Banks in CREDIT CRUNCH TRAP

Since the second half of this fiscal (2016-17), banks have almost halted issuing fresh loans or even already committed loans as they are running out of loanable funds. This pheneomena is known as ‘credit crunch’. The aggressive lending policy of banks overlooking the sluggish deposit collection is pointed as cause of the acute crisis. In the first half of this fiscal 2016-17, the operational 28 commercial banks have issued credit worth Rs 204 billion against deposit collection of Rs 155 billion. As the loan amount outpaced deposits in the review period, the crisis was obvious and bankers are being blamed for ‘inefficient planning’. Lack of loanable funds simultaneously reacted to the interest rate on both credit and deposit. Interest rates of credit and deposit have skyrocketed. Almost all commercial banks have announced short term fixed deposit schemes at 12% interest per annum. Likewise, the interest rate in credit has also increased. In sum, the crisis of loanable funds coupled with interest rate volatility has adversely impacted the economy. This problem may further affect the financial sector stability. Nepal Rastra Bank (NRB) — the central regulatory and monetary authority— has warned banks to adopt corrective actions to cope with the crisis. According to NRB Governor Dr Chiranjibi Nepal, the root cause of this problem is the breach of prudent banking norms and values. First, banks started floating loans aggressively to book high profits. Banks have to float loans based on deposit growth as the Central Bank allows them to lend up to 80 percent of the sum of its core capital and deposit, also known as credit to core capital cum deposit (CCD) ratio. As banks have collected Rs 155 billion deposit in first half of this fiscal, they were supposed to issue loan around Rs 125 to Rs 130 billion only. Governor Nepal opines that the deposit growth which is around 20 percent in the first half of this fiscal is sound despite slowdown in remittances and slow capital expenditure of the government. “While comparing it with the last five years average, annual deposit collection of banks increased by around 20% and lending by 19% on average,” he said adding, “However, in the first half of this fiscal, credit growth witnessed 30% outpacing the deposit growth”. All banks except the government owned Rastriya Banijya Bank (RBB) have extended credit beyond the permissible CCD ratio. Sluggish deposit collections are posing a threat to the banks to maintain CCD ratio as they stand on verge of exceeding permissible lending levels. High interest rate in deposit schemes have been announced to retain depositors as one aspect to combat this. Secondly, according to the Central Bank, banks over concentrated on real estate, hire purchase, home loans, overdrafts and margin-lending (loan against collateral of stocks). The Central Bank has flagged off banks and financial institutions for their concentration in ‘risky’ areas. Banks have issued around Rs 100 billion loan in these areas in the first half of this fiscal. According to Central Bank officials, though the banks are within a permissible threshold in these sectors, their strategy of making high profit through short-term lending is inherently risky because chances of loan default is high in these sectors. On other hand, banks and financial institutions need to pay penalty if they fail to meet the target of productive sector lending. As per the Monetary Policy of 2016-17, in case the minimum amount of credit is not extended to specified productive sector as directed by the Central Bank, penalty at bank rate (optimum interest rate fixed by the concerned bank in any particular loan product in this year) will be charged on shortfall of such amount of credit. As per the requirement of NRB, Class ‘A’, Class ‘B’ and Class ‘C’ financial institutions have to lend 20%, 15 % and 10 % of their total loan portfolio to the productive sectors defined by the central bank. Out of 20%, Class ‘A’ banks must lend 15% to energy and agriculture sectors. Central Bank officials have said that banks are unlikely to meet this target in this fiscal as they are running out of funds to lend in the second half of the fiscal.

Business Impact

Businesses will be affected due to lack of credit from banks. This scenario will likely create a trust deficit between banks and businesses which will further affect in deposit collection. Business firms start parking revenue generated from business as working capital. “Business requires working capital to run and it is the duty of banks to serve the credit requirement of businesses,” said Senior Economist Prof. Bishwambher Pyakuryal. Similarly, businesses like hydroelectricity that cannot top off the cost of increased interest rate will be badly hit. Cost of production will rise, import will be dearer and ultimately the consumer will have to pay for this, according to Pyakuryal. He criticised the Central Bank for its ineffective role in regulating the banks in a proper manner. “Banks have created artificial credit demand in the unproductive sector. It is due to lack of effective regulation and supervision from the Central Bank,” he emphasized. The Monetary Policy 2016-17 envisioned an annual credit growth of 20% to achieve growth target of 6.5%, however the Central Bank failed to make any intervention when banks started to lend rampantly in unproductive sectors surpassing the annual credit growth target. Credit growth of BFIs in the first half of this fiscal witnessed 30% which is substantively higher than the five years annual average of 19% credit growth. Access of credit in rural areas further declined, according to economist Pyakyurel. “The branches of the banks in rural areas will be focused on collecting deposits only as per the target of deposit collection given by the head office. In this regard, the rural resources will be siphoned to the urban areas”.

