Stock Market Crashes in Bangladesh

7/31/2019 Stock Market Crashes in Bangladesh

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Study on Causes ofStock M arketCrashes andSubsequent PolicyPrescriptions inBangladesh

April 04, 2011


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Stud y on

Ca uses of Stoc k Ma rket C ra shesa nd Sub seq uent Polic y

Presc rip tions in Ba ng la d esh

Analyst Team

Mahmudul Bari

Arif KhanNoman Ahmed KhanMd. Farjad Siddiqui

Qazi Mussadeq AhmadN. M. Al Hossain

Syed Abu Redowan

Disclaime This material is produced by Mindspring Research (Mindspring), an independent research firm registered with Registrar of JointStock Companies and Firms, Bangladesh. This document is not to be used or considered as an offer to sell or a solicitation of anoffer to buy any securities, or to enter into any other agreement. Projections of potential risk or return are illustrative, and should notbe taken as limitations of the maximum possible loss or gain. Past performance is not indicative of future results. The informationand any views expressed in this document are given as at the date of writing and subject to change. While the information has beenobtained from sources believed to be reliable, Mindspring do not represent that it is accurate or complete and it should not be reliedon as such. Mindspring and its employees accept no liability for any direct or consequential loss arising from the use of thisdocument or its contents or otherwise arising in connection therewith. This document is not to be relied upon or used in substitutionfor the exercise of independent judgment. It is being furnished to you solely for your information, and by accepting this report youagree to be bound by the foregoing limitations.


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Table of ContentsExecutive Summary ..vi

1.0 Introduction ................................................................................................................................................... 1

1.1 Objective of The Study .............................................................................................................................. 2

1.2 Methodology ............................................................................................................................................. 2

1.2.1 Sources of Data .................................................................................................................................. 3

1.3 Background of Stock Exchanges in Bangladesh ...................................................................................... 3

2.0 Stock Market Crash in 1996 .......................................................................................................................... 42.1 Causes Behind The Bubble Formation ..................................................................................................... 6

2.2 Calendar Chronicles in 1996 ................................................................................................................... 13

2.4 Causes Behind The Plunge ...................................................................................................................... 18

3.0 Stock Market Crash in 2010 ........................................................................................................................ 22

3.1 Beginning of Bubble ................................................................................................................................ 22

3.2 How The Liquidity Comes Into Market .................................................................................................. 23

3.2.1 The Bangladesh Bank Policies ......................................................................................................... 24

3.2.2 The Government Policies ................................................................................................................ 27

3.3 How The Liquidity Used In Manipulation .............................................................................................. 29

3.3.1 The Corporate Announcements & SEC Policies ............................................................................. 29

3.3.2 The Government Policies ................................................................................................................ 36

3.4 Beginning of Bear .................................................................................................................................... 38

4.0 Evaluative Remarks of 1996 and 2010 ....................................................................................................... 39

5.0 Recommendations ...................................................................................................................................... 40

6.0 The Way Forward ........................................................................................................................................ 457.0 Conclusion.................................................................................................................................................... 47

References ......................................................................................................................................................... 48


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List of Figures & Tables

Figure 1: DSI Index : 1995 - 1997 ........................................................................................................................ 5

Figure 3: Y2Y Interest Rate Level ........................................................................................................................ 8

Figure 2: National Savings & Budget Deficit in FY 1995-96 .............................................................................. 8

Figure 4: Y2Y Return of DSI ................................................................................................................................. 9

Figure 5: Calendar Chronicles in 1996.............................................................................................................. 17

Figure 6: How the Bubble Formulated in 2010 ............................................................................................... 22

Figure 7: Excess Liquidity .................................................................................................................................. 23

Figure 8: Growth Rates of Domestic Credit & Broad Money (Year on Year) ................................................ 23

Figure 9: Banks That Exceed Exposure Limit ................................................................................................... 24

Figure 10: Growths of Domestic Credit & Broad Money ................................................................................ 26

Figure 11: Growth of Net Sales of NSD Certificates (Y-o-Y) ............................................................................ 27

Figure 12: DSE General Index : 2009 - 2011 .................................................................................................... 38

Figure 13: DSE Turnover : 2009 - 2011............................................................................................................. 38

Table 1: Stock Market Size, 1990 - 2010 ............................................................................................................ 1

Table 2: Macro Economic Variables in Year 1996 ............................................................................................. 5

Table 3: % Price appreciation of selective companies during 1996 bubble .................................................... 7

Table 4: Right Share Offerings in Year 1995 .................................................................................................... 11

Table 5: Right Share Offerings in Year 1996 .................................................................................................... 11

Table 6: IPO Offerings in Year 1996 ................................................................................................................. 18

Table 7: Foreign Portfolio Investment ............................................................................................................. 20

Table 8: Revised Interest Rates on NSD Certificates ....................................................................................... 27Table 9: List of Companies That Used Book Building ...................................................................................... 31

Table 10: List of Companies That Have Privately Placed Shares .................................................................... 32

Table 11: List of Companies That Used Direct Listing ..................................................................................... 33

Table 12: Revision of Margin Rules From Feb 2010 to Feb 2011 ................................................................... 34


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Acronyms

BB : Bangladesh BankBO : Beneficiary Owner Account

CDBL : Central Depository Bangladesh LimitedCSE : Chittagong Stock Exchange

DGEN : DSE General IndexDSE : Dhaka Stock ExchangeDSI : DSE All Share IndexDVP : Delivery Versus PaymentGDP : Gross Domestic ProductGR : Growth RateICB : Investment Corporation of BangladeshIPO : Initial Public Offering

M Cap : Market CapitalizationMoF : Ministry of FinanceMPS : Monetary Policy StatementNBFI : Non Bank Financial InstitutionsNSD : National Savings Directorate

NYSE : New York Stock ExchangeOTC : Over The CounterP/ E : Price EarningsSE : Securities & Exchange CommissionSOB : State Owned BanksSOI : State Owned Insurance CompaniesSRO : Self Regulatory Organization


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Executive Sum m ary

Since the ending part of 2009, indices of the both of Bangladesh Stock Exchanges started toclimb at a supersonic pace that made the consensus market observers to rethink about itsrationality. During mid 2010, alarm of sudden hurtles started to form among analysts, butno one was convinced about precise timing. Later part of 2010 observed the same bullishinclination, while in early December ahead of implementing several strict regulatorymeasures by FIs, first major struck was observed. Since then consecutive sharp fall inbenchmark index crafted ruthless market panic and made the situation worse. Marketstarted to experience a completely different scenario when every market parameters likeindex level, transaction volume, register of gainers spicily plunged. A long debated topicthen revived that accelerate the extent of market panic- Is another 1996 going to repeat?

Obviously 1996 market scam deserve its own worth as Historical scandal in terms of indexfall and subsequent time needed to restore investors confidence. From November 16 th peakof 3627, DSI lost over 80% within just five months and it took long 8 years to cross 1000level. Loads of experienced market observers compared 2010-11 scam with that of 1996because of similarity in pace of rise and steepness in fall. So this research attempts todetect the respective basic drivers of bubble formation and subsequent slump of both 1996and 2010-11 market scams. Throughout the details, researchers endeavor to analyze therespective market structure, investors consensus, Regulators confidence, macroeconomicstrength to reach operational conclusion.

Most importantly, market structure in 1996 and 2010 vary substantially. During 1996 theprimitive market structure like manual ordering and settlement, Delivery Versus Payment(DVP) system, non-existence of central depository, paper share, Existence of kerb Market contributed to make the market upset. In contrast, piled up excess liquidity in bankingsector as a sequence of global turmoil and domestic macroeconomic imbalances, policydebate at the Government and regulators level opened up the way of market unrest despiterelatively mature market structure in Year 2010-11.

Besides that, some common factors like violation of ethical codes by some issuers,corporate insiders, untimely rigid policy, gap of perceived confidence of regulators,governments poor interpretation and actions during bubble formation, lack of coordinationamong regulators has commendable impact behind both scams.

On the ground of factual findings, it can be summarized that exact nature of these twohurtle is not precisely same in terms of extent of fall and time to recover!


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1.0 IntroductionThe 1990s are often generalized as a decade of good times in Bangladesh as it came underthe rule of democratic government. There had been lots of prudential deregulations in thefinancial sector, including privatization of nationalized banks, allowing banking in the privatesector, interest rate liberalization. But until mid 1996 Bangladesh securities market failed toattract investors, both local and international. Things suddenly changed in the later half of 1996 and the market experienced an unprecedented bullish run. Unfortunately, it was veryshort lived and the market crashed. This crash is the hallmark event frequently said to havebrought about these economic hard times. After that economic policies including taxholidays and increased the merchant banking were taken for contributing the recovery of

economic misery because of stockmarket crash. The stock market crashbegan in beginning of November, andcontinued to fluctuate for the next twoweeks. Politicians and financiersexpected the market to self-correct,but it did not, and the effects lastedfor years.

