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The Current State of the Financial Sector of Bangladesh: An Analysis

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 The Current State of the Financial Sector of
Bangladesh: An Analysis
Chu V. Nguyen, Anisul M. Islam, Muhammad Mahboob Ali

Office of Research and Publications (ORP)

American International University-Bangladesh (AIUB)

Working Paper No. AIUB-BUS-ECON-2011-03

Citation
Chu V. Nguyen, Anisul M. Islam, Muhammad Mahboob Ali (2011). The Current State of the
Financial Sector of Bangladesh: An Analysis. AIUB Bus Econ Working Paper Series, No
2011-03, http://orp.aiub.edu/WorkingPaper/WorkingPaper.aspx?year=2011

November 2011

Copyright © 2011 American International University-Bangladesh (AIUB)

1
 The Current State of the Financial Sector of Bangladesh:
An Analysis

Abstract

The financial sector of Bangladesh is generally small and underdeveloped. This sector consists of a
banking segment and an emerging but still nascent capital market segment. The banking segment in the
country is relatively more developed than the equity market segment, even though both are quite
underdeveloped in international comparison. The root causes of the Bangladeshi financial sector
problem are the lack of market discipline due to lack of competition in the banking industry. Excessive
government intervention and political connections, economic and political corruptions, operational
and managerial inefficiency and ineffectiveness result in vicious circle that inhibits economic
development, industrialization, and social progresses in poor and developing countries in general and
in Bangladesh in particular. Authors’ suggested that in the financial regulation should be
strengthened and further needed reforms should be carried out. In addition, an ombudsman may be
appointed in the financial sector. The ombudsman can act independently to investigate any complaints
regarding financial services and must work freely and independently. Better financial services and
diversified financial products would be the natural consequence of competitive financial industry. The
authors argue that a strengthened regulatory environment and additional much needed financial sector
reforms, a better and more efficient financial sector may evolve over time and serve better the
development needs of the country.

Keywords: Financial sector, financial institutions, investment bank, NGOs, Bangladesh

JEL Classifications: G21 ,G24

2
1.0 Introduction

Since the independence of the country on December 16th, 1971 until December 1989, the Bangladeshi
financial sector has been controlled under the strict directives of government and Bangladesh Bank-the
Central Bank of Bangladesh. From 1974, the discount rate policy was often used to support Bangladesh
Bank’s administered interest rate policy. In the early years of Bangladesh, discount rate, reserve ratios
and moral suasion (known as open mouth operation) were important instruments to control money
supply. With the introduction of Financial Sector Reform Program in 1990, the Bangladesh Bank
almost closed both the refinance and rediscount windows with a view to developing an inter-bank
market. Nevertheless the central bank kept the discount rate between 5-8 percent. Any bank that needed
finance started approaching the inter-bank market instead of Bangladesh Bank’s windows; thereby,
discount rate policy, though intentionally, lost its credibility.

The financial sector of Bangladesh is generally small and underdeveloped. This sector consists
of a banking segment and an emerging but still nascent capital/equity market segment. The banking
segment in the country is relatively more developed than the equity market segment, even though both
are quite underdeveloped in international comparison. The primary research question of the study is to
examine the current state of the financial sector and whether it can play an important and necessary role
in resource mobilization and economic development of the country. A brief analysis of the two major
segments of the country’s financial system is given in the following two sections, with the banking
segment discussion first followed by a discussion of the equity market segment. The next section
discusses challenges; the final section providing some concluding remarks

2.0 Banking Industry

In the banking segment, immediately after the independence of the country in 1971, the then
government nationalized the commercial banks (except a few foreign banks) and organized them into
six distinct banks by the Bangladesh Bank (the central Bank of the country) nationalization order 1972.
As saving and investment in the country is very low, in order to channel saving and investment through
the formal sector and to expand banking services in the remote areas of the country, the nationalization
of the banking sector was considered as one of the major objectives at that time. The central bank,
known as the Bangladesh Bank (BB) is the central body to oversee the banking sector of the country
and at that time, the BB directly controlled the interest rates (both lending and deposit rates) by fiat
(Nguyen et al. 2010-b).

