The payment system

A payment system is any system used to settle financial transactions through the transfer
of monetary value. This includes the institutions, payment instruments such as payment cards,
people, rules, procedures, standards, and technologies that make its exchange possible.

It encompasses various mechanisms, including traditional methods such as cash, checks, and wire
transfers, as well as electronic payment systems like Automated Clearing House (ACH) transfers,
electronic funds transfers (EFT), and real-time gross settlement (RTGS) systems. Efficient payment
systems are essential for treasury management to ensure timely and accurate processing of
payments, optimize cash flow management, mitigate operational risks, and enhance liquidity
management.

NFCD/RFCD Rates
NFCD and RFCD rates typically refer to the interest rates offered on Non-Resident Foreign Currency
Deposit (NFCD) and Resident Foreign Currency Deposit (RFCD) accounts in Bangladesh. These rates
are set by banks and financial institutions and may vary depending on factors such as the currency
of the deposit, prevailing market conditions, and the policies of the central bank.

NFCD accounts are designed for non-residents, allowing them to hold foreign currency deposits in
Bangladesh. RFCD accounts, on the other hand, are meant for residents (Bangladeshi nationals) to
hold foreign currency deposits domestically. Both types of accounts offer the potential for earning
interest on foreign currency funds held in the respective accounts.

The rates offered on NFCD and RFCD accounts can be influenced by various factors, including
changes in global interest rates, exchange rate movements, economic conditions, and regulatory
requirements. Treasury managers and investors often monitor these rates closely to make
informed decisions regarding foreign currency deposits and investment strategies.

CAMELS rating
CAMELS rating is a supervisory rating system used by regulatory authorities, particularly banking
regulators, to assess the overall health and soundness of financial institutions, such as banks and
credit unions. The acronym "CAMEL" stands for the following five components:

C - Capital Adequacy: This component evaluates the financial institution's capital adequacy and
assesses whether it has sufficient capital to absorb potential losses and risks.

A - Asset Quality: Asset quality refers to the quality of the financial institution's loan portfolio and
other assets. This component assesses the institution's credit risk management practices, the
quality of its loan portfolio, levels of non-performing assets (such as loans in default), and the
adequacy of loan loss reserves.

M - Management: The management component evaluates the effectiveness of the financial

institution's management team in overseeing the institution's operations, risk management
practices, strategic planning, corporate governance, and compliance with regulatory requirements.
It considers the competence, integrity, and effectiveness of senior management and the board of
directors.

E - Earnings: Earnings assessment focuses on the institution's profitability and revenue generation
capabilities. It evaluates factors such as net interest margin, return on assets (ROA), return on

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equity (ROE), operating efficiency, and the sustainability of earnings in relation to the institution's
risk profile.

L - Liquidity: Liquidity refers to the ability of the financial institution to meet its short-term
obligations and fund its operations without experiencing funding shortages. This component
assesses the institution's liquidity risk management practices, funding sources, liquidity ratios, and
contingency funding plans.

S - Sensitivity to Market Risk: This additional component in CAMELS focuses on a bank's

vulnerability to changes in market conditions such as interest rates, exchange rates, and asset
prices.

Advance to deposit ratio

The Advance to Deposit Ratio (ADR) is a financial ratio used to assess the lending activities of banks
and financial institutions. It measures the proportion of a bank's total loans and advances to its
total deposits. The ADR indicates how much of a bank's deposit base is being used to extend loans
and generate interest income.

The formula for calculating the Advance to Deposit Ratio is:

Where:

𝑇𝑜𝑡𝑎𝑙 𝐿𝑜𝑎𝑛𝑠&𝐴𝑑𝑣𝑎𝑛𝑐𝑒𝑠 refers to the total amount of loans, advances, and credit facilities
extended by the bank to its customers.

𝑇𝑜𝑡𝑎𝑙 𝐷𝑒𝑝𝑜𝑠𝑖𝑡𝑠 refers to the total amount of deposits held by the bank, including demand
deposits, savings deposits, and term deposits.

