Bank as broker: The good, the bad and the ugly

Although commercial banks have a larger network across the country, they cannot operate the brokerage business with their existing branches. Thus, the question arises, are banks willing to establish such subsidiary companies outside Kathmandu? 

Nepal Bankers’ Association (NBA), an independent group of commercial banks, has been trying to coax Nepal Rastra Bank to provide commercial banks with the license of a stock broker. The Ministry of Finance has already directed the Security Board of Nepal (SEBON), and SEBON to the Nepal Stock Exchange (NEPSE) to initiate the process. The banking institutions are required to establish one sister organisation (subsidiary company) to perform this job. In this race, some A class commercial banks have already started opening subsidiary firms. Thus, beneath the surface, the tectonic plates of share trading are shifting. And this has not gone down well with the existing brokers and the lawmakers. The issue is now under discussion with the Economic Committee in the House of Representatives.

The brokerage firms are arguing that giving licenses to banks, major players in the capital market, will promote a yet more important anomaly in the stock market – information asymmetry, as availability of internal information about the parent company – the bank – could lead to an increase in defrauding small investors and the public. But the NBA argues that a larger network, throughout the country, of banks will help the stock market gain momentum.

The Economic Committee has issued a note to stop the process for the time being until the pros and cons of issuing broker licenses to banking institutions become clearer.

Let’s first understand the constituents of NEPSE.

Banking institutions are the big dogs of the Nepali financial market, accounting for more than 60 per cent of the total market capitalisation. The insurance companies come second, with a market share of about 16 per cent. The remaining 24 per cent encompasses hydro, manufacturing, hotels, trading and other industries. According to NEPSE, there are 50 licensed brokers who facilitate share trading in Nepal.

Their transactions are largely domiciled in the Kathmandu Valley, barring a few who provide services from outside.

In fact, the Nepali capital market is Kathmandu-centric.

This is where banking institutions will give NEPSE the much-needed impetus with their wide network, becoming a conduit between rural Nepal and the capital market. Granting banks access to trading in the stock exchange will not only help expand its wings in the rural areas, but also make it more efficient with their huge capital base.

These organisations in comparison to the existing brokers can easily sustain themselves during an economic downturn. Similarly, banking institutions that are responsible for deposit collection and loan disbursement could enhance the margin of trading, a timidly practised phenomenon in NEPSE, with their easy access to loans for share trading. Besides, what is important is the tight regulations that banking institutions operate under the supervision of the central bank. This will further increase transparency in share trading.

From the technological aspect, banking institutions could make large investments in trading technologies, such as appbased trading, online selfmade trading, and iterative applications for investors’ analysis.

However, as a major player in the Nepali financial system, the commercial banking industry once in a while makes headlines for promoting cartelling and syndicates in interest rate setting and other activities in the market.

Such misconduct is what makes stakeholders to question the bank’s role as stockbroker. The NBA had prevented NIC Asia Bank from increasing its fixed deposit rates under the free market practices by surpassing NRB’s guidelines.

Other businesses of a similar nature and frequent interbank lendings are enough to heap distrust on the banks.

Thus, the chances of information asymmetry in the market are high. Once such institutions that outperform the number of shares of other companies from trading frequencies in NEPSE - out of the top 10 traders by number in the last year, eight were commercial banks - hold grip on the stock market, market imperfections cannot be ignored. This will lead to market upheavals. Especially, during the time of down-turn, to create market demand and push the industry’s share prices up, banks as broker could play a role in enticing small and naive investors to engage in misconduct.

So the issue is not about whether banks should be allowed to do this business, rather it is about whether the authorities have sufficient policies to control probable misconduct. Because, given the status quo of the Nepali capital market, banking institutions are the only institutions that could reshape the stock market’s landscape.

More specifically, the issue is about the expansion of the existing market. Therefore, the regularity bodies must ensure that banking institutions will not renege on expanding brokerage services throughout Nepal.

The point is that though banks have a larger network, they cannot operate this business with their existing branches. Thus, the question arises, are banks willing to establish such subsidiary companies outside the Valley? If not, it will create nothing but a mismanaged heap of brokers in the Kathmandu Valley.

Likewise, attention should be paid to the issue of information asymmetry and unhealthy competition.

Otherwise, the huge capital base of banks will oust the existing brokers from the business.