Electronic copy available at: http://ssrn.com/abstract=1517219

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Asset Backed Securitization in Bangladesh: Prospects and Hindrances

Muhammad Saifuddin Khan1

Md. Hashibul Hassan2

Farhana Islam3

Abstract

Structured finance covers all advanced financial arrangements that serve to refinance and hedge any profitable asset efficiently beyond the scope of conventional forms of on-balance sheet securities to lower cost of capital, to mitigate agency costs of market impediments on liquidity and to bypass regulatory requirement. Asset Backed securities (ABS), leading form of structured finance, is growing rapidly in developed country as well as developing country. In Bangladesh, it is first issued privately by Industrial Promotion and Development Company (IPDC) in November, 2004. But so far the development of this potential sector is impeded. Basic reasons for the impediment are unsophisticated debt market for governmentand corporate bond, lack of legislation, capacity lacking of related parties. Some other problems like tax incentive, tax neutrality among all fixed income securities etc. are not very profound. Furnishing dynamic securitization act, mobilizing the formal debt market, market, strengthen the primary dealer network, acting market maker role by government etc. can pull up the ABS market with wide variety of prospects.

Keywords: Asset Backed Securities, Securitization, Special Purpose Entity, Pass Through

Securitization, Originator

Introduction

Securitization is an innovative form of capital market-based risk transfer mechanism by

which the cash flows of one or more assets or claims are bundled and conveyed to a SPE

(Special Purpose Entity) that in turn issues securities that represent claims on those

underlying assets or the cash flows. It substitutes lending and deposit-taking activities of

banks and financial institutions by sponsoring financial relationships in capital market. The

generation of securitized cash flows from a diversified asset portfolio represents an effective

method of redistributing asset risks to a different group of investors and broader capital

markets. As opposed to ordinary debt, a securitized contingent claim on a promised portfolio

performance affords investors at low transaction costs to quickly adjust their investment

holdings due to changes in personal risk sensitivity, market sentiment and/or consumption

preferences. The paper aims to illustrate the structure and scope of asset securitization

practices as well as the state, prospects and hindrances in Bangladesh.

1 Muhammad Saifuddin Khan, Lecturer, Department of Finance, University of Dhaka, Dhaka, Bangladesh.2 Md. Hashibul Hassan, Lecturer, Shanto-Mariam University of Creative Technology, Uttara, Dhaka, Bangladesh. 3 Farhana Islam, Lecturer, School of Business, Southeast University, Banani, Dhaka, Bangladesh.

Electronic copy available at: http://ssrn.com/abstract=1517219

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The study is followed by several sections. In section two the brief history of asset

securitization is explored, and then a hypothetical scenario is presented in order to simplify

the securitization process in section three. The basic structure of asset backed securitization,

effectiveness of asset backed securitization, practices of asset backed securitization in

Bangladesh, prospects of asset backed securitization in Bangladesh, hindrances of asset

securitization in Bangladesh and conclusion are presented respectively is section four, five,

six, seven, eight and nine.

Brief History of Asset Securitization

Asset securitization, in developed economy, began with the structured financing of mortgage

pools in the 1970s. For decades before that, banks were essentially portfolio lenders; they

held loans until they matured or were paid off. These loans were funded principally by

deposits, and sometimes by debt, which was a direct obligation of the bank. (Investopedia)

But after World War II, depository institutions simply could not keep pace with the rising

demand for housing credit. Banks, as well as other financial intermediaries sensing a market

opportunity, sought ways of increasing the sources of mortgage funding. To attract investors,

investment bankers eventually developed an investment vehicle that defines the mortgage

pools, segments the credit risk and structures the cash flows from the underlying loans.

Although it took several years to develop efficient mortgage securitization structures, loan

originators quickly realized the process was readily transferable to other types of loans as

well. (Asset Securitization, Comptroller’s Handbook, November, 1997)

Since the mid 1980s, better technology and more sophisticated investors have combined to

make asset securitization one of the fastest growing activities in the capital markets. The

growth rate of nearly every type of securitized asset has been remarkable with estimated, total

amount outstanding at the end of 2004 at $1.8 trillion only in the United States. This growth

continues untill 2008. In year 2008 as the result of the credit crunch precipitated by the

subprime mortgage crisis the market for bonds backed by securitized loans was very weak

unless the bonds were guaranteed by a federally backed agency. (Asset Securitization,

Comptroller’s Handbook, November,1997)

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In Asian economies like Japan, Hong Kong, China and Thailand, securitization gained

recognition during the 1990s. More recently Asian companies have begun to securitize future

cash flows from exports, toll roads and international credit card settlements.

