The Capital Market and the Non-Bank Financial Sector

Chapter 4 The Capital Market and the Non-Bank Financial Sector 4.1 Background 99 The capital market and the non-bank financial sector play a major role to meet the long-term financing needs of a country. Prior to the liberation in 1971, the industrial financing and capital market institutions in Bangladesh were dominated by the public sector. While the insurance businesses were mainly in the private sector, agricultural, industrial, housing finance and capital market institutions were in the public domain. The development of the private sector got added importance given the growing long-term investment needs of the country. Since the eighties, a number of non-bank financial institutions in the private sector, primarily leasing and insurance companies have come into existence (Kazemi, 1998). In addition, private commercial banks have also started to play a major role in industrial term financing. According to provisional estimates of BB, a total of BDT50.8 billion (58.4 percent of total) of industrial term loans were disbursed by the private commercial banks in comparison to BDT17.3 billion (19.9 percent of total) by non-bank financial institutions, BDT11.4 billion (13.1 percent of total) by foreign banks, BDT4.5 billion (5.2 percent of total) by nationalized commercial banks and BDT3.0 billion (3.4 percent of total) by SBs in the FY05 (Bangladesh Bank, 2006, p. 49). The above figures depict the private sector dominance especially the private commercial banks in investment financing in Bangladesh. Moreover, the role of capital market in mobilizing funds for investment is still very limited; only BDT 1.2 billion was issued in FY05 as new capital in the capital market through private placements and public offerings (Bangladesh Bank, 2006, p45). Increasing involvement of banks in term lending also increases the liquidity risk for the banks from the perspective of funding of long-term loans with typically shorter-term deposits. In order to meet the long-term credit needs on a sustainable basis, development of non-banking sector is extremely important for the country. In Bangladesh, major players of the Non-Bank 99 Prepared by Md. Shahiduzzaman, Research Economist. 129

4.2 Capital Market in Bangladesh 100 sector include stocks exchanges, leasing and investment companies, merchant banks, insurance companies etc. Recently, a new trend in nonbank financial sector is the development of micro-financial institutions; where "small" savers actually save and borrow small amounts of money to expand their "small" enterprises. Each of the institutions in the non-bank sector encompasses a distinct nature of the sources and uses of funds, asset portfolio and risk exposure. In order to get a comprehensive view of the overall non-bank sector, the analysis here has been broadly divided into four subsections. The first section analyzes the development of the capital market in Bangladesh, which focuses on the security markets, mutual funds, merchant banks and the Investment Corporation of Bangladesh. The second section analyses the SBs and the third section discusses the contractual savings products like insurance and pension. Earnings, profitability and the efficiency, depth and breath of each of the sub-sectors are included in the analysis. The fourth section discusses the evolution of the micro-finance services, its regulatory and supervisory issues. The final section of the chapter incorporates an outlook of the aggregate non-bank sector. (a) Background The capital market in Bangladesh is growing at a slow pace. In last few years, especially after inception of SEC in 1993 and given the experience of share market bubble in 1996, there has been enormous changes in rules and regulations regarding public issues, right issues, acquisition, mergers and so on in order to accelerate market activities. Market surveillance and awareness have also been improved after 1996. However, the capital market in Bangladesh is still at a nascent stage and challenges remained towards gaining the investor's confidence. Historically, as a consequence of the liberation war in 1971, the existing capital market activities came to a halt because majority of the members of the stock exchange were domiciled in Pakistan who left the country. In fact, there were no longer any companies listed at the DSE, which was inherited from the East Pakistan Stock Exchange Association (established on April 28, 1954).The then government also took the nationalization measures that continued until 1975 that totally disrupted the capital market activities. As a 100 Prepared by Md. Shahiduzzaman, Research Economist. 130

result, capital market activities actually suspended during the period. Eventually, as privatization began in the mid-seventies DSE started trading activities in 1976 with only 9 companies, mostly multinational. 101 In 1977, The ICB was established in order to give institutional support to the stock exchange. In 1979, the first ICB Unit Fund came to the market. From early eighties, some banks including the AB Bank Bangladesh Ltd were listed and started trading at the exchange. During the period of 1979-85, trading at DSE, however, remained negligible. Continuous attempts were made by the Government to improve the trading activities for the next few years. Listing of the exchange crossed 100 in 1988 along with an increase in trading. In early 1990s, Foreign Exchange Regulations were revised and certain control regarding the transfer of shares and flow of foreign exchange were relaxed and the first international investor came to the market in 1993. The Chittagong Stock Exchange on the other hand was established in 1995 with 129 listed companies. 102 From October 1993, trading at DSE started to rise at a relatively high rate. The DSE general index, which was introduced in September 1986, increased to 560.21 in January 1994 from 391.77 in December 1993. Market started to show a bullish trend and general index reached to 1156.18 in July 1996 and as high as 2300 in December 1996 before plummeting to 957.48 in April 1997. The stock market bubble and its demise of 1996 happened at the cost of thousands of individuals and households who came to participate in the market for the first time having little or no knowledge about the market fundamentals and who were mostly misled by the advices given by their brokers, and rumours (see Box-4.1 for details). For the next seven years the bear continued; the Decrmber 1998 index was 540.22 in comparison to 487.77 in December 1999, 642.68 in December 2000, 829.61 in December 2001, 848.41 in December 2002 and 967.88 in December 2003. Figure 4.2.1 shows the evolution of monthly DSE General Share Price Index and turnover from January 89 to December 05 in terms of taka. The index reached a peak of 3064.99 in November' 96 from a level of 555.24 in January 89 then moved down to 484.44 in January 2000. After the 1996 crisis, the market index at DSE, in fact, started to revive from the first quarter of 2004. The monthly turnover, however, showed its volatility and reached a peak of Taka 11,168.83 million in March 2005. 101 For more detail of the history of DSE, see Monetary Policy Review, BB (2005: p 75). 102 Note that all CSE-listed companies are also listed on the DSE. 131

