Small investors may be getting a raw deal from some financial services providers at a time when they really cannot afford to see their nest eggs smashed by wrong decisions in the difficult market conditions that have prevailed for the last three years. There are various reasons behind this assessment.

Low interest rates in the last few years have had a lethal effect on many retail investors and small savers. Pensioners and other people depending on the interest earned on their bank accounts have been enticed to seek riskier investment products, including junk bonds issued in both the local and international debt market. The relation between risk and reward is often obscure to many unsophisticated investors.

This phenomenon should have spurred the local regulators to insist on the grading of risk for corporate bonds issued locally. The most recent IMF report sends an implied warning that we are risking serious consequences by not protecting retail investors in local bonds by not rating these debt instruments. It says: “For capital markets, transparency should be raised as credit rating for domestic corporate bond issuance is absent and often involves retail investors.”

Unfortunately, some players in the financial services industry exploited the low interest regime. They sometimes targeted their captive market of conservative and inexperienced investors and enticed them to move out of the “boring” bank deposits to venture into higher risk products, including collective schemes that invested in the riskier markets. A lethal combination of investors’ blind trust in financial service operators, occasional investors’ greed, and an unflinching belief that investing in property is risk-free resulted in many small investors getting hurt very badly.

There are still many risks lurking around and small investors should be aware of them. The IMF report sends another discreet warning on the excessive dependence of some financial operators in the local market on the fate of our property market. Not only is the lending made by some of our banks to the property industry too high, but a substantial part of their other lending is also secured by a charge on property. “Concentration risk is quite significant and many banks remain highly exposed to the real estate sector where variable mortgage rates prevail. Low coverage ratios and high uncertainty associated with real estate collateral valuation require a more conservative supervisory approach to ensure appropriate provisioning,” it says.

Some banks have an additional issue to deal with - a risky business model. The IMF is clearly not happy with those banks operating locally that tap the international debt market to raise money that they then use to buy corporate and sovereign bonds. These banks know that they can rely on the European Central Bank’s facilities to provide the necessary liquidity should the international debt market face turmoil. The IMF urges our regulators to be tougher and curb this undesirable practice.

So, those retail investors who may be ecstatic about the “opportunities” that exist in the local equity market will do well to understand what the IMF report is telling them.

In a recent business programme on the BBC World Service a financial adviser rightly pointed out that investors cannot argue like socialists when their investments go sour, only to change tack and argue like capitalists when their investment decisions are successful. It is crucially important to understand the dynamics of risk and reward in financial markets.

But regulators should also do their part by defining a charter for small investors. The bonus culture that prevails in the local financial sector may have been very different from that of the big investment banks that have caused such massive havoc in international markets. However, there is no doubt that aggressive selling tactics practiced by local banks’ staff motivated by the prospect of personal reward has had undesirable effects on small investors.

In the absence of a financial ombudsman, our regulators should take the initiative to define a charter of rights for retail investors. This initiative should rely on the enforcement of good ethical practices and not on legalistic considerations. Banks have deep pockets and have no problem protecting their backs by getting clients to sign complex and often incomprehensible legal documents crafted by good lawyers.

Protecting small investors is essential to ensure stability in the local financial market. The financial media needs to focus more on how to achieve this aim because not enough is being done on this front. But ultimately, the main responsibility for protecting small investors falls on the shoulders of our regulators.

jcassarwhite@yahoo.com