The idea of asset securitization in Bangladesh originated in 1999. The issuance of first-ever

asset backed securities took place on November 08, 2004. Industrial Promotion and

Development Company (IPDC) of Bangladesh issued asset-backed securitized zero-coupon

bond against debt receivable. Later February 09, 2005, Industrial Development Leasing

Company (IDLC) of Bangladesh Ltd., a leading joint-venture multi-product financial

institution, formally launched Asset Backed Securitized Zero Coupon Bonds. At present total

amount of asset-backed securities (ABS) issued in Bangladesh is about BDT 1,500 million

and all issues are privately placed among some Participating Financial Institution (PFI).

Global financial crisis of 2008 and Asset Backed Securities

The world economy entered a major downturn in 2008. The first major financial crisis of the

21st century involves esoteric instruments, unaware regulators and skittish investors. Global

growth is slowing markedly, following more than four years of strong expansion, while

inflation has risen to rates not seen in a decade, especially in emerging economies. The

financial sector was affected immediately because banks had packaged their claims from

mortgage lending together with other debt instruments into new products and sold them on in

the form of so called ABSs (mainly Sub-Prime Mortgage Backed Securities) or CDOs

(Collateralized Debt Obligations), traded globally and therefore internationalizing credit risk.

That is the cause of the potentially high “contagion” of recent turbulence. But the main theme

of securitization is not proves wrong. This crisis occures basically uwarrented nature of

securities and greedy attitude of the investor. If securitization designed carefully and less

aggressively the benefits can be extracted effectively.

A Hypothetical Scenario of Asset Backed Securitization

We can perhaps best explain the use of the technique of securitization by means of an

example. We start with a hypothetical Bank, Structured Finance Bank Ltd (SFBL). The bank

has 150,000 customer holding credit cards with outstanding receivable of BDT 300 million.

While the receivables have a reliable payment history, the growth of SFBL’s business means

that it has strained the limits of its leverage to dangerous levels. Equity capital is scarce, and

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the owners are not willing to relinquish control by issuing public stock. Issuing a corporate

bond would be difficult and costly, particularly since SFBL’s financial ratios would not

produce a top credit rating.

In short, this company is ripe for asset securitization. The assets themselves are sufficiently

strong to support a high credit rating without the backing of the originating lender. While

many investors may not have the means to scrutinize and evaluate the assets, one or more

rating agencies will do so, as will a specialized, highly rated, financial institution which will

provide its own guarantee. After working with its bankers, the financial guarantee company,

the regulatory and rating agencies and the lawyers to structure the deal, SFBL establishes the

new trust, called SFBL 2009-A, to buy its credit cards receivables and to issue asset-backed

securities. This new trust has no other purpose and will be dissolved when the securities

become matured and for that reason it is named as special-purpose entity (SPE). The process

is illustrated in exhibit 1.

The specially formed entity purchases the assets of BDT 300 million from SFBL and sells

notes or certificates to investors. The investors’ stake is secured by the assets in the trust,

which are held on behalf of investors and are no longer controlled by the originator or its

creditors. The investors, however, are getting more than secured claims. They are receiving

predictable cash flows from a selected pool of assets that has been screened by the originator,

by the rating agency, and in many cases by an independent guarantee company. The latter not

only guarantees timely payment of principal and interest, but also offers expertise in ensuring

that the security is of very low risk. After all, the financial guarantee company stands to lose

the most if something goes wrong, and it will do all it can to avoid losses.

Credit cardAgreement

SF Bank Ltd(Seller)

SFBL 2009-A(Special Purpose entity)

Investors

Rating AgencySF Bank’sCustomers

TrusteeFinancial Guarantee

Provider- Generally an Insurance Co.

Servicing Agreement

Sale of assets

Proceeds

Asset Backed Securities

Proceeds

Exhibit 1: The securitization process

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Soon after the initial transfers (transformation of asset backed securities from general assets)

have been affected, revenues received from underlying assets will be channeled to the

investors. Exhibit 1 illustrates the ongoing flow of cash payments. Installment payments are

made to the finance company, which continues its role as servicer and continues to derive

income from this activity. These payments are transferred, less servicing and other fees, to

the SPE, which passes them on to investors. The installment payments include both interest

and principal. Any prepayments of principal are also passed through to the investors. The

excess of revenues over costs, if any, is often returned to the seller under an agreement that

gives the seller/servicer an incentive to keep costs and risks low. Eventually, on or before the

final maturity date, the investors get back the full principal they invested. Accumulated

income is returned to the seller/servicer.

Basic Structure of Asset Backed Securitization

The structure of an asset-backed security determines how cash flows are allocated to different

investors, the servicer, and the seller, what protects promised cash flows to investors, and the

responsibilities of the seller and servicer of the collateral. There are many structures

commonly used in the asset-backed securities market depending on the type of

securitization1. But following three general features are common among the alternative

structures – pooling and transferring receivables; structuring and issuing securities; servicing,

allocating payments, and monitoring (Savarwal, 2005).

