Foreign Currency Bond as Solution to Trade Deficit Induced Liquidity Crisis in Banks: Evidence from Bangladesh

Abstract

The purpose of the paper is to identify the impact of trade deficit of the economy on liquidity crisis of banks and develop the model of foreign currency bond to solve the problem in the banking industry of Bangladesh. From the data of 20 years, statistically significant negative correlation (-0.946) has been found between trade deficitof the economy and demand deposit of banks. Hence, simple linear regression has been applied to assess the impact of trade deficit on demand deposit of banks. Besides, a model of foreign currency bond in association with central bank and commercial banks has been proposed to solve the problem of liquidity crisis resulting from trade deficit. The period studied in this paper is 20 years out of available data of 25 years (1993-2018) omitting the data of 5 years due to outliers in value and unavailability of data just after Liberation War 1971. Besides, only trade deficit has been taken into consideration as determinant of liquidity crisis ignoring other factors as non-performing loan and statutory liquidity reserve however only trade deficit demonstrates 89.5 percent of the variation in the demand deposit of banks under this study.The paper is significant for the banking industry as it faces the problem of liquidity crisis frequently where the proposed model will generate fund for the commercial banks to solve the problem.