A Qualitative Analysis on the Ups and Downs in the Capital Market of Bangladesh (2010-2011)

Table of Contents
Acknowledgement Executive Summary 1. Introduction
1.1 1.2 1.3 1.4 1.5 Origin of the Report Background Objectives of the Study Research Questions Research Methodology 1.5.1 Approach of the Study 1.5.2 Sources of Data and Method 1.5.2.1 Primary Source 1.5.2.1.1 Self-Administered Questionnaire 1.5.2.1.2 Questionnaire 1.5.2.1.3 How the Respondents were Selected 1.5.2.2 Secondary Source 1.5.2.2.1 Books 1.5.2.2.2 Investigation Report 1.5.2.2.3 Data of Indices 1.5.2.2.4 Past Researches 1.5.2.2.5 Newspaper, Journal and Other Sources 1.5.3 Reliability and Validity Scopes Limitations

1
1 1 2 2 3 3 3 3 3 3 4 4 4 5 5 5 5 5 5 6

1.6 1.7

2. 3.

Some Important Concepts Regarding Capital Market Capital Markets in Bangladesh

3.1 3.2 3.3 3.4 3.5 3.6 3.7 History of Bangladesh Capital Markets Dhaka Stock Exchange (DSE) Chittagong Stock Exchange (CSE) Structure of the Capital Markets in Bangladesh Settlement and Clearing Securities and Exchange Commission (SEC) Central Depository Bangladesh Limited (CDBL)

7 8
8 9 10 10 12 14 14

4.

Capital Market Crash of 1996

4.1 Background 4.2 Reasons 4.3 Regulators Responses Capital Market Crash of 2010-2011 5.1 Reasons for Market Upsurge 5.2 A Brief Account of the Timeline of the Historic Fall 5.3 Roles of Different Market Participants during the Market Crash 5.3.1 Role of Bangladesh Bank in Capital Market Crash 5.3.2 Role of Institutional Investors in the Capital Market Crash 5.3.3 Role of Securities and Exchange Commission in the Capital Market Crash 5.3.4 Role of Brokerage Firms in the Capital Market Crash

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15 16 17 17 17 18 22 22 23 24 25

5.

Table of Contents
5.4 5.3.4 Role of Brokerage Firms in the Capital Market Crash Reasons Behind the Crash 25 25

6. 7. 8.

Survey Report Recommendations Concussion

31 36 37 38

References

1. Introduction

1.1 Origin of the Report

The report has been prepared as a requirement for the completion of BBA Degree and course BUS 498, Project Work, Engr. Kamrul Hasan, course instructor, assigned to do an analytical report on A Qualitative Analysis on the Ups and Downs in the Capital Market of Bangladesh (2010-2011). For this purpose I, Afif Abul Fattah, ID# 2009-3-10-069 choose to prepare this report on finding the root causes of the capital market crash in 2010-11. The date of submission of the report is August 1, 2012.
1.2 Background

One of the most important financial institution within an economy is the capital market. Capital market opens door for companies to raise huge amount of capital form a lot of individual and institutional investors inside & outside of a country. Here investors participate voluntary to buy ownership of a company in the public market. It is said that stock market is an intermediary institution to adjust a gap between surplus units and deficit units of an economy. In these days for millions of middle class educated people in Bangladesh investing in stocks is more popular than investing in any other investment sectors. For an investor, stocks are more liquid than any other investment sources as it gives ability to sell and buy ownership anytime without any hassle. Over the years many have characterized stock market or capital market as a Speculative Market, which means market participants can earn a return from their investment from the differential of prices. Although this price differential are supposed to be out of participants control, in reality participants can control this price differential through insider trading. As a result, the market turns to a Manipulative Market. In the event of such illegitimate trading, the market collapses and wrongdoer earns a huge profit in the expense of the loss of majority investors. Investors in Bangladesh experienced such an event in 2010-2011.

Since 2007 share prices of Bangladesh capital market have been increasing steadily over the past four years and it outperformed almost all the worlds markets. For instance, it performed as 2nd best in the world after Srilanka in 2010 gaining nearly 83%. The financial year 2008-09 is known for the global financial and economic crisis. Many developed and developing countries fall into recession. However, it could not affect Bangladesh economy greatly. So, the stock market of the country did not see any significant changes or fall. As CPD (2011) reported, financial year 2008-09 was a volatile year but during this year Bangladesh economy benefited from low prices of import-able and was able to avoid negative pressure on its export of goods and services

The consecutive outstanding performance of Bangladesh stock market in recent years before the crash lured millions of investors to the stock market to invest their little savings. Before the stock market crash the market had become a route of easy money for too many new individual investors. That is why millions of fresh investors invest their small saving in the market during this period. For these fresh investors investing in this market provided a way to avoid working a job. Even some BO account holders worked as intermediaries of friends, relatives to invest their money in the stock market. On January 9, 2011 the benchmark index of the Dhaka Stock Exchange (DSE) suffered the steepest ever single-day fall in the bourse's 55-year history. The DSE General Index (DGEN) plunged by 600 points, and all indices fell nearly 8 percent in the wake of panic-sales. Breaking the previous day's record, on January 10, DGEN shed 660 points or 9.25 percent between 11 am and 11:50 am. The capital market was shut; small investors turned vandalistic; and the business district of Motijheel was transformed into a battlefield between protesters and law-enforcers. Despite the measures taken by the regulatory commissions people suffered major financial loss and worse than that, many lost confidence in the stock market.

1.3 Objectives of the Study

The topic of this study is very significant for the understating problems and prospects in emerging capital markets like Bangladesh. Identification of the root causes the 2010-2011 can improve stakeholders awareness regarding capital market manipulation. Yet, very little research has been done to provide knowledge about the crash. So, the study tries to examine the reasons that leaded the Bull Run for dramatic increase of different instruments in Bangladesh stock market and the fundamental factors of the collapse. It also analyzes the role of DSE, CSE, and SEC as market regulators during the bubble formation and burst. Besides, the study tries to provide knowledge for the stakeholders related to this stock market. So that investors and other stakeholders in Bangladesh stock market and emerging stock markets can be aware of similar kind of collapse.
1.4 Research Questions

The key questions that would be answered by the study are following: What were the reasons for the unusual boom in the capital market from mid February 2009? What were the reasons for the crash in the market price in the early January 2011? Was the regulators responses were adequate to control ups and downs in the market ? If regulators responses are not adequate, then what can be the long term consequence regarding stabilizing the market?

1.5 Research Methodology

The aim of this section is to show how the data was collected, by which method and source and the process of analyzing the data.
1.5.1 Approach of the Study

Because of nature of the research, a qualitative research method has been used. Finding reasons of the crash and role of the regulators and the government is the aim of the re-search. The required information itself asks for a qualitative research approach.
1.5.2 Source of Data and Method

The data used for this research were obtained and used from both primary and secondary sources. Moreover, a self-administered questionnaire has been used to collect primary data.
1.5.2.1 Primary Source

For the primary data, self-administered questionnaire will be sent to 15 employees of three different brokerage houses and 10 general investors. The questionnaire consists of 10 questions.
1.5.2.1.1 Self-Administered Questionnaire

The self-administered questionnaire fashioned on the basis of the Investigation Report of Khondokar Ibrahim Khaled (2011). Although the primary reasons behind the crash have been provided in the report, the self-administered questionnaire will help to find out other causes, if there is any that did not appear in the investigation report. It asks about the role of regulators and government that has played to improve market conditions since the crash. Besides, the selfadministered questionnaire finds to recommend some steps that regulators and government can adopt to protect investors or this kind of collapse in future. The self-administered questionnaire enables the writer to gather information to solve the re-search questions and make recommendations. Expected result would carry: new ideas includes causes of the stock market crash that were not in the investigation report suggestions for development of the market by the regulators and government after the crash recommendations for the regulators and government to prevent this kind of crash answers in details and according to respondents feelings

1.5.2.1.2 Questionnaire

The questions for the questionnaire were selected logically to match the expected result. There were 10 questions in the questionnaire which were in English version. The questionnaire consists of 3
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closed questions and 7 open questions. The questionnaire is attached in the appendices of the thesis.

