Central bank struggles with liquidity surplus in financial system

KATHMANDU: Nepal Rastra Bank (NRB) is grappling with the challenge of managing an overwhelming liquidity surplus in the financial system. Excess liquidity has become a pressing issue for the central bank, prompting it to deploy various measures to regulate the financial sector effectively.

The NRB has actively utilized deposit collection instruments to absorb surplus funds from the market. Today, the bank is set to withdraw NPR 40 billion through a deposit collection auction, continuing its efforts to address the liquidity imbalance.

In the past three months, the central bank has absorbed over NPR 1.2 trillion from the banking system. Between mid-October and mid-January, NRB withdrew NPR 1.27 trillion. During this period, NPR 340 billion was absorbed in October, NPR 450 billion in November, and NPR 480 billion in December.

These interventions involved liquidity withdrawal for short-term periods ranging from 7 to 21 days. Despite these measures, managing liquidity remains a complex task for NRB as the financial system continues to witness a substantial influx of funds.

NRB’s Deputy Spokesperson, Dilliram Pokharel, explained that the funds withdrawn through these mechanisms are returned to the financial system after the specified period. This cyclical process of absorbing and reintroducing liquidity is a standard method of short-term liquidity management.

The primary reason for excess liquidity, according to Pokharel, is the rise in foreign exchange reserves and remittance inflows, which have significantly boosted the financial sector’s cash flow.

While NRB’s interventions provide temporary relief, Pokharel emphasized the need for banks to prioritize loan disbursement to ensure a sustainable balance in the financial system. He stated that the central bank’s role in liquidity management cannot replace the proactive efforts of financial institutions to stimulate credit growth. Banks must focus on enhancing loan disbursement to mitigate the risks associated with surplus liquidity.

Despite the central bank’s efforts, the banking sector faces a lack of demand for loans. NRB data reveals that deposits in banks and financial institutions stood at approximately NPR 6.7 trillion by mid-January. However, the total loan disbursement during the same period was significantly lower, highlighting a disparity between deposit accumulation and credit distribution.

Sudesh Khaling, CEO of Everest Bank and a member of the Bankers’ Association, acknowledged the lower-than-expected demand for loans in the market. He expressed hope that loan demand might increase in the coming months, particularly from February onward. However, he also noted that banks are currently adopting a cautious approach, observing market trends before making significant investment decisions.

Khaling further explained that while banks have made efforts to promote credit disbursement, market conditions have limited their ability to increase investments. Previously, real estate loans were a major driver of credit demand, but the sector has witnessed a considerable decline in borrowing activity.

This shift has further constrained banks’ ability to expand their loan portfolios. Khaling highlighted that banks must adhere to specific investment criteria and cannot take on high-risk ventures indiscriminately.

Although deposit collection in the banking sector has increased, the growth in loan disbursement remains modest. By mid-January, banks and financial institutions had disbursed loans amounting to NPR 5.387 trillion, a figure that falls short of the overall deposit accumulation. Commercial banks alone reported deposits exceeding NPR 5.9 trillion as of December 1, while loan disbursement during the same period stood at NPR 4.774 trillion, according to NRB statistics.

The disparity between deposit accumulation and credit disbursement reflects broader challenges in Nepal’s financial sector. While the surplus liquidity provides opportunities for financial institutions, it also underscores the need for effective regulatory measures and strategic planning. Stakeholders in the banking sector have urged the NRB and other regulatory bodies to strengthen the financial system’s capacity to manage liquidity and promote sustainable credit growth.

As the central bank continues its efforts to stabilize the financial system, the challenge of aligning deposit growth with credit demand remains a critical issue. Policymakers and industry leaders must work collaboratively to address these challenges and ensure the long-term stability of Nepal’s financial sector.