İSTANBUL İKTİSATÇILAR DERNEĞİ
İÜ İKTİSAT FAKÜLTESİ
CURRENT PROBLEMS AND ISSUES AFFECTING THE DEVELOPMENT OF CAPITAL MARKET IN BOSNIA AND HERZEGOVINA – RETROSPECTIVE AND REAL OPPORTUNITIES Mehmet Ganic* Abstract The picture of the capital market and financial sectors of B&H is still relatively unfavorable. In comparison with the advanced transition economies, capital market in B&H is underdeveloped and less important to the domestic economy in general and to corporate finance in particular. The focus of this paper is to analyze and examine the trends in capital market in B&H with the assessments and perspectives of its development in the future. In order to understand better the functioning of the financial system and its workings the paper discusses some general aspects of the financial system and its impact on economic development of national economies, and provides a brief overview of developments in the banking sector of the countries of former Yugoslavia. The analysis is then directed to review developments in the financial sector of B&H, their direct links with the capital market, followed by analysis of current events and the dynamics of trading as well as capital markets activities in B&H. Key Words: capital market, stock market capitalisation, stock trading volume, private placement and public offerings
1. Introduction Contemporary theory of finance suggests that financial institutions can significantly influence on the economic development or better yet, it is assumed it to be in function of economic development. The degree of economic development is closely correlated to the degree of development of the financial system and financial institutions. Economies at a higher level of economic development have developed an efficient financial system, while financial institutions as part of such financial systems provide an access to a range of diversified financial services, which *
Assistant Professor, Faculty of Economic and Business Administration, International University of Sarajevo, Bosnia and Herzegovina, e-mail:
[email protected]
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are used for economic development. On the other hand, underdeveloped and illiquid financial markets restrict access to investors, reducing the possibility of efficient allocation of capital. Without a developed financial market system, no investor is willing to accept risk and invest. It means, if we have the efficient functioning of financial institutions then there is a fundamental market mechanism that ensures optimal diversification of your capital according to your investor profile. Developed financial markets, and in particular its significant segment of the capital market is essential for encouraging companies to apply the concept of quality risk management. In economic theory there is almost complete unanimity of opinion of close association between financial development and economic development (Levine R, 2004: 6). There is a change of management by the owner in the case of a significant drop in prices of securities in the capital market due to poor management of the company. However, there are different views about the intensity of the relationship of financial development and economic development. One of them assumes that the financial development initiates the economic development, ie. it is more significant to offer financial services than the demand. Creation of a deeper and more efficient financial system can have significant impact on economic development. It is primarily achieved by the action of market mechanisms as well as increased competition in the financial market and the money markets and capital markets (de la Torre - Schmukler, 2007:149)
2. A brief review of developments in the financial sector of the former Yugoslavia The basic dilemma in the conduct of financial policies in transition countries is based on whether financial markets should be developed in the presence of foreign investors or not. There is no doubt that foreign investors influence the dynamics and structure of financial markets. However, the presence of local investors is significant impact on the quality of investment in the long run and reduces the risk of speculative foreign investment in the short term. In the case where foreign investors for some reason (often speculative) move their capital to other markets, it is essential that local investors are willing to invest and thus prevent significant disruption to financial markets. For this reason it is very important for countries in transition to make the active use of economic policies measures to ensure a balanced financial structure of financial institutions, to expand the range of funding sources and build a stable domestic financial institutions. As a result it may increase financial system stability by reducing the adverse effects of financial liberalization and internationalization (de la Torre – Gozzi – Schmukler, 2007: 70). In almost all transition economies the inevitable step was in the restructuring and transformation of banking sector. In fact, experience in transition economies shows that most of them suffered more or less serious crisis at the begining of 1990s as a result of weak corporate control and the absence of regulatory and legal regime. As it can be seen from Table 1 a significant progress has been made over the twenty years in the banking sector of the countries of former Yugoslavia. Gradual abandonment of earlier practices highlighted a new direction that clashed with the dogmatic ideas and retained the existing situation. The transformation of the banking sector in the countries of former Yugoslavia as part of a general process of creating an efficient and reliable banking sector was fully focused on a different way of doing business. This primarily refers to the strengthening of their capital strength, improving efficiency and eliminating all distortions expressed in non-profit activities of banks in the field, where they accumulated losses and outstanding debts from other sectors of the economy. 2
There is no doubt, in recent years that banking is proved to be a highly profitable business. Confirmation of interest is best expressed by foreign investors who are always glad to invest in these countries in order to take advantage of new market opportunities. Progress achieved in development of the banking sector in selected countries in the region can be best illustrated by the data in Table 1. Overall, the banking markets in former Yugoslavia can today be characterized as follows: -
-
-
As privatization and restructuring have progressed, the participation of foreign ownership in banking sector has increased significantly. In the most of these countries the banking sector is dominated by a small number of banks (oligopoly structure with 4-5 of banks), which often control (depending on individual countries) over 90% of banking sector assets, except for Slovenia. Low base of financial development signalled a high long-term potential of market in these countries, sparking a strong interest in the presence of international banking groups. Significant progress has been made in the terms of management practices, modern technology in the banking business has been intoduced , supply of banking products has been increased It is a made rapid expansion of credit growth comparing it with the beginning of the transition process (Domestic credit to private sector, Domestic credit to households). Excluding the banking sector of Croatia, Slovenia, the one in B&H by its relative size is behind these countries.
