## Technical Assistance Mission Report — Bangladesh Bank (tarea2024051-print-pdf)

## Source details

**Canonical URL:** [Technical Assistance Mission Report — Bangladesh Bank (tarea2024051-print-pdf)](https://www.imf.org/-/media/files/publications/tar/2024/english/tarea2024051-print-pdf.pdf)

## Other formats

- [Markdown version](/-/media/files/publications/tar/2024/english/tarea2024051-print-pdf.pdf.md)
- [Structured JSON version](/-/media/files/publications/tar/2024/english/tarea2024051-print-pdf.pdf.json)

---

### Executive summary — context and mission
- BB announced in its July−December 2023 Monetary Policy Statement (MPS) a transition from a monetary targeting to an interest rate targeting monetary regime.
- Mission aim: assess alignment of BB’s governance and operational frameworks with the new monetary policy regime and identify a possible TA program by SARTTAC.
- Mission lead and experts:
  - Led by Oleg Churiy (SARTTAC Monetary and Foreign Exchange Operations Advisor).
  - Included Bernard J. Laurens (short-term external expert).
- Stakeholder engagement: meetings with Deputy Governor, Chief Economist, MPD, Research department, MoF Finance division, BB Executive Director, Director MPD, Bangladesh Institute of Bank Management, and commercial banks.

### Governance — key findings and recommendations
- Main finding:
  - Bangladesh Bank Order (BBO) requires substantial amendment so that price stability is the overriding objective of the new monetary policy regime.
- Specific governance findings:
  - Monetary policy continues to be guided by a double objective of economic growth and price stability; no formal primacy assigned to price stability.
  - De jure autonomy of BB is not guaranteed by BBO; Sections 10, 15, 77, and 82 create constraints and Government powers affecting BB operations and budget/salary approvals.
  - BBO Section 9A.(1) creates a Co-ordination Council that can constrain BB actions by requiring BB to reflect the Council’s macroeconomic framework in BB policies.
  - BBO Section 38A makes BB accountable to Parliament; BB publishes an MPS twice a year.
  - Multiplicity of official BB rates (BR, Policy Rate, SMART) complicates communication and transmission.
- Governance recommendations:
  - Enshrine in the BBO a de jure primary objective of price stability over the medium term.
  - Enhance the de jure autonomy of BB.
  - Enhance BB’s accountability arrangements consistent with a clarified primary objective.
  - Eliminate BB’s direct lending to priority sectors (Rural Credit Fund, Industrial Credit Fund, Export Credit Fund); handle subsidies via fiscal accounts.
  - Adopt the Bank Rate (BR) as BB’s Policy Rate to have a single official rate for communications.
  - Prioritize amendments to the BBO as soon as possible to leverage momentum from BB’s announcement.
- Timing and outreach:
  - While reforms may be difficult short-term, launch them without delay and conduct outreach to build broad-based consensus.

### Operational framework — Stage 1 (immediate technical adjustments)
- Objectives: incentivize interbank trading and enhance monetary policy transmission via Interest Rate Corridor (IRC) and monetary instruments.
- Key Stage 1 recommendations:
  - Introduce a weekly 7-days main Open Market Operation (OMO) at the policy rate and with full allotment. Priority: High. Timeframe: Short-term.
  - Conduct fine-tuning OMOs as needed towards the end of RMP. Priority: High. Timeframe: Short-term.
  - Increase the level of Cash Reserve Ratio (CRR) averaging. Priority: High. Timeframe: Short-term.
  - Align the main OMO with the RMP. Priority: High. Timeframe: Short-term.
  - Ensure automatic access to the Standing Facilities (SFs). Priority: High. Timeframe: Short-term.
  - Uniformize the legal framework for collateralized liquidity-providing monetary operations and include haircuts and margin requirements. Priority: Medium. Timeframe: Medium-term.
  - Adopt BB’s policy rate as the base for setting the SMART (eliminate SMART’s backward-looking features). Priority: High. Timeframe: Short-term.
  - Active BB communications to enhance banks’ treasurers’ understanding. Priority: High. Timeframe: Short-term.
  - Normalize the FX market to facilitate coordination of monetary and FX policies. Priority: High. Timeframe: Short-term.
  - Participate in development of Islamic finance instruments. Priority: High. Timeframe: Medium-term.
  - Take active part in the Local Currency Bond Market (LCBM) project where BB has a distinctive role. Priority: Medium. Timeframe: Medium-term.

### Operational framework — Stage 2 (conditional)
- Preconditions: BB’s short-term liquidity forecasting capacity improves and interbank trading increases.
- Key Stage 2 recommendations:
  - Shift to fixed-quantities, variable prices OMOs calibrated using enhanced short-term liquidity forecasting. Priority: Medium.
  - Increase CRR ratio on foreign currency deposits at least to the level of CRR on local currency deposits. Priority: Low. Timeframe: Medium-term.

