Catch 22 for banks and the capital market
Banks’ reluctance to invest in the stock market has inconvenienced the country’s premier bourse – as it is not receiving support from institutional investors to pull back price indices
It's a Catch 22 situation for the capital market and the banks as well.
The starving capital market needs funds to salvage itself from the bottom it has hit and wants money flowing from the banks.
But the banks are once beaten twice shy. They have suffered hefty losses on their portfolio investments in the last few years and don't want to burn their fingers again. More than that, they are now cash-strapped and have no spare money to risk in the capital market. The lack of confidence on the market makes them even shyer.
In 2010, the Bangladesh Bank was desperate to prevent banks from investing in the stock market because banks' excessive exposure had created a bubble in price indices.
Now, the situation has reversed. Despite offering multiple incentives such as low-cost liquidity support at 6 percent interest rate, cut in the banks' requirement for keeping cash with the central bank and loosening the banks' requirement to balance advance and deposit, the central bank has not been able to lure the banks back to the ailing stock market.
The central bank is now planning yet another incentive to increase banks' exposure to the market beyond the authorised limit of 25 percent capital. Whether that would work is anybody's guess.
Banks are the main institutional investors in the stock market and their presence can bring the much-missed confidence, but that is not happening at the moment and the indices are on a tail spin, clocking newer records of low.
The DSEX, the benchmark index of the Dhaka Stock Exchange (DSE), lost more than 300 points in the last two weeks, according to the bourse.
The current situation is the consequence of a steady deterioration of the banking sector's health over the last decade.
Since the market crash in late 2010, banks' shares never rebounded, causing massive losses – not only to retail investors but even to the banks' portfolios.
Currently, of the 30 listed banks, shares of nine are being traded below their face values and most banks' shares have remained at Tk20.
The market capitalisation of banks' shares has declined to almost half since 2010 – when the market witnessed a boom.
Therefore, retail investors have stayed away from bank shares, causing a slump in prime indices of the stock market.
When shares of the banking sector remain down, overall price indices head the same direction.
Banks' shares largely dominate the capital market. The banking sector, alone, makes up 18 percent of total market capitalisation of the stock market – the highest holdings of a single sector.
So, share price movement of the banking sector and market indices are correlated.
Moreover, banks used to be involved with the stock market in many ways – such as by investing in their own portfolios via brokerage houses and merchant banks. The stock market is intensely affected when banks' health deteriorates – as has recently been apparent.
Stock investors' confidence has eroded as a result of: increasing numbers of default loans, loan scams, a lack of good governance, and a tendency to display inflated profits by taking provisioning forbearance for years.
Usually, when the stock market goes down, institutional investors like banks create buying pressure by injecting funds to pull back price indices. However, recently, banks seem not to be doing this because they are not in a comfortable position with their liquidity amid mounting bad loans.
The government's move to force banks to implement a single-digit interest rate has made them more conservative in investing in risky instruments like stocks.
Moreover, most banks are in loss in their own portfolios – keeping them away from further investing in the stock market.
For instance, in nine months of the current year, Islami Bank's operating income from share investment was Tk125 crore, 16 percent down from the same period of the last year.
This bank had a net loss of around Tk8 crore in 2018 against its portfolio investment of Tk3,800 crore – pressuring its profitability.
The bank, with the highest investment in the stock market, almost halved its portfolio size in 2018 from Tk6,000 crore in the previous year after having faced a significant fall in profits.
Thus, banks' investment in the stock market has been gradually declining since 2016.
Bangladesh Bank data revealed that banks' investments in the stock market decreased to 14 percent in June last year – while they had been 20 percent in December 2016.
However, according to the Bank Company Act, the maximum allowable limit to invest in the capital market is 25 percent of the capital, on a solo basis, while on a consolidated basis the limit is 50 percent.
Solo basis means an investment only by banks and consolidated basis means an investment by banks and their subsidiaries.
On a consolidated basis, the banks' investment in the stock market declined to 25 percent in June last year from 32 percent in 2016, according to the central bank's data.
In 2010, banks' overexposure contributed to a boom in price indices on the capital market. The banks were allowed to invest 10 percent of their liabilities. Later, the government amended the Bank Company Act in 2013, limiting the banks' exposure to 25 percent of the capital.
The banks had three years to limit their overexposure until July 2016. Since then, the banks' investments continued to decline, reducing their shares to total market capitalisation – the market value of a publicly traded company's outstanding shares.
The Bangladesh Bank, which once was tough on the banks' portfolio investment, is now providing an incentive to encourage banks to invest in stocks.
In September, the central bank offered liquidity support to banks – at only 6 percent interest – to invest in stocks.
The central bank issued a circular to temporarily increase the supply of liquidity in the capital market for six months. The liquidity support will be provided through repurchasing agreements.
Despite this lucrative offer, banks responded poorly; with just one bank taking Tk50 crore of liquidity support from the central bank to invest in the market.
Moreover, no good news in the banking sector appears to have reflected much on the stock market because of a growing disconnect between the banking sector and stock market.
For instance, the decision to reduce the Cash Reserve Requirement, in early 2018, seemed to have a minimal impact on the market index.
Even the decision to keep the Advance Deposit Ratio unchanged last year, which had been due to be cut in 2018, did not greatly impact stock indices.
Mirza Azizul Islam, former adviser to a caretaker government, said the ailing banking sector is responsible for the current febrile situation of the stock market.
The abnormal rise in default loans has created a liquidity crisis in the banking sector, making banks reluctant to invest in shares. Moreover, the continuous deterioration of banks' health has eroded investors' confidence significantly, he said.
As the banking sector largely dominates the capital market, piling default loans and a liquidity crisis have negatively impacted price indices, he added.