Whither international bank guarantees in Bangladesh?

The guarantees are becoming common in the rapidly increasing cross-border project activities, trade finance
and export-import businesses. This is particularly true when the business conditions are characterised by
distance of clients and there are difficulties of real assessment of credit standing of the business partners. Such
a situation may be there in all types of business and economic transactions irrespective of locations. However,
these are particularly relevant for cross-border or international transactions.
Traditionally, there were several security arrangements to handle the difficulties. In order to solve the pitfalls
encountered with the traditional means of security, the independent guarantee was invented that is mainly
issued by the reliable and sustainable institutions.
The guarantees are commonly issued by banks and have been in use in most global economies for diversified
purposes. Today, bank guarantees are known by various names, such as 'independent undertakings',
'performance bonds or guarantees', 'tender bonds or guarantees', 'independent guarantees', 'demand guarantees',
'first demand guarantees', 'bank guarantees', and 'default undertakings'. In addition to these common names,
these payment undertakings are also commonly known as 'standby letters of credit', although such a letter of
credit has a very different historical development than the demand guarantee. The bank guarantees operate in
much the same way as documentary credits.
Practically, demand guarantees, standby letters of credit and commercial letters of credits are all treated as
autonomous contracts whose operation should not be interfered on grounds immaterial to the guarantee or
credit. However, these instruments have distinctive features in terms of operational efficiency, use, preference
and regulatory environment.
Bank guarantees are increasingly in use in Bangladesh as in other parts of the world in response to the realities
of world commerce and increasing activities and concerns in public and private infrastructure and industrial
installations, and growth of buyers' powers and increasing competition of sellers. In the context of Bangladesh,
demand guarantees are already in use in infrastructure, export, import, financing and service sectors.
In case of infrastructure sector, a large number of indirect demand guarantees or counter guarantees are
received by Bangladeshi banks whereas in case of exports, there are a few instances of the receipt of direct
demand guarantees (issued by the foreign banks) that are advised through the commercial banks of
Bangladesh.
In the service sector, there are a few cases of the issuance of indirect bank guarantees by the Bangladeshi banks
whereas there are a good number of instances of offering repayment direct bank guarantees from Bangladesh.
Though there are scopes of receiving direct repayment bank guarantees from abroad in case of import under
cash in advance, instances are rare.
There are also a few cases of receiving standby letter of credit in the country. It can be observed that bank
guarantees received are mostly for cross-border big installation projects and trade purposes. On the other hand,
most bank guarantees issued by Bangladeshi banks serve as securities. It may be a reflection of the trade
regulation (explicit and implicit) of the country that mainly allows import and export using documentary
credit. It may also indicate that greater use of contract based trade payment methods in future would
necessitate higher demand for bank guarantees to and from Bangladesh in trade services.
There are potentials of increasing use of bank guarantees in cross-border financing. The Bangladesh Bank has
some general provisions and guidelines on the issuance and receipt of international bank guarantees in its
guidelines/circulars. Though the instruments are also in use to meet domestic trade and industry need, the
Bangladesh Bank does not have any guideline in this connection. The growing use of bank guarantees both in
domestic and international transactions necessitate comprehensive guidelines and rules to improve efficiency
and to reduce risks. And the guideline needs to cover both domestic and international bank guarantees.

Moreover, some issues like the authority, formalities etc to issue bank guarantees, needs to be addressed.
It is more or less recognised that acceptance of the International Chamber of Commerce (ICC) publications as
guidelines are essential for the uniform and efficient operation of cross border bank guarantees. The Uniform
Rules for Demand Guarantees (URDG 758) is already a globally recognised guideline for that. The
International Standby Practices (ISP 98), used in the USA, could be another option. Some local guidelines and
rules could complement the ICC publication for better customization. The Bangladesh Bank accepted UCP as
rules of documentary credit. The central bank may think of allowing appropriate ICC guideline to handle the
bank guarantees. In this regard, the potentials and the challenging area of the respective ICC guidelines, in
respect of Bangladesh's business environment need to be examined first.
It can be observed that the ICC rules are not widely in use in the demand guarantees issued from and received
in Bangladesh. In most cases, our banks are in the habit of accepting dictated terms in demand guarantees.
These practices are facilitating the vulnerability of banks and local clients in handling fraud potentials and
risks. Thus, alongside acceptance of ICC publication, we may need to accept specific rules to handle fraud and
to minimize risks. So we should consider formulating rules for handling frauds covering both demand
guarantee and documentary credit.
Approach of handling 'unfair call' in demand guarantees is another issue to be handled by the policy-makers. It
is mainly about the independence of bank guarantee from that of the underlying contract. The guidelines and
rules of the central bank could work as the most critical factors for the courts to handle the issue. The
international 'case laws' may offer contradictory results. Thus country approach and national interest should be
the key.
In some cases, banks are supposed to obtain permission from the Bangladesh Bank to issue international bank
guarantees. Though these permissions are duly issued, data are not maintained in structured form. Even there
are cases where permission was not sought at the time of the issuance of guarantee. Currently the guarantees
are reported to the central bank as part of their non-funding liabilities.
Comprehensive and separate monitoring and reporting arrangement by the central bank might help store
structured information, improving efficiency and minimising risks. To promote healthy bank guarantee
business in Bangladesh, alongside issuing a comprehensive operational guideline, the central bank needs to
identify the effective monitoring and reporting arrangement.