After 14 years, the marketexperienced the same pulse in 2010;

after having gained by about 80%during the year 2010, Dhaka StockExchange has shown anunprecedented nose-dive. An abruptcrash of the market sparked violentprotests from the investors. After therecovery of 1996-crash; investment inthe stocks has been popular businessamong the educated middle class of Bangladesh who were left frustratedwith the sudden loss to their capital.

They were finding ways and means toexit from the market in order tominimize the losses. The governmentof Bangladesh may be under pressureto intervene in order to protect thehard earned money of the smallinvestors from being lost due to thisunusual crash of the stock market.

The analysts expressed their opinion in the media that the immediate reason for this crashwas the policy of the regulators of the market who laid down a limit for investment by the

Table 1: Stock Market Size, 1990 - 2010

YearMarket

capitalization(billion Taka)

Marketcapitalization

to GDP

MarketCapitalization

Growth1990-91 11.485 1.40% -1991-92 10.397 1.10% -9.51992-93 12.29 1.30% 18.21993-94 18.098 1.80% 47.31994-95 80.657 5.10% 345.7

1995-96 315.149 18.90% 290.71996-97 124.134 6.90% -60.61997-98 91.637 4.60% -26.21998-99 81.324 3.70% -11.31999-00 120.69 5.10% 48.42000-01 70.7 2.79% -41.42001-02 63.13 2.31% -10.72002-03 69.2 2.30% 9.62003-04 136.64 4.10% 97.52004-05 222.04 5.99% 62.5

2005-06 215.42 5.18% -3.02006-07 475.86 10.18% 120.92007-08 931.02 17.06% 95.62008-09 1241.34 20.19% 33.32009-10 2700.74 39.01% 117.6

Source: Statistical Yearbook of Bangladesh & the Securit ies andExchange Commission (Quarterly and Annual Reviews)


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banks and other financial institutions in the stocks. In addition, there may be more reasonsthat ensured the panic amongst the investors to sell shares for minimizing their loss.Therefore, this research report tries to investigate the reasons of the two market crashesand critically analyzes the policies that were taken by the different regulatory bodies of ourcountry.

1.1 Objective of The Study

Stock market debacle is not a completely new phenomenon in Bangladesh. Franklyspeaking, 1996 scam created such a negative impression in participants mind that it took along 8 years to back the market on bullish trail. However, during year 2009-10 marketagain showed sky rocket pace which made the consensus market participants predictanother major collapse. In December 2010, their trepidation became reality that leftmillions of small investors into another market paradox. After consecutive sessions of majorfall associated with extreme intraday volatility, possible repetition of another 1996 becametalk of the bourses. But Statistical facts suggest creditable difference in market structureand economic strengths between 1996 and 2010-11. This particular Research effortendeavors to detect the economic reality behind the two market scams by analyzingrelevant facts with analytical prowess. The prime reason of this Research was to ensure thelong run smoothed sustenance of our capital market with other relevant objectives of:

Identifying the basic nature of the two market scams.

Identifying critical grounds behind the bubble formations.

Identifying the vigor and pace of bubble explode. Recommending possible course of action to avoid same slip in future.

Evaluating and assessing the way forward for our capital market.

1.2 MethodologyThe procedure that followed to conduct this research can be divided into the followingstages:

Stage I I dent ify ing the Key I ssues: This was done based on the objectives of the

report and discussions among the team members.

Stage I I Collect ing I nformat ion: Information were collected from different sources,mainly from newspapers and reviews published by regulators. Because of time constraintonly secondary sources of information were used in this research.

Stage I I I Processing & Analyz ing I nformat ion : Analysis of information done in twoways. The qualitative information were analyzed chronologically. The quantitativeinformation were analyzed using statistical tools i.e., mean, median, CV.

Stage I V Preparat ion of Report : The researchers finally prepared the report based ontheir analysis of data and their findings.


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1.2.1 Sources of Data

The secondary sources are as follows:

National Public Library (Newspapers)

DSE Library

SEC Library

Bangladesh Bank

Bangladesh Bureau of Statistics

Literature Research

Newspaper

1.3 Background of Stock Exchanges in Bangladesh

There are two stock exchanges in our country. A brief description about these two stockexchanges are given below:

Dhaka Stock Exchange:

The Dhaka Stock Exchange (DSE) is registered as a Public Limited Company and its

activities are regulated by its Articles of Association rules & regulations and bye-laws alongwith the Securities and Exchange Ordinance, 1969, Companies Act 1994 & Securities & Exchange Commission Act, 1993.

At The Time Of Incorporation The Authorized Capital Of The Exchange Was Rs. 300000Divided Into 150 Shares. Of Rs. 2000 each and by an extra ordinary general meetingadopted at the extra ordinary general meeting held on 22.02.1964 the authorized capital of the exchange was increased to Tk. 500000 divided into 250 shares of Tk. 2000 each. Thepaid up capital of the exchange now stood at Tk.460000 dividend into 230 shares of Tk.2000 each. However 35 shares out of 230 shares were issued at TK. 80, 00,000 only pershare of TK. 2000 with a premium of TK. 79, 98,000.

Although incorporated in 1954, the formal trading was started in 1956 at Narayanganj afterobtaining the certificates of commencement of business. But in 1958 it was shifted to Dhakaand started functioning at the Narayangonj chamber building in Motijheel C/A. On 01 st October 1957 the stock exchange purchase a land measuring 8.75 Kattah at 9F MotijheelC/A from the government and shifted the stock exchange to 9F Motijheel C/A.

Chittag ong Stock Exchange:

The Chittagong Stock Exchange (CSE) began its journey in 10th October of 1995 fromChittagong City through the cry-out trading system with the promise to create a state-of-the art bourse in the country.


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Founder members of the proposed Chittagong Stock Exchange approached the BangladeshGovernment in January 1995 and obtained the permission of the Securities and ExchangeCommission on February 12, 1995 for establishing the country's second stock exchange.The Exchange comprised of twelve Board members, presided by Mr. Amir Khosru MahmudChowdhury (MP) and run by an independent secretariat from the very first day of itsinception.

As legal entity CSE is a not-for-profit public limited company. All of its 129 members arecorporate bodies. It has a separate secretariat independent of policymaking Board. TheBoard comprises of brokers and non-brokers directors with equal proportion to ensure thetransparency. The Board constituted Committees to delegate such functions and authorityas it may deem fit. There is an independent secretariat headed by a full time Chief Executive Officer. CSE activities are regulated by its own regulations and bye laws alongwith the rules, orders and notification of the SEC.

2.0 Stock Market Crash in 1996Dwelling the pattern of market performances over 1980s and 1990s would provide someinsight into the nature of shocks that happened in 1996 period. The first ever marketdownturn experienced by Bangladesh was in 1989 which continued until 1991. The DSE All

Share Price Index fell from 533.6 in 1988 to 498.2 in 1989, 349.1 points in 1990 and finally296.2 in 1991. So the total percentage of fall was about 44% that was not dubbed asmarket crash because of relatively longer duration. Two important points are that over midto late 1980s Bangladesh economy suffered double digit inflation associated with worldwideeconomic downturn following 1987 market crash. Due to high domestic inflation, exchangerate was highly overvalued. And finally anti autocratic movements, all these factorscontributed toward that slump.

However, from 1992 onwards, the market begins to pick up again and it rose from 369.5 inJune 1992 to 959.1 in June, 1996 that means 160% rise in four years. From July 1996 toNovember 16 1996 DSI surged 213.75% and crashed by declining 38.21% within December22. Since then it fell further 29.31% in March 4, 1997 than December 22 level. So the totaldecline within 4 months was 56.32%!


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The third massive market scam was in 2010-2011 when market gained 92.07% just within11 months and finally fell around 41.66% within next 3 months periods. But this percentageterm might fail to detect the actual extent of crash. Considering absolute numerals statesthat during 11 months rise index gained 4275.12 points and slumped 3715.43 points over 3next three months. So the speed of fall substantially outperformed that of rise, as havebeen for most of the historical records.

The first shock was due to high domestic inflation and world recession; the second was notdue to the similar factors at all. The inflation rate from early to mid 1990s was very lowbetween 2-5%, exchange rate was stable, external reserve was growing substantially, thusthe economy was performing well. An abridged key statistics of major economic indicatorsare following [ 1 ]

On the basis of these favorable economic states, the price shock in 1996 seems to be due tosome other complex factors that drove the market wild and eventually crash [ 2 ] .