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Table 1. Recent Financial Market Developments in selected countries B&H Serbia Financial sector/ Country 2004 2009 2004 2009 Number of banks 33 30 43 (foreign-owned) (17) (21) (11) n.a Asset share of stateowned banks (in per cent) 4.0 0.8 23.4 n.a Asset share of foreign-owned banks (in per cent) 80.9 94.5 37.7 n.a Non-performing loans (in per cent of total loans) 6.1 6.0 n.a n.a Domestic credit to private sector (in per cent of GDP) 32.3 50.2 24.8 45.0 Domestic credit to households (in per cent of GDP) 13.6 26.3 4.9 n.a Of which mortgage lending (in per cent of GDP) na na 0,7 n.a Stock market capitalisation (in per cent of GDP) 23.7 26.2 13.7 26.5 Stock trading volume (in per cent of market capitalisation) 5.0 n.a n.a 5.0 Source: EBRD Transitional Report 2010.
Croatia
Macedonia
Montenegro
Slovenia
2004 37 (15)
2009 32 (15)
2004 21 (8)
2009 18 (14)
2004 10 (3)
2009 11 (9)
2004 22 (7)
2009 25 (11)
3.1
4.1
1.9
1.4
16.4
0.0
12.6
16.7
91,3
91.0
47.3
93.3
31.0
87.1
20.1
29.5
7.5
7.8
27.5
12.6
5.7
13.5
7.5
6.0
51.8
69.6
22.1
42.9
16.8
80.4
48.1
92.7
30.4
36.9
5.6
n.a
4.8
28.7
12.2
22.6
10,1
15,9
n.a
n.a
na
n.a
2.8
9.0
25.2
39.2
7.7
9.5
n.a
99.8
26.2
23.1
6.0
5.6
8.6
7.2
n.a
9.4
14.8
8.7
In contrast to the trends and results in the banking sector, the situation in other financial market segments in the countries of former Yugoslavia is unsatisfactory. It can be concluded according to the previus trends of key indicators of financial markets the following: - Poorly developed financial market, where the flow of funds was intermittent. There is no corresponding monetary - credit and financial policies to regulate the current financial blockade, which affects the economic trends, - In most countries of former Yugoslavia a rigid and bank based system of finance is prevalent where the significance of money market and its role is underestimated. Strategic-conceptual issues are focused on the banking sector while the money market and capital market is largely ignored. - Despite the significant efforts during the 1990s a depth of financial markets is insufficient because the trading activity in the stock market is in general much lower than those for banking development; and - Low liquidity of capital markets and an increased sensitivity of the financial markets to the movements of speculative capital. Although level of stock market liquidity in most countries of former Yugoslavia rose significantly in recent years but it is still far away from those in advanced transition economies (Hungary ,Czech, Poland). The majority of shares listed on the stock exchanges is illiquid. The initial success of exchange traded stocks were the result of concentration based on mass privatization scheme which includes substantial free distribution of shares. In addition, liquidity, as measured by the yearly turnover ratio per stock market capitalization in all countries of former Yugoslavia is too modest, except Slovenia. (figure 1).
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Figure 1 Stock market capitalization (in percent of GDP)
Source: EBRD Transitional Report 2010.
