The purpose of this level is to teach you how deal with compressed files of various sorts. The password for bandit13 is in the file data.txt which is a hexdump of a file that has been repeatedly compressed.
This is perhaps the longest and most annoying level of the entire game. I suggest you write down each step as you go through it, because if you ever need to start over for whatever reason, remembering everything you have done up to that point is quite a pain. When getting started make sure you read the description of the file correctly – it is a hexdump of a repeatedly compressed file, not a repeatedly compressed hexdump of a file – that is important.