### Liquidity management — current situation (selected facts)
- New regime elements announced:
  - Introducing an IRC centered on BB’s policy rate currently set at 6.5 percent, with a corridor width of +/-_200 bp.
  - Adopting the overnight call MM rate as the intermediate objective.
  - Replacing a ceiling on banks’ lending operations by a market-driven reference rate indexed to the six months moving average rate for T-bill: the “SMART”.
- BR and penalties:
  - BR currently set at 4 percent and not linked to the policy rate.
  - Penalty for CRR under-fulfillment equals BR plus 500 pb.
  - Under current circumstances, a penalty rate of 9 percent appears rather low or could be lower than the SLF if BB tightens policy further.
- OMOs and facilities:
  - Overnight (O/N) OMO is main policy instrument providing liquidity daily at the policy rate using full allotment auctions.
  - O/N operations conducted using 2 facilities: Repurchase Agreement (REPO) to Non-Primary Dealers (NPD) and Liquidity Support Facility (LSF) to Primary Dealers (PD).
  - One-week REPO to PDs and non-PDs at fixed rate set 10 basis points above the policy rate using full allotment auctions.
  - Islamic banking liquidity facility for Islamic Banks (IB)s conducted at rates between 6.75-7 percent.
  - BB uses two legal arrangements for liquidity-providing operations: Repo with title transfer and lending facility where collateral ownership remains with owner.
- Collateral and haircuts:
  - Haircuts for PDs: 5 percent for government bonds and 15 percent for T-bills to face value.
  - NPDs: collateral valued using market-based estimations.
  - BB does not use margining requirements; collateral valuation metrics vary by borrower type.
- CRR design and numbers:
  - Average CRR required: 4 percent for Bangladesh Taka (BDT) liabilities and 2 percent for Foreign Currency (FCY) liabilities, applicable to both CBs and IBs.
  - Regulated non-banking financial institutions: CRR of 1,5 percent.
  - BDT liabilities must be fulfilled in BDT; FCY CRR can be fulfilled either in BDT or in FCY on accounts maintained with BB.
  - FCY deposits account for about 10 percent of total banks’ liabilities.
  - CRR averaging requirement: banks must maintain daily balances of a minimum of 3,5 percent of their BDT liabilities or about 88 percent of CRR during the RMP.
- Market segmentation and liquidity distribution:
  - Islamic banks (IBs) represent about 23 percent of total deposits as of end 2022.
  - Segmentation: no instrument consistent with Islamic principles exists to transfer liquidity from IBs to Conventional Banks (CBs); CBs can provide to IBs but reverse transactions are not yet possible.
  - Foreign-owned banks (FOB) have substantial liquidity surplus but keep involuntary excess reserves with BB due to risk aversion and limitations on SDF access.
  - Wholesale Borrowing limit: 100 percent of capital for PMs and 80 percent of capital for NPDs.

### Liquidity management — detailed recommendations
- Phased operational transition:
  - Downsize BB presence in the market considerably.
  - Replace multiple daily OMO auctions with a one-week main OMO instrument, conducted weekly at the policy rate with full allotment.
  - Establish a similar one-week facility for IBs based on Islamic principles.
  - Interim option: conduct 3-4 days main OMO to provide liquidity support more frequently as banks adjust.
  - Increase CRR averaging substantially, and occasionally conduct fine-tuning OMOs.
  - Improve liquidity forecasting capacity to avoid interest rate volatility and help banks adjust.
- RMP alignment and calendar:
  - Align the main OMO instrument with a 2 weeks RMP; replace half-month calendar-based RMP with a 2 weeks RMP that starts/ends mid-week.
  - Within each RMP, have 2 main one-week operations and an O/N fine-tuning OMO on the last day.
- Access to Standing Facilities:
  - Make access automatic with a “no questions asked policy” while investigating frequent recourse to SFs to address root causes.
  - Main criterion for accessing SLF: availability of sufficient collateral.
- CRR policy changes:
  - Clearly define the role of CRR for monetary policy; in interest rate targeting, CRR with averaging serve as a buffer against autonomous factor fluctuations.
  - Consider transferring CRR regulation monitoring from DOS to the MPD when CRR are not used for prudential objectives.
  - Propose increasing CRR on FCY at least to the level of CRR on BDT; requirement should be met in FCY, phased due to current FCY liquidity shortage.
  - Link CRR non-compliance penalty to the policy rate or other instruments tied to the policy rate; set penalty above the SLF to incentivize compliance while avoiding excessive liquidity hoarding.
- Collateral and legal framework improvements:
  - Analyze legal arrangements and prefer arrangements offering better balance sheet protection for BB (title transfer preferred).
  - Make collateral valuation and risk mitigation universal regardless of borrower type; include haircuts and margin requirements.
- Market development and segmentation remedies:
  - Actively participate in market-making development initiatives, especially Islamic finance instruments to permit free flow of liquidity between CBs and IBs.
  - Remove impediments to interbank trading and financial stability constraints to enable liquidity migration within the banking system.

