Financial and Capital Market of Bangladesh The financial sector in Bangladesh comprises the money and capital markets, insurance and pensions, and microfinance. In addition to the Bangladesh Bank—the central bank of Bangladesh— there are 4 state-owned commercial banks (SCBs), 5 state-owned specialized banks, 30 domestic private commercial banks (PCBs), 9 foreign commercial banks, and 29 nonbank financial institutions (NBFIs) as of 2008. Figure 1 below depicts the nature of the financial sector in Bangladesh. Financial Sector In Bangladesh Money Market Micro Capital Market finance 1. Nongovernment 1. Bangladesh bank Security Insurance and Organizaons Market Pension and 2. All banks profident fund Affairs Bureau 3. Non- Bnk 2. 2. Palli Karma financial Institution 1.Controller of Shahayak 4. Money Changer Insurance Foundation 1. Sequirities 2. General and 3. Grameen Bank 5. Credit rating and Exchange Agency comission life insurance 4. Bangladesh Rural companies Development 2. Stock Exchanges 3. Government Board and other Pension Scheme nongovernment 3. Investment 4. Central Provident organizaons, Bank Fund microfinance 4. Merchant 5. Private sector bank institutions pension funds (typically small) Performance Evaluation of Non-Banking Merchant Bank in Bangladesh 1 The Capital Market Bangladesh has achieved stable growth over the last 9 years. It seems that the global financial crisis has not significantly affected Bangladesh mainly due to growth in exports and remittances. Although pressures from the global slowdown are building up and the financial crisis in the developed countries is unfolding and recession lasting longer than expectation, we had a growth rate in the range of 5.5 per cent to 6.0 per cent (data: June 2009). Although external debt is on the rise in recent years, it looks manageable because of declining ratio of exports to external debt. Compared to the neighboring countries, the Bangladesh capital market is small and has yet to play a bigger role in the economy. The share of domestic debt securities in the country’s GDP was approximately 12% in 2006 and that of India and Pakistan was 35.9% and 26.3%, respectively. Likewise, equity market capitalization over GDP was substantially lower among the South Asian countries. Therefore, Bangladesh has to accelerate to develop the capital market because it has a pressing need for investment resources to bolster its stretched infrastructure resources, to build more power stations, bridges, ports and gas- pipelines to empower the people in the development of enterprise and the creation of jobs. Debt markets are an extremely effective mechanism for matching the long term needs of savers with those of issuers. Performance Evaluation of Non-Banking Merchant Banks In Bangladesh 2 Financial Market Profile (2006) Source: World Bank “South Asian Bond Markets” (2008) Regulatory bodies of the capital market The Securities and Exchange Commission exercises power under the Securities and Exchange Commission act 1993. It regulates institutions engaged in capital market activities. Bangladesh Bank exercises powers under the Financial Institutions Act 1993 and regulates institutions engaged in financing activities including leasing companies and venture capital companies. Further to the regulations the following regulations also cover the capital market operation: 1. Dhaka stock exchange Automated Trading Regulation, 1999 2. Dhaka stock Exchange Investors protection fund Regulations, 1999 3. The listing Regulation of the Dhaka Stock Exchange Limited 4. SEC Margin Rules, 1999 5. DSE Settlement of Stock Exchange Transaction Regulation, 1998 6. Dhaka Stock Exchange (Members Margin) Regulation, 2000 7. SEC Corporate Governance Guidelines, 2006 Performance Evaluation of Non-Banking Merchant Banks In Bangladesh 3 Activities in the capital market: Activities in the capital market can be classified as follows: 1. Primary market activities Securities are issued in the primary market by one or more of the following methods: a) Public Issue b) Private placement c) Right issue d) Offer for sale 2. Settlement and securities administration: a) Settlement: The Chittagong and Dhaka Stock Exchanges each have their own automated trading system. The clearance system has daily netting facilities. The settlement system allows for early settlement of securities and funds. Failed trades are squared up by the stock exchanges and members are penalized for such failed trades. b) Collection: Dividends on shares are usually paid to the holders annually. Interest on debentures in paid semi-annually. Payments are made by banks cheque. The benefit of the share/debenture goes to the person whose name is on register during a pre- declared book closure period. Interest calculations are based on the normal calendar year. c) Capital changes and recognition: In case of right issues, existing shareholders are required to accept or renounce the shares within a specific time period. On the other hand, in case of bonus issues, share holders receive the share certificates by mail. Bonus shares are issued within 60 days of reopening of share transfer register. Performance Evaluation of Non-Banking Merchant Banks In Bangladesh 4 The recent development of capital market: The role of capital market in financing private investment remained at a nascent stage in the context of Bangladesh. Banks and financial institutions disbursed BDT 96.5 billion as industrial term loans during FY06, whereas only BDT 1.7 billion was raised in the capital market through private placements and public offerings (BB Annual Report FY06). As of December, 2006 a total of 310 securities were listed at DSE comprising 255 companies, 13 mutual funds, 8 debentures and 34 treasury bonds as opposed to a total of 249 securities comprising 230 companies, 10 mutual funds and 9 debentures as of December 2001. Thus during the last five years only 54 new companies got listed in the DSE of which only three were listed by direct listing route, and the rest were listed by public offering. Total market capitalization of all listed securities in DSE, however, increased substantially (by around 130 percent) in 2004 to BDT 224.9 billion. At the end of December '06 it stood at BDT 323.4 billion. DSE market capitalization as share of GDP fell to 5.41 in June '06 from 6.06 in June '05. MERCHANT BANK Financial institution that specializes in services such as acceptance of bills of exchange, hire purchase or installment buying, international trade financing, long-term loans and management of investment portfolios. Merchant banks also advise on (and invest own funds in) acquisitions, mergers, and takeovers. Merchant banking is an emergent sector in the capital market. According to Securities and Exchange Commission (Merchant Banker and Portfolio Manager) Rules, 1996, merchant bankers is defined as “… those who manage