During this time, bank branches have expanded rapidly, particularly in the rural areas. On the
positive side, the expansion of bank branches reduces transaction costs associated with the mobilization
and transfer of funds and to thereby to increase savings and investments, and deposit creation. But due
to corruption, mismanagement, and government interference, many branches of the commercial banks
cannot work properly and some branches incurred heavy losses, and some of these branches were
subsequently closed down. To overcome these problems, financial sector reform program has started in

3
earnest since 1990. These reforms include flexible interest rate, convertibility of ‘taka’, introduction of
91 days bill, recapitalization of banks, and new procedures for loan classification system, introduction
of REPO in the money market, and strengthening of money and capital markets. Although before 1990,
open market operations and bank rate policies were hardly used, currently they are getting emphasis
due to change in the post-reform policy environment (Nguyen et al. 2010-b).

In the initial years after independence, six nationalized commercial banks (NCB’s) dominated
the banking segment. In the post reform period, the structure of the banking system has changed
significantly. Total numbers of scheduled banks are forty seven. As part of the reform program, some
NCB’s were privatized, foreign ownership of banks has been opened up, and additional new
commercial banks were allowed to start and operate. Consequently, the banking system in the country
consists of several NCB’s along with a number of home based privately owned commercial banks
(PCB’s), some foreign owned commercial banks (FCB’s), some privately owned Sharia compliant
Islamic banks (IB’s) and some state owned specialized financial institutions (SFI’s) such as the
Bangladesh Krishi (agricultural) Bank and Bangladesh Development Bank ltd., all under the
supervision of the central bank. Besides that, the Investment Corporation Bank (ICB) also plays vital
role as an investment banking .Unfortunately for the last ten years, their services were not active like
previous time periods, though it has been divided into three wings with the objective of improving its
performance.

In spite of many different kinds of banks operating side by side, and even though the central
bank no longer directly control the lending or deposit rates in the post-1990’s reform period; however,
a strong competitive and efficient banking system has not yet developed. The banking system is mired
in corruption, mismanagement, and direct interference from government in power. Further, the
commercial banks still do not determine interest rate under competitive environment. Rather they are
determining interest rates (both lending and deposit rates) within an oligopolistic framework, possibly
following some collusive or cartel type arrangements. This is perhaps true for all types of banks,
nationalized banks, domestic private banks and foreign owned banks.

The last decade witnessed some major policy shift as the Bangladesh Bank introduced
repurchase agreement in July 2002 and Reverse Repo in April 2003 and reintroduced Bangladesh Bank
Bill in 2006. These were introduced as indirect monetary policy tools for day-to-day liquidity
management in response to temporary and unexpected disturbances in the supply of and demand for
money. The initiatives of the Central Bank to face the situation through reform measures since 1990 no
doubt have improved the capital adequacy, governance, regulation and supervision, and the legal and
payment systems in the economy. Ali(2003) nowadays, the traditional banking business system of the
country through depositing and advancing of money has almost ended. Segmentation in the banking
system is required so that banks’ can provide a broad range of financial services. Through fund
management, banks can earn profit.

The banking sector has evolved to become the dominant financial intermediary in Bangladeshi
financial system due to the underdeveloped money and capital markets, limited availability of financial

4
instruments, and lack of confidence in the financial system as a whole. Bangladesh Bank still cannot
determine monetary policy independently (Nguyen et al. 2010-b). Government is still playing
important role in the financial sector as borrowers from the banking system. In Bangladesh, there is
very limited scope for individuals to invest in the capital markets and lack of alternative opportunities
for investment compelled them to invest mainly in bank deposits, post office saving certificates and
government bonds. Banks operate with old and outdated banking procedures, lack of coordination
between proper manpower planning and bank schemes, lack of market research for customer
psychology analysis, scarcity of financial derivatives, inefficient banking services, and lack of long
term planning, to name a few, are creating bottlenecks preventing local banks from attaining
international standards Ali (2005). Though reform measures in the financial sector were initiated in the
nineties, the overall stability and performance of the banking sector is still not satisfactory.

