The Perspective Plan and the Roadmap to Vision 2021 - ICAB

January-March 2010
The Bangladesh Accountant January-March 2010 Vol. 66 No. 37
The Perspective Plan and the
Roadmap to Vision 2021

January-March 2011
Vol. 69 No. 40
Chairman: M Farhad Hussain FCA
Associate Editor: Harun Mahmud FCA
Members
Md. Abdus Salam FCA
Md. Shahjahan Majumder FCA
Showkat Hossain FCA
Masih Malik Chowdhury FCA
Anwaruddin Chowdhury FCA
ASM Nayeem FCA
Dr. Md. Abu Sayed Khan FCA
Md. Humayun Kabir FCA
Akhter Matin Chaudhury FCA
Parveen Mahmud FCA
Abdur Razzaque Mollah FCA
Md. Abdur Rashid FCA
M A Baree FCA
Md. Nurul Haque FCA
Kazi Ehsanul Huq FCA
Md. Akbar Hossain FCA
Md. Sayeed Ahmed FCA
Md. Jakir Hossain FCA
M. Abu Bakar FCA
Mohammad Kamrul Hasan FCA
Md. Kahir Mahmood FCA
Mizanur Rahman Khan FCA
Pradip Paul FCA
Mohammed Jashim Uddin ACA
Md. Rokonuzzaman ACA
Md. Selim Reza ACA
Md. Yasin Miah ACA
Mohammad Mazharul Haque ACA
Member Secretary
N I Chowdhury FCA, Secretary-ICAB
CONTENTS
EDITORIAL
The Perspective Plan and the Roadmap to Vision 2021
ACCOUNTING
Editorial Board
Application of Different IAS/IFRS in Preparing Financial 01
Statements-A Study of Bangladeshi Private Commercial Banks
• Md Ali Arshad Chowdhuary
• Mostafa Ali
• Reza Humayun Morshed Hayat ACA, ACMA
Determinants of Financial Reporting Outcomes Following 10
IFRS Adoption-Implications for Bangladesh
• Sumon Bhattacharjee
• Md Shakawat Hossain
Islamic Accounting and Traditional Accounting 20
Some Conflicts and Their Resolutions
• Dr Syed Mohammad Ather FCMA
• Md Hafij Ullah
FINANCE
Contemporary Issues in Bond Market Development in Bangladesh: 25
Experience and Evidence from Asian Countries
• Dr M Abu Misir
• Mohd. Mohsin
• Aktar Kamal
E-trading and Stock Market in Bangladesh: 34
Problems, Prospects and Way Forward
• Shah Md Safiul Hoque
• S M Shafiul Alam
ECONOMICS & BANKING
Banking Supervision as per International Standards: 42
A Comparative Study of Bangladesh and India
Md Alamgir
Rising Price Level and Consequences of Inflation: 61
Concern for Bangladesh
Tanweer Mehdee
Credit Distribution Model, Supervision and 68
Monitoring System of the Grameen Bank
• Dr Md Nurul Alam
• Dr Zahurul Alam
• Mrs Sharmeen Ahmed
INVESTMENT
FDI in the Context of SAARC Nations with Particular 75
Reference to Bangladesh: An Analytical Study
• Dr Dilip Kumar Sen
• Chowdhury Rajkin Mohsin
BUDGET
Suggestions for Budget 2010/2011 93
Pertaining to Income Tax Aspects of NBR
Masih Malik Chowdhury FCA
Proposed new VAT act should be judiciously 96
framed to make business friendly law
Akhter Zamil FCA
INFORMATION TECHNOLOGY
Using Radio Frequency Identification (RFID) Technology 103
to Improve Supply Chain Efficiency
• Mohammed Abu Jahed
• Mohammad Monoar Hossain
Published by the Editorial Board of the Council, The Institute of Chartered Accountants of Bangladesh (ICAB)
100 Kazi Nazrul Islam Avenue, Dhaka 1215
Tel: 9117521, 9112672, 9115340, 9137847 Fax: 880-2-8119399 E-mail: secretary@icab.org.bd Website: www.icab.org.bd

Editorial
The Perspective Plan and the Roadmap to Vision 2021
T
he Perspective Plan 2010-2021 of the
Government was framed to achieve vision
2021 and thereby a digital Bangladesh by
eliminating the digital divides that segregate
Bangladesh from the digitally developed world. The
Perspective Plan envisages among others the
following.
1. A prudent macroeconomic framework.
2. Setting of strategic goal to accelerate growth to
8 to 9%.
3. Generate per capita income to around US$2800
4. Digitize the country, eliminate underemployment
and engage at least 90 per cent of the work
force into production.
5. Maintain a moderate inflation of 6 to 8 percent
or below per annum.
6. Bring down poverty to 14 percent or to a
minimum level.
The growth strategy of the Government reflected in
the Perspective Plan is set to elevate the country to
the level of a middle income nation through the
missionary declaration of - vision 2021..A small
country with huge man power potential and natural
resources and more than 300 million working hands
Bangladesh has proved its inherent strength to
combat successfully natural disasters, inadequate
economic infrastructure facilities and the economic
turmoil resulting from the global financial crisis.
With the passage of time the struggling and
unedifying people of the country have proved the
stamina to survive catastrophe or misfortune of any
dimension.
Bangladesh has proved time and again that she has
the feat and national vigor to repulse economic
crisis of any magnitude to survive prestigiously in
the comity of nations. Over the last about 40 years
since independence the longevity of the people
have increased from an average age of more or less
37 years in 1971 to more or less 67 years now. The
per capita income has multiplied from a meager
configuration of about U$100 in 1971 to U$750/-in
the current fiscal with a simultaneous GDP growth
rate 5.7% to 6% in the fiscal 2009-2010 from 2.5%
to 3% in 1971.
Bangladesh is a land bridge between the emerging
markets of South Asia and fastest growing markets of
South East Asia and ASEAN countries around “Bay
of Bengal Growth Triangle” with Chittagong port
strategically located. The economic policies of the
country are investment friendly coping with the
Vision 2021. The nation is in the brink of achieving
self-sufficiency in food production with the support
of a resilient community of dedicated farmers. The
country has never defaulted in its debt-servicing and
has built up a very strong and resolute foreign
currency reserve to meet its foreign currency
obligations. The economy of the country never
experienced negative growth since it achieved
independence in 1971 and boldly faced the
financial crisis that engulfed the world economies
during the last couple of years.
The country has a policy of rapid liberalization of
import to cope with globalization of the economy.
Risk factors for FDI in Bangladesh are minimal
The Bangladesh Accountant/January-March 2010

Editorial
compared to other countries of this region. Cost of
production especially cost of labour is
comparatively lower. Cost of living is also
reasonable and there is no communal or ethnic
problems. English language is widely spoken and
understood. The Government has Avoidance of
Double Taxation Agreements and Bilateral
Investment Promotion Treaties with many countries
of the World.
In the modern world economy Foreign Direct
Investment is considered and recognized as the most
convincing and potential contributor to growth and
development. It brings with it not only cash capital
but also technology, management know-how and
access to new markets. In comparison with other
forms of capital flows, it is also more stable, with a
longer-term commitment to the host economy.
Bangladeshis is situated in a very good location for
foreign investment in consideration of socioeconomic
and environmental factors. A Japanese
survey has found Bangladesh as the cheapest
destination for investment among 21 major cities
and countries in Asia.
The Government has provided legal security for
investment. The Foreign Private Investment
(Promotion and Protection) Act, 1980 ensures legal
protection to foreign investment.. Bangladesh is a
member of Multi-Lateral Investment Guarantee
Agency (MIGA), Overseas Private Investment
Corporation (OPIC) of USA and International Centre
for Settlement of Industrial Disputes (ICSID) and
Member of World Intellectual Property
Organization (WIPO) and World Association of
Investment Promotion Agencies (WAIPA).
In spite of all these favourable factors the Foreign
Direct Investments (FDI) in Bangladesh during the
last couple of years are the lowest in the history of
the country’s records. It is apprehended that this
downfall in FDI flow was caused due to the
following unfavorable factors::
1. Power Crisis – Particularly Gas and Electricity
2. Corruption in different stages of the Government
machinery
3. Procedural handicaps in the bureaucracy in the
formation stage of the business
4. Continued Political Confrontations and unrest
The country has been lagging far behind in its
expectation of FDI.The neighbouring countries of
Bangladesh are much ahead in attracting FDI. In
Pakistan and India FDI is 3.7% and 2.2%
respectively of the GDP while in Bangladesh FDI is
more ore less 1% of GDP.During the current fiscal
the FDI inflow into Bangladesh fell drastically in
comparison to the previous years
due to global
financial crisis, political instability and severe
shortage of natural gas and electricity. During July to
March period of 2009-2010 fiscal years, the country
received only US$288 million to US$300 million in
FDI against $782 million during the same period of
2008-2009 fiscal. So until the bottlenecks as
described above are overcome vision 2021 through
the Perspective plan will be very difficult to achieve.
M Farhad Hussain FCA
Chairman, Editorial Board
The Bangladesh Accountant/January-March 2010

Accounting
Application of Different IAS/IFRS in Preparing Financial
Statements-A Study of Bangladeshi Private Commercial Banks
Md Ali Arshad Chowdhuary
Mostafa Ali
and
Reza Humayun Morshed Hayat ACA, ACMA
Prelude:
Quality financial reports provide information that is reliable,
comparable, relevant and, of course, transparent to the
potential users resulting in an enhanced investor confidence.
Uniform financial report is possible if it is prepared in
accordance with complying accounting standards set by the
different national and international accounting bodies.
Uniformity of financial reporting is emergent because
effective competition among the capital markets of the world
may be impaired in its absence and the difficulties in financial
analysis might lead to intractable costs of capital as well as
might hamper cross boarder financing decisions (Salim, The
Bangladesh Accountant, October-December.’05.). Uniform
accounting standards provide efficiency gain both internally
and externally. A similar internal reporting system gives the
chance of better comparisons, less confusion and mistakes
between the parts of the company and external reporting
system provides uniform performance figures in different
countries (Salim, The Bangladesh Accountant, January-
March,’06.). Good financial reporting based on widely
accepted accounting principles, policies and practices
facilities, and effective communication encourages flow of
investment funds and thereby accelerates economic growth.
Such demand creates a strong case for convergence with the
IASs and IFRSs (Nayeem, The Bangladesh Accountant,
October-December.’05.). Application of IASs and IFRSs
would reflect greater “accountability” of corporate
management and “transparency” of published financial
information as well as enhance the “credibility” of the
statutory audit function of Bangladesh. This will make the
business environment in Bangladesh more transparent and
thus enable the country to attract foreign and local investment
which ultimately contributes to business growth and
economic development of the country. Since Bangladesh tries
to move forward to the process of globalization, so it has to
take initiative to prepare uniform financial statements in
accordance with IASs and IFRSs which will overcome a
major global challenges facing business enterprises.
Statement of the problem/ The Study Rational:
Bank is a very old financial institution that is contributing
toward the development of any economy and is treated as an
important service industry in modern world. Now a days the
function of bank is not limited to within the same
geographical limit of any country. Due to globalization and
free market economy, this industry is facing severe
competition in any country and implementation of WTO will
further increase the competition. Commercial banks are the
most dominant financial institutions in the domain of
commerce and industry. The efficiency of Commercial bank
depends on its productivity, profitability, maintenance of
accounting standards and disclosure thereof.
Despite recurrent floods, devastating cyclone, temporary
disruption in domestic production and supply, widespread
outbreak of avian influenza (bird flu) in the poultry sector,
persistent price hike of essential commodities including fuel
oil in the global market and the recent financial crisis in the
world market, Bangladesh banking sector plays a vital rule in
the economy. The services sector contributed 49.10 percent of
the total GDP. Monetary intermediation (banks) was
estimated to achieve a moderate growth of 7.10 percent,
reflecting healthy profit margin in the private sector banks
(Annual Report, Bangladesh Bank ’06-’07.). Banking sector
Md Ali Arshad Chowdhuary, Lecturer, Department of Accounting and Information Systems, Chittagong University, Chittagong, Mostafa
Ali, Lecturer, Department of Finance and Banking, Chittagong University, Chittagong and Reza Humayun Morshed Hayat ACA,
ACMA, Head of Audit, Aramit Group, Head of Accounts Aramit Footwear and Alu.
The Bangladesh Accountant/January- March 2010 1

Accounting
provides facilities to rebuild the agriculture, industry as well
as services sector by allowing loans, credit and advances. It
creates an opportunity of lucrative jobs for its better
employment structure. Moreover, it contributes to overcome
the volatility in capital market of Bangladesh. The banking
sector accounted for 53 percent of total market capitalization
in June 2008 with only 46 listed companies out of 294 listings
(Bangladesh Bank Quarterly, April-June,’08.).
Disclosure requirements relating to financial statements of
banks and similar institutions are contained in IAS-30. Since
banks operation differ in many material respects from other
commercial enterprises and liquidity and solvency is of
paramount importance, their financial reporting inevitably
will be somewhat specialized in nature. Some of IAS-30
disclosures have been made mandatory for banks, keeping in
view the special characteristics of banks operations and the
role they play in maintaining public confidence in the
monetary system of the country through their close
relationship with regulatory authorities and the government.
Further, a bank is exposed not only to liquidity risk but even
risk arising from currency fluctuation, interest rate
movements, changes in market prices and counter party
failure (Willey, IFRS 2005). Institute of Chartered
Accountants of Bangladesh (ICAB) adapted the standard
IAS-30 with minor changes in para 9,10,24,25 as BAS-30 on
27 January 1998. Standards adopted by ICAB are
recommendery but not compulsory for the users (Milan and
kanchan, Commerce Education in the New Millennium.).
Bangladesh Bank, the controlling authority of private banks
in Bangladesh, in exercise of powers given to them under
section 38(4) of the Banking Companies Act 1991, amended
the form of Balance Sheet and Profit and Loss Account
(BPRD Circular No. 14 dated 25 June 2003) and added to
disclose Cash Flow Statement in accordance with BAS-7 and
statement in changes in equity in accordance with BAS-1 and
status of liquidity.
Standards are of little value unless they are observed. The real
challenges therefore lie in application of the standards. The
main challenges faced for speedy implementation of
IASs/IFRSs are the following (Nayeem, The Bangladesh
Accountant; October- December,’05.):
• Lacking of general awareness about BAS/IAS.
• Lacking of proper understanding and technical knowledge.
• Lacking of overall accountability and transparency.
• The deep-rooted culture and strong mind set of the
management for minimum disclosure mainly with a view
to pay least tax or no tax.
• Recommendatory nature of BAS, so far ICAB members
are concerned.
• Lack of implementation guidelines for BASs/IASs
application.
As a result Banking Sector, one of the leading structured
industries controlled by the BB, in what extend the
accounting standards are complied with, is of our prime
concerning matter in this paper.
Objective of the study:
The main objective of the research work is to examine
whether the banking companies of Bangladesh followed or
observed the adapted IASs and IFRSs. To achieve this main
objective, the followings specific objectives of the study are
identified:
a. To examine the disclosures of the minimum requirements
of Income Statement and Balance Sheet items as per IAS-
30 (Para 9, 10, &19).
b. To know whether the statement of changes in Equity
disclosed according to IAS-1 (Para-96) or not.
c. To verify the minimum requirements in disclosing
accounting policies as per IAS-1 (Para-99, 108,110).
d. To know the application of IAS-7 (Para-1, 10, 13) in
presenting cash flow statement.
e. To highlight the various issues of IAS-30 (Para-24, 25,
26, 30, 40).
f. To test whether the companies observed or not the IAS-
16 (Para-73), IAS-33 (Para-66, 69, 70), IAS-10 (Para-21).
Methodology & Scope of the Study:
Secondary data as well as desk research method was used for
the purpose of the study. Secondary data and information
were collected from existing literature in the field of
international accounting. Out of 30 private commercial
banking companies, 12 were selected randomly for the
purpose of the study. All the selected companies’ annual
reports of 2007 were considered for examining the
application of IAS/IFRS in disclosing or preparing financial
statement. Though, a great number of important issues were
available for checking but the authors considered the existing
emergent issues of IASs/IFRSs that has a public interest
globally. In desk research, the supporting and relevant
The Bangladesh Accountant/January- March 2010 2

Accounting
research material were evaluated in order to present the facts
in a logical format. It covered research papers, articles, text
books, publications, web sites of international accounting
standards setting bodies, Bangladesh Bank annual reports
different published statistics related to banking companies
and various published and unpublished research materials on
this subject.
At present, there are 48 banking companies in Bangladesh out
of which four nationalized commercial banking companies,
five specialized banking companies, 30 private commercial
banking companies and nine foreign commercial banking
companies. From these, the study was limited to only private
commercial banking companies which covered only 40
percent of Private Commercial Banks (PCBs) and 25 percent
of total banking companies. It is also noticeable that the study
covered only the period of 2007(January-December).
Analysis and Finding:
Minimum requirements for Balance Sheet items according to IAS-30 (Para 19):
Assets
Liabilities
a. Cash and balances with Central Bank a. Deposits from other banks
b. Treasury bills and others bills eligible for b. Other money market deposits
rediscounting with central bank
c. Government and other securities held for dealing purposes c. Amount owed to other depositors
d. Placements with and loans and advances to, others banks d. Certificates of deposits
e. Other money market placements e. Promissory notes and other liabilities evidenced by paper
f. Loans and advances to customers f. Others borrowed funds.
Almost all the sample companies follow the IAS requirements but the names of the headings are slightly different from the
above-mentioned headings which are given as follows:
Assets
Liabilities
a. Cash in hand a. Borrowing from other banks, financial institutions
b. Cash balance with Bangladesh Bank (BB) b. Deposits and other accounts
and its agent banks
- Current deposits
c. Balance with other banks and financial institutions - Demand deposits
(in /outside Bangladesh)
- Bills payable
d. Money at call and on short notice (with banking/ - Saving bank deposits
non-banking companies)
- Short term deposits
e. Investment in government securities - Fixed deposits
f. Investment in others - Bearer certificates of deposits
g. Loans and advances - Other deposits
h. Bills purchased and discounted
i. Fixed assets
IAS-30 (Para 24 and 25):
The fair values of each class of financial assets and financial liabilities, as required by IAS-32 and IAS-39, should be disclosed.
According to IAS-39, the four classifications of financial assets are:
a. Loans and receivables originated by the entity No financial companies follow the classifications and not disclosed
b. Held to maturity investment any information as required by the section due
c. Financial assets held for trading, and to the incompliance of the paras in BAS-30.
d. Available for sale financial assets.
The Bangladesh Accountant/January- March 2010 3

Accounting
IAS-30 (Para-26): Contingencies and Commitments
including Off-Balance Sheet items.
The disclosures required in this regard are the following:
a. The nature and amounts of commitments to extend
credits that are irrevocable because they can not be
withdrawn at the discretion of the bank without incurring
significant penalty or expenses.
b. The nature and amount of contingencies and
commitments arising from off balance sheet items
including those relating to,
i. Direct credit substitutes, which include general
guarantees of indebtness, bank acceptances and
standby letters of credits, which serve as financial
back up for loans and securities.
ii. Transaction related contingencies, which includes
performance bonds, bid bonds, warranties and stand
by letter of credit related to particular transaction.
iii. Short term self liquidating, trade related contingent
liabilities arising from movement of goods such as
documentary credits where underlying shipment is
used as security and
iv. Other commitments including other Off-Balance
Sheet items such as revolving underwriting
facilities and note issuance facilities.
All the sample companies disclosed off-balance sheet items
as contingencies and commitment but Bangladeshi banking
companies (sample) hasn’t any information about
commitments rather than following contingencies headings:
Contingent Liabilities:
a. Acceptances and endorsements
b. Letters of guarantee
c. Irrevocable Letters of Credit
d. Bills for collection
e. Other contingent liabilities.
IAS-30 (Para-30):
An analysis of assets and liabilities into relevant maturity
groupings based on remaining periods at the balance sheet
data to the contractual maturity date should be disclosed.
All the sample companies maintained the section by
disclosing the following groups-
- On demand
- Less than three months
- More than three months but less than one year
- More than one year but less than five years
- More than five years.
The Bangladesh Accountant/January- March 2010 4

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The Bangladesh Accountant/January- March 2010 8

Accounting
3. Companies should report on their market risk by
analyzing different types of market variables such as
interest rate, exchange rate and equity markets.
Not only qualitative information but also present or prepare a
quantitative interest rate sensitivity position for future
decision making.
4. For measuring currency risk, companies should prepare
a schedule of breakdown of assets and liabilities by
currencies.
5. The companies should disclose equity risk, issuer risk,
credit risk and liquidity risk. All these risks can be
measured by maturity analysis of assets and liabilities.
6. Risk Weighted Assets (RWA) basically depends on
credit risk, other assets and market risk. The company
should prepare a schedule to understand the degree of
risk involved in assets.
7. In the cash flow statement, the following matters should
be disclosed:
a. Amount of indrawn borrowing facilities including
restriction on their use, if any.
b. Amount of cash flows segregated by reported industry
and geographical segments.
8. All the banking companies should follow companies
should follow the similar depreciation method.
9. Losses on loans and advances should be disclosed
according to IAS-30 (Para-39).
n
REFERENCES:
Ahmed, Jamaluddin Karim, and Wares, AKM, 2005, Compliance to International Accounting Standards in Bangladesh, The Bangladesh Accountant (July
–September): 23-41.
Annual Report, 2006- 2007, Bangladesh Bank.
Azizuddin, B.M., 2001, IAS 30: Disclosure in the Financial Statements in Banks and Similar Financial Institutions – Its Adoption and implementation, The
Bangladesh Accountant (October-December).
Bangladesh Bank Bulletin (April-June), 2007.
Bangladesh Bank Quarterly (April- June), 2008, 5(4).
Epstein, Barry J., and Mirza, Abbas Ali, 2005, Willey IFRS 2005: Interpretation and Application of IASs and IFRSs: 848-900, Hoboken, New Jersey: John Willey
and Sons Inc.
Hye, Md. Abdul,1984, An Evaluation of the Annual Reporting Practices of Some Selected Corporation, The Bangladesh Accountant (October-December),
8(2):10-22.
Hye, Md. Abdul, 1985, Accounting Standards and Bangladesh, The Bangladesh Accountant (July- September).
Hye, Md. Abdul, 1986, An Evaluation of Annual Reporting Practices of the Bima Corporation in Bangladesh, Chittagong University Studies (Commerce).
Hye, Dr. Md. Abdul, 1988, A Study of the Accounting and Reporting Practices of Bangladesh Shipping Corporation, Chittagong University Studies (Commerce),
4:167-190.
Kamal, Mohammed Mostafa, 2007, Productivity, Profitability of National Commercial Banks of Bangladesh: A Comparative Analysis, The Cost and Management
(March- April),35(2):19-28.
Muttakin, Mohammed Badrul, 2002, The Practice of Cash Flow Statement- A Study of Cement Companies, The Cost and Management Accountant (July
–August), 30(4): 4-8.
Nag, Amal Bhusan, 1990, Setting and Implementation of Accounting Standards in India & Bangladesh, Association of Management Development in South Asia,
Hyderabad.
Nayeem, ASM, 2005, Status of BASs, IASs/IFRSs & Challenges faced and steps taken by Bangladesh for speedy Adoption of IASs/IFRSs, The Bangladesh
Accountant (October- December): 58-69.
Purohit, Kanchan Kumar, and Bhaacharjee, Milan Kumar, Financial Reporting Practices By the Banking Companies of Bangladesh and IAS-30: 100-111,
Kalkata: Commerce Education in the New Millennium.
Sarma, Binoy Krishna, 1987, Conceptual Framework of Accounting, Chittagong University Studies (Commerce).
Sarma, Dr. Binoy Krishna, 1993, Some Aspects of Accounting Standards, Chittagong University Studies (Commerce), 9:209-230.
Schedule Banks Statistics Quarterly (July- September), 2007.
Uddin, Md. Salim, 2005, Interim Financial Reporting: An overview, The Bangladesh Accountant (October- December): 153-166.
Uddin, Md. Salim, 2006, Harmonization of Accounting Standards: Global Perspective, The Bangladesh Accountant (January-March): 79-94.
Appendix –A:
1. Shahjalal Islami Bank Limited.
2. Pubali Bank Limited.
3. Standard Bank Limited.
4. AB Bank Limited.
5. Dhaka Bank Limited.
6. One Bank Limited.
7. Dutch-Bangla Bank Limited.
8. National Bank Limited.
9. Bank Asia Limited.
10. NCC Bank Limited.
11. EXIM Bank Limited.
12. Trust Bank Limited.
The Bangladesh Accountant/January- March 2010 9

Accounting
Determinants of Financial Reporting Outcomes Following
IFRS Adoption-Implications for Bangladesh
Sumon Bhattacharjee
Md Shakawat Hossain
Abstract:
The adoption of IFRS around the world is occurring rapidly
to bring about accounting quality improvement through a
uniform set of standards for financial reporting. But recent
accounting literature provides the evidence that at least part
of the observed quality improvements around voluntary
adoption is driven by the changing incentives rather than the
standards per se. This article is an effort to review the
research on the consequences of changing accounting
standards and to portray the determinants financial reporting
outcomes following IFRS adoption. We argued that, financial
reporting outcomes depends on a variety of factors that
influence those outcomes and accounting quality does not
depend only on accounting standards but also on the firm’s
overall institutional setting, including the legal and political
system of the country in which the firm resides. Thus other
factors like incentives, enforcement mechanism, ownership
structure, capital structure, market and legal forces and cost
benefit trade off deserves equal importance as adoption of
IFRS. IFRS has an effect on accounting quality but adoption
of IFRS is actually a manifestation of other underlying
factors. We also highlighted the issues that are hindering
contribution of IFRS adoption as a determinant of financial
reporting outcomes in Bangladesh.
1. Introduction
International accounting literature provides evidence that
accounting quality has economic consequences, such as costs
of capital (Leuz and Verrecchia, 2000), efficiency of capital
allocation (Bushman et al., 2006; Sun, 2006), and
international capital mobility (Young and Guenther, 2002).
Following the recent adoption of IFRS/IAS 1 in many regions
of the world, much attention is being given to the association
between accounting standards and accounting quality.
However, research in the accounting literature convincingly
concludes that accounting standards alone do not determine
financial reporting outcomes (see, e.g., Ball, Robin, and Wu
[2003], Leuz, Nanda, and Wysocki (2003), or see the survey
by Leuz and Wysocki (2008). By financial reporting
outcomes, we mean the quality of financial reporting,
measured in a variety of ways. Many forces shape the quality
of financial reporting, and accounting standards should be
viewed as but one of those forces. Indeed, the international
accounting literature suggests that the effect of accounting
standards alone may be weak relative to the effects of forces
such as managers’ incentives, auditor quality and incentives,
regulation, enforcement, ownership structure, and other
institutional features of the economy in determining the
outcome of the financial reporting process.
Improvement in the information environment following
change to IFRS is contingent on at least two factors. First,
improvement is based upon the premise that change to IFRS
constitutes change to a GAAP that induces higher quality
financial reporting. For example, Barth et al. (2006) find that
firms adopting IFRS have less earnings management, more
timely loss recognition, and more value relevance of earnings,
all of which they interpret as evidence of higher accounting
quality. Second, the accounting system is a complementary
component of the country’s overall institutional system (Ball,
2001) and is also determined by firm’s incentives for
financial reporting. La Porta et al. (1998) provide the first
investigation of the legal system’s effect on a country’s
financial system. They find that common law countries have
better accounting systems and better protection of investors
than code law countries. Other factors associated with
financial reporting quality include the tax system (Guenther
and Young, 2000; Haw et al.; 2004), ownership structure
(Ball and Shivakumar, 2005; Fan and Wong, 2002), the
political system (Leuz and Oberholzer-Gee, 2006), capital
structure (Sun, 2006), and capital market development (Ali
and Hwang, 2000) 2 .
In Bangladesh, the Securities and Exchange Commission
(SEC) requires the issuers of listed securities to prepare
financial statements in accordance with the requirements laid
Sumon Bhattacharjee, Lecturer, Department of Accounting and Information Systems, University of Chittagong and Md Shakawat
Hossain, Lecturer in Accounting , National University, Gazipur.
The Bangladesh Accountant/January- March 2010 10

Accounting
down in the Regulations and the IFRSs as adopted by the
Institute of Chartered Accountants of Bangladesh (ICAB).
Despite the focus on regulation, this paper should not be
understood as advocating the necessity of regulation or
reforms to existing regulations. In fact, we highlight the
importance of market forces in influencing firms’ disclosure
and reporting choices, both in isolation as well as interactions
with regulatory acts.
2. Objectives of the study
The main objective of the paper is to review the theoretical
and empirical literature on the economic consequences of
financial reporting and disclosure regulation, with a particular
emphasis on recent research advances in the field of IFRS
adoption and disclosure regimes. The specific objectives are –
- To list the determinants of financial reporting outcomes
following IFRS adoption.
- To highlight that ensuring quality of accounting
information is a joint outcome of market forces and the
incentives provided by various rules and regulations
(including the quality of their enforcement).
- To find out some country specific and industry specific
legal and economical issues, in the context of
Bangladesh, that deserve equal degree of attention to
IFRS adoption and enforcement for ensuring disclosure
quality.
3. Methodology of the study:
The study has been conducted mainly on the basis of
literature survey and secondary information. Various journals
and research papers, diagnostic study reports and newspaper
articles have been surveyed in making this study. Few
academicians and qualified accountants (Chartered
Accountants and Cost and Management Accountants) have
been personally consulted with in order to have their thoughts
in this regards.
4. Determinants of Financial Reporting Outcomes:
Financial reporting outcomes (can also be expressed as
quality of financial reporting) reflect the overall
informativeness of a firm’s disclosures and depends on the
amount, timeliness, and precision of the disclosed
information. Such outcomes are ensured by a firm’s
effectiveness in communicating with investors and the extent
to which a firm’s aggregate disclosures ensure that investors
have the information necessary to make informed judgments.
To remain with the main idea of the paper, we specified the
determinants of financial reporting quality as follows-
Figure 1 depicts a schematic framework describing
determinants of disclosure quality of accounting. It shows
that accounting standards, legal and political systems,
incentives of financial reporting and the cost of adoption all
affect accounting quality. 3 Although conversion to IFRS is
likely to affect financial reporting, it is only one of the
determinants of overall accounting quality.
Financial reporting is determined by the quality as well as the
cost of adoption of accounting standards (arrow 1 in Figure
1). Comprix et al. (2003) find that positive market reaction to
the news on the possibility of IFRS adoption in the EU is
related to the number of new disclosures and accrual
measures under IFRS relative to respective national
standards. As far as financial reporting quality is concern, the
IASB has done remarkably well in developing a nearly
complete set of standards that, if followed, would require
companies to report “high quality, transparent and
comparable information. 4 ” The ICAB has its objectives as to
“develop ... high quality, understandable and enforceable
global accounting standards … that require high quality,
transparent and comparable information … to help
participants in the world’s capital markets and other users
… 5” Besides ensuring quality of standards, we must provide
importance on the cost of adoption of IFRS (for the individual
firm and industry within the country’s institutional settings)
and the compliance costs associated with transition from local
GAAP to IFRS. It has been suggested that the incremental
cost of changing from domestic GAAP to IFRS may have
been significant for some firms, and this may be especially
true under this mandatory setting (ICAEW 2007). Prior
research has found that firms that voluntarily adopt IFRS tend
to be larger firms and are therefore able to benefit from
economies of scale. 6
In addition to the quality of standards, adoption and
enforcement mechanism have to be effective. Nevertheless,
we think that using a single set of accounting standards may
not improve accounting quality uniformly for each firm
because of additional factors such as legal and political
systems and incentives of financial reporting that may affect
earnings quality. The existing literature on accounting quality
improvement through voluntary IFRS adoption will be
discussed in the next point.
Legal and political systems influence quality of financial
reporting in several ways. First, they affect accounting quality
indirectly through accounting standards (arrow 2 in Figure 1).
Accounting standard setting is a political process, in which
users of accounting such as tax authorities, banks,
shareholders, managers, and labor unions have significant
influence on standard setters. In an effort to reduce the
political influence on standard setting, in 2001, the IASC was
replaced by the IASB. The IASB is responsible only to a non-
The Bangladesh Accountant/January- March 2010 11

Accounting
for-profit organization, the IASC Foundation. This change
mirrors the model in the U.S., where the Accounting
Principles Board (APB) of the American Institute of Certified
Public Accountants (AICPA) was replaced by the FASB in
1972 because of its lack of independence. 7 Even with
increased independence, the IASB continues to be under
enormous pressure from global politics (Soderstrom and Sun,
2008). In Bangladesh, the adoption of IASs was actually
initiated by the international agencies and the whole process
eventually transformed into political exertion (See Mir et al,
2005, p. 826). The SEC of Bangladesh then empowered the
ICAB to adopt those standards specified by SEC and the
Government of Bangladesh. At present, a committee named
“Research and Technical Committee (RTC)” under the ICAB
is working to give acceptance to the IASs for adoption in
Bangladesh. The committee comprises of thirteen members
and all of them are Chartered Accountants. Though we can
not provide evidence to prove lack of independence of ICAB
as a standard setter, but, considering the history and current
position of FASB and IASB as well as legal and political
background of Bangladesh, we can fairly express our doubt
about it.
Legal and political systems also affect accounting quality
directly, through enforcement of accounting standards and
litigation against managers and auditors (arrow 3 in Figure 1).
La Porta et al. (1998) find that legal enforcement is higher in
common law countries. This enforcement role of legal
systems is especially important when considering the
accounting quality following the adoption of IFRS. The IASB
issues IFRS, but does not have enforcement power.
Enforcement power thus resides in the security exchanges and
courts where firms are listed (Schipper, 2005). In Bangladesh,
there is ambiguity of role and responsibility of the SEC and
the ICAB. Once the adoption process is over the SEC then
has the responsibility, as delegated by the Government of
Bangladesh, to monitor compliance with these standards by
listed companies. According to the Sec 12 (2) of the
Securities and Exchange Rules 1987, ‘the financial statements
of an issuer of a listed security shall be prepared in
accordance with the requirements laid down in the Schedule
and the International Accounting Standards/IFRSs as adopted
by the Institute of Chartered Accountants of Bangladesh’.
Though the SEC does not participate in the IAS/IFRS
adoption process, it is the only regulatory body in Bangladesh
enforcing IASs/IFRSs for the listed companies.
Political systems also directly affect accounting quality.
Political rent-seeking is prevalent in countries with corrupt
political systems. Firm managers and owners have incentives
to bribe politicians to seek favorite treatment such as
purchase orders from governments, lower tax payments, and
monopoly status. They, therefore, have incentives to omit
such bribes from financial statements to avoid political and
social scrutiny. Moreover, firms in countries with a higher
possibility of government interference are likely unwilling to
show high profits in an effort to avoid government
expropriation. Bushman and Piotroski (2006) find that firms
in code law countries with high risk of government
expropriation expedite bad news recognition.
Legal and political systems affect accounting quality
indirectly through different factors that can provide incentives
to different related parties on the basis of their financial
reporting (arrow 4 in Figure 1). First of these factors is
financial market development. Strong investor protection and
lower levels of government expropriation guarantee investors
a return on their investments and increases the number of
investors who are willing to provide financing. La Porta et al.
(1998) find that the character of legal rules and the quality of
law enforcement determine the size of capital markets.
Because the demand for accounting information is dependent
on the nature of financial markets, and the legal and political
systems impact the markets 8 , characteristics of the legal and
political systems will impact the quality of earnings, a
common GAAP notwithstanding.
Legal and political systems also affect accounting quality
indirectly through capital structures. In countries with high
creditor protection, firms are more easily able to get bank
financing at lower cost. In countries with high possibility of
government expropriation and corruption, contracting is
mostly completed privately to avoid social and political
scrutiny, and financial reporting is a less frequently used
method to reduce information asymmetry.
Incentives derived from different ownership structure also
affect financial reporting outcomes. Firms with concentrated
ownership and high divergence between cash flow rights and
control rights have low incentives for financial reporting. Ball
and Shivakumar (2005) and Burgstahler et al. (2007) find that
earnings quality of private firms is lower than that of public
firms, although both groups are subject to the same
accounting, tax, and auditing standards.
Finally, legal and political systems affect accounting quality
through tax systems. Earnings are less likely to reflect
underlying business in a country with a close linkage between
financial accounting income and taxable income (Guenther
and Young, 2000). A high tax rate will increase the incentive
to reduce taxable income. Burgstahler et al. (2007) find that
European firms in high book-tax-alignment and high tax-rate
countries manage earnings more. Moreover, a country’s tax
authority has statutory power in verifying a company’s
profits. Tax authorities’ demand for disclosure can be
different from shareholders’ because there is no beneficiary
of tax collection other than the government. Haw et al. (2004)
find that a country’s tax compliance is associated with lower
The Bangladesh Accountant/January- March 2010 12

Accounting
earnings management, and has a greater effect than judicial
system efficiency in curbing earnings management.
Incentives in direct or indirect forms received by all the
relevant parties associated with financial reporting affect its
quality. For an individual firm, ensuring reporting quality
reduces the cost of capital; for example, Merton (1987).
Moreover, higher quality financial reporting and better
disclosure should reduce adverse selection problems in share
markets and lower estimation risk (e.g., Verrecchia (2001),
Lambert, Leuz, and Verrecchia (2007)) thus reduce the cost
of capital. Francis et al. (2005) find that firms in need of
external financing voluntarily disclose more information than
a country’s minimum requirement and have lower costs of
capital. Many studies in agency theory suggest that more
transparency and better corporate governance increases firm
value by improving managers’ decisions or by reducing the
amount that managers appropriate for themselves (e.g.,
Shleifer and Wolfenzon, 2002). 9 Additionally, an individual
firm’s disclosures may have externalities that benefit noncompeting
firms in other industries by revealing relevant
information about new consumer trends, technological
shocks, best operating practices, governance arrangements,
etc. While the incremental contribution of each firm’s
disclosure is likely to be small, these information transfers
could carry substantial benefits for the market or the economy
as a whole. Dye (1990) and Admati and Pfleiderer (2000)
analyze positive externalities in the form of information
transfers and liquidity spillovers in capital markets. Corporate
disclosure can mitigate the adverse selection problem and
increase market liquidity by leveling the playing field among
investors (Verrecchia, 2001).
The final determinant of accounting quality outcome is the
cost an individual firm has to incur for fair reporting and the
disclosure pressure appeared from the investors and/or
creditors and the regulatory requirements (Arrow 5). The
direct costs of ensuring reporting quality, including the
preparation, certification and dissemination of accounting
reports, are conceptually straightforward. Undoubtedly, fair
reporting is a matter of maintaining an effective information
system which is a matter of massive expense. In Bangladesh,
a significant portion of the business community does not
consider transparency as an essential criterion for financial
reporting. Moreover, fixed disclosure costs lead to economies
of scale and can make certain disclosures particularly
burdensome for smaller firms. In a country with very low
market control like Bangladesh, such disclosure costs can
also occur as an opportunity lost for individual firms from
getting excessive return. For example, disclosing actual
production cost would create burden for overpricing a product
and similarly actual income disclosure would force the firms
to pay higher tax which can be managed through corrupt
practices with the regulators. Disclosures can also have
indirect costs because information provided to capital market
participants can also be used by other parties (e.g.,
competitors, labor unions, regulators, tax authorities, etc.).
For example, detailed information about line-of-business
profitability can reveal proprietary information to competitors
(e.g., Hayes and Lundholm, 1996).
We have discussed the determinants of financial reporting
outcomes. In fine, we can argue that, we should focus not
only on the adoption of quality standards (local or
international) but also on the cost of adoption of such
standards as well as the cost to be incurred for and incentives
to derived from fair financial reporting. The cost incentive
factor of financial reporting can be better expressed as-
Financial reporting incentives stem from both the supply and
demand for information. Ball (2001, p.131) argues that “all
parties contracting or contemplating contracting with the firm
demand information about the firm’s ability to meet its
contractual obligations. Firms therefore agree to incur the
costs of supplying information, and in return they receive
better terms of trade from factor owners and customer”.
Financial reporting is therefore an equilibrium outcome from
the cost of disclosure, which includes the cost of preparing
financial reports and leaking proprietary information, and
from the benefit of meeting contracting parties’ demand for
information.
5. IFRS adoption and financial reporting quality
Existing literatures document improvements in accounting
quality following voluntary IFRS adoption (e.g., Barth et al.,
2006; Gassen and Sellhorn, 2006; Hung and Subramanyam,
2007; Barth et al., 2008; Christensen et al. 2008) to reduce
information asymmetry between managers and shareholders
and it can be evidenced by proper assets and earnings
management, lower cost of capital, and high forecasting
capability by the investors about firm’s future earnings.
Gordon (2008) listed the benefits from adaptation of IFRS
globally as-
• Better financial information for shareholders;
• Better financial information for regulators;
• Enhanced comparability;
• Improved transparency of results;
• Increased ability to secure cross-border listing;
• Better management of global operations; and
The Bangladesh Accountant/January- March 2010 13

