Since Bangladesh’s independence in 1971, various sectors of the country’s economy have witnessed remarkable growth. The big highlight is its decade-long high GDP expansion starting from 2012. However, in any lasting growth story, the country’s financial sector is the backbone. Within the financial sector, a fairly regulated long-term lending framework can propel the economy.

A core challenge for a business is its liquidity. Liquidity is basically a company’s cash flow and its cash in hand. Simply put, the more cash a company has, the more readily it can grow to meet its business needs. Liquidity is driven by funding sources. Bangladeshi businesses are often constrained by lack of liquidity. For them, having diverse cost-efficient funding sources can help in meeting their liquidity needs. This is where securitised products can play an effective role.

Securitisation

Let’s revisit the basics. Secured and unsecured loans are the fundamentals of lending, and each has implications for businesses. A secured loan requires the borrower to pledge assets (like land or factories) as collateral, which serves as security for the loan. This collateral acts as a safety net for the lender, reducing the risk of loss if the borrower defaults. As they are less risky, secured loans typically have lower interest rates. Meanwhile, unsecured loans do not require any assets as collateral. They are often given at higher interest rates because they are seen as riskier.

Zooming out, securitised products are broader-based. They package cash flow from receivables to act as an asset. Receivables are essentially unpaid money owed to a company by its customers. They are money expected to be received in the future. Companies can now use receivables as collateral to borrow money from a lender. Hence, the cost of the borrowing will be lower. These securitised products can be bought and sold in the financial markets.

In any case, since secured products are backed by cash flow, they cost businesses less compared with unsecured products. Moreover, in this way, businesses don’t have to put up any hard collateral (assets like land or factories) to borrow money at a lower cost.

To familiarise the financial sector of Bangladesh with this concept, there have to be lenders with the vision to offer innovative financial products. Additionally, there need to be actionable policies that facilitate these products.

To familiarise the financial sector of Bangladesh with this concept, there have to be lenders with the vision to offer innovative financial products.

The lending side

Lending products should ideally enhance a business’ liquidity position. They offer alternative capital at a fair cost to the business. Bangladesh currently has very traditional financing, whereby lending products are backed either by hard collateral or by no collateral at all. There are few lending products which finance receivables (like invoices) but they are not packaged as a whole.

Bangladeshi lenders need to evaluate the liquidity needs of their clients and educate them on the benefits of receivables securitisation. Once a client is engaged, the client’s data needs to be analysed. This will provide insight into how the product can be structured at a reasonable cost to the client.

Policy side

Policies and regulations directly impact financial products. For securitised products to be successful in Bangladesh, there needs to be a robust legal framework overseeing their creation and trading. This includes regulations to allow the formation of special purpose entities (SPEs). SPEs are integral in facilitating securitised products because they help with reducing the risks to investors.

SPEs are separate companies handling the receivables (money owed to a business) independently from the original sponsor company (the owner of the receivables). The receivables are sold to the SPE, which then uses them as security for a loan.

This setup will work only if there are actual regulations in place that allow lenders and borrowers to dispute issues legally. In this arrangement, receivables are the least affected, even when the sponsor company stops operating.

The good news is that Bangladesh already has a regulatory framework for asset-backed securities that can be leveraged for securitised products. In particular, rules of 2004 of the Securities and Exchange Commission, the country’s financial market regulator, can address many of the concerns regarding securitised products (including SPE formation and receivables sales to SPEs). A smart revision of this regulation will yield better guidance for investors.

A framework for securitised products

To design successful facilitation of securitised products in Bangladesh, the following points should be considered:

Efficient servicing mechanisms

Servicing includes the collection of cash from receivables and remediating any issues with the receivables. Typically, the company that generates the receivables handles servicing, as it understands the customers best. However, back-up servicers should be an option, in case the primary servicer falters.

The importance of data

Data plays a crucial role in securitisation. Maintaining data on the performance of receivables is very important. Data is one of the primary drivers in assessing the credit risk of the receivables. The performance data gives an insight into how many receivables may default. Such data can also help decision-makers understand macroeconomic stress.

Data plays a crucial role in securitisation.

User-centric product design

When creating financial products, the focus should be on the end users – the businesses of Bangladesh. Instead of copying from other countries, product design should consider the unique challenges facing local businesses. Blindly importing grand ideas based on foreign financial landscapes will only create harmful products.

Further opportunities

Securitised products will be a new introduction into Bangladesh’s financial landscape. Once businesses and lenders gain confidence in these products, new opportunities will open up. The securitised receivables can then also be packaged into bonds. The bonds may be tranched – that is, stacked based on varying levels of risk. This will benefit capital market investors by providing the opportunity to diversify and to get a return higher than from other similar bonds.

External example

The US is undoubtedly the most advanced in the securitisation space. Lessons from the US can provide Bangladeshi regulators with insights into basic steps to use in building a securitisation infrastructure. For example, US markets develop securitised products organically, focusing exclusively on the business environment in the US. Bangladesh should follow a similar approach – catering to its own special needs. After the 2008 financial crisis, laws were revised in the US to ensure a similar situation does not arise again. This means that the legal framework needs to be updated regularly to address concerns in this space.

Lessons from the US can provide Bangladeshi regulators with insights into basic steps to use in building a securitisation infrastructure.

Parting thoughts

Bangladesh surely needs investments to dynamise its economy. Securitised products can bring immense liquidity benefits to the financial and business landscape of the country. Through these products, businesses will be able to borrow at lower cost. This means more cash will be available for businesses. In essence, this means better liquidity. Overall, this will improve the competitiveness of the country.

 

Photo © Mahmud Hossain Opu

Zarif Ahmed is Associate Director of the Structured Finance Group at KBRA, New York. He is a financial analyst. His area of expertise is credit analysis, cash flow analysis and asset-backed securities. He pursued his graduate studies in Actuarial Science at Columbia University, US.