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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. 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.
Introduction
Non-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 country’s financial 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.
In relatively advanced economies there are different types of non-bank financial institutions namely
insurance companies, finance companies, investment banks and those dealing with pension and
mutual funds, though financial innovation is blurring the distinction between different institutions. In
some countries financial institutions have adopted both banking and non-banking financial service
packages to meet the changing requirements of the customers. In the Bangladesh context, NBFIs are
those institutions that are licensed and controlled by the Financial Institutions Act of 1993 (FIA ’93).
NBFIs give loans and advances for industry, commerce, agriculture, housing and real estate, carry on
underwriting or acquisition business or the investment and re-investment in shares, stocks, bonds,
debentures or debenture stock or securities issued by the government or any local authority; carry on
the business of hire purchase transactions including leasing of machinery or equipment, and use their
capital to invest in companies.
The importance of NBFIs can be emphasized from the structure of the financial system. In the
financial system of Bangladesh, commercial banks have emerged in a dominant role in mobilizing
funds and using these resources for investment. Due to their structural limitations and rigidity of
different regulations, banks could not expand their operations in all expected areas and were confined
to a relatively limited sphere of financial services. Moreover, their efforts to meet long term financing
with short term resources may result in asset-liability mismatch, which can create pressure on their
financial base. They also could not broaden their operational horizon appreciably by offering new and
innovative financial products. These drawbacks led to the emergence of NBFIs in Bangladesh for
supporting industrialization and economic growth of the country.
The purpose of this paper is to highlight different features of NBFIs, their contribution to the overall
economy and product base of NBFIs. The paper also describes the performance of NBFIs measured
by different financial indicators, along with the effects of banks’ entry into the non-bank financing
area. Special emphasis has been given to identify the challenges faced by NBFIs in Bangladesh.
Finally, development of NBFIs as well as their role in strengthening the financial system has been
discussed. The analyses have been conducted on the basis of the secondary data obtained from
different sources like NBFIs, Bangladesh Bank, Leasing Year Book etc.
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.
3. Recent Development and Activities of NBFIs
The major business of most NBFIs in Bangladesh is leasing, though some are also diversifying into
other lines of business like term lending, housing finance, merchant banking, equity financing,
venture capital financing etc. Lease financing, term lending and housing finance constituted 94
percent of the total financing activities of all NBFIs up to June 2006. A break-up of their financing
activities reveals that the share of leasing and housing finance in the total investment portfolio of
NBFIs has gradually decreased from 59 and 15 percent, respectively, in 2002 to 46 and 14 percent in
June 2006. The share of term loans, on the other hand, has increased from 20 percent to 34 percent
during the same period implying increased focus on the former. The evolvement of NBFI business
activity is observed in Figure 1. It can also be seen from the figure that the portfolio mix of NBFIs has
become quite stable from 2004.
NBFIs offer services to various sectors such as textile, chemicals, services, pharmaceuticals, transport,
food and beverage, leather products, construction and engineering etc. The percentage of the sectorwise
distribution of NBFIs investment in 2005 is given in Figure 2. Although an individual NBFI may
have a different portfolio as per its business strategy, the aggregated data shows that NBFIs mainly
focus on real estate & housing (13%), power & energy (12%), textile (11%) and transport sector (9%).
Service (finance and business) is another area of importance for NBFIs. From the perspective of
broad economic sectors, investment in the industrial sector (42%) dominated that in the service
sector (33%) in 2005. NBFIs are also exploring other sectors namely ‘pharmaceuticals & chemicals’,
‘iron, steel & engineering’, ‘garments & accessories’, ‘food & beverage’ and ‘agro industries &
equipment’. The weight of these sectors is 23 percent of the total portfolio.
The contribution of NBFIs’ financing activities (lease, loan, housing, investment etc.) to the overall
economy persistently increased over the years as can be seen in Figure 3. In 2001, the share of NBFIs’
financing to total GDP had been only 0.84 percent, which was more than doubled within 5 years and
became 1.83 percent in 2005. The comparative figures for the banking sector were 34.55 and 41.32
percent in 2001 and 2005, respectively. The average yearly growth of NBFIs’ contribution to GDP
was about 22 percent during this period as compared to 4.7 percent of that by the banking sector.
Even in the regional context, performance of NBFI sector is quite robust. As of December 2004,
NBFIs contributed 5 percent of the total bank credit as against 3 percent in India, 6 percent in Pakistan
and 8 percent in Sri Lanka (Chowdhury, 2005). The share is increasing over the years and reached 5.2
percent in 2005.
Products and Services Offered by NBFIs
Non-Bank Financial Institutions play a key role in fulfilling the gap of financial services that are not
generally provided by the banking sector. The competition among NBFIs is increasing over the years,
which is forcing them to diversify to a wider range of products and services and to provide innovative
investment solutions. NBFIs appear to offer flexible options and highly competitive products to help
customers meet their operational and financial goals. The table below provides a summary of the
product range offered by existing NBFIs of Bangladesh.
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 activities 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 (Choudhury, 2001), though Figure 6 suggests that this has
not been the case.
7. Challenging Issues for NBFIs
(a) 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.
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
company’s 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)). Therefore, NBFIs have
to explore alternative ways for raising funds. Information about the asset-liability mismatch scenario
of selected NBFIs is shown in table 3.
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 non-performing 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).
(e) 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 the
financing requirements of the evolving economy. With regard to deployment of funds, the total
outstanding lease, loan and investment by NBFIs stood over BDT 34 billion, BDT 26 billion and BDT 3
billion respectively by the end of September, 2006. 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.
(f) 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.
(g) 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.
(h) 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.
(i) Lack of a 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 prevalent mode of finance lease in
case of these recovered assets to create a demand for second hand or used machinery and equipment.
8. Suggested Alternatives
(a) 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