MAFS Modules 01-03

JAIBB : Monetary and Financial System
Module-1: Money and Monetary System
Concept and Functions of Money; Kinds of money; Demand for Money; Measures of
money supply: narrow money and broad money; Constituents of Monetary System:
Central Bank and Commercial Banks. Creation of Money by Commercial Banks.
Module-1: Money and Monetary System
1.1 What is Money

1.2 Functions of Money
1.2.1 Money as a Medium of Exchange
1.2.2 Money as a Unit of Account
1.2.3 Money as a Standard of Deferred Payment
1.2.4 Money as a Store of Value
1.3 Kinds of Money
1.4 Demand for Money
1.5 Measures of Money Supply
1.6 Nominal Vs. Real Interest Rates
1.7 Constituents of Monetary System
1.8 Creation of Money by Commercial Banks
1.9 Review Questions
1.10 Probable Questions
1. True-False Questions
Circle whether the following statements are true (T) or false (F).
T F 1. Since checks are accepted as payment for purchases of goods and services,
economists consider checking account deposits as money.
T F 2. Of its four functions, it is as a unit of account that distinguishes money from other assets.
T F 3. Money is productive because it promotes economic efficiency by lowering transactions
costs and thereby encouraging specialization.
T F 4. Money is a unique store of value, since physical goods depreciate over time.
T F 5. Money can be traded for other goods quickly and easily compared to all other assets.
T F 6. Money proves to be good store of value during inflationary episodes, since the value of
money is positively related to the price level.
T F 7. Money is most liquid among all financial instrument.
T F 8. Crypto currency is a legal tender money.
T F 9. Not only debit card, credit card is also money.
T F 10. The problem of defining money has become troublesome now in the past due to financial
innovation.
COMPLIANCE ROUTE 1
Answer with Explanation
1. True: Checks are accepted as payment for goods and services, and checking account deposits are
part of the money supply.
2. False: While the unit of account is one of the functions of money, it is not the one that distinguishes
money from other assets. Money is primarily defined by its functions as a medium of exchange, a
unit of account, a store of value, and a standard of deferred payment.
3. True: Money promotes economic efficiency by lowering transaction costs and allowing for
specialization. By eliminating the need for barter, money allows for a more complex division of labor
and the development of markets.
4. False: Money is not a unique store of value, as its value can be affected by inflation, deflation, or
changes in interest rates. Physical goods can also hold value over time, especially if they are durable
or have a long useful life.
5. True: Money is generally considered the most liquid asset because it can be traded quickly and
easily for other goods and services.
6. False: Money can lose value during inflationary episodes, as the value of money is inversely related
to the price level. Inflation reduces the purchasing power of money, making it a poor store of value
in periods of high inflation.
7. True: Money is the most liquid of all financial instruments, as it can be easily exchanged for goods
and services without a significant loss of value.
8. False: Cryptocurrency is not legal tender and is not widely accepted as a medium of exchange.
9. False: While debit cards allow for electronic transactions using funds in a bank account, credit cards
represent a line of credit that must be repaid with interest. They are not considered money in the
same sense as cash or deposits.
10. True: The development of new financial instruments and technologies has complicated the task of
defining and measuring money. The rise of digital payments and cryptocurrency, for example, has
raised new questions about what should be included in the money supply.
2. Money has three primary functions: It is a medium of exchange, a store of value, and a unit of account.
The statements below provide examples of these three functions. Indicate which of the three functions
of money illustrated by each statement. Let M-medium of exchange, S-store of value, and U=unit of
account.
1. Raihan calculates that the opportunity cost of his time is Tk. 100 per house
2. Any sort of transaction is valued by IMF in terms of SDR.
3. The function of money that measures value of all goods and services.
4. Mamun purchases tickets of the Black concert by writing a cheque.
5. The prices of commodities traded are stated in terms of cigarettes.
6. Sharmin purchases for Tk. 500 videotape she plans to give to her child for Eid.
7. The role of money that would not be provided if bananas were to serve as money.
8. Ahsan drops the change from his pocket into the leather bank on his study desk.
9. This function of money is important if people are to specialize at what they do best.
10. The traders at the shopping centres agreed to value their brinjals in terms of
muttons.
COMPLIANCE ROUTE 2
Answer with Explanation:
1. U (unit of account): Raihan is using money to calculate the opportunity cost of his time in terms of
a monetary value.
2. U (unit of account): The IMF is using money to measure the value of transactions in terms of SDRs.
3. U (unit of account): Money serves as a unit of account by measuring the value of all goods and
services in terms of a common currency.
4. M (medium of exchange): Mamun is using a check as a medium of exchange to purchase tickets
to a concert.
5. U (unit of account): Commodity prices are stated in terms of cigarettes, which are serving as a unit
of account.
6. M (medium of exchange): Sharmin is using money to purchase a videotape for her child as a
medium of exchange.
7. S (store of value): Bananas would not serve as a store of value, which is one of the functions of
money.
8. S (store of value): Ahsan is using money as a store of value by saving his change in a piggy bank.
9. S (store of value): The ability to store value is important for people to specialize in what they do
best.
10. U (unit of account): The traders are using money to value their brinjals in terms of mutton, which is
serving as a unit of account.
3. Multiple Choice Questions
1. Which of the following identifies the unit-of-account function of money?

(a) Money is a convenient means of measurement.
(b) Money facilitates the exchange of goods and services.
(c) Money allows the postponement of consumption.
(d) Money provides its holder with perfect liquidity.
2. Which of the following financial assets is not included in the M1 definition of money?
(a) Currency in the vaults of Banks
(b) Demand deposits
(c) Money market mutual fund
(d) Both (a) and (c)
3. If cows serve as a medium of exchange, a unit of account, and a store of wealth, cows are
said to function as
(a) bank deposits.
(b) reserves.
(c) money.
(d) loanable funds.
4. Which of the following is not included in the money aggregate M2?
(a) Currency outside Banks
(b) Demand Deposit of Banking System
(c) Time Deposit of Banking System
(d) None of the above.
COMPLIANCE ROUTE 3
5. Which one of the following is not a function of Money -

(a) A means of fund transfer
(b) A store of value
(c) A medium of exchange
(d) A unit of account
6. Which of the following is not included under M1?

(a) Time Deposit
(b) Euro Deposit
(c) Currency Kept in the vaults of Banks
(d) All of the above.
7. Which of the following demand for money is influenced by rate of interest?
(a) Transaction demand for money
(b) Precautionary demand for money
(c) Speculative demand for money
8. Banking system creates money to the extent of -

(a) excess reserves of the banking system
(b) reciprocal times of excess reserve
(c) reciprocal times of required reserve
(d) instruction given by the central bank
9. The narrow definition of money consists of-

(a) Currency Outside Banks
(b) Demand Deposit
(c) Time Deposit
(d) Both (a) and (b)
10. Suppose, a bank has Tk. 1000 as deposit and if its reserve requirement is 20%, then the bank
can create credit/money up to-
(a) Tk. 200
(b) Tk. 5000
(c) Tk. 800
(d) Tk. 1200
11. Which of the following is a legal tender money?
(a) Debit card
(b) Credit card
(c) Cheque
12. Which of the following is not a constituent of monetary system:

(a) Banking Financial Institutions
(b) Non-Bank Financial Institution
(c) Central Bank
(d) Only (a) and (b)
COMPLIANCE ROUTE 4
Correct Answer with Explanation:
1. (a) Money is a convenient means of measurement, which is known as the unit-of-account function
of money. It allows us to compare the value of goods and services and express them in a common
unit of account, such as a currency.
2. (d) Both (a) and (c) are not included in the M1 definition of money. Currency in the vaults of banks is
not in circulation and cannot be used for transactions, while money market mutual funds are not as
liquid as demand deposits and can only be redeemed at certain times.
3. (c) If cows serve as a medium of exchange, a unit of account, and a store of wealth, they are
considered as money. Money is any widely accepted medium of exchange that is used as a unit of
account and a store of value.
4. (d) None of the above. All the options listed (a), (b), and (c) are included in the money aggregate M2.
M2 includes all the components of M1 along with some additional assets, such as savings deposits
and small time deposits.
5. The correct answer is (a) A means of fund transfer. Money serves as a means of exchange, allowing
individuals to buy and sell goods and services. It also functions as a unit of account, enabling us to
measure the value of goods and services in a common way. Additionally, money serves as a store
of value, allowing individuals to save purchasing power for the future. However, money itself is not a
means of fund transfer, as there are various financial instruments and mechanisms that allow
individuals to transfer funds such as wire transfers, checks, and electronic payment systems.
6. (d) All of the above are not included under M1. M1 includes the most liquid components of the money
supply, such as demand deposits and currency held by the public.
7. The correct answer is (c) Speculative demand for money. The speculative demand for money refers
to the demand for money for speculative purposes, i.e., holding money for the purpose of making a
profit by speculating on changes in asset prices. This demand is influenced by the rate of interest
because changes in interest rates affect the expected return on alternative assets, such as stocks,
bonds, and real estate. As the interest rate rises, the expected return on holding money falls, and
the demand for money for speculative purposes decreases, and vice versa. Therefore, the
speculative demand for money is influenced by the rate of interest. Transaction demand for money
refers to the demand for money to make purchases of goods and services. Precautionary demand
for money refers to the demand for money as a precautionary measure to meet unexpected future
expenses. Neither of these demands is directly influenced by the rate of interest.
8. The correct answer is (c) reciprocal times of required reserve. When a bank receives a deposit, it
must hold a fraction of that deposit in reserve, as required by the central bank. This fraction is known
as the reserve requirement ratio. The bank can lend out the remaining portion of the deposit as loans,
which in turn can become deposits in other banks. This process of lending and re-depositing
continues, resulting in a multiple expansion of deposits in the banking system. The maximum amount
of money that the banking system can create through this process is determined by the reciprocal of
the reserve requirement ratio. For example, if the reserve requirement ratio is 10%, then the banking
system can create up to 10 times the initial deposit amount. Therefore, the correct answer is (c)
reciprocal times of required reserve.
9. (d) The narrow definition of money includes currency outside banks and demand deposits. It does
not include time deposits or other less liquid assets.
10. The reserve requirement of 20% means that the bank is required to keep 20% of its deposits
in reserve and can loan out the remaining 80%.
COMPLIANCE ROUTE 5
So, if the bank has Tk. 1000 as deposit and the reserve requirement is 20%, it must keep Tk. 200
(20% of Tk. 1000) as reserve and can loan out Tk. 800.
However, if the bank has received a new reserve of Tk. 1000, then its total reserves would be Tk.
1200. The reserve requirement would still be Tk. 200 (20% of Tk. 1000) and the excess reserve
would be Tk. 1000.
Using the money multiplier formula, we can calculate the maximum amount of credit/money the bank
can create as:
Maximum Money Creation = (1 / Reserve Requirement) x Excess Reserves Maximum Money
Creation = (1 / 0.2) x Tk. 1000 Maximum Money Creation = Tk. 5000
Therefore, the bank can create credit/money up to Tk. 5000 with Tk. 1000 as deposit and Tk. 1000
in new reserves, if its reserve requirement is 20%.
The correct option is (b) Tk. 5000.
11. (d) None of the above options are legal tender money. Legal tender money is any form of payment
that is recognized by law as a valid means of payment for debts and taxes, such as cash or coins
issued by the government.
12. (d) Only (a) and (b) are not constituents of the monetary system. The monetary system includes
institutions such as banks, non-bank financial institutions, and central banks, which play a crucial
role in the creation and management of the money supply.
Probable Questions for Examination
Q1. Why is the unit-of-account function of money crucial to the operation of an

economy?
Answer: The unit-of-account function of money is crucial to the operation of an economy
because:
■ It serves as a common measure of value for goods and services, which facilitates economic
transactions.
■ Without a unit of account, it would be difficult for individuals and businesses to assess the
relative value of goods and services, making it hard to determine prices and engage in trade.
■ Money's ability to provide a common unit of measurement enables individuals and
businesses to compare the value of different goods and services and make informed
economic decisions.
■ This helps to allocate resources efficiently and produce goods and services that meet
consumer demand, which promotes economic growth and development.
Q2. Explain how money functions as a standard of deferred payments.
Answer: Money functions as a standard of deferred payments by providing a means for individuals
and businesses to make transactions that involve payments that are to be made at a future date. In
this context, deferred payments refer to obligations that are incurred today but paid in the future.
COMPLIANCE ROUTE 6
Money serves as a standard of deferred payments because it is widely accepted as a means of

settling debts and obligations. For example, if an individual takes out a loan, they will typically be
required to repay the loan at a future date, usually with interest. The lender is willing to make the
loan because they have confidence that the borrower will be able to repay the loan with money
that is widely accepted as a means of payment.
Money also functions as a standard of deferred payments by enabling individuals and businesses
to enter into contracts that involve future payments. For example, a company might agree to sell
goods to a customer on credit, with the understanding that the customer will pay for the goods at
a future date. The company is willing to extend credit because they have confidence that the
customer will be able to pay with money that is widely accepted as a means of payment.
In both cases, money serves as a standard of deferred payments because it is widely accepted as a
means of settling debts and obligations, both in the present and in the future. This provides
individuals and businesses with a reliable means of making transactions that involve deferred
payments, which helps to facilitate economic activity and growth.
3. (a) Explain how money functions as a store of value.
Answer: Money functions as a store of value by providing individuals and businesses with a means
of holding and preserving wealth over time. In this context, a store of value refers to any asset or
commodity that can be saved and retrieved later with its value intact.
Money can function as a store of value because it is generally accepted as a means of payment and
as a store of wealth. When individuals and businesses hold money, they can be confident that its
value will remain relatively stable over time, at least compared to many other assets that may
experience significant fluctuations in value.
For example, if an individual receives a paycheck, they can deposit that money in a savings account
or invest it in a low-risk investment, such as a bond or money market fund. By doing so, they are
preserving the value of their wealth, at least in nominal terms, over time.
Money also functions as a store of value because it is divisible and portable. This means that
individuals and businesses can easily store and transport money from one location to another,
making it a convenient means of storing and preserving wealth.
However, it is important to note that money may not be a perfect store of value, as inflation and
other economic factors can cause the value of money to fluctuate over time. Nonetheless, money
remains a widely accepted means of storing wealth, and many individuals and businesses continue
to hold money as a means of preserving their wealth over time.
COMPLIANCE ROUTE 7
3. (b) Is money the only store of value?
Answer: No, money is not the only store of value. In fact, there are many other assets and
commodities that can serve as a store of value, including:
1. Precious metals, such as gold and silver, which have been used as a store of value for
thousands of years.
2. Real estate, which can appreciate in value over time and provide a source of rental income.
3. Fine art and collectibles, which can appreciate in value over time and may have a high
degree of cultural or historical significance.
4. Stocks and bonds, which can provide a source of capital appreciation and/or income.
5. Cryptocurrencies, which have emerged as a new type of digital asset that some investors
view as a store of value.
Each of these assets has its own advantages and disadvantages as a store of value, and the choice
of which asset to use as a store of value will depend on individual circumstances and preferences.
For example, some individuals may prefer to hold a diversified portfolio of assets, including both
money and other types of assets, in order to mitigate risk and maximize returns over time.
3. (c) What is the difference between money as a store of value and the other assets?
SL Money Other assets