Accounting
• Decreased cost of capital.
Barth et al. (2006) suggest that accounting quality could be
improved with elimination of alternative accounting methods
that are less reflective of firms’ performance and are used by
managers to manage earnings. Barth et al. (2006; 2008) also
found that an international sample of firms that voluntarily
adopted IFRS up to 2003 exhibits lower levels of earnings
management and more timely loss recognition than a matched
sample of firms using local GAAP. As an extension of these
findings, Daske et al. (2007) focus on the heterogeneity in the
consequences of voluntary IFRS adoption and find that on
average capital markets respond modestly to voluntary IFRS
reporting.
IFRS adoption could make it less costly for investors to
compare firms across markets and countries (e.g., Armstrong
et al., 2007; Covrig, Defond, and Hung, 2007). Also reducing
international differences in accounting standards through the
adoption of IFRS assists to some degree in facilitating
international integration of capital markets (Covrig, Defond,
and Hung, 2007) by removing barriers to cross-border
acquisitions and divestitures, which in theory will reward
investors with increased takeover premiums (See Bradley,
Desai and Kim, 1988). To signify the effect of IFRS on
investors’ ability to forecast earnings; some researchers argue
that better accounting standards make reported earnings less
noisy and more accurate, hence more “value relevant.” (e.g.,
Ashbaugh and Pincus (2001), Hope (2003)). Other things
equal (for example, ignoring enforcement and
implementation issues for the moment) this would make
earnings easier to forecast and would improve average analyst
forecast accuracy.
All the above studies show the evidence on the association
between voluntary IFRS adoption and financial reporting
outcomes. A common feature of these studies is their focus
on voluntary adopters to establish the link between IFRS
compliance and accounting qulaity, which by definition suffer
from selection bias (Asbaugh, 2001). This raises the question
as to whether we can attribute the improved quality to the
application of IFRS per se. That is, does the application of
IFRS have an incremental effect on accounting quality, or is
the observed quality improvement a result of other changes
implemented simultaneously by the adopting firms? Let us
review the literature that may provide answer to the query.
Several papers provide empirical evidence that express
doubts on standards to be the sole force for ensuring
accounting quality. For example, Ball, Robin, and Wu (2003),
show that financial reporting quality is low in Hong Kong,
Malaysia, Singapore, and Thailand despite presumably high
quality reporting standards because the institutional structure
provided incentives to issue low-quality reports. They also
argue that countries that want to increase financial reporting
quality have to think about changes in managers and auditor’s
incentives and other institutional features and that those may
be more important than mandating higher quality reporting
standards. They continued that the pressure to reduce
variation in accounting standards across countries will not
resolve differences in the quality of financial reporting. 10
Daske et al. (2008) provide evidence that the effects of
voluntary adoption of IFRS on market liquidity and the cost
of capital depend on whether the voluntary adopters make a
serious commitment to transparency; they find that only those
making a commitment to transparency experience significant
capital-market effects. They also find that the capital-market
benefits associated with mandatory adoption of IFRS occur
only in countries where firms have incentives to be
transparent and where legal enforcement is strong. Thus, both
of these papers suggest that the mere adoption of IFRS does
not lead to effective financial reporting outcomes, at least not
initially.
Leuz (2006) argues that the degree of concentration in
ownership structures affects managers’ incentives to manage
earnings and provides evidence that more concentrated
ownership structures result in greater earnings management.
Leuz [2006] argues that even if enforcement were held
constant, ownership structure, home-country market forces,
and varying incentives for earnings management would lead
to differences in the quality of financial reports. Thus, as long
as there is discretion in financial reporting (and it is hard to
believe that discretion could or should ever be eliminated),
even strict enforcement will not successfully eliminate all of
the variation in reporting quality.
Other studies, such as Ball and Shivakumar (2005) and
Burgstahler, Hail, and Leuz (2007), among others, support the
view that changes in standards alone will not lead to
substantially similar financial reporting outcomes and that
again the standards may be less important than the other
institutional features of the reporting and legal environment.
This argument is evidenced by the financial reporting
scandals in the USA, the UK, and Australia, among others,
after several decades of standards.
In fine, we can say that, market and incentive forces are
indeed powerful and hence it is not surprising that financial
reporting outcomes will be strongly influenced by incentives
of managers and auditors, the nature of the ownership
structure of corporations, other market and political forces in
the home country, and the degree of enforcement in the home
country, even if accounting standards are held constant.
Indeed, accounting standards (whether local or IASs) per se,
do not improve the quality of financial reporting, while other
environmental factors need to be carefully considered.
6. Financial Reporting Scenario in Bangladesh:
The financial reporting of all countries of the world is
regulated by one or more legal structure. In Bangladesh,
financial reporting practices of different types of companies
are controlled by the following legal structure:
The Bangladesh Accountant/January- March 2010 14

Accounting
Till today, The Companies Act 1994, which is the legal
framework regulating the functions of limited companies
(both listed and unlisted), is quite silent about the application
of IASs in Bangladesh. Despite silence of the Act, many
listed companies (local and foreign) follow IASs in
compliance with Securities and Exchange Commission Rules
1987, which made IASs mandatory for the listed by amending
the rule number 12(2) vide notification no. SEC/Section-
7/SER/03/132, dated 22 October 1997. That is, the SEC is the
only regulatory body working to improve the quality of
financial reporting. Quite surprisingly, no effective
mechanism exists to enforce requirements for accounting and
financial reporting provided in the Companies Act 1994, and
the same is true for the regulators of the banking and the
insurance companies of Bangladesh (ROSC, p.6-7). In line
with the stipulated requirements a Standard Disclosure and
Compliance Checklist has been developed under the ICAB
World Bank finance project for use of all concerned as a
model checklist. The checklist has become an important
framework of Financial Reporting of Bangladesh. But, in
general, actual accounting and disclosure practices in
Bangladesh fall far short of the applicable requirements and
the compliance gaps demonstrate serious weaknesses of
corporate financial reporting (ROSC, p 8).
7. Issues Hindering Application of IFRS as a
Determinant of Reporting Outcome in Bangladesh-
In the above points, we signified quality of standard as a
determinant of disclosure quality and also reviewed literature
on accounting quality improvement through IFRS adoption
over the world. IASs have become an integral part of the legal
framework of Bangladesh from 1997 by inserting section
12(2) into the Securities and Exchange Rules 1987. The
ICAB has so far adopted 29 out of 34 IASs and all issued
IFRSs as Bangladesh Accounting Standards (BAS) and
Bangladesh Financial Reporting Standards (BFRS)
respectively. But financial reporting practices are far away
form achieving required accounting quality. We have
identified following issue relating to IFRS adoption that are
to be considered for ensuring the contribution of standards on
financial reporting outcome in Bangladesh.
Role of Management is ignored: Business houses are the
field of IAS implementation. But in Bangladesh, the
management of the business organizations are nowhere in the
acceptance and adoption process of IASs/IFRSs in
Bangladesh. IASs/IFRSs have been imposed on the business
organizations paying no attention to their stand and problems
with IASs/IFRSs (see Paul, 2005). Consequentially, it has
become a choice for the business organization. Business
houses, which are thinking of getting some marginal benefits
by the implementation of IFRS, are adopting IFRS
voluntarily. Whereas, other business houses, who do not
perceive the incentives from implementing IFRS as sufficient,
are adopting IFRS only to follow mandatory rules without
actually following it. In Bangladesh, due to weak
enforcement mechanism and lack of auditors’ independence,
it is not difficult at all to avoid the pains of adopting IFRS
even by the listed companies which are bound to follow
standards as per SEC rules. It is evidenced by a diagnostic
study carried out in Bangladesh by a team from World Bank,
in which a large number of financial statements of listed
companies were reviewed by the consultants. It revealed-
Most of the reviewed financial statements had material
noncompliance with one or more requirements of the
applicable IASs. Despite these irregularities, the auditors
issued an unqualified audit report on the financial statements.
(ROSC, p 11)
Problems of fair value: IFRSs are instilled into fair value
The Bangladesh Accountant/January- March 2010 15

Accounting
accounting (FVA). Particularly 11 IFRS 2 (share-based
payments to be accounted at fair value); IFRS 3 (minority
interest to be recorded at fair value); IAS 16 (fair value option
for property, plant and equipment); IAS 36 (asset
impairments (and impairment reversals) to fair value); IAS 38
(intangible asset impairments to fair value and some others);
IAS 39 (fair value for financial instruments other than loans
and receivables that are not held for trading, securities held to
maturity; and qualifying hedges (which must be near-perfect
to qualify) 12 ; and IAS 40 (fair value option for investment
property). Some conditions in Bangladesh are not favorable
for implementing FVA like achieving observable market
prices or independently observable, accurate estimates of
liquid market prices that cannot be materially influenced by
managers due to less perfect market liquidity. Moreover, new
fair value disclosures could potentially increase the volatility
of earnings and make them more difficult to predict
increasing uncertainty about earnings and thereby increasing
forecast dispersion even though the market is potentially
better informed about the firms’ economic prospects. Brown
[1983] and Elliott and Philbrick [1990] reported evidence
consistent with this possibility for US firms.
Only compliance with IFRS does not ensure full
disclosure: It is quite often seen that, in a rule based
regulatory system, financial reporting requirements are
narrowly viewed as embodied in rules, not principles, and
compliance with rule-based GAAP is considered sufficient.
For example, in the most scandalous cases like Enron,
financial statements were found to be in technical compliance
with GAAP but that did not reflect the economic substance of
the transactions they were reporting. A “rule checking”
mentality to have crept over the accounting profession,
including the Financial Accounting Standards Board (FASB,
a fittingly named successor to the Accounting Principles
Board), audit firms, researchers and educators. (See Ball
2008).
Not all the IFRSs are relevant in the context of
Bangladesh: There are some IASs adopted by ICAB that
may be grouped as irrelevant to Bangladesh context. These
IASs are Income Taxes (IAS 12), Post Employment Benefits
(IAS 19), Accounting for Govt. Grants (IAS 20), Business
Combination (IAS 22), Interests in Jointly Controlled
Operation (IAS 31), Financial Instruments (IAS 39) and
Agriculture (IAS 41). Another problem of the adoption of
IASs is the lack of IAS for major sectors of the Bangladeshi
economy. This includes the jute, tea, garment, and oil and gas
sectors. Apart from that, general remarks of the highly
interested groups (other than ICAB members) is that most of
the IASs/IFRSs are adopted in Bangladesh are adopted
directly without modification and wholesale importation of
the highly sophisticated rules like IASs/IFRSs is not suitable
for the less sophisticated economic and regulatory structure of
Bangladesh (See Mir et al, 2005, p. 835) Such situation is
also evidenced by the observation of Bangladesh Enterprise
Institute (BEI) 13 .
Ownership structure and low capital market dependency:
Bangladesh lagged behind its neighbors and the global
economy in corporate governance (Gillibrand, 2004). One
reason for this absence of corporate governance is that most
companies are family oriented. A recent stream of literature
argues that controlling shareholders and corporate insiders
(e.g., the family in the preceding example) can extract
substantial private benefits from firms and thereby effectively
expropriate outside investors (e.g., Shleifer and Vishny,
1997). As a result, controlling insiders may be reluctant to
provide disclosures that limit their ability to consume private
benefits. That is, controlling insiders may not seek a
disclosure commitment, even when it increases firm value
and reduces the cost of capital.
Problems with the issuer and the implementers: There has
always been a conflict of interest arising from audit firms
performing non-audit work for clients. To many observers,
auditors had incentives to appease their clients by giving
them favorable audit treatment, in order to retain lucrative
consulting engagements. The situation in Bangladesh is even
worse due to lack of professional independence. In an
interview, a SEC official elaborates:
. . . we are a bit disappointed about the roles played by
auditors concerning compliance with IASs for preparing
financial statements . . . they are signing reports without
properly investigating whether compliance is okay . . . If this
continues like that we will never be able to make sure
concerning the compliance with IASs in Bangladesh (see Mir
et al., p 830)
Moreover, to apply and implement IFRS properly and
sensibly, the account preparers of the firms have to have
adequate expert accountant. In Bangladesh, due to the limited
supply of well-skilled, qualified accountants (chartered
accountant), corporations often hire the lesser-qualified CC
accountants (“CA Course Complete”) for their accounting
departments. (ROSC, p.5)
8. Concluding remarks:
This paper reviews the research on the consequences of
changing accounting standards and discusses determinants of
accounting quality following IFRS adoption. While extant
literature has found a positive impact of IFRS adoption on
accounting quality, we argue that accounting quality after
IFRS adoption hinges on some factors like: 1) the quality and
cost of adoption of the standards; 2) a country’s legal and
political system; 3) financial reporting incentives and 4) cost
The Bangladesh Accountant/January- March 2010 16

Accounting
of fair reporting and disclosure pressure.
We often say about regulatory solution which would in fact
achieve better outcomes or be cheaper than a market solution
(e.g., Stigler, 1971). In the U.S., the Sarbanes-Oxley (SOX)
Act, and the revised, New York Stock Exchange (NYSE) and
NASDAQ listing rules have created more stringent standards
for financial disclosure, committee and board nominations,
and audit policies. In Asia, revised corporate governance
regulations in several countries such as Hong Kong,
Singapore, and India mandate a much stricter standard of
compliance for corporations. But in Bangladesh with poor
legal infrastructure, regulatory processes are far from perfect
and face many problems (e.g., Peltzman et al., 1989). So we
should provide equal importance on both regulatory solution
and market solution simultaneously. In fact, apart form
regulatory effort and quality of standards, financial reporting
outcome is largely dependent on individual firm’s
commitment to transparency, e.g., they may hire higher
quality auditors, improve corporate governance, or change
ownership structures, along with IFRS adoption. Moreover,
firms are likely to be better informed about their cost-benefit
tradeoff with respect to disclosure than regulators.
Accounting quality improvements in connection with the
application of new standards are dependent on the incentives
of those preparing the accounts, rather than on whether the
new standards are perceived to be of higher quality. So, in
Bangladesh, the enforcement authorities (auditors, courts and
regulators), the adopter (ICAB), and the users (Business
community and other parties who does financial reporting)
should seat together to create an environment in which the
determinants discussed above can operate freely.
Analysis of the determinants of accounting quality has
important policy implications. For Bangladesh, future
improvements in accounting quality will be largely dependent
on changes in the country’s legal and political system and
financial reporting incentives. We must try to change the
overall institutional infrastructure for ensuring positive
outcomes of financial reporting. Undoubtedly, it is a difficult
and time consuming process.
So addressing financial reporting incentives as well as
potential costs for such reporting perhaps deserves equal
importance to adoption and enforcement of IFRS in achieving
any further improvements in accounting quality.
n
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1 IASs were issued between 1973 and 2001 by the International Accounting Standards Committee (IASC). In April 2001 the International
Accounting Standards Board (IASB) took over the roles of the IASC and adopted all IAS and continued the development, calling the new
standards IFRS. Terminologically, IAS(s) and IFRS(s) are often used in an exchangeable way.
2 There are many alternative definitions and measures of quality in the accounting literature. For example, Francis et al. (2004) summarize seven
common earnings attributes that are often associated with earnings quality (associating these attributes with firms’ cost of capital).
3 These factors may interact with each other to affect earnings quality. Burgstahler et al. (2007) examine the relation between earnings
management and the interaction among ownership structure, capital market structure and development, tax system, accounting standards, and
investor protection. Ding et al. (2007) examine how a country’s legal system, economic development, the importance of stock markets, and
ownership concentration shape the country’s accounting standards, which in turn affect the country’s quality of financial reporting. A detailed
discussion of these interaction effects is beyond the scope of this paper.
4 Deloitte & Touche LLP provide a comprehensive review of IFRS at www.iasplus.com/dttpubs/pubs.htm.
5 Source: http://www.iasb.org/about/constitution.asp
6 See Harris et al. (1999), Leuz et al. (2000), Ashbaugh (2001), Tarca (2004) Cuijpers and Buijink.(2005).
7 Members of the APB are from public accounting firms, industry and academia, and must be CPAs. The APB is also a committee of the AICPA.
Therefore, the standards issued by the APB, called APB opinions, were subject to various influences by its members’ affiliation and the AICPA.
In contrast, all members of the FASB must sever their private ties with industry and academia.
8 Stulz and Williamson (2003) find that not only legal systems, but also culture and religion are associated with investor protection and the size
of financial markets.
9 See also the surveys by Shleifer and Vishny (1997) and Lambert (2001).
10 See Holthausen [2003] for a discussion of Ball, Robin, and Wu [2003].
11 See also Ball (2005).
12 Available-for-sale securities are to be shown at Fair Value in the Balance Sheet only.
13 A Comparative Analysis of Corporate Governance in South Asia: Charting a Roadmap for Bangladesh (August 2003); Edited by Farooq
Sobhan and Wendy Werner, Published by Bangladesh Enterprise Institute. Can be retrieved at http://www.bei-bd.org/docs/cg1.pdf
The Bangladesh Accountant/January- March 2010 19

Accounting
Islamic Accounting and Traditional Accounting
Some Conflicts and Their Resolutions
Dr Syed Mohammad Ather FCMA
Md Hafij Ullah
Abstract:
Accounting is a mechanism of recording and reflecting the
real financial aspects of any person or organization. This
man-made mechanism is facing some problems in view of
Islamic perspective in recording and reflecting the financial
and others aspects of the organization. But Allah (SWT) and
His Messenger (SAW) gave directions to solve all sorts of
problems faced by mankind in the world. This article is an
endeavor to give an overview of some conflicts of Traditional
Accounting with Islamic Accounting as well as the resolutions
of these conflicts. This Article also highlights the advantages
of Islamic accounting over the Traditional Accounting.
Key Words:
Islamic Accounting, Traditional Accounting, Islamic
Shari’ah,
Introduction:
Accounting is a mechanism of recording and reflecting the
real financial aspects of any person or organization.
Accounting is the process of identifying, recording,
classifying, interpreting and communicating economic events
to permit users to make informed decisions (AAA, 1966).
Like all other disciplines of measuring, recording, and
communicating information, traditional accounting suffers
from some problems. We know that the Al-Qur’an gives right
directions to all aspects of human life and Islam is a complete
code of life (Al-Qur’an, 5:3); Allah (SWT) and His
Messenger (SAW) gave us guidelines regarding every aspect
of human life to be dealt with (Al-Qur’an, 16:89). This paper
is a humble attempt towards the resolutions of the conflicts of
the traditional accounting in the light of Islamic accounting
(based on Islamic Shari’ah).
Objectives of the Study:
The main objective of the study is to provide resolutions of
some problems of traditional accounting in Islamic
perspective. The specific objectives of the study cover the
following areas:
1. To identify and analyze the problems of traditional
accounting.
2. To resolve of the identified problems according to
Islamic accounting.
3. To focus the advantages of Islamic accounting over the
traditional accounting.
Methodology of the Study:
The methodology followed in this study is mainly of library
work basically based on the study of the Holy Qur’an,
Hadiths and related literatures of available accounting written
in traditional and Islamic perspective.
Traditional Accounting:
Traditional Accounting process aims to allow informed
decisions whose ultimate purpose is to efficiently allocate
scarce resources available to their most efficient (and
profitable) uses by providing information efficiency in the
market. Therefore, the accounting systems which identifies,
measures and records the financial aspects of an entity with a
true and fair view and communicates the information to the
interested users is termed as Traditional Accounting (Without
any compliance to Islamic Shari’ah).
Islamic Accounting:
The branch of accounting which sets its goals and performs
all of its activities to achieve those goals ethically and
objectively within the limits and boundary of Islamic Shari’ah
is called Islamic Accounting. Therefore, the accounting
systems which identifies, measures, records and analyzes the
Dr. Syed Mohammad Ather FCMA, Professor, Department of Management Studies, Faculty of Business Administration, University of
Chittagong and Md. Hafij Ullah, Lecturer, Department of Business Administration, Faculty of Business Studies, International Islamic University
Chittagong.
The Bangladesh Accountant/January- March 2010 20

Accounting
financial aspects of an entity on the basis of Islamic Shari’ah
(That is, Rules and Principles of Islam) is termed as Islamic
Accounting.
Problems in Traditional Accounting and their
Solutions in Islamic Accounting:
There are some conflicts between Traditional Accounting and
Islamic Accounting. The following discussion focuses these
conflicts and suggests their resolution.
a. Determination of Zakat:
Muslims are compulsorily required to pay Zakat based on the
value of their wealth if it crosses the ‘Nisab’ (minimum value
of assets for charging Zakat). One of the important objectives
of Islamic financial reporting is to assist in determination of
Zakat (Askary and Clarke, 1997). In case of business, the
trading goods (inventory or stock), cash, current receivables
and marketable securities (Maliah, 2003) after deduction of
any liabilities regarding these items are subject to Zakat
(Quardawi, 2007), Zakat is not paid on fixed assets (capital
assets) such as building, machineries, which are used in the
business to earn revenues (Quardawi, 2007). Computation of
Zakat requires determining the value of these assets at current
market price (Maliah, 2003). Deduction of allowance for
doubtful accounts from gross accounts receivable is not
permissible in computation of Zakat (Clarke et al., 1996).
Reportedly the market value may be difficult to determine,
since it would require the accountant to keep trace of the ups
and downs of market price (Khan, 1989). Notably the balance
sheet, prepared as per traditional accounting, reveals the value
of assets at cost price or at cost or market which ever is lower.
Therefore, valuation of assets in traditional accounting is not
suitable for determination of Zakat. Hence, Islamic
accounting systems recommends recording of assets at
current market price for the computation of Zakat.
b. Determination of Operating Result:
The operating result or net profit for a certain period is
determined deducting the amount of total expenses from the
amount of total revenues of that period. Total revenues and
total expenses are determined considering both the collected
and accrual revenues and paid and accrued expenses as per
accrual concept in traditional accounting respectively. The
application of accrual concept requires subjective judgment
which may be biased and create doubts in account (Napier,
2007). In accrual basis of traditional accounting, profits may
be distributed collecting cash from other sources before
collecting cash from that account which may turn into bad
(Napier, 2007). Considering the above issues, Islamic
accounting recommends Cash basis of accounting where
operating results are determined based on actual collections
of revenues and actual payment of expenses in cash.
c. Determination of Financial position:
One important basic criteria of an account is its relevance but
the accounts prepared based on cost concept of traditional
accounting is not relevant at the point of time when it is
prepared because investors and other related parties are more
interested in what the business is actually worth today rather
than what the assets cost originally (Khan, 1989). Another
characteristic of the accounts is completeness, but the
accounts prepared based on traditional accounting do not
show the complete situation of the organization (Hye &
Yeasmin, 2000). The assets shown on the Balance Sheet
don’t reveal the real financial position of the organization
(Hye & Yeasmin, 2000). Some of the assets (cash and its
equivalent) remain at market values readily at the time of
preparing the financial statements and some stated at their
original costs. When the units of measurement is unstable, the
view can not be true and fair if the suitable adjustments are
not made in the accounts to allow for variations in the value
of money (Grimsley, 1975). As per International Accounting
Standard-2 (IAS-2), the traditional accounting may value
inventory (stock) at lower of cost and net realizable value. As
a result, the reduction in the realizable value of inventory
below cost is recognized immediately but the increase in the
realizable value of inventory is not recognized until the
inventory is sold (Hye & Yeasmin, 2000). But for
computation of Zakat, inventory is required to be valued
always at current market price (whether it is higher or lower
from cost). As there is no Zakat for fixed assets, therefore,
these assets are not required to be shown at current market
value. Further, it would not be justified to show fixed assets
at current prices because these are not intended to be sold in
near the future. If the fixed assets are stated at current value
then unrealized profit would be recognized in the income
statement and hence profit would ultimately be overstated as
like as traditional method. On the other hand, other assets and
liabilities, that is, claims of the organization to others and
claims of others to the organization will not change due to the
change in price level and these would not be required to be
adjusted as per Islamic accounting. Mirza and Baydoun
The Bangladesh Accountant/January- March 2010 21

Accounting
(2000) suggested for using both the valuation methods in
Islamic Accounting, i.e., the contractual transactions with
other parties should be based on cost and Zakat calculation
(assets valuation) should be based on current market value.
d. Interest:
The word ‘Interest’ originated from the Arabic word ‘Riba’
which means ‘Addition’, ‘Expansion’, or, ‘Premium’. Interest
on loan is a fixed charge made for borrowing/investing a sum
of money (Oxford, 2006). Traditional accounting recognizes
and records interest in the books of account but as per the
directives of Islamic Shari’ah, interest is strictly prohibited
(Qur’an-2:275). Interest is unjust (Hamid et al, 1993) and
makes the rich people richer and poor people poorer (Shafi,
1992) A fixed interest rate guarantees a profit on money
contributed, regardless of whether the borrower has made a
profit or a loss. Thus it is possible that labor and hard work
may go unrewarded while lending of capital. On the other
hand, interest is a guaranteed remuneration which entails no
exertion or effort on the part of the lender, and the capital (or
original money lent) is not eroded or reduced in value by its
use, (Shafi, 1979). Due to the avoidance of
debt/bond/debenture and Preference share (which are based
on interest), the capital structure of the firm would be
different. As per Islamic financial system, Islamic accounting
uses different modes of financing like- Mudarabah (trust
financing), Murabaha (cost-plus trade financing), Musharaka
(Participation financing), Ijara (Rental/lease financing) all of
which are based on profit and loss sharing. If any firm cannot
avoid interest due to the prevailing rules and regulations, they
must give an explanation as to why it has arisen and the steps
they have taken to avoid the payment of interest (Maliah,
2003).
e. Ratio analysis:
Ratio analysis is done to evaluate organizational performance
based on which users of accounting information made
different decisions in relation to that organization. As per
traditional accounting (based on cost and conservatism
concepts) profit is overstated but assets and owners’ equity, to
some extent, are understated and therefore, return on assets
(ROA) and return on investment (ROI) will also be
overstated. These overstated ratios may mislead the intended
investors to invest their money in the organizations from
where they may not earn the same returns in future. If Islamic
accounting is applied then the realized accurate profit would
be shown by the Income Statement and value of assets would
be higher due to use of current value for some assets and
amount of owners’ equity would reflect the more up-dated
position.
f. Comparative Analysis:
One of the important characteristics of the accounts or
accounting reports is their comparability. But the information
provided by the accountants will not be possible to be
compared with the information provided earlier to justify the
improvement of profitability or operating efficiency of the
firm as because the depreciation expense and cost of assets
are not the real amount (Hye & Yeasmin, 2000). Under the
cost concept of traditional accounting, generally, the revenues
are stated at current prices, some costs are also stated at
current prices but some other costs are expressed at historical
cost and hence the net income determined in one accounting
period loses its comparability with that of earlier ones. In the
balance sheet of traditional accounting, assets are stated at
original cost or at lower of cost and market value and
therefore, the assets and liabilities of one period are
incomparable with that of another one. If the balance sheets
were actually stated on a current value basis, this would help
us make better comparisons (Brigham & Houston, 2006).
Thus the application of Islamic accounting, which is based on
current market prices for the inventory or stocks, will make
the income statement and balance sheet information
comparatively more comparable than that of traditional
views.
g. Reduction of Capital:
At the time of inflation, if the accrual revenues are
considered, profit would be overstated and it will result
excess payment of dividend but due to accrual concept,
sufficient amount of cash would not be available in the hand
of the firm to pay the dividend. But if the accrual revenues
turn into uncollectible then the firm will require using other
funds to recompense the depositor, which will violate the rule
that the loss should be borne by the investors. So, Islamic
accounting emphasizes using cash basis of accounting rather
than accrual basis of accounting (Hamat, 1994). At the time
of inflation, the dividend payout ratio tends to be low (Khan
& Jain, 1999). But the overstatement of profit results in
excess payment of dividend to the stockholders; as a result of
which, the capital of the firm would ultimately be reduced.
The Bangladesh Accountant/January- March 2010 22

Accounting
h. Determination of Tax Payments:
Income tax is levied by the government on the profit
determined by the company. But overstatement of profit as
per traditional accounting on accrual basis may require
paying higher amount of income tax payments. Further some
revenues (which are on account) shown in the income
statement may not be realized/received in cash or may
become bad and therefore will have to written off in future. In
this context Islamic accounting suggests showing the
revenues that are realized in cash and hence, there will be no
scope of over payment or under payment of income tax.
i. Replacement of Fixed Assets:
Organizations accumulate funds charging depreciation for
replacement of fixed assets. As the funds generated from
depreciation may be inadequate to replace obsolete assets, the
firms have to rely upon retained earnings as a source of funds
to make up the short falls and hence dividend payout ratio
tends to be low (Khan & Jain, 1999). But under accrual basis
of accounting overstatement of profits encourages the
organization to pay more dividends to the investors and as a
result the retained earnings balance may be inadequate as
well as there may not be any cash fund to replace the fixed
assets. But as Islamic accounting on cash basis recognizes the
realized profits and there would not be any excess payment of
dividend. Moreover, there will be availability of cash funds to
replace the fixed assets when needed.
j. Disclosure of information for decision making:
Relevant and reliable information are the basis for making
any decision regarding organization. As per traditional
accounting (based on cost and conservatism concepts), assets
shown in the accounts don’t indicate the current market value
and hence there is a common mistake by the uninformed
persons using accounting reports when they consider these
figures as akin to market value (Khan, 1989). But Islamic
accounting provides comparatively more reliable and relevant
information showing some assets in current value for Zakat
purpose and determining actually realized net profit on cash
basis of accounting. Traditional accounting provides
information just related to financial aspects of the firm and it
provides only that information which is required by the users
of accounting information. On the other hand Islamic
accounting has to cover wider range information including
social, environmental, and religious transactions as per their
accountability and justice to the related parties and also as per
their accountability to almighty Allah (SWT) (Shahul and
Yaya, 2003).
k. Social Contribution and Shari’ah Compliance
The traditional view of accounting is much more
materialistic. Therefore maximization of profit and wealth is
emphasized and there is no consideration of ‘Halal’
(permitted) and ‘Haram’ (forbidden) of Shari’ah. In Islamic
organization it is required to get a Shari’ah clearance from the
Shari’ah board (consisting of recognized experts in Islamic
Shari’ah) before finalization of any financial transactions
(Algaoud and Lewis, 1999). Islam encourages to give own
money to others for the sake of Allah (SWT). Allah (SWT)
said, there is a claim of the poor in the wealth of the rich
(Qur’an 51:19). Qard-E-Hasana (a zero return investment for
the betterment of the society) is encouraged by Islam (Al-
Qur’an 2:245 & 57:11) and these transactions are also
revealed in the statements of Islamic Accounting. As per the
guidelines of The Accounting and Auditing Organization for
Islamic Financial Institutions (AAOIFI), Islamic accounting
requires to prepare a separate report regarding social
contribution named ‘Social Responsibility Reports’
(AAOIFI).
Advantages of Islamic Accounting over Traditional
Accounting:
Islamic accounting gives emphasis on truth and justice in
recording and communicating the information regarding any
organization. Therefore, the application of Islamic accounting
in any organization is expected to provide the following
advantages:
i. Application of Islamic accounting satisfies compliance
of the Islamic Shari’ah in maintaining the books of
account by the organization.
ii. Application of Islamic accounting enables the
organization to determine the accurate amount of Zakat
payable by the firm during the period.
iii. Islamic accounting reveals the accurate realized profit
earned by the organization during the period as per cash
basis of accounting.
iv. Islamic accounting as compared to traditional accounting
reveals comparatively the more accurate financial
position of the organization to the users of the statements
in terms of the current value.
v. Comparatively better ratio and comparative analyses of
the information would be expected from Islamic
accounting.
The Bangladesh Accountant/January- March 2010 23

Accounting
vi. As per Islamic accounting the organization would be
able to maintain appropriate amount of retained earnings
paying just dividends to the investors to cover the short
fall of accumulated fund for replacement of fixed assets
in inflationary situation.
vii. Application of Islamic accounting will reveal the just
amount of realized profit for payment of income tax.
viii. Determination of just profit will result determination of
right tax liability and right dividend.
ix. Unlike traditional accounting, Islamic accounting
provides an wide range of information covering
religious, social, environmental, and others aspects of
the organization.
Conclusion:
There are some conflicts between Islamic Accounting and
Traditional Accounting . But they are not as such as cannot be
resolved. With intuitive and transperent thinking they can be
reconciled. In this article a modest attempt is endeavored in
this direction. The researchers view that Islamic accounting is
a must for any organization ventured and run by Muslim
entreprenuers. It is considered to be more objective,
transperent and just for computation of Zakat and providing
information and services to the interested persons and others.
And hence the contemporary traditional accounting should be
gradually replaced through further research and studies in
Islamic accounting.
■
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AAA (1966), A Statement of Basic Accounting Theory, US: American Accounting Association.
AAOIFI web site: www.aaoifi.com
Algaoud, L.M. and Lewis, M.K. (1999), ‘Corporate Governance in Islamic Banking: The Case of Bahrain’, International
Journal of Business Studies 7(1), pp. 56-86.
A. Riverin (1961), “Accounting Profit: Myth or Reality?” Cost and Management, October, p.442.
Askary, S. and F.L.Clarke (1997), Accounting in the Koranic Verses, Proceedings of the conference on Accounting, Commerce
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Brigham, E.F. & Houston, J.F. (2006), Fundamentals of Financial Management, Thomson Business India P. Ltd., ISBN: 81-
315-0002-0, Tenth Edition, p .81.
Grimsley, B. (1975), Practical Accounting for Inflation, Gower Press, London, p.20.
Hamat S. (1994), Accounting Standards and Tax Laws in Islamic Banking, New Horizon 25, 8-10.
Hamid, S., Craig, R. and F. Clarke (1993), Religion: A Confounding Cultural Element of International Harmonization of
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Horngren, C.T. & Harrison, Jr. W.T. (1992), Accounting, Prentice Hall, Englewood Cliffs, New Jersey, Second Edition, p.12.
Hye, M.A. & Yeasmin, K. (2000), Accounting Theory, Saikat Prokashani, Third Edition, p.18-63.
Khan, M.M. (1989), Advanced Accounting, Volume-I, Ideal Library, Dhaka, Eighth Edition, p.19.
Khan, M.Y. & Jain, P.K. (1999), Financial Management, Tata McGraw-Hill Publishing Company Limited, ISBN 0-07-463225-
6, Third Edition, p.14.10.
Maliah, bt.S. (2003), The Influence of Riba and Zakat on Islamic Accounting, Indonesian Management and Accounting Review,
Volume 2 (2), 149-167.
Mirza, M. and Baydoun, N. (2000), Accounting policy in a Riba Free Environment, Accounting, Commerce, and Finance: The
Islamic Perspective Journal, No. 4 (1), pp.30-40.
Napier, C. (2007), Other Cultures, other accountings? Islamic Accounting from past to present, 5 th Accounting History
International Conference, Banff, Canada, August 9-11.
Oxford (2006), Oxford Dictionary of Business, Oxford University Press, New Delhi, ISBN: 0-19-566905-3, Third Edition,
pp.271-309.
Quardawi, Y. (2007), Islamer Zakat Bidhan, Volume-1, Seventh Edition, ISBN: 984-8455-57-17, Khairun Prokashani, Dhaka,
pp.308-309.
Shafi M. (1992)(1413 Arabic), Tafsir Mareful Qur’an (Summary), Qur’an Printing Project, P.Box No. 3561, Madina Monawara,
p.155.
Shafi, M. (1979), Distribution of wealth in Islam, Karachi: Ashraf Publications.
Shahul H. and Yaya, R. (2003), “The Future of Islamic Corporate Reporting: Lessons from Alternative Western Accounting
Reports”, The International Conference on Quality Financial Reporting and Corporate Governance, 28-29 July, 2003.
Tokunga, T., Blakeway-Phillips, M. & Aitken, R. (1989). Accountancy-Bank audit: Abreast of the trend (Part 2), Banker, 139
(764), pp. 18-23.
The Bangladesh Accountant/January- March 2010 24

Finance
Contemporary Issues in Bond Market Development in Bangladesh:
Experience and Evidence from Asian Countries
Dr M Abu Misir
Mohd. Mohsin
and
Aktar Kamal
Abstract: For a country’s economic development, a deep
well functioning domestic bond markets are extremely
important as they facilitate long term financing for areas such
as infrastructure, housing and private sector development. But
developing deep and diversified bond market is not so easy.
Due to the importance of this market to the entire economy, it
is necessary that the governments lead the process of
developing bond market by creating a domestic securities
market and providing an adequate framework to develop
corporate bond market. This paper makes an attempt to
address some prerequisites to the development of
government bond market in Bangladesh economy in general
and to bring into focus the arts and states of government
bond market development in India. Having based on
exploratory research, the study finds that the development of
Indian government bond market has been developed
comparable to the other emerging and developed bond
markets of the globe in terms of size and efficiency since its
inception and thus contributed to accelerate its GDP .This has
become possible due to enacting the reforms of financial,
legal and regulatory reforms, presence of vibrant trading,
clearing and settlement system and investor diversity in the
government bond market. The study also suggests some
lessons for bond market development in Bangladesh.
Introduction
The Financial sector is a crucial sector of any economy,
affecting its business environment, investment, economic
prospects and social dimensions, including poverty. A vast
empirical and analytical literature suggest that in addition to
other economic factors, the performance of long term
economic growth and welfare of a country are related to its
degree of financial sector development. Though it is not
always necessary for a country to develop a government
security market, experience from industrial countries suggests
that a healthy government bond market creates conducive
environment for the development of a robust corporate bond
market. The financial markets, the pivotal point of financial
sector, perform a vital function within the global economic
system such as attracting and allocating savings, setting
interest rates and discovering the prices of financial assets
(Rose, 2003). A well diversified financial sector is highly
dependent on the extreme collaboration of financing from
equity market, bond market, and banks. The government
bond market forms the backbone of a modern securities
market in both developing and developed countries. With
infrastructure comparable to that in the developed markets,
the government debt market of Indian is deep, and liquid
(Kiatchia, et. al, 2008). In March 2008, the government bond
market represented 36.1% of GDP which is comparable to the
other emerging East Asian government bond market namely
Malaysia, Singapore and Thailand the size of which is 48.1%,
41.2% and 40.7% of their respective GDP (Asian Bonds
Online, 2008). In contrast, Bangladesh has not been blessed
with the contribution of both Government and Corporate
bond and accordingly experiences the poor economic growth.
With the current financial structure, characterizing the
dominating presence of commercial banks, especially the
State Owned Commercial Banks (SCBs) and Private
Commercial Banks (PCBs), the debt market of Bangladesh is
very small relative to other South Asian countries amounting
only 5.5 percent of country’s GDP (Mujeri and Rahman,
2008). It is in the light of above perspective; this study seeks
Dr. M. Abu Misir, Professor, Department of Finance, Jagannath University Dhaka, Mohd. Mohsin, Lecturer in Finance, International
Islamic University Chittagong, Dhaka Campus and Aktar Kamal, Lecturer in Management, International Islamic University Chittagong,
Dhaka Campus.
The Bangladesh Accountant/January- March 2010 25