Financial institution managers in general, and bank managers in particular, in this country
does not properly assess risks as well as the costs of various types of bank sources of funds. While
managing their financial assets, the financial institutions were not cautious about handling funds with
the utmost care. Lack of ethics in the banking sector is a part of a wider and long lasting socio-
economic and political problems in Bangladesh literature (Ahmed et al. 2006, Ali 2003, Mian et al.
2005, and Mujeri et al. 2008).

Loopholes in the financial sector are a part of the overall corruption that plagued almost all
segments in the country. Unhealthy competition among different banks display lack of ethics in doing
banking business. Variation of higher interest rate and profit paid to the client sometimes involve
bankers in immoral practices. In the name of trade unionism, especially nationalized commercial
banks, trade union leaders create unethical work culture in Bangladesh. Pervasive corruption in
Bangladesh is a form of agency problem in which bank management tries to maximize the amount of
its personal gains (bribery) has been documented in the literature.

ADB (2011) argued that the half-yearly monetary policy statement (MPS, July-December
2011) aims to continue the central bank’s tighter monetary policy stance to rein in credit expansion to
control inflation and preserve external sector balance. Economic Trends (2011) indicated that the
annual rate of inflation increased to 9.43 percent at the end of August ‘11 from 7.87 per cent at the end
of august ’10.

Bangladesh Bank (2011) described that in bolstering stability of the financial sector include
mandatory implementation of the BASEK –II capital regime from 2010,with the attendant shoring up
of risk management structures and practices that this will entail. Mandatory periodical stress testing
routines in banking sector have also been introduced to bring out early warnings about their
vulnerabilities.

Bangladesh Bank cannot guide commercial banks as evidenced by the fact that commercial
banks are charging higher interest rates, even cross the limit of margin requirements, taking high
spread between buying and selling rate of foreign exchange and devaluation of Bangladesh Taka

5
against US Dollar has been going on. As such inflation rate is rising and purchasing power of the
people has been declining Moreover, commercial banks are investing in the share market to gain short
term profit since 2005 making depositors deposit risky as in Bangladesh if any bank fails then there is
no reinsurance system from which depositors get their amount. These problems cannot be corrected
without the infrastructure of the more modernized banking sector and proper staffing in the top
management level i.e. Deputy Governor posts where one should be macroeconomic specialist and
another one should have depth knowledge in practical commercial banking and developing an
effective and efficient market economy. Moreover, government should take appropriate steps to
develop bond market so that it can contribute in the growth of Gross domestic Product.

From the countercyclical monetary policy time lag perspective, empirical research suggests
that when formulating the current countercyclical monetary policy, Bangladesh Bank is influenced by
its actions taken in the last three quarters and the change in the real GDP a year ago. The
countercyclical monetary policy actions and the change in the real GDP a year ago affect the current
change in the real GDP. Stated differently, it will take two quarters for the implemented countercyclical
policy to achieve it effectiveness fully (Nguyen et al. 2011-a). Customarily, the time period when the
adverse economic condition occurs until the corrective policy action achieves its effectiveness fully is
divided into the recognition lag, the formulating and implementing lag, and impact lag (Nguyen et al.
2011-a). Thus, however long it take for the Bank of Bangladesh to recognize the macroeconomic
problem and to formulate and implement the corrective policy actions, it will take two quarters for the
implemented countercyclical monetary policy to achieve its full effectiveness.

