Looking back at the past year, I feel Bangladesh’s stock market was quite active and the financial sector’s performance managed to exceed expectations. When Bangladesh Bank directed the banks to implement the Basel III from January 01, 2015 in phases and fully by January 01, 2019, everyone became slightly anxious---how would the financial institutions cope with these changes?
Over the years, numerous financial institutions fell short of capital requirements set by BASEL-I along with BASEL-II which had been in practice in Bangladesh since 2010. The unrest persisted until 2017 as banks and other financial institutions (FI) finally decided to tackle the issue. Consequently, banks and other FIs started focusing more on asset liability management and interest rates sloped downwards.
NBFIs enjoyed a very profitable tenor in the past 12 to 15 months which ultimately strengthened their capital. In terms of price to NAV (Net Asset Value), the financial sector has been undervalued. Our banks were presumed to trade at 0.78 back in 2015 and 2016, whereas the standard global ratio of price to NAV is around 1.1 to 1.2. Only a handful of banks could trade at a higher ratio and the rest were undervalued.
Unfortunately, IPO income has been the lowest since 2010. We have not seen any large company enter the market. There was a discussion of a certain telco being listed in Dhaka Stock Exchange. However, it was postponed due to an M&A. In the coming years, IPOs have a high chance of gradually declining if the large companies don’t list in line with market capital’s growth. Companies used to enter the stock market because they preferred equity over debt. Instead of taking loans from banks, they went to the Stock Exchange to raise funds.
Our Banks and Capital Market
In developed and emerging capital markets, banks play a pivotal role in preparing entities entering the capital market. However, that’s not the case in Bangladesh. We should think about the meagre amount of money we are earning as a manager to the issue or as a banker to the issue.
In Bangladesh, the capital market listing is viewed as an opportunity gainer. So it becomes a daunting task for banks to get the entity ready for public listing. Everyone is solely focused on the rate the IPOs will be issued. If an alternate source promises to get an IPO approved by the regulators at the desired premium, the prospect invariably prefers to switch.
Even though the banks performed satisfactorily in 2017, foreign investment in our banks continues to be woeful. The yield on asset went down at the beginning of 2017, but a huge number of banks were still offering out of the market interest rate for attracting deposits. Some of those banks were the top choices or favourites for capital market investment. Local investors are quite indifferent to how the capital market should be run in their constant chase of insider information.
Although some of the banks’ value might be understated or under-traded, my biggest concern remains on the real quality of the asset portfolio, the diversity and depth of the deposit portfolio, and the multiplicity of the revenue streams. We need to emphasise more on their revenue streams, earning streams, average yield on asset, average cost on deposit and the process of managing the spread side of it to realise the ultimate goal of the monetary policy statement (MPS) of the central bank or the inclusive financial management strategy of the government as a whole.
Bangladesh needs to sort out two major issues soon. Firstly, intense competition in the banking sector has resulted in a highly squeezed spread and the asset quality of these banks are questionable with some acting like black boxes revealing nothing. Compared to most economies, the number of banks in ours is extremely high; so is the number of banks to GDP ratio. Numerous NBFIs coupled with such a high number of banks have ultimately made banking even more challenging than usual.
Secondly, the organisation of the equity structure of few banks are quite dubious as investments are poured in from different sources in the form of equity and mutual funds. These banks have failed to show the premium on their balance sheet. How are their decisions being taken? How are the asset management companies making their investors aware? Surprisingly, these banks’ sponsors are now being invited to further inject money without any due diligence of their balance sheet, asset quality, type negative network effect and identification of the actual network. Taking all these into account, I have an unfortunate hunch that Bangladesh might lag behind if it doesn’t revamp its bank governance policy soon.
We have also not seen any responsible trading on the insurance sector which can be attributable to the small amount of earning insurance companies make. Insurance companies are still offering mundane products to their customers. In order to upgrade the system and diversify the earnings, we need to re-evaluate Bangladesh’s entire insurance sector. We should consider having bancassurance. Bangladesh is possibly the only exception among its peer countries where banks are not selling insurance products. The central bank and IDRA (Insurance Development and Regulatory Authority) should seriously consider introducing bancassurance in the market and allow banks to come up with a proper risk management policy for selling and distribution of insurance products.
The Year gone by
People lack awareness on how the capital market functions, which in itself is a major hurdle. As long as we do not have educated investors in the market, we cannot completely rely on the market. Blue chip stocks’ performance has not been phenomenal and only had sustainable growth during the last 5 or 6 years. Even the small capital and mid capital stocks could not perform well.
We have little information about the changes that took place that resulted in the growing investors’ confidence in 2017 which has driven the market from an index value of around 4,000 to 6,000. What could possibly be the factors that have resulted in a 20% to 25% upward deviation?
To answer that, investors who usually invested in mid capital and low capital stocks have suddenly gained confidence in the market. Does that imply they have suddenly become educated and realised the value of the market? In the past, whenever stock market performed better, the momentum was mostly driven by speculative investors.
If we look at the price to earnings ratio of Bangladesh stock market, we will find it is fairly valued. Our market capital to GDP ratio is extremely low as it is very small with a very low depth and liquidity. Thus in order to keep any momentum of the stock market sustainable, investors need to be fundamentals-driven rather than being speculative. That change is yet to happen in our market.
Mutual Funds: Our Savior?
