Written by Dr Nasrin Sheely
Dr Nasrin Sheely
The financial systems of frontier economies are often dominated by banks, which play a central role in providing financing across all tenors and sectors. This dominance may seem like a sign of strength, but it is, in fact, a symptom of an underdeveloped financial architecture. Nowhere is this more evident than in the case of term financing – where banks provide long-term loans, often for seven to fifteen years, to fund infrastructure, industrial expansion, or real estate development. While such financing is vital for economic growth, its provision through banks rather than bond markets creates a structural imbalance that inhibits financial deepening, market-based pricing, and systemic resilience.
In mature economies, term financing is typically the domain of capital markets, particularly the bond market. Corporations, municipalities, and even state-owned enterprises issue long-term debt instruments to a diverse pool of institutional investors. This allows for risk-sharing, better price discovery, and reduced concentration of credit risk. In contrast, in countries like Bangladesh, banks continue to be the primary – often the only – source of long-term funds. They finance long-term assets with short-term liabilities, such as demand and time deposits with maturities of less than a year. This asset-liability mismatch creates vulnerabilities, especially during times of liquidity stress or interest rate volatility.
The dominance of banks in term lending crowds out the development of a bond market. When banks are willing to provide long-term loans, often at rates that do not adequately reflect credit and duration risks, the incentive to issue bonds diminishes. Borrowers prefer banks over the capital market because the former involves fewer disclosure requirements, more negotiable terms, and quicker access to funds. On the investor side, households and institutions find bank deposits safer, more liquid, and more familiar than corporate bonds. This creates a reinforcing cycle in which the bond market remains shallow, illiquid, and underutilized.
In Bangladesh, the corporate bond market remains nascent. Outstanding corporate bonds account for less than 1 percent of GDP, far below the levels seen in even comparable regional economies. There are very few active issuers, and the market lacks breadth, depth, and diversity. Most bond issuances are one-off events, with limited subscription and virtually no secondary trading. The absence of a reliable yield curve, benchmark securities, and credit rating infrastructure further erodes investor confidence.
The existing regulatory framework is also not conducive to bond market development. The process of issuing a bond requires approvals from multiple regulators and is time-consuming, costly, and complex. There is a lack of clarity in tax treatment, accounting rules, and disclosure norms. Institutional investors – such as pension funds, insurance companies, and mutual funds – are either too small or too risk-averse to meaningfully participate in the corporate bond market. Most of their holdings are in government securities or bank deposits, reflecting their limited mandate and lack of market-making capabilities.
Meanwhile, banks continue to expand their term lending portfolios. This is facilitated by regulatory leniency and a lack of policy pressure to reorient long-term finance to capital markets. Banks face limited penalties for maturity mismatches and continue to price credit based on relationships rather than risk-adjusted returns. As a result, they often lend to corporates at rates that are artificially low when compared to what the market would demand in a transparent bond issuance. This leads to a mispricing of risk and reinforces the inefficiencies in the allocation of capital.
International experience offers important lessons. In many emerging economies, such as South Korea, Malaysia, and India, the development of the bond market was catalyzed by deliberate policy shifts. Governments introduced streamlined regulations, developed benchmark sovereign bond yield curves, created credit rating frameworks, and facilitated the entry of institutional investors. For example, in India, large corporations are now required to raise a portion of their incremental borrowings from the bond market rather than through banks. These have helped increase issuance volume and improve pricing transparency.
By contrast, Bangladesh has made limited progress in this direction. While some Islamic bonds (Sukuk) and perpetual bonds have been introduced, these instruments remain niche and are not yet part of a vibrant ecosystem. The bulk of corporate borrowing still flows through the banking system. Banks act not just as lenders but also as quasi-investment banks, determining pricing and structure in the absence of a functioning capital market advisory network.
This imbalance has broader economic implications. When banks provide the bulk of term financing, their balance sheets become concentrated with long-duration loans. This makes them vulnerable to maturity mismatches and sectoral shocks. It also limits their ability to support short-term credit demand, particularly during economic downturns. In such a system, banks become both the enabler and bottleneck of credit growth. Moreover, the systemic concentration of risk within banks raises financial stability concerns and undermines the transmission of monetary policy.
The absence of a strong bond market also means the economy lacks a tool for long-term resource mobilization. Infrastructure projects, which require funding horizons of 15 to 30 years, cannot be sustained on short-term bank credit. Similarly, new industries, startups, and green finance initiatives need access to tailored financing instruments that the banking sector alone cannot provide. A mature bond market can support securitization, structured products, and hybrid instruments, thereby expanding the menu of options for both borrowers and investors.
Addressing this structural constraint requires a multi-pronged policy approach. The central bank and securities regulator should coordinate efforts to streamline the bond issuance process, reduce costs, and introduce standardized documentation. The Government can play a catalytic role by issuing municipal bonds, project bonds, and asset-backed securities to establish benchmarks and build investor confidence. At the same time, policies should be designed to gradually disincentivize term lending by banks. This could be done by increasing capital charges for longer-duration loans or setting quantitative limits on bank exposures to long-term assets.
Institutional investors need to be empowered through reform of investment guidelines. Insurance companies and pension funds should be allowed and encouraged to invest in longer-tenor corporate debt instruments. Tax incentives can be introduced for bond investors, and credit enhancement mechanisms – such as partial guarantees or first-loss cover – can be used to mitigate perceived risk. Establishing a centralized trading platform, supported by real-time pricing and settlement infrastructure, will help address the problem of illiquidity and attract secondary market participants.
Education and awareness are also key factors. Both issuers and investors need to be informed about the benefits and mechanics of the bond market. Market associations, chambers of commerce, and academic institutions can play a role in capacity building and advocacy.
Ultimately, the goal is to develop a financial system where banks, capital markets, and non-bank financial institutions coexist in a complementary manner. Banks should focus on short-to-medium-term credit and transaction services, while the bond market should take on the responsibility of financing long-term investment. This rebalancing will not only enhance financial sector resilience but also improve the efficiency and inclusiveness of economic growth.
Bangladesh, like other frontier economies, stands at a crossroads. The banking sector has shouldered the burden of financing for decades, but the limits of this model are becoming increasingly apparent. To move forward, a strategic shift is required – one that recognizes the limitations of bank-centric term finance and embraces the potential of a vibrant, transparent, and liquid bond market. Such a shift will not happen automatically. It requires vision, coordination, and a willingness to confront entrenched interests. But the rewards – in terms of financial stability, investment mobilization, and economic diversification – are well worth the effort.