01 Money is generally considered a highly Other assets, such as real estate or fine
liquid asset, meaning it can be easily art, may be less liquid and may require a
converted into cash without significant loss longer time period or more effort to sell
of value. in order to access their value.
02 Money is typically seen as a low-risk store Other assets, such as stocks or
of value, as it is not subject to significant cryptocurrencies, may experience
fluctuations in value over short periods of significant volatility in their value, and
time. may be subject to more risk.
03 Money may not be a perfect store of value Other assets, such as real estate or
over the long-term, as inflation and other precious metals, may be better suited for
economic factors can cause its value to preserving value over longer periods of
erode over time. time.
04 Money is a fungible asset, meaning that Other assets, such as real estate or fine
each unit of currency is interchangeable art, may be more difficult to exchange or
with any other unit of the same may require specialized knowledge to
denomination. This makes it a convenient accurately assess their value.
means of exchange and a widely accepted
medium of payment.
05 Money is often viewed as a low- However, in some cases, holding money
maintenance asset, as it does not require may come with opportunity costs, as the
ongoing maintenance or storage costs, returns on other investments may
unlike other assets such as real estate or outpace the rate of inflation and erode the
collectibles. value of cash holdings over time.
COMPLIANCE ROUTE 8
3. (d) Are long-term bonds a store of value?
Answer: Long-term bonds can be used as a store of value, but they may not be suitable for all
investors, depending on their investment goals and risk tolerance.
Bonds are debt securities that represent a promise to pay a fixed amount of interest over a set
period of time, and to repay the principal amount at the end of the bond's term. The value of a bond
can be influenced by a variety of factors, including changes in interest rates, credit quality, and
inflation expectations.
Long-term bonds typically have maturities of ten years or more, and may offer higher yields than
short-term bonds due to their longer duration. However, they are also subject to greater interest
rate risk, as changes in interest rates can have a significant impact on their value.
As a store of value, long-term bonds may be attractive to investors who are seeking a fixed income
stream over a long period of time, and who are willing to accept the risks associated with
fluctuations in interest rates and inflation. They may also be used as a hedge against inflation, as
the fixed interest payments on a bond can help to offset the impact of rising prices.
However, it is important to note that long-term bonds are not without risk, and their value can
fluctuate significantly over time. As with any investment, it is important to consider one's
individual circumstances and investment goals before investing in long-term bonds, and to consult
with a financial advisor to determine if they are an appropriate investment for one's portfolio.
4. (a) Rank the following financial assets in terms of their liquidity: coins and paper
currency, common stock, demand deposits, long-term government bonds, long- term
corporate bonds, saving deposits at deposit institutions, Treasury bills. (b) Explain your
ranking.
Answer : Ranking the financial assets in terms of their liquidity from most to least liquid:
1. Coins and paper currency - Physical currency is the most liquid form of money, as it can
be easily used for transactions and is universally accepted.
2. Demand deposits - Also known as checking accounts, demand deposits are highly liquid
as they can be easily accessed and withdrawn from banks and financial institutions.
3. Treasury bills - T-bills are short-term debt securities issued by the US government, with
maturities of one year or less. They are highly liquid and can be easily bought and sold in
secondary markets.
4. Saving deposits at deposit institutions - Savings accounts are fairly liquid, but they may
have withdrawal limits and penalties for early withdrawal.
5. Common stock - Stocks represent ownership in a company, and can be bought and sold in
public markets. While they are fairly liquid, it may take some time to find a buyer or seller,
and the value of the stock can be volatile.
6. Long-term government bonds - These bonds typically have maturities of 10 years or more,
and can be less liquid than shorter-term bonds or T-bills.
COMPLIANCE ROUTE 9
7. Long-term corporate bonds - These bonds are issued by companies rather than
governments, and may be less liquid than government bonds due to higher credit risk.
It's worth noting that the liquidity of financial assets can also vary based on market conditions,
supply and demand, and individual circumstances.
Q5. What effect does inflation have on the use of money as a unit of account, a medium of
exchange, a standard for deferred payment, and a store of value?
Answer: Inflation can have significant effects on the use of money as a unit of account, a medium
of exchange, a standard for deferred payment, and a store of value.
As a unit of account, inflation can make it more difficult to accurately measure the value of goods
and services. Prices may rise rapidly, and the purchasing power of a given amount of money may
decline over time. This can lead to confusion and uncertainty in the economy, as prices become
less stable and harder to compare.
As a medium of exchange, inflation can lead to higher prices for goods and services, as the cost
of production and distribution increases. This can make it more expensive for individuals and
businesses to purchase goods and services, and can lead to decreased demand for certain products.
As a standard for deferred payment, inflation can make it more difficult to accurately predict
the value of future payments or obligations. For example, if a loan is made with a fixed interest
rate, inflation may erode the real value of the loan over time, making it more difficult for the lender
to recoup their investment.
As a store of value, inflation can erode the purchasing power of money over time. As prices rise,
the value of cash holdings may decline, making it more difficult for individuals and businesses to
maintain their wealth. This can lead to increased demand for alternative stores of value, such as
gold or real estate.
Overall, inflation can have complex and far-reaching effects on the use of money in the economy.
Central banks and governments may take steps to manage inflation through monetary policy, such
as adjusting interest rates or controlling the money supply, in order to promote stability and
maintain the effectiveness of money as a tool of exchange and measure of value.
Q6. Most of the time it is quite difficult to separate the functions of money. Money performs
its functions at all times, but sometimes we can stress one in particular. For each of the
following situations, identify which function of money is emphasized.
a) Tabinda accepts money in exchange for performing her daily tasks at her office,
since she knows she can use that money to buy goods and services.
b) Tashfi wants to calculate the relative value of oranges and apples, and therefore
checks the price of each of these goods quoted in currency units.
c) Tonmoy is currently married, He expects his expenditures to increase in the future
and decides to increase the balance in his savings (fixed deposits) account.
COMPLIANCE ROUTE 10
Answer :
a. Medium of exchange - Tabinda is using money as a medium of exchange to facilitate

transactions for goods and services, such as paying for her daily tasks at her office.
b. Unit of account - Tashfi is using money as a unit of account to compare and calculate the relative
value of different goods, such as oranges and apples.
c. Store of value - Tonmoy is using money as a store of value by depositing it into his savings
account to preserve its value over time and prepare for future expenses.
Q7. Which of the Central Bank measures of the monetary aggregates – M1 or M2 – is

composed of the most liquid assets? Which is the larger measure?
Answer: M1 is the more liquid of the two monetary aggregates as it includes only the most liquid
assets, such as physical currency, demand deposits, and other highly liquid assets. M2, on the
other hand, includes all of the assets in M1 plus additional, less liquid assets such as savings
deposits, time deposits, and other similar assets.
M2 is the larger measure as it includes a broader range of assets than M1, which is more narrowly
defined. While M1 only includes the most liquid assets, M2 includes a wider range of assets that
can still be considered a part of the money supply, albeit less liquid than those in M1.
Q8. For each of the following assets, indicate which of the monetary aggregates (M1 and
M2) includes them:
a. Currency outside Banks
b. Demand Deposits
c. Time deposits
d. Checkable deposits
Answer:
a. Currency outside banks is included in both M1 and M2.
b. Demand deposits are included in both M1 and M2.
c. Time deposits are only included in M2.
d. Checkable deposits are included in both M1 and M2.
Q9. Why general people will have demand for money? Which sort of demand for money is
influenced by income and which by rate of interest?
Answer: People have a demand for money for several reasons:
 Transactions demand: People need money to facilitate their day-to-day transactions, such
as buying goods and services, paying bills, or making rent or mortgage payments. The
amount of money people demand for transactions varies depending on their income,
spending habits, and the level of economic activity.
 Precautionary demand: People also hold money as a precaution against unexpected
expenses, emergencies, or income fluctuations. The amount of money people hold for
COMPLIANCE ROUTE 11
precautionary purposes is generally determined by their level of income, risk tolerance, and
financial goals.
 Speculative demand: People may also hold money for speculative purposes, such as
anticipating a future increase in asset prices or investment opportunities. The amount of
money people hold for speculative purposes depends on their expectations of future returns
and their willingness to take risks.
Overall, people have a demand for money as a means of facilitating transactions, as a precaution
against uncertainty, and as a potential source of future income or returns.
The demand for money for transactions and precautionary purposes is typically influenced by
income. As income increases, people tend to have a greater demand for money to facilitate
transactions and to hold as a precaution against unexpected expenses.
Q10. We must note two things about any measure of money supply. State those two things.
Answer :
The two things that we must note about any measure of money supply are:
1. The components of the money supply: Any measure of money supply is made up of
different components, such as currency, demand deposits, time deposits, and other similar
assets. The composition of the money supply can affect its behavior and its ability to
function as a medium of exchange, a store of value, and a unit of account.
2. The definition of money: There are different definitions of money, and each definition
includes different types of assets that can be considered as part of the money supply. For
example, the narrowest definition of the money supply (M1) includes only the most liquid
assets, while broader definitions (such as M2 or M3) include less liquid assets such as time
deposits and other similar assets. Different definitions of money can have different
implications for monetary policy and the economy as a whole.
Q11. What constitutes non-legal tender money and why are they called so?
Answer: Non-legal tender money refers to any form of money that is not recognized as legal tender
by the government, which means that it cannot be used to settle debts and taxes. Examples of non-
legal tender money include foreign currencies, cryptocurrencies, and other forms of alternative
currencies.
These forms of money are called non-legal tender because they do not have the backing of the
government, and are not recognized as a valid form of payment for debts and taxes. They are not
accepted by merchants and businesses as readily as legal tender money, and they may not be as
widely accepted in a particular country or region.
Despite not being recognized as legal tender, non-legal tender money can still be used for certain
types of transactions, such as international trade or online purchases. However, their value and
COMPLIANCE ROUTE 12
acceptance may fluctuate based on various factors such as market demand, government
regulations, and technological developments.
It's important to note that while non-legal tender money may have some advantages such as
decentralization, anonymity, and potentially lower transaction fees, they also carry risks such as
price volatility, lack of legal protections, and potential use in illicit activities.
Q12. What is a monetary standard?
Answer: A monetary standard refers to a system or framework used to establish the value of
money in a particular economy. It serves as a basis for determining the exchange rate between
different currencies and the value of other financial assets such as stocks and bonds.
A monetary standard can be based on various criteria, such as a fixed quantity of a commodity
(such as gold or silver), a fixed exchange rate with another currency, or a target level of inflation.
It provides a stable and predictable framework for monetary policy and helps to promote financial
stability and economic growth.
Historically, gold has been one of the most common monetary standards used by countries around
the world. Under the gold standard, the value of a country's currency was tied to a fixed quantity
of gold, which provided a stable foundation for the economy. However, many countries have
abandoned the gold standard in favor of fiat currencies, which are not tied to a specific commodity
but are instead backed by the government's ability to honor its debt obligations.
Overall, a monetary standard provides a crucial framework for maintaining trust and confidence
in the monetary system and ensuring that money can function effectively as a medium of exchange,
a store of value, and a unit of account.
Q13. Why demand deposits are included in the M1 definition of money?
ANSWER: Demand deposits are included in the M1 definition of money because they are
considered to be highly liquid and readily available for use as a medium of exchange. Demand
deposits are funds held in checking accounts and can be accessed by depositors at any time without
any notice or penalty.
Since demand deposits can be quickly and easily converted into cash, they are often used to make
purchases, pay bills, and conduct other day-to-day transactions. As such, demand deposits are an
important component of the money supply and play a critical role in facilitating economic activity.
The inclusion of demand deposits in the M1 definition of money provides a useful metric for
policymakers and economists to track the amount of money in circulation and monitor changes in
consumer behavior and economic activity. Additionally, the M1 definition of money is often used
as a benchmark for measuring the effectiveness of monetary policy in controlling inflation and
promoting economic growth.
COMPLIANCE ROUTE 13
Q14. What do you mean by Supply of Money? How do you classify them? Why inter bank
deposit is not included in the definition of money supply?
ANSWER : The supply of money refers to the total amount of money available in an economy at
a given point in time. It includes all forms of money, including currency, demand deposits, and
other liquid assets that can be easily converted into cash.
The supply of money is determined by several factors, including the actions of the central bank,
the behavior of banks and other financial institutions, and the demand for money by individuals
and businesses.
Central banks play a critical role in controlling the supply of money by adjusting interest rates,
buying and selling government securities, and regulating the activities of banks and other financial
institutions. By manipulating these various tools, central banks can increase or decrease the supply
of money in the economy, which can have a significant impact on inflation, economic growth, and
other key macroeconomic variables.
In addition to the actions of central banks, the supply of money is also influenced by the behavior
of banks and other financial institutions. Banks create money by making loans and extending
credit, and the amount of money in circulation is therefore affected by the lending practices of
banks and the demand for credit by individuals and businesses.
Overall, the supply of money plays a critical role in shaping the overall health and performance of
the economy, and is a key focus of macroeconomic policymakers and analysts.
The supply of money refers to the total amount of money that is available in an economy at a
particular time. It includes all forms of money that are used for transactions, such as cash, checking
and savings deposits, and other liquid assets.
There are different ways to classify the supply of money. One common classification is based on
the level of liquidity of the assets included in the money supply. The most commonly used
classification divides the money supply into two main categories: M1 and M2.
M1 includes the most liquid forms of money, such as cash and checking deposits, which can be
used to make immediate transactions. M2 includes M1 plus savings deposits, money market
mutual funds, and other relatively liquid assets that can be easily converted into cash.
Interbank deposits, which are deposits made by one bank with another, are not included in the
definition of the money supply because they are not directly available to the public for use in
transactions. Interbank deposits are instead considered a component of the broader money market,
which includes various financial instruments that are used by banks and other financial institutions
to manage their short-term liquidity needs.
COMPLIANCE ROUTE 14
Overall, the classification of the money supply and the specific assets that are included in each
category can vary depending on the country and the specific definitions used by central banks and
other economic policymakers.
Q15. How banks can create money? To what extent a single bank can create money? A
banking system as a whole?
Answer : Banks can create money through a process called fractional reserve banking, which
allows banks to lend out a portion of the funds they receive as deposits while keeping a fraction of
the funds in reserve.
Here is an example of how banks create money:
Suppose Bank A receives a deposit of BDT 100 from a customer. The bank is required to hold a
certain percentage of this deposit in reserve, typically set by the central bank. Let's say the reserve
requirement is 10%, so Bank A must hold BDT 10 in reserve and can lend out the remaining BDT
90 to another customer.
The customer who receives the loan can then use the BDT 90 to make purchases or pay bills. The
recipient of these funds may then deposit the money into their bank account, and the process can
repeat itself, with the bank holding a portion of each subsequent deposit in reserve and lending out
the rest.
Through this process, banks can effectively create money by increasing the overall supply of funds
in circulation. The extent to which a single bank can create money is limited by the amount of
reserves it holds and the demand for loans from borrowers. However, when multiple banks engage
in fractional reserve banking, the banking system as a whole can create even more money, as each
bank can lend out a portion of the deposits it receives, increasing the overall supply of money in
the economy.
It's important to note that while banks have the ability to create money through fractional reserve
banking, this process also creates a risk of bank runs or other financial crises if depositors lose
confidence in the banking system or if banks make risky loans that lead to defaults. To mitigate
these risks, central banks often set reserve requirements, oversee the banking system, and provide
liquidity support to banks when necessary.
COMPLIANCE ROUTE 15
Q16. How do you differentiate between Real and Nominal interest rate?
Answer : Real and nominal interest rates are two different concepts used to measure the cost of
borrowing or the return on lending.
Nominal interest rate refers to the interest rate expressed in current dollars. It is the rate that is
usually quoted by banks and financial institutions. The nominal interest rate does not take into
account the effect of inflation on the value of money.
On the other hand, the real interest rate takes into account the effect of inflation on the value of
money. It is the nominal interest rate adjusted for inflation. The real interest rate measures the true
cost of borrowing or the true return on lending after adjusting for inflation.
For example, if the nominal interest rate is 5% and the inflation rate is 2%, the real interest rate
would be 3% (5% - 2% = 3%). This means that the real return on the loan or investment is only
3% after adjusting for inflation.
In summary, the nominal interest rate is the actual interest rate charged or earned on a loan or
investment, while the real interest rate is the nominal interest rate adjusted for inflation.
Q17. How to you define monetary system? What are the constituents of monetary system?
How come it is different from financial system?
ANSWER: A monetary system is a system of money in a particular economy that facilitates

transactions and serves as a medium of exchange. It is the mechanism by which money is created,
circulated, and controlled in a particular economy.
The constituents of a monetary system include:
1. Currency: Physical currency, such as coins and banknotes, that are used as a medium of
exchange.
2. Deposits: Bank deposits that can be withdrawn on demand or after a certain notice period.
3. Central bank: The central bank is responsible for regulating the money supply, controlling
inflation, and setting interest rates.
4. Financial institutions: Banks and other financial institutions play a crucial role in the
monetary system as they create credit, lend money, and facilitate financial transactions.
The monetary system is different from the financial system, which includes all financial markets,
institutions, and intermediaries that enable the flow of funds between savers and borrowers. While
the monetary system deals with the creation and control of money in an economy, the financial
system deals with the allocation and transfer of funds between different economic agents.
In summary, the monetary system is a subset of the financial system that deals with the creation,
circulation, and control of money, while the financial system encompasses a broader range of
activities, including capital markets, investment, and risk management.
COMPLIANCE ROUTE 16
Q18. What are near monies?
Answer : Near monies, also known as money substitutes, refer to financial assets that are highly
liquid and can be quickly converted into cash, but are not considered as part of the official money
supply. These assets serve as alternatives to holding money and are often included in broader
measures of the money supply.
Examples of near monies include:
1. Savings deposits: These are interest-bearing deposits held at banks and other financial
institutions. They are highly liquid and can be withdrawn on demand, but are not
considered as part of the M1 money supply.
2. Time deposits: These are deposits held at financial institutions for a specific period of time,
such as a certificate of deposit (CD). They typically earn higher interest rates than savings
deposits, but cannot be withdrawn before the maturity date without a penalty.
3. Money market funds: These are mutual funds that invest in highly liquid, short-term
securities such as Treasury bills and commercial paper. They are considered to be very safe
and highly liquid, making them a popular alternative to holding cash.
4. Treasury bills: These are short-term government securities that are highly liquid and
considered very safe. They are often used as a benchmark for short-term interest rates.
Overall, near monies provide individuals and businesses with a way to earn a return on their liquid
assets while maintaining a high degree of flexibility and safety.
Q19. Use the information of the following table to calculate M1 and M2 money supply for
each year and also its growth rates.
Year (Taka in crore)
2019-2020 2020-2021 2021-2022
Currency in Circulation 208094.1 226888.3 256182.3
Money in Vaults of DMBs 15979.6 17370.6 19733.8
Time Deposits of DMBs 1045471.1 1185066.6 1282217.5
Demand Deposits of DMBs 135528.4 165724.5 188859.4
ANSWER:
To calculate M1, we need to add Currency in Circulation and Demand Deposits of DMBs:
M1 = Currency in Circulation + Demand Deposits of DMBs
For 2019-2020: M1 = 208094.1 + 135528.4 = 343622.5
For 2020-2021: M1 = 226888.3 + 165724.5 = 392612.8

