3 main report

AN ANALYSIS OF THE RECENT FLUCTUATIONS IN THE INTER-BANK CALL MONEY MARKET

Call money market has been a very important source of fund for banks and financial institutions whenever they have been in liquidity crisis. It has been a lifesaver for most financial institutions that have banked on the stable and low rates and immediate availability of funds. However, from December 2004, the call money market has been experiencing great instability and the rates have been extremely volatile and very high.

The purpose of this report is to to analyze the unusual fluctuations in rates that the call money market has been experiencing from December 2004. A survey was conducted of 10 banks and NBFIs and Bangladesh Bank to gain insights to the working of call money market, its recent fluctuations in rates and the role of the government in controlling such volatility.

The call money market is a system that permits banks with excess reserves over the required position for the day to lend out the same excess to reserve deficient banks. The inter bank call money market rate of a day is determined by the demand and supply of funds. From 2001, the call money market has been fairly stable and has hardly experienced any unusual spikes in the call rates. Other than during eid an din June before the fiscal budget, call rates have been less than 10%. In 2005, call money market rates have been very volatile, averaging over 15 – 20% daily.

The money market has been suffering from liquidity crisis from December 2004 with the government making huge withdrawals from the market. One reason the government has borrowed so heavily from the money market is to curb inflation. This is the last year of government tenor and it has been trying to keep prices down. Moreover, the government has not been receiving payment for its donor funded projects, and to meet its expenditure, it had turned to the money market.

The call money market has also allowed banks and NBFIs to borrow at very low cost. Banks have borrowed short term from the call money market to fund investments over a year believing that they would be able to acquire funds anytime and at very low cost. Moreover, with shortage of funds in the market from December 2004, call rates have accelerated and it has became a lucrative market to lend. Not only have institutions that have surplus cash lent, those who didn’t even have idle funds also lend and then through repo, they sold treasury bills and acquired funds from Bangladesh Bank and nationalized banks to meet their daily needs. And those who were in acute need of funds paid higher and higher rates to acquire funds.

The liquidity crisis in the money market worsened with Bangladesh Bank’s circular issued on February 10 for banks to immediately meet their mandatory 4 per cent Cash Reserve Ratio (CRR) deposits at the central bank with foreign exchange. Moreover, Bangladesh bank has increased cash reserve requirement from 4% to 4.5%. Banks now have to keep aside a greater portion of their funds for the central bank and hence can participate less in call money market All these resulted in total crisis in the market and the call money market has become quite erratic.

To bring stability, the government has intervened in the market. Bangladesh Bank has imposed a ceiling on call money market rates – 20% is the maximum the banks can lend to the market. Moreover, banks who lend are not allowed to do repos. There is also lending restriction on the amount NBFIs can borrow – 15% of net assets.

However, call money market rates will remain volatile for at least the next three months.

With increase in pay scale of the government, increase in CRR rate and irregular activities of 2

banks and NBFIs, call money rates will be volatile. If government removes the ceiling, call rates will again rise and cause huge losses to financial institutions. After that it will be very difficult to predict in which direction call rates will move.

CHAPTER 1: ORGANIZATION 1.1 OVERVIEW OF CITIBANK NA 1.1.1 CITIBANK NA Citibank NA (National Association) is a part of Citigroup, the renowned global financial services company with some 190 million-customer accounts in 104 countries across six continents. Citibank is ranked as the top bank in the world while Citigroup is the world’s number one multinational company.

1.1.2 CITIBANK NA BANGLADESH Citibank Bangladesh is 100% owned by the branch office of Citibank, New York and started its operation in Bangladesh during 1987, by opening of a representative office.

Full-fledged operation of Citibank started on June 24, 1995. Then on June 18, 2000 a new full service branch was opened in Chittagong, the commercial capital of Bangladesh. Then Citibank opened its third branch in Gulshan in 2003.

At present Citibank employs around 94 permanent staff and 40 full time equivalents (comprising of people with contract jobs and interns), making the total headcount 104. The operation of Citibank in Bangladesh is still conservative and limited to serving financial needs of the leading business and corporate houses. The bank has plans to introduce consumer banking in the future.

Citibank N.A. Bangladesh had been able to establish itself as one of the largest overseas correspondents for the nationalized banks in Bangladesh. Citibank’s revenue was $ 3.093 million in April 2005. This was quite a feat since the budgeted revenue for the month was $ 1.89 million. The expected annual revenue for 2005 is $25 million dollars. Citibank aims to achieve $ 50 million revenue by 2008.

1.2.1 DIVISIONS The bank is divided into divisions based on business segments and operations with vice presidents in charge of each division. The support departments are controlled by heads of the department. There are around 19 departments in Citibank. Each business segment and operation provides differentiated products.

Business Segments ● Corporate - Global Banking Relationship and TTLC ● Financial Institutions ● Treasury (Proferssional markets) ● Priority Banking Operations ● Cash Management ● Trade, Treasury and FI Operations ● Global Transaction Services (GTS) ● Credit Risk Administration ● Electronic Banking Support ● Finance Control Unit ● Human Resource ● Internal Control Unit ● Technology 4

● Corporate Affairs ● Compliance ● GIS (Administration)

1.2.2 BUSINESS SEGEMNTS CORPORATE BANKING Corporate Banking in Citibank is divided into two main segments: 

GRB (Global Relationship Banking), in which the RMs basically deal with the clients (multinational companies in Bangladesh) with whom Citibank has global relationship.

The RMs establish contact with key CBG customers, customer information and make a detailed analysis of the needs of the client matched with what the bank can offer.

After agreement of both parties, the bank gets approval from the lending unit. Once a company has become a client with credit relationship, the RMs then have to monitor the performance of the company and ensure that no classification of credit occurs.



TTLC (Top Tier Local Corporates), is the segment in which only the top performers (basically the first three ranked companies) of any industry are approached to be Citibank’s clients.

Corporate banking provides the following products: •

Corporate Finance - commercial paper, syndicated loans and project finance

•

Working Capital Finance - pre-export and import finance, receivable financing

•

Trade Finance - letters of credit, export L/C advising & transfer and guarantees

FINANCIAL INSTITUTIONS

The Financial Institutions department caters for the need of various banks and non-bank financial institutions as well as NGOs, not-for-profit organizations and diplomatic missions.

