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Improving the critical financial infrastructure in Bangladesh.
Subject:
Development banks (Economic aspects)
Credit management (Analysis)
Securities offerings (Analysis)
Securities offerings (Forecasts and trends)
Authors:
Banerjee, Prashanta K.
Rahm, Matiur
Siddique, Mohiuddin
Pub Date:
09/01/2010
Publication:
Name: Indian Journal of Economics and Business Publisher: Indian Journal of Economics and Business Audience: Academic Format: Magazine/Journal Subject: Business; Economics Copyright: COPYRIGHT 2010 Indian Journal of Economics and Business ISSN: 0972-5784
Issue:
Date: Sept, 2010 Source Volume: 9 Source Issue: 3
Topic:
Event Code: 010 Forecasts, trends, outlooks Computer Subject: Market trend/market analysis
Product:
Product Code: 6100040 Development Banks; 6010016 Commercial & Development Banks; 9915320 Credit Management NAICS Code: 522298 All Other Nondepository Credit Intermediation; 52211 Commercial Banking
Geographic:
Geographic Scope: India Geographic Name: Bangladesh Geographic Code: 9BANG Bangladesh; 9INDI India

Accession Number:
237941306
Full Text:
Abstract

This paper reviews the current critical financial infrastructure that includes commercial banks, stock market and bond market, identifies the impediments to capital market development and suggests remedies to improve it in Bangladesh with a set of policy recommendations. The issues of developing a corporate bond market that is currently near non-existent in Bangladesh are also discussed. Qualitative analyses are performed using both secondary time series and primary cross-sectional data. The latter are collected by administering questionnaires to current and prospective issuers of equities and equity investors.

INTRODUCTION

One prerequisite of having a healthy investment climate in an economy is the availability of financing facility for the existing and potential borrowers. The two major sources of financing are the banks and capital market. However, the proportion of bank financing and equity financing differs from country to country. Historically, Bangladesh economy heavily depends on bank dominated financial system. Equity financing from capital markets through issuing new shares is lenient whereas debt financing through issuing corporate bonds is almost nonexistent. Bank financing was around 94 per cent of total financing while equity financing accounted for the remaining 6 per cent in 2007. This is expected in Bangladesh insofar as banks' loan typically precedes equity and bond financing as the important source of financing. This is quite likely in an economy that evolves from agricultural to more manufacturing and services oriented. Barth et al. (2006) shows that high-income countries own 91 per cent of the world debt securities, followed by middle-income countries (7 per cent) and low-income countries (around 2 per cent).

Investment and economic growth are highly positively correlated. Growth might result from the quantitative or qualitative changes in factors of production or improvement in technology or a combination of both. The importance of the capital market lies in the fact that it is the primary source of external funds for corporate investment. A number of recent theoretical contributions suggest that stock markets promote long-term growth. Well-developed stock markets give due return to prudently-managed firms in the form of rising shareholders' wealth. The wealth effect increases consumer spending. This may also raise managerial compensation. Thus it mitigates the principal-agent problem by aligning the interests of managers and owners, in which case, managers strive to maximize firm value (Jensen and Murphy 1990).

The following specific issues are addressed in this paper:

1. To review the current status of the critical financial infrastructure in Bangladesh.

2. To identify the reasons for heavy dependence on bank financing and its associated problems.

3. To understand the limitations of the existing capital market that includes both stocks and bond.

4. To provide policy recommendations for further improvement and how to develop a viable corporate debt market in Bangladesh.

Primary data from the investors are collected with the help of brokerage houses and merchant banks. Both open-ended and close-ended response questionnaires are administered. Secondary data are collected from the different issues of World Development Indicators, International Financial Statistics, Asian Development Outlook, Annual Reports of Bangladesh Bank (BB) and Bangladesh Association of Publicly Listed Companies (BAPLC) and Securities Exchange Commission (SEC).

The remainder of the paper proceeds in sequence as follows: a brief survey of the related literature; current status of the financial infrastructure; existing impediments and a set of policy recommendations; and brief summary of major findings with conclusions.

BRIEF SURVEY OF RELATED LITERATURE

Stock market contributes to economic development as it facilitates equity finance, spreads ownership among a large set of investors and thus mobilize the savings of the population, provides a mechanism for allocating capital to productive use and facilitates a link between the capital markets of a particular country and the markets of the industrial world (Ryrie, 1991). Demirguc-Kunt and Maksimovic (1998) find a positive relationship between stock market activity and a firm's ability to grow through the external acquisition of funds. Bencivenga et al. (1995) formulate models where more liquid stock market (less expensive to trade equities) encourages investors to fund long-duration projects because investors can easily sell their stakes in the project if they need their savings before the project matures. Thus, liquidity of the market boosts economic growth by facilitating investment in longer-run and higher-return yielding projects.

In contrast, Stiglitz (1993) argues that stock market liquidity does not enhance incentives for acquiring information about firms or improving corporate governance. Shleifer and Vishny (1986) and Bhide (1993) argue that more liquidity reduces the incentives of shareholders to undertake the costly task of monitoring managers resulting in weaker corporate governance and slowdown in effective resource allocation and decelerating productivity growth. Corbett and Jenkinson (1994) while discussing the contribution of stock market to corporate investment financing suggest that it was negative in the United Kingdom and only marginally positive in the United States during the 1970s and the 1980s.

Well-functioning capital markets including equity and corporate debt markets are one of the most important factors to attract investors, both local and foreign. Greater emphasis on generating competitive and strong capital markets would ensure a sustainable flow of sufficient funds and efficient mechanisms for funding the private sector. An expanding literature views in favor of capital market for long-run growth. Capital market encourages specialization as well as acquisition and dissemination of information, thereby reducing the cost of mobilizing savings and facilitating investment (Greenwood and Smith, 1997).

Nakamura (2002) empirically studies the determinants of the amount of outstanding corporate bonds of Japanese manufacturing firms consisting of firms in the manufacturing industries that are listed in the first section of the Tokyo Stock Exchange and finds that the quantity of public debt issued by firms is positively correlated with the quantity of bank loans and the quality of firms. Barth et al. (2001) suggest that the size of a nation's financial market (the sum of bank assets, equity market capitalization and value of outstanding bonds) is positively and significantly correlated with its level of economic development.

Corporate debt market is virtually non-existent in Bangladesh, although bond markets are prerequisite for a country to enter into a sustained phase of development driven by market-based capital allocation. At the same time, domestic bond markets markedly increase the resilience of a country's financial system by allowing corporate borrowers to choose from a broader range of financial instruments to fund their operation and insulate it against external shocks by reducing a country's dependence on foreign funds. Moreover, diversified sources of financing reduce firms' liquidity risk. Herring and Chatusripitak (2001) note that the absence of corporate bond markets may render an economy less efficient and significantly more vulnerable to financial crises. The ability of the US corporate bond market to tackle the banking crisis of 1980s is a constructive and shining example. The .debt market helped the US corporate sector get required finance at the time of banks' liquidity problems.

To say the least, Bangladesh capital market till today is not broad and deep enough. Current and prospective issuers do not use the full potential of the market for raising equity capital by issuing shares and borrowing funds by issuing corporate bonds. Moreover, surplus units of savings feel uncomfortable in investing in Bangladesh capital market instruments. Rather they feel more comfortable in maintaining their savings with banks as FDRs and Savings Certificates. It seems that regulators fail to address the problems faced by both the issuers and the investors adequately. In this perspective, knowing the bank financing system, examining the structure of organized capital market, sorting out and addressing the problems of issuers and investors are required in order to enable the capital market to play its due role in creating a friendly investment climate in Bangladesh.

REVIEW OF CURRENT STATUS

Bangladesh is dominated by bank-based financing system. The amount of industrial term-loan disbursements by banks and financial institutions stood at Tk. 201 billion ($2.92 billion) in 2008. This amount is many times higher than the amount of Tk. 5.6 billion ($815 million) raised by new share issue in 2008. The disbursed loan Amounts as percentages of GDP range from 1.32 to 3.72 compared to amounts raised through IPOs percentages of which vary from 0.01 to 0.10. The following table 1 thus shows overdependence on bank financing system in Bangladesh.

The outstanding amount of term-loan of Tk. 400 billion ($5.82 billion) in 2008 is lower than the total amount of market capitalization of Tk. 964 billion ($14.03 billion) showing less dependence on bank finance. However, market capitalization of manufacturing & service sector amounting to Tk. 289 billion ($4.20 billion) is lower than the outstanding amount of term-loan financing. In addition, outstanding term-loan as percentage of GDP is 6.26. This is also higher than percentage of market capitalization of manufacturing and service sector to GDP, 4.52 per cent in 2007-08. These indicate overwhelming preference for bank-based industrial financing in Bangladesh as revealed in Table 2.

