Abstract

Non-Bank Financial Institutions (NBFIs) in Bangladesh are gaining increased popularity in recent times. Though the major business of most NBFIs is leasing some are also diversifying into other lines of business like term lending, housing finance, merchant banking, equity financing and venture capital financing. The purpose of this paper is to highlight different features of NBFIs, their contribution to the overall economy and the product base of NBFIs. The paper also describes the performance of NBFIs as measured by different financial indicators, along with the effects of banks entry into the non-bank financing area. In addition, non-bank financial sector is important to increase the mobilization of term savings and for the sake of providing support services to the capital market. The focus of this paper is to highlight the necessity and importance of NBFIs to strengthen the financial system for rapid economic development of the country. Special emphasis has been given to identify the challenges faced by NBFIs in Bangladesh. And finally, development of NBFIs as well as their role in strengthening the financial system of Bangladesh has been discussed. It is found that despite several constraints, the industry as a whole is performing reasonably well. Given appropriate support, NBFIs will be able to play a more significant role in financial intermediation.

TABLE OF CONTENTS

Sl no. 1 2 3 4 5 6 7 8 9

Topics Introduction Industry definition Services provided Emergence of NBFIs in Bangladesh Classification Ownership pattern Market capitalization The business cycle and industry sectors

Page no 4 4 5 6 6 7 10 11

Some economic variables and effect of their changes in 15 different industries

10 11 12 13 14 15 16 17 18

Global industry analysis Major players in NBFI sector NBFI tax structure Valuation of socks in NBFI Key success factors Driving forces Highlights of major events Banks entity in Non Banking Financial activity Challenge issues for NBFI

18 19 19 20 21 22 24 26 27

19 20 21 22

Suggested alternatives Conclusion References Annexure : listing of NBFI

30 32 33 35

1. Introduction

system. According to Goldsmith (1969), financial development in a country starts with the development of banking institutions. As the development process proceeds, NBFIs become prominent alongside the banking sector. Both can play significant roles in influencing and mobilizing savings for investment. Their involvement in the process generally makes them competitors as they try to cater to the same needs. However, they are also complementary to each other as each can develop its own niche, and thus may venture into an area where the other may not, which ultimately strengthens the financial mobility of both.

on-Bank Financial Institutions (NBFIs) play a significant role in meeting the diverse financial needs of various sectors of an economy and thus contribute to the economic development of the country as well as to the deepening of the countrys financial

2. Industry Definition

NON-BANK FINANCIAL COMPANY

Non-bank financial companies (NBFCs) are financial institutions that provide banking services without meeting the legal definition of a bank, i.e. one that does not hold a banking license. These institutions are not allowed to take deposits from the public. Nonetheless, all operations of these institutions are still exercised under bank regulation. However this depends on the jurisdiction, as in some jurisdictions, such as New Zealand, any company can do the business of banking, and there are no banking licenses issued.

NON-BANK FINANCIAL INSTITUTION

A non-bank financial institution (NBFI) is a financial institution that does not have a full banking license or is not supervised by a national or international banking regulatory agency. NBFIs facilitate bank-related financial services, such as investment, risk pooling, contractual savings, and market brokering.[1] Examples of these include insurance firms, pawn shops, cashier's check issuers, check cashing locations, currency exchanges, and microloan organizations.

3. Services provided

NBFCs offer all sorts of banking services, such as loans and credit facilities, private education funding, retirement planning, trading in money markets, underwriting stocks and shares, TFCs and other obligations. These institutions also provide wealth management such as managing portfolios of stocks and shares, discounting services e.g. discounting of instruments and advice on merger and acquisition activities. The number of non-banking financial companies has expanded greatly in the last several years as venture capital companies, retail and industrial companies have entered the lending business. Non-bank institutions also frequently support investments in property and prepare feasibility, market or industry studies for companies. However they are typically not allowed to take deposits from the general public and have to find other means of funding their operations such as issuing debt instruments

4. Emergence of Non-Bank Financial Institutions in Bangladesh

Initially, NBFIs were incorporated in Bangladesh under the Companies Act, 1913 and were regulated by the provision relating to Non-Banking Institutions as contained in Chapter V of the Bangladesh Bank Order, 1972. But this regulatory framework was not adequate and NBFIs had the scope of carrying out their business in the line of banking. Later, Bangladesh Bank promulgated an order titled Non Banking Financial Institutions Order, 1989 to promote better regulation and also to remove the ambiguity relating to the permissible areas of operation of NBFIs. But the order did not cover the whole range of NBFI activities. It also did not mention anything about the statutory liquidity requirement to be maintained with the central bank. To remove the regulatory deficiency and also to define a wide range of activities to be covered by NBFIs, a new act titled Financial Institution Act, 1993 was enacted in 1993 (Barai et al. 1999). Industrial Promotion and Development Company (IPDC) was the first private sector NBFI in Bangladesh, which started its operation in 1981. Since then the number has been increasing and in December 2006 it reached 29.1 Of these, one is government owned, 15 are local (private) and the other 13 are established under joint venture with foreign participation.

