Describes Clean float and Dirty float of foreign exchanges rates, Difference between Clean float and dirty float

Clean float and dirty float are terms used to describe different exchange rate regimes and practices related to currency valuation and management. Here’s an explanation of each:

Clean Float: Clean Float, also known as a freely floating exchange rate refers to a situation where the exchange rate is determined purely by market forces of supply and demand without any intervention or control by government or central bank. Under a clean float system, the exchange rate fluctuates freely in response to economic factors such as inflation, interest rates, trade balances, capital flows, and market speculation. The government or central bank does not actively intervene in the foreign exchange market to influence the exchange rate. The exchange rate is solely determined by the interactions of buyers and sellers in the market.

Advantages of clean float:

·        Reflects market forces and economic fundamentals.

·        Allows for automatic adjustments to change in supply and demand.

·        Reduce the need for frequent intervention by the central bank.

·        Enhances market efficiency and transparency.

Disadvantages of clean float

·        Exchange rate volatility can create uncertainty for business and investors.

·        May lead to speculative movements and sudden exchange rate fluctuations.

·        Can affect import/export competitiveness due to unpredictable exchange rate movements.

Dirty Float: Dirty float, also known as a managed float or a floating exchange rate with intervention, is a system where the exchange rate is predominantly determined by market forces but with occasional intervention by the government or central bank may intervene in the foreign exchange market by buying or selling its currency to stabilize or manage the exchange rate within a certain range or to address specific economic objectives.

Intervention in the foreign exchange market can be done through various measures:

Direct intervention: The central bank actively buys or sells its currency in the foreign exchange market to influence the exchange rate.

Indirect intervention: The central bank may implement policies such as interest rate adjustments, capital controls, or reserve requirements to influence capital flows and indirectly impact the exchange rate.

Advantages of dirty float:

·        Allows some level of exchange rate stability and control

·        Provides a buffer against excessive exchange rate volatility

·        Can help manage external shocks and maintain competitiveness

·        Supports specific economic objectives, such as controlling inflation or promoting exports.

Disadvantages of dirty float:

·        Government or central bank intervention can create moral hazard and distort market signal

·        The timing and effectiveness of interventions can be challenging to determine.

·        Intervention may deplete foreign exchange reserves if not managed prudently

·        Can lead to conflicts or disputes with trading partners if perceived as currency manipulation

 

It is important to note that the distinction between clean float and dirty float is not always clear-cut as exchange rate regimes can lie on a spectrum between fully fixed and fully floating. Some countries may also adopt hybrid systems or make occasional interventions even within a clean float framework, depending on their specific economic circumstances and policy objectives.

Aspects	Clean Float	Dirty Float
Definition	Clean float refers to a system where the exchange rate is purely determined by market forces without any intervention or interference from the central bank or government	Dirty float refers to a system where the exchange rate is allowed to fluctuate but may be subject to occasional intervention or management by the central bank or government
Central Bank Intervention	No direct intervention or management by the central bank or government in the foreign exchange market	Central Bank may occasionally intervene in the foreign exchange market to stabilize or influence the exchange rate
Exchange Rate stability	Exchange rates are subject to market forces, leading to potentially higher volatility and fluctuations	Exchange rates may be influenced or stabilized by occasional central bank intervention, resulting in relatively more stable exchange rate
Market Forces	Market forces of supply and demand primarily determine the exchange rate	Market forces still play a role in determining the exchange rate, but occasional central bank interventions may influence it
Flexibility	Exchange rate movements are flexible and respond solely to market dynamics	Exchange rates may be subject to occasional adjustments or management by the central bank or government for policy reasons
Transparency	The exchange rate determination is transparent and based on market mechanisms	The exchange rate determination may be less transparent as the central bank’s occasional interventions may not be disclosed
Exchange Rate Stability and Predictability	Exchange rate may experience higher volatility and wider fluctuations, making it harder to predict future rates	Exchange rates may experience relatively more stability and predictability due to occasional central bank interventions
Government Influence	The government does not directly influence or manage the exchange rate	The government or central bank may have some influence or control over the exchange rate through occasional interventions.

