Making the most of bonds

In recent years, banks in Bangladesh have raised a sizable amount of funds by issuing bonds chiefly to comply with regulatory standards. Corporates have also borrowed using the tool to cut their cost of funds and as a hedge against any future interest rate spike. The Daily Star's Ahsan Habib explores various aspects of the budding bond market and its prospects and challenges   

Appetite for bonds growing

Scheduled banks and corporates in Bangladesh have been opting for issuance of bonds for the last couple of years to diversify treasury management and strengthen capital base.

The amount of funds raised through issuance of bonds rose 13 per cent year-on-year to Tk 9,967 crore in fiscal 2020-21. This was 13 times the Tk 686 crore raised in fiscal 2010-11, according to data of the Bangladesh Securities and Exchange Commission (BSEC).

Banks need to maintain capital as per Bangladesh Bank's regulations and the Basel III guidelines, said Ershad Hossain, CEO of City Bank Capital Resources.

So, they have three options to beef up capital: through direct injection of funds, issuance of rights share, and issuance of tier 1 perpetual bonds.

Tier 1 capital is a bank's core capital and includes shareholders' equity and retained earnings.

Tier 2 capital is a bank's supplementary capital that includes undisclosed funds, which do not appear on a bank's financial statements, revaluation reserves, hybrid capital instruments, subordinated term debt and so on.

Issuance of tier 1 or tier 2 bonds is cost-effective compared to share issuance as the interest rate is paid before tax payments whereas dividend payments on common equity are made after tax deductions, Hossain said.

Bonds are cheaper to issue, less cumbersome and quicker, he said, adding that debt securities rules have laid down conditions for a faster approval process for debt securities.

"Moreover, no dilution of existing shareholders happens if bonds are issued rather than shares. Therefore, we see financial institutions issuing bonds," Hossain said.

In Bangladesh, the bond market lacks an investor base and banks are the primary investors of bonds. However, good-rated corporate bonds can woo insurance companies and pension funds.

Mohammed Monirul Moula, managing director of Islami Bank Bangladesh Ltd, says that banks have to keep capital at 12.5 per cent against their risk-weighted assets in line with the Basel III.

The ceiling is up from 10 per cent required as per the Basel II.

"Some banks that faced shortage of capital have issued bonds to strengthen their financial health," said Moula, adding that the issuance of the securities has also given a boost to the overall bond market.

Officials of the BSEC say most of the issuers have been able to raise funds through bonds, and subscriptions were mainly high thanks to elevated confidence among investors.

The responses, however, were not that high in case of subscription of corporate bonds. This prompted the regulator to grant additional time to the issuers in order to enable them to raise funds.

Samiul Rabbi, executive director for business operations at OMS Advisory Ltd, says scheduled commercial banks are raising funds through perpetual and fully redeemable bonds to meet mainly their tier 1 and tier 2 capital requirements.

The subscribers of these bonds are mainly banks, life insurance companies, general insurance companies, and non-bank financial institutions.

However, the picture of the subscription of corporate bonds has not been rosy.

The main reason is the Bangladesh Bank's restriction on the investment by banks in corporate bonds, debentures, or sukuks, Rabbi added.

"Corporates are issuing zero-coupon bonds targeting cash-rich corporates as investors as the tax authority has offered exemption on the investment in the zero-coupon bonds by companies and individuals."

He said corporates raise funds through bonds in order to fix their costs of funds and as a hedge against any future interest rate spike. "This helps mitigate the interest rate fluctuation risk."

Tanzim Alamgir, CEO of UCB Investments, says since the interest rate is relatively low, it is perfect time for the corporates to raise funds by issuing bonds, especially the zero coupon bonds.

"Corporates have also become more interested in issuing zero coupon bonds because of the tax advantage associated with it."

A top official of the BSEC says the commission is working hard to make the bond market vibrant. But wholehearted support is yet to come from the National Board of Revenue (NBR).

"But if it allows exemptions on some costs now and the bond market becomes vibrant, the NBR will get a much higher amount of tax."

"The bond market can be a big source of funds for government projects and for the private sector to expand business. So, the NBR should ease all conditions that are deterring the bond market from flourishing."

Recently, the central bank issued a sukuk, an Islamic financial certificate similar to a bond, helping the government raise Tk 8,000 crore for the implementation of a safe water supply project.

"Bonds can be a big investment tool," said the BSEC official.

The secondary trading should be ensured and strong regulations should be framed so that products aren't nipped in the bud, according to analysts.

Tradable bonds key to stable money, stock markets

Says Mirza Elias Uddin Ahmed, MD of Jamuna Bank

A strong and vibrant bond market is necessary to stabilise both the money market and the stock market, according to Mirza Elias Uddin Ahmed, managing director of Jamuna Bank.

"Bonds could work as a balance between the two markets if they are overheated," he said. For example, corporations could turn away from banks with high lending rates and head towards the bond market to secure funds.

Similarly, when the stock market turns volatile and shares become overvalued or pay lower profits, then companies have an alternative investment tool in the form of bonds.

General investors can also benefit from bonds if the yield rate is higher than that of bank deposits. For instance, if a bank's lending rate is 9 per cent and the deposit rate is 5 per cent, the corporation can choose to issue a bond instead.

And by offering an 8 per cent yield on maturity, bonds can be a lucrative venture for both buyers and the issuing company.

While this indicates that bonds can provide higher returns compared to bank deposits, it also shows that it is cheaper for the company to borrow using the investment tool rather than taking loans from lenders, Ahmed said.

"So, a direct connection between savers and borrowers will be created through bonds in a win-win situation.

Banks will also make business by giving acceptance to the bonds."