1 “There are three principal types of securitization: true sale, synthetic and “whole business” (the latter primarily used in the United Kingdom and, to a lesser extent, continental Europe). In a true sale securitization, a company sells assets to a special purpose vehicle/company (the SPE) which funds the purchase by issuing bonds to the capital markets. In a synthetic securitization, the company does not sell any assets, but transfers the risk of loss associated with certain of its assets to an SPE or a bank against payment by such company of a premium or fee to the SPE. “Whole business” securitization is essentially a secured loan granted by an SPE to the relevant company. To grant the loan, the SPE uses proceeds of bonds issued into the capital markets whereby the company grants security over most of its assets in favor of the bondholders.”- Securitization: Key Legal and Regulatory Issues, IFC.

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Pooling and transferring receivables: A lender pools together and transfers loans (or, other

receivables) to a special purpose Entity (SPE). Standard accounting rules1 govern when such

a transfer is a sale, a financing, a partial sale, or a part sale and part financing. These

distinctions are important, because a transferor can take the transferred assets off its balance

sheet in a sale, but it cannot do so in a financing. To the extent that transferors retain

servicing rights, or some security interest, or securitize only a fraction of the transferred

assets, an asset backed transaction is closer to a partial sale. In a partial sale, a transferor can

take the sold assets off its balance sheet, but continues to account for retained interests on its

balance sheet. The transfer of assets to an SPE as a sale should be legally clear enough so that

these assets are separate from the transferor even in the event of the transferor’s bankruptcy.

Such a transfer is sometimes called a bankruptcy-remote transfer, and a SPE is thought of as

a bankruptcy-remote entity.

Structuring and issuing securities: The SPE issues several securities backed by the

receivables on these loans. Securities issued by an SPE can be rated differently, depending on

the credit risk associated with them. Credit risk in asset backed securities depends on the

performance of the underlying collateral pool of receivables and on credit enhancements.

Important factors affecting collateral credit quality are a lender’s underwriting criteria such as

borrower credit score, credit history, loan-to-value ratio, and debt-service coverage ratio,

economic variables such as unemployment and bankruptcies, and payment patterns over the

age (or, seasoning) of the loans. Credit enhancements affect credit risk by providing more or

less protection to promised cash flows for a security. Common credit enhancements are a

senior/subordinated security structure, a reserve or spread account (in such an account,

funds remaining after expenses such as principal and interest payments, charge-offs, and

other fees have been paid-off are accumulated, and these can be used when SPE expenses are

greater than its income), third party insurance or guarantee of principal and interest

payments on the securities, and over-collateralization (usually created by using finance

income to pay off principal on some securities before principal on the corresponding share of

collateral is collected). Other credit enhancements include cash funding or a cash collateral

account (which usually consists of short-term, highly rated investments purchased either from

the seller’s own funds, or from funds borrowed from third parties that can be used to make up

1 Financial Accounting Standards Board (FASB) Statement No. 140: “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” – a replacement of FASB Statement No. 125,” (September, 2005).

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shortfalls in promised cash flows), a third party letter of credit, a corporate guarantee, a

back-up servicer for the loans, discounted receivables for the pool, or other related measures.

Servicing, allocating payments, and monitoring: The servicer (usually the same as the

seller) collects proceeds (cash flows) on the loans, and these are allocated to the investors, the

seller, and the servicer according to the structure of the particular transaction. A servicer can

significantly affect cash flows available to an asset-backed transaction, because it controls the

collection policy, which influences proceeds collected, charge-offs, and recoveries on the

loans. Any income remaining after expenses such as investor and seller payments, charge-

offs, and servicing fees are paid off is usually accumulated to some extent in a reserve or

spread account, and any further excess is returned to the seller. In monitoring issue, periodic

reports on the performance of the collateral pool are filed with the Securities and Exchange

Commission for public securities. Moreover, bond rating agencies publish ratings of asset-

backed securities, and update these ratings based on their monitoring of performance of

collateral pool, credit enhancements, and probability of default.

Securitization Structures on the basis of cash flow

There are three most common forms of securitizations from the perspective of cash flow:

Collateralized Debt, Pass-Through and Pay-Trough structures.

Collateralized debt is the form most similar to traditional asset-based borrowing. The owner

of assets borrows money and pledges assets to secure repayment. The assets pledged may be

measured according to their market value upon sale or their ability to generate a cash flow

stream. The debt instrument need not match the cash flow configuration of any of the assets

pledged.

Pass through securitization is the simplest way to securitizes assets with a regular cash

flow. A pass-through certificate represents an ownership interest in the underlying assets and

thus in the resulting cash flow. Principal and interest collected on the assets are “passed

through” to the security holders; the seller acts primarily as a servicer.

A pay-through debt instrument is a borrowing instrument, not participation. Under the pay-

through structure, the assets are typically held by a limited purpose vehicle that issues debt

collateralized by the assets. Like a pass-through, the debt service is met by cash flow “paid

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through” to investors out of the pledged collateral. Investors in a pay-through bond are not

direct owners of the underlying assets; they have simply invested in a bond backed by some

assets. Therefore, the issuing entity can manipulate the cash flows, into separate payment

streams.