Table 2: Macro Economic Variables in Year 1996

GDP ($b) ExchangeRate

InterestRate

Inflation NationSavings(% ofGDP)

Budget deficit(% of GDP)

1991 20.8 36.6 9.25 7.221992 20.4 39 8.5 4.281993 20.9 39.4 6 -0.03 10.5 -5.41994 21.6 40.2 5.5 3.61 12 -51995 22.4 40.3 6 5.78 12.9 -5.3

Source: Bangladesh bank

698.93

3648.75

749.85

0

500

1000

1500

2000

2500

3000

35004000

Source: Monthly Review, Dhaka Stock Exchange

Period SD CV Range

Mar-95 16.15 1.97% 62.02

Jun-95 23.71 3.15% 84.67

Sep-95 22.70 2.92% 96.11

Dec-95 24.74 2.88% 72.39

Mar-96 22.73 2.86% 81.16

Jun-96 47.72 5.47% 166.31

Sep-96 225.41 17.99% 722.54

Dec-96 577.24 21.68% 1959.87

Mar-97 305.77 17.56% 1375.61

Jun-97 72.24 6.43% 339.80

Sep-97 87.66 9.31% 363.24

Dec-97 79.18 9.50% 273.67

Figure 1: DSI Index : 1995 - 1997


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expected to follow strict fairness and sense of honesty [ 6 ] . In DSE, Directors of listedcompanies were allowed to act as brokers, obviously which highly persuade malpracticeslike inside trading. Another crucial point is that DSE does not have a class of brokers knownas market makers in NYSE. These market makers are responsible for stabilizing the marketduring both abnormal price hike and depression by taking the opposite position intransaction. Director broker of the DSE acted for their own interest instead of to be the truemarket maker.

Acute shortage of fundamentally sound scripts made the investors passion run behind scrap securities

Short of fundamentally sound scripts has always been a crucial problem in Bangladesh

market. When market zeal reached sky high, psychological irrationality compound everypiece of information irrespective of real worth. This fanaticism geared the investors moneyrun behind some scrap issues and put the whole market prospect into questions.

From any perspective, this sizeable return was abnormal. And the fundamental strength of these firms was much wicker than most comparable entities. The ultimate output of thisspeculative game was unknowledgeable investors with these scrap holdings purchased atabnormally high price from the manipulators and got locked.

Widespread use of DVP system in transaction settlement that was totally suboptimal in nature from any perspective

One of the most dominant mechanisms used in price distortion was Delivery versuspayment (DVP) System that was bulk in nature, shown to dealt but not actually settled.Some estimates suggested that these failed DVP deals was around BDT 2 billion, certainlya substantial amount at any measure in 1996 price level! The main danger was whethersuch DVP transaction executed or not, set a price, that provide wrong signal about actualdemand or supply around a specific script thus distort price. Some DSE councilors admittedthese gross failures of DVP deals subsequently eroded the confidence of both foreign and

Table 3: % Price appreciation of selective companies during 1996 bubble

Name of Company % Price ChangeZeal Bangla Company 603.22Ambee Pharmaceutical 440.50Rupon Oil & Feeds Ltd 287.60Swan Textile 137.50

Bangladesh Monospool 83.21National Oxygen 59.62

Source: DSE Database


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local investors [ 7] . It was reported during the bubble formation in September to November1996 some influential brokers-members alone traded among themselves about 30% of totalshares transected on DSE. In value terms their trade amounted to BDT 2 billion out of totalamount BDT 7.07 billion. And most of the deals were under the coverage of DVP whereprice was fixed outside the trading floor. Under the relevant rules, the buyer and seller hadto declare the intention to settle the deal through DVP method. Declaration had to be on thetrading floor mentioning time and day. But in no case this time limit had to exceed thegeneral settlement periods of T+4 codified by Bangladesh rules. Matter of fact was thateither technically or intentionally large participants failed to strictly follow the code.

Cutback of bank deposit rate made relative rate of return from equity market more attractive to investors in general.

On September, 1996 deposit growth rate was only 8% against historical average growth of 15%. Since 1993 bank interest rate was only around 6% which was average 10.21% overyear 1985-1992. This reduced bank yield associated with augmentation in national savingsand stable budget deficit made the marginal savers to rush toward capital market forbagging handsome profit opportunity [ 8 ] .

Figure 3: Y2Y Interest Rate Level

Besides that, the market wide return gauge DSE All share index (DSI) generated a splendidaverage yearly return of 40% from year 1990-96 periods and 18% from 1990-1995 periods.As this return series includes numerous extreme values, if we take Median as the measureof representative gauge, it was 6%. Remind one very important notion, DSI return seriesdoesnt encompass periodic earnings distribution (dividend) by firms that are alsoconsidered as component of total return from equity investment. So in all respect equitymarket yielded much better return than that of bank deposits on risk unadjusted basis. If we take risk mathematics on this comparison, conclusion might change. But the burningquestion is that whether our market participants have resistance or competency to injectrisk appetite on investment decisions?

0

2

4

6

8

10

12

1987 1989 1991 1993 1995

InterestRate(%)

-10

-5

0

5

10

15

1993 1994 1995

10.5 1212.9

-5.4 -5 -5.3

Nation Savings(% of GDP)

Budget deficit (% of GDP)

Figure 2: National Savings & Budget Deficit in FY 1995-


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Figure 4: Y2Y Return of DSI

Corporate Insiders used material non public information to take undue advantage over public in general

The independent committee formed to investigate the probable reasons behind the 1996scam accused the malpractices by some companies insiders who pursued a policy of inducing public interest in respective share(s) through making news in the press whichcame in the form of announcement of the company later on. In most cases main parties,

either as buyers or sellers, were the sister concerns and associates. Besides that significantportion of the total shares traded of the same entities were accomplished through selective3-4 trade houses. It was observed large portion of securities sold through these houses viaDVP couldnt be traced directly in DSE record. Even statements submitted by several foreignbanks proved the disagreement between actual shares sold and record kept for the same inDSE. The chronicle of malpractices has yet to end! Firm insiders sale shares to outsidersbypassing both of the stock exchanges, while they even showed reluctance to reply SECinquiry in this regards. Besides that the committee found that in foreign fund account anamount of BDT 2820 million remained unsettled for long, which directly violated Section 17of Securities & Exchange Ordinance, 1969 thus a clear sign of manipulation.

Lack of modernization like electronic trading, zero involvement of DSE in settlement, existence of Kerb Market etc had great deal of impacts on bubble creation

Prior to originating Central Depository Bangladesh Ltd (CDBL), shares certificates weremainly in paper format that were defenseless in terms of physical sustenance, forgery,mismatch of sellers signature, return of certificates without registering in the name of buyeretc. it took around 40-60 days after buying to register in the name of buyer [ 9 ] . So in allcases the traded shares were not the part of legally issued capital of respected companies

-100% 0% 100% 200%

1990

1991

1992

1993

1994

1995

1996

DSI Return(%)


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or alternatively these certificates just were printed sheets of paper, some of whichregularized later by backdated issues and return of allotment. A printing press of counterfeitshares certificates was detected and more or less everyday kerb market trader has to dealwith these inconvenient situations [ 1 0 ] . Another major infrastructural drawback was non-involvement of Stock Exchanges on trade settlement process. By using this discretion, stockbrokers and dealers intentionally booked fake higher bid quote on buying side of order bookthat pursued retail investors to bid in a price inconsistent with fundamental strength [ 1 1 ] .

Existence of informal Kerb market which neither compiled with any regulation nor formal trading procedure

Here was an informal Kerb Market outside both of stock exchanges which was completely

informal in nature that it didnt abide any regulations. This market started in the early of themorning and continued till past dusk. The bidding process was basically outcry system thatpersuaded participants to ask for sale immediately after buying a particular script(s). As,most of the participants possessed very slight to no knowledge about stock marketfundamentals; zeal and associated price hike was quite abnormal. Alongside absence of anyprice ceiling forced a BDT 500 script leaped to BDT 2500 within a single day. In most casesbidding price was substantially higher than formal trade floor that persuaded even brokersto buy from trade floor and instantly sell the same in Kerb market and bagged abnormalarbitrage opportunity. Still price discrepancies made some traders to buy script(s) fromDhaka in morning and sell it Chittagong in the same evening [ 1 2 ] .