portfolio on behalf of its clients or performs the business of underwriting or are related to securities as underwriter or advisor or are providing corporate advisory services on completion of all the activities relating to Issue Management.” Generally the term merchant banking refers to a negotiated private equity investment by financial institutions in the unregistered securities of either privately or publicly held companies. Performance Evaluation of Non-Banking Merchant Banks In Bangladesh 5 Investment banking is an American synonym of merchant banking. Investment Banks provide advice on mergers and acquisitions and are involved in financing industrial corporations through buying shares and selling them in relatively small lotto investors. In the context of Bangladesh, merchant banking includes all financial institutions that combine the functions of both development banking and investment banking. Origin of Merchant Banking: Merchant banks first arose in the Italian states in the Middle Ages, when Italian merchant houses—generally small, family-owned import-export and commodity trading businesses—began to use their excess capital to finance foreign trade in return for a share of the profits. This trade generally consisted of lengthy sea voyages. In late 17th and early 18th century Europe, the largest companies of the world was merchant adventurers. The colonies of other European countries were started in the same manner. For example, the Dutch merchant adventurers were active in what are now Indonesia; the French and Portuguese acted similarly in their respective colonies. The American colonies also represent the product of merchant banking, as evidenced by the activities of the famous Hudson Bay Company. Later, the center for merchant banking shifted from the Italian states to Amsterdam and then, in the eighteenth century, to London, where immigrants from Prussia, France, Ireland, Russia, and the Italian states formed the core of early British merchant banking. As the nineteenth century opened, virtually no mercantile houses remained focused on both trade and finance. During the 20th century, however, European merchant banks expanded their services. They became increasingly involved in the actual running of the business for who the transaction was conducted. Today, merchant banks actually own and run businesses for their own account, and that of others. Merchant Banking in Bangladesh: The concept of merchant banking is in a development phase in our country. Regulatory bodies and Government is always trying to develop the capital market focusing the welfare of the investor through building a stable and secured market. The first ever stock exchange came into existence in Bangladesh (then East Pakistan) in the name of “East Pakistan Stock Performance Evaluation of Non-Banking Merchant Banks In Bangladesh 6 Exchange Association Ltd”. It took two years more to launch its formal operation. 1964, the name of East Pakistan Stock Exchange Limited was changed to "Dacca Stock Exchange Ltd." Investment Corporation of Bangladesh (ICB) was the pioneer in the country that has performing with strong reputation in the country’s capital market spreading its activities in all the segments of capital market. In 1987, the Bangladesh Government prepares and presents the Securities & Exchange Rules. In 1993, DSE took step ahead to update its all share price index on the basis of the design suggested International Finance Corporation (IFC). In 1994, Securities & Exchange Commission (SEC) published rules regarding the activities of dealers and brokers. The title of the rules is set (Stock-dealers, Stock-brokers and Sub brokers). In 1996, SEC introduces SEC (Merchant Baker & Portfolio Manager) Regulations, along with SEC (Mutual Funds) Regulations, 1996. Except the activities of ICB, merchant banking in Bangladesh had started their activities. Now there were no legal obligations of the issuer companies to engage an issue manger at the time security issue. In 1997, some bank and non banking organization give proposal to get the permission of operate merchant banking operation. In 1998, DSE introduced automated trading; it is a great break through both for the country and stock exchange. IDLC of Bangladesh got license full-fledged merchant banker. It is the first licensed full-fledged merchant banker in the country. Another 10 full-fledged merchant banker introduces in this. In 1999, another 5 non banking organization started as full-fledge merchant banker. Prime Finance and Investment Limited started their full-fledge merchant banking operation from this year. In 2000, only one non banking organization introduced as a full-fledge merchant baker. In 2001, Prime Bank and Arab Bangladesh Bank started their operation as a merchant banker, another 2 non-banking organization started their merchant banking operation. From 2002 to 2009, another 10 merchant banker are introduced and most of them are private commercial banking organization. The number of full-fledged merchant banker is now 29. Another two companies is also registered as merchant banker but currently deals with issue management and portfolio management only. Performance Evaluation of Non-Banking Merchant Banks In Bangladesh 7 To register as a merchant banker, SEC placed some requirements. They are discussed below: Issue Manager At least 1 (one) proposal for public issue be submitted to the Commission in each calendar year Portfolio Manager In addition to own portfolio, at least 5(five) new portfolio accounts be opened in each calendar year Merchant Banker 1 (one) issue management, 2 (two) underwriting, 5(five) new portfolio accounts be opened in each calendar year Besides these, merchant bankers need a pre-condition of capital of TK 100 million for the registration of full-fledged merchant banker. Tk 10 million of capital is needed of a company is registered for issue management and underwriting or portfolio management only. For issue management, it is needed 2.5 million only. Merchant Banking activities in Bangladesh Although in the U.S., merchant banks offer a wide range of activities, including portfolio management, credit syndication, acceptance credit, counsel on mergers and acquisitions, insurance, etc, in case of our country, these services may differ. In Bangladesh, a merchant bank can perform multiple activities including underwriting, issue management, portfolio management, merger & acquisition etc. The merchant banking activities were largely fostered by two distinct developments: Merger &acquisition activities and increased demand for venture capital. 