The KASE of the missing trades

Is the Kazakhstan Stock Exchange getting any better?

Though it bills itself as the second-largest in the Commonwealth of Independent States, the Kazakhstan Stock Exchange (KASE) suffers from thin trading. While the volume of trade doubled in the stock market over 2011, other KASE markets were less fortunate. The trade in the two largest – for foreign exchange and overnight loans (“repos”) – barely grew. The market for government securities shrank by a fourth. Overall, trade at KASE grew by less than 3% in the first nine months of 2011, less than half the rate of growth of the national economy.

The stock market at KASE illustrates its main problem. Stock purchases are large, few and far between. Consequently, prices are volatile. On August 19 alone, the KASE Index fell by nearly 5%. In a press statement, the Exchange blamed turbulence in global markets. The share price of copper mining alone fell more than 10% that day.

Such tailspins scare off risk-averse investors: Thin trading gets thinner. The volatility may also hinder the national economy. A sudden fall in stock prices reduces wealth and thus national spending. A steep rise may mislead stockholders into thinking that they are rich. Conceivably, they may try to buy more goods than producers can provide. Prices will rise throughout the economy. Hello, inflation.

KASE may seem too small to damage the macroeconomy. In terms of capitalization (the value of stock shares offered), the New York Stock Exchange is 325 times larger. But the volume of trade at KASE in 2011 exceeded the value of Kazakhstani production that year (gross domestic product). While fewer than 10,000 Kazakhstanis may trade at KASE, they include rich citizens who hold a disproportionate share of national private wealth.

Although its listings have been declining since 2009, KASE is in better shape now than in the late 1990s, when it had to suspend trading for a year or longer in government securities and currency futures (essentially bets upon the value of currency on a given date). One of its new rules, however, may handicap it. A firm that wants to list on KASE must offer at least a fifth of its shares there before going to foreign exchanges. This restriction cuts the rate of return to offering stocks. It may lead firms to prefer debt to equity more strongly than before, or perhaps to sell all shares on foreign exchanges rather than mess around with KASE. The Exchange’s trading may diminish again.



Brisk risk



Another reform may have ambivalent effects on KASE. Originally, KASE granted one vote for each share owned by the Exchange’s shareholders. When KASE went commercial in 2007, its general meeting decided to give each shareholder one vote regardless of his number of shares. Indeed, no shareholder can hold more than a fifth of KASE shares, reported Wikipedia. Had these rules not taken effect, a few large shareholders – like the pension funds – could have dominated KASE policy. Now a diverse group may influence what the Exchange does, but most of the decision-makers have too little at stake in KASE to want to gather much information about it. In effect, the new rules empower the management.

More auspicious for KASE is the People’s IPO (initial public offering), in which the government is selling off portions – ranging from 5% to 15% -- of its enterprises. Air Astana and KazTransOil may go public this year. The government estimates that Kazakhstani citizens may demand $100 million to $200 million of state-held shares. Kazakhstani pension funds, already major players in KASE, may snap up $200 million to $300 million of shares.

Now all we need is a People’s Exchange. KASE is caught in an infernal loop: Its lack of investors leads to price volatility, which in turn discourages potential investors. To attract them, KASE needs some relatively safe products, despite their small payoffs. The economic justification for this is the widely-accepted idea that an additional dollar of spending adds less satisfaction than did the dollar before it. A dollar means more to a pauper than to a millionaire because he needs it to survive. Given this assumption, an investor will turn down a “fair bet” – say, a financial investment with a 50% chance of gaining $1,000 and a 50% chance of losing $1,000 – because he likes the gain less than he dislikes the equivalent loss. A major stock that drops 10% in a day does not exactly commend itself to the risk-averse investor. – Leon Taylor, tayloralmaty@gmail.com





Good reading

Michael Quinn. Is the Kazakhstan Stock Exchange efficient? MBA thesis, KIMEP University, 2012.



References

Interfax-Kazakhstan. JSC Kazakhstan Stock Exchange President Kadyrzhan Damitov: New defaults possible. July 2011. Online. Yet another cheerleader interview with KASE’s president, retold in mangled English.

Wikipedia. Kazakhstan Stock Exchange. Online.

World Finance Review. Kazakhstan Stock Exchange: Better years ahead. December 2011. Online. Full of softball questions and grammatical gaffes.

Danger – insurance ahead

Does deposit insurance really insure against trouble?


Even before 2008, banking crises were common around the globe. One study reports 160 calamities in more than 150 countries over two decades. The currency crash of 1997 cost Thailand and South Korea nearly a third of their GDP – and Indonesia, almost half -- thanks to tottering banks.

Small wonder, then, that depositors demand insurance. In 1974, only 12 countries offered deposit insurance; by 1999, 71 did, according to Asli Demirgüc-Kunt and Edward Kane. Kazakhstan has offered deposit insurance since 1999, through the Kazakhstan Deposit Insurance Fund. It’s owned by the National Bank of Kazakhstan, which initially kicked in a billion tenge for the till. The Fund said it had enough to pay for the failures of two mid-sized banks, or 7 billion tenge. That was before 2008-9, when two of the nation’s largest banks collapsed. A deposit had been insured for up to 400,000 tenge ($2,700 at today’s exchange rate). In 2008, the Fund increased coverage to 5 million tenge ($33,800).

Yet insurance may increase the chances of a bank collapse. After all, a fully-insured depositor no longer has reason to monitor the care that the bank takes in lending. The insurance may also make the banks careless about their loans, because they know that most of their depositors can get their money back, regardless of whether the borrower pays back. In the United States, most banks paid no premiums for their deposit insurance, even though the risk of failure was not zero, reported Fred Furlong and Simon Kwan in 2002.

