Banks Face Perennial Challenge of Credit Crunch

Banks and financial institutions (BFIs) have been facing perennial crisis of loanable funds since the increase of regulatory capital. The problem has been acute in two consecutive years during the second and third quarters of the fiscal year calendar. Credit crunch is due to mismatch in deposit collection and credit expansion, and has an adverse impact on the economy. Banks can extend loans of up to 80% of core capital plus deposits as per Nepal Rastra Bank rules. Of the remaining 20%, 6% is deposited with Nepal Rastra Bank (NRB) as cash reserve, around 5% remains as liquid cash in bank vaults, and 8-9% is invested in government bonds/treasury products. Liquidity crisis is when there is pressure on the cash reserve in NRB and credit crunch is a situation when the banks are close to crossing the permissible credit to core capital cum deposit (CCD) level of 80%. The banks have a very thin cushion to overshoot CCD level and have halted loan expansion. Currently, average CCD level of the 28 commercial banks in operation is at 77.41%. Credit crunch means banks have not adopted prudent lending practice balancing credit expansion with deposit collection. However, the mismatch in deposit collection and loan expansion has pushed the banks into a crisis of loanable funds. Credit expansion has outpaced deposit growth in recent years as banks practiced aggressive lending to sustain the profit growth generated before the regulatory paid up capital increment.

Loan expansion stalled

Credit expansion is essential for sound economic growth but almost the banks have halted it citing slow deposit mobilisation. Private sector players have said that the banks are not even disbursing earlier loan commitments which are resulting in delay in projects and increase in costs. Bankers, however, say that they are disbursing critical loans. “We do not have funds to disburse big loans, but we have not stopped floating loans to micro, small, medium enterprises and critical loans committed earlier,” said Sudesh Khaling, CEO of Laxmi Bank, adding, “If the bank has made commitment of big loan, we have been disbursing the loan in installments based on the requirement of the project.” He further said that the bankers’ are expecting the situation to improve after the government’s expenditure rises in the fourth quarter of this fiscal. Economist Keshav Acharya said that there is a multiplier impact on the economy when banks stop lending. The borrowers will be directly affected as they have to face huge losses due to delay in project completion and/or business expansion. It will also have negative impact on the overall economy creating a slow down.

Rise in interest rates

Interest rate of the banks has been on the incline since last year along with slowdown in deposit collection. Banks have raised the interest on deposits from the mid of last fiscal. Though it has benefited depositors but borrowers are in a difficult situation. Interest rate in credit hiked substantially from 8-9% from last year to 13-14% which has impacted business viability. “Predictable interest rate is essential to flourish businesses,” said Gyanendra Lal Pradhan, a hydropower developer, “For hydropower projects, which already has fixed returns and cannot top up the liability, there remains no option but to drop the project.” Traders can pass on the liability to consumers through price rise in commodity or service, Pradhan elaborates, but the production sector is hit hard from increased interest rates on loans. Those paying EMI (Equated Monthly Installment) on auto or home loans are also facing challenges as their liability increased in an unplanned way. Anil Keshary Shah, past President of Nepal Bankers’ Association said that interest of 4-5 % on deposits and 9-10% on credit is ideal for the economy. He said that the increased interest rate in both deposit and lending is ‘unnatural’; it will not help the economy. The central bank has recently introduced the provision of fixed interest rate to institutional depositors (like employees provident fund, citizen investment trust, Nepal Telecom among others) at least for one quarter for stability in interest rate and market. The Central Bank has started implementing interest rate corridor for short term borrowing/lending like inter-bank transactions, and plans to gradually enforce it on deposits and lending of BFIs. The Central Bank has fixed 3% lower bound and 7% upper bound for interbank lending. If the interest rate goes down from 3%, the Central Bank absorbs excess liquidity from the market and if rate goes up from 5%, then it injects liquidity into the market.

Profits go down

Profits of BFIs slowed down as banks faced lack of funds for loan expansion. BFIs are under pressure to collect more deposits to expand loans because ‘interest income’ from credit is the main source of earning for banks. However they are unable to expand loans as deposit collection has slowed down because of negative remittance growth, sluggish exports, snail-pace government development work and slow capital expenditure. In the first half of this fiscal, commercial banks have mobilised loans worth Rs 1,911.89 billion against deposit collection worth Rs 2,214.51 billion. In the review period average deposit witnessed 16% growth where as credit growth was at 21%. This shows a clear mismatch in deposit collection and loan expansion. Average profit of commercial banks in first half hovers at 10% compared to 40% in the similar period of the previous fiscal 2016-17. Nabil bank secured the position of top profit maker in the review period as it generated profits worth Rs 1.837 billion. It was followed by Nepal Investment Bank at Rs 1.830 billion, government owned Rastriya Banijya Bank at Rs 1.78 billion, Nepal Bank at Rs 1.63 billion and Everest Bank at Rs 1.14 billion, as per the financial statements published by the commercial banks. Along with top five profit makers, altogether nine banks made it to the billionaire club in the first half, namely Himalayan Bank, Agricultural Development Bank, Standard Chartered Bank and NMB Bank. Similarly, Civil Bank, Janata Bank, Century Bank, NCC Bank and Mega Bank ranked at the bottom five in terms of profit generation in first half of 2017-18. In the review period, eight banks landed in the red zone in terms of profit growth, namely Prabhu Bank, NIC Asia Bank, Nepal Bangladesh Bank, Nepal Bank, Machhapuchchhre Bank, Bank of Kathmandu, Sunrise Bank, Citizens Bank International, as per the financial results till the second quarter of the current fiscal year.

What they say?

According to Chiranjibi Nepal, Governor, Nepal Rastra Bank, BFIs must put their effort on deposit collection.BFIs also have to make an effort to collect deposits and make balance between credit expansion and deposit collection. But there is huge mismatch, deposit growth is just 16% where as credit expansion is 21% in the first half of this fiscal. If any BFI breaches the permissible CCD, the Central Bank will take action. If they cannot collect deposits, they have to stop lending and there is no other option. We cannot always be kind to banks because they are just trustees of the public money and they should be better regulated because the people at large have trust in the Central Bank. If the banks deviate from the rules they will suffer and they will lose people’s trust. This is the reason that financial institutions should be self-regulated to earn the trust of the people. Banks have to start becoming habituated to working with low profits because the Central Bank is going to narrow down the interest rate spread (gap between interest in credit and deposits). If the promoters of BFIs need more profits, I would like to urge them to offload their shares in BFIs and start high-profit generating businesses. Banks, in fact, are not doing anything to increase deposits and depend on the government. They have been seeking refinancing facility from the Central Bank. We are looking into how we can raise the refinancing facility.

From where can we bring deposits if there is no money in system.

Gyanendra Prasad Dhungana, President, Nepal Bankers Association Banks have expanded credit more patiently in this fiscal due to slow deposit growth. Deposits in banks continue to be withdrawn for the purpose of filing taxes and other investments. We expanded credit on assumption that there will be flow of funds during elections, government’s capital expenditure will gather pace, and foreign direct investment will also rise as the country has moved towards stability after promulgation of the constitution and successful elections. However, these have not materialised as expected. Government’s capital expenditure is low, remittance growth is negative, export is not encouraging, and foreign direct investment and capital transfer are negligible. In this scenario, it is difficult for banks to collect deposits. Banks have made loan commitments as per the assumption made for deposit collection but that could not materialised.