1. Underwriting: Underwriting operation is one of the important functions of a merchant banker by which it can increases the supply of stock/shares and debentures in the market. It is an arrangement whereby the underwriter undertakes to subscribe the unsubscribed portion of shares/debentures offered by any public limited company. These encourage the Performance Evaluation of Non-Banking Merchant Banks In Bangladesh 8 prospective issuers to offer shares/debentures to the public for subscription and they can raise funds from the public. One or more investment banking firms may underwrite public offerings. The underwriters have the responsibility of pricing new shares and selling them to investors. The company pays the underwriters a fee. Underwriter also provides advice to a company issuing securities or to an issue manager. Before granting authority to17 non-bank financial institutions in 1997 to conduct merchant banking business in Bangladesh under the Securities and Exchange (Merchant Bankers and Portfolio Manager) Regulations 1995, specialized financial institutions, and the nationalized commercial banks and insurance companies were the key underwriters in the country's securities market. 2. Issue Management: Issue Management function of merchant Banking helps capital market to increase the supply of securities. Being a Issue Manager these FIs provide assistance to the Private Limited Companies intended to be converted into Public Limited Companies by way of obtaining necessary permission from the relevant authorities, preparing prospectus for public issue of shares and debentures, involving itself in the collection of application money, scrutiny of applications, arranging for lottery relating to allotment, if required, allotment of shares and debentures, refund of application money etc. 3. Portfolio Investment Management Services: Portfolio means a collection of investments owned by an investor, an institution or a mutual fund and portfolio manager means the entity responsible for investing a mutual fund's assets, mapping out its investment strategy and managing day-to-day securities trading. Portfolio management is the process of building, managing and assessing an inventory of company products and projects. One of the most important functions of merchant banking is to provide Portfolio Management service to the customer. Basically, Portfolio Management Services program has four different wings to provide portfolio investment management services. Performance Evaluation of Non-Banking Merchant Banks In Bangladesh 9 The SEC allowed banks to launch merchant banking operation through opening of separate wing mainly to deal in portfolio investment on behalf of clients' account in order to channel pool of investors' fund into the stock market in an organized manner. 4. Merger and Acquisition: The phrase mergers and acquisitions (abbreviated M&A) refers to the aspect of corporate strategy, corporate finance and management dealing with the buying, selling and combining of different companies that can aid, finance, or help a growing company in a given industry grow rapidly without having to create another business entity. Merchant banking helps to negotiate companies in this case. Other functions that differ from FIs to FIs are Factoring, Asset Securitization, OTC Market, Capital Re-Structuring etc. In addition these FIs can also perform the activities of: Project counseling Lending to stock investors Pre-Investment Studies, etc Customers of Merchant banking: In our country, the customers of merchant banking are as follows in general: 1. Any Bangladeshi over 18 years of age. 2. Any Corporate body. 3. NRB (s) through NITA Account. Role of merchant banks The role of merchant banks can be categorized into two broader phases- 1. Primary market making: Merchant bank performs the role of advisory management, administrative services, underwriting, private placement, and banker of the issue. 2. Secondary market making: Merchant banks play an important role in the development of the capital market for previously issued securities providing a number of merchandising services. Performance Evaluation of Non-Banking Merchant Banks In Bangladesh 10 Performance of merchant banks The overall performances of the merchant banks are not very impressive. Most of the merchant banks are engaged only on issue management and underwriting. In case of portfolio management, only three companies are fully operational in the market. The remaining areas untouched mainly because of the limited scope of business in the context of an under-performing capital market of Bangladesh. This makes some of the merchant banks dormant. Actual picture of Merchant Banking activities in Bangladesh: In reality, merchant, banks of Bangladesh operates only in three functional areas, i.e., issue management, underwriting and portfolio management (as corporate advising being untouched).Of those, the first two are fee-based business, while the latter one is fund- based. But the cost of fund for merchant banks is much higher than that of the commercial banks. In a step to make merchant banks fully operational, SEC recently amended the Securities and Exchange Commission (merchant banker and portfolio manager) Regulation, 1996 which permits the commercial bankers to conduct the portfolio management business with their own fund. This -step was taken as an attempt to help commercial banks to conduct portfolio management more profitably. As a result, all the three companies that are doing portfolio management are the commercial banks. Under the limited scope of business it would be very difficult for other merchant banks to operate competitively as the earning potential for these companies are very restricted. Performance Evaluation of Non-Banking Merchant Banks In Bangladesh 11 PERFORMANCE EVALUATION Uttara Finance and Investment Limited a joint venture leasing and financing company registered as a NON-BANK FINANCIAL INSTITUTIONS under the Financial Institution Act 1993 and the COMPANIES ACT 1994. It commenced business on 1 November 1995 with an authorized capital of BDT 250 million divided into shares of BDT 100 each. The paid up capital of the company is BDT 120 million. Of the total share capital, 25% is held by Bangladeshi sponsors, 20.83% by foreign sponsors (Singaporean), 14.10% by the INVESTMENT CORPORATION OF BANGLADESH , 0.09% by its employees and 39.98% by the general public. The company is listed with both Chittagong and Dhaka Stock Exchanges. Main areas of business operations of the company are related to leasing for providing benefits of asset-based lease facilities. The company signed business contracts on lease and term finance for BDT 423.44 million in 2000. Of the total contracts processed, those for BDT 383.71 million were executed. Up to 31 December 2000, total amount of net leased assets and net term finance of the company stood at BDT 624.14 million. Assets of the company comprised leased assets, term finance, investment in shares, and other current assets. The company earned a net profit of BDT 33.99 million in 2000. Principal Activities General: Uttara Finance