Finance
to explore some prerequisites to a sustainable bond market by
studying available literature, especially for the Government
segment, and putting some lessons for the development of
Bangladesh Government bond market from the Indian
experience. However, the objectives of the study are to put
forth some essential prerequisites to the development of
government bond marketing an economy in general and to
recommend some worthy lessons for government bond
market development of Bangladesh from the experience of
some Asian countries.
The Importance of Bond Markets
Bond markets gained prominence after the 1997 financial
crisis in East Asia. The crisis prompted a rethinking of the
role of financial markets in economic development. Several
weaknesses of banking systems were exposed, including
maturity and currency mismatches and moral hazard
problems. When confidence was shaken during the crisis,
banks called in their loans, subjecting their borrowers to a
painful credit crunch. Governments incurred huge fiscal costs
in restructuring banks. The banking crisis in East Asia created
an awareness of the need to supplement bank finance with
better diversified debt securities markets and, specifically,
medium- to long-term bond markets. Bank and bond finance
each have different advantages. Bonds do better at sharing
risks, by better matching the liabilities of investors with the
assets of borrowers. Yet bond finance is not inherently
superior to bank finance. Countries have benefited and still
benefit from well-diversified financial systems with roles for
both well-regulated banks and well-functioning bond and
equity markets. Diversification helps an economy achieve a
better position on the frontier of feasible tradeoffs between
risks and returns. It also promotes financial stability and
efficient resource allocation in support of medium-term
economic growth. Realizing these benefits, however, requires
developing debt securities markets in ways that ensure their
soundness. That lesson is apparent in the subprime mortgage
crisis that emerged in 2007 in the United States. The paradox
of the crisis is its apparent roots in both the successes of
financial markets (securitization, globalization, nonbank
mortgage lending) and their failures. Financial innovations
have tended to obscure rather than expose underlying risks.
The problem can lead to a crisis of confidence in the financial
system. That has emerged, for example, in banks’ increasing
unwillingness to lend to one another, as reflected in the rising
interbank rates in Europe and the United States. Reasonable
regulation of debt securities markets allows them to function
in an efficient and constructive way. What led to the crisis
were debt instruments made and sold in the unregulated
sector. At every step in the process-from loan origination to
the use of exotic, unsuitable mortgages to the sale of
securities backed by those mortgages-largely unregulated,
uninsured firms have created problems, while regulated,
federally insured banks and savings institutions have not.
Literature Review
Every capital market has its unique features, derived from
history, culture, and legal structures but increasingly they also
have common features (Wells and Zibell, 2008). To the
backdoor of this study, a large number of studies such as
Aktaruzzaman et. al (2008), and Jahur (2009) have been
conducted to diagnose the present context of government
bond market of Bangladesh. The above studies have
investigated that Bangladesh finds it difficult to move
forward for developing the bond market for several reasons:
weak governance at the institutional and market levels; high
nonperforming assets among the nationalized commercial
banks (NCBs); poorly defined and overlapping
responsibilities of the Bangladesh Bank, Securities and
Exchange Commission, and Ministry of Finance; and the lack
of incentives and private initiative to drive market
developments. He identifies these four problems as the
principal obstacles to the development of bond markets in
Bangladesh. The government is aware of them, and the World
Bank and other organizations have been pushing for
solutions. However, change is slow. The Bangladesh bond
market is shallow compared to the neighboring countries. At
the end of 2005, the outstanding bond volume over GDP was
only 1.4%, compared with India (34.8%), Pakistan (30.9%),
Sri Lanka (53.6%), and Nepal (9.8%). The share of the
Bangladesh bond market in South Asia (0.2%) is also the
smallest among the five countries. According to Mu the main
impediments to the Bangladesh debt market include (i) the
weak regulatory framework; (ii) supply-side constraints such
as a lack of the benchmark bonds; (iii) demand-side
constraints such as the limited investor base; (iv) a lack of
intermediaries with expertise in debt products; (v) a lack of
confidence in corporate borrowers; (vi) market distortions
which are caused by the National Savings Scheme (NSS)
offering above-market returns; and (vii) a lack of interest
The Bangladesh Accountant/January- March 2010 26

Finance
from private companies, including financial intermediaries
and large business, in launching new debt products due to
high fees. The ratios of private sector bonds and international
bonds to GDP are nearly non-existent in Bangladesh, while
the ratio of public sector bonds to GDP is small relative to
other regional economies (Aktaruzzaman et. al, 2008). They
pointed out that the thin bond market in Bangladesh faces
manifold challenges emanating from several sources
including excessive reliance on bank credit, government debt
instruments dominated by primary auction based activity,
absence of benchmark yield curve, and lack of product
variation. They suggested well prioritized policies and actions
in several areas like reduction in interest on government
savings instruments and registration fees, tax exemption on
interest income of bonds/debentures, rating of bond
instruments by independent rating agency prior to issue are
some measures that can be implemented without delay. Jahur
(2009), has pointed out six important impediments to the
development of bond market in Bangladesh by taking
personal interview from 22 financial executives from
different economically important companies. Using Factor
Analysis, he has ranked six important barriers to the bond
market development in Bangladesh in order of their
magnitude such as risk and return factor (rank-1), liquidity
and government policy factor (rank-2), issue management,
(rank-3), investment policy factor (rank-4), macro economic
and regulatory factor (rank-5) and market and issue related
factor (rank-6).
Most of the researchers have investigated why bond market
has not been developed so far from different standpoints. But
no study has been found what should be the prerequisites for
sustainable developments of government bond market of
Bangladesh, to what degrees the selected countries are
fulfilling that requisites and what lessons we can take from
the countries which have got momentum and accelerated their
positions in bond market development, especially from a
comparator economy like some Asian countries.
Findings and Analysis
A) Essence of Bond Market for Economic Development
i. Need for Bond Market
Bond markets play an important part in diversified financial
systems by linking borrowers that have financing needs with
investors that are willing to place funds in interest-bearing
securities (Kiatchia, et. al, 2008). They help avoid excessive
dependence on banks and diversify corporate risks beyond the
banking system. Deep, well-functioning domestic bond
markets are extremely important for a country’s economic
development, as they facilitate long-term financing for area
such as infrastructure, housing, and private sector
development. They also provide long-term investment
instruments for institutional investors, such as pension funds
and insurance companies. Finally, bond markets help
diversify a country’s financial sector and reduce foreign
currency risk which arises when local investments are
financed with foreign currency denominated loans.
ii. Factors Influencing the Bond Market Development
Why does not Bangladesh have an efficient and smooth
operating bond market like other Asian countries? The
answer of the question innovates some crucial determinants
affecting the bond market of Bangladesh and identifies 14
fundamental economic variables which have been proved to
have close relation (positive or negative) with the
development of bond market in a country like Bangladesh.
Exhibits-1 in the appendix explains the properties of the
variables.
iii. Beneficiaries of the Government Bond:
Parties who can directly be benefited form the government
bond are outlined below:
a. Governments: The government can use this market to
smooth the path of economic aggregates over time, fund
their expenditures, and minimize the welfare cost of
financing them (Jorge, 1998). It also provides a key
barometer of the markets’ reaction to governments’
actions, and a benchmark yield curves which helps in
pricing of different assets
b. Central Bank: Central bank gets the idea of the term
structure of interest rates that provides the paramount
guide to the underlying structure of inflationary
expectations in forming the monetary policy (Jorge,
1998)
c. Public Enterprises: Government securities market
facilitates the issuance facility of debt by other public
institution (Jorge, 1998). Government interest rates
establish a benchmark for the borrowings of all public
institutions, facilitating the timing of their borrowings.
d. Financial System: To financial institutions, the term
structure provides essential information on interest rates.
It offers the best estimate of their future behavior, the
The Bangladesh Accountant/January- March 2010 27

Finance
primary determinant of the demand for loanable funds.
Moreover, the term structure allows financial institutions
to evaluate the relative worth of financial contracts with
very dissimilar cash flows.
e. Business: The term structure of interest rates provides
the basic criterion to evaluate business investment by
having a look on the minimum standard for fixed rate
financing that allows potential investors to judge the
worth of the project.
f. Households: Government bonds are an indispensable
instrument to meet the investment needs of households.
These bonds entail a minimum amount of credit risk, a
source of uncertainty that households do not assess or
diversify well due to their limitations.
iv. Prerequisites for Development of Government Bond
Market
Government securities market development must be viewed
as a dynamic process in which continued macroeconomic and
financial sector stability are essential for building an efficient
market and establishing the credibility of the government as
an issuer of debt securities. Prerequisites for establishing an
efficient government securities market include:
a. credible and stable government;
b. sound fiscal and monetary policies;
c. effective legal, tax, and regulatory infrastructure;
d. smooth and secure settlement arrangements; and
e. a liberalized financial system with competing
intermediaries.
v. ‘Four Is’ perspective of Bond market development
The Nomura research institute, in 2004 has developed a
framework (figure-1) showing the four different perspectives
of bond market development namely; issuer, investor,
intermediary and infrastructure, and also articulates their
intra-relationship that contributes towards the harmonious
development of bond market.
The Bangladesh Accountant/January- March 2010 28

Finance
In that framework, centered by issuer, the investor
perspective has been emphasized very clearly. The point is
that the lack of diverse investor with different risk appetites
leads to conservative investor behavior and accordingly
insufficient liquidity in the bond market which has bearing
impacts on other three perspectives. In essence, the figure
clears that the problems in different perspective constitute a
“chicken-and-egg” vicious cycle and they can not be resolved
individually.
B) Bond Market Strategies: Lessons for Bangladesh
The debt market in India comprises mainly of two categories,
firstly the government securities or the G-Sec markets
consisting of central government and state governments’
securities. The second category comprises of the non G-Sec
markets i.e. the corporate securities consisting of FI (financial
institutions) bonds, PSU (public sector units) bonds and
corporate bonds/debentures.
i. Comparison of Government Bond Market in Some Asian
Countries
The size of Bangladesh government bond market which is
17.1% of GDP, has not developed in a same line with the
emerging East Asian bond market like China, Singapore,
Malaysia and Thailand as depicted in Tabale-1. India has the
largest part of Government bond market of all the south Asian
countries while Bangladesh holds the lowest position with the
size of 17.1% of GDP.
Table- 1: Size of some Asian Bond Markets (% of GDP)
Category China, Korea Mala Phili Sing Thailand India BD PAK Sri Lanka
Govt. 46.1 48.8 48.1 33.3 41.2 40.7 36.1 17.1 27.5 31.6
Corporate 4.7 61.8 37.5 3.5 30.7 15.9 3.9 - - -
Source: Asian Bond on Line, BIS, RBI, March 2008.
i. Maturity Structure
of government securities (Kiatchia et. al, 2008). These efforts
Barry and Pipat (2004) argue that the more mature bond have extended the sovereign yield curve to 30 years.
markets exhibit longer average maturity since investor ii. Assessment on The Basis of Capital Access Index (CAI)
confidence is gauged by their willingness to commit Index
resources to longer time horizons. In South Asia, India is the The Milken Institute’s Capital Access Index (CAI) enables
only country to have succeeded in building a risk-free countries to see how they compare to others in terms of
sovereign yield curve that can provide guidance to market creating the conditions necessary for firms to raise capital,
players across the broad spectrum of maturities. The central and it assists countries in deciding what actions can improve
bank has followed a consistent policy of passive the required linkage between finance and economic growth
consolidation-largely reopening existing securities rather than (Barth et. al, 2008). The comparative performance of some
launching new ones and a lengthening of the maturity profile south Asian bond markets is exhibited in Table-2.
Table-2: Performance South Asian Countries on CAI index
Bangladesh India Pakistan Sri Lanka
Macroeconomic environment (ME) 4.83 89 6.00 60 4.25 104 5.50 67
Institutional environment (IE) 3.35 109 5.12 63 5.18 61 4.65 78
Financial and banking institutions (FI) 3.33 60 5.78 39 3.44 76 4.89 48
Equity market development (EM): 3.33 60 6.33 21 4.67 40 3.17 63
Bond market development (BM): 1.5 75 5.25 35 2.75 63 2.50 65
Alternative sources of capital (AC): 0.75 92 5.00 29 2.00 69 1.75 73
International funding (IF) 3.00 95 4.83 42 4.17 70 3.42 89
Overall CAI Rank 92 41 72 70
Source: Milken Institute, CAI Index, 2008.
The Bangladesh Accountant/January- March 2010 29

Finance
The index serves to help nations understand where financing
barriers exist that could dampen their global competitiveness.
The CAI ranks Bangladesh 89th in Macroeconomic
environment, 109th in Institutional environment, 60th in
Financial and banking institutions 60th in Equity market
development, 75th in Bond market development 92nd in
Alternative sources of capital and 95th in International funding
(Table-2). In fact India scored the best while Bangladesh
scored the worst in south Asia in every component of CIA
which depicts that India has necessary perquisites of Bond
market development bit Bangladesh still lags.
iii. Analysis on Finance Indicators
In terms of the assessment of Finance Indicators as depicted
in Table-3, India has the soundest financial sector of all south
Asia. It secured the top rank with an overall composite score.
India has brilliantly done well (ranked 1) in three micro
indicators namely financial stability, capital market
development and market concentration and competitiveness.
It has also shown efficiency in the corporate governance
category.
Table-3: Getting Finance indicators for South Asian Countries during 2001-06
Individual indicators rank India BD Nepal Pak Lanka
Overall rank 1 4 5 2 3
Access to finance 3 2 5 4 1
Financial stability 1 4 5 2 3
Performance and efficiency 3 4 4 1 2
Capital market development 1 4 5 2 3
Market concentration and competitiveness 1 2 3 4 5
Corporate governance 2 5 4 1 3
Source: Getting Finance Indicators.
iv. Corporate Governance
The assessment of south Asian Bond Market in terms of Good Governance Indicators, India has a better level of good
governance in terms of voice and accountability, political stability, control of corruption and regulatory which has led to the
financial development (Table-4). Moreover, the legal right and credit information index in Table-4 shows that the lender and
borrower of capital are not well protected in Bangladesh and they not get the credit information more easily.
Table-4: Indicators of Governances, South Asia 2007
Country Voice & Political Government Regulatory Rule of Control of legal Right Credit info
Accountability stability effectiveness quality law corruption index index
Bangladesh -0.63 -1.4 -0.81 -0.86 -0.81 -1.05 8.0 2.0
India +0.38 -0.01 +0.03 -0.22 +0.10 -0.39 8.0 4.0
Pakistan -1.05 -2.44 -0.62 -0.56 -0.93 -0.83 6.0 4.0
Sri Lank -0.39 -1.96 -0.29 -0.11 +0.06 -0.13 4.0 5.0
Source: South Asian Financial sector review, 2009.
Note: Governance score from -2.5 +2.5, with higher (lower
values) denoting better (poor) governance. The legal right
index ranges from 0 to 10, with higher scores indicating
better designed and bankruptcy and collateral laws, the
credit information index ranges from 0 to 6, with higher
scores depicting more credit information available
C) Problems in G - Bond Market in Bangladesh
Of the 100% domestic savings, only 30 % are invested in the
debt market in Bangladesh which is entirely dominated by
government instrument. Among these government
instruments, NSD certificates, the no marketable instruments,
occupy more than three-fifth of the total invested capital and
the remaining portion is shared by treasury bills and BGTB.
The government bond market in Bangladesh is currently
characterized by excessive reliance on nontransferable debt
instrument, NSD ,primary auctions based activity, relatively
high and risk-free interest rates, nearly non-existent corporate
The Bangladesh Accountant/January- March 2010 30

Finance
and international bonds, absence of market based or
benchmark yield curve, lack of institutional investors, poor
confidence on the private sector, shallow capital market, lack
of appropriate regulations and infrastructure, lack of expertise
and innovation, inefficient and unaccountable trustees, high
tax incidence and issue cost, and lack of product variations
(Aktaruzzaman et. al, 2008). Moreover, degree of efficiency
of credit rating agencies, standards of accounting, auditing
and disclosures, institutional infrastructure, prevalence of an
environment for enforcement of contracts are important
determinants of a well functioning bond market.
D) Measures to Improve Bangladesh Bond Market
As India achieved the second fastest growth, after china, there
is a lot to be learned from sharing experience by other
neighboring financial centers. Despite earlier set backs, the
bond market of Bangladesh is ready for take off. It seems
reasonable that Bangladesh can take the following lessons to
boost up its government bond market from the golden
experience and many other reforms, which has already been
implemented to develop the Indian Government bond market.
i. Establishing a Sovereign Yield curve to serve the
pricing Guide in the Bond Market: Lack of benchmark
bonds has been among the main reasons that the
Bangladesh debt securities market has not taken off.
Without benchmarks in place, all other fixed-income
instruments, including corporate bonds will be lacked by
a pricing base. It can take the experience that like India
to lengthen the maturity of government bond issues by
issuing a bond of 30 years of maturity.
ii. Proving the Government as a credible Issuer and
Market Developer: The developed financial markets
have been brilliant in issuing standard, diversified and
high quality debt instruments on regular basis. For
example Indian government issues treasury bills of three
maturities: 91, 182 or 364 days and medium and long
term securities: zero-coupon bonds, capital-indexed
bonds, floating-rate bonds, bonds with call and put
options, and “plain vanilla” bonds (the most popular and
actively traded). In contrast, the government of
Bangladesh issues only Treasury bill, treasury bonds,
National Investment Bonds, and National Saving
certificates. Excessive dependence on NSD certificate by
the government of Bangladesh has distorted the market
by establishing a high benchmark rate for corporate
sector. This is why; the government of Bangladesh
should come forward with broad spectrum of
government securities like India.
iii. Relaxation of SLR for Cementing a strong Institutional
Investor Base: In Bangladesh there are some captive
institutional investors in government securities as the
commercial bank has to maintain 12.5% of SLR in
government securities, the SLR for the insurance
companies is 30% and pension funds are to keep 75% in
Government securities and they keep the security until
maturity for which investor base remain undiversified
and thus affecting the liquidity and development of
government bond market (Kiatchia, et. al, 2008). It can
take the lesson of India which has removed the 25% of
SLR obligation of commercial banks by the Banking
Regulation Amendment Act, 2007. Moreover, the limit
of SLR for Insurance and pension funds are also 25% in
India that may be fixed in Bangladesh as well.
iv. Level Playing Field for Foreign and Retail Investor:
Security and Exchange commission of Bangladesh like
those of developed countries should permit registration
to foreign institutional investor to invest in Bangladesh.
The government of Bangladesh should also take
necessary steps to encourage retail participation in the
government debt security market.
v. Establishing well functioning system for Primary
Dealers: With 13 PDs, 10 are commercial banks, and 3
are non bank financial institution, Bangladesh
government bond market has not been served to full
swing right yet. Bangladesh should practice the scale,
scope, and regulation of the primary dealer network like
India. In India the primary dealers can operate their
business being a subsidiary dealer of a bank or to be a
stand alone primary dealer. The Reserve Bank conducts
on-site inspections of each primary dealer as well as offsite
supervision. Bangladesh can learn many things as
regard of primary dealers from India.
vi. Steps to Enhance Secondary Market Liquidity: The
secondary market for government debt market in
Bangladesh is still in very ignorable stage. For example,
in the DSE, 18 BGTBs were listed in 2005 while another
16 BGTBs got listed in 2006 with a total worth of Tk.
4.5 billion. However, only one 10 year BGTB was
transacted on the secondary market since the inception
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Finance
of debt securities in DSE in 2005. Thus, the BB, in favor
of Bangladesh government can lower minimum
denomination to Tk 1000 and give wide range of
facilities to the PDs.
vii. Increasing Transparency in the Secondary market
through Dissemination of Market Information:
Transparency in the secondary market for government
debt securities remains limited in Bangladesh. There is
no central source of information on trading activity in
the OTC market. While Bangladesh Bank receives
reports on OTC trading from primary dealers, it does not
publish the information. Information on debt securities
and the money market should be distributed through
press releases or by the Bank’s publications.
Bangladesh can take this kind of steps.
viii. Setting up the Negotiated Dealing System (NDS) &
Negotiated Dealing System–Order Matching Segment
(NDS-OM): To enhance the trading system in the
government bond market, Bangladesh may set up
Negotiated Dealing System (NDS), the role of brokers
that may diminish in the Government securities market
which facilitates market participant to deal directly each
other.
ix. Introducing Delivery Vs Payment System (DVP):
Though both stock exchanges, DSE & CSE have an
automated system for the trading of securities, the
payments in securities transactions are handled
manually, which means that securities cannot be settled
on a delivery-versus-payment basis. Bangladesh may be
benefited by following this mechanism.
x. Developing Bond Index: Market participants need an
index to compare their performance with as well as the
performance of different classes of assets. The
government of Bangladesh can establish some bond
index which will reflect the benchmark of this sector
xi. Following the Reforms program recommended by
Expert committees: The government of Bangladesh can
examine the viability of the recommended actions of
different high level expert committees like Committee
on Making Mumbai an International Financial Centre,
2007, Patil Committee on Corporate Bonds and
Securitization, 2005, and Rajan Committee on Financial
scoter reforms, 2008, and many notable others to
accelerate the bond market.
xii. Developing Qualitative Strength: As Bangladesh is still
lacking the qualitative strength of a mature financial
market due to its poor performance in macroeconomic
environment, institutional environment, equity market
development, financial stability and corporate
governance and voice and accountability, political
stability regulatory quality with compared to India, it can
share the know-how of India to accelerate their position
in these aspect.
Conclusion
Though explorative in nature, this paper investigates the
current status of government bond markets of some Asian
countries. In India, the government debt security market has
grown rapidly due to the need to finance the fiscal deficit by
domestic savings and the introduction of impressive and wide
range of reforms since the early 1990s. Interest rates have
been largely liberalized, capital markets deregulated,
restrictions on capital inflows gradually eased and the
financial sector opened to competition, both domestic and
foreign. These policy reforms achieved clear results: the
government securities market is liquid and deep, with
infrastructure comparable to that in developed markets. The
thin government bond market in Bangladesh faces manifold
challenges like excessive reliance on bank credit, government
debt instruments dominated by primary auction based,
absence of benchmark yield curve and lack of product
variation. The lists of prerequisites of government bond
market and factors to influence the bond market indicates that
India has dramatically progressed in almost all the category
while Bangladesh does not meet most of the preconditions to
develop an efficient government bon market. Toward this
end, it is hoped that Bangladesh will be able to speed up its
momentum in the public sector bon market if she adopts all
viable strategies, experiences and reforms program of
developed bond markets.
■
The Bangladesh Accountant/January- March 2010 32

Finance
REFERENCES:
Akhtaruzzaman, M., Rahman, M. H. and Rahman, M. H. 2008. “Prospects and Challenges of Bond Market Development in Bangladesh”, Policy
Note Series: Bangladesh Bank,: PN- 0901, PP. 1-8.
Barth, J. R., Li, T., Lu, W., Phumiwasana, T and Yago, G. 2008. “Capital Access Index 2007: Best Markets for Business Access to Capital”,
Milken Institute, PP. 15-19.
Barry, E and Pipat, L. 2004. “Why does not Asia have bigger bond market,” Bank for International Settlement (BIS), N0. 30.
Jahur, M. S. 2009. “Development of Bond Market in Bangladesh: Issues, Status and Policies,” Portfolio, Chittagong Stock Exchange Ltd.
Jorge, C. 1998. “Developing a Government Bond Market: An Overview-(2002)”, Hand Book, IMF & World Bank.
Kiatchai, S., Mu, Y. and Saporito, C. 2008. “South Asian Bond Markets”-Developing Long Term Finance for Growth”, The World Bank,
Washington DC. PP. 57-58.
Mujeri, M. K. and Rahman, M. H. 2008. “Financing Long Term Investment in Bangladesh: Capital Market Development Issues” Policy Paper:
Bangladesh Bank,: 0905.
Rose, P. S. 2003. “Money and Capital Markets”, Financial Institution and Instruments in a Global Market Place, Eighth Edition, McGraw Hill
Higher Education. PP. 4-7.
Wells, S. and Zibell, L. S. 2008. “India’s Bond Market –Development and Challenges Ahead”, Working Paper, Asian Development Bank, No.
22, PP. 1- 45.
The Bangladesh Accountant/January- March 2010 33

Finance
Shah Md. Safiul Hoque (Corresponding author), Assistant Professor, School of Business Studies, Southeast University, Banani Dhaka
and S. M. Shafiul Alam, Senior Lecturer, School of Business Studies, Southeast University, Banani, Dhaka.
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Economics & Banking
Banking Supervision as per International Standards:
A Comparative Study of Bangladesh and India
Md Alamgir
Abstract
The Basel Committee on Banking Supervision of Bank for
International Settlements has moved aggressively to promote
sound supervisory standards worldwide. In close
collaboration with many non-G10 supervisory authorities, the
Committee in 1997 developed a set of "Core Principles for
Effective Banking Supervision", which provides a
comprehensive blueprint for an effective supervisory system.
To facilitate implementation and assessment, the Committee
in October 1999 developed the "Core Principles
Methodology". On the basis of Core Principles Methodology,
effective banking supervision of Bangladesh Bank has been
analyzed in a detailed manner. Principles regarding capital
adequacy, non-performing loans, international accounting
standard, on-site and off-site banking supervision, CAMELS
Rating, problem bank, anti-money laundering activities etc
are assessed. But principles regarding operational
independence of Bangladesh Bank, licensing commercial
banks, skills and professionalism of staff of Bangladesh Bank
are not sufficiently covered with. When a comparison is made
between Bangladesh and India regarding compliance of BIS
Core Principles for Effective Banking Supervision, it is seen
that India is well ahead in ensuring risk-based supervision
than Bangladesh. A set of recommendations closes the
discussion.
1. Introduction and Objectives
1.1 Introduction
In recent years, we have witnessed dramatic changes in the
business of banking driven by such key factors as
globalization, deregulation, technological changes, financial
innovation and the growth of ever-larger financial
conglomerates. Collectively, these various developments
have given rise to major challenges, not just for bankers but
also for bank supervisors. And over the past decade,
significant banking problems have been experienced in many
countries, both large and small, industrial and developing. In
the background of this scenario, serious questions have been
raised about the adequacy of bank supervisory techniques and
overall performance, and about the need for fundamental
changes in the approach to supervision.
The supervision exercise can be termed as ‘inspection’ or
‘audit’. The outcome of regulatory compliance checking is
attained through ‘examination’. Supervision is checking of
adherence to rules while regulation confines to making the
rules themselves. Supervisory measures can not be
categorized as preventive and protective, but regulations can
be separated according to these two categories. The examples
of preventive regulation include branch licensing, capital
adequacy requirement, limits on forex exposures, permissible
business activities, limits on loan concentration, liquidity
matching prescriptions etc. Protective regulations include
deposit insurance, facility as lender of last resort and
emergency measures for bailing out weak banks.
The primary goal of any supervision/regulation is
“maintaining safety and soundness of the banking system”, or
“maintaining (depositors) confidence in the banking system”.
At the macroeconomic level the rationale for such a
mechanism could be (a) control over the quantity of money
(b) playing key role in channeling resources (c) operating as
the watchdog for consumer protection regulations and (d)
keeping an eye on the vulnerability of the financial system.
At the same level, it would also address risk areas like high
financial gearing, reliance on widely dispersed withdrawable
funds, adequacy of transparency or lack thereof and
contagion effects across countries, sectors or industry. The
procedures followed for the exercise are directed towards
preventing, monitoring and eliminating dishonest,
Md Alamgir, Lecturer, Bangladesh Institute of Bank Management (BIBM).
The Bangladesh Accountant/January- March 2010 42

