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Background of Money Market in Bangladesh As an integral part of the financial market of a country, money market provides a medium for

the redistribution of short-term loan able funds among the financial institutions. The money market of Bangladesh reached its present phase through a series of changes and evolutions. Structurally, money market in Bangladesh is composed of two broad groups of institutions: formal and informal. The formal institutions (up to February 2005) include Bangladesh Bank, 4 NCBs, 30 PCBs, 10 FCBs, 5 Specialized Banks (SBs) and 28 Non-bank Financial Institutions (NBFIs). Informal institutions comprises mainly of the moneylenders and small co-operative organizations which are not under the control of central bank. The five distinct components under the organized segment of money market in Bangladesh are: inter-bank market, call money market, bill market, repo market and reverse repo market. Among them inter-bank call money market is very important for the financial institutions for their required fund management. A short brief on the above five markets is given below. Inter bank market in Bangladesh operates in a limited scale in the form of inter bank deposits and inter bank borrowings, and has virtually no interest rate 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 deposit and borrow as and when needed against the lien of those deposits. Usually, small banks keep their funds as deposits with large banks for their safety. Non-bank financial institutions also take part in this market by way of lending their fund to the deficit banks. The inter bank transactions are concentrated mainly in Dhaka city. Call money market was initially a part of inter-bank market. In 1980s, banks participated in a limited scale in the call money market mainly to wipe out the temporary mismatch in their assets and liabilities. Formation of private banks during the 1980s provided new opportunities to develop the call money market. In 1985, two investment companies and in 1989, one leasing company were allowed to participate in the call money market. But at present, all banks including specialized banks and non-bank financial institutions are allowed to participate in this market. Bill market is restricted to buying and selling of government treasury bills. Commercial banks and non-bank financial institutions are obliged to buy these bills as approved securities to meet their Statutory Liquidity Requirement (SLR) under the Banking Company Act. Moreover, these instruments are being used to mop up excess cash from the banking sector and help government to borrow money from the banks to meet its budgetary shortfall. But the commercial bill market remains very narrow in our country. Treasury bill rate largely influences the market rate of other segments of the money market, particularly, the rate of interest in the call money market.

Repo market is a market in which securities are exchanged for cash with an agreement to repurchase the securities at a future date. Repo is attractive as a monetary policy instrument because it carries a low credit risk and serves as a flexible instrument of liquidity management. Scheduled banks and financial institutions are the participants of this market. Reverse repo auctions were introduced in FY 2003 as a counterpart of repo auctions with the view to limiting excess funds that the banks offered in the reverse repo auctions. The reverse repo auctions are used as a fine-tuning supplement to the weekly treasury bills auctions to mop up excess liquidity. Money Market Participants It is usually well known that in money market there are two main participants: supplier and demander of money market securities. It is quite natural that participants in the money market acts both supplier and demander of loans and securities. Generally, the participants in money market are: i) individual ii) Business and iii) Government; More specifically, we can identify different participants as: 1) Government Treasury Department They are the only demander of fund. 2) Central Bank They are both supplier and demander of fund. 3) Commercial Bank They are both supplier and demander of fund. 4) Business They are also both supplier and demander of fund. 5) Investment and Securities Firm a. Investment Companies/Bank b. Finance Companies c. Insurance Companies d. Pension Fund etc 6) Individuals ; Nature of the Participants in the Money Market: In inter bank money market there are three types of participants: a. Only lender b. Both Borrower and lender c. Only borrower All NCBs, most of SBs and some FCBs are the lender of the inter bank money market. Some PCBs who are well recognized and financially sound, borrow a lot of money from NCBs, SBs and FCBs and lend it to other PCBs and NBFIs. Therefore, they played as the unofficial intermediaries in inter bank money market. These types of PCBs at first take the opportunity of borrowing money at a low interest rate from the NCBs, SBs and FCBs and lend it to other PCBs and NBFIs at a higher interest rate and earn a lot of profits. Therefore, these banks are responsible in raising the interest rate during the period of a shortfall of fund. The third type of participant in the inter bank call money market is financially weak banks and NBFIs. They are

