The prevailing trend of share/capital market has a direct impact on banking stability – evaluate the statement

Abstract

This paper explains the workings of a stock market as well as its effects on a country’s economy. The main point of this paper of to prove that the volatility of a country’s capital market can have a negative effect on banking stability of a country. The fall of a country’s capital market could mean the demise of the country’s banking sector as well.

Introduction

The stock market can be quite a confusing concept to grasp. To those who have no knowledge about the stock market, it could look similar to gambling, guessing, placing bets etc. In truth, the stock market is actually an intricate system which has a massive effect on almost all levels of an economy, from affecting businesses to the common individual’s finances. It can be considered to be the heart of an economy. The fluctuations of a capital market effect several macroeconomic factors of an economy.  To understand the stock market, we will firstly need to be familiar with the components of it

Basic Explanation of the Stock Market

A stock is a partial ownership of a corporation, which is issued for sale in order for the corporation to generate money (to cover startup costs etc.). A stock entitles the owner to the growth and a share of profits and increments of the corporation. Stocks are issued at stock exchanges, which is where stocks are bought and sold. Each nation has its own major stock exchange. The Major stock exchange of Bangladesh is the Dhaka Stock Exchange (DSE). The largest stock exchange in the world is the New York Stock Exchange, located in the USA.

Stocks are initially priced by the corporation issuing the stock. After is has been issued in the stock exchange the market forces of the stock market determine its price. The price of stocks is determined by the forces of demand and supply much like the market forces in the market for goods and services. However, these fluctuations in the market forces occur due to several factors, such as, quarterly earnings, reputation of the corporation, labor union actions, etc. For example, if the quarterly earnings of a corporation are significantly lower than their previous figures, shareholders may wish to rid themselves of the stock before profitability declines further. This will increase the supply of shares in the market, thus lowering the price. Each stock market has an index which indicates the overall standing of the price of stocks in a particular market, economy, etc.

Stock brokers use this system to their advantage to earn money. Their aim is to buy shares for low prices and sell for high prices. This requires them to gather information about the company whose shares they are purchasing, forecasting future market trends, etc. Often times they must pic or expect that the shares they purchase will increase in value in the future. However, this can have disastrous effects for the entire stock market. Often time’s people overestimate the profits in certain projects. When the true figures are exposed, they scramble to sell their shares. This causes the stock prices to plummet. Also, other stock brokers could see the plummet in the stock prices and assume that the market is heading for a crash. They may also resort to selling, leading to a further plummet in the price of stocks. Thus, resulting in a crash of the stock market.1 (BD Stock)

Dhaka Stock Exchange (DSE)

The Dhaka Stock Exchange (DSE) is the main stock exchange of the country of Bangladesh. It is located in the country’s capital which is Dhaka city. The DSE was incorporated in 1954 (then known as East Pakistan Stock Exchange) and formally began trading in 1956.The index for the DSE is the DSI index. The DSE is regulated by the Securities Exchange Commission (SEC), the objective of which is to regulate and implements rules in the capital market.2(DSEbd.org) The policies of the Dhaka Stock Exchange are as follows:

  • ‘DSE can introduce automated monitoring systems that may control price manipulation, etc.’
  • ‘Make sure that all listed companies publish their annual reports with proper information which can serve the interest if  investors’
  • ‘Dispense listed companies to declare and pay regular dividends through conducting annual general meetings’
  • ‘Make arrangements to set up merchant banks, investor banks and circulation of more mutual funds’
  • ‘Encourage more financial institutions to get involved in the capital market’
  • ‘Management of DSE should be trusted only to professionals who should not be linked with stock ownership’
  • ‘Inform investors about the fundamentals of share transactions’
  • ‘Penalize brokers for breaching terms of contract’3(Slideshare)

Legal Control of DSE:

‘The Dhaka Stock Exchange is registered as a Public Limited Company and its activities are regulated by its Articles of Association rules and regulations and by laws along with Securities and Exchange Ordinance – 1969, Companies Act 1994 & Securities & Exchange Commission Act 1993’2 (DSEbd.com)

