Assignment

On
NBFI sector in Bangladesh

Prepared For
Palash Saha
Course Instructor
Financial Institutions and Markets, Fin-402

Prepared By
Asrafuzzaman
ID 1907
BBA 25th Batch

Institute of Business Administration

Jahangrinagar University

Date of Submission
11th July, 2018
A non-bank financial institution (NBFI) is a financial institution that does not have a
full banking license or is not supervised by a national or international banking regulatory agency. NBFIs
facilitate bank-related financial services, such as investment, risk pooling, contractual savings, and market
brokering. Examples of these include insurance firms, pawn shops, cashier's check issuers, check
cashing locations, payday lending, currency exchanges, and micro loan organizations. Alan
Greenspan has identified the role of NBFIs in strengthening an economy, as they provide "multiple
alternatives to transform an economy's savings into capital investment [which] act as backup facilities
should the primary form of intermediation fail."

NBFI in Bangladesh
NBFI or Non-Bank Financial Institution is also known as NBFC (Non-Bank Finance Companies). In
Bangladesh NBFI sector is monitored and controlled by Bangladesh Bank under the guideline of
Financial Institution Act, 1993. According to Financial Institution Act 1993, NBFIs are defined as,
“financial institution means such non-banking financial institutions, which- make loans and advances for
industries, commerce, agriculture or building construction; or carry out the business of underwriting,
receiving, investing and reinvesting shares, stocks, bonds, debentures issued by the Government or any
statutory organization or stocks or securities or other marketable securities; or carry out installment
transactions including the lease of machinery and equipment; or finance venture capital; and shall include
merchant banks, investment companies, mutual associations, mutual companies, leasing companies or
building societies”. At present, there are in total 32 NBFIs with 198 branches are operating within the
financial sector of Bangladesh among which three NBFIs are state owned, nineteen privately owned and
ten joint venture NBFIs.
LankaBangla Finance Ltd. Industrial Promotion and Development Company of Bangladesh Limited
(IPDC), IDLC Finance Limited, Uttara Finance and Investments Limited are the some familiar NBFI
institutiond in Bangladesh

Why NBFI’s are needed though existence of plenty number of commercial

banks
The necessity for the development of NBFIs could be best judged with the following issues.
Firstly, the NBFIs are markedly different from the banking institutions and with different phenomena.
These two kinds of financial institutions are complementary rather than substitute organs in the financial
system. Existence of banking and non-banking financial institutions, money market and capital market
keep the financial sector complete and enhance the overall growth of the economy.
Secondly, there is a maturity mismatch in the sources and uses of funds in our financial system, which
leads inefficiency in the financial system. Commercial banks by their definition are unsuited for long term
lending. Inefficiency of BFIs in long-term loan management has already leaded an enormous volume of
outstanding loan in our economy. However, with the present status, expertise and efficiency, the NCBs
are barely able to serve the future investment demand of the country. Private commercial banks are less
experienced and less equipped in this regard and they would not take the load or be able to take future
challenges of term lending of the country. At this backdrop, in order to ensure flow of term loans and to
meet the credit gap, development of NBFIs is a compelling necessity for the economy.
Thirdly, sophisticated and well-developed capital market is considered as the hallmark for a market
economy worldwide. Although our country is moving toward a full market based economy, capital
markets are still in infancy. This is due to lack of requisite institutions those are needed in the system. In
the last twenty years there has been a tremendous growth worldwide of non-bank financial institutions to
provide support services to the capital market. These range from broker dealer to investment banker. The
health of the capital market is largely relied upon the health of the banking and non-banking financial
institutions. The key players are the non-bank financial institutions in the development of the capital
market.

Difference between bank and non-banking financial institution

A Bank is an organization that accepts customer cash deposits and then provides financial services like
bank accounts, loans, share trading account, mutual funds, etc.

A NBFC (Non-Banking Financial Company) is an organization that does not accept customer cash
deposits but provides all financial services except bank accounts.

