The outstanding negative equity against margin loans taken for investments in the country's capital market fell more than 18 per cent to Tk 66.3 billion between December 2020 and September 2023.
Though market stakeholders say such a high volume of prevalent negative equity exerts an adverse impact on the market, 87 organisations -- brokers and merchant banks - still bear the burden.
The recent sharp correction of the market is seen as fallout from forced selling in margin accounts, executed as assets' value went below the loan amount.
Forced selling happens when the market shows as upward trend as lenders want to make adjustments in the margin accounts. Market operators thus blame the negative equity for not letting the market flourish.
BSEC Commissioner Dr. Shaikh Shamsuddin Ahmed echoed the view and said the market needed to get rid of the negative equity.
One way to get the solution is if lenders shoulder the burden of loss because investors do not have any stake in the assets when what they owe is greater than what they own, said Md. Ashequr Rahman, managing director of Midway Securities.
"Top officials of the lenders [brokers and merchant banks] will have to convince their boards into bearing the loss."
In that case, the stock brokers' capital adequacy ratio may fall short of the requirement.
"The securities regulator can offer a waiver and ask lenders to come up with action plans for adjusting negative equity," added Mr Rahman.
What's the way out
AIBL Capital Market Services reduced negative equity by writing off the bad investments and selling off holdings in the margin accounts.
For example, some margin accounts had an aggregate amount of negative equity worth Tk 10 million. In that case, the company contributed Tk 5 billion and the clients deposited Tk 5 million, said Md. Rezaur Rahman, director of the company.
Midway Securities cut down negative equity in the margin accounts that it has been handling from Tk 20 million in 2010 to Tk 1.2 million at present.
In 2014, the then Bangladesh Securities and Exchange Commission (BSEC) allowed lenders to conduct transactions in the margin accounts, subject to re-investing the funds that would be realised from selling securities in the accounts.
Usually, reinvestment is forbidden with the funds coming from assets with negative equity.
Midway Securities purchased fundamentally-strong stocks, including Grameenphone, against the sale proceeds and kept the holdings for a long time, said the MD, Ashequr Rahman.
He said many lenders had misused the margin accounts with negative equity, conducting transactions in bad stocks. Though clients no longer had any stake in the accounts, lenders showed huge interest amounts as cash receivables.
Emergence of negative equity
Before the 2010-11 stock market debacle, lenders disbursed margin loans aggressively boosting liquidity in the market.
The regulator at the time allowed lenders to lend at a ratio of 1:1 and then raised the ratio to 1:1.5, meaning a borrower could get Tk 150 in credit against an investment of Tk 100 in a marginable stock.
Insider said some lenders had disbursed loans even at a ratio of 1:2 or 1:3 or above. They also provided margin loans to pull specific stocks on the bourses.
Stock brokers and merchant banks provide margin loans from funds received from parents companies, most of which are banks.
The 2010 market ballooned, owing to margin loans, and then it burst rendering massive erosions in asset values. That led to negative equity piling up.
As per the stipulated rules, there was no scope of negative equity as the lenders were supposed to sell the assets in margin accounts before their market value dropped below the money lent.
But after the market collapsed, the regulator verbally instructed lenders not to conduct sales in the margin accounts, assuring them of market rebound, but that did not happen.
Eventually, wrong regulatory decisions led to a culmination of negative equity to more than Tk 81 billion by December 2020.
The regulator's pressure on lenders drove down negative equity until the end of 2022, but then it went up again in 2023 when the market was mostly illiquid with good stocks languishing on the floor.
Md. Saifuddin, chief executive officer of IDLC Securities, said the lack of financial prudence of both lenders and borrowers was responsible for the market bubble.
Then the regulator and investors did not allow lenders to adjust margin accounts by selling out assets, deepening the problem, he said. Banks were supposed to write off the negative equity but could not do so for failing to show good profits.
How effective margin
loans are
Marginal loans are meant for short terms, given on the basis of investors' capacity of repayment.
"Margin loan is not a right for general investors. It also cannot be an investment vehicle," said IDLC Securities' chief Mr. Saifuddin.
Many lenders have begun speaking against margin loans.
Preferring anonymity, the chief executive officer of a leading brokerage firm said investments made with margin loans were not suitable in the context of the country's capital market.
"Firstly, clients get in trouble and secondly lenders face difficulties in realising their funds," he said.
Referring to global practices, BSEC Commissioner Mr. Shamsuddin Ahmed said the regulator would not remove the provision of margin loans.
"We are discouraging investments based on margin loans. We suggest investors avoid redundant credits for the sake of their own hard-earned money."
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