3.0 Equity Markets

As to the capital market segment, Bangladesh is still at a nascent stage of capital market development.
It is well documented in the literature that a well-functioning capital market is of great significance for
a developing country like Bangladesh which is expected to help the country’s development by
channeling domestic saving to productive investments, attracting foreign investors to the market, and
allocating the national savings most efficiently, among others. However, as in many other developing
country equity markets, the Bangladesh equity market is relatively underdeveloped, it is small, the
market is thin and non-transparent, and it is quite inefficient (Bashar, Hassan and Islam (2007).
Bangladesh has two major exchanges, the Dhaka Stock Exchange (DSE) and the Chittagong Stock
Exchange (CSE). The DSE is the larger of the two stock exchanges in the country. Formal trading on
the DSE began in 1956 two years after the establishment of the East Pakistan Stock Exchange Ltd. on
April 28, 1954. It was renamed as the East Pakistan Stock Exchange Limited on June 23, 1962, and
finally came to be known by its present name of the Dhaka Stock Exchange (DSE) Limited on May 14,
1964.

Prior to the independence of Bangladesh in 1971, there were 196 securities listed on the DSE with a
total paid-up capital of about Taka 4 billion and the daily average transaction of shares during that
period was about 20,000 (Basher, Hassan and Islam 2007). Trading activity of the Exchange remained

6
suspended since the start of the war of liberation in 1971 until it restarted in 1976. When the DSE
restarted in 1976, the DSE had only 9 listed companies with a paid-up capital of approximately Taka
137.52 million and at the end of that year total market capitalization of listed securities was about Taka
146.73 million. By 2002-03, the number of listed companies has grown to 251 companies listed with
the DSE having total issued capital of Taka 35,537 million (US$ 612 million) and total market
capitalization of Taka 72,167 million (US$ 1,244 million). In 2008, the number of listed companies is
about 295 with a market capitalization of about US$ 7,067 million (Basher, Hassan and Islam 2007).

The second stock exchange, the Chittagong Stock Exchange (CSE) was established in 1995
and started its operation in that year with 30 listed securities. Like the DSE, the CSE has been
registered as a public limited company and is a self-regulated non-profit organization. It has currently
129 members even though there is a provision for up to 500 memberships. The foreigners can also
become member of the CSE. But unlike the DSE, every member of the CSE has to be a corporate body.
On September 30, 2003 there were 187 listed securities with the CSE. On the same day, the total issued
capital and market capitalization of all listed securities with the CSE stood at Taka 33,085 million (US$
570 million) and Taka 59,855 million (US$ 1,032 million), respectively (Basher, Hassan and Islam
2007).

In terms of regulatory structure, the capital markets of Bangladesh received its first legal
backing with the passage of Securities and Exchange Ordinance in 1969. More than two decades later,
in 1993, the Securities and Exchange Commission (SEC) was established under the Securities and
Exchange Act, 1993. The functions of the SEC include regulation of equity trading, protection of
investors, ensure legislative and regulatory compliances, and promote a fair, transparent and efficient
security markets. To supervise and regulate the activities of the capital markets in Bangladesh, the SEC
does it by performing constant real time monitoring and post-trading analysis of transactions in the
DSE and the CSE.

The underdeveloped and non-transparent nature of the capital market in Bangladesh provides
ample opportunities for unethical and even illegal manipulations resulting in market crashes as
happened in 1996 (as reflected by a steep decline of the market capitalization value in US$ shown in
Figure 1 below). Such unwarranted crashes usually cause severe financial damages to investors,
particularly many small investors and erode confidence in the markets. This painful episode occurred at
both stock exchanges in summer and fall of 1996. During this episode, DSE index increased from 832
in January 1996 to its peak at 3,567 on November 14, 1996 and back down to 507.33 in November
1999. To control the damages caused by the 1996 crash and with the support from Asia Development
Bank (ADB), Bangladesh government introduced the Capital Market Development Program in
November 20, 1997 with several objectives such as to (i) strengthen market regulation and supervision,
(ii) develop the stock market infrastructure, (iii) modernize stock market support facilities, (iv) increase
the limited supply of securities in the market, (v) develop institutional sources of demand for securities
in the market, and (vi) improve policy coordination.