Basic Elements and Parties of Asset securitization

The securitization (security issuance) process redistributes risk (of the Assets) by breaking up

the traditional role of a bank (intermediation) into a number of specialized roles: originator,

servicer, credit enhancer, underwriter, trustee, and investor. Banks and financial institutions

may be involved in several of the roles and often specialize in a particular role or roles to take

advantage of expertise or economies of scale. Following diagram attach all the parties and

elements involve in securitization process.

Exhibit 2: Elements and Parties of Asset Backed Securitization.

Borrower: The borrower is responsible for payment on the underlying loans and therefore

the ultimate performance of the asset-backed security. Because borrowers often do not realize

that their loans have been sold, the originating bank is often able to maintain the customer

relationship. Securitization has made popular the practice of grouping borrowers on the basis

of creditworthiness.

Originator: Originator is an entity that underwrites and makes loans; the obligations arising

with respect to such loans are originally owned to this entity before the transfer to the SPE.

Borrower

Originator/ Servicer

Special Purpose Entity/ Trustee Credit EnhancerRating Agencies

Underwriter

Investor

The Asset

The Securities

Elements of Securitization

Parties of Securitization

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The Assets: While residential mortgage loans provide the core of the global asset-backed

securities market, a wide range of other financial claims can and have been securitized.

Indeed virtually any income-producing asset with an adequate performance record and some

diversification of credit risk can be securitized. Consumer finance receivables -- in particular

car loans and credit card receivables -- constitute the most important segments of the non-

mortgage ABS market. According to the section 2 (1)(ka ka) of SEC (Asset Backed

Securities) Rules, 20041 asset for Asset Backed Securities includes- Credit Card Receivables,

Lease Rental, Franchise, License, Healthcare Receivables, Cash Flows from different sources

and any other assets selected by the SEC.

Servicer: The originator/lender of a pool of securitized assets usually continues to service the

securitized portfolio. (The only assets with an active secondary market for servicing contracts

are mortgages.) Servicing includes customer service and payment processing for the

borrowers in the securitized pool and collection actions in accordance with the pooling and

servicing agreement. Servicing can also include default management and collateral

liquidation. The servicer is typically compensated with a fixed normal servicing fee.

Trustee: A third party, often a specialist trust corporation or part of a bank or FI, appointed

to act on behalf of investors. In the case of a securitization, the trustee is entrusted with

responsibility for reaching certain key decisions that may arise during the life of the

transaction. The role of the trustee may also include holding security over the securitized

assets and control over cash flows. Listing of ABS in the exchange requires the appointment

of an independent trustee. Trustees receive regular reports on the performance of the

underlying assets in order to check whether, for instance, cash flow procedures are being

followed.

Credit Enhancer: Credit enhancement is a method of protecting investors in the event that

cash flows from the underlying assets are insufficient to pay the interest and principal due for

the security in a timely manner. Credit enhancement is used to improve the credit rating, and

therefore the pricing and marketability of the security.

Rating Agencies: The rating agencies perform a critical role in structured finance —

evaluating the credit quality of the transactions. Such agencies are considered credible

because they possess the expertise to evaluate various underlying asset types, and because

they do not have a financial interest in a security’s cost or yield. Ratings are important

1 Published in 16 October, 2004 under the power of section 24(1) SEC Rules, 1993.

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because investors generally accept ratings by the major public rating agencies in lieu of

conducting a due diligence investigation of the underlying assets and the servicer. The rating

agencies review four major areas:

Quality of the assets being sold,

Abilities and strength of the originator/servicer of the assets,

Soundness of the transaction’s overall structure, and

Quality of the credit support.

The Securities: Asset-backed instruments may take a wide range of forms. They may pay

interest at fixed or floating rates; they may be short or long in term; they may have a fixed

maturity or be pre-payable or callable under a variety of conditions. Some are publicly issued

and others privately placed; some denominated in local currency and others in foreign

currency. In general, the securities represent an accommodation between the originator’s

needs, the payment characteristics of the assets, and investors’ preferences and constraints.

Exhibit 3: Categorization of Securities in terms of liquidity

Underwriter: The underwriter of ABS is responsible for advising the seller on how to

structure the security, and for pricing and marketing it to investors. Underwriters are often

selected because of their relationships with institutional investors and for their advice on the

terms and pricing required by the market. They are also generally familiar with the legal and

structural requirements of regulated institutional investors.

Investors: The great majority of ABS are held by institutional investors, such as insurance

companies, unit trusts (mutual funds), money managers, banks, pension funds etc. In the

United States, however, many individual investors hold mortgage- backed securities. In Asia,

commercial banks own a major share of ABS, but pension funds and insurance companies are

increasingly interested in these instruments. In Bangladesh, commercial banks and insurance

companies are the main investor of ABS though the market is very shallow.

