Capital market hits a snag due to lack of coordination

Dr. Toufic Ahmad Choudhury, former Director General of the Bangladesh Institute of Bank Management (BIBM), stated, "Entrepreneurs in developed countries rely on the capital market for long-term loans because long-term bank loans carry the risk of mismatch. We can encourage entrepreneurs to shift towards the capital market, but first, it must be established as a center of trust for them." He shared these insights in an exclusive interview with Views Bangladesh, where he discussed the current state of the country's capital market with M A Khaleque, an economics writer, and Girish Goiric, the associate editor.

Views Bangladesh: Considering the current functioning of the country's capital market, would you describe it as normal? What are your thoughts based on your experience?
Dr. Toufic Ahmad Choudhury: The capital market plays a crucial role in a country's economy. In developed nations, entrepreneurs typically do not depend on the banking system for long-term loans; instead, they meet their capital needs through the stock market. Long-term bank loans pose the risk of 'mismatch,' whereas funds raised from the capital market do not carry this issue. However, our capital market has yet to fulfill its potential within the economy. Many people in our country view trading as synonymous with the stock market, lacking awareness of concepts like market size and capitalization. Their focus tends to be on daily trading volumes and fluctuations in share prices.

I think our capital market is not improving as expected and is not expanding adequately. A healthy stock market is essential for the overall economic development of our country. We are witnessing a lack of coordination among various financial sectors; the banking sector is disconnected from the stock market, and the insurance sector also operates in isolation. Each sector is attempting to develop separately, but all parts of the financial system need to evolve simultaneously. Focusing on just one or two sectors will not suffice.

Currently, the banking sector receive more attention than insurance companies or the capital market. However, it is vital to pursue integrated development across all sectors. Effective and realistic measures must be implemented to foster the growth of the capital market. By mandating that entrepreneurs seek long-term financing from the capital market, we could alleviate pressure on banks and reduce the inclination toward excessive borrowing. If entrepreneurs could finance themselves through the capital market as they do in developed countries, it would significantly lessen the undue burden on banks.

Views Bangladesh: When approving a project, could it be a condition that entrepreneurs meet their long-term loan needs from the stock market?
Dr. Toufic Ahmad Choudhury: Absolutely, I believe that could be an effective approach. When an entrepreneur applies for loan project approval, a condition could be set requiring them to raise a portion of their long-term debt—at least 25 percent, if not the entirety—from the capital market. Currently, many large and reputable companies in our country are hesitant to enter the stock market. Entrepreneurs often fear potential issues, such as losing family control over their organizations or facing increased accountability to authorities and shareholders. Additionally, they recognize the need for transparency in their financial activities, which can be daunting. As a result, many feel more comfortable staying out of the capital market.

Legislation could mandate that companies issue a certain number of shares, but that alone wouldn’t suffice. We need to actively encourage entrepreneurs to understand the benefits of entering the stock market. By effectively communicating these advantages, we can boost investor confidence and attract quality companies to the market. When reputable firms participate in the stock market, it will enhance market dynamism and ultimately lead entrepreneurs to realize that raising capital from the stock market can be safer and more profitable than relying on the banking sector.

There are significant challenges that deter reputable companies from entering the stock market. The process of raising investment through the capital market is often lengthy and complex, involving numerous legal requirements. In contrast, securing a loan from a bank tends to be more straightforward, particularly for influential individuals who can easily obtain loans on demand. For instance, if a company owner wants to raise 500 crore taka from the capital market, they must navigate a cumbersome process that can consume a lot of time and effort. Meanwhile, obtaining the same amount from a bank typically involves a much faster loan sanction and disbursement process.

Views Bangladesh: What other advantages do you think can be gained from raising investment through the capital market?
Dr. Toufic Ahmad Choudhury: One major advantage is the reduced risk of mismatch when obtaining financing from the capital market. Unlike bank loans, where repayment obligations begin shortly after disbursement—even if project implementation is delayed—capital market financing allows for more flexibility. Interest and installment payments on bank loans start after a set period, which can place significant pressure on entrepreneurs before their projects even begin generating revenue.

In contrast, funds raised through the capital market do not come with immediate repayment obligations. Dividends are only distributed to shareholders once the project is profitable and has officially commenced production, meaning there is no expectation of profit claims prior to that point. Additionally, profits from the stock market manifest as dividends, while profits from banks typically come in the form of interest. It's also important to note that there is a reluctance among many to accept interest from bank deposits, particularly due to concerns around compliance with Islamic law, which views interest as impermissible. This further underscores the need for a more appealing capital market for entrepreneurs seeking financing options aligned with their values.

The growing popularity of Islamic banks can be attributed to the increasing awareness of finance options that align with Islamic principles. Unlike conventional bank interest, dividends from the stock market are viewed differently and are considered permissible in Islamic finance. This distinction could encourage entrepreneurs to explore share issuance in the capital market if they fully understand the benefits. In the capital market, the financing structure is known as the "direct mode of finance," whereas the banking sector operates through an "indirect mode of finance." If a project financed by a bank fails, the bank bears the responsibility. However, in the stock market, if a company fails, the shareholders incur the losses, leaving no liability for merchant banks or other intermediaries. This fundamental difference contributes to the higher perceived risk of investing in the stock market.

Additionally, there are disparities in taxation between listed and unlisted companies. Listed companies benefit from slightly lower tax rates, while unlisted companies face higher taxes. By widening this tax gap further, we could incentivize more companies to consider listing. Simplifying the procedures and regulations for listing in capital markets would also encourage more organizations to take that step, enhancing the overall vibrancy and stability of the market.

Views Bangladesh: What do you think needs to be done to bring the country’s top companies to the stock market?
Dr. Toufic Ahmad Choudhury: As I mentioned earlier, when approving project proposals, guidelines can be mentioned regarding the percentage of funding that must be raised from the capital market. However, it’s crucial for entrepreneurs to view the stock market as a viable option for long-term financing.

Phasing out state-owned companies or institutions could be beneficial, and one effective approach to facilitate this transition would be to list these institutions on the stock market. In particular, we should focus on bringing loss-making state-owned enterprises to the market. The persistent losses of these enterprises often stem from poor internal governance and widespread corruption. Listing them could enhance governance and help reduce corrupt practices. Of course, internal resistance may arise from employees within these companies, so a potential solution would be to allocate a fixed number of shares to them. During the tenure of the late Abul Mal Abdul Muhith as Finance Minister, there was an initiative to list 26 state-owned enterprises, but unfortunately, it did not materialize. We should consider floating shares of loss-making state-owned enterprises on an emergency basis to boost market activity. Successfully bringing reputable companies to the stock market would significantly enhance public confidence in the market. To sustain this confidence, it is essential to ensure that the stock market is trustworthy and transparent.

The highest or lowest profits in the stock market do not necessarily reflect its overall health. What truly matters is whether the market operates with transparency and fairness. Currently, the internal governance of Bangladesh’s stock market remains uncertain, and there are frequent reports of negative developments. For the stock market to be robust and transparent, it is essential that laws and regulations are adhered to rigorously. The significant scandals of 1996 and 2010 left many investors devastated, and the memories of those events still linger, fostering a climate of distrust. The greatest asset of any financial institution is its credibility and the trust it garners from the public. When trust is eroded, as has happened due to past experiences, people are understandably reluctant to invest. Ensuring that laws and regulations are properly enforced can mitigate risks associated with investing in the stock market, banks, or insurance companies.