1.5.2.1.3 How the Respondents Were Selected

For this research selecting respondent is a very hard job as it involves conflict of interest of opinions among the stakeholders. Respondents were chosen on the author`s judgment. Different market analysts and economist pointed that there are so many investors in this stock market who dont have enough knowledge about investment in the capital market. The aim of the writer is to ignore this sample of investors too. To select the respondent author used following criteria: Does the respondent have the corrected as well as accurate information about the crash? Is the respondent adequately experienced and educated about the subject to opine? Does the respondent have information about market conditions even after the crash? Keeping all these questions in mind, the author selected two different sample groups of respondents which are employees of brokerage houses and general investors. The employees of the brokerage houses have daily updates information about the market and regular relationship with different stake holders of the market and good educational background that help them to obtain a job in broker house. The respondents of three brokerage houses were from different departments including research and sales. Moreover, the author personally knows that most of the employees of brokerage houses invest in the stock market. So, many of these respondents have experience of investing in the market with working experience. So, it would be possible to obtain information from employee and investor point of view. Though there are so many brokerage houses in Bangladesh, the author selected three broker houses as it was easy for the author to get information from these houses. To select investors for the self-administered the author took suggestion from the employees of brokerage houses. Investors were selected on the basis of their educational background, knowledge about the market and investment in it, regular updated information of the market and experience of the stock market crash of 2010-11.
1.5.2.2 Secondary Source

The used secondary sources for the study are Books, investigation report, past researches, newspaper, journal, electronic publications and indices data of DSE and CSE.
1.5.2.2.1 Books

Although books were not the major secondary source for the study, some books have been used too. Books on the capital markets have been studied for preparing this paper.

1.5.2.2.2 Investigation Report

For this research, Investigation Report of Khondkar Ibrahim Khaled (2011) is used as the main resource for theoretical part. The report was collected from bdnews 24.com. The full report consists of 300 pages. The report is very useful for the research as it gives complete idea about the context of the problem with case studies and serves to solve the research questions. It also helps to estimate the role of regulators and government in the capital market of Bangladesh during and before the crash.
1.5.2.2.3 Data of Indices

Indices data of DSE was collected from DSE website and indices data of CSE from Chittagong stock Exchange website. These data was used to examine significant fall and rise of share prices in both exchanges and to draw graphs of indices for different time periods.
1.5.2.2.4 Past Researches

Past researches for stock market crash of Bangladesh in 2010-11 was very difficult to find. But the author found some articles on the crash and researches on other crashes done by different scholars.
1.5.2.2.5 Newspaper, Journal and Other Sources

Newspaper, Journal and other electronic sources are the most important and more used sources than other sources used for the study. Important daily news and other information were collected from the newspaper which is crucial for this kind of research. The used journals for the study were both recent and archives. Different articles were collected from these sources. The resources of these sources are downloaded via internet.
1.5.3 Reliability and Validity

All the questions self-administered questionnaire were made as simple as possible to avoid unnecessary deceptiveness. It helps respondents to provide accurate and credible answers. Also the indices data collected from both stock exchanges are highly reliable. Therefore, the study claims to have reliability. The sample of respondents and the questions fit with the findings of the study which is valid to the research.
1.6 Scopes

The scope of this paper is limited to only the causes capital market crash in Bangladesh during 20102011. The mechanism of stock exchanges, scientific methods of investing in the securities, the

mechanism of brokerage firms and commercial banks and stock market crash in other parts of the world are beyond the scope of this paper.

1.7 Limitations

Followings are the perceived limitation of this paper: Identifying the detailed causes of the market crash requires enormous time and resources. Thats why the paper should not be viewed as an entire pool of reasons for the capital market crash rather it only entails the most important ones. The author could not approach all stakeholders related to the stock market of Bangladesh to conduct self-administered questionnaire. So, getting different views of different stakeholders was not possible. Thats why there might be conflict of interest among the stakeholders.

2. Some Important Concepts Regarding Capital Market

What is Capital Market?

According to Dr. Guruasamy, Capital market is the market where long term funds are borrowed and lent, the primary purpose is directing the flow of savings into long term investments (mostly for period of one year and above) Capital Markets usually demonstrates following features:
1. Demand for funds: Demand for long term funds arise from institution, government and the private corporate sector. 2. Instruments: Funds are raised through issue of financial instruments such as shares, debentures and bonds. 3. Supply of funds: Individuals (household sectors), institutions, banks and industrial financial institutions are the main source of supply of long term funds. 4. Ideal conduit: The capital market acts as an ideal conduit for the transmission of savings of surplus units to deficit units which demand long term funds. 5. Economic growth: Capital market plays a significant role in the financial system by prompting savings and investments, which are vital for the development and growth of an economy. It accelerates the pace of economic development. 6. Price Mechanism: The price mechanism prevalent in active capital markets ensures optimal allocation of scarce financial resources to the most productive sectors of the economy. The system of allocation of funds works through incentives and penalties. Accordingly, companies that operate efficiently can sell securities at premium (incentives). Conversely, companies with poor performance face problems in selling their securities and may have to issue securities at a discount to raise addition funds or offers higher rates of interest.
What is stock market bubble?

We can define an Economic Bubble as a surge in the market caused by speculation regarding a commodity which results in an explosion of activity in that market segment causing vastly overinflated prices. The prices are not sustainable and the bubble is usually followed by a crash in prices in the affected sector. An economic bubble taking place in the stock market where market participants drive stock prices above their value in relation to some system of stock valuation (e.g. dividend model) is called a Stock Market Bubble.

What is stock market crash?

In general, a stock market crash is a sudden dramatic decline of stock prices across a significant crosssection (i.e. different industry) of a stock market.
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Amadeo (n.d.) defined stock market crash as more than 10% loss within few days in a stock market. But stock market crash has differentiated from stock market correction where the loss is 10% or less.

What is Stock Exchange?

Stock exchange is an organized place or arrangement where the buyer and seller is brought together so that they can buy sale their stocks/share. For example Dhaka Stock Exchange has an electronic trading system called TESA and Chittagong Stock Exchange has an electronic trading system called VECTOR. These two system work as an arrangement to help buy/sale of listed securities.

What is Brokerage Firm?

A broker is an intermediary who works as an agent to bring together buyer and seller and it takes commission from the successful buy/sales. A broker must be listed member of any stock exchange (i.e. DSE, CSE).

What is Kerb market?

Kerb market is an unofficial name for an unofficial activity - the trading of securities outside a recognized stock exchange. The name derives from the historical practice of dealers continuing to trade on the pavement after the exchange's hours of business.

3. Capital Markets in Bangladesh

In Bangladesh there are two Capital markets, (1) Dhaka Stock Exchange (DSE) and (2) Chittagong Stock Exchange (CSE). In the following sections describe the history of capital markets in Bangladesh, its structure and the import institutions related with it.

3.1 History of Bangladesh Capital Markets

First capital market of Bangladesh was established in the Pakistani period on April 28, 1954 as East Pakistan Stock Exchange Association Ltd. With a total paid up capital of Tk. 4 billion and 196 securities, the market started its trading activities from 1956. On June 23, 1962, the market was renamed as Dhaka Stock Exchange (DSE). Trading on Dhaka Stock Exchange was suspended from 1971 to 1976 because of liberation war and its post8

independence weak economy. Then the trading was resumed in 1976 with 9 listed securities having a total paid up capital of Taka 137.52 million. (Hassan, Islam & Basher, 2000) By 1987, the number of listed companies in DSE increased up to 92. But high development of the market is noticeable in the 1990s comparing with any other time since its establishment. (Economy watch, 2010)

3.2 Dhaka Stock Exchange (DSE)

The operation of Dhaka Stock Exchange started on May 14, 1964 after renaming East Pakistan Stock Exchange Limited. 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 along with the Securities and Exchange Ordinance - 1969, Companies Act - 1994 & Securities & Exchange Commission Act 1993. In the beginning DSE was a physical stock exchange and used to trade in the open outcry system. After that to secure smooth, timeliness & effective operation on the market, DSE uses automated trading system. The system was installed on 10th August, 1998 and was upgraded time to time. The latest upgrading was done on 21st December, 2008. There are 238 members and total 507 listed securities in Dhaka Stock Exchange. The working days of DSE is 5 days in a week without Saturday, Sunday public holidays & other government holidays. The trading time is from 11:00 am to 3:00 pm (local time). Investment options for an investor in this market are ordinary share, Debenture, Bond & Mutual funds. As mentioned by Fellowes (2008), Every stock market has its indices to show movements in the market as a whole. In the beginning DSE had only one index. However, now there are three different indices which are DSI (All share), DGEN (A, B, G & N) and DSE 20. (Source: www.dsebd.org)