  1. (2008). Definition of a Stock. Retrieved from Bangladesh Stock Ltd. Website: http://www.bdstock.com/education.php
  2. Introduction to DSE. Retrieved from Dhaka Stock Exchange Ltd. Website: http://www.dsebd.org/
  3. (2009). Capital Markets Development in Bangladesh: The Status of Dhaka Stock Exchange. Retrieved from:  http://www.slideshare.net/Zafour/capital-markets-development-in-bangladesh-the-status-of-dhaka-stock-exchange

The major functions of the DSE are:

  • ‘Listing of Companies according to listing regulations’
  • ‘Providing automated trading of listed securities’
  • ‘Settlement of trading according to settlement of transaction requirements’
  • ‘Gifting of shares/getting approval of transactions/transfer of shares outside the trading system of shares
  • ‘Market administration & control’
  • ‘Market Surveillance’
  • ‘Publication of market review’
  • ‘Monitoring the activities of listed companies’
  • ‘Investors grievance cell’
  • ‘Investors protection fund’
  • ‘Announcement of price sensitive and other information regarding listed companies’

But the DSE is plagued with many problems. Like most of the country, DSE is also infested with corruption. There is a presence of syndicates in the DSE who artificially raise the price of stocks in order to make money themselves. This leads to a wrong estimation of the price of a stock. Furthermore the SEC seems to be involved with these syndicates, thus this problem continues down the spiral. It is also speculated that the DSI calculation method is incorrect, which tends to overestimate the DSI index.4(The Daily Star, 2011) Another problem is that there is inadequate information about corporations enlisted in the DSE. Due to the lack of independent research groups, many people must suffice on information gathered from brokers. This information may be based on rumors and etc. Also, the market is not properly supervised to maintain international standards.5 (The Daily Star, 2008)

  1. Mohsin, M. (2011, April). Capital market: structural problems& solution. The Daily Star.  Retrieved from: http://www.thedailystar.net/newDesign/news-details.php?nid=181626
  2. Rashid, M. (2008, May). The Potential of the Bangladesh Capital Market. The Daily Star. Retrieved from: http://www.thedailystar.net/forum/2008/may/potential.htm

Recent trends of the stock market of Bangladesh

Since the stock market crash of 1996, the capital market of Bangladesh slowly began to prosper. Despite existing in a volatile political environment, in 2006 the growth rate reached 7% and Bangladesh was dubbed as a key investment opportunity by prestigious financial house in the world.5 (The Daily Star, 2008) However in 2010 the market took a turn for the worse. The trend of the market in 2010-2011 seemed similar to that of 1996 (where demand was artificially inflated to raise share prices), however market capitalization has increased. This ensured more confidence among investors, thus urging them to invest more. The DSE general index in April 2010 stood at 5654.88. December 2010 saw the index drop by 3.62% and in February 2010 it dropped a staggering 30.5%, leaving the index at 5203.08. This declining trend continued further, and in November 2011 the index stood at 4645.89, the lowest it had been in the last 22 months.6 (Unnayan.org)

The volatile nature of this market causes several problems. Firstly, the fluctuations in the price of stocks reduce the representation of the stock prices. It becomes a poor reflector of the value of the corporation. This volatility also dismisses investor confidence.6 (Unnayan.org)

Effects on Banking Stability

The stock market changes can have massive effects on banks and the finances of the people of an economy. In simple terms, when the stock market crashes or seems to be crashing, it sets the people into a panic. People scramble to withdraw their money from the banks in fear that their money is at risk. This acts as a sort of self-fulfilling prophecy. This drains the money supply and may fail supply all the people with their money, thus the banks fail. This mad increase in the demand for money can also push the interest rate up. It is argued that in this case the central bank of the country must intervene to improve the situation.