 

Offshore Banking

 

Offshore Banking refers to the practice of establishing and operating a bank account or financial institution in a foreign jurisdiction with favorable financial regulations and tax benefits. Offshore banking has been historically associated with certain tax advantages, privacy, asset protection, and international business transactions.

Basically, an offshore bank is a bank located outside the country of residence of the depositor, typically in a low tax jurisdiction or tax haven that provides financial and legal advantages.

In Bangladesh, the use of offshore banking services is governed by various laws and regulations, including foreign exchange regulations, anti-money laundering laws, and tax laws. The Bangladesh Bank is responsible for overseeing and regulating offshore banking activities carried out by residents of Bangladesh.

The regulations in Bangladesh Place restrictions on residents’ ability to open and maintain offshore bank accounts without proper authorization or disclosure. Residents of Bangladesh are generally required to obtain prior approval from the Bangladesh Bank to open and operate offshore bank accounts.

Offshore banking in Bangladesh is primarily aimed at facilitating international trade and investment activities, remittances, and other foreign currency transactions. It provides a means for business and individuals to engage in cross-border transactions, access foreign currency transactions and manage international financial activities.

Offshore banking acts as a unique solution for banks across the globe to carry out international banking business involving foreign currency denominated assets and liabilities taking the advantages of low or non-existent taxes/levies and higher return on investment.

It is important to note that the specific rules, regulations and requirements related to offshore banking in Bangladesh may be subject to change over time. Therefore, individuals and businesses interested in offshore banking should consult with the relevant authorities, such as the Bangladesh Bank and seek professional advice to ensure compliance with the latest regulations and requirements.

Describes Secured overnight Financing Rate (SOFR)

The Secured overnight Financing Rate (SOFR) is a benchmark interest rate that serves ass a replacement for the London Interbank Offered Rate (LIBOR) in the United States. It is administered by the Federal Reserve Bank of New York and is based on transactions in the U.S Treasury repurchase agreement (repo) market.

SOFR reflects the cost of borrowing cash overnight collateralized by U.S Treasury securities. It is considered a robust and representative benchmark rate because it is based on a large volume of actual transactions in a highly liquid market.

The Secured Overnight Financing Rate is a broad measure of the cost of borrowing cash overnight collateralized by Treasury securities.

The SOFR is calculated as a volume-weighted median of transaction-level tri-party repo data collected from the Bank of New York Mellon as well as GCF Repo transaction data and data on bilateral Treasury repo transactions cleared through FICC’s DVP service, which are obtained from the U.S Department of the Treasury’s Office of Financial Research (OFR)

 

Here are some key features and characteristics of SOFR:

1.     Calculation: SOFR is calculated as a volume-weighted median of transaction-level tri-party repo data, bilateral Treasury repo transactions cleared through the Depository Trust and Clearing Corporation (DTCC), and General Collateral Finance GCF repo data.

2.     Overnight rate: SOFR is an overnight rate, reflecting the interest rate for borrowing or lending cash on an overnight basis. It is published each business day at approximately 8.00 a. am Eastern Time.

3.     Secured Rate: SOFR is a secured rate because it is based on collateralized transactions, where U.S Treasury securities are pledged as collateral. This differs from LIBOR, which is an unsecured rate.

4.     Risk free rate: SOFR is considered a risk-free rate as it is based on the U.S Treasury market, which is considered to have minimal credit risk.

The transaction from LIBOR to SOFR is part of a global effort to reform benchmark rates and establish more reliable and representative alternatives. The use of SOFR helps to mitigate the risks associated with LIBOR discontinuation and ensure a more stable and resilient financial system.

Dhaka Interbank Offered Rate

 The Dhaka Interbank Offered Rate (DIBOR) is an interest at which banks in Bangladesh offer to lend funds to one another in the interbank market. It serves as a reference rate for various financial transactions within the country.