Opportunity tapping attitude of issuers that inscribed substantially overvalued IPO and secondary issue

One of the mere responsibilities of SEC is to establish fairness in respect of IPO and Rightissuance that ensure full protection of investors interest. Key issues that need to scrutinizeare timing, purpose and most vitally pricing. In some instances of early 1997, SEC seemsoverlook general investors interest in the favor of issuing firm(s). One such case was theright offer of Alpha Tobacco Manufacturing Co Ltd which consist three very unique features.Firstly, the offer was made without issuing any offer document. Secondly, full and fairdisclosure regarding past and prospective performance, and utilization of right issuance fundwere not depicted. Thirdly, the right offer was made at an abnormally high premium of BDT240 against BDT 10 face value, thus an astonishing 2400% premium! The previous highestpremium for IPO was 800% for Square Pharmaceuticals and 1100% for Apex Foods andBeximco Pharmaceuticals that was fairly backed by their NAV, Earning based value etc,except the case of Apex Food. But the market of Alpha Tobacco as on January 5, 1997 wasBDT 201, obviously much lower than the intended right offering price. In addition to thatlast audited NAV was BDT 39.69 and earnings based value was determined to BDT 139based on market PE of 20 multiple. So by considering all these valuation numbers the offerprice of Alpha was obviously unjustified. The SEC, at that time, completely failed to carry


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out its surveillance duty and no specific guidelines were found for stopping such amalpractice. Later within January 31 the market price of the share come below BDT 185.

The following tables depict the Right Share register that was offered during the period 1995& 1996.

As the share prices of most of the issues surged abnormally to an all time high during 1996bullish, some companies deliberately took the opportunity and offered right share at veryhigh premium, mostly were not justified by dividend pattern. Moreover average one yearprices that also include September to November abnormal hike were not in the line, if thatabnormal hike were deducted. Keep reality on mind one investor quoted I had received theletter of Right offer from the company few days back and threw it away as I can now buythe same from the exchange at much lower rate [ 1 3 ] .

Table 4: Right Share Offerings in Year 1995

Company Name Bonus Right Dividend(%) Average Price

Ratio Premium Issue PriceIslami Bank 1:1 1000 2013.15NBL 7.5:100 1:3 100 200 10 119.32Shine Pukur 125:1 100 94.97Ashraf Textile 1:4 1:2 10 20 28.63ACI 2:5 120 130 131.23Lexco 1:1 100 22 819.53Quasem Drycell 1:1 10 20 23.47GQ Ballpen 1:2 90 100 55 149.99

Table 5: Right Share Offerings in Year 1996

Company Name Bonu Right Dividend(%)Ratio Premium Issue Price

Apex Food 1:1 1:1 1100 1200Apex Tanerry 1:1 475 575Chittagong Cement 1:2 1:2 1000 1100 20Tripti Industries 1:2 125 225Orion Infusion 1:2 100 17Alpha Tobacco 1:3 1:3 240 250Delta Miller 1:1 100 15Chic Tex 3:5 10BCI 1:1 200 300Raspit Food 1:1 100 200Olympic Industrie 1:2 3:2 500 600Tripti 1:1 125 225AMC 1:1 100 200

Sources: Mazhar M Islam, Texas A&M University.


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Lack of proper investing knowledge and behavioral irrationally of most investors drove the bubble to become bigger

When such irrationalities are dominant, stock prices might deviate from their fundamentalvalues for long periods. Rising stock prices mostly creates over optimism. If investors simplyextrapolate from past returns to predict future return, a stock might become high priced forno reason other than the fact that its price has increased in the past. Each new investor issomehow convinced that the upward swing in prices will continue infinitely and even buyingstocks at abnormally high prices is justified by the prospect of short term gain. Precisely ourinvestors positive market psychology was not created from fundamentals but was the resultof collusive bulk trading of shares by a few large brokers [ 1 4 ] . Sometimes, thesetransactions were not executed as per the DSE rules.

Faulty measures taken by the regulators

Dhaka Stock Exchange: September to October 1996 stock markets were very heated andindex, transaction and market capitalization level were abnormal. Normally in the developedstock market, such sharp amplification without any true economic backup would have beenfollowed by at least temporary suspension of trading of overheated scripts. But the DSEdidnt take any action in the shape of suspension of trading or investigation into theanomalous augmentation in trends. DSE Chairman himself admitted in the press that DVPdeals shouldnt be accused as price manipulators, rather dubbed as scope for maneuveringin the market.

Securities & Exchange Commission: Both SEC and DSE have been operated as Self Regulatory Organization (SRO) while it is obviously unwise to draw an explicit and rigid linebetween the government and SROs. Best practice is to conduct frequent communication,coordination and consultation between them and take necessary measures, if necessary. Ina meeting organized by FBCCI, the Finance Minister reportedly announced that SEC wouldbe reorganized with new recruitments in policy making level and allegations of pricemanipulation and inside trading would be probed. In this regards government took somesteps like 1) formation of a non judicial enquiry committee, 2) two professional members of SEC were removed in the face of allegations against them and 3) two new members wereappointed. But were these steps appropriate or adequate to solve the problems?Subsequently it was proved that government steps were not effective in the short run withthe aim of sharpen the efficiency of SEC. Ultimately the result was that the SEC failed toprotect the interest of the investors, why only two policy makers were suspended? Whatabout the responsibility of SEC Chairman, who was also the Chief Executive Officer?

Government: In the time of bubble formation many in the government bagged the credit inthe short lived optimism despite its backless situation from real economy. Tremendousinterest shown by the public in the market was certainly a positive sign for industrializationof Bangladesh. This interest should be restored by the government itself by stabilizing themarket, ensuring transparency in operations and cumulatively, guarantee an environment


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with proper code of conducts and ethics practiced by the investment related professionals.The Ministry of Finance should be very active and cautions in formulating policy related toboth money and capital market so that interrelated variables do affect each other.

2.2 Calendar Chronicles in 1996

This relevant section tries to portray day by day proceedings in both stock exchanges duringthe most tempted moment of November and December 1996. This discussion covers retailinvestors action, regulators endeavors, government response, malpractices by brokers,members and corporate insiders which would facilitate the understanding of 1996 scam.

November 2 nd : Huge volume of trading, but it was limited to some selective issues like

Bata Shoe, Beximco Pharma, Chic Textile, Monno Ceramic, SP Ceramic, Eastern Housing,ACI and Ashraf Textile. The market index gained 171.17 points from the previous day andended the day with 3157.46 points.

November 3 rd : Bank rate and floor rate of deposits were increased to raise the flow of deposit. This rise was obviously to pursue depositors to supply fund that would enablebanks to continue their normal lending business. Why banks normal lending operation wasinterrupted? It can be explained from two perspectives. Firstly, deposit GR decreased to8% as on 19 th September that enjoyed historical average GR of 15%. A high official from BBdenied this capital market rush besides that Banks is running out of liquidity. Lending ratewas not allowed to augment that means % spread remained around 8%. BB Governor

himself claimed that savings from banks are not going to capital market. The marketcontinued its bullish run and the index reached 3352.10 points which is 194.64 pointshigher from previous level.

November 4 t h : Acute supply shortage in trading floor in addition to price ceiling. Butuninterrupted price hike in Kerb Market that made Tk. 500 shares to jump to Tk. 2500within a single day. Nevertheless, thousands of investors bid the hike at this abnormal price.Situation was like that, immediately after buying a certain scripts traders were asking forthe same! This so called out market continued till night that started in 9 am. As it wasNovember, large companies bonus and right issues were announced that add incrementalfuel to market zeal. Even market overreacted with the notice of AGM and EGM. The indexvalue was 3587.69 with a substantial gain of 235.59 points from the previous day.

November 5 th : BB stopped loan against share certificates, previously which was 40% of equity that can be taken by any eligible client. Besides deposit shortages, two IPOpressurized overall bank liquidity that pursues investors to withdraw more fund from banks.As a consequence, some banks failed to honor depositors claims on timely manner and abank official informed that they were in l iquidity crunch. In contrast, BB informed that bankshad ample liquidity as banks were investing in BB bills and not fully exploiting BB discountswindows. BB further informed that surplus on banking system stood BDT 13 billion. Heidentified banks rush to unofficial kerb market as the possible reason of liquidity crunch.


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November 20 t h : Brokers didnt take any buy order. Shortage of funds was started. Themarket seemed to have some corrections as the index continued to fall for the last 4 daysand touched 3298.05 points, losing 328.97 points

November 22 t h : Circuit breaker was set to 5%. Government decided to form a NationalStock Exchange with automated facilities. A change in the policy making body occurred asthe new BB governor, Mr. Lutfar Rahman Sarkar took the charge. Stoppage of bank loanfacilities very adversely affected market confidences. Despite formal market was closedbecause of lack of Members Coram, informal kerb market was open.

November 23 rd : No foreign investors were buying, with excessive selling force in motion.BDT 5000 million was washed out to Mark and HR Textile IPO and Marks share were sellingin forward basis.

November 24 t h : Dhaka and Chittagong Stock Exchange ware booming again. The DSIindex continued to rise for two consecutive days and it ended up with 3368.04 points.However, foreign investors were involved in selling shares. Turnover slowed down becauseinvestors were reluctant to sell shares with high capital loss that encumbered a substantialportion of funds.

November 25 th : Several investors didnt come to the floor to take delivery of orderedshares that make brokers fund to tie up. Huge chaos and procession took place in front of DSE building at Motijheel as the index again started to fall. At the end of the day the indexdropped to 3317.58 points.

