If banks invest in stocks, there is no fear of loss for them even if the price indices go down further
Just four months back, when the Bangladesh Bank offered banks with low cost fund for stock investment, the market jumped albeit for a short period as the banks hesitated to use the facility for lack of confidence.
And now again, a similar offer has been made to support the ailing market with a similar resultant jump in the market yesterday.
The question is: will it work this time as the banks have been allowed to invest up to Tk200 crore each in the stock market beyond their regulatory limit, or will the market once again fizzle?
The market hopes that the new initiative may work because of some relaxation in regulatory requirements.
Exemption from provisioning
The first lucrative offer in the new incentive package is exemption from provisioning.
Banks will not need to maintain provisioning if they make loss against their investment in stocks.
Currently, banks have to keep provisioning if share price goes below the cost price. Setting aside of money from Profits to compensate a probable loss caused on lending a loan is known as Provisioning.
For instance, if a bank invests Tk10 for purchasing a share and the price goes down to Tk5 than the respective bank has to keep provision for the lost amount.
This provisioning requirement makes banks shy in coming to invest in the turbulent market because they are afraid that if price indices remain downward, their provisioning requirement will go up after further investment which will ultimately erode their profit. Provisioning is kept from solid profit.
This was the reason banks did not come to take the low cost fund previously.
The total equity investment of all banks were around Tk7,500 crore before September last year. After offering low cost fund for stock investment by Bangladesh Bank, DSEX lost around 330 points in a month then. As a result, the equity investment came down to around Tk3,200 crore compelling banks to make provision of Tk4,000 crore thus cutting the banks' profits significantly.
The central bank had this in mind when it prepared its new offerings that gave banks exemption from provisioning to mitigate the risk from any possible downfall of price indices.
Now, if banks invest in stocks, there is no fear of loss for them even if the price indices go down further.
Moreover, if price indices go up, banks will get back Tk4,000 crore of provisioning amount which will add to their profit. So banks may be interested in warming up the price indices by increasing their investment.
Meanwhile, another factor that will encourage banks to build fund is interest rate.
Currently, banks are getting 10percent interest rate from Bangladesh Bank against their treasury bills and bonds. If they take fund from central bank at 5 percent against their bond and lend to 7 percent to subsidiaries. As a result, banks will get 2 percent margin from lending taking their total profit margin to 7 percent. This 7 percent interest income is more risk free than lending at 9 percent to other sector. On top of that, banks will get capital gain from stock investment.
Issuing loans from this fund to subsidiaries is risk free because the borrowers will have to maintain separate BO (Beneficiary Owners) account for taking this loan. This account will be linked with DSE or CSE (Chittagong Stock Exchange) and no other fund will be allowed to enter that specific account. All proceeds of selling shares will have to be deposited in that loan account.
If the borrower fails for any reason to pay back the loan, the lender has been given authority to confiscate that account.
Discount from capital requirement
Banks will also get discount from capital requirement for giving loans from this fund.
According to Basel III, an international regulatory accord, 125 percent risk weight is calculated for such exposure but in case of loan from this fund, the risk weight will be 100 percent. Basel III is part of the continuous effort to enhance the banking regulatory framework
For instance, if a loan is for Tk100 and calculating it risk weight 125 percent, capital requirement of the bank will be Tk12.5. When risk weight will be calculated as 100 percent, capital requirement against such exposure will be Tk10.
So low capital requirement is another advantage for banks to invest this fund in stocks.
Selective shares will get boost
The fund can be invested into the shares of some 214 companies out of 316 listed with the DSE, the central bank says.
In the guideline for investable equity, the Bangladesh Bank filters the companies based on some requirements. For instance, the companies which have been declaring cash dividend of a minimum of 10 percent for three consecutive years will be considered as investable shares. Moreover, sponsor holdings of these companies will be at least 30 percent. As a result, there is no chance for the fund to flow into junk shares.
In case of mutual funds, 5 percent cash dividend is required for consecutive three years to get such investment. Only four or five mutual funds match with this requirement. However, the Bangladesh Bank encouraged banks to invest in newly formed mutual funds.
Dr Mahmud Osman Imam, professor of Finance at the Dhaka University, said that such interventions of the central bank could have positive impacts on the capital market, however, the positive effect could fizzle out soon like those in the past unless capital market manipulators are marginalized and anomalies removed.
Investors' confidence is completely absent in the market, and any such improvised initiative will only generate short-lived response as long as manipulators linked to big shots are active, he told The Business Standard.
Such market interventions of the central bank to enhance cash flow to capital market can be effective and sustained only after strict monetary surveillance mechanism are put in place, he pointed out.
Bangladesh Bank yesterday issued a circular allowing banks to invest Tk200 crore each in stocks in excess of their exposure limit. The initiative will enable banks to invest Tk12,000 crore afresh in the ailing stock market.
"All banks are not in a position to avail of the offer. And banks do not behave prudently," Prof Osman said, expressing little hope in the outcome from the offer that opened the way for additional flow to capital market.