The major functions of DSE are:

Listing of Companies (As per Listing Regulations). Providing the screen based automated trading of listed Securities. Settlement of trading (As per Settlement of Transaction Regulations). Gifting of share / granting approval to the transaction/transfer of share outside the trading system of the exchange (As per Listing Regulations 42). Market Administration & Control. Market Surveillance. Publication of Monthly Review.
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 Monitoring the activities of listed companies (As per Listing Regulations). Investors grievance Cell (Disposal of complaint by laws 1997). Investors Protection Fund (As per investor protection fund Regulations 1999). Announcement of Price sensitive or other information about listed companies through online

3.3 Chittagong Stock Exchange (CSE)

Chittagong Stock Exchange is the 2nd stock exchange of Bangladesh. It is said that CSE is the pioneer of the modern capital market of the country as it introduces modern technology & sophisticated logistic support. It was incorporated as a self-regulated non-profit organization on 1st April, 1995 and formally opened on November 4, 1995. It started its trading through cry-out system. Then Chittagong Stock Exchange started first automated trading bourse of the country. CSE started its automated trading on 2nd June, 1998 and internet trading service on 30th May, 2004. The trading time of CSE is between 11:00 am to 3:00 pm. The working days & holidays of CSE are same as like as DSE. CSE consists of 25 members of whom 12 are elected through election of CSE members, 12 members are elected from different major economic & social arena of Bangladesh and CEO is nominated and appointed by its own board but the approval of SEC mandatory. Now CSE has 147 members and 238 of listed securities. There are four different markets in CSE too which are public, Spot, Block & Odd Lot market. Trading is done through all these four markets. A, B, N, G and Z these are the 5 categories of company listed in CSE and it is mentionable that in G category there is not any company. Chittagong Stock Exchange has its own indices to calculate movements of its total market value. CSE maintained only one index that was All Share Price Index until 10th October, 1995. Now CSE has 3 indices in the stock exchange. Indices are All Share Price Index (CASPI), CSE Selective Index (CSE30) and CSE Selective Categories Index (CSCX).
(Source: www.cse.com.bd)

3.4 Structure of the Capital Markets in Bangladesh

Capital markets in Bangladesh are the other part of the countrys financial markets which is again can be divided into two broad segments: (a) Non-security segment and (b) security segment. Both of them together determine the atmosphere of the capital market. 1. Primary Markets: Primary market is the market for securities which come first time in the market through Initial Public Offerings (IPOs. Companies can issue new securities after getting permission from the market regulators.

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2. Secondary market: A market where investors purchase securities or assets from other investors, rather than from issuing companies themselves. Securities can be sold or bought from this market. In a stock exchange most of the trading figures comes from the secondary market. This market is also divided according to its different trading characteristics.

Financial Markets

Money Markets

Capital Markets

Commercial Banks

NBFIs

Non-Security Segment

Security Segment

BSB

BSRS

ICB

Primary Market

Secondary Market

BSB Bangladesh Shilpa Bank BSRS Bangladesh Shilpa Rin Shanghastha ICB Investment Corporation of Bangladesh NBFI Non-Banking Financial Instituion

DSE

CSE

Figure 1: Structure of the financial markets in Bangladesh

Within the secondary markets there are again four divisions: Public Market: Instruments are traded on this market in normal volume which is called lot share.

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 Spot Market: Trading is done in normal volume under corporate actions and must be settled in 24 hours.

Public Market

Odd Lot Market

Secondary Market

Spot Market

Block Market

Figure 2: Types of Secondary Market

Block Market: In this market bulk volume of instruments are trades through pick & fill basis. Odd Lot Market: Odd lot refers to a quantity of shares that is less than market lot. Odd lots of all instruments are traded through pick & fills in this market. Basically odd lots generated from bonus and rights issues.

3.5 Settlement & Clearing

Settle of price and transfer of securities is done through automated software platform e.g. TESA (The Electronic Securities Architecture) in DSE. The Clearing and Settlement module provides the management of trade from the point of entry into the Settlement Pool trade database until it has been delivered, settled and removed from the Settlement Pool. It consists of three major business processes.
1. Trade in Public, Block & Odd-lot Market: Trade in Public, Block & Odd-lot market has two different settlement periods for A, B, G, N & Z categories shares and Settlement is executed

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through stock exchange clearing house. Here the settlement period is same for A, B, G & N. However, for Z category share settlement period is different.

a) A, B, G & N Category: Settlement is done through DSE or CSE clearing house on

T+1(pay in day) and T+3 (pay out day).

b) Z Category: Settled on the basis of T+1 (pay in day) and T+9 (pay out day).

Day T: Both Brokers & DSE Sign Contract

Selling Broker Buying Broker

Day T: Both Brokers & DSE Sign Contract

Selling Broker Buying Broker

T+1 Securities T+3 DSE Clearing House Cheque (In favor of DSE) T+3 T+9 Securities

T+1 Cheque (In favor of DSE) DSE Clearing House T+9

Cheque (In favor of DSE) Settlement for A, B, G & N Category

Securities

Cheque (In favor of DSE) Settlement for Z Category

Securities

Day T: Both Brokers & DSE Sign Contract

Selling Broker Buying Broker

Day T: Both Brokers & DSE Sign Contract

Selling Broker Buying Broker

T+0 Securities T+1 DSE Clearing House Cheque (In favor of DSE) T+1 T+6 Securities

T+5 Cheque (In favor of DSE) DSE Clearing House T+6

Cheque (In favor of DSE)

Securities

Cheque (In favor of DSE)

Securities

Settlement for Spot Market

Settlement for Foreign Traders

Figure 3: Settlement Mechanism

2. Trade in Spot Market (A, B, G, N & Z category): Settlement period is same for all category shares traded in this market through clearing house that is T+ 0 (pay in day), T+1 (pay out day). 3. Settlement of foreign traders: Foreign buyers and sellers settle their transaction between themselves involving custodian bank. It is processed within T+5 (pay in day) and T+6 (Pay out day).

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3.6 Securities and Exchange Commission (SEC)

The Security and Exchange Commission (SEC) was formed on 8th June, 1993 under the Securities and Exchange Commission Act, 1993 with a view to protect investors interest, improvement of securities markets, appropriate issuance of securities and proper guiding of securities laws. The most important organizations and intermediaries under supervision of SEC are DSE, CSE, CDBL, stock brokers, merchant banks and asset management companies. Khaled (2011) The commission is consists of a chairman and four members. The Chairman & members of security exchange commission are appointed by the government of Bangladesh. SEC is directly connected with the ministry of Finance and has rights to supervise all of securities laws & regulations. According to Securities and Exchange Ordinance, 1969 SEC has been empowered to control even self-regulatory institutions for instance Stock Exchanges. The main functions of SEC are following:
Registering and regulating the business operation of DSE, CSE, stock brokers, merchant

banks, underwriters, share transfer agents, portfolio managers and other intermediaries. Developing investor`s education, providing training for intermediaries, executing market research and publishing those. Controlling every authorized self-regulatory organizations too Inspecting and controlling fraudulent and unfair trading in security markets Auditing and investigating of any intermediaries or stock exchanges Collective investment scheme registering & controlling.

3.7 Central Depository Bangladesh Limited (CDBL)

CDBL was incorporated as a public limited company on 20th August, 2000. Before the establishment of CDBL process of transferring and delivering ownership was too lengthy and risky. The establishment of CDBL added value to the stock market of Bangladesh and attracted more investors especially foreigners. After implementing automated trading system in DSE & CSE and introducing central depository system, the stock market of Bangladesh became more effective and credible to the investors. (Bepari & Mollik, n.d.) The owners of CDBL are DSE, CSE, banks, Investment Corporation of Bangladesh and some other financial institution. The participants of CDBL are called Depository Participant (DP). CDBL charges fees from its participants for different services provided by CDBL.

The functions of CDBL are given below:

Operate and maintain the Central Depository System (CDS) of Electronic Book. Recording and maintaining securities accounts and registering transfer of securities Changing the ownership without any physical movement or endorsement of certificates Supervision of Depository participant activities
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 Providing different investor services including providing a platform for the secondary

market trading of Treasury Bills and Government Bonds issued by the Bangladesh Bank.