DIBOR is calculated and published daily by the Bangladesh Foreign Exchange Dealers Association (BAFEDA). The rate is determined based on the submissions from a panel of participation banks which provide their estimated borrowing costs in the interbank market.  These submissions are then aggregated and DIBOR is calculated as the average or weighted average of these rates.

DIBOR is typically available for various tenors, including overnight, one week, one month, three months and six months. Each tenor represents the length of time for which banks are willing to lend funds to one another in the interbank market.

Bangladesh Bank Governor Atiur Rahman formally launched Dhaka interbank offer rate DIBOR, which will help banks get a benchmark interest rate or reference rate.  The governor said “An established benchmark rate is required for the buoyancy and transparency of any interbank market. Hopefully, this is a beginning towards the development of a liquid interbank term market in Bangladesh.”

As a widely recognized benchmark rate, DIBOR is used in Bangladesh for pricing a range of financial instruments, including loans, mortgages, and derivatives contracts. It provides a standardized reference rate for determining interest rates and serves as a basis for pricing various financial products in the country.

Commodity Derivatives in brief

Commodity derivatives are financial instruments that allow market participants to trade in commodities, such as gold, oil, wheat, and other raw materials, without having to take physical delivery of the underlying asset.

These derivatives typically take the form of futures contracts or options contracts, which give the buyer the right (but not the obligation) to buy or sell the underlying commodity at a specified price and time in the future.

Commodity derivatives are used by a variety of market participants, including producers, consumers, traders, and speculators, to manage price risk and to speculate on price movements in the underlying commodity market.

For example, a farmer may use commodity derivatives to hedge against a drop the price of his crop before it’s harvested, while a speculators may buy a futures contract in anticipation of rising prices.

For example, let’s assume that in April 2024 the farmer enters a futures contract with a miller to sell 5000 bushels of wheat at $4.404 per bushels in July. On the expiration date in July 2017, the market price of wheat falls to $4.350, but the miller has to buy at the contract, price of $4.404, which is higher than the prevailing market price of $4.350. Instead of paying $21750 (4.350*5000), the miller will pay $22,020 (4.040*5000) while the farmer recoups a higher than the market price.

However, had the price risen to $5 per bushel, the miller hedge would have allowed the wheat to be purchased at a $4.404 contract price versus the $5 prevailing price at July expiration date. The farmer, on the other hand, would have sold the wheat at a lower price than the $5 prevailing market price.

Duration and Option

Duration is a measure of the sensitivity of the price of a bond or other debt instrument to a change in interest rates. A bond’s duration is easily confused with its term or time to maturity because certain types of duration measurements are also calculated in years.

·        Duration measures a bond’s or fixed income portfolio’s  price sensitivity to interest rate changes

·        Macaulay duration estimates how many years it will take for an investor to be repaid the bond’s price by its total cash flows.

·        Modified duration measures the price change in a bond given a 1% change in interest rates.

·        A fixed income portfolio’s duration is computed as the weighted average of individual bond durations held in the portfolio.

Duration is defined as the length of time that something lasts. When a film lasts for two hours, this is an example of a time when the film has a two hour duration. A measurement of bonds price sensitivity of changes in interest rates.

Options: Options are a form of derivative financial instrument in which two parties contractually agree to transact an asset at a specified price before a future date. An option gives its owner the right to either buy or sell an asset at the exercise price but the owners is not obligated to exercise (buy or sell) the option.

When an option reaches its expiration date without being exercised, it is rendered useless with no value. There are two types of options: calls and puts

·        Call options allow the option holder to purchase an asset at a specified price before or at a particular time.

·        Put options are opposites of calls in that they allow the holder to sell an asset at a specified price before or at a particular time.

For example, a stock options is for 100 shares of the underlying stock. Assume a trader buys one call option contract on ABC stock with a strike price of $25. He pays $150 for the option. On the option’s expiration date, ABC stock shares are selling for $35.

The holder of a call speculates that the value of the underlying asset will move above the exercise price (strike price) before expiry. Conversely, a holder of put option speculates that the value of the underlying asset will move below the exercise price before expiry.