Quasi-money
Quasi-money refers to highly liquid assets that are not considered legal tender but can be easily
converted into cash or used as a substitute for money in financial transactions. These assets
typically include short-term, interest-bearing securities and instruments that are readily marketable
and serve as a store of value.

Examples of quasi-money include bank deposits, such as savings accounts and time deposits, as
well as money market instruments like Treasury bills, commercial paper, and repurchase
agreements (repos), certificates of deposit (CDs).

Certificates of Deposit (CDs)

Certificates of Deposit (CDs) are financial instruments offered by banks and credit unions that allow
individuals to deposit funds for a specified period at a fixed interest rate. They are considered low-
risk investments and are commonly used for saving money while earning a higher interest rate than
standard savings accounts.

Here are some key features of CDs:

Term: CDs have a fixed term or maturity period, which can range from a few months to several
years. During this period, the funds are held by the financial institution, and the depositor cannot
withdraw them without incurring a penalty. The longer the term of the CD, the higher the interest
rate typically offered.
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Interest Rate: CDs offer fixed interest rates for the duration of the term. These rates are generally
higher than those offered for regular savings accounts because depositors agree to leave their
funds with the bank for a specified period. The interest can be paid out periodically (e.g., monthly,
quarterly) or at the end of the term.

Liquidity: While CDs offer higher interest rates, they also come with restrictions on liquidity.
Depositors cannot withdraw funds from a CD before its maturity date without paying an early
withdrawal penalty, which is typically a percentage of the interest earned or a set number of days'
worth of interest.

Safety: CDs are considered low-risk investments because they are typically insured by the Federal
Deposit Insurance Corporation (FDIC) for banks or the National Credit Union Administration (NCUA)
for credit unions, up to certain limits. This insurance protects depositors' funds in the event of a
bank or credit union failure.

Types: There are various types of CDs available, including traditional CDs with fixed interest rates
and terms, as well as specialized CDs such as callable CDs, bump-up CDs, and jumbo CDs, each
offering different features and benefits.

Overall, CDs are popular among individuals seeking a safe and predictable way to earn interest on
their savings, especially when they have a specific timeframe in mind for their financial goals. They
provide a balance between higher interest rates and liquidity constraints, making them suitable for
both short-term and long-term savings strategies.

Lender of last resort

The lender of last resort is a role typically assumed by a country's central bank, where it provides
emergency liquidity assistance to financial institutions facing severe funding or liquidity problems.
Here's a brief description:

Definition: The lender of last resort is a function performed by a country's central bank to provide
emergency financial support to solvent but illiquid financial institutions during times of crisis.

Purpose: The primary purpose is to prevent widespread financial instability and systemic collapse
by ensuring that solvent institutions have access to liquidity when normal sources of funding are
disrupted.

Mechanism: The central bank may provide liquidity through various means, such as discount
window lending, emergency loans, or asset purchases. These interventions aim to alleviate short-
term funding pressures and restore confidence in the financial system.

Conditions: Assistance from the lender of last resort is typically provided against eligible collateral
and subject to appropriate terms and conditions to mitigate moral hazard and protect taxpayers'
interests.

Importance: The lender of last resort function helps maintain financial stability, promotes
confidence in the banking system, and prevents contagion effects that could lead to broader
economic downturns.

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 Banker’s Acceptance
A Banker's Acceptance (BA) is a financial instrument issued by a borrower, typically a corporation,
to obtain short-term financing. Here's a brief description:

Definition: A Banker's Acceptance is a time draft drawn on and accepted by a bank, creating a
legally binding obligation to pay a specified amount of money at a future date.

Purpose: BAs are used primarily to finance commercial transactions, particularly international
trade. They provide a mechanism for sellers to obtain immediate cash by selling their future
receivables at a discount.

Process: In a typical transaction, a seller draws a draft (BA) payable to themselves, which is then
accepted by a bank, indicating the bank's commitment to pay the specified amount on the maturity
date.

Maturity: BAs usually have short-term maturity dates, typically ranging from 30 to 180 days,
though longer-term BAs are also possible.

Discounting: Sellers often sell BAs to investors at a discount from their face value to obtain
immediate cash. The discount represents the interest earned by the investor for holding the BA
until maturity.

