Unattractive capital market powers high-risk lending by banks

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Siddique Islam
Insignificant contribution of the capital market is apparently creating pressure on banks and financial institutions to provide industrial term loans at high risks as such credits are being arranged from short term deposits.
"The banks and financial institutions are financing long term loans with funds received from relatively short term deposits, creating asset-liability mismatch," a senior official of the Bangladesh Bank (BB) told the FE Saturday.
He also said the capital market should be developed in such a manner that it reduces such risk, undertaken by the banks and financial institutions.
"Banks will provide the working capital to run the industries while long term financing should be mobilised from the capital market. This is the international practice," the official noted.
Sources said despite high demand from stock market investors for new issues, entrepreneurs are found reluctant to go to the capital market to raise the capital for setting up new industrial units or expansion of the existing ones. This could be due to their reluctance to expose their individual performance to scrutiny by general shareholders and also by the capital market regulator, the Securities and Exchange Commission (SEC), they added.
The amount of industrial term loans disbursed by banks and financial institutions stood at Tk 124 billion in fiscal 2006-07 compared to only Tk 3.1 billion raised by new capital issues through private placements of public offerings in the capital market, according to the provisional figures of the central bank.
"So far, the capital market has played a minor role in investment financing in Bangladesh," the BB said in its quarterly for October-December, 2007.
Such high dominance of term loans through bank financing implies low equity stake and high risk exposure on lending banks and financial institutions, including liquidity risk arising from financing long term loans with funds from short term deposits, according to the quarterly.
The commercial bank officials, do also acknowledge such mismatch, saying that the banks mobilise funds form long term deposits but those are not sufficient for substantial investments. In such cases, the banks have no alternative but to depend on short term deposits to minimise the gap.
"Most of the banks are providing long term loans from short term deposits because the funds we mobilise from our long-term financing schemes are not adequate to meet demands for long term loans," a senior official of a private commercial bank told the FE.
He also said some short term deposits are usually transformed into long term ones when depositors concerned renew their investment schemes. Most short-term depositors take profit after maturity of their investments and reinvest the principal amount. As a result, some short-term deposits turn into long term investment, he added.
Besides, the commercial banks are now maintaining five-point core risks guidelines, issued by the central bank earlier, to improve their managerial capacity.
The risk factors are: credit, asset and liability, foreign exchange, internal control and compliance and money laundering risk.
During fiscal 2006-07 (FY 07), 12 companies raised new equity of Tk 3.1 billion in the primary market, up from Tk 1.7 billion raised by 14 companies in the previous fiscal, the BB's data showed.
Of the new equity issues, Tk 0.04 billion was raised through private placements and Tk 3.1 billion through public offering in FY 07 as against Tk 0.2 billion raised through private placements and Tk 1.5 billion through public offerings in FY 06.
"One private sector corporate bond, namely 'IBBL Mudaraba Perpetual Bond' got listed in the stock market during Q2 (second quarter) FY 08 ushering a new development in the history of the country's capital bank," the BB noted.