November 28 th : No cooperation among stock exchanges, SEC and Government in additionto lack of money supply because of halting bank loan. There was another surprising findingsalso. Participants blamed that brokers purchase shares on behalf of customers at lower rateduring market slump and later handed the same in the name of previous higher price.Besides that as there was no participation of stock exchanges in settlement process, brokersinscribed fake buy order at higher price in order book to make the customers believe thatthese particular issue(s) has/have higher demand and pursue them to bid for the same.Retail investors showed protest and violent demonstration in front of DSE building accusingthe brokers as the culprits. The index fell by substantial amount and dropped to 3033.37points.

November 29 t h : Margin loan facilities that were halted on 10 th November, 1996 revivedagain at 1:0.40 ratios, while the ceiling for a single customer was BDT 1 million. ICB startedto purchase shares as instructed by the government. These measures helped the index togain 31.62 points on this day and the index touched 3064.99 points.

December 2 n d : Total BDT 10000 million was halted on the IPO of 6 companies and ICBcame up with BDT 1250 million funds to stimulate buying side. The index continued to losepoints and it ended with 2921.70 points.


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December 4 t h : Trading in formal market for less than half hour. Sell pressure was allaround but it became very difficult to find buyers. Share buying by ICB and margin loanenhancement eventually failed to stabilize the market as the index again lost 67.28 pointsand reached 2718.90 levels. Experts identified some possible reasons for market slump: 6IPOs with more than BDT 10000 million; credit crunch; lack of participation of institutionalinvestors who have already grabbed around BDT 100000-150000 million profits frommarket; lack of proper stabilization measures from regulatory authorities.

December 5 th : Government stated price slide as logical correction and declared that theywould come up with Contingency Plan only if index would fall around 1500 points as indexwent 2718 points just from 1000 within 2 weeks. Ministerial policy sometimes didnt work inthe short run and further destabilized the market and investors confidence. The index fell51.74 points again to reach 2667.16 points level.

December 8 th : Lowest ever transaction in history. Finance minister stated that he will gofor action if index comes down to 1500 points, that he thought quite rational level. Indexwas at 2618.35 points after experiencing decline for six consecutive days. Meanwhile, SmallShare Investors Forum started 11 point movement demanding kerb market legalization andquick delivery of refund warrants as well as share certificates.

December 1 2 th : The same share traded in floor at BDT 2500 was asked BDT 3600 in kerbmarket. Massive sale pressure continued. However, the index took a pause after six dayfalling and recorded a marginal gain. The index value was 2656.65.

December 21 th : Another record in lowest trading. Market slumped again after two daysBull Run. Basically economic downturn, banking year end and liquidity crisis were attributedto this slump. Index continued its falling trend and lost 176 points in the last 3 days. Theindex ended the day with 2514.15 points.

December 26 th : IMF prescribed some stringent measures to BB includes: adoptingstringent monetary policy by squeezing loan supply in unproductive sectors, besides loansqueezing in banking sector; no loan to public sector firms more than BDT 2500 million;building foreign reserve to USD 2300 million within June, 1997 that was less than USD 2000million in that time; keep the broad money GR within 8-10%; withdraw control over interestrate. The index value was 2269.51 losing 1357.51 points (37.43%) in just 30 days.

December 2 8 t h : There were hardly any buyers. An investigation committee was formed inthe face of questions about SECs fairness and capacity. The index reached 2241.83 pointslevel by losing another 27.67 points.


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Figure 5: Calendar Chronicles in 1996

Participantsaccused theSEC for not

taking propermeasure

5% Circuitbreakerimposed

Chaso &procession in

DSEMarginloan

ressurected

Lowestever

transaction

IMFprescribed

somestringentmeasures

Very fewbuyers

Bank rateincreasedBB stopped

loan againstshare

certificate

Shortage offund started

Brokersdenied to take

buy orders

ICB cameup with f resh

fundGovt.

dubbedmassive fall as

correction

Anotherrecord in

lowest t rading

WEEK1

WEEK2

WEEK3

WEEK4

WEEK1

WEEK2

WEEK3

WEEK4

NOVEMBER 1996 DECEMBER 1996


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Table 6: IPO Offerings in Year 1996

Company IPO Size (BDT) Subscription(BDT) Oversubscription(BDT)

Over sub.Ratio

StandardCeramics

43,950,000 2,254,395,000 2,250,000,000 51.22

MarkIndustry

270,000,000 3,750,000,000 105,000,000 13.89

MAKEnterprise

83,750,000 1,760,000,000 1,676,250,000 20.95

HR Textile 100,000,000 1,480,000,000 1,380,000,000 14.80ExcelsiorShoes

100,000,000 2,100,000,000 2,000,000,000 21.00

BSRS MutualFund

50,000,000 660,000,000 610,000,000 13.20

2.4 Causes Behind The Plunge

Unplanned and untimely IPO that made substantial amount of money to lock in, thus created acute liquidity crisis

General rule is that firms indented to enter into market to collect growth fund in bullishonslaught. And as our market historically generated abnormal first day return for IPO withvirtually no risk of losing, both nave and knowledgeable investors always perceive IPO asgold mine without any efforts. Being conscious about these market emotions, issuers alsotarget such time when capital market become flooded with excessive money that pave theirway to collect double digit time fund in comparison to actual subscription value. As onDecember 1996, 6 companies issued BDT 650 million while total applied amount wasaround BDT 12000 million. That means oversubscription of around BDT 11350 million.

The following table shows the IPO over subscription details of these 6 companies:

Basically 7-9 days were allowed to investors to deposit application money that wasabnormally high than that of practices followed in regional markets like India, Pakistan,Singapore etc. In the same time issuing companies unduly delayed to issue refund warrantmostly that delayed for 1.5 to 2 months without providing any yield to investors. In thisinterim periods these issuing companies generated millions form interest income [ 1 5 ] .

Brokers denied executing clients purchase order rather transecting fundamentally sound shares among themselves

After the slump began when the price of most fundamentally sound scripts weredownward, knowledgeable investors tried to buy these scripts at relatively cheaply. But


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brokers made them wait for long after submitting buy order and most cases these orderwere not honored. Rather brokers transferred these sound scripts among themselves. EvenICB was made deprived from buying these stocks directly from formal trade floor [ 1 6 ] .

Allowing liberal policies for foreign portfolio investment

With the aim of encouraging foreign investors to invest in capital market, government tooksome very liberal measures in terms of foreign portfolio investment, all of these were notequally innocent rather pave the way to free repatriation in time of slump. Some of thesemeasures that accelerated market crash are followings:

Free repatriation of capital and fully abolishing capital gain tax Withdrawal of all regulatory restrictions on international portfolio investors for

investing in secondary securities market. Underwriting by foreign investors op to one-third of IPO and right issues. Withdrawal of ceiling on holding of international portfolio investors. Allowing foreign investors to participate in IPO and right issues without any

regulatory restrictions [ 1 7 ] .

Liberal policy pursued by government that made the fund transfer across border relatively easier

It was reported that during market zeal in October-November 1996 foreigners repatriatedaround US 110 million or BDT 4260 million from stock markets that was substantially higherthan the inflow in same sector. And all of these funds were repatriated through formalbanking channel. Besides that another several million funds are repatriated viainformal/illegal channel by using hundi. These excessive fund outflows highly pressurizedforeign reserve that stood US 1860 million in November 1996 against US 2070 million inJune and US 2041 million in August, same year. In FY 1995-96 the level of net foreigninvestment was zero that was first deficit year is 1990s. In comparison to that, FY 1994-95observed net FDI of US 60 million and Portfolio investment of US 610 million. In FY 1993-94, net FDI was US 160 million and Portfolio investment was US 530 million. The observedfigure indicates that foreign investment situation become worse day by day [ 1 8 ] .

Foreign portfolio investment scenario for the year 1993-94 and 1994-95 are shown belowthat will facilitate the comparison with year 1996 [ 1 9 ] .


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Ministerial statement in the media broke investors confidence on market

After November 16 when the overall market experienced extreme sluggish trends in termsof index, activities slump, then Finance Minister stated on a press conference that thisslump is just a price correction and he will dub it as real crash after coming below 1500points. On the same day DSI was 2718.90 points which comes below his stated level justwithin two-half months [ 2 0 ] .

SEC regulation did not improve the situation

On March 1997, SEC suddenly and most importantly silently halted the right of shareholdersto transfer securities freely and unrestrictedly. This restriction didnt comply with theSection 8(3) of Securities & Exchange Ordinance 1969 and damaged investors confidenceand seemed untimely action. SEC banned Kerb market activities and it contributed lot forreducing the efficiency in capital market operations. Now the critical thinking is that whenKerb market was forming outside the formal trading floor and thousand of unknowledgeableinvestors becoming engaged with their risk capital, where were all of these prudent (!)decisions? Rationally, if anyone treats anything as incorrect, he/she should come up withright attempt in right time before it do any severe damage, so timing is the decisive point.In contrast, SEC did it in such a moment when confidence restoration was much more

essential than applying justice[ 2 1 ]

.