Banking sector in Bangladesh consists of four categories of banks in terms of their ownership. These are: State Owned Commercial Banks (SCBs), Development Finance Institutions (DFIs), Private Commercial Banks (PCBs) and Foreign Commercial Banks (FCBs). Among these groups, PCBs hold more than 50% of both total deposit and asset in the banking industry followed by SCBs with a deposit share of 32.6% and asset share of 33.1% in 2007 (BB Annual Report 2007/08). However, the number of bank branches of SCBs is nearly double than those of PCBs and the geographical coverage of SCBs is also far more extended than the PCBs. There are some big state owned DFIs, some of which have been developed to finance agriculture sector and the others to meet long term need of the industrial sector. Banking sector in Bangladesh has over the years since the 1990s gone through a long reform process with the ultimate objective of making it more sound, competitive and resilient to adverse economic condition.

The demand for stocks seems to far exceed their supply. 78166 (Seventy eight thousand one hundred sixty six) companies are registered as private limited companies with the Registrar of Joint Stock Companies & Firms and 2795 (two thousand seven hundred ninety five) companies as public limited companies. However, only 293 companies are in the secondary market. Small and mid-sized enterprises, major industrial base of Bangladesh and immune to external shocks, do not issue equities to raise capital. Readymade garments industry is not in the purview of the capital market. The market, therefore, needs more and more issuers with good securities. It may be difficult to bring more issuers without creating an enabling environment for them.

Quick and easy process of obtaining bank loans is a major cause for overdependence on bank financing. About 83 per cent of the issuers and 33 per cent of the prospective issuers concur on this view. Commercial banks necessarily should not be in a position to provide adequate long-term project financing due to deposit-duration and loan maturity mismatch. Traditionally, they provide such financing largely through annual rollovers. Influential borrowers are very quick to get loans as banks ask for less disclosure requirements and relaxed regulations in lending. Furthermore, lower cost of borrowed funds from banks as compared to uncertain higher returns on the equity capital convinces business firms to borrow from banks instead of equity market. No respondent borrowers disclosed that they may get waiver of loan interest payment and even can deceive on repaying bank loans. But this is not possible for equity issuers.

Around 33 per cent issuers felt that raising capital directly from market is time consuming and requires compliances of numerous formalities. As they opined, it takes about 6-8 months to collect funds through IPOs. It is interesting that prospective issuers' voices are more pronounced in this regard. 75 per cent of them mentioned these lengthy and complex procedures for their reluctance to seek equity financing. Starting from the preparations of different documents and ending with the listing of DSE and CSE make them tired of using capital market for raising funds (Appendix I).

To make corporate bonds attractive to the investors, credit standing of the issuing companies reflected in grading by the Credit Rating Agencies should be reasonably high. For example, Asian Institutional Investors are required to invest in bonds rated not lower than 'A' and multinational development banks operating in Asian Regime can only invest in bonds rated 'AA' or above. Rating issue is, therefore, important for corporate bond issuers in order to access to the institutional savings. However, credit standing of most of the private business entities and SOEs is not up to the mark. Moreover, rating culture is almost absent in Bangladesh corporate sector. These are the opinions of 25 per cent of respondents among current issuers and 50 per cent of respondents among prospective issuers.

Availability of lower cost Bank finance is an obstacle to the development of corporate bond market. 17 per cent respondents among issuers and 50 per cent respondents among prospective issuers advanced this opinion. Because of dominance of relationship-based bank finance, bank loan is easier to secure. This financing is also cheaper on account of imperfections in the capital markets. As a result, major borrowers rely heavily on bank finance.

Statutory restriction on the issuers of fixed-income securities as viewed by 17 per cent and 33 per cent respondents respectively among current and prospective issuers is another barrier to corporate debt market. The way the minimum size of the new debt issues is fixed, it effectively keeps small business borrowers out of the corporate bond market. In a normally operating capital market, financial leverage decision should be left to individual corporate issuers, and underwriters without government regulations.

Twenty five per cent respondents viewed that repressive regulations create hurdles for corporate bond market. Bank Companies Act and Financial Institutions Act delineate the issuance of bonds as a deposit-taking activity which, therefore, needs a prior approval by the Bangladesh Bank and then by the SEC. This dual approval frequently causes long delays. In addition, SOE bond issues must have approval of the relevant ministry which requires more time and formalities to be met.

Captive demand from banks and financial institutions limits the demand for bonds. Around 17 per cent and 58 per cent of respondents respectively among current and prospective issuers are of this opinion. Government bonds, representing around 98 per cent of the entire bond market are sold to banks and financial institutions at a rate lower than market rate. For example, coupon rate of T & T bonds is 7.5% whereas Grameen Phone is going to issue bonds at 14.5%. Banks and financial institutions buy government approved bonds to satisfy SLR. But individual & institutional investors are not interested in buying government bonds at a lower rate (Appendix II). A strong investor-based bond market was not, therefore, created. Furthermore, banks and financial institutions are not eager to buy corporate bonds as they are not considered as a part of SLR. One lesson can be learned from the primary and the secondary markets for Japanese government bonds that became active in 1977. This was the case when the Japan government stopped relying on captive financial institutions and began offering new issues of government securities in an open and competitive manner (Rhee 1993).

Bond Market is considered anti-religion by a large segment of the society, as opined by 8 per cent respondents. As it is an interest-bearing instrument, bonds may have some limited prospects and appeals in Bangladesh.

Equity market capitalization shows the overall size of the capital market. It reflects the level of investment in securities in the secondary market. Given the supply of stocks, price surges will increase market capitalization and vice versa. Market capitalization was at its peak in 2008 climbing to Tk.1043 billion ($15.18 billion) in 2008 from only TK. 224 billion ($3.26 billion) in 2004. The role of financial sectors in market capitalization is evident in Table-3. Financial sectors including banks, insurance companies and investments hold over 43.44% of market capitalization in 2008 whereas manufacturing sectors together with service and miscellaneous sectors capture only about 34.42% of market capitalization. In terms of compound annual growth rate (CAGR), the market capitalization of manufacturing sector also shows a slow growth rate (19.80%) compared to financial sector's 37.36% growth rate. The share of market capitalization of manufacturing sector dwindled from 43.37% in 2004 to 19.18% in 2007. These indicate subdued preference of manufacturing sector to raise funds from the organized capital market as shown below:

Capacity of DSE: DSE's capacity of dealing with trade volume is limited. Earlier, DSE was able to handle 10,000 transactions per day while now it can handle 15,000 transactions after completion of the first phase and will be able to increase this capacity to 25,000 transactions after completion of the second phase of expansion program. Still, this capacity is not enough. Recently, when Grsmeen Phone has proposed to float around 1480 million shares at TK. 1 ($0.015) per share through IPO, DSE has recommended to SEC to fix face value at Tk. 10 ($0.15) instead of TK. 1 ($0.015). Because if SEC approves the Grameeen Phone's offer at TK.1 ($0.015), at the time it will make debut on the stock market, the number of transactions may exceed 2.5 lakhs a day.

Category of Companies: Dearth of good shares in the capital market of Bangladesh is observed from Table 4. Number of shares under A-category in DSE having good fundamentals is only 171 out of total of 293 in 2008. Of the remaining shares, Z-group represents 94 shares, followed by B, and N categories, respectively. This indicates a scarcity of good shares before a huge number of investors. Moreover, numbers of shares under different categories move very slowly. The share of A-category moved from 47.37 per cent to 58.36 per cent during 2005-2008 while share of Z-category decreased from 40.08 per cent to 32.08 during the same period representing slow addition with A category share and lenient graduation from Z to other categories of share.

Volatility: Volatility in share markets has become a matter of concern in recent years for investors, regulators and brokerage firms. This concern centers on the perception that high volatility can lead to a general erosion of investors' confidence and flow of capital away from the share market. Levine and Zervous (1998, p.550) in their seminal paper find that stock return volatility is not linked with future growth and productivity improvements. During the past four years, significant fluctuations have been observed persistently in all indexes used in DSE and all share price indexes in CSE. Coefficient of variation of all share indexes climbed up to 25.57% in 2007 from 6.81% in 2005 which dropped again to 7.13% in 2008. Almost same variability has been observed in the case of general index and top 20 indexes of DSE. Volatility of CSE in terms of all share price indexes is less compared to DSE.

Dividend and Capital Gain: Amount available from dividend (cash + stock) and capital gain depicts shareholders preference either for dividend or capital gain. Table 6 shows that seven of 11 selected sample companies offered shareholders more capital gain than dividend, remaining four gave more dividend than capital gain in 2008. One may conclude from this statistics shareholders may be more interested for reaping capital gain through frequent buying and selling shares instead of enjoying yearly dividend by undertaking costly task of monitoring fundamental of the company. It may cause more volatility in the market.

Liquidity: A large stock market does not necessarily imply a liquid market. A large but inactive market will have large capitalization but small turnover. Market liquidity as measured by turnover and value traded ratio of Dhaka Stock Exchange (DSE) and Chittagong Stock Exchange (CSE) shows substantial variations during the period of 2003-2008. DSE has turnover ratio from 17.40 per cent to 56.31 per cent while CSE turnover ratio ranges between 5.81 per cent and 10.21 per cent. Value traded ratio also indicates high liquidity variation of secondary market of Bangladesh. This is supported by the Coefficients of Variation of both ratios of DSE and CSE, which are exorbitantly high. In addition, Bangladeshi stock exchanges seem less liquid as compared to India and Pakistan. The average turnover ratio and value traded ratio of Bangladesh are less than those of India and Pakistan. Now the issue is whether liquid market is good or bad. More liquid market encourages investors to invest in long-duration projects as investors can easily sell their stakes if they need money. This, in turn, boosts capital market. However, since more liquidity reduces the incentives of share holders to undertake costly task of monitoring managers, weaker corporate governance slows productivity growth.