Over the past decade, equity markets have increased their importance as sources of funds in these countries though the banking sector still dominates the development of financial markets. Graph 1 provides the stage of financial development in selected countries of former Yugoslavia. 2.1. The main features of capital market in B&H The capital market as a segment of the financial market in BiH is conditioned by the development and expansion of primary and secondary capital market. In general, similar to other countries in the region capital market in B&H is developing with the continuation of privatization of the circumstances. As an aggravating factor for its deepening is a poor investment climate due to a legal uncertainty and a lack of economic projections of future trends of development. In this sense it can be noted that due to lack of consistent economic policy, and a poorly developed financial institutions, there is no corresponding impact on economic development, as in developed countries. The development of financial institutions in B&H is not satisfactorily complited with the activities in the real sector of the economy. It does not mean that financial institutions were not the purpose of promoting economic growth. On the other hand, their effect is mostly related to the banking sector, which is the dominant channel of financing B&H economy. As it is shown in figure 2 and figure 3 banking sector recorded a positive growth in the period from 2004 to 2007. The ratio of domestic credit provided by the banking sector to GDP and ratio of total assets of bank-like institutions to GDP indicates credit expansion banks in B&H. During the time period covered in Figure 3, GDP growth rates did not follow a very high annual rate of credit expansion. These trends were understandable due to financing needs of a company. In addition, a loan supply was below the loan demand as the interest rates have been kept at a high level. Monopoly power of banks in financing the economy should have a downward trend with the development of the financial system due to increasing competition and the presence of other financial institutions. For the reasons above mentioned, it seems that at the end of 2010 the loans of commercial banks amounted to 14.58 billion KM, which is almost 2.5 times more than at the end of 2004, but also near the limits of the amount from 2008. It is evident that the expansion of credit was pronounced by the end of 2007, after which credit activities have had a weak impact on GDP growth. However, the average annual growth rate for banks' assets and loans in 2009 had a declining trend as a result of the global financial crisis and as a consequence the amount of credit available is decreased. In addition, there were no other financial institutions to supply long-term finance to B&H economy. 5
Figure 2. Assets/ GDP, total loans/GDP: 2004-2010. Figure 3 Selected indicators in banking sector of B&H
Source the authors’ elaborations on CB of B&H data Source: the authors’ elaborations on CB of B&H data
The capital market in the developed market economies was created on the basis of financial relationships that were established in the money market. However, this is not the case in B&H. In fact, in our conditions we have the structure of the economy dominated by small and medium sized enterprises, which are usually not listed on exchanges. In addition, we have a process of consolidation of the banking system that is inconsistent with the structure of the company which may have an adverse impact on the financial resources of companies. The financial market with its institutional structure in B&H is in a process of development. The capital market was established in the specific conditions of the ownership transformation of the economy through mass privatization scheme . As a result privatization investment funds (PIFs) have emerged so that conditions have been created for establishment of other institutions in the capital market as follows: a broker-dealer companies, stock exchanges, Registrar of Securities and Securities Commission. It is noticeable that there are no a short-term money market instruments - very flexible instruments to fulfill short-term financial needs of private company. It certainly slows down the development of capital markets and adversely affects the efficient management of liquidity. Non-functioning of official money market is one important reason for encouraging the informal economy, which in our environment takes significant proportions. Current financial institutions in the capital market of B&H by the name can mostly be compared with the financial institutions in developed financial systems. Secondary capital market segment has stagnated over three years and it is slowing the pace of the primary securities market development Reforms introduced so far, at a very slow pace, have been insufficient to speed up the issue of government securities on the basis of public debt, which can have a significant impact on the development of the capital market and financial institutions into this market, and thus on economic growth. In addition, it turned out that the institutions in the capital market mainly served to the concentration of ownership through property acquisitions. Similar market movements in the primary and secondary capital market and institutions within them there is the position of the IFs which are passive financial institutions in B&H. Privatization Investment Funds (PIFs) were transformed into closed-ended investment funds in 2008 and genarally speaking they have not met the basic objectives of its establishment. In particular, after more than 10 years it can be concluded that IFs had a negative impact on the financial markets and prospects for economic prosperity of B&H. It was expected that these financial institutions become an important segment of the financial system and a new channel of financing the economy by providing incentive to the development of capital markets and economic development. But in the our circumstances, at the end 2010 net assets managed by companies managing investment funds (Closed-end investment funds and Open-End Investment Funds) in the total assets of the financial sector in B&H are very small (3,64%) 6
