Article Review on the Banking Sector Reform in Bangladesh:

An Unfinished Agenda

Prepared for:

Syeda Mahrufa BasharAssistant Professor

Course: Financial Markets and Institutions

Prepared by: Group -7

Sifat Ishtiaq Hossain ZR-10

Rahul Saadat ZR-26

Tayabur Rahman ZR-33

Asif Iqbal ZR-35

Sheikh Salman Mehedi ZR-36

Wasiq Rabbi ZR-77

BBA 19th Batch

Institute of Business Administration, University of DhakaJune 11, 2014

Central Idea of the Article

1 | P a g e

The banking sector of a country is one of the most important sectors in terms of mobilizing funds

and resources from one sector to another for investment, economic growth and development.

Since the inception of People’s Republic of Bangladesh in 1971, the banking sector has grown

significantly. More and more people have come under the coverage of banking services. The

sector has also encountered countless reforms. But problems like inefficient resource allocation

through disbursement of credit, imprudent risk analysis, ill-supervision and unqualified

management and most importantly, lack of governance have hindered the banking sector from

delivering expected satisfactory results. The article mostly deals with historical data regarding

banking sector reforms in Bangladesh and sheds light on the pressing issues. With historical

performances and the on-going issues that need to be addressed to improve the banking sector,

the author concludes that despite numerous reforms in the banking sector since its inception,

there are a lot of work that are still needed to be done.

Importance of Asset Liability Management

In recent era, the banking industry has seen unexpected interest rate instability and strong

competition because of globalization, deregulation and especially with the development in

technology. This situation leads to increase in efforts to manage credit, market and interest rate

risk. Banks are now forced to not only see the return on equity but also on assets as well. These

elements called for the (ALM) Asset Liability Management system.

Over the past few years the financial markets have witnessed wide ranging changes at fast pace.

Intense competition for business involving both the assets and liabilities, together with increasing

volatility in the domestic interest rates as well as foreign exchange rates, has brought pressure on

the management of banks to maintain a good balance among spreads, profitability and long-term

viability. These pressures call for structured and comprehensive measures as far as asset liability

management is concerned.

Bangladesh Bank has set aside guidelines, according to which banks in Bangladesh are

conducting their ALCOs every month. These guidelines provide guidance to management and to

train new staffs. This is intended to be the basic framework for further development as the skill

sets go up the curve and also, to introduce new policies and processes as banks make progress in

understanding and implementing the basics.

2 | P a g e

Bangladesh Bank Policy for Asset Liability Management of Banks

The central bank has the following policies which are more or less followed by all the banks

currently operating in Bangladesh:

Loan Deposit Ratio (LD): The AD ratio should be 80%-85%. However, the Loan Deposit

ratio of the bank should go up to 110%. The ratio will be fixed based on the bank’s capital,

Bank’s reputation in the market and overall depth of the money market.

Wholesale Borrowing Guidelines (WBG): The guideline should be set in absolute amount

depending on bank’s borrowing capacity, historic market liquidity. The limit should be

capped at the bank’s highest level of past borrowings. However, this limit can be increased

based on the match funding basis.

Commitments: The commitments Guideline limits should not exceed 200% of the unused

wholesale borrowing capacity of the last twelve months. The limit can be increased if there

are natural limitations on customer discretion to draw against committed lines or a bank’s

access to additional funds via realization of surplus statutory holdings.

Medium Term Funding Ratio (MTF): The MTF of a bank should not be less than 30%. The

ideal scenario should be 45%. Given, the overall scenario of current market, it will be

suitable to move towards the MTF limit of 45% as we progress.

Maximum Cumulative Outflow: MCO up to I month bucket should not exceed 20% of the

balance sheet.

Liquidity Contingency Plan: A liquidity contingency plan needs to be approved by the

board. A contingency plan needs to be prepared keeping in mind that enough liquidity is

available to meet the fund requirements in liquidity crisis situation. An annual review of the

contingency planning should be made.

Local Regulatory Compliance: There should be a firm policy on compliance to the

Bangladesh Bank in respect of CRR, SLR, Capital adequacy etc.

