High volumes of letters of credit (L/Cs) are contributing to a persistent liquidity problem in Bangladesh's banking sector that has caught the country's central bank in a dilemma.

Bangladesh Bank (BB) feels that banks need more funds to provide more liquidity but for the moment, central bankers say they are refraining from supporting the banking sector because their interventions could speed-up an already fast-spinning inflationary spiral.

Inflationary pressure

"Though we have noticed the liquidity crisis, a higher rate of inflation is forcing us not to take any steps to help increase the supply of money in the banking system," a senior BB official said.

The central bank is apparently pumping some funds into the market through auctions of repurchase agreements, but not in the amount required to ease liquidity.

Import L/Cs

Another central banker said last week that recent increases in the value of import L/Cs opened for purchases of capital machinery, food, intermediate goods, petroleum products and other goods was contributing to the acute liquidity crisis.

Official figures showed that the overall L/C values increased by over 24 per cent to US$7.02 billion during the six months to December 2004 compared with the same period the previous year (DC World News, 28 February 2005).

Wait-and-see

Another factor contributing to the overall liquidity crisis is government borrowing from the banker sector. This has put an extra pressure on the overall money market according to central bankers.

Bank officials say they are monitoring the situation carefully but are reportedly adopting "a wait-and-see policy before taking regulatory measurers to help solve the liquidity problems".

This article represents the views of the author and not necessarily those of the ICC or any of the other partners in DC-PRO.