Risk: BAs are considered relatively safe investments because they are backed by the
creditworthiness of the accepting bank. However, they still carry some credit risk associated with
the underlying transaction and the bank's ability to honor its obligation.

Usage: BAs are widely used in international trade, providing a secure and efficient means of
financing transactions and mitigating credit risk between buyers and sellers in different countries.

In summary, Banker's Acceptances are short-term financial instruments used to facilitate

commercial transactions, particularly in international trade, by providing sellers with immediate
cash while allowing buyers to defer payment until a specified future date. They are widely used in
trade finance and are considered relatively safe investments backed by the creditworthiness of the
accepting bank.

The foreign exchange (forex) market

The foreign exchange (forex) market is a decentralized global marketplace where currencies are
traded. Here's a brief overview:

 Definition: The foreign exchange market is where participants buy, sell, exchange, and speculate on
currencies. It facilitates the conversion of one currency into another for various purposes, including
commerce, investment, and speculation.
 Participants: The forex market includes a wide range of participants, such as central banks,
commercial banks, multinational corporations, hedge funds, institutional investors, retail traders, and
governments.
 Market Structure: The forex market operates 24 hours a day, five days a week, across different
time zones worldwide. It is decentralized, with trading taking place electronically over-the-counter
(OTC) through a network of interconnected banks, brokers, and electronic trading platforms.
 Major Currency Pairs: The most actively traded currencies in the forex market are known as major
currency pairs. These include pairs such as EUR/USD (euro/US dollar), USD/JPY (US
dollar/Japanese yen), GBP/USD (British pound/US dollar), and USD/CHF (US dollar/Swiss franc).

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 Liquidity: The forex market is the largest and most liquid financial market globally, with an average
daily trading volume exceeding trillions of dollars. Its high liquidity ensures that participants can buy
and sell currencies quickly and at competitive prices.
 Factors Influencing Exchange Rates: Exchange rates in the forex market are influenced by a
variety of factors, including interest rates, inflation, economic indicators, geopolitical events, central
bank policies, and market sentiment.

In summary, the foreign exchange market is a dynamic and liquid marketplace where currencies are
traded around the clock, providing opportunities for participants to profit from fluctuations in
exchange rates through various trading strategies.
Risks in FX
The foreign exchange market involves various risks that participants should be aware of. Here are
some key risks associated with foreign exchange transactions:

Exchange Rate Risk: Exchange rate risk, also known as currency risk, arises from fluctuations in
exchange rates. Changes in exchange rates can impact the value of foreign currency-denominated
assets, liabilities, revenues, and expenses, leading to gains or losses for market participants.

Transaction Risk: Transaction risk, also called settlement risk or delivery risk, refers to the risk that
arises when transactions are settled at different times or prices due to timing differences between
trade execution and settlement. This risk can result in financial losses if exchange rates move
unfavorably during the settlement period.

Interest Rate Risk: Interest rate risk arises from changes in interest rates, which can affect currency
values and exchange rates. Higher interest rates in one country relative to another can attract
foreign investors, leading to currency appreciation, while lower interest rates can have the opposite
effect.

Credit Risk: Credit risk, also known as counterparty risk, is the risk that a trading partner defaults on
its obligations. In the foreign exchange market, credit risk can arise from counterparties failing to
honor their contractual commitments, such as failing to deliver currency or make payments on
time.

Liquidity Risk: Liquidity risk refers to the risk of being unable to buy or sell currencies at desired
prices due to insufficient market liquidity. In times of market stress or during periods of low trading
activity, liquidity may dry up, leading to wider bid-ask spreads and increased transaction costs.

Country Risk: Country risk, also called sovereign risk, arises from political, economic, and social
factors specific to a particular country. Events such as political instability, government intervention,
economic crises, or changes in regulatory policies can impact exchange rates and investor
sentiment.

Operational Risk: Operational risk stems from internal processes, systems, and human error. In the
foreign exchange market, operational risk can arise from errors in trade execution, settlement
failures, technology outages, or inadequate risk management practices.

Regulatory Risk: Regulatory risk arises from changes in government regulations, laws, or policies
affecting the foreign exchange market. Regulatory changes can impact trading conditions, market
access, leverage limits, and compliance requirements for market participants.