(a) A bank interacts directly with customers ; while an NBFI interacts with banks and governments

(b) A bank indulges in a number of activities relating to finance with a range of customers; while an NBFI
is mainly concerned with the term loan needs of large enterprises

(c) A bank deals with both internal and international customers; while an NBFI is mainly concerned with
the finances of foreign companies

(d) A bank's man interest is to help in business transactions and savings/ investment activities; while
an NBFI's main interest is in the stabilization of the currency.

Functions of NBFI
1. Financial Intermediation:
The most important function of the non-bank financial intermediaries is the transfer of funds from the
savers to the investors.
Financial intermediation is economical and less expensive to both small businesses and small savers,
(a) It provides funds to small businesses for which it is difficult to sell stocks and bonds because of high
transaction costs,
(b) It also benefits the small savers by pooling their funds and diversifying their investments.
2. Economic Basis of Financial Intermediation:
Handling of funds by financial intermediaries is more economical and more efficient than that by the
individual wealth owners because of the fact that financial intermediation is based on
(a) The law of large numbers, and
(b) Economies of scale in portfolio management.
(i) Law of Large Numbers:
Financial intermediaries operate on the basis of the statistical law of large numbers. According to this law
not all the creditors will withdraw their funds from these institutions. Moreover, if some creditors are
withdrawing cash, some others may be depositing cash. Again, the financial intermediaries also receive
regular interest payments on loans or investments made by them. All these factors enable the financial
intermediaries to keep in cash only a small fraction of the funds provided by the creditors and lend or
invest the rest.
(ii) Economies of Scale:
Large size of the asset portfolios enables the financial intermediaries to reap various economies of scale in
portfolio management. The main economies are:
(a) Reduction of risk through portfolio diversification:
(b) Employment of efficient and professional managers; and
(c) Low administrative cost of large loans and
(d) Low costs of establishment, information and transactions.
3. Inducement to Save:
Non-bank financial intermediaries play an important role in promoting savings in the country. Savers
need stores of value to hold their savings in. These institutions provide a wide range of financial assets as
store of value and make available expert financial services to the savers. As stores of value, the financial
assets have certain special advantages over the tangible assets (such as, physical capital, inventories of
goods, etc.). They are easily storable, more liquid, more easily divisible, and less risky. In fact, saving-
income ratio is positively related to both financial institutions and financial assets; financial progress.
Induces larger savings out of the same level of real income.
4. Mobilization of Saving:
Mobilization of savings takes place when the savers hold savings in the form of currency, bank deposits,
post office savings deposits, life insurance policies, bills, bond's equity shares, etc. NBFI provides highly
efficient mechanism for mobilizing savings. There are two types of NBFTs involved in the mobilization
of savings;
(a) Depository Intermediaries, such as savings and loan associations, credit unions, mutual saving banks
etc. These institutions mobilize small savings and provide high liquidity of funds.
(b) Contractual Intermediaries, such as life insurance companies, public provident funds, pension funds,
etc. These institutions enter into contract with savers and provide them various types of benefits over the
long periods.
5. Investment of Funds:
The main objective of NBFIs is to earn profits by investing the mobilized savings. For this purpose, these
institutions follow different investment policies. For example, savings and loan associations, mutual
saving banks invest in mortgages, while insurance companies invest in bonds and securities.
The role of NBFI in economy
Funds Mobilization
The NBFI’s helps in the mobilization of resources by converting sales into investments. Without
mobilization of resources, there will not be a balance between intra-regional income and asset
distribution. In the absence of NBFI’s in the finance markets; turning savings into investments will
remain a dream for any economy. The primary objective of these lending institutions is economic
development and not just mere profit maximization.
Long term credit
Traditional banks are not keen giving long-term credit to trade and commerce industry. This is because
they hold only short-term repayable deposits which cannot be used for long-time lending purposes which
are a mismatch of deposits maturity and long-term credit. This is where NBFI’s come into the picture.
Large projects and mega infrastructure projects depend to a great extent on the funds advanced by the
non-bank lending institutions which boost economic development. One unique feature of NBFI is
advancing funds to corporations through equity participation.
Creates employment
One of the primary objectives of every macroeconomic policy is to create more jobs in the country.
NBFI’s helps in achieving full employment in the economy by working with the government and
disbursing funds to private sectors. These private sectors create more employment opportunities with their
business activities.
Increase productive potential
Development funding institutions aim at increasing the capital formation of a country by increasing the
capital stock. These institutions are part of NBFI’s and aim at increasing long-term capital formation of
industrial and other sectors. The increase in the capital stock of a country results in employment, national
income and GDP growth.
Development of financial market
NBFI’s are an important part of financial markets of a country. These lending institutions underwrite
public issues of corporations and provide the funds needed by the start-up companies as capital. They are
the significant part of the financial market and are a source of liquidity. The financial markets depend on
NBFI’s to function effectively.

