Monetary Policy attempts to ease banking problems

NRB Governor Chiranjibi Nepal presenting Monetary Policy 2018-19, in Kathmandu, on Wednesday. Photo: Skanda Gautam/ THT

Kathmandu, July 11

The country’s stock of foreign currency fell below $10 billion mark in mid-May for the first time since mid-November, 2016. Although the foreign exchange reserves of $9.99 billion recorded in mid-May were adequate to cover imports of merchandise goods and services of 9.6 months, the erosion in stock of foreign currency does not augur well because it shows the volume of money that is leaving the economy is surpassing the volume of money that is entering the economy.

The outflow of money from the economy always surpassed inflows in the first 11 months of the current fiscal year, except in the third and fourth months, shows the report of the Nepal Rastra Bank (NRB), the central bank. This is largely because of soaring imports.

The country spent Rs 1,107.3 billion to finance imports in the first 11 months of the current fiscal year, up 23.5 per cent than in the same period a year ago. This capital flight would not have created much problem, had the country been able to foster exports. But Nepal’s exports stood at mere Rs 74.3 billion in the 11-month period from mid-July to mid-June. This export-import gap widened the country’s trade deficit by Rs 1,033 billion in the first 11 months of 2017-18, which is 34 per cent of the gross domestic product.

Nepal’s economy is still in a pretty good shape despite soaring trade deficit because of steady inflow of money sent by Nepalis working abroad. But over the years, remittance growth rate has taken a hit with the fall in number of outgoing Nepali workers.

Nepal’s remittance income stood at Rs 679.7 billion in the first 11 months of the current fiscal year, up 7.3 per cent than in the same period a year ago. This amount is lower than the money that exited the country to foot the import bill. What is also worrying is low inflow of foreign direct investment (FDI), another source of foreign income, which stood at Rs 15.9 billion in the first 11 months. This FDI, as a share of GDP, is among the lowest in low-income developing countries.

All these problems that are preventing the country from expanding the foreign income are hitting deposit collection of banks. The deposit collection of banks and financial institutions went up by 17.6 per cent in the first 11 months of the current fiscal year, whereas credit disbursement jumped 21 per cent in the same period. This mismatch in credit and deposit growth has created shortage of funds that could be immediately disbursed as loans.

The problem of shortage of loanable funds is likely to continue in the next fiscal year as well, as the central bank has said imports will continue to surge in the coming days due to higher demand for materials used in post-earthquake reconstruction and construction of roads, hydropower projects and other infrastructure.

The central bank, through the Monetary Policy for 2018-19 unveiled today, has tried to partially address this problem by allowing banking institutions to borrow Indian rupee equivalent to up to 25 per cent of the core capital from Indian financial institutions.

Previously, the central bank had allowed banking institutions to borrow convertible currency, like the US dollar and euro, equivalent to 25 per cent of the core capital from foreign financial institutions. Since then, a number of banks have reached out to the International Finance Corporation, a private sector arm of the World Bank, but none of them has been successful in bagging the loan due to high insurance cost.

The central bank, through the Monetary Policy, has said it would introduce instruments to hedge foreign borrowing risks at relatively lower costs, but those tools will only provide cover to foreign funds borrowed to build infrastructure projects.

So, it is not known whether this initiative, although commendable, will provide a proper cure to the problem of shortage of loanable funds.

Nepal has been facing the problem of loanable funds since last fiscal year, as banks have failed to strike a balance between deposit collection and credit disbursement. This has caused lending rates to soar, hitting confidence of businesses, especially small and medium-sized enterprises, which create ample of jobs.

The latest Monetary Policy has made efforts to address the problem of high lending rates as well by reducing cash reserve ratio (CRR) for commercial and development banks to four per cent.

CRR is the amount of money that banks and financial institutions must park at the central bank at zero interest rate. Currently, commercial banks must park six per cent of their total deposit at the central bank, while CRR for development banks stands at five per cent.

The reduction in CRR will release Rs 48 billion in the banking system, according to the Monetary Policy.

Although this additional money cannot be disbursed as loans — due to regulatory provision that bars banking institutions from issuing 20 per cent of deposit and core capital as credit — it can be invested in government securities and other areas stipulated by the central bank. Returns from these investments will offset other expenses, thereby helping banks and financial institutions to reduce the base rate — the minimum interest at which loans can be offered.

At present, even commercial banks are charging interest as high as 25 per cent on loans. This has raised questions on efficiency of these big banks, as microfinance institutions, which generally deal with small loans of Rs 100,000 to Rs 200,000, are charging interest of 18 per cent or less on credit.

