Banking crisis looms large

  • The saga of the liquidity crisis has been running in parody for several years now
- ACHYUT WAGLE
The completely dried up investment portfolio of the BFIs has taken its toll on the entrepreneurship and thereby the productivity of the the overall economy

Nov 27, 2018-During the last couple of months,managements in almost all commercial banks of the countryhave instructed their branches not to process any new loan files for sanctions, citinglooming—if not already experienced—pressure in their reserves. The officially published average base rate of commercial banks in the first quarter of the current fiscal year is 10.23 percent compared to 10.08 percent a year ago. But the actual uptake cost of funds for the private sector, if any small or medium-sized loans were disbursed at all, easily exceeds 15 percent. In addition, banks and financial institutions (BFIs) issue substantial charges for processing and logistics, effectively raising the cost of borrowed capital well above 20 percent.

Needless to say, the completely dried up investment portfolio of the BFIs has taken its toll on the entrepreneurship and thereby the productivity of the the overall economy. The phenomenon is adequately reflected in dwindling exports, fast ballooning trade deficit which now touches an average of $1.5 billion a month, and decelerating contributions of manufacturing to the gross domestic product (GDP).

The saga of the liquidity crisis, however, has been running in parody for several years now. On the one hand, Nepal Rastra Bank (NRB), the central bank of the country, unfailingly insists that there is no such thing as a liquidity crisis. Its staple assertion is: the problem of only a few BFIs, mainly out of 28 commercial and 24 development banks that all resort to unscrupulous lending, cannot be portrayed as a ‘national’ liquidity crisis. In its recently released first quarter report, NRB has stated that credit to the private sector from BFIs increased at 7.2 percent as against the increase of only 2.4 percent in deposit collection. On the other hand, the ground realities are strikingly different. The private sector borrowers are not only subjected to unsustainably high interest rates due to an alleged mismatch in demand and supply of loanable funds but excruciating difficulties in borrowing, even at higher rates.

 

Government-made crisis

Dashing all hopes that an elected, powerful and stable government would usher in an era of economic growth and physical development, the current Nepal Communist Party (NCP) governmenthas failed to meet the capital expenditure mark set even by its ‘unstable’ predecessors. During the first quarter of the current fiscal year, the government barely spent 6 percent out of about $3 billion allocated to the developmental budget. Despite the fact that expending authority has been constitutionally decentralised to provincial and local governments in line with the federal set up, the performance of sub-national as well as local levels is still, understandably, far more disappointing.

The poor performance is primarily due to the fact that the federal government didn’t take any initiative to devise institutional and policy frameworks required to implement the federal system nor did it employ efforts to build the capability of sub-national and local governments, specifically, in public financial management. As such, the liquidity crunch experienced exacerbation as the cash that had to flow into the banking system from the governmental exchequer remained clogged.

  The largest two lenders in the economy, namely the Employees’ Provident Fund (EPF) and Citizen Investment Trust (CIT), are not only above and beyond the regulatory oversight mechanism of the monetary policy but also disrupt the financial market by waging a two edged sword. They are the largest and most direct wholesale lenders to the commercial ventures and, at the same time, the biggest source of deposits for the banking system. Apparently, as fully government-owned entities, their lending and other operational decisions are invariably influenced more by the government’s pressure than by risk-return considerations.

For example, some six months ago, these two entities provided $240 million credit to the national flag carrier, Nepal Airlines Corporation, obviously at the behest of the government to purchase two wide-body Airbuses (the deal now in national controversy). This siphoned away Rs24 billon from the banking system, which further constricted the liquidity supply. The airline’s doubtful credentials to profitably utilise the loan and pay it back on time is a different debate altogether.

 

Risks aggravated

The expansionary monetary policy of the current fiscal year adopted  a risky approach. The cash reserve ratio (CRR) for BFIs was reduced to 4 percent from 6 percent for commercial banks and 5 percent for development banks. Similarly,the statutory   liquidity ratio (SLR) was reduced to 10 from 12 percent for commercial banks and to 8 from 9 for development banks. This was expected to release additional liquidity,equivalent to $500 million, in the financial system. Due to added supply, the interest rate was also expected to come down. But these initiatives in monetary terms have proved to be ‘too little too late’ to ameliorate the hardships in the financial system engrained over longer periods of time. But the systemic risks posed by the steady loosening of the noose attached to the BFIs has dramatically raised apprehensions about the stability of the entire financial system.

Despite the rise in the number of BFIs, particularly in commercial banks, their deposit base has alarmingly remained dependent on a handful of large depositors, including EPF, CIT and a few insurance companies. The share of institutional deposits in BFIs is roughly half of the total deposit. Besides, instead of working to increase the retail deposit base, BFIs often resort to unhealthy competition to attract institutional depositors, which is only contributing to rate flare up, making commercial borrowing unviable. Therefore, the BFIs’ lending is now increasingly concentrated on consumer financing than on generating a productive sector.

The oversight capacity of the central bank is likely to erode further for two apparent reasons. One, as the fiscal authority of the state is now shared with the provincial governments in line with the adoption of the federal polity, the supervisory mechanism of the financial system compatible to a new state structure is yet be streamlined.

It must be understood that regulatory function of the NRB is different from the monetary policy function, the latter may be exclusive to the central bank. Two, lately, there is a widespread feeling in the market that the central bank independence has been increasingly compromised. The NRB functionaries complain that NRB, again, is becoming an extended wing of the finance ministry, resembling its functions during the notorious Panchayat times.

 

Wagle tweets at @DrAchyutWagle.

Published: 27-11-2018 07:40

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