COMPLIANCE ROUTE 17
For 2021-2022: M1 = 256182.3 + 188859.4 = 445041.7
To calculate M2, we need to add M1, Time Deposits of DMBs, and Money in Vaults of DMBs:
M2 = M1 + Time Deposits of DMBs + Money in Vaults of DMBs
For 2019-2020: M2 = 343622.5 + 1045471.1 + 15979.6 = 1411073.2
For 2020-2021: M2 = 392612.8 + 1185066.6 + 17370.6 = 1571050.0
For 2021-2022: M2 = 445041.7 + 1282217.5 + 19733.8 = 1724992.9
To calculate the growth rate of each money supply measure, we can use the following formula:
Growth rate = (Current year value - Previous year value) / Previous year value * 100%
For M1:
 Growth rate from 2019-2020 to 2020-2021: (392612.8 - 343622.5) / 343622.5 * 100% =

14.25%
 Growth rate from 2020-2021 to 2021-2022: (445041.7 - 392612.8) / 392612.8 * 100% =
13.34%
For M2:
 Growth rate from 2019-2020 to 2020-2021: (1571050.0 - 1411073.2) / 1411073.2 * 100%

= 11.32%
 Growth rate from 2020-2021 to 2021-2022: (1724992.9 - 1571050.0) / 1571050.0 * 100%
= 9.79%
20. If Narrow Money is 25% of Broad Money, which was around Tk. 440,528 crore as on
June, 2011, then what was the amount of time deposits as on the same date? If demand
deposit was almost 50% of M1, then what was the amount of currency outside banks?
Answer : Given:
Narrow Money = 25% of Broad Money
Broad Money = Tk. 440,528 crore (June, 2011)
Demand Deposit = 50% of M1
To find: Amount of time deposits on June, 2011. Amount of currency outside banks.
Solution: Let's start by finding M1: M1 = Narrow Money + Demand Deposits
Narrow Money = 25% of Broad Money Narrow Money = 0.25 x Tk. 440,528 crore Narrow Money
= Tk. 110,132 crore
Demand Deposit = 50% of M1 Demand Deposit = 0.5 x (Narrow Money + Demand Deposits)
Demand Deposit = 0.5 x (Tk. 110,132 crore + Demand Deposits)
COMPLIANCE ROUTE 18
Simplifying the equation: Demand Deposits = 0.5 x Tk. 110,132 crore + 0.5 x Demand Deposits
0.5 x Demand Deposits = 0.5 x Tk. 110,132 crore Demand Deposits = Tk. 55,066 crore
Now we can calculate M1: M1 = Narrow Money + Demand Deposits M1 = Tk. 110,132 crore +
Tk. 55,066 crore M1 = Tk. 165,198 crore
We know that: Broad Money = M1 + Time Deposits Tk. 440,528 crore = Tk. 165,198 crore +
Time Deposits Time Deposits = Tk. 440,528 crore - Tk. 165,198 crore Time Deposits = Tk.
275,330 crore
Finally, we can calculate the amount of currency outside banks: Currency outside banks = Broad
Money - Time Deposits Currency outside banks = Tk. 440,528 crore - Tk. 275,330 crore Currency
outside banks = Tk. 165,198 crore
Therefore, on June 2011, the amount of time deposits was Tk. 275,330 crore and the amount of
currency outside banks was Tk. 165,198 crore.
Q21. How do Banks create money? To what extent a single bank can create money? A
banking system as a whole?
Answer: Banks create money through the process of fractional reserve banking, where they keep
only a fraction of their deposits as reserves and lend out the rest. This process increases the money
supply as the borrowed funds are spent and deposited in other banks, who in turn lend out a
portion of those funds, leading to a multiplier effect on the money supply.
To understand this process, let's consider an example. Suppose a person deposits Tk. 100,000 in a
bank. The bank is required to keep a certain percentage of the deposit as reserves, say 10%, and
can lend out the remaining 90%, which is Tk. 90,000. The borrower, in turn, spends the borrowed
money, say on a car, and the seller of the car deposits the money in another bank. This bank is also
required to keep a certain percentage of the deposit as reserves, say 10%, and can lend out the
remaining 90%, which is Tk. 81,000. This process can continue, with each successive bank
keeping a fraction of the deposit as reserves and lending out the rest, leading to an increase in the
money supply.
A single bank can create money up to the limit of its excess reserves, which is the difference
between its reserves and the required reserves set by the central bank. However, in practice, banks
lend out only a portion of their excess reserves, as they need to keep a buffer to meet deposit
withdrawals and other demands.
The banking system as a whole can create money based on the total excess reserves held by all
banks. The larger the excess reserves, the more money the banking system can create through the
process of fractional reserve banking. However, the central bank has the power to influence the
money creation process by setting the reserve requirements and the interest rate at which it lends
to banks, which affects the banks' willingness to lend and the demand for loans.
COMPLIANCE ROUTE 19
Module-2: Payment System:

Concept, Different payment options, Pros and Cons of different payment types
(Cash, Cheques, Debit Card, Credit Card, Mobile payments,
On-line payments, and Electronic fund transfers).
Evolution and Growth of Bangladesh Payment System.
Module-2: Payment System:
2.1 Concept
2.2 Evolution of the Payment System
2.2.1 Commodity Money
2.2.2 Paper Currency/Fiat Money
2.2.3 Checks
2.2.4 Electronic Fund Transfer Payment
2.2.4.1 Credit or Debit Card Payment
2.2.4.2 ACH Payment
2.2.4.3 eCheck
2.2.4.4 Wire Transfers
2.2.5 Mobile Payment
2.2.6 QR Code Payment (Contactless Payment)
2.3 Advantages and Disadvantages of Different Payment Methods
2.3.1 Cash
2.3.2 Checks
2.3.3 Debit, Credit and Prepaid Cards
2.3.4 Mobile Payments
2.3.5 Electronic Bank Transfers
2.3.6 Mobile Wallet
2.3.7 QR “Quick Response” Code
2.4 Evolution and Growth of Bangladesh Payment Systems
COMPLIANCE ROUTE 20
Modules: 02_ Payment System

Review Questions
1. What is E-payment?
a) Electronic Payment for buying and selling through the internet
b) Payment for online software
c) Payment for line services
d) None of the above
2. A is a credit or debit card swipe system that connects to a smart phone but operates
under all established financial regulations.
a) Credit Card Terminal
b) On-line Payment
c) Mobile Payment System
d) Point of Sale System
3. What do electronic payment systems replace?

a) Cash and Checks
b) Cash and debit card transactions
c) Letters and checks
d) Cash and Money Orders
4. Which one of the following is a sine-qua-non for an efficient payment system:

a) Efficient financial system
b) Efficient credit system
c) Efficient fund transfer system
d) Efficient monetary system
5. Which one of the following was not a characteristics of Commodity Money:

a) It was made up of precious metals
b) It was universally acceptable
c) It functioned as Medium of Exchange in most of the primitive societies
d) It was very easy to carry/transport
6. Which one of the following is not correct?

a) Checks allow transactions to take place without the need to carry large amount of currency
b) Checks reduces loss from theft
c) Checks are fiat/legal tender money
d) Checks can be written for any amount up to the account balance
7. Which of the following is not true for EFT payment

a) EFT is an electronic transfer of money
b) EFT payments can be made between any two accounts
c) EFT payment refers to a single type of payment
d) EFT payment is done between accounts of same or different financial institutions
COMPLIANCE ROUTE 21
8. Which one is the most dominant form of medium of transaction in Bangladesh?

a) Cheque
b) Mobile payment
c) Credit card
9. QR Code Payment:
a) is a contactless payment
b) is a two-dimensioned barcode
c) functions like a normal POS terminal
d) All of the above is true
10. Which of the following does not allow a customer to safely make large purchase?
a) Check
b) Credit card
c) Cash
d) EFT
Answer With Explanation
1. (a) Electronic Payment for buying and selling through the internet. E-payment refers to any payment
made electronically, usually through the internet.
2. (c) Mobile Payment System. A mobile payment system is a credit or debit card swipe system that
connects to a smartphone but operates under all established financial regulations.
3. (a) Cash and Checks. Electronic payment systems replace the need for cash and checks by allowing
payments to be made electronically.
4. (d) Efficient monetary system.
5. (d) It was very easy to carry/transport. Commodity money was made up of precious metals, was
universally acceptable, and functioned as medium of exchange in most of the primitive societies.
However, it was not always easy to carry or transport.
6. (c) Checks are fiat/legal tender money. Checks are not legal tender, and they are not considered fiat
money as they do not have intrinsic value. They are simply a means of transferring funds.
7. (c) EFT payment refers to a single type of payment. EFT payment refers to a broad category of
electronic payment methods, including ACH transfers, wire transfers, and electronic bill payments.
8. (d) None of the Above, Because it is cash still now.
9. (d) All of the above is true. QR code payment is a contactless payment made using a two-dimensional
barcode that functions like a normal POS terminal.
10. (c) Cash. While cash is a form of payment that allows for anonymity, it is not always safe to make
large purchases with cash as it is more susceptible to theft or loss.
COMPLIANCE ROUTE 22
Probable Questions
Q1. How come payment system is different from financial system and Monetary System?
Answer: The payment system, financial system, and monetary system are all related to the
management of money, but they are distinct concepts with different roles.
The payment system refers to the infrastructure and processes that enable the transfer of funds
between individuals, businesses, and financial institutions. This includes various payment methods
such as cash, checks, credit cards, and electronic transfers. The payment system plays a crucial
role in facilitating transactions and commerce in the economy.
The financial system, on the other hand, encompasses a broader range of institutions, markets,
and intermediaries that deal with the creation, allocation, and management of financial assets and
liabilities. This includes banks, insurance companies, investment firms, stock and bond markets, and
other financial institutions. The financial system helps to mobilize savings, allocate capital, and
manage risks in the economy.
The monetary system is the system through which a government or central bank manages the
supply of money and the interest rates in an economy. It includes the policies, tools, and instruments
used to regulate the money supply, control inflation, and promote economic stability. The monetary
system plays a critical role in determining the overall level of economic activity and the performance
of the financial system.
While there is overlap between these three systems, each serves a distinct function in the economy.
The payment system enables transactions to occur, the financial system helps to allocate capital,
and the monetary system regulates the supply of money and interest rates.
Q2. Describe the evolution of payment system.
Answer: The evolution of payment systems has been a gradual process that has spanned thousands
of years, from the use of barter systems in ancient times to the sophisticated electronic payment
systems used today. Here is a brief overview of the major stages in the evolution of payment
systems:
1.Commodity Money
For any object to function as money, it must be universally acceptable; everyone must be willing to
take it in payment for goods and services. An object that clearly has value to everyone is a likely
candidate to serve as money and a natural choice is a precious metal such as gold or silver. Money
made up of precious metals or another valuable commodity is called commodity money and from
ancient times until several hundred years ago, commodity money functioned as the medium of
exchange in most of the primitive societies. The problem with a payments system based exclusively
on precious metals is that such a form of money is very heavy and is hard to transport from one
place to another.
COMPLIANCE ROUTE 23
2. Paper Currency/Fiat Money

The next development in the payments system was paper currency (pieces of paper that function
as a medium of exchange). Initially, paper currency carried a guarantee that it was convertible into
coins or into a fixed quantity of precious metal. However, currency has evolved into fiat money,
paper currency decreed by governments as legal tender (meaning that legally it must be accepted
as payment for debts) but not convertible into coins or precious metal. Paper currency has the
advantage of being much lighter than coins or precious metal.
3 Checks
A check is an instruction from account holder to her bank to transfer money from her account to
someone else’s account when she deposits the check. Checks allow transactions to take place
without the need to carry around large amounts of currency. The introduction of checks was a major
innovation that improved the efficiency of the payments system. The use of checks reduces the
transportation costs associated with the payment system. Another advantage of checks is that they
can be written for any amount up to the balance in the account, making transactions for large
amounts much easier. Checks are also advantageous in that loss from theft is greatly reduced and
because they provide convenient receipts for purchases.
4 Electronic Fund Transfer Payment

An EFT is an electronic transfer of money from one bank account to another, meaning there is no
need for direct intervention by staff. EFT payments can be carried out between any two accounts,
whether they are based on the same financial institutions or not. It is important to understand that
the term EFT payment does not refer to a single type of payment rather refers to different electronic
payment. Here are some of the most common types EFT payments.
4.1 Credit or Debit Card Payment
A credit or debit card payment is a type of EFT payment for consumers when paying businesses for
goods or services, through a device or a mobile card reader. They can also be used to move money
from business bank accounts or to pay bills.
4.2 ACH Payment
Automated Clearing House (ACH) payments are payments processed through the Automated
Clearing House via the ACH network and not through traditional card networks.
4.3 eCheck
An electronic alternative to paper checks, eChecks work in similar to a paper check but allow
businesses and consumers the ability to use these payments in an increasingly digital world. All you
need is the routing number and bank account number, and an eCheck transfer can be made.
4.4 Wire Transfers
Wire transfers are typically used when transferring large sums of money from one financial institution
account to another. This type of payment is often used for consumers or businesses making a big
purchase, such as a new property or new equipment.
COMPLIANCE ROUTE 24
5 Mobile Payment
A mobile payments (also referred to as mobile money, mobile money transfer or mobile wallet) is a
money payment made for a product or service through a portable electronic device such as Tablet
or Cell Phone. Invested of paying bills with cash, cheque or credit cards, a consumer can use a
payment app on a mobile device to pay for a wide range of service, digital or hard.
6 QR Code Payment (Contactless Payment)

QR is the abbreviation for quick response. It is essentially a two dimensioned barcode that contains
information such as contact details, website link or payment information (on both the merchant and
payment provider). This type of payment functions like a normal POS terminal. A customer can use
her/his phone to scan the QR code and completes the payment on the spot. Every modern
smartphone has a camera that recognizes QR codes. Once the same detects the QR code, a push
notification comes up taking them to a screen where they input their payment details and complete
the purchases.
In conclusion, the evolution of payment systems has been a gradual process that has been driven
by the need for greater efficiency, convenience, and security in payment transactions. From the
barter system to mobile payment systems, payment systems have evolved to meet the needs of an
increasingly complex and interconnected world.
Q3. Describe different components of EFT payment.