The core product is the correspondent banking services. Besides, there are various electronic banking services, which enable FI, clients perform large domestic and international transactions efficiently and safely.

PROFESSIONAL MARKETS The professional market or treasury of Citibank Bangladesh meets all the foreign exchange related requirements of the valued corporate customers. The products include: •

Foreign Exchange - ready & spot, forward, currency swaps, bills discounting and

inter-bank term deposits •

Money Market - overnight deposits, term deposits and discounted securities

1.2.3 OTHER DIVISIONS OPERATIONS The operations departments of the bank basically handle the documentation of the business segments. They deal with account opening, deposit management, loan booking, L/C opening, advising, etc

CREDIT ADMIN This department deals with credit risk or market risk of projects. Other responsibilities of the department include monitoring credit facility, checking the credit approvals prepared by the Relationship Managers, monitoring the Relationship Managers’ activities relating to plant visits. The Head of this unit reports to the Country Risk Manager (in case of Citibank Bangladesh, it is the Chief Country Officer).

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FINANCIAL CONTROL Fincon deals with managing the financial books of the bank; checking all entries of the book are according to standards, preparing reports for Bangladesh Bank, corporate reports, revenue appropriation and calculations and setting the internal pricing rates etc.

TECHNOLOGY & ICU (INTERNAL CONTROL UNIT) Technology is involved in processing of transactions and maintenance; and ICU is involved in reconciliation of Nostra accounts and also making sure that every day the suspense account balance is zero.

HUMAN RESOURCE The responsibilities involved in the Human Resource department include recruitment, selection, employee performance evaluation etc. Being a multinational bank, besides Citigroup policies, certain US laws are applicable to the operation of Citibank in Bangladesh.

One person is in charge of human resource and administration of the bank.

CORPORATE AFFAIRS The main task of this department is to maintain liaison with different organizations, especially with those who work in close proximity with Citibank, Bangladesh. This department is a very crucial for the bank as it establishes relationship with other organizations in the corporate world. Moreover, this department arranges various seminars and workshops and also takes the initiative in undertaking various training programs to enhance the knowledge of the employees regarding Citibank, its customers and suppliers.

COMPLIANCE Being a multinational bank, besides Citigroup policies, certain US laws are applicable to the operation of Citibank in Bangladesh; anti money laundering and adhering to such general compliance issues of the bank are other major responsibilities of this department.

1.3 INSIGHTS TO CITIBANK

1.3.1 HUMAN RESOURCE At present Citibank Bangladesh has a permanent staff of only 94 people in its three branches. The rest 30 to 40 people, called full time equivalents are on contracts or interns.

There is severe level of understaffing in Citibank. The permanent employees have so much workload that they have to work till very late everyday. The bank is unable to increase the number of permanent staff because they do not have permission from the regional head office in India to recruit more people.

The bank outsources and hires people on contract, called full time equivalents. These people are given the same workload as a permanent employee. However, the salary they are pad is low and they do not enjoy facilities and benefits that permanent employees get.

The bank also hires fresh BBA and MBA graduates as interns. These students are engaged in manual work – documentation, filing, verfication of documents, data entry into the PCs, etc. Sometimes they are even send on errands to different institutions to collect or deliver official papers. Especially during January to April when universities have most students graduating, Citibank employed over 25 interns, 21 only in the Motijheel Branch. Especially during audits, there is more intake of interns.

Most of employees work from 9 in the morning to usually very late at night. Sometimees they even work on weekends and holidays.

1.3.2 WORKING ENVIRONMENT Culture Citibank has a very work oriented culture and people tend to be very workaholic. The culture between departments and floors in Citibank Motihjheel also varies. In the ground floor of Mojheel branch which houses the operation divisions and the seventh floor where the support departments are, the atmosphere is very casual. People tend to work hard but they also have very good congenial relationship with colleagues. This is same for permanent 8

and temporary staff and interns. This may have to do with the behavior and outlook of the heads of departments. The units are expected to work to their level best but they are also encouraged to talk to each other during working hour and enjoy life. Here the relationship between supervisor and employees is also quite friendly and informal.

The ninth floor, called the corporate floor, houses Corporate and FI divisions and the offices of the CCO and other top level managers of Citibank. Here people are only expected to work and do nothing else even if they have free time. The relationship between boss and employee in most departments is very strained. Although the bank is still small, the top level do not know many of the employees and tend to behave very coldly towards them. Some of the people with contract jobs and interns are also not treated well. There is a dinstinct difference between other departments and the management level. Non manegerial people of this floor are highyly dissatisfied.

However, one unique thing about Citibank is the dedication and comitment of the employees. All employees work for very long hours and sacrifice a lot of things in life – their aim is to ensure that Citibank becomes the top bank in the country, not only in name but also through performance and quality of services. People are willing to help each other, not only within a divison but also between divisions.

Secondly, although Citibank is a MNC, unlike other companies, it is completely run by only Bangladeshis. There is only one Indian, who is the head of Credit Administration. The employees daily correspond with citibank people in other parts of the world and are completely at ease with it.

Work place The workplace of Citibank is another area where employee satisfaction is very low. The seventh floor is very cramped up. In a single room, about 15 people work with barely any space to move. The other departments are also filled to capacity and usually interns are

given neither table nor computer but are expected to sit next to their supervisor and share the same table.

However, the bank is moving its head office to a new location within two months and hopefully the space contraint will be less there.

1.3.3 LEVEL OF SATISFACTION The level of satisfaction among the employees, especially the non manegerial staff, is quite low. The main reason may be the long hours they have to spend at the bank. The employees are not able to spend time with family and enjoy life. The compensation package is also not attractive enough to offset such sacrifices. On the contrary, there is quite a very wide gap between the compensation package of the management and other employees.

1.4 RECENT DEVELOPMENTS CONSUMER BANKING Citibank is planning to introduce consumer banking within three years. However, they have still not got permission from its head office in New York. The management feels that Citigroup cannot associate with corrupted people of the society and that the top customers of consumer banking in Bangladesh are the defualters and corrupted people of the country who have acquired funds through illegal means.

Hence, introducing consumer banking

would imply tarnishing the reputation of the bank. Moreover, the management claims there is still some doubts of whether the bank would be able to maintain uniform quaility of services compared to other countries.