4. Capital Market Crash of 1996

4.1 Background

The first capital market fiasco in Bangladesh occurred in November 6, 1996. 15 years after that, the country again experienced another stock market debacle in 2010-2011. However, the scenario of these two market crashes is completely different. Back in 1996, the number of BO accounts was only 300,000. During that period paper shares are used to be sold in front of DSE and it was not easy for investors to identify fake and original shares. The market was enough developed to gain confidence of investors. There was no automated trading system, surveillance was not enough strong and no circuit breakers as well as international protections. (Hossain, 2011)

4000 3500 3000 2500 2000 1500 1000 500 0

Monthly High Index

Monthly Low Index

Figure 4: DGEN index from 1995-97

From 1991 to the end of 1995 DGEN price index gained by 139.3% and reached to 834 point. But in 1996 the market experienced dramatic change and pushed the price index up by 337%. DGEN Index recorded high growth from July and stood at 3648.7 points or by 280.5% on 5th November 1996.

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Chittagong Stock Exchange experienced the same change and grew by 258%. Chittagong stock exchange index increased from 409 to 1157 points in 1996 within one year time. (Bepari & Mollik, n.d.) Market was growing fast every day in that boom period. For, example the news posted by both DSE and CSE that the market capitalization reached $2billion which is equal to 20% of total GDP. At the point when the market got overheated, the government took step by selling state owned institutions and by giving ICB TK.2 billion to buy shares and support the market. However, the steps appeared futile. (Hossain, 2011) On November 6, the index lost over 233 points and DGEN index dropped to its lowest point at 957 in April 1997. DSE General Price index lost almost 70% from its highest point of November 1996. Then index continued to decrease for next 7 years until April 2004. During this long time period DGEN Index seldom crossed 1000 point of the index. (Mansur, 2010)

4.2 Reasons

There are there main reasons for the events of 1996. Those are noted bellow: The stock price manipulation in October 1996 was the work of a syndicate consisting of some foreign portfolio managers, few brokers and sponsors of few listed companies. Through their endeavors, they were successful to increase all share price index of DSE from 1000 points to 3600 just in six months. Few foreign & local investors that had inside information made huge profit and a lot of general investors paid heavily. (Alam and other, n.d.) Another major reason was the failure of market regulators. During June to November 1996, Stock exchanges did nothing to tackle the dramatic price increase of listed companies. Bubble formed due to abnormal demand of securities by new investors where the numbers of listed securities were very few. The reason of huge influx of investors was political stability in the country and bringing confidence in investor`s mind. (Afroz. 2006) Another problem was the delivery versus payment (DVP) system of trading used to allow buyer-seller to settle their transactions between them without stock exchange participation. Many brokers/dealers used it as a tool to show fake trading to increase demand of share from the general investors side. According to Bangladesh Bank analysis that there was an unauthorized Kerb market consisting of over 25,000 investors outside the stock exchange where securities were traded at a very high price. Moreover, SEC could not handle the crisis for its defective infrastructure. Weak regulations and surveillances could not monitor market manipulators and market intermediaries. Even information inefficiency, artificial financial statements certified by chartered accountants, false information and rumor were other important factors that overheated the market and burst the bubble. (Afroz, 2006)

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4.3 Regulators Responses

SEC formed a probe committee for investigating and finding manipulators behind the stock market fiasco on 26th December, 1996. On 27th March, 1997, the committee published a report affirming a number of listed companies, investors and brokers who were in the market manipulation. Finally, Court issued arrest warrants against 32 people in 7 brokerage firms, 8 listed companies. SEC also filed 15 share-scam cases in court. (Afroz, 2006) However, it took too long for the government and market regulators to restore the market conditions. As an aftermath of the capital market crash of 1996, investor lost their faith on the market. On 20th November, 1997, government launched Capital Market Development Program (CMDP) to calm the capital market, and attract more local and foreign investors. After that adopting automated trading system and establishment of CDBL increase the credibility of capital market to the investors. (Bepari & Mollik, n.d.) The Bull Run of 1996 leaded to some positive reforms for the market. It created stronger surveillance and improved rules relating to public issue, rights issue, acquisition, mergers and surveillance of secondary market became more active than before. The SEC is adopting strict rules and guidelines, trading circuit breakers and international standard surveillance to protect investor rights and ensure fair play. (Rashid, 2008)

5. Capital Market Crash of 2010 2011 5.1 Reasons for Market Upsurge

Several factors contributed to the creation of the bubble after the election of 2007. They are listed below. In, 2007, State of emergency was declared by a military backed regime in Bangladesh owing to the political upheaval. During military-backed regime investment in real sectors as well as FDI decreased but the inflow of foreign remittance increased. Investors tried to find alternative investment sector to invest their savings and found stock market as an attractive alternative. (Khaled, 2011) According to CPD (2011), the total number of BO Account holders on 20th December, 2010 reached to 3.21 million though the number was 1.25 million in December 2009. Most of these new investors dont have enough knowledge about the stock market but invest their most or all savings in the market. 238 brokerage houses opened 590 branches at 32 districts. As CPD (2011) found, internet-based trading operation, opening branches of brokerage houses across the country, easy access to the market information, arranging a countrywide 'Share Mela (fair)' are the factors for increasing investors. But supplies of new securities through IPOs were not enough to chase huge capital of too many investors in the market.

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 Moreover, in the recession period of 2009-10, Banks & other financial institutions had lot of surplus liquidity thanks to less business opportunities. Consequently, theses financial institutions & its officials as well as other people took loan and invest in the capital market to minimize the cost of bearing excess liquidity and to capitalize on this great opportunity. This made a huge influx of liquidity in the share market. It was seen that the daily transaction in the share market was on an average from TK. 20,000 to 30,000 million in 2010 and the figure was double comparing to 2009. (Raisa, 2011) During that period, Bangladesh bank adopted expansionary monetary policy to allow the budgetary target of 7-8% of GDP growth and to support investment in the high inflation period. Bangladesh Bank pegged Taka against dollar to support exports. As Taka had been undervalued it made excess growth in money supply. A big portion of this excess liquidity had gone to the stock market but there were very few shares in the market. The policy that was adopted by BB to grow economy by increased exports & investment eventually misguided and ended up forming the mother of all bubbles. Then government again fuelled the bubble after per-mitting whitening of black money through tax breaks and schemes. (Rahman, 2011) The inability of SEC to monitor the market conditions properly also fueled the enormous bubble. Due to the poor monitoring & market surveillance share prices of Z Category Companies and small companies increased dramatically. Moreover, some initiatives taken by SEC were not effective and changed directives frequently such as; it changed directives of margin loan ratio 19 times. (Raisa, 2011)

5.2 A Brief Account of the Timeline of the Historic Fall

Timeline of historical fall of the crash has been divided into two sections which are December 2010 and January 2011.

December 2010

The last glorious day for the investors of capital market in 2010 was 5th December. On that day DSE General Index (DGEN) gained its all-time highest 8, 918.51 point & broke all old records of DSE turnover by Taka 32.50 billion. In 2010, both SEC and Bangladesh Bank took a number of initiatives to keep the market under control. But in December both BB & SEC changed many of their previous directives and applied new more. On 6th December, 2010 SEC introduced a directive saying that buy orders will be performed after encashment of Investor`s cheque. On the following day another directive called netting facilities was applied. This indicates that no investor will be able to purchase securities against the sale proceedings of any other securities during the settlement & clearance period. But both directives

18

of 6 & 7th December were cancelled on 8th December. The reason of cancel-ling these directives was a significant fall of share prices on 8th December. (Bhuiyan, 2011)
th

SEC changed directive of margin loan ratio by increasing it from 1:0.5 to 1:1 on 13th December and later it was again hiked to 1:1.5 & 1:2 because of free fall of share prices. (Bhuiyan, 2011) Bangladesh Bank got a complaint that Banks are investing money in the stock market from their reserve. On the 1st day of December BB sent 50 teams in different banks of Dhaka & Chittagong to investigate and found some banks in such irregularities. Again on December 2010, BB issued directives to withdraw the illegally invested industrial loans and to increase Statutory liquidity Ratio (SLR) & Cash Reserve Ratio (CRR). On 15th December, BB increased CRR and SLR by 0.5 percent and increased to 19 & 6 percent. Another important directive initiated by BB was withdrawal of illegally invested industrial loans by December 31, 2010. As a lot of the reserved money was invested in capital market, banks started selling shares and withdrawing that money from the market. By the time investors became panicked. To handle the disastrous & assure the panicked investors BB extended its deadline for submitting and adjusting loans. For the merchant banks the deadline was January 15, 2011 and for the commercial bank February 15, 2011. (Raisa, 2011) As December is the closing period form any organizations, Institutional investors including financial institutions started selling shares from the beginning of December to show high return on investment at their balance sheet. As the institutions & bank started selling their shares from the beginning of December the turnover of DSE was the highest ever in its history on 5th December. (Raisa, 2011)

DGEN
9000 8800 8600 8400 8200 8000 7800 7600 7400 7200 7000

Figure 5: DSE Daily Index of December, 2010

19th December was a historical day of the financial year 2010-11 in Bangladesh stock market. On this day DSE witnessed its biggest one day fall in 55 years history until the date with losing 551.76 points or 6.71 percent. The losing index was even higher than 284.78 points or 3.32 percent of 12th

19

December. Prices started to nosedive in an hour after the trading started and about 200 points were wiped off. In the middle of the session it recovered little bit and ended up the session at 7654 point.