5. Classification

Depending upon their nature of activities, non- banking finance companies can be classified into the following categories: 1. Development finance institutions 2. Leasing companies 3. Investment companies 4. Mudaraba companies
6

5. House finance companies 6. Venture capital companies 7. Discount & guarantee houses

6. Ownership Pattern
The ownership pattern of NBFIs, nature of activities and share percentages are in below:

Ownership pattern

Name of NBFIs

% of local

Share foreign

Govt.

Nature Activities

of

Govt. (100%)

IDCOL

100

Leasing, Project fiancing

LocalPrivate

2 3

PLC UCL

100 100

Leasing Leasing, Investment Banking

PFIL

100

Leasing, Investment & Merchant Banking. Housing

BLIL

100

Leasing, Merchant

banking 6 7 8 9 10 PLFSL NHL MIDAS FLIL BFIL 100 100 100 100 100 Leasing Housing Loan Loan Investment Banking 11 12 IIDFCL Islamic Finance Joint Venture 13 14 ULCL IDLC 28 46.8 60 45 12 8.11 Leasing Leasing, Loan, Merchant Banking 15 SABIN CO 50 50 Loan, Investment & Merchant Banking 16 UFIL 25 25 50 Leasing, Merchant Banking 17 UAEBIC 40 60 Loan, Investment 100 100 NA* NA*

18

ILFS

NA

Leasing Loan

19

GSP-FCL

14

76

Leasing, Merchant Banking

20

BBFIL

70

30

Leasing, Loan

21 22

DBH VANIK

70 70

30 30 -

Housing Leasing, Investment, Merchant Banking and Housing Finance

23

BIFL

NA

Leasing

24

IPDC

30

70

Leasing, Loan, Investment.

25 Data Source BB, NBFIs *NA- Not available

FA

NA

NA*

7. Market Capitalization and Listed Securities

The total market capitalization at DSE reached Tk. 1,043.8 billion in December 2008 with 412 listed securities consisting of 276 companies, 16 mutual funds, eight debentures, 111 Government bonds, and one corporate bond. The capital market reached new heights in terms of market capitalization. At the end of 2008, market capitalization at DSE was 19.3 percent of the country's GDP compared with 15.7 percent in December 2007. During 2008, total issued capital rose by Tk. 33.2 billion of which Tk. 16.5 billion was through bonus and right issues and Tk. 16.7 billion was by new issues. During the year, 15 companies were listed in DSE of which five were listed through the direct listing route. In terms of sect oral composition, the financial sector (including banks, investment and insurance) continues to hold the majority share in total market capital capitalization at DSE: 55.6 percent as compared with 24.6 percent for manufacturing and 19.5 percent for service and miscellaneous sector in December 2008. The share of the financial sector in total market capitalization was 64.2 percent in December 2007.

10

Figure: Sector-wise Composition of Market Capitalization in DSE Note: Figures in parentheses show the share of the sub-sectors in total market capitalization of listed companies. Source: The Monthly Review, Dhaka Stock Exchange, December 2008.

8. THE BUSINESS CYCLE AND INDUSTRY SECTORS

Industry performance can be largely affected by economic trends. This economy can be monitored by identifying and monitoring the key economic variables, different assumptions and theories. There are some other measures like gathering up new information about economic outlook and conducting various analysis of relevant industry on the basis of accumulated information.

11

Economic trend basically falls in following two basic categories  Cyclical change  Structural change  Cyclical change: this sort of change arises from the fluctuation (ups and downs) of the business cycle.  Structural change: this sort of change occurs when an economy undergoes through major structural reform and functional change. Transition of United States from manufacturing to service economy or transition from social to market economy are he popular examples of structural changes.

INDUSTRY PERFORMANCE IN BUSINESS CYCLE

It is believed by various experts that, industry performance is very much related to the different stages of business cycle. And these stages make the analysis of industry challenging. As the cycle rotates or fluctuates it also creates variation in analysis of performance. So, it is important to realize the position of that industry first in the business cycle before forecasting or analyzing. If anyone takes into account the history only then he will miss the changing trend of that industry and definitely the forecasting will contain substantial misstatements.

Her, another thing should also be mentioned that, sometimes , switching from one industry group to another also takes place in a business cycle which is known as Rotation Strategy. In this case also, it is necessary to determine the position of industry in the business cycle. If it ensures that, the next stage of business cycle is going to benefit the industry group, only then the investors should go for that industry group and need to identify and monitor the key variables related to the economic trends.