maintains an as and when decision making policy in both securing and investing fund, basing on over-all micro and macro socio-economic-political scenario. Lease: Uttara Finance extends Finance Lease facility to acquire capital assets to any sector preferably to ongoing concerns. Performance Evaluation of Non-Banking Merchant Banks In Bangladesh 12 Loans: Uttara Finance extends short to mid Term Loans in following areas: Working Capital Loan, Bridge Finance, Personal loan, Home Loan. Small and Medium Enterprises: Uttara Finance extends this facility to enterprises as defined by Bangladesh Bank from time to time. Deposit schemes: Uttara Finance offers competitive rate of interest to individuals for tenure of 12 months to 36 months and to and corporate business houses for tenure of 6 months to 36 months. Performance Evaluation of Non-Banking Merchant Banks In Bangladesh 13 Merchant Banking Unit: Uttara Finance offers full range of asset management services like Underwriting; Portfolio management; Bridge Finance; mutual fund; Individual investor's accounts in capital market. Zero Down Payment Scheme: The scheme has been introduced to assist individuals and business concerns to facilitate acquiring of vehicles. Profit and Loss Statement of Merchant Banking Operations is as follows: Performance Evaluation of Non-Banking Merchant Banks In Bangladesh 14 Some important ratios are presented below for evaluation of this unit’s performance: Ratios 2008 2009 Return on Assets 0.32% 1.62% Return on Equity 1.95% 9.87% Net Interest Margin 0.08% 1.22% Reserve as a percentage of loans 7.19% 9.13% Long Term Debt to Total Liabilities and 27.74% 23.65% Equity Loans to Assets 67.58% 51.91% Equity to Assets 16.57% 16.40% Capital Adequacy Ratio (CAR) 15.05% 13.91% Return on assets and equity has increased but it is still very low. Net Interest Margin is very low but increasing. But this is due to the fact that we have considered the profit and interest income of only merchant banking unit with total asset and equity of the firm. Reserve as a percentage of loans has increased. This is a bad indication. It suggests that company is giving out loans that higher default risk. So they are maintaining a higher percentage of loan loss reserve. According to Banking Regulation & Policy Department of Bangladesh Bank, Uttara finance is maintaining a CAR of greater than 9% but it has decreased 1.14% from last year. Performance Evaluation of Non-Banking Merchant Banks In Bangladesh 15 Industrial development Leasing Company of Bangladesh (IDLC) a multinational joint venture public limited company and the first leasing and multi-product non- bank financial institution in Bangladesh. It became a listed company in Dhaka stock Exchange on 20 March 1993 and in the Chittagong stock exchange on 25 November 1996. IDLC started to accept deposits after receiving the license from BANGLADESH Bank on 10 September 1994. Issue management: IDLC provide innovative solution for raising capital (debt and equity) from the market suiting the unique needs and constraints of the corporate clients. Issue Management services of Merchant Banking Division include Public Issue Management of Initial Public Offering, Repeat Public Offering, Bond Issuance, Rights Share Offering, Corporate Advisory Service in various matters. IDLC has a qualified, experienced and innovative team to provide best solution in terms of managing public offers. Issue Issue Size Year of issuance Bank Asia Ltd. (co-manager) BDT 300M 2003 Berger Paints Bangladesh BDT 139M 2005 Ltd. Marico Bangladesh Ltd. (Joint BDT283M 2009 manager) RAK Ceramics Bangladesh BDT 1200M (tentative) 2010 (expected) Ltd. (Lead issue manager) Vantage Electrical & BDT 100M 2010 (expected) Electronics Ltd. Performance Evaluation of Non-Banking Merchant Banks In Bangladesh 16 LR Global Bangladesh Asset BDT 3,000 M 2010 (expected) Management Co. Mutual Fund 1 BRAC Bank Limited (Issuance BDT 3,000 M 2010 (expected) of Subordinated Convertible Bonds) Under writing: Review valuation of the company to justify issue price Review previous audited and current management accounts Company's business appraisal and due diligence visits Meeting with top management of the Company Analyzing Financial Ratios and other indicators 2005 Nature of Underwriting Tk In Million Premier Leasing IPO 2.775 Pragati Life Insurance IPO 1 Jamuna Bank IPO 10.8 Berger Paints IPO 36.15 Eastland Insurance Rights 12 Dhaka Bank Rights 47.5 110.225 Performance Evaluation of Non-Banking Merchant Banks In Bangladesh 17 2006 Nature of Underwriting Tk In Million BRAC Bank IPO 42.5 LankaBangla Finance IPO 2.5 S. Alam Cold Rolled Steels IPO 5 InTech Online Rights 5.0 Southeast Bank Rights 250 Uttara Finance & Invesment Rights 22.5 Ltd. 327.5 2007 Nature of Underwriting Tk In Million Phoenix Finance & IPO 3 Investment Paramount Insurance IPO 9 Islami Bank Bangladesh RPO 50 Limited Mudaraba Perpetual Bond 62 2008 Nature of Underwriting Tk In Million Summit Alliance Port IPO 15 Limited Dacca Dyeing & IPO 10 Manufacturing Company Limited 25 Performance Evaluation of Non-Banking Merchant Banks In Bangladesh 18 2009 Nature of Underwriting Tk In Million Marico Bangladesh Limited IPO 44 Grameenphone Limited IPO 224 Golden Son Limited RPO 25 Crystal Insurance Company IPO 5 Limited Beacon Pharmaceuticals IPO 20 Limited RAK Ceramics Bangladesh IPO 75 Ltd. Vantage Electrical & IPO 15 Electronics Ltd 408 IDLC works as an underwriter from 2005 and they had gathered enough experience to perform underwriting activities. Advisory service: IDLC offers a range of advisory services to corporate clients to meet their specific requirements. Their Fund Raising and Advisory Services can also complement each other in satisfying the unique needs of clients. The Advisory Services are: Merger and acquisition Joint venture match making Feasibility Study Performance Evaluation of Non-Banking Merchant Banks In Bangladesh 19 Syndicate and Fund Raising: They also make a syndicate for fund raising as per client need. They offer it service in various models. The models are: Loan Syndication Private Placement of Equity Project Finance Foreign-Currency Loan and Special Funds Under its broader merchant banking functions, IDLC also operates Trusteeship manager, bridge financer and investor in the placement of shares and stocks. Few ratios are given below to evaluate the current performance of the IDLC finance ltd. Ratios 2008 2009 Return on Assets 1.51% 2.40% Return on Equity 17.96% 27.28% Rate Paid on Funds 10.18% 7.63% Net Interest Margin 13.48% 12.83% Reserve as a percentage of loans 4.10% 3.23% Charge offs as percentage of loans 10.50% 13.51% Long Term Debt to Total Liabilities and Equity 19.64% 16.45% Loans to Assets 24.51% 27.89% Equity to Assets 8.39% 8.79% Capital Adequacy Ratio 3.52% 4.45% Performance Evaluation of Non-Banking Merchant Banks In Bangladesh 20 