Economics & Banking
incompetent and inadequate elements in banking.
At the individual bank level, the supervisory/regulatory
efforts aim at the following:
• Determining the quality of assets by prescribing the
norms and procedures for income recognition, asset
classification, provisioning requirements for each class of
assets and the like.
• Examining the nature and composition of liabilities with
particular reference to their maturities, pricing and spread
over various sources.
• Analyzing the Asset/Liability and Risk Management
issue with particular reference to interest rate sensitivity,
liquidity, off-balance sheet exposures, and hedging
mechanism.
• Ascertaining the compliance of various rules and
regulation relevant to bank operations. (e.g. separate
rules/regulations/prescriptions for private sector, public
sector and co-operative sector banks and foreign banks).
• Evaluating the internal controls, procedures and practices
on accounting standards, operations in various
services/products offered, etc.
• Assessing the capability of the management particularly
at the top level with a view to understanding the
competence, versatility and knowledge/experience profile
to run the bank continually and successfully.
• Determining the adequacy and appropriateness of policies
particularly for loans, investment, pricing,
assets/liabilities and risk management.
• Checking on the incipient trends and leakage of income
by comparing the same with peer groups.
• Assessing the adequacy of capital through Capital Risk
Weighted Assets Ratio and similar indicators.
1.2 Objectives of the study
The objectives of the study are:
To highlight the organizational structure and activities of
Bank for International Settlements.
• To describe the “Core Principles Methodology”
developed by the Basel Committee in October, 1999
in order to facilitate implementation and assessment.
• To describe BIS Core Principles for Effective
Banking Supervision with its essential and additional
criteria.
• To assess the implementation of effective banking
supervision in Bangladesh as per the guidelines given
by Basel Committee on Banking Supervision of
Bank for International Settlements (BIS) in its “ Core
principles for Effective Banking Supervision”,
which provides a comprehensive blueprint for an
effective supervisory system.
• To make a comparison of compliance of BIS Core
Principles for Effective Banking Supervision between
Bangladesh and India.
• To recommend necessary measures to be undertaken
by the regulatory and supervisory authority of
Bangladesh to improve its banking supervision in the
light of “Core Principles for Effective Banking
Supervision”.
2.1 Setting International Standards
The Bank for International Settlements (BIS) is an
international organization, which fosters global cooperation
towards monetary and financial stability and serves as a bank
for central banks. The BIS fulfils this mandate by acting as: i)
a forum to promote discussion and facilitate decision-making
processes among central banks and within the international
financial community; ii) a center for monetary and economic
research; iii) a prime counter party for central banks in their
financial transactions; iv) agent or trustee in international
financial operations.
Thus, the decision to develop the Core Principles by the BIS
largely reflected a growing realization that inadequate bank
supervisory systems had been a major contributor to the
financial difficulties in many countries. Indeed, the
importance of effective prudential supervision has been a
subject of discussion at the two most recent Group of Seven
Summit meetings, in Lyon and Halifax. In response to this
growing interest, the Basle Committee – working closely with
supervisors from 15 non-Group of Ten countries – developed
a set of 25 Core Principles for use by both industrial and
emerging market countries.
The principles cover a broad range of topics, including
licensing and structure, prudential regulations and
requirements, methods of ongoing banking supervision,
information requirements, formal powers of supervisors, and
cross-border banking. They are intended as minimum
requirements, and it is expected that national supervisors will
strengthen them as necessary to address the specific
circumstances of their local systems.
A number of the Core Principles address key prudential
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Economics & Banking
supervisory issues, including capital adequacy, loan loss
reserves, asset concentrations, liquidity, risk management,
and internal controls.
On the crucial subject of risk management, the principles
state that bank supervisors must be satisfied that their banks
have risk management systems that accurately identify,
measure, monitor, and control market risks and other material
risks. In addition, the banks are expected to hold an adequate
amount of capital against those risks.
In the real sense, the principles reflect a growing expectation
that banks must bear the principal responsibility for adequate
risk management themselves. Translating the Core Principles
into practice at the individual country level is a major
undertaking. In fact, in some countries like Bangladesh,
legislative changes will be necessary to provide supervisors
with the adequate authority needed to effectively carry out
their responsibilities.
Thus, the Core Principles of Effective Banking Supervision
have become the most important global standard for
prudential regulation and supervision. The vast majorities of
countries have endorsed the Core Principles and have
declared their intention to implement them. As a first step
towards full implementation, there should be an assessment
of the current situation of a country’s compliance with the
Principles. Such an assessment should identify weaknesses in
the existing system of supervision and regulation, and form a
basis for remedial measures by government authorities and
the bank supervisors. Such assessments are typically
conducted by the countries themselves or by various outside
parties.
1.3 Organization of the Study
The paper is organized as follows: Section-1 incorporates the
introduction of the report; section-2 describes the salient
features of the Bank for International Settlements (BIS) and
the Core Principles Methodology developed by BIS. The
application of the Core Principles for Effective Banking
Supervision in Bangladesh has been incorporated in section-
3. Section-4 deals with the comparison of compliance of BIS
Core Principles for Effective Banking Supervision between
Bangladesh and India. Finally, section-5 ends with
conclusions and recommendations.
2.2 Core Principles Methodology
The Core Principles for Effective Banking Supervision have
become the most important global standard for prudential
regulation and supervision. The vast majority of countries
have endorsed the Core Principles and declared their intention
to implement them. As a first step towards full
implementation, there should be an assessment of the current
situation of a country’s compliance with the Principles. Such
an assessment should identify weaknesses in the existing
system of supervision and regulation, and form a basis for
remedial measures by government authorities and the bank
supervisors. Such assessments are typically conducted by the
countries themselves or by various outside parties.
The Basel Committee on Banking Supervision has decided
not to make assessments of its own due to lack of necessary
resources; however, the Committee is prepared to assist in
other ways, inter alia by providing advice and training.
Committee members may also individually participate in
assessment missions conducted by other parties such as the
IMF, the World Bank, regional development banks, regional
supervisory organizations and private consultants. “Peer
reviews” are also possible, whereby supervisory experts from
one country assess another country and vice versa.
In order for the assessments to be objective and as uniform as
possible, there should be harmonized standards for the
fulfillment of the Core Principles. Experience has already
shown that the Principles may be interpreted in widely
diverging ways, and incorrect interpretations may result in
inconsistencies among assessments.
With this in mind, at its October 1998 meeting, the Basel
Committee took the initiative to have a document prepared
for use in compliance assessments. The drafting was done by
an ad hoc working group consisting of representatives from
Basel Committee member institutions and the IMF and World
Bank. The Core Principles Liaison Group, consisting of G-10
and non-G-10 senior supervisors and the IMF and World
Bank, was also consulted during the drafting process.
The document is structured as follows: the first chapter
outlines the background to the Core principles and explains
the need for their timely and effective implementation. It also
describes under what conditions assessments should be made,
as well as the preconditions for effective banking supervision
that should be taken into account when forming an
assessment. The second chapter raises a few basic
considerations regarding the conduct of an assessment and the
compilation and presentation of the results. It notes that the
assessor must have access to relevant information, without
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Economics & Banking
violating legal requirements for supervisors to hold certain
information confidential, and to a wide range of organizations
and experts. The chapter emphasizes that the assessment must
consider a chain of related requirements, which may
encompass laws, prudential regulation, supervisory
guidelines, on-site examinations and off-site analysis,
supervisory reporting and public disclosures, and evidence of
enforcement or non-enforcement. It also emphasizes the
importance of the supervisory agency having the necessary
skills, resources and commitment to implement the Core
Principles. The third chapter discusses each Core Principle in
detail. All significant criteria, which are relevant for
compliance, are enumerated. Two categories of criteria are
used: “essential criteria” and “additional criteria”. The
essential criteria are those elements that should be generally
present in individual countries in order for supervision to be
effective. The additional criteria are elements that further
strengthen supervision and which all countries should strive
to implement. The essential criteria, and to a significant
degree the additional criteria, are drawn from the Core
Principles document (September 1997) and related Basel
Committee papers. The working group has tried not to break
new ground by introducing additional concepts or
interpretations, although in some cases, particularly regarding
the additional criteria, the language and/or substance may be
more explicit or detailed than in previous documents.
To achieve full compliance with a Principle, the essential
criteria generally must be met without any significant
deficiencies. There may be instances, of course, where a
country can demonstrate that the Principle has been achieved
through different means. Conversely, due to specific
conditions in individual countries, the essential criteria may
not always be sufficient to achieve the objective of the
Principle, and therefore the additional criteria and/or other
measures may also be needed in order for the aspect of
banking supervision addressed by the Principle to be
considered effective.
By way of example, the Basel Committee includes, as an
appendix, the format developed by the IMF and World Bank
for conducting their own assessments of the state of
implementation of the Core Principles in individual countries.
The Committee sees the formulation of this document as an
iterative process, with refinements made as experience is
gained. Developments of regulatory and supervisory
standards and procedures will lead to additions and revisions.
Thus, there will be a need to update the document
periodically.
2.3 Objectives of the Core Principles for Effective
Banking Supervision
The Core Principles for Effective Banking Supervision,
developed by the Basel Committee on Banking Supervision
in cooperation with supervisors from non-G-10 countries,
provide the international financial community with a
benchmark against which the effectiveness of bank
supervisory regimes can be assessed.
The need for strengthening supervision of banks has
particularly been stressed as a major priority since it is now
widely recognized that weaknesses in banking systems have
been at the core of financial crises in many countries over the
last decade. As current banking crises affect many countries,
both developed and emerging economies, the monitoring of
banking systems becomes both more critical and more
challenging for supervisors. As a result, and in order to
minimize the risk of contagion, developed and emerging
countries are being strongly urged to adopt and effectively
implement sound supervisory methods.
The Core Principles were issued by the Basel Committee in
September 1997, and endorsed by the international financial
community during the annual meeting of the IMF and World
Bank in Hong Kong in October 1997. The report of the
Working Party on Financial Stability in Emerging Market
Economies endorsed the Core Principles and requested that
the IMF and the World Bank play a critical role in their
implementation. In October 1998, the group of 22 countries
issued its reports on the international financial architecture,
and in its report on Strengthening Financial Systems, the
Group endorsed several sets of internationally acceptable
principles including the Core Principles and underscored the
importance of their timely implementation. The International
Conference of Banking Supervisors in Sydney endorsed the
Core Principles and pledged to actively contribute to their
implementation while requesting more comprehensive
guidance from the Basel Committee. The request has resulted
in this document.
As a result of the heightened concern about financial sector
stability, the community of banking supervisors is under
pressure to ensure the effective supervision of banks. In
particular, this has been reflected in growing international
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Economics & Banking
demands for countries to implement the Core Principles.
The Basel Committee recognizes that both financial reforms
and better banking supervision require broad ranging and
intensive efforts over a long period of time. However, it is of
the utmost importance that national supervisory authorities
take immediate steps to: (1) identify weaknesses in their
supervisory system (2) address the their utmost weaknesses,
and (2) urge public authorities to support fully all necessary
measures to strengthen financial sector stability, including the
implementation of the Core Principles.
As standard setter, the Basel Committee will remain very
active in interpreting the current Core Principles, providing
training to supervisors world-wide, and disseminating norms
and sound practices. The Basel Committee might find it
necessary to refine further the Core Principles to ensure that
they are not only comprehensive, but also relevant and useful
for all countries wishing to apply them. With respect to
interpreting or revising the Core Principles, the committee
will be working very closely with non-G-10 countries, as well
as the IMF and the World Bank, within the Core Principles
Liaison Group.
Both the IMF and the World Bank will play an active role in
the implementation process. In the context of its surveillance
mandate, the IMF will encourage its member countries to
comply with the Core Principles, and will work with them in
assessing compliance on a case-by-case and priority basis. In
the course of its regular operations, then World Bank will
encourage its client countries to adopt the Core Principles and
also work with them to assess their supervisory framework
against the Principles. Both the IMF and the World Bank will
seek to have countries remedy identified weaknesses in their
regulatory and supervisory regimes, and will provide
technical assistance and training to address such weaknesses
on a priority basis. To meet the increasing demands in the
financial sector area, both institutions are increasing the
number of staff with financial sector expertise.
The Basel Committee, the Core Principles Liaison Group, the
IMF and the World Bank have an ongoing dialogue to i)
coordinate initiatives so that common objectives in this field
can be met; and ii) ensure that scarce expert resources are
used in he best possible way. given the challenging objective
of strengthening banking supervision worldwide and the
scarcity of resources to do so, the above groups are fully
aware of the need to closely coordinate their respective
activities. These organizations will also utilize resources
made available by supervisors world-wide as a means to help
countries that ask for technical assistance with the intention
of assessing their supervisory systems against the Core
Principles.
2.4 Preconditions for Effective Banking Supervision
The Basel Committee recognizes that effective banking
supervision requires a set of preconditions to be in place.
While these preconditions are largely beyond the control of
the supervisory authority, weaknesses or shortcomings in
these areas may significantly impair the ability of the
supervisory authority to implement effectively the Core
Principles. Hence, the assessors should form a view as to
whether these preconditions are in place, as well as the
potential problems. Any shortcomings might entail and
whether best efforts are being met to correct these
shortcomings. As discussed in the following five paragraphs,
the preconditions cover a range of areas, including: (1) sound
and sustainable macroeconomic policies; (2) a welldeveloped
public infrastructure; (3) effective market
discipline; (4) procedures for the efficient resolution of
problems in banks; and (5) mechanisms for providing an
appropriate remedy for risks that have implications for the
effectiveness of prudential safeguards or the stability of the
financial system. Thus, the assessment of the overall
effectiveness of banking supervision and compliance with
individual Core Principles should give consideration to the
structure of the banking sector and the macroeconomic
environment in which the banks operate.
The public infrastructure may have a profound impact on the
potential to comply with the Core Principles. Perhaps the
most important aspect is the existence of a proper credit
culture, i.e., an environment that fosters the honouring and
enforcement of financial contracts. The credit culture must be
built on an adequate body of laws, covering a range of
financial issues, including inter alia, contracts, bankruptcy,
collateral and loan recovery. But good laws are not enough,
they must be supported by a body of ethical and professional
lawyers and judges, and a reasonably efficient court system
whose decisions are enforceable. An adequate infrastructure
also requires that accounting standards approach international
best practices, so investors can properly evaluate the financial
condition of the banks, and the banks can monitor the health
of the institutions to which they lend. Accurate financial data
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Economics & Banking
requires a professional body of accountants and auditors.
Other key considerations in evaluating the public
infrastructure are the effectiveness of supervision in other
financial sectors and markets, as well as the risks inherent in
the payment system.
Effective market discipline is based on financial transparency
and effective corporate governance; however, the process can
be undermined by government efforts to influence
commercial decisions, particularly lending operations. Hence,
any influence government policies have on lending operations
should be as transparent as possible, with government
policies published and government guarantees clearly
disclosed.
Supervisors should have a sufficient and flexible range of
procedures to achieve the efficient resolution of problems in
banks. The Core Principles note the need for such a range of
powers, including responsibility for, or ability to assist in, the
prompt and orderly resolution of problem banks.
There is a need to ensure that an appropriate public safety net
is in place. The key aspects of this safety net may include a
lender of last resort facility and/or formal deposit insurance
arrangements. While minimum standards for a public safety
net have not been agreed, shortcomings in the safety net have
implications for banking supervisory practices.
2.5 Criteria for Assessing Compliance with the
Core Principles
The following set of criteria for each of the 25 Core
Principles are listed under two separate headings: “essential
criteria” and “additional criteria”. The essential criteria are
those elements that should be present in order to demonstrate
full compliance with a Principle. The additional criteria are
elements that further strengthen supervision and are
recommended for improved financial stability and effective
supervision. They may be particularly relevant to the
supervision of more sophisticated banking organizations or
may be needed in instances where international business is
significant or where local markets tend to be highly volatile.
The individual criteria are largely based on materials
provided in full Core Principles document (September 1997)
and in related Basel Committee papers on sound practices. It
should be noted that, while many of the criteria refer to
supervisors having the authority to conduct such activities as
setting certain standards and requirements for banks, these
can also be contained in laws and regulations. Conversely,
where it is mentioned that laws and/or regulations are in place
on certain issues, the same effect can, in some circumstances,
be achieved through some guidelines.
3.0 Core Principles for Effective Banking
Supervision: Its application in Bangladesh
Principle 1. An effective system of banking supervision will
have clear-cut responsibilities and objectives for each agency
involved in the supervision of banks. Each such agency
should possess operational independence and adequate
resources. A suitable legal framework for banking
supervision is also necessary including provisions relating to
authorization of banking establishments and their ongoing
supervision; power to address compliance with laws as well
as safety and soundness concerns; and legal protection for
supervisors. Arrangements for sharing information between
supervisors and protection for confidentiality of such
information should be in place.
Bangladesh Bank, which was formed under an act of
parliament, viz., Bangladesh Bank Order, 1972, has the sole
responsibility of supervision and regulation of banks in
Bangladesh. Bank Companies Act, 1991, The Bangladesh
Bank (Nationalization) Order 1972, Bankruptcy Act, 1997,
Prevention of Money Laundering Act, 2009, Money Loan
Court Act, 2003 etc., lay down the law relating to banking
regulation and supervision.
The laws supporting regulation and the guidelines and
prudential norms issued by Bangladesh Bank from time to
time provide a framework of minimum prudential standards
that banks must meet. While by and large the prudential
norms conform to the international standards, in some cases
considering the special circumstances prevalent in the
banking system, Bangladesh Bank has permitted some
deviations from the international benchmarks. These
deviations are being reviewed regularly and where considered
desirable a movement toward achieving these benchmarks on
a time bound basis is being made. Supervision of commercial
banks is the sole responsibility of Bangladesh Bank. Off-site
supervision of Bangladesh Bank prepares CAMEL Rating of
different banks. Banks with marginal and unsatisfactory
rating are treated as problem bank. Bangladesh Bank signs
Memorandum of Understanding (MOU) with the problem
bank specifying targets which need to be achieved over a
period of time in order for the bank to improve its CAMEL
Rating. Problem Bank Unit of Bangladesh Bank regularly
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Economics & Banking
reviews and analyses the monthly/quarterly statements and
returns submitted by the banks and periodical meetings with
the top management of each of the problem banks are also
held to review and analyze the progress made by them against
those set in the MOUs; and to find out measures for further
improvement of governance. Apart from this, observers from
Bangladesh Bank are placed on the Board of Directors of
problem banks to attend the bank’s board meetings and other
committee meetings so that decisions of their management
are in conformity with the objectives and targets set in the
MOUs.
Bangladesh Bank’s objectives as a supervisory agency are set
out in the Bangladesh Bank Order, 1972. An annual report
on the working of Bangladesh Bank with detailed analysis of
its annual accounts and an assessment of Bangladesh
economy is also submitted to the Government under Section
40(2) of the Bangladesh Bank Order, 1972. The system is
transparent. Bangladesh Bank ensures that information on
financial strength and performance of the industry under its
jurisdiction is publicly available. It produces and publishes,
besides its Annual Report, Economic Trends, Scheduled
Banks’ Statistics, Bangladesh Bank Bulletin and several other
reports and statistics on a periodical basis which provide
information on the performance and strength of the banking
industry. Recently the Government has given Bangladesh
Bank partial autonomy by amending the Bangladesh Bank
Order, 1972, Bank Companies Act, 1991 and the Bangladesh
Bank (Nationalization) Order, 1972. The following initiatives
have been taken for the independence of Bangladesh Bank:
(1) Governor of Bangladesh Bank will be accountable to the
Parliamentary Committee related to the Ministry of Finance,
not to the Government of Bangladesh. (2) There will be a
Monetary and Fiscal Coordination Committee headed by
Minister, Ministry of Finance, the Government of the
People’s Republic of Bangladesh to coordinate between the
Government and Bangladesh Bank. (3)The Board of
Directors of Bangladesh Bank has been given more
autonomy.
As per section 31 of Bank Companies Act, 1991, Bangladesh
Bank has the sole right to give license to a commercial bank.
According to the section 9(1) of Bangladesh Bank Order,
1972, the Government may from time to time, give such
directions to Bangladesh bank as it may consider necessary in
the public interest. The Board of Directors of Bangladesh
Bank consists of a Governor, Deputy Governors, other
directors nominated by the Government. According to section
36(2) of Bangladesh Bank Order, 1972, the Government may
change Cash Reserve Ratio (CRR) of banks by notification in
the official gazette though it should be the responsibility of
Bangladesh Bank. According to section 82(1) of Bangladesh
Bank Order, 1972, the Board of Directors of Bangladesh
Bank can transact its business as specified in the section 82(1)
of Bangladesh bank Order, 1972, subject to the approval of
the government. Bangladesh Bank has earned operating profit
of Tk. 25.66 billion in FY 2009 as against Tk. 31.92 FY2008.
So, it has necessary resources to carry out its mandate.
Bangladesh Bank is so constituted and financed that its
autonomy and independence are not undermined. It conducts
effective supervision and oversight without facing any
limitations and is able to raise the required resources for that.
According to the section 10(5) of Bangladesh Bank Order,
1972, Governor of Bangladesh Bank is appointed for such
period not exceeding 5(five) years and shall be eligible for
reappointment.
According to the section 15(1), the Government may remove
the Governor or Deputy Governor from office, if he becomes
permanently incapable of performing his duties or subject to
any of the disqualification specified in clause 9 of article 10
or has done any act which is a breach of the trust reposed in
him or if his continuance in office is regarded as manifestly
opposed to the interest of the Bank. But breach of the trust
reposed on Governor is not defined anywhere in Bangladesh
Bank Order, 1972. Bangladesh Bank Order, 1972 does not
place any obligation on the Government to make the reasons
for removal public.
According to the section 31 of Bank Companies Act, 1991 ,
Bangladesh Bank has sole responsibility to give license to
commercial banks. But Ministry of Finance has taken final
decision to issue license to commercial banks. According to
the section 36 of Bank Companies Act, 1991 and section 43,
44 & 45 of Bangladesh Bank Order, 1972, Bangladesh Bank
may ask for any information from banking company.
According to the section 48(1) of Bangladesh Bank Order,
1972, if any banking companya.
fails to submit any statement required under Article 44 or
submits under the article a statement which is false in
any material particular, or
b. fails to comply with any conditions imposed on every
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Economics & Banking
director or other officials of the company and every other
person who is knowingly a party to the breach shall
punishable with fine may extend to Tk. 2000.
According to section 109 of Bank Companies Act, 1991,
Bangladesh Bank can impose punishment on the bank.
According to the section 36 of Bank Companies Act, 1991
and section 43, 44 & 45 of Bangladesh Bank Order, 1972,
Bangladesh Bank may ask for any information from banking
company.
Section 41 of Bangladesh Bank Order, 1972 provides for
explicit protection to the supervisors. No suit or other legal
proceeding shall lie against Bangladesh Bank or any of its
officers for anything done in good faith or in pursuance of the
Bangladesh Bank Order, 1972.
Bangladesh Bank, Security & Exchange Commission,
Ministry of Finance, Ministry of Commerce and other
regulatory authorities share information when needed.
Bangladesh Bank shares information with overseas
supervisors based on reciprocity.
Principle 2: The permissible activities of institutions that are
licensed and subject to supervision as banks must be clearly
defined, and the use of the word “bank” in names should be
controlled as far as possible:
The term “Banking” is clearly defined in section 5 (p) of
Bank Companies Act, 1991.
The permissible activities of a banking company are clearly
defined and listed in section 7 of Bank Companies Act, 1991.
As per section 8 of Bank Companies Act, 1991, every
banking company carrying on the business of banking in
Bangladesh shall use the word ‘Bank’ or any of its derivatives
as part of its name and no company other than a banking
company shall use in its name any word to indicate that it is a
banking company. Only banks licensed under section 31 of
Bank Companies Act, 1991 can take deposits.
Principle 3: The licensing authority must have the right to set
criteria and reject applications for establishments that do not
meet the standards set. The licensing process, at a minimum,
should consist of an assessment of the banking organization’s
ownership structure, directors and senior management, its
operating plan and internal controls, and its projected
financial condition, including its capital base; where the
proposed owner or parent organization is a foreign bank, the
prior consent of its home country supervisor should be
obtained:
The criteria for licensing are set out in section 31 of the Bank
Companies Act, 1991. Bangladesh Bank has also set
prudential norms including norms for capital adequacy, which
are followed, in licensing banks. The criteria for issuing
licenses laid down in Bank Companies Act, 1991 are
consistent with major objectives of ongoing supervision.
Bangladesh Bank takes declaration from sponsors of a bank
about source of initial capital. But Bangladesh Bank does not
take information from Tax Department about the initial
capital of the sponsors. According to the section 13(2) of
Bank Companies (Amendment) Act, 2003, minimum
requirement of paid up capital is Tk. 200 crore for a new
bank. Fit and proper test is applied to evaluate the directors
and senior management. Operational structure of banks is
examined as part of licensing process. Bangladesh Bank is
both the licensing as well as the supervisory authority.
Bangladesh Bank can cancel the license of a bank if the
banking company ceases to carry on banking business in
Bangladesh, or it fails to comply with any of the conditions
imposed under section 31 of Bank Companies Act, 1991. As
per common law, any consent obtained through
misrepresentation of facts is no consent. On this basis also,
Bangladesh Bank can revoke the license of a banking
company that is obtained based on false information. The
compliance with conditions imposed on new banking
companies is monitored through quarterly system of on-site
supervision till annual financial inspection commences. The
required procedures are thus in place.
Principle 4: Banking supervisors must have the authority to
review and reject any proposals to transfer significant
ownership or controlling in existing banks to other parties:
According to section 14(a) of Bank Companies Act, 1991, the
shares of a bank shall not be centralized in any person,
company or among member of a family and no person,
company or among member of a family shall buy more than
10% share of a bank either personally, jointly or both.
Supervisory approval of Bangladesh Bank is needed for
proposed change in ownership. Bangladesh Bank has
requisite powers to reject/prevent any proposal for a change
in significant ownership or controlling interest in a bank.
Bangladesh Bank receives a half-yearly return on ‘ownership
and control’ from all domestic banks. Any significant change
in ownership is also examined during on-site inspection.
Principle 5: Banking supervisors must have the authority to
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Economics & Banking
establish criteria for reviewing major acquisitions or
investments by a bank and ensuring that corporate affiliations
or structures do not expose the bank to undue risks or hinder
effective supervision:
Formation of subsidiaries by banks requires prior approval of
Bangladesh Bank. Banks are allowed to set up subsidiaries
for specified activities mentioned in section 26 of Bank
Companies Act, 1991. Bangladesh Bank examines viability
of the proposed subsidiary or acquisition before granting
permission. All major acquisitions are looked into from the
point of view of their impact on the bank and its ability to
manage the investment/acquisition well. Banks are allowed to
set up subsidiaries for specified activities mentioned in
section 26 of Bank Companies Act, 1991.
Principle 6: Banking supervisor must set minimum capital
adequacy requirements for banks that reflect the risks that the
bank undertakes, and must define the components of capital,
bearing in mind its ability to absorb losses. For internationally
active banks, these requirements must not be less than those
established in the Basel Capital Accord:
According to section 13A of Bank Companies Act, 1991,
every bank must have minimum 8% capital against riskweighted
assets. Bangladesh Bank has increased minimum
capital adequacy ratio to 10% which is effective from June,
2003. The whole calculation of capital adequacy is based on
the Basel Capital Accord. Bank-specific capital ratios have
not yet been introduced. The components of capital have been
defined as per Basel norms.
If a bank cannot maintain minimum capital adequacy ratio,
the CAMEL rating of that bank will be downgraded. A bank
with 4 or 5 CAMEL rating is treated as a problem bank.
Compliance with capital adequacy is monitored through halfyearly
prudential reporting and on-site inspection of banks.
Risk-adjusted ratio for individual grouping of on- and offbalance
sheet for arriving at capital adequacy ratio is
prescribed by Bangladesh Bank. It is computed and reported
by banks in detail to Bangladesh Bank as part of off-site
return on capital adequacy.
Banks are at present assessing their capital adequacy in the
light of standard risk weights for assets as advised by
Bangladesh Bank. They are, however, not yet attuned to
assess capital adequacy in relation to their individual risk
profile. Bangladesh Bank has increased minimum capital
adequacy ratio to 10% which is effective from June, 2003 as
against the international standard of 8%.
Principle 7: An essential part of any supervisory system is
the independent evaluation of a bank’s policies, practices and
procedures related to the granting of loans and making of
investments and the ongoing management of the loan and
investment portfolios:
In the course of on-site examination, adequacy of credit and
investment policies and adherence thereto are looked into.
There are laws, and banks’ internal as well as supervisory
guidelines to ensure that credit decisions are made free of
conflicting interests, on arms length basis and free from
inappropriate pressures from outside parties. According to
section 36 of Bank Companies Act, 1991 and section 43, 44
&45 of Bangladesh Bank Order, 1972, Bangladesh Bank may
ask for any information from banking company. Banks
generally follow a well laid out loan policy and have a
structure for delegation of discretionary powers at different
managerial levels under which credits are sanctioned or
investments are made. Credit monitoring systems are in place
in all banks. However, in the case of quite a few banks, the
adequacy of MIS can be questioned. In the light of recent
developments in information technology, there is need and
scope for improvement in credit-related MIS at banks. As per
DBOD Circular No. 3 dated September 2002 of Bangladesh
Bank, a bank can extend credit limit up to maximum 50% of
bank’s capital, of which 25% is funded facilities and 25% is
non-funded facilities.
Principle 8: Banking supervisors must be satisfied that banks
establish and adhere to adequate policies, practices and
procedures for evaluating the quality of assets and the
adequacy of loan loss provisions and reserves:
Bangladesh Bank has laid down detailed guidelines on
income recognition, asset classification and provisioning in
line with international standards through BRPD Circular No.
16 dated December 6, 1998. The guidelines specify quarterly
review of asset classification and provisioning requirements.
This is being done in Bangladesh. The system of on-site
inspection comprises of appraisal of asset quality and the
impairment of the asset values. The quality of assets is also
monitored on quarterly basis through off-site monitoring
returns. The system of classification and provisioning include
only such off-balance sheet items that are likely to get
converted into on-balance sheet items.
Bangladesh Bank has determined the asset classification and
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Economics & Banking
provisioning norms and no discretion is left to the
management of banks. Loss items have to be provided in full.
If a bank chooses to write off, the compromise/settlement
should be as per the policy laid down by BRPD Circular No.
2 dated July 13, 2003. Loan recovery policies of banks are
studied during on-site inspections to assess adequacy of
procedures and organizational set-up to recover past due
loans.Bangladesh Bank has powers to give banks specific
directions for ensuring adequacy of provisions. Bangladesh
Bank impresses upon banks to reduce exposure to certain
sectors, if found excessive, and improve quality of credit
appraisal, if found lacking. Quarterly detailed reporting of
asset classification and provisioning is in place.This practice
is being followed. Loans are being classified as impaired even
if the default in payment of principal/interest is less than two
quarters. A credit facility is classified as non-performing if
interest and installments of principal remain unpaid for two
quarters after it has become past due. Asset classification and
provisioning exercise is done account-wise.
Principle 9: Banking supervisors must be satisfied that banks
have management information systems that enable
management to identify concentrations within the portfolio
and supervisors must set prudential limits to restrict bank
exposures to single borrowers or groups of related borrowers:
A “closely related group” is not explicitly defined to reflect
actual risk exposure in Bangladesh.As per BRPD Circular
No. 8 dated 18, 2003 of Bangladesh Bank, credit limit to a
person or group of companies cannot be more than 50% of
Bank’s capital as mentioned in the section 13A of Bank
Companies Act, 1991. Again funded facilities to any person
or group of companies cannot be more than 25% of the
Bank’s capital. Off-balance sheet exposures that carry 50
weight are treated as non-funded facilities.
The MIS of banks enables concentration to be identified on
solo, group and industry levels. The supervisor examines such
concentrations through periodic returns received from banks
as well as at the time of on-site inspection. A half-yearly
reporting to management of banks on the exposure ceilings
on solo as well as group basis is in place. The supervisor also
monitors this exposure. Bangladesh Bank compiles and
publishes basic statistics bank-wise and group-wise on
sectoral and geographic concentration of credit. As per BRPD
Circular No. 8 dated 18,2003 of Bangladesh Bank, an
exposure of 15 per cent and above of bank’s capital funds is
treated as large credit. Banks are required to adhere to
prudential exposure limit of 50 per cent for individual
borrowers and groups of borrowers including both funded and
non-funded facilities.
Principle 10: In order to prevent abuses arising from
connected lending, banking supervisors must have in place
requirements that banks lend to related companies and
individuals on an arm’s length basis, that such extensions of
credit are effectively monitored, and other appropriate steps
are taken to control or mitigate the risks:
A comprehensive definition of ‘connected’ or ‘related parties’
needs to be provided by law/regulator. However, in
Bangladesh credit extended to directors of the bank is known
as insider lending.
According to BRPD Circular No. 7 dated August 5, 1999, a
bank can extend directors or director-sponsored companies up
to maximum 50% of his/her shareholding in the bank.Banks
normally have procedures in place to prevent persons
benefiting from the loan being associated either with its
appraisal or sanction. However, there is no clear-cut
requirement to this effect stipulated by the supervisor
excepting in regard to the directors.As per BRPD Circular
No. 7 dated August 5, 1999, every bank must report lending
to connected parties in the format mentioned in BRPD
Circular No. 8 dated June 19, 1997. The term “connected
lending” includes directors of banks, firms/companies in
which he is interested and individuals to whom director is a
guarantor or partner, senior management and their relatives,
directors of subsidiaries/trustees of mutual funds/venture
capital funds established by banks and other banks.
Principle 11: Banking supervisors must be satisfied that
banks have adequate policies and procedures for identifying,
monitoring and controlling country risk and transfer risk in
their international lending and investment activities, and for
maintaining appropriate reserves against such risk:
No compliance by local banks in Bangladesh.
Principle 12: Banking supervisors must be satisfied that
banks have in place systems that accurately measure, monitor
and adequately control market risks; supervisors should have
powers to impose specific limits and/or a capital charge on
market risk exposures, if warranted:
No compliance by local banks in Bangladesh.
Principle 13: Banking supervisors must be satisfied that
banks have in place a comprehensive risk management
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Economics & Banking
process (including appropriate board and senior management
oversight) to identify, measure, monitor and control all other
material risks and, where appropriate, to hold capital against
their risk.
Bangladesh Bank has issued detailed guidelines to banks for
putting in place effective asset Liability Management
systems. Every bank has an Asset Liability Management
Committee (ALCO) or Credit Committee headed by the Chief
Executive Officer and Managing Director or Deputy
Managing Director. Banks are required to lay down policy on
identification, monitoring and control of various kinds of
risks such as liquidity risk, interest rate risk and currency risk
and to review the policy from time to time to incorporate
changes in business environment and the perception of the
top management about the risks.
Bangladesh Bank has advised banks to monitor liquidity
through maturity or cash flow mismatches. Future cash flows
are to be bracketed in different time brackets. Banks are
required to fix tolerance levels for various maturity
mismatches depending upon their asset – liability profile,
extent of stable deposit base, nature of cash flows, etc. To
abide by the guidelines, banks have been advised to put in
place adequate and efficient MIS.
Liquidity in foreign currencies is measured and monitored
through quarterly maturity and position statements in US $.
Banks are expected to measure interest rate risk through
traditional gap analysis. Each bank is required to set
prudential limits on gaps for each time bracket considering
total assets, earning assets and equity. Banks may fix prudent
level for Net Interest Margin (NIM).
All banks have a system of internal audit. Bangladesh Bank
has issued various guidelines on putting in place appropriate
checks/procedures to prevent occurrence of frauds. Banks
also have to report large value frauds to Bangladesh Bank.
Bangladesh Bank has issued guidelines to manage liquidity
risk, interest rate risk and currency risk. Banks have been
advised to fix prudential internal limits for all kinds of risks.
Bangladesh Bank monitors the liquidity position of banks
through a fortnightly return on structural liquidity. Banks are
required to submit a monthly return on interest rate sensitivity
for exposures in Taka as well as foreign currencies to
Bangladesh Bank. Besides, off-site inspections ensure
adherence to the set guidelines by banks.
The top management is involved in fixing and monitoring of
limits on foreign exchange positions. Stress testing of foreign
currency liquidity for large banks active in foreign exchange
market has been prescribed.
Principle 14: Banking supervisors must determine that banks
have in place internal that banks have in place internal
controls that adequate for the nature and scale of their
business. These should include clear arrangements for
delegating authority and responsibility; separation of the
functions that involve committing the bank, paying away its
funds, and accounting for its assets and liabilities;
reconciliation of these processes; safeguarding its assets; and
appropriate independent internal or external audit and
compliance functions to test adherence to these controls as
well as applicable laws and regulations:
Corporate governance in banks and financial institutions has
lately been receiving considerable attention. As per BRPD
Circular No. 12 dated December 23,2002, Audit Committee
of the Board of Directors is constituted in every bank. The
Annual Report of the Company shall disclose composition of
the Audit Committee and the Audit Committee should have
discussions with the auditors periodically about Internal
Control Systems, the scope of audit including the
observations of the auditors and review the half yearly and
annual financial statements before their submission to the
Board of Directors. This committee has also been charged
with the responsibility of ensuring compliance at the
organization-wide level with internal control systems.
Bangladesh Bank has issued a number of
instructions/guidelines to banks requiring them to streamline
their inspection and audit machinery, monitor treasury
operations, introduce concurrent audit, introduce internal
control systems for prevention of frauds, monitor cash flows
in accounts, promptly reconcile inter-branch accounts, etc.
and balance books periodically. Bangladesh Bank has also
issued guidelines from time to time on definition and
segregation of duties and responsibilities for different areas of
business. Checks and balances principle is fundamental to
banking. Each bank is required to have a written policy on
delegation of powers for managing credit, investments,
money market operations, foreign exchange operations, etc.
There are separate internal control guidelines covering forex
transactions, conformity to which is verified during on-site
inspections by Bangladesh Bank. The Director’s
responsibility statement aims at ensuring that the members of
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Economics & Banking
the boards of banks understand the underlying risks in
banking business and are both committed to and legally
responsible for control environment obtaining in the bank.
The supervisor has the legal authority to require changes in
the composition of the board and management although these
go into play very late in the deteriorating performance
scenario of the bank. In this context, the real issue relates to
the public sector banks in which the regulator has, at least in
practice, very little say in composition and continuance of the
board and/or the senior management even in persistently
deteriorating performance scenario. The prerogative lies with
the owner, i.e., the Government, which it rarely exercises.
Each bank has an internal audit department that inspects the
bank’s functioning periodically and reports to the Audit
Committee.
Banks have sufficient resources and invest in training their
staff to conduct internal inspections. They also avail of the
training facilities offered by Bangladesh Bank for this
purpose.
Additionally, many banks have also instituted separate
“system audits” which focus on whether the internal
procedures and controls are being adhered to at the
operational level and commensurate with the requirement of
the changing business environment.
Principle 15: Banking supervisors must determine that banks
have adequate policies, practices and procedures in place,
including strict “know-your-customer” rules, that promote
high ethical and professional standards in the financial sector
and prevent the bank being used, intentionally or
unintentionally, by criminal elements:
Money Laundering Prevention Act, 2009 has been enacted.
Bangladesh Bank has set up Anti-Money Laundering
Department to deal with money laundering activities.
Bangladesh Bank has issued guidelines to banks and financial
institutions for identifying and reporting unusual suspicious
transactions to anti-Money Laundering Department.
Suspicious transactions with prima facie evidence of money
laundering offences are referred to the Bureau of Anticorruption
or the Police Authorities for formal investigation
and eventual prosecution under the law, where the necessary
court orders for freezing or seizing of the assets involved.
Principle 16: An effective banking supervisory system
should consist of some form of both on-site and off-site
supervision:
Bangladesh Bank has on-site and off-site inputs. Accuracy
and reliability of information is verified in the course of onsite
inspection conducted by Bangladesh Bank officials. Onsite
inspections are based on CAMELS (Capital adequacy,
Asset quality, Management, Earnings, Liquidity and
Sensitivity to risk) model and aim at evaluation of banks’
safety and soundness, appraisal of the quality of board and
management, compliance with prudential regulations and
analysis of key financial factors such as capital, earnings and
liquidity to determine banks’ financial soundness and
continued solvency. Independent verification of the corporate
governance function is covered as part of management
evaluation under the CAMELS based on-site inspection.
Financial condition of individual banks is reviewed on the
basis of both off-site as well as on-site work. Analysis of the
returns is done for individual banks, peer groups and industry
as a whole for various macroeconomic indicators. These
analyses help in detecting early warning signals. On-site
inspection is also used to validate supervisory information
received in the form of off-site returns. Bangladesh Bank
verifies compliance with prudential regulations and legal
requirements through annual on-site inspection and quarterly
off-site supervisory returns frequency of inspection is
generally annual, which can be varied depending on the
financial position, methods of operation and compliance
record of the bank. For instance, problem banks are now
quarterly monitoring regime including on-site visits.
Periodical on-site inspection is supported by off-site
monitoring, periodicity whereof could be increased
depending on bank-specific conditions.
Principle 17: Banking supervisors must have regular contact
with bank management and a thorough understanding of the
institution’s operations:
Contact with banks is continuous. the findings of on-site
inspection are discussed first by inspection teams with banks’
Chief Executive Officer. This is followed by a meeting of top
management of Bangladesh Bank with banks’ management to
discuss matters of supervisory concerns identified during onsite
inspection. The overall CAMEL rating is not
communicated to the banks’ management. Banks are
consulted before introduction of major reporting changes and
senior bank officers are associated with the working groups
and committees set up by Bangladesh Bank to examine
/deliberate on regulatory/supervisory issues. The supervisor
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Economics & Banking
has a thorough understanding of the activities of its banks
accomplished through off-site and on-site surveillance
mechanism at its disposal.
Principle 18: banking supervisors must have a means of
collecting, reviewing and analyzing prudential reports and
statistical returns from banks on a solo and consolidated
basis.:
According to the section 36 of Bank Companies Act, 1991
and section 43, 44, & 45 of Bangladesh Bank Order, 1972,
Bangladesh Bank may ask for any information from banking
company. Presently, Bangladesh Bank receives prudential
reports and statistical returns from banks on a solo basis only.
Bangladesh Bank receives quarterly/half-yearly/yearly
statutory returns on various aspects like assets and liabilities,
profitability, capital adequacy, large exposures, asset quality,
connected lending, maturity profile of foreign exchange
positions and interest rate sensitivity for overseas operations.
Prudential returns are required to be signed by the Chief
Executive Officer or a whole time director of banks to ensure
high-level involvement. Any inconsistency or inaccuracy in
reporting is taken up with the top management of the bank.
Submission of any wrong information to Bangladesh Bank
can invite imposition of penalties specified in section 109 of
Bank Companies Act, 1991 and section 48(1) of Bangladesh
Bank Order, 1972.
Principle 19: Banking supervisors must have a means of
independent validation of supervisory information either
through on-site examinations or use of external auditors: As
per section 44 of Bank Companies Act, 1991, Bangladesh
bank can inspect any bank as when needed. As per section
39 of Bank Companies Act, 1991, external auditors are
appointed. The balance sheet and profit and loss account
of banks are to be audited by qualified auditors, whose
appointment, reappointment and removal is subject to
prior approval of Bangladesh Bank (section 39 of Bank
Companies Act, 1991). Section 39A of Bank Companies
Act, 1991 gives powers to Bangladesh Bank to appoint
external auditors for special audit.
According to section 36 of Bank Companies Act, 1991 and
section 43, 44 & 45 of Bangladesh Bank Order, 1972,
Bangladesh Bank may ask for any information from banking
company. According to section 49(d)(ii) of Bank Companies
Act, 1991, Bangladesh Bank can depute its officer to observe
the proceedings at any meeting of the Board of Directors of
the banking company or of any committee or of any other
body constituted by the Board of Directors. Accuracy and
reliability of supervisory returns are verified by in-house
examiners of Bangladesh Bank during the course of annual
financial inspection. The auditors are at present required to
verify the calculation of the net demand and time liabilities
and maintenance of Cash Reserve ratio (CRR) and Statutory
Liquidity Ratio (SLR) by banks on sample basis. The auditors
also certify the income recognition and asset classification
procedures, capital adequacy calculations, etc.
Principle 20: An essential element of banking supervision is
the ability of the supervisors to supervise the banking group
on a consolidated basis.:
In Bangladesh there is no banking group.
Principle 21: Banking supervisors must be satisfied that each
bank maintains adequate records drawn up in accordance with
consistent accounting policies and practices that enable the
supervisor to obtain a true and fair view of the financial
condition of the bank and the profitability of its business, and
that the bank publishes on a regular basis financial
statements that fairly reflect its condition:
Bangladesh Bank has the authority to hold management of a
bank responsible for ensuring that financial record keeping
system and the data they produce are reliable. Submission of
any wrong information to Bangladesh Bank can invite
imposition of penalties specified in section 109 of Bank
Companies Act, 1991 and section 48(1) of Bangladesh Bank
Order, 1972.
It is mandatory for all banks to get their annual accounts
audited every year by external auditors who are appointed
with the approval of Bangladesh Bank (section 39 of Bank
Companies Act, 1991). The auditors are required to report
specifically whether the financial statements exhibit a true
and fair view of the affairs of the bank. Adequacy and
accuracy of records maintained by banks are verified during
on-site inspection by Bangladesh Bank
Bangladesh Bank does not at present interact with the
external auditors of banks. Regular consultation with audit
profession also takes place through meetings of Bank Audit
Committee, which decides on the accounting standards and
audit coverage.
Bangladesh Bank has adopted International accounting
Standard 30(IAS-30) vide BRPD Circular No. 3 dated August
18,2000 for preparing Annual Accounts of the bank which is
effective from December 2000.
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Economics & Banking
Bangladesh Bank has laid down stringent asset classification
and provisioning norms vide BRPD Circular No. 34 dated
November 16, 1989 and BRPD Circular No. 16 dated
December 6, 1998.
The formats for preparation of financial statements are
prescribed under section 38(4) of Bank Companies Act, 1991.
The financial statements are prepared based on accounting
standards prescribed by BRPD Circular No. 3 dated 18,2000.
Appointment of external auditors needs approval of
Bangladesh Bank.
The selection process for external auditors for statutory and
branch audit of banks is administered by Bangladesh Bank
which ensures that only those having the necessary
competence and experience would be entrusted with bank
audit tasks.
Principle 22: Banking supervisors must have at their disposal
adequate supervisory measures to bring about timely
corrective action when banks fail to meet prudential
requirements (such as minimum capital adequacy ratios),
when there are regulatory violations, or where depositors are
threatened in any other way. In extreme circumstances, this
should include the ability to revoke the banking license or
recommend its revocation:
Bangladesh Bank is vested with powers to issue directions
under Bank Companies Act, 1991 and Bangladesh Bank
Order, 1972 where necessary in the interest of banking
policy, in public interest or where the affairs of the banking
company are being conducted in a manner detrimental to the
interest of the depositors. It has powers to initiate action
against banks, which fail to fulfil prudential requirements.
Such remedial actions are wide ranging and are taken
depending upon the severity of the situation. They range from
informal oral communication to restrictions on branch
expansion, assets expansion and setting up of subsidiaries and
can extend up to actions, which can lead to revocation of
license.
Section 45 of Bank Companies Act, 1991 gives Bangladesh
Bank wide powers to issue directions to banks on any aspect
of their business. Bangladesh Bank can appoint nominees on
the Board of Directors of the Bank ( section 49(d) (ii) of Bank
Companies Act, 1991), can remove Chairman, Director or
Chief Executive Officer of the bank (section 46 of Bank
Companies Act, 1991), cancel their license (section 31 of
Bank Companies Act, 1991), take monetary and nonmonetary
penal measures (section 109 of Bank Companies
Act, 1991 and section 48(1) of Bangladesh Bank Order,
1972), cause merger/amalgamations, impose restrictions or
even close a problem bank. There are provisions for imposing
monetary penalties against delinquent officials. In extreme
cases, the top management of banks or the directors on the
board may be replaced. The sanctions applied by the
supervisor depends upon its assessment of the severity of the
situation. In deciding the course of its action, the supervisor
takes into account the consequences of the default and
violations observed in the functioning of banks and the
impact its own actions will have on the individual banks,
shareholders and the entire system. However, the public
sector character of banks remains a limitation in the
supervisor deciding upon and initiating remedial action in
respect of banks.
Principle 23: Banking supervisors must practise global
consolidated supervision over their internationally active
organizations, adequately monitoring and applying
appropriate prudential norms to all aspects of the business
conducted by these banking organizations worldwide,
primarily at their foreign branches, joint ventures and
subsidiaries:
Section 44 of Bank Companies Act, 1991 gives powers to
Bangladesh bank to inspect overseas activities of banks
incorporated in Bangladesh. Bangladesh Bank has prescribed
periodic review of working of overseas branches to be put up
to the board. Bangladesh Bank undertakes annual appraisal of
banks’ overseas activities based on records maintained at
Head Office to ensure that prudential regulations are
complied with and management has necessary expertise to
manage these operations in a safe and sound manner.
These are assessed during on-site inspection of head office
and overseas branches of banks and through off-site reporting
system specifically designed to cover overseas branches of
Bangladeshi banks. The branches are also covered by
independent internal audit function either by an in-house
group or external professional accountant firm appointed in
consultation with the host country regulator, where such
approvals are necessary. Bangladesh Bank has the required
authority for closing of overseas offices of Bangladeshi banks
or imposing limitations on their activities.
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Economics & Banking
Principle 24: A key component of consolidated supervision
is establishing contact and information exchange with the
various other supervisors involved, primarily host country
supervisory authorities:
Bangladesh Bank maintains contact/relations with overseas
supervisors. High level teams from Bangladesh Bank
periodically visit overseas supervisors and share information.
Bangladesh Bank has the powers to prohibit banks or their
affiliates from establishing operations in countries where its
supervisory reach will be limited in any manner. Bangladesh
Bank shares information with foreign supervisors on
reciprocal basis.
Principle 25: Banking supervisors must require the local
operations of foreign banks to be conducted to the same high
standards as are required of domestic institutions and must
have powers to share information needed by the home
country supervisors of those banks for the purpose of carrying
out consolidated supervision:
While permitting opening of branches by foreign banks,
Bangladesh Bank checks whether home country supervisor
takes a consolidated view of the group operations. But no
proposal is rejected merely on the grounds of non-existence
of consolidated supervision at the home country level. No
objection certificate from home country is required for
permitting opening of a branch in Bangladesh.
Bangladesh Bank shares information with home country
supervisors of foreign banks depending on need.
Confidentiality is maintained by convention.
Home country supervisors have to obtain prior permission for
on-site access to branches of foreign banks operating in
Bangladesh, which is normally granted.
As of now there is no formal or set arrangement for
Bangladesh Bank to share information with the home country
regulator directly about any material remedial action it takes
regarding the operations of a bank from that country. There is
also no clear view as to what would constitute ‘material
remedial action’. The view so far has been one of reciprocity
and subject to Bangladesh Bank has shared such information
with home country supervisors.
4.0 Compliance of BIS Core Principles for Effective
Banking Supervision in Bangladesh and India
Any type of comparison usually involves both similarities and
dissimilarities. So, similarities can be ascertained by
reviewing the section four where assessment of compliance of
BIS Core Principles for Effective Banking Supervision has
been given in detail. Only dissimilarities in compliance have
been highlighted in the following paragraphs:
Principle 1: Indian supervisory agency has the operational
independence, whereas Bangladesh Bank has no operational
independence in the supervision of NCBs. In India, the
supervisory agency and its staff have credibility based on
their professionalism, while in Bangladesh, such
professionalism is very poor; because in the last 10 years,
Bangladesh Bank has recruited only 10% direct officers and
the remaining 90% are promotee officers. This situation has
badly damaged the professionalism of the staff of the Central
Bank. The salary scale of the employees of Bangladesh Bank
is very low in comparison to that of private banks, whereas
the salary scale of the employees of Reserve Bank of India is
more or less comparable to that of their private banks. In
Bangladesh, Ministry of Finance takes the final decision to
issue/revoke license to commercial banks while in India, the
sole authority of issuing/revoking license lies with the
Reserve Bank of India.
Principle 3: In issuing license, Bangladesh Bank may often
be pressurized to take decision on political consideration,
whereas Reserve Bank of India can take the decision of
issuing license more or less on non-political basis.
Principle 3: Reserve Bank of India asks detailed strategic
and operating plans of banks seeking licenses and thus ensure
that an appropriate corporate governance will be in place,
while in true sense, no such strategic and operating plan of
the bank is submitted to Bangladesh bank.
Principle 4: In India, there is no specific provision in law
requiring prior supervisory approval for proposed change in
ownership or change in controlling interest, but in
Bangladesh such provision in law is available.
Principle 6: In India, market risks (both off- and on-balance
sheet risks) are considered in determining bank specific
capital ratios, but in Bangladesh it was not taken care of
under BASEL–I framework though recently such measures
are taken into consideration under BASEL-II framework.
Principle 9: In India, a ‘closely related group’ is explicitly
defined in the Companies Act. Reserve Bank of India has the
discretion to interpret the definition on case by case basis,
while ‘closely related group’ is not explicitly defined to
reflect actual risk exposure in Bangladesh.
Principle 10: In India, section 20 of Banking Regulation Act
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Economics & Banking
prohibits lending to directors and certain other related parties
in order to check unethical practices of granting loans and
advances to relatives of directors of banks, directors of other
banks and/or their relatives, whereas in Bangladesh, a bank
can extend directors or directors’ sponsored companies up to
maximum 50% of his/her shareholding in the bank.
Principle 11: In India, both the essential criteria and
additional criteria of this principle are being complied within
adequate risk management process, while none of these
criteria of this principle are being complied with by local
banks in Bangladesh.
Principle 12: In India, both the essential criteria and
additional criteria of this principle are being complied with
adequate risk management process, while none of these
criteria of this principle are being complied with by local
banks in Bangladesh.
Principle 12: In India quality of MIS is assessed during onsite
inspection, but in Bangladesh it is not performed.
Principle 12: Reserve Bank of India has the requisite skill to
ensure that a model or any other risk management mechanism
used by any of the banks supervised by it is not beyond its
own understanding, whereas Bangladesh Bank has not the
requisite skill to ensure that.
Principle 13: Reserve Bank of India has already started
‘Risk-Based Supervision’, whereas Bangladesh Bank has
recently taken steps to start it.
Principle 16: In India, there is close coordination between
on-site supervision and off-site supervision, whereas in
Bangladesh there is hardly any coordination between the two.
Principle 19: Reserve Bank of India conducts all annual
financial inspections based on CAMELS pattern, while
Bangladesh Bank also now conducts all annual financial
inspections based on CAMELS pattern.
Principle 20: In Bangladesh, there is no banking group,
while in India there is banking group, so their supervisors
need to supervise the banking group on a consolidated basis.
Principle 21: In Bangladesh, there is no such body to whom
banks are required to report if professional incompetence of
external auditors is noticed; but in India, banks are advised to
report to the Institute of Chartered Accountants of India
(ICAI) which initiates appropriate action if professional
incompetence is noticed.
Principle 22: In India, the scheme of Prompt Corrective
Actions (PCA) is in place whereas in Bangladesh such
scheme has not been undertaken.
5.0 Recommendations and Conclusion
Effective prudential regulation and supervision of banks are
essential to the financial stability and efficient functioning of
any economy, because the banking system plays a central role
in the payments system and in the mobilization and
distribution of saving. The task of such regulation and
supervision is to ensure that banks operate in a prudent
manner and that they hold capital and reserves sufficient to
support the risks that arise in their business. Strong and
effective regulations and supervision provide a public good
that is needed to complement market forces for prudent
banking to be ensured in any country.
Weaknesses in the banking system of a country can threaten
financial stability, both in that country and internationally.
Thus ways to strengthen financial systems have attracted
growing international concern. Several official bodies,
including the Basel Committee on Banking Supervision, the
Bank for International Settlements, the IMF, and the World
Bank, have recently been examining ways to do so.
Bangladesh is progressively moving towards financial
liberalization. But in order to avoid any future catastrophe or
financial crisis, proper regulatory and supervisory framework
for the banking system is a must before a full-fledged
financial liberalization. Ensuring proper regulatory and
supervisory framework requires compliance with the BIS
Core Principles for Effective Banking Supervision. Thus, in
order to comply with the BIS Core Principles for Effective
Banking Supervision by the Bangladesh financial system, the
following measures/recommendations may be taken into
consideration.
• The authority of the closing of a problem bank is not
directly vested in Bangladesh Bank. Rather the central
bank’s decision to close a bank has been impeded
because of the present provisions of law requiring the
courts and government’s intervention. So the provisions
should be made in such a way that central bank can
implement the closure of a bank on its own.
• The professionalism of the staff of the central bank
should be increased by employing more direct officers
and giving them proper and adequate training for the
targeted performance.
• Since low salary scale is a hindrance to attract and retain
qualified staff, so the salary scale of the employees of
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Economics & Banking
Bangladesh Bank should be enhanced for the sake of
ensuring effective supervision by qualified staff. Besides,
training academy and thus training program in
Bangladesh Bank should be modernized; budget for
computer and other equipment should be made sufficient;
the travel budget for on-site supervision should be made
such that it does allow appropriate on-site work.
• The present Act does not place any obligation on the
government to make the reasons for removal of Governor
public. So, in the interest of proper perception of the
independence of the office of the Governor/Deputy
Governors, it would be desirable to consider suitable
amendments to the relevant provisions of law.
• The power to revoke license of a bank is subject to
government concurrence. There should be such provision
so that Bangladesh Bank can unilaterally revoke the
license.
• There is no provision in law that can ensure maintenance
of confidentiality to be a precondition for release of
information by supervisors to other agencies. So, such
provision should be made in the Banking Company Act.
• In order to fulfil the essential criteria of principle 3,
stricter norms (especially criminal activities, or adverse
regulatory judgments) should be applied for the ‘fit and
proper test’ and in issuing license Bangladesh Bank
should not take decision on political consideration.
Bangladesh Bank should adopt a more detailed and
stricter approach while reviewing the operational
structure of a proposed bank (license applicant). Banks
seeking licenses should be asked to submit in detail their
strategic and operating plans and these should ensure that
appropriate corporate governance is in place.
• In order to fulfil the additional criteria of principle 3, it is
preferable to stipulate clearly that boards should have at
least one director with a sound knowledge of each type of
financial activity the bank intends to pursue. Particular
areas are risk management, transfer-pricing etc.
• In order to fulfil the another additional criterion of
principle 3, Bangladesh Bank should take information
from tax department about the initial capital of the
sponsors.
• Bangladesh Bank receives a half-yearly return on
‘ownership and control’ from all domestic banks. Such
provisions would need to be put in place also in respect of
foreign banks operating in Bangladesh.
• Bangladesh Bank should gradually move towards setting
bank specific capital ratios based on the risk profile of
individual banks.
• Bangladesh Bank is constrained in its measures against
banks which fail to meet the requirements in respect to
capital adequacy largely because of their government
ownership. Where the bank is owned by the government,
Bangladesh Bank has shown forbearance in view of
implied government guarantee. Such forbearance cannot
be long term and specific measures against banks failing
to meet the capital adequacy requirement need to be
stipulated in the interest of overall soundness of the
system.
• Bangladesh Bank may assist and guide banks in their
efforts to stabilize advanced risk management systems. It
should encourage the larger and more capable banks to
complete the process early so that they can act as leaders
and models for the smaller and not so well equipped
banks. Only by continuous encouragement and regulatory
pressure, the system as a whole will be able to improve its
risk management systems and raise it to international
standards.
• In the light of recent developments in information
technology, there is a need and scope for improvement in
credit-related MIS at banks. Bangladesh Bank may ensure
this in the banking system by injecting competition in
services.
• Banks in Bangladesh are yet to acquire adequate expertise
on sophisticated credit risk mitigation techniques. Until
banks improve their expertise, properly controlled credit
risk environment will not be established. Bangladesh
Bank has to guide the banks in these regards and enable
them to enhance their expertise.
• Although there are laws, and banks’ internal as well as
supervisory guidelines to ensure that credit decisions are
made free of conflicting interests, on arms length basis
and free from inappropriate pressures from outside
parties, the bank supervisors should ensure its
implementation through supervisory tools and techniques.
• For classification and provisioning purposes, off-balance
sheet items should receive more attention than at present.
Like funded exposures, these should also be classified
and a note to that effect should be provided in banks’
financial statements.
• There is a wide scope for improving the assessment of
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Economics & Banking
guarantees and worth of collaterals. Banks have to
enhance their capabilities in this regard. Bangladesh Bank
may also consider issuing suitable detailed instructions to
banks in this regard.
• “Closely related group” should be clearly defined in Bank
Companies Act. 1991.
• A comprehensive definition of ‘connected’ or ‘related
parties’ and ‘large shareholdings’ should be provided by
law/regulation.
• Though there are guidelines given by Bangladesh Bank in
regard to connected lending, the approach of banks in
following the guidelines is not uniform. Bangladesh Bank
should make its follow-up of this aspect of banks’ lending
stricter so that the risks related to such exposures are
clearly understood and managed.
• Banks normally have procedures in place to prevent
persons benefiting from the loan being associated either
with its appraisal or sanction. However, there is no clearcut
requirement to this effect stipulated by the supervisor
excepting in regard to the directors. Bangladesh Bank
should consider issuing instructions in this regard.
• Bangladesh Bank (BB) should assist banks in hastening
introduction of scientific and sophisticated risk
management systems. BB should also consider setting
fixed percentage for exposures to each country until
banks are in a position to assess and provide for such risk
on objective and scientific basis.
• Bangladesh Bank should adopt a risk management
oriented approach to supervision. It should also advise
banks to set internal limits on various market risks like
liquidity risk, interest rate risk and foreign exchange risk.
• Though Bangladesh Bank recently require banks to
include a statement on their risk management policies and
procedures in their publicly available accounts. However,
since such a statement presupposes a clear understanding
of the risk profile of bank by their top management and
boards and a well-defined policy and strategies for their
management, any meaningful statement can be made only
when adequate risk management systems are in place in
all banks. BB may therefore consider giving banks a
timeframe within which this goal may be achieved.
• Greater stress should be laid on the responsibility of the
board in exercising control over all aspects of risk
management. It is further suggested that the regulator
should adopt rating of board’s performance with the
provision that if the rating falls below a certain level
specified, prompt corrective action should be triggered.
• There is hardly any coordination between on-site
supervision and off-site supervision of Bangladesh Bank.
So, BB should ensure coordination between these two
types of supervision through automation by computer
network in order to maximize synergy and avoid
supervisory gaps.
• Bangladesh Bank should formulate such system that the
supervisory returns and prudential reports called for from
the commercial banks have to provide means for
detecting early warning signals of weakening financial
position, if any.
• In meetings with banks, the supervisor as of now does not
involve the non-executive directors. Bangladesh Bank
may consider introducing this practice which can be
expected to ensure better involvement of the entire board
with the concerns of the regulator as also its assessment
as regards the performance of the board.
• Bangladesh Bank does not generally meet with external
(statutory) auditors of banks. The practice of BB meeting
with external auditors could be introduced. It is expected
to result in considerable advantage to the system of
examination of banks’ operations by BB.
• Legal provisions by authorizing external auditors to
report to the supervisor matters of material significance,
for example, failure to maintain licensing criteria, or
breaches of banking or other laws etc. should be made so
that the law protects auditors from breach of
confidentiality when information is communicated in
good faith. Because such provisions will be helpful to
Bangladesh Bank in its oversight of banks and will keep
banks as well as other auditors more vigilant about the
fairness and accuracy of banks’ financial statements and
their actual state of affairs. It will also enable the
supervisors to place greater reliance on the role of
external auditors in the audit of banks.
• The scheme of Prompt Corrective actions (PCA) should
be undertaken to expedite the remedial action. Laws
should have provisions which mitigate against undue
delay on the part of supervisor in taking appropriate
corrective action. Bangladesh Bank should consider
introduction of measures by which clear accountability
can be fixed on individual directors and/or the board of
directors for non-performance and/or negligence of their
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Economics & Banking
duties. Accountability, if fixed, should lead to penalties
and, in extreme cases, if necessary, criminal prosecution.
• The present approach of supervising the overseas
activities of locally incorporated banks, which is selective
and therefore has some elements of adhocism, should be
replaced by a system under which all foreign operations
of Bangladeshi banks receive on-site supervisory
oversight in planned manner. The assessment of the host
country’s supervision should be more rigorous. It would
be desirable to introduce a structured assessment and not
permit banks to open offices in areas where the quality of
supervision does not measure up to international
standards.
• In case of supervising the overseas activities of locally
incorporated banks, formal arrangements between home
and host country supervisors for sharing of information
and concerns would be preferable to having only informal
arrangements. Bangladesh Bank should try to get into
formal relationship with host country supervisors on the
basis of MOUs. It is only when there is good
understanding between home and host country
supervisors that the overall quality of supervision can
come up to the desired level.
• There should be a formal framework for ‘Home country
and Host country Supervisory Relationship’ for the
effective supervision of foreign banks.
There is a sign of hope that Bangladesh Bank has undertaken
an initiative to modernize the Training Academy in order to
impart better and effective training to the staff of Bangladesh
Bank. It has also undertaken ‘Central Bank Strengthening
Project’ that would improve its functional efficiency.
To ensure safe and sound banking system, the compliance of
the international standard of banking supervision is a must for
both developed and developing countries and Bangladesh is
no exception to it.
n
REFERENCES:
Ahmed, A. K. N., 1987, Role of Central Bank in Economic Development- Financing of Public and Private Sectors, Commerce
(Bombay), Vol. 154.
Annual Reports, Bangladesh Bank, 2007-2008, 2008-2009.
Prevention of Money Laundering Act, 2009.
Bangladesh Bank (Nationalization) Order, 1972.
Bangladesh Bank Order, 1972.
Bank Companies Act, 1991.
Bank Reforms Committee Report, 1999.
Bhuiya M. Abul Bashar, 1996,Bangladesh Laws on Banks and Banking,.
Choudhury, T. A., An Overview of Banks and Their Services, Reading Materials on Theory and Practice of Banking (B-101),
Bangladesh Institute of Bank Management, Dhaka, 2000.
Companies Act, 1994.
Core Principles for Effective Banking Supervision – Self Assessment for Australia, Australian Prudential Regulation Authority,
April, 2000.
Core Principles for Effective Banking Supervision, Basel Committee on Banking Supervision, September, 1997.
Core Principles Methodology, Basel Committee on Banking Supervision, October, 1999.
Goodhart, Charles, 1988, The Evolution of the Central Bank, Cambridge, Massachusetts: MIT Press.
Mayes, D.G. (2001), Improving Banking Supervision, Palgrave, New York.
The Bangladesh Accountant/January- March 2010 60