12

The figure presents a graphic of which several industries perform well in several stage of business cycle.
TOWARD THE END OF A RECESSION

No 1

Impact Financial stock value soars

Reason Investors anticipates that - banks earnings will rise - both economy and loan recover

Brokerage house become attractive Sales and earnings of brokerage houses are investments expected to rise because Investors trade securities Businesses sell debt and equity.

consumer staples outperform others

Actually consumer staples are irrelevant with recession or boom. If the overall spending declines at a higher rate, people will still spend for food, pharmaceuticals, beverages.

13

WHEN THE RECESSION ENDS

No 1 2 3

Impact Increase in loan demand Increase in house construction Increase in security offering

AT THE BEGINNING OF RECOVERY LEVEL

No 1

impact

Reason

Consumer durable industry (car, A reviving economy increases PC, refrigerator etc)experiences boom goods Consumer confidence personal income

Capital flourishes

industries When the economy recovers, people think about modernizing renovating purchasing capital goods

Cyclical

industries

become High degree of operating leverage makes this industry lucrative.

attractive investments

AT THE PEAK OF BUSINESS CYCLE

No 1 2

Impact Rate of inflation increases

reason Demand surpasses the supply

Basic material industries becomes Inflation has little influence on the cost o extracting investors favorite those products and they can increase price ensure higher profit margin.

If a weak domestic economy cause weak currency, industries with large export components to growing economies may benefit because their goods become more cost competitive in the overseas market.
14

9. SOME ECONOMIC VARIABLES AND EFFECT OF THEIR CHANGES IN DIFFERENT INDUSTRIES

INFLATION

NO INDUSTRY 1 Stock market

IMPACT Negative

REASON Inflation causes higher market interest rate increases uncertainty about future price and cost harm to ims those can not pass through their cost increase

Natural resources

Positive

If production cost do not ise with inflation they can likely to sell their output at a higher price

Industries having Benefit high leverage operating

their costs are fixed with nominal terms revenue increase with inflation

Industries high leverage

with benefit

Their debts are repaid in cheaper dollars

financial

INTEREST RATE

No. INDUSTRIES 1 Financial institutions 2 Housing construction

IMPACT negative

REASON It is difficult o pass on the higher rates to customers .

and negative

People

get

reluctant

to

spend

additional amount of money in this sector

Do-it-yourselfer

positive
15

supplier 4 retirees positive As retirees income depends on the interest, it increases their income

INTERNAIONAL EONOMICS

The fluctuation of dollar or euro or other currency may cause significant variation in recognition of revenue in the international export/import business
CONSUMER SENTIMENT

Optimistic consumers are more wiling to spend money for expensive goods like- house, car, furniture etc. therefore performance of consumer cyclical industries will be affected by changes of consumer sentiment Consumers willingness and ability to borrow and spend money.

STRUCTURAL ECONOMIC CHANGES AND ALTERNAIVE INDUSTRIES

Apart from the factors described below, there are some other important factors which have significant impact on the cash low and risk prospect of different industries, likeDEMOGRAPHICS

Demography has a large impact on a countrys consumption in several issues like Advertizing House construction Health care Social security and so on.
16

AND POPULATIONS OF DIFFERENT AGE HAVE DIFFERENT USAGE TO THE ECONOMY

No 1

Population type Young people

Impact Adequate storage of entry level workers Decreasing labor cost Resource person available for replacing the retiring person

Senior citizen

Save more Invest their savings. Therefore good or financial industries

LIFESTYLES

Consumer behavior is highly affected by trends and fads. And sales in several industries have affected from exercise of consumer wide variety of choices. No 1 2 3 4 Consumer choice Junk food Private residence Private transport Dual career families Affected industries Restaurants, fast food shops Housing and real state Automobile Day care center

TECHNOLOGY

Trends in technology can affect numerous industry factors. For example, demand has fallen for carburetors and shifted electronic fuel injection due to advancement of technology. Information super highway is becoming a reality and encouraging linkages between telecommunication and cable television system. Changes in technology have spurred capital spending in technological equipments as a mean to gain competitive advantage. Retailing industry has become a user of new technology. It helps retailing business to be more decentralized and geographically diversified. Major retailers use bar-code scanning to speed up
17

the check out process. EDI allows the retailers to connect with the suppliers electronically and to order new inventory and pay accounts payable EFT allows moving funds quickly and easily through local banks and headquarters

POLITICS AND REGULATIONS

Todays social value may be tomorrows law as political change reflects social values. Some impacts of political change on business are as follows Heavy regulation of an industry can result in increasing firms cost but restricts entry to the industry. Changing regulation of industry brings participants of financial service industries together Political regulations and law affect international commerce trade laws, tariffs, embargoes and other trade barriers.

10.

GLOBAL INDUSTRY ANALYSIS

In the era of globalization, so many firms of different industries are involved in the foreign market as well as foreign firms are also doing business In our country. That is necessary to consider the effects of foreign firms on industry returns.we must extend analysis to include global factor. Following major factors are needed to be analyzed in this respect  The macro environment of the parent country and the demand in the subsidiary country
18

 Accounting differences by different countries.  Effect of currency exchange rate trends  Socio political factors, barriers etc. In summary, it is necessary to consider global factors while analyzing industry.