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CRR and SLR
Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) are two key monetary policy tools used
by central banks to regulate the liquidity in the banking system and influence credit creation. Here's
a brief overview of each, along with the components of CRR:

Cash Reserve Ratio (CRR):

 CRR is the percentage of a bank's total deposits that it must hold as reserves in the form of
cash with the central bank.
 The primary objective of CRR is to control the money supply in the economy by restricting
the ability of banks to lend out all of their deposits.
 By adjusting the CRR, central banks can influence the liquidity in the banking system and
thereby regulate inflation and economic growth.
 CRR is a non-remunerative reserve requirement, meaning banks do not earn any interest on
the reserves held with the central bank.
 CRR is set by the central bank as part of its monetary policy framework and is subject to
periodic review and adjustments.

Statutory Liquidity Ratio (SLR):

 SLR is the percentage of a bank's total deposits that it must maintain in the form of specified
liquid assets, such as government securities, cash, and gold.
 The primary purpose of SLR is to ensure the stability and solvency of banks by requiring
them to hold a certain proportion of their deposits in safe and liquid assets.
 SLR serves as a secondary liquidity reserve, providing banks with a buffer against unforeseen
liquidity shocks and depositor withdrawals.
 SLR assets are generally more liquid and less risky than CRR reserves, as they can be readily
sold or pledged to meet liquidity needs.
 SLR is also set by the central bank as part of its monetary policy framework and is subject to
periodic review and adjustments.

Components of CRR: The components of CRR include:

Cash in Hand: Physical currency held by banks in their vaults.

Cash with Reserve Bank: Cash reserves maintained by banks with the central bank as part of the
CRR requirement.

Balances with Reserve Bank: Any balance maintained by banks with the central bank in their
current accounts as part of the CRR requirement.

Others: Any other forms of cash reserves or balances held with the central bank as specified by the
regulatory authority.

These components collectively constitute the CRR, which banks are required to maintain as a
percentage of their total deposits to ensure the stability and soundness of the banking system.

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 Basel III
Basel III is a comprehensive set of international banking regulations developed by the Basel
Committee on Banking Supervision (BCBS) in response to the global financial crisis of 2007-2008.

Capital Adequacy Requirements:

Basel III introduces more stringent capital requirements for banks to ensure they have sufficient
capital to absorb losses and maintain financial stability.

Leverage Ratio:

Basel III introduces a leverage ratio, which measures a bank's Tier 1 capital relative to its total
exposure, including both on-balance-sheet and off-balance-sheet assets.

Liquidity Requirements:

The LCR requires banks to hold sufficient high-quality liquid assets to cover their short-term
liquidity needs during times of stress.

Counterparty Credit Risk:

Basel III introduces new requirements for measuring and managing counterparty credit risk,
particularly in the context of over-the-counter derivatives transactions.

1. Increased capital requirements to enhance banks' resilience.

2. Introduction of liquidity standards to ensure banks maintain sufficient liquidity.
3. Implementation of leverage ratio to complement risk-based capital requirements.
4. Enhancements to risk management and governance practices.
5. Measures to address systemically important banks and mitigate systemic risk.
Loan pricing and main elements of loan pricing
Loan pricing refers to the process of determining the interest rate and other terms and conditions
for extending credit to borrowers. The main elements of loan pricing include:

Interest Rate: The interest rate charged on the loan is a key component of loan pricing. It
represents the cost of borrowing for the borrower and the return on investment for the lender.

Loan Amount: The size of the loan or principal amount is another crucial factor in loan pricing.
Larger loans may command lower interest rates due to economies of scale and reduced risk for the
lender.

Loan Term: The duration or term of the loan affects its pricing. Longer-term loans typically have
higher interest rates to compensate lenders for the longer exposure to credit risk and inflation.

Credit Risk: The creditworthiness of the borrower influences loan pricing. Lenders assess the
borrower's credit risk based on factors such as credit history, financial stability, collateral, and debt-
to-income ratio. Higher-risk borrowers may face higher interest rates or stricter terms.

