My UK bank requires a password and a separate secret phrase that they do the letter selection from. You need to supply the password and 3 letters from your secret phrase.

As my phrase is quite long I pretty much always end up writing it down or using an editor.... :-)

I suspect it may be more related to being keylogged or an equivalent, and not revealing your entire password in the process.

It's more than likely plaintext or "encrypted" (and decrypted to check if it's correct)