### Liquidity monitoring and forecasting — deficiencies and reform priorities
- Current deficiencies:
  - Liquidity forecasting relies mainly on the calendar of OMOs and G-secs redemptions.
  - BB produces a 1-week forecast on changes in Net Foreign Assets and Currency in Circulation (CiC) only.
  - MoF does not provide BB with forecasts of government expenditures and revenues; provides only a monthly calendar of planned government BDT debt placements.
  - Obstacles: banking segmentation; CRR non-compliance by IBs; relatively light penalties for CRR non-compliance; banks’ flexibility in meeting FCY CRR in either BDT or FCY.
- Recommendations to modernize forecasting:
  - Modernize liquidity monitoring and forecasting framework as critical for transitioning to fixed quantity variable-rate OMOs.
  - Distinguish clearly between liquidity monitoring and forecasting.
  - Differentiate autonomous factors (FX transactions, GOB operations, changes in CiC) from BB’s liquidity operations in the monitoring framework.
  - MoF must develop capacity to generate government cash flow projections and incorporate them into BB liquidity forecasts.

### FX market normalization and LCBM development
- FX market issues:
  - Current BAFEDA periodic consensus-setting of exchange rates lacks transparency; informal BB guidance contributes to ambiguity.
  - Some actors perceive the official exchange rate as not reflecting market forces and transact at differing rates.
- FX recommendations:
  - Rescind current arrangements and have BB assume fully and transparently its role in the FX market as outlined in Article 7A of the BBO.
  - Clarify the exchange rate regime the authorities want to follow.
  - Design FX intervention instruments to accumulate international reserves or reduce disorderly developments and volatility.
- Local Currency Bond Market (LCBM):
  - MoF has embarked on LCBM reform; joint IMF/World Bank mission of July 5 to 17, 2023 provided recommendations and a roadmap.
  - Development of LCBM will enhance monetary policy transmission by facilitating an effective yield curve and transmission of BB’s policy rate.
  - Mission encourages BB to take an active role where it has distinctive responsibilities.

### Communications and implementation support
- Communications findings:
  - BB’s July−December 2023 MPS effectively announced key transition measures (IRC and SMART).
  - Banks’ treasurers have limited understanding of BB’s policy rate as the primary signal; focus remains on SMART.
- Communications recommendations:
  - Eliminate backward-looking features of SMART; adopt BB’s policy rate as the base for setting SMART to reinforce signaling.
  - Explain rationale for operational recommendations (greater CRR averaging, less frequent BB market presence) to banks’ treasurers so they distinguish stance changes from technical operations.
  - Emphasize role of interbank market in redistributing liquidity.
  - Request TA to elaborate a medium-term monetary policy communication strategy.
  - Follow the golden rule: “Do what you say, and say what you do”.
- Suggested TA areas (selected from proposed SARTTAC scope):
  - Monetary operations framework including liquidity forecasting: support IRC reforms (SFs, OMOs, CRR) and enhance liquidity forecasting to enable fixed-quantity, variable-rate OMOs.
  - FX market and operations: design a FX intervention strategy and calibrate a reaction function once exchange rate regime is clarified.
  - Modernize collateral framework: develop operational arrangements for collateral valuation, haircuts, and margin requirements (can be combined with ELA framework support).
  - Develop a money market benchmark rate based on IOSCO Principles.
  - Emergency Liquidity Assistance (ELA) framework: help develop an ELA framework consistent with best central bank practices.

*IMF technical assistance mission report excerpts provided in the supplied content.*

### Preface ................................................................................................................

### Preface

### Mission purpose and composition
- The IMF South Asia Regional Training and Technical Assistance Center (SARTTAC) undertook an in-person Technical Assistance (TA) Mission during August 13−17, 2023, to Bangladesh Bank (BB).
- Aim: assess progress in implementation of previous TA recommendations on the transitioning from reserve money targeting to an interest rate-focused monetary policy framework (MPF), and identify additional capacity development (CD) actions to support the transition.
- Mission lead and experts:
  - Led by Oleg Churiy (SARTTAC Monetary and Foreign Exchange Operations Advisor).
  - Included Bernard J. Laurens (short-term external expert).
- Stakeholder engagement:
  - Meetings with Kazi Sayedur Rahman (Deputy Governor); Dr. Md. Habibur Rahman (Chief Economist); Monetary Policy Department (MPD); Research department; Finance division of Ministry of Finance (MoF).
  - Meetings with Dr. Md. Ezazul Islam (Executive Director); Md. Abdul Kayum (Director, MPD) and colleagues.
  - Met Additional Secretary in the Finance Division at the MoF, Bangladesh Institute of Bank Management, and representatives from commercial banks.
- Report incorporates comments from relevant IMF departments and BB.

### Executive Summary

### Context and objective
- BB announced in its July−December 2023 Monetary Policy Statement (MPS) a transition from a monetary targeting to an interest rate targeting monetary regime.
- Mission focus: assess alignment of BB’s governance and operational frameworks with the new monetary policy regime and identify a possible TA program by SARTTAC.