Economics & Banking
Rising Price Level and Consequences of Inflation:
Concern for Bangladesh
Tanweer Mehdee
Abstract: Persistent rise in the general price level in an
economy over a period of time is termed as inflation, which
plays a vital role in the movement of different variables. Ups
and downs in the rate of inflation are caused by a number of
factors and at the same time cause a set of changes in the
economy as well. As an important macroeconomic variable
inflation does not appear as an unmixed blessing. Considering
the consequences of inflation, it is found to hurt some agents
of the economy while favouring the others. Governments or
concerned authorities are to be aware of the movements in
inflation in order to keep the economy on a right track. As a
transitional economy Bangladesh is not an exception to it.
Here, sources influencing inflation are multidimensional and
consequence of rising price level is a matter of great concern.
It is very important for Bangladesh to rightly identify the
tolerable limit of inflation and to get the proper response of
the relevant economic agents in this regard.
1. Introduction:
Inflation is a term that is defined as the persistent increase in
the general price level of a given economy over a period of
time. It is measured as the percentage rate of change of a
price index. Inflation should not be confused with the
increase in price of a single commodity. It is concerned with
the change in general price level of the economy. So rise in
the price of a particular commodity does not necessarily
imply inflation. In a basket of commodities each and every
commodity of an economy is not equally important. The set
of commodities affecting the general price level usually
differs among economies. Price of some commodities may go
up and that of some may go down. But there will be an
overall impact on the general price level. Inflation has great
influences on many relevant variables of an econmy. It is an
important macroeconomic indicator. Now a days this is a
phenomenon deserving attention in the world economy.
Bangladesh is also concerned with the accelarated inflation
affecting the economy. In a transitinal economy like
Bangladesh inflation has its significant impact on different
factors. Inflation reaching near double digit may casuse
tremendous trouble for the people of this country. It is a
matter of great concern for Bangladesh whether inflationary
trend is going right for the economy.
2. Objective:
The paper attempts to analyze the concept of inflation as an
influential macroeconomic variable and its relationship with
other economic factors. It includes the causes behind and
consequences of inflation as well. Besides its relevance and
importance for the economy of Bangladesh is also
considered. Various implications for Bangladesh are
highlighted in this regard.
3. Methodology:
In this paper help is taken from the secondary sources of
information to collect the data. Then it is analyzed from
different angles of vision to find out the various implications
for the economy. Some tables and graphs are presented to
help the description.
4. Conceptual Issues:
4.1 Definition:
Inflation means a process of rising prices. In economics,
inflation is a rise in the general level of prices of goods and
services in an economy over a period of time. A chief
measure of price inflation is the inflation rate, the annulalized
percentage change in the general price index (usually the
Consumer Price Index) over time (Mankiw 2002). Inflation is
also a sort of erosion in the purchasing power of money or a
loss of real value in the internal medium of exchange and unit
of account in the economy (Walgenbach 1973). To measure
overall inflation, the price change of a large „basket“ of
representative goods and services is measured. This is the
purpose of a price index, which is the combined price of a
The author is Lecturer, Bangladesh Institute of Bank Management.
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Economics & Banking
„basket“ of many goods and services. The combined price is
the sum of the weighted average prices of items in the
„basket“. A weighted price is calculated by multiplying the
unit price of an item to the number of those items the average
consumer purchases. Weighted pricing is a necessary means
to measuring the impact of individual unit price changes on
the economy’s overall inflation. The Consumer Price Index,
for example, uses data collected by surveying households to
determine what proportion of the typical consumer’s overall
spending is spent on specific goods and services, and weights
the average prices of those items accordingly. Those
weighted average prices are combined to calculate the overall
price. To better relate price changes over time, indexes
typically choose a „base year“ price and assign it a value of
100. Index prices in subsequent years are then expressed in
relation to the base year price (Taylor 2008).
4.2 Other Related Concepts:
• Consumer Price Index (CPI): The Consumer Price Index
measures prices of a selection of goods and services
purchased by a “typical consumer” (Mankiw 2002).
• Deflation: Deflation is the opposite of inflation. It usually
means an excessive fall in prices (Dewett 2001).
• Disinflation: It is a decrease in the rate of inflation.
• Hyperinflation: Hyperinflation is an out-of-control
inflationary spiral.
• Stagflation: It is a combiantion of inflation, slow
economic growth and high unemployment.
4.3 Importance of Inflation:
Inflation may have both positive and negative impacts on an
economy. Most mainstream economists favour a low steady
rate of inflation (Hummel 2007). Low inflation may reduce
the severity of economic recessions by enabling the labour
market to adjust more quickly in a downturn, and reduce the
risk that a liquidity trap prevents monetary policy from
stabilizing the economy (Svensson 2003). Due to having
various important implications, inflation deserves attention in
every economy. Inflation casuses several things to happen
and at the same time inflation itself is influenced by a number
of factors.
5. Factors Causing and Influencing Inflatoin:
There are different thoughts regarding the causes behind
inflation. Inflation may be caused by demand side or supply
side of the economy. An increase in the aggregate demand
will cause prices to rise. In such a case it is called a demandpull
infaltion. On the other hand inflation may be caused by a
decrease in aggregate supply due to a rise in the cost of inputs
or factors of production. This is called a cost-push inflation.
Supply shock may also occur because of natural calamities,
war etc. Inflation may be caused by an increase in money
supply if it is not supported by the ablility of the economy. In
many cases such event occurs when government finances its
budget deficit by printing money excessively. Money supply
is thought to play a major role in determining levels of
inflation, although there are differences of opinion on how
important it is. For example, Monetarist economists believe
that the link is very strong; Keynesian economics, by
contrast, typically emphasize the role of aggregate demand in
the economy rather than the money supply in determining
inflation. That is, for Keynesians the money supply is only
one determinant of aggregate demand. Some economists
disagree with the notion that central banks control the money
supply, arguing that central banks have little control because
the money supply adapts to the demand for bank credit issued
by commercial banks. This is the theory of endogenous
money. But this position is not universally accepted. Banks
create money by making loans. But the aggregate volume of
these loans diminishes as real interest rates increase. Thus, it
is quite likely that central banks influence the money supply
by making money cheaper or more expensive, and thus
increasing or decreasing its production. Inflation may also be
influenced by the activities in international trade (export and
import) and the position of currency in the foreign exchange
market.
6. Consequences of Inflation:
It is necessary to look at the effects of inflation. In many
cases the consequences are linked with the causes behind
inflation. In the case of a demand-pull inflation usually output
level increases for satisfying the excess demand. But in the
case of a cost-push inflation output level declines with the
increase in prices. This obviously describes a worse situation.
High inflation hurts people on fixed incomes by reducing
their purchasing power. Workers with low wage suffer in the
case of rising inflation. It often causes dissatisfaction among
them and leads to lower level of productivity.
A fundamental concept in economic analysis is the
relationship between inflation and unemployment. It is
presumed that there is a trade-off between price stability and
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Economics & Banking
employment. In an economy some level of inflation could be
considered desirable in line with the ongoing investment.
Another important thing to consider is the predictablility
regarding inflation. Fluctuation in the rate of inflation is not
unlikely. But if it is totally unpredictable it may create lack of
comfort and confidence in many economic activities. It will
contribute to increase in levels of risk and uncertainty.
Investment decisions will be very much affected by this
situation. So, it has a great impact on other variables.
It is a matter of consideration whether inflation is necessarily
damaging for the economy. The anwer is not. Inflation, at a
tolerable limit, is good for the economy. The opposite term of
inflation is called deflation. That means a declining price
level. But decline in the price level affects the incentive of the
suppliers adversely causing reduction in the level of output
and it is more likely to reduce employment of labour force.
So a reasonable degree of inflation may work well. It is likely
to create an incentive for the suppliers and this may have a
positive impact on growth and employment.
7. Controlling Inflation:
The monetary authority of a country, usually the central bank,
has a great responsibility to keep the inflation rate under
control. The central bank controls the size of the money
supply through the setting of interest rates, through ope
market operations and through the setting of banking reserve
requirements (Taylor 2008).
There are different measures to control inflation. Some follow
a method of inflation target while others tend to control
inflation when it rises above a target. Monetarists emphasize
the use of monetary policy to control inflatoin using the
instruments like interest rate, money supply etc. On the other
hand Keynesians emphasize the use of demand management
policies [Fiscal and Monetry Policies] to influence aggregate
demand during economic expansions or recessions. Usually
reducing aggregate demand during expansions and increasing
aggregate demand during recessions are suggested to keep
control over inflation. The fiscal measures include changes in
government expenditure, changes in taxation, management of
saving sheme and public debt etc.(Dewett 2001).
With the changing scenario of the world economy and
different types of economic activities the mechanism of
inflation controlling is sure to be a dynamic issue rather than
following some static structure.
8. Situation in Bangladesh:
Experience of high inflation is not new in Bangladesh. Over
the time inflatoin moves up and down in this country. In
Bangladesh the average inflation (general) in FY 1996/97 was
3.96% while it is found 9.94% in FY 2007/08 [Table 1]. But
during these years changes in inflation did not follow any
monotonic pattern. Figure 1, which is drawn on the basis of
Table 1, shows the inflation rate was significantly high
(8.66%) in FY 1997/98. Then it follows a declining trend for
the next few years up to FY 2000/01. After that again it took
a rising trend reaching remarkably high (9.94%) in FY
2007/08.
Table 1: Inflatoin (general) in Bangladeh during
FY 1996/97-FY 2007/08
Period
Inflation (general)
12-month average
1996/97 3.96
1997/98 8.66
1998/99 7.06
1999/00 2.79
2000/01 1.94
2001/02 2.79
2002/03 4.38
2003/04 5.83
2004/05 6.48
2005/06 7.16
2006/07 7.2
2007/08 9.94
Source: Economic Trends, Bangladesh Bank
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Economics & Banking
Figure 1: Trend of Inflation (general) in Bangladesh
According to the economic structure of Bangladesh, food inflation deserves great importance and attention. The changing pattern
of food inflatoin is to some extent similar to that of general inflation reaching a very high figure (12.28%) in FY 2007/08 [Table
2 and Figure 2]. Price hike in necessary food items is really troublesome for the general people of Bangladesh. It also carries a
large weight in the consumption basket of the country.
Table 2: Inflatoin (food) in Bangladeh during FY 1996/97-FY 2007/08
Period
Inflation (food)
12-month average
1996/97 3.67
1997/98 10.46
1998/99 9.3
1999/00 2.68
2000/01 1.39
2001/02 1.63
2002/03 3.46
2003/04 6.92
2004/05 7.91
2005/06 7.76
2006/07 8.11
2007/08 12.28
Source: Economic Trends, Bangladesh Bank
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Economics & Banking
Figure 2: Trend of Inflation (food) in Bangladesh
Fluctuation pattern is a little bit different in the case of non-food inflation in Bangladesh [Table 3 and Figure 3]. Its variation is
comparatively lower with the highest level of 6.4% in FY 2005/06.
Table 3: Inflatoin (non-food) in Bangladeh during FY 1996/97-FY 2007/08
Period
Inflation (non-food)
12-month average
1996/97 4.47
1997/98 5.99
1998/99 3.95
1999/00 3.08
2000/01 3.05
2001/02 4.61
2002/03 5.66
2003/04 4.37
2004/05 4.33
2005/06 6.4
2006/07 5.9
2007/08 6.32
Source: Economic Trends, Bangladesh Bank
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Economics & Banking
Figure 3: Trend of Inflation (non-food) in Bangladesh
Causes behind inflation in Bangladesh are of different types.
Bangladesh is a densely populated country struggling for
developmentInflation is caused by both demand and supply in
the economy. A rise in the level of aggregate demand
obviously increase inflation. In Bangladesh production
technique is not that much efficient in different sectors. As a
result cost of production is high. Consequently it brings a
high price of those commodities. Historically this is an
agrarian economy. But over time the composition of GDP has
changed. Now the proportion of the contribution of
agricultural sector has gone down than that was in the past.
Even then a large proportion of our labour force is engaged in
activities directly or indirectly related with agriculture.
Agricultural production influenced by the weather condition
and natural calamities often disturbs the expected harvest in
Bangladesh. For this price and quantity of foodgrains move
unfavourably with uncertainty in many cases. In this age of
globalization participation in international trade is very much
important for any economy. Bangladesh is not an exception in
this case. External trade has its great influence on the
economy of Bangladesh. Some causes behind inflation are
related to the issues of external trade. Bangladesh always
faces trade deficit, which means its import expenditure
exceeds its export earnings. In Bangladesh variety of
commodities are imported ranging from the necessary to
luxurious ones. Movement of prices in the international
market directly affects the prices in the domestic market.
Exchange rate of taka with other important currencies has a
great influence on the prices of many commodities. Some
unfavourable movement in exchange rate causes prices to rise
in the market. International oil price moves often and we need
to make adjustment with that. Rising oil price sometimes
causes indirect effects on the price level. Market Syndication
is another strong source of inflation in Bangladesh. This is a
form of unfair practice by some suppliers by creating an
artificial supply shortage in the market. This causes prices to
go up and scope of black marketing and other unethical
practices arises. Expectation of the people is very much
related to the movement of prices. In Bangladesh it
tremendously affects the rate of inflation. Usually whenever
there is a panic among people of rising price then demand for
certain relvant goods increases. As a result of this kind of
expectation the rate of inflation shows its rising nature.
Inflation affects the purchasing power of the people very
much. Excessive inflation becomes troublesome for the
people with lower or limited income. This is one of the most
important direct effects of inflation. In Bangladesh rising
prices are being experienced in the case of necessary goods
than that of luxurious ones. A significant portion of the
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Economics & Banking
population is still staying below the poverty line. In such a
situation inflation creates various effects on the socioeconomic
condition of the country. Excess inflation has its
negative impact on savings and investment. Impact on
savings has its direct reflection in the area of invenstment.
Investment, both doestic and foreign, is essential for
Bangladesh and it is important for growth and economic
development. An unfavourable and unpredictable movement
of inflation often creates lack of confidence among the
investors. Many potential investments face bleak prospect and
avoid the game of facing risk and uncertainty. So the pace
and predictability of inflation really matters in this economy.
Inflation has its implications for the banking sector as well.
Both for the banks and their customers inflation causes a
reshuffle in the flow of activities. Rates of interset offered by
the banks seem less attractive to the depositors. Bank lending
has also a great role in the economy. In recent years there is
an increasing trend of providing consumer credit by the
banks. It will add to the demand side. But if its contribution to
the production side remain weak there will be a lack of
balance and the consequences of inflation will be difficult to
handle for the country. Without the increase in production
level inflation will cause the real magnitudes of different
variables move downward. So bank loans should be effective
for increasing investment and output and thus contributing to
the growth and development. It will be helpful to bring a
balance between demand side and supply side and inflation
will stay at a tolerable range.
9. Conclusion:
Irrespective of the sources of origination inflation affects the
economic agents of a country in various ways. Consumers,
producers, investors, government or different other agents
take their relevant signal from the levels of inflation. Inflation
today, trend in the changing pattern of inflation, nature of its
fluctuation, expectation and prediction regarding the direction
of the movement of inflation in future influence the process
of decision making. Sometimes controlling inflation is also a
sort of necessity. Judging the right limit for this is very much
important. Learning from the past and applying the correct
instruments in a proper way to handle inflation have no
alternative to ensure efficient decision making. For
Bangladesh fighting the unfavourable nature of inflation is
necessary. In the rapidly globalized world, policy makers and
the concerned authorities should carefully monitor the future
development of prices in the international market and take
necessary steps in time. There should be better coordination
between fiscal policy and monetary policy. There should be
an environment such that people have confidence in the
governments ability to keep inflation within the target and
control it when necessary. In an economy inflation is a
natural phenomenon. If it can be kept within a tolerable limit,
it is better for economic growth. Whenever inflation tends to
reach a double digit figure in a country like Bangladesh, it
becomes difficult for the people to go with that.
n
REFERENCES:
1. Ahmed, Shamim and Mortaza, Md. Golam (2005), “Inflation and Economic Growth in Bangladesh: An Empirical Analysis,” Bank Parikrama, Volume XXX & XXXI
2. Centre for Policy Dialogue (2006), State of Bangladesh Economy in FY2006 and Outlook for FY2007, CPD.
3. Dewett, Kewal Krishna and Chand, Adarsh, Modern Economic Theory (2001), Chand & Company Ltd.
4. Dornbush, Rudiger and Fischer, Stanley (1994), Macroeconomics, McGraw Hill Co.
5. Federal Reserve Bank of Boston, Understanding Inflation and the Implications for Monetary Policy: A Phillips Curve Retrospective“, Conference Series 53,
June 9–11, 2008, Chatham, Massachusetts.
6. Friedman, Milton, Nobel lecture: Inflation and unemployment 1977.
7. Gordon, Robert J. (1988), Macroeconomics: Theory and Policy, 2nd ed., Chap. 22.4, ‘Modern theories of inflation’. McGraw-Hill.
8. Hummel, Jeffrey Rogers., Death and Taxes, Including Inflation: the Public versus Economists“ (Jan 2007).
9. Majumder, Md. Alauddin ((2006), “Inflation in Bangladesh: Supply Side Perspectives,” Policy Note Series: PN 0705, Policy Analysis Unit (PAU), Research
Department, Bangladesh Bank.
10. Mankiw, N. Gregory (2002), Macroeconomics (5th ed.), Worth
11. Mishkin, Frederic S., The Economics of Money, Banking, and Financial Markets, New York, Harper Collins, 1995.
12. Monthly Economic Trends, Statistics Department, Bangladesh Bank, Feb 2009, Volume XXXI No.2.
13. Svensson, Lars E.O., Escaping from a Liquidity Trap and Deflation: The Foolproof Way and Others“, Journal of Economic Perspectives, Volume 17, Issue
4 Fall 2003.
14. Taylor, Timothy (2008), Principles of Economics, Freeload Press.
15. Walgenbach,Paul H., Dittrich, Norman E. and Hanson, Ernest I. (1973), Financial Accounting, New York: Harcourt Brace Javonovich, Inc.
The Bangladesh Accountant/January- March 2010 67

Economics & Banking
Credit Distribution Model, Supervision and Monitoring
System of the Grameen Bank
Dr Md Nurul Alam
Dr Zahurul Alam
and
Mrs Sharmeen Ahmed
Abstract
A good credit distribution model is essential for the success of
any rural financial institution. But this does not ensure
recovery of loans. Effective supervision and monitoring
process is a principal requirement for such an achievement.
Besides, efficient monitoring and supervision of credit is
inevitable for ensuring the proper growth of rural area. This
paper critically examines the credit distribution model,
supervision and monitoring system of the Grameen Bank
(GB). This paper reveals that GB has a sound credit
distribution model. It has also an effective supervision and
monitoring system. Supervision and monitoring system of GB
flows form the branches which monitor the activity of the
individual member, groups, centers up to the head office
through the area and zonal offices.
1.1 Introduction
At present a large number of institutions like Bangladesh
Krishi Bank (BKB), Rajshahi Krishi Unnayan Bank
(RAKUB), Bangladesh Samabaya Bank Ltd. (BSBL),
Nationalized Commercial Banks (NCBs) and other Private
Banks, Grameen Bank (GB), Bangladesh Rural Development
Board (BRDB) are mainly involved in financing agriculture
and off-farm activities of the rural population in the rural
areas of Bangladesh. But the irony of fact is that most of them
have poor loan recovery system and are technically insolvent.
Some of the private banks also are technically insolvent due
to the poor loan recovery performance. The recovery
performance of the NCBs is not very satisfactory. It is true
that the recovery of loan is not so easy in developing country
like Bangladesh. There is a proverb, “It is easy to lend, but
difficult to recall.” In this back-drop specialists express their
views saying that recovery of loan in time is too hard like that
of conquering the Himalayas. After independence, illtendency
of many borrowers not to repay loan has dropped a
black-shade on the overall banking structure. As a result,
Bangladesh Government and Bangladesh Bank have taken
some useful attempts to bring back healthy banking climate in
the country by recovering over due loans. But the scenario is
still gloomy in terms of the rate of recovery. For this reason,
sound credit distribution model, supervision and monitoring
of credit have become very significant.
Close and intensive supervision is a must for any successful
credit operation. Supervision is a day-to-day function of
management to control the quality of work or to achieve a
fixed target. Supervision is the job to be charged with
overseeing any activity. Supervision is often defined as the
overseeing of a process, a worker or workers plus linking of
these employees with the top level of management. To guide
the activities toward achievement of goals, supervision is a
very essential component of any management process. On the
other hand, monitoring is a process that collects data to
measure an organization’s actual achievement of its stated
target. Without any good monitoring system an organization
can not measure its success in terms of the goals achieved.
Monitoring assesses whether project inputs are being
delivered, are being used as intended and are having the
initial effect intended and as planned. Monitoring is an
internal project activity and an essential part of good
management practice. Rural financial institutions have the
opportunity to supervise and monitor the activities and
behavior of borrowers very closely. In every stage of credit
management supervision and monitoring of credit is an
Dr Md Nurul Alam, Associate Professor, Department of Management Accounting, Government College of Commerce, Chittagong, Dr
Zahurul Alam, Assistant Professor, Department of Management Studies, University of Chittagong, Chittagong and Mrs Sharmeen
Ahmed, Assistant Professor, Department of Management Studies, University of Chittagong, Chittagong.
The Bangladesh Accountant/January- March 2010 68