Non-tradable Private

placement

Tradable Private

placement

Commercial Paper

Public Issue

Actively traded Bond

Illiquid Highly Liquid

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Asset Backed Securitization: Why it is necessary?

Motives of Securitization-Issuer

Banks began to securitize a large volume of their loan portfolios in response to changing

regulations and market forces during the 1980s. Starting with the International Banking Act

of 1978, and partially in response to debt problems of the less-developed countries during the

early 1980s, regulators around the world enlarge the capital requirements1. However, raising

capital is costly for the bank owners. For example, regulators may force the bank to raise

equity when stock market conditions are not favorable for a new stock issue, or the bank may

have to retain its earnings instead of distributing them to shareholders as dividends. But there

is a way to circumvent capital requirements, and it hinges on the fact that the bank does not

have to hold capital against the loans it originates, only those it actually carries on its balance

sheet. So, there is no capital requirement if the bank originates loans and transfers their

ownership to a special-purpose entity, effectively removing them from its balance sheet.

Unless there is an arrangement in the securitization deal whereby investors can demand

compensation from the bank for loan defaults in the securitized asset pool (recourse),

regulators allow banks to keep these loans off the balance sheet, reducing the need for

additional capital and improve balance sheet efficiency.

Moreover ABS helps entities by improving asset liability management, lowering financing

cost, enhancing revenue through servicing right, retaining of competitive advantage by not

selling business franchise.

Motives of Securitization-Investor

In general, investors do not like to put all their eggs in the same basket so that something

awful happens to that basket and they lose all their eggs. Therefore, they diversify their

holdings among a number of unrelated baskets that are not all likely to get knocked down at

the same time. Now, suppose an investor wishes to invest some money in a bank’s credit card

business for diversification purposes. In the absence of asset-backed securities, the easiest

thing to do it is to buy the bank’s stock. But the return on the stock will depend not only on

the success of the credit card business, but also on other activities. If the investor is only

interested in the credit card business, he can create a “homemade” credit card portfolio; that

1 Ergungor, O.E., 2003, “Securitization”, Federal Reserve Bank of Cleveland , August

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is, he needs to find a way of undoing the effect of the bank’s other activities on the stock

price. But this is not an easy task. Investor may be unable to find a security or a combination

of securities that will undo the effect of other banking activities. Consequently, the investor

may never be able to build an exact replica of the bank’s credit card business. Even if we

assume that the homemade portfolio is good enough, there are transaction costs associated

with buying and selling multiple securities.

So, the presence of a security that represents an ownership claim on a certain class of the

bank or financial institution’s assets is advantageous to the investor because it is exactly what

investor wants. That means ABS enhances the investment horizon for the investors by an

enormous way. Moreover, investor gets some other benefit over “homemade” any asset

portfolio by investing in ABS, such as, greater liquidity; superior return; mitigation of event

risk etc.

More Than an Ownership Claim

Asset securitization differs from traditional asset-based lending in that the assets are legally

segregated from the originator’s credit condition and marketable securities are created out of

the assets’ cash flows. Furthermore, in order to assure that these securities will be liquid, the

asset pool is commonly credit enhanced by including excess collateral or cash reserves and/or

by securing a third-party guarantee for the financing. Following example will clarify this idea

of how ABS serves as more than an ownership claim.

Ownership of credit card receivable entitles two types of risk. First, it bears the default risk;

every uncollectible credit card debt is money out of owner’s pocket. Second, it assumes the

prepayment risk; when interest rates go down, consumers prepay their credit card bills by

switching to a lower-interest credit card. So, an income-generating credit card receipt

converts into cash, which the investor must reinvest may be at lower rate and thereby incur

additional transaction costs.

An asset-backed security lessens the impact of these two risks. As a protection against default

risk, banks issue securities against only a fraction of the asset pool. The rest of the pool is

used to absorb any loan defaults. For example, the bank (originator) may put BDT 300

million (the asset) worth of credit card receipts in the SPE (trustee) and sell securities against

BDT 260 million. The remaining BDT 40 million is excess collateral that loan defaults are

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deducted from, while the investors’ claim remains intact. At maturity, whatever is left from

the excess collateral goes back to the bank. This kind of over collateralization protects the

investor from the occasional loan default, although the investor still has an exposure to the

large, industry wide fluctuations in the credit card business.

As a protection against prepayment risk, the bank replenishes the asset pool with new credit

card receipts whenever a payment occurs. Again, as with default insurance, the protection

from prepayments is limited—usually to a pre specified percentage of the asset pool. In other

words, the goal is to protect the investor from the occasional prepayment and not to

completely eliminate his exposure to the industry.

Practices of Asset Backed Securitization in Bangladesh

Securitization has played an exclusive function in all developed and developing capital

markets. Even in our very neighboring country India, during financial year 2007, Indian

Structured Finance market grew by 44% over the previous year amounting to Rs. 370 billion.