CASPI
26000 25000 24000 23000 22000 21000 20000 19000

Figure 6: CSE Daily Index of December, 2010

In the mid December, to meet CRR & SLR requirements of BB by the deadline created liquidity crisis in banking sector and call money rate made a new record of 180%. Investment Corporation of Bangladesh (ICB), state-owned commercial banks (SCBs), regulators and government brought some kind of stability in the market after the big fall of 19th December & liquidity crisis. As a result, share prices increased from 20th to until 30th December and index stood at 8290 point at the end of the financial year 2010-11.

January 2011

From 3rd January, 2011, Stock prices started to fall as investors had the information of ongoing liquidity crisis in the financial & non-financial institutions that limiting the margin loan. On 9th January DSE General (DGEN) Index declined by 600 points and all indices declined nearly 7.75 percent. On 10th January Dhaka Stock Exchange General (DGEN) Index lost by 660 points or 9 percent & Chittagong Stock Exchange Selective (CSE) Index declined by 914 points or 6.8 percent within 50 minutes of trading. CSE All Share Price Index (CASPI) stood at 19212.34 losing by 1,396.21point, which is 6.77 percent. CSE Selective Categories Index (CSCX) lost 914 points or 6.87 percent and CSE-30 Index also lost 1490.83 or 8.28 percent. It had broken all previous records of decreasing index. After that Security & Exchange Commissions called for an emergency meeting with BB and stop trading at both Dhaka & Chittagong Stock Exchanges Investors came out in the street with processions and demonstrated against free fall of Share index in both bourses as well as suspension of trading.

20

DGEN
9000 8500 8000 7500 7000 6500 6000 5500 5000

Figure 7: DSE Daily Index of January, 2011

The Government, Central Bank & SEC took immediate actions following the two days consecutive historical fall of stock prices to soothe the market. As a result, recovery was initiated with institutional buyers i.e. merchant banks, state-owned banks & non-financial institutions. Institutional buyers were asked not to sell shares rather to buy. Bangladesh Bank pushed money into the market as liquidity support and repo. DGEN made the largest gain in the history of Bangladesh on 11th January by recovering 15.6%. (Chowdhury, 2011)

CASPI
24000 23000 22000 21000

20000
19000 18000 17000 16000

Figure 8: CSE Daily Index of January, 2011 21

However, on 18th January, the index started to decline and the market hit the lowest turnover in nine months which is TK. 8.49 billion. Thus, investors came out in the street once again and started protesting against free fall of share prices. SEC asked DSE & CSE to halt trading for the 2nd time within 8 days. DSE General Index (DGEN) declined by 243 points or 3.29 percent and CSE Selective Category Index 298 points after a trading of around 2.4 hours. Though steps were taken and applied by the government, BB and regulators to improve the market conditions and bring the investors confidence market index declined heavily on 20th January as DGEN slipped by 599.77 points or 8.68 percent. From 26th of January there was an increase trend of index. But finally Index stood at the lowest point which is 5579 from 7th to 14th February. (Khalid, 2011)

5.3 Roles of Different Market Participants during the Market Crash

Investigators, analysts and economics have question the roles of different market participants in the forming and diffusing stock price bubble. In the following sections, the role of different market participants during the market crash are discussed.

5.3.1 Role of Bangladesh Bank in Capital Market Crash

As a monetary authority of the country, Bangladesh Bank plays significant contribution in channeling funds in the various sectors of the economy. Therefore the role of central bank in stock market is obvious. In the recent stock market crash, BB was at the center point of all debate. The reasons of recent crash may lies in the question of whether the monetary policy response was appropriate during the period of stock market rise as well as during the time of subsequent crash. At time of market upswing, commercial banks invested heavily in the capital market to capitalize on the opportunity. This has been going on for a while over last few years mostly form 2007 when the military backed civilian caretaker government took power in Bangladesh. Moreover, during the same time merchant bankers became the key player in the stock market. Undoubtedly, any policies to control commercial banks exposure to the stock market will result significant impact on the stock market. Deregulations during the last three to four years from 2007 as indicated by a more than 22 percent rise in money supply during the period, surely have helped stock market to remain floating during these days. Surprisingly, perhaps, Bangladesh Bank (BB) was not much aware about banks' exposure to the stock market, probably because banks profit from stock market investment as shown in their balance sheet seemed to be negligible to Bangladesh Bank. But with the daily follow up of a rigorous operating procedure by the central banks about the activities of commercial banks make this explanation very naive. In fact there was a widely held public perception that banks were making handsome profits from stock market investment. Correct information of banking industrys exposure to the stock market remained unknown for unexplained reasons, which has been a total governance failure on the part of the central bank as a supervisory authority.
22

Bangladesh Bank began to control commercial banks exposure in the second-half of 2010; when the ASPI of DSE had reached to an alarming level crossing all time highest limits of 8000 points. However, most of the policies taken by BB seemed misappropriate and mistimed. For instance, Bangladesh Bank all on a sudden issued a proclamation that calls for all banks to maintain their investment in the stock market equivalent to 10 percent of their total deposit and to conform to such directives by December, 2010 with less than a months remaining, when in reality, the ratio was much higher than 10%. Some banks even had almost 60% of their deposits invested in stock markets. Additionally, Bangladesh Bank suddenly increased CRR from 5.5% to 6% and SLR from 18.5% to 19% and call for an increase of paid up capital created an extra pressure for commercial banks to raise their liquidity. It prompted a sales pressure. Moreover this mistimed monetary policy announcement also cast doubt on the previously reported amount of excess liquidity in the banking sector in BB. Thus withdrawal of banks' large investments from the stock market appeared to be the main reason for the recent crash in the stock market in Bangladesh. Bangladesh Bank might have some additional reasons behind those decisions, such as to hold inflation, to channel more credit to the real sector, and to protect the interest of the bank depositors by limiting them from risky investments. But surely there was the problem of timing.

5.3.2 Role of Institutional Investors in the Capital Market Crash

A significant portion of investors in terms of investment volume are institutional investors in Bangladeshs capital markets. These institutional investors are consisting of commercial banks, insurance companies, mutual fund companies, merchant banks, finance and investment corporations etc. However, commercial banks are the biggest among the institutional investors in DSE & CSE. In maximum cases December is the accounts closing month for all of these various type financial institutions. As mentioned earlier, due to serious supervisory lacking form BB most of these financial institutions especially scheduled commercial banks have overinvested in stock market beyond their legal boundaries of stock market exposure limit. Latter on as the closing days for financial accounts loomed nearer most of these institutional investors tried to close out their position to realize the capital gain and to fulfill the regulatory guidelines regarding the maximum limit of stock market exposure which is 10% of the deposits. Thus commercial banks have taken the role of sellers rather than buyers to dry up liquidity from the market leading to market crash. Merchant banks are another large portion of institutional investors in the capital market. Similar to commercial banks, merchant banks also participated in the stock market to realize capital gain on their investment and they also sold their shares at the end of year, which had further escalated the crisis. For example, in DSE most of the time clients took loan from merchant banks against their equity in order to average their cost of investment. Since market was continuously falling for last few months and those investors who already took loan from merchant bank were in problem with their debt to equity position as shown in their respective BO accounts. As price continued to fall merchant banks were forced to forced sale to save their own investment and interest income in their clients accounts. Thus a change in margin requirement continuously forced merchant banks to take different positions which forced the market to become even more volatile. Apart from the commercial banks and a big number of active merchant banks, insurance companies and mutual funds have also played their part primarily in formulating and then diffusing the bubble realizing their share of the cake.
23