Payment defaults under LCs

Bangladesh Bank has recently issued a circular underscoring the importance of prompt payment of import bills
under letters of credit (LCs). Non-payment of these bills, the circular added, tarnishes the image of the country
and raises the cost of imports because, apprehending the risks of non-payment, foreign suppliers often insist on
adding confirmation of reputable banks abroad as a token of guarantee of payment. This reputation, or the lack
of it, also translates into higher costs for the merchandise apart from limiting the scope for buying at
competitive prices. On the other hand, defaults by a few importers and their bankers impose an additional
burden on the entire business community engaged in foreign trade.
Non-payment of import bills is a serious issue that needs more than gentle reminder. At the root of the problem
is the ignorance of a section of the trade and some of the bank officials regarding the guiding principles of LCs
and their lackadaisical attitude regarding fulfillment of contractual obligations under them. I have heard many
bank officials, even those at the high levels, talking about non-funding or off-balance sheet activities like issue
of bank guarantee, performance bond and letters of credit as an opportunity to earn money through 'sale of
paper'. What many of them forget is that the 'potential risks' of this 'paper' are as real as those against cash
credits. So, unmindful of the perceived risks, they lower their guards for assessment of the creditworthiness
and reputation of the clients and assume obligations without collateral security and adequate margins, often
without any margin. However, they begin to feel the pinch and remain clueless when the customers do not

come forward to fulfill their part of the obligations. It is then that the bank officials who sponsored the 'sale of
paper', starts dilly-dallying to avoid payments against their LCs or guarantees to earn a respite from the
scrutiny of the Credit Committee or the Board of Directors. Sometimes, they even encourage the clients to
collect injunctions from a lower court to withhold payment.
The system of import on credit terms, especially by the garment sector, has spawned serious unethical practices
in the trade and banking arena. Many importers, often in collusion with their bankers, do not pay the suppliers
on flimsy grounds like poor quality or quantity of materials received. The refusal to pay militates against the
spirit of the Uniform Customs and Practices (UCPDC) for Documentary Letters of Credit of the International
Chamber of Commerce. Under the UCPDC the LC opening bank cannot renege on its obligation to pay if the
documents are apparently in order, even though the quality, quantity etc are not in accordance with the
contracts between the buyers and sellers. This dictum follows from the well-known principle that 'banks deal in
documents and not in goods'. It means, if there is any dispute concerning quality, quantity or anything else that
does not show up in the documents, it must be settled by the buyer with the seller mutually or, if need be,
through legal means.
The starting-point for understanding the true nature of LCs, the following are some important guiding
principles of the UCPDC, 600 that must be borne in mind by everyone connected with foreign trade or
financing of this trade:
n Letters of credit are separate transactions from the sales or other contracts on which they are based, and
banks are in no way involved with or bound by such contracts, even if reference to them is included in the
letter of credit. It means that banks are concerned only with broad terms of the contract embodied in the LC,
like brief description of the merchandise, its quantity and unit and total price, country of origin, last dates of
shipment and negotiation and terms of shipment e.g. FOB or CFR (Free on Board or Cost and Freight). The
obligations of the issuing and negotiating banks do not extend beyond ensuring compliance with these terms
and that too on the basis of documents produced.
n In letters of credit transactions, all parties deal with documents and not with the underlying contracts to
which the documents may relate. It means that the bank would not verify the contents of consignments but
would go by the description of the merchandise mentioned in the bill of lading and other shipping documents.
n Before payment or acceptance of drafts is effected, banks bear the responsibility for examining the
documents to ensure that they appear on their face to be in accordance with the terms and conditions of the
letter of credit.
n Banks bear no responsibility for the form or genuineness of documents; for the goods described in the
documents; or the performance of the seller of the goods.
The following are some of the suggestions to avoid the stigma of defaults against letters of credit:
(1) The banks should be reminded to promptly settle the payments on due dates against the bills accepted by
them. If they have any problem with discrepancies in the documents regarding the quantity, quality or other
aspects of the consignments, that should be sorted out before accepting the bills. If any branch is found to be
unnecessarily sitting on the accepted bills beyond the due dates, its Authorized Dealership license may be
suspended.
(2) The Bangladesh Garment Manufacturers and Exporters Association (BGMEA) and Bangladesh Knitwear
Manufacturers and Exporters Association BKMEA, whose members account for most of the defaults, may
organise training and orientation programmes for the officials of the apparel units on various aspects of exports
and imports including the laws, regulations and customs at the domestic and international levels. It will also
strengthen their hands to deal with unscrupulous buyers who try to defraud or extract heavy discounts on
flimsy grounds.

