There is a wide speculation going among general investors that the commercial banks are manipulating the interest rate and they are creating an artificial liquidity shortage. This statement was further supported when the commercial banks denied subscribing Rs 30 billion worth repo issued by the central bank to ease liquidity shortage some time before. Repo is a monetary instrument for banks that is generally meant to provide short-term liquidity for maintaining cash reserves.
Further, on Magh 4 and 5, NRB published a notice to buy back NRB Bonds worth Rs 40 billion to inject liquidity in the market but very few commercial bank were seen interested to sell NRB bonds they had previously bought.
Nepal Rastra Bank officials are continuously informing that there is no liquidity shortage in the market. This statement was further supported when the commercial bank denied taking liquidity offered by the central bank.
The commercial banks are offering high interest rates in recent months to the general public and institutional depositors in fixed deposit and call account (as much as 10-11%). This clearly suggests that they are in deep shortage of funds.
Now, a big question arises “Is this the real liquidity crunch or are banks just short of investable fund?”
Let’s analyze,
The major sources of fund for the commercial banks are variety of public and institutional deposits, plus shareholders’ capital. The banks need to maintain some portion of deposits to meet public withdrawal demand. So, the banks cannot invest or lend all the deposit. They have to maintain 6% Cash Reserve Ratio (CRR) and 12% Statutory Liquidity Ratio (SLR) as per NRB directive, and the banks need to maintain CCD Ratio up to 80% as per NRB directive.
CCD Ratio is calculated;
CCD Ratio = Loan and Advances / (Core Capital + Domestic Deposits)
This clearly suggests that the banks cannot lend all the deposits. As part of maintaining liquidity, most of the banks invest on government securities (both short term and long term) issued by NRB.
Average CCD ratio of Overall Commercial Banks:
| Period |
Average CCD Ratio |
| Q1 2073/74 |
76.32% |
| Q1 2072/73 |
72.96% |
| Q1 2071/72 |
73.00% |
Over the first quarter of fiscal year 2073/74, the average CCD ratio of overall commercial banks has risen to 76.32% which means most of the banks are using their maximum capacity on lendings.
Average Deposits Growth and Average Loan and Advances Growth:
| Period |
Domestic Deposits "000" |
Growth (%) |
Loans "000" |
Growth (%) |
| Q1 2073/74 |
1,689,050,179.95 |
36.66% |
1,376,456,924.14 |
39.11% |
| Q1 2072/73 |
1,235,994,825.04 |
24.46% |
989,461,876.08 |
17.13% |
| Q1 2071/72 |
993,090,446.97 |
- |
844,762,109.71 |
- |
Let’s understand why CCD ratio rises so much. During the last year fiscal year, the average deposits of commercial bank has risen by 36.66% whereas at the same time the average loan and advances has risen by 39.11%. Due to this, there is a big imbalance created between average deposits and loans.
The rise in credit flow from BFIs despite slow deposit growth in recent months has now resulted in the lendable fund shortage, which in turn, has created pressure on banks to increase additional deposits on recent days.
CCD ratio of most of the banks is close to 80% which indicates that they are desperate to attract new deposits, otherwise they won’t be able to issue further loans and this will halt future growth of the banks. Due to this, most of the commercial banks whose CCD ratio is close to 80% are attracting deposits by offering handsome interest rate. This is the major cause of increment in interest rate in the recent days.
Why was NRB Rs 30 billion Repo not fully subscribed?
Since the banks have adequate liquid fund to maintain CRR and SLR, most of the banks are not interested to take cash from NRB in the form of repo. Out of Rs.30 billion repo, only Rs 5.39 billon worth was subscribed by the commercial banks. This clearly suggests that there is no liquidity shortage, and more—this fund cannot be used by the banks to issue loan.
Why NRB’s plan to inject Rs 40 billion through buying back of NRB Bond failed?
On Magh 4 and 5, NRB issued a notice to buy back Rs 40 billion worth NRB Bond from the commercial banks to push extra liquidity in the banking system and NRB has clearly stated that this money can be used by the bank to issue loan.
Here, we need to understand that NRB is not injecting fresh Rs.40 billion in the banking system. Rather, they are buying back the bonds they had earlier issued. The investment on government securities or bonds is used by the banks to maintain mandatory liquidity.
This offer is lucrative for those banks whose CCD ratio is low and non-lucrative for those banks whose CCD ratio is close to 80%.
Case I
As per the FY 2073/74 Q1 report, Standard Chartered Bank Limited (SCB)’s CCD ratio is 72%. This means they still have 8% margin and they might have used this extra fund on buying NRB Bonds. In this case SCB can use the NRB offer and sell NRB bond and recover cash. SCB can use this cash to issue further loan since their CCD ratio is quite low.
Case II
As per the FY 2073/74 Q2 report, Citizens Bank International Bank Limited (CZBIL) CCD ratio is 79.40%. Here, CZBIL is in such a condition that they are not in a position to issue further loan without having new deposits. Here, they have just 0.6% margin left and having cash by selling NRB bonds also won’t be a solution because CCD ratio won’t allow any further lending.
Since the CCD ratio of most of the banks is already close to 80%, they cannot issue loan by recovering cash from selling liquid assets.
From the above evidence, we come into the conclusion that interest rate is rising not due to shortage of liquidity shortage but mainly due to shortage of investable or loanable funds.
How to overcome this situation immediately and what really is the solution?
- Only 6% of the fund set aside for capital expenditure by the government is used so far in five months of this FY 2073/74. This means that huge fund has been dumped in the government treasury. This fund must be utilized rapidly by the government in the development of the country. This will increase the economic activities and in turn, increase the deposits in the banking system.
- Government must attract remittance through formal banking system. Informal remittance like “Hundi” must be immediately stopped.
- Public money which is outside banking system must be attracted.
- NRB may provide some flexibility in increasing CCD ratio, but this step can be risky for banks.
What will the consequences in the overall economy and banking sector be?
- Overall credit expansion will be halted hampering economic growth. Banking sector growth will also be affected.
- Interest rate will be increased. Due to this, business will suffer a lot.
- Credit will be highly expensive. Due to this, share market investors will be discouraged to take loan and invest.
- Inflationary pressure will be eased.
- Unproductive loans will be discouraged.
So, it’s high time for Nepal Rastra Bank, Ministry of Finance, and bankers to sit together and find a solution for the ongoing problem. Otherwise, the problem will spread so far that it won’t be easily corrected.
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