How printing money without creating real assets fuelled inflation

The central bank in FY23 and FY24 supplied liquidity to problem banks, mostly controlled by S Alam Group, by printing new money without generating real assets. 

As a result, the country's reserve money increased by Tk66,000 crore during these two fiscals, the highest ever in the country's history, which had an immediate impact on inflation by depreciating the taka, Bangladesh Bank data shows.

Reserve money is central bank-issued money backed by foreign and domestic assets that function as the monetary base of an economy. 

Total reserve money increased to Tk4.13 lakh crore in June 2024, for the first time in history, recording 10.49% year-on-year growth in FY23 and 7.84% in FY24, central bank data shows.

The central bank issued reserve money backed by government guarantees, which was considered as domestic assets when foreign assets declined substantially, meaning the newly circulated money added no value to the economy. 

Domestic assets increased by Tk1.67 lakh crore during FY23 and FY24 when the country's economy was bleeding due to banking corruption. 

However, net foreign assets declined by Tk1 lakh crore during the period due to the faster erosion of foreign exchange reserves.

The reason for the rise in domestic assets was that the Bangladesh Bank started printing money in June 2022 to meet the liquidity shortfall of S Alam Group-controlled banks and provide for the budget deficit amid low revenue earnings. 

Explaining the impact of rising domestic assets, Sabeth Siddique, former assistant director of the Federal Reserve Board, Washington DC, said that when domestic assets increase and foreign assets decrease, it means there are more takas circulated versus dollars. 

This leads to a decrease in demand for taka and an increase in demand for the dollar, causing a depreciation of the taka, which fuels inflation, he explained. 

He said, "When the central bank increases money supply to help banks, it doesn't create real assets. For money creation to work, the economy needs to grow. "But when Bangladesh Bank prints money and puts it in banks without real growth, it just fuels inflation."

As an example, he added, "If that money were used for importing raw materials that generate exports, like garments, it could create real assets. If you invest Tk100 in imports to generate $2 in exports, you create a real asset worth $1. This contributes to GDP growth, builds reserves, and benefits everyone."

However, what happened in the country is that the balance of payments was improving despite reserves going down because imports were declining, Siddique said. This meant manufacturing was being affected, resulting in exports also going down, which meant real assets were not being generated.

"So, if you just print money but do not generate real assets, that will create inflation, increasing excess money in people's hands. Such a situation creates a mismatch between demand and supply. You have money to buy, but supply is limited due to the lack of production of real assets. As a result, demand goes up because of excess money, which causes inflation," he added.

Post-Hasina gov measures to improve banking

The Bangladesh Bank stopped printing money after the formation of the interim government ending the Hasina regime on 5 August. 

It has introduced a new mechanism of providing guarantees against weak banks to borrow from other banks to meet their liquidity shortage making the call money market operational. 

The regulator also imposed various restrictions on the business operations of cash-strapped banks until their cash flow rebounded which helped to stop further erosion of the liquidity position.

Soon after joining the Bangladesh Bank, the new Governor Ahsan H Mansur identified weak banks affiliated with political influence and exposed their real health. 

He then dissolved the boards of nine banks which were looted by S Alam Group, former private sector advisor to the then prime minister Salman F Rahman, and former land minister Saifuzzaman Chowdhury. 

The Bangladesh Bank took a new liquidity support policy for those banks after reconstituting their boards to stop further erosion of financial health through corruption. 

So far, troubled banks have been allowed to borrow Tk5,000 crore from other banks under a guarantee from the central bank.

How cenbank generated new money

The Bangladesh Bank generated new money, also known as printing money, through various tools including devolvement, ways and means, overdraft, and suspense accounts. 

It started printing money from June 2022 through the devolvement process amid a severe liquidity crisis when point-to-point inflation was 7.56%.

In the devolvement process, the central bank generates new money against the government's treasury bills and bonds. In this case, the central bank itself purchases treasury bills and bonds instead of selling them to commercial banks. 

The central bank generated a total of Tk88,000 crore in new money through the devolvement process in FY23 when inflation reached 9.76%.

The central bank stopped printing money through devolvement in August 2023 under pressure from the IMF (International Monetary Fund), as this money was creating domestic assets without generating foreign assets. 

Later, the bank started printing money through two accounts – Ways and Means Advances, and Overdraft – as the cash crisis worsened since it stopped printing money through the devolvement process amid huge criticism.

An overdraft occurs when there is not enough money in an account to cover a transaction or withdrawal but the bank allows the transaction anyway. 