with a tendency of further decrease of assets.1 An attempt animation of private investors for investment funds, has proven to be limited in its intention. In recent years, assets of IFs are significantly reduced, while the average NAV tends have decreased since 2008. Figure 4 Average net assets all closed-end investment funds per share in F B&H by Year
Figure 5 Average net assets all closed-end investment funds in F B&H by Year 150,000,000 100,000,000 50,000,000 0 2007
2008
2009
2010
Source: the authors’ elaborations on Securities Commission of the FB&H data
According to data on the movement of average net assets for all IFs in the period from 2007 to 2010 (figure 4 and figure 5) it can be concluded that there has been reduction of its assets.2 Reduction of average net assets is the result a falling market value of shares and portfolio of marketable securities of IF, but also because of higher percentage the management fee from the management contracts concluded between investment fund management companies and IFs. Activities of the fund management companies in recent years has been at a very low level. The number of transactions is very small, which showed weak activity in order to preserve the value of assets of investment funds and creation of financial position in order to lower the fall of the net value of asset. Also, it is evident from the graph 5 that the average net assets all closed-end investment funds in F B&H in the 2007- 2010 period is decreased almost 3 times. Furthemore, from the total number of realized transactions in SASE in 2010 only 13,33% related to the purchase of shares of IFs (20,65% in 2009). It is unbelievable that in recent years IFs have had a negative business result and negative operating until fund management companies pulled funds through a management fee from the IFs and express positive business results. 3 A general conclusion may be drawn from previus years that NAV has been decreasing as a result of irresponsible governance of assets IFs by fund management companies. Also, during the last two years investors are pulling back from the IFs due to financial crisis and higher liquidity preference. The inability to sell securities held in the portfolio due to the absence of a well developed and liquid secondary market passivizes all participants in the financial market, which create an unfavorable perspective on the capital market in B&H. The fall of interest in the shares of IFs lately is the result of completing the processes of ownership 1
At the end of 2010, net investment funds at the state level (in B&H) were KM 888,4 million, which was by KM 21.4 million or 2.5% less than at the end of 2009. The decline in value was caused by a fall in the value of open end funds by 7.5%. Closed end investment funds had a very dominant share of KM 874.5 million KM (98.4 %) in the total value of assets. (CB of B&H, Anuall Report 2010, p. 98) 2 Up till 2009, the NAV of funds was mainly based on the book value of the securities from portfolio and therefore did not reflect a fair and objective evaluation of the portfolio of the fund . The low liquidity of the majority of shares from the privatization, had the consequence that the book value has dominated in the evaluation of the asset value. Adopting by new legislation (The Investment Funds Act) the net assets of closedended investment funds is calculated on the basis of average trading prices weighted by the amount of securities traded on the stock exchange and reported block transactions. 3 Based on the preliminary data on business results for 2010, fund management companies in F B&H made a total profit of 13.279.129 KM, which is an increase by 4.649.244 KM or 54% in comparison to 2009. A significant increase of profit from the management fee is the result of the application of new, higher percentage used to calculate the management fee from the management contracts concluded between fund management companies and supervisory boards of funds at the end of 2009. SUMMARY ANNUAL REPORT of the Securities Commission of the Federation of Bosnia and Herzegovina (2010).
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concentration in certain companies, as well as the lack of investor interest in buying shares of IFs. In the last two years alone, trading of shares of IFs has been decreased. 2.2. The primary and secondary segments of the capital market in B&H - A Critical analysis of current trends The financial market in B&H has all characteristics of those in the poorest countries in transition. It certainly has an adverse impact on the quality of investment and thus economic growth. In recent years, the liquidity of capital markets was based mainly on trading in the company's shares so that B&H significantly lags behind the other countries of the region. Undeveloped capital markets adversely affect the increase in volume and quality of investment, which has its effects and significant impact on economic growth. Development of the capital market in small and open market, it is not possible without the presence of foreign investors and domestic investors. The capital market in B&H is a small, separated and illiquid. It also requires improving the supply of securities in the form of the presence of more liquid stocks, as well as improved quality and transparency of information. Regulation needs to be able to adapt to developments in the capital market to be sufficiently flexible so that it does not impede further development and operations of financial institutions. The debt market, however, is almost nonexistent in B&H even though there has been for last 3 years a