Too much, too soon

At the end of two trading days following the earthquake and tsunami in Japan on Friday, March 11, the stock market in Japan—as measured by the Nikkei index—plunged more than 17 percent wiping out all the gains made during 2011. Although the Japanese market has recovered somewhat since then, the fear of a radioactive meltdown in the nuclear reactors damaged by the tsunami has been holding back foreign institutional investors from entering Japan’s stock market. This unprecedented event, not modelled into sophisticated trading strategies, has once again highlighted the importance of tail risk in the financial market. The 17 percent dive in the Nikkei index during two consecutive trading days was the largest since Black Monday of 1987.

While many of the global equity markets grappled with that tail risk from the aftershocks of the earthquake and tsunami in Japan last week, back home our domestic equity market, already under a severe bearish trend for more than a year, came under extreme selling pressure due to proposed amendments in the Banks and Financial Institutions Act (BAFIA). As a result, the NEPSE index has reached a five-year low. While most of the proposed amendments to BAFIA are counter-intuitive and against the spirit of a liberal economy, the proposal to limit the investment of businessmen (the definition of businessmen is one who is involved in a business with an annual turnover of over Rs 10 million) in banks and financial institutions to 5 percent has spooked investors the most.

The argument as to whether businessmen should be allowed to own banks or financial institutions has been raised for a long time not only in Nepal but all over the world; and it can be argued over and over again without reaching a proper conclusion. There are pros and cons to having businessmen own a bank. The pros and cons depend on the size and state of an economy. To some extent, even in the developed world, there has been a certain leeway recently in the notion of businessmen or businesses owning banks. For example, in Germany, Siemens recently received approval from the German authorities to engage in banking activities. GE, a global business conglomerate, has been involved in financial transactions through GE Capital, and so have General Motors and countless other businesses. Even our neighbouring country India is in the process of liberalizing its licensing policy regarding financial institutions.

In the context of Nepal, given the current state of our equity market, the proposal to limit the stake of businessmen in banks and financial institutions to 5 percent can be suicidal as it will inundate the market with an excess supply of shares. Already, demand for investment in the equity market has not been able to keep pace with supply, which is one of the reasons for the current bearish trend at NEPSE. Following the recent promulgation of mutual fund regulations and the progress made in introducing the Central Depository System (CDS) in the Nepali equity market, there had been a modicum of hope among investors that demand would pick up due to both the participation of institutional investors and increased retain penetration. However, the recent developments regarding proposed amendments to BAFIA have put a major dent in investor confidence.

As mentioned above, the question as to whether businessmen or businesses can own banks can be debated on its merits. One valid argument against having businessmen or businesses own banks is that they can deprive credit to competitors and, in the process, harm the overall economy. However, checks and balances can be put to minimize these transgressions. In the Nepali context, banks and financial institutions are probably the most transparent corporate institutions. So there is room to believe that they will abide by the rule of law. Yes, there has to be some limit to the stake a single business or businessman can hold in a particular bank or financial institution—that limit can be more than 5 percent or even less than that. However, given the state of the equity market in Nepal, it’s not the right time to make a decision to limit the stake to 5 percent. Let the equity

market develop and reach a certain stage, then maybe we can make a decision.

Investors are not only concerned about the proposal to limit the investment of businessmen in banks and financial institutions but also the overall direction that they perceive our economy is heading towards. At a time when India and China are reaping benefits by shedding socialistic

and mixed economic policies towards in favour of market oriented ones, the Nepali policymakers’ vision of a “mixed” economic model is not only perplexing but also sadistic to the aspirations of the Nepali people.

This article was first published in The Kathmandu Post on March 21, 2011
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