Bonds have long been a stable source of finance for companies and government throughout the world. The market capitalisation of bond in USA, China, Malaysia, Indonesia and Vietnam is around 144 per cent, 68 per cent, 98 per cent, 19 per cent, and 23 per cent, of their GDP (gross domestic product) respectively; whereas it is only about 2.4 per cent of GDP in Bangladesh.
The absence of a sufficiently large corporate bond market is resulting in an overly large corporate lending by the banking system and creating maturity mismatch in the market. As a result the over-sized banking system becomes fertile ground for crony capitalism, resulting in lax lending criteria and relaxed investment standards by companies.
As a consequence, it leads the whole financial sector towards poor accounting transparency, regulatory imperfections, moral hazard problems, and, in too many cases, complicity and/or inaction tends to delay the necessary corrective measures until a genuine crisis is in full bloom.
If we look at banking system of Bangladesh it is observed that the entrepreneurs are much interested in taking loans from the commercial banks. But the capacity of the banks with short-term tenure funds is already narrowed to provide long-term finance. Banks are collecting mostly short-term (3 months to less than 1 year) liabilities to fund long-term financial need of their customers. If we go through the deposit structure of the banking sector, we would see that around 70 per cent deposits are within 1 year bucket, 25 per cent are more than 5 years bucket and rest are in 5 years and above bucket. The presence of short-term liabilities and relatively long-term assets in the books of the banks create a huge maturity mismatch in the banking sector.
Commercial banks are always trying to address the maturity mismatch in their books by booking more and more deposits. Sometimes this creates uneven competition in the market which affects the interest rates. As a result, both liquidity and interest rate volatility is observed in the market which affect the profitability of the banking sector as well as other components of the financial sector, particularly the capital market.
In the absence of the long-term bond market, banks are financing businesses and households for shorter than actually needed tenors creating overdue and asset quality impairments in books of lenders, which is reflected in the recent uptrend in non-performing loans (NPLs) in banking and financial institutions. Such a deficient market structure creates capital and money market volatility and deters the development of derivative markets required for effective risk management in the financial systems. The lack of a well-functioning bond market also blunts the effectiveness of monetary policy operations: it weakens the transmission of policy measures and thereby prevents the desired effect on the real economy (WB, 2008).
PROSPECT OF DEVELOPING BOND MARKET: There are many factors in our economy to boost an effective bond market; some of the important factors are:
1) Consistent GDP growth rate,
2) Government budget deficit,
3) Significant role of private sector in credit disbursement,
4) Declining ability of state-controlled banks to fund industrial loans,
5) Moderate inflation and exchange rate,
6) Huge fund of insurance companies,
7) Increasing investors confidence in the capital market, and
8) Benefits of bond market participants.
READY FOR TAKE-OFF: Despite earlier setbacks, the bond market in Bangladesh is ready for a rapid take-off. It is inspiring to know that Pran Group and Ashuganj Power Limited have come up with two debt securities. Additionally, banks have, although all are in private placement, issued a total of 57 subordinate bonds amounting to Tk 230 billion (23000 crore) since 2009 to insert capital under tier II.
Large infrastructure projects and the housing sector are coming up as major destinations for finance. Capital-intensive large industries and service units are increasingly being set up. A huge amount of long-term debt capital, alongside equity capital, is necessary to finance this inevitable change of the economy.
REQUIRED REGULATORY ENVIRONMENT: To develop a strong corporate bond market in Bangladesh, an important pre-requisite is to ensure a fully functioning regulatory body. There should be coordination on a regular and collaborative basis to address the accountability, transparency and compliance issues of the bond issuing agency and their trustees. Also, proper regulation of stock brokers, sub-brokers, share transfer agents, merchant bankers, underwriters, portfolio managers, investment advisers, and other intermediaries who are associated with the securities market is a priority.
Currently, service-holders of government, university and other autonomous bodies are entitled to get retirement pension. There are also private funds and gratuity schemes for the corporate sector, banks or nongovernmental organizations (NGOs). Many who work in other sectors at home and abroad and contribute to the development of the country during their working life are being expected to be included under the pension system or retirement benefit schemes in future. It is, therefore, believed that accumulated amount of pension funds will be enormous in future.
CHALLENGES: The major functional challenges in developing an effective bond market can be grouped as supply side constraints and demand side constraints. Some of the supply side constraints are
* Corporate borrowers prefer to rely for fund on banks other than bond market to avoid the need to comply with disclosure and strict governance norms of market
* Lack of benchmark yield for pricing of bonds
* High cost for launching new debt products and high transaction cost of bond-registration fee, stamp duties, annual trustee fees, and ancillary charges
* Government bond comprises 98 per cent of the existing market but are very inconsistent in maintaining market availability
* Low free float - Total bond outstanding BDT1617.68 billion & SLR requirement of banks & FIs BDT1132.29 billion
* Lack of varied corporate debt supply
* Absence of vibrant secondary market
On the other hand some of the demand side constraints are
* Investor poor confidence in issuers, the market, and legal and regulatory framework
* The investor base: Banks and a few institutional investors like life insurance companies, provident funds. No long-term funds like pension fund, mutual fund for bond investment are available
* Banks and financial institutions (FIs) are captive investors in government securities as a result of their need to comply with mandatory reserve requirement or investment restriction
* No vibrant secondary market operation
WAY FORWARD: In this backdrop, it now calls for policy and market reforms bringing in new long-term savings; and creating some liquidity augmenting mechanism at the long-term end as well as driving the borrowers and investors towards the capital market. In order to achieve this we should consider following policy measures
* Introducing long-term savings vehicles, like defined contribution individual retirement/pension funds regulated by the government
* Deepening life insurance penetration
* Promotion of loan securitisation by concerted BB-BSEC (Bangladesh Bank-Bangladesh Securities and Exchange Commission) initiative of streamlining the issue processes and paring down the issue costs
* Activation of market in mortgage-backed securities
* Ensuring the proper legal and regulatory frameworks
* Reducing corporate dependency on banks for long-term financing
* Developing market infrastructure by upgrading the depository, clearing, and settlement arrangements
* Creating an enabling legal and regulatory framework, and strengthening the credit rating industry.
* Ensuring sufficient supply of government debt securities to enhance the secondary market operation and its liquidity which will help to develop a market-based yield curve
* Bangladesh Bank should look for alternatives of T-Bill (Treasury Bill) and Bonds for maintaining SLR (statutory liquidity ratio) so that market float can be created
* BSEC and NBR (National Board of Revenue) should take necessary steps to reduce issuing costs, tapping potential new issuers and creating an enabling environment for asset-backed securitisation and infrastructure bonds
* Need a market makers: For non-corporate bonds, there may be a government-sponsored market player like ICB (Investment Bank of Bangladesh) and for mortgage bonds, HBFC (Banglasesh House Building Finance Corporation) can play that role
* BSEC/DSE (Dhaka Stock Exchnage) may create a pool of market maker for corporate bonds
SK Sur Chowdhury is the Banking Reforms Advisor and Former Deputy Governor of Bangladesh Bank.