KARACHI, March 26: Banks and development finance institutions or DFIs seem set to enter the stock market early next week to help the market recover heavy losses it suffered in the last 10 days. On Saturday, the State Bank allowed banks and development finance institutions to restart financing carry over transactions or COT commonly known as badla financing in the stock market even beyond their exposure in such transactions as on February 25, 2005. Exactly a month ago, on February 26, the central bank had asked them to cap their exposure in badla financing in each stock at the level of February 25. The State Bank circular issued to banks and DFIs to convey this decision had stated that this would “ensure smooth transition from COT to margin financing”. Pakistan is committed to phasing out COT or badla financing by June 3 and replace it with margin financing. On Saturday, the State Bank said it had withdrawn this decision “till further orders.”

The central bank reversed its earlier decision after bourses’ chief regulator Dr Tariq Hasan and Managing Director of Karachi Stock Exchange Mr Moin Fudda called on Governor Dr Ishrat Husain and discussed with him the ways for restoring investors’ confidence into the stock market. Sources in the KSE said Dr Tariq Hasan who heads Securities and Exchange Commission of Pakistan also held a separate meeting with deputy governor of the SBP Mr Tawfiq Husain and exchanged views with him on how banks and DFIs can help in reversing the bearish sentiment in the stock market.

The central bank’s decision to lift the lid it had put on the exposure of banks and DFIs in badla financing came as the main Karachi Stock Exchange 100-share index lost 22.7 per cent value between March 15 and March 25 on panic selling. The index lost 2338 points, coming down to 7965 on March 25 from 10303 on March 15, wiping out Rs634 billion from the market: Total worth of stocks listed on KSE fell from Rs2813 billion on March 15 to Rs2179 billion on March 25.

With the stage set for the banks and DFIs to restart badla financing in all stocks over and above the February 25 level, optimists have a reason to believe that the stock market would recover partly next week. Another indication that reinforces optimism is that the central bank has informally asked major banks and some other financial institutions to support the stock market. “This is something of a routine. Whenever the stocks witness a free fall we are approached informally and asked to pump in some money to help the market recover,” said a senior official of one of the major banks.

But he made it clear that not only his bank but other major banks and financial institutions would make some buying next week not only in response to informal suggestions from the regulators but more because “of the attractive low prices of stocks.”

After speaking to more than half a dozen bankers and officials of other financial institutions Dawn got the impression that they would lend a helping hand to the stock market both by direct buying of low-priced, high-potential stocks as well as by increasing their badla financing.

Badla financing or lending by banks to investors for settlement of their purchase contracts comes handy when there is a need to regenerate investors’ interest in the stock market. Banks’ and DFIs exposure in badla financing was worth Rs13.5 billion on June 26, 2004 which rose to Rs17.2 billion on February 26, 2005, showing an increase of Rs3.7 billion within eight months.

Precisely because of this significance of badla financing, the Karachi Stock Exchange increased the maximum permissible rate for badla financing from 18 to 24 per cent the other day.

But the central bank’s decision to uncap the exposure limits of banks and DFIs on badla financing marks a U-turn in its policy of allowing market forces to interact freely. When it had capped banks’ and DFIs’ exposure in badla financing at February 25, 2005 level it had said the move would “ensure smooth transition from COT to margin financing.”

That the SBP was serious in preparing banks and DFIs to switch over to margin financing from badla financing was evident from the fact that it had asked them to cap their exposure in badla financing in each single stock and not just their overall exposure. Those who believe in transparency and discipline in the finance market were expecting that the Securities and Exchange Commission of Pakistan would also cap the exposure in badla financing of the non-bank financial entities that fall in its jurisdiction including mutual funds. The SECP did not do this. But its boss Dr Tariq Hasan had the courage to point out to the State Bank that some of the banks had not fully capped their exposure in badla financing.

Those were good old days when the stock market was rising by leaps and bounds. It is an irony that the SECP chief had to eat his words and request the SBP to reverse its decision of capping banks and DFIs’ exposure in badla financing to lift sagging stocks.

Whereas half a dozen theories are taking rounds in the financial circles on the fall of the stock market, one that is most obvious but least spoken about is that “finally the bubble has burst.” The fact that the KSE 100-share index more than doubled to 10303 on March 15, 2005 from 5106 on June 25, 2004 was presented before the nation as an indicator of sound economic growth, faster flows of foreign investment and soaring corporate profits.

But no senior economic manager, not even middle-level regulators of the financial market, acknowledged publicly that business tycoons were using part of the money they borrow from banks to invest in stocks and real estates for making quick bucks.

It does not take a genius to figure out why private sector credit disbursement rose by Rs328 billion between July 1, 2004 and March 5, 2005, up from Rs300 billion in a year-ago period. Bankers and businessmen admit privately that part of this huge bank credit was used by businessmen for short term speculative investment in stock market and the real estate.

That the real estate prices have started falling down immediately after the stock market crash also indicates that investment in real estate was coming from those making millions overnight in an over-heated stock market and that investment in stock market as such was being made out of the money borrowed from the banking system.

Whereas the SBP decision to remove the cap on banks and DFIs exposure in badla financing for the time being should be seen in the context of an urgent need to ease off the stock market crisis, the central bank should not lose sight of the equally important need to prepare the market to switch over from badla financing to margin financing.

The more smoothly the market can make this switch-over the better it would be for long term growth of the stock market as margin financing is more transparent and market based than badla financing.