11. MAJOR PLAYERS IN NBFI SECTOR

In NBFI sector of Bangladesh, there exists 29 NBFIs and their major players are as follows Bangladesh Bank  Securities & Exchange Commission  Inter bank call money market  Existing applicanle rules, regulation, laws and acts.

12. NBFI INDUSTRY TAX STRUCTURE

The standard rate of corporate tax in Bangladesh is 27.5% in 2010 - 2011 tax year. This is the standard corporate tax rate applicable to publicly traded companies in Bangladesh, a list including tax rates for other corporations are as follows:

No. Industry sector 1 2 Publicly Traded Company Non-publicly Traded Company

Tax rate 27.5% 37.5%

19

3 4 5

Bank, Insurance & Financial Company Mobile Phone Operator Company Publicly Traded Mobile Operator Company

42.5% 45% 35%

13. VALUATION OF STOCK IN NBFI

Following system is applicable in valuation of stocks in NBFICOMPARABLE INDUSTRY MULTIPLE

Valuation using multiples is a method for determining the current value of a company by examining and comparing the financial ratios of relevant peer groups, also often described as comparable company analysis. The most widely used multiple is the price-earning ratio(P/E ratio or PER) of stocks in a similar industry. Using the average of multiple PERs improves reliability but it can still be necessary to correct the PER for current market conditions. P/E multiples are popular in part due to their wide availability. The value of a business should, however, be reflected in multiples based on enterprise value of a company. These multiples reveal the rating of a business independently of its capital structure, and are the most commonly used in transactions on private companies. Formula:

Condition: Peer company is profitable.

20

Rf = discount rate during the last forecast year tf = last year of the forecast period. C = correction factor P = current stock Price NPP = net profit peer company S = number of shares NPO = net profit of target company after forecasted period.

And from recent study, it is found that Non-bank financial institutions (NBFIs) have logged huge profits from the stock market in step with banks, moving away from their core business. NBFIs recorded 25% growth in operating profits in 2010. On average, 60% of the profits were generated through the capital market operations. Some institutions earned as high as 80-90% of their profits from the stock business. As the energy crisis slowed demand for industrial loans, NBFIs had no alternative avenues for investment other than the stock market. Twenty-nine NBFIs are operating in the market and 21 of them are listed on the stock exchange. All these 29 NBFIs made combined operating profits worth BDT 8.62 billion in 2010, 25% more than the profit in 2009. IDLC, Lanka Bangla and Prime Finance, which are the market leaders in terms of business size, made most of their profits from the capital market operations. Companies such as United Leasing and Uttara Finance made the least from stock market business. Sensing increasing restrictions on NBFI's exposure to the stock market, the companies are now thinking of alternative windows for income such as SMEs and housing sector

14. Key success factors:

1. Globalization: Todays world is like a global village. Competition is more critical in a global market. Globalization is the most important key success factors of NBFIs. NBFIs have to cope with globalized competition to achieve the optimum success. Globalization increases the scope of business of this sector in a large scale.

21

2. Cost Efficiency: Cost efficiency means to reduce the cost and the same time to increase the quality of the service. It means cost has to be reduced but the quality should not deteriorate when reducing the cost. 3. Quality: Long term success of NBFIs can only be ensured by providing the required quality of goods & services to the consumer. Without enhancing quality of service no NBFIs can survive in the long run. 4. Increase Market Share: No companys growth & development is not possible until & unless it increases its market share. Market share means the coverage of markets segment of the relevant industry by any particular company. 5. Advertisement: Advertisement is like the light-house of any company. It is advertisement that introduces a company to all over the world and increases the consciousness of potential consumers about the service or products of a company. By using the advertisement properly any company can ensure its smooth success. 6. Marketing Mix: Marketing mix as a comprehensive business policy is a recent hallmark in achieving business success. Marketing mix means the perfect combination of present and potential marketing policy to increase the companys identity throughout the world with a view to increase revenue.

15. Driving Forces

NBFIs are specialists of the intermediation process and their origins can be traced to the development of specialized financial institutions. Some survived centuries of changing economic and financial developments. Others appeared in response to special opportunities or needs and have disappeared just as quickly. Their survival and existence depend upon their ability to (a) offer contracts that serve the needs of specialized customers, (b) maintain a spread between the

