We are open to discussions if the cap on interest spread has prevented banks from booking normal profit

The banking sector faced liquidity surplus throughout this fiscal year. This was because of huge growth in deposits — triggered largely by rise in flow of money sent by Nepalis working abroad. However, these deposits could not be fully converted into loans. Hence, the surplus. Rupak D Sharma of The Himalayan Times caught up with Nepal Rastra Bank Governor Yubaraj Khatiwada to discuss reasons that are preventing banking institutions from disbursing credit at a desirable level.

The banking sector is under pressure of liquidity surplus. What is the central bank’s observation?

Excess liquidity is a misnomer, as it is the case of available liquidity not being absorbed by the real economy. The banking system definitely has excess liquidity but the real economy is still in need of lots of money. Currently, we have excess liquidity of around Rs 50 billion, which is nothing, as it is not even enough to build a 500MW hydropower project. So, this is an artificial situation created by lack of credit disbursement to productive areas. The other point that has to be taken into consideration is the country’s credit to GDP ratio, which hovers around 65 per cent, but can be extended to 100 per cent. This shows we have ample room for credit expansion. However, this credit should not be channelled towards share or real estate markets for speculative purpose. This money should be directed towards productive areas. This is because higher production means more jobs, higher purchasing power and better supply situation, which stabilises prices. So, the focus should be on increasing lending to the productive sector.

But it appears that won’t happen in the short term, isn’t it?

We are also worried that banks might overreact to the problem of liquidity surplus and further reduce deposit rates, discouraging depositors from saving and forcing them to look for alternatives. This tendency might trigger a second round of resource crunch. We are doing everything to prevent repetition of this cycle. In this regard, tools like reverse repos are being used to mop up excess liquidity. But if the problem persists, we will have to resort to alternative measures.

And what measures would those be?

There are several ways. The upcoming monetary policy would speak more on this issue. One way to deal with the problem is asking contractual saving institutions, like Employees Provident Fund and Citizen Investment Trust — that have flooded banks with deposits — to look for alternative investment avenues. Second, the central bank has certain instruments at its disposal and will continue to use them. But with the investment scenario improving and upcoming budget expected to give a boost to private sector sentiment, we are hopeful about credit demand going up in the coming days. So perhaps the problem of liquidity surplus would be automatically resolved.

Is it true that NRB is mulling over issuing its own bonds to address the problem of liquidity surplus in the long term?

That’s one of the options. But it would be premature to discuss about it now because we have not been able to confirm that the situation of excess liquidity would persist. Also, private sector credit growth has remained within the central bank’s projection and we are yet to be convinced about lack of credit demand in the market. So, we are not in a hurry to make use of long-term instruments. We still think further credit expansion can take place if there are corrections in lending practices and rates. Also, innovations in tailoring of credit products would increase lending.

One of the concerns of bankers is low returns on treasury bills here, as against India’s eight-and-a-half per cent on 91-day T-bills. What is your take on the issue?

Yields on Indian treasury bills are high because of fiscal deficit, which had once crossed five per cent of the GDP. So we cannot compare the

situation with India’s. Besides, treasury bills here are issued through bidding and we have never asked banks to place low bids. If returns on treasury bills are very low, then they should be innovative and look for better options. If commercial banks were bidding for treasury bills just to maintain 12-per-cent statutory liquidity ratio, then we would have considered their problem. But that’s not the case, because their liquidity ratio hovers around 30 per cent. So they are voluntarily holding the liquidity. Also, banks usually ask us to fix the treasury bill, repo and reverse repo rates. But such a practice would only be a step towards reviving the fixed interest rate regime. This, however, doesn’t mean we are not concerned, as we do not want low returns on treasury bills to hit profitability of banks. But to address the problem, credit portfolio diversification is a must.

So what areas should banks look into for credit expansion?

Banks have to look into areas that have remained unbanked, such as small and medium enterprises (SMEs). Also, banks should revise credit authorisation limit for branch offices. Because of low credit authorisation limit, most of the deposits collected by various branches, especially those located in rural areas, are being channelled to head offices, rendering many borrowers without access to bank finance. So banks should not only concentrate on big clients.

But SMEs are generally considered as riskier clients, isn’t it?

Yes, they may be riskier clients but they are not necessarily loan defaulters. This is how microfinance sector has survived. Also, risks entailed with SMEs are measurable and insurance schemes are being introduced to manage risks. Before issuing a loan of, say, half a million rupees, you don’t have to be that particular — all you need to see is business prospect and cash flow.

So you mean to say banks should go for project financing rather than issuing secure credit?

Banks have to assess project viability and determine security that is required. However, the problem here is not related to risk. It’s more about operating expenses because it is cheaper to administer a loan of Rs one billion to a single client than administering loans of half a million rupees to multiple clients. This is why banks look for bigger clients as it allows them to achieve higher growth at lower cost. The focus, therefore, should shift more towards retail banking and banks here should take a leaf from Indian banking practices.

It is also said five-per-cent cap on interest spread has hit credit expansion. What is your take on the issue?

We are closely monitoring the situation. We’ll see improvements that have been made in the last few months and take appropriate measures through the monetary policy.

What measures would those be?

It would be premature to discuss on this topic. But lending rates are undergoing positive corrections. If corrections that we sought are achieved by the fiscal-year-end, then the problem would be resolved on its own. If not, we’ll see what to do.

There are also talks about NRB revising the formula on interest spread calculation. Are they true?

We were, and are, open to discussions on making it more effective.

One of the issues that bankers always raise is carryover cost of maintaining 20 per cent liquidity ratio as directed by central bank. Referring to this, they argue the five-per-cent interest spread cap is not practical.

Of course, banks want to impose whatever deposit and credit rates they wish. But our intention is to ensure that lending and deposit rates make positive contribution to financial stability. This will ultimately prevent creation of bubbles or crisis in the financial market. We still come across borrowers who complain that they are not subject to new lending rate reductions just because they had entered into contract with banks before the credit rate revisions were made. So, banks need to change such approach. However, this does not mean we are turning a deaf ear towards the banks. We have told them that we are open to discussions if the cap on interest spread has prevented them from booking normal profits. But if the cap is not hitting their normal profit margins, and banks are protesting just to maximise profits, then they have to be more efficient.

NRB is soon bringing a new monetary policy. How different will it be from the current one?

Currently, the objective of monetary policy has been reoriented towards financial stability — mainly containing inflation, supporting growth and keeping the reserves at a comfortable level. In this regard, we are preparing financial sector development strategy, which will be ready by the fiscal-year-end. We have just completed financial sector assessment programme with the support of the World Bank and the International Monetary Fund, and technical notes and suggestions have been exchanged. We’ll see how we can address issues raised by the WB and the IMF and implement those recommendations. So, we would be focusing more on ensuring financial stability. However, considering the present situation we think there is not much space for a loose monetary policy.

Source: THT