7
Ali and Wise (2007) argued that Bangladesh capital market is not yet well-developed. Figure 1 shows
the time trend of the number of listed companies along with the market capitalization in US$ from
1988 to 2008. This graph suggests that the stock market has grown rapidly from 101 companies with a
market capitalization of US$ 430 million in 1988 to 295 companies with market capitalization of US$
7,067 million in 2009, an impressive growth rate of 1,543% in market capitalization value over about
20 year time period. But the even with this growth rate, the market capitalization as the percentage of
GDP is still quite low compared to international standard.

Figure 1: Listed companies and Market Capitalization in Bangladesh: 1988-2009

300
8.E+09 Left Scale: Market Cap Value US$
Right Scale: No. of Listed Companies
250
6.E+09 No. of Listed Companies
200

4.E+09
150

2.E+09 100

Market Cap Value (US$) 50

0.E+00
88 90 92 94 96 98 00 02 04 06 08 10 Year
Source: W orld Bank: W orld Development Indicators CD Rom database

The market capitalization as the percentage of GDP increased from 1.68% in 1988 to about 8.39% in
2008, also an impressive growth. But this rate for Bangladesh (BGD) compares quite poorly compared
to India (IND), Pakistan (PAK), and South Asia (SAS) as shown in Figure 2, which shows BGD line is
at the bottom of Figure 2 below the other reference countries. In fact, the ratio for India and South Asia
reached around 150% and 125% of GDP respectively in 2007, just before the crash of the markets due
to the 2007-09 global financial crisis. It is worth noting that the Bangladesh capital market showed
resilience in the face of this massive crisis. However, given the relatively low market capitalization-
GDP ratio of 8.39% in 2008, it appears that Bangladesh capital market needs much more development
in order to catch up even with its comparable neighboring countries.

Figure 2: Market Capitalization as % of GDP: 1988-2009

160
% of GDP IND
Market Cap as % of GDP

120

80
SAS

40
PA K

BGD
0
88 90 92 94 96 98 00 02 04 06 08 10 Year

Source: W orld Bank: W orld Development Indicators CD Rom Database

8
As to the relationship between Bangladesh money supply and the share price index, Figure 3 shows the
two monthly percentage changes in the stock price index narrow money supply from 1999.01 to
2010.01. This Figure shows that both series has displayed significant month to month fluctuations.
Further, the apparent synchronized co-movement of the two series gives preliminary indications that
the two series would likely be co-integrated (Nguyen et al. 2010-c).

Figure 3: Relations between Changes in Money Supply and Share Price Index: 1999.01-2010.01
30
% SPt: % Change in Sh are Price Ind ex (Right Scale)
20
10
0
12 -10
8 -20

4 -30

-4
MSt: % Change in M1 (Left Scale)
-8
99 00 01 02 03 04 05 06 07 08 09
Month / Year

Source: Data obtained from International Financial Statistics databas

As to the long-run relationship, empirical studies confirm the co-integration relationship between the
stock price index and the narrowly defined money supply. In fact their co-integrating relationships are
asymmetric. This asymmetric relationship indicates that the counter cyclical monetary policies affect
the cost to raise new financial resources of corporations differently in different phases of business
cycles in the long-run. More specifically, the results reveal that the stock price adjusts more slowly to
the threshold value when the Bangladeshi monetary authority eases the money supply than when the
Bangladeshi monetary authority tightens the monetary policy. These findings suggest that the stock
price is more responsive to signals of possible contractionary monetary policy as reflected in the
decline money supply M1. These in turn indicate that equity (debt)-market-dependent firms are more
vulnerable to business cycle fluctuations (at least in regard to their cost of capital) than firms with
access to other sources of financing. Thus, policymakers should be aware that counter-cyclical
monetary policy may have different effects due to the asymmetric behavior of stock prices in their
formulation of monetary policy.