MONOGRAM OF CITIBANK 10

Citbank has recently changed its monogram from Citibank to Citigroup to bring uniformity.

However this has created quite a confusion because the letterhead has Citigroup’s logo in the top and Citibank’s name, in very small font, in the bottom. Many documents have not been accepted by Bangladesh Bank because they have assumed that the legal name of the company has changed since the name “Citibank” is barely legible.

CITIBANK BOOTH IN US EMBASSY On June 12, 2005 Citibank opened a booth and ATM in US Embassy, Baridhara. They took over Amex and will maintain accounts of employees of US embassy. Moreover, visa fee collections for USA will also be done from the counters of Citibank Dhaka and Chittagong branches. This is a very important development in Citibank Bangladesh’s history.

1.6.1 PROFITABILITY MEASURES Table 1.1 : Profitability measures

Net

Profit Net Income After Taxes/

Margin Return

Total Operating Revenue on Net Income After Taxes /

Equity Asset

Stockholders Equity (Interest Income +

Utilization

Interest Income)/Total Asset

Ratio Return Asset

2001

2002

2003

2004

32.90

36.40

40.36

31.61

41.16

11.45

16.53

22.35

19.07

25.00

12.94

5.80

9.33

10.38

11.68

1.25

2.11

2.82

2.14

3.52

Non

on Net Income After Taxes/ Total Assets

2000

The Net Profit Margin reflects the effectiveness of expense management and service pricing policies. Citibank’s net profit margin has been steadily increasing over the past years. This indicates that management of Citibank has been very efficient in managing and controlling costs. The management has also been very successful in rightly designing and implementing the service pricing policies.

Return on Equity measures how much of the investments of the stockholders, has been turned into profit. It shows the rate of return flowing to the bank’s shareholders. Citibank has been showing a healthy and steady growth in it ROE over the last few years except for 2003. This was mainly because of its increase in net income over this period of time.

Citibank’s treasury has been very efficient in performing money market and the foreign exchange transactions. In money market they did not keep any ideal cash in hand; they only kept the minimal amount to maintain the CRR and invested rest of the ideal cash into T-bills.

In foreign exchange they have rarely missed any large customer payments that generate high volume of profit.

Thus for the efficiency of the treasury and other financial departments Citibank has earned a steady growth in profit. Even though Citibank doesn’t issue shares in Bangladesh, but it performance affects the share of Citicorp enlisted in NYSE. Thus indirectly the shareholders of Citibank Bangladesh are the investor who has invested in Citicorp.

Asset Utilization Ratio reflects the portfolio management policies, especially the mix and yield on the bank’s assets. Citibank’s assets utilization ratio increased from 1999-2000 and then it suddenly dropped in 2001 and again went up in the preceding year. The reason for the rate to fall in 2000 was because of the banks investment in some low yield assets during this year.

The Return on Asset (ROA) is an indirect measure of management efficiency, it shows how efficiently the management has been able to use the assets of the bank in order to generate income. Citibank has had a steady growth in its ROA over the last five years. The fall in ROA in the year 2003 is due to the introduction of the new branch in Gulshan. Assets increased at a higher rate than income. The expansion paid off very well since in the very next year the ROA increased by almost 65%.

1.6.2 LIQUIDITY MEASURES Table 1.2 : Liquidity measures

12

2000

2001

2002

2003

2004

29.12

36.00

59.48

56.80

59.89

and with other Banks and 19.89

20.28

21.31

22.67

9.45

(Total

Loans

-

Net Loans to Total Provision For Loan Assets

Loss)/

Total Assets Cash and Balance with Cash and Balance other

Banks

Financial Institutions

FI/Total Assets

Net Loans to Total Assets The Net Loans to total Assets (NLTA) has steadily increased over the years except in 2003.

Due to it efficient and strict fund management by the credit department; Citibank has had very few bad debts. Therefore due to small provision for bad loans the NLTA has been increasing over the past few years.

Cash and Balance with other Banks and Financial Institutions to Total Assets Total cash and balance with other banks of Citibank as a percentage of total assets increased between 2000 and 2003. Although this improved the bank’s liquidity position, it also decreased the bank’s earning capability. In 2004, this ratio has decreased significantly, which weakened the liquidity position of the bank but it increased the bank’s earning capability.

1.6.3 SOLVENCY / DEFAULT RISK MEASURES

Equity

Capital Total Equity Capital /Total

to Total Assets Assets Total Equity to Total Equity/Risky Assets Risk Assets Equity Capital to Total Assets

2000

2001

2002

2003

2004

13.34

12.74

12.62

11.21

14.09

26.22

25.71

16.06

14.56

15.64

This measures the solvency risk of a bank - the danger that a bank may fail due to negative profitability and erosion of its capital. Capital account of a bank absorbs losses if the bank has large bad loans in the portfolio. If the equity funding relative to the total asset goes

down then it may indicate that the risk exposure for the bank’s investors and debtors has increased. Citibank’s ratio has been steadily decreasing over the past few years. This shows that the risk exposure for the bank’s debtors and investors has slightly gone up. But in 2004, the ratio has increased a bit indicating that Citibank is trying to minimize the risk of default.

Equity Capital to Risk Assets This ratio reflects how well current bank capital covers potential losses from those assets that are most likely to decline in value. Here also the total equity has gone down relative to the risky assets increasing the risk of the assets to decline in value. In order to increase the ratio, management can liquidate some of the risky assets and in 2004 the ratio increased indicating that the risk of potential losses from risky assets is slowly decreasing

CHAPTER 2: PROJECT SPECIFICATION 2.1 BACKGROUND Call money market has been a very important source of fund for banks and financial institutions. Whenever the financial institutions have been in liquidity crisis, either to meet working capital need or cash reserve ratio of the central bank or even to pay off obligations, they have been able to acquire funds immediately from other banks at very low cost. The call money market has been a lifesaver for most financial institutions that have banked on the stable and low rates and immediate availability of funds. In case of organizations with surplus funds, the inter bank market has meant acquiring fine return on idle cash.