only borrowers in the inter bank money market and have to take loans at a very high rate of interest. Nature of the Access to the Money Market as a Borrower: In the inter bank call money market every bank or non-bank financial institution has not had an easy access to borrow money from any bank. Basically NCBs and FCBs lend money at a low rate. But all the banks and NBFIs cannot borrow money from NCBs and FCBs because they are not well trusted by them. Naturally well-established and financially sound PCBs have got the priority to borrow money from NCBs and FCBs. So, the financially weak banks and NBFIs have borrowed money from intermediaries in the money market. This scenario in the money market influences interest rate for upward fluctuations. Nature of the Necessity of Borrowing: The necessity of borrowing money from the inter bank money market is not similar all the time. At a particular point of time, deposit withdrawal by the public may create a shortfall of fund in some banks. This behavior of the public may be judged during the Eid-festival. Excessive credit expansion is another reason for banks to borrow money from the inter bank money market. Besides these, any change in the monetary policy regarding reserve requirement, foreign exchange management, open market operations and other policy related issues by the central bank may create a shortfall of fund of the banks. Thus, the nature of the necessity for borrowing money is a factor for upward rising of interest rate in the inter bank money market. Features of Call Money Rate Call money market is the most sensitive part of money market, in which a good number of players from banking sector as well as the non-bank financial sector actively participate on a regular basis. The transactions of call money market are concentrated mainly in Dhaka. 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 organization, the transaction in call money market usually takes place on the basis of bilateral negotiations among the financial institutions. The NCBs are the main source of fund in the call money market. The cost of funds for FCBs is very low as compared to the local banks but they prefer to preserve the excess reserve rather than lend in the inter bank money market mainly because of lack of confidence. The NBFIs are now participating in the inter-bank money market in both borrowing and lending but they borrow more than lending. Therefore, they play an important role in the inter bank money market. In Bangladesh changes in the inter bank call money rate were more pronounced than the bank rate i.e. the rate at which the central bank lends to the scheduled banks.

Effects of High Call Money Rate in the Economy Increases the Cost of Fund: The high interest rate in inter bank money market increases the cost of fund of the weak banks and NBFIs may incur loss by frequent borrowing at a high interest rate. Therefore, the financial health of the

weak NBFIs may be lost by the borrowing of money from the inter bank money market at a high interest rate. Increases the Interest Rate in other financial markets: High interest rates in inter bank money market can push the interest rates in other financial markets, like borrowing from foreign exchange market, financial derivatives and other instruments in financial markets. Moreover, an increase in interest rate will negatively affect the investment. Creates Volatility in Financial Market: High interest rates in inter bank money market increases the volatility in financial market. Borrowing money from inter bank money market at a high interest rate by the NBFIs may create panic in the financial sector which may result a loss of credibility of NBFIs and may also create a liquidity crisis. From the recent behavior in the inter bank money market, it may be concluded that the need for additional inflow of cash may arise from different reasons. One bank can not expect what is going to be happened in the other bank at a particular period of time due mainly to bilateral negotiations among the financial institutions. The situation is almost uncontrollable for any bank which feels the need of additional inflow of cash. Under the circumstances banks need to come to central bank for soft lending like discount loan, repo facilities etc. But central bank has some limitations regarding outflow of money due mainly to keep the price level stable. Therefore, the banks/NBFIs have no other way but to borrow their necessary fund from the inter bank money market at a high rate of interest which may help the market to be volatile. But to keep the interest rate in the inter bank money market at a reasonable level, central bank has already advised (FID circular No-01, dated on 05/03/2005) the NBFIs to avoid their high dependency on call money market and also advised to seek their required fund through credit line, mortgage-based securitization, asset securitization etc. as the substitute source of call money market for their long-term fund. Accordingly, it has been decided that all registered Financial Institutions (FIs) will be allowed to borrow money maximum 15% of their net asset from the call money market from July 01, 2005. Besides these, we may recommend the following policy options to limit the upward fluctuations in call money market of our country: a. The central bank can consider soft lending through its repo operations for those banks and NBFIs who are financially weak. b. To eliminate unofficial money broking business by the banks, a money broking house/company may be established. c. Prudential guidelines may be issued for the participants so that the call money market should be perfectly competitive. For example all banks/NBFIs having excess cash reserve, should have willingness to participate in the inter bank call money market for lending their fund. d. Prudential guidelines may also be made for the utilization of money from inter bank money market. Banks and NBFIs should mention the purpose of borrowing money from the call money market in their daily statements. In this regard, penalty may be charged for the banks those have taken the opportunities of borrowing money at a low interest rate and lend it to other banks/NBFIs at a high interest rate during the same period.

e. A strong data base on call money information (including the name of borrower and lender; bank-wise highest, lowest and weighted average interest rates on borrowing and lending; bankwise amount of borrowing and lending etc.) along with a monitoring cell may be formed by the central bank for close monitoring of the movement of call money market etc.