22

rate they pay for funds and the rate they receive that will support their costs, and (c) meet commitment to suppliers of funds. The non-bank financial sector has a wide diversity of institutions. Despite their importance as alternative sources of finance to the commercial banks, their liabilities may nevertheless be regarded as 'near money'. The key driving forces of the NBFIs are as follows: 1. Product innovation: Innovation of new product & services leads any NBFIs to drive its present business operation. Coping with new product or service is essential to survive in the market. Obsolete product line cannot ensure smooth success. 2. Product Differentiation: No NBFIs should wait for innovating new services by other institutions. They themselves should try to differentiate its present service or product line to strengthen its market position. This force also leads the diversification of the sectors institutions. 3. Changes in long term growth: Potential symptoms of changes in long term growth leads diversification of institutions. It may be required by customer demand or regulations or by competitors. Even the size of potential growth drives the institutions. 4. Business Contracting: Contracting with new & new businesses works as a key force to diverse the sector. Business contracting may be required to change the framework of the institutions. Different businesses have different types & nature of contracts that works as a driver of the institutions. 5. Marketing Innovation: Innovation of modern marketing concept also drives the institutions. The NBFIs have to realize and implement the developed marketing theory to compete. New concepts lead the diversification of contemporary marketing policy. 6. Economies of Scale: To obtain the economies of scale, many NBFIs change its contemporary business cycle and processes. Because economies of scale is a key success factor. And in some cases after attaining the economies of scale many NBFIs diverse its operation of business.

23

7. Regulations: Most of the time different regulations imposed by controlling authority drive the operations of the NBFIs. As there is no option to escape from the hand of regulation, the NBFIs have to implement the changes required by the rules and regulations.

16. HIGHLIGHTS THE MAJOR EVENTS

LARGE PROFITS FROM CORE BUSINESSES

Non-bank financial institutions (NBFIs) have logged huge profits from the Booming Stock market from their core business. They recorded 25 percent growth in operating profits in 2010, statistics show. On average, 60 percent of the profits were generated through the capital market operations alone.

PAID UP CAPITAL DOUBLE

The Bangladesh Bank directed non-bank financial institutions (NBFIs) to double their paid-up capital to Tk 50 crore from the existing Tk 25 crore. Central bank sets December 2010 deadline
24

OPPORTUNITY OF TAKING FOREIGN LOANS

Recently The Central Bank said , Non-bank financial institutions (NBFIs) can now take foreign loans only for funding manufacturing and infrastructure (except housing) sectors.
LIQUIDITY PRESSURE

NBFIs will come under fresh liquidity pressure between April and June in fiscal year (FY) 201011 (FY11) when the government will be borrowing, at least, an amount of Tk 63.25 billion from them.
BB TO BRING NBFIS UNDER BASEL-II FROM 2012

The Basel-II accord from January 2012 aiming at consolidating capital base of the country's financial institutions. NBFIs would calculate minimum capital requirement under the Basel-II on test basis from January 1, 2011 using the draft guideline.

25

17. Banks Entry in Non-Bank Financial Activity

The activities of NBFIs witnessed an impressive growth during the last five years. As per Section 7 of the Banking Companies Act 1991, commercial banks also started different activit ies offered by NBFIs, specially leasing. The entry of banks in this sector is expected to brace the growth momentum and will fill the gap in acquiring the institutional finance and serve the needs of the industrial sector in the acquisition of capital assets. Commercial banks worldwide are directly or indirectly involved in activities such as leasing, hire purchase, term lending, house financing and capital market operation. In developed countries commercial banks are also actively involved in different activities other than banking. In Turkey, banks are empowered to arrange lease finance by virtue of special laws relating to this particular activity. Following the deregulation of the local banking system as well as diversification of business, a number of banks in Taiwan established their own independent leasing companies (Chen 2001). In India, commercial banks are permitted to transact leasing business through subsidiaries. In Bangladesh, commercial banks started their leasing operation effectively in 1995 (Banarjee and Mamun, 2003). At present, almost all major private commercial banks are involved in non-bank financial operations. Operation by banks in what have been traditional non-banking areas is often questioned by NBFIs although both can act as complementary to each other rather than being competitors. Bangladesh Lease and Finance Companies Association (BLFCA) alleged that commercial banks of the country are engaged in non-bank finance activities within the existing banking rules, which is posing difficulties for non-bank financial institutions.4 This is because by having access to cheaper rate funds, banks have a comparative advantage over NBFIs that does not ensure proper competition for both. Again, it is argued that if banks continue in the leasing business then the default culture of the banking system may also infect the leasing industry.