In addition, if the bond market becomes vibrant and strong, the Bangladesh Bank will no longer need to cap the interest rate on savings and borrowing at 6 per cent and 9 per cent respectively.

"To make it happen, investor participation needs to increase through massive awareness campaigns with a view to informing people about the potential benefits of the bond market," Ahmed told The Daily Star in an interview recently.

The former chairman of the technical committee of the Primary Dealers Bangladesh Ltd went on to say that investors must have diversified products in their portfolios to minimise market risks, and bonds could play a big role in this regard.

One of the main products offered by banks is loans. If some of these loans go bad, the banks have to give out even more to offset losses.

"This is a very risky task," Ahmed said, adding that by providing other products such as bonds, investors can lower the risks by diversifying their portfolios.

Loans are an interest-based product while stocks are price-based. The tradable bond market is a mix of both interest (coupon) rate and demand-supply-driven market price.

When the money market offers handsome interest rates, all investors rush to the banks, but when the situation reverses, they go to the stock market by liquidating their fixed deposit receipts.

The total process is like a boat which rolls regularly, creating volatility in the market. As a result, interest rates swing quite fast in Bangladesh.

"Our money and stock markets are not stabilised due to the absence of a vibrant bond market, so the volatility will remain in both markets until we get a strong bond market," Ahmed said.

If stock investors want to keep their funds in fixed-income secured instruments, then they can invest in bonds while money market investors seeking higher returns from price-based instruments can do the same, he added.

Volatile interest rates are not good for the economy as changes come in waves that are not favourable for any industry.

"It is easy to swim in a calm river. The economy can also smoothly navigate when interest rates are stable," Ahmed said.

Interest rates in the banking sector had surged to 16-18 per cent in 2011-12 while it is now 8-9 per cent.

Many industries, especially small and medium enterprises, became financially sick due to this "interest wave".

In developed countries, the bond market is also developed, so 40 per cent to 50 per cent of the trade in their stock exchanges comes from bonds.

The yield rate of government bonds is not market-based and is lower than the normal deposit rate. This ultimately creates crises in the money market.

"So, the bond yield rate should be market based. We are doing business so the loans to the government should be profitable for us," said Ahmed.

During the Covid-19 pandemic, the government took loans from abroad but the funds could have been raised from local banks by issuing bonds.

The government allowed non-primary dealers to participate in the auction of government bonds, which went for very lower rates. Now, the yield rate is rising and when it rises, it creates losses for bond buyers if they bought it at a low price.

"So, non-primary dealers should not be allowed to take part in the auctions to ensure smart bidding. Swift changes to bond yields are also not good, so the central bank should work to this end," Ahmed added. 

Lack of investor diversity stunts market growth

Say experts

The bond market in Bangladesh has been facing numerous challenges due to a lack of investors and issuers from diverse backgrounds, credibility of financial reports and a non-supportive tax policy, according to analysts.

Besides, there is no active secondary market in the country for trading bonds, they said while recommending that these issues need to be resolved in order to secure the full benefits of the fund-raising tool.

The bond market is necessary to help develop a sustainable banking system in Bangladesh and so the government should remove all barriers for the market to flourish, said Syed Mahbubur Rahman, managing director of Mutual Trust Bank.

Most bonds are issued by financial institutions for the purpose of raising capital but the participation of corporations is very little.

At present, only banks invest in each other's bonds.

"So, listing the bonds and secondary trading is very crucial here as the participation of other parties is needed to make the market more vibrant," he said.

In some cases, tax has been cut but other issues also need to be addressed to popularise the financial tool.

To attract corporations and other big investors, the authenticity and confidence on related disclosures should be nurtured to much higher levels, added Rahman, also former chairman of the Association of Bankers, Bangladesh.

"For a sustainable bond market, we need strict trustee eligibility criteria and expertise to manage complex asset backed securities," said Ershad Hossain, chief executive officer of City Bank Capital Resources.

In addition, the credibility and expertise of credit rating agencies should be increased while bond and preference share default issues should be included in the primary legal instrument dealing with local financial institutions, namely the Artha Rin Adalat.

"Or a tribunal needs to be set up to settle bond defaults with the appointment of professional administrators for restructuring or liquidation of the issuer," he added.

Hossain, who is working to issue the country's biggest private sector sukuk bond worth Tk 3,000 crore for Beximco, said the tax structure was not facilitativefor asset-backed securities or the Islamic sukuk structure.

Only a capital gain tax of 4 per cent has been exempted for sukuk transactions between the originator and SPV/Trust, he said, adding that a stamp duty of 1.5 per cent, VAT of 2 per cent of the total value, and registration cost has not been exempted yet.

A top official of a bank, preferring anonymity, said perpetual bonds' coupon rate should be allowed to be determined by the market, otherwise it would not be sustainable.

"However, now the central bank fixes a coupon rate," he said, adding that this was not the international practice.

A vibrant bond market is necessary for both banks and investors, said Shaheen Iqbal, head of treasury of Brac Bank.

Banks are providing long term loans depending on short term deposits which creates a mismatch in the treasury. Therefore, bonds can make banks more comfortable in lending long-term loans, he said.

On the other hand, investors also will get a product to invest for higher rate, at a safe place.

"The regulations should be strict on the (fledgling) bond market so that it cannot not be nipped in the bud," he said

Traditionally banks issued subordinated bonds as capital instruments but recently they are issuing perpetual bonds too.

As perpetual bonds have no maturity period, they are considered a tier-1 capital whereas other bonds are considered tier-2 capital.

"I think perpetual bonds should be listed in the stock market to ensure an exit route for investors as it has no maturity period," he said.

On the other hand, its coupon rate should be determined by the market, otherwise it will not be sustainable, he added.