Answer: Electronic Funds Transfer (EFT) is a type of electronic payment system that allows for the
transfer of funds between accounts using electronic means. The components of EFT payments
include:
1. Originator: The originator is the person or organization that initiates the EFT payment. This
can be an individual, a business, or a government agency.
2. Receiver: The receiver is the person or organization that receives the EFT payment. This
can also be an individual, a business, or a government agency.
3. Financial Institutions: Financial institutions play a crucial role in EFT payments by facilitating
the transfer of funds between accounts. This includes banks, credit unions, and other
financial institutions that provide EFT services.
4. Payment Gateway: A payment gateway is a software application that enables the secure
transfer of payment data between the originator and the receiver. Payment gateways are
used to process EFT payments made through the internet or other electronic channels.
5. Automated Clearing House (ACH): The ACH is a nationwide electronic funds transfer system
in the United States that is used for EFT payments. The ACH is operated by the Bangaldesh
Bank and is used for a variety of payment transactions, including direct deposit of paychecks,
bill payments, and business-to-business transactions.
In summary, the components of EFT payments include the originator and receiver, financial
institutions, payment gateways, the ACH system. These components work together to facilitate the
secure and efficient transfer of funds between accounts using electronic means.
COMPLIANCE ROUTE 25
Q4. State the advantages and disadvantages of card payment systems.
Answer: Card payment systems refer to electronic payment systems that use payment cards such
as credit cards, debit cards, and prepaid cards. These payment systems have become increasingly
popular in recent years due to their convenience and ease of use. Here are some of the advantages
and disadvantages of card payment systems:
 Advantages:
1. Convenience: Card payment systems are extremely convenient, as they allow customers to
make purchases without carrying cash.
2. Speed: Card payment systems allow for quick and easy payment transactions, which can
save time for both customers and merchants.
3. Security: Card payment systems offer enhanced security features such as chip-and-pin
technology and encryption, which can help to prevent fraud and protect sensitive financial
information.
4. Rewards Programs: Many card payment systems offer rewards programs that provide
customers with incentives such as cash back or airline miles for making purchases with their
cards.
5. Record Keeping: Card payment systems provide a record of all transactions made, which
can be useful for tracking expenses and budgeting.
Disadvantages:
1. Fees: Card payment systems often charge fees to merchants, which can increase the cost
of doing business.
2. Interest Rates: Credit cards may have high interest rates, which can lead to significant debt
if not managed carefully.
3. Fraud Risk: Despite the security features of card payment systems, there is still a risk of
fraud and identity theft, which can have serious financial consequences.
4. Dependence on Technology: Card payment systems rely on technology, which means that
they can be vulnerable to technical glitches and downtime.
5. Lack of Anonymity: Card payment systems provide a record of all transactions made, which
means that purchases are not anonymous and can be tracked.
In summary, card payment systems offer many advantages, including convenience, speed, security,
rewards programs, and record keeping. However, they also have some disadvantages, such as fees,
interest rates, fraud risk, dependence on technology, and lack of anonymity. It is important to carefully
consider these pros and cons when deciding whether to use card payment systems.
COMPLIANCE ROUTE 26
Q5. State the advantages and disadvantages of Mobile Payment System.
Answer : Mobile payment systems are a type of electronic payment system that allows users to
make purchases or transfer funds using their mobile devices. Here are some of the advantages and
disadvantages of mobile payment systems:
 Advantages:
1. Convenience: Mobile payment systems allow users to make purchases or transfer funds
from anywhere at any time using their mobile devices.
2. Speed: Mobile payment systems are quick and easy to use, which can save time for both
customers and merchants.
3. Security: Mobile payment systems offer enhanced security features such as encryption,
biometric authentication, and tokenization, which can help to prevent fraud and protect
sensitive financial information.
4. Integration with Loyalty Programs: Many mobile payment systems allow users to integrate
their loyalty programs, which can help to earn rewards and discounts.
5. Reduced Need for Cash: Mobile payment systems reduce the need for cash, which can
help to lower the risk of theft or loss.
Disadvantages:
1. Compatibility: Mobile payment systems may not be compatible with all mobile devices,
which can limit their usefulness.
2. Connectivity: Mobile payment systems require an internet connection, which can be a
problem in areas with poor connectivity or when the network is down.
3. Security Risk: Despite the security features of mobile payment systems, there is still a risk
of fraud and identity theft, especially if the mobile device is lost or stolen.
4. Limited Acceptance: Mobile payment systems may not be accepted at all merchants or
businesses, which can limit their usefulness.
5. Privacy Concerns: Mobile payment systems may collect personal information about users,
which can raise privacy concerns.
6. Fraud Risk: Despite the security features of mobile payment systems, there is still a risk of
fraud and identity theft, which can have serious financial consequences.
In summary, mobile payment systems offer many advantages, including convenience, speed,
security, integration with loyalty programs, and reduced need for cash. However, they also have
some disadvantages, such as compatibility issues, connectivity problems, security risks, limited
acceptance, and privacy concerns. It is important to carefully consider these pros and cons when
deciding whether to use mobile payment systems.
COMPLIANCE ROUTE 27
Q6. Write Short Notes on:
Bangladesh Automated Clearing House (BACH)
The Bangladesh Automated Clearing House (BACH) is an important component of the payment
system in Bangladesh. Here are some of the key points about BACH:
1. It is a payment processing system used in Bangladesh to facilitate electronic fund transfers

between bank accounts.
2. The system is operated by the Bangladesh Bank, the central bank of Bangladesh.
3. BACH processes bulk transactions, allowing for the efficient and cost-effective transfer of
funds between multiple accounts at different banks in Bangladesh.
4. The system is used for various payment transactions, including salary payments, vendor
payments, and utility bill payments.
5. The BACH system provides features such as real-time fund transfer, bulk payment
processing, and electronic fund transfer services.
6. BACH is a reliable, secure, and efficient system that plays a significant role in the banking
system of Bangladesh by facilitating electronic payments.
Overall, the BACH system is an important component of the payment infrastructure in Bangladesh
that allows for the efficient transfer of funds between bank accounts.
Real Time Gross Settlement
RTGS stands for Real Time Gross Settlement. It is a type of electronic funds transfer system used
for high-value transactions between banks and financial institutions. In RTGS, the funds transfer is
settled in real-time and on a gross basis, meaning that each transaction is processed individually
and immediately settled, without the need for batching or netting.
RTGS is used for large-value transactions that require immediate and secure transfer of funds. In an
RTGS system, the funds are transferred from the sender's account to the receiver's account in real-
time, usually within a few hours or even minutes. This makes it an ideal system for transactions that
require immediate settlement, such as large corporate payments, interbank transfers, and
government payments.
The RTGS system is generally considered to be more secure and reliable than other electronic
payment systems because it provides immediate settlement and confirmation of the transfer.
However, it may also involve higher transaction fees and require more complex technical
infrastructure and operational procedures compared to other payment systems.
COMPLIANCE ROUTE 28
Point of Sale
POS stands for Point of Sale. It refers to a system used by merchants or retailers to process
payments from customers using credit or debit cards. A typical POS system includes a card reader
or terminal that is connected to a computer or mobile device, which is used to initiate and process
the payment transaction.
When a customer makes a purchase using their credit or debit card, they insert, swipe, or tap their
card on the POS terminal, which reads the card information and sends it to the payment processor
for verification and authorization. Once the transaction is authorized, the payment is transferred from
the customer's account to the merchant's account.
POS systems offer several benefits to merchants, including faster and more efficient payment
processing, reduced risk of fraud and errors, and improved customer experience. Additionally, many
modern POS systems also include features such as inventory management, sales reporting, and
customer relationship management tools.
Overall, POS systems are an essential component of modern retail and commerce, enabling
merchants to securely and efficiently process payments from customers using credit and debit cards.
National Payment System
The National Payment System (NPS) in Bangladesh refers to the system that facilitates the transfer
of funds between individuals, businesses, and government entities within the country. The NPS is
overseen by the Bangladesh Bank, the central bank of Bangladesh, and is comprised of various
payment instruments and systems, including:
1. Real-time Gross Settlement System (RTGS): This is a system that facilitates high-value
interbank fund transfers in real-time.
2. Bangladesh Automated Clearing House (BACH): This is a system that facilitates the clearing
and settlement of low-value interbank fund transfers, such as checks, direct debits, and
credits.
3. Electronic Fund Transfer (EFT): This is a system that enables the transfer of funds from one
account to another electronically.
4. Payment Cards: These include debit cards, credit cards, and prepaid cards, which allow
consumers to make payments at point-of-sale terminals and online.
5. Mobile Financial Services: These are services that allow consumers to make payments and
transfer funds using their mobile phones.
The NPS plays a crucial role in facilitating economic activity in Bangladesh, enabling businesses to
make and receive payments, individuals to pay bills and transfer money, and the government to
COMPLIANCE ROUTE 29
collect taxes and disburse payments. The Bangladesh Bank continues to work on improving the
efficiency and safety of the NPS, promoting financial inclusion, and ensuring that it meets the
evolving needs of the country's economy.
Bangla QR
Bangla QR is a Quick Response (QR) code-based payment system that was launched in Bangladesh
in 2020. It is a joint initiative of the Bangladesh Bank and several leading commercial banks in the
country, including Dutch-Bangla Bank, BRAC Bank, and Bank Asia etc.
The Bangla QR system allows consumers to make payments using their mobile phones by scanning
a QR code displayed at a merchant's point-of-sale terminal or on a bill. The payment is then
processed through the customer's bank account, which is linked to their mobile number. The system
is interoperable, which means that it can be used across multiple banks and payment service
providers, allowing for greater convenience and access for consumers and merchants.
The Bangla QR system is expected to increase the adoption of digital payments in Bangladesh,
which has traditionally been a cash-dominated economy. By making payments more convenient and
secure, the system can help to reduce the cost and risk associated with cash transactions, promote
financial inclusion, and contribute to the country's economic growth.
The Bangladesh Bank and participating banks continue to work on expanding the reach of the Bangla
QR system, promoting awareness and education among consumers and merchants, and enhancing
the features and functionality of the system to meet the evolving needs of the market.
COMPLIANCE ROUTE 30
Module-3: Financial System

Concern of Finance, Modes of Finance (Direct and Indirect); Concept of Financial System,
Relationship among Financial, Monetary and Payment Systems; Constituents of Financial System: Financial
Institutions, Financial Instruments and Financial Markets. Financial Infrastructure and Superstructure.
Financial System of Bangladesh.
Module-3: Financial System
3.1 Concern of Finance
3.2 Different Forms of Finance
3.2.1 Rudimentary finance, 3.2.2 Direct Finance 3.2.3 Indirect Finance
3.2.4 Gains to Lenders and Borrowers
3.2.5 The economic Basis of Financial Intermediation
3.3 Financial System and Its Constituents
3.3.1 Financial Instruments , 3.3.2 Financial Intermediaries 3.3.3 Financial Markets
3.4 Functions Performed by Financial Systems
3.5 Financial Sector and Economic Development
3.6 Financial Development
3.6.1 Introduction
3.6.2 Meaning and Importance 3.6.3 Indicators of Financial Development
3.7 An Economic Analysis of Financial System
3.7.1 Introduction
3.7.2 How Transactions Costs Influence Financial System
3.7.3 Asymmetric Information: Adverse Selection and Moral Hazard
3.8 Financial System of Bangladesh
3.9 Financial System of Bangladesh and Legal Framework of Banking
3.10 Development Role of Finance: Development Banking, Microcredit and Microfinance, Inclusive
Finance and Sustainable Finance.
3.10.1 Development Banking
3.10.2 Micro Credit and Micro Finance
3.10.3 Micro Finance Providers and Clients
3.10.4 Inclusive Finance
COMPLIANCE ROUTE 31
Modules: 03_ Financial System
Review Questions
Q1. For each of the following financial transaction indicate whether it involves direct finance or
indirect finance by writing in the space provided a D for direct finance and an I for indirect finance.
SL Issues Answer
1 IFIC Bank issues commercial paper to T & T. I
2 You buy a share of a mutual fund. I
3 You buy a life insurance policy. I
4 You buy a share of a company. D
5 You borrow TK.1000 from your father. D
6 You obtain a TK. 50,000 mortgage from DBHL. I
7 You buy a govt. savings bond. I
8 SQUARE sells a share of its stock to APEX. D
9 You take out a car loan from a NBFI I
10 T & T issues commercial paper to Petro Bangla D
Answer with explanation:
1. I - This is an example of indirect finance as the transaction involves the use of a financial intermediary
(IFIC Bank) between the borrower (T&T) and the ultimate lender (savers or investors who have
provided funds to IFIC Bank).
2. I - Buying a share of a mutual fund can be considered a form of indirect financing. Indirect financing
refers to a situation in which a borrower obtains funds through an intermediary or middleman, such
as a bank or financial institution. In the case of a mutual fund, the mutual fund company pools money
from many investors and uses it to purchase a portfolio of assets, such as stocks, bonds, or other
securities. When an investor buys a share of a mutual fund, they are effectively lending money to the
mutual fund company, which in turn invests the money in the underlying assets. Therefore, buying a
share of a mutual fund can be considered a form of indirect financing since the investor is providing
funds to the mutual fund company, which then uses the funds to invest in a portfolio of assets.
3. I - This is an example of indirect finance as the life insurance company acts as a financial intermediary
between the policyholder (ultimate lender) and the borrower who will receive the funds from the life
insurance company.
4. D - This is an example of direct finance as you are buying a share of a company directly, which
means that your funds are going directly to the company and then to the borrowers who have
received financing from the company.
5. D - This is an example of direct finance as you are borrowing money directly from your father, who
is the ultimate lender.
6. I - This is an example of indirect finance as you are obtaining a mortgage from DBHL, which is acting
as a financial intermediary between you (the borrower) and the ultimate lender (savers or investors
who have provided funds to DBHL).
COMPLIANCE ROUTE 32
7. I - Buying a government savings bond can be considered a form of indirect financing. Indirect
financing refers to a situation in which a borrower obtains funds through an intermediary or
middleman, such as a bank or financial institution. In the case of a government savings bond, the
government issues the bond to the investor, who is effectively lending money to the government.
However, the investor does not directly provide the funds to the government, but rather purchases
the bond through an intermediary, such as a bank or broker.
8. D - This is an example of direct finance as APEX is buying a share of SQUARE's stock directly,
which means that APEX's funds are going directly to SQUARE and then to the borrowers who have
received financing from SQUARE.
9. I - This is an example of indirect finance as the NBFI (financial intermediary) is providing the car loan
to you (the borrower) on behalf of the ultimate lender (savers or investors who have provided funds
to the NBFI).
10. D-Based on the information provided, it appears that T&T is issuing commercial paper to Petro
Bangla, which suggests that this is a form of direct financing. Direct financing refers to a situation in
which a borrower obtains funds directly from a lender, without the involvement of any intermediary
or middleman. In this case, T&T is obtaining funds directly from Petro Bangla by issuing commercial
paper to them.
Q Multiple Choice Question

1. A financial system is concerned with mobilization of fund from:
a) Banker to Borrower
b) Depositor to Banker
c) Saver to Borrower
d) Saver to Lender
The correct answer is c) Saver to Borrower.
Explanation: A financial system facilitates the transfer of funds from those who have excess funds
(savers) to those who need funds (borrowers).
2. The equity gap of your company has been financed by a commercial bank by
purchasing the shares. This is an example of:
a) indirect Finance
b) Direct Finance
c) Direct Financial h1strument
d) Both(a)and(c)
The correct answer is d) both (a) and (c).
Explanation: Direct finance involves the flow of funds directly from savers to borrowers, while direct
financial instruments are securities that represent a direct claim on the underlying asset. In this case,
the commercial bank is purchasing shares in the company, which is a direct financial instrument.
3. indirect finance refers to flow of savings

a) from savers to entrepreneurs
COMPLIANCE ROUTE 33
b) from ultimate lenders to ultimate borrowers

c) from depositors to financial intermediaries
d) from providers to users of funds via agents
The correct answer is c) from depositors to financial intermediaries.
Explanation: Indirect finance refers to the flow of funds from savers to borrowers through financial
intermediaries like banks and other financial institutions.
4. Financial intermediation is done by -

a) Brokers and Jobbers
b) Mutual Funds
c) Central Bank
The correct answer is b) Mutual Funds.
Explanation: Financial intermediation involves the process of mobilizing funds from savers and
channeling them to borrowers. Brokers and jobbers are involved in trading of securities, while central
banks are responsible for monetary policy and regulating the banking system.
5. Who practices direct mode of finance?

a) Mutual Fund
b) Bond Market
c) Stock Market
d) All of the above
e) Only (b) and (c)
The correct answer is e) only (b) and (c).
Explanation: Direct mode of finance involves the flow of funds directly from savers to borrowers
through financial instruments like bonds and stocks. Mutual funds pool funds from investors to invest
in various securities, and therefore, do not practice direct mode of finance.
6. Bangladesh Govt. asks banks to offer subsidized credit to farmers and exporters and banks
are complying it. It is a/an-
a) Inte1mediation function
b) Credit function
c) Policy function
d) Social function
e) All of the above
The correct answer is c) Policy function.
Explanation: The government asking banks to offer subsidized credit to farmers and exporters is an
example of a policy function.
COMPLIANCE ROUTE 34
7. Which one of the following is a direct financial instrument

a) Savings Deposit
b) Deposit Pension Scheme
c) Share of Companies
d) Shares of financial institutions
e) Both (c) and (d)
The correct answer is c) Share of Companies.
Explanation: Shares of companies represent a direct claim on the underlying assets and are
therefore, direct financial instruments.
8. Which one of the following is not included under financial superstructure

a) Regulatory system
b) Financial institutions
c) Financial instruments
d) Leasing companies
e) Merchant banks
The correct answer is d) Leasing companies.
Explanation: Leasing companies are a type of financial institution and are included under financial
superstructure.
9. Which of the following is not a feature of rudimentary finance?