However, from December 2004, the call money market has been experiencing great instability - the rates have been extremely volatile and very high. It has become a very exorbitant source of fund and banks have been suffering huge losses because they have been unable to afford the higher rates. Many financial institutions have failed to realize that inefficient risk-management in the face of spiraling call-money rates would leave them with massive losses in their day-to-day operations. Those who could afford have been unable to find money from the market. It has been very difficult for institutions to invest and take 14

decisions because the call money market has failed to follow the usual trend and has become very unpredictable.

2.2 PURPOSE This report aims to analyze the unusual fluctuations in rates that the call money market has been experiencing from December 2004.

2.3 OBJECTIVE The objective of the report is to analyze the call money market and the recent fluctuations it has been experiencing in its rates.

2.4 SCOPE An analysis of the recent fluctuations in the inter bank call money market

The scope of the report is limited to the activities of only the local inter bank call money market. Data of only last five years has been analyzed.

2.5 METHODOLOGY Type of Study This study aims to analyze the unusual fluctuations in rates that the call money market has been experiencing from December 2004. This is basically a qualitative study.

Intent of Study The project was undertaken to understand the mechanism of the call money market and analyze the instability that the call money market has been experiencing from December 2004. The study also takes into account government’s role in the call money market.

Data Collection Method A survey was conducted of only the banks and financial institutions of the country. The list was acquired from the web. From the sampling frame 10 institutions were targeted.

Interviews were conducted with employees of the treasury department of the following 10 banks and NBFIs. Table 2.1 : Sample

Foreign banks Local private banks Nationalized banks Non-banking Financial

Citibank NA , Commercial Bank of Ceylon Dhaka Bank, Dutch Bangla Bank, Prime Bank, IFIC Bank Agrani Bank Industrial Development Leasing Company (IDLC), United Leasing

Institutions

Company Limited (ULC), IIDFC

In addition, interviews were conducted with three official of Bangladesh Bank of Treasury and Monetary policy departments to gain insights to the working of call money market, its recent fluctuations in rates and the role of the government in controlling such volatility.

An analysis of the recent fluctuations in the inter bank call money market

Daily data of the average call money market for years 2001 – 2005 was also acquired from Citibank N A. This was used to analyze how fluctuations in call money market rates from December 2004 have been unusual. All table and figures have been derived from information given by Citibank.

For secondary data, internet and newspaper were the main sources.

Type of design Convenience sampling was used as samples were selected on basis of availability of contacts in the organizations.

2.6 LIMITATIONS Limitations in completing the report include: •

Non disclosure of classified information by some institutions.

•

Many respondents failed to understand and answer some of the questions.

•

For the information collected from sampling to be reliable, repeatability and internal consistency have to be checked. While the internal consistency was verified by asking various questions to get the same answer, test for repeatability could not be done because the respondents were unable to spare time for extra questioning, let alone answer the same questions over again.

2.7 PROJECT PREVIEW An analysis of the recent fluctuations in the inter bank call money market 16

The report firstly gives an overview of the call money market in terms of what the market actually does, its major players, process and instruments used. Then the report deals with call money market rates, the factors that affect them, how they change and trend of the rates from 2001 – 2005.

The report then analyzes the recent fluctuation in call rates, reason for such instability in the market and volatility in rates and government’s measures to stabilize rates. Finally some recommendations are gven on how to bring stability to the call money market.

An analysis of the recent fluctuations in the inter bank call money market

CHAPTER 3: THE CALL MONEY MARKET 3.1 OVERVIEW OF THE CALL MONEY MARKET 3.1.1 INTRODUCTION Call money market is a medium whereby banks with excess cash or shortage of cash transact with each other in order to meet short term working capital needs and make profit.

In other words, the call money market is a system that permits banks with excess reserves over the required position for the day to lend out the same excess to reserve deficient banks.

Banks borrow from the market when they fall short of funds to meet withdrawal requirements from customers and the central bank’s statutory reserve requirements and to relend at more attractive rates On the contrary, banks lend to other banks when they have surplus idle funds.

The borrowing and lending in the money market is high volume, low risk and short-term.

Since it is short-term, transaction costs are high relative to the interest that can be earned.

For this, transactions in the money market tend to be for very large amounts. Here, shortterm does not imply a period of less than one year - in fact, most money market activity is concentrated in terms to maturity between overnight and one week.

3.1.2 THE MARKET PLAYERS The parties involved in the money market are ● Nationalized banks – Sonali, Janata and Agrani Banks, the nationalized commercial banks, have the largest surplus available since they are government owned, large in size and have some regulatory restrictions on their lending. Hence they are the largest lenders in the market with their huge amount of deposits and reserve requirements.

Foreign banks – Multinational banks like Citibank NA, Standard Chartered Bank and HSBC and other regional banks have large amount of liquid funds and tend to actively lend and borrow in the overnight market.

An analysis of the recent fluctuations in the inter bank call money market

● Private banks – Most private local banks like Dhaka Bank and Prime Bank are net borrowers and transact similar volume in a day. ● Non banking financial institutions – NBFIs include institutions other than banks like leasing and insurance companies. They only take deposits over a year and so are very dependent on the call money market for meeting short term liquidity crisis.

3.1.3 CALL MONEY MARKET – THE PROCESS The transactions of call money market are mainly capital based. Since the head offices of all banks and financial institutions are located in Dhaka, the branches of the banks and financial institutions from all over the country remit their excess funds to their respective head 18

offices in Dhaka for investment. These head offices, after meeting their usual liquidity requirements, invest the surplus funds in the call money market.

As there is no brokerage house or central treasury unit, the transactions in the call money market usually take place on the basis of bilateral negotiations.

Nationalized banks and foreign banks are the main source of liquidity in the call money market. Cost of funds for these foreign banks is very low compared to that of the indigenous ones and as such the former can hold a substantial amount of excess liquidity for lending in the call money market. In case of borrowing, they are also at an advantageous position over the local banks.

Information systems of banks in Bangladesh are outdated. Market players, therefore, do not know much about the demand for and supply of funds. Banks and financial institutions having surplus funds take advantage of the market imperfections of domestic banks, running short of the required amount of liquidity from time to time.