5.3.3 Role of Securities and Exchange Commission in the Capital Market Crash

In the capital market crash, Securities and Exchange Commission (SEC) as a supervisory authority has failed the market by frequently changing rules and regulations, imposing new policies related to margin trading, interest on margin. Years of researches have shown that, margin requirement is one of the most important tools for manipulating, maintaining the outcome in the stock market. While, during the entire life of New York Stock Exchange (NYSE), the margin requirements has been changed only 22 times. In Bangladesh, during the period of stock market crash (Dec10 Jan11), SEC changed the margin requirements 19 times. Apart from the frequency of change, Schwert (1989) showed based on empirical studies that margin requirements changes tend to precede volatility. With this empirical reference from developed markets across the world, a closer study of the SECs role in recent stock market crisis in Bangladesh suggests that SEC as a regulatory body has shown a total incompetency in stabilizing the market by undertaking different faulty measures including using its margin requirement tools. SEC began their experiment on margin loan ratio from the commencing of 2010 crisis. On 1st February, 2010, SEC changed the margin loan ratio from 1:1 to 1:1.5 which created more leveraged trading opportunities. Consequently, investors began to take margin loan recklessly.

Changes in DGEN with Margin Ratio Changes

122.60 84.00 52.20 34.40 36.90 27.80 9.80 67.70 103.90 66.60

31-01-10

-23.40

28-02-10

31-03-10

30-04-10

31-05-10

30-06-10

31-07-10

31-08-10

30-09-10

-103.70 -124.80 -129.00

-187.80

Figure 9: Changes in DGEN with Changes in Marin Ratio

On 3rd February, SEC restored margin ratio to 1:1. Again on 15th March, 2012, SEC increased the margin loan ratio to 1:1.5 and then again reduced it to 1:1 in July and 1:0.5 in October. However, SEC failed to provide explanation for such recurrent revisions. The above graph shows the relationship between margin ratio and index volatility. The positive quadrant show the increase in margin ratio while the negative quadrant shows the decrease in margin
24

ratio. From the above graph, we can see that every time SEC changed margin loan ration there has been a considerable decline in the index. It is clear that SEC was totally incompetent in exercising its authority to guide the market in a proper direction using margin loan ratio tool.

5.3.4 Role of Brokerage Firms in the Capital Market Crash

There are certain rules and compliance guidelines for brokerage firms set by SEC to ensure market stability and to help the trading procedure for investors. During the period of market crisis, many brokerage houses violated those rules and guidelines. Under the securities and exchange laws, brokerage firms and merchant banks cannot grant loans to their clients for purchasing shares of companies under Z category which groups low profile shares. But SEC found that the share prices of Z category companies rose abnormally in recent times as investors bought shares of the low profile companies with the loans provided by the stockbrokers. The price of Z category shares had become overpriced as the brokerage houses continued providing margin loans to their clients to buy shares of the issues under the category. Upon the intervention of the SEC, the market reacted with increased sell pressure leading to further aggravating of the situations. Moreover, experts questioned the timing of the SECs decision to take action against 23 brokerage firms for violating the guideline concerning granting loans for purchasing Z category shares.

5.4 Reasons behind the crash

After the historic capital market manipulation, Government of Bangladesh formed a four-membered probe committee led by Mr. Khondokar Ibrahim Khaled to find out the individuals and institutions responsible for the market scam. The committee submitted a report consisting of the reasons for the crash and recommendations with couple of case studies on 7th April, 2011. The report has identified a group of manipulators including key officials, auditors, issuers, issue-managers, brokers, individual investors and some other stakeholders. Moreover, some independent researchers, analysts and economists have also published some articles and given interview in a view to discuss the reasons of the crash. In the following sections, the factors contributed to the market crash are discussed.

Incompetency of and Exploitation by the Market Regulators

In the previous section, the incompetency of the market regulators have been broadly discussed. Here a summary of the findings by Ibrahim Khaled has been presented. In the probe report, the role of SEC to control & monitor capital market, working in favor of manipulators, approving unethical proposal and issuing wrong directives which lead to unexpected market conditions have been
25

indicated. Some corrupt employees of SEC who were directly or indirectly participated in the market manipulation have been identified by the probe committee. Manipulation in the listing process new companies and placement of mutual funds & IPO at a price lower than the market value were the few example of their deeds. The following table summarizes the wrong actions taken by regulators and subsequent market reaction.

Date

Regulations
Bangladesh Bank (BB) extended the deadline on banks in recovering industrial credit1 that was diverted into the stock market Transferred 14 companies share trade to public market 2 instead of spot market3 Allowed netting or financial adjustment4 facilities for non-marginable stocks5 Withdrew restrictions on merchant exposure6 to the stock market. banks'

Authority

Index

% Change
1.58

10-Jan-11

BB

6499.43

10-Jan-11 10-Jan-11 10-Jan-11 10-Jan-11 18-Jan-11

SEC SEC SEC SEC SEC

Do Do Do Do 7140.24

Do Do Do Do -0.03

All listed7 companies would change face value8 to BDT. 10 from BDT. 100 or BDT. 1,000 Rectification of Margin Loan9 - increasing margin loan ratio to 1:1, to 1:1:5 and 1:2 Revised the members' margin rule, increasing the free limit of stockbrokers' and dealers' exposure to the market Introduction of circuit breaker10 on share index to protect against a big rise or fall Cancellation of Book Building method Sanctioned fund amounting to BDT. 600 crore for the Investment Corporation of Bangladesh to buy shares, also sanctioned fund Sonali Bank Limited, Agrani Bank Limited, Rupali Bank Limited and Janata Bank Limited in two phases to buy shares from the stock market Approval of BDT. 5,000 crore Bangladesh Fund, an open-ended mutual fund Undisclosed money can no longer be invested into the share market in a process for whitening Ordered all companies and funds listed in the stock market to change their face value to BDT. 10 Reduction of Single Party Exposure limit of Banking Institutions Undeclared money would not be questioned if it is invested in the capital market Regulator made it compulsory for sponsors, directors and promoters of a listed firm to jointly hold at least 30 percent stake in the firm.

18-Jan-11

SEC

Do

Do

19-Jan-11 27-Jan-11

SEC SEC

6913.39 7385.91

-8.49 1.45

28-Feb-11

BB, SEC, Other Regulators

5203.08

--

18-Apr-11 09-June11 15-Sep-11 19-Sep-11 20-Nov-11

SEC Finance Minister SEC BB NBR

5601.60 6250.00 5960.74 5966.51 5800.42

7.66 -1.08 -0.10 --2.78

21-Nov-11

SEC

5322.68

0.18

26

Date
21-Nov-11

Regulations
Set the new rule to stop sales of shares by the sponsors and directors within their companies. Sponsors and directors of a company will only be able to sell their shares in 'block market' instead of public market. A circular on four issues in the newly unveiled incentives package had been issued. 138 companies and mutual funds cannot be traded on Dec 1 on account of record date for changing the face value of shares.

Authority
SEC

Index
5596.96

% Change
5.15

21-Nov-11

SEC

5372.66

-4.01

24-Nov-11 26-Nov-11

BB SEC

5373.30 5065.18

0.01 -5.73

1Banking 2A

institution invested portion of industrial loan in stock market, as a result BB ordered banks to recover those investment.

stock market or equity market

3The

spot market is a public financial market, in which financial instruments or commodities are traded for immediate delivery. It contrasts with a futures market in which delivery is due at a later date.
4Netting

or financial adjustment means no investor will be allowed to buy shares against the sale proceedings of other securities within the existing settlement period.
5Securities 6SEC 7A

that cannot be purchased on margin at a particular brokerage.

withdrawn Merchant Banks restriction on stock market investment.

company is said to be listed, quoted or have a listing if its shares can be traded on a stock exchange.

8All

companies issue shares with a fixed denomination called the face value (or par value) of the share. This face value is indicated on the share certificate.
9Margin

loans are loans taken to finance the purchase of securities, usually the purchase of stock (also known as

equity).
10Circuit

Breaker is the maximum permissible deviation of the price (specified as percentage) of the incoming ord er from the Circuit Breaker Base Price for that instrument. Orders violating circuit breaker will result rejection of the order.