26

18. Challenging Issues for NBFIs

SOURCES OF FUNDS

NBFIs collect funds from a wide range of sources including financial instruments, loans from banks, financial institutions, insurance companies and international agencies as well as deposits from institutions and the public. Line of credit from banks constitutes the major portion of total funds for NBFIs. Deposit from public is another important source of fund for NBFIs, which has been increasing over the years. NBFIs are allowed to take deposits directly from the public as well as institutions. According to the central bank regulation, NBFIs has the restriction to collect public deposits for less than one year, which creates uneven competition with banks as banks are also exploring the business opportunities created by NBFIs with their lower cost of fund. Although recent reduction of the minimum tenure of the term deposit from one year to six months for institutional investor has had a positive impact on their deposit mobilization capacity. NBFIs can develop attractive term deposit products of different maturities to have access to public deposits as these are one significant source of their funds. Although share capital is another prospective source of fund for NBFIs, many companies have not utilized this opportunity fully. As all NBFIs are incorporated as public limited companies, it could be a better alternative for them to raise fund through initial public offerings in order to finance the expanding horizon of activities. Figure 7 shows the composition of the sources of fund for NBFIs. It is evident that loan from bank and deposit base are the key sources for NBFIs fund and account for nearly 75 percent of the total. It can also be seen that the dominance of bank loan in the total fund is decreasing while the importance deposit base is gaining momentum.
COST OF FUND

The structure of cost of fund for NBFIs does not follow any unique trend. Banerjee and Mamun (2003) showed that weighted average cost of fund for the leasing companies is always positioned much higher than that of banks. According to their study, cost of funds for leasing companies
27

varied between 8.4 to 15.3 percent while that of banks was between 8.5 to 9.5 percent. Choudhury (2001) mentioned that about 15 percent of the deposit of the banking sector was reported to be demand deposits, which are interest free while 35 percent constituted low cost saving deposits having an average of 4 to 5 percent interest rate and the rest were fixed deposits bearing an average of 9 percent interest rate. Thus the weighted average cost of fund for banks would be at best 7 to 8 percent, which is almost half of that of NBFIs.
ASSET-LIABILITY MISMATCH

Asset-liability mismatch is another cause of concern for NBFIs. Demand for funds to meet the increasing lending requirements has increased many times. But the availability of funds has become inadequate as NBFIs are mostly dependent on loan from commercial banks. International Finance Corporation (1996) observed that leasing companies are in a great dilemma while managing the mismatch between their asset and liability. According to IFC, the average weighted life of the companys business portfolio should be less than the average weighted life of its deposits and borrowing in its operating guidelines for a leasing company. Only one company in Bangladesh was successful in maintaining the above guideline (Banerjee and Mamun (2003).
INVESTMENT IN HIGH RISK PORTFOLIO

It is already mentioned that cost of funds for NBFIs are higher than that of banks. In order to sustain the high cost of borrowing, NBFIs may be inclined to invest in the high return segments, which can expose them to commensurately higher risks. Moreover, fierce competition among competitors may also force many NBFIs to reduce the margin at the expense of quality of the asset portfolio. This strategy may eventually create the possibility of an increase in the nonperforming accounts. Unless adequate risk management capabilities are developed, the growth prospects of NBFIs would not only be hindered but it might also be misapprehended (Sarker, 2004).
PRODUCT DIVERSIFICATION

NBFIs emerged primarily to fill in the gaps in the supply of financial services which were not generally provided by the banking sector, and also to complement the banking sector in meeting
28

the financing requirements of the evolving economy. NBFIs are permitted to undertake a wide array of activities and should therefore not confine themselves to a limited number of products only. Leasing, no doubt, presents a good alternative form of term financing. Even in leasing, investments were not always made in the real sector and non-conventional manufacturing sector. Almost all the leasing companies concentrated on equipment leases to BMRE (Balancing, Modernization, Replacement and Expansion) units only. New industrial units were hardly brought under the purview of leasing facilities. This implies that the new customer base has not been created and the growth of industrial entrepreneurship could not be facilitated through NBFI financing packages. Diversifying the product range is a strategic challenge for NBFIs in order to become competitive in the rapidly growing market.
COMPETITION WITH BANKS

With the advent of new NBFIs, the market share is being spread over the competing firms and the demand facing each firm is becoming more elastic. Active participation of commercial banks in the non-bank financing activities has further increased the level of competition in the industry. Leasing was considered as a non-bank financing activity until recently. But a large number of banks has also shown their interest in the leasing business and has already penetrated the market. For banks, public deposit is one major source of funds which they can collect with relatively lower cost. Thus the business environment for NBFIs has become more challenging as they have to face uneven competition with banks in terms of collecting funds.
LACK OF HUMAN RESOURCE

Skilled and trained human resource is considered as an important component for the development of any institution. Due to the recent growth of NBFIs, availability of experienced manpower is a challenge for this industry. The supply shortage of efficient resource personnel has been leading to a significant increase in the compensation package, which is also a cause of concern for NBFIs. The industry experts believe that although there exist enormous growth opportunity the market is still quite small and scope of work for skilled personnel is very limited compared to that of banks. This makes the competent personnel to switch from NBFIs to other institutions after a certain period implying low retention rate of skilled human resource.