Economics & Banking
important and essential factor to ensure proper utilization of
fund in the project of the borrower. The key point of success
in recovery of loans lies in ensuring proper use of the fund
through effective monitoring. Lack of supervision and
monitoring on the part of financial institutions tend to cause
the loans to become stuck-up due to diversion, mis utilization
of loan by the borrower etc. On the basis of the facts
mentioned above and keeping in mind the significance and
relevance of the study the present study “ Credit Distribution
Model, Supervision and Monitoring System of the Grameen
Bank” has been planned.
GB is a specialized rural financial institution in Bangladesh.
The bank has gained national as well as international
reputation for successful operations. GB has developed a
unique credit- distribution model. A good credit delivery
model is essential for any rural financial institution’s success,
but this does not ensure recovery of loans. An efficient credit
management system including effective supervision and
monitoring process is a prime requirement for such an
achievement. This paper attempts critically to review the
credit delivery model, supervision and monitoring system of
the GB.
1.2 Objectives of the Study
The study covers the following objectives:
course of time. The present study exclusively uses this
method by compiling the data from relevant documents
published so far which could be made available. The authors
also conducted surveys, personal interviews and observations.
The study is based on primary and secondary sources of data.
For the collection of relevant data, personal visits were made
to the selected branch offices and centers. Personal visits
were also made to the head office at Dhaka and the zonal and
area office at Chittagong. Secondary sources like Annual
Reports, quarterly and monthly statements, weekly and
related reports from the branches of the GB and research
reports of the GB have also been consulted in this connection.
Four groups of samples have been used on the survey
method. First sample comprising 10 female borrowers, 5 each
from the selected branches. In selecting 5 members from a
particular branch firstly, two members were selected in the
same manner from both the branches. Second sample
included all the workers of the selected branches. Generally,
the branch exists of a branch manager, one senior assistant
and 6 to 8 workers. Third sample included 10 elites from the
branch office areas, 5 from each of the branches. Purposive
sampling technique was used for selecting the elites. Fourth
sample comprising 5 GB officials from the head office.
Firstly five departments were selected through purposive
q To evaluate and examine the credit distribution model of
the GB
sampling and one official from each of the departments was
selected randomly.
q To review the supervision system of the credit of the GB
For collecting primary data, questionnaires were prepared.
q To evaluate the monitoring system of the GB
Questions were designed focusing on supervision and
monitoring system of the GB.
1.3 Methodology of the Study
In all, the authors have run structured and semi-structured
The present study makes an attempt to apply the method of
questionnaires on 10 elites, 10 GB members (borrowers), 10
documentary analysis and survey method. Documentary
GB workers and 5 GB officials from the head office. The
analysis is an attempt to find out what has happened in the
distribution of the respondents is given below:
Table-1: Selection of the Respondents
Branches
Number of Respondents
Local Elites GB Workers GB Members GB Officials
Hazir Hat 05 05 05
Anwara
Gunagari 05 05 05 05
Total 10 10 10 05
Source: Field Investigation
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Economics & Banking
2.1 Credit Distribution Model of Grameen Bank
Grameen Bank has integrated group organization with credit
delivery to assist the rural poor. Individual organizes
themselves into group of five. Men and women from different
groups in accordance with the socio-cultural, norms of rural
Bangladesh (Khandker P.10). Membership in a particular
group is strictly limited to people who do not own more than
half an acre of land, are not members of the same household,
have similar economic resources and therefore equal
bargaining strength, enjoy mutual trust and confidence, and
live in the same village.
Each groups elects a chairperson who is responsible for the
discipline of group members, and a secretary. Both hold
office for one year. Each group member must have a chance
to be elected before office-holders can be re-elected.
Members have weekly meetings, where they practise, learn,
and discuss the rules of the Grameen bank and other group
activities.
Group members have to pass a test before they are granted
recognition and hence eligibility for loans. During the test the
members must satisfy the bank staff of their integrity and
seriousness understanding of the principles and procedures of
the GB and ability to write their signature.
Loan applications and most other baking procedures are
carried on at centre meeting which is held once a week
regularly. This meeting is held in a special kendro ghar
(centre room) which is expressly built for that purpose. Loan
proposal emerge during the weekly centre meeting. The
group members discuss among themselves on the need and
the loan volume to be borrowed by any member of their
group. After that any member or the concerned group
proposes the loan request for her fellow member and hand it
over to the group chairperson. The group chairperson
forwards it to the centre chief. Finally, the centre chief
recommends to the proposal to the GB through the centre
manager attending that centre. Within a group all members do
not get their initial loan at the same time. First, two members
obtain loan and after they have had a chance to make regular
payments for a few weeks then two others acquire loans and
finally the last member gets her money. All general loans
must be paid back within the year. Payments are made in
equal weekly installment over fifty weeks with the first
payment due two weeks after the cash has been obtained.
Members must spend the money within seven days or if that
is not possible, they must open a special Bank Account and
deposit the cash there until they are ready to make use of it.
Every member gets a pass book from the bank where regular
entries are made each week as to how much she has paid
back, what she still owes to the bank, and so on. Under the
GB lending system, each member of the group receives
individual loan; however, they are mutually responsible for
all five credit. In Grameen lending system there is no grace
period and repayment have to start almost immediately. They
are to be paid back in weekly installments, each installment
being 2% of the principal. This coincides with the anticipated
income theory of loan administration. This theory tells that
the borrower may repay loans from the loan project’s income
as well as his other sources of income. The bank workers
supervise borrower’s activities very intensively. GB credit
delivery model has the following features:
i. There is an exclusive focus on the poorest of the poor
Exclusivity is ensured by:
q establishing clearly the eligibility criteria for selection
of targeted clientele and adopting practical measures
to screen out those who do not meet them.
q in delivering credit, priority has been increasingly
assigned to women.
q the delivery system is geared to meet the diverse
socio-economic development needs of the poor.
ii. Borrowers are organized into small homogeneous groups
Such characteristics facilitate group solidarity as well as
participatory interaction. Organizing the primary groups of
five members and federating them into centers has been the
foundation of Grameen Bank’s system. The emphasis from
the very outset is to organizationally strengthen the Grameen
clientele, so that they can acquire the capacity for planning
and implementing micro level development decisions. The
Centers are functionally linked to the Grameen Bank, whose
field workers have to attend Centre meetings every week.
iii. Special loan conditionality, which are particularly suitable
for the poor
These include:
q very small loans given without any collateral
q Loans repayable in weekly installments spread over a
year
q eligibility for a subsequent loan depends upon
repayment of first loan.
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Economics & Banking
q individual, self chosen, quick income generating
activities which employ the skills that the borrowers
already posses.
q close supervision of credit by the group as well as the
bank staff.
q stress on credit discipline and collective borrower
responsibility or peer pressure
q special safeguards through compulsory and voluntary
savings to minimize the risks that the poor confront
q transparency in all bank transactions most of which
take place at the centre meetings.
(iv) Simultaneous undertaking of a social development
agenda addressing basic needs of the clientele
This is reflected in the “sixteen decisions” adopted by
Grameen Borrowers. This helps to:
q raise the social and political consciousness of the
newly organized groups.
q focus increasingly on women from the poorest
households, whose urge for survival has a far greater
bearing on the development of the family.
q encourage their monitoring of social and physical
infrastructure projects-housing, sanitation, drinking
water, education, family planning, etc.
(v) Design and development of organization and management
systems capable of delivering program resources to targeted
clientele
The system has evolved gradually through a structured
learning process that involves trials, errors and continuous
adjustments. A major requirement to operationalze the system
is the special training needed for development of a highly
motivated staff, so that the decision making and operational
authority is gradually decentralized and administrative
functions are delegated at the zonal levels downwards.
(vi) Expansion of loan portfolio to meet diverse development
needs of the poor
As the general credit program gathers momentum and the
borrowers become familiar with credit discipline, other loan
programs are introduced to meet growing social and
economic development needs of the clientele. Besides
housing, such programs include:
q credit for building sanitary latrines
q credit for installation of tube wells that supply
drinking water and irrigation for kitchen gardens
q credit for seasonal cultivation to buy agricultural
inputs
q loan for leasing equipment| machinery e.g. cell
phones purchased by G B members
q finance projects under taken by the entire family of a
seasoned borrower
The above procedure ensures both proper distribution of loan
and proper use of the same which acts as a strong base for
recovery.
3.1 Supervision System of Grameen Bank
GB follows a very extensive supervision system. Close and
competent loan supervision and serving are important
features underlying the success of GB ( Ahmed, p. 10). In
every sphere of its banking activities supervision acts as an
invisible hand( Hossain, p. 10).GB supervisors not only
oversee whether the loan is utilized properly but also provide
necessary stimulatory, supporting and sustaining cooperations.
GB supervisors also play advisory role in
marketing the products produced by the borrowers.
There are 21 zonal offices of GB around the country to
supervise field level activities. Under each zonal office there
are 10 to 12 area offices. In each area office there are 10 to 15
branch offices. Area managers supervise the work of branch
managers. Central office also supervises the activities of
Zone, area as well as branch managers.
The above procedure ensure both paper distribution of loan
and proper use of the same which acts as a story base for
recovery.
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Economics & Banking
Source: Memorandum of GB
3.1.1 Supervision Model of Grameen Bank
GB’s supervision never bases on the traditional concepts of
supervision. To achieve the best possible result and to ease
the supervisory function, the team of supervisors are
categorized into two main groups viz. (a) Field Supervisors
and (b) Planning Supervisors. These two groups are again
divided into some sub-groups. All the groups maintain proper
relation to their assigned borrowers. The GB model of
supervision can be depicted by the following diagram:-
According to the Model, the initial supervisor conducts the
pre-lending supervisory function. The guiding supervisor’s
operation starts from the loan disbursement to the utilization
of loan. The inspecting supervisor oversees whether the initial
and guiding supervisors are doing as per the regulation and
expectation of the bank. The planner group of supervisors
show the way that the field supervisors follow. This model
also depicts that every sphere of operation is associated with
more than one person as supervisors. There is no hard and
fast rule that a supervisor is to do a single job. At the same
time the same person may perform different supervisory
functions.
3.1.2 Supervision within the Group
It must be remembered that the supervision of loan does not
depend on the aggressive and brilliant performance of the
supervisors alone. The institutional setting is also important.
In GB, the borrowers themselves also conduct the
supervision. Before loan disbursement a group of persons
engaged in the same occupation and of similar mentality is
organized and the loan is primarily extended to only 2
persons of the group, the rest 3 persons will be entitled to get
loan if the previously extended loans are usefully utilized and
the credit discipline is strictly observed. So it is the duty of
each member of the group to supervise the operation of other
members in the group. Practically, it is observed that the
members of the group guide, supervise and assist the
members who get the loan for its proper utilization, timely
repayment and marketing of produced commodities. Such
process of group supervision within the group brings welfare
of the group as a whole. In this connection, the researchers
want to know the borrowers’ opinions. Following table shows
the picture:
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Economics & Banking
Table #2 Supervision by the GB Workers
Does the GB workers supervise them?
Frequency
(No. of borrowers) Percentage
Yes 89 89%
No 11 11%
Total 100 100%
Source: Faced Investigation.
From the above table-2 it is seen that 89% respondents’
opinion was positive i.e. the GB workers supervised them.
Only 11% of the respondents answered negatively. This
reveals more or less satisfactory position as regards
supervision aspects of GB loan.
4.1 Monitoring System of Grameen Bank
GB has been successful in integrating its program monitoring.
The field level officers and workers monitor program
activates very exclusively. The branch workers every day
monitor the activities of certain number of borrowers. Branch
managers also visit the group level activities and supervise
the activities of the workers. Area and zonal offices also
monitor the group and branch level activities. The role of
zonal and area mangers is not operational rather managerial
to see that branches are following the appropriate procedures.
Strong monitoring keeps management in touch with field
level operation which is very important for the success of any
rural financial institution. GB maintains a strict and
systematic monitoring system which is active basically in two
levels, namely, branch level and head office level
(Habibullah, p. 67).
4.1.1 Branch Level Monitoring
The steps involved in operating the computer system at the
branch level are as follows:
q Data collection and use as inputs;
q Updating and processing of field operation data;
and
q Report writing
Mainly two types of data are collected at branch level. Those
are: field operation data and financial operation data. At first
field operation data is collected. Then these are updated and
processed at the branch office and finally reports are written
on weekly basis. Branch and staff Work Progress Reports
(WPR) and monthly staff work progress reports are sent to
upper level offices. Similarly, financial operation data, loan
proposal form and collection sheet are collected at the field
level and these are used for writing reports like monthly
branch WPR at the branch office and distributed to area office
and head office. (Ibid, p. 68) For quality control the branch
manager or senior assistant conducts activities like reinterviews,
comparing of financial statements that ensure
accuracy of such data.
4.1.2 Data Collection and Use as Inputs
Field operation data is used for monitoring potential new
members and these are mainly collected from loan proposals
and supplemented by relevant information on the other
activities of field staff. After a field test, form is completed.
Selected items of information are put as input into the
computer. The items consist of serial number, identification
information, i.e., name, gender, address, age, number of
member, date of interview conducted by the branch manager
or senior trust assistant and its positive or negative outcome.
Financial position of the branch is monitored by the financial
data, which consist of information about disbursement and
repayment of loan. Data on loan disbursement is collected
from loan proposal forms and data on repayment of loan is
collected from the collection sheets.
4.1.3 Updating and Processing of Field Operation Data
Every group of a Grameen center consists of five members.
First, the information for the five members test form is
installed into the computer and then the system reserves it as
a new temporary group until the people concerned complete
their compulsory group training and appear in the Group
Recognition Test. The result is entered into the system and if
the group concerned passes, it is automatically registered as a
new group of a given center. Relevant information from
activities and events like motivation work, members dropping
out are continuously updated.
Financial operation data is collected from center meetings
where the details of disbursement and repayment of loans are
recorded on the collection sheets. The concerned branch
worker who organizes the center meeting collects such data.
She then presents the collection sheet to the branch manager.
When the branch manager finds everything is in order, he/she
attaches the bank receipt to the collection sheet. Validates it
with his/her signature and sends it to the computer for
updating the system.
1.4 Report Writing
Every branch prepares and maintains WPR and Cumulative
Consolidated Statements (CCS). WPR is a report consists of
both statistical and narrative information which measure the
work progress performance of a particular unit like staff
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Economics & Banking
member, branch, area or organization for a certain period i.e.
weekly and monthly. WPR are produced for the branch and
individual staff member.
The process of recruiting new members, amount of loan
disbursed and other financial information is included in the
statistical section. This section is designed to compare target
with actual achievement and percentage of target achieved for
a specific period. A written explanation of the statistical
information with details about the location of work activities,
reasons for under or over achievement, technical issues and
new strategies are contained in the narrative section.
CCS is a cumulative financial report and its function is to
provide a cumulative update that allows management to
evaluate the cumulative progress of each unit from its first
day operation until the present. The CCS is a standardized
format and it includes cumulative amount disbursed to date,
cumulative number of loan disbursed to date, cumulative
amount repaid to date and cumulative balance outstanding to
date.
5.1.5 Head Office Level Monitoring
Head office collects WPR and CCS from all the branches and
compiles them into global report covering all branches and
areas using computer. Head office level monitoring involves:
(a) collection, (b) data input and (c) report writing. How data
will be transferred from the branch office to the Head office
depends on the communication facilities available to the
branch manager. However, usually data is sent by posting
computer disk or hard computer facility which is available at
the branch. In the absence of computerized system, data are
couriered or mailed.
In fact, CCS and WPR are sent to the head office from the
branches through computer system as monitoring report. The
process includes:
q Relevant items form the branch manager’s WPR and CCS
are extracted by the monitoring unit
q Data are checked for reliability
q Relevant data are used as input by the operator branch
q WPR and CCS are printed for head office use
q Head office produces WPR and CCS on monthly,
quarterly, half yearly and yearly basis for the Deputy
Director of the loans division who analyzes and evaluates
the reports and takes necessary actions
The Monitoring and Evaluation Unit of the head office
collects information for all aspects of GB and analyzes them
which are transmitted head to all concerned parties for use
and necessary action. Following are note worthy monthly
reports brought out by monitoring and evaluation unit of the
GB (Rahman, p. 23) :-
q Cumulative figures on loan disbursement and repayment
q Comparative figures on loan disbursement and repayment
with reference to last month’s figures
q Comparative picture (Zone-wise) on loan disbursement,
members, and branches from the date of inception
q Statement on savings and new membership
q Extract of loan defaults (Zone-wise)
q Statement on special activities
q A trend report on the loan recovery, and
q Statement on house building loan
Further, monitoring and evaluation unit makes qualitative
reports on various aspects of banking procedure, personnel
management and other administrative matters.
Conclusion
GB follows a very intensive and systematic supervision and
monitoring system. Almost in every sphere of its banking
activities, supervision acts as an invisible hand. GB’s
supervisors not only oversee whether the loan is utilized
properly but also provide necessary supports to its clients.
More-over, GB’s supervisors work like a team. In GB the
borrowers themselves also conduct supervision activities. The
members of the group guide, supervise and assist the other
members in all respect. Such process of group supervision
within the group makes the job easier for the GB’s
supervisors. GB’s monitoring system is quite active in its
branch and Head office level. GB’s monitoring and
Evaluation units collect information on all aspects of GB and
analysis them for the use of all concerned. At the branch
level, on every Tuesday the branch manager and other bank
officers visit beneficiaries’ houses in order to find out how
they are utilizing the loans. This weekly visit is considered as
an effective means for ensuring good monitoring. Thus
effective distribution, supervision and monitory system
combinedly found to form an excellent model of credit
distribution system of GB.
n
REFERENCES:
1. Khandaker Shahidur Rahman(1995), “ Grameen Bank: Performance and Sustainability”, World Bank Discussion Papers, Vol. 306, The
World Bank, Washington, D.C. 1995.
2. Ahmed Fazal (2003), “ Self-Sufficiency, Empowerment & Poverty Alleviation of Rural Woman with the Assistance of Grameen Bank” An
Unpublished M.Phil Dissertation, Dhaka Uuniversity, 2003.
3. Hossain Mohammad Zahid (1994) Grameen Bank Financial Philosophy (Dhaka: Grameen Trust, 1994).
4. Habibullah, MNuhammad(2000), Monitoring and Control System of Grameen Bank and Its Effect on the Recovery Rate(Dhaka: Grameen
Trust, 2000).
5. Ibid.
6. Rahman Atiur (1987), Participative Management Style of Grameen Bank(Dhaka: BIDS, 1987).
The Bangladesh Accountant/January- March 2010 74

Investment
FDI in the Context of SAARC Nations with Particular
Reference to Bangladesh: An Analytical Study
Dr Dilip Kumar Sen
and
Chowdhury Rajkin Mohsin
Abstract
This is a brief analysis-based study on Foreign Direct
Investment (FDI) in the context of SAARC nations in
particular reference to Bangladesh. This paper aims at
examining present situation of FDI in Bangladesh and
investigating the determinants and tracing out some specific
problems that slow the FDI inflows in Bangladesh. Since long
it has been observed that FDI inflow in Bangladesh is far
below the expected level. The major impediments are poor
infrastructure, urban violence, political unrest, inconsistent
economic policies, and government bureaucracy. With the
most urgent need for boosting industrial production,
Bangladesh greatly needs to enhance mobilization of
foreign resources. Government policies, both short term and
long term, are urgently needed to improve the existing
scenario of FDI, and finally, in view of this dire need, the
paper provides a few recommendations.
Keywords: Foreign Direct Investment, Balance of payments,
Infrastructure, Economic growth, South Asian Countries,
Political unrest, SAARC Countries.
Introduction
In view of a largely benign view of foreign direct investment
(FDI), there has been an intense global race for foreign
investment (Mottaleb, 2007). Notwithstanding several
significant caveats, it is almost universally acknowledged that
FDI has a potentially important role to play in a country’s
economic growth and development. FDI is a major source of
external finance which means that countries with limited
amount of capital can receive finance beyond national borders
from wealthier countries. From the pages of literature
reviewed a little later, it emerges that FDI is an important
growth factor in the globalization of the world economy. The
economic benefits of FDI are wide-ranging. It opens new
avenues of knowledge, transfer of technology, training of
manpower, market networking, and many other spillover
effects and externalities in the host countries. This study
intends to investigate the position of FDI in the SAARC
countries including Bangladesh, in particular. The view of
some other countries has also been depicted in order to make
the comparative position of FDI in the SAARC belt
transparent. One might view foreign direct investment (FDI)
as making capital investments in a country that is owned by a
foreign entity. According to IMF (International Monetary
Fund), FDI refers to an investment made to acquire lasting or
long-term interest in enterprises operating outside the
economy of the investor. The investment is direct because the
investor, which could be a foreign person, company or group
of entities, is seeking to control, manage, or have significant
influence over the foreign enterprise. It does not include
foreign investment into the stock markets. FDI (Foreign
Direct Investment) is the movement of capital across national
frontiers in a manner that grants the investor control over the
acquired asset. Firms that use FDI are known as multinational
enterprises. Production in the foreign country is largely
financed by the multinationals. Foreign Direct Investment
(FDI) is conventionally defined as a form of business that
works within the international inter-firm co-operation and
own significant amount of equity and effective management
power. FDI also encompasses other broader and
heterogeneous non-equity forms of co-operation that involves
supply of tangible and intangible assets by a foreign
enterprise to a domestic firm.
The growing importance of FDI is exemplified by the shift
towards greater openness of national economies to inward
FDI particularly in the Least Developed Countries (LDCs),
Dr. Dilip Kumar Sen, Professor of Accounting and Finance, School of Business, Independent University, Bangladesh and Mr.
Chowdhury Rajkin Mohsin, Lecturer in Finance, School of Business, Independent University, Bangladesh.
The Bangladesh Accountant/January- March 2010 75

Investment
where a growing number of countries have been attempting to
attract FDI by liberalizing economic policy and offering
alluring incentive package to Transnational National
Corporations (TNCs).
Realizing the immense importance of FDI to economic
development, the developing countries have been taking
liberal economic policies to swell up the FDI inflow, and
have succeeded in attracting the substantial amount of FDI.
Bangladesh along with other SAARC countries, however,
lagged behind considerably compared with their other fellow
Asian Countries.
Both neighboring countries India and Pakistan experienced a
significant rise in FDI in past two decades. Bangladesh has
been able to attract foreign investment at a much slower rate.
Current domestic investment has taken a rinse due to the
financial crisis and is expected to shrink further. This sharp
decline of FDI inflow in Bangladesh will evidently hamper
the pace of economic development. The findings along with
the financial crisis of most studies show that the poor
infrastructure, militant trade unionism, poor governance and
frequent strikes are the major impediments to attract FDI
inflow in Bangladesh. Some studies have clearly addressed
this important issue. This study endeavors to investigate the
major causes of low FDI inflow in Bangladesh and also to
determine the significance of these factors empirically. In
fine, the study suggests some recommendations for improving
the FDI position in the SAARC belt.
Section-II
Methodology
The present study is partly exploratory and partly analytical.
Prior research works have been used to make this study
informative, meaningful and substantial. This study has also
done empirical analysis. Regression analysis has been
conducted for the purpose of presenting the empirical results
scientifically. The result of a regression analysis is an
equation expressing the relationship between the dependent
and independent variables, including coefficients that indicate
the sensitivity of the former to a unit change in the latter. In
this context, most important factors influencing FDI inflows
in Bangladesh have been considered. Data limitation is one
reason to drop some influencing factors in empirical analysis.
Here, dependent variable is Growth of FDI (LFDIG), and
independent variables are Interest (LINTEREST)--an
indication of marginal productivity of foreign capital, ratio of
domestic fixed investment (LDINVEST) on GDP, ratio of
total employed labor working in manufacturing sector (LM
LABOR), infrastructure spending (LINFRA), percentage of
education spending on GNP (LHU) and ratio of export to
GDP (OPEN). All the variables are in Log form. Data were
taken from World Development Indicators, International
Financial Service (IFS) and Bangladesh Board of Investment
(BOI) from 1980 to 2000. It deserves mention that although
the study is limited to SAARC nations, some other countries
of the South-Asian belt as well as a few developed countries
have also been included in the discussion for the purpose of
making this paper more informative and substantial. This
scenario is expected to make the comparative position of FDI
in the SAARC belt very clear and transparent.
This article has been organized into seven sections. It begins
with introduction. The second section is on methodology.
The third section reviews some literature related to the
present study, while the fourth section addresses some
studies linking FDI to economic growth. Section five focuses
on the FDI inflow scenario of Bangladesh and other
countries. Section six examines the factors influencing the
inflows of FDI in Bangladesh as well as some developing
and developed countries. The last section draws a concluding
line to the study.
Section-III
A Brief Review of Related Literature
In view of the guidelines of the journal (where the present
authors have already committed to send this paper) not to
make the article a lengthy one, here an attempt has been made
to make this literature review part quite brief. Besides, the
research studies on FDI in the SAARC belt, in particular were
not available in plenty to the present authors. It may,
however, be added in this connection that throughout the
study wherever needed relevant literature has been referred to
in order to substantiate the discussion of the present study.
Here in this section the review adresses the literature on (i)
FDI in the countries other than those of the SAARC belt, (ii)
FDI in the SAARC countries excluding Bangladesh and (iii)
FDI in the context of Bangladesh exclusively.Here the
purpose is to survey the related literature to the extent
possible indicating genesis of the problem as well as to
identify the research gap in the specific area of FDI in the
SAARC nations with particular reference to Bangladesh.
The Bangladesh Accountant/January- March 2010 76

Investment
Literature on FDI in the Countries other than those
in the SAARC belt
The earliest explanation of FDI was viewed as a part of
portfolio investments by Iverson (1935). From the industrial
organisation view, Hymer (1960) was the first to link FDI as
a means of transfering knowledge and optimising the use of
firm’s assets to organize production in a foreign country.
Vernon (1966) used the concept of production life cycle to
rationalise setting up of production facilities abroad due to the
standardization and maturity of goods in the home market.
Caves (1971) and Dunning (1958) proposed FDI as a means
of exploiting ownership advantages. Rugman (1979) saw FDI
as a means of risk diversification. Dunning (1980), in the
eclectic paradigm, provides a framework using Ownership,
Location and Internalization advantages to justify why and
where multi-national companies should invest. Empirical
studies have found wages, barriers to trade, production,
transportation, political instability, market size, market
growth and host government’s trade and taxation regulation
affected the decision to locate. The Upsaala model by
Johanson and Vahlne (1977) proposes multi national firms
engages in FDI incrementally. Firms engage in small
investments in a foreign territory and accrues larger
investments as the firm gains experience in the new country.
Foreign direct investment faces a major barrier particularly in
developing nations. Most foreign firms have found it
notoriously difficult to access both Southeast Asian countries
and African nations. Engaging in corruption is almost
unavoidable in these regions. Transparency International, a
German based firm has contributed empirical research on
corruption since 1995 by publishing the Corruption
Perceptions Index (CPI). Corruption mainly comes in three
different forms which include bribery, extortion and
embezzlement. Many scholars have analysed the impact of
corruption from an economic perspective. Mauro (1995)
concluded that corruption hindered investments and slowed
economic growth. Goudie and Stasavage (1997) found that
corruption depended on the level of efficiency of the nation.
Contrary to its negative impacts, it has also been found that
corruption tends to have a positive impact on the economy
(Nye 1979). Economists have developed the disincentive and
distortionary arguments against corruption. The former states
that corruption has a disincentive impact as it creates
uncertainty for investors and increases exposure to risk (Getz
and Volkema, 2001) whereas the latter proposes that bribery
paid is due to inefficient resource allocation (Goudie and
Stasavage, 1997).
Most researches have aimed at economic factors for the
motivation of FDI as well as the nature of multi-national
firms or the foreign investment to explain the rationale to
invest abroad. Their research suggests primarily economic
factors for the expansion. A lot of analyses have been done
from the economic perspective, but very little research has
been done in this field of FDI keeping in view political
perspective. Political instability and violence discourage FDI
as it creates uncertainty and difficult atmosphere for
conducting business (Brunetti, Kisunko & Weder, 1997).
Henisz (2000) has found that institutions with multiple veto
players constrain policy change and attract FDI as these
institutions decrease the risk of uncertainty. Other researches
have found regime type to be a major ingredient to attract
FDI. Feng (2001) and Jenson (2003) have found democracies
to attract more FDI which is contrary to earlier findings by
Bornschier and Chase Dunn (1985) which suggested that
multi-national firms preferred autocrat’s ability to suppress
labor demands and by the absence of election induced policy
uncertainty. Harms and Ursprung (2002) in their research
found no significant effects on FDI over regime types.
It has been questioned whether there exists any relationship
between FDI and economic growth (Carkovic & Levine
2002) as FDI is a small fraction that matters to growth.
Research has shown that FDI is beneficial to only developed
countries (Borensztein et al, 1998) whereas other research has
shown that less developed countries are the most that benefit
from FDI (Bloningen & Wang 2004). A variety of studies
have examined the effect of FDI on economic growth and
income inequality. Findings on the direct effects of foreign
investment have been inconsistent and contradictory
(Syzmasnki 1983). Infrastructure development, corruption,
cheap labor, technology are some of the several variables that
are needed to be explored with respect to least developed
countries for attracting FDI.
Literature on FDI in the Perspective of SAARC
Countries excluding Bangladesh
Quite interestingly, in 2003 in the 9th International
Conference (from 28th to 30th November) on Sri Lanka
Studies, Wasantha Athukorala presented an excellent paper
on “The Impact of Foreign Direct Investment for
The Bangladesh Accountant/January- March 2010 77

Investment
Economic Growth: A Case Study in Sri Lanka”. This
paper indicates that foreign direct investment (FDI) is
assumed to benefit a poor country like Sri Lanka, not only by
supplementing domestic investment, but also in terms of
employment creation, transfer of technology, increased
domestic competition and other positive externalities. Sri
Lanka offers attractive investment opportunities for foreign
companies and has adopted a number of policies to attract
foreign direct investment into the country and the country
seems to offer perhaps one of the most liberal FDI regimes in
South Asia. But the net attitude of the civil society towards
the impact of FDI on opportunities for domestic business and
economic activities is positive and the net attitude of foreign
firms towards FDI reveals that the investment climate has not
improved in Sri Lanka owing to lack of good governance,
corruption, political instability and disturbance, bureaucratic
inertia, and poor law and order situation. The available
second study in reference to FDI in Sri Lanka is on “Foreign
Direct Investment and Economic growth in Srilanka” by
N.Balamurali and C.Bogahawatte, published in Srilankan
Journal of Agricultural Economics (2004). This examines the
relationship between FDI and economic growth of Sri Lanka
for the period from 1977 to 2003. The results indicate that
FDIs exert an independent influence on economic growth and
there is bidirectional causality between FDI and economic
growth. The findings suggest that better trade policy reforms,
implementation aimed at promoting FDI and domestic
investment and restoring international competitiveness to
expand and diversify the country’s exports have the potential
of accelerating economic growth in the future. The paper of
Ashfaque H. Khan and Yun-Hwan Kim on “Foreign Direct
Investment in Pakistan: Policy Issues and Operational
Implications”, published in EDRC Report Series No. 66
(July 1999) spells out that Pakistan needs to significantly
increase her mobilization of foreign resources, given her
fragile balance of payments position and urgent need to boost
industrial production. It is, therefore, crucial to accord high
priority to foreign direct investment (FDI). Foreign direct
investment is perceived in many developing countries as a
key source of much needed capital, foreign advanced
technology, and managerial skills. Realizing its central
importance to economic development, these developing
countries have taken wide-ranging steps to liberalize their
inward FDI regime and have succeeded in attracting
substantial amount of FDI. Another related paper is on
“Economic Evaluation of Foreign Direct Investment in
Pakistan” by Mahr Muhammad Yousaf, Zakir Hussain and
Nisar Ahmad, published in Pakistan Economic and Social
Review, (Summer 2008). This literature indicates that foreign
direct investment (FDI) in Pakistan is one of the major
external sources of funding to meet obligations of resources
gap and goal achievement. FDI has played a vital role in the
economic growth of Pakistan and contributed significantly in
the human resources development, capital formation, and
organizational and managerial skills of the people in the
country. Next comes the contribution of Ramkishen S. Rajan
on “Measures to Attract FDI Investment Promotion,
Incentives and Policy Intervention”, published in
Economic and Political Weekly ( January 2004). This paper
reflects that foreign direct investment (FDI) is attracted into
countries for different reasons. At a general level, in order for
a country to be more attractive to investors, there is a need to
create an enabling environment by reducing so-called hassle
costs. Ramkishen S. Rajan’s another paper on “Foreign
Direct Investment and the Internationalization of
Production in the Asia-Pacific Region: Issues and Policy
Conundrums”, published in Asia-Pacific Trade and
Investment Review (April 2005) draws on the relevant
academic literature to examine selected policy issues relating
to foreign direct investment (FDI) and its links to
international production, trade and technological
development. The paper stresses the importance of
“production fragmentation”, broadly defined as the
decoupling of a product into its constituent parts, the
production of which are spread across countries according to
the basis of comparative advantage. This cross-border multistaged
production process in turn has been facilitated
immensely by major improvements in transportation,
coordination and communication technologies. The paper
focuses on investment promotion activities and the potential
effectiveness (or lack thereof) of fiscal and financial
incentives. It also emphasizes that FDI policy intervention
should not be biased sector wise. This study ends with a brief
discussion of the proliferation of regional trade agreements
(RTAs) in the Asia-Pacific region and their consequent
implications for regional trade, investment and development.
Another important research study done in India by Aradhna
Aggarwal (July 2008) is on “Regional Economic
The Bangladesh Accountant/January- March 2010 78

Investment
Integration and FDI in South Asia: Prospects and
Problems” , published by Indian Council for Research on
International Economic Relations . This paper argues that
there is a need to forge deeper integration within the South
Asian region. Essentially, it looks at the effect of deepened
regionalism on investment flows. It argues that regional
integration has the potential to promote intra and extra
regional FDI flows and economic development in individual
countries of the region. It analyses the factors that can impede
growth of both intra and extra regional FDI flows and
explores how these constraints maybe addressed through
greater economic integration. This paves the way for the most
efficient use of the region’s resources through additional
economies of scale, value addition, employment and diffusion
of technology. The study concludes that a deeper form of
cooperation is an urgent necessity for the region for
promoting FDI. P.Agarwal’s paper on “Economic Impact of
Foreign Direct Investment in South Asia” (2000)
scrutinized the economic impact of Foreign Direct Investment
in South Asia by undertaking time-series, cross-section
analysis of panel data from five South Asian countries: India,
Pakistan, Bangladesh, Sri Lanka and Nepal, and concluded
that there existed complementarily a linkage effects between
foreign and national investment. However, using time series
data from the Sri Lanka economy, Athukorala (2003) showed
that FDI inflows did not exert an independent influence on
economic growth and the direction of causation was not
towards from FDI to GDP growth but GDP growth to FDI.
Now a word on FDI of another SAARC country, Nepal. The
article of Rana, Madhukar SJB and Stalin Man Pradhan is on
“Implementation Evaluation of Foreign Direct Investment
Policy in Nepal” (August 2005), presented in the meeting of
the Advisory Committee on Economic Policy on International
Trade, Investment, and Employment. This is the Policy Paper
1 of Economic Policy Network, His Majesty’s Government of
Nepal, Ministry of Finance, Singha Durbar, Kathmandu,
Nepal. This study analyses the problems facing foreign direct
investment (FDI) in Nepal and prescribes policy interventions
to attract more FDI in the country. It is the challenge for the
Government to bring peace & security, maintain law & order,
and His Majesty’s Government needs to bring favorable FDI
policy, create an environment to attract maximum number of
FDIs. His Majesty’s Government of Nepal should open FDI
for service sector [Tourism, Health, Education, Financial
Services, Warehousing and Multi-Model Transportation,
Banking, Insurance, Consulting, Legal, Accounting,
Infrastructure (Water, Power, Roads, Tunnel, Cable Car,
Airports etc)].
Bhutan is also not lagging behind in respect of enhancing
FDI. She is now officially open to FDI. The Royal
Government of Bhutan made a landmark decision regarding
FDI on December 3, 2002 by approving the FDI policy 2002.
This policy provides an overall framework for approval of the
regulations for FDI in Bhutan. The decision to open the
agriculture-based Bhutanese economy to FDI is to boost
private sector development and industrialization through
easier excess to capital, technology and markets (Press
Release of the Bhutanese Cabinet, 2002).
The position of FDI in Maldives is also worth reviewing.
“Opportunities to Economic Growth and Investment in
the Maldives” is a background paper prepared the Ministry
of Economic Development and Trade (MEDT), and the
Foreign Investment Services Bureau (FISB) for the Maldives
Partnership Forum held in the Maldives on June26, 2006.
This paper indicates the keen interest of Maldives to enjoy the
benefit of FDI. Maldives relaxes FDI to develop 35 new
islands (Sisodia, Reema 2006). The country has further
liberalized its investment policy making it more investmentfriendly
and hassle-free for Indian investors as well as
investors of other countries. Maldives has opened doors for
35 more resort islands to be developed out of which 20 would
be given solely for private investors to develop, while the
other 15 would be in the hands of Government on an
agreement to provide some share to locals, which in turn
could be subleased to private players. At present, Maldives
has in total 1192 islands out of which approximately 87
islands are operational. On his recent visit to India,
Mahamood Shougee, Minister for Tourism and Civil
Aviation, Government of the Republic of Maldives expressed
his keen interest to invite foreign investors to develop the
islands . He told that they were very serious about gaining
more links with India. According to Murad Hassan of
Maldives Tourism Promotion Board (MTPB), Maldives
provides excellent return on investment (ROI), which makes
Maldives the leading tourism destination in terms of ROI. The
Government of Maldives has simplified the rules and
regulations regarding FDI. Technical rules and regulations have
also been made transparent and clear (Sisodia, February 2006).
Now the status of FDI in Afghanistan deserves mention.
The Bangladesh Accountant/January- March 2010 79

Investment
The Government of Afghanistan is working to turn the
country into a pro-business environment that would entice
foreign firms to invest in Afghanistan. With multinationals
already biting, the plans seem to be working. The country has
taken significant steps towards fostering a business-friendly
environment for both foreign and domestic investment. The
Law on Private Investment of Afghanistan, 2005 specifically
prohibits discrimination against foreign investors. In this
connection, it deserves mention that Multinational Investment
Guarantee Agency (MIGA), a member of World Bank Group,
promotes beneficial foreign direct investment. It was
developed to promote FDI. MIGA provides several tools to
assist investors in evaluating and making investments in
Afghanistan (FDI Magazine June, 2005).
Literature in Bangladesh Perspective
The article on “Foreign Direct Investment in Bangladesh:
Problems and Prospects” authored by Md. Abdullahel Kafi,
Mohammad Main Uddin and M.Muzahidul Islam, and
published in The Journal of Nepalese Business Studies (
December 2007) indicates that economic development for the
developing countries like Bangladesh is dependent on FDI.
The major challenges for the host country are to ensure an
eye-catching and conducive investment climate to foreign
investors for FDI inflow. This paper portrays the FDI inflow
since 1995 and finds out causes of low-inflow based
secondary data. It reflects that Bangladesh is not full of
hindrances of FDI, but some opportunities and prospects are
also available in this host country. So, quarrelsome political
environment has to be done away with. Then the new era of
investment for the native and foreign investors will hopefully
appear.
Next comes Rajeen Kabir’s contribution of an unpublished
thesis on “Foreign Direct Investment and Sustainable
growth: A Case Study on Bangladesh”, submitted to the
Faculty of Emory college of Emory University in 2007 in
partial fulfillment of the requirements of the degree of
Bachelor of Arts with Honors in Economics. This thesis
reveals that there are several benefits of FDI on macro level,
particularly for a Third World Nation such as Bangladesh,
where inflows of foreign investment can expand economic
production and growth. FDI provides capital from sources
abroad which the country is unable to supply domestically.
The inflows facilitate the growth of a number of economic
sectors, including industry, manufacturing, infrastructure and
energy. The expansion leads to a rise in the availability of
jobs and a fall in the unemployment rate. Consequently, GDP
and per capita income increase which, in a developing
country, fosters poverty alleviation. In addition, FDI
strengthens ties with developed countries that may yield cost
advantages in the form of advanced technology transfers and
resulting positive externalities. Increased financial
associations also lead to stronger capitalistic markets and
ideals of corporate governance and social responsibility. On
the basis of this intricate link between FDI and growth, the
trade regime of Bangladesh has to be intensely liberalized to
maintain the streams of investments and finances from
abroad. This study has conducted a historical and statistical
analysis between FDI inflows and sustainable economic
growth.
Muhammad Amir Hossain’s contribution on “Impact of
Foreign Direct Investment on Bangladesh’s Balance of
Payments: Some Policy Implications” (2008) is an
interesting research study. According to him, foreign direct
investment (FDI) is a potent weapon of economic
development, especially in the current global context. It (FDI)
enables a capital-poor country like Bangladesh to build up
physical capital, create employment opportunities, develop
productive capacity, enhance skills of local labor through
transfer of technology and managerial know-how, and help
integrate the domestic economy with the global economy.
This study reports high positive correlation between FDI
inflows and Bangladesh’s aggregate exports and imports.
Khan Md. Azizur Rahman’s paper on “Globalization and
the Climate of Foreign Direct Investment: A Case for
Bangladesh”, published in Journal of Money, Investment and
Banking (2008) portrays that FDI is dramatically increasing
in this age of globalization. FDI plays an important role for
economic growth in the global process. The study explores
the determining factors of FDI in Bangladesh. It investigates
the significant determinants of a country’s inflow of FDI. In
fine, it draws a conclusion to promote the inflow of FDI with
a view to adopting measures to strengthen the positive
impacts and reduce the negative impacts of FDI.
Then the contribution of Shafiun Nahin Shimul,
S.M.Abdullah and Salina Siddiqua on “An Examination of
FDI and Growth Nexus in Bangladesh: Engle Granger
and Bound Testing Co-integration Approach”, published
in BRAC University Journal ( 2009). This paper has tried to
The Bangladesh Accountant/January- March 2010 80

