The central bank yesterday permitted banks to raise capital through debt instruments instead of issuing only rights and bonus shares, following bankers' demand.

The new product, called subordinated debt, is designed to help banks boost their paid-up capital, in line with a Basel II requirement, said Bangladesh Bank officials.

In finance, this instrument is also known as subordinated loan, bond or debenture.

“Banks' cost of capital will come down significantly thanks to the new product,” said KM Abdul Wadud, deputy general manager for BB's Banking Regulation and Policy Department.

The issuance of rights and bonus shares costs banks heavily because of 40 percent tax, besides a reduction in a bank's earnings per share, he said.

BB officials said the move would boost the capital market as well.

The interest rate on the debt instrument is expected to be more than 12 percent -- the current rate for savings certificate.

The debt of its kind is referred to as subordinate because debt providers (lenders) have a subordinate status in relationship to the normal debt. A typical example for this will be when a promoter of a company invests money in the form of debt, rather than in the form of stock.

The banks will have to seek approval from BB to issue and repay the debt. The central bank also issued a set of guidelines on subordinated debt.

The scheduled banks should have a capital plan approved by their boards of directors. To attain the capital plan, the banks may issue a subordinated debt instrument to qualify as regulatory capital (Tier 2 and Tier 3).

Subordinated debt eligible to be considered Tier-2 capital must have a maturity period of more than five years. It must be clear that investment in the instrument is not a deposit, nor insured by the Deposit Insurance Scheme.

The debt also may be convertible into equity subject to approval from the central bank and the Securities and Exchange Commission. The instrument should be rated and could not be eligible as collateral for a loan made by the issuing bank.

Subordinated debt will be limited to a maximum of 30 percent of the amount of Tier 1 capital, the guidelines mentioned.

The total amount of subordinated debt will be disclosed in the balance sheet under the head "subordinated debt" in the nature of long-term borrowings.

Foreign banks operating in Bangladesh may also raise capital with approval from the central bank in the form of subordinated debt in foreign currency and in the form of foreign currency borrowings from the head office for inclusion in Tier 2 capital.

Of the other eligibility criteria, the BB said a bank would be eligible to issue subordinated debt, which has composite CAMELS rating 2 and BB Rating Grade 2.

sajjad