### Main governance finding
- Bangladesh Bank Order (BBO), which holds the effective power of law, needs substantial amendment so that price stability is the overriding objective of the new monetary policy regime. Key required changes:
  - Enshrine in BBO a primary objective for monetary policy in the form of price stability over the medium term.
  - Enhance the de jure autonomy of BB.
  - Enhance BB’s accountability arrangements.
  - Eliminate BB’s direct lending to priority sectors.
- Recommendation: Amendments to the BBO should be considered as soon as possible to leverage momentum from BB’s announcement.

### Operational recommendations — Stage 1 (immediate)
- Technical adjustments to the Interest Rate Corridor (IRC) to incentivize interbank trading and enhance monetary policy transmission:
  - Introduce a weekly 7-days main Open Market Operation (OMO) at the policy rate and with full allotment.
  - Increase the level of Cash Reserve Ratio (CRR) averaging.
  - Ensure automatic access to the Standing Facilities (SF)s.
  - Uniformize the legal framework for collateralized liquidity-providing monetary operations.
- Additional technical measures summarized in Table 1.

### Operational recommendations — Stage 2 (conditional)
- As BB’s short-term liquidity forecasting capacity improves and interbank trading increases:
  - Shift to fixed-quantities, variable prices OMOs calibrated in the context of enhanced short-term liquidity forecasting.

### Supporting measures
- Eliminate backward-looking features of the Six Months Moving Average rate of Treasury bill (SMART); adopt BB’s policy rate as the base for SMART to reinforce signaling.
- Normalize the foreign exchange (FX) market:
  - Adopt a clear exchange rate policy and a transparent, aligned BB FX intervention policy to coordinate monetary and FX policy and allow interest rates to play their role in the FX market.
- Participate actively in money market development initiatives, including Islamic finance instruments to facilitate liquidity flow between Conventional Banks (CBs) and Islamic Banks (IBs).
- Take an active role in Local Currency Bond Market (LCBM) development where BB has responsibility to facilitate an effective yield curve.
- Review BB communications policy and tools to enhance transparency and treasurers’ understanding.

### Key recommendations (selected items from Table 1)
- Governance:
  - Amend BBO to align with the new monetary regime; enshrine price stability as de jure primary objective; enhance de jure autonomy and accountability; eliminate priority-sector lending; adopt the Bank Rate (BR) as BB’s Policy Rate. Priority: High. Timeframe: Medium-term.
- Monetary operations modernization — 1st stage:
  - Introduce a weekly 7-days main OMO at policy rate and full allotment. Priority: High. Timeframe: Short-term.
  - Conduct fine-tuning OMOs as needed towards the end of RMP. Priority: High. Timeframe: Short-term.
  - Increase the level of CRR averaging. Priority: High. Timeframe: Short-term.
  - Align the main OMO with the RMP. Priority: High. Timeframe: Short-term.
  - Ensure automatic access to the SFs. Priority: High. Timeframe: Short-term.
  - Uniformize legal framework for collateralized liquidity operations and include haircuts and margin requirements. Priority: Medium. Timeframe: Medium-term.
- Liquidity monitoring and forecasting:
  - Upgrade the liquidity monitoring and forecasting framework. Priority: High. Timeframe: Medium-term.
- SMART:
  - Adopt BB’s policy rate as the base for setting the SMART. Priority: High. Timeframe: Short-term.
- Monetary operations modernization — 2nd stage:
  - Shift to fixed quantities, variable rate OMOs once liquidity forecasting is upgraded. Priority: Medium.
  - Increase CRR ratio on foreign currency deposits at least to the level of CRR on local currency deposits. Priority: Low. Timeframe: Medium-term.
- Supporting measures:
  - Active BB communications to enhance bank treasurers’ understanding. Priority: High. Timeframe: Short-term.
  - Normalize the FX market to facilitate coordination of monetary and FX policies. Priority: High. Timeframe: Short-term.
  - Actively participate in developing Islamic finance instruments. Priority: High. Timeframe: Medium-term.
  - Take active part in the LCBM project where BB has distinctive role. Priority: Medium. Timeframe: Medium-term.

### Proposed SARTTAC Technical Assistance (Table 2)

### TA scope and objectives (selected)
- Monetary operations framework, including liquidity forecasting:
  - Objectives: support reforms of BB’s policy instruments in relation to the IRC (standing facilities, OMOs, CRR) and enhancements to the liquidity forecasting framework to facilitate calibration of OMOs at variable rates fixed quantities.
  - Note: Could be done in conjunction with support to Money market benchmark rate.
- Foreign exchange market and operations:
  - Objectives: design a FX intervention strategy supportive of FX market development and calibrate a reaction function to guide BB in its FX interventions.
  - Note: To be provided once BB has clarified the exchange rate regime it wishes to implement.
- Modernization of the collateral framework for liquidity-providing monetary operations:
  - Objectives: develop operational arrangements for collateral valuation, haircut, and margin requirements.
  - Note: Could be done in conjunction with support to develop an ELA framework.
- Developing a money market benchmark rate:
  - Objectives: develop a money market benchmark rate based on IOSCO Principles.
  - Note: Could be done in conjunction with monetary operations and liquidity forecasting support.
- Emergency Liquidity Assistance (ELA) framework:
  - Objectives: help develop an ELA framework consistent with current best central bank practices.
  - Note: Could be done with support to modernize the collateral framework.