Difference between Offer Price and Initial Trading Price: Issuers offer their issues at a price fixed by them in tune with the guidelines of the SEC of Bangladesh. Fixing offer price is crucial both for the issuers and investors. If the promoters float their shares with hefty premium, investors have to suffer great loss of funds. In contrast, the company does not receive proper value in case of under-pricing of new issues. Table 8 shows that offer price of all shares floated in 2008 was much less than average trading price of first three days. Average trading price is more than offer price by two times to eight times. Mann-Whitney test also supports these findings. It means the issuer is not getting proper value of shares.

Issue Cost of IPO: Amounts of IPO costs are considered as a barrier to public offerings. It still includes several costs, namely, manager to the issue fee, SEC fee, Stock Exchange fee, underwriting fee, CDBL fee, bankers to the issue commission and credit rating fees. The amount of cost sometimes seems huge in case of small amounts of IPOs. Issue costs reach around 5 per cent of issue amount in case of raising amount of Tk. 200 million ($2.91 million) and below. However, relative amount comes down in case of big issues, although absolute amount of costs shows a large amount. For example, issue costs amounting to Tk. 22 million ($0.32 million) of First Security Bank though appear higher in absolute term; it is only 1.99 per cent of IPO amount.

P/E Ratio: A high P/E ratio suggests investors are expecting higher earnings growth in the future compared to companies with a lower P/E ratio. The P/E ratio of DSE rose steeply from 13.04 to 23.10 between 2006 and 2007, and CSE has depicted a similar trend. Comparing with P/E ratios of regional exchanges, only Bombay SE has higher P/ E ratio over DSE and CSE. Colombo and Thai P/E ratios are far below DSE and CSE P/ E ratios. However, P/E ratio does not tell us a whole story by itself. P/E ratio shows how much investor is willing to pay per Tk. of earnings. However, investing in Bangladesh, perhaps, depends more on speculative analysis. These result in overpricing of the share. So willingness of the investors to pay per Tk. earnings is not reflected in P/E ratio. Moreover, investors are not getting good returns.

Institutional Investment: Institutional Investment is negligible in Bangladesh. Institutional investment as percentage of total market capitalization ranges between 4.53 and 4.88 during 2005-2008. Institutional investment brings long-term commitment and greater focus on the fundamentals and, hence, stability in the market. Furthermore, the presence of institutional investor is also expected to ensure better valuation levels due to their special analytical skills. Bangladesh capital market missed this efficiency as institutional investment is very small in both absolute and percentage terms.

Investments by Non-Resident Bangladeshis (NRBs): Amounts of investment by NRBs do not reveal their strong presence in the Bangladesh capital market. Furthermore, it shows year-to-year substantial variations. In 2006 and 2007, net investment by NRBs recorded a discernible positive amount (Table 12). The positive investment atmosphere in local market prevailing throughout 2007 is considered to be one of the main reasons behind this investment. However, net investment reached negative territory amounting to Tk. 2170 million ($31.59 million) in 2008. Someone may conclude, in the wake of global financial meltdown an existence of selling pressure instead of fresh investment is observed. This slowed down the net portfolio growth, although very insignificant market integration is presumed between Bangladesh and some selected countries.

The size of debt market of Bangladesh is tiny relative to other South Asian countries. In June 2008, the market value of the outstanding volume of bonds (including government treasury bills) was 5.5 per cent of GDP that compared poorly with 43.4 per cent in India, 29.8 per cent in Pakistan and 39.5 per cent in Sri Lanka. Furthermore, this tiny debt market of Bangladesh is to a significant extent dominated by government bonds whereas corporate bond market is nearly invisible. The number of govt. bonds in June 2008 was 84 whereas the number of corporate bonds was only 9. The corporate bonds and debentures together constituted only around 2 percent of the market capitalization of all types of bonds in 2008.

In Bangladesh, the first private sector debenture was issued in 1987 by Apex Tannery: Since then, there has been an uneven trend of private issuance. Around 17 private corporate issuers participated in the secondary market to raise debt finance and 6 corporate issuers raised through private placement during 1987-1999. Private corporate issuers participated in the secondary market by placing a major portion of their securities in the private placement market. However, corporate issuance in the secondary market has been completely non-existent since 1999.

Impediments

(i) Bank Financing

1. Banks by their nature are not well suited for long term lending. According to a report published by the World Bank in 2008, 69 per cent of lending has a maturity period of less than 3 years in metropolitan areas. The average term for bank loans in non-metropolitan areas was 17 months. After independence, state-owned Bangladesh Shilpa Bank and Bangladesh Shilpa Rin Sangstha were entrusted with the responsibility of providing industrial term loan to meet the long term financing needs of the economy. But, the attempt was not very successful as a significant percentage of credit given through those institutions became non-performing.

2. A major problem in the banking sector is the accumulation of huge amount of nonperforming loan (NPL). The NPL ratio stood at 13.2% as at end-December 2007(BB Annual Report, 2007-08) which is still very high by any standards, although a downward trend of NPLs is observed in the banking sector for the last couple of years. SCBs and DFIs suffer most from NPL problems as about 30% of loans disbursed by these categories of banks are non-performing. PCBs are doing better in this regard as 5% of their loan is non-performing. In developed countries, the tolerable range of NPL is up to 3%. The performance of the banking sector in the neighboring countries in this regard is also much better than the Bangladesh banking sector. NPL ratios in India, Sri Lanka and Pakistan are 1.9%, 5.6% and 7.7%, respectively. (1) The NPL problem has several damaging effects in the way of optimum utilization of resources. On the supply side, it is limiting the recycling of fund and forcing some banks to follow a very conservative policy which ultimately makes it difficult for a new firm to get required financial assistance.

3. Ideally, interest rate should reflect the risk of the borrower i.e. the more risky borrower should pay a higher interest rate and vice versa. But such a variation is not observed in the interest rate among the borrowers classified in the same sector. Banks' risk analysis of borrowers is mainly reflected in the decision of accepting or rejecting the loan proposal; not so in differentiating interest rate of the credit. The country also lacks an updated, adequate and reliable data base of the business enterprises. However, we might expect the increasing availability of company risk profile with the institutional development of the few number of credit rating agencies that are operating in the country.

4. In many cases, banks assign undue weight to collateral security rather than future cash flow in making credit decision. It becomes difficult ,for some potential entrepreneurs to meet the banks' requirement (The World Bank Report, 2008). As a result, the idea of 'entrepreneurship development' by banks is not practiced or cultured in the Bangladesh banking system.

5. Sound credit management using professional standards is required for insider-loans. Bank management must ensure the same set of standards both for the insider loan and loans granted to others. The issue of loans, given to insider parties, emerged as a matter of concern in the mid 1980s after allowing the operation of private commercial banks in Bangladesh. Although, Bangladesh Bank has adopted various measures for ensuring prudent management of insider-loan, still the benking sector is burdened with a high amount of default loan, granted to the insiders.

6. Although there are wide branching networks of state-owned commercial banks in the country, lending is heavily concentrated in urban areas. Thus, inequitable transfer of funds from the rural areas to the urban areas is evident. Moreover, private commercial banks established since 1990 have very few rural activities. This pattern of urban-based credit portfolio makes the target of equitable development unachievable. Also, there is a disparity between the rural areas and the urban areas in the quality of the banking services offered. In recent years, a number of modern information and communication technology based banking products have been made available mainly in the urban areas. Clients of many non-urban areas do not have access to such products.

7. One of the major problems in the existing financial system is the absence of exit policy. In one way or another, banks are allowed to continue their operations even in the face of severe problems. A number of banks, in the past, continued their operations without meeting the minimum capital requirement and with a substantial amount of defaulted loans. It seems that depositors axe also not aware of varying levels of risk with different banks and do not take their deposit decisions based on the insolvency risk of the bank. This is an example of moral hazard problem where weak banks are not pressurized by the stakeholders, especially, by the depositors to make their operations more sound and efficient which eventually keep Bangladesh banking sector away from having adequate market discipline.

8. One of the major objectives of the regulatory body is to ensure financial stability which, in turn, depends on the compliance with the existing prudent measures by the commercial banks. There are numerous instances of regulatory failures in the banking sector, such as, violations of the provisions relating to the members of the board of directors, amount of shareholding by the directors, etc. Inadequate regulatory compliance and lack of market discipline in the banking sector might be due to incompetence on the part of the regulatory body and/or lack of autonomy of the central bank. Like most other developing countries, there is a sharp difference between legal independence and de facto independence of the central bank in Bangladesh. Thus, it becomes difficult for the central bank to take punitive actions against the wrongdoers within the prevailing overall legal environment of the country.

