Chapter Seven

Central Banking
 Central Bank-Definition
 A central bank plays an important role in monetary and banking system of a
country.
 It is responsible for maintaining financial sovereignty and economic stability
of a country, especially in underdeveloped countries.
 A Central Bank is the bank in any country to which has been entrusted the duty
of regulating the volume of currency and credit in that country” -Bank of
International Settlement (BIS).
 “Central Bank may be defined as an institution which is charged with the
responsibility of managing the expansion and contraction of the volume of
money in the interest of general public welfare.” –Kent.
 Central Bank-History
 The Central Bank, in one form or another, has a long history. It dates back at least to the
seventeenth century (1668) when the Swedish Riksbank, the first institution recognised
as a Central Bank, was established. It was charged with the responsibility of lending
funds to the government and acting as a clearing house for commerce.
 Later, the most famous central bank of the era, the Bank of England was founded in
1694 to purchase government debt.
 The central bank of France, Banque De France, was established in 1800 to stabilise the
currency after the hyperinflation during the French Revolution.
 A severe financial crisis that hit the United States in 1907 led to the creation of the
country's central bank, the Federal Reserve, in 1913. It was mandated to provide a
common currency which would respond to the changing seasonal, cyclical and secular
needs of the economy and to serve as a lender of the last resort.
 Bangladesh Bank
 Bangladesh Bank, the central bank and apex regulatory body for the
country's monetary and financial system, was established in Dhaka as a
body corporate vide the Bangladesh Bank Order, 1972 (P.O. No. 127
of 1972) with effect from 16th December, 1971.
 Founded: December 16, 1971
 Governor: Fazle Kabir
 Reserves: ৳3400 billion (US$40 billion)
 Headquarters: Dhaka, Office: 10
 Subsidiary: The Security Printing Corporation (Bangladesh) Ltd.
 Central Bank-Functions
 The controller of Money Supply and Credit: The primary function of the
central bank is to control the supply of money and the flow of credit in the
market. It is facilitated through quantitative instruments (bank rates, cash
reserve ratio, statutory liquidity ratio and open market operations) and
qualitative instruments, i.e. fluctuating the rate of interest for loans.
 (https://www.thefinancialexpress.com.bd/economy/bangladesh/bb-cuts-crr-
repo-rate-to-enable-banks-to-implement-tk-7275b-stimulus-
1586439379#:~:text=Bangladesh%20Bank%20(BB)%20has%20re,effective
%20from%20April%2015%2C%202020.)
 Central Bank-Functions
 Printing Currency: The Bangladesh bank
has the authority of printing the notes of all
denominations except for Tk. 1 & 2 notes
and the coins.
 Custodian of Cash Reserve: All the banks
have accounts with the central bank where
they can maintain some cash reserve for
future needs.
 Central Bank-Functions
 Custodian of Foreign Exchange Reserve: This bank is responsible for managing,
controlling and exchange of the foreign currency and gold in a country, by
maintaining the foreign exchange reserve to keep the exchange rates stable.
 Bangladesh Bank is empowered by section 7A of BB Order, 1972 to hold and manage
the official foreign exchange reserve of Bangladesh. It maintains its foreign exchange
reserve in different currencies. BB has established Nostro account arrangements with
different Central Banks. Funds accumulated are invested in Treasury bills, repos and
other government papers.
 Forex Reserve & Treasury Management Department (FRTMD) performs the operational
functions regarding investment. The Bank's assets held in foreign investments amounted
to BDT 2,243.97 billion, equivalent to 66.74% of the Bank's total assets in FY 2018-19.
 Central Bank-Functions
 Clearing House: The central bank acts as a mediator between the two or more
commercial banks to settle their accounts at the time loss and manage the
transactions between the commercial banks. https://
www.bb.org.bd/fnansys/paymentsys/paysystems.php
 (https://www.bb.org.bd/fnansys/paymentsys/bach.php#:~:text=Bangladesh
%20Automated%20Clearing%20House%20(BACH)%3A%20BACH%2C
%20the%20first%20ever,Electronic%20Funds%20Transfer
%20(EFT).&text=Digital%20Certificate%20has%20been
%20formulated,Bangladesh%20for%20secured%20data%20communication.)
 Lender of the Last Resort: One of the essential functions of the central bank is
to provide loans to commercial banks at the time of emergency, loss and
insolvency.
Central Bank-Functions
 Central Bank-Functions
 Lender of the Last Resort: One of the essential functions of the central bank is
to provide loans to commercial banks at the time of emergency, loss and
insolvency.
 Theoretically, the central bank can assume the lender-of-last-resort function in
three main forms. First, it can lend liquidity to individual banks. Second, it can
lend liquidity to the market, rather than to specific individual financial
institutions. Third, it can inject risk capital into troubled banks, which effectively
also implies a takeover of the banks by the government
 Central Bank-Functions
 Banking Services to Banks and Government: This bank provides all the general banking
services like accepting deposits and sanctioning loans to the other banks and the
government.
 Issuing Government Bonds: The central bank issues various government bonds to generate
funds, encourage public deposits and investments in the country.
 Formulates Banking Rules and Regulations: This bank performs various regulatory
functions like licensing banks, framing banking norms and policies, preparing a judicial
mechanism for debt recovery by banks, monitoring the banking operations, etc. The central
bank even practices moral suasion for making the commercial banks to abide by the policies so
framed. BRPD, FEPD.
 Financial Agent and Advisor to the Government:  The central bank acts as a financial
advisor to the government by providing an expert opinion at the time economic crisis,
fiscal deficit, and advancing loans to other countries. At the same time, it also acts as an
agent by representing the country and the government in international conferences and
meetings, along with issuing the government bonds and securities on behalf of the government
 Bangladesh Bank-Functions
 BB performs all the core functions of a typical monetary and financial sector regulator, and a number
of other non core functions. The major functional areas include :
1)  Formulation And Implementation Of Monetary And Credit Policies.
2)  Regulation And Supervision Of Banks And Non-Bank Financial Institutions, Promotion And
Development Of Domestic Financial Markets.
3)  Management Of The Country's International Reserves.
4)  Issuance Of Currency Notes.
5)  Regulation And Supervision Of The Payment System.
6)  Acting As Banker To The Government.
7)  Money Laundering Prevention.
8)  Collection And Furnishing Of Credit Information.
9)  Implementation Of The Foreign Exchange Regulation Act.
10)  Managing A Deposit Insurance Scheme .
Central Bank vs Commercial Bank
 Monetary Policy-defined