(3) The Bangladesh Bank (BB) may organise training programmes and seminars for banks to underline the
importance and ways of handling international payments.
(4) A law may be enacted to prohibit the courts from issuing injunctions to stall payments towards international
obligations. I think there was an order from the High Court to this effect sometimes in the eighties. It could be
dug out and circulated for guidance of all concerned.

Trends in global trade service activities by banks

International trade is heavily dependent on trade services as it involves certain forms of commercial risks that
are often assumed by banks. These services by banks become essential since importers and exporters are often
unwilling to bear these trade related commercial risks. It is well recognised that expansion of trade service
activities by banks and financial institutions are connected with the expansion of cross-border trade flows and
both developed and developing countries have been playing increasingly prominent role. There are indications
that following a downward trend and slower pace of trade flows in the aftermath of global crisis, world trade
growth strengthened in recent time. The most recent International Chamber of Commerce (ICC) survey of
2014 provided us encouraging data in which it has been reported that the availability of trade finance increased
by value though the changes are marginal.
'Trade finance' is at the heart of trade services as part of which banks facilitate transactions between exporters
and importers. There are also very common practices of commercial trade finance (non-bank trade financing),
in which importers and exporters extend credit to each other. Even in such non-bank trade financing, banks do
play role in transferring funds and other support services. In many instances banks are also legally obliged to
undertake responsibility on behalf of the policy makers and traders. Trade services are the lifeline of trade, and
trade finance and related services contribute to international trade in four areas: payment facilitation, risk
mitigation, and financing and the provision of information about the status of payments or shipments. Trade
services by banks are also relevant for strengthening business relationships; bringing reliability and speed in
documentation and payments in international business; and offering appropriate expertise to help improve
earnings and develop opportunities in the global market place. Every trade service transaction by banks
involves some combination of these four elements, adjusted to suit the circumstances of a particular market or
of a trading relationship. It is to be remembered that alongside safe features, challenges are to be kept in mind
while offering trade services. Among loans, trade finance is seen as a relatively safe and liquid asset, with low
default rates. However, since trade finance is self-liquidating and short-term in nature, banks can run down
their trade finance portfolios quickly in times of financial stress. Trade services products or services include the
products or services related to trade payment and trade finance. There is no doubt that sometimes it is hard to
make distinction between trade payment and trade financing. Some commonly used trade services techniques
in international trade are cash in advance, open account, documentary collection, documentary credit (LC),
standby LC or other bank guarantees, bank payment obligation, supply chain financing, factoring, forfeiting
etc. In every country, trade services operations of banks are subject to special regulations and restrictions.
Alongside ensuring satisfaction of the clients, the efficiency level of bankers in trade services is connected
with the compliance of these regulations and restrictions. It is widely recognised that credibility of the traders
and trade service providers or banks are important factors that determine the availability, quality and efficiency
of trade services; and efficiency in trade services affects trade flows and bargaining power of the traders.
Adequate and reliable information are crucial in this connection.
Expansion of trade services banks are directly related to the expansion of cross-border trade activities.
Following global crisis of 2008-09, Eurozone crisis in 2011-12 also affected global trade. Trade growth over
the last few years has been heavily fuelled by weak overall demand in high-income countries. At the same
time, in many countries, government spending and fiscal stimulus have favoured domestic products over
imports. Developing countries have mitigated the decreased demand from the North by trading more with each
other. The year 2013 came across some positive changes as USA and EU countries began to report stable
growth, coupled with growth in import demand. As the US remains the world's largest importer and the Euro