Figure 4.2.1 DSE General Index and Monthly Turnover (in million) (Jan '89-Dec' 05) Index 3500.00 3000.00 2500.00 2000.00 1500.00 1000.00 500.00 0.00 Jan-06 Jul-05 Jan-05 Jul-04 Jan-04 Jul-03 Jan-03 Jul-02 Jan-02 Jul-01 Jan-01 Jul-00 Jan-00 Jul-99 Jan-99 Jul-98 Jan-98 Jul-97 Jan-97 Jul-96 Jan-96 Jul-95 Jan-95 Jul-94 Jan-94 Jul-93 Jan-93 Jul-92 Jan-92 Jul-91 Jan-91 Jul-90 Jan-90 Jul-89 Jan-89 12000 10000 8000 6000 4000 2000 0 Tk. in million General Index Turnover (in million Tk.) Source: Data from Dhaka Stock Exchange After the dramatic crash of the stock market in 1996, the country s capital market witnessed a remarkable turn in recent years especially during the year 2004; the market capitalization at DSE increased by 130.83 percent from the previous year in 2004 in comparison to 36.7 percent increase in 2003 and 11.7 in 2002. Figure 4.2.2 shows how market capitalization at DSE has advanced in 2004. The main reasons behind this growth were increased confidence of the investors in the capital market, changing of the settlement system of shares, which allowed more efficient. Chittagong Stock Exchange s index rose from 1838.99 as of June 2002 to 1841.24 as of June 2003, 2329.46 as of June 2004 and 3347.1 as of June 2004. Figure 4.2.2 No. of Securities Listed and Market Capitalization at the DSE (1985-2005) 300 250 200 150 100 50 0 1985 1986 1987 1988 1989 1990 No. of Securities 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Market Capitalisation (million Tk) Source: Data from Dhaka Stock Exchange 250,000 200,000 150,000 100,000 50,000 0 132

(b) Securities and Exchange Commission, DSE and CSE Over the last few years, especially after the bubble in 1996, equity market in Bangladesh has undergone several structural changes in order to bring efficiency into the market. The SEC came into existence as capital market regulator as on 8th June 1993 through promulgation of the Securities and Exchange Commission Act, 1993 in order to ensure proper issuance of securities, to protect interest of the investors in securities, to develop and regulate the capital and securities market. CDBL was incorporated as a public limited company on 20th August 2000 to operate and maintain the Central Depository System (CDS) in order to provide efficient delivery, settlement and transfer of securities through a computerized book entry system. As of June 2005, 61 companies having 72.84 percent of the total market share in the Dhaka Stock Exchange have been brought under the depository system. Recent development regarding prudential regulations include, among other, amendment of the Rights Issue Rules (1998) and BB's instruction to the banks for sanctioning loan against dematerialized (demat) shares instead of paper scrip of the listed companies to avoid financial risk. SEC has also made it mandatory to open beneficiary owners (BO) account for application of shares through public offering. Table 4.2.1 points out some basic statistics on the performance of DSE and CSE from June 2002 to June 2005. As of June 2005 a total of 277 securities were listed at the Dhaka Stock comprising 239 companies, 12 mutual funds, 8 debentures and 18 treasury bonds as opposed to the total of 267 securities comprising 248 companies, 11 mutual fund and 8 debentures as of June 2004. At the Chittagong Stock Exchange a total of 198 securities were listed comprising 184 companies, 12 mutual funds and 2 debentures as of June 2005 as opposed to the total of 195 securities comprise 182 companies, 11 mutual fund and 2 debentures as of June 2004. Table 4.2.1 Some Selected Statistics of Dhaka and Chittagong Stock Exchanges June 2002 June 2003 June 2004 June 2005 DSE CSE DSE CSE DSE CSE DSE CSE No. of listed companies 238 170 241 172 248 182 239 184 No. of mutual funds 10 10 10 10 11 11 12 12 No. of debentures 9 4 9 3 8 2 8 2 No. of treasury bonds - - - - - - 18 - Total No. of Listed Securities 257 184 260 185 267 195 277 198 Total Market capitalization (BDT in million) 65518.0 56145.0 72998.0 60208.6 142369.0 125911.3 224611.0 202139.1 Source: Various Reports of Securities and Exchange Commission (SEC), Dhaka and Chittagong Stock Exchanges. 133

Total market capitalization at DSE increased to Taka 224,611.0 million as of June 2005 in comparison to Taka 14236.9 million as of June 2004; a 57.77 percent annual growth from 2004 to 2005 (Table 4.2.1). The annual growth rate of total market capitalization was 95.03 from June 2003 to June 2004 and 11.42 percent from June 2002 to June 2003. Total market capitalization at CSE increased to Taka 202139.1 million as of June 2005 in comparison to Taka 125911.3 million as of June 2004; a 60.54 percent annual nominal growth from 2004 to 2005. The annual growth rate of total market capitalization was a 109.13 from June 2003 to June 2004 and 7.24 percent from June 2003 to June 2004. Figure 4.2.3 Recent Trends (monthly movement) of Price Indices in Dhaka and Chittagong Stock Exchanges (Jan'04-Dec'05) 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 Dec-05 Nov-05 Oct-05 Sep-05 Aug-05 Jul-05 Jun-05 May-05 Apr-05 Mar-05 Feb-05 Jan-05 Dec-04 Nov-04 Oct-04 Sep-04 Aug-04 Jul-04 Jun-04 May-04 Apr-04 Mar-04 Feb-04 Jan-04 CSE All Share Price Index DSE General Index Source: Data from DSE and CSE Recent trends of share price indices of Dhaka and Chittagong Stock Exchanges are presented in the Figure 4.2.3. It is apparent from the figure that the two follow the same pattern. Indices in the both the markets showed a steady upward trend during March 2004 to December 2004, and then faced some volatility during Jan.-Aug.,2005 before becoming stable for the balance of 2005. During March 2004 to December 2004, the CSE index moved steeper than that of the DSE. Again, the DSE general price index in December 05 is nearly at the same level as that of October 04 level while the CSE all share price index in December 05 is nearly similar to the November 04 level. Raising of Capital through Initial Public Offering (IPO): A total of seventeen companies floated IPOs amounting to BDT3206.9 million of capital at DSE, of which BDT1265.7 million were raised from initial public subscription in 2005. Table 4.2.2 shows IPOs in last three years (2003-134