Further, in a recent article, Chu and Ali (2011) found that due to the common characteristics associated
with poor developing countries, their equity markets are not even weakly efficient. This is not viewed
positively given that most well developed countries have efficient equity markets. This observation
coupled with the status of a poor developing country and their attendant problems suggest that to
develop an efficient equity market, Bangladesh should first concentrate its efforts on developing better
market infrastructures for a more effective market economy. In this environment, a strong political will
to reform the system and a strong commitment to implement the reforms are needed to establish a more
competitive and efficient overall market economy that would be conducive for building an efficient
stock market.

9
With regard to the short-run relationship, empirical studies further reveal that the short-run counter-
cyclical monetary policy is ineffective in stimulating or cooling down the equity market i.e., the stock
price responds to monetary policy action in the long-run but not in the short run (Nguyen et al. 2010-c).
These empirical result suggest the lack of central bank creditability, i.e., investors do not believe that
central bank can carry out its policy objectives; thus, they wait and see. The Bangladesh Bank (Central
Bank of Bangladesh) may have personally persuaded the commercial bankers to change their rate
setting behavior because there are few of them, and there may be some incentives for banks to listen.
The Bangladesh Bank authority cannot utilize the same tactic to deal with investors because there are
more of them and they may not have any incentive to listen.

Further, there are many allegations of insider trading, market manipulation, and corruption in
the equity market, leading to demonstrations by investors in the country on a number of occasions,
eroding confidence in the equity market. Unfortunately, neither the government including the
Securities and Exchange Commission, nor any regulatory authorities including the Bangladesh Bank
had taken serious steps to deal with these allegations in a serious and effective manner to restore
investor confidence in an already small and unstable market environment.

4.0 Challenges

With regard to the Bangladeshi corrupted business environment and for whatever it is worth, the
Transparency International (2009, 2008, and 2007) ranked Bangladesh as the 147th, 147th, and 162th,
most corrupted country out of 180 nations that it studies, 1st being the least corrupted. Moreover, Ali
(2005) reported that 75% of the unethical practices in the banking sector are attributable to the personal
gain motivation, 20% due to the business interest of banks such as charging high interest rates in the
call money market or discrimination of charging commission or service charges from one customer to
another. Only 5% of unethical practices are attributable to social reasons such as waiver of interest up
to Tk. 10,000 against agricultural loans. Though this waiver is done due to the Government decision, it
creates inequality among those persons who have taken loans. When such waiver is made, those who
are not benefited get jealous and their interest is not protected. Moreover, when big defaulters get a
lump sum amount of waiver for rescheduling, those who are regularly paying interest think that they
are being deprived!

One of the consequences of corruption is that the pervasive default culture in the Bangladeshi
economy, as evidenced by huge amount of nonperforming loans, which prevented reductions in loan
pricing. This is because cost of funds is high. Through moral suasion, Bangladesh Bank has been
requesting reduction in lending-deposit rate spread in veil because with the exception of few public
banks, other banks want to earn “super normal profits” resulting in high lending rates. Lack of ethics in
the banking sector is a part of wider and long lasting socio-economic and political problems in the
country. Loopholes in the banking sector are a part of the overall corruption that plagued almost all
segments in the country. There is a dilemma between the making money and business ethics.

10
Corruption is the buyer-seller collusion resulting higher business cost structures and raising simulated
shortage of funds in general, and in the banking sector, in particular.

As a direct the consequence of extensive government interventions in the form of licenses and
permits as well as directives, the ownership of private institutions and management and control of
public institutions are given to a few interests (individuals or businesses) who are well-connected
politically, explicitly or implicitly resulting in monopoly and oligopoly type behavior in the banking
and financial system. The monopolistic and oligopolistic market structures coupled with the political
connections of a few powerful individuals and corruptions would invariably lead to cartels and price
fixings. These factors would hinder the effectiveness of national economic policy actions and result in
asymmetric adjustment in product and service pricing, and an unfair distribution of national income in
favor of the few (Nguyen et al. 2010-a). Naturally, these above-mentioned phenomena would likely
result in higher lending rates, lower deposit rates and hence higher lending-deposit rate spread as well
as predatory pricing behavior in the banking industry.

