Conundrum of Liquidity Crunch

 Conundrum of Liquidity Crunch

KATHMANDU: Shailendra Guragain, former president of the Independent Power Producers’ Association of Nepal (IPPAN was paying the interest rate of 7.5 percent for the loans he had taken for his one of the hydropower projects until a few months ago.

“Now, the bank has increased the interest rate to 8.5 percent,” he said. Even though the interest rate goes up and down depending on the situation in the banking system, the current acute crisis of liquidity in the banking system has worried the hydropower developers.   They are pretty apprehensive particularly about the possible cost escalation of the project because of the prolonged high interest rate. “If the interest rate increases by three percent, it is equivalent to cost escalation by around 10 percent for a project whose construction is completed in three years,” said Guragain.

 “If the return on asset (RoE) of the project is estimated at 15 percent, a 10   percent rise will turn the project unfeasible.”

 Unlike the business of other goods and services, hydropower developers   cannot pass on the increased cost to their customer- Nepal Electricity     Authority.

 They have to supply the electricity based on a predetermined power   purchase agreement signed by the state-owned power utility body. So, the    current liquidity crisis in the banking system has rattled the hydropower developers.

The Nepal Rastra Bank is not sure about how long the current crisis will last.  “We cannot say whether it is a short-term phenomenon or long-term,” said Dev Kumar Dhakal, executive director at the central bank. But he insisted that the increased interest rate at the moment is not as alarming as it has been projected. The average interest rate has remained at 9.29 percent since the middle of December last year, according to the NRB. 

“Interest rate has reached as high as 11 percent during the past liquidity crunch,” said Dhakal.

Based on the availability of the loanable funds with the banking institutions, interest rate fluctuates which is a natural phenomenon.

Current lack of loanable funds with the banks and financial institutions is the result of basically two factors— excessive lending over deposit and the government's failure to spend its budget which prevented the government from reaching the banking system.

 

Total deposits of the banks and financial institutions increased to Rs 4.78 billion   till February 1 from Rs 4,740 billion from mid-July but their credit flow reached as  high as Rs 4,669 billion  from Rs 471.5 billion during the same period, according to  the Nepal Rastra Bank statistics.

Considering these figures, the credit to deposit ratio of the banks and financial institutions reached over 95 percent, far more than the regulatory limit of 90 percent. This means, the banks and financial institutions don’t have room to make  extra lending. So, most of the banks have either halted lending or are lending selectively.

“The growth of deposits is natural while lending growth is unnatural,” said Dhakal. Officials at the central bank said that most of the lending during the first half of the current fiscal year 2021-22 has gone for import financing.

In a recent meeting at the Parliamentary Finance Committee, the NRB said that the huge gap between deposit and lending figures contributed to the current crisis. According to it, half of the lending made by the banks and financial institutions have gone for import financing, fueling a surge in imports. 

This has also resulted in a depletion of foreign exchange reserves by 13.2 percent from mid-July to Rs 1214.03 billion in mid-December last year, according to the central bank.

 Meanwhile, the government spending has remained very poor this fiscal year. For example, as of January 31 this year, government spending stood around 34 percent percent of total allocation and capital expenditure remained poorer at just around 15 percent percent of total capital budget, according to the Financial Comptroller General Office, a government body responsible for maintaining the government’s accounts.

“The government expenditure, remittances and exports should rise while imports need to come down to help deposits to grow in the banking system,” said Dhakal.

There has been been a downturn in the inflow of remittance to this fiscal year which is also an important source of deposits in the banking system. According to the NRB data, the amount of money sent by home by Nepalis abroad decreased by 6.8 percent to Rs 388.58 billion as of mid-December last year compared to 11 percent in the same period of the previous year, according to the central bank. 

With deposits not growing in line with lending, the credit to deposit ratios have crossed the regulatory limit of 90 percent, practically barring them from making further lending. 

As the banking system is facing a liquidity crunch, the government has started raising internal loans which could put further pressure on the liquidity of the banking system. The government plans to raise Rs 239 billion in domestic borrowing in the current fiscal year 2021-22.

The central bank told the banks and financial institutions that they cannot increase the interest rate on deposits by more than 10 percent in a month compared to the rate maintained in the previous month. Likewise, the interest rate to be offered to the institutional deposit should be at least one percent less than what is offered to individual fixed depositors.

With the banks not being allowed to offer attractive interest on deposits, it will be difficult for them to attract more deposits so as to reduce credit to deposit ratio creating difficulty for them to make further lending.

From its part, the NRB has however been pumping liquidity in the banking system by issuing repo. A repo is a monetary instrument under which the central bank provides cash to the banks against the collateral of other securities. It has also been depositing its own resources in banks and financial institutions in large amounts lately.

“From our part, we will make efforts to increase liquidity in the banking system through monetary instruments like issuance of repo,” said Dhakal.