a) Absence of an any of financial instrument
b) No financial instrument other than money
c) All economic units are forced to be balanced units
d) All economic units can invest more than their savings
e) It ends up with low levels of savings ai1d investments.
The correct answer is d) All economic units can invest more than their savings.
Explanation: Rudimentary finance refers to a basic financial system that is characterized by a limited
range of financial instruments and a lack of financial institutions. In such a system, all economic units
are forced to be balanced units, meaning they cannot invest more than they save.
10. In a financial intermediation process, the ultimate lender is:

a) Banks
b) Depositors
c) Shareholders
d) Central Bank
The correct answer is b) Depositors.
COMPLIANCE ROUTE 35
Explanation: In a financial intermediation process, banks act as financial intermediaries by

mobilizing funds from depositors and channeling them to borrowers. Therefore, the ultimate lender
in this process is the depositor.
3. Name the nature of following financial instruments (whether Direct or Indirect):
Sl Financial Instruments Answer

i) Mutual Fund Indirect finance
ii) Debenture Direct finance
iii) Certificate of Deposit Indirect finance
iv) Bank Loan Indirect finance
v) Prize Bond Indirect finance
vi) Currency Notes and Coins Direct finance
vii) Bill of Exchange Drawn on importer Indirect finance
viii) Treasury Bill Indirect finance
ix) Cheque Direct finance
x) Lottery Slip Indirect finance
Answer with explanation:
i) Mutual Fund - Indirect finance. Mutual funds pool money from multiple investors and invest in a diversified
portfolio of securities, making it an indirect way of investing in the financial market.
ii) Debenture - Direct finance. Debentures are a type of debt instrument issued by companies to borrow
money from the public. It is a direct way for companies to raise money from investors.
iii) Certificate of Deposit - Indirect finance. A certificate of deposit is a financial instrument that represents
a time deposit with a bank. It is a way for banks to raise money from the public by offering a fixed rate of
interest.
iv) Bank Loan - Indirect finance. Because Bank is an intermediator.
v) Prize Bond - Indirect finance. Prize bonds are a type of lottery bond issued by the government. It is an
indirect way for the government to raise money from the public.
vi) Currency Notes and Coins - Direct finance. Currency notes and coins are physical forms of money that
are issued by the government and directly used for transactions.
vii) Bill of Exchange Drawn on importer - Indirect finance. A bill of exchange is a financial instrument that
represents a debt owed by one party to another. In this case, it is an indirect way for an exporter to obtain
financing by selling the bill to a financial intermediary who then sells it to the importer.
viii) Treasury Bill - Indirect finance. Treasury bills are a type of short-term debt security issued by the
government to borrow money from the public. It is an indirect way for the government to raise money from
investors.
ix) Cheque - Direct finance. A cheque is a type of direct finance where the payer directly pays the payee by
writing a cheque on their account.
x) Lottery Slip - Indirect finance. Lottery slips are a type of lottery bond issued by the government. It is an
indirect way for the government to raise money from the public.
COMPLIANCE ROUTE 36
Q4. Indicate whether the following terms belong to financial infrastructure or financial
superstructure;
Sl no Terms Answer
i) Bank Company Act - 1991 Financial Infrastructure
ii) Currency Notes Financial Infrastructure
iii) Mutual Fund Financial Superstructure
iv) Bangladesh Shilpa Bank Financial Infrastructure
v) IAS - 30 for Bank Accounting Financial Superstructure
vi) Bangladesh Bank Circulars Financial Infrastructure
vii) Banking Financial Institutions Financial Infrastructure
viii) OTC market Financial Superstructure
ix) Bill of Exchange Financial Superstructure
x) Janata Bank General Banking Manuals Financial Infrastructure
Explanations: Financial infrastructure and financial superstructure are two important concepts in the field of
finance. Here's an overview of what these terms mean:
 Financial infrastructure: This term refers to the basic systems, institutions, and services that
underpin financial transactions and activities. Examples of financial infrastructure include payment
and settlement systems, financial market infrastructure, regulatory frameworks, and financial
intermediaries such as banks and other financial institutions. Financial infrastructure provides the
foundation for financial activities and supports economic growth and development.
 Financial superstructure: This term refers to the more advanced and complex financial
instruments, markets, and activities that build upon the foundation of financial infrastructure.
Examples of financial superstructure include derivatives, securitization, structured finance, and other
advanced financial products and services. Financial superstructure can provide greater opportunities
for risk management, investment, and financing, but it also requires more sophisticated knowledge,
expertise, and regulation.
3. Put the following financial instruments in the appropriates box or boxes below:
 Treasury Bill
 Mutual Fund
 Common Stock
 Inter Bank Loan
 Cheque
 6 Months Fixed Deposits
 Working Capital Loan
 Syndicated Terms Loan
 Inter Bank Deposit
 Corporate Bond
COMPLIANCE ROUTE 37
Answer:
Issues Direct Financial Instruments: Indirect Financial Instruments:

 Cheque  Inter Bank Loan
 6 Months Fixed Deposits
Banking Market  Working Capital Loan
 Syndicated Terms Loan
 Inter Bank Deposit
 Treasury Bill  Mutual Fund

 Corporate Bond
Security Market  Common Stock
4. Please look at the following financial transactions and decide whether they fit in
(a) the money market or the capital market,
(b) the primary or the secondary market, and
(c) the debt or equity market.
a. You visit a local bank today and secure a three-year loan to finance the purchase of a new car
and some furniture.
MM/CM PM/SM DM/EM
b. You purchase a new Treasury bill for Tk.800 through the Central bank in a neighboring city for
delivery today.
MM/CM PM/SM DM/EM
c. You have purchased 100 shares of a company's stock through a phone call to your broker, who
is linked to a major stock exchange.
MM/C PM/SM DM/EM
d. You contact a local bank and purchase a Tk.15,000 two-year CD bearing an interest rate on
which you and the bank's officer have agreed.
MM/CM PM/SM DM/EM
e. The corporation you represent needs to raise Tk.25 million immediately to purchase raw
materials. You contact a securities dealer who agrees to advertise the sale of Tk. 25 million in
commercial paper and maturing in 90 days.
MM/C PM/SM DM/E
Answer :
a. Money market, Primary market, Debt market
b. Money market, Secondary market, Debt market
c. Capital market, Secondary market, Equity market
d. Money market, Primary market, Debt market
e. Money market, Primary market, Debt market
COMPLIANCE ROUTE 38
5. What functions of the financial system do the following transactions illustrate or

represent?
a) Mamun purchases health and accident insurance policies through the company
where he works.
b) Sharrnin uses her credit card to purchase wallpaper for a home remodeling project.
c) Dynamic Corporation places some of its current earnings in a bank CD, anticipating a
need for funds in about a year to build a new warehouse.
d) The Treasury sells new bonds in the open market to cover a large deficit.
e) Mr. and Mrs. Habib hope to put their three young children through college
someday. Accordingly, they begin buying Govt. Savings bonds.
f) Needing immediate spending power, a Corporation sells its holdings of Beximco bonds
through a security broker.
g) Banks have been asked to repo1t central bank all suspicious transactions in order to
prevent money launder.
Answer :
a) The transaction represents the function of risk management in the financial system. By purchasing
health and accident insurance policies, Mamun is transferring the risk of potential future medical
expenses to the insurance company.
b) The transaction represents the function of payment and credit in the financial system. Sharrnin is
using her credit card to make a purchase, deferring the payment until a later date when she receives
her credit card statement.
c) The transaction represents the function of savings and investment in the financial system. Dynamic
Corporation is saving its current earnings by placing them in a bank CD, anticipating a future need for
funds for a specific purpose.
d) The transaction represents the function of government finance in the financial system. The Treasury
is selling bonds in the open market to raise funds to cover a large deficit, which is a form of government
borrowing.
e) The transaction represents the function of savings and investment in the financial system. Mr. and
Mrs. Habib are buying Govt. Savings bonds as a form of investment for the purpose of future
education expenses.
f) The transaction represents the function of liquidity and investment in the financial system. The
Corporation is selling its holdings of Beximco bonds to raise cash quickly, thereby converting an
investment into cash.
g) The transaction represents the function of regulation and supervision in the financial system. The
banks are being asked to report suspicious transactions to the central bank to prevent money
laundering and ensure compliance with regulations.
COMPLIANCE ROUTE 39
Probable Questions
Q1. In terms of concerns of Finance, differentiate between direct and Indirect Mode of Finance. What
are the distinguishing features of Rudimentary Finance?
Answer:
Direct finance involves the transfer of funds from savers to borrowers directly, without the involvement of a financial
intermediary.
Indirect finance, on the other hand, involves the use of a financial intermediary, such as a bank, to channel funds from
savers to borrowers.
There are some distinguishing features of each:
Direct Finance Indirect Finance

Direct transfer of funds between savers and borrowers Involves the use of a financial intermediary to channel
funds from saver to borrowers.
Usually involves larger borrowers and lenders, such Often involves small-scale savers and borrowers, such
as corporations and institutional investors as households and small businesses
Generally results in higher costs for both borrowers Typically results in lower costs for both borrowers and
and lenders, due to the lack of economies of scale lenders, due to the economies of scale provided by the
financial intermediary
May involve higher risks for lenders, due to the lack May involve lower risks for lenders, due to the
of diversification and expertise in managing risks diversification and expertise provided by the financial
intermediary
Examples include direct loans, bonds, and equity Examples include bank loans, mortgages, and mutual
investments funds
Q. What are the distinguishing features of Rudimentary Finance?
Rudimentary Finance:
Answer: Rudimentary finance refers to the earliest forms of financial activities, which were simple and basic compared
to modern finance. Some distinguishing features of rudimentary finance include:
 Primarily based on barter trade, where goods and services were exchanged directly without the use of
money.
 Limited use of money, which was often in the form of precious metals, such as gold and silver.
 Lack of formal financial institutions, such as banks and stock exchanges.
 Limited financial innovation, such as the absence of complex financial instruments and derivatives.
 Relatively low levels of financial intermediation, as most transactions were conducted directly between
parties.
 Limited access to credit, especially for small-scale borrowers, due to the absence of formal credit markets.
 Relatively low levels of financial literacy and education among the general population.
Q2. Why do both surplus units and deficit units prefer Indirect Mode of Finance to Direct Mode of
Finance?
Answer: Both surplus units and deficit units may prefer indirect mode of finance to direct mode of finance for several
reasons:
COMPLIANCE ROUTE 40
1. Risk reduction: Financial intermediaries can help to reduce risk for both borrowers and lenders. For example,
banks can diversify their loan portfolios to reduce the risk of default, and they can provide expertise in
managing risk.
2. Convenience: Indirect finance can be more convenient for both borrowers and lenders. For example, a
borrower may find it easier to obtain a loan from a bank than from individual lenders, and a lender may find it
easier to invest in a mutual fund than to invest directly in individual securities.
3. Information advantages: Financial intermediaries may have better information about borrowers than
individual lenders do, which can help to reduce information asymmetry and the risk of adverse selection. For
example, a bank may have access to a borrower's credit history and financial statements, which can help to
assess creditworthiness.
4. Liquidity: Indirect finance can provide greater liquidity for both borrowers and lenders. For example, a
borrower may be able to obtain a loan quickly from a bank, and a lender may be able to sell shares in a mutual
fund quickly if needed.
5. Cost savings: Indirect finance often involves lower costs for both borrowers and lenders, due to the
economies of scale provided by financial intermediaries. For example, a bank can offer lower interest rates
on loans than individual lenders can offer because the bank can spread its fixed costs over a larger number
of loans.
Overall, indirect finance can provide benefits for both surplus units and deficit units, which is why it is often preferred
to direct finance.
Q3. In a formal financial system, who does practice direct mode of finance? Which one is more risky
(between direct and indirect mode of finance) from surplus economic unit point of view and why?
ANSWER:
In a formal financial system, large institutional investors such as pension funds, sovereign wealth funds, and insurance
companies typically practice direct mode of finance. These investors have the resources, expertise, and risk appetite
to invest directly in a range of financial instruments, including stocks, bonds, and other securities.
From the surplus economic unit's point of view, direct mode of finance is generally considered more risky than indirect
mode of finance. This is because direct finance involves investing in individual securities or loans, which may be subject
to greater volatility and risk than diversified portfolios or loans managed by financial intermediaries.
Direct mode of finance may be more risky for surplus economic units due to the following reasons:
 Concentration risk: Investing directly in a single security or loan can expose the investor to concentration
risk, meaning that if that security or loan performs poorly, the investor may suffer significant losses.
 Lack of expertise: Many surplus economic units may not have the resources or expertise to adequately
evaluate individual securities or loans, increasing the risk of making poor investment decisions.
 Lack of diversification: Investing in a small number of securities or loans directly can lead to a lack of
diversification, which can increase the risk of losses.
 Credit risk: Directly lending money to a borrower can expose the lender to credit risk, meaning that the
borrower may not be able to repay the loan.
In contrast, indirect mode of finance through financial intermediaries can help to reduce risk for surplus units by
providing greater diversification, expertise, and risk management.
COMPLIANCE ROUTE 41
Q4. Why NBFI are is also known as financial intermediaries? In terms of intermediation, is there any difference
between BFI and NBFI?
Answer : Non-bank financial institutions (NBFI) are also known as financial intermediaries because they perform
financial intermediation, which is the process of channeling funds from savers to borrowers or investors.
Like traditional banks, NBFI also provide financial services such as loans, investments, and insurance, but they are not
regulated as banks and do not accept deposits from the public. Instead, they raise funds through various means such
as issuing bonds, commercial paper, or taking loans from banks or other financial institutions.
NBFI act as intermediaries between savers and borrowers or investors by collecting funds from savers and then
investing or lending those funds to borrowers or investors who need capital for their business or personal needs. This
intermediation process helps to bridge the gap between the demand for funds and the supply of funds, which ultimately
promotes economic growth and development.
Therefore, NBFI are called financial intermediaries because they play a critical role in channeling funds from savers to
borrowers or investors and help to facilitate economic activity by providing financial services to various sectors of the
economy.
Q. In terms of intermediation, is there any difference between BFI and NBFI?
Answer: The comparison of banks and non-bank financial institutions (NBFI) in terms of intermediation:
category BFIs (Banking Financial Institutions) NBFIs (Non-Banking Financial Institutions)

Assets Accept deposits that are considered money, Do not accept deposits that are considered money.
such as demand deposits and time deposits. Instead, they accept funds that are not readily
transferable, such as fixed deposits, bonds, and
other securities.
Liabilities Liabilities of BFIs are money Liabilities of NBFIs are not money
Their deposits are chequable. their deposits are not chequable
Customer Provide services to both individual and Provide services mainly to corporate customers
Base corporate customers
Examples Commercial banks, specialized banks, and Investment banks, merchant banks, leasing
other types of banks that accept deposits. companies, finance companies, house finance
companies, and insurance companies.
Q5.Why do deficit economic units have preferences for Indirect Mode of Finance?
ANSWER: Deficit economic units, such as businesses and individuals, may prefer indirect mode of finance for several
reasons:
1. Access to a wider range of funding sources: Indirect mode of finance provides access to a wider range of
funding sources, such as banks, NBFI's, and capital markets, which can help to diversify funding sources and
reduce reliance on a single source of funding.
2. Lower transaction costs: Indirect mode of finance may involve lower transaction costs than direct finance,
as financial intermediaries can achieve economies of scale in processing and underwriting loans and issuing
securities.
3. Reduced risk: Indirect mode of finance can help to reduce risk for deficit units by spreading the risk across a
larger pool of investors, which can make it easier to obtain funding and reduce the risk of default.
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4. Professional expertise: Financial intermediaries have professional expertise in managing risk and selecting
investments, which can help to ensure that funds are invested in a prudent and efficient manner.
Overall, indirect mode of finance can provide several advantages for deficit economic units, including access to a wider
range of funding sources, lower transaction costs, reduced risk, and professional expertise. These advantages can
help to support economic growth and development by enabling businesses and individuals to obtain the funding they
need to invest and expand.
Q6. Describe the economic reasons for which financial intermediaries have been able to offer better
financial services to both depositors and borrowers and also earn reasonable profits.
Answer : Financial intermediaries play a crucial role in the economy by bringing together savers and borrowers and
facilitating the flow of funds between them. They are able to offer better financial services to both depositors and
borrowers due to several economic reasons:
1. Economies of Scale: Financial intermediaries can take advantage of economies of scale in their operations,
which allows them to lower their costs of providing financial services. As they gather a large number of
deposits from savers, they can lend out these funds to borrowers at a lower cost than if each borrower had to
seek out individual savers. This also allows them to offer higher interest rates to depositors and lower interest
rates to borrowers.
2. Diversification: Financial intermediaries are able to diversify their investments by investing in a wide range
of financial assets, which reduces the overall risk of their portfolios. This allows them to offer better returns to
their depositors and borrowers by providing access to a more diversified set of investments.
3. Information Asymmetry: Financial intermediaries have the advantage of better access to information than
individual savers and borrowers. This allows them to better assess the creditworthiness of potential borrowers
and reduce the risk of default. It also allows them to offer better investment opportunities to their depositors,
by investing in higher-yielding assets while still managing risk.
4. Liquidity Transformation: Financial intermediaries can transform the liquidity of assets, by converting less
liquid assets (such as long-term loans) into more liquid liabilities (such as deposits). This allows depositors to
withdraw their funds on demand, even though the intermediaries have invested in less liquid assets.
5. Risk Management: Financial intermediaries are able to manage risk better than individual savers
and borrowers. They can diversify their portfolios to reduce risk and use various financial instruments,
such as derivatives, to hedge against specific risks. This allows them to offer better risk-adjusted
returns to their clients.
6. Regulatory Benefits: Financial intermediaries also benefit from regulations that ensure their stability
and solvency, and protect their clients. This helps to build trust in the financial system and
encourages savers and borrowers to use their services.
7. Expertise and Innovation: Financial intermediaries have the expertise to design and offer
innovative financial products that meet the needs of their clients. They can also use technology to
offer services more efficiently and at a lower cost, which benefits their clients and allows them to
earn higher profits.
These economic reasons allow financial intermediaries to offer better financial services to both depositors and
borrowers, while also earning reasonable profits. By taking advantage of economies of scale, diversification,
information asymmetry, and liquidity transformation, financial intermediaries can provide a range of financial services
that are not easily accessible to individual savers and borrowers. This also allows them to earn reasonable profits by
charging fees and interest rates that cover their costs of operation and generate a return for their shareholders.
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Q6. What do you mean by financial institutions? Discuss the similarities and differences between BFIs
and NBFIs.
Answer: Financial institutions are organizations that provide financial services to their clients, such as individuals,
businesses, and governments. These services may include deposit-taking, lending, investment management,
insurance, and other related services. Financial institutions may be classified into different types based on the services
they provide, their legal structure, and their ownership. Examples of financial institutions include commercial banks,
investment banks, credit unions, insurance companies, mutual funds, and pension funds. These institutions play a
critical role in the economy by facilitating the flow of funds between savers and borrowers and promoting economic
growth. They also help to manage risk, allocate capital efficiently, and promote financial stability.
BFIs (Banking Financial Institutions) and NBFIs (Non-Banking Financial Institutions) are two broad categories of
financial institutions. While both types of institutions play a crucial role in the economy, they have some similarities and
differences that set them apart.
Similarities:
1. Both types of institutions offer financial services to their clients, such as deposit-taking, lending, investment
management, insurance, and other related services.
2. Both BFIs and NBFIs are subject to regulatory oversight and supervision by government bodies.
3. Both types of institutions are involved in the process of financial intermediation, which involves pooling savings
from savers and lending to borrowers.
Differences:
1. Liabilities: One of the main differences between BFIs and NBFIs is the nature of their liabilities. The liabilities
of BFIs, such as demand deposits, are considered money and are chequable, while the liabilities of NBFIs,
such as bonds and other securities, are not money and are not chequable.
2. Services: BFIs typically offer a wider range of services than NBFIs, including deposit-taking, lending,
investment management, insurance, and other related services. NBFIs, on the other hand, tend to specialize
in specific areas, such as leasing, factoring, and venture capital.
3. Regulation: BFIs are subject to more stringent regulations than NBFIs, as they are considered to be
systemically important institutions and have a greater impact on financial stability. NBFIs, on the other hand,
are generally subject to lighter regulation.
In summary, while both BFIs and NBFIs offer financial services and are subject to regulatory oversight, they differ in
their liabilities, range of services, ownership structure, and regulatory requirements.
Q7. How do you define financial instruments? In how many ways, financial instruments can be classified?
Explain with examples.
Answer: Financial instruments are tradable assets that represent a financial claim or a contractual agreement
between two parties. These instruments can be bought and sold in financial markets, and their prices are determined
by supply and demand forces. Financial instruments can take many forms and serve a wide variety of purposes, such
as raising capital, managing risk, and facilitating financial transactions.
Financial instruments can be classified in various ways based on different criteria. There are some common ways to
classify financial instruments:
1. Equity instruments: These are instruments that represent ownership in a company, such as stocks, shares,
and equity funds. Equity instruments entitle the holder to a share of the company's profits and voting rights in
the company's management.
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2. Debt instruments: These are instruments that represent a loan or a fixed-income security, such as bonds,
notes, and certificates of deposit. Debt instruments entitle the holder to a fixed or variable stream of interest
payments and repayment of the principal at maturity.
3. Hybrid instruments: These are instruments that combine characteristics of both debt and equity, such as
convertible bonds, preferred shares, and warrants.
4. Derivative instruments: These are instruments that derive their value from an underlying asset or
benchmark, such as options, futures, and swaps. Derivative instruments are used to manage risk and
speculate on price movements in various markets.
5. Commodity instruments: These are instruments that represent commodities, such as gold, oil, and
agricultural products. Commodity instruments are used for trading, investment, and hedging against
commodity price movements.
6. Depository instruments: These are instruments that represent a deposit in a financial institution, such as
checking and savings accounts, money market funds, and certificates of deposit.
7. Insurance instruments: These are instruments that provide insurance coverage against various risks, such
as life insurance, health insurance, and property and casualty insurance.
8. Fixed-income instruments: These are instruments that provide a fixed rate of return over a specific
period, such as bonds, Treasury bills, and notes. They are typically issued by governments,
municipalities, and corporations.
9. Variable-income instruments: These are instruments that provide a variable rate of return, such as
dividend-paying stocks and mutual funds. The returns on these instruments are typically tied to the
performance of the underlying assets.
These are just a few examples of the many ways financial instruments can be classified. The classification of financial
instruments can be based on various criteria, such as the type of issuer, the maturity date, the market in which they
are traded, and the level of risk involved.
Q9. What are the main purpose of Secondary financial markets? How come they are different from primary
financial markets?
ANSWER: The main purpose of secondary financial markets is to provide a platform for the buying and selling of
previously issued financial instruments such as stocks, bonds, and other securities. These markets facilitate the
transfer of ownership of these securities from one investor to another, without the involvement of the issuing company
or organization. Secondary markets are also known as aftermarket or exchange markets.
Primary Financial Markets Secondary Financial Markets

