Since the Nepalese Stock Exchange (NEPSE) first opened its trading floor in January 1994, the capitalization of the Nepalese equities market has been steadily increasing. Simply put, the overall market capitalization of NEPSE increased by nearly NRs. 3,76,871 million between 2010 and 2020, reaching NRs. 17,92,762 million. That’s an increase of more than fourfold in just one year. Banks and other financial organisations in Nepal must be given the majority of the credit for these types of expansions and renovations. This group of institutions has consistently contributed more than 60% of the overall market capitalization of the NEPSE throughout the course of the past decade.
This is the point at which we begin to ask ourselves why the banking and financial sectors of Nepal are having such a significant impact on the market in the first place. Moreover, even if they do have such a significant impact on market capitalization, are other elements such as market value and institutional productivity behaving in accordance with expectations?
There are a variety of factors that could influence our conclusions, including the vast number of shares issued by these institutions, changes in government regulations, mergers and acquisitions amongst enterprises, and the fact that these companies are publicly traded on the stock exchange. However, it is the investors who are genuinely necessary for the well-ordered operation of an equities market to function well. After all, a stock market that does not have investors is analogous to a ship that does not have a rudder. All of these criteria are eventually influenced, in one way or another, by the behaviour of active investors as well as the entry of new ones.
In late July of 2015, the Nepal Rastra Bank issued an order requiring financial institutions in the country to increase their minimum paid-up capital by up to four times, to a whopping eight billion rupees, within two years of being established. Although it was possible to increase the paid-up capital base by nearly six billion rupees in such a short period of time, doing so was far from straightforward. The forking out of money from existing or new investors, according to Mr. Upendra Poudyal, then President of the Nepal Bankers’ Association, was a significant technique that may assist banks in complying with the NRB policy. In fact, the stock prices of commercial banks increased by an average of 6.85 percent on the day after the National Reserve Board announced this policy to the public..
As banks and other financial institutions began to issue bonuses and right shares, experienced investors were enticed to purchase large quantities of firm stock at a discount. Due to the fact that these incentives and shares could be purchased at their face values rather than their actual trading prices, they seemed to be extremely profitable, especially for novice and so-called “inexperienced” investors. Furthermore, investors who believed that stock dividend-paying companies had higher potential for capital gain were attracted by the chance to convert their cash dividends into stock dividends. These banks were plainly making progress toward attaining their aim for paid-up capital base over time. In response to the increasing volatility on the stock exchange, the number of outstanding shares had begun to soar. However, when the performance of these companies is compared to their market capitalization, the former appears to be comfortably falling behind the latter in terms of profitability. Everest Bank Limited, for example, had a price-to-earnings ratio of 42.7 just a few of months after the NRB implemented its policy. However, the PE Ratio for the same bank was calculated to be 27.17 a month before the statement, indicating that the bank was performing well. After this policy was made public, it was clear that the stock of EBL, regardless of its improved performance, had become significantly overvalued as a result. If this is the case, why wouldn’t the Earnings Per Shares respond in a similar manner? The difference between Everest Bank’s earnings per share (EPS) before and after declaring this policy was a paltry 5.93 percent. And it appeared that this, too, had a downhill slope.
Even for other commercial banks, such as Nepal Investment Bank Limited and Standard Chartered Bank Nepal, the PE Ratios had unexpectedly skyrocketed, but their earnings per share (EPS) had only experienced minor fluctuations during the same period. Clearly, the influx of foreign investors into the Nepalese equities market between 2015 and 2016 did not result in a significant increase in the productivity of the local financial institutions. With volume growth rates increasing by about 174 percent for banks such as Nabil, the only parts of the bank that saw the most significant changes as a result of the influx of investors and investments were the paid-up capital base and the overall market capitalization of the institution. However, this does not rule out the possibility that this may continue to be the case in the future.
Another example that we may look at in order to guess on the impact that an influx of investors can have on the market is the case of COVID-19. By examining numerous aspects of financial institutions in 2020 and 2021, we will be able to determine whether or not there has been a favourable shift in the market as a result of new investors’ participation. The lockup and COVID scenario as a whole, it is crucial to note, before digging into the facts, has prompted new investors to become involved in the NEPSE.
While it is unquestionably true that some inactive investors, whose primary source of income is their salary, have expressed reluctance to invest in the market, we should not overlook the fact that employees who would otherwise be actively involved in their workplaces have expressed reluctance to remain idle during the lockdown. The equities market becomes the next realistic option for people in these scenarios when their only source of disposable income begins to run out and they need to fund their consumption requirements. The NEPSE online trading platform enables these new investors to view their orders and trade from the comfort of their own homes using a single account. This type of investing has shown to be a profitable source of revenue for those who have only a little amount of stock to buy and sell.
Although poor occupancy in Nepalese hotels has resulted in decreased revenues and intimidation of investors, cheaper borrowing rates as a result of the country’s interest rate corridor appear to have more than compensated for this. Short-term interest rates that are lower than the policy rate established by the central bank readily entice traders to take out loans and increase their capital investments. In addition, the decline in remittances has had a negative impact on not only the availability of money in the financial system, but also the discretionary income of the majority of people. The scenario played a part in encouraging households to invest in the stock market to a certain extent. To summarise, the influx of new investors into NEPSE during COVID appears to have outnumbered the exodus of current investors by a large margin.
Now that we’ve determined that COVID has resulted in an influx of new traders into the market, it’s vital to understand how this influx of investors has influenced various features of the stock exchange. While most banks and financial institutions experienced significant increases in their volumes and prices, there were no noticeable improvements in their earnings per share throughout the period under consideration in terms of growth rates. It is vital to highlight that novice investors are unfamiliar with some trading restrictions, such as maintenance margins and margin calls, which should be taken into consideration. For example, a “inexperienced” investor who is enticed by lower interest rates and skyrocketing price growth rates may elect to take out margin loans from his broker to supplement his income. Ultimately, this results in an increase in the volume of stocks that have been accumulated by the investor, as well as an inflated Volume Growth Rate over the entire NEPSE. What’s more intriguing is that there hasn’t been any development in terms of the Earnings Per Share Growth Rate. This is due to the fact that the availability of margin loans is not jeopardised until the market functions properly. Margin calls are issued by brokers when the market begins to experience negative turns and the value of an investor’s margin account falls below a certain threshold set by the broker in order to avoid a margin call. He asks the client to either make new deposits of money or securities into his account or to liquidate his existing investments. Despite the fact that the purpose of these margin calls is to prevent brokers from going below their maintenance margins, uncalculated margin loans made by investors frequently result in an imbalance between the volume growth rates and the earnings per share growth rates in the stock market.
Following the implementation of COVID, leading commercial banks such as Nabil Bank and Everest Bank have been able to demonstrate massive volume growth rates (453.5 percent and 612.6 percent, respectively), despite the fact that their earnings per share growth rates do not appear to be particularly attractive (8.3 percent and 49.2 percent respectively). In reality, the rates of earnings per share growth have been shown to be declining over this time period. This depicts a straightforward description of the Nepalese stock market in basic and understandable terms. Despite the fact that the market valuations of corporations have increased, their performance has not been as good. As a result, enhancing productivity should be the primary emphasis of the banking sector in Nepal, rather than focusing on the expansion of an excessive market capitalization that will finally certify them as “just overrated.”