NRB calls on banks to raise deposit rates to ease liquidity

KATHMANDU, Feb 13:

The liquidity strain felt by the banking sector has worsened as excess money held by banks and financial institutions fell to Rs 7.5 billion on Tuesday from around Rs 10 billion a week ago.

As in the previous week, many blamed stockpile of over Rs 43 billion in state coffers, which has remained unused due to the government´s inability to ramp up capital spending, for the liquidity shortfall.

Nepal Rastra Bank, the central monetary authority, too agreed with this argument. But not totally. It said commercial banks´ decision to slash deposit rates also played a key role in reducing the portion of excess liquidity.

"Banks are witnessing flight of funds from accounts as one-year fixed and savings deposit rates of commercial banks are lower than inflation (of 10.4 percent as of December)," Dr Min Bahadur Shrestha, chief of the Research Department of Nepal Rastra Bank, told Republica.

He called the tendency of people to remove deposits natural, as they are not getting any return, in real terms, by parking funds in bank accounts.

"Against this backdrop, how will liquidity situation improve?" Dr Shrestha wondered, as he called on banks to raise deposit rates.

Around a year ago, almost all commercial banks slashed one-year deposit rates by up to 4 percentage points to around 7.5 percent after the banking sector became flush with liquidity. Development banks and finance companies also followed suit.

This caused fixed account deposits of banks and financial institutions to fall to Rs 338.81 billion by the end of first five months of the current fiscal year to mid-December 2012, as against Rs 341.03 billion recorded in mid-July 2012. In the same period, fixed account deposits held by commercial banks also dipped to Rs 288.97 billion from Rs 297.62 billion in mid-July.

"Banks should learn a lesson from the latest development and should not hurry while cutting deposit rates upon getting faint indication of improvement in the liquidity situation," Dr Shrestha said.

Around two years ago, when the banking sector was hit by severe liquidity crisis all banks and financial institutions had immediately raised interest rates. In those days, even commercial banks were providing up to 12 percent yield on one-year fixed deposits.

"High rates worked as bait and facilitated flow of money from informal economy to the banking sector. That is not happening now because of low deposit interest," Dr Shrestha said.

Nonetheless, the situation still hasn´t gone out of control, he informed. "The banking sector has excess liquidity of around Rs 7-8 billion. And if commercial banks raise deposit rates, they can still attract funds."

But in case the situation worsens, he continued, Nepal Rastra Bank will use appropriate tools to inject liquidity in the economy. "Yet such a measure will provide short-term solution," Dr Shrestha said. "In the long run, banks and financial institutions will have to play their part well in maintaining sound liquidity levels."

Source: Republica