Customarily, originating loans would provide some non-interest incomes besides the interest
incomes to the originating institutions in any economic environment. However, in a fairly corrupted
environment, there may be some “other benefits” for both the originating institutions and possibly their
management as well. Naturally, it is easier to ask for and the borrowers are more likely to agree to
providing “other benefits” in the declining lending rate environment than when the rate is rising.
Certainly, a decline in deposit rate widens the spread, which allows lending institutions to originate
loans at lower lending rate and still maintain the old spread. This coupled with the high elasticity of
demand precipitate a significant increase in demand for loans, which in turn will create opportunities
for lending institutions and their management to generate lucrative “other benefits” and hence the
observed quicker responses. Asymmetrically, in the rising rate environment, the new loans must be
generated at higher lending rate and the possibly negative attendant impacts on “other benefits” do not
provide attractive opportunities for lending institutions and their management, and hence the observed
slower responses. As aforementioned, Bangladeshi banking industry is operating in the high rate,
corrupted environment, when deposit rate changes causing changes in the spread, lending institutions
must weigh the marginal non- interest benefits to both the originating institutions and their
management against marginal loss in interest income in originating new loans at the new lending rate
to restore the spread to the threshold. This benefit maximizing process in the face of highly elasticity of
demand for loans precipitated by high rate environment would be a very plausible explanation of the
empirical findings of the above pattern of the asymmetric adjustment process in the Bangladeshi
banking industry (Nguyen et al. 2010-b).

Another challenge for the banking industry in the country is with electronic banking such as
online banking. This system was introduced since 2009. Ali (2010) argued that, although online
banking has bright prospects, it involves some serious financial risks. The major risk of online banking
includes operational risks (e.g. security risks, system design, implementation and maintenance risks);
customer misuse of products and services risks; legal risks (e.g. without proper legal support, money

11
laundering may be influenced); strategic risks; reputation risks (e.g. in case the bank fails to provide
secure and trouble free e-banking services, this will cause reputation risk); credit risks; market risks;
and liquidity risks. Therefore, identification of relevant risks, and formulation and implementation of
proper risk management policies and strategy formulations and implementations are important for the
scheduled banks while conducting online banking system.

It is theoretically well articulated and supported by empirical studies that investment in

physical capital or otherwise is inversely related to the level of market interest rates. Moreover, the
positive relationships between investments and economic growth as well as social progress are well
established. National economic policy consists of three components: Monetary policy, fiscal policy and
exchange rate policy. These three policies must be coordinated to achieve overall economic goals
because their adjustment processes operate in different time frames. To this end, whatever reasons
causing high market rates would definitely hinder the economic growth, industrialization, as well as
social progress of the country. Bangladesh is, no doubt, one of the vivid examples of these phenomena
in the world! It is a very difficult to address these issues using only one component without free
market disciplines! Bangladeshi banking sector has gone through several restructuring and reforms, but
cannot overcome any of these problems. The main reason is the nexus between bureaucrats, politicians,
civilians, bankers. They are playing prisoner's dilemma game whose winning strategy is not to disclose
the corruption but to participate in the process. Moreover, exchange rate is being manipulated in favor
of a group of business magnets and remittance senders to Bangladesh to give them special privilege.
How else can the fact of slow economic development, industrialization, and social progress in the last
41 years, including perennial banking sector problems be explained?

Not only Pareto optimality theory but even the theory of second best cannot be applied in the
economy as alternative funding sources from the non-government organizations are also charging too
high interest rates. Ahmad and Imam (2007) has shown that effective interest rate charged by the four
largest micro-credit institutions are the Grameen Bank, which charges around 30.5%, the BRAC at
44.8%, ASA at 44.8%, and the PROSHIKA charging at around 42.3%. Through Micro credit
regulatory agency, the current government did set the ceiling interest rate in case of NGOs at 27%
which is still relatively high. Moreover, starting from the Grameen Bank (which is a statutory
institution) and some big NGOs have a number of other types of business for stated social development
purposes in the informal sector. However, these activities of these micro credit agencies are not
currently regulated, but needs to be supervised and regulated as well. It is not understandable why the
micro credit regulatory agency doesn’t look after these businesses.

