Illusion of independence: Why Bangladesh Bank needs market instruments, not just legal autonomy

Whenever systemic distress in Bangladesh’s banking sector surfaces, "central bank independence" is invoked as the sovereign remedy. Strip the Ministry of Finance of its informal veto, insulate Bangladesh Bank from executive directives and institutional discipline—we are told—will return.
Yet this diagnosis confuses legal autonomy with operational capacity.

Central bank independence is not merely a statutory shield inscribed in an amended Bangladesh Bank Order; it is an institutional technology. When a monetary authority lacks market-clearing transmission tools and non-discretionary supervisory mechanisms, even an ostensibly autonomous regulator is forced to govern by administrative decree. In finance, administrative discretion is the primary currency of cronyism.

To understand why autonomy has repeatedly unraveled, we must first ask: independence from whom?

Conventional macroeconomic theory fixates on fiscal dominance—preventing elected governments from printing money to finance deficit spending ahead of elections. In Bangladesh, however, the far deadlier capture has been commercial. Over recent decades, concentrated conglomerates colonised commercial bank boards and captured the regulatory perimeter.

Ordinary depositors are widely dispersed, unorganised, and possess zero lobbying power. Chronic delinquent borrowers, by contrast, are concentrated, highly capitalised, and politically entrenched. A central bank’s essential mandate is to act as the fiduciary guardian of public savings against the insatiable appetites of concentrated capital. When that independence fails, depositors bear the quiet tax of negative real yields, currency misalignments, and systemic bailouts.

Why was Bangladesh Bank structurally unable to defend this perimeter? Because it suffered from an acute dual instrument deficit across both monetary policy transmission and banking supervision.

In a functioning architecture, a central bank steers the macroeconomy impersonally. It adjusts its policy rate, which transmits through an active interbank market, anchors a competitive yield curve across liquid secondary government debt, and prices commercial credit and deposits.

The foreign exchange market clears based on external supply and demand. In Bangladesh, these mechanisms were systematically suppressed:

• Absence of a Secondary Debt Market: Government securities remained a captive, buy-and-hold space dominated by statutory reserve requirements rather than active trading. Primary Treasury auctions were routinely subjected to yield caps and direct devolvement onto Bangladesh Bank's balance sheet, destroying yield-curve discovery and rendering Open Market Operations (OMO) toothless.

• Managed Exchange Rate Distortions: Rather than allowing market-clearing price discovery, the central bank maintained an artificially defended exchange rate. When external balances deteriorated, authorities resorted to fragmented administrative rates, moral suasion on Authorized Dealer banks, and import-letter-of-credit rationing. This depleted foreign exchange reserves, fueled wide curb-market premiums, and delayed macro adjustments.

• Administrative Rate Ceilings: To suppress borrowing costs by fiat, the central bank enforced rigid 9% lending and 6% deposit caps. This severed the link between monetary policy rates and commercial bank pricing, penalised savers with negative real returns, and subsidized corporate leverage while inflation accelerated.

This reliance on administrative fiat in monetary policy mirrored an identical failure in bank supervision. In mature jurisdictions, supervisors rely on automated Prompt Corrective Action (PCA) frameworks and statutory resolution tools. When capital or asset quality deteriorates past statutory thresholds, mandatory sanctions trigger by law: dividends are halted, balance-sheet expansion is frozen, and non-viable management is removed without political negotiation.

Crucially, an effective PCA regime relies on timely, honest provisioning. In Bangladesh, banks systematically fail to make adequate or timely provisions, aided by external auditors who rubber-stamp cosmetic balance sheets. Because Bangladesh Bank lacks automated supervisory tools to detect and penalise balance-sheet misrepresentation in real time, profound information asymmetry is created. Depositors and investors are kept in the dark, believing distressed institutions are well-capitalised until capital deficits become catastrophic.

Deprived of objective, automated tools, the central bank substituted supervision with administrative circulars:

• Instead of enforcing non-discretionary provisioning and Basel III deductions, it issued ad-hoc circulars that repeatedly relaxed loan classification criteria to conceal bad debt.

• Instead of forcing credit recognition, it permitted repeat defaulters to regularize massive bad debts through nominal 2% down payments and multi-year rescheduling windows.

• When distressed assets choked interbank liquidity, the central bank quietly deployed emergency liquidity lifelines to keep zombie lenders alive.
The result of this supervisory vacuum is the catastrophe of Non-Performing Loans (NPLs). Today, bad loans represent a massive share of the banking sector's balance sheet, with total distressed assets exceeding Tk 600,000 crore and several captured institutions completely decapitalised.

The lesson across both mandates is identical: administrative measures are never a systemic substitute for market instruments.

A market-determined Treasury yield, a floating exchange rate, or an automated PCA trigger is impersonal—blind to borrower identity, bank ownership, or political clout. An administrative decree, by contrast, requires an official’s signature.

The moment monetary transmission and supervisory enforcement hinge on a signature—whether granting an LC quota, fixing a rate cap, or approving an ad-hoc loan-rescheduling circular—that signature becomes a prize to be lobbied for, pressured, or bought. Administrative discretion did not resolve market frictions; it created a lucrative marketplace for regulatory forbearance, the evergreening of bad debt, and policy capture.

Housing both mandates under one roof without statutory separation worsened this: central bank liquidity was repeatedly deployed to prop up failing banks under its supervisory watch, compromising price stability to conceal supervisory failure.

If Bangladesh Bank is to escape this trap, reform must focus on operational instruments rather than legal platitudes:

1. Build Secondary Sovereign Debt Markets: End Treasury bill devolvement onto the central bank. Establish genuine auction discovery and secondary liquidity so the policy repo rate transmits across an authentic yield curve.

2. Transition to Market-Clearing Exchange Rates: Eliminate administrative rationing in foreign exchange pricing, letting an authentic market rate clear external balances and protect reserves.

3. Statutory PCA with Automated Provisioning Triggers: Enact legally binding Prompt Corrective Action legislation where asset impairment and provisioning shortfalls trigger mandatory restrictions automatically. Integrate automated supervisory audit systems to penalise misrepresentation by banks and their external auditors, eliminating information asymmetry.

4. End the Bureaucratic Duopoly: Dismantle the Financial Institutions Division’s administrative oversight over state banks, establishing a single supervisory standard for all deposit-taking institutions.

5. Establish a Modern Resolution Architecture: Equip the central bank with statutory resolution powers to haircut wholesale creditors, wind down insolvent lenders, and transfer viable deposits to bridge institutions without judicial delays.

Central bank independence cannot survive as an abstract legal virtue. As long as Bangladesh Bank lacks secondary debt markets, flexible pricing channels, and automated resolution tools, it will remain hooked on administrative discretion—and wherever discretion reigns, capture will follow.

True autonomy will arrive not when a governor is granted absolute personal discretion, but when the central bank is equipped with the market instruments to govern impersonally, and bound by statutory rules to let the consequences fall where they may.

*Sajed ul Islam is a senior banking executive and financial markets specialist with three decades of global institutional experience across treasury, capital markets, and corporate governance.