### I. Introduction (key points)

- Modernizing monetary policy is a focus under the Extended Credit Facility /Extended Fund Facility arrangements for Bangladesh approved by the IMF’s Executive Board in January 2023.
- Reforms include adopting an IRC and implementation of a policy rate as operational target by the end of the program period.
- July−December 2023 MPS announced the transition to an interest rate targeting framework involving:
  - Introducing an IRC centered on BB’s policy rate currently set at 6.5 percent, with a corridor width of +/-_200 bp;
  - Adopting the overnight call MM rate as the intermediate objective;
  - Replacing a ceiling on banks’ lending operations by a market-driven reference rate for all types of bank loans indexed to the six months moving average rate for T-bill: the “SMART”.

### II. Governance Arrangement at Bangladesh Bank

### A. Current Situation and Assessment (selected findings)
- Monetary policy continues to be guided by the double objective of ensuring economic growth and price stability, with no formal primacy assigned to price stability.
- BB’s Strategic Plan 2020-2024 includes Strategic Goal 01 to “Conduct of accommodative monetary management to ensure inclusive economic growth and price stability”.
- Recent policy communications signaled price stability as monetary policy primary objective; July-December 2023 MPS states “Containing inflation will be the first and foremost objective of this MPS”, which led to a 50 basis points upward move of the policy rate.
- BB counterparts indicated no changes to BB’s governance arrangements regarding autonomy, transparency and accountability since the September 18-30, 2018 SARTTAC TA mission assessment.
- De jure autonomy:
  - Improved by the 2003 amendments to BBO, 1972, but constraints remain.
  - BBO Sections 10, 15 and 77 give Government powers that could constrain BB’s ability to “do whatever it takes” to achieve objectives, particularly if BB is assigned a primary medium-term inflation objective.
  - BBO Section 82 places BB under de facto control of the Government of Bangladesh (GOB) in relation to budget, salary & compensation approvals.
- Assessment summary: the de jure autonomy of BB is not guaranteed by BBO.

### Table 3 — Bangladesh Bank Current Governance Arrangements (selected elements)
- Autonomy:
  - BBO Section 9A.(1) establishes a Council for the co-ordination of fiscal, monetary and exchange rate policies made of the MoF, the Minister of Commerce (Chairman), BB Governor, the Secretary of the Finance Division, the Secretary of the Internal Resources Division, and a member of the Planning Commission. BB “shall ensure that the macro-economic framework as coordinated by the Co-ordination Council is reflected in the policies of BB”.
  - BBO Section 77 allows GOB to declare BB Board to be superseded and the affaires of BB placed in an agency if GOB is of the opinion that BB fails to carry out obligations imposed on it by GOB. BB indicated this provision has never been activated.
  - BBO Section 15.(1) allows GOB to remove the Governor/Deputy Governor if he “has done any act which is a breach of the trust reposed on him, or if his continuance in office is regarded as manifestly opposed to the interests of BB”.
  - BBO Section 10 authorizes the Governor to direct and control BB; the Governor is appointed for a term of 4 years and is eligible for re-appointment.
  - BBO Section 82.(2) places BB under the de facto control of GOB as the budget, salary & compensation of employees are subject to GOB approval.
  - Assessment: the de jure autonomy of BB is not guaranteed by BBO.
- Transparency and Accountability:
  - BBO, Section 38A makes BB accountable to Parliament.
  - BB publishes a MPS twice a year.
  - Assessment: Absence of a primary objective for monetary policy and BB’s eclectic monetary regime (elements of exchange rate, monetary, and inflation targeting) complicates BB’s transparency, communication, and accountability.

*Source: tarea2024051-print-pdf - Preface ................................................................................................................*

### 7. Furthermore, while close macroeconomic policy coordination is not only desirable, but

### 7. Furthermore, while close macroeconomic policy coordination is not only desirable, but

### Governance and policy coordination
- BBO Section 9A (1) establishes a Council for the co-ordination of fiscal, monetary and exchange rate policies consisting of the MoF, the Minister of Commerce (Chairman), BB Governor, the Secretary of the Finance Division, the Secretary of the Internal Resources Division, and a member of the Planning Commission.
- BBO requires that BB “shall ensure that the macro-economic framework as coordinated by the Co-ordination Council is reflected in the policies of BB”.
- Assessment:
  - Close macroeconomic policy coordination is desirable and indispensable to support sound policies.
  - Establishing a dedicated body under BBO chaired by the MoF could, if inadequately used, constrain BB actions under pressure.
  - Arrangements outside of the BBO, therefore less likely to undermine BB autonomy, would be preferable.

