Weak merchant banks at risk of losing licence

Merchant banks, failing to ensure net worth above half of their respective paid-up capital, would face licence cancellation after December 2023, said the capital market regulator.

The Bangladesh Securities and Exchange Commission (BSEC) issued a directive on Monday ordering the merchant banks to repair their books in the next 13 and half months.

The regulator, from the beginning of 2024, would not grant any quota facility for lucrative primary shares to the merchant banks which would not have the minimum net worth then, alongside initiatives to cancel their business licences.

The hardline was long pending, believe observers.

"We appreciate the regulatory push to clear the weakness many merchant banks have been suffering from," said Bangladesh Merchant Bankers Association President Md Sayadur Rahman.

The painful asset erosion

This entire problem of many merchant banks operating without the required net worth is a legacy of the 2010 market crash, the aftermath of which had been handled too unprofessionally by the regulator.

Almost all the merchant banks that lent their portfolio management service clients for buying additional shares faced capital erosion over the next one decade of the notorious market crash as they failed to act professionally due to some verbal regulatory orders then.

According to margin loan rules, when the price of held securities drops and the leveraged investors' own equity depletes to near zero, the lending broker or merchant bank should call for more margin – fresh capital injection, so that the lent money remains safe.

And the respective broker or merchant bank needs to forcefully liquidate the investment account as soon as the market bites into its lent money.

But, showing sympathy to the unsophisticated retail investors on the verge of collapse then, the government and the market regulator verbally ordered brokers and merchant bankers not to forcefully sell any securities.

The market did not turn around before a two-thirds correction in a few years and the major indices are yet to reach the 2010 peak.

And, the capital market intermediaries sunk thousands of crores of taka in the toxic assets – technically called negative equity – as the decade-long bear market not only wiped out the investors, but also most of the lent money.

The prayers for market turnaround only deepened the financial wounds.

Having most of the toxic balance sheet assets already cleared, the brokerage and merchant banking industries together are still holding over Tk4,600 crore in negative equity, according to the regulatory compilation at the end of June this year.

BMBA President Rahman said the majority of merchant banks are deprived of the minimum revenue due to the market structure and culture of fewer investment banking activities and fewer funds under management.

Had the market allowed the industry to flourish over the last decade, added revenue streams would help merchant banks offset the negative equity losses entirely, which unfortunately did not happen for most of the merchant banks, said Ershad Hossain, managing director of merchant bank City Bank Capital Resources Ltd.

Only the merchant banks with multiple revenue sources better handled the crisis, he added.

The window dressing

The accounting standard demands firms set aside profits as provisions against their negative equity exposures and clear the non performing assets.

But, the industry, barely seeing profits in the bearish decade, was seeking continuous waivers and the regulator knowing well that their verbal unprofessional orders not to trigger the forced selling in time was the evil kept granting the waiver.

The latest directive allowed the industry to window-dress its negative equity problems till the end of 2023.

However, many top-tier merchant banks did not wait enough to be pushed by the regulator to end the accounting of loss hiding and they took hits in the 2013-18 period.

The new income helped some of them to cover up losses and walk strong, while very few are yet to succeed.

At least two of the eight merchant banks failing to maintain 50% net worth are big-name ones, said BSEC officials.

Many window-dresser merchant banks are under real pressure to clear negative equity and make provisions by the next one year and if that drags their net worth below half of their respective paid-up capital, they must inject fresh capital or face the music.

Operating without adequate assets reduces the industry's capacity to operate professionally, said experts.

Also, it becomes impossible for regulators to recover stolen client money from financially weak firms committing fraud as seen in the brokerage industry in recent years.