MAFS — Monetary and Financial System

Money, wealth and purchasing power

Income is earned over a period; money is measured at a point in time; wealth includes financial and real assets less liabilities. A house can store wealth without being readily usable for payments. Money reduces the need for a double coincidence of wants in barter. Its unit-of-account role makes prices comparable; its deferred-payment role lets contracts specify future amounts. Inflation can weaken the store-of-value function without immediately stopping exchange. Commodity money has a nonmonetary use; fiat money depends on institutional acceptance. A debit card accesses an existing balance; a credit card accesses borrowing and is not itself a separate stock of money.

Why people hold money

Transaction balances meet routine purchases; precautionary balances meet uncertain expenses; portfolio choices balance liquidity against returns on other assets. Higher nominal income usually increases transaction needs, while a higher return on alternative assets raises the opportunity cost of idle balances. Payment technology may reduce required balances, but uncertainty can increase desired liquidity. Separate a change in money demand from a change in the quantity supplied. For an exam answer, specify which motive changes and why rather than asserting that every interest-rate movement affects every household identically.

Worked exercise: inflation and money balances

Assume a deposit earns 8% over one year and prices rise 6% over the same year. Exact real return = 1.08 / 1.06 − 1 = 1.8868%; the subtraction approximation is 2%. For a non-interest-bearing BDT 10,600 balance, purchasing power at beginning-year prices is 10,600 / 1.06 = BDT 10,000. All rates are hypothetical. Explain why a positive nominal return does not ensure a positive real return.

Can a bank create unlimited money?

No. A new loan can create a matching deposit, but capital, settlement funding, liquidity, borrower demand, profitability and credit risk constrain lending. Transferring that deposit to another bank creates a settlement requirement. Do not confuse an accounting entry with unlimited funding.

What happens when BDT 50,000 loan principal is repaid from a deposit?

In a simplified same-bank entry, the loan asset falls by BDT 50,000 and the deposit liability falls by BDT 50,000. Principal repayment reverses deposit creation; interest accounting is separate.

Why can money demand rise during uncertainty?

Households and businesses may retain larger precautionary balances to cover disrupted income or expenses. This can occur even when holding liquid balances sacrifices interest income.

Choose a payment method using a decision framework

Compare urgency, value, reach, cost, evidence, security and reversibility. Cash offers immediate physical exchange but theft and handling risks. Cheques provide a documented instruction but depend on verification and clearing. Debit cards draw on available balances; credit cards add a credit relationship. Mobile and online interfaces improve access but introduce authentication and fraud risks. A channel is not necessarily a settlement system: a mobile interface can initiate a transfer processed through another infrastructure. Avoid claiming all digital payments settle instantly.

Bangladesh payment-system revision map

Learn the distinct purposes of cheque clearing, electronic funds transfers, switches and real-time gross settlement. BACPS concerns automated cheque processing; BEFTN concerns electronic funds transfers; NPSB connects participating payment channels; RTGS concerns individual real-time gross settlement. Operational hours, eligibility, limits and finality conditions must be checked in current Bangladesh Bank system rules. Study the progression from paper handling to electronic processing as a change in speed, reach and controls, not simply as a list of launch dates.

Worked exercise: gross versus net obligations

Assume A owes B BDT 70 million and B owes A BDT 45 million in the same settlement cycle. The gross payment instructions total BDT 115 million. Under legally effective bilateral netting, A owes B a net BDT 25 million. This saves settlement funding in the simplified example, but does not remove default or timing risk. Actual peak liquidity under gross settlement depends on sequence, incoming funds and liquidity facilities.

Is a successful app notification proof of final settlement?

No. Distinguish initiation, acceptance, clearing and final settlement. Reconcile system records and the applicable rules before treating a status message as final discharge.

A customer repeats a pending transfer. What controls matter?

Check the original transaction identifier and processing state; use duplicate-prevention controls, reconcile ledger entries, communicate verified status and reverse confirmed errors through an authorised process.

Why can net settlement create exposure?

Participants may accumulate obligations before the settlement cycle completes. Netting reduces funding requirements, while final settlement still depends on participants and the system meeting their obligations.