5.0 Discussions and Conclusions

Clearly, the root causes of the Bangladeshi financial sector problem are the lack of market discipline
due to lack of competition in the banking industry. Excessive government intervention and political
connections, economic and political corruptions, operational and managerial inefficiency and
ineffectiveness result in vicious circle that inhibits economic development, industrialization, and social

12
progresses in poor and developing countries in general and in Bangladesh in particular. The desired
characteristics of the economy have been elusive for Bangladesh due to the political will, or lack
thereof. The competitiveness and the transparency of the market economy will reduce the lending-
deposit rate spread. These cannot be achieved in the absence of the infrastructure of a well-functioning
market economy. Bangladesh bank recently decides to give permission to open more new banks. This
may bring fruitful results if it can be properly handled to mobilize savings and channel those into
productive sectors. Besides, loans obtained by the government from the banking sector seems to
overburden the banking system and may be a cause of crowding out private investment. Bangladesh
Bank seems to even fail in its primary function of price stabilization with current inflation creeping into
a rate around 8.126% per year (source: International Monetary Fund - 2011 World Economic
Outlook).As a resultant factor purchasing power of the people of the country has declined. Moreover,
the capital market, especially share market should be more properly regulated and try deal with the
perennial problem of corruption, insider trading, and market manipulation by selected but powerful and
politically well-connected few elites.

With a market economy structure, the following changes will significantly improve the
financial sector, economic growth, industrialization, and social progress in Bangladesh. But first and
foremost is still the free market discipline, provided by the free market economy subject to prudent
regulation and oversight, and not excessive government direct interventions. Micro credit regulatory
agency may be redesigned and renamed and it should take steps for regulating both lending as well as
social businesses of NGOs as well as the Grameen Bank. Otherwise it will be difficult for reducing
poverty in the rural areas and improving women empowerment.

In a well-functioning market economy, financial business and management of bank and non-
bank intermediaries would likely be more efficient; otherwise, they would be eliminated from the
market place. Undesirable phenomena such as unethical behavior, crimes and irregularities like money
laundering, black-marketeering, undue profiteering and loan defaulting are fairly easy to detect (sooner
or later) and rectify by effective rules, regulations and supervision in a market economy. Additionally,
sound financial business can be established so that financial sector can be free from all sorts of political
interference. Political pressure for disbursing loans and prohibiting against those who create scam in
the capital markets in 2010-11 and several other times should be stopped and legal actions against
perpetrators should be taken without any sort of prejudice. Defaulters as well as market manipulators
would be disciplined. Investment Corporation of Bangladesh should be reactivated and the DSE and
the CSE should be strengthening by improved corporate governance.

Additionally as to the personnel, code of conduct, audit and monitoring systems, de-
politicizing the process of appointment of the directors to curb their excessive power to sanction loans
and advances can be established to assure efficiency and effectiveness. Manpower planning process
can be established in the banking industry to improve productive human resources to prepare the sector
for the global challenges. In the financial sector an ombudsman may be appointed. The ombudsman
can act independently to investigate any complaints regarding financial services and must work freely

13
and independently. Better financial services and diversified financial products would be the natural
consequence of competitive financial industry. Operational and administrative expenditures may be
reduced through implementing contemporary financial and competent management structure. Improved
customer relationship management system to retain existing customers of the financial institutions can
be established in a market economy. If the above measures are carried out and implemented along with
strengthened regulatory environment and additional much needed financial sector reforms, a better and
more efficient financial sector may evolve over time and serve better the development needs of the
country.

References
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 Mujeri, Mustafa K. and Islam, Md. Ezazul (2008), Rationalizing Interest Rate Spread
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