An analysis of the recent fluctuations in the inter bank call money market

3.1.4 HISTORY The call money market is the most sensitive part of money market. Initially, this market developed as an inter-bank market where the banks in temporary deficit of cash resorted to borrowings from other banks having surplus funds. As banks were in the public sector until the beginning of the 1980s, the Bangladesh Bank (BB) provided them with liberal refinance facilities at concessional rates. There was hardly any need for raising funds from the call money market during this period.

Moreover, administered interest rate regime, easy availability of borrowings from central bank and its directive to provide credits to priority sectors were the major impediments to development of a well-functioning call money market in the country. Banks participated in a limited scale in the call money market mainly to wipe out the temporary mismatch between their assets and liabilities.

A turning point was the disinvestment of Uttara Bank and Pubali Bank in 1983 and 1984 respectively and the government’s decision to allow private banks to operate in the country.

Formation of private banks during the 1980s provided new opportunities to develop this segment of the money market.

After the 90s, there was huge supply of money in the market and call rates were low, less than 8%. All banks -- third generation banks and non-bank financial institutions – started to borrow funds from the overnight market. From 2002, the government allowed banks to sell treasury bills for cash regularly. The banks then not only borrowed when they faced liquidity crisis but also lent. They borrowed not only to meet short term needs but also for long term investments.

At present the call money market has been experiencing great instability and the rates have been extremely volatile and very high 3.1.5 MONEY MARKET INSTRUMENTS An analysis of the recent fluctuations in the inter bank call money market

Money market borrowing and lending utilizes a variety of different instruments. These include: •

Call money

•

Treasury bills

•

Repurchase agreements (repos)

Call money is a short term financing instrument. Banks borrow and lend among themselves for a period of not more than 3 days for meeting emergency liquidity crisis. The availability of funds among banks determines the rate at which the bank can place funds.

Treasury bills issued by Bangladesh Bank have the lowest default risk. All banks are eligible to invest in T- Bills and submit tenders through their own accounts maintained with the Bangladesh Bank. The rate of discount is determined through auction.

20

Repurchase agreement (repo) can be seen as a short term swap between cash and treasury bills. Repurchase agreements, or repos, are specialized but important aspects of many markets, especially those for government securities. In essence, if a bank or NBFI wants to maintain his or her long-term position but needs cash for a short period, the organization can enter into a repo contract whereby the securities are sold together with a binding agreement to repurchase them at a future date, usually fairly near-term. The effect is to provide the bank with a short-term loan based on the collateral of the government securities it owns. Repo is a cheap, simple and effective way to raise short-term funds.

Bangladesh Bank has only allowed repo of 28 days T-bills. Whoever is interested for a REPO has to submit a bid to Bangladesh bank in prescribed form against the 28- day bills in a regular auction. The participating institutions must go through an auctioning procedure held on all working days to avail of the REPO facility for 1 to 7 days.

An analysis of the recent fluctuations in the inter bank call money market

The Bangladesh Bank usually supports the market with Treasury bill Repo facility when there is a liquidity problem. Similarly, in times when there is high liquidity in the market or the government requires funds, then Bangladesh bank goes for reverse repo and sells T-bills to financial institutions.

3.2 CALL MONEY MARKET RATES

An analysis of the recent fluctuations in the inter bank call money market

3.2.1 CALL MONEY RATES The inter bank call money market rate of a day is determined by the demand and supply of funds in the market for that day. It varies from banks to banks and from time to time.

Usually the rate is around 5% to 10%.

3.2.2 FACTORS AFFECTING CALL RATES •

Eid - During Eid, especially during Eid-ul-Azha, customers withdraw most of their

deposits. Banks have to then borrow heavily from the call money market to meet obligations. With most institutions demanding cash, the call money market rates tend to increase significantly.

•

Government borrowing – Call money market rates also tend to increase before the

fiscal budget in June when government pays for maturity of treasury bills and salaries.

•

Government policy – The monetary policy of the government affects the call money

rate. Usually when the government goes for an expansionary policy to enhance growth and employment, it injects huge money into the economy. This increases the supply of cash and with most banks experiencing increase in deposits, call money market rates fall.

•

T-Bills – Government issues treasury bills every week, either to meet expenditure or

withdraw money from the economy. Banks are one of the major buyers of T-bills.

Moreover, the government also pays for maturity of T-bills. The net effect on call money market rate depends on which is higher - maturity or issuance of treasury bills? If amount of maturity of T-bills at a particular time is higher than issuance of T-bills, then there is an overall increase in supply of money and hence call money market rates fall.

An analysis of the recent fluctuations in the inter bank call money market

•

Repos and reverse repos – Financial institutions buy treasury bills to do repos. When

banks are in need of funds and the money market has shortage of funds, they sell treasury bills to Bangladesh Bank for a few days to meet liquidity crisis. The banks submit tenders to the central bank based on their liquidity requirements. The central bank then decides on which banks to give repos to. Repurchase agreement increases the supply of money in the market and reduces call money market rates. Repo rates are usually a little higher than call money market rates.

22

Government also goes for reverse repos – The central bank forces financial institutions to buy T-bills that they have sold to it. This results in withdrawal of money from the market and increases call money market rate.

3.2.3 TRENDS IN CALL MONEY MARKET Call money market rates usually follow a regular pattern. In a year, rates tend to be similar and stable in all months except during Eid ul Azha and before the fiscal budget in June. Call money market rates usually range from 6 to 10%. It is only before Eid, when most individuals withdraw their deposits and during June-July when government pays for maturity of treasury bills that the call money market goes over 10% However, it again falls back to less than 10%.

From 2001, the call money market has been fairly stable and has hardly experienced any unusual spikes in the call rates. As can be seen from the diagrams, from 2001 – 2004, the rates have been high around June-July and around the first quarter of the year, the time of Eid. In other months the rate has been stable and low. Only in 2001 call rates have fluctuated in many months but the rate was most of the time around the normal level of 10%.

An analysis of the recent fluctuations in the inter bank call money market

3.2.4 YEARLY

Figure 3.1 : Trend of call money market rates

ANALYSIS OF RATES

2003 An analysis of the recent fluctuations in the inter bank call money market

Call rates were mostly stable in 2003. Call money rates only saw sudden spikes in early February due to usual substantial cash outflows from the Banking sector during Eid-ul-Azha.