Define cross rate

 A cross rate is a foreign currency exchange transaction between two currencies that are both valued against a third currency. In the foreign currency exchange markets, the U.S dollar is the currency that is usually used to establish the values of the pair being exchanged.

The calculation of cross rates involves the exchange market price made in two currencies which are then valued to a third currency. During the process, two transactions are being computed. The first being the individual trading their one specific currency (EUR, JPY, GBP) for that same equivalent value in U.S dollars. Once U.S dollars have been received, an exchange occurs again when the U.S dollars are traded for the second specific currency.

Describes Credit Risk and Treasury Risk with example

 Credit Risk: Credit Risk is the possibility of a loss resulting from a borrower’s failure to repay a loan or meet contractual obligations. Traditionally, it refers to the risk that a lender may not receive the owed principal and interest, which results in an interruption of cash flows and increased costs for collection. Excess cash flows may be written to provide additional cover for credit risk. When a lender faces heightened credit risk, it can mitigate via a higher coupon rate, which provides for greater cash flows.

 

Although it’s impossible to know the exact who will default on obligations, properly assessing and managing credit risk can lessen the severity of a loss. Interest payments from the borrower or issuer of a debt obligation are a lender’s of investor’s reward for assuming credit risk.

Loan portfolio and risk management is not just about avoiding risk. It is also about balancing risk while seizing opportunities in your marketplace and serving your community well. So, go for the opportunities while balancing your risk management strategy. It can help make your organization even more successful.

 

Example:  A company extends credit to its customers but one of them goes bankrupt and is unable to repay the outstanding amount. This can lead to a bad debt expense for the company.

 

Treasury Risk: Treasury risk refers to the potential financial losses or adverse effects on a company’s financial health due to the various risks encountered in managing its treasury operations. Treasury operations involve the management of cash, liquidity, investments, funding, and financial risk exposures such as interest rates, foreign exchange rates and commodity prices. Treasury risk encompasses several specific types of risk, including liquidity risk, interest rate risk, foreign exchange risk, and credit risk.

 

Example of Treasury risk:

Foreign exchange risk (Currency risk): Foreign exchange risk arises from fluctuations in exchange rates that can affect the value of a company’s financial transactions denominated in foreign currencies.

Describes Credit Derivative with example

 A credit derivative is a financial contract between two parties that transfers the credit risk of a particular asset or portfolio of assets from one party to another. The common types of credit derivatives are credit default swaps (CDS), collateralized debt obligations (CDO) and credit-linked notes (CLN), and credit-linked notes (CLN).

Credit default swaps (CDS): A credit default swap is a type of credit derivatives that provides protection against a default of a particular credit asset. The buyer of a CDS pays a premium to the seller in exchange for a promise to receive a payment if the underlying credit asset defaults. For example, a hedge fund may purchase a CDS on a corporate bond to protect against the risk of default.

Collateralized debt obligations: A collateralized debt obligation is a type of credit derivative that pools together multiple credit assets, such as bonds or loans, and creates different classes of securities with varying levels of risk and return. Investors purchase these securities based on their risk and return preference. For example, a CDO may be created by pooling together a portfolio of mortgage-backed securities and creating different tranches of securities with varying levels of risk.

Credit-linked Notes (CLN): A credit-linked note is a type of credit derivative that is tied to the performance of a particular credit asset or portfolio of assets. The buyer of a CLN receives a return based on the performance of the underlying asset, but also assumes the credit risk associated with the asset. For example, an insurance company may issue a CLN that is tied to the performance of a particular corporate bond. If the bond defaults, the investor in the CLN will lose money.

Overall, credit derivatives are used by investors to manage their exposure to credit risk and to create investment opportunities based on the performance of credit assets. However, credit derivatives can also be complex and risky financial instruments that require a deeper understanding of credit risk and financial markets.

What is Transfer Pricing

Transfer pricing refers to the practice of setting prices of goods and services that are exchanged between related parties, such as different subsidiaries of a multinational corporation. These related parties may be in different countries, and transfer pricing is used to determine the price at which goods or services are transferred between them.