Demutualization of Exchanges

The executive board of both DSE and CSE is formed with members both elected and nominated. The elected members mostly comes from a pool of big investors. Due to the less interest and relation of nominated members, these elected members run the administration. Consequently, the players of the capital market act as controller. It has been found that, during the period of market manipulation, controllers are inactive because of conflicting interest. In the investigation report it has been pointed out that, different stakeholders of capital market support demutualization of exchanges which is the process of converting exchanges from non-profit, member owned organization to for-profit, investor owned corporation.

Illegal Investment of Banks in the Capital Market

During the booming period of 2009-2010, many banks invested heavily in the capital market crossing the limit of using deposit money. As a result, this enlarged supply of capital increased the stock prices. However, when Bangladesh bank imposed restriction to invest maximum of 10% deposit

27

money in stock market, bank began to sell their investments which caused downward pressure in stock price. As result market suffered enormously and banks also couldnt regain lost capital.
Fraudulent Pre-IPO & IPO Process

Investigators found that, underwriters in connection with some dishonest operatives of regulators manipulated share prices in the Pre-IPO and IPO process. In the Pre-IPO stage, they illegally created a kerb market through which they place shares to investors bypassing the legal procedures. Moreover, SEC approved the application for IPO without recommendation of the listing committee of DSE & CSE. Due to SECs insignificant surveillance, underwriters calculated fixed abnormal indicative price and asset value. As a result of all these, in the Pre-IPO and IPO stage, Kerb market overvalued share prices which eventually created liquidity crisis in the market.
Uniform Face Value of Shares

In 2009 & 2010, 62 listed companies spilt their shares to make a uniform face value of share at Tk. 10. In theory, splitting shares doesnt intend to change revenue or asset and thus should not affect share prices. However, as splitting shares make it possible for small investors to buy those shares which were previously expensive, small investors showed a lot of enthusiasm to buy split shares and consequently pushed the price up. This began to transform market capitalization; for instance, companies which had split their shares witnessed 655% increased market capitalization. On the contrary, companies which did not split their shares noticed only 46% rise in market capitalization. From July 2009 to December 2010 the role of total MC were 81.5% of companies which adopted share uniform and only18.5% those that did not adopt. (Khaled, 2011)

Trade in Pre-IPO Placement

Private placement or Pre-IPO placement is the process by which Issuer Company sells shares to a selected number of investors without having to register with SEC. In such kind of placement, companies doesnt require to disclose detailed financial information. Although in Europe and America, there are certain guidelines for private placement, in Bangladesh SEC didnt have such regulations. Consequently, underwriters used it as device of manipulation. In the most of the cases the placement was offered at less than IPO price. According to Khaled (2011), eight companies issued convertible preference share in 2009 & 10 in which average 69% went for placement. So, participation of the public was hindered and that created placement trade or Kerb market. Some companies distributed 50-90 percent of their paid up capital in private placement. As a result, the number of free floating shares decreased as companies went for more private placement of shares. Accordingly, difference between demand & supply push share prices up. As private placement doesnt require any registration with SEC, many non-listed companies drain off huge investment from capital market.

Misuse of Omnibus Accounts

An omnibus account is a stock holding account that involves more than 10,000 investors. Although actual shareholders, individual investors don't have the accounts in their names. Omnibus accounts were another major device of manipulation. In Bangladesh, ICB has 9 omnibus accounts and each merchant banks have only one omnibus account. According to Khaled (2011), at least Tk 2.5 billion
28

has been traded from hidden or omnibus accounts used as a major tool of stock market manipulation. The syndicate players of the Investment Corporation of Bangladesh (ICB) traded Tk 2.3 billion from nine omnibus accounts of the ICB alone. The probe report published the name of 30 big players including ICB for a lot of suspicious transactions and says most manipulators traded from the omnibus accounts. Most big players chose omnibus accounts to gamble in the market, as it's not possible to find out issue-wise or client-wise transactions of actual number of shares from omnibus accounts.
Faulty Asset Revaluation

The revaluation of a company's assets to take account of inflation or changes in value since the assets were acquired. The change in value is credited to the revaluation reserve account. With the collaboration of dishonest auditors, companies generated artificial audit reports in which assets were shown overvalued. As a result, when calculating Net Asset Value (NAV) based on this overvalued asset, it provided wrong signal about the companys true financial capabilities. Moreover, those companies issued bonus shares showing unrealized gain of revalued asset price which is a faulty accounting practice. Although, companies are required to maintain provision against deferred tax during asset revaluation to pay tax in future, companies did not follow it. Investigation reports pointed some companies which got NAV more than 100% to 3,472% after asset revaluation.

Irregularities in Book Building Method

Book building method is the globally recognized technique of determining the offer price of IPO. In this process, the fair price is obtained from the demand of a security from institution investors and their indicative price through road shows. The motivation for introducing this method in Bangladesh stock market was to attract more firms for enlisting in the stock exchanges through fair share pricing. However, it was found as an instrument of manipulating market prices, Investors obtained too high price for the security through the price discovery stage and offloaded those stocks after the lock in period. As a result they pulled out a lot of profit within a short period and after that the share price did not increase. In this process corrupted Issuer and issue manager manipulated the price.

Lack of knowledge of small investor

Most of the investor of our capital market are small investor. And we have seen many of them have lack of proper knowledge about the market. They just buy a share to get profit after 3 days when the shares got matured. But how and why they are supposed to get a profit they dint know well. So when market goes decline the investors are supposed to wait and not to sell in loss. But the got panicked and sold off their share in loss even. So this attitude prolonged the market to go in bearish situation.

29

 December Closing of Financial Institutions

The market crash happened at the end of November and December. It was the time closing for many of the financial institution. So institutions, who had investments in the market, started to pack their profit into their bag. So lots of profit taking took place in that time. It influenced the market to go in the bearish too.

Serial and Artificial Trading

Some manipulators created artificial active trading environment among themselves through bulk transaction and increased share prices. Moreover serial trading and price manipulation by many buysell orders through different accounts and broker houses which overheated the market.

Issue of Right and Preference Shares

Right share indicates issuing new shares to the existing shareholders at a discount price. The issuance of right share increase number of share which should decrease share price but it did not happen. Mysteriously, it took SEC five months to come to a decision regarding right issue proposal. Preference share are the share which contain fixed percentage of dividend at cost of voting right. Issuer companies provide an option to convert into general shares to make it more attractive and it is called Convertible Preference Share. However, in Bangladesh, companies issue preference share for only 1-3 moths which is very unusual. SEC also didnt have proper guidelines for Preference Share issuance.
Suspicious Transaction of Top Players

During the time of unusual ups and downs in the index, some individual and institutional investors did many suspicious trading revealed by probe report. These investors are main reasons for the capital market crash; they with collaboration with government high-ups and regulators manipulated stock prices.

Block Placement

There was a lot of suspicious block trading of mutual funds. Some investors got enormous amount of placement time to time.

Direct Listing

With the approval of SEC few companies have been directly listed in the stock exchange. These companies come to the market with inflated share prices. Investigation report mentioned that indicative prices of these companies were determined even 58 times more than EPS and 9 times of NAV. Though share prices of these types of directly listed companies have been artificially determined, but SEC or exchanges did not investigate the reason of abnormal price.
30

6. Survey Report

This section of the study presents results of the self-administered questionnaires. Out of 15 employees 12 and out of 10 investors 6 returned the questionnaires. In case of this study, it is believed to be a merit to present the result of every question separately. The result is analyzed and summarized according to the objectives of the study. Here, the author represents reasons of the stock market crash, the role of regulators and government.

Relation of Respondents with Bangladesh Capital Market

There was a closed question to the respondents regarding their relationship with capital market with 3 different possible answers which are Employee, Investor and Both. In the first group of sample, out 12 employees of broker houses 5 were found as Employee and 7 were Both (employee and investor). On the other hand, in the second group of sample all 6 respondents were general Investor who invest in the market. So, the result of the question number 1 fits with the expected sample of the author for the Self-administered questionnaire.

