FIs at crossroads: Where to go?

Since the inception of financial institutions (FTs) in Bangladesh in the 1980s, their operation has not been cost-effective. Their cost of borrowing is always higher than banks' because of the limited sources of fund at higher rates of interest. As FIs are not that much known as publicly trusted institutions and do not offer services to all kinds of people due to their limited operation, especially in big towns and cities with fewer deposit or loan products than those of banks, the FIs have to depend on borrowings from banks always to meet their funding requirement. They offer higher rates of interest to attract deposit holders and thus collect operational funds and so they are far behind banks in competitiveness when it comes to working capital mobilisation through public deposits.
So, the cost of fund of FIs is higher, but they are competing with banks with similar loan and lease products. There is always an uneven competition with banks that results in less profitability but the income tax rate of FIs is the same as that of the banks. Other disadvantageous issues include operational functions that are limited compared to banks resulting in less profitability but disallowing depreciation of finance lease leading to inflated taxable profit.
Basically, FIs are at a crossroads with four problems: (i) uneven competition with banks, (ii) higher tax rate, (iii) disallowance of depreciation of finance lease, and (iv) limited functions compared to banks.
Banks can easily collect zero-cost funds through current accounts and low-cost funds through savings accounts and term deposits. Another source of fund-call money-is also matching banks' short-term loan financing to clients or liquidity management strategy. The FIs can get only term deposits at a very high cost than banks' and such term deposits are not also trustworthy to people like that of a bank. Generally, such deposits are collected from the network of directors and management offering a higher rate of interest than that of a bank.
Another general source of fund for FIs is term loans from banks at the same lending rate a bank charges its clients for lease and loan. As such, the cost of fund of FIs is equal to or higher than the lending rate of banks. For an example, at present banks generally invest at the interest rate of 14-15 per cent (lending rate of banks) for industrial lease or loan, where FIs' costs of fund in many cases are more than 15 per cent. The banks charge interest rates of 14-15 per cent for lease and loan financing for the same clients for whom the FIs' lending rate is more than 18-20 per cent. What an uneven competition they are facing! Very few companies that borrow money from FIs in the form of lease or loan can register a big profit margin of higher than 20 per cent from their operation to repay the money to lessors.
Who will come to FIs to borrow at such a high rate of interest?  When the borrowers fail to get any credit line from banks due to a lengthy processing hassle, they will come to FIs to take such a lease or loan facility at such a high rate of interest. So, the companies/borrowers availing taking lease and loan financing from FIs may not be also very good performing ones. Apparently it is true that FIs' portfolio cannot attract good companies in the investment portfolio due to such higher lending rates.
The income tax rate for both banks and FIs is 42.5 per cent, but the operational platforms for banks and FIs are uneven. Due to such an uneven platform of operation, the profitability of FIs will be less compared to banks, as higher lending rates and significant risks are associated with investments because of (i) a higher rate of return expected from lending companies and (ii) inclusion of bad investments in the portfolio failing to avail lease or loan from banks at a lower rate. Considering less profitability of FIs, the tax rate should not be same as applicable to banks and it should reasonably be less to the relief of FIs.
The term 'lease' simply indicates the asset is rented out by the owner. The legal owner of the asset is lessor i.e., the leasing company. The International Accounting Standard (BAS) 17 classifies the lease either as 'Financing Lease' or 'Operating Lease' accounting for 'Lease Receivables' and 'Lease Assets' respectively in the account of lessor. The method of accounting does not cancel the legal right of ownership of the asset. According to legal ownership of the asset, the depreciation of both types of lease asset should be allowed to leasing companies.
In Bangladesh depreciation of the asset under finance lease is allowed to a lessee as per clause 3(4) under 'Third Schedule' of the Income Tax Ordinance 1984. It is not in accordance with the legal ownership based on terms of the lease agreement. As per finance or lease agreement, at the end of the tenure the asset is transferred to a lessee at a minimum token amount of value subject to paying all installments in due time. Before the transfer of that asset, the lessee should not have any legal right to the asset in spite of economic ownership belonging to the lessee. So, depreciation should be claimed by the leasing company/lessor for both types of leasing. Although depreciation is allowed for operating a lease in Bangladesh, such a type of leasing is not in operation in most cases and it is effective in papers only. In Bangladesh, the full lease portfolio is under finance lease and as such, disallowance of depreciation on finance lease creates inflated taxable profits and a tax burden. The Indian Supreme Court has issued a verdict to allow depreciation on finance lease for lessors considering the legal ownership of the assets irrespective of economic ownership belonging to a lessee.
The line items of income for FIs are limited to lease income, interest income on term loan or any form of loans and fee or commission-based services, when the banks have diversified and extended line items of income like L/C commission, guarantee commission, income from foreign exchange operations etc. in addition to line items of FIs. Banks are open to deal with the general people. So, the acceptability of activities of banks is more than FIs'. With such fewer operational line items, FIs are less profitable than banks.

The writer is an Associate Member of ICAB and Head of Finance of Venture Investment Partners Bangladesh Ltd. (VIPB).  roy_dipok@yahoo.com