Stocktaking of stock market | The Daily Star
12:00 AM, March 10, 2015 / LAST MODIFIED: 04:22 PM, March 23, 2015

24th Anniversary of The Daily Star (Part 1)

Stocktaking of stock market

Faruq Ahmad Siddiqi

Dhaka stock market started functioning in 1956. Sixty years have passed since then. But the Bangladesh stock market remained immature and failed to be an important force in shaping the economy of the country. The predominant source of funding for the private sector investments has always been the banking sector and contribution of the stock market has been marginal.Investments in recent years have been sluggish. Private sector credit growth has remained stagnant for some time. Many banks have started investing their surplus funds in government securities following lower demand for private sector credit. Due to the slow growth of private sector investment, access to long-term bank credit has been easy. This is one of the reasons why entrepreneurs prefer bank credit instead of raising funds from the capital market, notwithstanding the higher cost of funds from banks. Stock markets mobilise household savings and idle funds and can influence economic activity though the creation of liquidity. However this becomes complicated when the banking sector has enough liquidity to offer long-term financing. Therefore we cannot perhaps expect rapid development of the stock market unless private sector investments pick up to a level where banks cannot afford long-term loan with short-term borrowing.
In spite of these limitations, stock markets have the potential to grow increasingly with time. Stock market funding has certain advantages. It offers lower cost of fund without the obligation of repayment. It also helps reduce financial expenses of the corporate sector, making it more competitive. It dilutes ownership concentration and contributes to improved corporate governance practice.We need to grow an effective stock market to mobilise savings, provide relatively low cost funding, improve transparency of companies, and advance corporate governance in the interest of long-term development of commerce and industry. 
Stock markets function in a regulatory regime and it is important that the regulators are professional, efficient and transparent. Bangladesh Securities and Exchange Commission (BSEC) is the apex regulator for the stock market. It was formed in 1993. More than twenty years after its formation, BSEC is yet to develop as an efficient watchdog competent to discharge its most important responsibility of protecting the interest of investors. The debacle of 2011 was basically a massive regulatory failure. BSEC lacks quality professional manpower, competent accountants, financial analysts and legal experts. Instead of developing as a highly professional organisation, it has grown into more of a bureaucratic body.
There is also a persistent lack of co-ordination between the Ministry of Finance, Bangladesh Bank, Securities and Exchange Commission, Insurance Development and Regulatory Authority,National Board of Revenue and other related organisations. This isolation of BSEC was, perhaps, a crucial factor for the regulatory failure in 2011. Close understanding and coordination between Bangladesh Bank and the Securities and Exchange Commission is particularly important because the money market often has an impact on the capital market. Besides, Bangladesh Bank regulates banks and financial institutions. At present there are 30 banks and 23 financial institutions listed on the stock exchanges. These organisations represent a very large part of market capitalisation. These organisations, together with insurance companies, have substantial investment in the stock market. Therefore BSEC needs a close liaison with their regulators for stability of the market.

Some constructive reforms were undertaken after the market collapse of 2011. Most important of these reforms was the demutualisation of the exchanges. Demutualisation is likely to bring a long-term qualitative change in the management of the exchanges. But implementation of the demutualisation process seems to be slow. Separation of the traders (brokerage house owners) from the owners (shareholders) is the basic requirement of demutualisation. That has not happened yet. Traders still remain as the only owners. 60 percent of blocked shares are required to be transferred to strategic partners, institutional and general investors. There is no visible progress of the process and shareholders (former members) still remain owners of the blocked shares. The only positive progress in the demutualisation process has been the formation of the new boards of directors in the exchanges. But demutualisation cannot have a meaningful impact without transfer of the blocked shares. Collaboration with strategic investors by transfer of shares to them is important for the purpose of importing international skills and capabilities to the domestic market. Transfer of shares to strategic investors can accelerate development of technology related infrastructure and promote global integration of the market. Similarly, transfer of the remaining portion of blocked shares to domestic institutional and general investors can dilute the concentration of ownership and reduce the influence of the vested groups leading to improved management of the exchanges.
The stock market should now be poised for development. There are several encouraging factors. Nearly four years after the market collapse, the stock market has regained stability to an extent. Investors may consider this to be a favorable time for long-term investment because, at the current level of price, this is an investable market. Banks have enough liquidity as well as low demand for private sector credit. Therefore, fund transfer from the money market to the capital market is probable. Bank interest on deposits is low and prudent investment in the stock market is likely to be more rewarding than fixed deposits in the banking sector, notwithstanding the risk factor.