Raise the living standard

NBFI’s can be considered as government instrument in improving the standard of living of the masses
with their operations. Some NBFI’s attract foreign grants in bulk amounts from various countries and
donor agencies which will help in boosting the economic growth of the country.
The NBFI’s actively participate attracting funds from the public and divert it into capital for industrial and
other sectors to facilitate economic growth. In short, NBFI’s play a significant role in the economic
development of the country.
Performance and Rating of NBFIs
Like banks, the performance of NBFIs is also evaluated through the CAMELS rating which involves
analysis and evaluation of the six crucial dimensions. The six indicators used in the rating system are
capital adequacy, asset quality, management efficiency, earnings, liquidity and sensitivity to market risk.

1. Capital Adequacy
Capital adequacy focuses on the total position of NBFIs' capital and protects the depositors from the
potential shocks of losses that an NBFI might incur. It helps absorb major financial risks related to credit,
market, interest rate, etc. NBFIs in Bangladesh have been instructed under the Basel Accord to maintain
Capital Adequacy Ratio (CAR) of not less than 10.0 percent with at least 5.0 percent in core capital. At
the end of June 2016, out of 33 NBFIs, (one NBFI is yet to come under this operation) 2 were evaluated
as "1 or Strong", 15 were "2 or Satisfactory", 14 were "3 or Fair" and 1 was "4 or Marginal" in the capital
adequacy component of the CAMELS rating.
2. Asset Quality
The ratio of gross nonperforming loan /lease to total loan/lease is used to judge the asset quality of
NBFIs. At the end of June 2016, the NPL ratio for NBFIs was 9.0 percent. In the total asset composition
of all NBFIs, the concentration of loans, lease and advances was 74.2 percent. At the end of June 2016,
out of 33 NBFIs, 1 was evaluated as "1 or Strong", 7 were "2 or Satisfactory", 14 were "3 or Fair", 9 were
"4 or Marginal" and 1 was "5 or Unsatisfactory" in the asset quality component of the CAMELS rating
matrix (the remaining one NBFI is yet to come into rating).
3. Management Efficiency
In financial institutions, management efficiency represents the ability of management for transforming
inputs (deposits, other funds and human resources) into outputs (investments/ leases and other income
generating assets). Total expenditure to total income, operating expenses to total expenses, earnings and
operating expenses per employee and interest rate spread are generally used to gauge management
efficiency. At the end of June 2016, out of 33 NBFIs, 4 were evaluated as "1 or Strong", 21 were "2 or
Satisfactory", 4 were "3 or Fair", 2 were "4 or Marginal" and 1 was "5 or unsatisfactory" in the
Management Capacity component of the CAMELS rating (the remaining one NBFI is yet to come into
rating)
4. Earnings and Profitability
Earnings and profitability of an NBFI reflects its efficiency in managing resources and its long term
sustainability. Among various measures of earnings and profitability, the best and widely used indicator is
the return on assets (ROA) which is supplemented by return on equity (ROE). ROA and ROE of all the
NBFIs in June 2016 were 0.8 and 5.6 percent respectively. At the end of June 2016, out of 33 NBFIs, 3
were evaluated as "1 or Strong", 16 were "2 or Satisfactory", 11 were "3 or Fair" and 2 were "4 or
Marginal" in the earnings and
5. Liquidity
NBFIs are allowed to mobilize term deposit only. At present, term liabilities are subject to a statutory
liquidity requirement (SLR) of 5.0 percent inclusive of average 2.5 percent (at least 2.0 percent in each
day) cash reserve ratio (CRR) on a bi-weekly basis. The SLR for the NBFIs operating without taking term
deposit is 2.5 percent. The Infrastructure Development Company Limited (IDCOL) established by the
Government of Bangladesh is exempted from maintaining the SLR. At the end of June 2016, out of 33
NBFIs, 19 were evaluated as "2 or Satisfactory", 10 were "3 or Fair", 2 were "4 or Marginal" and 1 was
"5 or Unsatisfactory" in the liquidity position component of the CAMELS rating (the remaining one
NBFI is yet to come into rating).
6. Sensitivity to Market Risk
The sensitivity to market risk reflects the degree to which changes in interest rates or equity prices can
adversely affect an NBFI's asset-liability position, earnings and capital. When evaluating this sensitivity
component, consideration should be given to management's ability to identify, measure, and control
market risk via the implementation of effective Core Risk Management System. Vulnerability of the
NBFI in a stressed situation from either an interest rate or equity price shock (or both) should be taken
under consideration to evaluate sensitivity. For many NBFIs, the primary source of market risk arises
from non-trading positions and their sensitivity to changes in interest rates. At the end of June 2016, out
of 33 NBFIs, 3 were evaluated as "1 or Strong", 9 were "2 or Satisfactory", 15 were "3 or Fair", 4 were "4
or Marginal" and 1 was "5 or Unsatisfactory" in the sensitivity to market risk component of the CAMELS
rating matrix (the remaining one NBFI is yet to come into rating).