Securitization of single corporate loans climbed up the stairs and amounted for one-third of

the total issuances. In 2008 structured finance market faces negative growth for world

financial crisis. Bangladesh is quite late in these advance financial instruments. The first ever

asset securitization in the country has been launched by Industrial Promotion and

Development Company (IPDC) of Bangladesh on November 08, 2004. But the idea of

introducing asset securitization in the country developed back in 1999 when the World Bank

Group was working on the problems of non-bank financial institutions (NBFIs) in mobilizing

funds from the market. Then the World Bank team, along with the Government of

Bangladesh (GOB) designed the Financial Institutions Development Project (FIDP), which

floated the idea that NBFIs might issue asset-backed securities. With the help and

cooperation from different national and international bodies, the first issue of ABS in

Bangladesh took place after four stagnant years in 2004. But after the first issuance, no

significant development took place in this market though very good prospect exists.

Industrial Promotion and Development Company (IPDC) of Bangladesh launched

Bangladesh’s first asset-backed securitized bond on November 08, 2004, opening a new era

of fund mobilization especially for the NBFIs (IPDC, 2005). The move will obviate the

dependency of IPDC on costly bank funds and provide it funds at low cost. Investment

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Corporation of Bangladesh (ICB) has been made trustee for the special purpose entity (SPE)

which issued BDT 35.9 crore worth zero coupon bonds against debt receivables of IPDC.

ICB being the trustee will be handling the transaction by receiving the payments and

forwarding these to IPDC as per agreements after certain time period. Dhaka Bank, Jamuna

Bank, Mutual Trust Bank, Southeast Bank and International Leasing and Financial Services

Ltd. have already invested in the BDT 35.9 crore IPDC asset-backed securitized bonds in

private placement arrangement. As the instrument is floated through private placement

arrangement and credit rating is not mandatory for private placement, there is no credit rating

agency involved in the process. This is true for both the issue (IPDC as well as IDLC)

because only the institutional investors can participate in these issues. IPDC is also planning

to introduce similar instruments through initial public offering (IPO) to be traded in

secondary market.

IDLC of Bangladesh Limited (IDLC), a leading joint-venture multi-product financial

institution formally launched Asset Backed Securitized Zero Coupon Bonds with an issue

value of BDT 190 million on February 9, 2005 (IDLC, 2005). This marks a significant

achievement in the company’s quest to mobilize funds, at lower cost, as part of its continuing

commitment to assist in the industrial development of Bangladesh. The FIDP of Bangladesh

Bank initiated the debt instrument to enable financial institutions to mobilize funds against

credit receivables, with World Bank support.

The Investment Corporation of Bangladesh (ICB) is nominated as the trustee of the issue and

IDLC Securitization Trust 2005 is formed to serve as the Special Purpose Entity (SPE),

which will issue Zero Coupon Bonds against lease receivables of IDLC. ICB, being the

trustee will handle the transaction by receiving the subscription payments and forwarding

these to IDLC as per agreements. Commercial Bank of Ceylon Limited, BRAC Bank

Limited, The City Bank Limited, Green Delta Insurance Company Limited and Reliance

Insurance Limited have subscribed to the issue under private placement.

There are a number of reasons why the issuers were not interested in public placement.

Administering cost is one of them. For a large number of investors (in case of IPO), definitely

this cost will be much higher. Apart from this, compliance requirement is huge, as the issuers

need to comply with various regulatory authorities, such as SEC, Bangladesh Bank, or

National Board of Revenue (NBR). Moreover, it is expected that general investors may lack

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knowledge of a complicated instrument like ABS, although this problem can be easily solved

by investment bankers of the country.

Prospects of Asset Backed Securitization in Bangladesh

The generic benefits of securitization for Originators and investors have been discussed

above. In the Bangladesh context, securitization is the only ray of hope for funding resource

starved infrastructure sectors like Power, Public Transport. Public Private Partnership (PPP)

is very much talked issue now a days. The basic idea behind this PPP is simply creating

opportunity for the private investor to participate in public sector. When any private entity

wants to invest in public sector then this entity will be provided the right of that public

property for a certain time to make pay off. This idea is quite new in Bangladesh. To make

PPP fruitful GOB need to build huge capacity in terms of rules, regulation, monitoring etc.

Moreover pricing conflict between public and private entity, protecting competition of market

economy, private sector incentive issues are very much complex to deal. Asset Securitization

can be implemented more easily. Unlike equity transfer in PPP, ABS issue debt securities

backed by future revenue flow. And ABS is more efficient in respect to time, flexibility, fund

generation etc.