The goal of transfer pricing is to ensure that the price set for the transfer of goods and services is fair and reflects the market value of those goods or services. However, there is often a risk that related parties may set artificially low or high prices for the transfer of goods and services to shift profits to jurisdictions with lower tax rates or to avoid taxes altogether.

To prevent this, many countries have established regulations and guidelines for transfer pricing. These regulations generally require that the transfer price be determined based on the arm’s length principal, which means that the transfer price should be similar to what would be charged between unrelated parties in a similar transaction. Companies are required to document their transfer pricing policies and practices and to report them to tax authorities. Failure to comply with transfer pricing regulations can result in penalties, fines, and legal actions.

Define ALCO Paper, Contents of the Asset Liability Committee Paper or What is ALCO Paper? Briefly describe the contents of the ALCO Paper.

An ALCO paper, covering all the prescribed issues, must be presented in every meeting of ALCO. The Treasury Management Department will be to present the paper incorporating all necessary information, analysis and suggestions from the related departments including its own opinion, if necessary, on the related issues. A separate observation from RMD regarding market and liquidity risk shall also be included in the ALCO paper. The decision taken against each issue should be carefully noted and preserved for a reasonable time (Not less than 3 years).

The Asset Liability Committee (ALCO) paper typically includes a range of information related to the management of a financial institution’s balance sheet, with a focus on managing risks related to interest rate risk and liquidity risk. The specific contents of an ALCO paper may vary depending on the institution’s specific circumstances and priorities, but it may include the following:

·        Confirmation of Minutes of last meeting that contains formal confirmation of the last ALCO meeting minutes.

·        Review of the action items of the previous meeting contains detailed discussion on the progress of the action items and review deadlines if appropriate.

·        Review of economy items that may be included are GDP growth, inflation, credit growth, govt borrowing, export, import, remittance, FX Reserve and current account balance and markets items that may be included are: movement of interbank market liquidity, call money rates, term money rates, govt. securities yield. Also, a comparison of interest rates offered by comparable banks can be important.

·        Review of Balance Sheet limits utilization- AD ratio, Commitments, LCR, NSFR, Loan and Deposit Concentrations (If applicable), etc. Items which are not at acceptable levels are reviewed further in details and corrective actions proposed.

·        Review the various regulatory liquidity requirements (CRR, SLR, Capital Adequacy, etc.) and compliance with those, i.e. Top 10 Depositors and Borrowers list etc.

·        An analysis of the institution’s liquidity risk profile an discussion of the strategies and tools used to manage that risk, such as maintaining adequate levels of liquid assets, establishing lines of credit, and monitoring cash flows.

The ALCO should closely monitor the developments around various liquidity issues in every meeting. It is also mandatory for the Treasury Department to inform the board (ALCO in case of foreign bank) regarding various liquidity issues (e.g. CRR/SLR, SLP, LCR, NSFR, ADR and IDR) in every board/ALCO meeting of the bank.

 

Features of Wholesale Borrowing

Wholesale Borrowing Guidelines (WBG) are a set of guidelines developed by Bangladesh Bank (BB) to regulate the borrowing activities of Non-Bank Financial Institutions (NBFIs). The guidelines are intended to ensure that NBFIs are able to access wholesale funding sources in a prudent and sustainable manner, without compromising the financial stability of the system. The main features of WBG as per the BB circular are:

1.     Eligibility Criteria: The BB circular requires NBFIs to meet certain criteria before they can access wholesale funding sources. These criteria include maintaining a minimum capital requirement, complying with prudential norms on capital adequacy and asset classification, and maintaining a track record of profitability and regulatory compliance.

2.     Limits on Exposure: The WBG sets limits on the amount of wholesale funding that NBFIs can raise from a single lender or group of related lenders. These limits are intended to reduce the concentration risk for both the lender and the borrower.

3.     Risk Management: The BB circular requires NBFIs to have a robust risk management framework in place to manage the risks associated with wholesale borrowing. This includes a clear policy on the use of funds, adequate systems and controls to monitor and manage risks, and regular reporting to the board of directors and regulatory authorities.