area persists as the most important trading partner for many developing countries, their recovery started
pushing global trade moving forward. According to most recent ICC survey, the global trade is expected to
gradually strengthen through 2016. This trend should occur on the heels of steady recovery in import demand
in the US, China, Indonesia and EU, as well as continued export success amongst developing countries as they
continue to trade more amongst themselves. Exporters of manufacturing products and services such as China,
Malaysia, the Philippines, and Thailand, as well as economies with relatively low unit labour costs and
competitive exchange rates might be benefitted most from this projected trade increase. Bangladesh might be
greatly benefitted alongside Cambodia, Lao PDR, Myanmar, and Vietnam out of the trade increase.
Global trade changes were accompanied by parallel developments in trade finance and other trade service
activities. In the context of overall trade finance activity the reported figures by ICC are encouraging. About
60 per cent of respondents reported an increase in overall trade finance activity. As a collective group it was
interesting to see that approximately 45 per cent respondents reported an increase in demand for 'bank
undertakings' which encompasses commercial letters of credit, bank guarantees and standby letters of credit.
On the import side, as a whole the use of documentary credit decreased. Commercial Letters of Credit - down
from 44 per cent in 2011 to 39 per cent in 2012 and 36 per cent in 2013, as observed in the most recent ICC
survey. Consistent with trends on the export side, respondents have reported an increase in the demand for
guarantees to cover the potential risk of default under commercial contracts. Practices of guarantees increased
from 16 per cent in 2012 to 20 per cent in 2013. The use of Standby Letters of Credit also witnessed a small
increase from 8 to 9 per cent in between 2012 and 2013. In case of export trade, commercial letters of credit as
a proportion of overall trade finance products are in a slow but steady decline from 44 per cent in 2011 to 41
per cent in 2013, as shown in the ICC survey. This slow downward trend is consistent with the reported slow
shift to open account or transactions structured with the risk of default covered by an independent guarantee or
standby letter of credit. The growth in cross-border factoring has again been driven by an increase in open
account trade, especially from suppliers in the developing world, pushed by the major retailers/importers in the
developed world. The ICC Survey observed significant differences among regions in terms of use of different
payment/financing techniques. Asia-pacific region extensively rely on LC that registered highest volumes of
letters of credit use covering 68 per cent of imports and 75 per cent of exports. In the context of Bangladesh,
trade is the key component of international business activities, and trade facilitation is directly connected with
the country's global integration. As part of trade facilitation, banks facilitate payment and finance services to
the traders and thus contribute in growing global trade integration of Bangladesh and other economies of the
world. As in most Asia-pacific region, LC is the most widely used trade finance/payment technique to facilitate
trade in Bangladesh. Available published data identified significant gap in the provision of trade finance,
especially for the growing SME (small and medium enterprises) sectors in emerging markets. In 2014, ADB in
cooperation with partner organisations, surveyed financial service providers and found that trade finance gaps
are a persistent feature of the global trade landscape. Banks reported a global rejection rate of trade finance
applications of 29 per cent. Geographically, much of the gap in trade finance happens within Asia where more
than 90 per cent of all firms are SMEs. Malpractice in Trade Services is a critical challenge. Trade-based
money laundering is a critical area of malpractice which can be accomplished through the misrepresentation of
the price, quantity or quality of imports or exports. Though the malpractices (especially fraudulent activities) in
trade services are not very frequent, these could, however, prove to be very costly for banks and the concerned
parties. Some of the requirements of regulatory compliance related to Anti-Money Laundering and Know Your
Client (KYC) are creating significant impediments to their provision of lines of credit, as claimed in some
recent surveys. Globally, Asia and Africa were said to be most negatively impacted. There are opinions that
implementation of Basel III regulations is to some extent or a large extent affecting the cost of funds and
liquidity for trade finance. Moreover, sanctions may restrict banks' ability to perform their role as trade service
providers and may confront with different sanctions regimes imposed in the multiple jurisdictions.