### Financial vehicles and quasi-fiscal activities
- BBO provisions related to lending to priority sectors (Rural Credit Fund, Industrial Credit Fund, Export Credit Fund) require reconsideration.
- Findings:
  - Such quasi-fiscal activities are inconsistent with the new monetary regime.
  - They can complicate liquidity management and obstruct monetary policy transmission.
  - Any subsidy associated with these schemes would be better handled via the fiscal accounts.

### Multiplicity of Bangladesh Bank (BB) rates and communication
- Identified de facto three types of BB rates:
  - (i) the BR mentioned in Article 21 of the BBO, made public from time to time and applied by BB to buy or rediscount bills of exchange or other commercial paper eligible for purchase under the BBO; the BR serves also as the base for penalties in the event of non-compliance with the CRR;
  - the Policy Rate introduced via the new monetary policy regime;
  - the SMART, also introduced in the context of the transition to the new monetary policy regime.
- Assessment:
  - Coexistence of these rates can complicate BB’s monetary policy communication and undermine monetary policy transmission.

### Recommendations (B. Recommendations)
- Align BBO with the new interest rate targeting monetary policy regime and BB governance with best central bank practices. Specific measures:
  - Enshrine a de jure primary objective of price stability over the medium term for monetary policy in the BBO.
    - Rationale: July-December 2023 PMS identifies “containing inflation as the first and foremost objective” only for “this MPS”, creating ambiguity for future priorities.
  - Enhance the de jure autonomy of BB.
    - Rationale: BBO provisions regarding the role of the GOB in conduct of monetary policy create uncertainty damaging to BB’s long-term credibility.
  - Enhance BB’s accountability frameworks.
    - Once the primary objective is clarified, BB should comply with current accountability provisions in the BBO.
  - Eliminate BB’s involvement in provision of direct credit to priority sectors.
    - Rationale: Government policies in this domain are better handled transparently via fiscal policy.
  - Adopt the BR as the Policy Rate of BB.
    - Rationale: Having only one official rate will facilitate communications and be consistent with central bank practices.
    - Interim guidance: Until reform, BB communications should focus on the newly introduced Policy Rate and downplay the role of the BR.
- Timing:
  - While reforms may be difficult short-term, launching them should not be delayed. BB is already giving highest priority to price stability in practice, and enshrining primacy of price stability in the BBO would facilitate communications and accountability.
  - Outreach toward all stakeholders is recommended to build broad-based consensus on BB’s role and responsibilities.

### Liquidity management — current situation and assessment
- Operational framework transition:
  - BB announced adoption of a symmetric IRC centered on its Policy Rate and adoption of the interbank call rate as operational target.
  - Monetary operations aim to align the interbank call money rate with the policy rate.
- Limited bank recourse to Standing Facilities (SFs) for three main reasons:
  - Banks can satisfy short-term liquidity needs using BB OMOs offered daily with different maturities.
  - The IRC is quite wide, creating a high opportunity cost of using the Standing Lending Facility (SLF) instead of OMOs.
  - Access to SFs has not been automatic; BB has routinely declined requests to tap the Standing Deposit Facility (SDF), advising banks to place excess liquidity in the interbank market, leading some banks to keep involuntary excess reserves and weakening monetary policy transmission.
- BR characteristics and implications:
  - BR currently set at 4 percent and not linked to the policy rate; changes to the policy rate do not affect the BR.
  - BR is used to price BB’s refinancing facilities and to set the penalty rate for CRR under-fulfillment (BR plus 500 pb).
  - Under current circumstances, a penalty rate of 9 percent appears rather low, or could be lower than the SLF if BB tightens policy further, complicating liquidity management.
- OMOs and instruments:
  - Overnight (O/N) OMO is main policy instrument providing liquidity daily at the policy rate using full allotment auctions.
  - O/N operations conducted using 2 facilities: Repurchase Agreement (REPO) to Non-Primary Dealers (NPD), and Liquidity Support Facility (LSF) to Primary Dealers (PD); multiplicity complicates operational communication.
  - Other OMOs: one-week REPO to PDs and non-PDs at fixed rate set 10 basis points above the policy rate using full allotment auctions; Islamic banking liquidity facility for Islamic Banks (IB)s conducted at rates between 6.75-7 percent.
  - BB uses two legal arrangements for liquidity-providing operations: Repo with title transfer and lending facility where collateral ownership remains with owner; title transfer generally offers better balance sheet protection for the central bank.
  - Collateral valuation metrics vary by borrower type:
    - Haircuts for PDs: 5 percent for government bonds and 15 percent for T-bills to face value.
    - NPDs: collateral valued using market-based estimations.
    - Observation: Good practice implies distinction by collateral type rather than borrower type; BB does not use margining requirements.
- CRR design and issues:
  - CRR regulated by BB’s Department of Off-site supervision (DOS) and used for prudential objective, but DOS has Liquidity Coverage Ratio and Statutory Liquidity Ratio, making CRR less useful for prudential objectives.
  - CRR rates and requirements:
    - Average CRR required: 4 percent for Bangladesh Taka (BDT) liabilities and 2 percent for Foreign Currency (FCY) liabilities, applicable to both CBs and IBs.
    - Regulated non-banking financial institutions: CRR of 1,5 percent.
    - BDT liabilities must be fulfilled in BDT; FCY CRR can be fulfilled either in BDT or in FCY on accounts maintained with BB.
  - Observations:
    - Lower CRR on FCY deposits relative to BDT deposits could encourage dollarization.
    - FCY deposits account for about 10 percent of total banks’ liabilities.
    - CRR averaging is low: banks must maintain daily balances of a minimum of 3,5 percent of their BDT liabilities or about 88 percent of CRR during the RMP.
    - Low averaging, coupled with structural liquidity deficit, necessitates regular BB presence in the market and hampers interbank market arbitrage during the RMP.
- Interbank market segmentation and inefficiencies:
  - Segmentation between Islamic banks (IBs) and conventional banks (CBs): no instrument consistent with Islamic principles currently exists to transfer liquidity from IBs to CBs (CBs can provide to IBs but reverse transactions not yet possible). IBs represent about 23 percent of total deposits as of end 2022.
  - Foreign-owned banks (FOB) have substantial liquidity surplus but keep involuntary excess reserves with BB due to risk aversion and limitations on SDF access.
  - Regulatory constraints hinder market-making: Wholesale Borrowing limit stands at 100 percent of capital for PMs and 80 percent of capital for NPDs.