Collinear movement of all market participants

In an inefficient market, more or less all scripts irrespective of fundamental strength ordividend pattern showed approximate positive unit Beta (measure of responsiveness) withoverall market movement. And this prototype remained the same in both market zeal andslump. Especially during massive fall, most fundamentally strong shares price went farbelow respective intrinsic value. Again during market acceleration gain was shared by all

Table 7: Foreign Portfolio Investment

Indicators 1994-95 1993-94 % ChangeGross portfolio capital Inflow 3094.4 3196.6 -3.20%Gross portfolio Investment 2982.7 3101.8 -3.84%Gross Proceed of Securities Sold 1334.2 965.1 38.24%Capital gain 406.1 454.6 -10.67%Dividends 92.7 17.6 426.70%Gross portfolio capital outflow 1388.9 918.4 51.23%

Source: SEC Annual Reports, 1993-96


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scripts, whether sound, bad or even fake. Even companies that have either no existence orproductive capacity experienced windfall gain. These close co-movement of all scripts couldbe produced by lack of sufficient market knowledge possessed by general participants, whoalways tried to imitate the investment strategy adopted by so called reliable role model,irrespective of his/her actual motive. In a market with large bunch of naives everythingcould be possible even by modest knowledge possessor [ 2 2 ] .

Tight monetary policy and bank liquidity crunch

On late December 1996, when market went through severe plunge associated with liquidityshortage, IMF instructed Bangladesh Bank to follow some stringent measures [ 2 3 ] thatarguably worsen the situation. Among the suggestions were- contacting money supply in

unproductive sector and banking sector, rebuild foreign reserve to US 2300 million frombelow US 200 million ceiling of BDT 2500 million on loan granted to public sector, withdrawcontrol over interest and most importantly, squeeze broad money supply growth rate to 8-10%. All these factors restricted BB from pumping ample cash into economy and propelledlong term capital market recession.

But prior to these measures, on late October 1996, overall Banking sector running liquiditydifficulties stem from lower growth in deposit and incremental withdrawal of funds ahead of some large IPOs. [2 4 ] [2 5 ]. Surprisingly then BB officials denied these liquidity crunches andexclaimed stating that total excess fund was BDT 13000 million in Banking system withBanks reluctance to use BB discount window.


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3.0 Stock Market Crash in 2010This part of the report deals with the stock market crash in 2010. As mentioned earlier,after 14 years, our capital market once again experienced a huge capital influx followed bymassive slump. A scrutinized analysis of this crash is covered in this part.

Figure 6: How the Bubble Formulated in 2010

3.1 Beginning of Bubble

The creation of bubble started back from 2009. The worldwide financial recession in 2008slowed the pace of world economy as well as the economies of major partner countries of our country. That was the time, when excess liquidity in banks was started to climbing up.The recession in 2008 caused the export to fall substantially. The demand for loanable fundsalso decreased due to ongoing energy crisis particularly power failure. Banks credit alsodeclined due to lower import orders for capital machinery as well as falling trend of majorcommodities prices in the global market. Import orders for capital machinery plummeted bynearly 30% in the fiscal year ended on June 30, 2009.

Excess Liquidity Low Growth of Real Economy Power Shortage Excess broad money Releasing funds for ADP

How The Liquidity ComesInto Market Banks & NBFIs Over exposure Credit Diversion Deposit Rate Curtail Savings Certificate InterestCurtail

Black Money Whitening Low taxes

How The Liquidity UsedIn Manipulation Corporate Announcement Frequent Intervention byRegulators

Manipulated Audited Accounts Right Share/Split Book Building/Direct Listing Private Placement Asset Revaluation


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Releasing funds for ADP (Annual Development Programmes) projects also pushed up theliquidity in banks.

Figure 7: Excess Liquidity

Source: Monthly Major Economic Indicators, Bangladesh Bank

Another factor that affected the liquidity and inflation was the high growth rate of broadmoney (M2). During the last two years, the average growth rate of broad money was19.96%. This was substantially higher than the average nominal GDP growth rate (12.63%)of the same period. This happened because of an unintended consequence of our exchangerate policy. The cost of keeping the taka undervalued has been the excess growth in moneysupply. The 7.33% excess supply of money contributed to drive up the inflation and excessliquidity.

The excess liquidity reached its highest peak of Tk.347 billion in June 2009. Banks, in anattempt to reduce the cost of such excess funds, invested heavily in treasury bills andbonds. A substantial amount of fund also went to the capital market for making quick profitsin the backdrop of rising inflation. Due to poor monitoring by regulator, 11 banks crossedtheir capital market exposure limit of 10%. For some the exposure limit went as high as

35%.

3.2 How The Liquidity Comes Into Market

The excess liquidity that formed in the economy found its way in capital market throughvarious channels. As mentioned earlier, several policies set by the regulatory bodies alsohelped quick channeling of funds into capital market. These policies, categorized by thepolicy makers, are analyzed below:

05000

10000

15000

20000

25000

30000

35000

40000

Tk. in crore

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

Figure 8: Growth Rates of Domestic Credit & BroadMoney (Year on Year)


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3.2.1 The Bangladesh Bank Policies

The policies involving the Bangladesh Bank that helped to transfer liquidity in capital marketare discussed below:

Banks exposure on capital market

On mid October 2010, it was reported that overall Banking industrys capital marketexposure as on August 2010 reached to some hazardous level. 12 banks were identifiedwith capital market exposure exceeding 10% of respective total liabilities, a standard set byBB as on international best practice. Despite overall industrys exposure around 6.3% oncapital market these 12 banks exposure range from 10-24%. Obviously this profiteeringmotive made the whole industry significantly diverge from their core lending-borrowingbusiness that not only impair sustenance of banks but also dampened the overall realeconomic activities.

Figure 9: Banks That Exceed Exposure Limit

Source: The Daily Star, October 18 th 2010

However there existed differences between BB and banks about the exact definition of exposure. BB definition of exposure included own portfolio of shares on market price, shareunder lien, and share under custody. But banks had severe objection about the basis of valuing the exposure who tried to pursue BB that cost price might be a relatively fair valuemeasure of exposure. BB denied this claim without any constructive discussion and referredinternational practice on their standings. Banks also added their dissatisfaction aboutincluding customers purchased share through banks beneficiary owner (BO).

0 5 10 15 20 25 30

Shahjalal

The City

One Bank

Standard

MTBL

IFIC


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Situation Anatom y:

Simple economic consensus asserts that investors always value relative rate of return when

comparing alternative investment opportunities. In a situation where cap was imposed onlending rate of prime productive sectors to stimulate real growth simultaneously withextremely abnormal high return prospect in capital market, how bank management couldresist them from diverging operational core? Historically market participants of our countryseldom input risk variables in investment decision model if high return prospect isperceived. Now it is BB who has to make sure that the rules of game is fair and consistentwith professional code of conduct. That is to say BB is the definitive supervisor of bankingindustry and it is their mere responsibility to back the banking firms on track. Obviously thestated over exposure not happened overnight, rather it was a gradual process. If BBsrespective department(s) inspect the banks capital market exposure on daily basis,certainly overexposure would detected before crossing the specified level. We think there

should have some margin call type limit reminder that would automatically send warningmessage when 7-8% limit would crossed and send another final warning after exceeding9.75% limit. Hopefully this automated warning system could prevent banks fromsubstantially made the prospective core business perilous and vulnerable.

Lending cap & subsequent reduction of deposit rates

As Bangladesh was one of the countries that showed immunity from 2008 Global recession,interest rate was not substantially decreased in comparison to world market. With the aimof boosting industrial growth that showed 6% growth in comparison to 7% of last year, BB

capped lending rate to 13% for five prime sectors like agriculture, real estate, term loan tosmall & medium industry, working capital to small & medium industry and trade finance.Despite this lending rate reduction, interest spread would remain above 5% withoutsimultaneous increase in deposit rate. Mentionable here with a substantial asset base 3%spread is good enough to keep a bank profitable. More importantly, banks shouldconcentrate on increasing client base that would automatically augment profit base with thehelp of economies of scale. But obviously they didnt think so compactly and immediatelyreduced deposit rates twice in a short period of five months [ 2 6 ] .

Situation Anatom y:

Following 2.5% cut in corporate taxes for banks, interest rate was expected to reflect thatcut. Rather banks elaborated the lending rate cap from previous 16 %+ rate as reduction indeposit rate. Relative rate of return concept discussed earlier forced the depositors to cashout even fixed deposit from banks and rushed toward capital market with excess fund.

