Credit crunch looms as commercial banks grapple with liquidity mismatch

KATHMANDU: The banking sector in Nepal is currently grappling with a myriad of challenges as it attempts to maintain stability and contribute to building a resilient economic system under the guidance of the central bank’s monetary policy.

The economy’s increasing dependence on monetary policy, as opposed to fiscal policy, has led to complications that are reverberating across various sectors. Despite having ample investable funds in the banking system as of May last year, the expansion of credit has failed to align with the available liquidity, contributing to the ongoing economic conundrum.

One of the pressing issues is the building pressure on foreign exchange reserves, leading to a rise in interest rates between banks and financial institutions. The ongoing price war exacerbates this situation, creating a challenging environment. The central bank had set an ambitious target of 12.6 percent credit expansion for the fiscal year.

However, due to the government’s import bans and the central bank’s credit expansion restrictions, the credit flow achieved a mere 3.8 percent of the set target, with tangible consequences now felt in the broader economy.

The Nepal Bankers’ Association’s move to eliminate cartelization in interest rates has added to the woes of commercial banks. While banks and financial institutions are inclined to reduce interest rates on institutional deposits, they face challenges in increasing lending rates.

Commercial banks have been consistently reducing interest rates on long-term deposits since July, causing a significant negative impact on the banking and financial sector, excluding specific short-term industries such as liquor, cigarettes, and cement.

Industrialists who paid the seventh installment of the 10 percent interest on loans in Saun are now facing the possibility of restructuring and refinancing by the central bank.

Despite the central bank’s efforts to provide facilities for restructuring and refinancing, a significant portion of industrialists, around 90 percent, has refrained from utilizing these facilities. This reluctance is perceived as an indicator of the challenging economic phase, impacting the overall sentiment in the industrial sector.

The second-quarter reports reveal a challenging situation for banks, with the increase in bad loans putting significant pressure on their primary capital.

The implementation of Basel-3 guidelines mandates commercial banks to maintain a capital adequacy ratio of 8.5 percent. However, banks like Kumari, Prabhu, and Himalayan are facing difficulties in further lending due to pressure on their primary capital.

The non-performing loans for Kumari Bank, Prabhu Bank, and Himalayan Bank have reached alarming levels, impacting their distributable earnings. Kumari Bank, in particular, has incurred a substantial loan loss of NPR 3.77 billion, while Nepal Investment Mega Bank has suffered around NPR 1.95 billion in loan losses.

Other banks, including Global IME Bank, Laxmi Sunrise Bank, Machhapuchchhre Bank, NIC Asia Bank, Nepal Bank Limited, NMB Bank, Prabhu Bank, Himalayan Bank, and Siddhartha Bank, have reported distributable losses in varying amounts.

The negative impact on distributable earnings has also led to negative retained earnings, calculated as a percentage of the primary capital. Banks falling below the minimum primary capital adequacy ratio of 8.5 percent include Prabhu Bank and Kumari Bank.

Even with an increase in paid-up capital following mergers, Nabil Bank faces pressure on primary capital. The overall scenario points towards potential struggles for these banks to distribute profits in the coming fiscal year.

Several prominent banks, including Himalayan, Prabhu, Kumari, and Nepal Investment Mega banks, have refrained from distributing dividends from the profits of the last fiscal year. Agriculture Development Bank, which turned into a loss last fiscal year, has also abstained from distributing profits from distributable earnings.

The challenges in the banking sector are mirrored by broader economic concerns. The Nepal Rastra Bank reports an investment-ready amount of approximately NPR 5 trillion 84 billion in the banking system.

However, high interest rates and capital pressure have resulted in a sluggish flow of debt, with the average deposit to loan ratio in Nepal’s banking and financial institutions standing at 80.48 percent.

Acknowledging the increased liquidity in the system, the central bank has taken measures such as reducing the statutory liquidity ratio and policy rates to maintain a balance.

Despite these efforts, the interbank interest rate remains relatively low. Banks have responded by consistently reducing interest rates, making the cost of funds cheaper.

The impact of economic challenges is evident in the slowing down of projects that increase capital expenditure, affecting the construction industry.

The completion of key projects, such as the Upper Tamakoshi Hydropower, Gautam Buddha International Airport, and Pokhara International Airport, has not been sufficient to counter the broader economic slowdown.

The decrease in demand, coupled with the trend of Nepali youth seeking opportunities abroad, has led to a shortage of skilled manpower, impacting the economy’s overall demand.

Corruption and bribery have increased the informal economy, eroding confidence in the economy and affecting overall demand. The decrease in imports has further impacted government revenue and expenditure.

The government, unable to meet revenue targets, has resorted to raising internal loans to manage expenses, with an aim to take internal loans of around NPR 1.4 trillion by the end of the current fiscal year.

In summary, the challenges in Nepal’s banking system are indicative of broader economic issues, and collaborative efforts between the government, central bank, and financial institutions will be essential to navigate these challenges and pave the way for sustainable economic growth.