Why is stability essential in financial markets?

Financial markets throughout the planet play a pivotal role in establishing and contributing economic welfare within a society. Financial markets are a sector of the economy in which the trade-off securities occur. Hence, this can include such sub-markets as the bond market, stock market, forex market, and derivatives market.

The bond market and the derivatives market are presumably not much available here in our economy. As a result, the real financial markets here in Bangladesh are a kind of constraint. By creating capital, financial markets can redirect funds from governments, firms, and individuals with a surplus of funds and allocate resources to those units who have a shortage of funds, in other words, investors and borrowers.

TBS illustration.

Thus, in effect, it provides a market that permits a bridge between borrowers and savers, allowing opportunities for those who require extra financial wealth to obtain funds. For example, we can place the Herbert Hoover's 'trickle-down theory' where taxes on businesses and therefore the wealth in the society simultaneously used to stimulate investment in the short term, thus benefiting the mass people at large in the long term.

In Bangladesh, the lending and borrowing process has been disrupted due to the higher percentage of non-performing loans (NPL) in the scheduled banks and non-banking financial institutions (NBFIs). Thus, it is creating a negative impact on the financial markets in Bangladesh. The government, however, has intended to cap the lending and borrowing rate within nine percent to six percent with a view of generating more employment opportunities through new investments.

Apart from higher NPL, the profitability of the banking sector is going to decline due to the interest cap. The banks and NBFIs, which could not afford to manage the credit management appropriately due to different loan scams, have a substantial fund crisis. At present, the commercial banks are not ready to take the fixed rate.

I think the interest rate cap should be fixed based on purely market demand and supply. The initiative to have a nine percent to six percent rate is undoubtedly a right decision; however, before executing the new rate, the central bank should fix all those anomalies to flow the money freely within the financial markets.

The capital market is the place where a company trades shares and securities with investors. The capital market provides opportunities for individuals to gain dividends through investment from a company through investment based on the confidence of individuals and firms on the economy.

Similarly, firms benefit from the stock market by providing companies with the need for equity capital and investors' funds. Thus, the stock market further allows firms to invest and thus creates more revenue for the company and its employees.

Moreover, in Bangladesh, most of the companies are highly dependent on bank loans for business expansion or even operational activities which has a higher interest rate risk then offloading shares in the capital market. For the long-term loans, the companies should not go to commercial banks; instead, they must issue bonds or offloading shares and collect the required funds from the investors.

Thus, the pressure within the money markets for loans will come down, and the original demand for loans will subsequently come down in line with the government's internet cap.

With the current catastrophe of the Covid-19 pandemic, confidence over the past two quarters starting from March 2020 has been tiny due to fears that many sectors will not recover from the crisis. As a result, unemployment has increased worldwide, and financial stresses have caused instability in the world financial markets.

However, the government has been tactically dealing the matters in Bangladesh; as a result, the economic activities did not utterly close in Bangladesh instead with the declaration of the Prime Minister's bailout packages it has been slowly moving forward positively. After July 2020, the scenario has been changing rapidly.

According to central bank data, the total loans disbursed domestically at the end of July amounted to Tk13.2 trillion, including Tk1.96 trillion government borrowing. The rest of the amount went to the private sector. The overall domestic credit growth stood at 14.14 percent at the end of July 2020, which indicates a positive vibe in the financial markets.

Furthermore, the government's two percent incentive programmes for inbound remittance and Bangladesh Bank's initiatives of easing the money transfer process played vital roles in augmenting remittance inflows at 10.9 percent growth in the country in FY20.

The markets heavily collapsed, and therefore the index began to free-fall in early March 2020 and continued till the end of June 2020. The recovery has started with the leadership and various reforms, e.g., termination of ambiguous IPOs. The newly selected BSEC chairman and commissioners eventually build the confidence and trust among the investors to invest at a large scale.

Bangladesh has secured the top rank amid frontier, emerging, and developed markets in August 2020 in terms of rate of return. The premier bourse of the country Dhaka Stock Exchange (DSE) showed a 15.8 percent index gain which was the highest among all the countries in the global capital market. Low-interest rate due to interest cap and an upward trend in exports and remittances have made Bangladesh achieve such a return in the capital market.

To ensure the stability in the financial markets after absorbing the early shock of the Covid-19 pandemic, the government's expansionary monetary policy for the fiscal year 2020-21 has cut down the repo rate from 5.25 percent to 4.75 percent and a discount of reverse repo rate from 4.75 percent to 4.00 percent.

Hence, as an outcome of these changes has confirmed the availability of less costly funds in the financial markets, e.g., banks and rationalised the policy rates' corridor (the gap between the repo and reverse repo rates) to support the additional demand for funds.

Furthermore, the bank rate has also been reduced from 5 percent to 4 percent to justify it with the current interest rate. I think the objectives of all these changes will be to keep a sufficient amount of funds available in the money market to overcome the sluggish economic activities to vibrant the financial markets as well as to maintain the lower inflation rate.

M Shahriar Azad Bhuiyan is the head of Internal Control & Compliance, UniCap Securities Limited; Email: shahriar@unicap-securities.com