Diversion of funds to capital market

Since the 2008 global recession that was followed by acute power and infrastructure crisis,overall economic activities slowed down. A large number of exports oriented and otherindustries were struggling to secure the minimal return on investment. Private investment


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during FY 2009-10 was BDT 1362.8 billion (19.7% of GDP), with the lowest level of growthin last 5 years [ 2 7 ] . This slowdown basically derived from power and gas shortages thatforced export oriented sector to rely on costly source of power (petroleum) to keep theoperation continuing. Certainly it pressurized margin ratios and in some extreme cases shutthe operation as a whole. But the scenarios of credit disbursement depicted completelyreverse image.

Figure 10: Growths of Domestic Credit & Broad Money

Some of such unethical fund diversion was detected by Bangladesh Bank Surveillance Team.One was the case of Loadstar Fashion, who borrowed BDT 420 million as Industrial Credit

from EXIM Bank and diverted BDT 370 million to capital market. Another fund diversiondetection was Cosmos Enterprise who diverted BDT 50 million by taking loan in the name of industrial credit [ 2 8 ] .

Situation Anatomy:

It is the mere responsibility of central bank to track the dissemination and destination of loan portfolio that flow from banking sector to real economy. Obviously as a single entity itis so tough to BB to serve the whole purpose. Thats why banks have to provide cordial allout support to BB in this regard. But it is not very pragmatic without proper force ormotivation in action. The BB governor said in the announcing of MPS of 2 nd half in fiscal

"Strict surveillance will be there to discourage expansion of bank loan in the wasteful andunproductive sectors to prevent inflationary pressure caused by excessive growth of domestic credit." [ 2 9 ] In July, the central bank in its MPS for the first half of FY 2010-11aimed at bringing down private sector credit growth to 16% by next June from 24% of Junelast. As already mentioned BB must have to take proper feat to establish fair law of gameand pursue banks to fully comply with it.

0.00%

5.00%

10.00%15.00%

20.00%

25.00%

2005-06 2008-09

Industry Growth Domestic Credit Growth


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3.2.2 The Government Policies

The policies involving the government that helped to transfer liquidity in capital market arediscussed below:

Reduction of NSD certificates interest rate

After the introduction of lending cap on bank lending rates and subsequent reduction inbank deposit rates, the sale of NSD certificates increased substantially. In March 2010, thegrowth of net sales of NSD certificates reached 869% on year on year basis. Thegovernment in its 2010-11 fiscal budgets reduced the interest rate on its NSD certificates inan attempt to bring down its borrowing costs. The government also imposed an advance10% tax deduction on the interest income. The table below shows the revised interestrates:

On an average, all rates were decreased by 1.50%. In June 2010, the inflation rate was8.70% and the weighted average bank deposit rate was 5.95%. The low real interest ratesfrom these popular investment sectors forced many savers to look for better alternativeinvestment opportunities. At that period, the capital market was booming with increasedturnover and higher rate of returns. As a result, a huge flow of funds switched to capitalmarket which would otherwise invested in other sectors. This scenario can be sensed fromthe following graph. The growth of net sales of NSD certificates on year over year (Y-o-Y)basis experienced a sharp decline and became negative. In November 2010, the growth was-81.3%.

Figure 11: Growth of Net Sales of NSD Certificates (Y-o-Y)

-200%0%

200%400%600%800%

1000%


Table 8: Revised Interest Rates on NSD Certificate

Scheme Revised Rate Previous Rate5 Year Bangladesh Sanchay Patra 10.50 12.00%3 Year (3 month interval profit) 10.00 11.50%Post office fixed deposit 1 year 8.00% 9.00Post office fixed deposit 2 year 9.00% 10.00%Post office fixed deposit 3 year 10.00 11.50%Family savings certificates 11.04 NEW SCHEME (ONLY FOR FEMALES)



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Black Money Provision

The present government in its first fiscal budget for 2009-10 kept a provision for whiteningof black money. On payment of a nominal 10% tax the government allowed legalizing of black money for investments in any of the three categories; industries and BMRE projects,share market and purchase of apartments.

The share market investment was subject to a two year lock-in-period. However, there wereno specific guidelines. It is anticipated that, a huge amount of money flowed to the capitalmarket at that time because of phenomenal gains that the sector was fetching. In fiscal2009-2010, 296 persons took the opportunity and whitened Tk. 4.27 billion. But the actualfigure was substantially higher than the recorded figure as there is no accurate mechanismof identifying and checking the entry of 'black money'.

The National Board of Revenue (NBR) refuted the allegation that the offer of the taxadministrator to whiten 'black money' has resulted in an overheated capital market. Thegovernment, however, scrapped this provision in its last fiscal budget for 2010-11.

Capital Gain Tax

Observing the rapid growth of capital market and record level of turnovers, the governmentin the last year budget imposed 5.0% capital gain tax on securities of sponsor shareholdersand directors of banks, financial organizations, merchant banks, insurance and leasingcompanies, portfolio management companies, stock dealers and stock brokers. However, it

kept the retail investors untaxed. The government also imposed for the first time a 3% taxon the premium value of shares. The government further increased tax at source onstockbroker commissions from 0.025% to 0.05%.

From an analytical point of view these moves were taken at the very right time when theindex was at 6153 points level. Exemption on capital gain tax encourages short-termspeculative investments by the investors in the secondary stock market. As such, tax oncapital gains would limit the free flow of funds. Most of the countries including India andPakistan have tax on capital gains at varying rates.

The provision for taxes on premium share value drew some criticisms. Capital marketgeniuses affirmed that such a provision is contrary to the basic principles of taxation, as thetax on the premium value of shares basically amounts to taxing the equity of a company,which goes against taxation principles. But the government remained strict to its decision.


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3.3 How The Liquidity Used In Malpractice

This part of the report deals with how the liquidity was used in influencing the stock prices.It also covers the policies that helped speculators in making profits.

3.3.1 The Corporate Announcements & SEC Policies

Corporate announcements play an important role in appreciation or depreciation of stockprices. Because of strong relationship between announcement and price, manipulators haveused this as a weapon to change the price levels. All these types of announcements alongwith some SEC policies which gave opportunities to speculators are discussed below:

Right Share

A total of Tk. 20.145 billion (2014.5 crore) has been raised by 16 companies throughannouncing right shares between July 2010 and second week of December 2010. (DuringFY2009-10, only two companies raised capital through offering right shares which wasamounted to be Tk.716.22 crore) [ 3 0 ] in response to the every right share announcementmarket zeal soared sky high that failed to take into consideration respective companies fundamentals and relative valuation parameters, actual purpose of issuing right shares andfeasibility of stated projects. Basically banking institutions had some regulatory obligation tomeet specified % of risk weighted capital within June, 2011 that pursued them to take the

windfall opportunity of booming market and issue right shares to fill capital gap. With thewake of banking institutions other firms also came with seasoned offering most whichpricing was not very justifiable. The basic traders psychology was to multiply their investingshares. They had no conception about what are they buying at what price and mostimportantly, after right adjustment what should be the price. Obviously SEC had lot to do toprotect this scam by vigorously verifying issuers offering purpose and price the issue in theline with fundamental strength.

Bonus Share

Another corporate announcement that virtually had no fundamental backings was Bonusshare offerings. Conceptually bonus share has no impact on shareholders value as it is amere transfer of fund from retained earnings/reserve to capital accounts that leave bookvalue of equity unchanged. But market participants responded as if they found an open goldmine gifted by companies management. Most sizzling zeal was seen with theannouncement of 143% bonus share of UCBL that accumulated preceding 3 years bonus.On 13 th June 2010, market price of UCBL was BDT 1620 that soared to BDT 3090 on 18 th July then dropped to BDT 2690 within 15 days just before the actual announcement. Afterbonus announcement adjusted price was set to BDT 1210 [ 3 1 ] that started to jump againwith the expectation of further bonus in next financials. This is just one of the many cases


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when firm insiders adopt the market vibe very well and utilized the same to boost marketprice.

Stock Split

With the so called aim of accelerating velocity of securities transfer, regulators decided toconvert more or less all scripts face value to BDT 10. On May 10, 2010, the SEC issued anotification saying that the commission would take initiatives to approve the face value splitof shares of the companies, which would complete the required formalities. Mentionablehere this purpose of liquidity augmentation only be served if number of shares in one lotwas increased at a lower proportion than face value split, which was not true for manyscripts. So splitting these stocks keep the liquidity completely unchanged. But situation was

that every corporate announcement, irrespective of its merit, was rewarded with substantialprice amplification. And issuers absolutely seized that opportunity as the wave of spilt newsbecame a part of daily news.