Return on assets and equity has increased significantly, it indicates that firm efficiently use their resources and get maximum output from it. Net Interest Margin is decreasing from previous year. But it still satisfactory. Reserve as a percentage of loans has decreased. It indicates that company efficiently collects the loan and default risk is minimized for the firm. According to Banking Regulation & Policy Department of Bangladesh Bank, IDLC finance is unable to maintain standard CAR which is 9%. LankaBangla Merchant Banking Services LankaBangla Finance Limited provides merchant banking services in the following areas: Issue-Management LankaBangla provides such services to an issuer company which includes inter alias regulatory compliance, placement arrangement, underwriting arrangement, post issue service, distribution, etc. Underwriting LankaBangla is providing underwriting service offers comfort to the issuing company. Apart from acting as underwriter to public issue also act as the Arranger of Underwriting. Merger, Amalgamation and Private Placement Merger of two companies may represent the culmination of years of effort by their owners and management. Shareholders and management teams through the merger and acquisition process to maximize value and minimize disruption to the business. Performance Evaluation of Non-Banking Merchant Banks In Bangladesh 21 Portfolio-Management LankaBangla Portfolio Management service is designed to provide personalized, secure and simple financial solutions for a wide variety of investors who wish to enhance their opportunities while minimizing their administrative burden. Business Overview and Profit Growth Bangladesh stock market has performed very well throughout the year 2008 promising encouraging future ahead. Bull beating bear for excess demand over shortage of supply of good securities was observed in the market. Market capitalization at the end of December 2008 was BDT 10 billion which is 15.88 percent of GDP while it was 7.59 percent in 2007. In 2008 Company registered a tremendous business growth with leading market share in terms of turnover in both the bourses. The operating results and the performance graph are shown below: Performance Evaluation of Non-Banking Merchant Banks In Bangladesh 22 Market Share of Lanka Bangla Securities in DSE & CSE Few ratios are given below to evaluate the current performance of the LankaBangla finance ltd. Ratios 2008 2009 Return on Assets 1.82% 1.47% Return on Equity 22.02% 18.69% Rate Paid on Funds 88.01% 24.91% Net Interest Margin 17.59% 12.02% Reserve as a percentage of loans 2.24% 2.97% Charge offs as percentage of loans 4.11% 1.64% Loans to Assets 43.32% 41.80% Equity to Assets 8.25% 7.86% Capital Adequacy Ratio 8.02% 8.06% Performance Evaluation of Non-Banking Merchant Banks In Bangladesh 23 Return on Asset and Return Equity is decreasing from last financial year. Net Interest Margin also decreasing. It indicates that firm managements did not efficiently use their current resources. On the other side Reserve as a percentage of loans is increasing from the last financial year. It predicts that a firm has more risky loans investment compare to last year. Firm is trying to maintain CAR in a standard point. But it still below standard 9%, so they have to improve it from 8.06% to at least 9%. Performance Evaluation of Non-Banking Merchant Banks In Bangladesh 24 Listed on both the Dhaka and Chittagong Stock Exchange, Prime Finance is an integrated financial services provider offering a comprehensive range of products and services in the local markets. Prime Finance is one of the largest NBFIs in Bangladesh by market capitalization. Market capitalization as on the last day of 2009 was Tk. 11,992 million. Prime Finance’s core competencies cover lease finance, term finance, real estate finance, SME finance, public issue of shares, portfolio management, margin loan, share trading and many more. Public Issue of shares: Prime Finance assist corporate clients in meeting their financial needs and advising them on the most advantageous means of raising capital. It manages or co-manages public offerings of shares or arrange private placement of shares with institutional or individual investors. In addition, it provide consulting services, including mergers and acquisitions and advising clients with respect to financing plans and related matters. Performance Evaluation of Non-Banking Merchant Banks In Bangladesh 25 Underwriting: Underwriting services is another product of Merchant Banking Operation. During 2009, Prime Finance entered into agreements with 12 companies for underwriting of their shares for total amount of Tk. 385.02 million. Participation in underwriting can expose to financial risk since the possibility exists that the securities it has committed to take up may not be fully subscribed at the initial public offerings. Private placement: Prime Finance & Investment Limited arranges private placement of debt and equity securities for the companies seeking a broad range of corporate finance alternatives. Through its relationship with institutional and private investors, Prime Finance has developed an outstanding private placement track record to help its clients expand their existing projects or set up new projects. With a reputation for superior service and results in private capital rising, Prime Finance & Investment Limited has broad experience in placement of: Debt instrument Convertible and equity-linked securities Private equity Portfolio management: Own portfolio: Our investment in capital market performed well. In the second half of the year, the stock Exchange went up significantly. This rise was due to a number of factors. In 2009 total income from investment in capital market was Tk. 480.15 million made up as under: Capital gain from sale of share: Tk. 465.88 million Dividend income: Tk. 14.27 million Investors' portfolio: Prime Finance manages investors' portfolio of its 706 clients worth Tk. 4.11 billion. Prime Finance provides margin loan to its clients as per policy and within the framework of regulatory authority, the Securities and Performance Evaluation of Non-Banking Merchant Banks In Bangladesh 26 Exchange Commission. During the year 2009 Prime Finance earned a total Tk. 196.98 million as interest on margin loan and a Tk 34.19 million as fee from managing investors' portfolio. Margin loan: Prime Finance provides margin loan to its portfolio investors for investment in the listed securities against their equity. The Company's revenues from portfolio clients include interest on margin loan, portfolio management fees and annual charges. Corporate financial services: Prime Finance offers an extensive range of professional corporate financial services. We specialize in tailor-made, value-added solutions, which are particularly suited to small and midsized companies. We