Call rates also jumped as high as 36% in June when the central bank dried out the liquidity from the local market to restrain the holding of dollars that could lead to undesired and artificial spike in the USD/BDT rates. However, call rates eased from the end of June and remained stable until December. The call rates did not even see the pre-Eid upward 24

movements during the November end as Bangladesh Bank supplied funds to the banking sector through Repo facility. Bangladesh Bank injected 38 Billion Taka through Repo facility in that period at rates ranging from 4.50 % to 5.00 %.

Call Money Market Rates (2003)

Rate 40 35 30 25 20 15 10

Dec-03

Nov-03

Oct-03

Sep-03

Aug-03

Jul-03

Jun-03

May-03

Apr-03

Mar-03

Feb-03

-

Jan-03

5

Month

Figure 3.2 : Call money market rates in 2003

A major reason for such stability was fall in government borrowing through treasury bills by almost 66% from 2002. This ensured adequate supply of money in the market to meet the needs of the financial institutions and keep call rates low.

An analysis of the recent fluctuations in the inter bank call money market

Figure 3.3 : Government borrowing through treasury bills (1999 – 2003)

2004 The call money market was more stable in 2004 than 2003. The market hardly experienced unusual spikes in the call rates as the Bangladesh Bank supported the market with Treasury bill Repo facility when there was liquidity problem. Similarly, Bank’s were seen to actively use the Treasury bill Reverse Repo facility at times of high liquidity to invest the surplus funds. Call rate throughout the year was around 6%. Only during the Eid ul Azha in January, call rates suddenly shot up to 55% for a day, as there was a gap in the Bangladesh Bank’s Repo auction. Banks unaware of the Repo schedule were caught off guard by heavy cash withdrawals before Eid. However, during the Eid Ul Fitr period in November the market was cautious of the Repo gap and collected the required funds beforehand from the Repo auction. As a result, the call rate was within the normal levels.

Call Money Market Rates (2004)

Ra te 50 45 40 35 30 25 20 15

Dec-04

Nov-04

Oct-04

Sep-04

Aug-04

Jul-04

Jun-04

Apr-04

Mar-04

Feb-04

-

Jan-04

5

May-04

10

Month

Figure 3.4 : Call money market rates in 2004

An analysis of the recent fluctuations in the inter bank call money market

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A major reason for such stability was fall in government borrowing through treasury bills by almost 66% from 2002. This ensured adequate supply of money in the market to meet the needs of the financial institutions and keep call rates low.

Figure 3.5 : Government borrowing through treasury bills (1999 – 2004)

2005 In 2005, call money market rates have been very volatile. Call money market rate has been over 15% throughout the 5 months from January to May. Call rate started to increase in January and shot up to 70% in February, during Eid. It again fell down to less than 10% in March. However, again in April it went up as high as 40%. In May the rate was around 20%.

Ra te

Call Money Market Rates (2005)

70 60 50 40 30 20 10 Jan05

Feb05

Mar05

Apr05

May05

Month

Figure 3.6 : Call money market rates in 2005

An analysis of the recent fluctuations in the inter bank call money market

3.2.5 ANALYSIS OF RATES FROM JANUARY – MAY (2001 – 2005)

Call rates from January to May for 2001 – 2004 have been stable. There has been fluctuations in some months but rates have never accelerated over 30%. Rates have been around 30% only in one month, mainly during February – April, when there was eid.

Rates have also increased significanlty in May before the fiscal budget. Other than this, fluctuations have been insignificant in the other months.

However, in 2005, the trend has been quite different from the previous four years. Rates were volatile and fluctuating in all months from January to May. Around February and March, rates peaked to over 70% . Rates were extremely fluctuating – in just one month, February, around eid, rates first rose to 70%, fell down to less than 10% and then again peaked to 60%. Between March and April too rates increased from 5% to 40%.

By the end of April, rate fell to less than 10% but then again started to increase due to the upcoming budget.

Hence,

call

money

rates

have

been

extremely volatile and quite unusual from 2005 in comparison to the previous four years.

28

Figure 3.7 : Jan – May call money market rates (2001 - 2005)

3.3 ROLE OF GOVERNMENT An analysis of the recent fluctuations in the inter bank call money market

The call money market operates on its own without much intervention. The government through the central bank only intervenes when the call money market rates increase and become unusual.

The central bank can control the call money market in several ways.

•

Statutory reserve requirements - A main way of controlling the inter bank rate is

through its statutory reserve requirements – statutory liquid reserve and cash reserve ratio. The banks have to maintain a cash reserve with the central bank, which is a certain percentage of their total demand and time liabilities in the form of balances in their account with BB. If Bangladesh Bank wishes to reduce the supply of funds, then it can increase this rate. This will result in outflow of money from the call money market and will restrict ability of the commercial banks to lend.

•

Special Deposits - The central bank can also affect the supply of money through

special deposits that banks have to keep with BB. If the balance is increased or frozen, then banks will be forced to keep a higher percentage of deposits in reserve, this reducing their ability to lend.

•

Interest rates – Bangladesh Bank can increase the overall interest rate. This will

result in an increase in call money market rates because cost of funds will increase.

Higher rate means that banks will borrow less from the call money market.

Open market - The central bank may also control the money supply through operating in the open market. Bangladesh bank will be able to manipulate the money supply by buying or selling treasury bills. If government wants to reduce supply of money, BB will sell treasury bills to banks and this will result in withdrawal of funds from the market. On the contrary, government can buy securities from banks, this increasing supply of money for banks and reducing call rates.

An analysis of the recent fluctuations in the inter bank call money market

•

Repurchase agreements – If call rates increase, Bangladesh Bank can issue more

repos to banks by buying their treasury bills for a certain period. This will increase the supply of money in the call money market and reduce call rates.

•

Ceiling – Government can impose a ceiling on the call money market rate, the

maximum rate at which banks can trade with each other. This will ensure that rate remains stable and affordable to all financial institutions.

An analysis of the recent fluctuations in the inter bank call money market

CHAPTER 4: FINDINGS 4.1 VOLATILITY OF RATES

The call money market has been fairly stable in 2004. As depicted in the diagram, call rates have been less than 10% from October to December 2004. However, from the end of December 2004, call money rates have been very volatile. Call money rates started to increase from Decmeber and reached record high of 70% in late January ahead of eid. The high trend continued even after eid until it settled somewhere below 10%. However, again in March, the rate rose to 30% in some deals, with the rate in average being 25% for private banks and 11% from nationalized banks. In April the rate rose to 40% and remained high and quite fluctuating till May.

