They had it coming
- The current liquidity crunch is the result of faulty operation and management of BFIs
Feb 6, 2017-
The financial sector is in a temporary yet recurring state of disarray right now as a self-inflicted ‘liquidity crunch’ has handicapped most banks and financial institutions (BFIs). While the business community is unnerved by the rapid shrinkage of loanable funds and prospects of an interest rate hike, BFIs are struggling to stay within the mandated credit-to-deposit threshold. Nepal Rastra Bank (NRB) has rightly refused to increase the 80 percent threshold as it is one of the widely used tools to ensure the viability of the financial system and security of deposits. The liquidity/credit crunch is the consequence of flawed operation and management practices of BFIs.
BFIs are required to maintain at least 20 percent of their deposits in the form of very liquid assets, which means cash or assets that can be readily turned into cash. The credit to core capital plus deposit ratio should not exceed 80 percent. If they are close to the ceiling and are unable to attract more deposits, they need to hold back on aggressive lending. Any drop in deposits means that BFIs will have to lower credit growth too so that they do not overshoot the threshold.
To better secure deposits, reduce the number of BFIs and improve the financial sector, NRB instructed BFIs to increase their paid-up capital by mid-July 2017
(Rs8 billion for commercial banks). In response, several weak BFIs merged or were acquired by stronger ones. Others floated shares or are in the process of doing so. BFIs also had to increase credit growth to maintain a high profit target. Without many alternatives, they engaged in aggressive, unproductive and irresponsible lending to three particular sectors: real estate, hire purchase and share investment. Demand for loanable funds in these sectors is always high, and with little hassle and transaction cost, BFIs earn disproportionally large profits compared to lending to other sectors such as energy, agriculture, infrastructure and tourism. Underneath this lending practice lies ever-greening and at times imprecise classification of risky assets.
Socialise losses, privatise profits
Real estate prices began heating up after the earthquakes in 2015 following a few years of stability. Most BFIs had some room left for real estate lending, and due to lack of other bankable investment opportunities, they started issuing loans generously. Simultaneously, they increased margin lending, which contributed to a bullish stock market despite no noticeable change in economic fundamentals.
The other profitable market segment that could absorb credit quickly was vehicle purchase whose import demand spiked after a lull triggered by a crippling supplies disruption last year. Lending to these sectors swelled so fast, and without proper scrutiny of sustainability of the balance sheet, that the total credit growth outstripped deposit growth. At the same time, deposit growth slowed because of a deceleration in remittance inflows and the inability of BFIs to offer innovative savings instruments. The situation exacerbated to such a level that
BFIs are now imploring the central bank to temporarily increase the credit-to-deposit threshold to 85 percent.
Pleading for an increase in the upper limit is akin to begging for a subsidy so that BFIs can continue enjoying the profits from imprudent and unsustainable lending practices and meet their high profit targets year after year. This is utterly reckless and reeks of an intention to socialise losses but privatise profits. The central bank should remain steadfast in its policy on the credit-to-deposit rate and defend the measures required to ensure a prudent financial system.
We went through this kind of situation in 2011 when there was a slowdown in deposit growth and unhealthy and cutthroat competition to increase lending and the real estate bubble burst disrupting financial flows. It resulted in a severe liquidity crisis and a loss of confidence in the banking system after the then Vibor Bikas Bank knocked the doors of the central bank in June 2011 to either inject money or take over its management. Subsequently, NRB imposed a 25 percent cap on real estate and housing loans and implemented reforms to improve the health of the financial sector.
BFIs still have not learnt from their mistakes. First, the recommendation by BFIs to increase the credit-to-deposit threshold is nonsensical. It will not solve the structural operational and management flaws on which they try to flourish. They point to a liquidity crunch, but react unenthusiastically when the central bank offers temporary liquidity facilities. It looks like BFIs just want to cover up their reckless and imprudent operations. Second, they argue that slow capital expenditure and a slowdown in deposit growth led to the credit crunch. Yes, that is true. But then these two factors (which tend to drive deposit growth) were expected anyway. Given that there has not been any change in the expenditure absorption capacity, low capital spending was entirely predictable when the fiscal budget was introduced. Similarly, overseas migration started declining immediately after the earthquake and remittances started decelerating from May 2016. This was also anticipated well in advance.
BFIs knew that they were close to the threshold as early as the beginning of 2016, but they still engaged in aggressive lending to quick return and unproductive sectors to attain high profit targets. Whining for an increase in the threshold by floating incongruous arguments is irresponsible. They presented the same arguments in 2011 too. BFIs should have been conservative on credit growth (and its quality), which should be consistent with deposit growth to avoid a sustained asset-liability mismatch. The central bank should not increase the threshold now. The situation will likely normalise in the last trimester when most of the capital spending happens.
Unless BFIs change their operational and management model, the same thing is going to happen again. They should scrutinise loan proposals more intensely, invest more in research and personnel training, introduce innovative deposit and credit schemes, diversify their asset portfolio, lower unsustainable profit targets, improve corporate governance and continue consolidation efforts.
Sapkota is an economist
Published: 06-02-2017 08:45