  1. Saleh, A., & Hossain, M. (2011, October). Bangladesh Economic Update. Retrieved from: http://unnayan.org/reports/meu/oct_11/meu_Oct_2011.pdf

Bangladesh Bank

The Bangladesh Bank is the central bank of the country of Bangladesh. It is the regulatory body for the fiscal and monetary policy of the country.7 (Bangladeshbank.org) the major functions of the Bangladesh Bank are as follows:

  • ‘Formation and implementation of monetary and credit policies’
  • ‘Regulation and supervision of banks and other financial institutions, promotion and development of domestic financial markets’
  • ‘Management of the country’s international reserves’
  • ‘Issuance of currency notes’
  • ‘Regulation and supervision of the payment system’
  • ‘Acting as a banker to the government’
  • ‘Preventing money laundering’
  • ‘Collecting and furnishing credit information’
  • ‘Implementing Foreign Exchange Regulation Act’
  • ‘Managing a deposit insurance scheme’7(Bangladeshbank.org)

It is argued that Bangladesh Bank did not make plausible decisions to revive the stock market. The central bank claims that it had limited the exposure of commercial banks in the stock market, in order to control inflation and to keep the interest rate at a good level. However, the banks pulling out their investments from the stock market could have been the main cause for this crash. Also, the central bank failed to give the banks adequate time to adjust to its policies. Causing sharp declines in share prices.8 (The Daily Star)

  1. Hossain, M. (2011, February). Market crash and the role of Bangladesh Bank. The Daily Star. Retrieved from: http://www.thedailystar.net/newDesign/news-details.php?nid=172300
  2. Chowdhury, S. (2011, November). The second coming of stock crash? The Daily Star. Retrieved from: http://www.thedailystar.net/newDesign/news-details.php?nid=210266

The crash of the market led to many people losing their saving and earnings. This means that commercial banks found themselves to be in a short supply of money. This has increased interest rates highly.

It is because of these volatile changes that the banking stability is in low existence in our country. Although we can be certain that strong well established banks are able to endure such crashes far better than others. Due to this pattern the interest rate fluctuates wildly.

The pattern of the stock market of our country has shattered investment confidence among investors. Unless proper governance, regulation and policies are implemented, the banking sector of Bangladesh will continue to suffer, in the volatile environment of our country.

Conclusion

The stock market of Bangladesh is an uncertain plain. It is in this state due to poor governance, improper regulations, corruption,etc. Unless corrupted practices are removed from the market, the price of a share may never fully reflect the value or state of a corporation. This way both shareholders and corporations will lose out. The government of Bangladesh must learn to take better care of the capital market of Bangladesh. We have seen for ourselves that when the capital market faces downturn it affects the economy as well. In November 2011, it has been reported that the inflation rate has increased to 11.97%, the interest rate on bank loans stand at 15% and the government has taken TK15000 crore worth loans from the banking sector.8 (The Daily Star) If these issues are well taken care of Bangladesh can again return to the status of being a key investment opportunity, and our economy can avail the opportunity to flourish.

Bibliography

  1. (2008). Definition of a Stock. Retrieved from Bangladesh Stock Ltd. Website: http://www.bdstock.com/education.php
  2. Introduction to DSE. Retrieved from Dhaka Stock Exchange Ltd. Website: http://www.dsebd.org/
  3. (2009). Capital Markets Development in Bangladesh: The Status of Dhaka Stock Exchange. Retrieved from:  http://www.slideshare.net/Zafour/capital-markets-development-in-bangladesh-the-status-of-dhaka-stock-exchange
  4. Mohsin, M. (2011, April). Capital market: structural problems& solution. The Daily Star.  Retrieved from: http://www.thedailystar.net/newDesign/news-details.php?nid=181626
  5. Rashid, M. (2008, May). The Potential of the Bangladesh Capital Market. The Daily Star. Retrieved from: http://www.thedailystar.net/forum/2008/may/potential.htm
  6. Saleh, A., & Hossain, M. (2011, October). Bangladesh Economic Update. Retrieved from: http://unnayan.org/reports/meu/oct_11/meu_Oct_2011.pdf
  7. Hossain, M. (2011, February). Market crash and the role of Bangladesh Bank. The Daily Star. Retrieved from: http://www.thedailystar.net/newDesign/news-details.php?nid=172300
  8. Chowdhury, S. (2011, November). The second coming of stock crash? The Daily Star. Retrieved from: http://www.thedailystar.net/newDesign/news-details.php?nid=210266