Involve the issuance of new securities to raise funds Involve the buying and selling of previously issued
securities
Securities are sold to the public or select groups of investors Securities are traded among investors
Securities are offered through underwriting or private Securities are traded on exchanges or over-the-
placement arrangements counter (OTC) markets
Issuing company or organization receives funds raised from Funds go to seller of securities, not the issuer
sale of securities
Primary markets provide a platform for companies to raise Secondary markets provide liquidity and price
capital discovery for securities
Prices of securities are generally fixed Prices of securities fluctuate based on market demand
and supply
Examples include initial public offerings (IPOs), private Examples include stock exchanges, bond markets,
placements OTC markets
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Q10. Differentiate between:

a) Open Market and Negotiated Market
b) Spot Market and Forward Market
c) Future Market and Forward Market
d) Future Market and Option Market
e) Perfectly Competitive Market and Efficient Market.
f) Money and Credit
g) Money and Financial Instrument
Open Market Negotiated Market

In an open market, securities and other financial In a negotiated market, the prices of securities are
instruments are bought and sold openly, without any negotiated between the buyer and the seller.
interference from the government or any other regulatory
body.
The prices of securities in an open market are The price of the security is not determined by the market
determined by the market forces of supply and demand. forces of supply and demand, but rather by the negotiation
between the two parties.
The buyers and sellers of securities interact directly with Negotiated markets are often used for trading large blocks
each other, and the prices are determined by the highest of securities, such as stocks or bonds, where the buyers
bidder or the lowest seller. and sellers are typically institutional investors.
Open markets are typically used for trading small to Negotiated markets are less liquid than open markets, and
medium-sized securities, and they are generally more they can take longer to execute trades.
liquid than negotiated markets.
In Bangladesh, the Dhaka Stock Exchange (DSE) and A negotiated market in Bangladesh is the over-the-counter
the Chittagong Stock Exchange (CSE) are examples of (OTC) market, which is a decentralized market where
Open Markets. securities are traded between parties outside of formal
exchanges.
Spot Market Forward Market

In a spot market, financial assets are bought and sold for In a forward market, financial assets are bought or sold for
immediate delivery. delivery at a future date.
The price of the asset is determined by the current The price of the asset is determined by the expected
market price, which is based on the demand and future price of the asset and the interest rates
supply of the asset at the time of the transaction applicable to the transaction
Spot markets are typically used for short-term Forward markets are typically used for hedging or
trading, and they are generally more liquid than speculation, and they are generally less liquid than
forward markets spot markets
Examples of spot markets include stock exchanges, Examples of forward markets include the foreign
currency markets, and commodity markets. exchange market, the commodity market, and the
bond market
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Future Market Forward Market

Standardization: Futures contracts are standardized Customization: Forward contracts are customized contracts
contracts that are traded on exchanges. The contract that are traded over-the-counter (OTC) between two parties.
specifications, such as the size, delivery date, and The contract specifications, such as the size, delivery date,
settlement method, are predetermined and uniform. and settlement method, are negotiated and agreed upon by
the parties involved.
Liquidity: Futures markets are highly liquid and have Liquidity: Forward markets are less liquid than futures
high trading volumes. They are accessible to a large markets and have lower trading volumes. They are typically
number of market participants, including speculators, accessed by large institutions and businesses that require
hedgers, and arbitrageurs. tailor-made contracts to meet their specific needs.
Counterparty Risk: The exchange acts as the Counterparty Risk: The absence of a centralized
counterparty to both the buyer and seller, which clearinghouse in the forward market exposes the parties
eliminates the counterparty risk. Additionally, futures involved to counterparty risk. This risk can be managed
contracts are marked to market daily, which means through credit assessments and collateral agreements.
that gains and losses are settled every day.
Price Discovery: Futures prices are determined by the Price Discovery: Forward prices are determined by the
market demand and supply, which reflects the expectations of the parties involved, which may differ from
collective expectations of market participants about the market consensus. The lack of transparency in the OTC
the future value of the underlying asset. market can lead to information asymmetry and price
inefficiencies.
Regulations: Futures markets are regulated by Regulations: Forward markets are less regulated than futures
exchanges and regulatory authorities, which set rules markets, as there are no centralized exchanges or regulatory
and monitor trading activities to maintain market authorities. The terms of the contracts are governed by
integrity. private law and are subject to legal enforcement.
Future Market Option Market

Obligation: Futures contracts obligate both parties to Right: Option contracts give the buyer the right, but not the
buy and sell the underlying asset at a specific price obligation, to buy or sell the underlying asset at a specific price
and date. and date. The seller of the option is obligated to sell or buy the
underlying asset if the buyer decides to exercise their right.
Price: The price of a futures contract is determined Price: The price of an option contract is determined by several
by the market demand and supply, which reflects the factors, including the current market price of the underlying
collective expectations of market participants about asset, the strike price, the time to expiration, the volatility of the
the future value of the underlying asset. underlying asset, and the risk-free interest rate.
Profit/Loss: The profit or loss on a futures contract is Profit/Loss: The profit or loss on an option contract depends
realized when the contract is closed out before its on whether the option is in the money, at the money, or out of
expiration date. If the price of the underlying asset the money at expiration. If the option is in the money, the buyer
moves in the opposite direction to the position taken, can exercise their right and realize a profit. If the option is out
the trader incurs a loss. of the money, the buyer incurs a loss.
Risk: Futures trading involves high leverage, which Risk: Option trading involves lower leverage than futures
can amplify profits and losses. Traders need to trading, which limits the potential losses. However, the buyer
maintain margin accounts to cover potential losses, of the option needs to pay a premium to the seller, which
and the exchange may require additional margin if represents the maximum loss if the option is not exercised.
the price of the underlying asset moves against the
position taken.
Flexibility: Futures contracts have limited flexibility, Flexibility: Option contracts offer greater flexibility than futures
as they are standardized contracts with fixed delivery contracts, as they can be customized to suit the needs of the
dates and sizes. parties involved. Option contracts can have different strike
prices, expiration dates, and underlying assets.
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Perfectly Competitive Market Efficient Market

Competition: In a perfectly competitive market, there Information: In an efficient market, all relevant information
are many buyers and sellers, none of whom have about the asset is reflected in its price. This includes
significant market power. No single buyer or seller can information about the asset's fundamentals, such as earnings
influence the market price of the product. and financial metrics, as well as information about external
factors that may affect its value, such as economic news or
political events.
Pricing: Prices in a perfectly competitive market are Price Accuracy: Prices in an efficient market are believed to
determined by the forces of supply and demand. be accurate and reflect the true value of the asset, based on
Sellers offer their products at a price that covers their all available information. Prices may fluctuate in response to
costs, while buyers seek the lowest price possible. new information, but the market is expected to quickly
incorporate this information into prices, leaving little
opportunity for investors to make excess profits.
Entry and Exit: In a perfectly competitive market, there Competition: In an efficient market, competition among buyers
are no barriers to entry or exit, meaning that new firms and sellers helps to ensure that prices reflect all available
can easily enter the market to compete with existing information. Investors who are able to obtain and analyze
firms, and existing firms can easily exit the market if information faster and more accurately than others may be
they are not profitable. able to generate excess returns, but such opportunities are
believed to be limited and quickly arbitraged away by other
market participants.
Homogeneity: In a perfectly competitive market, all Transparency: In an efficient market, information about asset
products are identical or very similar, so buyers and prices, trading volumes, and other market data is widely
sellers cannot differentiate between them based on available and easily accessible to all market participants. This
brand, quality, or other attributes. helps to ensure that prices are set based on objective criteria,
rather than on insider knowledge or other forms of
manipulation.
Profitability: In a perfectly competitive market, firms Efficiency: An efficient market is believed to be the most
earn only normal profits, which are just enough to productive and efficient way to allocate resources, as prices
cover their costs of production. Firms that earn excess reflect the true value of assets and guide investors to the most
profits in the short run are likely to face increased profitable investments.
competition in the long run, which will drive down
prices and reduce profits.
Money Credit
Medium of Exchange: Money serves as a medium of Borrowing: Credit allows individuals and businesses to
exchange for goods and services, facilitating borrow money, which they can use to finance purchases or
transactions between buyers and sellers. investments.
Store of Value: Money is a store of value, meaning it Interest: Credit comes with interest payments, which reflect
can be saved and used to make future purchases or the cost of borrowing and compensate lenders for the risk of
investments. default.
Unit of Account: Money is used as a unit of account Debt: Credit creates debt, which borrowers are obligated to
to measure the value of goods and services in an repay according to the terms of their loan agreement.
economy.
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Divisible: Money can be easily divided into smaller Collateral: Credit may require collateral, such as a house or
units, making it easier to buy and sell goods and car, which lenders can seize if borrowers fail to repay their
services of different values. loans.
Portable: Money is portable and can be easily carried Credit Score: Creditworthiness is evaluated based on credit
and used to make transactions in different locations. scores, which measure a borrower's ability to repay loans and
their history of borrowing and repaying.
Money Financial Instruments

Medium of Exchange: Money serves as a medium of Claims: Financial instruments are claims on real assets or
exchange for goods and services, facilitating future cash flows, such as stocks, bonds, and derivatives.
transactions between buyers and sellers.
Store of Value: Money is a store of value, meaning it Transfer of Risk: Financial instruments can transfer risk from
can be saved and used to make future purchases or one party to another, such as through insurance policies or
investments. options contracts.
Unit of Account: Money is used as a unit of account Investment: Financial instruments can be used for investment
to measure the value of goods and services in an purposes, allowing investors to earn returns on their capital.
economy.
Widely Accepted: Money is widely accepted as a Liquidity: Financial instruments can have varying levels of
means of payment and is recognized as legal tender liquidity, meaning they can be easily bought and sold in the
by governments. market.
Centralized Control: The production and supply of Diverse Types: Financial instruments come in diverse types,
money is typically centralized and regulated by each with its own features, risks, and potential rewards.
governments and central banks to ensure its stability
and consistency.
Q11. State and explain the functions of a finai1cial system in a modern economy.
ANSWER: A financial system plays a crucial role in a modern economy by facilitating the flow of funds
between savers and investors or borrowers. It is a network of institutions, markets, and Intermediaries that
provide various financial services and products to individuals, businesses, and governments. There are some
of the key functions of a financial system:
Saving Function: The system of financial markets and institutions provides a conduit for the public's savings.
Bonds, stocks, and other financial claims sold in the money and capital Markets provide a profitable,
relatively low-risk outlet for the public's savings, which flow through the financial markets into investment.
Wealth Function: The financial investments sold in the money and capital markets provide an excellent way to
store wealth (i. e., preserve the value of assets) until funds are needed for spending. One may choose to store
COMPLIANCE ROUTE 49
his wealth in "things" (e.g., automobiles), such items are subject to depreciation and often carry great risk of loss.
However, bonds, stocks, and other financial instruments do not wear out over time and usually generate income:
moreover, their risk of loss often is much less than for other fo1ms of stored wealth.
Liquidity Function: For wealth stored in financial instruments, the financial marketplace provides a means of
converting those instruments into cash with little risk of loss. Thus, the financial markets provide liquidity for savers
who hold financial instruments but are in need of money. However, money generally earns the lowest rate of return
of all assets headed in tl1e financial system, and its purchasing power is seriously eroded by inflation. That is why,
savers generally minimize their holdings of money and hold other financial instruments until they really need
spendable funds.
Credit Function: The financial markets furnish credit to finance consumption and investment spending. Credit
consists of a loan of funds in return for a promise of future payment. Consumers need credit to purchase a home,
buy groceries, repair the family automobile, and retire outstanding debts. Businesses draw on their lines of credit
to stock in their shelves, construct new buildings, meet payrolls, and grant dividends to their stockholders.
Payments Function: The financial system also provides a mechanism for making payments for goods and
services. Ce1tain financial assets, mainly checking accounts and negotiable order of withdrawal (NOW) accounts,
serve as a medium of exchange in making payments. Plastic credit cards issued by banks and credit unions
give the customers instant access to short-term credit but are also widely accepted as a convenient means of
payment.
Risk Function: The financial markets offer business, consumers, and governments, protection against life, health,
property and income risks. This is accomplished, by the sale of insurance policies. In addition to making possible
the sale of insurance policies. In addition, the money and capital markets have been used by businesses and
consumers to "self- insure" against risk.
Policy Function: Finally, in recent decades, the financial markets have been the principal channel through which
government has carried out its policy of attempting to stabilize the economy and avoid inflation. By manipulating
interest rates and the availability of credit, government can affect the borrowing and spending
Q12. Explain, in what way, a financial system can contribute towards economic development of a country.
Answer: A well-functioning financial system can contribute significantly to the economic development of a
country in several ways:
1. Mobilization and allocation of capital: A financial system allows individuals and firms to save and
invest their money, which provides a source of capital for businesses and entrepreneurs to start and
expand their operations. The financial system also helps allocate capital to its most productive uses,
which can lead to increased efficiency and economic growth.
2. Risk management: The financial system provides tools and mechanisms for managing risks, such
as insurance and hedging instruments, which can help individuals and businesses mitigate the
negative impact of unexpected events, and provide stability to the overall economy.
3. Facilitating trade and commerce: A well-functioning financial system can facilitate trade and
commerce by providing a means of payment and financing for domestic and international
transactions. This can increase economic activity and promote growth.
4. Encouraging innovation: The financial system can encourage innovation by providing funding for
research and development, as well as venture capital for start-ups and small businesses. This can
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lead to the creation of new products and services, and foster technological advancements, which
can enhance productivity and competitiveness.
5. Increasing financial inclusion: By providing access to financial services such as savings accounts,
loans, and insurance, the financial system can help individuals and small businesses participate in
the formal economy and increase their economic opportunities.
Overall, a well-functioning financial system can help to promote economic development by mobilizing and
allocating capital, managing risks, facilitating trade and commerce, encouraging innovation, and increasing
financial inclusion.
Q13. How come the payment role of financial system can contribute towards economic development of
a country?
Answer: The payment role of a financial system can contribute towards economic development of a country
in several ways:
1. Facilitating transactions: The payment role of a financial system allows individuals and businesses
to make transactions more efficiently and securely. This can reduce transaction costs and increase
the speed and ease of doing business, which can lead to increased economic activity.
2. Improving financial inclusion: A well-functioning payment system can provide access to financial
services for individuals and businesses that were previously excluded from the formal economy. This
can increase economic opportunities and promote financial inclusion.
3. Supporting economic growth: A reliable and efficient payment system can support economic
growth by facilitating trade and commerce, reducing barriers to entry for small businesses, and
promoting innovation.
4. Enhancing monetary policy: A well-designed payment system can support effective
implementation of monetary policy by allowing central banks to manage interest rates, control
inflation, and maintain financial stability.
5. Promoting financial innovation: The payment role of a financial system can encourage innovation
in financial services by creating opportunities for new payment technologies and systems. This can
lead to new business models, increased efficiency, and more inclusive financial services.
Overall, a well-functioning payment system can contribute towards economic development by facilitating
transactions, improving financial inclusion, supporting economic growth, enhancing monetary policy, and
promoting financial innovation.
Q14. How can you explain "financial development"? How it can be differentiated between "demand-
following" and "Supply-lending" financial development?
Answer: Financial development refers to the process by which a financial system evolves and becomes more
sophisticated, efficient, and inclusive over time. It involves the development of financial institutions, markets,
instruments, and regulations that allow for the efficient mobilization and allocation of capital, the management of risks,
and the provision of financial services to individuals and businesses.
Financial development can take many forms, depending on the specific context of a country or region. For example, it
may involve the establishment of new financial institutions such as banks, insurance companies, and investment firms,
the development of financial markets such as stock exchanges and bond markets, or the introduction of new financial
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instruments such as derivatives and securitized products.
Financial development can also involve the adoption of new technologies and systems for financial transactions, such
as electronic payment systems, mobile banking, and blockchain technology.
Financial development is generally considered to be an important driver of economic growth and development, as it
can increase access to finance, promote financial inclusion, and support innovation and entrepreneurship. However, it
is also important that financial development is accompanied by appropriate regulatory frameworks and safeguards to
ensure financial stability and protect consumers from financial risks and fraud.
How it can be differentiated between "demand-following" and "Supply-lending" financial