Investment
find out the relationship or co-integration between FDI and
economic growth for Bangladesh using time series data of
1973-2007. For testing co-integration, the two modern time
series econometric approaches -- bound testing Autogressive
Distributed Log (ARDL) Model and Engle Granger two-step
procedures were executed and this study found that FDI and
GDP were not co-integrated. Besides, using Granger
Causality test it was found that the FDI and openness were
not significantly causing the GDP per capita both in the short
and long run. The study suggested taking steps so that FDI
could be used as a contributing factor to economic
development.
Another interesting paper is on “Determinants of, and the
Relationship between FDI and Economic Growth in
Bangladesh” by Ahamad, Mazbahul Golam and Fahian
Tanin (January 2010). This paper shows that FDI inflows to
Bangladesh have increased dramatically in recent years and
have had some positive influence on development. The study
reviews the long-run trend on the time scale of FDI to
Bangladesh over the period 1975-2006 and major factors
determining foreign Companies’ decisions to invest in
association with economic growth. It shows that FDI inflows
enhance the production capacity of the economy and raise
employment levels. This leads to an increase in exports
allowing the country to earn foreign currency with which to
pay for external debt, import volumes, and further inflows of
FDI. The process continues to help sustain economic growth.
To add another relevant paper on “Does FDI intensify
economic growth? Empirics from Bangladesh” by Ahmed
Mazbahul Golam, Fahian Tanin,and Zahir Uddin Ahmed
(February 2010). This paper has shown that some important
determinants like GDP per capita, average growth rate of
GDP, foreign reserve, gross capital formation, human capital,
terms of trade and other essential infrastructure have effect on
FDI inflows. Overall, the study has analyzed the determinants
of FDI and economic growth nexus as well as the
relationship, either positive or negative. It has further shown
that FDI is pivotal in providing Bangladesh the necessary
finance and capital to achieve sustainable growth as well as
poverty alleviation. FDI inflows have been able to increase
GDP by raising the economy’s output capacity and
employment level. At the same time, it has delivered
development by improving people’s per capita income.
It follows ultimately that FDI is a promising subject of socioeconomic-managerial
finance in which obviously further
substancial researches are warranted. This review bears
evidence that several research studies have appeared in the
literature. Yet, it is felt that more research studies on FDI in
the context of SAARC countries with special reference to
Bangladesh are required to be done to enrich literature in this
field. Therefore, to accomplish this what is needed most
today is an in-depth research study on the problem of FDI in
the SAARC belt with particular reference to Bangladesh.
Hence, this study to bridge the research gap related to FDI in
the context of SAARC belt.
Section-IV
Studies Linking FDI to Economic Growth
In this section, an endeavor has been made to discuss some
empirical and theoretical studies to explain the differences of
economic growth rates across countries. In these studies,
technological diffusion and capital formation are the primary
focuses of interest in analyzing economic growth.
Technology diffusion can take place through a variety of
channels, and FDI is viewed as one of the major channels for
access to advanced technologies. Jyun-Yi and Chih-Chiang
(2008) postulated that FDI would promote economic growth
through its effect on technological progress. The empirical
study by Borensztein, De Gregorio and Lee (1995) shows that
FDI is positively correlated with economic growth.
For instance,Fosu and Magnus (2006) and Boi (2007)
concluded that the rates of capital formation determine the
rates of economic growth. As mentioned above, many
empirical studies have shed light on the scope for long-run
growth rates through FDI inflows. A simple theoretical model
is proposed to reveal that the FDI inflows with superior
technology contribute to the sustainable growth of the
recipient economy. The following production shows that a
firm in a closed economy (having no connection with external
economies) can produce output per worker:
Y(i) = A(K,t)F(K(i) ….. (1)
Y(i) and K(i) are the per-firm quantities of output and capita!
per worker respectively; K. is the economy-wide capital-labor
ratio; and t is time. Here, F' > 0 and F" < 0. No distinction is
made between human and physical capital K, which
comprises the both. Each firm chooses its inputs taking the
economy-wide level of technology, as given in A. Since firms
are identical, in equilibrium K(i) = K. Assuming that the
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firm-level production function is Cobb-Douglas type (a
special type of production), the aggregate production function
for per-capita output in the economy can be written as:
Y=A(K,t)(Ka) ….. (2)
where a < 1, is the
share of capital in the
output.
Now, it is assumed that the economy is opened to global
economy. Various economic transactions are made with
developed economies, which bring superior technology and
knowledge in the economy. FDI is considered to be one of the
channels of technology transfer. Both foreign Firms (with
superior technology) and domestic firms in the economy are
assumed. Therefore, the equation (2) can be written as
follows:
Y = A (K),t)(a+e,e >0) ….. (3)
£ can be considered the positive externality of FDI. The
value of this £ depends upon the nature of FDI received and
the characteristics of the recipient country. If a + £ > l,
country would experience increased returns to scale, if a + £
=1, country would get constant returns to scale and if a + <
1, it will experience diminishing returns. Considering the
foreign firms with superior technology and having
complementary/ positive effect, one can only think of
increasing or constant returns to scale. Many economists'
(Kohpaiboon, 2004, Mansouri, 2005, Ukpolo, 1994, and
Alfaro, 2003) works support the conclusion of constant or
increasing returns in presence of externalities. If a + £ = l,
then the aggregate production function can be written as;
Y=BK ….. (4)
Where B =A(K,t)
The final model becomes very much similar to the growth
theory- AK model- developed by (Pesaran, Shin and Smith,
1997,2001) but the process of the model (positive externality
derived from FDI) is different. According to the model,
sustainable growth is possible in the recipient economy if
FD1 inflows continue. For the sake of simplicity, other pans
(dynamics of the model) of the model are not considered.
The objective of the study is also not intended to develop any
theoretical model.
East and Southeast Asian countries have acquired remarkable
long term growth largely depending on inward FDI, which
justifies the conclusion drawn from this simple model.
Therefore, the possibility of acquiring sustainable growth in
Bangladesh through inward flow of FDI is needed to
examine.
Section-V
FDI Inflow: Scenario of Bangladesh and other Countries
FDI flows continued to expand even when world trade was
slow to grow. It provides support for the argument that trade
growth is retarded by trade barriers. There are many theories
explaining FDI. It is convenient to divide the principal
theories into two categories. The first one explains FDI in the
portfolio-allocation framework and predicts that FDI depends
largely on international differences in interest rates, profit
rates and other measures of returns to capital. An important
weakness of this approach is that it can explain international
portfolio diversification but not FDI per se, that is, why
wealth-holders carry out FDI rather than simply purchasing
foreign equity instead of debt instruments.
The second category resolves this difficulty by posing market
imperfections of various kinds. Carkovic & Levin (2002)
note that "for foreign direct investment to thrive, there must
be some imperfections in the markets for goods or factors or
some other interference in competition by government or by
firms with separate markets." The first explanation for the
causes of market imperfection is the wage differential. The
natural expectation is that a rise in the host country's wages
(given the wage rates in the source country) would
discourage FDI flows. While some researchers such as Fry,
(1993), Culem (1988) and Alam(1999) have found no
significant effect or even a perverse effect.
Bornschier et al (1985) have offered a possible explanation of
this ambiguity. Within the framework of profit maximizing
model of an individual firm, he shows that a rise in the wage
rate of the host country increases the costs of production and
hence, discourages production and the use of capital.
However, the wage rise changes the factor price-ratio and
encourages the substitution of capital for labor, which, ceteris
paribus, increases the demand for capital and hence FDI. The
second cause of market imperfections is distortion in the
foreign exchange market. It has been argued that FDI flows
from hard to soft currency areas because of interest
differentials Accolley, (2004).A broader and closely related
consideration is the general state of the openness of the host
country's economy. If the host country is relatively closed in
commodity market, incentives are created for FDI as a means
of circumventing the barriers to trade. On the other hand, a
relatively closed capital account (such as tight restrictions on
foreign ownership) will hinder FDI inflow and foreign
investment.
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The third argument often used in empirical work is that of
economies of scale and market size. It is argued that, in the
face of economies of scale, FDI is more likely to be greater
in the host market. Although Agarwal (1980) points out that
this argument applies only in the case of production targeted
at the domestic market and does not capture FDI designed to
stimulate exports from the host country. The great majority
of empirical studies of FDI define the size of the host market
by real GDP. Bajo-Rubia and Sosvilla-Rivero (1994), Alam
(1999) and so on---all use real GDP and find it to be a
significant determinant of FDI flows. Alternative measures
are the rate of growth of real GDP (which Wang and Swain
find significant) and GDP per capita (Fry, 1993).
Finally, political factors in the host country are often of
crucial importance. Some variables already mentioned will
have an important political dimension, such as the level of
tariffs and the severity of non-tariff barriers to Fry (1993) and
Bajo-Rubia and Sosvilla-Rivero (1994) have used inflation
rates to capture the stability of macroeconomic policy. Both
found that inflation and FDI flows are negatively related. In
some other papers dummy variables are used to capture
specific political events, which might have an important
impact on FDI flows.
From the discussion of theories and empirical work, the
determinants of FDI can mainly be attributed to the following
variables: a rate of return variable, the wage rate, the
measures of openness such as the ratio of trade to GDP,
human capital, the host country's exchange rate and the level
of GDP. Now the scenario of FDI in Bangladesh is presented
in figure # 1:
Figure # 1: Scenario of FDI in Bangladesh (1985-2010)
Source: World Investment Report, 2009, 2006, 2003, 1998 & 1992
* Bangladesh Bank, The Financial Express, 23rd May, 2010
** Bangladesh Bank, The Financial Express, 23rd May, 2010 (July 2009-March 2010)
Beginning with small amount in the 1980s, inflows of private
foreign direct investment in Bangladesh have risen to over
$500 million in recent years. Although, the beginning of 2000
era marked a sudden boom in FDI, it failed to maintain
consistency. With $793 million inflows in 2006, the sudden
boom was followed by 16% decline the following year. 2008
witnessed the highest ever FDI record, a whopping $1 billion
inflow according to UNCTAD. Blessings from the countries
garments and energy sectors have helped the inflows. Cheap
labor which entrepreneurs have taken advantage of in
utilization in manufacturing garments contributes 70% of
GDP. Garments manufacturing has been the prime
contributor for FDI. Other sectors such including Tea,
Chemical and Gas exploration have also contributed. Along
with the aid of the various sectors, trade and exchange
liberalization, current account convertibility and the
liberalization of the investment regime have all helped to
bring about this. Most importantly, it is' the opening of
infrastructure and public services to the private sector, both
domestic and foreign, which has provided the biggest impetus
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to foreign investment in Bangladesh. Unlike Sri Lanka, where
the bulk of FDI is export-oriented, FDI in Bangladesh is
characterized by its inward-orientation with some exceptions;
where heavy concentration is in the energy sector. As a result,
its direct impact on exports and generation of incremental
foreign exchange is difficult to gauge. Since the cities’ power
shortage is the major constraint to higher production in the
manufacturing sector including the export-oriented garments
sector in Bangladesh, it is only befitting to assume that
removal of energy constrains through FDI in gas development
and power generation will ultimately lead to higher exports
Table # 1
FDI in Selected SAARC Countries (Millions of Dollars)
and increased foreign earnings. This is inevitably a
productivity enhancing mechanism.
Globally, FDI comes mainly from three countries, namely-
USA, Japan and the UK, while other countries such as
Australia, Germany and France also contribute to some
extent. Some Asian Countries such as Malaysia, Hong Kong,
Singapore, China, South Korea and Japan have emerged as
the prospective foreign investors in Bangladesh. UK is also
an important source of FDI flows in Bangladesh. A
comparative scenario of FDI in SAARC countries
is presented in the following table #1:
Country 1986 1990 1995 2000 2001 2002 2003 2004 2005 2006 2007 2008
Bangladesh 2 3 2 280 79 45 350 460 692 793 666 1086
India 118 129 1,964 2,319 3,403 3,449 5,474 5,335 6,598 20,336 25,127 41,554
Pakistan 105 249 719 305 385 823 534 1,118 2,183 4,273 5,590 5,438
Sri Lanka 30 31 56 175 82 242 229 233 272 480 603 752
Nepal 1 0 5 - 21 10 15 - 5 -7 6 1
Source: World Investment Report, 2009, 2006, 2003, 1998 & 1992
Southeast Asia witnessed tremendous boost in FDI with India
and China contributing the major inflows. Most South East
nations had moderate growth including Bangladesh but the
opening of foreign investment and removal of trade barriers
by India and China enabled both countries to have robust
growth. From the above comparative table, Bangladesh in
comparison to India and Pakistan, witnessed no such robust
growth. Rather, inflows declined in 2007 whereas India’s FDI
increased 23.6% and Pakistan’s 30.8% compared to 2006.
The flow of FDI to most developing countries is rapidly
increasing. FDI flows are important in both low-and middleincome
countries. Indeed, the average ratio of FD1 to GDP in
1997-1998 was almost the same in the two groups, 2.7% in
middle-income countries and 2.6% in low-income countries
as shown in the table 2. But the latter number reflects the
influence of China, the largest developing country recipient
of FDI. Excluding China, FDI equaled only 1% of lowincome
countries' GDP from 1997to1999 because of very low
level of FDI to South Asia (0.7% of GDP). On the contrary,
FDI to low income countries in Sub-Saharan was relatively
robust, just under 1.5% of GDP.
According to the World Investment Report, the flow of FDI
to Bangladesh stood at $6 million during 1998. The following
table # 2 shows a comparison about the amount of FDI
between Bangladesh and some major countries of the world.
Table # 2: FDI in Bangladesh and Some Major Countries Both Inside and Outside the SAARC Belt (Millions of dollars)
Country 1990-95 (Annual Average) 1996 2000 2005 2008
Bangladesh 6 14 280 692 1086
USA 40829 84455 300912 99443 316112
United Kingdom 17467 24434 116552 164530 96939
India 703 2525 2319 6598 41554
China 19360 40180 40772 72406 108312
Switzerland 2341 3079 16285 5795 17415
Japan 1144 228 8322 2775 24426
France 16293 21960 42930 63576 117510
Source: World Investment Report, 2009, 2006, 2002
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From the above table, FDI in Bangladesh substantially
increased during the period between 1996 and 2008. The
boom however was a minor growth in comparison to China,
US, and immediate neighbors India and Pakistan. Bangladesh
showed substantial improvement which was due to policy
liberalization towards foreign investment. Despite
liberalization in policy among South Asian countries, the
growth of investment rate in Bangladesh is not at a
satisfactory level. If anybody looks at the position in
Bangladesh with other selected Asian countries having
similar economic and demographic characteristics, it will be
evident in table # 3 that Bangladesh has received the smallest
amount of FDI.
Table # 3
FDI as a Percentage of GDP in Some Asian Countries
(Including three countries of the SAARC belt)
Country 1995 2000 2005 2007
Bangladesh 0 0.6 1.3 1
Singapore 13.7 17.8 11.6 15
India 0.6 0.8 0.8 2.2
Pakistan 1.2 0.4 2 3.7
Thailand 1.2 2.7 4.6 4.6
Source: Key Indicators for Asia and the Pacific 2009, Asian
Development Bank, WDI Indicators 2005
FDI in Bangladesh can be analyzed in relation to percentage
of GDP. Among SAARC countries (table#3) Pakistan has the
highest (3.7%), followed by India (2.2%) and Bangladesh
(1%).A fair portion of GDP in Singapore (15%) and in
Thailand (4.6%) is contributed by FDI, which in other words
demonstrate the high economic growth in those countries.
The Financial Express (a daily News Paper of Bangladesh),
dated 23rd May, 2010 presents the current status of FDI in
Bangladesh based on the report of Monira Munni. The
country’s foreign direct investment (FDI) inflow recorded a
63% fall in the first three quarters of current fiscal year owing
to global recession (as revealed by the Central Bank’s
monthly update). During July to March period of 2009-2010
fiscal year, the country received only US $ 288 million in FDI
against $782 million during the same period of 2008-2009
fiscal year (as shown by the Bangladesh Bank data). The data
indicates that the FDI flow drastically fell during the period
due to the global meltdown that had hit different countries
including Bangladesh. Besides, acute shortage of gas and
electricity in the country also contributed to cut FDI inflow to
a great extent. However, another official of Bangladesh Bank
expressed the hope that the FDI flow might rise in coming
months due to recovery of the major global economies.
Though the FDI fell in the latter nine months of 2009-2010
fiscal year, it has been increasing gradually since the first half
of the current fiscal year. However, experts are of the view
that the country’s infrastructure facilities, including gas and
electricity supply, are not favorable for domestic as well as
foreign investment. Unless the Government takes quick and
effective measures for infrastructure development and gas
exploration, there is little hope of increasing FDI in
Bangladesh in the near future (May 23, 2010:16). The current
status of FDI is now from another source. According to
(Reuters), Dhaka, Bangladesh's foreign direct investment
(FDI) halved to $297 million during the first half of the fiscal
year to end June 2010 because of global recession and
crippling shortages in local power supply. FDI was $603
million in the same period of the fiscal year of 2008/09.
Professor Mustafizur Rahman, an eminent economist and
Executive Director of the Centre for Policy Dialogue (CPD),
a leading think tank in the Private Sector said: "The flow of
the FDI drastically fell during the period due to recession
across the globe and also severe natural gas and electricity
shortages in Bangladesh". He told Reuters that the
government should initiate emergency measures to raise the
supply of natural gas and electricity, the lifeline for economic
activities. Bangladesh is currently facing shortages each day
up to 300 million cubic feet of gas and up to 1,500 megawatts
of electricity."The flow of FDI may increase in January after
adjustment of $300 million, invested by Bharti Airtel, that
acquired 70 percent stake of Warid Telecom". In this regard,
Professor Rahman added: "We are hopeful to see a reverse
picture in the second half of the current fiscal year as there
are indications to invest in the energy, power and telecom
sectors."
Section-VI
Factors Influencing the Inflows of FDI in Bangladesh
Developing nations have shown impressive success in
attracting FDI in recent years. Especially, Asian Countries
have strengthened their role as the largest amount of FDI
recipient region with an estimated $87 billion of inflows in
1997. The East and Southeast Asian Countries have attracted
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$82 billion in FDI in 1997 accounting for 21% of the total
world flows and 55% of total developing countries flows.
Bangladesh remains far away from the expected level of FDI
inflow, despite numerous incentives of the government to
foreign investors. Incentives, like 100% foreign ownership of
capital, opportunity for foreign investors to operate without
enlisting in the stock exchanges, no limit for remittance of
profits and dividends abroad, facility to dis-invest originally
invested capital at any time, no prescribed limits for
remittance of royalties and technical fees abroad by foreign
investors, are highly competitive with incentives offered by
many other developing countries to prospective foreign
investors.
Bangladesh with a population of more than 150 million offers
abundant potential for the marketing of consumer as well as
durable goods. Bangladesh has attracted a respectable amount
of FDI with the incentives in these two sectors. However, the
amount of FDI attracted in recent years compared to most
Southeast Asian countries indicates that the incentives and
other factors government offers are little bit successful.
Compared with Hong Kong, China, Malaysia, Thailand and
other Asian Countries, Bangladesh is not able to attract
sufficient amount of FDI in spite of having alluring
incentives, favorable geographical location and quite a large
population. This section attempts to investigate this query.
Most FDI problems in Bangladesh are primarily related to
social, political, economic and cultural spectrum. Over the
last twenty-five years, the government of Bangladesh has
offered quite a number of incentive packages and brought
about series of changes in the FDI policies and administrative
set-ups with a view to attracting more FDI. The cheap and
abundant labor coupled with liberal policies and incentive
packages was expected to help swell up the FDI inflow
substantially. However, available data on FDI influx reveal
that the FDI level yet has remained far below the desired
level.
Political unrest, bureaucratic tangles and corruption, poor and
fragile infrastructure, regular donation to political and nonpolitical
bodies are the most obvious factors that most people
blame for augmenting the total cost of the foreign investors
which results in least amount of FDI attraction. But there are
quite a large number of sunk and invisible hindrances, like
cost of unskilled labor, losses arising out of poor
infrastructure, contribution to local hoodlums under duress on
regular basis, that are far away from our range of vision. All
these contribute to raising the cost of foreign investment and
keeping the FDI far below the desired level. These overt and
covert obstacles diminish the labor cost advantages as well as
privileges provided by the governments through liberal
policies and alluring incentive packages.
Labor cost in Bangladesh is comparatively cheap than any
other country. Most labors in Bangladesh are unskilled and
their incidental costs sometimes become too much and too
numerous. The low productivity of unskilled labor sometimes
fades away the cost advantage of labor. Labor unrest and
political instability lead to frequent interruptions of working
days. Thus, the real cost of labor increases because of the loss
of paid hours.
But there are too many hidden costs that most people are
unaware of these. To install a new telephone/fax line, foreign
investors, have to pay a fixed amount of money to
telephone/fax authority and failing to pay this amount must
result in longer period of delay. Payment of this amount does
not ensure the better telephone/fax service. They have to
make monthly contributions to avoid fake telephone/fax bill
and to keep the telephone/fax in working conditions.
Likewise, to install new gas lines and to keep them in
working order, foreign investors have to continue the same
type of subscription. Failing to make this donation must result
in unnecessary delay and regular disruption in gas supply.
The episode with the Gas line in RPZ-Chittagong where one
designated engineer from Titus Gas did not show up in spite
of repeated requests was probably due to the lack of
understanding of the foreign investor to make personal
donations. Moreover, frequent power failure, fluctuating the
voltage of power, delay in installing power point, unnoticed
long time power failure, fictitious electric bill etc. directly
contribute to augmenting the cost of foreign investors.
To avoid the chaos and turmoil, and to ensure the peaceful
atmosphere in factory premises, foreign investors have to
make regular donations to keep local hooligans happy.
Frequent hartals, strikes, labor unrest hamper and sometimes
stop the flow of production, transportation, marketing and
other regular activities of the company. Consequently,
company usually fails to reach its production goal or
marketing goal or sales goal. Sometimes, export oriented
companies may lose foreign customers due to failure of
delivery of goods timely. This fact is truer in case of garment
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industry in Bangladesh. Apart from these costs, foreign
investors have to regularly pay tolls to the law enforcing
agencies and local administrations to have a minimum
guarantee of safety and security. Sometimes, theft, robbery
and some other types of mishaps also increase the total
amount of costs. All these types' hidden incidental costs
straightly outweigh the apparent cost advantage of labor in
Bangladesh. Therefore, investment in Bangladesh is
perceived less lucrative to the foreign investors.
The size and growth of the domestic economy is another
important determinant of foreign investment inflows. The
economic factors and parameters Bangladesh inherits are not
conducive to FDI attraction. The population of around 140
millions may apparently be large enough to make an
impressive market for consumer products. But the negligible
amount of per capita income (below $1500) does not create
any effective demand for most consumer goods. The amount
of domestic, which sometimes serves as a parameter to
attract FDI, investment is very low and thus, foreigners do
not get much interest in direct investment in Bangladesh.
The predicament of most roads and highways is miserable.
The country astoundingly lacks sufficient number of roads
and highways and they are not properly maintained and
repaired. Moreover, most roads are not wide enough for
different vehicles to freely move. All these factors spawn
horrendous traffic jam, delay in transportation and sometimes
deterioration of the quality of some products. Moreover, to
ensure the smooth/flow of raw materials and finished goods,
most investors have to pay tolls at different points of the
roads. These factors eventually lead to increase the overall
costs of foreign investors.
Since independence, Bangladesh has not yet achieved
desirable stability in its political arena. But political stability
is a crucial of factor determining the amount of FDI. At
present, the political environment is sharply partitioned into
two sections-ProAwamileague and AntiAwamileague.
Possible hartals and blockage, politically biased civil and
government administration, brittle law and order situation etc.
have reduced the confidence of the foreign investors.
Moreover, government policy drastically changes with the
changes of government. This discontinuity of government
policy coupled with the political instability induces the
foreign investors to shy away from investing in Bangladesh.
These days, foreign investors are quite likely to be afraid of
the prevalent hostile political atmosphere.
Existing cultural environment is not suitable for foreigners.
Language barrier, religion conservatism, and the lack of
western style or oriental style, recreation facilities, relatively
poor accommodation and broadcasting facilities all over the
country in general and the major cities in particular make it
quite difficult for foreign investors to stay in Bangladesh for a
prolonged period of time. Singapore, Malaysia. Indonesia and
Thailand have been successful to resolve some cultural
problems maintaining the traditional religious values as well
as providing some facilities like sufficient number of bars and
liquor shops, other recreational facilities at night etc. that
closely match their style. In this respect, people of
Bangladesh are far behind the people of these countries and
also Bangladesh lags behind FD1 attraction.
Apart from physical infrastructure, the development level of
social infrastructure is not at all up to the mark. A foreigner
can hardly manage and recruit expert technicians or expert
mid-level/top-level management personnel or expert/qualified
workers from Bangladeshi. Mostly they have to hire these
people from foreign countries at higher salaries. These higher
salaries eventually neutralize the cost advantages of labor.
Moreover, Bangladesh's labor laws are complicated and
overprotective which means discouraging for job creation,
inhibiting to business expansion, and frightening for
productive investment. Such labor laws have created
unnecessary labor disputes posing problems for management
and causing productivity losses, which have also discouraged
foreign investment. Lack of welcoming attitude in the offices
of immigration & customs department at airports, and other
related offices also discourage the foreign investors. Mostly,
the ancillary government agencies and officials seem to have
an indifferent and unsympathetic attitude towards foreign
investors. The opinion of a UN official, "Bangladesh is the
most difficult country in the world in which to get any
development work done" (Fry,1993), clearly indicates the
overall investment environment for the foreign investors.
However, the problems of FDI in Bangladesh are myriad and
multifarious--some are visible and some are invisible. But the
ultimate cost of invisible factors is no less than that of visible
factors. The steps hitherto taken by the government have not
been expectedly successful in attracting FDI because most of
them are primarily intended to remove visible problem factors
only. The area of hidden cost factors is so vast that
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researchers can further investigate these aspects of FDI.
However, it is worth giving equal emphasis on identifying
and solving visible as well as invisible problem factors to
attract more FDI. But it may be difficult to identify all the
hidden factors.
For empirical purpose, most important factors influencing
FDI inflows in Bangladesh have been considered. Data
limitation is one reason to drop some influencing factors in
empirical analysis. Here, dependent variable is Growth of
FDI (LFDIG), and independent variables are Interest
(LINTEREST)--an indication of marginal productivity of
foreign capital, ratio of domestic fixed investment
(LDINVEST) on GDP, ratio of total employed labor working
in manufacturing sector (LM LABOR), infrastructure
spending (LINFRA), percentage of education spending on
GNP (LHU) and ratio of export to GDP (OPEN). All
variables are in Log form.
Data were taken from World Development Indicators,
International Financial Service (IFS) and Bangladesh Board
of Investment (BOI) from 1980 to 2008. The single equation
is denoted as follows;
LFDIG = Constant + a1LINTEREST + a2LDINVEST +
a3LMLABOR +0.4LINFRA + a5LHUu + a6 0PEN + Error Term.
The result of the estimation is
Table # 4
Dependent Variable: Log of Fdi Growth (LFDIG)
JOINT LTNTEREST LDINVEST LMLABOR LINFRA LHU LOPEN
015.7 .38 .37 -.25 .45 .20 .19
(-1.84)** (2.92)*** (1.99)** (-1.96)** (2.72)*** (.80) (1.10)
R2-90.DW-2.63, Note: t values in parentheses, ** and *** are significant at 5% and 1% levels, respectively.
summarized in table # 4.
The above empirical results support that infrastructure,
domestic investment and interest are positively related (also
significant) with the inflow of FDI in Bangladesh. Whereas,
higher labor wage discourages (in labor as proxy of wage)
the inflow of FDI. Human capital (education is taken as
proxy), meaning (the quality of labor, has positive role, but
not significant. Openness is a positive sign, but not
significant. Empirical results are very much relevant with the
analysis of section two. The estimated results need to be
considered cautiously as the analysis failed to take many
other variable into consideration due to lack of data and this
is a single equation estimation.
Section-VII
Concluding Observations
Based on the foregoing discussion and analysis, it may be
stated that as Bangladesh has not yet been successful in
creating a favorable environment for attracting sufficient
amount of FDI, it is likely that dialing the flows of FDI will
remain at the bottom level. The country is lagging behind
most of the other regional developing nations in attracting
FDI. Therefore, all barriers that stand in the way of
industrialization and attracting FDI are required to be
overcome.
This empirical analysis suggests that infrastructure is number
one determining factor in attracting FDI. Poor infrastructure
and highly priced utilities in Bangladesh shy away foreign
investors from their investment. In every sector of
infrastructure, the availability of quality and reliable services
are vital factors in attracting FDI. Compared with other
developing countries that have huge FDI, Bangladesh is
highly deficient in providing infrastructural services. If
Bangladesh wants to catch up the Southeast Asian Countries
in terms of FDI attraction, it will have to invest more in the
areas of infrastructure and education.
Empirical analysis also shows that productivity and domestic
investment are important in attracting FDI. Therefore,
productivity enhancing steps like better training to
workforces, reducing X-inefficiency, ensuring better
management, and increasing domestic investments to the
sectors that have complementary relation with FDI should be
taken up. Long term policies are needed to implement the
above steps.
In general, deteriorating law and order situation is the number
one problem to attract FDI, although it is very difficult to
support it with statistical data. The news items on Bangladesh
as the most corrupt country (Transparency International
Report, 2001, 2002) in the world have worsened the
The Bangladesh Accountant/January- March 2010 88

Investment
investment situation in Bangladesh. Therefore, foreign
investors have every reason to shy away from investment
activities because of political instability and unsatisfactory
law and order, which offer them hardly good returns. Even
the presence of all positive macro economic indicators like
favorable fiscal and monetary policies, abundant supply of
labor, good infrastructure support etc. may not contribute to
attract foreign investment due to the singular problem posed
by deteriorating law and order situation. Therefore, it is the
duty of the political leadership to improve the law and order
situation especially in the major "growth poles" of the
country including Dhaka, Chittagong and Khulna. Proper
steps like the legislation of time-suiting laws and their proper
enactment with sincerity can improve the present situation
that will help in creating favorable investment climate.
Country's political leadership must take practical steps to
improve the macroeconomic stability, which plays a vital role
in accelerating economic growth and restoring foreign
investor's confidence in the economy. But as long as the law
and order situation remain in its present form, any persuasive
step or incentive system of the government will be of no
effective use.
Foreign investors confront different reality when they begin
to set up and operate their business activities in Bangladesh.
Even though the approval for investment requirement has
been removed, various permits, procedures and clearances
from different national, regional, and local level agencies are
still applied to foreign investors, causing unexpected delays
to complete the process. For the long-run economic benefits
of FDI in SAARC countries with particular reference to
Bangladesh, the following recommendations maybe given:
1. Policy makers should provide conducive and friendly
environment to foreign investors for attracting more FDI.
2. Foreign investors should be given more incentives for the
transfer of technology to the host country. This would
lubricate the local enterprises.
3. For SAARC countries, import-substitution policy related
FDI is likely to prove good. So, endeavor has to be made
in this direction.
4. Appropriate reform measures are needed in the countries’
administrative systems. The authorities should streamline
administrative procedures and easygoing formalities to
simplify their business activities.
5. SAARC countries need to move forward through
implementing investment-friendly policies, simplifying
regulatory practices, and removing inefficient
bureaucratic procedures.
6. The investment climate in the SAARC belt should be
improved through appropriate measures such as deregulation
in economic activities, increase domestic
serving, developing the port network, road network,
railways and telecommunications facilities etc., creating
more transparency in the trade policy and more flexible
labour markets and setting a suitable regulatory
framework and tariff structure.
7. The government must improve the law and order situation
of the country. Other political parties should also come
forward to cooperate with the government for improving
the country’s law and order situation which is the most
important consideration for the foreign investors to invest
in Bangladesh. Everyone should keep in mind that
“Rajniti” (i.e. “Politics”) does not mean “Rajar Niti”
(i.e. “King’s Policy”). “Rajniti” (i.e. “Politics”) means
“Nitir Raja”, i.e. “Shreshtha Niti” (i.e. “King among
Policies”, in other words, the kingly policy exclusively
meant for serving the people according to the
commitment given to them at the time of election). The
government and other political parties must rise above the
debilitating clutches of partisan politics and self-serving
activities. In accordance with the timeless proverb,
“Charity begins at home”, if all political parties can put
aside their differences and change themselves from
within in order to collectively serve the nation, only then
will they be able to most sincerely honor “Shreshtha
Niti”, and their activities should then quite naturally
be in tune with the innermost spirit of Abraham
Lincoln’s most prudently crafted address
“Government of the people, by the people, for the
people”. This will lead people from all quarters of life to
have the urge from the innermost core of their hearts to
honor law and order as well as to religiously serve the
nation, as a result of which the political situation is sure
to be calm and quiet, the economic condition is sure to
improve and, ultimately people’s welfare is sure to occur.
As a sequel, foreign investors will be attracted to invest in
the SAARC belt including Bangladesh in particular. The
government and all political parties including all the
members of the parliament in particular should, therefore,
The Bangladesh Accountant/January- March 2010 89

Investment
feel an urge from within to make all out efforts to
improve the law and order situation for the purpose of
attracting FDI in Bangladesh to promote economic
growth and development as well as alleviate poverty.
8. Country’s political leadership must take practical steps to
improve the macroeconomic stability, which plays a vital
role in accelerating economic growth and restoring
foreign investors’ confidence in the economy.
To conclude: FDI is more than an external resource inflow
and it can modernize industry and better integrate the
economy into international production. Keeping all that in the
foregoing in view, it may be stated that FDI acts as a major
stimulus to economic growth in developing countries
including SAARC belt in particular. Its ability to deal with
two major obstacles, namely, shortage of financial resources,
technology and skills has made it the centre of attention for
policy-makers in low-income countries in particular.
Only a few of these countries have been successful in
attracting significant FDI flows. To draw the ending line:
Bangladesh has tremendous potential for absorbing greater
flow of FDI in the days to come. Serious efforts are needed to
attract greater inflow of FDI in the country by taking several
steps both on policy and implementation fronts. In
recognition of the important role of FDI in the accelerated
economic growth and development of the country, the
Government of Bangladesh has to initiate a slew of economic
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Budget
Suggestions for Budget 2010/2011
Pertaining to Income Tax Aspects of NBR
Masih Malik Chowdhury FCA
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Bonus Shares/Stock Dividends reap large chunk of
unearned income for big ones. This augments the
persisting black economy but does not really add value
to mainstream economy in terms of Investments,
Savings & Employment. Upon dividend 10% or a higher
rate of tax deduction at source (TDS) should be applied
on Income of Bonus shares /Stock dividends on a final l
settlement basis.
Amount for Investment credit on tax can be increased
for higher tax payer as rewards for higher tax payments.
Tax payers from lower slabs can avail this if they have
paid 20% tax slab in past three years. Like wise
taxpayers who pay tax in the slab of @ Tk. 25% can
avail 40% of taxable income for investment to avail tax
credit / investment to result into higher savings scenario
and lower tax incidence.
Banks and FIs pay 42.5% tax on operational income.
However larger part of their income stems from capital
gain in Capital/Share market. Indeed they very lawfully
avail this tax relief from the investment of deposit in
capital market. A bank because of this tax avoidance
facility reduces the effective income tax rate to even
below 20% taking dividend, bonus shares & capital
gains together.
Stock dividends/ Bonus Shares are not taxed now under
the disguise of exemption Banks & Large Investments
are hugely profiting by Capital Gains from selling these
shares and sale of these are embargo free. The tax rate of
Banks & FI is 42.5%. These profit of those institutions
now mainly stem for Capital Gains and the effective rate
of tax is 20%. Moreover the Capital market has been
heated by this Capital Gain scope making micro level
investors to suffer. This needs immediate attention by
imposition of altleast 15% income tax on capital gains
and dividends from all investments in capital market
.Alternatively a comfortable rate of tax on capital gain
can be imposed along with fixed charge for each BO
Account should be imposed .
City congestion tax for all vehicles plying in capital &
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other divisional towns. Rate applicable in the capital
city should be higher than other metropolitan towns.
When the income tax returns are submitted u/s 82BB or
82C etc.the assessments are virtually completed. Instant
upon such submission TIN certificate & NO Tax
claim for the year should be delivered as a mandatory
service to Taxpayers by the tax office concerned.
Land sales instant upon submission for registration must
follow TIN certificate issuance by the receiving tax
office.
Likewise shopping mall- shop sales, PDB & Gas
connections can be required to take TIN.
Recognition of top 50 or 2% top tax payers of each
profession by naming them in media like Doctors,
Lawyers, Teachers, CAs, Engineers, Economists etc.
Likewise top 2% tax payers of classes of Tax Payers
such as Salary, HPI, Income tax business, Agricultural,
Interest on Securities and Capital Gain from other
sources should also be recognized.
Rejection of Accounts during IT assessments even
when Bank Accounts are furnished must be stopped
ASAP.
The Taxes Appellate Tribunal has been holding appeal
cases for many long years. These cases have been
resulted by unilateral exercise of discretionary powers of
Tax officials. These pending cases can be brought for
resolution under ADR.The intervention of NBR’s R & D
division can be a welcome means to raise revenue from
those hanged cases. Services for these can be outsourced
by NBR.
This would increase efficiency of Tribunals. Also the
Tribunals should be increasingly manned by more
professionals prone to justice to cater to the increased
and diversified nature of Taxpayers. The members also
need to deliver judgments honestly based on new
orientation for various businesses of Taxpayers. The
Tribunal should be truly quasi-judicial if not judicial.
To make a Broad based budget we should stress for New
TIN holders. Tax net needs to be continually widened
by new TIN holder’s enrollment in the TAX NET.
Author is Member Council-ICAB and Senior Partner, Masih Muhith Haque & Co., Chartered Accountants.
The Bangladesh Accountant/January- March 2010 93

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Budget
Commencement of R & D division NBR has long been
overdue. This will firstly bring in all circles under
computer/digital network. It should be manned by Tax
personnel of professional integrity and acumen who are
seldom available now. They more than anything should
be having knowledge to adopt digital transformation.
Reward and penalties should be simultaneously offered.
This will improve quality of assessment & reduce
sufferings of Taxpayers. Many new tax avenues would
also come under tax coverage every year.
Refunds of tax agreed as refund by DCTs in
assessments are lawful claims of Taxpayers from NBR.
For non-deposit of AIT by Bank into proper coded
account number, like Customs code instead of IT code,
both under NBR, tax Authority often declines Refund
claims. This is adverse for revenue collection while
going into litigation can also be a good option for the
deprived taxpayer. On the contrary commercialization of
Income Tax offices along with better client and
collector relationship should replace the current
bureaucratic procrastination practices.
During office hours for pretty long hours Taxpayers and
their representatives are held up outside the DCT’s
office in the plea of meeting of the DCTs. Most often
these meetings are ‘Personal’ level matters. Value of
tax payers’ time should be cognized by collectors in
order to give it a moral boost and commercial look.
The assessing offices should be more attentive to
Taxpayers interests.
Again DCTs are burdened with too many files. They can
not look into details of these files, they allege. This is
not a mere rhetoric but a reality. They also need more
extensive orientation of the tax laws along with moral
persuasive training and patriotism.
Automation, training& orientation for improved services
by tax offices to Taxpayers can boost up their efficacy
for revenue collection. these are crying needs of digital
Bangladesh.
Quite often DCTs on the basis of projection go for
increased income of the Taxpayers when actually raw
materials cost have gone high, imports duties and or cost
increased, production went down & many adversities in
business had taken place. They fail to show where the
projected income has been deposited. The DCTs do not
even posses some knowledge about the Taxpayers’
business notwithstanding which they resort to
projections. While doing so they do not bother to
sections 28,29,30 and 30A or alike of ITO 1984.
Tax Proposal for Finance Act-2011
◆ Bangladesh’s one of the major foreign currency earning
sector, readymade garments (RMG) has been enjoying
final settlement as per section 53BBBB of the Income
Tax Ordinance, 1984 with the deduction at source of
0.25% on export value. But there is a conflict arises with
the above mentioned final settlement section through the
SRO 205-Ain/Aikor/2005 dated 22 Ashar 1412/6 July
2005 which makes one condition that income will be
calculated based on deemed tax rates of 10% for these
institutions. Under this SRO, the tax officials takes the
decision that the RMG institutions make whichever
amount of profit, it will only be allowed to have net
profit prorating the tax at source to 100% tax deducted
at source @ 0.25%. One example can better explain the
situation as follows: A Company‘s Tk Export income is
Tk 1,00,00,000, AIT @ 0.25% and total Tk.25,000,
Net Profit- 10,00,000.
◆ On the calculation of final income, it has been practiced
by the Tax Authority that this company has paid AIT of
Tk 25,000 which should be treated as 10%. So, 100%
prorated income computes to Tk 2,50,000. This
contradicts the principle when this company has paid
AIT which should be treated as final settlement and
accordingly the total net profit of Tk 10,00,000 should
be allowable income and not Tk 2,50,000.
◆ Online Income Tax Return could be a respite for all
the taxpayers & should be opened up soon to avert
further deterioration in the revenue due to direct
relationship between Taxpayers & Assessing office. The
assessing offices are deprived from availing scopes of
larger revenue collections.
◆ From the point of import & AIT/ TDS
collections/deduction, trail of the payers should be
searched by R& D division of NBR.This would leave
ample scope for new revenue and check evasion at large.
◆ Circles/ offices of Revenue Collection should be
advised to motivate Taxpayers and not resort to
enforcement only as the collection of revenue is a
business. They need to be business friendly & service
oriented. They should serve but not cause sufferings to
Taxpayers.
◆ When Trade License is issued TIN can be
simultaneously issued getting a TIN often involves
hassles & office expenses. Measures for relieving them
from this vicious cycle should be urgently taken.
The Bangladesh Accountant/January- March 2010 94

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The Bangladesh Accountant/January- March 2010 95