During 2010, the SEC gave consent to about 63 companies to split the face value of theirshares. As mentioned, a split should cause no change in price other than the adjustmentwarranted by the split factor. Splits do, however, ensure substantial profit to marketmakers, i.e., brokerage houses. Due to the increased number of share trading and higherbid-ask spread brokerage, brokerage firms will be able to make larger profits when theircustomers buy and sell the stocks involved. Hence, to make tons o f money, brokerage firmsdo recommend split stocks [ 3 2 ] .

Before giving its decision, SEC didn't do any study about the impact of uniform face valueon the capital market of Bangladesh. Experts have been criticizing this mechanism from thevery beginning of its introduction, as a group of people made huge profits using it, thoughnothing was added to company fundamentals. But the SEC remained cling to its decision.Even the SEC urged the government to give its consent to its decision of stock split. ButFinance Minister A M A Muhith refused the proposal. Finally the SEC postponed its earliernotification on February 02, 2011 in line with the government's decision and stopped givingapproval to stock splits.

Assets Revaluation

Apparent vehicle of corporate wealth distribution among shareholders is cash dividend thatis directly linked to periodical earnings prospects. In contrast asset revaluation is just a sortof accounting discretion that enable management to report corporate assets in market valuerather accounting book convention which imply no other impact than increasing equity bookvalue. Ideally it has nothing to do with shareholders value increment because, whetherprior or post of revaluation, the similar piece of asset belongs to equity holders. Price of some scripts like Eastern Housing Limited increase at rocket pace that observed pricemovement from BDT 677 in July to BDT 1880 in September 2010 with the rumor roundingrevaluation of huge land bank.


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Book Building Procedures

General consensus is that issuers always try to tap the bullish market onslaught by bringingtheir securities offerings to public market. And obviously book building has already dubbedthe fairest method of initial price building in developed market. But look what we have donewith that method! Primary distortion that our regulators failed to detect is the simplestagency relationship, that is to say most of the participants adhered in price building processare active merchant bankers who have their own dealings to facilitate other issuers to getbest price from market. So for the sake of their own business all merchant bankingparticipants tried to match their bids with indicative price irrespective of their own valuationmodels. Because they know very well where the real business lies. Besides that severalother distortions like inadequate and non transparent accounts, erroneous pricingmethodologies, lack of professional attitude from issuers etc all blundered the purpose of

establishing a fair price.

The short lock in period (15 days) in case of book building also made an easy come out formanipulators.

Table 9: List of Companies That Used Book Building

Company IndicativePriceOfferPrice

% Change FromIndicative Price

P/E MultipleAt Offer

Price

FaceValue

OfferPrice/Face

Value

PriceAfter 1Month

PriceAfter 6Months

RAK Ceramics 40.0 48.0 20% 31.17 10 4.8 170.1 172.3Khulna PowerCompany 162.0 194.0 20% 69.53 10 19.4 203.2 136.5OceanContainer 121.4 145.0 19% 31.39 10 14.5 258.6 162.8

Mobil Jamuna 127.0 152.4 20% 26.41 10 15.2 Yet to be tradedM.I. Cement 93.0 111.6 20% 87.87 10 11.2 Yet to be traded

The above table shows some key information about the 5 companies that used the bookbuilding method. All the companies had substantial high P/E multiple before hitting themarket. Manipulation can also be sensed from the % Change From Indicative Price column.20% is the maximum limit set by the SEC and all the companies got that maximum limit.

The book building system is now temporarily suspended. The SEC is preparing a newguidelines for book building, attempting to restrict such malpractices. The SEC needs toensure that the new guidelines should cover all the issues and at the same time encourageentrepreneurs to come into market.


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Private Placement

A huge amount of money is being siphoned off from the stock market by the name of private placement. It is also very shocking that there is no detailed guidelines by the SEC inthis regard. Taking this as an advantage, a report shows that, 6 companies raised Tk. 15.72billion through private placement even before going to IPO, charging astronomicalpremiums. It is also alleged that, many private placement holders sold their shares toordinary people even before getting the IPO approval. The SEC cancelled the IPO proposalof one company after investigating such allegations.

Almost all the companies that applied for IPO in 2010 used the private placement to raisefunds. But they did not use any meaningful way to determine the offer price. They even didnot disclose the full list of placement holders. The SEC needs to look into this matter on an

emergency basis. The table below shows the companies that are yet to be listed eventhough they have privately placed their shares:

Table 10: List of Companies That Have Privately Placed Shares

List of Companie List of CompanieOrion Pharmaceut icals KYCR CoilGMG Airlines Golden HarvestUnique Hotel & Reseorts Fareast Knit ting & DyeingLankaBangla Securities Ananda Shipyard

STS Holdings PHP Float Glass

Keya Cot ton Navana Real EstateSummit Shipping

Source: Sheersha News, February 14, 2011.

Direct Listing

Direct listing was another hoax that the companies used for manipulation. This was firstintroduced in 2006 for government companies IPO. Later on, private companies also usedthis method. Shinepukur Ceramic was the first private company to use such system. Underdirect listing, directors sell their portion of shares directly to investors. So the excess pricethat is received over the minimum fixed price goes directly to directors pockets. No moneyis received by the company. Also, in this system, there is no upper price limit.

So manipulators had their own cartel start quoting the shares at astronomically high pricesto lure unsuspecting investors. Strangely, the SEC allowed two companies in 2010 to go fordirect listing even after discontinuation of this system for private companies.


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Table 11: List of Companies That Used Direct Listing

CompanyListingYear

FaceValue

Close Price At 1stDay

Close Price

After 6Months

% Change in

Price (6 Months -1st Day)JAMUNAOI 2007 10 360.9 165.7 -54.1%KPC 2010 10 273.6 136.5 -50.1%MPETROLEUM 2007 10 300 158.1 -47.3%OC 2010 10 297.6 162.8 -45.3%ACIFORMULA 2008 10 220 161.3 -26.7%SPCERAMIC 2008 10 96 102.9 7.2%TITASGA 2008 100 386 524.5 35.9%NAVANACNG 2009 10 193.9 267.6 38.0%

DESCO 2006 100 250 394.25 57.7%POWERGRID 2006 100 250 487 94.8%

The table above shows that, total 10 companies used direct listing during the last 4 years.Among them, 5 companies had experienced serious price deteriorations. Especially, all thecompanies that used direct listing in 2010 saw substantial fall in prices after 6 months.

Frequent Changes in Margin Loan Rule

As per Margin Rules 1999, the SEC is sole responsible for setting the margin loan ratio andassociated guidelines. During 2009-2011 period, the SEC changed its stance regardingmargin loans several times. As discussed below, the SEC brought various changes in marginloan ratios, criteria for margin loan eligible stocks and the margin loan valuation method.The impact of all these changes were mainly short lived and in many cases created hugeconfusion and criticisms.

Perhaps the most changing policy of the SEC was regarding the margin loan ratio. Duringthe last 12 months (Feb 2010 to Feb 2011) the SEC changed the margin loan ratio 5 times.Loan ratio varied from 1:2 to 1:0.5 during this time period. Such unprecedented frequent

changes in loan ratio signaled the whimsical mentality of our regulator and represented theSEC as near sighted. It caused the market to fluctuate heavily, bringing losses to investors.It also seriously damaged SECs image as the regulator and investors confidence.

At the starting of 2010 stock market bubble creation, on December 10, 2009, the SEC ruledthat stocks having P/E ratio above 75 wouldnt be eligible for margin loans. Later, SECchanged the break even P/E ratio to 50. On 15 th June, 2010, SEC further reduced the P/Eratio to 40. The rationality behind setting such break even P/E was unclear. Many expertsbelieved that this action might falsely indicate that all the stocks having P/E ratios below thebreak even were fundamentally strong. It might also indicate a price ceiling/limit for thestocks which was quite irrational. However, the outcome of changing the break even P/E


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was very short lived. Huge flow of investors own funds and speculative demand minimizedthe impact of this action.

Table 12: Revision of Margin Rules From Feb 2010 to Feb 2011

Date Particular Revised Loan Ratio

02 February -2010 Marginable stocks P/E reduced to50 from 75 -

03 February 2010 - Decreased to 1:116 March 2010 - Increased to 1:1.5

15 June 2010 Marginable stocks P/E reduced to40 from 50 -

08 July 2010 - Decreased to 1:1

22 November 2010 Diluted EPS will be considered to

calculate the marginable stocks P/EDecreased to 1: 0.5

13 December 2010 - Increased to 1:119 December 2010 - Increased to 1:1.510 January - 2011 - Increased to 1:2

Source: DSE Website

In August 2010, the SEC instructed the lenders to follow a Net Asset Value (NAV) basedcalculation for loan disbursement as well as maintenance. The NAV-based calculation forceda merchant banker or a stockbroker to provide loan on the basis of value of a stock asdetermined by adding the market value to NAV and

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