One of the reasons for high lending rates is soaring interest on fixed deposit of institutions like Employees Provident Fund, Citizen Investment Trust and Nepal Telecom, which are wholesale fund providers for banking institutions. These institutions generally seek quotations from banks and park funds in institutions that offer highest rates. Banks generally up the ante to outperform competitors during times when funds are scarce, driving up both deposit and lending rates. The central bank now wants this malpractice to end, as the Monetary Policy says banking institutions, in the next fiscal year, will not be allowed to add more than a percentage point to the published fixed deposit rate to attract institutional deposits.

Many banking institutions rely heavily on institutional deposits to increase the stock of funds, which is risky, as sudden withdrawal can drive them into a corner. The central bank has therefore said share of institutional deposits in total deposit should not exceed 45 per cent. The latest Monetary Policy has further tightened the noose around banks that are over-dependent on institutional deposits, as it has said the deposit of one institution should not account for more than 15 per cent to the total institutional deposits.

It is commendable that the central bank has introduced a host of measures to reduce lending rates and increase the stock of loanable funds, as risks have started building in the financial system due to high borrowing costs, which have eroded loan repayment capacity of borrowers.

Commercial banks set aside Rs 5.8 billion in the first 10 months of the current fiscal year to cover potential losses from non-payment of loans, shows the central bank report. The fund was allotted as ‘special loan loss provision’, meaning loan instalments had not been paid for at least three months to more than a year. Under the special loan loss provision, banks must set aside 25 per cent to 100 per cent of the credit disbursed to the borrower.

Although the special loan loss provision of 28 commercial banks accounts for less than a per cent of total loan disbursed till date, it marks an increment of 60 per cent than in the same period last year. This calls for further strengthening of supervision and risk management.

Their points of view

The Nepal Rastra Bank on Wednesday unveiled the Monetary Policy for 2018-19 fiscal year, with an objective to propel the growth targets set by the federal budget. The Himalayan Times spoke to various stakeholders on pros and cons of the Monetary Policy.

‘Doesn’t ensure funds for microfinance’

The Monetary Policy did not address the crunch of funds that microfinance sector has been facing since long. It’s good that the government has increased the amount of loan that development banks and finance companies should provide to microfinance companies to five per cent each. However, loan portfolio of development banks and finance companies is small. We had expected the central bank to increase the lending cap of commercial banks to microfinance companies, which is currently at five per cent of the total loan portfolio of class ‘A’ banks. Nonetheless, the best part of the monetary policy is that it has scrapped the 18 per cent lending rate cap previously imposed on the microfinance sector. Similarly, the decision to allow microfinance companies to bring in funds from abroad equivalent to 25 per cent of their paid-up capital is praiseworthy.

— Ram Chandra Joshi, president, Nepal Microfinance Bankers’ Association

‘Will propel growth’

I think the Monetary Policy is progressive and will help the growth spree of the market. One of the major aspects of the Monetary Policy that has encouraged the finance companies is inclusion of a representative from finance companies in the Grievances Hearing Unit of the central bank. Meanwhile, the central bank’s decision to allow finance companies to issue margin calls only if share value drops by 20 per cent will discourage forced selling of shares. This is good news for share investors, who used to receive margin calls from finance companies as soon as the value of their shares fell by 10 per cent.

— Saroj Kaji Tuladhar, president, Nepal Financial Institution Association

‘Supportive to govt’s growth target’

The monetary policy is progressive and has adopted measures to support the economic growth target of eight per cent set by the government. Two major problems being faced in the market today are unavailability of loanable funds with the banks and financial institutions, and instability of interest rates. I believe the Monetary Policy has tried to address both these issues. The implications of a few new provisions in the Monetary Policy, like necessity of a third-party valuation while issuing loans of above Rs 250 million, will be clear only in the future.

— Gyanendra Dhungana, president, Nepal Bankers’ Association

‘Has prioritised interest rate stability’

The private sector had been primarily raising three issues with the government since long — stability in bank interest rate on loan, easing credit crunch and assurance of refinancing facility. The Monetary Policy seems to have prioritised stabilising the bank’s interest rate and increasing loanable funds. The decision to reduce the spread in interest rate to 4.5 per cent from five per cent and cash reserve ratio for commercial banks, development banks and finance companies to four per cent each will help improve the credit crunch situation in the market. This will create Rs 48 billion worth of extra funds in the banking system. Once the credit crunch problem is addressed, I believe that bank’s interest rate will come down gradually. However, the Monetary Policy has not addressed the refinancing facility that private sector had sought since long. Similarly, the Monetary Policy does not seem to have adopted specific measures to control inflation, which is likely to increase in the future.

— Shekhar Golchha, senior vice-president, Federation of Nepalese Chambers of Commerce and Industry