Banks in stock market: Shot in the arm or recipe for disaster?
Financial intermediaries like banks play a pivotal role in a developing economy like ours. So their involvement in the stock market, perhaps, requires close surveillance
Banks are no strangers to investing in the stock market as they are allowed to do so all around the globe. It helps in keeping the stock market buoyant and acts as an alternative source of revenue for the banks.
However, it can be a double edged sword. Banks can help a capital market be more vibrant and thriving but the outsized impact of their activities might spell doom for individual investors. Since banks possess the financial muscle to impact the stock market, rogue elements like gamblers might form unholy alliances with unscrupulous bank officials and try to use the banks to their advantage.
Private commercial banks' profit from investment in the Bangladeshi stock market surged to Tk481 crore in the first nine months of 2021, up by 568% from Tk72 crore earned in the same period a year ago, according to the Bangladesh Bank quarterly report for July-September last year.
Professor Dr Mahmood Osman Imam, Department of Finance, University of Dhaka said, "The reason behind this is twofold. The first one being - the global pandemic. Banks were sceptical about handing out loans due to the state of the economy caused by the Covid-19 pandemic, so they had to look for alternative sources of revenue.
They needed to do something with their surplus liquidity. The other reason is the special liquidity package which allowed banks to form a Tk200 crore special fund each by taking low-interest loans from the central bank to invest in the stock market."
In order to increase liquidity flow in the stock market, on 10 February 2020, Bangladesh Bank allowed scheduled banks to form a special Tk200 crore fund. The banks also had the option to borrow from Bangladesh Bank at a 5-7% interest rate. And this consequently did seem to have a very positive impact on the stock market as the DSEX closed the year 2021 at 6,756. It even went as high as 7,367 points in October 2021, significantly up from 4,564 in February 2020, just before the announcement came about the Tk200 crore fund.
But once the benchmark index of the Dhaka Stock Exchange crossed 6,500 points, the central bank started to consider the index as overvalued.
So, the BB has been investigating banks' participation in the market. It is looking into banks' investments on a daily basis to prevent them from overexposure. The move has led the BB to unearth a series of discrepancies. They found multiple banks breaching the investment policy of the special liquidity package which allowed banks only to invest in companies that have dividend records of at least 10% in three consecutive years.
In the latest findings, the central bank found that all six banks had invested in junk shares under the special liquidity package. Of the six banks, two were fined due to severe violations in stock investment and four were warned.
Most recently Private sector lender Premier Bank was penalised for investing in junk shares. So what are the implications of banks making risky investments for individual investors?
Dr Imam said, "Banks are ethically bound to invest responsibly [in the stock market] as they are accountable to the depositors, whose money they are investing. Also, they should not make mistakes an individual might make since they are privy to more information and other resources than an average individual investor."
Additionally, "When banks invest a large sum of money on junk shares it has an outsized impact on the market as individual investors also become interested in such stocks. The risk of losing money investing in junk stocks is very real for uninformed investors," said Mujtaba Rafid, Lecturer, Department of Finance, Bangladesh University of Professionals.
So what is the way forward? How do the regulatory bodies ensure banks' involvement in the stock market is beneficial for all relevant stakeholders? As the traumatic events of 2011 still remain a sore point for many investors, is there a cause for concern?
According to industry experts, the events of 2011 are unlikely to repeat, thanks to preventive measures like the circuit breaker taken by the regulatory bodies.
Dr Imam opined, "The rules regarding how much banks can invest can be tweaked so that their exposure is measured based on the original cost [initial investment] rather than on the current value of the stocks. Since, if the price of their stocks goes up they have to offload shares even though the risk element has not increased."
Experts agree on the fact that there needs to be constant surveillance undertaken by BB. So that whatever actions need to be taken can be taken swiftly. "Bangladesh Bank can try to be more proactive instead of being reactive," added Rafid.
In regards to the actions taken by Bangladesh Bank so that they play fast and loose with the depositors' money, Abu Ahmed Honorary Professor, Department of Economics said, "Monetarily punishing the banks is sufficient. Bangladesh Bank should decide what action to take on a case by case basis. Punishing banks too harshly might not bring forth the desired result and discourage banks from investing in the capital market."
Additionally, Dr Imam said, "Banks can be fined 70-80% of their revenue made from investing in junk stocks. That should be a good deterrent for banks."
Bangladesh Bank shouldn't get too wrapped up in the capital market, the NPL situation must be monitored closely as too much NPL might lead to disaster for the pandemic hit economy, experts warned.
Up until September last year, non-performing loans (NPLs) stood at Tk101,150 crore, up 14 per cent from nine months earlier and 7.1 per cent year-on-year, Bangladesh Bank data showed. Defaulted loans totalled Tk116,288 crore in September 2019.
Financial intermediaries like banks play a pivotal role in a developing economy like ours. Their involvement in the stock market might have been a shot in the arm for the fledgling stock market but banks flouting rules and overexposing themselves can also snowball into a disaster.
However, as the economy recovers, the traditional revenue channels warm up and new avenues for investment like private Green Sukuk bonds open up. Bangladesh Bank has already allowed all scheduled banks to invest in such bonds from the banks' special funds meant for investment in the stock market.
Perhaps, there will be no reason for concern in future. However, in the current landscape, savvy investors must also keep an eye on market trends brought on by banks being involved in the capital market, and remain vigilant.
Nasif Tanjim is a journalist