29

WEAK LEGAL SYSTEM

Although the default culture has not yet infected NBFIs to any major extent, they face difficulties in recovering the leased assets in case of a default. Moreover delays in court procedures create another cause of concern. The situation cannot be improved only by making the legal system stronger through enactment of new laws rather ensuring proper implementation existing ones is more of concern.
LACK OF AN ESTABLISHED SECONDARY MARKET

Even in cases when the defaulted asset is recovered, the disposal of the same becomes difficult because of lack of an established secondary market. For the promotion of a secondary market, NBFIs may consider initiating the concept of operating lease instead of the prevale nt mode of finance lease in case of these recovered assets to create a demand for second hand or used machinery and equipment.

19. Suggested Alternatives

EXPLORING ALTERNATIVE SOURCES OF FUNDS

The finance and leasing companies across the world are using different sources for collecting funds. NBFIs in Bangladesh may also explore the possibilities of gaining access to new sources of funds like issuance of commercial paper and discounting or sale of lease receivables. However, in releasing such new products, some regulatory changes have to be made. Another innovative and promising source of funds may be the securitisation of assets.6 In this connection, IPDC launched first asset backed securities in 2004 as an alternative source of funding. This new instrument emerged as an important tool and added a new dimension in the financial market. The core attraction of this scheme was the tax benefit made available to investors at the rate of 10
30

percent at the time of credit of such interest or at the time of payment thereof, whichever is earlier, and this deduction was deemed to be final discharge of tax liability (Chowdhury, 2005). But changes in taxation policy in 2005 by the government have made the future of this instrument less attractive for the concerned financial institutions.
COMPETITION AND PRODUCT DIVERSIFICATION

NBFIs in Bangladesh are operating in a highly competitive environment. The competition for NBFIs is even more challenging as they have to compete with banks. Given the changes in the business environment, the need for product diversification is very important. At present, lease financing constitutes 55 percent of the total long term assets of NBFIs. The remaining part concentrates mainly on term financing and housing finance. Some of NBFIs are primarily engaged in leasing, some are also diversifying into other lines of business like merchant banking, equity financing etc. Currently, 22 NBFIs (out of 29) specialize in lease financing. NBFIs are permitted to undertake a wide array of activities and therefore should not confine themselves to one or two types of product only. Leasing, no doubt, presents a good alternative form of term financing but NBFIs should also venture into diversified use of their funds such as merchant banking, venture capital financing, factoring, etc. for a healthy growth of the capital market.
ENHANCING CAPITAL MARKET ACTIVITIES

NBFIs around the world carry out a significant role in the development of the capital market. Strong institutional support is necessary for a vibrant capital market which is the core of economic development in any market based economic system. NBFIs through their merchant banking wing can act in this regard.
ISSUES OF TAXATION

The financing mode of lending and leasing are totally different from one another. The concept and procedure particularly the accounting and taxation system are also quite different. So it is advisable not to mix up the two different operations, otherwise it might distort the basic financial norms. As the tax treatment is totally different in leasing business, mixing up of lending and leasing in the same business portfolio might create the possibility of tax evasion (Sarker, 2004).

31

MARKET SEGMENTATION

It has been discussed earlier that though banks and NBFIs compete with each other they can also perform complementary functions. As suggested by Jamal (2004) and Sarker (2004), to function as complementary institutions both banks and NBFIs should follow some ethical and technical norms. Banks wishing to enter in the leasing business, which is essentially a core operation of NBFIs, should do so through opening subsidiaries so that a level playing field for NBFIs can be maintained. This is needed as banks have access to lower cost funds compared to NBFIs, which puts the former in an advantageous position. Alternatively, banks can go for joint financing under syndication arrangements with leasing companies on any project proposal. Again, banks can concentrate on working capital finance and foreign exchange operations, which matches more with their asset-liability management. Long term investment like financing capital machineries can be done by NBFIs and in the event when banks want to engage in such activities they can place their funds with an NBFI to extend lease facility for those machineries. Jamal (2004) mentioned that this is important for two reasons: first, in case of lease facility, the machineries will remain under the ownership of leasing companies, who will have absolute authority and control on their assets. Second, machineries will be imported in the name of a leasing company and letter of credit will be opened against its name. So, over invoicing or under invoicing may be averted and thereby more transparency will be ensured and tax evasion may be plugged.

20. Conclusion

Banks and Non-Bank Financial Institutions are both key elements of a sound and stable financial system. Banks usually dominate the financial system in most countries because businesses, households and the public sector all rely on the banking system for a wide range of financial products to meet their financial needs. However, by providing additional and alternative financial services, NBFIs have already gained considerable popularity both in developed and developing
32

countries. In one hand these institutions help to facilitate long-term investment and financing, which is often a challenge to the banking sector and on the other, the growth of NBFIs widens the range of products available for individuals and institutions with resources to invest. Through their operation NBFIs can mobilize long-term funds necessary for the development of equity and corporate debt markets, leasing, factoring and venture capital. Another important role which NBFIs play in an economy is to act as a buffer, especially in the moments of economic distress. An efficient NBFI sector also acts as a systemic risk mitigator and contributes to the overall goal of financial stability in the economy. NBFIs of Bangladesh have already passed more than two and a half decades of operation. Despite several constraints, the industry has performed notably well and their role in the economy should be duly recognized. It is important to view NBFIs as a catalyst for economic growth and to provide necessary support for their development. A long term approach by all concerned for the development of NBFIs is necessary. Given appropriate support, NBFIs will be able to play a more significant role in the economic development of the country.

