Bangladesh Bank Training Academy Journal

Abstract

The central bank’s sound liquidity management is crucial for the stability of the financial system as well as the overall economy of any country, including Bangladesh. Identifying the core component of banks’ liquidity and its determining factors from the central bank’s point of view is important in this context. In addition, identifying the proper liquidity forecasting technique is essential for sound liquidity management. This study attempts to identify these factors with regard to Bangladesh. It is found that excess reserves (total reserves with the Bangladesh Bank minus required reserves) are the most liquid assets of banks. There are two types of determining factors for excess reserves. These are autonomous factors (net foreign assets, claims on government, currency in circulation, and net other items) and policy factors (net claims on banks and required reserves). Bangladesh Bank cannot directly control the autonomous factors, but the policy factors can be controlled through applying the monetary policy instruments like reserve ratio, repo facilities, and Bangladesh Bank bills. In this context, BB needs to know how much liquidity should be injected/mopped up from the market on a daily basis. Proper liquidity forecasting is the only way to find this idea. Therefore, the Monetary Policy Department (MPD) of BB Head Office forecasts the banks’ liquidity every morning for the next five working days. MPD basically forecasts the autonomous factors to forecast the overall liquidity situation. To forecast the autonomous factors, MPD uses the moving average method, the judgmental approach, and adjustments of seasonal and festival impacts on the trend values of these autonomous factors. This study finds the positive impacts of liquidity forecasting on liquidity management. However, to enhance the effectiveness of liquidity forecasting, this study seems to extend the forecasting horizon up to the reserve maintenance day. Regarding the forecasting technique, this study suggests that MPD should apply the econometric technique, like the ARMA model, particularly for the currency in circulation. In addition, MPD should take help from the Forex Reserve and Treasury Department of the BB Head Office and the Ministry of Finance in forecasting the net foreign assets and net claims on the government, respectively.