3 | P a g e

Organizational Structure of the ALM Committee of Citi N.A. Bangladesh

The responsibility of Asset liability Management is on the Treasury Department of the bank.

Specifically, the Asset liability Management (ALM) desk of the Treasury Department manages

the balance sheet. The results of balance sheet analysis along with recommendation is placed in

the ALCO meeting by the Treasurer where important decisions are made to minimize risk and

maximize returns. Typically, the organizational structure looks like the following:

Figure 1 : Organization Structure of ALCO of Citibank, N.A

The key roles and responsibilities of the ALM Desk:

To assume overall responsibilities of Money Market activities.

To manage liquidity and interest rate risk of the bank.

To comply with the local central bank regulations in respect of bank’s statutory obligations

as well as thorough understanding of the risk elements involved with the business.

Understanding of the market dynamics i.e. competition, potential target markets etc.

Provide inputs to the Treasurer regarding market views and update the balance sheet

movement.

Deal within the dealer’s authorized limit

Core Activities of the ALM Committee of Citi N.A. Bangladesh

The key activities under ALCO process are discussed below:

a) Information inputs: The ALCO process involves information and inputs from various

departments. The ALCO process or the ALCO meeting reviews the ALCO paper along with

4 | P a g e

Citi Country Officer

Country Treasurer &

Head of Markets

Global Banking

Head

Country Compliance & Control

Chief Financial Officer

Head of Country

Operations &

technology

Head of Financial

Institutions

Head of Risk

Treasury

the prescribed agendas. The Chairman of the committee, that is the Treasurer or the CEO,

raises issues related to the balance sheet. Treasurer suggests whether the interest rates need to

be reprised, whether the bank needs deposits or advance growth, whether growth of deposits

and advances should be on short or longer term, what would be the transfer price of funds

among the divisions, what kind of interbank dependency the bank should have etc. In short,

all issues related to liquidity and market risk are covered. Based on the analysis and views of

the Treasurer, the committee takes decisions to reduce balance sheet risk while maximizing

profits.

b) Detailed analysis: Inputs regarding macro indicators and bank’s balance sheet status are

analyzed thoroughly taking into consideration recommendation of the ALCO members.

c) Action Points: After analysis, the ALCO takes decisions for implementation of any/all of the

following issues:

Need for appropriate Deposit mobilization or Asset growth in right buckets to optimize

asset-liability mismatch.

Cash flow (long/short) plan based on market interest rates and liquidity.

Need for change in Fund Transfer Pricing (FTP) &/or customer rates in line with strategy

adapted.

Address to the limits that are in breach (if any) or are in line of breach and provide

detailed plan to bring all limits under control.

Address to all regulatory issues that are under threat to non-compliance.

d) Implementation and Review of Strategies: All ALCO members are provided with the

minutes (Appendix 2) of the meeting within the next day. The minute includes:

The attendees.

The issues addressed.

The recommendations provided by the Chairman.

The action points that were fixed in the meeting.

The members communicate the action points to their respective divisions to implement the

strategies undertaken.

e) Special ALCO Meeting: While the above process remains the same, it is important to

address unique situations though ALCO management. Hence, apart from the regular monthly

5 | P a g e

meeting, ALCO meeting is also called as and when any contingent situations arise. A very

good example may be, during the Eid period. At those times, market liquidity dries out and

overnight rates shoot up. Banks who are net borrowers from the market may be exposed to

huge interest expense the high rates in the market. This is an ideal time for a special ALCO

meeting, where the committee may take critical decisions for deposit mobilization on an

urgent basis for reducing dependency from the market.

Figure 2: The ALCO process of Citibank, N.A

Day-to-day operations of the ALM Committee of Citi N.A. Bangladesh

The key operational activities of the ALM Committee is described below:

a) Review of previous month’s ALCO decisions : In every ALCO meeting, decisions taken in

the previous meeting are reviewed. Target dates for implementation of the decisions are

specified, and update on status of previous meeting’s decisions is given by the responsible

parties.

6 | P a g e

b) Review market & economic conditions: Market conditions and major economic indicators

are discussed by ALCO. The situation and pattern of movement in different markets are

analyzed (namely the money market, FX market and equities market).

c) Triggers : Citi assigns benchmark/trigger values for different critical factors that significantly

affect the bank’s performance, and measures actual performance as opposed to the

benchmark values to assess deviation and potential risk.