(ii) Primary Stock Market

The volume of public offerings in FY 2008 was oversubscribed by more than four times (BB Annual Report, 2008). It indicates high demand for new securities in the primary market. Despite this enormous response to initial public offerings, investors feel uncomfortable for several reasons. They are enumerated from (Appendix III-Panel A) as follows:

Time consuming and hassle in collecting refund amount is a major problem to the investors in the primary market. 90 per cent of the investors consider it as the main problem in the case of IPOs. Investors are skeptical regarding the time and, in some cases, low chance of refunding. It is alleged that issuers in collaboration with banks use the opportunity to hold the money of the unsuccessful investors for several months in order to get undue benefits through reinvestment. Sometimes, investors face problems in getting refunds because their names are not properly written in issuers' book. Moreover, investors get refundable money late because of accusation against them for maintaining multiple BO accounts or making several applications in the same name.

Forty per cent investors claimed that issuers do not provide sufficient as well as reliable information in their prospectus. As issuers are not accountable to regulators and SEC does not check the items of the prospectus meticulously, they are ambivalent in this regard.

Investors in IPOs are uncomfortable in collecting and depositing application forms because of a limited number of bankers to the issues. 40 per cent of investors opined that a limited number of bankers to the issues and time-consuming depositing process constitute a hurdle in case of IPOs.

Delay in holding draw is another barrier to unsuccessful investors for getting back their money in time. It is understandable that issuers need some time for lottery and allotment process. But 6(six) weeks from the closure of the subscription date, is considered too long for this process according to thirty-eight per cent respondents. They opined that lottery should be conducted within maximum 3 (three) weeks and the whole process should be completed within one month.

Genuine investors face harassments because of multiple BO accounts held by unscrupulous investors. Thirty six per cent respondents concurred on this view. They linked more problems with BO accounts opened at the initial stage of this provision, as fake and multiple BO accounts are opened by some investors.

Depositing the entire amount with application is a deterring factor to many investors. Around 26 per cent respondents mentioned that it would be burdensome on them. They added that 20-25 per cent money can be paid during the application time and the remaining amount payable within 10 days after allotment would ease such pressure.

Small size of IPOs compared to total capital requirement of the issuers, scarcity of good security and excess premium s are also considered as problems in the primary market. 30 per cent, 22 per cent and 12 per cent of the respondents respectively believed these reasons are the barriers to the flourishing of primary equity market in Bangladesh.

(iii) Secondary Stock Market

The secondary market experiences unreasonable ups and downs, despite neither any changes in the economy nor any earning forecast downshifts by any leading companies (Appendix II-Panel B).

Investors make decisions based on rumors in maximum cases instead of analyzing company-specific fundamentals. This was conjectured by 70 per cent of the respondents. Small and new investors are pronouncedly affected by rumors. More than one hundred thousand new investors entered the equity market in 2007 and 2008. Most of them depended on rumors as they have no clear access to market information and are not equipped with sophisticated analytical investment tools or techniques.

Inadequate brokerage houses, poor services and high brokerage cost are discouraging factors to the secondary market investors. Forty per cent respondents consider these as hurdles in the secondary market. Brokerage houses are confined to major urban areas very sporadically with poor infrastructure. Aspirant investors in many parts of the country are not therefore getting the needed service of brokerage houses. Moreover, quality of brokerage houses is usually assessed by the quality of research produced by the independent research department, which is nearly nonexistent here. Brokerage fees range from 0.5 per cent to 1.0 per cent in Bangladesh. It varies from brokerage house to brokerage house and even investor to investor too. However, this cost is almost at par with other Asian countries. Brokerage fees in Pakistan, Thailand and China are also 1%, 0.64% and 0.56 %, respectively.

High volatility, already shown earlier, is a matter of serious concern to 40 per cent respondents. Margin regulations, circuit breakers, price stabilization funds and securities transaction taxes are used to tackle short-term price volatility in different countries. Unfortunately, very little empirical work has been done in Bangladesh on these issues about their practicalities and implications.

Dearth of quality securities is, again, considered as an obstacle in the secondary market by 38 per cent of the respondents. This is supported by the number of shares under A-category. In DSE, only 171 out of total enlisted companies of 293 in 2008 have good fundamentals. Similarly, lack of reliable information and undue interruption by SEC are also causes of concern in the secondary market.

Cashing after selling shares is time-consuming and 28 per cent of the respondents are worried about the length of time in settlement process. It requires T+3 days for A, B, G and N category and T+ 7 days for Z category in Bangladesh.

Off and on changes in margin loan ratio destabilize the market. SEC uses margin loan ratio to control market and re-fixes it from time to time. Furthermore, merchant banking division of NBFIs cannot also provide more amount to the investors as they are not allowed to hold exposure (loan to investors, own investments, and commitment for underwriting) more than five times of their paid up capital. Respondents also added that merchant banks sometimes compelled their clients to sell off shares to adjust loans. These reduce their investing capacity. SEC should let merchant banks to lend investors within their own parameters. As loans are collateralized by securities and mark to market system is introduced, banks are capable of lending on the basis of their own norms. However, if the stock price declines to the point where equity drops by a prescribed percentage, the investors may be asked to provide more money to replenish the collateralized value.

Insider trading transactions on the basis of undisclosed price sensitive information to public manipulates the market. This is viewed negatively by around 24 per cent respondents. For example, the share price of Popular Life Insurance peaked from TK. 911 ($13.26) to TK. 5000 ($72.78) between June 2007 and March 2008. SEC found insider trading behind this excessive price movement and punished the culprits. However, this is not a common practice. Investors expect that stock market watchdogs should take exemplary actions against insider traders and persons responsible for leaking the sensitive information.

An important role of stock market regulators is to ensure that there is transparency to create a level playing field for small, large and institutional investors. 16 per cent respondents are not satisfied with the current status of monitoring supervision, and transparency of the secondary market. They opined that companies' ongoing reporting of financial results is not honest and so called syndicate in price manipulation does exist.

Private placement market for corporate securities in Bangladesh has been growing rapidly since 2001. Since the introduction of Credit Bridge Standby Project Facility in 2001, financial institutions emerged as the main issuers of debt instruments through private placement with the consent of the SEC. A total of Tk. 5178.58 million ($75.38m) worth of corporate securities were placed privately between 2001 and 2004. However, issuance of debt instrument was limited to a few blue chip financial institutions and a private commercial bank. Since 2005, corporate units resumed to collect funds by issuing bonds and debentures. Currently, corporate units are more active in collecting debt funds than banks and other financial institutions. However, all except IBBL Mudaraba Perpetual Bond are issued in the private placement market.

(iv) Reasons for Non-existence of Corporate Bond Market

Government initiatives and proper nurturing are required for having a good corporate bond market in Bangladesh which can act as a complementary source of financing besides bank-financing. However, 34 per cent respondents viewed that government initiative is not enough. The primary reasons are listed as follows (Appendix IV):

High interest rate is a barrier to the corporate bond market. 30 per cent respondents among investors hold this view. Government still borrows through various national savings schemes at high interest rates and banks collect deposits at quite high interest rates in competition with government securities. High interest rates deterred public borrowings by the corporate bodies, thereby thwarting the expected development of a corporate debt market.

Thirty per cent respondents felt that absence of secondary bond market is a major reason for non-existence of corporate bond market in Bangladesh. They mean that secondary organized market which includes OTC market, and private placement market for corporate bonds.

Twenty eight per cent of the respondents felt that lack of awareness, and education deter to attract right issuers and investors in the corporate bond market. SOEs, multinational companies, infrastructure projects and large as well as medium enterprises shy away. The corporate sector of Bangladesh, for instance, insurance companies, provident funds and pension funds of various organizations, mutual funds, etc, are not involved in this venture.

Lack of knowledge-based trading even for government bonds is an important reason for inactive corporate bond market according to 22 per cent of the respondents. Bangladesh Bank has issued nine PD licenses but these are yet to fully start their activity. In the government bond market, PDs can play an important role to activate the secondary market of treasury bills and government securities. This would require more liquidity and greater depth of the market by facilitating price discovery and turnover, decreasing buy-and hold mentality, and by developing underwriting and market making capabilities. Later on, PDs can spread this knowledge based trading to the corporate sector.

Lack of innovative products has kept the market unattractive as opined by 16 per cent respondents. Securities bearing zero and fixed coupons, and bonds following Islamic shariah only are available currently in Bangladesh. Bonds like Treasury Inflation Protected Securities (TIPS), Islamic Bonds (SUKUK Bond), High-Yield Bonds (HYB), and Deep Discount Bonds may help formation of corporate bonds market in Bangladesh.

Lack of information pertaining to current trading opportunities and recently completed trading is a limitation of the market as perceived by 14 per cent respondents. In the market, the pre-and the post-trade information quality is poor. Acquiring information about the buying or selling or quality of assets of recently completed executions seems costly and time consuming.