Bangladesh economy currently faces a substantial fund shortage in the housing sector. Total

housing loans from banks and financial institutions as of end June 2008 amounted to Taka

142.5 billion which was 7.5 percent of total credit to the private sector1. Taka 50.8 billion has

been provided by PCBs and Taka 33.6 billion has been provided by SCBs. The state-owned

House Building Finance Corporation (HBFC) had the third largest share of Taka 24.4 billion

in outstanding housing loans as of end June 2008.The sources of HBFC's fund are paid-up

capital by the government and the proceeds as received by selling government guaranteed

interest bearing debentures to different organizations. Except HBFC all other institutions

mainly depend on deposit beside paid up capital. But currently government guaranteed

interest bearing debentures are unavailable. In the past, the HBFC funded its housing loans by

issuing low interest debentures bought by the SCBs and the Bangladesh Bank. Now this non

competitive source of finance is not available. In FY04, the Corporation got approval from

the government to sell debenture amounting Taka 1.0 billion, it could not sell them till end of

1 Chapter-6, Annual Report 2007-2008, Bangladesh Bank.

16

FY 2008. Banks and financial institutions can securitize a pool of housing loans to raise fund

at cheaper cost and make their balance sheets free. Moreover housing companies can directly

make securitization to achieve disintermediation. This also helps FIs to invest individual

deposit more efficiently.

The banking sector of the country experienced a total of Taka 226.2 billion non-performing

loan (NPL). Securitization can play a critical role to mitigate the burden of NPL largely.

Banks and FIs can sell their non-performing loans to the SPE; the SPE would then pool the

loans and issue asset-backed securities. For example, the book value of a particular bank’s

NPL is Taka 50 billion; and the probability of recovering the loans is very low. The collateral

has a market value about Taka 15 billion. The bank can sell this NPL portfolio of Taka 50

billion to a SPE and remove it from the balance sheet. It is superior way to give healthy look

to the balance sheet than NPL rescheduling. In case of securitizing the NPLs the issuance of

zero coupon bonds are usually favored on the ground that the estimated amount loans to be

sold to the SPE and the size of the ABS program may not be economical to have monoline

insurers insure the interest payments. The use of zero-coupon bonds would compensate for

the questionable timing of the cash flow obtained from the sale of the properties. Moreover

the government could support the ABS program through providing insurance to the ABS

program as a contingent credit enhancement.

Hindrances of Asset Securitization in Bangladesh

Lack of active debt market: Lack of a sophisticated debt market is always a drawback for

securitization due to the absence of benchmark yield curve for pricing. ABS is a complex

secondary market based debt instrument and it is very tough to introduce it in a completely

new channel. The bond market has played a limited role in the Bangladesh economy in

compared to the neighboring countries. In Bangladesh the outstanding bond volume over

GDP was only 1.4%, compared with India (34.8%), Pakistan (30.9%), Sri Lanka (53.6%),

and Nepal (9.8%) in the year 2005. The share of the Bangladesh bond market in South Asia

(0.2%) is also the smallest among the five countries1. The main impediments to the

Bangladesh debt market are the weak regulatory framework, supply-side constraints such as a

lack of the benchmark bonds, demand-side constraints such as the limited investor base, a

lack of intermediaries with expertise in debt products, a lack of confidence in corporate

borrowers, market distortions which are caused by the National Savings Scheme (NSS)

1 South Asia Bond Markets: Bangladesh, Yibin Mu, Version April 2007, World Bank.

17

offering above-market returns and a lack of interest from private companies, including

financial intermediaries and large business, in launching new debt products due to high fees.

The development of the debt market would naturally increase the securitization activity in

Bangladesh.

Inadequate Strength of credit rating industry: In Bangladesh legislation was established

in 1996 to provide a framework for credit ratings, as well as there are two domestic credit

rating agencies capable of rating securitized products. They are:

CRISL, created in 1995. Its shareholders include RA Malaysia Berhard, JCR-VIS

Credit Rating Co of Pakistan, Prime Commercial Bank of Pakistan and the Investment

Corporation of Bangladesh (ICB). It is a founding member of the ACRAA, or

Association of Credit Rating Agencies in Asia (sponsored by the ADB).

Credit Rating Agency of Bangladesh (CRAB), established recently.

The capabilities of the domestic credit rating agencies are questioned by those familiar with

international rating agencies. This is partly due to compensation arrangement. On the one

hand, rating fees approximate $3,623 and annual fees come in at about $1,4501. Low fees, by

international standards, contribute to making ratings affordable for Bangladesh companies

and increasing usage. On the other hand, lower revenues translate into lower pay for

employees and less investment in software and systems for analysis. But securitization

market needs highly qualified and credible credit rating to motivate investors and

mobilization of participants.

Lack of appropriate legislation: There are no laws specially governing securitization

transactions in Bangladesh. The idea of introducing asset securitization in the country

originated in 1999. Since then Bangladesh Bank as a regulator has not provided any guideline

regarding asset securitization. But Bangladesh Bank issued only a tentative guideline on

mortgage-backed securitization which is insufficient to promote the securitization. Moreover,

the Asset Backed Securities Issue Rules, 2004 under Securities and Exchange Commission

Act, 1993 is unable to depict the trading guideline. Besides the two regulators Government of

Bangladesh also failed to support the securitization process such as Government had the

scope to securitize their receivables from infrastructure and housing sector. No bill has been

1 South Asia Bond Markets Bangladesh, Yibin Mu, Version April 2007, World Bank.

18

tabled in the parliament of Bangladesh yet to transform an act for securitization. The

following are the key areas where legislators should focus:

1. True Sale (Isolation from bankruptcy of the originator): The central idea of a

securitization transaction is to isolate the assets of the originator from originator’s

balance sheet and seek a higher credit rating than the originator’s own rating. A key

requirement for that is to achieve a “true sale” of the assets to the Special Purpose

Entity.