large volume of government bonds traded (exception, trading of bonds issued by the Federation of B&H based on war-time claims and on the basis of settlement of obligation based on accounts of old foreign currency savings). Debt market in B&H still lagged behind other neighboring countries. Capital market development has to be supported by overall macroeconomic and financial sector environments. Given the low level of economic development of B&H it is shown that the development of banking institutions is relatively more important in relation to the development of non-bank financial institutions. Complementary development of banking and nonbanking financial institutions is an important for the financial market and economic development of B&H. At this point it is important because of the limited amount of public offering of shares (stock exchange listing of shares on the so-called Initial Public Offering - IPO), continues to pursue the privatization process through IPO. This could significantly affect the development of capital markets and investment growth. In addition, the inclusion of the shares of prominent state enterprises on exchange trading then can maximize revenues from privatization, it can affect the growth of prices of other stocks, as well as to attract domestic and foreign investors in capital market. In this way, it can be expected to gain a significant impact on the overall business and economic development. Primary capital market includes all activities related to the issuance and placement of securities issued in a capital market, namely the introduction and its first sale. This market should be a source of financing for development projects and its functioning should be an alternative source of financing enterprises. Certainly, the lack of IPOs could also be a serious problem and may hamper development of capital market in our country. In the primary market in B&H the issue of new shares is mainly carried out through private placement which is offered solely to institutional investors, the issuer’s existing shareholders or employees. What is most important of all, however, is that missing o significant raising capital in the public equity market - or through public offerings. In addition, a modest number of public offerings was recorded in the period between 2005 and 2010 with a small number of interested investors. It is resulting in even less liquidity in the secondary market certainly affecting the interest and desire of companies to finance its expansion directly through the capital market (Table 2). 8
Table 2 Collective review of issuance of securities by private placement and public offerings in B&H: 2005-2010. Aggregate data on offerings - Private placements Aggregate data on offerings - Public offerings Total Number of Total Local Private Currency Value of Total Number of Total Local Currency Value Placements Amount Sold Private Placements of Amount Sold F B&H 35 110.668.863,00 0 0,00 2005 RS 7 65.353.207,00 4 9.869.000,00 F B&H 25 205.881.883,00 1 10.000.000,00 2006 RS 10 54.423.438 3 22.532.500,00 F B&H 48 284.104.290,30 1 5.208.200,00 2007 RS 9 17.741.000 2 17.551.700,00 296.385.932,60 60.149.200,00 F B&H 27 7 2008 RS 13 53.374.434 10 74.318.232 46.538.785,70 9.112.500,00 F B&H 15 4 2009 RS 3 4.700.000 12 62.679.303 F B&H 13 48.249.905,50 1 800.000,00 2010 RS n.a n.a n.a n.a Source: Summary Annualy Reports of the Securities Commission of the FB&H and RS
Up till now, for all securities offerings, public and private, mostly are issued by private companies, while lacking the presence of state and IFs as issuers. The lack of significant presence of corporate bonds in order to encourage the development of debt markets is the result of the negligence of the state that did not provide any incentives (eg. tax breaks) for all issuers of debt securities. All in all, most of these issues are based on share issue, and there have been few cases of companies issuing on commercial bills and bonds. It can be noticed that open end funds industry in B&H remain largely underdeveloped compared with the advanced transitional economies (Estonia, Latvia, Lithuania). Figure 6 Total Value of Assets Open –end and Closed- Ends Funds (in Euro) in selected countries
Source: Capital Markets Trend for SEE and Euroasia, 2005- 2010, USAID and Partners for stability.
It is obvious that further development of capital markets in B&H is not possible without foreign investors. At the same time, there is no significant risk of international liberalization, because of given position of the domestic capital market, characterized by low liquidity in securities trading. All seem to be happening lately with capital market but only a continuation of the unfavorable trend in the second half of 2008 and 2009. What at first glance seems worrying is that, number of brokerage houses in the FB&H was reduced to 14 in 2010 (17 brokerage firms at the end of 2009) and generally only licensed to perform brokerage services. The trend component is strongly influenced by financial crisis, which resulted in the majority of brokerage firms lost the license for dealer operations. Due to the difficult economic situation, many brokerage firms are significantly rationalizing its operations. Except that, due to reported losses in the last 2 years and the amount of share capital of the brokerage firms is smaller. 9
Recently, the dynamics and structure of trading on the stock exhanges in B&H is characterized by reduction of turnover during the financial year 2009-2010. The following figure is given in order to realize the turnover in stock exchanges in B&H. Figure 7 Annual Stock Exchanges in B&H Turnover Volume by Year (in thousand KM) 1,500,000 1,000,000 500,000 0 2003
2004
2005
2006
2007
2008
2009
2010
Annual SASE Turnover Volume by Year (in thousand KM) Annual BLSE Turnover Volume by Year (in thousand KM) Source: Sarajevo Stock Exchange, Banja Luka Stock Exchange : 2002 – 2010.