2005) at DSE. A total of three companies' worth of BDT877.8 million and a total of fourteen companies BDT9776.7 million were floated IPOs in 2004 and 2003 respectively. In recent years, one observes an overwhelming response for IPO shares as evidenced by the oversubscription of the allotment by several times. In 2005, public subscription was 11.5 times higher than the public offering in comparison to 12.15 times higher in 2004 and 18.46 times higher in 2003. Reasons include the increased public confidence given some reforms of the stock market and the development of IPO distribution system by SEC. Table 4.2.2 Initial Public Offering at DSE (2003-2005) 2005 2004 2003 No. of IPO held 17 3 14 Issue size in million BDT 3206.9 877.8 9776.7 Public Offer in million BDT 1265.7 473.9 1351.2 Public Subscription in million BDT 15795.2 6233.4 26305.7 Source: Monthly Review, December 2005, Dhaka Stock Exchange Ltd. Bond and Debenture: One important departure for the financial market in Bangladesh has been that government securities began trading at DSE from January 01, 2005. A total of 18 treasury bonds were listed at the DSE. As on June 2005, total market capitalization of debt securities stood BDT11589 million which is only 5.16 percent total market capitalization at DSE. A total of 8 debentures are listed at DSE with a market capitalization of only BDT576 million which is only 0.26 percent of total market capitalization. Thus the bonds and debentures comprise of 5.42 percent of total market capitalization. Initiatives should be prompted to stimulate the secondary market trading of bonds and debentures that would provide the investors alternative investment options. Recent Movement of Earnings and Profitability at DSE: From Figure 4.2.1 we can also see the recent movement of DSE general index and turnover. The month closing DSE General Index stood at 1843.95 in January 2005, which went down to 1510.11 in July 05 before rising to 1677.35 in December 2005. Table 4.2.3 shows the comparative position of various DSE indicators from 2004 to 2005. It shows that the DSE General Index registered a 14.91 percent decline from end-december 2004 to end-december 2005. The DSE 20 index, which comprises the blue chips shares, also went down by 25.48 percent in 2005. Investors, however, continued to show their confidence as evidenced from the 26.64 percent increase in the value of daily average transaction. The market capitalization increased to BDT 233.08 billion (roughly 5 percent of GDP) 135

from BDT 224.92 billion in 2004 i.e., 3.62 percent increase from the previous year (DSE, 2005, p43). 103 The price-earnings ratio and the dividend yield ratios indicated better performance at end-december 2005 than that in 2004. Table 4.2.3 DSE Performance (2004 and 2005) 2004 2005 Change (%) General Index* 1,971.31 1,677.35-14.91 DSE 20* 2,158.66 1,608.63-25.48 Daily Averager Transaction (BDT mn) 198.44 251.30 26.64 Market Capitalization(BDT bn) 224.92 233.08 3.62 P/E Ratio * 15.51 13.85-10.70 Dividend yield* 3.41 4.02 17.89 * End-December Source: Monthly Review, Dhaka Stock Exchange Ltd. Regional Stock Market Scenario in 2005: As of December 2005, the total number of listed companies at KSE was 661 in comparison to 239 companies at CLSE and 286 companies were listed at DSE. 104 The market capitalization for KSE stood at Pakistani Rupees 2746.5 billion as at end- December 2005; a 59.4 percent increase from the previous year. The KSE All Share Index stood at 6444.64 at end- December 2005 in comparison to 4104.86 at end- December 2004, up by 57 percent. In the CLSE, the total market capitalization increased from Sri Lankan Rupee (SLR) 382 billion at end-december 2004 to 584 billion at end-december 2005, a 52.9 percent point-to-point increase from the previous year. The average daily turnover increased from Rs.240 million in 2004 to Rs.482 million in 2005 (Central Bank of Sri Lanka 2005). The month-to-month changes of share market activities at the CLSE, however, showed a rapid increase in the first nine months of 2005 and a slow down in the last three months of 2005. The present market capitalization at DSE is only 6 percent (approximately) of GDP in terms of USD but the ratio is 42 percent for KSE and 23 percent for CLSE at end-december 2005. Market capitalization at DSE grew at a very low rate (3.62 percent) in 2005 in comparison to 59.4 percent for KSE and 52.9 percent for CLSE in local currency. Even though the average value of daily turnover in local currency increased by 26.64 percent at DSE, 103 Taking inflation into account, market capitalization will be seen as having fallen in real terms during the year. 104 The DLSE indicators have been left out from the analyses because of huge international capital inflow into the Exchange, which has made DLSE capital base and features different from DSE. 136