4.     Disclosure and Transparency: The BB circular requires NBFIs to disclose information on their wholesale borrowing activities in their financial statements, including the names of the lenders, the terms of the borrowing, and the risks associated with the borrowing.

5.     Reporting Requirements: The BB circular requires NBFIs to submit periodic reports to the Bangladesh Bank on their wholesale borrowing activities, including details of their borrowing from different sources, concentration risk and compliance with the WBG.

Overall, the Wholesale Borrowing Guidelines (WBG) as per the BB circular are an important regulatory framework that helps to ensure that NBFIs are able to access wholesale funding sources in a sustainable and responsible manner. The guidelines help to reduce the risks associated with wholesale borrowing and promote financial stability in the system.

Liquidity coverage ratio

 LCR is a regulatory requirement that measures a financial institution’s ability to meet its short-term liquidity need under stressed market conditions. The LCR requires the institution to maintain a sufficient stock of high-quality liquid assets (HQLA) that can be quickly converted into cash to cover its net cash outflows over a 30-day period. The LCR is calculated by dividing the institution’s stock of HQLA by its expected net cash outflows over the next 30 days.

For example, suppose a bank has a total stock of $100 million in HQLA and is expected to experience net cash outflows of $50 million over the next 30 days. In that case, the bank’s LCR would be calculated as

LCR = HQLA/Net cash outflows over the next 30 days=$100 million / $50 million= 2.0

In that example the bank’s LCR is 2.0 indicating that it has sufficient liquid assets to cover its expected cash outflows for the next 30 days.

The projected net cash outflows consider potential cash outflows under stress conditions, considering factors such as deposit withdrawals, contractual obligations, and other funding needs. These outflows are typically categorized into different time horizons, with different percentages applied to each category.

The LCR is calculated by dividing the bank’s HQLA by its projected net cash outflow. A minimum LCR threshold us set by regulatory authorities, and banks are required to maintain an LCR equal to or higher than the prescribed minimum. This ensures that banks have enough liquidity to cover their cash outflows for a defined period, typically 30 days,

The LCR serves as a measure of a bank’s liquidity risk management and its ability to weather short-term liquidity stress. By maintaining an adequate LCR, banks can enhance their resilience to financial crises and contribute to overall financial stability.

 

 

Define Advance to Deposit Ratio (ADR) and how it works:

Advance to Deposit Ratio (ADR) is considered as a barometer of progress of all financial institutions. ADR is the ratio of total advances to total deposits, where advances comprise all banking advances, except foreign currency, held against export development fund (EDF), refinance and offshore banking unit exposure. Deposit comprises all demand and time deposit excluding bank deposit and additional borrowing.

A high ADR shows that banks are generation more credit from their deposits and vice-versa. The outcome of this ratio reflects the ability of the bank to make optimal use of the available funds. The ADR of commercial banks has great significance.

Primarily, it is a measure of the utilization of funds by the banking system. This ration is an important tool of monetary management. Magnitude of the said ration indicates management’s aggressiveness to improve income through higher lending.

The formula for calculating AD ratio is as follows:

ADR = Total loans and advances or investments / (Total time and demand liabilities +Interbank deposit surplus*+Bond surplus**)

Interbank deposit surplus = Deposit from other banks - Deposit with other banks (if -ve then 0)

**Bond surplus = Total amount raised from issuing bond – Total investment in bond of other banks (if -ve then 0)

ADR for Islamic banking operation of conventional banks: Conventional banks having Islamic banking business have to calculate and maintain ADR separately for conventional banking and Islamic banking operation. ADR for Islamic banking operation is same as that if Islamic Shariah based banks.

It is important to adjust the AD ratio limit with changing conditions of bank’s asset and liabilities. The Management of the bank should inform the board regarding AD ration in every meeting so that the board may take quick decision necessary to adjust the ratio.

 

Define LIBOR Rate

 The LIBOR rate (London Interbank Offered Rate) is a benchmark interest rate that represent the average interest rate at which major global banks are willing to lend to-ne another in the London interbank market for short-term loans.