Rate

Call money market rates ( Oct 04 - May 05)

80 70 60 50 40 30 20

30

10 Oct-04

Nov-04

Dec-04

Jan-05

Feb-05

Mar-05

Apr-05

May-05

Month

Figure 4.1 : Call money market rates from October 2004 to May 2005

An analysis of the recent fluctuations in the inter bank call money market

INFLATION

One of the main reasons for such fluctuation is government’s contractionary policy to curb inflation. In December the rate of inflation accelerated to 6.10% from less than 5.5 % and then to 6.2% in February. So the government started to decrease supply of money even though the market was already in liquidity crisis.

BANKS In the last few years, the call money market has been a very cheap means of acquiring funds. Call rates have only been around 6% for the last 3 years. This rate is much lower than the 8% they have to pay on deposits.

• Banks started to lend more than the amount of loanable funds they have in order to increase their profit margin. A bank’s total disbursement may have been higher than total funds available, however instead of borrowing or taking more deposits to cover the deficit, the bank on the contrary took money from the call money market and then re lent at higher rates. For instance, banks borrowed at only 6% from call money market whereas for deposits they had to pay 8%. They then lent at around 10%. So by participating in the call money they earned higher short-term profit.

• Repurchase agreement has been a very effective source of funds for banks with liquidity crisis. Usually the rate of interest on repos is around 10%, much higher than call rates. Only banks that experienced shortage of funds used to bid for repos to meet the daily requirements. However, from December 2004, with such a huge rise in call money market rates, lending has become so lucrative that banks that have surplus funds also tendered for repos. These banks had greater ability to pay the higher rates of interest and so they ended up acquiring the funds from the auctions. This not only resulted in shortage of funds in the market but also increased the call money market rates significantly.

An analysis of the recent fluctuations in the inter bank call money market

• In March, the central bank imposed a new rule that banks that lent to the call money market would not be able to take repos and vice versa. Since banks that took repos could not participate in call money market, banks now instead of giving one day loans gave 7 days loans to banks, terming it not call money but short term loans. This way they lent in call money market and also took repos.

• Many banks had borrowed heavily from the call money market to give long-term loans. This has created a severe asset-liability mismatch and most banks from January barely any funds. Banks had also bought Treasury Bills, with more than a year’s maturity, so that when required they could get cash through repos. However, with government’s rule on repos becoming so stringent, banks have started to suffer from acute shortage of funds, this accelerating the call rates more.

NON BANKING FINANCIAL INSTITUTIONS Non banking financial institutions do not have any short term source of funds – they do not keep time deposits less than a year. However they need funds daily to cover the shortage and meet working capital needs. It is very difficult and time consuming for NBFIs to take loans for banks for such short notice and then to renew it regularly since the daily needs tend vary. So taking bank loans is not feasible. Participating in call money market was the easiest and cheapest way to acquire funds.

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However, in doing so these leasing and insurance companies created severe asset-liability mismatch. They kept on borrowing from the call money market to fund long term investments. They borrowed amounts over taka 100 crore or even 300 crore and then kept on renewing/ rolling over the deals to fund investments or lending for over one year. Many companies financed even 100% of long term projects with overnight borrowing from the call money market.

An analysis of the recent fluctuations in the inter bank call money market

NBFIs also borrowed from the money market and lent it for over a year in the form of overdraft or fixed deposits. They took money at the lowest rate from the money market and then lent it at 11% -14% or more.

These companies became so dependent on the money market that they paid higher interest rates than banks to acquire funds. This gradually increased the call rates and depleted money from the market. With shortage of money supply, banks started demanding return of their funds. However due to the long term nature of lending, NBFIs have been unable to collect the money within short notice. This has created further shortage of money in the market.

GOVERNMENT AND CENTRAL BANK The government through the central bank has been one of the major players in the call rate hike. Usually the government borrows heavily from the call money market in June, before the fiscal budget, to pay for maturity of T-bills and salaries. The rest of the year the government injects or withdraws money based on the needs of the market.

When there is surplus of funds, the government borrows from the call money market by selling treasury bills or through reverse repo. Vice versa, when money market is suffering from liquidity crisis, the government buys treasury bills from financial institutions and auction repos to inject money into the market.

Although the money market has been suffering from liquidity crisis from December 2004, the government has been making huge withdrawals. One reason the government has borrowed so heavily from the money market is to curb inflation. This is the last year of government tenor and it has been trying to keep prices down. This is surprising since inflation rate has increased not due to excess funds in the market but due to increase in oil prices. Moreover, the government has not been receiving payment for its donor funded projects, and to meet its expenditure, it had turned to the money market. Bangladesh Bank has sold treasury bills to banks and through reverse repo has taken money from the market.

It has also encouraged nationalized banks not to lend to its counterparts.

An analysis of the recent fluctuations in the inter bank call money market

From December, in most weeks, more treasury bills have been issued than matured, implying that there has been a net outflow of money from the market. The government has also been accepting repos at very high rates, more than 10%. BB has issued T-bills at only 3 to 7% and then has bought the T-bills back through repo at 10%. This has discouraged flow of funds into a liquid market.

Moreover, banks that are in liquidity crisis have failed to cover their deficit through repo auction. Banks based on their fund requirement placed tenders for repos in the morning.

However, the auction took place in the afternoon, where Bangladesh Bank decided on which banks to give repos. So at the end of the day, a bank relied on the central bank to meet its crisis; however, the BB may not have issued repo to that bank or even if it had issued, the amount may be have been adequate. The bank then failed to overcome the liquidity crisis for the day. Moreover, since supply of money could not be determined, rates tended to be uncertain and volatile.

There has also been speculation that the government will increase its pay scales, which it did. So expectation that payment of salaries of more than Tk 500 crore will worsen the situation and may have resulted in many banks moving funds away from the call money market.

34

NATIONALIZED BANKS Nationalized banks have been the biggest lenders in the call money market. However, government borrowing has reduced their level of funds. Moreover, even though call rates in the last five months have been over 30 to 40% on average, the NCBs have not been allowed to lend at rates higher than 13%. Although 13% is much higher than the lending rates of banks, surprisingly, these banks have been unwilling to lend and have reduced their level of lending to the call money market.