Given the current trends, that govern capital markets, it can be concluded that the lack of interest of investors and weak liquidity of the most expresses the trend of steady decrease in demand. In 2010 , there was a significant drop in turnover on the both stock exchanges in B&H and the stock exchanges in the region so that the turnover achieved in 2010 was similar to that achieved in 2003. This is caused by the global economic crisis, which is particularly reflected in the decrease of turnover and decrease in share prices in the capital market. In the graph 7 it can be noticed that the peak trade volume in Sarajevo Stock Exchange was in 2007 when recorded the highest annually turnover value of 1.274.340.116 KM, while the lowest value was recorded in 2002 (41.673.040 KM). The trend of deepening crisis in the securities market from previous years has been continuing. Therefore, it is expected that in future the situation might be much worse than the actual situation. Many foreign investors that already have troubles in their home economies left the B&H stock market causing the price fall of shares. Lack of demand from citizens and foreign investors caused a further decline in share of prices, especially given that foreign investors has been up till a few years ago the main stimulator of demand. The situation in stock market of B&H is not much better on the supply side. Unfavorable the price-to-earnings ratio discourage new issuers that raise capital through security issuances. Such suspicions were doubly motivated. First, because of effects of the global financial crisis on economic growth and development and secondly, because of poor liquidity due to which the investors prefer more liquid and safer assets. In order to contribute to shed light on the developments in the capital market in F B&H, figure 8 provides a comparative overview of the trading volume, number of publicly traded securities and the number of realized transactions (in the period from 2007 to 2010). A significant decrease in the number of transactions indicates that there has been a decline the number of participants and investors in the stock market. Figure 8 Stock exchange operations in B&H
Source: the authors’ elaborations on Securities Commission of FB&H data
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On the other hand, the next relevant factors that explains movement in the capital market in BiH are the ratio of market capitalization to GDP and the ratio of total turnover on the stock exchanges to GDP (an indicator of liquidity of capital markets-figure 9). Figure 9 Selected indicators of capital market in B&H from 2007 to 2010
Source: the authors’ elaborations on CB of B&H data
Figure 10 Structure of purchase and sales transactions in F BiH: 2009-2010.
Source: the authors’ elaborations on Registry of Securities in F B&H data
Today's situation in the capital market in BiH is characterized by the fact that a large portion of the total capitalization is very illiquid, and many companies are listed on the stock exchanges prior de jure rather than de facto. In addition, only a small percentage of the company's assets are normally traded. While this is typical of almost all economies in transition, for our market, compared to many other transition markets, the situation is even more devastating. In support of this state that is in the period from 2008 to 2010, the value of market indicators (Figure 9) was unsatisfactory, suggesting us a little importance of the capital markets which cannot provide an answer to the needs of our economy. While the ratio of market capitalization to GDP is more than halved compared to 2007 yet it sounds self-defeating indicator ratio of total turnover on the stock market and GDP. In fact, its values of 1,22% were due to falling share prices and weak market liquidity. We emphasize this because liquidity in the private equity market is a magnet for attracting private investors (both individuals and institutions) to capitalize on their earnings due to changes in prices of securities. While markets are generally open and available to foreign investors, lack of liquidity often interferes with more serious level of investment by institutional investors. It is usually considered that the lack of liquidity is a key problem for market development on small markets, such as those in B&H. It is reasonable, because continued decline in share prices is caused by weak liquidity. The data indicates the behavior of two groups of investors: domestic and foreign investors (figure 10) in the stock capital in F B&H. In the analyzed period, the dominant role among investors in the stock market was played by domestic individuals. A vast majority of transactions at the SASE was executed by the domestic investors while the interest of foreign investors in the shares listed at the SASE was decreasing. In fact, in 2010 majority of deals (purchase or sales transaction) were carried out by domestic investors (64,17% and 61,28% respectively), while the foreign investor share started to fall after it reached the peak in 2007. There are several crucial reasons why it all happened. The interest of foreign investors in our market, before the global economic crisis, it was primarily motivated by large profit opportunities and lucrative earnings in the short term, with the possibility of rapid withdraw. In last two years, our stock market is currently quite illiquid and not attractive to many serious investors. This is the main reason for their withdrawal. It's not just the case in B&H, but also in neighboring countries. As the main reasons for the lack of attractiveness of these markets are explained by: a high risk investment, lack of adequate physical infrastructure, financial market is shallow and underdeveloped, delays in privatization of large enterprises and their reform, an inadequate level of development institutional infrastructure, administrative barriers to foreign direct investment and the unfavorable legal environment. 11