in case of KSE it increased by 92.9 percent and in case of CLSE it increased by 100.83 percent between 2004 to 2005. Given the above facts, it can be concluded that both KSE and CLSE showed a strong growth in 2005, while the DSE performance were dismal in the year in comparison to the other two stock exchanges of this region. However, as vigilance of SEC has improved over time, it is expected that the capital market will become a more attractive source of funds for industrial and commercial enterprises. (c) Mutual Fund, Merchant Banker and Asset Management Developing the base of institutional investor is of utmost importance for the growth of a capital market. This is because developing the institutional sources of capital increases the demand for securities on a sustainable basis because of their better risk and return management capacity than for an individual investor. Also, institutional investors like the merchant bankers involve in the screening process to bring the quality shares into the capital market. In Bangladesh, participation of the institutional investors is still very limited. However, having realized the role of institutional investment in capital market development, the government of Bangladesh has amended a number of relevant laws. For example, the Insurance (amendment) Act 2000 (sec. 27) reduced the mandatory investment in government and government approved securities to only 70 percent thereby allowing the insurance companies room to invest in alternative products e.g., in the security market. The Trusts (Amendment) Act of 2000 allows private pensions and provident funds to invest up to 25 percent of total investigable funds to listed securities. The SEC laws have been amended in order to encourage private sector -sponsored mutual funds to operate in the market. Further SEC (Merchant Banker and Portfolio Manager) Act of 1996 facilitated the operation of merchant bankers and portfolio managers. The first private mutual fund is the AIMS First Guaranteed Mutual Fund which started operating in the market in May 2000. As of June 2005, twelve mutual funds are operating in the market with a total market capitalization of BDT1247.00 million which is rather low relative to the value of total market capitalization. Among the twelve mutual funds eight are managed by Government owned ICB, two are managed by ICB Asset Management Company Ltd., one is managed by BSRS and the remaining one is managed by the AIMS of Bangladesh Ltd. More private mutual funds and their active participation are needed in order to revive the capital market. Table 4.2.4 shows the names of the mutual funds, share capital, market capitalization, price earning ratio and yield rate at DSE. The total market capitalization of all mutual funds was BDT1, 247 million 137

as on June, 2005, which is very low relative to the total market capitalization. The price-earnings ratio is the lowest and yield rate is the highest for Aims 1st Mutual Fund among the fund. Box 4.1: The Stock Market debacle in 1996 105 Stock markets in Bangladesh had experienced an unprecedented volatility in the latter half of 1996. During June 1996 to November 1996, all share price index increased from 959.05 to 3064.99 at DSE and 409.55 to 1472.68 at CSE. Market turnover and market capitalization also showed unusual hike during the period. Naturally, the bubble came to an end: the stock market prices dropped by close to 70 percent in end-april 1997 from the peaks in November 1996. However, in the meantime, it caused a lot of hard consequences from the perspective of stock market development in Bangladesh. Retail investors lost hugely in terms of money and confidence. After the stock market crisis in 1996, SEC described the situation by "Recent unusual and abnormal price fluctuation in the Dhaka Stock Exchange and Chittagong Stock Exchange led to strong reactions among the public and particularly among the investors in the capital markets. There has been general allegation by investors that there were some fraudulent acts and insider trading which may have contributed to the abnormal fluctuation in the (share) prices" (Equity Committee, 1997). An ADB report summarized the situation as due to the inability of the existing stock exchanges to service the requirements of small retail investors who jumped on the bandwagon, a huge unofficial kerb market in shares developed" (Program Performance Audit Report, ADB, May 2005). After reviewing some of the literature on this issue the common causes regarding the stock market crash in 1996 can be synthesised as follows: A general confidence among the investors along with the restoration of political stability, irrational exuberance of inexperienced new generation investors fuelled by fake stories of making profit quickly resulted in sky-rocketing demand for shares while market did not have adequate number of fundamentally sound shares. 105 Prepared by Md. Shahiduzzaman, Research Economist, PAU and Mahmud Salahuddin Naser, Joint Director, Monetary Policy Department, Bangladesh Bank 138

Box 4.1 : The Stock Market debacle in 1996 (Continued) The prevalence of big kerb market (number of small investors reached over 25,000) provided wider scope to have rumours affect share prices through infiltration into the kerb market by the agents of the sponsors and member-brokers (Alam and Jahan, 1996, p. 23). Inadequate infrastructure such as lack of proper settlement system, information efficiency and prudential regulations left scope for manipulating the market. There prevailed an absence of transparency of the activities of the stock exchange members, who concurrently functioned as brokers and dealers, and this led to malpractices with the investors when the interests of the investors and the members themselves were in conflict. Some policy decisions and their proper application such as declaration of withdrawal of lock-in to encourage activities of foreign investors and introduction of circuit breaker to hold unabated price of shares might make the retail investors feel that these policies were cushion, which would protect them from risk and made them over enthusiastic to get hold of some shares by any means. Name Table 4.2.4 Some Selected Statistics of Mutual Funds Year of listing Share Capital (BDT ml) Market Capitalization (29.06.05) (BDT ml) P/E Ratio Yield % 1st ICB M.F. 1980 5 132.75 13.91 7.53 2nd ICB M.F. 1984 5 41.00 10.41 6.10 3rd ICB M.F. 1985 10 69.70 16.92 7.17 4th ICB M.F. 1986 10 56.40 8.06 7.98 5th ICB M.F. 1986 15 51.15 16.23 7.04 6th ICB M.F. 1987 50 108.88 13.72 8.04 7th ICB M.F. 1995 30 65.33 13.02 6.89 8th ICB M.F. 1996 50 102.63 12.01 6.82 1st BSRS 1997 50 55.38 15.79 5.42 Aims 1st M.F. 2000 70 109.90 6.58 9.55 ICB AMCL 1st M.F 2003 100 302.25 21.39 3.97 ICB AMCL Islamic M. F. 2005 100 151.75 - - Source: Monthly Review, June 2005, Vol. 20, No. 6, Dhaka Stock Exchange Ltd. Note: P/E(x): Closing Price/ Earning Per Share Yield (%): (Dividend per Share/ Closing Price) x 100 Market Capitalization: Closing Price x Number of Shares. 139