### Liquidity management — recommendations
- Phased approach starting with streamlining and simplifying operational framework:
  - Downsize BB presence in the market considerably.
  - Replace multiple daily OMO auctions with reliance on a one-week main OMO instrument, conducted weekly at the policy rate with full allotment.
  - Establish a similar one-week facility for IBs based on Islamic principles.
  - As an interim step, consider conducting 3-4 days main OMO to provide liquidity support more frequently as banks adjust.
  - Increase CRR averaging substantially, occasionally conduct fine-tuning operations, and improve liquidity forecasting capacity to avoid interest rate volatility and help banks adjust.
- RMP alignment and calendar design:
  - Align the main OMO instrument with a 2 weeks RMP; replace half-month calendar-based RMP with a 2 weeks RMP that starts/ends mid-week.
  - Within each RMP, have 2 main one-week operations: first OMO commencing on first day of RMP, second OMO maturing on first day of subsequent RMP; on last day of RMP, conduct O/N fine-tuning OMO to minimize interest rate volatility.
- Access to Standing Facilities:
  - Make access automatic with a “no questions asked policy”, while investigating frequent recourse to SFs to identify and address underlying causes.
  - Main criterion for accessing SLF should be availability of sufficient collateral.
  - SFs are buffers to suppress interest rate volatility; frequent access should trigger improvements in instrument design, liquidity forecasting, and financial stability measures rather than denial of access.
- CRR role and design changes:
  - Clearly define the role of CRR for monetary policy objectives; in interest rate targeting regime CRR with averaging provisions serve as buffer against unpredictable autonomous factor fluctuations.
  - Consider transferring CRR regulation monitoring from DOS to the MPD when CRR are not used for prudential objectives.
  - Propose increasing CRR on FCY at least to the level of CRR on BDT to support de-dollarization and promote local currency usage; requirement should be met in FCY, but implementation could be in later stages due to current FCY liquidity shortage.
  - Link CRR non-compliance penalty to the policy rate or other instruments tied to the policy rate; set the penalty level above SLF to incentivize compliance while avoiding excessive liquidity hoarding.
- Collateral and legal framework:
  - Analyze legal arrangements for various collateralized instruments and select the most suitable one for BB’s monetary instruments, preferring arrangements offering better protection for BB’s balance sheet.
  - Upgrade collateral framework implementation: make collateral valuation and risk mitigating measures universal regardless of borrower type; include haircuts and margin requirements.
- Market development and segmentation:
  - Actively participate in market-making development initiatives, particularly development of Islamic finance instruments to facilitate free flow of liquidity between CBs and IBs.
  - Later stages: when liquidity forecasting improves, rely on fixed quantity variable-rate OMOs and remove impediments to interbank trading, including market segmentation and financial stability constraints, to enable liquidity migration within the banking system.

### Liquidity monitoring and forecasting — current situation
- Data gaps and coordination:
  - MoF does not provide BB with forecasts of government expenditures and revenues; provides only a monthly calendar of planned government BDT debt placements.
  - High-level debt committee meetings between MoF and BB occur four times annually; junior committee meetings take place six times a year, focusing mainly on debt management issues.

*Italicized original source attribution: IMF technical assistance mission report excerpts provided in the supplied content.*

### 32. BB’s liquidity forecasting framework has other deficiencies and it relies mainly on the

### BB’s liquidity forecasting framework and supporting measures

### Liquidity forecasting: deficiencies and constraints
- BB’s liquidity forecasting framework has other deficiencies and it relies mainly on the calendar of OMOs and G-secs redemptions.
- BB also produces a 1-week forecast on changes in Net Foreign Assets and Currency in Circulation (CiC).
- Several obstacles exist for liquidity forecasting:
  - banking segmentation,
  - CRR non-compliance by IBs,
  - relatively light penalties for CRR non-compliance,
  - bank’s flexibility in meeting their FCY CRR in either BDT or FCY.