Composite CAMELS Rating

At the end of June 2016, according to the composite CAMELS rating out of 33 NBFIs, 1 was "1 or
Strong", 15 were "2 or Satisfactory", 13 were "3 or Fair" and 3 were "4 or Marginal" (the remaining one
NBFI is yet to come into rating).

Problems in NBFI sector

Sources of fund
NBFIs collect funds from a wide range of sources including financial instruments, loans from banks,
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. According to the central
bank regulation, NBFIs has the restriction to collect public deposits for less than six months, which
creates uneven competition with banks as banks are also exploring the business opportunities created by
NBFIs with their lower cost of fund.
High Cost of fund
As most of the funds collected by NBFIs are from commercial banks, their cost of fund is much higher
than commercial banks. Current scarcity of funds has added to their sufferings. As per Bangladesh Bank,
department of statics, the weighted average interest rate for all banks is 8.47 percent on deposit and 13.80
percent on lending in December 2012. On the other hand the deposit interest rate of NBFIs ranges from
14 percent to 16 percent and lending interest rates ranges from 21.5 percent to 18 per-cent. Thus the
weighted average cost of fund for NBFIs would be at least twice that of banks.
Asset Liability Mismatch
For all types of depository institutions, it is a normal phenomenon that average maturity of assets are
higher than liability, it creates interest rate risk for the financial intermediaries. NBFIs are in a great
dilemma while managing the mismatch between their asset and liability. The average weighted life of the
company’s business portfolio should be less than the average weighted life of its deposits and borrowing.