Uncertainty of return is also a cause of concern to the investors, although very few (2%) of respondents considered this as a factor. Most of the bonds, issued earlier, have failed to honor interest and principal payment obligation as per the original schedule

Other barriers mentioned by the respondents include poor market infrastructure (20%), easy to get bank loan (16%), absence of tax incentives (12%), and hassles in issuing bonds (4%).

(v) Reasons for Thin Portfolio Investment by NRBs

An important class of investors that is absent from Bangladesh stock market is foreign investors. Net foreign investment amount is very small and sometimes negative. Numerous impediments discourage them from participating in Bangladesh stock market (Appendix V).

Poor market infrastructure discourages foreigners to invest in Bangladesh, as claimed by 64 per cent respondents. They cite outdated absence of clearing, settlement and depository systems; inactive OTC market; lack of online trading system, credit rating culture, etc. as impediments to foreign portfolio investment.

Political instability sends a negative signal to foreign investors. Fifty four per cent of the respondents viewed that political turmoil's act as a psychological deterrent to foreign investors.

Foreign investors become confused if government regulations are not transparent. 36 per cent respondents offered this opinion. They said that foreign investors need to spend an excess amount of Tk 2000 ($29.11) per application compared to local investors as draft fees. BB's commission to send money to Bangladesh and fees for refunding money for an unsuccessful applicant are the reasons for this excess amount. Regulators should pay attention to remove this anomaly.

Around 30 per cent respondents consider small size of the Bangladesh stock market as a major cause for reluctance of foreigners to invest here. Market capitalization of DSE as percentage of GDP was 15.87 in 2007. In contrast, the market capitalizations as percentages of GDP in Colombo, Karachi and Bombay stock exchanges are 24.32, 47.87 and 166.9, respectively.

Foreign investors consider country-specific risk in investing their money in portfolios. Twenty eight percent of the respondents advance this view. It is commonly felt that Bangladesh needs to build its good image abroad to attract increased volume of foreign investment.

Gradual depreciation of Bangladesh Tk. vis-a-vis other currencies is not favorable to foreign investors. This is perceived by around 10 per cent respondents. Foreign investors pay close attention to timing of their return conversions based on the anticipated exchange rate movements. When rates of return earned in Bangladesh are translated into a stronger currency, the adjusted rates of return decline.

A summary of policy recommendations is provided in Appendix V.

BRIEF SUMMARY OF MAJOR FINDINGS AND CONCLUSIONS

The corporate sector heavily relies on indirect financing by procuring bank loans with relative ease and low cost. Direct financing through equity issuance remains limited in scope. Overlapping of regulations, hassles and undue delays in approvals, high cost of issuance, lack of liquidity, high price volatility, etc. inhibit further growth of equity market in Bangladesh. Political instability, high country-specific risk, lack of liquidity and transparency, less sophistication, market shallowness, complex and time-consuming profit repatriation, etc., contribute to an inability to entice foreign equity portfolio investment. Additionally, domestic investors gain sour experience from erratic price behavior, rumors, insider trading and regulatory opaqueness.

To complement bank-financing and equity-financing for the corporate sector, Bangladesh should pay close attention as well to develop a viable corporate bond market. Currently, Bangladesh is focused on developing a government debt market. This market can be catalyst for developing a corporate bond market through market-based interest rate, innovation of different debt instruments, appropriate regulations for payment and settlement, insurance, and education.

Possible remedies on a broad spectrum may include ensuring and facilitating smooth market operations, price continuity, stable and workable margin loan ratio, timely dissemination of market and company related reliable information, market liquidity, expansion of issuer base, regulatory simplifications and transparency, credible corporate credit rating, speedy payment and settlement, innovative financial instruments, introduction of information technology integration, modern training and education, effective marketing, image-building, good governance, etc.

Appendix I: Factors in Equity Buying Decisions

Appendix-II

Appendix-III

Appendix-IV

Appendix-V

References

Bangladesh Bank Annual Report (2007-08).

Barth, James R., McCarthy, Donald, Phumiwasana and Yago, Gleen (2006), 'Opportunities and Challenges in Asian Bond Markets'. In Asia's Debt Capital Markets, edited by Arner, Douglas, Park, Jae-ha, Lejot, Paul and Liu, Qiao, Milken Institute, USA: 11-32.

Barth, James R., Nolle, Daniel E., Root, Hilton L. and Yago, Glean (2001), 'Choosing the Right Financial System for Growth,' Applied Corporate Finance, 13, pp. 116-123.

Bencivenga, Valerie R., Smith, Bruce D. and Starr, Ross M. (1995), "Transactions Costs, Technological Choice, and Endogenous Growth, "Journal of Economic Theory, Vol. 67, No. 1, 53-177.c

Bhide, Amar (1993), "The Hidden Costs of Stock Market Liquidity," Journal of Financial Economics, Vol. 34, No. 2, 1- 51.

Corbett, Jenny and Jenkinson, Tim (1994), 'The Financing of Industry, 1970-1989: An International Comparison' Discussion Paper no. 948, London: Centre for Economic Policy Research.

Demirguc-Kunt, Asli and Vojislav Kamsimovic (1998), "Law, Finance, and Firm Growth," Journal of Finance, December.

Greenwood, Jeremy, and Bruce Smith (1997), "Financial Markets in Development and the Development of Financial Markets," Journal of Economic Dynamics and Control, Vol. 21, 145-82.

Herring, R. and Chatusripitak, N. (2001), 'The Case of Missing Market: The Bond Market and Why It Matters for Financial Development', Wharton Financial Institutions Centre working paper, University of Pennsylvania. 1-61.

Jensen, Michael C., and Murphy, Kevin J. (1990), "Performance Pay and Top Management Incentives," Journal of Political Economy, Vol. 98, 225-64.

Levine, Ross and Zervoss, Sara (1998), "Stock Markets, Banks and Economic Growth," American Economic Review, Vol. 88, 537-38.

Lian, Teo Swee (2002), "Debt Market Development in Singapore." BIS Policy Paper No. 11.

Nakamura, Masao (2002), 'Mixed Ownership of Industrial Firms in Japan: Debt Financing, Banks and Vertical Keiretsu Groups,' Economic System, 26, 231-247.

Rhee, S. Ghon. (1993), "Fixed-Income Securities Markets of Six Dynamic Asian Economics". Paris, France: Organisation for Economic Co-operation and Development, pp. 43-135.

Ryrie, William (1991), "Stock Markets and their Role in Economic Development," The Stock Exchange Review.

Shapiro. Eli and Wolf, Charles R. (1972), 'The Role of Private Placement in Corporate Finance', Harvard University, Boston, USA. 1-187.

Shleifer, Andrei and Vislmy, Robert W. (1986), "Large Shareholders and Corporate Control," Journal of Political Economy, Vol. 96, No.3, 461-88.

Stiglitz, J. (1993), "The Role of the State in Financial Markets," Proceedings of the Annual BAnk Conference on Development Economics, pp. 19-52.

PRASHANTA K. BANERJEE

King Faisal University, Saudi Arabia

MATIUR AHM

McNeese State University, Lake Charles, LA

MD. MOHIUDDIN SIDDIQUE

Bangladesh Institute of Bank Management, DhaKa, Bangladesh

Notes

(1.) Data of NPL ratios in India and Pakistan are as of June, 2008 whereas the NPL ratio of Sri Lanka is measured in June, 2007.

(2.) GDP has been contemplated at current price.

(3.) Levine and Zervous (1998) estimates liquidity of stock market by using turnover and value traded ratios. Turnover ratio measures trading relative to the size of the stock market and value traded ratio captures trading relative to the size of the economy.
Table 3
Sector-wise Market Capitalization of DSE (Dhaka Stock Exchange)

BDT in Million

              Market Capitalization

Year            Financial Sector

          Banks    Insurance   Investment

2004      104816        9285         2070
        (46.71%)     (4.14%)      (0.92%)
       $1525.7 m   $135.1 m     $30.13 m

2005      118395        8507         2154
        (53.59%)     (3.85%)      (0.98%)
       $1723.3 m   $123.8 m     $31.35 m

2006      150861        8939         2322
        (54.57%)     (3.23%)      (0.84%)
       $2195.9 m   $130.1 m     $33.79 m

2007      372294       21709        10800
        (49.42%)    (2,.88%)      (1.43%)
       $5419.1 m   $315.9 m    $157.20 m

2008      373286       45194        35010
        (35.76%)     (4.33%)      (3.35%)
       $5433.5 m   $657.8 m    $509.61 m

CAGR      37.36%      48.55%      102.78%

                      Market Capitalization

Year                 Other than Financial Sector

                          Service &
       Manufacturing   Miscellaneous     Bond *       Total

2004           97336           10898        N.A      224,405
            (43.37%)         (4.86%)
          $1416.83 m       $158.63 m              $3266.4 n.