development?
Demand-following and supply-leading financial development are two different approaches to developing
financial systems. There are some key differences:
1. Demand-following approach: In this approach, financial institutions and products are developed in
response to demand from individuals and businesses. Financial institutions may develop products
and services based on the specific needs and preferences of customers. This approach is often used
in countries where there is a large unbanked population, and financial services are underdeveloped.
2. Supply-leading approach: In this approach, financial institutions and products are developed and
introduced into the market, with the goal of stimulating demand. Financial institutions may create
products and services that they believe will be in demand, and market them aggressively to potential
customers. This approach is often used in countries where financial systems are well-developed,
and financial institutions are seeking new sources of revenue.
There are some additional differences between the two approaches:
3. Focus: The demand-following approach focuses on meeting the specific needs of customers, while
the supply-leading approach focuses on creating new products and services that may not exist in the
market.
4. Risks: The demand-following approach may be less risky than the supply-leading approach, as
financial institutions are responding to established demand, while the supply-leading approach
involves more uncertainty and may require significant investment.
5. Customer satisfaction: The demand-following approach is more likely to result in high levels of
customer satisfaction, as financial products are tailored to meet specific needs. The supply-leading
approach may result in products that do not meet the needs of customers, leading to lower
satisfaction.
6. Market competition: The demand-following approach may lead to more competition among
financial institutions, as they respond to customer demand. The supply-leading approach may result
in less competition, as financial institutions create new products that are not yet available in the
market.
Overall, both demand-following and supply-leading approaches can be effective in developing financial
systems. The choice between the two approaches may depend on the specific context and needs of the
market.
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Demand-Following Supply-Leading
Financial institutions and products are developed in Financial institutions and products are developed and
response to demand from individuals and businesses. introduced into the market, with the goal of stimulating
demand.
Focus is on meeting the specific needs of customers. Focus is on creating new products and services that may
not exist in the market.
May be less risky, as financial institutions are May involve more uncertainty and may require significant
responding to established demand. investment.
More likely to result in high levels of customer May result in products that do not meet the needs of
satisfaction, as financial products are tailored to meet customers, leading to lower satisfaction.
specific needs.
May lead to more competition among financial May result in less competition, as financial institutions
institutions, as they respond to customer demand. create new products that are not yet available in the
market.
Q15. Name and explain the financial development indicators. Which is the most appropriate for indicating
financial development of a country like Bangladesh.
ANSWER: Please see the test book page no: 40-42
Q16. How did Goldsmith and Show-Mackinnon interpret "Financial Development"? Is there any
difference?
ANSWER : Goldsmith and McKinnon-Shaw are two prominent scholars who have contributed to the understanding of
financial development.
Goldsmith's interpretation of financial development focused on the growth of financial intermediaries, such as banks
and financial markets, and their ability to mobilize savings and allocate resources efficiently. He argued that financial
development was essential for economic growth and that the growth of the financial sector was a result of economic
growth. In other words, he believed that financial development was a consequence of economic growth.
On the other hand, McKinnon and Shaw's interpretation of financial development emphasized the importance of
financial repression and the need for financial liberalization. They argued that in many developing countries,
governments had imposed restrictions on interest rates, credit allocation, and the mobility of capital. They believed that
these policies had led to financial repression, which had stifled economic growth. They argued that financial
liberalization, which involved removing these restrictions, would lead to greater financial development and economic
growth.
While there are some differences in their interpretations of financial development, both Goldsmith and McKinnon and
Shaw recognized the importance of financial development for economic growth. Goldsmith's focus on the growth of
financial intermediaries and McKinnon and Shaw's emphasis on financial liberalization were both attempts to explain
how financial development could promote economic growth.
Q. In terms of relationship between financial development and economic development, state

Gurley-Shaw thesis.
Answer: The Gurley-Shaw thesis is a theory that explains the relationship between financial development and
economic development. It was developed by economists John Gurley and Edward Shaw in the 1950s and 1960s.
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According to the Gurley-Shaw thesis, financial development is a necessary condition for economic development. They
argued that the lack of adequate financial institutions and services was a major obstacle to economic development in
many developing countries. They believed that financial development was important because it enabled capital
accumulation, facilitated the transfer of resources from savers to investors, and provided the necessary financing for
investment and innovation.
Furthermore, Gurley and Shaw argued that financial repression, which involved government intervention in the financial
sector, was detrimental to economic development. They believed that financial repression led to the misallocation of
resources and the inefficient use of capital. In contrast, they argued that financial liberalization, which involved the
removal of government intervention and the promotion of market-oriented financial policies, would promote financial
development and economic growth.
Overall, the Gurley-Shaw thesis suggests that financial development is a necessary condition for economic
development and that financial liberalization is essential for promoting financial development and economic growth.
While the theory has been subject to criticism and refinement over the years, it has had a significant impact on the
understanding of the relationship between financial development and economic development in the developing world.
Q18. Pal lick identified two possible patterns in the causal relationship between financial development
and economic development. Explain the patterns.
ANSWER: Pranab Bardhan and Dipak Mazumdar, popularly known as Pallick, proposed two possible
patterns in the causal relationship between financial development and economic development:
1. Supply-leading: This pattern suggests that financial development can lead to economic growth by
increasing the availability of credit and investment capital. In this pattern, financial development is
seen as a driver of economic growth, and a more developed financial system leads to increased
investment and productivity in the economy.
2. Demand-following: This pattern suggests that economic growth can lead to financial development
by increasing the demand for financial services. In this pattern, economic growth is seen as the driver
of financial development, and a growing economy creates more demand for financial services and
institutions.
The supply-leading pattern is more common in developed countries, where a well-developed financial system
provides the necessary financing for investment and innovation. In contrast, the demand-following pattern is
more common in developing countries, where a growing economy creates demand for financial services,
which in turn spurs the development of the financial system.
It is important to note that the causal relationship between financial development and economic development
is not always clear-cut and can work in both directions. For example, a more developed financial system can
facilitate economic growth, but economic growth can also lead to the development of new financial products
and services. Similarly, a growing economy can create demand for financial services, but the availability of
financial services can also facilitate economic growth.
COMPLIANCE ROUTE 54
Q19. From the following data of Bangladesh how many financial development indicators you can
calculate. Also interpret the ratios.
(Figures in Billion Taka)
Year GDP at Market Money Supply Bank Credit Bank Deposit

Price (M2)
FY 2019 29514 12196 10103 11474
FY 2020 31705 13731 10973 12692
FY 2021 35301 15599 11888 14470
Source: Bangladesh Bank Annual Report, 2020-21.
Answer:
From the given data, we can calculate the following financial development indicators:
a) Financial Interrelations Ratio (FIR): This ratio represents the proportion of total bank deposits to
nominal GDP. It indicates the degree to which the financial sector is intermediating savings from
households and firms to support economic activity.
FIR for FY 2019 = 11474 / 29514 = 0.389 or 38.9%

FIR for FY 2020 = 12692 / 31705 = 0.400 or 40.0%
FIR for FY 2021 = 14470 / 35301 = 0.410 or 41.0%
Explanation: The Financial Interrelations Ratio has increased over the three-year period, indicating that
the financial sector is intermediating a greater proportion of savings from households and firms to support
economic activity.
b) Financial Intermediation Ratio (FIMR): This ratio represents the proportion of bank credit to
nominal GDP. It indicates the extent to which the banking sector is providing credit to support economic
activity.
FIMR for FY 2019 = 10103 / 29514 = 0.343 or 34.3%
FIMR for FY 2020 = 10973 / 31705 = 0.346 or 34.6%
FIMR for FY 2021 = 11888 / 35301 = 0.337 or 33.7%
Explanation: The Financial Intermediation Ratio has remained relatively stable over the three-year period,
indicating that the banking sector is providing a consistent level of credit to support economic activity.
c) Financialization Ratio: This ratio represents the proportion of financial sector output (measured
by financial intermediation services indirectly measured or FISIM) to nominal GDP. It indicates the degree
to which the financial sector is contributing to the overall economy. To calculate the Financialization Ratio,
we need data on FISIM which is not provided in the given data.
d) New Issues Ratio (NIR): This ratio represents the proportion of bank credit to bank deposits. It
indicates the extent to which banks are creating new credit to finance economic activity.
New issues ratio for FY 2019 = 10103 / 11474 = 0.880 or 88.0%
COMPLIANCE ROUTE 55

Explanation: The New Issues Ratio has declined over the three-year period, indicating that banks are
creating less credit relative to the amount of deposits they hold.
e) Monetization Ratio: This ratio represents the proportion of money supply (M2) to nominal GDP. It
indicates the extent to which the economy relies on money creation by the central bank rather than real
economic growth to support its level of spending.
Monetization ratio for FY 2019 = 12196 / 29514 = 0.413 or 41.3%
Explanation: The Monetization Ratio has increased over the three-year period, indicating that the economy
is relying more on money creation by the central bank to finance its spending.
Q20. What is Asymmetric Information problem of financial market? Define the problems
asymmetric information can generate for banks before and after lending.
Answer : Asymmetric information can create several problems for banks both before and after lending.
Before lending:
1. Adverse selection: Asymmetric information can lead to adverse selection, where borrowers with
higher risk characteristics are more likely to apply for loans. The bank may not have enough
information to distinguish between high-risk and low-risk borrowers, resulting in a higher risk of
default and loss for the bank.
2. Moral hazard: Asymmetric information can create moral hazard, where borrowers may take on more
risk than they can handle, knowing that the bank will bear the majority of the losses in case of default.
3. Inefficient lending: Asymmetric information can lead to inefficient lending, where the bank may
either deny loans to potentially productive borrowers due to incomplete information or lend to
unproductive borrowers due to a lack of information.
After lending:
1. Adverse selection: After lending, asymmetric information can also create adverse selection, where
borrowers with high-risk characteristics are more likely to default. The bank may have insufficient
information to identify high-risk borrowers beforehand, leading to higher default rates.
2. Moral hazard: Asymmetric information can also create moral hazard after lending, where borrowers
may engage in risky behavior or divert funds for purposes other than what the loan was intended for,
knowing that the bank has limited ability to monitor their actions.
3. Strategic default: Asymmetric information can also lead to strategic default, where borrowers may
default on loans even if they have the ability to repay, knowing that the bank may not have enough
information to take legal action against them.
To mitigate these problems, banks use various methods to gather information about borrowers, such as credit
scoring, collateral requirements, and due diligence, and may also charge higher interest rates to compensate
COMPLIANCE ROUTE 56
for the higher risk associated with incomplete information. Regulatory agencies also play a role in reducing
information asymmetry by enforcing regulations to prevent fraud and misconduct.
Q21. For mitigating asymmetric information problems of financial markets, which mode of finance
is more effective and why?
ANSWER : Asymmetric information is a common problem in financial markets where one party has more
information than the other, leading to adverse selection and moral hazard problems. To mitigate these issues,
financial markets use different modes of finance that can help to reduce information asymmetry.
Debt financing and equity financing are the two most common modes of finance. Debt financing involves
borrowing money from lenders, such as banks or bondholders, with a promise to repay the principal amount
and interest on the debt over time. Equity financing, on the other hand, involves selling ownership in a
company to investors, who receive a share of the profits and have voting rights in the company.
Both modes of finance can be effective in mitigating asymmetric information problems, but they have different
advantages and disadvantages. Debt financing can help to mitigate asymmetric information problems by
imposing strict conditions on borrowers, such as requiring collateral or covenants, which reduce the risk of
default. Debt financing can also be less risky for investors as they receive a fixed return on their investment.
However, debt financing may not be as effective in reducing information asymmetry as equity financing. In
debt financing, lenders have limited information about the borrower's financial situation, which can lead to
adverse selection problems. Also, borrowers may have an incentive to take on too much debt or engage in
risky behavior since the lenders bear most of the risk.
Equity financing, on the other hand, can be more effective in reducing information asymmetry since investors
have a greater ability to monitor the company's performance and management. By having a stake in the
company's ownership, equity investors have incentives to ensure that the company is well-managed and
profitable. However, equity financing can be riskier for investors since they do not receive a fixed return and
may lose their investment if the company performs poorly.
In summary, both debt financing and equity financing can be effective in mitigating asymmetric information
problems in financial markets. However, equity financing may be more effective in reducing information
asymmetry as investors have a greater ability to monitor the company's performance and management.
Q22. In what ways monetary system is similar to and different from financial system.
ANSWER : The monetary system and the financial system are two distinct but closely related systems that play
important roles in the economy.
The monetary system is the set of institutions, policies, and procedures that govern the creation, circulation, and
management of money in an economy. This includes central banks, commercial banks, currency exchanges, and other
financial institutions. The main purpose of the monetary system is to provide a stable and efficient medium of exchange
for goods and services, facilitate transactions, and promote economic growth.
The financial system, on the other hand, refers to the broader network of institutions, markets, and instruments that
facilitate the flow of funds between savers and borrowers. This includes banks, stock exchanges, bond markets,
COMPLIANCE ROUTE 57
insurance companies, and other financial intermediaries. The financial system plays a critical role in allocating capital
to its most productive uses, providing liquidity, and managing risk.
While there are some similarities between the monetary system and the financial system, there are also several key
differences:
1. Scope: The monetary system is primarily concerned with the creation and management of money, whereas
the financial system is concerned with the broader range of financial instruments and markets.
2. Objectives: The primary objective of the monetary system is to promote stable prices and economic growth,
while the financial system seeks to allocate capital efficiently and manage risk.
3. Regulation: The monetary system is typically more heavily regulated than the financial system, with central
banks and other government institutions playing a key role in setting monetary policy. The financial system is
also subject to regulation, but this is typically more focused on ensuring stability and protecting investors.
4. Tools: The monetary system uses a range of tools, such as interest rates and reserve requirements, to
manage the supply and demand for money. The financial system, meanwhile, uses a range of instruments
such as stocks, bonds, and derivatives to facilitate investment and risk management.
In summary, while the monetary system and the financial system are closely related, they have distinct objectives,
scope, and regulatory frameworks. Together, they form the backbone of the economy, facilitating transactions,
allocating capital, and promoting economic growth.
Q.23.Write Short Notes On:

Sustainable Banking
Sustainable banking refers to a banking system that considers environmental, social, and governance (ESG)
factors in its operations and decision-making processes. The goal of sustainable banking is to promote
sustainable development by allocating financial resources to environmentally and socially responsible
projects and businesses.
Some of the key practices of sustainable banking include:
1. Environmental risk management: Banks assess and manage the environmental risks associated
with their lending and investment activities.
2. Social responsibility: Banks prioritize the social impact of their investments and lending activities,
including human rights, labor standards, and community development.
3. Sustainable investment: Banks allocate capital to companies that have a positive impact on society
and the environment, such as renewable energy and sustainable agriculture.
4. Transparency and disclosure: Banks disclose their ESG policies, practices, and performance to
stakeholders.
5. Advocacy: Banks engage with stakeholders to promote sustainable development and advocate for
policies that support sustainability.
Sustainable banking is gaining popularity among consumers, investors, and regulators who recognize the
importance of sustainability in promoting long-term economic growth and stability. Many banks are adopting
sustainable banking practices, and some have established dedicated sustainable finance departments to
drive sustainability initiatives.
COMPLIANCE ROUTE 58
Inclusive Banking
Inclusive banking, also known as inclusive finance, refers to the provision of financial services to individuals
and businesses who have traditionally been excluded from the mainstream financial system. This includes
people with low incomes, those living in rural areas, women, and minorities. Inclusive banking is based on
the principle of financial inclusion, which aims to provide access to basic financial services to all individuals
and businesses, regardless of their socio-economic status.
There are some key characteristics and benefits of inclusive banking:
1. Access to Financial Services: Inclusive banking provides access to basic financial services such
as savings accounts, loans, insurance, and payment services to people who have previously been
excluded from the formal financial system.
2. Customer-centric Approach: Inclusive banking is focused on meeting the needs of its customers,
which often requires the development of innovative products and services that are tailored to the
specific needs of marginalized communities.
3. Financial Education: Inclusive banking often includes financial education and literacy programs to
help customers make informed decisions about their financial lives.
4. Social and Economic Development: Inclusive banking can contribute to social and economic
development by providing people with the financial resources they need to start or grow a business,
invest in education, or improve their standard of living.
5. Sustainable Growth: Inclusive banking can promote sustainable growth by expanding access to
financial services, reducing poverty, and promoting economic stability.
Inclusive banking is an important tool for promoting financial inclusion and reducing poverty, and it has the
potential to create significant social and economic benefits for individuals and communities around the world.
Green Banking
Green banking, also known as sustainable banking, refers to the practice of incorporating environmental and
social considerations into banking activities and operations. The goal of green banking is to promote
sustainable development by encouraging environmentally and socially responsible business practices within
the banking sector.
There are some key characteristics and benefits of green banking:
1. Environmental and Social Risk Management: Green banking involves the identification and
management of environmental and social risks associated with banking activities. This includes
assessing the environmental and social impact of loans and investments, as well as the operational
impacts of the bank itself.
2. Green Products and Services: Green banking includes the development of products and services
that promote environmental sustainability and social responsibility. This could include green loans
and mortgages, sustainable investment funds, and social impact investing.
3. Corporate Social Responsibility: Green banking involves taking responsibility for the social and
environmental impact of the bank's operations. This includes reducing the bank's carbon footprint,
promoting sustainable practices within the bank, and supporting community development initiatives.
COMPLIANCE ROUTE 59
4. Financial Innovation: Green banking involves the development of new financial products and
services that promote sustainable development. This requires innovation in financing mechanisms,
risk management, and investment strategies.
5. Stakeholder Engagement: Green banking involves engaging with stakeholders, including customers,
investors, and community organizations, to promote transparency and accountability in the bank's
environmental and social performance.
By incorporating environmental and social considerations into banking activities and operations, green
banking can help promote sustainable development, reduce environmental impact, and create social and
economic benefits for communities and businesses.
Adverse Selection
Adverse selection is a term used in economics and insurance to describe a situation where one party has
access to information that the other party does not have, and this information asymmetry results in an unfair
advantage or disadvantage for one of the parties. Adverse selection occurs when buyers or sellers have
access to different information that affects the terms of a transaction.
In insurance, adverse selection occurs when an individual with a higher risk of making a claim buys an
insurance policy, while an individual with a lower risk of making a claim does not. The insurance company
may charge higher premiums to cover the higher risk, which may discourage low-risk individuals from buying
insurance, resulting in a pool of policyholders with higher risk and increasing the overall cost of insurance.
Adverse selection can also occur in the labor market, where individuals with more information about their
productivity or health may self-select out of certain jobs or industries, leaving employers with a pool of workers
with higher risk or lower productivity.
To mitigate adverse selection, it is important to ensure that both parties have access to the same information
and can make informed decisions. In insurance, this may involve using risk assessment tools or offering
different policy options that better align with individuals' risk levels. In the labor market, this may involve
offering more comprehensive health benefits or using objective performance measures to assess
productivity.
Moral Hazard
Moral hazard is an economic concept that refers to a situation in which an individual or institution takes on more risk
because they are protected from the negative consequences of their actions. It arises when one party in a transaction
has an incentive to take risks that are not in the best interests of the other party.
Moral hazard can occur in a variety of contexts. In insurance, it arises when people behave more recklessly because
they know they are insured against the consequences of their actions. In finance, it arises when banks or other financial
institutions take on excessive risk because they know that they will be bailed out by the government or other institutions
in the event of a financial crisis.
To mitigate moral hazard, it is important to create incentives that encourage individuals and institutions to act in a
responsible manner. This can be achieved by implementing regulations and policies that promote transparency,
accountability, and responsible behavior. For example, in the case of banks, regulators can require banks to hold more
COMPLIANCE ROUTE 60
capital to absorb losses in the event of a crisis. This can help reduce the likelihood of moral hazard by making banks
more accountable for their actions.
Overall, addressing moral hazard is an important challenge in many areas of economics and finance. By promoting
responsible behavior and accountability, policymakers can help reduce the risks associated with moral hazard and
promote stability and fairness in the economy.
Asymmetric Information
Asymmetric information refers to a situation in which one party in a transaction has more or better information than the
other party. This can lead to inefficiencies and distortions in the market, as the party with more information may use it
to their advantage, while the other party may be at a disadvantage.
Asymmetric information can occur in a variety of contexts, such as in insurance, finance, labor markets, and other
areas. For example, in the context of insurance, it arises when the insured individual has better information about their
risk level than the insurance company. This can lead to adverse selection, where individuals with higher risk are more
likely to buy insurance, while those with lower risk may be discouraged from buying insurance.
In finance, asymmetric information can arise when borrowers have better information about their creditworthiness than
lenders. This can lead to moral hazard, where borrowers may take on more risk because they know that they have
better information about their ability to repay the loan than the lender.
To address the issue of asymmetric information, it is important to promote transparency and disclosure. This can be
achieved through regulation, disclosure requirements, and market competition. For example, in the case of finance,
lenders can use credit scoring models to better assess borrowers' creditworthiness, and borrowers can provide more
information about their financial situation.
Overall, asymmetric information is an important concept in economics and finance. By promoting transparency and
fairness in transactions, policymakers can help reduce the inefficiencies and distortions associated with asymmetric
information and promote a more efficient and equitable market.
Financial Development
Financial development refers to the process of improving the availability, accessibility, efficiency, and
effectiveness of financial systems and institutions. Financial development can occur in many ways and can
include various financial services, products, and technologies. Some examples of financial development
include:
1. Expansion of Banking Services: Banks play a critical role in providing financial services such as
savings accounts, loans, and credit. The expansion of banking services, especially in rural and
underserved areas, is an important aspect of financial development. For example, the Indian
government's Jan Dhan Yojana program aimed to provide bank accounts to millions of unbanked
people in the country, promoting financial inclusion and development.
2. Development of Capital Markets: Capital markets play an essential role in financing businesses,
governments, and infrastructure projects. The development of capital markets, including stock
markets, bond markets, and other financial instruments, is crucial for attracting investment and
promoting economic growth. For instance, the Shanghai Stock Exchange and the Shenzhen Stock
Exchange played a crucial role in financing China's economic growth in the past few decades.
COMPLIANCE ROUTE 61
3. Growth of Microfinance Institutions: Microfinance institutions provide small loans to low-income

individuals and small businesses who lack access to traditional banking services. The growth of
microfinance institutions is essential for promoting financial inclusion and development in developing
countries. The Grameen Bank in Bangladesh is a notable example of a microfinance institution that
has played a critical role in poverty reduction and financial development.
Overall, financial development is crucial for promoting economic growth and reducing poverty. However, it
requires careful management and regulation to ensure that it is sustainable and beneficial for all stakeholders.
Rudimentary Finance
Rudimentary finance refers to the earliest forms of financial activities, which were simple and basic compared to modern
finance. Some distinguishing features of rudimentary finance include:
 Primarily based on barter trade, where goods and services were exchanged directly without the use of
money.
 Limited use of money, which was often in the form of precious metals, such as gold and silver.
 Lack of formal financial institutions, such as banks and stock exchanges.
 Limited financial innovation, such as the absence of complex financial instruments and derivatives.
 Relatively low levels of financial intermediation, as most transactions were conducted directly between
parties.
 Limited access to credit, especially for small-scale borrowers, due to the absence of formal credit markets.
 Relatively low levels of financial literacy and education among the general population.
Financial Infrastructure
Financial infrastructure is the underlying systems and institutions that facilitate financial transactions and services.
1. It includes payment systems, clearing and settlement systems, credit rating agencies, financial market
infrastructure, and regulatory frameworks.
2. A robust financial infrastructure is essential for promoting financial inclusion, stability, and efficiency.
3. It provides a foundation for financial intermediation, risk management, and the mobilization and allocation of
savings to productive investments.
4. A well-developed financial infrastructure helps reduce transaction costs, increase transparency, and enhance
overall financial system efficiency and stability.
5. Policymakers and financial regulators often focus on promoting the development of financial infrastructure to
achieve these goals.
6. Initiatives can include promoting payment and settlement system development, enhancing transparency and
disclosure requirements, improving credit reporting and rating systems, and strengthening regulatory
frameworks.
As the diagram illustrates, financial infrastructure is composed of different components, including payment and
settlement systems, financial market infrastructure, credit rating agencies, and regulatory frameworks. These different
components work together to facilitate financial transactions and services, provide market access and liquidity, assess
creditworthiness, and ensure market stability and integrity. A well-developed financial infrastructure is essential for
promoting financial inclusion, stability, and efficiency and supports economic growth and development.
COMPLIANCE ROUTE 62
Financial Super structure

Financial superstructure refers to the top layer of the financial system, which includes specialized financial
institutions and instruments that facilitate more complex and sophisticated financial transactions. These
institutions and instruments are typically available only to sophisticated investors, such as institutional
investors or high net worth individuals, and are designed to meet their specific needs and risk tolerance.
Examples of financial superstructure include:
1. Hedge funds: These are private investment funds that use complex investment strategies, such as
leverage and derivatives, to generate high returns for investors. They typically require a high
minimum investment and are only available to accredited investors.
2. Private equity: This involves investing in private companies or taking them private, with the aim of
generating high returns through the sale of the company or an initial public offering (IPO). Private
equity funds are typically available only to institutional investors or high net worth individuals.
3. Structured products: These are financial instruments that are designed to meet specific investment
objectives or risk profiles. They typically involve the pooling of underlying assets and the creation of
complex securities that offer investors exposure to these assets.
4. Derivatives: These are financial contracts that derive their value from an underlying asset, such as
a stock, bond, commodity, or currency. They are used to manage risk, hedge against price
movements, or speculate on future price movements.
Financial superstructure plays an important role in the financial system by providing specialized financial
services and products that are not available through traditional banking channels. However, they also come
with greater risks and complexity, which require a high level of expertise and due diligence to manage. The
availability of financial superstructure also contributes to the growing wealth inequality as access to these
instruments is limited to sophisticated investors.
Financial Inclusion
Financial inclusion refers to the process of providing access to financial services and products to individuals
and businesses, especially those who are unbanked or underbanked. This includes services such as savings
accounts, credit, insurance, and payment services.
Financial inclusion is essential for promoting economic growth and reducing poverty, as it enables individuals
and businesses to participate fully in the economy, manage risks, and invest in productive activities. Access
to financial services can also help individuals and households to manage financial shocks, such as illness,
job loss, or natural disasters. Governments and international organizations have recognized the importance
of financial inclusion and have implemented policies and initiatives to promote it. These efforts include:
1. Financial literacy programs: These programs provide education and training on financial
management, including budgeting, saving, and investing.
2. Microfinance: This involves providing small loans, typically to low-income individuals or
entrepreneurs, to start or expand businesses.
3. Mobile banking: This uses mobile phones to provide financial services, such as payments, savings,
and loans, to individuals who may not have access to traditional banking services.
COMPLIANCE ROUTE 63
4. Simplified account opening procedures: This reduces the documentation requirements and other
barriers to opening bank accounts, making it easier for individuals to access financial services.
5. Digital financial services: These leverage digital technologies, such as mobile apps and online
banking platforms, to provide financial services to a wider range of customers.
Overall, financial inclusion is an essential component of inclusive economic growth and development. By providing
access to financial services and products, individuals and businesses can participate more fully in the economy,
manage financial risks, and achieve their financial goal.
COMPLIANCE ROUTE 64

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JAIBB : Monetary and Financial System

Module-1: Money and Monetary System

Module-1: Money and Monetary System

1.1 What is Money

Answer with Explanation

Answer with Explanation:

3. Multiple Choice Questions

1. Which of the following identifies the unit-of-account function of money?

5. Which one of the following is not a function of Money -

6. Which of the following is not included under M1?

8. Banking system creates money to the extent of -

9. The narrow definition of money consists of-

12. Which of the following is not a constituent of monetary system:

Correct Answer with Explanation:

Probable Questions for Examination

Q1. Why is the unit-of-account function of money crucial to the operation of an

Q2. Explain how money functions as a standard of deferred payments.

Money serves as a standard of deferred payments because it is widely accepted as a means of

3. (a) Explain how money functions as a store of value.

3. (b) Is money the only store of value?

SL Money Other assets

3. (d) Are long-term bonds a store of value?

a. Medium of exchange - Tabinda is using money as a medium of exchange to facilitate

Q7. Which of the Central Bank measures of the monetary aggregates – M1 or M2 – is

Answer: People have a demand for money for several reasons:

Q12. What is a monetary standard?

Q13. Why demand deposits are included in the M1 definition of money?

Here is an example of how banks create money:

ANSWER: A monetary system is a system of money in a particular economy that facilitates

The constituents of a monetary system include:

Q18. What are near monies?

Examples of near monies include:

M1 = Currency in Circulation + Demand Deposits of DMBs

For 2019-2020: M1 = 208094.1 + 135528.4 = 343622.5

For 2020-2021: M1 = 226888.3 + 165724.5 = 392612.8

For 2021-2022: M1 = 256182.3 + 188859.4 = 445041.7

M2 = M1 + Time Deposits of DMBs + Money in Vaults of DMBs

For 2019-2020: M2 = 343622.5 + 1045471.1 + 15979.6 = 1411073.2

For 2020-2021: M2 = 392612.8 + 1185066.6 + 17370.6 = 1571050.0

For 2021-2022: M2 = 445041.7 + 1282217.5 + 19733.8 = 1724992.9

 Growth rate from 2019-2020 to 2020-2021: (392612.8 - 343622.5) / 343622.5 * 100% =

 Growth rate from 2019-2020 to 2020-2021: (1571050.0 - 1411073.2) / 1411073.2 * 100%

Module-2: Payment System:

Modules: 02_ Payment System

3. What do electronic payment systems replace?

4. Which one of the following is a sine-qua-non for an efficient payment system:

5. Which one of the following was not a characteristics of Commodity Money:

6. Which one of the following is not correct?

7. Which of the following is not true for EFT payment

8. Which one is the most dominant form of medium of transaction in Bangladesh?

Answer With Explanation

Q2. Describe the evolution of payment system.

2. Paper Currency/Fiat Money

4 Electronic Fund Transfer Payment

6 QR Code Payment (Contactless Payment)

Q3. Describe different components of EFT payment.

Q4. State the advantages and disadvantages of card payment systems.

Q5. State the advantages and disadvantages of Mobile Payment System.

Q6. Write Short Notes on:

Bangladesh Automated Clearing House (BACH)

1. It is a payment processing system used in Bangladesh to facilitate electronic fund transfers

Real Time Gross Settlement

National Payment System

Module-3: Financial System