Developing countries must first have a sound banking system before setting up a new stock exchange, according to a new study at Rotterdam School of Management, Erasmus University (RSM).
The research - the first of its kind to focus on this issue - concluded that three main factors influence the long-run success of new stock exchanges. First, a country needs to possess or establish a strong financial backbone. As well as a well-structured banking sector, a significant stockpile of national savings, which is an indication of the demand by investors for trading on the exchange, is important. Finally, stock exchanges only thrive in the long run if they attract from the outset a sufficient number of listed companies.
Mathijs van Dijk, one of the research team, said: “These three factors – strong banking, national savings, and a good start - are essential if a stock market is to prove successful. This was evident in our research which examined 59 stock markets launched in developing countries during the past 40 years.”
The benefits in setting up a stock market can be considerable in boosting and growing an economy. It can stabilise household incomes and company revenues that often fluctuate in emerging economies.
The challenge, according to van Dijk and his research team, is that many low and even middle income countries not only have underdeveloped financial systems, but also have concentrated financial structures, dominated by banks and characterised by the absence of liquid public capital markets.
In striving to achieve this increased economic strength and prosperity, the number of stock markets around the world has been growing steadily over the past decades. Even now, there are countries without a stock exchanges and new stock exchanges continue to be opened. For example, 2016 saw the launch of the first stock exchange in Lesotho and both Angola and Brunei are scheduled to open their first stock exchange in 2017.
The research flags up actionable policy points for governments in such countries – they need to build a strong financial base, stimulate national savings, and must work hard to get companies to list their stocks early on. Otherwise, their efforts will be in vain.
He said: “We found that long-term success can be predicted quite accurately in the initial stage of a market’s development which suggests that stock markets thrive when they are established at the right stage of a country’s development.”
van Dijk did sound a warning note: “It’s important to understand that a failing stock market can damage a country’s reputation and undermine trust in its financial institutions. So, for countries that are still on the fence about opening a stock market, knowing whether and when the conditions are right for opening one is critical.”
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