Mutual funds deserve a shout out for their performance last year. A lot of closed-end mutual funds, undervalued over the years, have succeeded in keeping their promise with quite an improvement in their NAV’s. We can count this as a promising sign, but I would still urge the authorities to look into the management and overall governance of these mutual funds.
Mutual funds do not have much margins. It is around 1% to 2% of the total fund. Distribution has always been a challenge for mutual funds in terms of reaching out to the retail investors. Digitalisation of the economy and internet access have made this distribution easier. Thus a lot of mutual funds will be using these new distribution channels to move forward as they are low cost and highly effective.
I would hope that going forward, Bangladesh Securities and Exchange Commission (BSEC) will put more radar on these mutual funds. For a given market like ours, it can play a crucial role, since it is largely a small investors' market. If all these small investors eventually get united, they can actually mobilise the government to take positive action. If BSEC can put all the asset management companies under more scrutiny and try to help the disorganised or moderately organised individual investors in the capital market, it will turn out to be beneficial for all of us.
Potentials in Stock
Bangladesh is an attractive investment destination and within the next 30 years, Bangladesh should be able to see itself among one of the top 3 fastest growing countries. In 2017, we have received significant investments from large firms in the USA beyond the banking and financial sector. Foreign investors are now quite interested in the power sector, especially alternative energy sources. They are also interested in our manufacturing and pharmaceutical companies as these companies are now entering the capital market. Our small investors, institutional investors, IPO managers and issuers have increased leverage and can also expect more investment from foreign institutional investors in the coming days.
Some of the stocks in Bangladesh capital market are still undervalued. The average return has been quite attractive against other frontier markets or even the emerging markets in stocks, but there is still room for foreign institutional investors. It is necessary for us to focus on certain related guidelines, like the NITA account to facilitate foreign investment in our stock market. The recent valuation done by Bangladesh Bank on the Holcim acquisition by Lafarge has given a wrong message to the international investment community as Lafarge did not have much to do about it but to accept the central bank’s valuation in order to remit money to the Holcim headquarter.
Our power sector is viewed as an attractive zone where even foreign investors have bid for pre-IPO or post-IPO stocks. But they are a bit jittery as the power companies are being burdened with multilayer tax on their dividends. This matter has been referred to the Finance Ministry and the National Board of Revenue, but to no avail.
Anyone who will invest in the capital market is more likely going to check whether these companies are increasingly becoming profitable and to what extent they abide by the law and avoid cheating or depriving the investors, especially the foreign institutional ones. If the investors cannot reap a high amount of earnings, then stocks will not be that attractive to them on a continued basis. This is why we need to revamp our tax impositions on the listed companies.
Possible Way Outs
Short-term incremental improvements might be possible by tweaking market architecture and design. However, longer-term sustainable improvements are mostly possible by deep changes in economic and social policies. Firstly, SEC needs to improve its governance, supervision, surveillance and so on. They should work towards making Bangladesh capital market more reliable, trusted while protecting not only interest of the small investors but also of the domestic and international institutional investors. They need to consider developing a liquid government debt securities market and promote the development of a diverse and broad investor base.
We should try to increase issuer participation by listing or privatising government-owned entities, promoting capital markets for financing infrastructure and the development of fast-growing small companies outside of conglomerates. While regulating the market, we should not forget supporting price discovery and resource allocation as systematic and direct intervention might stifle market development, distort price signals, and slow the development of sophisticated investors.
Secondly, mutual funds, in a market like ours with severe information asymmetry, can play a significant role as a lending hand to the semi-educated small investors. The asset management companies should audit their books of accounts in line with the aspirations of the financial reporting council.
Then lastly, we should think of ways to help the listed companies, especially the large listed companies, to increase their revenue by reducing the multi-layer tax on dividend. The first imperative should be not to harm market development. We can follow Malaysia who removed double taxation rules that helped the development of the Sukuk10 market.
We need to build momentum by identifying and unlocking catalysts of change in the capital market. To identify those catalysts, we can take directions from the emerging and developed economies. Hong Kong, Malaysia, and Singapore went for demutualization and listing of exchanges that prompted innovation and investment in the equities markets. In France, certain reforms modernised the procedures for government bond issuance, carried out over 12 to 18 months, spurring growth in debt markets.
While pension reform only has an impact in the long-term, it may increase awareness and promote education within the investing community in the short-term, which would, in turn, promote investment in mutual funds as seen in Hong Kong with the introduction of the Mandatory Provident Fund in 1998. France in the 1980s or China over the past 15 years has shown that the privatisation or simply listing of government-owned or controlled institutions increases the size and activity of the equities market.
The Road Ahead
I expect the market to edge upwards in 2018. Hopefully, there will be more issuance of large IPOs and improvement in the transparency of the books of accounts. Additionally, I expect punitive actions to be taken against the companies who try to manipulate the market, manoeuvre the market or only serve certain people’s interest.
There will likely be very few policy changes in 2018. Keeping in mind that election is knocking at the door, policymakers will consider the impacts that might fall on the issuer of IPO and foreign investors who will be investing in the market. In other countries such as India, Indonesia, Korea, during the election year, things remain a little jittery.
So it is natural that our market may remain a little bit shaky as well. So I would request the senior stakeholders, regulators and even the political parties to remain very cautious. Even though there might be fewer cases of manipulation but there are still chances of companies withdrawing from the market and booking profit. We have to be aptly prepared to handle the issues of corporate governance, insider trading, “winner takes it all attitude” and lastly any undue influence from few individuals or groups trying to dictate our future.
Mamun Rashid is a leading economic analyst.