A total of 29 companies are now listed as merchant banks in Bangladesh, of which, 22 are full fledged (issue manager, underwriter and portfolio manager), 6 serve only as issue managers, and one is a portfolio manager. However, the performance of most of the aforesaid companies is not satisfactory and most of them have indeed become dormant. Newspaper sources say that only four merchant banks namely Arab Bangladesh Bank Ltd., ICB capital management Ltd., Prime Finance and Investment Ltd. and AAA Consultants and Financial Adviser are fully operational in the market (The Financial Express, April 19, 2006). However, SEC is now pressing hard to make the merchant bankers fully operational. Accordingly, the Securities and Exchange Commission (merchant banker and portfolio manager) Regulations, 1996 were amended on April 17, 2006 permitting the bankers to do portfolio management with the bankers' own fund. (d) Investment Corporation of Bangladesh (ICB) 106 The ICB was established on October 1, 1976 under the Investment Corporation of Bangladesh Ordinance, 1976. The major objectives of ICB are to encourage and broaden the base of investment, to develop the capital market, to mobilize savings, to form and develop subsidiaries to spread out the business and to provide for matters ancillary thereto. ICB performs the traditional functions of a merchant bank including underwriting, issue management, portfolio management, trading in stock exchanges, private placement and equity participation, fund management (both closed and open-end mutual funds), opening and maintaining investors accounts, providing advisory services to the investors, lease financing, project financing, providing consumer credit, providing bank guarantees, acting as a trustee etc. ICB s authorized and paid up capital are 1 (one) billion and 500 (five hundred) million taka respectively. Table 4.2.5 Major Indicators of ICB Operation (in million BDT) Operation 2002-03 2003-04 2004-05 P Deposit 6066 8519 11019 Loans and Advances 6810 3960 11401 Lease Finance 85 114 614 Investment 4816 4034 4753 Total Income 1138 1376 1713 Total Expenditure 1031 1210 1516 Total Profit 107 167 197 Source: Activities of Banks and Financial Institutions 2004-05, Finance Division, MOF, GOB. pp.251 Note : P = Provisional 106 Prepared by Mainul Islam Chowdhury, Research Economist. 140

4.3 Non Bank Financial Institutions 107 The latter is divided into 4660418 general shares each having a value of 100 (one hundred) taka, of which government of Bangladesh owns 29 percent, Bangladesh Bank 13 percent, Nationalized Commercial Banks 21 percent, Development Financial Institutions 15 percent and Insurance Companies 13 percent. The rest is owned by different Private Commercial Banks and general public. Major indicators of ICB operations are summarized in Table 4.2.5. In FY05, ICB s total income and expenditure are estimated to be BDT1713 and BDT1516 million respectively leaving a profit of BDT197 million. Total income, expenditure and profit are expected to have grown at the rate of 24.5 percent, 25.3 percent and 18 percent respectively in FY05. ICB has recently formed three subsidiaries namely the ICB Capital Management Company Ltd (ICML), the ICB Asset Management Company Ltd (IAMCL) and the ICB Securities Trading Company Ltd (ISTCL). ICML performs the roles of underwriter, Issue manager and placement service provider. The net investment of ICML in FY05 was 0.09 billion taka. IAMCL made a net investment of 0.4 billion taka in 2 close ended and 2 open ended mutual funds and the market price of this investment was 0.5 billion taka in FY05. IAMCL s net investment from its own portfolio stood at 0.1 billion taka and the market price of that investment was 0.2 billion taka. Launching its operation in ISTCL emerged as the largest stock broker both in Dhaka and Chittagong Stock Exchanges, handling a total transaction of 9.4 billion taka in FY05. Non-Bank Financial institutions 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 or housing; carries on business of the underwriting or acquisition of, or the investment or reinvestment in shares, stocks, bonds, debentures or debenture stock or securities issued by the government or any local authority; carries on business of hire purchase transactions including leasing of machinery or equipment; finances venture capital; gives loan for house building and property purchases and uses its capital to invest in companies. The major differences of NBFIs with commercial banks are that the former cannot accept any deposit which is payable on demand by cheques, drafts or orders drawn by the depositor and can not deal in foreign exchange. From July 2005 NBFIs have been allowed to receive deposits of minimum 6 month tenure only in case of institutional deposits; prior to this instruction NBFIs were not allowed to receive deposit of less than one-year tenure. NBFIs are expected primarily to fill in the gaps in the supply of financial 107 Prepared by Mainul Islam Chowdhury, Research Economist. 141

