Treasury Securities in Bangladesh

Letter of Transmittal

December 09, 2010

Dewan Mostafizur Rahman
The Course Instructor
FINANCIAL INSTITUTIONS
BRAC University
66 Mohakhali, Dhaka.

Subject: Submission of the term paper.

Dear Sir,
This is the report on “Pricing and bidding behavior of T-bills in Bangladesh” that is a
requirement for fulfillment of our FIN 424 course and it is our pleasure to present it before you.

We have tried our best to follow your guidelines in every aspect on our report. We have collected
what seems to be most important information to make our report as specific and coherent as
possible. We enjoyed the challenges of preparing the report with an opportunity to increase our
understanding of the Pricing and bidding behavior of T-bills in Bangladesh. We are earnestly
thankful to you for your guidance during the preparation of this report. We hope you will
appreciate our combined effort put forth hereby.

Sincerely yours,

Amit Kumar Das 08304015

Sunjun Aman 07204015
Farhan Sadik 07304033
 Acknowledgement

First of all we are graceful to almighty God for giving us the power to finish our term paper with
a well established way and at a perfect or schedule time period. To make a report it needs a lot of
information, effort, link, members’ coordination and so on.

In the preparation of this Project Report, We would like to acknowledge the encouragement and
assistance given to our group by a number of people. We are most grateful to our course
instructor Dewan Mostafizur Rahman for providing us detailed feedback and support on this
report.

We would also like to express our gratitude to Mr. K.M Asif, Assistant officer of Finance
department, Bangladesh Bank, Dhaka. Thanks to him for helping we with the relevant
information about the Pricing and bidding behavior of T-bills in Bangladesh that we needed to
prepare this report. Without his contribution, it would not have been possible for us to conduct
this project work.

We would like to thank all the group members of our group for the sincere effort to complete this
report. Without the teamwork and supportive attitude of the group members it wouldn’t have
been possible to prepare this resourceful report.

We would be thankful if this report comes to any benefit of our teacher as well as any students of
our department.
ABSTRACT
This paper examines the pricing mechanism and bidding behavior of T-bills in Bangladesh. We
analyze the yield patterns of different maturity T-bills from auction 222-273 including the
secondary T-bills market. In our analysis, we also focus on the pros and cons of local T-bills
market. In addition, the concept of Repo and Reverse Repo has been introduced. The primary T-
bills market in Bangladesh is still thin in the sense that the supply side is influenced by the
budgetary financial requirements of the government, while the demand side comprises mainly
the Deposit Money banks (DMBs) having SLR obligations. Finally, some suggestions have been
provided for strengthening and streamlining the T-bills market in Bangladesh.

1.1 INTRODUCTION

The Bangladesh economy is within the mainstream of the continuously changing global financial
system. Domestic as well as international trade also characterizes Bangladesh economy. Hence a
financial system has developed here consisting mainly of the capital and the money market. For
any underdevelopment country the existence of a well functioning money market is of
paramount importance. The money market currently existing has also developed due to certain
needs. In general, these needs can be termed as need for short term liquidity within our financial
system, to carry out the day to day economic activities and obviously to meet and match need for
short term lending and borrowing of the participants within the financial system. T-bill market is
by far the largest component of the money market in Bangladesh.
Treasury bill or T-bill is a short-term debt issued by a national government with a maximum
maturity of one year. Treasury bills are sold at discount, such that the difference between
purchase price and the value at maturity is the amount of interest. Although the maturity of T-bill
shouldn't be more than one year, in Bangladesh, 2-year and 5-year securities are also regarded as
T-bills. Treasury bills are fully guaranteed by the government and hence are free from default
risk. The biggest reason that T-Bills are so popular is because they are one of the few money
market instruments that are affordable to the individual investors. Basically, investors invest in
T-bills due to: 1) to maintain the Statutory Liquidity Reserve (SLR), 2) to maintain adequate
liquidity 3) to earn yields, 4) to utilize properly huge idle cash in banks, and 5) to averse highly
risky investments. Since they mature so quickly, T-bills are simply sold at a discount to their face
value at maturity. The discount is determined by the interest rate. If it is a six-month bill with a
5% discount rate, the investor pays 95% of the face value or Tk. 950, and then receives Tk. 1,000
back in six months. T-bills are indirect tools for monetary management of the central bank of a
country. Six types of T-bills are available in Bangladesh: 28-day, 91-day, 182-day, 64-day, 2-
year, and 5-year government treasury bills are duly issued by the Bangladesh Bank through
weekly auctions at rates determined by the market. The only downside related to T-bill is that the
investor won't get a great return because Treasuries are exceptionally safe. Corporate bonds,
Certificate of Deposits, and money market funds will often give higher rates of interest. What's
more, the investor might not get back all of his or her investment if he or she cash out before the
maturity date. The principle objective of this study is to identify and analyze the pricing
mechanism and bidding behavior of T-bills market in Bangladesh. The entire study is divided
into nine sections. Section two describes Creation of T-bills in Bangladesh, section three
describes Overview of T-bills market in Bangladesh, section four describes T-bills auction,
section five describes Pricing of T-bills through auction, section six describes T-bill yields and
Call Money Rate, section seven describes Repo and Reverse Repo, section eight describes
Secondary market for T-bills, and section nine describes Suggestions and concluding remarks.
1.2. CREATION OF T- BILLS IN BANGLADESH