21. References

1. Asian Leasing Association (1998), Asian Leasing Convention, Dhaka, 1998 2. Bakker, M. R and Gross, A (2004), Development of Non-bank Financial Institutions and Capital 3. Markets in European Union Accession Countries, World Bank Working Paper No.28 4. Banerjee, P. K. and Mamun, A.A (2003), Lease Financing in Bangladesh, BIBM Research Paper. 5. Bangladesh Bank, Annual Report (Various Issues) 6. Bangladesh Bank, Economic Trends (Various Issues) 7. Bangladesh Bank Quarterly (Various Issues)

33

8. Bangladesh Bank (2006), Financial Sector Review, Vol.1, No.1, May, Policy Analysis Unit, 9. Research Department. 10. Bangladesh Leasing and Finance Companies Association (BLFCA) Year Book (Various Issues) 11. Barai, M. K., Saha, S., and Mamun, A. A (1999), Progress and Prospects of Non-Bank Financial 12. Institutions in Bangladesh, Bank Parikrama, Vol. XXIV, No. 1 13. Chen Y.C. (2001), Lease Financing in Taiwan, In Lisa Paul ed.: World Leasing Yearbook 2001, 14. UK: Adrian Hornbrook. 15. Choudhury A. Q. (2001), Leasing in Bangladesh Problems and Prospects, The Daily Star, April 4, 2001. 16. Choudhury A. Q. (2005), Spotlight on the NBFIs of Bangladesh, published in BLFCA Year Book 17. 2005. 18. Goldsmith, R.W. (1969), Financial Structure and Development, Yale University Press, London. 19. Jamal, S.H. (2004), Banking and Leasing Complementary to Each Other, published in BLFCA Year Book 2004. 20. IFC (1996), Leasing in Emerging Markets, Lessons of Experience Series 3. 21. Sannamat, M. A. H. (2004), Merchant Banks of Bangladesh: Prospects and Problems, published in 22. BLFCA Year Book 2004. 23. Sarker, M. (2004), Managing a Non-Banking Financial Institutions Some Issues of Concern, 24. published in BLFCA Year Book 2004. 25. Khan, A.A. (2004), Leasing in Bangladesh, published in BLFCA Year Book 2004. 26. Khan, A.A. (2005), Product Options for Financial Institutions in Bangladesh, published in BLFCA 27. Year Book 2005.
34

28. Bangladesh Bank publication (January 2009), Chapter 4 :The Capital Market and NonBank Financial Sector 29. Financial Sector Review (February, 2008), Volume III No. 1, Policy Analysis Unit, 30. Bangladesh Bank 31. Banglapedia- National Encyclopedia of Bangladesh 32. Daily Newspapers

22. Annexure: The listing of NBFIs

Name of Non-Bank Financial Institution Year of Commencement 1 Industrial Promotion and Development Company of Bangladesh Ltd (IPDC) 2 Saudi-Bangladesh Industrial and Agricultural Investment Company Ltd (SABINCO) 3 Industrial Development leasing Company of Bangladesh Ltd (IDLC) 4 The UAE Bangladesh Investment Company Ltd 5 United Leasing Company Ltd (ULCL) 6 Phoenix Leasing Company Ltd 7 Uttara Finance and Investment Ltd 8 International Leasing and Financial Services Ltd (ILFSL) 9 GSP Finance Company (Bangladesh) Ltd. 10 Prime Finance and Investment Ltd. 11 Oman Bangladesh Leasing and Investment Company Ltd
35

12 Bay Leasing and Investment Ltd 13 Peoples Leasing and Financial Services Ltd. 14 First Lease International Ltd 15 Delta BRAC Housing Finance Corporation Ltd (DBH) 16 LankaBangla Finance Ltd. 17 Infrastructure Development Company Ltd (IDCOL) 18 Bangladesh Industrial Finance Company Ltd (BIFC) 19 Union Capital Ltd (UCL) 20 National Housing Finance and Investments Ltd 21 Midas Financing Ltd (MFL) 22 Bangladesh Finance and Industrial Company Ltd (BFIC) 23 Industrial and Infrastructure Development Finance Company Ltd (IIDFCL) 24 Islamic Finance and Investment Ltd (IFIL) 25 Fidelity Assets and Securities Company Ltd 26 Fareast Finance and Investment Ltd 27 Premier Leasing International Ltd 28 Self Employment Finance Ltd 29 Ahsania-Malaysia Hajj Investment and Finance Company Limited

36