An analysis of the recent fluctuations in the inter bank call money market

Moreover, when they have lent, they have not given huge sums to just one bank as they used to do before; rather they lent small amounts to numerous banks.

STATUTORY REQUIREMENTS

•

The liquidity crisis in the money market worsened with Bangladesh Bank’s circular

issued on February 10 for banks to immediately meet their mandatory 4 per cent Cash Reserve Ratio (CRR) deposits at the central bank with foreign exchange. The result was an overnight additional cash requirement of Tk.2000 crore in the banking sector. The funds required for the unexpected deposit with the central bank had to be met by a substantial exchange of funds in the inter-bank market.

•

Moreover, Bangladesh bank has increased cash reserve requirement from 4% to

4.5%. Banks now have to keep aside a greater portion of their funds for the central bank and hence can participate less in call money market. The outcome has been a further outflow of money from market, about TK 663 crore and further fall in supply of money of banks.

EID

Usually before Eid-Ul-Azha call money market rates tend to increase drastically. A major reason is because most people withdraw most of their deposits from banks to meet the high expenditure of the festival. Moreover, during eid most leather traders borrow large sum of money from financial institutions to buy leather. However, they usually pay back the loans immediately after selling hides and skins at a profit.

Banks to meet obligations then borrow heavily from the call money market. Since most banks experience withdrawal of cash, the aggregate increase in demand for funds in the call money market is quite substantial. With supply money remaining unchanged, the call rates increase by over 20%.

An analysis of the recent fluctuations in the inter bank call money market

In February 2005 also, before eid, call money market rates increased but not by the usual 20% but by over 20 – 60%. During February call rates were as high as 70% in some days and about 30% the other days. A major reason for such volatility was the already depleted call money market. With barely any cash available, huge demand for funds led to a boom in the rates. Secondly, unlike the other years, the leader traders failed to pay their loans on time, thus increasing the call rates to a great extent.

SPECULATION

There was speculation that the market had over Taka 600 crore of surplus cash. Financial institutions borrowed not only when they had shortage of funds but also to re lend at more attractive rates. They borrowed short term from the call money market to fund investments over a year believing that they would be able to acquire funds anytime and at very low cost.

Government also borrowed heavily from the money market. May be it thought that the surplus funds would cover such withdrawal. But then came the big surprise or more appropriately the shock!! The surplus money that was assumed to be in the market was actually not there. Maybe most had been in some not-so-liquid form or maybe there really wasn’t so much cash in the market, but whatever the reason, the market started to experience huge shortage of funds.

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IMPORTS

Imports have increased by 26% from 2003 -2004. During the period of July 2004-December 2004, about Tk 34,845 crore have been paid for L/Cs and Tk 49, 344 crore of L/Cs have been opened. In January 2005, about Tk 29,750 crore L/C payments were outstanding.

An analysis of the recent fluctuations in the inter bank call money market

Huge payment on imports has put pressure on both the foreign exchange market and money market. A lot of money from the inter bank market has been disbursed for making payment of imports, this putting pressure on supply of money and accelerating the rates.

BANK RATES

There has been pressure to increase deposit rate and this has resulted in rise in general rates of interest. Moreover, with the level of deposits gradually decreasing and lending becoming less available and more expensive, banks have become more dependent on call money market. Increased demand in the call money market has accelerated the rates.

4.2 MEANS OF STABILIZING RATES An analysis of the recent fluctuations in the inter bank call money market

The government has intervened and imposed new rules to bring stability to the call money market.

CEILING ON CALL RATES

The government has imposed a ceiling on call money market rates – 20% is the maximum rate at which financial institutions can lend and borrow from the market. This has ensured that call rates do not become too erratic and high and is affordable to all. However, this action is one of last resort and is not a permanent solution to the problem.

REPOS

The central bank is not allowing banks who lend to participate in repo auction. Banks that lend in a day cannot take repos. BB receives a daily list containing name of banks and NBFIs who lend. These companies cannot then take money from NCBs and BB through repos. This is a very good way of intervening since repo is only for banks that have liquidity crisis, not for those who have surplus funds. This will bring stability to the market and keep rates down.

RESTRICTIONS ON LENDING

Bangladesh Bank has imposed lending restriction on the amount that financial institutions can borrow – 15% of net assets. This rule may compel institutions that face severe asset liability mismatch to reduce their level of borrowing from call money market. This will bring stability as companies who have much higher borrowing will gradually reduce their level of borrowing to 15% of net assets However, this will harm the smaller firms and NBFIs who have no other source of source of short term funds.

An analysis of the recent fluctuations in the inter bank call money market

CHAPTER 5: RECOMMENDATIONS The call money market has to be strictly regulated and controlled so that financial institutions do not engage in irregular activities. •

BB should have stringent rules on asset-liability mismatch. There should a maximum

difference of period between asset and liability. Financial Institutions now may be borrowing for 25 months to fund asset of 45 months, making the asset liability mismatch period 20 months. This should be reduced to a minimum, maybe 5 months.

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•

More facilities should be given to NBFIs, schemes that will provide funds to them.

These organizations should be allowed to keep deposits for less than a year. This will reduce their dependence on the call money market. •

Government should keep ceiling on call money market rates till measures are taken

to stabilize the rates.

The government should also ensure that adequate injection and withdrawal of money takes place so that the call rates remain low and stable throughout the year.

An analysis of the recent fluctuations in the inter bank call money market

CHAPTER 6: CONCLUSION Call money market rates will remain volatile for at least the next three months. With increase in pay scale of the government, increase in CRR rate and irregular activities of banks and NBFIs, call money rates will be volatile. If government removes the ceiling, call rates will again rise and cause huge losses to financial institutions. After that it will be very difficult to predict in which direction call rates will move.

The government has to take measures to ensure that call rates decline to the normal level of 10%. 20% ceiling may be low for the time but compared to the usual trend, it is 100% higher. Call rates need to be below 10% to benefit financial institutions. The government also needs to tighten regulations on call money market to ensure that banks do not undertake any irregular activities and that call money market can function properly and efficiently.