Derivatives: A long way to go

'Derivative' is the new buzz word in the financial sector of Bangladesh. Some local and
international experts are continuously telling about the importance of introducing a derivatives
market to mitigate investment risks in a developing country like Bangladesh. The Bangladesh
Securities Exchange Commission (BSEC) also seems interested to introduce derivatives in the
country's financial market soon. Wide acceptance among investors and its use as a tool for
ensuring efficiency and depth of the capital market make the market for derivatives the largest
single segment of the financial market in the world. Derivative is actually a financial instrument
which has no intrinsic value; its value is derived from some other underlying assets or products.
The underlying asset includes stocks, currencies, interest rates, commodities, debt instruments,
etc. For example, one farmer is assuming price of his product say mango would drop in coming
days. If there is an efficient 'Derivative Exchange' in our country, he might go to an investor to
buy a 'contract' that specifies that the investor would buy determined quantity of mango at a
determined price in a certain day of future. The farmer has to be paid a pre-determined price by
the exchange for getting this commitment to buy. This type of contract is called future contract
which is actually a derivative. Derivatives also include other financial contracts like forward,
option, swap etc.
Presence of the derivative would not only hedge the risk but also would provide an alternative
investment opportunity for the market participants. To ensure a competitive capital market, there
is no denying fact that derivatives must be introduced. But there is still a question mark
regarding the readiness of Bangladesh's financial market to bring derivatives into play.
Sophisticated instruments like derivatives need sound institutional set-up and efficient regulatory
framework. Well-organised and full functioning market for securities and other commodities
from which the value of derivatives is derived is the fundamental requirement for introducing
derivative.
In Bangladesh, there is no commodity exchange so far though BSEC has taken a step forward to
establish a commodity exchange by amending the Securities and Exchange Ordinance 1969 in
November 2013. On the other hand, we have a volatile capital market which is still in a recovery
phase after the 2010-11 stock market crash. Before the crash, the market experienced an
astonishing growth which was not in line with the growth in real sector of the economy. As a
result, the market went for a huge correction at that time and many small investors were affected
badly. Even after years, investors still lack confidence in the market. It means the ghost of the
market crash is still prevalent. There is also an allegation that the market is highly manipulated
by a few players.
Former economist of the World Bank Oliver Fratzscher (2006) identified three critical issues that
must be considered before introduction of derivatives in his paper titled 'Emerging Derivative
Market in Asia'. These are: (i) a deep liquid cash market supported by market-determined prices,
(ii) how much regulation is needed in derivative markets and (iii) what infrastructure is
necessary. For a full functioning derivative market, an efficient and liquid cash market is very
necessary. In Bangladesh, we do not have a liquid secondary market for government bonds.
Though we have very few corporate bonds traded over stock exchanges, they are not popular
among investors due to lack of liquidity. Corporate bonds are treated like any other stocks in the
market. For example, transaction cost and maturity cycle are the same for bonds and general

equities.
Close monitoring and strict regulations are required to ensure a credible and sound derivative
market. A sound risk management tool has to be introduced to give security to the investors in
financial distress. The capability of the BSEC to ensure such monitoring and regulations is still
in a question due to its alleged failure to efficiently run the capital market. Infrastructure is
another concern that cannot be overlooked if we really want to see derivatives in our market.
It has been heard in recent days that a derivative market is necessary in Bangladesh to ensure
getting fair prices of agricultural products by producers. To do so, a commodity exchange for
agricultural goods must be established and it will not be an easy task for the authority. A lot of
things has to be considered in this regard such as product's quality, perishability etc.
However, basic knowledge of investors and participants about derivatives is a must for an
effective derivative market. In a country like Bangladesh where investors cannot even understand
the easy concept like mutual funds (mutual funds in Bangladesh were being traded at a very high
discount or premium on the net asset values in last few years which was not ideal in any
scenario), it can be said without any confusion that the investors will be surely in puzzle if
complex financial instruments like derivatives are introduced now. Without ensuring proper
training for potential investors and other parties including brokerage houses introducing
derivatives will not be a wise decision. Derivative is often termed as true capitalistic instrument
as it offers a 'zero sum game' for the investors. If derivatives are introduced now in our market,
speculators would be happy as they would get another gambling tool in their portfolio. But the
true intention of introducing derivative should be the reducing the investment risk and to fulfill
this, an efficient financial system and an adequate infrastructure are required.
Bangladesh has still a long way to go for ensuring a favourable condition for introduction of
derivatives. Derivative market should be in our long-term plan and the short-term plan should
include removal of existing problems of the capital market and the commencement of liquid
bond market. Some experts said that without derivatives, investors walk in investment market
barefooted. If the shoe is too big for their feet, general investors should not mind walking
barefooted.
Commercial paper market: Challenges and prospects