But in spite of these positive aspects, participation in the secondary market does not appear to be as encouraging. This is evident from the low turnover in both the exchanges. This is possibly an indication that market confidence is yet to be restored to a reasonable level. Our market is dominated by traders who expect short-term profit. But the current market is not tha tpositivefor short-term investments. A considerable segment of these investors have been victims of market manipulations that seem to have been taking place in recent times. Some companies have been listed in recent years whose credibility is not beyond question.  The price of shares of some of these companies rose to an abnormally high level after trading began and soon dropped rapidly to a much lower level.  In the process, inexperienced investors lost their money. It appears from the pattern of price movement of these companies that manipulators were very likely at work. This dampened the interest of some investors. 
There could be other reasons for dull trading in the market. The exposure limit of banks to the capital market has been decreased by amending the concerned law. This has probably been done in the interest of protecting the depositors. In the long run, such measures are likely to protect the safety of bank deposits and persuade the banks to focuson their core business. This is also likely to reduce volatility in the stock market and help improve its stability. However, in the short-term, this may have an adverse impact on the activities of the stock market. The other important factor is the cash flow problem of the merchant banks and brokerage houses that offered generous margin loans to their clients in 2010. Due to the abrupt plunge of the price level, balance of many of these accounts has turned negative and a huge amount of fund has been trapped. This is affecting the operational capacity of these institutions. The government's rescue package in this regard has been delayed and poorly structured and, consequently, of little help to overcome the situation.
Ideally mutual funds ought to be the most important institutional investors in the market. Inexperienced investors should invest through mutual funds for professional management of their funds. There are 40 mutual funds operating in the market but their contribution to market performance is extremely limited. Many of these funds were established in 2010 when the price level was very high and these funds probably wanted to take advantage of the rapidly rising stock price. But in the process they were trapped by the market crash and have not recover from this yet. This is apparent from the fact that the market price of 27 of these funds is below the issue price. Many of these funds lack professional expertise and failed to generate confidence among the investors. As a result, mutual funds can hardly stimulate activities in the market.
Bangladesh's stock market lacks depth. Equity is the only product traded in the market. Number of listed companies is inadequate and companies with excellent track record are fewer still. We need more listed companies with good fundamentals. But the listing of new companies is slow and good companies are not coming forward for various reasons. The progress of listing public sector enterprises has been extremely slow due to the lack of firm political commitment to withstand bureaucratic resistance. Derivative products and the bond market have not developed at all. There is practically only one corporate bond traded in the market. The Bangladesh bond market is dominated by treasury debt securities, which are not traded in the exchanges. Thus, the equity market is limited as there are particularly no other products in the market. Supply side constraint can lead to market instability when there is excess liquidity in the market and demand goes up. In 2010, money flowed to the stock market from banking and other sources while hundreds of branches of brokerage houses were allowed to be opened throughout the country, pushing the demand up and ultimately leading to the market collapse.  This supply side constraint is a persistent limitation of our exchanges.
Sometimes, it is said that the price movement of many shares is not rational in the Bangladesh market and investment decisions on the basis of financial analysis may not bring the best results. This may be so in the short-term because the market is dominated by retail investors, most of whom lack experience and are driven by rumors. Therefore, investors' education is very important and more attention is required to educate the investors. However, there may be other cogent reasons that make considered investment decisions difficult. Credible financial reporting is vital for appropriate investment decisions. Auditors are required to examine data, statements, accounts, records, performance and operation of the company, and record their independent opinion. Auditors, in turn, should be provided with reliable information by the management. In Bangladesh, management reporting may not always be the true reflection of the affairs of the company due to the intervention of the board, while in many cases the quality of audit may be far from satisfactory. Under such conditions, investment decisions on the basis of disclosures alone may be hazardous in some cases. This vital problem is known to everybody but the government has seemed to be indecisive for many years, presumably due to the influence of various pressure groups. Appropriate corporate governance practice is also essential for generating credible financial disclosure. In this area, we've just begun and it may take years to establish such practice.
It is unfortunate that since the establishment of the Securities and Exchange Commission in 1993, the stock market has crashed twice. On both occasions, thousands of small and inexperienced investors lost everything they had. Stock market crash is not something unique and it happened in many other countries. But market collapses in other countries were normally linked to some internal or external economic shock or global recession. In case of Bangladesh, it has not been so. Bangladesh stock market is isolated and is not globally integrated. Foreign investment is insignificant. Both the crashes were neither due to external economic factors nor internal economic malfunctions. These crashes were the results of poor governance, unbridled manipulations, undue influences and unlimited greed. Let us hope that this does not happen again.
The writer is the former Chairman of the Securities Exchange Commission.

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