### Recommendations: modernizing liquidity monitoring and forecasting
- Modernizing the liquidity monitoring and forecasting framework is critical for transitioning to fixed quantity variable-rate OMOs.
- A clear distinction between liquidity monitoring and forecasting is essential.
- The liquidity monitoring framework should differentiate between autonomous factors (FX transactions, GOB operations and changes in CiC) and BB’s liquidity operations.
- MoF must develop capability to generate government cash flow projections, which have to be incorporated into the liquidity forecasts.

### BB communications (supporting measures)
- BB communications will become even more critical with the transition to the new monetary regime.
- BB’s July-December 2023 MPS does a good job in announcing the key measures that have been taken to transition from a monetary targeting to an interest rate targeting framework, namely the introduction of the IRC and of the SMART reference rate.
- Banks’ representatives met by the mission appeared to have a limited understanding of the central role that would play BB’s policy rate as the tool to signal the stance of monetary policy, and their attention was more on the SMART.
- One option to avoid perceived inconsistencies in BB’s communications regarding the stance of monetary policy would be to eliminate the backwards looking features of the SMART.
- Adopting BB’s policy rate as the base for setting the SMART could serve that purpose, as it would reinforce the signaling role of BB’s policy rate.
- The rationale for the mission’s operational recommendations (greater room for CRR averaging, less frequent presence of BB in the market...) will need to be explained in detail to banks’ treasurers so that:
  - BB actions in the MM are well understood,
  - banks can distinguish actions that reflect a change in the monetary policy stance (i.e., a change in BB policy rate) from actions of a purely technical nature (i.e., response to changes in the autonomous factors of liquidity).
- Explain the critical role that will play the interbank market for the smooth redistribution among banks of liquidity left available to the market by BB.
- Rather than exercising some level of control on banks’ intermediation of funds, BB should encourage banks to trade in the market so that available liquidity flows freely and swiftly among banks.
- Development of Islamic finance instruments would allow the free flow of liquidity between CBs and IBs.
- The mission recommends active BB communications to enhance banks’ treasurers understanding of the new market environment needed to allow a smooth transmission of BB’s actions on the MM.
- The golden rule to be followed: “Do what you say, and say what you do”, as reflected in the Principe VII that characterize effective policy frameworks in countries with scope for independent monetary policy.
- Communication focus:
  - explaining past outcomes and actions necessary to align expected outcomes with the policy objective (i.e., BB’s liquidity management operations and their ability to ensure the alignment of short-term interbank market rate with BB’s policy rate),
  - reduce uncertainty, improve monetary policy transmission, facilitate accountability, and build credibility.
- The mission also recommends requesting TA to help BB to elaborate a medium-term monetary policy communication strategy.

### Normalizing the foreign exchange market
- The current FX market arrangements do not allow for proper coordination of monetary and FX policies under an interest rate-based monetary regime.
- Current arrangements where the Bangladesh Foreign Exchange Dealers’ Association (BAFEDA) set periodically “by consensus” the exchange rates to be applied for categories of FX transactions lack transparency, most notably with regard to the informal guidance played by BB, or the underlying exchange rate regime that may guide BB.
- There is anecdotal evidence that certain actors do not see the current exchange rate as reflecting market forces, and they find ways to transact at rates which differ from those set by the BAFEDA.
- Recommendation: rescind the current arrangements and for BB to assume fully and in a transparent manner its role in the FX market, as outlined in Article 7A of the BBO.
- Normalizing the FX market involves:
  - clarifying the exchange rate regime that the Bangladesh authorities want to follow,
  - designing appropriate FX intervention instruments aimed at either accumulating international reserves in order to maintain an adequate level or reducing disorderly or erratic developments in the FX market (to reduce volatility).

### Developing the Local Currency Bond Market (LCBM)
- The Ministry of Finance of Bangladesh has recently embarked in a reform agenda aimed at developing Bangladesh LCBM.
- A number of policy recommendations have been presented in the Aide-memoire of the recent joint IMF/World Bank mission that visited Bangladesh from July 5 to 17, 2023, to assist the authorities in assessing the functioning of the LCBM, and preparing a roadmap for further action and technical assistance in this area.
- The development of Bangladesh LCBM will be particularly relevant as it will enhance monetary policy transmission: it will facilitate the emergence of a robust and reliable yield curve, and enhance the transmission of BB’s policy rate to financial markets and ultimately the economy.
- The mission encourages BB to take an active part in this endeavor, in those areas where it has a distinctive role and responsibility.

*Source: https://www.imf.org/-/media/files/publications/tar/2024/english/tarea2024051-print-pdf.pdf*

---


_Source: https://www.imf.org/-/media/files/publications/tar/2024/english/tarea2024051-print-pdf.pdf_