Investment in High Risk Portfolio

Most of the officers of NBFIs under the survey agreed that they invest in comparatively high risk projects
as compared to banks. Reason behind this they identified that as their cost of fund is high they seek return
higher than the normal. So they choose projects that are declined by banks on high risk ground. It may
create unhealthy balance sheet for those NBFIs.
Poor Capital Market Condition
The stock market has been performing very poorly since early 2010. More than three million small
investors lost their capital. They were forced to protest in the street. This market crash accompanied by
sluggish economy affected the NBFIs abruptly. The trade declined drastically reducing the revenue for
the securities houses and NBFIs that maintain a portfolio also faced huge loss due to price reduction.
Competition with Banks
NBFIs serve the portion market that is untouched by the banks that is it left over. In our country, three are
fifty seven commercial banks and some nine are under process of starting their operation. So there is a
severe competition for selling loan products. It becomes tougher when commercial banks engage in non-
bank activities.
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.
Weak Legal System
Weak legal system creates a problem for leasing companies. Legal system hinders growth of leasing
companies in Bangladesh. 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. Another legal aspect that the
leasing companies face is right of depreciation for leased like many countries.
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 demand for second hand or used machinery and equipment.
SUGGESTED ALTERNATIVES
Exploring Alternative Sources of Funds
The NBFIs should take initiative to explore alternative source of fund like issuance of commercial paper
and dis-counting or sale of lease receivables to ease the fund crisis and reduce the cost of fund. Another
innovative and promising source of funds may be the securitization of assets. In this connection, IPDC
launched first asset backed securities in 2004 as an alternative source of funding. The government and
Bangladesh Bank should pro-vide necessary policy support in this regard.
Using Floating Interest Rates
We know one of the most important issues facing any lending organization is asset liability mismatch. If
NBFIs can match the duration of it asset products with its loan products it can solve the problem. But it is
next to impossible. So, NBFIs can use floating interest rate in its entire lending.
Using interest rate swap
Interest rate swap is an arrangement by which one set of fixed interest payment is exchanged for variable
one and vice versa. Financial institutions that have more interest rate-sensitive liability than assets are
adversely affected by increasing interest rate. Conversely, financial institutions that have long-term fixed
rate funding, but uses the funds primarily for floating rate loans are adversely affected by declining
interest rate. These financial institutions can successfully use interest rate swap to hedge interest rate risk.
Investment in Optimum Risk Assets
Optimal capital allocation is a tradeoff between risk aversion and optimum expected return. Investment
only in high risk assets reduces rating of an organization. So NBFIs should invest in assets that are of
standard risk. In this regard they may follow the guidelines of BASEL-II. In country, Delta Brac housing
has consistently maintained the high rating for several years.
Improving Capital Market
NBFIs around the world carry out a significant role in the development of the capital market. Strong
institutional support is necessary for a vibrant capital market which is the core of economic development
in any market based economic system. NBFIs through their merchant banking wing can act in this regard.
A total of 30 companies are now listed as merchant banks in Bangladesh, of which 23 are full-fledged, 6
are issue managers, and only one is a portfolio manager. Only nine NBFIs have registered with SEC for
performing merchant banking activities.
Developing Human Resource
The NBFIs should try to improve their human resources to compete in the market based economy. They
may arrange different seminar, workshop and other training programs to improve the quality of workforce
of their respective organizations.
Development of Commensurate Legal framework
A modern and dynamic regulatory framework is required for the rapid and effective development of
NBFIs. The NBFIs are now regulated by the Financial Institutions Act1993 and Financial Institutions
Regulations 1994. Some weaknesses of these regulations have been identified. NBFI regulations should
be the classification into deposit and non-deposit takers. Those NBFIs activities are involved with the
capital market that is those obtain funds through public offering of securities should be under the
regulatory jurisdiction of the Security and Exchange Commission.

Light of Hope in Capital Market

Banks and Non-Bank Financial Institutions are both key elements of a sound and stable financial system.
Banks usually dominate the financial system in most countries because businesses, households and the
public sec-tor all rely on the banking system for a wide range of financial products to meet their financial
needs. However, by providing additional and alternative financial services, NBFIs have already gained
considerable popularity both in developed and developing countries. In one hand these institutions help to
facilitate long-term investment and financing, which is often a challenge to the banking sector and on the
other; the growth of NBFIs widens the range of products available for individuals and institutions with
resources to invest. Through their operation NBFIs can mobilize long-term funds necessary for the
development of equity and corporate debt markets, leasing, factoring and venture capital. Another
important role which NBFI’s play in an economy is to act as a buffer, especially in the moments of
economic distress. An efficient NBFI sector also acts to mitigate systemic risk and contributes to the
overall goal of financial stability in the economy.
NBFIs of Bangladesh have already passed more than two and a half decades of operation. Despite several
constraints, the industry has performed notably well and their role in the economy should be duly
recognized. It is important to view NBFIs as a catalyst for economic growth and to provide necessary
support for their development. A long term approach by all concerned for the development of NBFIs is
necessary. Given appropriate support, NBFIs will be able to play a more significant role in the economic
development of the country.