Bangladesh Bank (BANGLADESH BANK), the central bank of Bangladesh, operates

throughout the country with its nine branches. Government receipts and payments are overseen
and managed by BANGLADESH BANK. Where there is no BANGLADESH BANK branch but
transactions of government occur, different branches of Sonali Bank (SB) are assigned to take
part in these transactions on behalf of BANGLADESH BANK. These branches are known as
'Chest Branches'. In a district, there may be one chest and some sub-chests. BANGLADESH
BANK directly monitors Chest branches. This function is known as 'Feed'. Chest branches feed
sub-chests. There are 464 chest branches throughout the country. However, it should be
remembered that chest branches aren't regarded as chest banks. there are some other small units
working for BANGLADESH BANK, which are known as 'Booth'. Booth is a counter of receipt
or payment. Booth may be of any bank's branch. Government's main source of revenue is tax,
and with this revenue government expends mainly for various establishments. While
expenditures exceed revenues, there is a deficit. Government meets this deficit through creation
of T-bills. Let's have a look on the following example.

Expenditure Revenue
Tk 1000 million Tk 800 million. Here in the example, Tk 200 million is deficit. This deficit will
be met up from T-bill creation. However, for small amount of deficit, a petty cash account is
maintained by Bangladesh Bank. This is called 'Ways and Means Advance'. Government can
borrow a maximum of taka 64 crore from this account of Bangladesh Bank. Government
generally borrows first from Ways and Means and then through T-bills. Bangladesh Bank
charges the Government a floating interest rate (Bank rate 1%) for this advance, while present
bank rate is 6%. Let's have a look on the creation of T-bills for the above example.

Expenditure Revenue

Tk 1000 million Tk 800 million

Tk 64 million (Ways and Means Advance)
Tk 136 million (Creation of T-bills)
1.4. OVERVIEW OF T-BILLS MARKET IN BANGLADESH

The market for Bangladesh Treasury bills has a complex structure and involves numerous
participants--Ministry of Finance, Bangladesh Bank, government securities dealers and brokers,
and other holders of Treasury securities. The Bangladesh government finances its expenditures
in excess of tax receipts through the sale of debt obligations. Currently, the total par value of
outstanding Treasury bills stood at about Taka 22000 crore approximately. Treasury bills are
short-term Government debt securities with maturity of a period less than one year. However, in
Bangladesh, two and five year securities are also regarded as T-bills since they are zero coupon
securities. They are the most well known of all Government securities. Treasury bills are
designated by the number of days to their maturity. There are six types of T-bills that prevail in
Bangladesh. These are 1) 28 days T-bill 2) 91 days T-bill 3) 182 days T-bill, 4) 364 days T-bill
5) 2 years T-bill 6) 5 years T-bill. Treasury bills are sold on a discount basis, which in simple
terms means that we have to pay for the bills less the interest receivable during the term of the
bill and receive the face value of the bill at the end of the period. Treasury bills are not listed at
the Stock Exchange. If one wanted to exit before maturity, rediscounting isn't possible at the
Central Bank, rather he or she may take part in the Repo auction. Repo and Reverse Repo will be
discussed later on.

