks etc. The transactions and the variations of the rate of interest in call money market normally remain high during November to April and as such the rate of interest during this period also goes up.

The underdeveloped nature of the inter-bank market in Bangladesh is evident from the large spread between the highest and lowest rates in the call money market. The lowest call money market rate always remained higher than the Bank Rate during the period from September 1985 to June 1992. One notable feature of the call money market is that the spread between lowest and highest call money market rate has been larger during the reform period. It is because of the fact that with the implementation of FSRP, the need for funds of banks other than the Bangladesh Bank increased with abolition of easy refinance facility from the central bank. Thereafter, the lowest inter-bank call money rate remained lower than the bank rate. The inter-bank call money rate varied with rise in excess cash reserves of banks.

Experience suggests that when there was a sufficient excess reserve with banks, the inter-bank rate came down but the rate denoted increase with the accentuation of shortfall in reserves position of banks. Compared to nationalised banks and domestic private banks, the foreign banks in general, and Islami banks in particular, held higher excess reserves with them. Foreign banks are the major sources of supplier of funds to the inter-bank market in recent years. Before the introduction of financial sector reforms, foreign banks preferred preserving excess liquidity to lending to inter-bank market partly because of lack of confidence and partly because of instructions from their head office. In addition, the information gap between borrowing and lending banks also discouraged transactions in the inter-bank market.

The rate of interest in the inter-bank call money market reached a maximum of 22.9% in November 1997. It recorded highest at 35.4 percent in 2002, 35 percent in 2003, 54.7 percent in 2004, 120 percent in 2005 and 190 percent in 2010. However, those higher rates were sudden and applied for a very insignificant amount, and in fact, had no market impact. After 2013, inter-bank call money rate did not cross single digit. At the end of June 2021 interbank call money rate was 2.25 percent.

The call money market exhibited highest volatility during FY 2001to FY 2006 due to prevalence of some unusual events and policy changes of Bangladesh Bank. Changes in the procedure of CRR calculation with local currency only instead of with the balances in foreign currency clearing account, increased borrowing by the government from the domestic market and picking up of credit demand from the private were the driving factors for fluctuation in call money rates. The behavior of the Primary Dealers (PDs) also seems to be responsible for this as despite adequate liquidity support from the BB, they are unwilling to provide repo facility to the deserving banks, rather they are more interested in call lending at higher rate. At the same time some local private banks in the market having large non-performing loan and less capitalized had no easy access in the market. Due to this segmentation of the market, the healthy banks, including Sate Owned Banks were unwilling to lend those through call market and very often they are compelled to borrow through a broker bank at a very exorbitant rate to avoid Bangladesh Bank's stiff penalties for non-compliance of Reserve Requirements. Moreover, in the deregulated regime many banks emerged as aggressive profit maxi miser and deploying their excess fund without considering liquidity maturity profile. Whenever, these banks faced liquidity shortfall, they rushed to the market without considering interest rate impact

Bill market is restricted to buying and selling of government treasury bills. In the past, it was basically concentrated in transaction of government treasury bills of 3-month maturity at predetermined rates. Commercial banks were obliged to buy these bills as approved security to meet their statutory liquidity requirement (SLR) under the Banking Companies Act. Moreover, these instruments were being used to mop up excess cash from the banking sector and help government to borrow money from banks to meet its budgetary shortfall. In fact, it was a guilt-edged market where both the principal and interest was guaranteed by the government. Bangladesh Bank, on behalf of the government, was entirely responsible for arranging buying and selling of treasury bills. However, the availability of the government treasury bills depended only on the fiscal consideration of the government. Bangladesh Bank had no scope of its own to increase or decrease their supply. Besides, interest rates were not market based and were fixed arbitrarily by the government from time to time. In addition to the commercial banks, Bangladesh Bank also had to hold a portion of government treasury bills.