There are numerous issues facing investors that need to be addressed within capital market in B&H. These are: a small number of shares with significant capitalization stocks, a very large number of illiquid securities, irregular high-frequency trading activity, lack of transparency in access to accurate and relevant information of listed companies. 3. What is the popular solutions now and what might be the next solution? One of the important problems of the domestic economy is its lack of liquidity, which is primarily caused by the underdeveloped financial markets, in terms of non-existing of money market. In our own case, it is becoming increasingly clear that the illiquidity has its own specificity, expressed by the ownership transformation, monopoly companies in the energy, telecommunications and the like. However, the underlying causes of illiquidity to be found in the system of financial relationships that do not motivate economic agents to continuously focus on optimizing its assets and liabilities. Underdeveloped nature of the money market in B&H further affects the liquidity on the real sector of the economy given the absence of conditions that allow a spectrum of assets of varying degrees of liquidity. In other words, there is no a stable system of investment and the possibility of disinvestment. This means that each borrower (recipient) and the lender (investor) is able to operate a conduct of business policy and affects the efficiency in capital formation and capital use. The privatization process is fully focused on the ownership takeover but it left key issues unresolved, such as restructuring and consolidation of companies. In this way a significant part of the assets remains blocked, which results in slower economic growth. In the economy of B&H the government control of the largest and most important companies whose securities are mainly listed and traded on the stock exchanges, but in their structure of financing is dominated by bank loans. It is expected that banks become a universal money market dealer, because they have shortterm deposit funds and have the ability to obtain additional funding arrangements for the dealer. At this stage the bank borrow and lend liquidity in the interbank market, but they lack a range of short-term financial instruments such as certificates of deposit, treasury bills, notes, commercial paper and the like in order to manage liquid funds and make profit. However, without starting the main lever of the financial market in the first row of the money market it cannot be expected to find a solution to the problem access to financing the current economic reproduction and thus investing activities. The process of initiating the development of money market depends primarily on banking institutions rather than on economics agents which should create conditions for the development of money markets. Banks are generally satisfied with their performances and with the substantial profit they made to the creditdeposit operations and payment transactions, and completely ignore productive activities that take place in the money market. Issuing of various money market instruments by banks it can significantly ease the current funding of economy and thus solve liquidity problems. As a part of contribution of central bank to money market development, it can encourage its development primarily by issuing short-term securities and stimulation of banks to support the process of creating the money market. It would certainly be an important support to the development of government securities market and creating conditions for the conduct of monetary policy on the principles of open markets. For further development of the financial market in B&H is necessary to meet several interrelated goals, namely: - First, that the Central Bank of B&H must take an active role in the financial system especially that encourages the development of money markets. This would result not only in the expanding its operations and influence in regulation of reserve requirements, but also in conduct open market operations by buying and selling securities, mostly short12
-
term securities. The central bank would thus have a significant effect on the movement trends of interest rate as the main market regulator in the financial market. Secondly, more important, continuing to focus on the developing range of government securities both short and long term, without that market liquidity cannot be provided; and Third, financial market liquidity is a fundamental factor that can have a significant impact on economic development. Only in conditions of a developed and liquid financial markets by buying and selling securities may provide sufficient liquidity.