serve our clients in their best interest, creating value for them and compliment their business expertise with our own, to maximize their opportunities for growth. Advisory services: Corporate counseling services are provided in the form of customized solutions for better corporate performance in terms of prolonged existence and steady growth. Project counseling services include systematic development of an idea into a plan, development of a financial structure and preparing project feasibility report. Performance Evaluation of Non-Banking Merchant Banks In Bangladesh 27 Few ratios are given below to evaluate the current performance of the Prime finance ltd. Ratios 2008 2009 Return on Assets 5.71% 8.89% Return on Equity 36.75% 49.72% Rate Paid on Funds 8.86% 7.17% Net Interest Margin 3.40% 1.70% Reserve as a percentage of loans 5.47% 2.97% Charge offs as percentage of loans 0.00% 0.00% Long Term Debt to Total Liabilities and Equity 49.73% 28.45% Loans to Assets 30.36% 26.29% Equity to Assets 17.61% 16.39% Capital Adequacy Ratio 17.75% 16.47% Performance Evaluation of Non-Banking Merchant Banks In Bangladesh 28 In 2009, compare to 2008 return on assets and equity has increased significantly (3.18% & 12.97% increase respectively), it indicates that firm efficiently uses their resources and gets maximum output from it. Net Interest Margin is decreasing from previous year which indicates the fall of income from interest. Expenses for paying interest have gone up in 2009. Reserve as a percentage of loans has decreased. It indicates that company efficiently collects the loan and default risk is minimized for the firm. According to Banking Regulation & Policy Department of Bangladesh Bank, Prime Finance is able to maintain standard CAR which is 9%. Performance Evaluation of Non-Banking Merchant Banks In Bangladesh 29 \ ICB Capital management Limited: ICB Capital Management Ltd. has been created as a subsidiary of ICB to carry out merchant banking activities including issue management, underwriting and portfolio management. The company was incorporated under the Companies Act, 1994 on 5 December 2000 and registration from the Securities & Exchange Commission was obtained on 16 October, 2001. The company started its' operation from 01 July, 2002 upon issuance of gazette notification by the government. Functions: Underwriting of initial public offering of shares and debentures Underwriting of right issue of shares Issue management Managing Investors' Account Providing investment counsel to issuers and investors' including financial engineering and corporate advisory services Purchase of shares and debentures including placement and equity participation To provide consultancy services for disinvestments program of the Government To provide financial consultancy services to different companies in respect of Equity & Entrepreneurship Fund of Bangladesh Bank and others Dealing in other matters related to capital market operation. Performance Evaluation of Non-Banking Merchant Banks In Bangladesh 30 ADVANTAGES OF MERCHANT BANKING IN BANGLADESH Effects on Capital market A well organized and efficient capital market is the essence of a market based financial system. The stock market is the first and foremost forum in which individuals can trade risk and return, llamas can raise capital and stockholders can maximize the value of their shares. In many countries of the world especially the countries of the continental Europe and Japan have started their reforms based on bank-dominated system first. So a full pledged reform program of financial sector includes the development of both bank and non-bank financial institutions in the financial system so that the overall savings and investment activities improve significantly. Merchant banking activities involves activities like a manager of the issue, underwriter and portfolio manager etc. Merchant bankers can venture in such types of risky businesses because of their particular types of sources of fund, which facilitate them to provide institutional support to the capital market. On the other hand, bank's money is the depositors’ money a nd so they go for less risky short term financing. For this reason banks are subject to h ig h regulations and merchant bankers are little or no regulations around the world and thereby can go easily for risky investment such as merchant banking, venture capital etc. Their funding is not covered by the government protection. The merchant banks accelerate the capital market which can expedite the economic growth of the country. More and more investors would be interested in buying securities as they have the necessary fund. Citigroup can contribute to bringing good products, bonds and corporate entities in t h e stock market. They will help in bringing companies including foreign ones in the stock ma rket and all this will increase the supply side in the market. Performance Evaluation of Non-Banking Merchant Banks In Bangladesh 31 Effects on the Investors General investors as well as corporate investors will now focus more on investing in shares and coming into the market as Citi Bank, a reputable and trustworthy firm will be leading them fund which they lacked before. Now foreign investors have an opportunity to contribute to the stock market of Bangladesh. Through corporate advising, the merchant bank helps the issue analyze its financing needs and suggest various ways to raise needed funds. Effects on the Economy Merchant banking causes a great impact on the economy of Bangladesh Bank. It contributes to the National GDP as well as to contribute to the growth of national economy. Due to the merchant banking, people will be more encouraged to use their unutilized money in the investment of different stocks and securities which are expected to grow. As a result the unutilized portion which was not counted earlier in GDP in included now. The investment area w i l l be more safe and predictive. As due to the merchant banking more and more investors will invest in the market, the market will be spread and as market will spread, there will be less risk to be default. Performance Evaluation of Non-Banking Merchant Banks In Bangladesh 32 Problems and Restrictions of Merchant Bankers Unscrupulous and frequent policy changes by SEC: The Security and Exchange Commission of Bangladesh tends to change the policy frequently which sometimes drastically affects the market situation. To temporarily control the market they take at times take measures that affect the market negatively in the long term. Consequently, it compels some investors to leave the market and merchant banks are affected. In the year 2010 SEC has revised the margin lone ratio four times in last eleven months. Reduced Margin ratio: According to the new SEC guideline, the margin ration for disbursing loan has been reduced to 1:1 (14.12.10) which