Agreeing with Major Causes of Investigation Report of Khondkar Ibrahim Khaled (2011)

None of the respondent from both employee and investor group who agreed with all the causes given in the questionnaire. Every respondent selected few causes as major reasons behind the crash. The following table provides information about number of respondents agreed with different causes:

Reasons
Book Building method Direct listing Placement share Audit report Corrupted employees of regulators Split Share Serial trading Block trading Insider trading

No. of Respondents
6 8 2 3 11 1 2 0 8

31

Reasons
Over exposure of banks & financial institutions Omnibus account Poor monitoring or regulators Margin loan Kerb market Issue of Right & preferences shares

No. of Respondents
15 7 12 11 2 2

As the result shows, over exposure of banks & financial institutions is the most important reason behind the crash where 15 respondents selected the cause. Then poor monitoring of regulators was found 2nd important reason for the crash chosen by 12 respondents. Corrupted employees of regulators, Margin loan were chosen by 11 respondents and direct listing & insider trading was selected by 8 respondents. Other causes were selected by different number of respondents. Though anyone did not chose Block trading as a reason for the crash but it was mentioned by the respondents in other questions.

Any Other Reasons that were Liable for the Capital Market Crash

The aim of asking this question was to find out if there is any other reason that caused the stock market crash but did not appear in the investigation report of Ibrahim Khaled. Therefore, the answer of the question serves to generate new ideas about major causes of capital market crash and it was successful to do so. Most of the respondents answer the question with following causes: Imbalance of demand and supply of shares in DSE & CSE Investors didnt have idea about financial report of listed securities / unfair audit report Buying shares based on rumor & without study Majority of general investors dont have knowledge about capital market Intervention of Bangladesh Bank (central bank) Over expectation of general investor Liquidity crisis

The question number 2 and 3 was structured to find result of research question one and two. Poor knowledge of general investor about the stock market was the most common reason mentioned by the respondents of broker houses which was not in the investigation report. They mentioned that many of general investors dont have enough knowledge about the stock market. They buy shares
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without studying companies, on rumors and they have over expectations. However, most of the general investors did not mention it. Intervention of Bangladesh Bank, imbalance of demand & supply of shares and liquidity crisis were other reasons mentioned by the respondents of both groups.

Do the Investigation Report Leads to any Market Improvements

The question was another closed question with Yes and No two different possible answers where 9 respondents answered Yes and 9 answered No. Publishing investigation report was a decision of high court. So, the regulators and government will work according to the report and its recommendations were a great expectation of all stake-holders of the market. There was another investigation report in stock market crash of Bangladesh in 1996. But it was blamed that steps were not taken according to the report. So, the answer of this question reveals usefulness of the report and effectiveness of it by the regulators and government. Most of the general investors believe that investigation report didnt lead to any market improvements. However, most of the employees of broker houses agreed that it leads to market improvements and some mentioned it as slowly effective.

Development of Rules & Regulations by Regulators that were Blamed for the Crash

Respondents answered the question providing brief idea about the improvement of rules and regulations since the crash. 12 respondents of employee of broker houses & general investor agreed that regulators developed their many rules and regulations which were blamed as the causes of the crash. According to the respondents developed rules and regulations are following: Margin loan decision would be taken by broker houses and merchant banks not SEC Sponsor director mandatory holds individually 2% and all together 30% shares Book building method in IPO has been developed Bangladesh Bank imposed limitations on Bank & financial institutions about their exposure in the market

Should here be More Development of Market Regulations, Directives or Surveillance by the Regulators

Respondents mentioned that there should be more development of rules and regulations in following ways: Adoption of Software (surveillance) and surveillance team to monitor overall trading activities Trustworthy IPO approval process Actual book building process should be introduced
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 Offloading government shares Margin loan decision should be taken by broker houses and merchant banks not SEC Insider trading would be strictly prohibited

Suggesting Tools That Should Regulators Adopt to Prevent This Kind of Crash in Future

Every respondent makes recommendation regarding how regulators can protect this kind of crash in future by answering the question. The expected answer for the question will contain different tools that can or should adopt by the regulators. Most of the respondents of both sample groups provided accurate and clear answer for the question. They made following recommendations for SEC and stock exchanges. Provided recommendations are: Regulators should perform their job honestly and sincerely SEC needs honest officials Insider trading should be prohibited Omnibus account should be converted to BO account

Effective Steps That Government Took To Improve the Market Condition after the Crash

Respondents answered that the government of Bangladesh took initiatives to improve the stock market situation mentioning different strategies, tools, policies and rules-regulations taken by Bangladesh government. The effective steps taken by the government to improve the market condition are following: Opportunity to whiten the black money by investing in stock market Appointing new chairman and members in SEC Establishment of law division
Actions Taken by the Government Were Sufficient to Handle the Situation or Not With Suggestion
16 respondents of the general investor and employee group agreed that actions taken by Bangladesh

government are sufficient to tackle the condition of the stock market after the crash. In addition, some respondents also suggest implementing the actions taken by the government. Only two respondents did not agree with them and recommended following actions that should the government take to handle the situation: Government should announces incentives through SEC to attract companies to the capital market Government should take long term actions for the market
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 Role of Government to Prevent This Kind of Crash in Future

The answer of the question contains recommendations of steps or actions for government that should adapt to prevent or avoid and tackle same kind of crashes in future. Recommendations are given following: Actions should be taken against those who were involved in this recent stock market crash Improving security laws and penalty for breaking those Balancing of demand and supply of shares Follow-up the market and protect against any kind of manipulation

The question number 5, 6, 7, 8, 9 & 10 were designed to serve the research question three and four. The result of these questions describe that the regulators and the government of Bangladesh has contributed in the development of stock market after the crash. However, more developments are necessary.

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7. Recommendations

By now, the major factors that contributed to capital market debacle have been discussed. Here some recommendations have been prepared for the various stakeholders of the capital market: SEC should coordinate its surveillance activities with other regulators like DSE & CSE. Moreover, SEC needs to make long term decisions for capital market, and avoid making short term confusing directives. Manipulation in Pre-IPO and IPO process must be checked. SEC should frame new sets of effective regulation relating to book building method and private placement. These two tools were mostly used by manipulators in 2010-11 market scam. Moreover, SEC needs to monitor unusual trading pattern to identify insider trading and serial trading. All omnibus accounts of ICB and merchant banks must be converted into general BO accounts, no more secretive trading.

A new act regarding more comprehensive financial disclosure of companies must be enacted. Such act will prevent the auditors from making faulty audit reports. More Comprehensive guidelines for corporate governance in the listed companies mast be formulated. Such acts will prevent the sponsor and directors of different listed companies to manipulate companies financial statements for their own interest. An act regarding the protection of small investors must be enacted. Small investors are most vulnerable in market manipulation, so there must be some legal avenues for them to protect themselves. DSE and CSE must be demutualized that is it must be transformed into an investors owned organization from current member owned organization. As currently majority investors lost their confidence on SEC, a total reform of SEC is required. SEC must be reorganized with qualified financial analyst. Bangladesh Bank requires to be more careful in taking monetary policies. They must analyze the potential impact of monetary policies in the capital market. Government must ensure the punishment of culprits this time. It has been found in the investigation report that many masterminds of this market scam were also responsible of

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1996 crash. So unless government take legal action against them, investors will not be able to

regain their confidence on capital market. Government can also offload the shares of many state-owned organizations to bring a balance between supply and demand for the stocks in the capital market. A balanced supply and demand for the stocks can ensure fair price. Finally small investors are the most important decisive force in determining market behavior. It has been found that, most the small investors in Bangladeshs capital market are illiterate of investing. They gamble on their life savings without knowing the true condition of the company they are investing. They take their investment dictions based on rumors. In this circumstance, educating small investors are top most priority. An educated pool of investors is most strong shield against the exploitations of manipulators.

8. Conclusion

In conclusion, the current stock market crisis has highlighted numerous vulnerabilities in the financial system which has been build up on with excessive leverage, serious mispricing of the securities, misguided reliance on institutional investors and finally a pathetic response of out of shorts regulators especially the SEC and BB. After the crash, the regulators took several polices to address the issues that cause this historical misfortune for the countrys economy. However, the question is whether these policy measures of the regulators will be able to calm & stabilize the market? The answer is obviously not very encouraging since most of the reasons behind the downfall of the market involve policy blunder by regulators which has not been addressed long term programs. The experiences of developed markets like New York Stock Exchange, London Stock Exchange and Tokyo Stock Exchange cast shadows on the success of government to punish the real culprits and prevent the repetition of such financial disaster.

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