These triggers/tripwires can be divided into the following broad categories:

Economic

Political

Market

Bank’s performance can be rated under any of the categories: green, yellow, orange or red,

representing ascending level of risk for the bank.

d) Branch asset/ liability review: ALCO regularly reviews the total asset and liability position

of the bank. Growth/reduction of each asset and liability product is analyzed, and the

underlying reason is discussed. Performance of the branches and OBU is also a topic of

discussion.

e) Ratio positions review: Every month, a large number of balance sheet ratios are calculated

and presented before the ALCO. From these ratios it is determined whether they are in

accordance with Annual Funding and Liquidity Plan. They are compared with the ratios from

the previous month as well.

f) MAR profile: The MAR profile expresses possibility of loss arising from market risk. Key

indicators for managing Market Risk include the likes of Value at Risk (VaR) and Factor

Sensitivity, described in more detail later.

g) AFS portfolio: The AFS (Available for Sale) portfolio consists assets that usually are traded

actively in the market. For such assets, a number of issues including their book and market

values, Mark-To-Market position, and market risk exposure (using techniques like VaR and

Factor Sensitivity) are evaluated.

h) Review of Capital Position and Cash Capital: In every ALCO meeting, a number of figures

and ratios that indicate the capital position of the bank (e.g. total capital, unremitted profit,

cash capital ratio) are talked about.

7 | P a g e

i) Review of liability and interest rate structure : Under this agenda, a more detailed view on

the bank’s liability position is given. Based on the performance of products and the bank’s

strategy, interest rates adjustment decisions may be taken.

j) Asset & liability Projections: Asset and liability position of the bank for the next few months

is projected and discussed in ALCO meetings, and the gap between actual and projected

amounts for previous periods is also assessed.

Key issues tackled by the ALM Committee of Citi N.A in 2013

1. The Market Outlook :

During the beginning of 2013, demand for the overnight fund rose after Central Bank started to

refuse repo bids from the non-Primary Dealers. Central Bank was focused on the prevailing

double digit inflation rates and wanted to reduce the credit growth rate. Demand for USD

remained very high in December 2012, due to sharp rise in import LC settlement. The major

import items were fertilizer, fuel, sugar and edible oil, furnace oil for the rental power plants,

industrial raw materials and other consumer goods. Demand for USD however was less in

February due to lower import LC settlements. Along with declining trend of import payments,

higher inflow of remittance and the steady growth of export earnings helped BDT get stronger

against USD.

During quarter 3 of the year, Demand for USD again rose due to import LC settlements.

However, Central Bank continued to rigorously monitor interbank USDBDT exchange rate

The year ended with BDT gaining against the USD due to lower import payment from state-

owned banks coupled with higher workers’ remittance flow. Beginning of the month USDBDT

traded around 81.40-50 and at the end of the month USDBDT traded at 79.75-80.

2. Triggers :

These Triggers mainly refer to the Economic Triggers/benchmarks that have been set and which

are monitored regularly to identify any potential breaches. They include factors like:

GDP

Rate of Inflation

Public Sector Debt as a % of GDP

8 | P a g e

Reserve Coverage of Imports measured in months of Imports

Current account Deficit as % of GDP

Government stability

Interbank rates

Citi has set benchmarks for these factors and every month the figures are being matched against

the benchmark to avoid any potential risk factor. These benchmarks are within the guidelines of

Bangladesh Bank, however set by regional Citi policies and practices.

3. Liquidity/ Branch Assets and Liability Review :

A key issue that banks need to focus on is the maturity of its assets and liabilities in different

tenors. A typical strategy of a bank to generate revenue is to run mismatch, i.e. borrow short term

and lend longer term. However, mismatch is accompanied by liquidity risk and excessive longer

tenor lending against shorter-term borrowing would put a bank’s balance sheet in a very critical

and risky position.