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 Market Conditions: Economic conditions, prevailing interest rates, inflation expectations, and
market competition can impact loan pricing. Lenders adjust loan rates in response to changes in
market conditions to remain competitive and manage risk.

Collateral: Collateral provided by the borrower can affect loan pricing. Secured loans backed by
collateral typically have lower interest rates than unsecured loans because they involve less risk for
the lender.

Fees and Charges: Lenders may impose fees and charges, such as origination fees, application fees,
processing fees, and prepayment penalties, which contribute to the overall cost of borrowing and
affect loan pricing.

Lender's Cost of Funds: The cost of funds for the lender, including borrowing costs, operating
expenses, and profit margin considerations, influences loan pricing decisions.

Regulatory Requirements: Regulatory constraints, such as capital adequacy requirements, liquidity

requirements, and usury laws, may impact loan pricing practices and terms.

Risks of treasury management in BD

Treasury management in Bangladesh, like in any other country, involves various risks that
organizations need to identify, assess, and manage effectively. Some of the key risks
associated with treasury management in Bangladesh include:

1. Foreign Exchange Risk: Bangladesh's economy is highly dependent on imports and

exports, making it vulnerable to fluctuations in exchange rates. Treasury departments need
to manage foreign exchange risk associated with exposure to multiple currencies,
import/export transactions, and foreign currency-denominated assets and liabilities.

2. Interest Rate Risk: Treasury management involves managing interest rate risk associated
with changes in market interest rates. Fluctuations in interest rates can impact the cost of
borrowing, investment returns, and the value of fixed-income securities held in the
portfolio.

3. Liquidity Risk: Ensuring sufficient liquidity to meet short-term obligations and funding
requirements is essential for treasury management. In Bangladesh, liquidity risk may arise
from factors such as mismatches between cash inflows and outflows, inadequate access to
funding sources, and disruptions in the domestic financial market.

4. Credit Risk: Credit risk arises from the possibility of counterparties defaulting on their
obligations. Treasury departments in Bangladesh need to assess and manage credit risk
associated with counterparties, including banks, financial institutions, and corporate clients,
particularly in the context of lending, investments, and derivative transactions.

5. Regulatory and Compliance Risk: Compliance with regulatory requirements and

adherence to relevant laws and regulations pose challenges for treasury management in
Bangladesh. Changes in regulatory frameworks, reporting requirements, and tax laws can
impact treasury operations and increase compliance-related risks.
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6. Operational Risk: Operational risk encompasses risks arising from internal processes,
systems, and human error. In Bangladesh, operational risk in treasury management may
arise from factors such as inadequate systems and controls, fraud, cybersecurity threats, and
disruptions in business continuity.

7. Market Risk: Market risk encompasses risks associated with changes in market prices,
including equity prices, interest rates, exchange rates, and commodity prices. Treasury
departments in Bangladesh need to monitor and manage market risk exposure in
investment portfolios, trading activities, and derivative transactions.

8. Political and Economic Risk: Political instability, policy changes, and economic
uncertainties in Bangladesh can impact treasury management decisions and introduce
additional risks. Treasury departments need to stay informed about political and economic
developments and their potential implications for financial markets and business
operations.

Effective treasury management in Bangladesh requires robust risk management frameworks,

policies, and procedures to identify, assess, and mitigate various risks. Treasury
professionals need to employ appropriate risk management tools, such as hedging
strategies, diversification, and stress testing, to safeguard the organization's financial assets
and optimize its liquidity, funding, and investment activities.

Sources of funds of banks

Banks acquire funds from various sources to meet their lending and investment activities and to
support their operations. Some of the primary sources of funds for banks include:

1. Deposits: Deposits are the most significant source of funds for banks. Banks accept deposits from
individuals, businesses, and other entities, which are held in various types of accounts such as
savings accounts, current accounts, and term deposits. Deposits provide banks with a stable and
relatively low-cost source of funding.

2. Interbank Borrowing: Banks can borrow funds from other banks in the interbank market to meet
short-term liquidity needs or manage temporary funding shortfalls. Interbank borrowing typically
occurs through overnight loans, term loans, or repurchase agreements (repos).