2005           77373           14480        N.A      220,909
            (35.02%)         (6.55%)
          $1126.24 m       $210.77 m               $3215.5 m

2006           80597           33710        N.A      276,429
            (29.17%)        (12.20%)
          $1173.17 m       $490.68 m               $4023.7 m

2007          140163           81845     126,568     753,379
            (18.62%)        (10.86%)    (16.79%)
          $2040.22 m      $1191.34 m                $10966 m

2008          200207          159089   246616 **     1043799
            (19.18%)        (15.24%)    (23.63%)
          $2914.22 m      $2315.71 m               $15193. m

CAGR          19.80%          95.47%                  46.85%

* Bond includes Govt. bond, corporate and debenture.
** As on November 30, 2008

Note: Figures in parentheses represent percentages of
sector-wise market capitalization to total market capitalization.

Sources: BAPLC Annual Reports and DSE Monthly reviews


Reasons for Dependency on Bank Finance over Equity Finance (Issuers)

Quick and Easy Process of obtaining bank loan      83.33%
Agencies involved in IPO and throughout the life   50%
Time consuming and more formalities in IPO         33.33%
Less incentive                                     33.33%
Higher cost of IPO                                 25%
Desire to Maintain control                         25%
Desire to avoid indiscipline in AGM                8.33%

Note: Table made from bar graph.

Reasons for Dependency on Bank Finance over Equity Finance
(Prospective Issuers)

Time consuming and more formalities in IPO         75%
Agencies Involved In IPO and throughout the life   41.67%
Quick and Easy Process of obtaining bank loan      33.33%
Higher cost of IPO                                 25%
Less Incentive                                     16.67%
Desire to avoid indiscipline In AGM                8.33%
Desire to Maintain control                         8.33%

Note: Table made from bar graph.


Reasons for Dependency on Bank Finance over Debt Finance (Issuer)

Poor Credit Standing of Issuing Companies                25.00%
Repressive Regulations                                   25.00%
Availability of Lower Cost Bank Finance                  16.67%
Captive demand from Banks and Financial Institutions     16.67%
Statutory Restrictions on the Issuance of Fixed Income
 Securities                                              16.67%
Anti-Religious                                           8.33%

Source: Survey Results

Note: Table made from bar graph.

Reasons for Dependency on Bank Finance over Debt Finance (Prospective
Issuer)

Captive Demand from Bank and Financial Institutions   58.33%
Poor Credit Standing of Issuing Companies             50.00%
Availability of Lower Cost Bank Finance               50.00%
Statutory Restrictions on the Issuance of fixed
 Income Securities                                    33.33%
Repressive Regulations                                25.00%

Source: Survey Results

Note: Table made from bar graph.


Problems Faced by the Investors in the Primary Market (Panel A)

Time Consuming and Hassle in Collecting Refund   90%
Sufficient and Reliable Information              40%
Limited Number of Bankers to the Issue           40%
Delay in Holding Lottery                         38%
Multiple BO Account                              36%
Small Size of IPO                                30%
Depositing Full Amount with IPO Application      26%
Scarcity of Good Security                        22%
Excess Premium                                   12%

Note: Table made from bar graph.

Problems Faced by the Investors in the Secondary Market (Panel B)

Rumor anti Price Manipulation by Syndicate                   70%
Problems with Brokerage House                                40%
Price Volatility                                             40%
Lack of Reliable Information and Undue Interruption by SEC   38%
Want of Quality Securities                                   38%
Cash After Selling is Time Consuming                         28%
Margin Loan Ratio                                            26%
Lack of Monitoring & Supervision                             24%
Insider Trading                                              24%
Lack of Transparency                                         16%

Note: Table made from bar graph.


Reasons for Near Non-existence of Corporate Bond Market (n=50)

Lack of Government Initiative             34%
High Interest Rate of Other Instruments   30%
Absence of Secondary Bond Market          30%
Lack of Awareness/Education               28%
Lack of Knowledge Based Trading           22%
Poor Market Infrastructure                20%
Inadequate Number of Bonds                16%
Easy to Get Bank Loan                     16%
Lack of Information                       14%
Absence Of Tax Incentives                 12%
Hassle in Issuing Bond                    4%
Uncertainty of Return                     2%

Note: Table made from bar graph.


Reasons for Thin Foreign Portfolio Investment (n = 50)

Poor Market Infrastructure                     64%
                                               54%
Lack of Quality Securities                     42%
                                               36%
Lack of Marketing in Abroad                    34%
                                               32%
Small Market Size and Integration to Foreign   30%
                                               28%
Lack of Transparency                           26%
                                               20%
Price Volatility                               18%
                                               14%
Exchange Rate                                  10%

Note: Table made from bar graph.

Appendix V
Summary of Policy Issues and Recommendations

Equity Market

Policy Issues                  Policy Recommendations

1. Smooth Operation in      1. Paying 20-25 per cent of the total
   Primary market              money during application time and
                               remaining amount within 10 days after
                               allotment will ease the pressure on
                               investors.

                            2. Holding draw should be ensured within
                               three weeks and the whole process be
                               completed within one month.

                            3. Increasing the number of bankers to
                               the issuers including locations of
                               bank branches and provision of
                               accepting online application will
                               ensure smooth participation of all
                               types of investors.

                            4. Refund amount should not be delayed
                               on the grounds that names are not
                               properly written in issuer book or
                               multiple BO accounts are maintained
                               or several applications are made by a
                               single investor.

                            5. Allegation that issuers in
                               collaboration with banks delay the
                               refund intentionally in order to reap
                               undue pecuniary benefits through
                               re-investment deserve thorough
                               investigation and immediate
                               remediation.

2. Margin Loan Ratio        1. The SEC may think of instituting a
                               permanent policy for the margin ratio
                               and let merchant banks lend investors
                               within their own parameters. To this
                               effect, 'maintenance margin' or
                               'credit balance' rule may be
                               considered

                            2. Currently allowed capacity of NBFIs
                               to hold maximum exposure (loan, own
                               investments and commitment for
                               underwriting) is required to be
                               enhanced. They are not permitted to
                               leverage more than five times of
                               their paid-up capital.

3. Rumors                   1. The SEC can notify investors
                               immediately about the securities
                               undergoing large deviations in terms
                               of price and volume without sound
                               justifications.

                            2. Merchant bankers and brokerage houses
                               can organize regular awareness
                               program for investors to help them
                               make rational investment decisions
                               and to warn them in advance against
                               rumors to mitigate possible stock
                               market
                               over-reactions/under-reactions.

                            3. Merchant bankers and brokerage houses
                               should stop comments about price hike
                               of the shares without fundamental
                               analysis.

4. Market Volatility        1. A comprehensive empirical research
                               work on the efficacy of currently
                               used mechanisms, trading halts and
                               daily price limit in mitigating
                               market volatility, is warranted.

                            2. Suitability of the mechanisms like
                               margin regulations, price
                               stabilization funds and securities
                               transaction taxes merit proper
                               attention of the policy markers.

5. Multiple BO Accounts     1. Meticulous examinations of required
                               information in the BO accounts form
                               namely, passport/voter ID number,
                               driver license and bank statement are
                               required to stop unscrupulous
                               investors to open fictitious multiple
                               BO accounts.

                            2. Many fake BO accounts opened at the
                               initial stage of this provision
                               should be detected and closed
                               immediately.

                            3. No individual shall be allowed to use
                               another investor's BO accounts for
                               investment purpose.

6. Expansion of             1. More profitable state-owned
   Issuer Base                 enterprises, multinational
                               corporations and large homegrown
                               private enterprises with cleaner and
                               stronger balance sheets should be
                               listed with the SEC.

                            2. Government can improve guidelines
                               relating to capital structure of SOEs
                               similar to those for financial
                               institutions and banks.

                            3. Multinationals might be agreed during
                               their registration time to go to
                               public for capital after a certain
                               period of operation in Bangladesh.

                            4. SMEs particularly export oriented
                               garments industries should be
                               encouraged to be listed under
                               separate rules and regulations, as
                               appropriate.

7. Fair Value of            1. In addition to direct listing rules,
   the Share                   book building system should be
                               introduced quickly. Unnecessary
                               formalities and transaction costs
                               should also be cut down to improve
                               market efficiency.

                            2. Local and foreign institutional as
                               well as individual investors need to
                               be enticed for fair price in the
                               secondary market.

8. Incentives for           1. Less time-consuming compliances of
   Issuers                     numerous formalities, low cost of
                               initial public equity offerings, tax
                               free dividend income from PLC,
                               elimination of double taxation, tax
                               holiday and granting CIP status to
                               the sponsors of PLC will be helpful
                               to equity market improvement.

                            2. Shares with smallest denomination
                               (say with paisa one/Tk.1) like US
                               penny stocks may be made available in
                               the equity market.

                            3. Monitoring agencies, namely, SEC,
                               DSE, CSE, CDBL and credit rating
                               agencies need to play an integrated
                               role in avoiding duplications of
                               works of different agencies.

9. Advertisement            SEC should initiate awareness,
                            educational and promotional programs
                            through institutional training and go
                            for advertisement in domestic as well
                            as foreign print and electronic media
                            for a vibrant market with active
                            presence of issuers and investors.

10. Foreign Portfolio       1. Ensuring political stability,
    Investments                developing information infrastructure
                               and making selective deregulations
                               are required to entice foreign
                               investors.