To address this risk and to make sure a bank does not expose itself in excessive mismatch, a

bucket-wise (e.g. next day, 2-7 days, 7 days-1 month, 1-3 months, 3-6 months, 6 months-1 year,

1-2 year, 2-3 years, 3-4 years, 4-5 years, over 5 year) maturity profile of the assets and liabilities

is prepared to understand mismatch in every bucket. However, as most deposits and loans of a

bank matures next day (call, savings, current, overdraft etc.), bucket-wise assets and liabilities

based on actual maturity reflects huge mismatch; although we know that all of the shorter tenor

assets and liabilities will not come in or go out of the bank’s balance sheet. As a result, banks

prepare a forecasted balance sheet where the assets and liabilities of the nature of current,

overdraft etc. are divided into ‘core and non-core’ balances, where core is defined as the portion

that is expected to be stable and will stay with the bank; and non-core to be less stable. The

distribution of core and non-core is determined through historical trend, customer behavior,

statistical forecasts and managerial judgment; the core balance can be put into over 1 year bucket

whereas non-core can be in 2-7 days or 3 months bucket.

Central Bank has recently instructed banks to maintain spread between assets and liabilities at

lower single digit, and in case of Citi if we exclude the non-interest bearing deposit portion, then

the spread between our assets and liabilities is within the prescribed limit of Bangladesh bank.

9 | P a g e

4. Ratio Positions Review :

Various balance sheet ratio positions are being calculated every month and presented in these

ALCO meetings for review and analysis. Few of them are:

Deposits as a % of loans

Core deposits as a % of loans

Available for Sale Portfolio review

These ratios are assessed and decisions are taken regarding whether to focus on assets growth or

liabilities growth based on market conditions or regulatory requirement and management

discretion.

5. MAR Profile and AFS Portfolio :

Market Risk and Asset Liability Management Market Risk measures the risk of loss due to

adverse movements in market prices or rates such as interest rates, FX rates. Following are the

key management indicators for managing Market Risk:

(a)Value at Risk (VaR): Value at Risk (VaR) is a statistical estimate of an upper boundary,

within a specified confidence level, of the potential amount a trading position or portfolio could

decrease in value during the time needed to close out a position. Specifically, it is a measure of

potential loss from an event in a normal, everyday market environment.

(b) Factor Sensitivity: It is the sensitivity of an instrument/book to changes in a particular risk

factor. For example, PV01 = the impact of ‘+1bp’ parallel move in the zero curve.

(c) Management Action Trigger: The MAT is a trigger level to warn of a persistently loss-

making position. It defines management's tolerance for accepting market risk related losses on a

rolling 30 day calendar day basis: MAT level = current VaR + latest rolling monthly P/L (21

business days) When a MAT is exceeded, trading management must review the current position

and decide whether it should be maintained, reduced or closed out.

6. Review of Liability Situation and Interest Rate Structure :

Under this point, the bank’s detailed update on liability situation is given, which includes points

relating to:

10 | P a g e

Month on month BDT deposit trend (increasing or decreasing)

Different types of Deposits breakdown

Loan book exposure

Transfer pricing i.e. the asset book needs to bear a certain portion of the cost of fund

generated from booking deposit

Conclusion

The ALCO is a decision making unit responsible for balance sheet planning from risk -return

perspective including the strategic management of interest rate and liquidity risks. Each bank

will have to decide on the role of its ALCO, its responsibility as also the decisions to be taken by

it. The business and risk management strategy of the bank should ensure that the bank operates

within the limits/parameters set by the Board. The business issues that an ALCO would consider,

inter alia, will include product pricing for both deposits and advances, desired maturity profile of

the incremental assets and liabilities, etc. In addition to monitoring the risk levels of the bank, the

ALCO should review the results of and progress in implementation of the decisions made in the

previous meetings. The ALCO would also articulate the current interest rate view of the bank

and base its decisions for future business strategy on this view. In respect of the funding policy,

for instance, its responsibility would be to decide on source and mix of liabilities or sale of

assets. Towards this end, it develops a view on future direction of interest rate movements and

decide on a funding mix between fixed vs. floating rate funds, wholesale vs. retail deposits,

money market vs. capital market funding, domestic vs. foreign currency funding, etc.

References

All information have been collected via interviews from:

1. Nusrat Sharmin MoutushiManagement AssociateCiti N.A. Bangladesh

11 | P a g e