Commercial Paper (CP) is basically a short-term debt security issued by highly rated
companies to raise funds for funding operating expenses as well as current assets such as
account receivables and inventories. Maturities on CP rarely range any longer than 270
days though it can be up to 365 days. CP is being issued in the form of promissory note
in Bangladesh. It is typically issued at discount like Treasury Bills, reflecting prevailing
market interest rates. That means, investors purchase promissory notes at less than face
value and receive the face value at maturity. The difference between the purchase price
and face value, called the discount, is the interest received on such investment.
CP is sporadically issued as an interest-bearing note, i.e., investors pay the face value
and, at maturity, receive the face value and accrued interest. All the commercial papers

issued so far in Bangladesh are interest-bearing only. Generally, companies and

financial institutions can issue commercial paper. Even though banks and non-bank
financial institutions (NBFIs) can act as arrangers for the issuers, only a scheduled bank
can act as an issuing and paying agent (IPA) for the issuance of CP. Banks, NBFIs and
corporate bodies are the major investors in CP.
Commercial paper market is experiencing rapid growth in Bangladesh for the last couple
of years owing to its low cost and easy access. CP is a highly promising product for a
developing country like Bangladesh for at least two reasons: First, it fosters the goal of
reducing cost of borrowing which can stimulate growth. Through CP, companies can
now get funds at lower cost compared to bank loans. Weighted average interest rate on
CPs issued in the last three years stands at 10.34 per cent against the weighted average
bank lending rate 13.06 per cent during the same period. Secondly, there are limited
investment opportunities in the financial market of Bangladesh. Often banks remain
overburdened with surplus liquidity and heavily dependent on government securities
amid low credit growth in the economy. The sharp fall in yields on the recently
auctioned Treasury bonds highlight the need for additional investment instruments.
Yields on the recently auctioned 2-year, 5-year, 10-year, 15-year and 20-year bonds fell
sharply by 60, 80, 93, 136 and 161 basis points respectively. Had there been more
investment instruments, fall in yields would not have been that much. Volatility of
interest rate would have been lower. CP can broaden investment opportunities as it
provides additional instrument to the investors. Thus, it can play an important role for
development and growth of sustainable financial market.
CURRENT STATUS IN BANGLADESH: Commercial paper market, popular around
the world, is in a very early stage of development in Bangladesh. Eastern Bank Limited
is the pioneer of CP in the country; it raised Tk. 500 million for ACI Limited in 2013.
Since then, this market is growing very fast in our country with approximate growth of
593.10 per cent in 2015. ACI Limited is so far the largest issuer of commercial paper in
the country with approximately 20 per cent market share. The amount of current
outstanding CPs is close to Tk. 10,050 million.
Commercial paper market: Challenges and prospects
MAJOR CHALLENGES: There is no standard pricing mechanism for CPs in
Bangladesh. Pricing is not in line with the risks inherent in different borrowers. All the
borrowers are getting access to CP market at almost similar rates. This should not be.
Adequate credit risk premium should be added. Bad borrowers should be charged higher
interest rates and vice versa.
Secured and unsecured CPs are being priced almost homogenously. Even investors are
willing to invest at lower rate compared to secured one finding no better investment
opportunities. If this trend continues, bad borrowers will feel more encouraged to enter
CP market in future.
For example, Company X borrowed from Bank A for one year. One year has gone by.
Company X is about to repay its debt to Bank A. In the meantime, company X is facing
severe cash flow problem and unable to repay its debt to Bank A which is on the verge of
having NPL (non-performing loan). Bank A might suggest, in its interest, Company X to
issue unsecured CP in which Bank A will work as arranger. Bank A is being paid from
the proceeds of CP issues and thus it is reducing its NPL but exposing other investors of
this CP to credit risk. On maturity of CP, the company might be unable to repay the
investors from its cash flows. To get rid of this problem, the company may issue another

CP to repay the previously issued CP.