Marketable Treasury securities are issued through regularly scheduled auctions in what is called
the primary market. The process importantly involves the Bangladesh Bank, which serve as
conduits for the auctions. Till date, government has outstanding borrowing of Taka 22000 crore
from issuance of T-bills. Each year, on an average, T-bills of total taka 50000 crore are issued.
During 2002-2003 fiscal, a total of taka 58358.75 crore was borrowed from T-bills.
2.1. TYPES OF T-BILLS IN BANGLADESH

There are six types of Treasury securities issued by Bangladesh Bank in Bangladesh. These ares-

1) 28 days T-bill
2) 91 days T-bill
3) 182 days T-bill,
4) 364 days T-bill
5) 2 years T-bill
6) 5 years T-bill

2.2. Mythology of issuing Treasury Securities in Bangladesh

With regard to treasury management, various reform measures were taken in FY07 for the
purpose of prudent management of cash and debt of the Government. Many important steps were
taken in FY07 for the purpose of increasing efficiency and maintaining discipline in the
management of cash and debt of the Government. These were as follows:
Structural change of record keeping system of Government transactions: The record
keeping system of Government transactions was changed for ensuring transparency and
accountability. For this purpose, Ministry / Division wise accounting system was introduced with
effect from 1 July 2006.
Formation of Cash and Debt Management Committee (CDMC) and separation of
Government Cash and Debt
Management: A Cash and Debt Management Committee (CDMC), which was formed in the
last fiscal year, started functioning during FY07. Deficit financing, which was made by auto
monetization through ad hoc Treasury Bills was discontinued. Earlier, the system of automatic
monetization through ad hoc Treasury Bills used to cater to both the Government's borrowing to
finance budget deficit and its financing requirement to meet cash flow mismatches. In FY07,
Government debt management was separated from cash management through enhancing Ways
and Means Limit and arrangement of drawing facilities with Bangladesh Bank beyond this limit,
and through identification of sources of financing budget deficit through specific debt
instrument. Ways and Means Limit was raised from Taka 64 crore to Taka 1000 crore with effect
from 1 July 2006 for the purpose of eliminating difference of intra-year cash. It was decided that
the amount exceeding the Ways and Means limit would be treated as Current Overdraft bearing
interest rate of
Reverse-repo + 1% and the rate of interest for the amount within the Ways and Means Limit
would equal to the interest rate of Reverse-repo. Outstanding amount of ad hoc Treasury Bills
was transferred to OD-Blocked Account and repayment of outstanding amount was decided to be
made according to an amortization schedule.
Paving the way for a completely market based primary auction system: A volume based
system of auctions of Government Treasury Bills and Government Treasury Bonds was
introduced in FY07 through publishing auction calendar for both Treasury Bills and Treasury
Bonds stating auction date and amount to be auctioned. This system has ensured transparency in
the auction of Government Securities and has also helped determine competitive price. The
CDMC prepared the first pre-announced volume based Auction Calendar of FY07 with effect
from September, 2006. It was decided that amount borrowed through auctions of Treasury Bills /
Bonds and repayment of principal and interest of the same instruments would be credited and
debited directly to and from Government account with effect from 1 July 2006.
Priority to Treasury Bonds as a means of deficit financing: The system of issuing 2-year and
5-year Treasury Bills was abolished to match the tenor of Treasury Bills with international
convention with effect from 1 September 2006. Priority was given to Treasury Bonds as a means
of deficit financing to ease the burden of shorter-term debt obligation of the Government. It was
decided that 15-year and 20-year Treasury Bonds would be issued from FY08. Moreover,
Treasury Bills was evened out for minimizing Refinance Risk arising from the issuance of
shorter-term Bills.
Devolvement and Private Placement of Treasury Bills and Treasury Bonds: A system
devolvement and private placement of Treasury Bills and Treasury Bonds with Bangladesh Bank
was introduced in FY07 to mitigate the risk of inadequate response from the market.
Introduction of issuance of Treasury Bonds at Face Value: It was decided that the Treasury
Bonds would be issued at Face Value through Yield based auctions from 1 July 2007 instead of
fixed coupon bonds issued at a discount to lessen long-term Government debt liability arising
from issuance of bonds.
Ensuring active participation of Primary Dealers in securities market: Steps were taken to
ensure active participation of the Primary Dealers in the securities market for the development of
a vibrant bond market through revision of existing guidelines for the Primary Dealers.

2.3. MARKET PARTICIPANTS

Market participants can be divided into issuers, investors, and intermediaries.