The rate is calculated and published daily by Intercontinental Exchange (ICE), based on submissions from a panel of banks that reflect their borrowing costs. LIBOR is used as a reference rate for a wide range of financial products, including variable rate mortgages, loans and derivatives. It is considered a key benchmark for the global financial system and is closely monitored by financial institutions, investors and regulators.

However, as of December 2021, LIBOR is being phased out and will no longer be available after December 31, 2021, due to concerns over its reliability and susceptibility to manipulation.

The LIBOR rate is determined by a daily survey of major banks, which report the interest rates they would charge to lend funds to other banks for various terms and currencies in the London Interbank market. The intercontinental Exchange (ICE), which is the administrator of LIBOR calculates the rate as the average of reported rate after excluding the highest and lowest 25% of submissions.

The survey is conducted for five currencies (USD, EUR, GBP, CHF and JPY) and seven tenors (overnight, one week, one month, two months, three months, six months and twelve months). For example, the USD LIBOR rate for the months is the average interest rate at which a panel of banks would lend US dollars to each other for a period of there months in the London interbank market.

The LIBOR rate is widely used as a benchmark for a variety of financial products, such as mortgages, loans and derivatives. Financial institutions use it t determine interest rates on loans and to price derivatives, such as interest rate swaps. Investors also use LIBOR as a benchmark to evaluate the performance of fixed income investments.

However, as mentioned earlier, LIBOR is being phased out and replaced by alternative reference rates due to concerns about its reliability and vulnerability to manipulation. The transition to these new rates, such as the Secured Overnight Financing Rate (SOFR) in the United States, is currently underway.

Demand for Money

Demand for money refers to the amount of money that individuals and businesses desire to hold for transactional and speculative purposes. The demand for money is influenced by several factors including.

Interest rates: When interest rates are high, the opportunity cost of holding money increases as individuals and businesses can earn more by investing in other assets. Therefore, the demand for money decreases. Conversely, when interest rates are low, the opportunity cost of holding money decreases, and the demand for money increases.

Income: As income increases, so does the demand for money, as people have more money to spend on goods and services.

Prices: When the general price level increases the demand for money increases because individual need more money to purchase the same quantity of goods and services.

Economic uncertainty: In times of economic uncertainty, individuals and businesses tend to hold more money as a precautionary measure. This leads to an increase in the demand for money.

Payment habits: Changes in payment habits can also affect the demand for money. For example, the increased use of credit cards and other electronic payments methods can reduce the demand for physical cash.

Overall, the demand for money is a complex concept that is influenced by various economic and social factors. Understanding the factors that affect the demand for money is essential for policy makers and financial institutions to effectively manage the money supply and promote economic stability.

Repo-Reverse Repo

 Basically, Repo is a repurchase agreement and refers to the rate at which commercial banks borrow money by selling their securities to the Central bank of our country, i.e. in case of shortage of funds or due to some statutory measures, Bangladesh bank have to maintain liquidity. It is one of the main tools of the Central Bank to keep inflation under control. Also known as a repo agreement, is a form of short-term borrowing, mainly in government securities.

The repo market is an important source of funds for large financial institutions in the non-depository banking sector, which has grown to rival the traditional depository banking sector in size. Large institutional investors such as money market mutual funds lend money to financial institutions such as investment banks, either in exchange for collateral, such as treasury bonds and mortgage-backed securities held by borrower financial institutions.

 

Reverse Repo Rate is a mechanism to absorb the liquidity in the market, thus restricting the borrowing power of investors. Reverse Repo Rate is when the Central Bank borrows money from a bank when there is excess liquidity in the market. The banks benefit from it by receiving interest on their holdings from the central bank.

An increase in the reverse repo rate will decrease the money supply and vice versa, other things remaining constant. An increase in reverse repo rate means that commercial banks will get more incentives to park their funds with BB, thereby decreasing the supply of money in the market.

During high levels of inflation in the economy, the Central Bank increases the reverse repo. It encourages the banks to park more funds with the Central Bank to earn higher returns on excess funds. Banks are left with lesser funds to extend loans and borrowings to consumers.