Debentures and What You Need to Know about It?

The monetary policy for 2019/20 includes mandatory issuance of debentures for banks of Nepal. The purpose of this policy is to create a solution for the shortage of loanable funds. Debentures will be made available for the general public to purchase. Howe

One of the major highlights of the recent monetary policy released for the fiscal year 2019/20 is the mandatory issuance of debentures for the A-Class banks of Nepal. Due to credit crisis, many banks fell short of lendable funds and thus Nepal Rastra Bank drafted this policy in-order to expand loanable funds and ease the liquidity crisis. This also implies banks will be reducing major reliance on client deposits as a source of funds for loan operations. Many banks have already begun issuing debentures in order to address the shortage of lendable funds. Banks are offering 10 to 10.5 percent interest in return. But it is still not easy to determine whether this policy will ease the crisis and provide solutions. 

To begin with, what exactly are debentures? Debentures are long term financial instruments that let companies or governments borrow money without having to increase its share capital. In simple terms, debentures are what companies turn to when they are running short of funds for their operations and need to borrow money which they will repay only after a certain period of time. Thus, issuing debentures generally is heavily based on the integrity of the borrower. Since these financial plans last for a long period of time, buyers need to have a great amount of trust in these companies to expect returns. For example a bank issues debentures worth 10 million for 10 years. People who purchase these debentures will be investing their money only to expect returns with interest at the end of the time period. Thus, borrowers need to have strong creditworthiness and reputation for people to trust that the company will not collapse before the period ends. 

There are various features of debentures one must be aware of before considering to purchase any. First and foremost, debentures offer a specific interest rate. For the entire time period, the rate stays the same, thus the final amount to be paid to debenture holders is fixed. Debenture holders have no claim over company surplus. Debenture holders are only creditors of the company. They do not get control or any place to participate in the management of the company. However, debenture holders have a higher priority over shareholders when it comes to company assets. If at any time the company is liquidated, debenture holders are paid their fair share first. 

For the country and the banks, debentures may not seem like the best deal. The market for debentures in Nepal has not yet prospered thus most of the general public are not aware about what debentures are and why they should invest in it. This also reduces the number of debentures sold, keeping banks that issue debentures in a tough spot. 

The debentures issued by the banks are for the general public to purchase. Many banks have already started making debentures available for people to purchase. When it comes to buying debentures, the simple idea of this scheme may easily lead one to believe that buying  debentures holds lower risks than investing in shares. But, purchasing debentures may not always be fruitful. Profit or loss, it all depends on whether people have a proper idea of what debentures are and the benefits or drawbacks of purchasing it. 

Debentures come with both advantages and disadvantages for the company as well as the buyers. While discussing advantages of debentures, first and foremost comes the low risks of returns for investors. Debentures certify you with a guaranteed return with interest at the end of the fixed time period disregarding any profit or loss that the company may incur. For the companies, they do not have to pay any extra dues to debenture holders if their company profits largely. In addition, for the management, debenture holders do not get to interfere in their plans and procedures of company control. Lastly, financing through debentures comes out to be less costly as the interest payments are listed as tax deductibles. 

For disadvantages, companies need to return the payments whether they are in profit or heavy losses. Even if it means to liquidate all its assets, the company has to pay its debenture holders the guaranteed amount. This may put a burden on the earning of the company during times of fluctuation. The fact that debenture holders do not get to participate in company management may also come out as a disadvantage to some buyers. For buyers, the invested amount will only mature when the time period ends; thus there will be no returns during the tenure. Lastly, issuing debentures reduces a company’s capacity to borrow funds. Since in most of the cases, the assets of the company are kept as security deposits for debenture holders, the credit worthiness of the company declines and makes further borrowing of funds difficult. 

Like everything else, debentures has its advantages and disadvantages. But if utilized wisely it can be of great benefit to both the company and the buyer. For Nepal banks, we can just hope that the new policy helps ease the liquidity crisis and finance the high demand that is taking place in the market. If enough information can be spread to investors seeking financial opportunities, this policy can be a huge success.