                            2. Image building activities through
                               seminars, symposium and fairs at home
                               and abroad deserve due
                               considerations.

11. Securities and          The SEC should protect investors'
    Exchange Commission     interest and create an enabling
                            environment for issuers. For
                            transparency in reporting financial
                            results, the SEC may consider an Act
                            similar to US Sarbanes-Oxley Act of
                            2002.

12. Brokerage Houses        1. Brokerage houses and their branches
                               should extend services beyond
                               metropolitan areas.

                            2. They should invest adequately in
                               quality research.

                            3. Fixed brokerage commission rates need
                               to be replaced by negotiable rates
                               for trading of all sizes.

                            4. Allegations, such as, selling shares
                               at high price without investors'
                               consent and later replacing them by
                               buying same number of shares at
                               convenient times are required to be
                               investigated.

13. Stock Exchange          1. Stock exchange should shorten
                               time-span for listing decision and
                               improve capacity to deal with rising
                               trade volume.

                            2. SME platform may be created in
                               current structure of stock exchanges
                               with separate rules and regulations
                               for registration, listing and
                               delisting. Perhaps, separate trading
                               time may be required as well.

14. Registrar of Joint      1. RJSCF should be more prompt in
    Stock Company and          registering issuers with specific
    Firms (RJSCF)              deadlines.

                            2. Issues of side payment, harassments
                               during registration and delayed
                               clearance by RJSCF call for immediate
                               resolutions

Corporate Bond Market

Policy Issues               Policy Recommendations

1. Government Initiatives   1. The government may take initiatives
                               to issue treasury bonds with a few
                               buckets of maturities extending to at
                               least 10-year for constructing a
                               benchmark yield curve

                            2. Government infrastructure projects
                               and state-owned enterprises may be
                               persuaded for mobilizing direct debt
                               financing through bond issuance.

                            3. Government may encourage institutional
                               investors to invest in corporate
                               bonds with good rating.

2. Innovative Financial     Introduction of bonds like Treasury
   Products                 Inflation--Protected securities (TIPS),
                            SUKUK Bond, High-Yield Bonds (HYB) and
                            Deep Discount Bonds may also help
                            laying out of corporate bond market
                            architecture in Bangladesh.

3. Market                   1. Private placement market may be
                               encouraged at the initial stage to
                               entice issuers. Marketability of
                               securities considered as a drawback
                               of private placements. This needs to
                               be addressed with due attention.

                            2. Public placement market should also
                               be there for issuers. Appropriate
                               fiscal incentives and regulatory
                               framework will be helpful in this
                               regard. Introduction of Shelf
                               Registration rules may be considered.

                            3. An Over-the-Counter (OTC) market that
                               is extensively used for corporate
                               bond trading should be established as
                               a secondary market.

4. Knowledge-Based          Banks and financial institutions that
   Trading                  already have PD licenses must be
                            activated at least for government bond
                            market at the initial stage.
                            Subsequently, PDs will use knowledge-
                            based trading techniques acquire from
                            government bond market for the
                            corporate sector.

5. Statutory Restrictions   1. A policy framework is required to be
   on the Issuers and          developed for SOEs in issuing bonds.
   Captive Demand

                            2. A joint cell of the BB and the SEC
                               can allow banks and financial
                               institutions to issue bonds in lieu
                               of dual approval process

                            3. To mitigate banks' and financial
                               institutions' captive demand for
                               securities, BB can approve corporate
                               bonds for SLR on the basis of credit
                               rating.

6. Interest Rate and        1. Coordination is necessary among
   Cost of Bank Finance        government, regulatory authorities
                               and banks to create level playing
                               fields in determining interest rates.

                            2. Banks manage to lend at lower rates
                               whereas corporate issuers need
                               to pay more interest to bond
                               investors. In this case, loan-
                               default culture, and interest waiver
                               provision should be rescinded.

7. Credit Rating Agencies   1. More credit rating agencies are
                               required to start their functions.

                            2. Regulatory authorities in
                               Bangladesh can designate rating
                               agencies in line with Nationally
                               Recognized Statistical Rating
                               Organization (NRSRO) of the USA on
                               the basis of agencies' organizational
                               structure, financial independence,
                               quality of staff, rating procedures
                               and internal procedures in processing
                               private information.

8. Trustee                  1. Apart from strengthening the capacity
                               of the existing trustee, commercial
                               banks (either local or foreign) may
                               be permitted to have a separate
                               professional trust department for
                               public debt issues.

                            2. The SEC and the Bangladesh Bank may
                               act as watchdogs to ensure that bond
                               indenture clearly delineates the
                               rights and the privileges of the bond
                               holders with no potential conflicts
                               of interest among investors, trustee,
                               and issuers.

                            3. The trustee should act judiciously
                               in initiating possible legal actions
                               against the issuers for their wrong
                               doings.

9. Bond Clearing and        1. Delivery versus Payment (DVP) systems
   Settlement Systems          introduced for government bonds
                               should also apply to corporate bonds
                               with greater efficacy.

                            2. The clearing and settlement systems
                               for equity instruments must be
                               expanded to include bond instruments.
                               The Asian Bond Funds has successfully
                               accelerated the integration of these
                               two systems in some markets.
                               Bangladesh can draw some valuable
                               lessons from this practice.


Table 1
Sources of Finance: Disbursed Amounts of Term-Loans and
Amounts through IPOs

BDT in Million

            Disbursement of            IPOs
               Term-Loans

                    Percentage             Percentage
Year      Amount    of GDP (2)   Amount       of GDP

2003       39,700         1.32   1351.17         0.04
         $577.87m                $19.67m
2004       66,800         2.01    473.88         0.01
         $972.35m                 $6.89m
2005       87,000         2.35   1265.70         0.03
        $1,266.38                $18.42m
2006       96,500         2.32   1433.95         0.03
        $1404.66m                $20.87m
2007      124,000         2.65   4638.13         0.10
        $1804.95m                $67.51m
2008       201500         3.72      5613         0.10
        $2933.04m                 $81.7m

Sources: BB Annual Reports and on BAPLC Annual Reports.
U.S. dollar figures are obtained by the current exchange rate
for $1.00 = Tk 68.70.

Table 2
Sources of Finance: Outstanding Term-Loans, Equity Market
Capitalization and Corporate Bonds

BDT in Million
                                  Market Capitalization

Year        Outstanding   % of            Total    % of
             Term-Loan    GDP    Capitalization     GDP

2004-05         226,300   6.10          427655.4   11.54
              $3294.03m               $6224.97 m
2005-06         273,800   6.59            421641   10.14
              $3985.44m               $6137.42 m
2006-07         339,200   7.18            890183   18.84
             $4937.41 m               $2957.54 m
2007-08         400,900   6.26            964800   21.35
             $5835.52 m               $4043.67 m

                         Market Capitalization

Year                               Corporate
            Manufacturing   % of      Bond &   % of
               & Services    GDP   Debenture    GDP

2004-05            91,853   2.48         576   0.016
                $337.01 m            $8.38 m
2005-06           114,307   2.75         576   0.014
                $663.86 m            $8.38 m
2006-07           222,008   4.70         576   0.012
               $3231.56 m            $8.38 m
2007-08           289,300   4.52        3503   0.065
               $4211.06 m           $50.99 m

Sources: Economic Trends, Bangladesh Bank, BB Annual
Reports, SEC Annual Reports and DSE  Monthly Reviews.

Table 4
Category of Companies

                               Name of Category

Year         A          B          Z         G          N    Total

2005        117         30         99         1          0     247
       (47.37%)   (12.15%)   (40.08%)   (0.40%)    (0.00%)

2006        124         32         93         1          5     255
       (48.63%)   (12.55%)   (36.47%)   (0.39%)    (1.96%)

2007        133         27         96         1         10     267
       (49.81%)   (10.11%)   (35.96%)   (0.37%)    (3.75%)

2008        171         19         94         0          9     293
       (58.36%)   (6.48%)    (32.08%)        -    (3.078%)

Source: BAPLC Annual Reports.

Table 5
Volatility of Index: Measured by Co-efficient of Variation

Year             DSE Index            CSE Index

          All      General   Top 20         All
        Shares                           Shares

2005      6.81        7.18     9.53        5.18
2006      9.31        7.04    21.88       11.66
2007     25.57       20.12    19.68       10.13
2008      7.13        6.43     5.38        6.95

Sources: BAPLC Annual Reports and SEC Annual Reports.

Table 6
Dividend and Capital Gain of Per Share of Selected Sample
Companies in 2008

                                         Dividend
      Name of             Par
Sl.   Company           Value     Cash      Stock     Total

1     AB Bank Ltd         100     0.00    2648.50   2648.50
                                           $38.55    $38.55
2     Lanka Bangla         10     1.50      22.13     23.63
      Finance                   $0.022     $0.322     $0.34
3     IDLC                100    15.00     528.35    543.35
                                 $0.22      $7.69     $7.69
4     Uttara Finance      100    30.00       0.00     30.00
                                 $0.44                $0.43
5     Aziz Pipe           100     0.00       0.00      0.00
6     Rangpur Foundry      10     1.60       0.00      1.60
                                $0.023               $0.023
7     Reckit and           10    22.00       0.00     22.00
      Benkeizer                  $0.32                $0.32
8     Monno Fabrics       100     5.00       0.00      5.00
                                $0.073               $0.073
9     Reneta              100    50.00    1480.30   1530.30
                                 $0.73     $21.55    $22.28
10    Prime Textile       100    10.00       0.00     10.00
      Ltd.                       $0.14                $0.14
11    Ashraf Textiles      10     0.00       0.00      0.00
      Ltd.