was previously calculated on Net Asset Value (NAV) basis. So the amount of loan given by the merchant banks have been reduced which ultimately affect their profit margin. Ceiling for margin loan The Securities and Exchange Commission set new ceiling for margin loan for merchant banks and brokerage houses. Under the new directive, merchant banks and brokerage houses are allowed to lend up to Tk 10 crore as margin loans to their clients, an official said. Margin loans, meant for share trading purposes, are disbursed against the shares an individual investor has in his or her possession. The impact of this decision sent a shockwave through the market and on the following day, DSE general index fell by over 200 points. Performance Evaluation of Non-Banking Merchant Banks In Bangladesh 33 Challenges of Merchant Banking In Bangladesh High government borrowing at high interest rates The government has traditionally been the major borrower through the various ‘national savings schemes’ and that too at the highest interest rate bracket and in unlimited (not predetermined) amounts. The government instruments were crowding out corporate borrowers and bank deposits in comparable tenures. Thankfully, the scenario is shifting lately as the government has discontinued some high interest paying instruments and restricted investments on others, accompanied with rate cuts. This has been attributed to the recent surge in stock prices. Lack of transparency in public sector borrowing Public sector borrowing has been riddled with lack of transparency that failed to eventually proffer any reliable demand-supply scenario in which an efficient debt market can function. Because of the frequent shifts and ad hoc culture and volatility of demand, many of the debt instruments could not be designed to be publicly traded that could fuel a vibrant market. Efforts are now on to issue tradable instruments and bring fiscal discipline. Supply of Funds: Although share capital is perspective source of fund for merchant banks, many companies have not utilized the opportunity fully. As most of the merchant banks are incorporated as public limited companies, it could be as better alternative for them to raise fund through initial public offerings in order to finance the expanding horizon of activities. It can be noticed that the dominance of bank loan in the total fund is decreasing while the importance deposit base is gaining momentum. Financial institutions have to raise capital reserve of at least BDT 250 million, a portion of which must be collected through the issuance of IPO. This arrangement will make their operations more transparent, bring accountability to the shareholders and reduce dependence on credit lines. Though all merchant banks were required to raise the minimum capital requirement through IPOs by September 2006 (extended from June 2006,) eight (8) companies’ share yet to float their shares in the market. Four of these have already submitted necessary documents to SEC for review while four others are still in the process of doing so. Performance Evaluation of Non-Banking Merchant Banks In Bangladesh 34 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 Merchant Banks, 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 Merchant Banks. The industry experts believe that although there exists enormous growth opportunity the market is still quite small and scope of work for skilled personnel is very limited compared to that of banks. This makes the competent personnel to switch from Merchant Banks to other institutions after a certain period implying low retention rate of skilled human resource. Weak Legal System Although the default culture has not yet infected Merchant Banks to any major extent, they face difficulties in recovering the leased assets in case of a default. Moreover delays in court procedures create another cause of concern. The situation cannot be improved only by making the legal system stronger through enactment of new laws rather ensuring proper implementation existing ones is more of concern. Cost of Fund: Merchant Banks face comparative disadvantage in collecting funds compared to the banks because Merchant Banks cannot collect short term (less than one year) deposits from individuals due to the central bank’s restriction, and again deposits in Merchant Banks are perceived to be less safe to the public. Due to the liquidity crisis, when interest rate goes up, the average rate of interest on bank credit lines and deposit rate also increases, which causes significant rise in the cost of fund for Merchant Banks. The high cost of fund for Merchant Banks compels them to operate on a relatively low profit margin. Performance Evaluation of Non-Banking Merchant Banks In Bangladesh 35 Asset-Liability Mismatch Asset-liability mismatch is another cause of concern for Merchant Banks. Demand for funds to meet the increasing lending requirements has increased many times. But the availability of funds has become inadequate. The average weighted life of its deposits and borrowing in its operating guidelines for a leasing company. Therefore, Merchant Banks have to explore alternative ways for raising funds. Investment in High Risk Portfolio It is already mentioned that cost of funds for Merchant Banks are higher than that of banks. In order to sustain the high cost of borrowing, Merchant Banks may be inclined to invest in the high return segments, which can expose them to commensurately higher risks. Moreover, fierce competition among competitors may also force many Merchant Banks to reduce the margin at the expense of quality of the asset portfolio. This strategy may eventually create the possibility of an increase in the non-performing accounts. Unless adequate risk management capabilities are developed, the growth prospects of Merchant Banks would not only be hindered but it might also be misapprehended. Product Diversification Merchant Banks emerged primarily to fill in the gaps in the supply of financial services which were not generally provided by the banking sector, and also to complement the banking sector in meeting the financing requirements of the evolving economy. the new customer base has not been created and the growth of industrial entrepreneurship could not be facilitated through Merchant Banks financing packages. Diversifying the product range is a strategic challenge for Merchant Banks in order to become competitive in the rapidly growing market. Competition with Banks With the advent of new Merchant Banks, the market share is being spread over the competing firms and the demand facing each firm is becoming more elastic. Active participation of commercial banks in the non-bank financing activities has further Performance Evaluation of Non-Banking Merchant Banks In Bangladesh 36 increased the level of competition in the industry. For commercial banks, public