Map the system from saver to investment

A surplus unit has funds available after its spending; a deficit unit seeks external finance. Securities provide direct claims on issuers, while bank deposits and loans place an intermediary between saver and borrower. Brokers can help arrange direct finance without becoming the ultimate borrower. Financial instruments specify cash-flow rights and obligations; institutions perform financial services; markets organise issuance and trading. Payments move funds and the monetary system supplies the monetary foundation. These components interact, rather than operating as independent lists.

Why infrastructure changes credit outcomes

Reliable accounts, credit information, enforceable contracts and functioning settlement reduce information and transaction costs. Adverse selection concerns hidden borrower quality before contracting; moral hazard concerns behaviour after funding. Screening, covenants, monitoring and borrower incentives address different parts of the problem. Intermediation offers expertise and scale but does not eliminate losses. Better access should be assessed alongside affordability, suitability and repayment capacity.

Worked comparison: bond or bank loan

Assume a company needs BDT 100 million for five years. A bond places a claim with investors and requires suitable issuance, disclosure and servicing arrangements. A bank loan creates the bank’s credit exposure and may allow negotiated covenants and monitoring. Compare total fees, coupon or interest, maturity, access to investors, collateral and refinancing risk. A lower quoted rate alone cannot establish which route is cheaper or more suitable.

Does employing a broker always make finance indirect?

No. Look at whose liability the investor holds. A broker may arrange a direct claim on the issuer without substituting the broker’s own balance sheet.

Give an adverse-selection and a moral-hazard example.

Before lending, an applicant conceals existing debt: adverse selection. After lending, a borrower diverts working-capital funds into speculative assets: moral hazard. Verification and post-disbursement monitoring serve different purposes.

Why is financial growth not automatically economic development?

Credit can fund viable investment or unproductive speculation. Assess allocation quality, productivity, inclusion and resilience, not only outstanding loan balances.

Read an institution’s balance sheet

Loans and investments are generally bank assets; customer deposits and borrowings are liabilities; equity absorbs losses. Maturity transformation funds longer assets with shorter liabilities. Diversification reduces concentration but common shocks can affect many borrowers together. A profitable institution may lack cash; a liquid institution may still have asset losses exceeding equity. Analyse asset quality, funding concentration, maturity gaps and capital together.

Compare institutions by function and permission

For each institution ask what it may accept, lend, invest, distribute and settle. Banks, finance companies, insurers, securities firms and microcredit institutions perform different functions. Names and historical labels alone do not establish authorised business. When discussing growth in Bangladesh, compare dated official statistics using the same definition and period; distinguish number of institutions, assets, outreach and service quality. Do not memorise undated counts as current facts.

Worked exercise: liquidity versus solvency

Assume assets of BDT 1,000 million, liabilities of 920 million and equity of 80 million. A recognised asset loss of 100 million reduces assets to 900 million and equity to −20 million, holding liabilities unchanged. Separately, a bank with positive equity can face a cash shortfall when immediate withdrawals exceed available liquidity. Selling assets quickly may realise further losses. These are simplified teaching balances, not regulatory capital calculations.

Does a profitable lender necessarily meet withdrawals?

No. Accounting income can accrue before cash collection. Long-term loans funded by short-term liabilities can create a funding gap despite reported profits.

How does depositor concentration matter?

Reliance on a few large depositors makes funding vulnerable to correlated or sudden withdrawals. Monitor concentration, maturity and available contingency funding.

What should a bank-versus-finance-company answer compare?

Authorised activities, deposit and funding types, payment functions, asset mix, maturity transformation, supervision and key risks. Verify local permissions instead of assuming identical powers.

Classify a market along several dimensions

Primary versus secondary describes issuance versus subsequent trading. Money versus capital describes the general maturity or funding function. Exchange versus OTC describes trading arrangements. A government bill may be issued in a primary auction and subsequently traded; these labels are compatible. Securities markets support valuation and liquidity, but a quoted price does not guarantee sale of any quantity at that price.

Risk transfer and cross-border finance

Insurance pools specified losses subject to policy conditions and exclusions. Microcredit focuses on small loans, whereas microfinance can encompass broader services where authorised. International finance expands funding and investment opportunities but introduces currency, country, settlement and legal risks. An importer earning BDT but owing USD faces currency mismatch. Matching foreign-currency assets and liabilities may reduce one exposure without eliminating credit or liquidity risk.