By making the banks careless, the insurance creates a “moral hazard” – that is, a change in behavior, arising from a contract, that hurts one of the signers. For example, in the Eighties, savings and loan associations in the U.S. – which offered home mortgages -- often had little net worth, so they literally bet the bank on risky loans. They figured that if the loans paid off, then they would profit handsomely, because they could charge a high interest rate for risk. And if the loans went bad? No problem: The federal government would pay off the depositors, and the thrifts weren’t worth much, anyway. In 1989 alone, 327 thrifts failed, according to Antoine Martin. The banks were also more likely to take risks in the Eighties when their charter value fell. Less efficient banks took on more risk, more loans per dollar of assets, concluded Thomas Siems in 2002.

In this light, Kazakhstan’s exemption of bank executives and top shareholders from insurance in bank failures seemed to address a special moral hazard. (The Kazakhstan Deposit Insurance Fund didn’t insure deposits of top executives and of shareholders who owned more than 5 percent of the bank’s voting shares. Neither did it insure the so-called VIP deposits – time deposits that exceeded 7 million tenge.) If the bank executive didn’t even have his own money at stake, then why should he object to risky lending that may indirectly push up his salary?

Ironically, the U.S. government offered deposit insurance to try to save the banks, during the Great Depression of the 1930s. If depositors knew that the government would reimburse them, then they might not have reason to run on the bank, all of them demanding their money at once. During the Depression, deposit insurance seemed to work: The number of bank failures fell from 4,000 in 1933 to just over 50 banks a year from 1934 to 1941, wrote Martin.


Branching for safety


Today, as developing countries with undercapitalized banks adopt deposit insurance, the moral hazards are more evident. Statistical studies suggest that banking crises are more likely in countries with extensive deposit insurance, particularly if its institutions are weak – for example, if the government is prone to corruption. You would think that the government of a developing country could stave off a banking crisis by guaranteeing to repay the depositors. But if the government is poor, then its promise is not credible.

We need not insure deposits in order to protect them. The bank could instead diversify its risk by offering branches. For example, YourBank may have a branch in Almaty and another in Astana. When education turns down, due to a booming national economy that attracts potential students into jobs, then the Almaty branch may do relatively poorly; but the Astana branch will be swimming in cash, and this will protect depositors in Almaty. During the 1920s in the United States, banks with branches were less likely to fail than banks without branches, according to economic historians Jeremy Atack and Peter Passell. Even before 2008, the number of bank branches in Kazakhstan was declining, according to First Initiative.

If the depositors will monitor the bank, then it will lend with care. One way to ensure that the depositors keep an eye on their institution is to make them co-pay for deposit losses, suggested Demirgüç-Kunt and Kane.

Otherwise, the government could motivate the bank to exercise caution by charging rates for deposit insurance that rise with risk; that rise, in particular, with the percentage of loans that are bad, since it is hard for the regulator to know exactly which loans are risky. Maybe the bank will promise to extend only safe loans, in order to procure the low premiums, but then lend to risky enterprises, in order to earn high rates of return, suggested Edward Simpson Prescott.

The government can also make clear that the healthy banks must repay the deposits at failed banks. This will give the healthy banks an incentive to monitor its ailing brethren. Finally, the government can close weak banks before they go under. Under a 1991 law in the U.S., the feds could close any bank with a capital-to-asset ratio below 2 percent. That is, if the bank’s net worth is less than 2 percent of its assets, which are mainly loans, then the government can shut it down. This, at the least, avoids the expense of reimbursing the depositors in the event of a bank failure, noted Martin. Canada has a provision like this. As a consequence, when Canada introduced deposit insurance, the banks did not take many more risks. – Leon Taylor, tayloralmaty@gmail.com





Good reading


Charles Calomiris. Is deposit insurance necessary: A historical perspective. Journal of Economic History 50. Pp. 283-296. 1990.

Fred Furlong and Simon Kwan. Deposit insurance reform – when half a loaf is better. Federal Reserve Bank of San Francisco Economic Letter. May 10, 2002. Online.

Asli Demirgüc-Kunt and Edward J. Kane. Deposit insurance around the globe: Where does it work? Journal of Economic Perspectives 16:2, summer 2002, pp. 175-195. Online.

Antoine Martin. A guide to deposit insurance reform. Federal Reserve Bank of Kansas City Economic Review. First quarter 2003. Online.

Thomas F. Siems. Survival and the hump in the CAMELS. Federal Reserve Bank of Dallas Expand Your Insight. October 2, 2002. Online.

Edward Simpson Prescott. Can risk-based deposit insurance premiums control moral hazard? Federal Reserve Bank of Richmond Economic Quarterly. Pp. 87-100. Spring 2002. Online.

Jeremy Atack and Peter Passell. A new economic view of American history. New York: W.W. Norton. Second edition. 1994.

Eugene Nelson White. State-sponsored insurance of bank deposit in the United States, 1907-1929. Journal of Economic History 41. Pp. 537-58. 1987.



References


First Initiative. www.firstinitiative.org

International Association of Deposit Insurers. Member profile: Kazakhstan Deposit Insurance Fund. www.iadi.org

Kazakhstan Deposit Insurance Fund. Otveti na chasto zadavaemie voprosi (FAQ). The Fund does not offer a FAQ for depositors in English. www.kdif.kz