It turned out that this market is fairly isolated from the influence of foreign investors so that domestic investors predominantly invest in domestic securities. B&H strategy in this segment of the financial market does not exist. Therefore, it is necessary to speed up process of the compilation of the financial market of B&H. At the same time it implies the inclusion on the quotation of securities of large public companies, as well as the development of government securities market. In order to create conditions for the development of the fund industry should create an an enabling environment for the development of securities market in terms of its depth and breadth. Financial system of B&H is lacking diverse range of short-term financial instruments issued by companies and financial institutions as well as governments. 4 At a time when B&H has a huge internal public debt incurred due to objective reasons (the war), the issuing of government securities (bonds) is the only solution to settle old liabilities. A substantial part of internal public debt burden is the old foreign currency savings which are just resolved through issuance of bonds. It is expected to have a positive impact on stock market turnover and stock market trading rate on both exchanges in B&H. The secondary market trading of debt securities can be facilitated by the inclusion of government bonds. It would certainly have an impact on the movement of short-term interest rates of banks, which are still high and negatively affect the securities market. 4. Conclusion Economic theory has a positive answer regarding the interrelationships between financial institutions and economic development. Economic development defines the structure and level of development financial institutions, as well as how financial institutions affect economic growth. For now, it turned out that the banking sector in B&H is evaluated with high scores on the development and quality, thus creating conditions for both rapid economic development. The result is a specific model and the privatization of the banking sector that has influenced its development. Such changes will depend on developing of changes and conditions in the real sector, in order to the effect of such changes in the real economy increased demand for financial services In addition, it will be necessary to make a turn and in terms of financial market deepening and strengthening the role of other financial institutions and their impact on their economic development. However, in reality this is not true. Activities of banking institutions are not identical or competitive tasks performed by non-banking institutions. Therefore, it can be said that banking institutions and non-bank financial institutions are complementary. They have a critical role to play in achieving sustainable development and make a major contribution to economic development if they have a balanced development of and involvement in providing financial services to the real sector of the economy. It is important for the future of B&H, to ensure a balanced structure of domestic financial institutions through the active management of economic policy. A diversified investor base is essential for the development of a functioning capital market in B&H. This would facilitate
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the government to extend the maturity structure of its debit portfolio and reduce the costs of outstanding debt with a fixed income. There are several reasons related to a possible recovery in the capital markets of B&H which must be taken into account. First, the process of ownership concentration is largely complete, so the new owners have lost an interest and incentive to appear in the capital market. It underestimates the shares and leads to the discharge of the market. Consequently, this makes it unlikely to stimulate interest both domestic and foreign investors; Second, the benefits of financial markets resulting from the significant effects of established organizational networks, as well as development and trading securities guided, above all, the unit fixed costs. If the market is less liquid, then the trading costs are high. This ultimately reduces the benefits of capital markets, discourage investors, in other words, a lack of demand. In addition, B&H has not yet fully adopted the culture of financing by issuing of new shares which means that companies regularly resort to capital markets for the raising of fresh capital. Third, that the performance of capital markets is still under the influence of bad political and economic environment of instability and poor social status of most citizens. Fourth, there is a weak mobility of the issuers and limited of trading in securities of the local companies, which resulted in the competitiveness of capital markets because of such restrictions at a very low level. Fifth, the capital market of B&H is limited due to the slow and incomplete process of privatization, following its further growth.
1. 2. 3.
4.
References Central Bank of B&H, Annually Report 2010 Capital Markets Trend for SEE and Euroasia, 2005- 2010, USAID and Partners for stability, June 2011. de la Torre A. and S:L. Schmukler. Emerging Capital Markets and Globalization The Latin American Experience, The International Bank for Reconstruction and Development/ The World Bank, 2007. Avalaible at http://siteresources.worldbank.org/DEC/Resources/Schmukler_ECMGBookwithdelaT orre.pdf de la Torre, A., J. C: Gozzi, and S. Schmukler, Financial Development: Maturing and Emerging Policy Issues, Oxford University Press 2007. Available ar http://www.econ.brown.edu/students/Juan_Carlos_Gozzi/research_files/Financial%20Development_Ma turing%20and%20Emerging%20Policy%20Issues.pdf
5. EBRD Transitional Report 2010. 6. Ganić, M. Gase se brokerske kuće, Magazin Banke u BiH, broj 124, mart 2011. 7. Levine, R. and Servos, S. (1996). Stock Market Development and Long-Run Growth. Policy Research Working Paper, The World Bank, March. 8. Levine R, Finance and Growth: Theory and Evidence, Carlson School of Management, University of Minnesota and the NBER, September 3, 2004. Avalaible at:http://www.econ.brown.edu/fac/Ross_Levine/Publication/Forthcoming/Forth_Book _Durlauf_FinNGrowth.pdf 9. Lieberman, Ira W., Andrew Ewing, Michal Mejstrik, Joyita Mukherjee and Peter Fidler (eds.) (1995), Mass Privatization in Central and Eastern Europe and the Former Soviet Union, A Comparative Analysis, Studies of Economies in Transition 16, The World Bank, Washington D.C. 14
10. SUMMARY ANNUAL REPORT of the Securities Commission of the Federation of Bosnia and Herzegovina, different issues. 11. SUMMARY ANNUAL REPORT of the Securities Commission of the Republic Srpska, different issues. 12. Registry of Securities in Federation of Bosnia and Herzegovina, http://www.rvp.ba/ 13. The Vienna Institute for International Economic Studies, Western Balkans: Economic Development since Thessaloniki 2003, 2006. 14. World Bank Group, MIGA, Investment Horizons: Western Balkans, 2006.
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