Will banks now stop inflating Nepali stock market?

The Covid-19 pandemic has hit the country’s economy hard yet its banks and financial institutions (BFIs) seem immune. Their third quarter reports show they are making profits even as other sectors suffer unprecedented losses. 

Another sector that has largely been unaffected and instead boomed during the Covid-19 scourge is the equities market. Investors in Nepal’s lone stock index NEPSE have been enjoying a bullish run for around a year. The index has now crossed 2,900 points compared to the high of 1,200 in June last year. The daily turnover, which was around Rs 200 million a year ago, has reached Rs 15 billion.

How was this possible? It was only a matter of time before Nepal Rastra Bank officials put two and two together. They suspected the banks had heavily invested in the bullish market to make quick money—deviating from their main business of accepting deposits and issuing loans. This may be why some banks and BFIs posted unusually high profits even amid excess liquidity created by low demand for loans. 

The central bank came up with a directive to address the issue. It said the BFIs could not invest in microfinance institutions, and they needed to hold the shares they bought for at least a year. This, the central bank believes, will discourage BFIs from speculative trading and further fueling an unsustainable bullish trend in the market.

The shares the BFIs traded were mostly of insurance, microfinance, and hydropower companies.  

Finance companies under scanner

While commercial and development banks may have made some profit by trading shares, finance companies have made the most out of lax regulations, greatly boosting their earning per share (EPS), a popular indicator investors use to decide to buy or sell a stock.

“Some finance companies have earned more from trading stocks than from their income interest and service fees,” says Basant Raj Lamsal, chairman of Nepal Microfinance Bankers Association. 

Although the NRB directive has set the microfinance sector on a bearish trend, the association welcomes the move to stop BFIs from investing in microfinance companies, adds Lamsal. 

The BFIs hereafter can only sell their stock investments equivalent to their primary capital in one fiscal year. (Primary capital includes paid-up capital, general reserve fund, and accumulated profit and loss.) 

But they can sell stocks bought before NRB’s directive by the end of this fiscal (mid-July). 

Investors have also welcomed the central bank’s decisions. Says Nepal Investment Forum’s chairman Chhote Lal Rauniyar, “BFIs were undoubtedly making money by trading stocks and it was a deviation from their primary role of providing banking service.” 

Likewise, the May 25 directive restricting BFIs from investing in the secondary market shares of microfinance institutions doesn't apply to BFIs’ loan investments in the deprived sector. By mid-January next year, BFIs need to get shares in microfinance companies off their books, according to the NRB directive. 

The BFIs were making money by trading in their own shares, as most of them also own promoter shares in microfinance companies.

Nabil Bank CEO Anil Keshary Shah welcomed the central bank’s directive saying that BFIs should not be involved in the speculative market. He however denied that his bank was into it. 

“We have sold some of our stakes in microfinance companies as required by NRB’s capping measures for BFIs. But those were long-term investments,” says Shah. 

Investors had feared the directive would hurt the share market, which has been breaking records every week. “But we haven’t seen any negative effect of the directive till date. The market’s bullish trend continues,” adds Rauniyar. 

Investors in bank scrips hope for good returns this year, despite the new restrictions. “We hope the BFIs’ fourth quarter financial statements will bring more good news as they have already booked profits in the equity market by selling shares of microfinance institutions and other high-value shares,” says Rauniyar. 

The central bank’s focus on long-term investments was also supported by the government, which introduced dual tax rates for profits made in the share market. As per the new budget, individual stock traders now need to pay a 7.5 percent capital gain tax for stocks they held for less than a year. The tax rates for those who sell their stock after holding on to it for a year has been fixed at 5 percent. 

Be that as it may, nothing, it seems, will stop the NEPSE bull-run in the near future.