services that are not in general provided by the banking sector and to complement the banking sector to meet financing requirements of the evolving economy. There are 28 NBFIs in Bangladesh (as of June 2005). 108 The major business of most NBFIs is leasing, though some are also engaged in merchant banking and housing finance. (i) Leasing Leasing involves a contractual relationship in which the owner (lessor) of an asset or property grants to a firm or a person (lessee) the use of the assets services for a specified period of time, usually for an agreed sum of rent. The firm can use the asset by paying a series of periodic amounts called lease payments or lease rentals to the owner of the asset at a predetermined rate. The payment may be made monthly, quarterly or annually. Recent Developments The first leasing company of the country, Industrial Development Leasing Company of Bangladesh Ltd (IDLC) started its journey in 1985. The leasing industry has experienced considerable growth over the last twenty years. Some of the leasing companies are primarily engaged in leasing, some are also diversifying in other lines of business like merchant banking, equity financing, term lending and house financing etc. Lease financing constitutes 54.5 percent of the total long term assets with the rest consisting mainly of term financing. The leasing industry offers its services to various sectors such as textile, chemicals, services, pharmaceuticals, transport, food and beverage, leather products, construction and engineering etc. The minimum capital requirement of NBFIs is 250 million BDT. All NBFIs are required to raise their minimum capital through IPO by June 2006. As of June 2005 total paid up capital and reserves of the NBFIs were 6.93 billion and 5.52 billion BDT respectively amounting to a total shareholders equity of 12.46 billion BDT. Earnings and Profitability The Leasing sector has witnessed a growth of 27.64 percent in 2005 (in terms of outstanding lease/loan) over the previous year. In 2004 the growth was 45.94 percent whereas the annual average growth over the last four years stood at 33.89 percent. Figure 4.3.1 shows that the leasing industry has been growing consistently. The share of classified lease/loans is a little above 6 percent (measured on the right axis) in 2005 which was about the same in 2004. The share of classified loans has however decreased since 108 A list of NBFIs in Bangladesh is presented in appendix 4.1 at the end of this chapter. 142

2002 (which was 8.42 percent of total outstanding). This trend is similar to that of their major competitor in the market namely the PCBs. Classified loans of PCBs have also decreased from 16.38 percent in 2002 to 5.62 percent in 2005. Though PCBs had a higher share of classified loans in 2002 they have been able to bring it down faster than the NBFIs have. Figure 4.3.1 Outstanding and Classified Lease/Loan of NBFIs Taka in Million 80000 70000 60000 50000 40000 30000 20000 10000 0 2001 2002 2003 2004 2005 9 8 7 6 5 4 3 2 1 0 Percentage Year Outstanding Classified (percentage of total) Source: Constructed by the author from data provided by the Financial Institutions Department, Bangladesh Bank. Total asset of the leasing industry is also growing at an annual average rate of 33.9 percent over the last four years (Figure 4.3.2). Growth of assets was over 62 percent in 2002 but fell gradually to 15 percent in 2004. Figure 4.3.2 Total Asset of Leasing Industry 109 60000 70 Taka in Million 50000 40000 30000 20000 10000 60 50 40 30 20 10 Percentage 0 2002 2003 2004 2005 (June) 0 Year Total Asset Growth Rate of Total Asset Source: Constructed by the author from data provided by the Financial Institution Department, Bangladesh Bank 109 Growth rate of total asset for 2005 is calculated on an annualized basis from half yearly data. 143

Growth in 2005 was over 45 percent at an annualized rate (data being available up to June). In a market with considerable competitive pressures from banks and other financial institutions, the leasing industry has exhibited significant resilience. For measuring the performance of the leasing industry we look at the current ratio, debt-equity ratio and return on equity of the industry as measures of liquidity, risk coverage and profitability respectively. 110 Table 4.3.1 and Figure 4.3.3 highlights these ratios. Table 4.3.1 Performance Ratios of the Leasing Industry Current Ratio Debt- Equity Ratio (times) Debt-Total Asset Ratio (times) Return on Investment (%) Return on Equity (%) 2002 1.98 (2.99) 1.61 (6.16) 0.61 (0.28) 2.50 (2.63) 6.57 (9.84) 2003 1.91 (4.32) 2.20 (5.30) 0.69 (0.26) 3.31 (2.01) 10.57 (8.76) 2004 1.81 (3.01) 2.42 (2.98) 0.71 (0.25) 4.79 (7.27) 16.37 (9.85) 2005* 1.93 (2.85) 2.87 (3.03) 0.75 (0.23) 2.08 (1.22) 7.91 (7.64) Source: Calculated by the author from data provided by the Financial Institution Department, Bangladesh Bank Note: Figures in the parentheses indicate standard deviation. *=Based on half yearly data of January-June, 2005 Current ratio measures the ability to meet current debts with current assets. The current ratio of the leasing industry hovered around a little below 2 over the last four years. In 2002 it was 1.98 and in 2005 it was 1.93 showing consistency in the industry s ability in managing their liquidity position. The current ratio of individual firms varied widely in 2005 from 0.37 to 11.82 (though one company has a current ratio of 77.95, which is treated as an outlier). In June 2005, five leasing companies had current 110 Industry wise ratios are calculated taking weighted averages of the ratios of individual firms in the industry. In calculating the industry average one leasing company was not considered as it has a very limited debt (close to zero) and therefore the ratios for this firm is far away from the industry average and can be treated as outliers. Current Ratio = Current Assets/Current Liabilities. The weight is calculated using current asset. Debt-Equity Ratio = Total Debt/Shareholder's Equity. The weight is calculated using shareholder's equity. Debt-Total Asset Ratio = Total Debt/Total Assets. The weight is calculated using total assets. Return on Equity = Net profit after taxes/shareholder's Equity. The weight is calculated using shareholder's equity. Return on Investment = Net profit after taxes/total Assets. The weight is calculated using total assets. Measures overall effectiveness in generating profits with available assets. Earning power of invested capital. 144