2. Transfer of collateral: Financial Institution cannot transfer the underlying collateral

securities of immovable property attached with the receivables though they are allowed to

sell or transfer the cash flows associated with the receivables to other interested investors.

This lapse of in the law should be eradicated.

3. Bankruptcy remote SPE: The special purpose entity that buys assets from the

originator should be a bankruptcy remote agent for distributing the income from the

assets to the investors. No clear vehicle has emerged for performing bankruptcy

remote securitization. This should be addressed by the securitization act.

4. Stamp Duties: Stamp Duties on transfer of assets in securitization can often make a

transaction unviable. Article 40 of the First Schedule of the Stamp Act of 1899, states

that the stamp duty is not required in case of a new mortgage but is silent about any

modification of mortgages which is essential in case of ABS.

5. Taxation & Accounting: At present there are no special laws governing recognition of

income of various entities in a securitization transaction. Furthermore tax disparity

between zero coupon bonds and other fixed income securities lessens the competitive

advantage of ABS. Accounting rules and standards practiced in Bangladesh is also

lacked in ABS issue. Bangladesh is yet to introduce Financial Accounting Standards

Board (FASB) Statement No. 140: “Accounting for Transfers and Servicing of

Financial Assets and Extinguishments of Liabilities” – a replacement of FASB

Statement No. 125,” (September, 2005) & IAS 39: Financial Instruments:

Recognition and Measurement (IAS, 2005).

Lack of Investor Appetite: Investor awareness and understanding of securitization is very

low. Most of our investors are not sufficiently sound in understanding company

fundamentals. Knowledge of the investors about structured finance and derivative is close to

19

zero. SEC, Dhaka Stock Exchange and Chittagong Stock Exchange often arrange investor

awareness programs, but those are not sufficient to build up economy wide awareness and

knowledge of numerous investors.

Conclusion and Policy Implications

Asset securitization is the separation of good assets from a company or financial institution

and the use of these assets as backing for high-quality securities that appeal to investors. This

process involves some features such as bringing out the target assets to a pool, designing the

structure of securities, adding some parties to enhance the quality of securities, eliminating

some steps of intermediation to reduce the cost, bringing the securities to the market for

liquidity. The end result of securitization is investor get access to some portfolios those can

not be replicated by any other means. On the other hand issuers can mobilize their funds and

get benefit from off balance sheet activities.

Around the world, asset-backed securities markets have also been growing rapidly. A dozen

or more countries in Asia, including Japan, Hong Kong, Thailand, Indonesia, India and the

Philippines have all seen the introduction of asset-backed securities. Though Bangladesh has

launched some ABS in different time, it is not very well known mode of financing. Moreover

market mechanism is not shaped yet. ABS can facilitate Bangladesh in various sectors like

Infrastructure finance, Housing finance, FI’s fund mobilization and reducing capital

requirement, capital market development.

The main reason that hinders the growth of ABS is lack of capacity. Related parties of ABS

market are not trained or structured yet to flourish this sector of economy. Besides lack of

capacity some other problems exist like imperfect legislative framework, inactive debt

market, incentive problem in tax structure, investor knowledge, absence of market maker etc.

It is not the high time to issue ABS in different sectors of Bangladesh rapidly despite if

Bangladesh wants to capture the benefits it is right time to reshuffle all related issues. Some

major issues are such as creating a dynamic debt market. To develop the debt market

regulators should strengthen the government securities market by (i) improving the efficiency

and transparency of the primary market in government securities, (ii) gradually increasing the

20

volume of the marketable government securities and reducing the volume of the non-

marketable securities, and (iii) strengthening the liquidity of the secondary market in

government securities. Government should promote the corporate bond market development

by (i) developing a comprehensive set of guidelines on issuing bonds and debentures under

the direction of the SEC, (ii) further reducing issuing costs. The investor base should be

broadened by (i) promoting the pension sector reform, (ii) strengthening the insurance sector

development, and (iii) adopting reforms to attract foreign investors.

Moreover, a joint cell should be setup taking representative from Ministry of Finance,

Securities and Exchange Commission (SEC), Bangladesh Bank (BB) and National Board of

Revenue (NBR) to make an act on securitization. A comprehensive securitization Act can

give a much-needed thrust to securitization activity in Bangladesh. Besides this government

should engage in market making to give confidence to the investors about liquidity of their

investment.

21

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