                                                        Difference
                               Price                       Between
                                                           Capital
      Name of            Jan 1,       June    Capital     Gain and
Sl.   Company              2008   30, 2008       Gain     Dividend

1     AB Bank Ltd       2641.75    1324.25   -1317.50     -3966.00
                         $38.45     $19.28    -$19.18      -$57.73
2     Lanka Bangla        98.90     221.30     122.40        98.77
      Finance             $1.44      $3.22      $1.78        $1.44
3     IDLC              1505.50    2641.75    1136.25       592.90
                         $21.91     $38.45     $16.53        $8.63
4     Uttara Finance     687.75     797.75     110.00        80.00
                        $$10.01    $$38.45       $1.6        $1.16
5     Aziz Pipe          222.25     200.75     -21.50       -21.50
                          $3.24     $11.61     -$0.31       -$0.31
6     Rangpur Foundry     29.40      57.90      28.50        26.90
                          $0.43      $2.92      $0.42        $0.39
7     Reckit and         370.40     519.40     149.00       127.00
      Benkeizer           $5.39      $0.84      $2.17        $1.85
8     Monno Fabrics       65.50      88.75      23.25        18.25
                          $0.95      $7.56      $0.54        $0.27
9     Reneta            7793.75    7401.50    -392.25     -1922.55
                        $113.45    $107.74     -$5.71      -$27.98
10    Prime Textile       87.50     144.25      56.75        46.75
      Ltd.               $1.277     $2.099      $0.83        $0.68
                           0.14
11    Ashraf Textiles     10.30       9.40      -0.90        -0.90
      Ltd.                $0.15      $0.14    -$0.015      -$0.013

Notes: Calculation procedures of the following are: Cash
Dividend= Par Value of the Share Cash Dividend Rate; Stock
Dividend = Market Value of the Share x Stock Dividend Rate and
Capital Gain = Price of June 30, 2008--Price of Jan 01, 2008.

Source: The Daily Star

Table 7
Market Liquidity: Turnover Ratio and Value Traded Ratio (3)

Year                     Turnover Ratio

                DSE      CSE      India   Pakistan

2003-04         17.4        6.7    14.1       40.1
2004-05        29.02       8.27   115.5      322.5
2005-06        20.41       5.81    93.6      375.7
2006-07        33.49       8.58    96.4      251.4
2007-08        56.31      10.21    N.A        N.A
Mean           31.33       7.91   79.90     247.43
S. Deviation   15.39       1.71   44.93     147.30
CV             49.13      21.65   56.24      59.53

Year                    Value Traded Ratio

                 DSE     CSE    India   Pakistan

2003-04          0.74    0.25    47.4       80.9
2004-05          1.76    0.45    54.8       76.9
2005-06          1.11    0.27      55      127.3
2006-07          3.52    0.73     N.A        N.A
2007-08         10.03    0.46     N.A        N.A
Mean             3.43    0.43   52.40      95.03
S. Deviation     3.84    0.19    4.33      28.02
CV             111.88   44.72    8.27      29.48

Sources: SEC Annual Reports and World Development Indicators.

Table 8
Pattern of Deviation between Par Value and Market
Value of Primary Shares

                              Average
Name of the Company           Trading   Offer
                              Price *   Price   Difference

Fidelity Assets                306.67     100       206.67
                                $4.46   $1.46           $3
Continental Insurance          159.92     100        59.92
  Ltd.                          $2.33   $1.46        $0.87
DBH                           1528.08     210      1318.08
                               $22.24   $3.06       $19.19
Golden Son Ltd.                 22.83      10        12.83
                                $0.33   $0.14        $0.19
ICB AMCL 2nd NRB               181.00     100        81.00
  Mutual Fund                   $2.63   $1.46        $1.18
Grameen One: Scheme Two         41.67      10        31.67
                                $0.61   $0.14        $0.46
First Security Bank Ltd.       191.42     100        91.42
                                $2.79   $1.46        $1.33
Summit Alliance Port Ltd.      901.67     100       801.67
                               $13.12   $1.16       $11.67
Takaful Islami                 319.58     100       219.58
  Insurance Ltd.
                                $4.65   $1.46        $3.19
Mann- Whitney U-Test
Calculated Value    -2.076   Alternative hypothesis is
                             accepted meaning there is
                             difference between average
                             trading price and offer price

Tabular value at 5%   1.96
level of significance

* Averages have been calculated on the basis of first three
trading days' closing prices.

Sources: www.dsebd.org. and The Financial Express

Table 9
Proposed Expenses of Some Selected Companies for Raising Funds through
Initial Public Offering (IPO) in 2008

Amount in Taka

                                                             % of IPO
                                                  Amount     Expenses
                               Total IPO          Raised    of Amount
Name of the Companies           Expenses        from IPO       Raised

First Security Bank Ltd       22,855,000   1,150,000,000         1.99
                              $332,678.3     $16,739,446
Bay Leasing and                5,687,750     250,000,000         2.23
  Investment Ltd.             $82,791.12    $3,639,010.1
BSRM Steels Ltd.              12,192,500     200,000,000         6.10
                             $177,474.52    $2,911,208.1
Delta Brac Housing Finance     5,580,000     105,000,000         5.31
Corporations Ltd              $81,222.74    $1,528,384.2
Summit Alliance Port Ltd.      6,672,000     100,000,000         6.67
                               $97,117.9      $1,455,604
Northern General               4,959,000      90,000,000         5.51
  Insurance CO. Ltd.          $72,183.41    $1,320,043.6
Republic Insurance Ltd.        4,890,000      90,000.000         5.43
                              $71,179.04    $1,310,043.6
Standard Insurance Ltd.        4,790,000      90,000,000         5.32
                              $69,723.44    $1,310,043.6
Maksons Spinning Mills Ltd     3,917,500      80,000,000         4.90
                              $57,023.29    $1,164,483.2

Source: Own calculations based on the prospectus of respective
companies

Table 10
P/E Ratio and EPS of DSE and CSE

Exchanges      2007    2006

DSE           23.10   13.04
CSE           22.70   13.15
Bombay SE     29.10   19.20
Colombo SE    11.60   14.00
Thailand SE   12.60    8.10

Sources: www.dsebd.org, www.econstats.com

Table 11
Institutional Investments ((ICB-Investment Corporation
of Bangladesh and Scheduled Banks)

BDT in Billion

                             Percentage
       ICB and                to Market
FY     Scheduled Banks   Capitalization

2005   20.00 ($291m)               4.68
2006   20.56 ($299m)               4.88
2007   33.45 ($486m)               3.76
2008   43.71 ($636m)               4.53

Source: Annual Reports of Bangladesh Bank

Table 12
Yearly Portfolio Investments by NRBs (Non Resident
Bangladeshis)

BDT in Million

                          Outflow          Net
         Investment in    of Sold   Investment
FY          Securities     Amount       by NRB

2004            298.90      56.20       242.70
                $4.35m     $0.82m       $3.53m
2005             53.10     315.50      -262.40
                $0.77m     $4.59m      -$3.82m
2006           2420.60     185.10      2235.50
               $35.23m     $2.69m      $32.54m
2007           8359.20    1482.30      6876.90
              $121.68m    $21.58m      $100.1m
2008 *            5500       7670     -2170.00
               $80.06m   $111.65m     -$31.59m

* As per calendar year

Sources: SEC Annual Reports and Bangladesh Bank Annual reports.

Table 13
Debt Financing. Govt. Bonds and Corporate Bonds

                                   Total Issued Capital
             Number of                of Securities
             Securities             (Taka in Millions)

Period   Govt.   Corporate     Govt.    % of   Corporate    % of
(as on    Bond      Bond &      Bond   Total      Bond &   Total
June)            Debenture                     Debenture

2005        18           8    13,587      99         140       1
                             $197.7m              $2.03m
2006        26           8    21,032      99         140       1
                             $306.1m              $2.03m
2007        44           8    80,553    99.8         140     .20
                              $1172m               $2.03m
2008        84           9   175,403      98        3140       2
                              $2553m               $45.7m

                Market Capitalization
                    of Securities
                  (Taka in Millions)

Period     Govt.    % of      Corporate   % of
(as on      Bond   Total   Bond & Total
June)                         Debenture

2005      11,589      95            576      5
         $168.6m                 $8.38m
2006      20,040      97            576      3
         $291.7m                 $8.38m
2007       79561      99            576      1
          $1158m                 $8.38m
2008     175,403      98           3503      2
          $2253m                 $50.9m

Source: DSE Monthly Reviews
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