ratios which are less than 1 and four had current ratios greater than 5 while the standard deviation was 2.85. Firms having a current ratio well below the industry average should carefully monitor their liquidity management. Figure 4.3.3 Current Ratio, Debt-Equity Ratio and Debt-Total Asset Ratio 3.5 3 2.5 2 1.5 1 0.5 0 2002 2003 2004 2005 Year Current Ratio Debt-Equity Ratio Debt-Total Asset Ratio Source: Financial Institutions Department, Bangladesh Bank The debt-equity ratios of leasing companies varied from 0.27 to 11.08 in 2005 (up to June) whereas the weighted average debt-equity ratio of the industry was 2.87 and the standard deviation was 3.03. As of June 2005 five companies had debt-equity ratios of more than 6. Though the leasing industry is conservatively leveraged, the increasing trend of the debt-equity ratio from 2002 as can be seen in Figure 4.3.3 indicates that the leasing industry is mobilizing a greater amount of debt gradually as the industry is attaining maturity. Return on Equity (ROE) and Return on Investment (ROI) of the leasing industry experienced an increasing trend during 2002 to 2004. As of June 2005 weighted average industry ROE and ROI stood at 7.91 and 2.08 respectively which were 16.37 and 4.79 respectively in 2004. The half yearly figures of 2005 are compatible with those of 2004 if considered on an annualized basis. Therefore, the leasing industry is doing well in terms of profitability having an increasing trend in the profitability ratios in recent years. These ratios are also quite adequate if compared with that of the PCBs. ROE of PCBs showed a similar pattern which increased to 19.53 in 2004 from 11.37 in 2003 and in June 2005 ROE of PCBs was 9.56 (19.12 on an annualized basis). Therefore the leasing industry has performed well vis-à-vis the PCBs and stood up to the challenges in a small market having a large number of competitors. 145

Figure 4.3.4 Return on Equity and Return on Investment 18 16 14 12 10 8 6 4 2 0 2002 2003 2004 2005 (annualized) (annualized) ROI ROE Source: Financial Institutions Department, Bangladesh Bank 4.4 Performance of SBs in Bangladesh (2002-2005) 111 The Government of Bangladesh established some development financial institutions with the aim of providing special attention to the development of agriculture, industry and commerce. There are 5(five) Development Financial Institutions (SBs) in the country namely, (1) Bangladesh Krishi Bank (BKB) (2) Rajshahi Krishi Unnayan Bank (RAKUB) (3) Bangladesh Shilpa Bank (BSB) (4) Bangladesh Shilpa Rin Shangstha (BSRS) and (5) Bangladesh Small Industries and Commerce (BASIC) Bank Limited. These SBs have been playing a leading role in the money as well as capital market in terms of providing short and long-term financial service in Bangladesh. Performances of each of the SBs are as follows: (a) BKB The BKB was established as a fully Govt. owned bank under presidential order 27 of 1973. It has 941 branches all over Bangladesh as of end March 2006. The BKB provides loans to individuals and corporate bodies in the field of production of crops, purchase of irrigation machineries and equipment, development of horticulture, pisciculture and animal husbandry including various socio-economic and poverty alleviation programs. The total assets of the bank stood at BDT 79303 million in FY02, BDT 82173 million in FY03, BDT 87417 million in FY04 and BDT 95284 million in FY05 respectively. The authorized as well as paid up capital of the bank also displayed an increasing trend over the period of FY02-FY05. 111 Heavily edited by Dr. M. Habibur Rahman, Senior Research Economist on the basis of an initial draft prepared by Shamim Ara (Deputy Director, Statistics Department) 146

The amount of loans and advances of the bank increased from BDT 55035 million in FY02 to BDT 65675 million in FY05 reflecting a substantial growth of 19.33 percent in disbursement of loan and advances along with a good recovery rate resulting in a declining trend in the NPL ratio during the period. The interest rates of lending and deposits also declined during FY02 to FY05. Because of the inefficiency and lack of competitiveness this bank s soundness indicators are not so encouraging. The ratio of debt to equity is getting larger and larger along with a negative CAR in every year. The profit/loss account of BKB also displayed huge losses over the years. (b) RAKUB The RAKUB was established with the aim of providing institutional agricultural credit for optimum utilization of agricultural potentials of Rajshahi Division taking over the branches and offices along with assets and liabilities of the Bangladesh Krishi Bank within Rajshahi Division. The bank started functioning on 15 March 1987, as the largest development partner in the northwest region. RAKUB aims at overall development of the farmers and all the sectors and sub-sectors of agriculture in the region. A total asset that belongs to RAKUB is continuously increasing over the years. Likewise BKB, the RAKUB also incurs negative profit every year resulting in a huge accumulation of debt to equity ratio. Recently, however, the debt against equity has decreased marginally. (c) BSB The BSB was established on 31st October 1972 under the Bangladesh Shilpa Bank Order 1972. BSB, the prime development financing institution of the country, provides financial assistances for setting up new industries and rehabilitation of sick industries. This bank started full-fledged commercial banking from 1993. As per the data of BSB, authorized capital remained same at BDT 2000 million during FY02, FY03, FY04 and FY05. The amount of paid up capital stood at BDT 1320 million during FY02 and FY03 and BDT 2000 million during FY04 and FY05. Likewise other government owned specialized financial institutions some indicators of the BSB s performance, such as debt to equity ratio, CAR, profit/loss account showing disappointing scenario over the last few years. (d) BSRS The BSRS was established on October 31, 1972 to provide credit facilities and other assistance to industrial concerns and to encourage and broaden the base of investment in Bangladesh. The condition of loans and advances 147