Ways and Means Advances is a mechanism used to provide temporary lending facilities for temporary mismatches in the cash flow of the government's receipts and payments. 

The central bank generated high-powered money through these two accounts against government guarantees, which contributed to increased domestic assets.

At the same time, the bank provided money to S Alam Group-controlled banks by creating suspense accounts, which is also new money creation against government guarantee. 

The Bangladesh Bank supplied money to banks totaling Tk1.45 lakh crore in just two years during FY23 and FY24 by generating money through all those tools, central bank data shows.

How cenbank printed money to support S Alam banks

Social Islami Bank, one of the S Alam Group-controlled banks, experienced a negative balance in its current account maintained with the Bangladesh Bank for the first time in November 2022 due to aggressive lending. 

The negative current account balance means that banks are not able to clear depositors' cheques, which reflects an extreme liquidity crisis for a lender.

However, the Bangladesh Bank allowed the bank to continue clearing cheques by providing liquidity support through printing money instead of taking measures to stop further erosion. 

Despite having a negative balance, the bank continued lending to S Alam Group with printing money support from the central bank, which ultimately dragged down the lender to the verge of collapse, making it unable to run regular operations.

"If the Bangladesh Bank had stopped lending at the beginning as per rule when the current account became negative, the bank would not have been in the current situation," said a senior executive of Social Islami Bank. 

The bank official said at least Tk1,000 crore would have been in the bank's current account balance if the central bank had stopped business at that time. "Rather, it was allowed to keep lending, which widened the negative equity, causing a severe liquidity crisis."

The official said despite the Advance Deposit Ratio (ADR) of the bank shooting up to 102% in 2022 as S Alam Group was borrowing aggressively, the central bank did not take action against the bank for exceeding the authorised ADR limit of 92% set for Islamic banks. 

When ADR is 102%, it means the bank lends Tk102 against its Tk100 deposits, he explained.

"Finally, the Bangladesh Bank sent a letter on 19 August 2024, after a change in political regime, imposing a limit on business operation due to the negative balance. If this letter was given in November 2022, the bank could've been saved," he said. 

He noted that there are many provisions to punish banks for current account shortfalls, like penalising the managing director and treasury head of the bank, and the extreme action is to cancel cheque clearing. 

"But the central bank did not take any action," he added.

The four other Islamic banks controlled by S Alam Group, including Islami Bank, First Security Islami Bank, Global Islami Bank, and Union Bank, were experiencing similar negative balances in their current accounts with the central bank since November 2022. 

All were allowed to continue clearing cheques with liquidity support from the central bank. Despite having negative current accounts, these banks continued aggressive lending.

For instance, Islami Bank lent nearly Tk2,500 crore in the first two weeks of November 2022, while First Security and Social Islami invested a total of Tk2,300 crore, according to media reports. 

Though the central bank on 28 November 2022 issued a warning letter to all five banks, including Social Islami, saying that their cheque clearing would be halted if they did not adjust the negative balance in 20 days, it backtracked from its stance in the face of pressure from S Alam Group.

Despite failing to adjust the negative balance, the Bangladesh Bank did not stop their cheque clearing, instead continuing to provide liquidity by printing money.

The total cash reserve ratio (CRR) of most Shariah-based banks was a surplus of over Tk6,000 crore in October, which turned into a shortfall of nearly Tk7,500 crore in December 2022, according to a central bank statement. 

The Cash Reserve Ratio (CRR) is the portion of deposits a bank must hold in cash to reduce risk. Banks must keep a 4% CRR with the central bank to ensure funds are available if customers need to withdraw their money in emergencies. 

If any bank fails to maintain the required CRR, the Bangladesh Bank fines the lender at the bank rate of 4%, along with an additional 4%, bringing the total to 9% on the total amount short daily.

The Bangladesh Bank not only provided undue liquidity support for day-to-day operations but also helped these banks artificially show a healthy balance sheet. 

For instance, on 28 December 2023, the Bangladesh Bank provided liquidity support of Tk22,000 crore to seven banks, including five Shariah-based banks, to prepare balance sheets. 

If liquidity support was not provided, those banks would have had to show a liquidity shortage on their balance sheets, which would remain documented. 

The Bangladesh Bank provided liquidity support for two days only to show surplus liquidity on 30 December 2023.

Similarly, the Bangladesh Bank provided Tk35,000 crore in liquidity support to Islamic banks, mostly owned by S Alam Group, on a single day on 30 June 2024 to prepare their half-yearly balance sheets. 

All this liquidity support came through printing money, which eventually fueled inflation.