This scenario poses great threat to the future sustainability of CP market. The
Bangladesh Bank (BB) as the regulator of banking system has to ensure that no such
things happen in the country. The BB could provide guidelines that an arranger in
unsecured CP has to invest a certain percentage, for example, 25 per cent of the issue.
Thus, risk-based pricing needs to be introduced to develop CP market.
Commercial paper market: Challenges and prospects
Commercial paper is typically a discount security worldwide. But all the commercial
papers issued so far in Bangladesh are interest-bearing only. One of the reasons may be
that the borrowers are comfortable with interest-bearing bank loans. They perceive
discount basis issuance as cumbersome. They need to be educated about this and
encouraged to issue CP on discount basis.
One of the main reasons of why the interest rate on CP is lower than that of bank loan is
market tradability. The investors in CP can liquidate the investment prior to maturity by
selling it in the secondary market. Because of this liquidity facility inherent in CP,
investors are willing to receive lower return than bank loans. But, secondary market for
CPs does not exist in Bangladesh. Still, the rate remains at the lower level. The BB
should strive for developing secondary market for CP to increase its marketability.
The longer the maturity is on a note, the higher is the interest rate the issuing company
must pay. The 9-month CP should contain higher interest rate than that of 6-month CP
and vice versa. But, appropriate maturity premium is not being added to the pricing of
CPs in Bangladesh.
CPs issued so far in Bangladesh are in the form of promissory notes. CP issues don't
contain clear clause regarding tradability. It would be helpful for secondary trading if it
were issued in dematerialised form through a depository approved by and registered with
the Bangladesh Bank (BB).
Dematerialised CPs can easily be transferred from one investor to another. This will play
a pivotal role to bring dynamism in secondary market trading of CP.
MEASURES FOR SUSTAINABLE CP MARKET: It's high time for the BB to come up
with comprehensive guidelines regarding issuance of CP. It can consider taking the
following measures to help develop sustainable CP market:
A. Setting eligibility criteria for issuers of CP: The BB should set certain conditions to
be eligible for issuance of commercial papers. Conditions could be as follows:
1) The companies can't have loss in previous three years as per the audited income
statements.
2) The companies should have certain equity as per the latest audited balance sheet
depending on the type of companies.
3) The financing banks or institutions haven't classified the account of the company.
4) The company has to have minimum credit rating by credit rating agencies approved
by the Bangladesh Bank and

5) The banks or financial institutions have sanctioned working capital limit to the issuer
company.
B. Setting eligibility criteria for investors: The Bangladesh Bank should provide
guidance as to who can invest in CPs. Individuals, banks, FIs (financial institutions) and
other corporate bodies can be allowed to invest in CPs. The BB should decide whether
non-resident individuals and institutional investors will be allowed to invest in CPs or
not.
C. Setting eligibility criteria for rating agencies: The BB should set certain criteria for
rating agencies. Accordingly, it will do rating of them. The topmost five rating agencies
can be made eligible by which the issuer has to be rated in order to become eligible for
issuing CPs.
D. Setting duties and obligations of issuing and paying agent (IPA):
n The IPA shall ensure that the issuer meets the eligibility criteria set by the Bangladesh
Bank.
n The amount of CP is within the limit given by CRM or as approved by its Board of
Directors.
n IPA shall verify all documents submitted by the issuer are in order and
n IPA shall notify the Bangladesh Bank about the issuance of CP.
On top of the aforementioned measures, the BB should provide guidelines delineating
the issuance procedures, mode of issuance and redemption, as well as accounting
procedures. It should provide a platform for commercial papers where participants can
provide two-way quotes. OTC (over-the-counter) trades of CPs can be settled through a
module like Market Infrastructure (MI) Module for Bill Bonds. The Bangladesh Bank
should provide guidelines on settlement cycle which can be T+0 like Bangladesh Bank
Bill or T+1 for Treasury Bill-Bonds. At the inception of CP, the issuer shall arrange to
credit the Demat (dematerialised) account of the investor with the depository through
IPA (Issuing and Paying Agent).
The holder of CP shall be allowed to resell the CP to other investors prior to maturity. On
maturity, the holder of CP in Demat form shall get the CP redeemed and receive payment
through IPA.
Commercial paper is likely to become popular with investors in the coming days given
the limited financial products we have. Corporate dependency on bank loans will then
substantially fall.