3. Wholesale Funding: Banks can raise funds through wholesale funding sources such as issuing
bonds, commercial paper, certificates of deposit (CDs), and other debt securities to institutional
investors, corporations, and other financial institutions. Wholesale funding provides banks with
additional liquidity and diversifies their funding sources.

4. Central Bank Facilities: Banks can access funding from the central bank through various facilities,
such as the discount window, standing lending facilities, and term lending programs. Central bank
funding serves as a liquidity backstop for banks and supports their liquidity management and
monetary policy objectives.

5. Equity Capital: Banks can raise funds by issuing equity capital through public offerings or private
placements to investors. Equity capital represents ownership in the bank and provides a permanent
source of funding, albeit at a higher cost compared to debt financing.
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6. Retained Earnings: Banks retain a portion of their profits and reinvest them into the business as
retained earnings. Retained earnings serve as an internal source of funding for banks' growth,
expansion, and capitalization requirements.

7. Subordinated Debt: Banks may issue subordinated debt instruments, such as subordinated bonds or
debentures, to investors. Subordinated debt ranks below senior debt in terms of priority of repayment
but provides banks with additional capital and funding flexibility.

8. Customer Loans and Advances: Banks can use the funds generated from customer loans and
advances, such as mortgages, consumer loans, commercial loans, and trade finance, to finance their
operations and support lending activities.

These are some of the primary sources of funds for banks, which banks utilize to support their
lending, investment, and operational activities while managing liquidity, capital adequacy, and risk.
The composition of funding sources may vary depending on factors such as bank size, business
model, regulatory requirements, market conditions, and risk appetite.

Components of cost of funds of a commercial bank

The cost of funds for a commercial bank represents the expenses incurred in acquiring
funds to support its lending and investment activities. The components of the cost of funds
include:

1. Interest Expense on Deposits: Commercial banks pay interest to depositors for the funds
held in various deposit accounts, such as savings accounts, current accounts, and term
deposits. The interest expense on deposits is a significant component of the cost of funds,
particularly for banks that rely heavily on retail deposits.

2. Interest Expense on Borrowings: Banks may borrow funds from other financial
institutions, such as other banks or the central bank, through interbank loans, repurchase
agreements (repos), or other borrowing facilities. The interest expense incurred on such
borrowings contributes to the overall cost of funds.

3. Interest Expense on Debt Securities: Commercial banks may issue debt securities, such as
bonds, commercial paper, or certificates of deposit (CDs), to raise funds from institutional
investors and other market participants. The interest expense on these debt securities
represents the cost of borrowing from the capital markets.

4. Interest Expense on Subordinated Debt: Banks may issue subordinated debt instruments,
such as subordinated bonds or debentures, to raise additional capital. The interest expense
on subordinated debt represents the cost of capital raised through these instruments.

5. Dividend Payments on Equity Capital: Commercial banks may pay dividends to

shareholders as a return on their investment in the bank's equity capital. While dividends
are not a direct interest expense, they represent a cost of raising equity capital and are
considered part of the overall cost of funds.

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6. Operating Expenses: Operating expenses incurred by the bank, such as salaries, rent,
utilities, and administrative costs, indirectly contribute to the cost of funds. These expenses
reduce the bank's profitability and increase the overall cost of acquiring and managing
funds.

7. Opportunity Cost of Capital: The opportunity cost of capital represents the return that
investors could have earned by investing their funds in alternative investments with similar
risk profiles. For banks, the opportunity cost of capital reflects the return required by
investors to invest in the bank's equity or debt securities.

8. Regulatory Costs and Compliance Expenses: Banks incur costs related to regulatory
compliance, reporting requirements, and compliance with prudential regulations imposed
by regulatory authorities. These regulatory costs indirectly contribute to the cost of funds by
increasing operational expenses and reducing profitability.

Overall, the cost of funds for a commercial bank encompasses various components,
including interest expense on deposits and borrowings, dividend payments on equity
capital, operating expenses, opportunity cost of capital, and regulatory costs. Managing the
cost of funds is essential for banks to optimize profitability, maintain competitiveness, and
support sustainable growth in their lending and investment activities.

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