Worked exercise: discounted bill

Assume a bill costs BDT 96,000 and pays BDT 100,000 after 182 days. Holding-period return = 4,000 / 96,000 = 4.1667%. A simple 365-day annualised investment yield is 4,000 / 96,000 × 365 / 182 = 8.3562%. A discount rate using face value has a different denominator. State day-count convention and formula; do not call these two yield measures identical.

Who receives money when an investor sells existing shares?

The selling investor receives the proceeds, less transaction costs. The issuer does not receive new capital from that secondary trade, though market liquidity can support later issuance.

Why do fixed-rate bond prices usually fall when required yields rise?

Existing fixed payments are discounted at a higher required return, reducing their present value. Credit quality, remaining maturity and embedded options also affect pricing.

Is a government security risk-free in every sense?

No. Even where domestic credit risk is low, price, inflation, liquidity and reinvestment risks remain relevant to the holder.

Contract structure before product labels

Murabaha is a cost-disclosed sale with an agreed profit; ijara concerns leasing an asset’s use; musharakah is a partnership; mudarabah separates capital provision and management. Study ownership, delivery, payment and risk at each stage. A commercial profit is not justified merely by replacing the word interest. Execution must match the approved contract and applicable governance requirements.

Sources, ethics and governance

The Quran and Sunnah are primary foundations of Shariah; recognised jurisprudential methods include consensus and analogy. Application requires qualified interpretation rather than a banker selecting isolated passages. Avoid prohibited activity and address excessive uncertainty and gambling within the applicable framework. Governance must cover product approval, execution review, exceptions and corrective action. Islamic institutions still manage credit, liquidity, market and operational risks.

Worked exercise: partnership allocation

Assume two partners contribute BDT 600,000 and 400,000. They agree that profit will be shared 50:50. If distributable profit is BDT 200,000, each receives BDT 100,000. For an ordinary capital loss of BDT 100,000, without negligence, misconduct or breach, the capital-based allocation is BDT 60,000 and 40,000. Do not apply a profit-sharing percentage automatically to capital loss. Contract specifics require qualified review.

What distinguishes a sale from a loan labelled as a sale?

A sale requires a genuine asset transaction meeting the applicable ownership, possession and contractual conditions. Renaming cash lending does not establish those facts.

Who normally bears a mudarabah investment loss?

An ordinary investment loss falls on the capital provider, while the manager loses effort and expected profit. Manager negligence, misconduct or contractual breach can alter responsibility.

Does Shariah approval remove credit risk?

No. A permissible contract can still default or suffer operational failures. Contract compliance and financial risk management are complementary controls.

Match oversight to the underlying activity

Build a functional map: central banking and banking supervision, securities markets, insurance and regulated microcredit correspond to distinct oversight responsibilities. Bangladesh Bank, BSEC, IDRA and MRA are the syllabus’s principal institutions. Identify both the institution and the activity involved. A distribution partnership can involve more than one framework; a bank’s involvement does not convert an insurance product into a deposit.

Prudential, conduct and systemic objectives

Prudential oversight concerns resilience, capital, liquidity and risk management. Conduct oversight concerns disclosure, fair treatment and market behaviour. Systemic oversight considers interconnectedness and common shocks. Supervision cannot promise that no institution will fail. Accountability, reliable information, enforcement and coordination matter alongside formal rules. Independence means scope for decisions under a mandate, not exemption from accountability.

Applied exercise: misleading product description

Assume a branch describes a third-party investment as a guaranteed bank deposit without evidence. First identify the actual issuer, contract and risk bearer. Correct the description, stop unsupported assurances, review affected sales and escalate under approved procedures. A strong exam response distinguishes customer disclosure, distribution controls and prudential exposure. Do not invent a current compensation rule or statutory penalty.

Why might more than one regulator be relevant?

A financial group or distribution arrangement may perform different regulated activities. Determine the legal entity, product and activity before assigning oversight.

How should an answer handle an unknown current regulatory limit?

Explain the principle, identify the responsible authority and state that the applicable current instruction and effective date must be checked. Do not substitute a classroom assumption for a legal requirement.

What makes a balanced central-bank-independence answer?

Explain credibility and insulation from short-term pressures, then discuss clear objectives, transparency, accountability and coordination. Independence is not a claim that all policy choices are beyond scrutiny.