Budget
Proposed new VAT Act Should be Judiciously Framed
to make Business Friendly Law
Akhter Zamil FCA
Finally the Govt. has understood the necessity of introduction
of a new business-friendly Value Added Tax Law to salvage
the business communities from the clutches of VAT officials
who used to impose VAT, interest on VAT amount, and
penalty over VAT outstanding frequently without considering
their own lapses in compliance to different sections of VAT
Act and VAT Rules from the view point of reality and
criticism from National and International communities. We,
welcome the move of the Govt. to remove all the illogical and
inconsistent provision of the VAT Act as well as its
applications. Thanks to IMF who has urged the Govt. to rewrite
the VAT Law to address the distortion and frequent
changes of law through circular, SRO etc.
Now, we highlight the Background of the introduction of
VAT Law in Bangladesh since 1991 and its misapplication by
the VAT officials creating injustice and hardship of the
Industrialists, Bankers, Suppliers, Business communities as a
whole. Such VAT Law has created panic in the minds of the
Business communities as well as to the ultimate consumers of
the goods and services. It is true, VAT is being charged at
every steps of the products till its final use and at every stage
the producer, wholesalers, retailers get recovery of VAT but,
the burden of cost (increase from stage to stage) falls upon
the end users due to rise in final product value through
different hands.
The introduction of VAT started as back as in 1921 when F.
Von Simons proposed Value Added Tax as a substitute in
place of German Turnover Tax. France as early as in the year
1954 introduced VAT in a limited way. VAT therefore
became one of the most fiscal innovations of the last century.
But now it is being practiced by over 150 countries all over
the World including Bangladesh. VAT was introduced in
Bangladesh in the year 1991 by enacting Value Added Tax
Act 1991 despite severe opposition from the business
communities. VAT is Collected at each stage of production,
processes, changes in productions and trading i. e. multipoint
tax running through different stages of production and trade
but levied in such a manner that the value addition in each
stage is taxed only once in order that there is no ‘cascading’
or ‘tax on tax’ effect and burden to the end consumer is no
more than what is intended by the prescribed rate of tax.
Before introduction of Value Added Tax in our country, the
business communities did not have the idea of its
complications in use and were totally ignorant of the scheme.
Some business Associations were also not fully aware of the
application effect that may arise while the VAT laws is in
practice. On the other hand, such law was introduced under
the pressure of the donor countries due to which, the law
framing authority, hurriedly, prepared such Act with very
confusing and difficult provisions to practice by the
manufacturer, producer, service Renderers and business
communities. Business communities had no knowledge about
the new law earlier as they were accustomed to sales Tax,
Excise duties, Customs duties etc., then prevalent in the
country. The rate of VAT was determined by the Govt.
without sufficient discussions about its implication and were
beyond the knowledge of Business communities. The
growing success of VAT found it’s way to be an effective
tool for mobilization of Revenue. It encourages the govt. to
enact the law accordingly without considering the structure
required for the collection
of VAT. Officials engaged for the job were inexperienced and
ineffective in handling the operation of the VAT law. After
pursuing the policy related to VAT, the Govt. is still in a
nascent condition and misapplication of law in different
stages have created a panicky situation amongst the
consumers, producers, manufacturers, service renderers and
wholesalers. Also the VAT machinery was in a fix and
continually issued SRO, circular, office order to mitigate the
problems but of no avail of the desired success till date.
The concerned officials engaged for the implementation of
the Act are playing a role of villain. Their activities appear to
Author is senior audit and tax partner, Howladar Yunus & Co., Chartered Accountants.
The Bangladesh Accountant/January- March 2010 96

Budget
be not in line with law and business communities are
suffering a lot in their way of doing business in the country.
Every stage of the procurement to production and
distribution, the concerned VAT officials are interfering
undesirably. Every point of provisions as incorporated in the
Act is full of controversy, indistinctness, and ambiguity while
practicing in the field of business, industries, Banks, and in
the different nature of business and services. Now, it becomes
a necessity to re-write the law considering the perspective of
the nature of business being carried through out Bangladesh.
The size of the business, industries need also to be considered
for application of such law. It is also to be considered about
the locality where such business are being carried out. The
application of rate of VAT for Dhaka, Chittagong, Khulna,
Rajshahi can not be same in consideration of the capacity of
the target consumers. Here we can refer the case of large
countries like U. K., India , Canada etc. where the VAT Act
has been enacted on regional basis under different name like
MOD VAT, CEN VAT , etc. Similarly rate of VAT has also
been considered for different types of consumers of each
regions.
As such, we should keep in our mind all the conditions
prevalent in our country and also the capacity of the
consumers to pay VAT while buying final products. The rate
of VAT for each product is to be seriously considered with
reference to its utility and necessity of the consumers. Food
items, and Medical items cannot be compared with that of
luxury goods. Therefore, present truncated rates and flat rates
on items basis should be considered and it will not be proper
to withdraw such rates rather the rate of 15% as value
addition need to be reconsidered at a reduced rate so as to
enable the people to pay VAT spontaneously and avoid
evasion of VAT.
Now, we would like to put forward a request to the committee
to be formed to consider the following proposal in the best
interest of collection of revenue for the Govt. to make the law
hassle-free, transparent, and accountable to follow if in its
true perspectives. As a Tax and VAT practitioners what we
notice is that a lot of ambiguity, indistinctness and twisted
ideas are incorporated in Sections and Rules in the present
VAT Act. VAT officials are using those sections and subsections
of the VAT Act according to their sweet will and are
charging VAT over the business communities, Banks,
Professionals, Traders abruptly creating disputes in the
collection of VAT leading to appeal to Appellate Forum,
Tribunal and Honourable High Court and Supreme Court by
the registered “Persons” as defined in the VAT Act.
As we feel all these impediments in collecting VAT should be
removed. Attitudes of the VAT officials towards “persons”
should be much friendlier and cooperative. There are some
sections in the present VAT Act which is very much
prejudicial to the collection of Revenue. In every action, the
VAT officials termed “persons” as evader, dogger of VAT
etc. and impose VAT indiscriminately without applying
judicial mind and exact point of law. Some times, it is found
that huge tax demand was imposed arbitrarily in the name of
evasion upon the “person” with a warning to pay the demand
within the specified time, failing which interest, penalty are
charged of course, after inviting the “person” to appear before
a mock hearing session. Although the person attending the
hearing, explain about misapplication of law and wrong
computation of VAT by VAT officials, the authorized officer,
ignoring the arguments put forward by the “person” imposed
penalty without showing any reasons for such actions. The
amount of penalty is also so high that a “person” cannot even
think to earn even in 10 years of business. This is done
because there are arbitrary sections in the VAT Act to
accommodate unjustified award of those VAT officials for
such collections.
These actions are simply against the principle of natural
justice. Very recently, the VAT authority has collected
enormous VAT from banking sector after expiry of time
limit although collection of VAT has the time limitations.
Even the state owned Banks and private banks had paid the
outstanding VAT under threat from the VAT authority.
Despite payment of VAT by the banks, the VAT authority
illegally imposed interest @ 24% per year at the discretion of
the VAT officials and penalty despite the fact that claims of
outstanding VAT was paid by the banks. Files related to VAT
of Banking sector may be verified to find the correctness of
the fact.
This sort of unjust claim of VAT is being imposed on the
concerned “person” by the VAT authority which can be
compared with that of the action of the mobile Court for
instant collection of VAT, fines etc.
Removal of the arbitrary, controversial, contradictory sections
included in the present VAT Act has become the necessity of
the time by incorporation of new suitable law
The Bangladesh Accountant/January- March 2010 97

Budget
commensurating the needs of the business comunities as a
whole. As such a new dimension of the value added Tax may
be found in the business sector to ensure easy collection of
VAT by Govt.
In context of the above discussion, we may now submit the
followingproposals for the purpose of enacting a new VAT
Law which will be a business friendlier Act.
1. (a) If possible, separate VAT Act should be introduced for
each of traders, manufacturers, wholesalers, retailers etc.
(b) Another Act may be enacted for suppliers, contractors,
services providers as service Tax Act.
It will be an independent Act for two purposes and no
confusion and contradictions will appear in those Acts.
2. Present VAT Act contains different sections of Excise Act,
Income Tax Act, Customs Act, Law of Civil procedures, and
Criminal procedures, Salt Act etc. This has made the present
VAT Act indistinct, ambiguous, contradictory in application
in practice. The relevant sections of the proposed acts may be
identical, independent being separate, distinct and simple for
easy use of the same by the “person” concerned with out
referring to the other Acts.
3. The present sections, sub-sections in the VAT Act 1991
needs to be suitably rewritten so that none should have
(persons and VAT machinery) any scope to twist it for their
own interest relating to VAT.
4. Present Sections, sub-sections which need to be rewritten
are as under for the reasons stated in the following
paragraphs.
So far, VAT Act and VAT Rules 1991 are concerned, its
relevant sections, sub-sections appear to be very clumsy,
complicated, and indistinct in using by the VAT Payers as
per requirement of the VAT authority.
In order to remove those impediments the Govt. may take
proper steps to avoid all sorts of ambiguity, confusion and
contradiction and make the Act Business friendly for the
purpose of speedy revenue collection.
Proposed amendments needed in the definition, sections, subsection,
Rules etc. are as under:
1. The entire existing VAT Act & Rules may be withdrawn
along with the SRO. Circulars, Govt. orders so far issued and
as found relatively difficult, indistinct, ambiguous, and
contradictory (already proposed by IMF).
2. Section-2:-Definations
“Total Receipt” – The present definition of ‘Total Receipts’
is found to be insufficient and meant for Service Renderer
only whose income including commission received or
receivable are subject to Tax. In fact VAT authority has been
charging VAT grossly on receipts wherein VAT amount is
also included. But this appears to be unjust and inconsistent
with the VAT law. Actually total receipts for VAT purpose
should be considered only in respect of the amount excluding
VAT and not on the gross receipts inclusive of VAT. Capital
receipts and expenditure should be excluded from the net of
VAT.
BASE VALUE: Base value for charging VAT on different
items of goods or services payable by Registered persons
needs to be defined for easy calculation of VAT for
Manufacturer Producer, Suppliers and Services
Renderer/provider clearly and distinctly to avoid disputes
leading to court cases.
3. Section-2(t) ‘Person’
The term “person” has been narrowly defined and is not
easily understandable as to by whom VAT is payable. It
should be broadly defined to include, individual, firm, HUDF,
local authority, AOP, company, artificial juridical persons
who are engaged in supply, trade, service renderer/ provider,
producer, manufacturer, importer, exporter, and trader of any
commercial item of goods (in special cases, items may be
excluded) and the persons by whom VAT is payable as per
VAT Act.
4. Section-3
Imposition of VAT– All items of income and expenditure to
be considered for VAT should be specified clearly and
distinctly and to be listed under a separate schedule for the
easy understanding of the “Person” like the present schedule
of exempted goods/services of VAT.
5. Section-4
Application of Tax Rates
It has been experienced that VAT payers find it difficult to
apply the rate of VAT for the manufacturer of goods, supplier
of goods and services provider/renderer on the items to be
considered for application of rate of VAT. Existing circular
do not appear to be sufficient for the business community.
There are several rates incorporated in existing VAT Act-
Flat Rate of 15%, Truncated rates ranging from 1.5% to 15%,
Fixed VAT for small retailer, traders, and others by using
The Bangladesh Accountant/January- March 2010 98

Budget
gross sale price divisible by VAT factor 15/115, 7.666, 3/23
etc. for the different categories of VAT payers. In the absence
of any specific items on which VAT rates are applicable, it
has made the things difficult for the VAT Payers and the
Regulators of VAT. It stimulates the VAT authority to apply
the rates indiscriminately and consequently VAT demand
become disputed leading to Court cases. This situation should
be removed as quickly as possible.
6. Section-5: Ascertaining/ for determination of Base
value & VAT
Under this section, several conditions have been fixed for
different categories of VAT payable by importer, producer,
manufacture, suppliers, service providers/ and requires for
determination of base value for VAT application on the items,
Section 25, 25A, 30 of the Customs Act, 1959 (IV of 1969)
are applicable for import of goods by importer, producer and
manufacturers, suppliers and they are required to compute
their base value of the goods on the basis of purchase cost
plus all other expenses (excluding VAT but including profit
etc.) while producer is required to follow instruction to be
issued by the Govt. from time to time for products of goods
on contract basis. In some cases, prior approval is to be taken
from Govt. subject to payment of VAT in advances for
computation of Base value of VAT. In case of Retailer, VAT
is to be considered as per Govt. notification etc. For the
service provider/renderer, the base for application of VAT is
to be fixed through Govt. notification. Base for VAT in case
of suppliers should be considered excluding Trade Discount
allowed to end consumers. In some cases, Govt. is required to
decide tariff value of the goods on which VAT is applicable
for service providers.
If the VAT payers are required to go through all these
formalities/procedures, it will be a gigantic exercise to be
undertaken by them.
Conditions to be complied with by a trader for Base value of
its goods/services should be simple, identifiable, distinct, and
clear for easy determination of Base Value.
Section 5 and Section-7 {Rule-3(1) & 3(2)}
Under this Section and Rules “registered person” are required
to submit declaration under Mushak-1 to the VAT authority
prior to marketing of their goods. It has been noticed that
producer, manufacturer has the tendency of showing
significantly low value of goods to avoid more value addition
tax. This tendency may be avoided if rate of value addition
tax is reduced corresponding to higher base value by
introducing a graduated scale of rate of VAT keeping in mind
that in no case Govt. should loose revenue in any manner i.e.
higher the base value lower the rate of VAT. This system may
help the registered person to avoid unreasonable formalities
with the VAT authority in case of any changes in the price
declaration at any time during the year under consideration.
7. Section-6: Time & Mode of Payment of VAT
This section is related to time and mode of payment of VAT
on imported goods, supplementary duty in a manner as
prescribed in Customs Act, 1925, VAT is payable on goods
manufacturered or produced for carrying out business,
imported goods or goods acquired or procured in any manner
by the registered person when goods are delivered or supplied
or, when challan patra relating to goods are supplied or when,
goods are consumed personally and for other persons when
full or part payment is made.
Similarly, when taxable service is rendered by a registered
person, VAT is payable when the service is rendered, challan
patra is issued (invoice) or when part and full payment is
received.
But such system is restricted and depends on the instruction
of the Govt. to be given from time to time on any goods or
class of goods or services including supplementary duty.
It is confusing for a business person and service providers
who could not collect information for charging VAT so
quickly.
Section 4, 4aa relating to collection/deduction of VAT at
source remain beyond the knowledge of the business
communities in certain cases. Provision made for services to
foreign aided project is another example of confusion. Details
of the VAT payer and its nature of business such as
Registration No., value of commission paid, base value for
VAT, amount of VAT collected or deducted, other
information as required under the rules, are not so easy to
collect.
4C is related to the obligation of the service renderer
regarding collection of VAT and its deposits.
4 (i) This clause is very much detrimental to the interest of
the service renderer 2% (two percent) interest per month i. e.
24% in a year has been proposed to charge against the
registered person in case of any failure in collecting VAT. No
time limit for charging interest has been fixed. Such interest
should not be charged from the date of transaction rather it
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should be charged from the date of short fall of VAT, if any,
detected by the VAT authority until the VAT is paid under
Section 4(ii). But in no case period of charging interest,
should exceed one year considering the return u/s 35 and 36
are filed by the person. Under section 36, the VAT authority
is required to examine the return and inform the registered
person about the correctness of the Return and shortfall of
VAT, if any be paid within the days to be fixed by the VAT
officials of the next following month. There should not be
any question of penalty for shortfall amount due to
negligence of VAT officials for their failure to detect the
shortfall and to notify the persons in time.
8. Section-7: Levy of supplementary duty- It requires a
complete list of items available to every persons. Any
inclusion and exclusion of any items be incorporated in the
Finance Ordinance relating to VAT so as to avoid confusion
in charging such duty on specific items.
9. Section-9: Tax Rebate- This area is full of controversy and
instigate litigations. The persons concerned should be
properly notified to avail this benefit. The list of items on
which tax rebate is allowable should be clearly and distinctly
mentioned with rate of rebate. There should not be any
confusion and disputes and there should not be any chance for
the corrupt officials to take the advantage. Tax rebate once
considered should not be reclaimable by the office unless any
fraudulent activities are found to be committed by the
persons. The relevant officers who allowed such rebate be
punished. Items which are not eligible for Tax rebate may be
listed specifically. In the past, we observed that most of the
litigation were created for Tax Rebate. The rate of Tax rebate
and base value are to be distinctly mentioned and related
documents needed to be furnished.
10. Section-13: Duty Drawback on imports used for
Production,
Manufacture and Exported goods.
At present duty drawback is considered for the goods which
are exportable and whose inputs are subject to Tax, VAT, SD.
etc. on the basis of Customs Act. In this respect, direct law
needs to be framed and included in the VAT Act to avoid any
confusion. Time for availing such benefit may be one year
from the date of export considering the time lag for export
from the country which involves various formalities by the
custom authority.
11. Section-14: Exemption:
Under this head, the Government by notification in the
official Gazette has exempted some goods or class of goods
or rendering of services. But no provision has been made in
the Act to waive/exempt interest, penalty charged by the VAT
officials arbitrarily and unlawfully over the “persons” for no
fault of them. The exclusive, discretionary power should not
be given to the Commissioner rather the Commissioner may
refer the matter to the Board for due consideration. Powers
under section 21 may be amended to suit the situation.
12. Section 35, 36 & Rule 25:- VAT disputes are mainly
due to misapplication of VAT Law.
These section relates to submission of VAT Return (Mushak-
19) and examination of such return by the VAT officials
fixing the time limit for 7 days for examination of return by
VAT officials. To the contrary if any defects in the return is
found resulting in shortfall of payment of VAT, the officer
concerned is required to issues notice on the person to pay
the unpaid VAT, SD etc. within the 7 days of the receipt of
the order (Rule 25 allowed 60 days for inspection and
examination of “Return” it is ridiculous to apply such law).
Recently, the VAT authority under the mischief of the section
36, has forced the “persons” under Bank sector to pay huge
amount of unlawful demand of VAT, interest on outstanding
VAT and also penalty varying from 10 crores taka to 100
crores taka in total disregard of the relevant laws. One
Commissioner of VAT denied the section 36 stating that
those sections 35 and 36 are not relevant in the matter of
VAT demand from the defaulting persons. Even he claimed
such VAT even after lapse of a considerable time. He also
charged VAT indiscriminately without giving a reasonable
opportunity to the person of being heard. In some cases, he
called for a hearing but without considering the facts
arbitrarily imposed Penalty for a questionable amount
although the person paid the outstanding VAT instantly on
demand by the VAT authority. Before, inflicting such VAT
the Commissioner should think that this abrupt practice falls
under law of estoppels by waiver and acquiescence under the
code of civil procedures as adopted in VAT Act also.
Therefore, we are of the opinion, that although time limit for
submission of “Return” (under Mushak-19) has been fixed for
each tax period within 10 (Ten) working days of the next
month after Tax period there must be provision in law for
submission of “final return” after year end with adjustment, if
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Budget
any, within a specified time on the basis of final audited
accounts in line with Income Tax Return. The practice of
submission monthly Return may be continued and at the same
time a “Final Return” for a particular year on the basis of
Audited Balance Sheet of the Enterprise may be allowed for
submission with the VAT authority along with the payment
of the admitted VAT liability by the Registered persons
within a specified date (the date may be counted from the
date of submission of Balance Sheet by the auditors). It may
help the VAT authority to avoid maximum disputes leading
to court cases in absence of adequate VAT officers and staff
and to avoid examination of Return u/s 36.
In this situation, we are of the opinion, that if any shortfall
amount (to be agreed by both the persons and VAT officials),
is paid within the time limit should not be brought under the
bracket of interest and penalty except in the case of evasion.
13. Section-37: Offences and Penalties
This section provides for charging penalty over a person in
case of any VAT evasion by a Tax Payer. It contains four
sub-sections of which sub-sections 1 and 2 are sub-divided
into as many as 20 clauses describing the nature of offences
liable for penalty. It includes the minimum penalty of Tk.
5,000/- but not more than Tk. 50,000/-, 25% or more than
75% of the outstanding VAT. Imprisonment for minimum 3
months and not more than 2 years, Fine less than 25% and not
more than 75% of the VAT amount and supplementary duty,
Additional Tax @ 2% per month on the unpaid tax. Business
premises may be put under lock and key for different nature
of irregularities and evasion of VAT by the VAT authority.
If this nature of penalty is imposed to a business person he
shall have no alternative but to close down his business. No
doubt, in case of evasion of VAT such section may be
applicable. But submission of return, compliance of orders,
payment of VAT within time limit should be considered
outside the above section. Shortfall of VAT payment cannot
be termed as “evasion” when the person filed return regularly
without any objection from the VAT authority for a
considerable time. So a fair and reasonable law should be
enacted to avoid defaming the business communities as a
whole.
The power to impose penalty by the empowered officer
should be curtailed suitably and if required the case for
penalty may be referred to Board for assessing the nature of
offence and proper decision in the matter.
14. Section-42 Appeal
If a person, being aggrieved or dissatisfied with the order of
the Commissioner of VAT may appeal to the Appellate
Tribunal for VAT to be framed in line with Taxes Appellate
Tribunal but it should not be not under the Customs Act,
section (196k).
On the other hand, if a person being aggrieved and
dissatisfied with the order of the Additional Commissioner or
any VAT officer subordinate to him to the Commissioner of
VAT (Appeal) in line with the case by Commissioner of
Taxes (Appeal).
If any person intends to prefer an appeal against a decision or
order relating to VAT payable on goods or services, he
should be allowed to appeal-
To Commissioner of Appeal without any payment.
To Appellate Tribunal by payment of 10% of the Tax
demanded or the monetary fine, imposed.
Appeal should be disposed off in accordance with VAT Act
and not under Custom Act. So, independent section needs to
be incorporated in the VAT Act without referring the
Customs Act.
15. Section-46: Appearances by authorized
Representative and VAT Consultant-
The appearance in the VAT Appellate Tribunal is restricted
for a person who does not have the “license” obtained u/s
196K of the Customs Act. This condition should be removed
and any person having professional qualification like FCA,
FCMA, LLB, lawyer etc. may be allowed to appear in the
Tribunal to contest any case on behalf of their clients. It is
commonly seen that retired Customs and VAT officers are
allowed to appear before the Tribunal frequently having no
requisite professional qualifications and looking after the
interest of the vested quarters, while tax authority has been
allowing every person having I. T. P. registration with the
NBR. There should not be any discrimination of class of
people, professional and non-professional for the VAT
purpose.
16. Section-55: To realize unpaid or short paid VAT and
other duties and Taxes
Under this section, VAT officials are empowered to collect
outstanding VAT, short paid VAT and other duties and
Taxes. Here a VAT official has been given freehand right and
pursuit of own whims to recover VAT, Duties, Taxes even if
benefits are given earlier to a person erroneously or
inadvertently including wrong interpretation of the law. Any
refund, repayment, drawback, adjustment of VAT may be
called back from person within 3 years from the date on
which such duty, taxes is payable. But this gesture is not
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Budget
allowed to a person to claim on the said matters within 3
years. As an example, we may quote that demand of short
paid VAT was made by the VAT authority in the year 2009
for the year 2004, 2005 and 2006.
The year 2004, 2005 are apparently beyond the period of
stipulated 3 years. VAT Commissioner on the other hand
having receipt of the short paid VAT, imposed interest from
the date of VAT due to the year of demand lodged and
monetary penalty at a highest amount but ignored totally
section 36, under which it is stipulated that “Return” to be
examined by VAT officials and to inform person within 7
days of the receipt of the Return directing payment of
outstanding VAT. In that case, a person could avoid short
payment of VAT, interest, monetary penalty in the year of
detection in place of claim of VAT subsequently, which
attracted huge amount in the form VAT, interest and penalty.
In this respect, section 35 and 36 may continue and person
should pay his due VAT accordingly. Any shortfall if
detected after finalization of Balance Sheet for a particular
year, the person may be allowed to pay its due VAT, when he
found the shortfall if any within one month from the date of
finalization of the audit of accounts and in that case no
interest, penalty, fine, shall be payable by the person in order
to make the procedure rational and for the avoidance of
litigation.
It is worth mentioning that VAT officials claimed their
shortfall amount of VAT on the basis of Balance
Sheet/Annual Report of a ‘persons’ after lapse of few years.
17. Section-56: Recovery of Govt. Duties:
This section needs to be rectified and fresh section need to be
introduced. It has been experienced while dealing with the
subject. VAT officials off and on charged VAT on items
which were made zero based in case of tax, and items which
were not in the list of imposable VAT, particularly exportable
goods, recovery of expenses from clients/customers
considered as receipt. All these, factors made the demand of
VAT arbitrary, and disputed. Some times VAT authority
collect VAT without the base value of VAT although no
further disputes remain outstanding against the person. But
local audit of Govt. again raise question about the base value
of VAT and the amount of VAT paid. Such demand are made
long after the approval of the Balance Sheet by the
shareholders in the AGM. It becomes a painstaking issue and
persons fall into a deep trouble to locate such amount from
the records dispatched to godown for its maintenance. After
finalization of VAT by the VAT authority, the issue should
not be raised again and if any explanation is required it
should be given by the VAT authority who finalized the
shortfall being fully satisfied and in full agreement with the
Registered person.
It will be better if shortfall amount of VAT demand is
determined after completion of due discussion between the
Directorate of local and Revenue Audit by the Commercial
Audit and VAT authority which may stop help the
harassment of the “person”.
18. Section-67-Refund:
VAT, SD, if paid in excess or overpaid through inadvertence,
error, misinterpretation of SRO, circular, statute or any other
reasons may be refunded within one year from the date of
detection of such error or excess payment or disposal of an
appeal by the Appellate Tribunal, Honourable High Court,
Supreme Court.
19. Section-77AA: Reward for unearthing of Tax evasion,
Law violation etc.
This section is being misused by the VAT officials by
dragging persons for payment of unrealizable and unlawful
demand of VAT. Laws are being twisted by the VAT officials
for frequent charges of interest and in the name of hearing
fines and penalty are being imposed unilaterally by showing
mock hearing mainly just to have the financial reward. The
word “Evasion” is being misused to inflict VAT, Tax penalty
etc. in their own way by the VAT officials.
Interpretation of legal words should be carefully defined so
that an innocent person can not be unnecessarily punished. Of
course, there are some persons who indulges in irregular
practice inconvenience with the VAT officials. Either this
practice should to be stopped or for the interest of the revenue
collection both persons and VAT officials should be equally
rewarded so that none have monopoly over the reward, rate of
reward should also be fixed considering the nature of offence
and be paid after finalization of the case through VAT
authority, Appellate Tribunal and Honourable Courts of the
country.
In the concluding para, we would like to add that all other
relevant laws included in the VAT Act quoting from Salt
Excise Act, Custom Act, Income Tax Act, Sales Tax
Ordinance, Gift Tax Act, Wealth Tax Act, Code of Civil
procedures 1908, penal code 1860, code of criminal
procedure 1896 should be incorporated independently without
referring to said Acts in the sections of VAT Act so that
persons liable to VAT may not be confused in paying their
VAT legitimately due by them.
n
The Bangladesh Accountant/January- March 2010 102

Information Technology
Using Radio Frequency Identification (RFID) Technology
to Improve Supply Chain Efficiency
Mohammed Abu Jahed
and
Mohammad Monoar Hossain
Abstract
Radio-frequency identification (RFID) is an old technology
that has recently generated enormous amount of interest in
the supply chain arena and it continues to evolve as a major
technology for tracking goods and assets around the world.
The use of RFID technology is impacting retail distribution
and supply chain to be more effective and efficient by having
real time, reliable and accurate information. This technology
replaces printed barcodes with electronic tags that can
discretely identify individual items and can be automatically
tracked as they move through the supply chain. By helping
companies observe and understand the movement of
inventory in real-time, RFID will reduce instances of out-ofstocks
and un-saleable product, reduce shrinkage and
product loss due to theft and dramatically reduce the cost and
manpower affiliated with moving and monitoring inventory.
This article makes an attempt to analyze how using of RFID
technology helps improve supply chain management. It
discusses the basics RFID technology, advantages of using
RFID technology in an ERP System, RFID security and its
range and the shortfalls of bar coding systems. Moreover, it
explores the factors that drive the adoption of RFID
technology in today’s environment.
Keywords: RFID Technology, Inventory Management
system, Supply Chain, SAP.
Introduction
Radio frequency identification technology provides a wireless
means of communication between objects and readers. It
makes use of small tags placed on the body of products.
When a small transmitter is passed through an RFID Reader it
will record the transaction, whether that is a product removal,
a product placement/put away, transfer or delivery. Unlike
bar codes, RFID has the ability to identity and track products
and equipment in real-time without contact or line-of-sight.
Some experts claim that with this technology inventories will
be 100 percent accurate. This hype of inventory accuracy is
similar to the one when bar coding first came in place.
Although it is true that RFID will improve inventory count,
all systems have weaknesses. However, statistical data
suggests that RFID has drastically cut down costs. For
instance, according to TIBCO (2004), a leading industry
specialist in RFID integration and implementation, British
brewery Scottish and Newcastle saves $25 million annually
by placing RFID tags on their high-value beer kegs. After a
three-month pilot program, The Gap, Inc. reported that RFID
tagging improved in store inventory accuracy from 85 percent
to 99.9 percent (TIBCO, 2004).
Objectives of the Study
In this study, an attempt has been made to how using of RFID
technology helps improve supply chain efficiency. However,
the specific objectives of the study are set forth as below:
a. To define the basics of RFID technology;
b. To explore the factors driving the application of the
technology in an ERP environment;
c. To evaluate its current application in supply chain;
d. To draw implications of RFID technology for
Bangladesh.
Methodology of the Study
In light of the objectives of the study, the paper has been
designed to investigate how using of RFID technology helps
improve supply chain efficiency. To this end an extensive
literature survey has been conducted. The study is based
largely on secondary data. Data and information from
Authors are Associate Professor, Department of Management Studies, University of Chittagong, Chittagong.
The Bangladesh Accountant/January-March 2010 103

Information Technology
secondary sources were collected by reviewing different
published articles, online journals, working papers, existing
case studies and websites.
Supply Chain and RFID Technology
A typical supply chain consists of supplier, manufacturer,
distributor, retailer, and customer. There could be multiple
tiers of suppliers, manufacturers, and distributors. As
materials move from the initial supplier in the chain to the
end-customer, value and costs are added at each node. As it
gets closer to the retailer, the supply chain becomes more
complex, with different products sourced from many different
business partners (Bose and Pal, 2005); a retailer like Wal-
Mart sells thousands of products sourced from thousands of
direct suppliers.
RFID is a form of automated identification (Auto ID) has
been in existence since the 1950’s and two decades ago they
were introduced as the ultimate replacement for bar codes
(Stone et al, n.d.). It is a low cost way to keep track of items
as they move through the supply chain. Unlike bar codes it
offers the possibility of reading, writing, transmitting, and
storing and updating information. According to WAKE, Inc.
(2003), RFID tags can hold up to 32 mega bytes of
information making them more difficult to counterfeit than
bar codes, and the data on existing tags can always be
changed or updated. In RFID systems, an item is tagged with
a tiny silicon chip and an antenna; the chip plus antenna
(together called a “tag”) can then be scanned by mobile or
stationary readers, using radio waves (the “RF”). The chip
can be encoded with a unique identifier, allowing tagged
items to be individually identified by a reader (the “ID”).
RFID proponents believe that the ability of these systems to
deliver precise and accurate data about tagged items will
improve efficiency and bring other benefits to businesses and
consumers alike. Retailers are very interested in turning the
supply chain management industry into an RFID dependent
business as long as it is cost efficient. One major retailer has
already announced a mandate for its largest suppliers to begin
tagging cases and pallets of merchandise. Other companies in
the U.S. and abroad reportedly are exploring similar
directives (Emigh, 2004).
Fig 1: RFID System Components
RFID and its Security
It is very difficult to hack into radio frequency identification
chips. Unlike bar code, which is merely a font, a hacker
would need specialized knowledge of wireless engineering,
encoding algorithms and encryption techniques to counterfeit
a frequency code (Pang, 2004). Moreover, different levels of
security can be applied to data on the tag, so information
could be readable at some points of the supply chain but not
others. RFID is very valuable as an authentication technology
as well as an identification technology, and some consumer
goods manufacturers are embedding it into their products to
fight counterfeiting and diversion.
The Bangladesh Accountant/January-March 2010 104

Information Technology
RFID And its Range
The distance from which a reader of radio frequency can read
the tag in order to read the information from its computer
chip is called the read range. This distance varies from a few
centimeters to tens of meters, depending on the frequency
used, power output, whether a tag is active or passive, and the
directional sensitivity of the antenna (Pang, 2004). The
presence of metals or liquids can also affect the range and the
read performance because these materials may cause
interference.
Advantages of RFID in an ERP Environment
According to Christian Koch, SAP's marketing manager for
consumer products and retail, when the RFID data enters into
the SAP system, the system knows where it is coming from.
As a result, it can trigger an appropriate activity; for instance,
when the inventory falls short from the required amount it can
send an advance shipping notice to the manufacturer (RFID
Journal, 2004). Moreover, the system can be configured in
such a way so as to alert a manager when warehouse
inventory needs to be replenished based on how many pallets
have been shipped. Since the business modules are all
integrated in SAP, this technology greatly increases
efficiency and can cut down costs.
In a few years from now the widespread adoption of RFID
will not be driven by internal initiatives such as cost control
but by mandates being established by large retailers and
consumers such as Wal-Mart or Target. These retailers knew
the benefits of RFID so they would require their suppliers that
cases and pallets delivered by them use RFID tags, with
deadlines ranging from 2005 to 2007 (RFID Journal, 2004).
These cost savings could be substantial for Wal-Mart, the
world's biggest retailer with sales of $217.8 billion in 2002
(Shim, 2003). Some analysts estimate that Wal-Mart's costs
associated with supply chain--including storing, transporting
and keeping track of goods are about 10 percent of overall
sales. According to Pete Abell, AMR Research Analyst,
RFID could save 6 percent to 7 percent of those costs
annually. Using the 2002 figures as a model, that would
amount to about $1.3 billion to $1.5 billion saved annually.
As we have noticed from the studies above that the collection
of data is made more efficient by the help of this technology.
Now, what should organizations do when they have this data
acquired? Enterprises can utilize data gathered from RFID
scans to create real-time supply chain visibility, making it
possible to identify and respond to challenges as well as
opportunities for improvements. When RFID tags at the case
level are read it will enable retailers to identify their potential
out-of-stocks and place immediate replenishment orders. As
high value products move through the supply chain, by
tracking individual cases, RFID tags help reduce theft and
tampering, and decreases costs associated with loss
prevention. From order to delivery, RFID speeds up this
whole cycle time by providing instant, accurate information
about the contents of a shipment. Moreover, it makes it
possible to quickly ensure correct delivery and improved
shipment receipt reconciliation or more accurately identify
the discrepancies and analyze root cause. Goods which have
a short life span on the shelf can be monitored more closely,
as a result older products can be rotated to the front of the
shelf before it even expires. RFID helps to improve
inventory and warehouse management by reducing the
number of times workers must touch a case of pallet to
determine its content without slowing down the process to
locate and scan each item. Warehouse and distribution costs
typically represent 2% to 4% of operating expenses for
retailers (Accenture Study, 2001). Replacing point-and-read
labor-intensive operations with sensors that track pallets,
cases, cartons and individual products anywhere in the
facility can significantly reduce labor, resulting in 30% or
more in savings (Accenture Study, 2001). The labor costs
and service fees of regular stock management and store shelf
inventory can also be reduced by using RFID at the product
level. With RFID-enabled products, the current 'scan-ityourself'
checkout can be improved with increased selfservice
adoption, shortened checkout times and reduced
fraud.
Defective products have long been a problem to
manufacturers. To improve quality control some have spent
millions to determine at which stage of a product’s life cycle
the product becomes defective. If a product is determined to
be defective after it has been shipped to the consumer, RFID
generated data can be used to analyze the product life cycle in
the supply chain. This information can be used to determine
the stage at which the product becomes defective thus
improving quality control. This real-time analysis of track
and trace information can be used to increase product velocity
by identifying sales velocity, improving inefficient business
processes.
The Bangladesh Accountant/January-March 2010 105

Information Technology
RFID Technology In Today’s Environment
The implementation of RFID for a company is a long term
investment and its benefits are substantial and gradually show
the results as described above. The price of the RFID tag
went from about $1 each in 2000 to somewhere between 25
to 40 cents in 2003 (Schwartz, 2003). Most companies follow
the track of other companies which have already implemented
this technology. For instance, GM uses RFID to track carriers
that move auto chassis and materials around assembly plants.
Eventually, assuming the price of RFID chips drops
substantially, Tony Scott, the chief technology officer at
General Motors Corp predicts that GM may use RFID to
track inventories of individual parts. Moreover, rewritable
RFID chips at some point could be built into cars to maintain
vehicle-maintenance histories.
Some analysts also suggest that this technology will advance
to the point that RFID tags will be coupled with sensors that
record temperature, motion, light, or other data, and as a
result the amount and value of the information collected will
increase dramatically. That could create scalability problems
for operational applications, similar to what many companies
experienced in the 1990s when they implemented firstgeneration
systems for enterprise resource planning.
According to Michael Bolles, DHL's industry and customerinnovation
manager, DHL Worldwide Express Inc. has
assembled a group of business and technical managers who
work in offices around the world that's examining how RFID
and the data it generates can be used to augment the
company's business. It has also formed a steering committee
which is looking at IT-infrastructure issues associated with
RFID (Rick, 2004). DHL has a number of pilot projects under
way and is trying to use collected RFID data to make vendormanaged
inventory, warehouse-management, and other
services more efficient.
As mentioned above U.K. brewer is already saving $25
million a year out of what it previously spent to replace lost
kegs. The company is using the data collected from RFID to
determine when the kegs are filled, delivered, returned, and
washed. Now they're depending on RFID tags to track
product freshness and calculate how much unconsumed beer
is returned by customers in exported kegs.
United Parcel Service Inc. is among the newcomers to RFID
trying to anticipate uses for the technology. UPS has several
projects under way in order to track vehicles and equipment.
According to John Nallin, an IT VP who oversees the
shipping company's global networks, UPS will consider
adding collected RFID data to its data-warehouse system
that's used to study information about problematic shipments
after this technology matures and individual packages are
tagged.
Barry Sommerville is the VP of IT at Pfizer Inc. He, like
other pharmaceutical manufacturers, is exploring the potential
of using RFID to closely track drug shipments to fight the
rising problem of counterfeit drugs in this country.
Implication of RFID Technology for Bangladesh
Both the private and public sectors are driving the RFID
market in Bangladesh. Deltech Ltd, a global RFID solution
provider has already helped several organizations implement
RFID (Bacheldor, 2008). According to Mr. Delwar Hossain,
founder of the Deltech, hands-free access control and
employee-tracking systems, as well as asset management are
the most popular applications businesses are asking for.
Appollo Hospital, Dhaka has completed the first phase of an
RFID project to track employee attendance as well as assets
(Bacheldor, 2008). The Bangladesh Army also plans to
employ this technology to track soldiers and visitors entering
its Dhaka Cantonment as well as track retail purchases. In
many export sectors of Bangladesh ranging from garments to
household and office furniture, large international buyers can
get rid of the age old barcode-based product identification
systems for RFID tags to reduce product tracking and
inventory management costs of the items which will
ultimately help the country to be competitive in the world
market. US retailers like Target, Wal-Mart, etc. are major
buyers of Bangladesh’s garment products. Since Wal-Mart
has already announced its plans to require majority of their
suppliers to implement RFID based tracking systems, the
Bangladeshi exporters have no choice rather to implement
RFID technology to survive in the world market. Besides
Wal-Mart and Target, German retailer Metro and furniture
maker IKEA (recently commenced operations in Bangladesh
on a limited basis), to name a few among the large number of
companies, have already started experimenting with RFIDintegrated
supply chain management systems. This sea
change in global integrated supply chain management
necessitates a rapid mobilization of our government, IT and
export industry leaders and experts to devise a uniform RFID
strategy for Bangladesh.
The Bangladesh Accountant/January-March 2010 106

Information Technology
Conclusion
There are numerous advantages of using RFID technology
and to list all is beyond the scope of this paper. However, as
mentioned, RFID technology is a capital investment and
companies should choose the best vendor available who
understands the business processes of that company and how
the RFID data will be used to improve the supply chain. This
technology is mature in many applications, highly functional
and supported by current and emerging standards. Today
companies in all segments of the supply chain are proving the
business value of RFID. Intermec Technologies and TIBCO
are one of the pioneering leaders in implementing RFID
technology.
Already Wal-Mart, Oracle Corp., Redwood Shores, Calif.,
are working with Intermec Technologies Corp. and Everett
Wash. to add RFID technologies (Albright, 2003). These
industry giants have realized the benefits of RFID and will
reap the benefits in a few years from now.
n
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Bose, I., and Pal, R., (2005), Auto-ID: Managing anything, anywhere, anytime in the supply chain, Communication of the ACM.
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The Bangladesh Accountant/January-March 2010 107

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AAA, Committee on Concepts and Standards for External Financial Reports.
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Becker, H. and D. Fritsche. 1987. Business ethics: A cross-cultural
comparison of managers’ attitudes. Journal of Business Ethics 6: 289-295.
Bowman, R. 1980a. The importance of market-value measurement of debt in
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Accounting Review 55 (April): 237-253.
Cohen, C. 1991. Chief or Indians—Women in accountancy. Australian
Accountant (December): 20-30.
Harry, J., and N. S. Goldner. 1972. The null relationship between teaching
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Jensen, M. C., and C. W. Smith. 1985. Stockholder, manager, and creditor
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Munn, G. G., F. L. Garcia, and C. J. Woelfel, eds. 1991. Encyclopedia of
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