 Monetary policy is the process by which the monetary

authority/central bank of a country controls the money supply
in the economy, by exercising its control over interest rate
and other instruments, in order to maintain price stability and
achieve high economic growth.
 Monetary policy is referred to as either being expansionary or
contractionary.
 MP operates with asymmetry(like a rope) and a lag (like a ship
constrained by domestic market development and global price.
Monetary Policy-defined (contd.)
Core objectives of monetary policy

 Price stability
 GDP growth
 Investment
 Fight recession
 Exchange rate stabilization
 Desired level of unemployment rate
 Monetary policy instruments- Quantitative

a. Open Market operation (OMO): Through OMO central bank

targets available liquidity flow in the market, routinely mop-up
excess liquidity and inject it as appropriate.
- buying & selling of securities
- buying & selling of bills
 Changes in the policy rates, i.e., repo and reverse repo rates.
Presently, the repo and reverse repo rates are 4.75% and 4.0 %
respectively.
 https://www.newagebd.net/article/105251/bangladesh-bank-to-
inject-tk-50742cr-in-government-stimulus-packages
 3.3 Monetary policy instruments-Quantitative
 3.2.b. Reserve Requirement (RR): Reserve requirement involves
variations in reserve ratios (i.e. CRR and SLR) which are primarily
used to influence the quality of credit available in the banking system.
 According to Bangladesh Bank order 1972 section 36(1), Bank
Company Act 1991, Sec. (33) and MPD circular no 01/2014.
 At present, CRR for all banks and SLR for conventional banks are 4%
and 13% of their total demand and time liabilities.
 3.3 Monetary policy instruments- Quantitative

 3.2.c. Bank rate or discount window: The interest rate which a

central bank charges on discounts or overdrafts (loans from the central
bank to commercial banks).
 If the interest rate on such transactions is sufficiently low, commercial
banks can borrow from the central banks to meet RR and use the
additional liquidity to expand their credit
 It is 5% since effect since November 06,2003, but now 4%.
3.3 Monetary policy instruments- Qualitative

 Regulation of consumer credit: Rules & regulations established by central

bank to increase/decrease purchasing power of consumer by peeking or
declining goods price and payment of installment.
 Margin requirement (MR): Central bank ordered commercial banks to
restrict their loans to stock brokers by rising the MR.
 Direct Action: Coercive measures taken by central bank against individual
bank, i.e.,
 Moral suasion: Persuasion and request made by central bank to commercial
bank to follow the monetary policy.
 Monetary policy

 https://tbsnews.net/economy/banking/bangladesh-bank-slashes-policy-rates-
support-banks-113122