Issuers: The foremost impediment here is that Bangladesh lacks a significant number of
potential, good-quality issuers. Its economy continues to be agriculturally based; agriculture
accounts for nearly30% of the country’s GNP, and more than 70% of the labor force is engaged
in agricultural activities. The industry and service sectors contribute 20% and 50%, respectively,
but compared with landholdings, the average size of industrial and commercial enterprises is
rather modest.

Most private sector enterprises are small and owner-run, many are of “cottage size” and most are
in the garment industry, which to date depends largely on short-term bank loans for financing.
These enterprises could benefit from longer-term funding but are neither large enough nor well
known enough to issue bonds. Most of the large-scale industrial units and commercial enterprises
are state owned. Their shares are not listed, and they do not offer debentures since their financing
needs are met by the government or by the state-owned NCBs. These state-owned firms
generally stay outside the capital market. The privatization program for state-owned companies
works too slow to influence the market.
Second, although Bangladesh has a debenture market, to date only a small number of well-
known issuers have used the market. The liquidity in those debentures at the stock exchange
is insignificant because of the small number of investors and their buy-and-hold mentality. The
investor community does not seem to find this market too attractive owing to weak disclosure by
the issuers, which in turn reduces credibility and investor confidence.
Third, companies find that issuing debt is costly, both in monetary and nonmonetary terms. The
interest rate distortion due to the GSCs mentioned earlier raises the ongoing cost of borrowing,
while various up-front costs amount to about 7% of the value of the issue (these include
registration costs—that is, stamp duties—totaling about 2.5% of the issue value).
Fourth, it is difficult to persuade issuers to disclose sufficient information about their companies
(although prospectus requirements for listed debentures do seem fair). Yet another problem is
that most potential issuers are unwilling to take the opportunity cost involved in issuing a long-
term bond. In addition, the absence of a yield curve makes pricing difficult.

Investors: On the investor side, few investors are sophisticated enough to think about investing
in bonds. About 80% of the base here is made up of retail investors, whose primary concerns
include the equity at the stock exchange or the government savings certificate. Of the few
institutional investors that could support a bond market, most are either prevented from investing
in corporate bonds by restrictive guidelines or are not professionally managed. The major
institutional investors are the Investment Corporation of Bangladesh—a government-owned
financial institution—and the insurance companies. The mutual fund industry in Bangladesh is
the exclusive domain of ICB. There are no private mutual funds to
mobilize savings toward the debt market, and the ICB’s monopoly has prevented new investor
companies, that is, mutual funds, from developing in Bangladesh. There are provident and
pension funds (total assets managed amount to Tk 6.7 billion; see The Financial Express), self-
managed by public and private corporate entities, but none are professionally managed. The
pension obligations of the government are not funded. The Trust Act of 1882 prohibits those
funds from being invested in equities, corporate debentures, and private money market
instruments.
In addition, no protective laws are in effect to ensure that investors will get their dividend and
capital back. Missing are higher audit standards together with SEC regulations on disclosure
standards in prospectus along with arbitrary institutions.
Furthermore, most investors lack a trading mentality and just buy and hold because of SLR
requirements or because they do not know how to trade. Few foreign investors are attracted to
this, mainly because of the weak disclosure by the borrowers. As for the general public, it has
little understanding of debt products, and the intermediaries are not much help because few
engage in research on markets, companies, and industries to encourage investment.

Intermediaries: Intermediaries in Bangladesh lack many of the skills needed to foster an active
local corporate bond market. As mentioned earlier, commercial banks dominate the financial
sector and not enough intermediaries are skilled in securities. Few are able to identify issuers and
investors and bring them to the market. They provide little or no research analysis on industries
or companies to encourage investment in the local debt market. Too few private merchant banks
are able to conduct financial advisory and trust services. Nor do any feel motivated to become a
market maker for an issue. Hence the market is illiquid, with large spreads. At the same time, the
fee structure and pricing are high enough to allow intermediaries to make money, but because
transactions are so limited, the intermediaries seldom make money. Even if they are able to
participate, intermediaries are reluctant to take any risk in dealing.

Conclusion :
The various impediments to bond markets in Bangladesh pose a large challenge for
policymakers. Nevertheless, some suggestions can be made for dealing with them.

Overall, given the current situation in Bangladesh, the country should focus on developing a
well-run primary market, both for private placements and for public offerings. That means
several steps need to be taken to fix the inside elements of the market, in addition to some
changes around and across the financial system.