of bank has been declined drastically during June 2002 to June 2005 due mainly to shutdown of its regional office outside Dhaka city and write-off of bad loans in 2003. Notwithstanding a sharp reduction in the amount of total assets, the performance of NPL and loan recovery situations improved during FY02 to FY05. At the same time the debt to equity ratio, CAR and profit/loss account of the institutions shows signs of improvement during the period. (e) BASIC The BASIC Bank Ltd., established as a banking company under the companies Act 1913, launched its operation in 1989. The bank initially started as a joint venture enterprise. From June 1992, however, BASIC bank is fully owned by the Govt. of Bangladesh. The paid up capital as well as loans and advances disbursed by bank is depicting increasing during 2002-2005. Because of lower recovery rate than that of disbursement the NPL ratio of the bank witnessed a moderately increasing trend during the period. Total assets of the bank increased to BDT 27136 million in 2005 from BDT 13019 million in 2002 reflecting a healthy growth in the total assets position of the bank. The scenario of debt to equity ration displayed a declining trend during 2002-2005 due to its continuous positive profit margin. The overall performance of the bank is relatively better than other SBs of the Government of Bangladesh. Conclusion 4.5 Microfinance Institutions (MFIs) 112 Although the Government of Bangladesh established some development financial institutions with the aim of providing special attention to the development of agriculture, industry and commerce, the overall performance of SBs as a group is not so encouraging. All most all of the SBs, as other government owned enterprises, suffer badly in terms of low capital base, high debt-equity ratio, low loan disbursement and recovery rate and make losses consistently mainly because of inefficiency, bad governance and lack of competitive environment. (a) Emergence and Proliferation of MFIs in Bangladesh At the time of independence in 1971 there existed a publicly managed cooperative system which looked after the financing for the rural people. The functions of the cooperative system were partly alike that of the 112 Prepared by Md. Alauddin Majumder, Research Economist. 148

institutions presently called microfinance institutions (MFIs). In course of time the cooperative system began to decay for various reasons. Gradually the moribund cooperative system was supplanted by group-based supervised microcredit delivery through NGOs. 113 Reportedly the MFIs origin dates back to 1970s when the nation was engaged in reconstructing the war-torn economy. In that period a few MFIs such as BRAC, ASA, Proshika came into existence, but not exactly in the form they are currently assuming. 114 Expansion of this sector began in the 1980s when small Table 4.5.1 Growth in the Number of NGO-MFIs in Bangladesh As of No. of NGO-MFIs Active Members (in million) Net Savings (million BDT) December 96 351 6.01 2390.72 27837.24 December 97 380 6.74 3381.51 43987.43 December 98 495 7.86 5216.26 66565.50 December 99 533 9.43 6921.66 92436.20 December 2000 585 11.02 8866.02 125607.61 December 01 629 12.45 10780.99 164261.67 December 02 656 12.86 12967.55 208619.05 December 03 720 14.63 15560.97 269472.09 December 04 721 16.62 17807.55 338635.65 Source: Various issues of CDF Statistics Cumulative Disbursement (million BDT) scale lending, microcredit was recognized as a weapon to reduce poverty. The Grameen Bank, which is considered the mother of modern-day microfinance institutions, was established in 1983 following successful completion of an experimental project that had started in 1976. MFIs attempted to consolidate the Grameen Bank model within them after continuing success of Grameen Bank in extending microcredit and related services. A rapid and robust expansion of MFIs occurred during 1990s and onward. The early expansion was facilitated by the inflow of soft donor funds. New MFIs entered and existing MFIs opened new branches. As a step to patronize microfinance activities and enhance their contribution towards the development process, the Ministry of Finance (MOF) and the Bangladesh Bank extended significant low-interest lending to Grameen 113 Kazemi (1998). 114 David and Karen (2005). The acronyms BRAC and ASA stand for Bangladesh Rural Advancement Committee and Association for Social Advancement, respectively. They were established in 1972 and 1978 respectively, and started microcredit activities in 1974 and 1991 respectively. 149

Bank for a period. Besides, government established Palli Karma Shahayak Foundation (PKSF) as a second tier MFI on May 2, 1990. Table 4.5.1 clearly projects the proliferation of NGO-MFIs in Bangladesh. The notable expansion of the microfinance industry in Bangladesh might be attributed to a number of factors such as the virtual absence of credit other than that at the usurial rates in the rural informal sector, availability of soft funds for on-lending, high population density, availability of a good transportation-infrastructure network, presence of strong NGO-MFI leadership and management skills, non-prudential regulatory regime, and a supportive environment created by government. 115 (b) MFIs Activities MFIs are engaged in a host of activities mostly dominated by microcredit. A World Bank survey of three hundred NGO branches in 2003 shows that while the total range of NGO interventions is wide, the typical NGO branch provides between three to four services. Around 90 percent of all NGO branches provide credit services, followed by health (56 per cent), Box 4.5.1 Core Functions of MFIs Savings Credit Insurance Training/ Counselling Marketing Institution Building 1. Mandatory 2. Voluntary 3. Flexible 4. Daily 5. Time deposit 6. Fixed 1. Term loans 2. Entrepreneur loans 3. Housing loans 4. Health & sanitation loans 5. Seasonal loans 6. Disaster loans 7. Special loans 8. Consump- tion loans 1. Health insurance 2. Life insurance 3. Credit insurance 4. Property insurance 5. Crop insurance 1. Business planning & management 2. Entrepreneurship development 3. Basic accounting and cash management 4. Product diversification 5. Innovation Research 1. Marketing outlay 2. Production centre 3. Promotional activities 4. Infrastruc-ture support 1. Group formation 2. Awareness raising 3. Leadership development 4. Linking/net-working 5. Information sharing sanitation (52 per cent), and education (45 per cent). Advocacy and public awareness work are also common areas of NGO work: 93 per cent reported awareness-raising activities, usually relating to sanitation, health and social issues. 116 Box 4.5.1 presents core functions of MFIs with categories and subcategories together. 117 It is worthwhile to mention that many of the functions are performed in collaboration with local and central government agencies. 115 World Bank (2005). 116 Cited in World Bank (2005). 117 Rashid and Matsaert (undated). 150