What Is NRB Doing

The Central Bank has concluded that BFIs have breached discipline and warned them of action. The Central Bank summoned the Presidents of umbrella associations of BFIs— Nepal Bankers’ Association, Development Bankers’ Association and Finance Company Association and asked them to focus on stabilizing the financial sector. The Central Bank is also considering fixing the loan to value ratio in loan products like automobile financing. As banks were found to be financing up to 90% of the market value, the Central Bank has applied brakes on automobile financing, and real estate and margin lending. The Central Bank has barred banks from issuing loans more than 50% of the market value in auto loans till the mid-term review of the monetary policy. It has asked BFIs to submit their loan portfolio every month to enable NRB to make necessary interventions promptly. Earlier, BFIs were submitting loan portfolio every three months. “Banks exceeding CCD ratio will be penalised from the third quarter end,” said Chinta Mani Siwakoti, Deputy Governor of NRB. Banks are permitted to lend only 80% of the core capital and deposit. They have to maintain 20% as liquidity. Out of 20%, six percent will be reserved as liquid cash in the Central Bank which is known as Cash Reserve Ratio (CRR), around two percent will remain with the bank and the rest needs to be invested in government securities. The Central Bank provides Standing Liquidity Facility (SLF) to BFIs up to 90% of the value against the collateral of government securities if BFIs seek long term liquidity facility with the Central Bank. However, such monetary operations of the Central Bank are only to address a liquidity crisis. This will not help on CCD ratio of the banks and they cannot lend such funds obtained from the Central Bank through its various monetary operation tools. However, there is refinancing facility of NRB through which the banks can lend to the productive sector but cannot count on CCD ratio. NRB has provided around Rs 10 billion as refinancing facility to banks since they faced the ‘credit crunch’ trap for lending to the productive sectors. Banks can make the five percent margin in interest rate in such refinancing facility and BFIs can obtain up to 25% of their core capital as refinancing facility.

Mid Term Review of Monetary Policy as Temporary Solution

The mid-term review of the Monetary Policy 2016-17 was held on February 21. NRB offered some relief to commercial banks in calculation of CCD. As per the current provision introduced through mid-term review of the monetary policy, Class ‘A’ banks can deduct 50% of their total exposure to the productive sector in CCD calculation at the end of this fiscal. It will create space for lending capacity saturated banks (as CCD was already closed to permissible 80%) to extend loan as they will be able to deduct 50% of the productive sector credit in total amount of loan disbursed while calculating CCD at the end of this fiscal. This will create lending capacity of around Rs 127 billion. Banks have lent around Rs 254 billion to the productive sector, according to Nara Bahadur Thapa, Executive Director of NRB. The CCD ratio is calculated by dividing loans disbursed in local currency by the sum of local currency deposit and core capital. As per the revised provision, banks can now deduct 50% of the loan amount disbursed to the productive sector from the total disbursed loan. This outcome is then multiplied by 100 and it should not exceed 80%. However, this provision is only for this fiscal. Central Bank has also revised the maximum threshold of personal overdraft through mid-term review of the monetary policy. Threshold of personal overdraft has been reviewed by 25% to Rs 7.5 million from Rs 10 million. From now banks will not be allowed to issue personal overdraft of above Rs 7.5 million, and for those that have already been issued it needs to be lowered to the given limit by the end of this fiscal. This provision will also create space for loanable funds. Banks exposure on overdraft facility accounted for Rs 286 billion. Likewise, the revised monetary policy also provisioned that the interest on savings accounts must not be less than the call deposit rate. Currently, banks are offering 7-10% interest on call deposits and only 2-3 % on general savings deposits. The general savings deposit weightage in total deposit hovers around 42%.

What do bankers say…

Bankers’ have said that the credit flow of BFIs could be rationalised if the government’s expenditure ramped up. “The government had unveiled a budget with Rs 311 billion to development projects and we have expected that the government expenditure to rise as massive development works and post earthquake reconstruction needs to be carried out,” said Anil Keshary Shah, President of the Nepal Bankers’ Association, adding, “However, that could not happen and the deposit collection of banks have remained slow.” The government has spent merely 17% of its development budget till the end of seventh month of this fiscal. Stating the government has Rs 203 billion in its treasury, Shah further said that this situation will no longer remain as the government’s expenditure takes momentum. Shah also admitted that the problem emerged due to aggressive lending of the banks overlooking deposit growth. He expressed commitment to focus on stabilizing the interest rate in credit and deposit. The recent respite offered by NRB will also provide an impetus to stabilise interest rate as banks will have space to lend around Rs 150 billion from the relaxation in CCD calculation and lowered threshold of personnel overdraft, according to Shah. He suggested banks not to lend rampantly as in the first-half because NRB has provided this facility only for this fiscal owing to hardships faced by the financial sector. “We will float loans only on the basis of deposit growth and reduce lending to unproductive sectors,” said Shah. Some other bankers have said that they were forced to raise lending due to pressure from promoters and Board of Directors to ensure higher profits in the aftermath of paid up capital increment of the BFIs. The two-year deadline given by the Central Bank to raise paid up capital up to four folds in the existing level is going to end by the end of this fiscal.