deposit is one major source of funds which they can collect with relatively lower cost. Thus the business environment for Merchant Banks has become more challenging as they have to face uneven competition with banks in terms of collecting funds. Comparison between Bangladeshi Merchant Bank services and Global services: Merchant Banks in Bangladesh mainly offer services like issue management, underwriting options, advisory service, portfolio management, Trusteeship management, bridge financing. But internationally banks provide a wind range of service which has not yet been introduced in our country due to small and weak capital market, government regulation and lack of expertise. So, Bangladesh is far behind from the international market in spite of great potential here. International merchant bank are large enough to provide services through the world. They have international client’s data base and serve beyond their market. They mainly provide advisory and syndication services to their clients about how to approach the international business and become a multinational service. On the contrary, Bangladeshi merchant bank are not capable to provide those services due to lack of resources. Many firms have the potential to do a profitable service by addressing its population’s varying needs. International merchant banks offer advices to their clients regarding differentiated needs by suggesting them realistic business ideas. Bangladeshi merchant banks have to take it into account. Merchant bank educate their clients about their services and notify about the future potential opportunities to their clients. But in Bangladesh it’s merely applied by the merchant bank. Performance Evaluation of Non-Banking Merchant Banks In Bangladesh 37 Recommendation Enhancing Capital Market Activities Merchant Banks 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. Merchant Banks 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 Merchant Banks have registered with SEC for performing merchant banking activities. But their activities in the capital market are rather limited (Financial Sector Review, Bangladesh Bank, 2006). Active participation of merchant banks is essential to accelerate the capital market activities which can expedite the economic growth of the country. The success of merchant banking operations is largely linked to the development of the security market. So Merchant Banks should concentrate more on their opportunities in the capital market. Alternative Sources of Funds The finance and leasing companies across the world are using different sources for collecting funds. Merchant Banks in Bangladesh may also explore the possibilities of gaining access to new sources of funds like issuance of commercial paper and discounting or sale of lease receivables. However, in releasing such new products, some regulatory changes have to be made. Another innovative and promising source of funds may be the securitization of assets. Market Segmentation It has been discussed earlier that though banks and Merchant Banks compete with each other they can also perform complementary functions. To function as complementary institutions both banks and Merchant Banks should follow some ethical and technical norms. 15 Banks wishing to enter in the leasing business, which is essentially a core operation of Merchant Banks, should do so through opening subsidiaries so that a level Performance Evaluation of Non-Banking Merchant Banks In Bangladesh 38 playing field for Merchant Banks can be maintained. This is needed as banks have access to lower cost funds compared to Merchant Banks, which puts the former in an advantageous position. Alternatively, banks can go for joint financing under syndication arrangements with leasing companies on any project proposal. Again, banks can concentrate on working capital finance and foreign exchange operations, which matches more with their asset- liability management. Competition and Product Diversification Merchant Banks in Bangladesh are operating in a highly competitive environment. The competition for Merchant Banks is even more challenging as they have to compete with banks. Given the changes in the business environment, the need for product diversification is very important. At present, lease financing constitutes 55 percent of the total long term assets of Merchant Banks. The remaining part concentrates mainly on term financing and housing finance. Some of Merchant Banks are primarily engaged in leasing, some are also diversifying into other lines of business like merchant banking, equity financing etc. Currently, 22 Merchant Banks (out of 29) specialize in lease financing. Merchant Banks are permitted to undertake a wide array of activities and therefore should not confine themselves to one or two types of product only. Leasing, no doubt, presents a good alternative form of term financing but Merchant Banks should also venture into diversified use of their funds such as merchant banking, venture capital financing, factoring, etc. for a healthy growth of the capital market. Issues of Taxation The financing mode of lending and leasing are totally different from one another. The concept and procedure particularly the accounting and taxation system are also quite different. So it is advisable not to mix up the two different operations, otherwise it might distort the basic financial norms. As the tax treatment is totally different in leasing business, mixing up of lending and leasing in the same business portfolio might create the possibility of tax fudging. Performance Evaluation of Non-Banking Merchant Banks In Bangladesh 39 Conclusion Merchant bank plays an important role to smooth follow of fund from surplus unit to deposit unit of the society. Merchant bank has wide range of activities such as advisory function, underwriter function, investment banker, transaction broker and so on which also ensure the expansion and improvement of the capital market and economic growth. Although 37 merchant banks are operating, officials said only a few are active while the performance of the rest is far from being satisfactory. The merchant banks should focus on forming their own portfolios in making the market sustainable. They should diversify their functions other than lending. In order to maintain sustainability they should diversify their activities because underwriting, advisory and syndication are not large enough in our weak and small economy. Merchant bank is highly necessary to raise fund for the public and private sector from the capital market in order to expansion and improvement of the corporation, take new project, diversify their products or services and so on. Merchant bank is making capital market more strong and powerful. Performance Evaluation of Non-Banking Merchant Banks In Bangladesh 40
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