The commercial bill market remained very narrow in the country largely due to a low level of industrialisation and a slow growth of trade and commerce. Banks traditionally financed two broad categories of commercial bills viz inland bills and export bills. These bills are marketable papers and can be resold in the market at a competitive rate. Usually, the holders of these bills sell them for cash to the banks, which pays the holder the face value of the bills less collection charges and the interest for the remaining period of the bill. Prevalence of cash credit system of the banks is a major hindrance in the way of the development of an active commercial bill market in the country. Stamp duty, procedural difficulties and reluctance of the drawees of bills to undertake the additional paper work involved in handling documents etc hindered the development of commercial bill market. With the introduction of FSRP, the commercial bill market is gradually developing in the country.

This added a new dimension in the bill market of Bangladesh. The bill was issued at a discount at par value of Tk 100 through monthly auctions held at the Bangladesh Bank. Banks, financial institutions and others including individuals, firms, companies and corporate bodies were eligible to invest in the Bangladesh Bank Bill. The bill was introduced primarily to control liquidity of the banking system in accordance with the requirement of monetary policy. The ultimate objective was the development of a workable secondary market for successful open market operations by the Bangladesh Bank. Later, Bangladesh Bank introduced 30-day Bangladesh Bank Bills. The frequency of auctions of these bills was also increased.

Despite regular auction of Bangladesh Bank Bills, government treasury bills continued its normal transaction in the market. However, following the declaration of Bangladesh Bank Bills as approved securities for the SLR purposes, the effectiveness of the bills weakened as an instrument of monetary control. The auctions of Bangladesh Bank Bills were, therefore, suspended from March 1997. On the other hand, the auctions of the four categories of government treasury Bills i.e, 30-day, 90-day, 180-day and 1-Year Bills were held on weekly basis regularly up to August 1998. The newly introduced 28-day, 91-day, 182-day, 364-day, 2-year and 5-year government treasury bills replaced these treasury bills later since September 6, 1998.

Treasury Bills continued to be the main instruments for monetary policy management till now although some major adjustments have been made up to 2010. As a part of this, in FY 2004 auctioning of Treasury bill of 5-year maturity had been discontinued. In auction procedure, the Treasury Bills are issued through treasury style French auction whereby the allotments are awarded to the bids which fulfill the notified issue amount starting from the lowest yield. Pro-rata partial allotments are also made for bids at the cut-off-yield. Another notable development of Treasury bill market is that with effect from October 20, 2003, electronic registry bases transactions of these instruments has been introduced in the country. Sale/purchase and transfer of treasury bills among the banks and financial institutions are being done through online mechanism. These new marketing strategies and arrangements have widened the base and will also help in deepening the financial market of the country. The market-based system of auction of Treasury Bills through publishing auction calendar containing date and amount was introduced in FY 2007. However, for matching the tenor of Treasury Bills with international convention, auctioning of 2-year treasubillrys had been dropped. Moreover, the auctioning of 28-day treasury bills had been discontinued to avoid the overlapping with 30-day Bangladesh Bank Bill from 1st July 2008. With these, at present the treasury bills of 91-day, 182-day and 364-day are being continued for sale/purchase in the market. To maintain money market liquidity at expected level, the central bank started operation with short maturity instruments: 30-Day BB Bill in 2009 and 7-Day BB Bill & 14-Day BB Bill in 2016 and those are still in operation.

Besides, to mobilise long term fund from domestic sources for financing government expenditure programme Bangladesh Government Treasury Bonds (BGTB), bearing half yearly interest coupons, with tenors of 5-year, 10-year, 15-year 20-year have been introduced which are being traded in the money market. These bonds are issued at par through yield based multiple price auction mechanism held in Bangladesh Bank with effect from 2007. These bonds can be used in the market to avail repo facilities.

The main features of the bill market are still a largely captive market financial institutions having no SLR obligations and corporate or non-corporate firms, semi-government or autonomous bodies having temporary surplus funds or the institutions having pension funds are investing in government treasury bills /bonds through auction mechanism under non-competitive bid. Thus, the scope of bill/bond market is growing in the recent year. Secondary market of this segment is increasing gradually which will largely remove the illiquidity of the instrument. The instruments are sold to the banks and financial institutions only on the basis of borrowing requirement of the government through auctions. [Syed Ahmed Khan and Abdus Samad Sarker]